Economics
Section 1: Introduction to economics
• social science: a science (the pursuit of systematic and formulated knowledge) as applied to humans
economics:
• microeconomics: the economics of individual parts of national economies
macroeconomics: the study of the features of national economies
• growth: an increase in the amount / quantity that an economy is able to produce
development: an improvement in the living standards of the average person
sustainable development: economic development for one generation that will not impact (negatively) on the livings standards of the next
• positive economics: economics that involves factual and testable statements that are either correct or incorrect
normative economics: economics that involves subjective, political or opinion statements
• ceteris paribus: “All other things being equal”
• scarcity: unlimited wants + limited resources / factors of production relative scarcity
factors of production:
land – “gifts of nature”
-- payment: rent
capital – products deliberately made for the purpose of producing other goods / services
-- payment: interest
labour – human effort (physical and mental) used in production
-- payment: wages
entrepreneurship/enterprise – the form of human resource which organises all the other factors of production, for the purpose of producing goods & services
-- payment: profit
-- functions: management – organising resources
ownership – providing finance
bearing risk – accepting responsibility
invention / innovation
• choice: utility – the satisfaction derived from the use of a good / service
opportunity cost – the opportunity foregone (ie. the next best alternative), due to the decision to use resources towards something
free good – a good that is in abundance (is relatively abundant)
economic good – a good that is scarce and therefore demands a price (is relatively scarce)
production possibility curves – a curve showing the maximum potential output of an economy given that: the economy makes only 2 goods
resources can be used to produce both goods
all available resources and the best technology is used
• rationing systems: 3 economic questions – What to produce?
How to produce?
For whom to produce?
• mixed economies:
Aspect central planning (public) free market (private)
Resource ownership no individual ownership
centralised private ownership
Pattern of participation in decision making government decisions / centralised
-decisions “move outwards” from planners, one person tells next person what to do -decentralised
there is economic freedom
-consumers make buying decisions
-entrepreneurs make production decisions
Mechanism used to achieve goals 5 year plans
1 year plans
input-output models
-all production is related and linked together in plan market/price mechanism:
-increase in consumer demand
shortage, so price rises
good more profitable, so supply increases
resources allocated to production of good increases
-vice versa for decrease in demand
Incentives used medals/awards/decorations
fines/penalties
(wage differences are limited, fixed by planners – little wage incentive) income and profit
-to increase profit costs are minimised
efficient resource use
development of new technology
What to produce? planners decide determined by consumer demand
How to produce? planners decide
-a guarantee of full employment
gross overstaffing determined by producer
-choose method that minimises costs
For whom to produce? -planners determine incomes & distribution of goods
-subsidised prices on basic goods
widespread shortages determined by income
-income is determined by the resources contributed to production
•
• advantages / disadvantages of market economies and planned economies
Aspect planned economy market economy
Consumer sovereignty / resource allocation unwanted goods are overproduced, wanted goods are underproduced – wastage of resources consumers determine what producers produce through purchases – no wastage on unwanted goods
Efficiency / degree of wastage - -less wastage on unnecessary duplication (of natural monopolies)
-no consumer sovereignty
-no price signals
-bottle necks in complex plans reduce efficiency
-wastage on planning - -see above
-profit encourages efficient resource use
-wastage on duplication
-wastage on advertising etc
-no planning wastage
Innovation no profit motive
plan must be adhered to, ∴unwise to take risks profit incentive to innovate (lowers production costs = more profit)
Flexibility production is interlinked, plans cannot be adjusted to demand market responds quickly to changes in demand
Economic freedom planners decide what is produced – no individual decision possible consumers decide what to buy, producers decide what to produce
can make individual decisions
Public goods government provision no profit can be made from supply – not supplied
Stability / inflation control fixed prices eliminate inflation
stable economic growth optimismboom/inflation
pessimismrecession/unemployment
no steady growth
Unemployment planning ensures jobs for all
overstaffing is a consequence unemployment during recession
Equality / income distribution wages are fixed
income distribution controlled income determined by amount of resources contributed to production
-many resourceshigh income
-few resourceslow income
Externalities / environmental damage - -in theory no profit motive for external damage/cost
-no private ownership results in environmental damage - -external costs incur no private cost -profit not affected
-private ownership means care of environment
Exploitation no private profit motive to underpay workers profit – firms want to cut costs
-poor safety standards
-low wages
-high prices in uncompetitive markets
Achievement of national goals national focus instead of individual focus focus on individual goals
Living standards / choice and quality of goods -poor quality – plan targets must be met
-wanted goods are scarce -market responds to changes in demand for goods
-competition encourages higher quality
•
• transition economies: (from planned to mixed / market)
causes of transition: disadvantages of planned
processes: introduction of private property ownership
-privatisation of state-owned firms by sale or voucher
deregulation of price / price controls removed – market signals “enabled”
wage controls removed – incentive to work etc.
