Sunday, August 28, 2011
Corruption
Today 28th August is a day which marked a remarkable change in the history of India The historians and economists memmorise the day by the works of Anna Hazarae and supporters who worked to introduce new janlokpal and for the viping out of poverty. we must support and work for our nation .The driving force which takes Indian economy to backward is increasing corruption and black money. when corrupted amount and black money started flowing inside the economy there will be a multiplier effect and ultimately it lead to increase in Aggregate Demand and national investment in the economy. so we must work for the removal of corruption and political instability in India.
Friday, August 19, 2011
macro economics
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
• methods of measurement: to total the value of production of the firms sector
income:
The values of all four payments for factors of production – rent/land, wages/labour, interest/capital, profit/entrepreneurship – that contribute to the production of each and every good and service are totalled.
GDP at factor cost = rent + wages + interest + profit
= R + W + I + π
[This results in a figure for the total income derived from each product, and therefore its value. When summed, this calculates the value of all production in the firms sector.]
expenditure:
The total spending on final goods and services (finished products) is totalled according to who these products are purchased by:
households: consumption
firms –the producing firm: investment
-other firms: investment (in stocks)
government: government spending
overseas customers: exports
However, national income only counts the value of domestic products spending on imports must be subtracted.
GDP at market prices = consumption + investment + government spending + exports – imports
= C + I + G + (X – M)
output:
The sum of production of all firms is calculated by totalling the value added by each firm to each product.
The value added is equal to the sales of each firm in the “production chain” minus the value of intermediate goods (to avoid the “double counting” intermediate firms’ production).
The change in stocks of the firm must also be taken into account.
GDP at market prices = value added by all firms
= (sales – value of intermediate goods + Δ stocks) of all firms
• distinction between:
gross & net: Gross National Product (GNP) vs Net National Product (NNP)
During the process of producing goods and services, capital resources depreciate. This loss of resource value represents a loss of income – depreciation.
“Net” takes this depreciation into account:
NNP = national income = GNP (at factor cost) – depreciation of capital
national & domestic: Gross Domestic Product (GDP) vs Gross National Product (GNP)
GDP is the value of all goods and services produced in an economy, in a given time period.
Some of the income generated from this production does not belong to the citizens of the country – it is sent overseas. Likewise, there is some income that is earned overseas that is not included in GDP.
“National” takes this into account:
GNP = GDP + overseas property income earned – property income paid overseas
= GDP + net overseas property income
nominal & real: real GDP/GNP/NNP/National Income vs nominal GDP/GNP/NNP/National Income
GDP/GNP/NNP/National income measures are recorded in current year prices and dollars (nominal).
Inflation may inflate the prices used in calculations.
“Real” takes this into account:
Eliminates effects of inflation by use of index numbers to deflate nominal figures
total & per capita: GDP/GNP/NNP vs GDP/GNP/NNP per capita
The size of an economy (and so its national income) can be affected by its population.
Per capita measures allow the national incomes of countries to be compared regardless of population.
eg GDP per capita =
3.2 Introduction to development
• economic growth: an increase in the production of goods and services over time
It is measured by calculating national income (GDP/GNP/NNP).
• economic development: the reduction or elimination of poverty, inequality and unemployment within the context of a growing economy
It should lead to a general improvement in the living standards of the average person.
• differences between economic growth and economic development:
-see Section 1: • choice –diagrams showing economic growth and economic development
...
• GDP vs GNP as measures of growth:
GNP measures the amount of income actually belonging to the people of the country, not foreign investors etc. GDP measures the income stemming from production in the country.
∴ ...
• limitations of using GDP as a measure to compare welfare between countries:
-income distribution: Income distribution may be uneven, that is, the average income is not the amount that the majority of people receive. Developing countries often have an elite high-income group along with widespread poverty.
-different costs of living in different countries: Average income may have differing purchasing power ($ value may not accurately reflect amount of products able to be bought).
-exchange rates (to US$): Conversion to US$ using the market exchange rate may not accurately reflect cost differences between the countries – currency may be overvalued or undervalued.
-non-market production: Informal markets that are ignored in official statistics may exist, thus some production is not counted (eg subsistence farming).
-non-financial factors: Other factors that affect standard of living are not factored in: environmental, security/safety, political freedom etc
-type of production: Production that is focused on capital goods (as opposed to consumer goods) does not add to welfare – eg spending on military goods.
-work-leisure balance: Leisure adds to welfare but has no $ value (ie no. of hours worked per week).
-collection methods/errors/falsification of data: Poorer countries may have poor data collection. Political interference with data may occur.
• allowance for differences in purchasing power when comparing welfare between countries:
Some of the difference in purchasing power between countries may be allowed for through the use of purchasing power parity (PPP). The relative cost (usually compared to in the USA) of a standard basket of goods is measured in terms of points (USA = 100 points), and this may used to adjust average income or GNI per capita figures.
eg GNI per capita Cost of a basket of goods relative to USA
Country A: local A$4000 80 points
Country B: local B$2000 65 points
In PPP terms, country A has:
GNI per capita = $4000 × = US$5000
In PPP terms, country B has:
GNI per capita = $2000 × = US$3077
• alternative methods of measurement:
sectoral transition:
Economic development should lead to a decline in agricultural production and employment, and an increase in manufacturing, and then service industries. That is, low income countries tend to be dominated by agriculture and developed countries by services.
human development index (HDI):
Composite social indicators such as HDI and Physical Quality of Life index attempt to produce a broader quantitative measure of development. Several social indicators (see below) are statistically combined to result in a numerical figure representing the extent of development.
The Physical Quality of Life index combines life expectancy at birth, infant mortality and adult literacy.
HDI combines GDP per capita (PPP-adjusted), life expectancy at birth and adult literacy (aims to measure longevity, knowledge and income). The weighting of the 3 aspects may vary – the index may be adjusted for gender disparity and income distribution.
This combination results in an average deprivation index – a number between 0 (no human progress) and 1 (maximum human progress).
social indicators:
These relate to the 3 “core values” of economic development: life sustenance, self-esteem and freedom/ability to choose – but most prominently life sustenance.
Development should result in the improved provision of basic needs and the elimination of absolute poverty. That is, improved access to food, water, shelter, health services etc and possibly rising incomes, access to education, more income equality and employment opportunities.
examples: calorie intake / protein intake (food)
square metres of floor space (shelter)
life expectancy / infant mortality / people per doctor or nurse (health services)
literacy / % primary and secondary school attendance (education)
income distribution quintile figures (income equality)
changes in social structures/attitudes/institutions:
Economic development often requires or results in changes in social structures, popular attitudes and national institutions.
social structure: family – less focus on family, more focus on individual
tribal loyalties – can result in conflict and civil war which hinder development
popular attitudes: enterprise – acceptance of risk-taking / possible business failures
innovation – new methods, as opposed to traditional methods in production
personal advancement – advancement of the individual and their higher income/wealth
discipline – acceptance of discipline of the workplace (punctuality etc)
national institutions: land ownership – ownership is an incentive to improve land and crop yields (a portion of the crop is not being given away as rent to a landlord as in subsistence farming)
style of government – democratic government
banking structures – acceptance of banking and lending
administration – an honest and transparent public service, no bribery/corruption
education/training programs – acceptance if are against traditional beliefs
(eg education of women)
• problems of measuring development:
-statistical/data collection errors
-broadness of definition of development
...
3.3 Macroeconomic models
• aggregate demand – components: Aggregate demand (AD) is the total amount of goods and services (ie real GDP) that will be purchased at each general price level (GPL).
AD represents total expenditure:
= consumption + investment + government spending + net overseas exports
= C + I + G + (X – M)
The AD curve is “downwards” sloping:
-As GPL rises, the real spending power of a given nominal income decreases AD is reduced
-If GPL rises, local prices are less competitive and so M↑ and X↓ AD is reduced
-As GPL↑, real value of savings↓, so to maintain real wealth people may cut back on spending AD↓
-If people borrow to maintain spending, interest rates↑ so C and I fall AD is reduced
• aggregate supply: The total supply by the business/firms sector
There are 2 time frames that apply to aggregate supply (AS) – short-run and long-run.
This is due to the “time-lag” between the adjustments of resource markets and those of goods and services markets.
short-run aggregate supply (SRAS):
Where goods and services markets have adjusted to equilibrium, but resource markets have not.
(Many resources are subject to long-term contracts, so prices cannot change until end of contract.)
ie Resource prices are assumed to be constant in nominal terms.
long-run aggregate supply (LRAS):
Both resource markets and goods and services markets are assumed to have attained equilibrium.
∴ LRAS is a vertical line at the “full employment” level of real GDP, as any increase in GPL is matched by an increase in resource prices real profit is constant and so production is unchanged.
• full employment level of national income: where LRAS is along x-axis (real GDP) –see above
• equilibrium level of national income: (short-run equilibrium?)
• inflationary gap & deflationary gap: ???