state subsidies cut
foreign investment allowed / new trading partners found (USSR case especially)
exchange rates introduced
problems: slow adjustment to new capitalist values and legal systems (eg. lack of property rights)
-lack of entrepreneurs
-people “ripped off” by entrepreneurs
fiscal crisis – much less revenue for government due to decrease in taxes, profits from state firms
collapse of traditional trade flows (eg. USSR)
high inflation – prices rise when price controls and subsidies removed
high unemployment – jobs lost when overstaffing eliminated from state enterprises
Section 2: Microeconomics
• market: any situation where buyers/demanders and sellers/suppliers can interact
may be local, national or international
• market structures:
Characteristic Perfect / pure competition Monopolistic competition Oligopoly Monopoly
Number and size of firms (sellers) Very many small firms Many small firms 2-4 dominant firms, possibly some other smaller firms One firm – occupies whole industry
Number of buyers
Type of product homogenous slight differentiation homogenous /
very similar
(differentiated by conditions of sale / characteristics of product) homogenous (more likely) or differentiated
Barriers to entry nil very few significant total
Other -individual firms are price takers – no control over price
-government supports industry research & development -firms have little control over price
-costs of running firm are high
-wide consumer choice firms are interdependent – respond to rivals’ actions generally aim to operate in elastic region of demand curve
Examples agriculture
wheat farmers
orchardists retail
trades/services
restaurants / cafés
hairdressers telecommunications
airlines
banks
pizza retail (ie. Pizza Hut, Dominos are dominant firms) Australia Post (50c letter)
gas / water (natural monopolies)
• price signals and resource allocation: goods that are in high demand and are therefore scarce demand a high selling price – this attracts producers to the market as high price means higher profit
goods in high demand are produced in preference to those not in demand
resource allocation is efficient
• demand: the quantity buyers are willing and able to buy at a given price per unit of time
law of demand: The quantity demanded decreases as the price increases and vice versa.
downwards sloping demand curve
Determinants of demand - factors affecting market demand (other than price) / “autonomous factors”:
-cause a shift of the whole demand curve
Factor Causing increase in demand Causing decrease in demand
[diagram]
Household real income increase in real income decrease in real income
Tastes, preferences, fashions move in favour of product move in opposition to product
Advertising successful advertising unsuccessful / less advertising
Health aspects improves health detrimental to health
Weather favours product goes against product
Change in price of substitute price of substitute increases
(this product is now relatively cheaper) price of substitute decreases
(this product is now relatively more expensive)
Change in price of complement price of complement decreases price of complement increases
Population higher population lower population
Expectations about prices expect higher future prices
(buy more now) expect lower future prices
(buy more later)
note: A move along the curve is caused by a change in the price of the good or a change in the quantity demanded of the good, and is termed an expansion or contraction in demand. A shift of the whole curve is caused by a change in an autonomous factor, and is termed an increase or decrease in demand.
• supply: the quantity of a good or service suppliers are willing and able to supply at each price per unit of time
Law of supply: As price increases the quantity supplied increases.
upwards sloping supply curve
Determinants of supply – factors affecting market supply (other than price) / autonomous factors:
-cause a shift of the whole supply curve
Factor Causing increase in supply Causing decrease in supply
[diagram]
Taxes decrease indirect taxes
(drops curve by amount of tax)
increase indirect taxes
(raises curve by amount of tax)
Subsidies increase subsidies
(drops curve by amount of subsidy)
decrease subsidies
(raises curve by amount of subsidy)
Costs of production lower production costs
(make product more profitable) higher production costs
(make product less profitable)
Level of technology improved technology decreased level of technology
Seasonal influences / weather favourable conditions unfavourable conditions
Price of producer substitute price of producer substitute falls price of producer substitute rises
Producer preferences in favour of product against product
Exports decrease in exports increase in exports
Imports increase in imports decrease in imports
• interaction of demand and supply: equilibrium market clearing price and quantity is established where demand and supply curves meet – when established the market is said to be “at equilibrium”.