• diagram illustrating trade/business cycle:
Business cycle stage Boom Downturn Trough Upturn
-Consumer confidence
-Consumption very high decreasing low increasing
-Business confidence
-Sales & profits
-Investment very high decreasing low increasing
aggregate demand very high decreasing low increasing
Unemployment low increasing very high decreasing
Inflation high decreasing low increasing
Economic growth strong slowing low/negative increasing
Trade balance worsens: X↓ M↑ improves: X↑ M↓ strongly positive worsens: X↓ M↑
tax receipts very high less very low more
welfare & u/e payments low more high less
budget position good/surplus likely worsens bad improved
fiscal policy contractionary:
T↑ G↓ expansionary:
T↓ G↑ expansionary:
T↓ G↑ contractionary:
(T↑) G↓
monetary policy tight:
interest rates↑ loose:
interest rates↓ loose:
interest rates↓ tight:
interest rates↑
3.4 Demand-side and supply-side policies
• shifts in the aggregate demand curve / demand-side policies:
AD`: increased AD
AD``: decreased AD
fiscal policy:
Fiscal policy is government budgetary policy:
If tax↓ and government spending↑, AD increases
-increases C (more after-tax income to spend)
-increases I (more incentive to invest)
If tax↑ and government spending↓, AD decreases
interest rates as a tool of monetary policy:
The changing of the money supply, and so interest rates, affects the level of AD.
[This is often left to the central bank of a country: eg Reserve Bank of Australia, US Federal Reserve.]
If interest rates↓, AD increases
-increases C (more after-interest income to spend, more desire to borrow to spend)
-increases I (less costly to finance projects)
If interest rates↑, AD decreases
consumer expectations:
If expectations improve, AD increases.
-C increases due to better job security (strong economy)
-I increases due to strong current and predicted sales/profits
If expectations worsen, AD decreases.
overseas sector / exchange rates:
Appreciation is when the exchange rate for the local currency increases and buys more overseas currency.
Depreciation is when the exchange rate for the local currency decreases and buys less overseas currency.
If local currency depreciates, AD increases.
-X increases as price of exports is lower for overseas customers – demand for exports increases
-M decreases as the price of imports is increased – demand for imports decreases
• shifts in the aggregate supply curve / supply-side policies:
SRAS (only?) will shift when the costs of productive inputs change – eg wages, raw materials, electricity, oil
When production costs increase, SRAS decreases. When production costs decrease, SRAS increases.
Factors which shift the potential output (productivity) will shift LRAS, and so also shift SRAS.
These factors are changes in the quantity and quality of resources, and technological improvements.
Quantity and quality of resources: for example:
Land – clear/reclaim land for use, discover minerals, increase access to fishing/hunting
Labour – employment of women, immigration, more education/training, improved health
Capital – increase in savingsincreased used of capital, invention of new capital/R&D
Enterprise – increase number and quality of entrepreneurs
Technological improvements: (in both physical and human capital)
“Microeconomic reform”: (the above + policies to increase productivity)
Labour
tax reform – (increase indirect tax and) lower income tax to increase incentive to work and enterprise
welfare reform – tighter rules take away the disincentive to work of generous welfare
industrial relations reform – productivity-based wage negotiationsincentive to be more productive
– less union power as unions raise cost of labour
– less wrongful dismissal laws
Enterprise
tariff reduction – increases import competition, local firms more efficient/productive
privatisation / increased competition – private firms more profit focused, more efficient/productive
less government red tape – will increase business and enterprise activity
key industry reform – lowers the cost of business inputs: financial sector, transport
infrastructure – improvements in infrastructure eliminate bottlenecks and inefficiencies
• strengths and weaknesses of these policies:
The strength and validity of these policies can be measure against the macroeconomic goals of government: full employment, economic growth, price stability/low inflation, external balance.
Demand-side policies:
Can achieve full employment, economic growth and external balance (increase AD), but at the expense of price stability – increased GPL inflation.
[Fiscal vs monetary......]
Supply-side policies:
Can achieve all goals (increase LRAS/SRAS) – in case of employment, the natural rate is decreased and thus more employment.
3.5 Unemployment and inflation
• full employment and underemployment:
full employment: Full employment is not 100% employment. It is the level of unemployment consistent with the rate of natural unemployment (frictional, structural, seasonal, (hardcore) –see below). This does not include cyclical unemployment.
Underemployment may occur when a full-time job seeker accepts a part-time job – they are now not unemployed, but underemployed. [Disguised unemployment is where firms are overstaffed – either in an attempt to produce low unemployment rates (planned economies) or to keep experienced workers. Workers in these situations may have little to do.]
• unemployment rate:
unemployment rate =
unemployed: workers who are able and willing to work but who do not have jobs
labour force: the percentage of the population of working age (over 15) who are willing and able to work (ie the number of employed + number of unemployed = participation rate)
=population × % working age × participation rate
• costs of unemployment:
-loss of foregone production in the economy; economy operates inside PPC
inefficient, lower living standards
-government budget position worsens: unemployment benefit payments increase, tax receipts decrease
other worthwhile government programs cannot be financed
The unemployed suffer large reductions in income and personal poverty.
-social costs of unemployment:
private costs (to the unemployed person): poor health, low self-esteem, boredom/isolation, financial hardship, substance abuse
external costs: family stress, vandalism/petty crime
• types of unemployment:
structural: when the structure of the economy changes
-significant loss of jobs in certain industries due to fall in demand for a product, or a shift in the geographical location of production
-includes regional u/e (result of a dominant industry in an area) and technological u/e (human skills replaced by technology)
-unemployment is reasonably long-term
frictional: due to workers entering/re-entering workforce or switching between jobs on day data is collected
-high frictional u/e during a boom (less risk in changing jobs), low in a recession (more risk)
-unemployment is short-term
seasonal: in occupations that are seasonal – have a busy working season and an off-season
eg tourism, fishing, agriculture
cyclical / demand-deficient: widespread, general u/e associated with the business cycle
-occurs during recessions, as aggregate demand (C + I + G + X – M) is too low the achieve full employment / the natural rate of u/e
[diagram – recessionary gap?]
real wage: where the price of labour (real wage) is above the equilibrium price of full employment
-due to legislated minimum wages above the clearing wage (a price floor for labour)
-due to strong union power winning high wage outcomes that flow on to other workers
• measures to deal with unemployment:
structural: quickly retrain the structurally u/e
frictional: improve the information stream from employers to job-seekers about job opportunities
seasonal: train workers in skills for employment in the off-season
cyclical / demand-deficient: government policy, [demand-side / supply-side policies]
real wage: restrict union power, remove/lower minimum wage
• definitions of inflation and deflation:
inflation: a general sustained increase in prices
deflation: a general sustained decrease in prices
• costs of inflation and deflation:
-inflation:
inequity: savers & borrowers – savings lose value; assets financed by loans gain value
exporters & importers – local exporters charge higher prices-X↓; imports are cheaper-M↑
financial asset holders & real asset holders – financial holders lose; real holders gain
price makers & price takers – price makers-monopoly/oligopoly- can raise prices; takers can’t
fixed income earners & talented / in demand – fixed incomes can’t increase, ∴real incomes↓
trade balance worsens – X↓ M↑ –see above
distorted investment, speculation – people buy existing assets, less new productive investment
lower business confidence – unpredictable prices increase riskless investment, so less employment
accounting problems – unable to predict future prices of capital equipment, so hard to plan ahead
industrial unrest – workers want wage increases to maintain real wage
less saving – disincentive to save less investment less productivity
wastage of resources – administration changes
-deflation:
......
• causes of inflation:
cost push:
Increases in costs push up prices of finished products.
Due to costs of: raw materials, wages, utilities (water/electricity/telecommunications), imported product
May also be due to monopoly/oligopoly firms making profits
demand pull:
When extreme demand (C+I+G+X–M) occurs and supply struggles to satisfy it, inflation may occur.
Widespread shortages cause prices to be bid up inflation.
Boom conditions exist, ie full employment.
excess monetary growth:
If the money supply increases (money is printed) without the quantity of goods increasing, inflation results.
equation of exchange: M × V = P × Q
M: money supply, total $ spent
V: velocity of circulation
P: average price
Q: quantity of goods
V is assumed to be constant in the short-/medium-term.
If M rises > Q rises, then P will rise (inflation)
3.6 Distribution of income
• direct taxation: tax liability targeted at one person on the basis of income
eg income tax, company tax
Incidence (person who pays the tax) is the same as impact (person levied tax – physically transfers $)
• indirect taxation: a tax imposed on spending
eg cigarette tax, petrol tax, GST
Incidence = consumer, impact = retailer
• progressive taxation: as income increases, the marginal tax rate increases (on the extra income)
-tax brackets increase with income
-the proportion of income paid as tax increases with income
eg
Tax bracket ($) Marginal tax rate
0-10000 0 cents per dollar
10001-50000 30 cents per dollar
50001+ 50 cents per dollar
∴ someone with an income of $80000 would pay:
(50000-10000) × $0.30 + (80000-50000) × $0.50 = $27000 in tax
• proportional taxation: (flat tax) the proportion of income paid in tax is the same for everyone
eg 30% of income paid whether one has income of $30000 or $200000
-marginal rate of tax = average rate of tax
• regressive taxation: the proportion of income paid in tax is less for those with higher incomes, and more for those with lower incomes
-marginal rate of tax < average rate of tax
• transfer payments: welfare payments from the government to the households sector
When combined with progressive taxation, income is effectively transferred from high income earners to lower income earners.