• At P1: QD1 > Q¬S1 shortage
∴ price is bid up by keen buyers
• At P2: QS2 > Q¬D2 surplus
∴ price decreases to clear surplus
• At PE: QS = QD no shortage or surplus
∴ no tendency for price to change; market is at equilibrium
• price controls:
maximum price / price ceiling: imposed below equilibrium price so that the product is affordable for all
-results in a shortage, which produces: queueing
waiting lists
ration vouchers to equally distribute good
A black market with illegal higher prices may develop where D meets Q¬S.
-solutions to shortage: subsidise private producers to increase supply (clears shortage)
government could supply the shortage
allow imports to increase supply
minimum price / price floor: imposed above equilibrium price to protect suppliers’ income (eg. rural producers)
-results in surplus: Those able to sells at minimum price receive good income, but those who hold surplus potentially receive no income.
A black market may develop at lower price where Q¬D meets S.
-solutions to surplus: government buys surplus (increases demand)
suppliers paid to leave industry (decreases supply)
Buffer stock scheme – excess can be stockpiled and resold when market is strong (ie PE > Pmin)...only successful where prices in market fluctuate
commodity agreements: where the supply of a product is limited through producer quotas (eg OPEC)
• price elasticity of demand (PED / PεD): the responsiveness of the quantity demanded to a change in price (in relative terms)
If: > 1, demand for product is price elastic (as %ΔQD > %ΔP)
= 1, demand for product has unitary price elasticity (as %ΔQD = %ΔP)
< 1, demand for product is price inelastic (as %ΔQD < %ΔP)
D1: perfectly inelastic demand
D2: relatively inelastic demand
D3: relatively elastic demand
D4: perfectly elastic demand
D5: D curve with unitary elasticity along whole length (retangular hyperbola)
Determinants of price elasticity of demand:
Goods with price elastic demand Goods with price inelastic demand
many close substitutes few/no substitutes
non-essential / luxury good essential / necessity
big budget item small budget item
non-addictive addictive
durable non-durable
May be a cheap complement to an expensive good
eg. petrol (complement to car)
• cross-elasticity of demand: the responsiveness of the quantity demanded of one good (X) when the price of another good (Y) changes
-If cross εD = 0, goods are unrelated
-If cross εD is +, goods are substitutes (the more positive, the closer the substitutes)
-If cross εD is -, goods are complements (the more negative, the stronger the complements)
• income elasticity of demand (YεD): the responsiveness of the quantity demanded of a good to a change in income
-If | YεD | > 1, good is income elastic
-If | YεD | < 1, good is income inelastic
normal good: a good where an increase in income results in an increase in the quantity demanded of it
∴ its YεD is positive +
inferior good: a good where the quantity demanded decreases as income increases
∴ its YεD is negative -
• price elasticity of supply (PES / PεS): the responsiveness of the quantity supplied of a good to a change in price
-If | PεS | > 1, supply of good is price elastic
-If | PεS | = 1, supply of good has unitary price elasticity
-If | PεS | < 1, supply of good is price inelastic
S1: perfectly inelastic supply
S2: relatively inelastic supply
S3: relatively elastic supply
S4: perfectly elastic supply
SU: curves with unitary PES
determinants of price elasticity of supply:
Goods with price elastic supply Goods with price inelastic supply
short production period long production period
production not at full capacity production at full capacity
able to hold stocks / non-perishable not able to hold stocks / perishable
long time frame (of measurement) short time frame (of measurement)
many producer substitutes few producer substitutes
• applications of concepts of elasticity:
PED and business decisions: the effect of price changes on total revenue:
To increase TR:
-If D is price elastic
decrease prices
-If D is price inelastic
increase prices
-If D has unitary price elasticity
keep prices the same (TR is at maximum)
PED and taxation:
-indirect taxes decrease the supply / raise the S curve by the amount of the tax
An indirect tax on goods with
price inelastic demand collects
more tax than one on goods with
price elastic demand.
∴ taxes on tobacco, petrol
alcohol are common
Significance of income elasticity for sectoral change as economic growth occurs:
-Production in developing countries consists mainly of primary sector industries (eg basic food crops, minerals) producing goods that have mostly income inelastic demand.
-As global incomes increase, this means demand for the countries’ produce does not increase much countries’ exports do not increase.