Section 4: International economics
4.1 Reasons for trade
• differences in factor endowments: different countries have different resources that enable them to produce certain products at lower cost
-eg Scotch whiskey, tourism from Uluru
• variety and quality of goods: trade enables a better match between wants of consumers and the products able to satisfy them, through greater variety.
Products may also be of better quality, as countries produce those products in which they already have expertise and resources.
• gains from specialisation: quality of products increases as countries can devote more resources into one area, in which they specialise
• political: trading partners often have improved international relations, and a reluctance to go to war with each other.
Trade increases cultural diversity and understanding.
4.2 Free trade and protectionism
• definition of free trade: where there are no government imposed restrictions on trade
• types of protectionism:
tariff: a tax imposed on imports
-increases price of imports making local products comparatively more competitive
-WTO preferred, as any producer willing to pay the tariff can compete openly global efficiency
quota: a number limit on the amount of imports allowed into a country
-guarantees local producers a proportion of the market
-quota allocated by import licences, which are auctioned off to highest overseas bidders
-overseas producers without licence cannot compete at all – barrier to entry
subsidy: a payment made by government to local producers on each unit produced
-gives local producers advantage over importers by effectively reducing costs of production
voluntary export restraint: a self-imposed limit on the amount of exports a country exports
-guarantees local producers market share
-usually applied when exporter faces threats of more formal protection measures
administrative obstacles:
-act as a disincentive for exporters, especially if only low volumes of exports
health and safety standards:
-local producers are unaffected, as all must abide by standards
-exporters may not wish produce an extra line of product to meet standards, especially in low volumes
environmental standards:
-see above
• arguments for protection:
Infant industry: (valid)
High initial costs (factories, training, marketing) may mean that newly established local producers will find it difficult to compete with established overseas producers. Thus protection can provide time for local producers to establish.
Protection should be short/medium-term, structured and phased out over a given period of time, or else inefficiency may result.
Efforts of a developing country to diversify:
Due to comparative advantage, excessive specialisation may occur in a free trade environment. There is large risk – if the major industry in a LDC fails – wider economic problems. Diversification, through protection, reduces risk.
However, increased protection may reduce real living standards – tariffs cause price increases; subsidies mean more taxes.
Protection of employment:
Protection expands local industries, creating employment.
But this employment is in inefficient industries (thus requiring protection) and resources could be better devoted to efficient productive industries export potential, higher incomes. Inefficient industries will eventually disappear and relocate to countries of comparative advantage.
Source of government revenue:
Tariffs may be a significant source of government revenue for some LDCs. Removal may cause hardship.
Strategic arguments:
self-sufficiency (valid)
Means to overcome a balance of payments disequilibrium:
Ideally exports and imports into and out of a country should be balanced – trade balance. Removal of protection may create a flood of imports and a negative trade balance.
Instead of imposing protection, inefficient import-replacement industries could be closed, and resources reallocated to competitive export industries. The rise in exports should compensate for increase in imports.
Balance of payments problems may be solved in other ways – see Section 4.7.
Anti-dumping: (valid)
When a country has an oversupply of a product that is unsaleable within the country, it may sell the product overseas at extremely low prices (in an attempt to recover some revenue). Local producers cannot compete with these prices, and so will disappear. The local country must now import the product.
Protection should be short-term only.
• arguments against protection:
Inefficiency of resource allocation:
Protected industry will expand, and more resources are allocated to an uncompetitive and inefficient industry. National efficiency is less.
Costs of long-run reliance on protectionist methods:
-entrenched inefficiency may occur in the industry...
Increased prices of goods and services to consumers:
Tariffs, quotas and subsidies all cause prices to be artificially high above the world price.
(see diagrams above)
The cost effect of protected imports on export competitiveness:
......
4.3 Economic integration
• globalisation:
-trade: integration of goods and services markets, WTO
-foreign investment: integration of capital markets
-free movement of labour integrates labour markets
-international agreements/decisions/relations: United Nations, WTO etc
• trading blocs: groups of countries who agree to liberalise trade amongst themselves
free trade areas (FTAs): free trade between FTA members, but members still impose tariffs on non-members wishing to export into their country
eg Australia-US FTA, North American FTA (US, Canada, Mexico, Chile)
customs unions: an FTA, but with a single uniform tariff for non-member countries wishing to export into union
common markets: all of the above, also with free movement of labour (no work permits), capital and enterprise
eg European common market
4.4 World Trade Organisation (WTO)
• aims: to promote global free trade – creates multilateral trade agreements, rules which all members must follow
acts as forum to hear disputes between members:
-certain standards must be met for membership (currently 148 members)
-membership gives equal access to all other members’ markets
-all members are treated the same (but LDC given longer timeframes to comply with rules)
-total consensus (from all 148 members) must be achieved for a rule to be instated
-holds “rounds of talks”: eg the Doha Round
WTO favours tariffs (open, visible competition) over other forms of protection
http://www.wto.org/
• success and failure viewed from different perspectives:
-Low protection achieved on manufactured goods, banking, telecommunications...
-attempts to protect intellectual property, prevent piracy
-Very slow progress on agriculture, textiles -footwear and clothing (LDCs have comparative advantage), as high subsidies in EU / USA and high tariffs in developed countries...has caused some conflict
4.5 Balance of payments
-a systematic record in monetary terms of a country’s transactions with the rest of the world
-a financial document that categorises and compares money inflows and outflows resulting from international transactions
• current account: contains regular or recurring transactions whose results are felt during the current period
-consists of four sections: net goods / balance on merchandise trade
eg exports, imports
net services
eg travel, education services, telecommunications services
net incomes
eg property incomes: rent, interest payments, dividends, profits from foreign investment
net current transfers
eg gifts, (non-capital) foreign aid, pensions/taxes/refunds from overseas
• balance of trade: balance of visibles: see net goods above, tangible goods only included
= goods credits (exports) – goods debits (imports)
• invisible balance: total on net services, net incomes and net current transfers above
= service/income/current transfer credits (money inflows) – debits (money outflows)
• capital account: records international capital transfers, loans and investments; transactions are large, irregular and have long-lasting effects
-consists of 2 main sections: capital (transfers) account
-net capital transfers = capital transfer credits – debits
eg money transfer with immigration, some foreign aid
-net acquisition of non-produced, non-financial capital
eg intellectual property, patents, trademarks
financial account
-net investment = investment credits – debits
direct investment: results in control of the enterprise by foreign investors
portfolio investment: purchase of shares/bonds in overseas companies
other investment: eg offshore borrowing, lending abroad
-net reserve assets
eg central bank transactions with foreign currencies/monetary gold
-net errors and omissions
On the balance of payments: overall credits = overall debits
(see Section 4.6 –floating exchange rate)
∴ this section reflects inaccuracies in data collected; it “balances” the whole account
4.6 Exchange rates
• fixed exchange rates: where the exchange rate (ER) has a constant value in terms of overseas currency
-ER is set by government / central bank and not market forces
• floating exchange rates: where the ER is determined by market forces – demand and supply in the foreign exchange (forex) market
Demand for local currency is comprised of credits to the balance of payments (foreigners wanting to pay money into country require the local currency):
-goods & services exports; incomes, current transfers paid into country
-foreign investment, loans into country
-central bank buying local currency
Supply of local currency is comprised of debits to the balance of payments (locals wanting to pay money to overseas require foreign currency, and thus sell some of their local currency):
-goods & services imports; incomes, current transfers paid overseas
-foreign investment, loans to overseas countries
-central bank selling local currency
• managed exchange rates: ......
• distinction between:
depreciation and devaluation: floating ER depreciates; fixed ER is devalued (decrease in value)
appreciation and revaluation: floating ER appreciates; fixed ER is revalued (increase in value)
• effects on exchange rates of:
Factor Effect on demand Effect on supply Effect on ER
Trade flow
-exports increase, imports decrease
-exports decrease, imports increase
increase
decrease
decrease
increase
appreciates
depreciates
Capital flows / interest rate changes
-FI into country increases, FI overseas decreases
-FI into country decreases, FI overseas increases
-local interest rates rise (loans into ↑, loans out ↓)
-local interest rates fall (loans into ↓, loans out ↑)
increase
decrease
increase
decrease
decrease
increase
decrease
increase
appreciates
depreciates
appreciates
depreciates
Inflation
-local inflation increases (exports ↓, imports ↑)
-local inflation decreases (exports ↑, imports ↓)
decrease
increase
increase
decrease
depreciates
appreciates
Speculation
-predict that ER will appreciate
-predict that ER will depreciate
increase
increase
appreciates
depreciates
Use of foreign currency reserves
-central bank buys local currency
-central bank sells local currency
increase
increase
appreciates
depreciates
4.7 Balance of payment problems
• consequences of a current account deficit or surplus:
Deficit:
In the short-term, exports have decreased or imports have increased (comparatively)
(X-M) is more negative AD is decreased:
YE falls to YE`: less growth, more unemployment
GPLE falls to GPLE`: less inflation
Longer-term: trade deficit causes depreciation of ER
AD increases, because exports ↑ (are relatively cheaper), imports ↓ (are relatively more expensive)
X and M are re-balanced
LDCs: current account deficit means capital and financial account surplus
build up of foreign debt due to foreign investment (loans)
[indicated by appreciating ER, as D for currency increases]
increase in interest payments on loans
[ER depreciates slightly as payments are made and S increases, but overall ER has appreciated]
current account deficit worsens...(cycle) debt trap
Surplus:
Short-term: [AD increased – more growth, less unemployment, more inflation]?