-But as incomes within these countries increase, domestic consumers’ demand for secondary/tertiary sector income elastic goods increases (through conspicuous consumption) imports into countries increase.
Trade balance is unfavourable/worsens.
Solution: Some developing countries have access to income elastic goods (but must be sustainable)
eg timber, seafood, tourism export and improve trade balance
• reasons for market failure:
positive and negative externalities:
In the market system: consumers buy products to satisfy private wants
only recognise private benefits of product
However: total benefits = private benefits + external benefits
external benefits/positive externalities: positive effects on external parties who had no part in the decision
merit goods: goods with external benefits
Merit goods are underproduced:
ie. QE is less than Q optimal
Solutions:
legislation
direct (government) provision
subsidies
advertising to encourage
Also, in the market system: suppliers produce products according to consumer’s demands
only recognise private costs of production and ignore external costs
external costs/negative externalities: negative effects on external parties who had no part in the decision
demerit goods: goods with external costs
Demerit goods are overproduced:
ie. QE is greater than Q optimal
Solutions:
legislation
subsidies on better substitutes
taxation
tradeable permits
extension of property rights
advertising to discourage
short-term and long-term environmental concerns:
-see negative externalities
sustainable development...
lack of public goods:
pure public goods: will not be produced in a free market situation as private suppliers cannot make profit from their production, due to the following characteristics:
-cannot exclude non-payers – “free rider” problem
-the extra/marginal cost of an extra user is zero
-
eg. defence, policing, street lights
Solutions: direct government provision through taxation
underprovision of merit goods:
-see positive externalities
overprovision of demerit goods:
-see negative externalities
abuse of monopoly power:
Strong market competition should result in low prices and good quality, ie the market is “self-regulating”.
eg. perfect competition, monopolistic competition (do not require strong regulation apart from misleading advertising laws)
But markets with few firms (oligopoly and monopoly) are uncompetitive and need regulation to prevent restrictive trade practices – practices that restrict competition.
eg. collusion
price agreements
resale price maintenance
exclusive dealing
monopolisation
price discrimination
merger
takeover
collective boycott
[In Australia: Australian Competition and Consumer Commission (ACCC)
Trade Practices Act]
Solutions: legislation
• possible government responses:
legislation:
Laws to render practices that lead to market failure illegal (decreases demand/supply).
-examples:
positive & negative externalities / merit & demerit goods: school leaving age, environmental laws
environmental concerns: fishing regulations
abuse of monopoly power: Trade Practices Act
direct provision of merit and public goods:
Where the government provides these goods, thus increasing supply and achieving Q optimal – is usually funded through taxation.
-examples:
positive externalities / merit goods: healthcare
lack of public goods: street lighting, defence
taxation:
[Direct taxation may be used to fund government provision of merit/public goods.]
Indirect tax on a good to the value of its external costs decreases supply and thus achieves Q optimal. Taxation revenue can then be used to remedy remaining external costs.
-examples:
negative externalities / demerit goods: cigarette tax
environmental concerns: petrol tax
subsidies:
Subsidies increase the supply of goods, enabling Q optimal to be attained.
-examples:
positive externalities / merit goods: subsidised education
negative externalities / demerit goods: subsidising a “better” substitute for demerit good
environmental concerns: (see negative externalities / demerit goods)
[lack of public goods: ??? ]
tradable permits:
Tradable permits are distributed to limit the provision of a demerit good to acceptable levels.
They may be auctioned off – the highest bidders are those who need the resource the most.
Once obtained the licences may be sold from one producer to another – an incentive to find/use “better” methods/technology with less externalities and so not requiring a licence.
-examples:
negative externalities / demerit goods:
environmental concerns: commercial fishing licences
extension of property rights:
The ownership of a resource or environmental asset is an incentive for the owner to take care of it, as when its value increases they receive direct benefit.
advertising to encourage or discourage consumption:
Successful advertising will either increase or decrease the demand for a product, hopefully to attain Qoptimal.
-examples:
positive externalities / merit goods: positive advertising for children’s literacy (increases D)
negative externalities / demerit goods: negative advertising against smoking (decreases D)
environmental concerns:
international cooperation among governments:
...
-examples:
environmental concerns:...
•
Section 3: Macroeconomics
3.1 Measuring national income
• circular flow of income: to give structure to the national economy by classifying the economy into sectors
• see “economics2.doc”...
Friday, August 19, 2011
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