Longer-term: [AD decreases as ER appreciates...X and M re-balanced]?
• methods of correction:
Managed changes in exchange rates: (very short term)
If current account deficit (depreciated ER), central bank buys local currency D ↑, ER appreciates
If current account surplus (appreciated ER), central bank sells local currency S ↑, ER depreciates
Reduction in aggregate demand / expenditure-reducing policies: (short-medium term)
-contractionary/expansionary fiscal policy (T and G); tight/loose monetary policy (interest rates)
If current account deficit, decrease AD lowers M helps rebalance trade balance, reduces deficit
Also decreases inflation, increasing global competitiveness rebalances trade
-M may also be reduced by increasing domestic savings:
Eg. superannuation, reducing government deficit (running a budget surplus)
If current account surplus, vice versa.
Change in supply-side policies to increase competitiveness: (long-term)
For deficit – increases efficiency, international competitiveness; boosts exports and import replacements
Protectionism / expenditure-switching policies: (medium-term, longer may be harmful)
Increasing level of protection reduces imports, reducing any current account deficit.
S of currency decreases, and ER appreciates.
However, may be prevented by WTO or long-term entrenched inefficiency may result.
• consequences of a capital account deficit or surplus:
Surplus may lead to debt trap, especially in LDCs
(see consequences of a current account deficit or surplus)
Surplus corresponds to current account deficit, whilst deficit corresponds to current account surplus.
4.8 Terms of trade
• definition of terms of trade: measures average export prices relative to average import prices
(price index is a measure of average price)
In the base year, X price index = M price index = 100, ∴ ToT index = 100.
• consequences of a change in the terms of trade for a country’s balance of payments and domestic economy:
Ceteris paribus, improved/more favourable ToT should increase X revenue, whilst decreasing M spending balance of trade and current account deficit should improve, ER appreciates.
• the significance of deteriorating terms of trade for developing countries:
LDCs generally have primary industry exports (minerals, food) whose PεD is inelastic.
∴ fall in price means large decrease in export revenue.
ToT worsens, along with trade balance and current account deficit
may fall into debt trap...
•
3.1 Measuring national income
• circular flow of income: to give structure to the national economy by classifying the economy into sectors
• methods of measurement: to total the value of production of the firms sector
income:
The values of all four payments for factors of production – rent/land, wages/labour, interest/capital, profit/entrepreneurship – that contribute to the production of each and every good and service are totalled.
GDP at factor cost = rent + wages + interest + profit
= R + W + I + π
[This results in a figure for the total income derived from each product, and therefore its value. When summed, this calculates the value of all production in the firms sector.]
expenditure:
The total spending on final goods and services (finished products) is totalled according to who these products are purchased by:
households: consumption
firms –the producing firm: investment
-other firms: investment (in stocks)
government: government spending
overseas customers: exports
However, national income only counts the value of domestic products spending on imports must be subtracted.
GDP at market prices = consumption + investment + government spending + exports – imports
= C + I + G + (X – M)
output:
The sum of production of all firms is calculated by totalling the value added by each firm to each product.
The value added is equal to the sales of each firm in the “production chain” minus the value of intermediate goods (to avoid the “double counting” intermediate firms’ production).
The change in stocks of the firm must also be taken into account.
GDP at market prices = value added by all firms
= (sales – value of intermediate goods + Δ stocks) of all firms
• distinction between:
gross & net: Gross National Product (GNP) vs Net National Product (NNP)
During the process of producing goods and services, capital resources depreciate. This loss of resource value represents a loss of income – depreciation.
“Net” takes this depreciation into account:
NNP = national income = GNP (at factor cost) – depreciation of capital
national & domestic: Gross Domestic Product (GDP) vs Gross National Product (GNP)
GDP is the value of all goods and services produced in an economy, in a given time period.
Some of the income generated from this production does not belong to the citizens of the country – it is sent overseas. Likewise, there is some income that is earned overseas that is not included in GDP.
“National” takes this into account:
GNP = GDP + overseas property income earned – property income paid overseas
= GDP + net overseas property income
nominal & real: real GDP/GNP/NNP/National Income vs nominal GDP/GNP/NNP/National Income
GDP/GNP/NNP/National income measures are recorded in current year prices and dollars (nominal).
Inflation may inflate the prices used in calculations.
“Real” takes this into account:
Eliminates effects of inflation by use of index numbers to deflate nominal figures
total & per capita: GDP/GNP/NNP vs GDP/GNP/NNP per capita
The size of an economy (and so its national income) can be affected by its population.
Per capita measures allow the national incomes of countries to be compared regardless of population.
eg GDP per capita =
3.2 Introduction to development
• economic growth: an increase in the production of goods and services over time
It is measured by calculating national income (GDP/GNP/NNP).
• economic development: the reduction or elimination of poverty, inequality and unemployment within the context of a growing economy
It should lead to a general improvement in the living standards of the average person.
• differences between economic growth and economic development:
-see Section 1: • choice –diagrams showing economic growth and economic development
...
• GDP vs GNP as measures of growth:
GNP measures the amount of income actually belonging to the people of the country, not foreign investors etc. GDP measures the income stemming from production in the country.
∴ ...
• limitations of using GDP as a measure to compare welfare between countries:
-income distribution: Income distribution may be uneven, that is, the average income is not the amount that the majority of people receive. Developing countries often have an elite high-income group along with widespread poverty.
-different costs of living in different countries: Average income may have differing purchasing power ($ value may not accurately reflect amount of products able to be bought).
-exchange rates (to US$): Conversion to US$ using the market exchange rate may not accurately reflect cost differences between the countries – currency may be overvalued or undervalued.
-non-market production: Informal markets that are ignored in official statistics may exist, thus some production is not counted (eg subsistence farming).
-non-financial factors: Other factors that affect standard of living are not factored in: environmental, security/safety, political freedom etc
-type of production: Production that is focused on capital goods (as opposed to consumer goods) does not add to welfare – eg spending on military goods.
-work-leisure balance: Leisure adds to welfare but has no $ value (ie no. of hours worked per week).
-collection methods/errors/falsification of data: Poorer countries may have poor data collection. Political interference with data may occur.
• allowance for differences in purchasing power when comparing welfare between countries:
Some of the difference in purchasing power between countries may be allowed for through the use of purchasing power parity (PPP). The relative cost (usually compared to in the USA) of a standard basket of goods is measured in terms of points (USA = 100 points), and this may used to adjust average income or GNI per capita figures.
eg GNI per capita Cost of a basket of goods relative to USA
Country A: local A$4000 80 points
Country B: local B$2000 65 points
In PPP terms, country A has:
GNI per capita = $4000 × = US$5000
In PPP terms, country B has:
GNI per capita = $2000 × = US$3077
• alternative methods of measurement:
sectoral transition:
Economic development should lead to a decline in agricultural production and employment, and an increase in manufacturing, and then service industries. That is, low income countries tend to be dominated by agriculture and developed countries by services.
human development index (HDI):
Composite social indicators such as HDI and Physical Quality of Life index attempt to produce a broader quantitative measure of development. Several social indicators (see below) are statistically combined to result in a numerical figure representing the extent of development.
The Physical Quality of Life index combines life expectancy at birth, infant mortality and adult literacy.
HDI combines GDP per capita (PPP-adjusted), life expectancy at birth and adult literacy (aims to measure longevity, knowledge and income). The weighting of the 3 aspects may vary – the index may be adjusted for gender disparity and income distribution.
This combination results in an average deprivation index – a number between 0 (no human progress) and 1 (maximum human progress).
social indicators:
These relate to the 3 “core values” of economic development: life sustenance, self-esteem and freedom/ability to choose – but most prominently life sustenance.
Development should result in the improved provision of basic needs and the elimination of absolute poverty. That is, improved access to food, water, shelter, health services etc and possibly rising incomes, access to education, more income equality and employment opportunities.
examples: calorie intake / protein intake (food)
square metres of floor space (shelter)
life expectancy / infant mortality / people per doctor or nurse (health services)
literacy / % primary and secondary school attendance (education)
income distribution quintile figures (income equality)
changes in social structures/attitudes/institutions:
Economic development often requires or results in changes in social structures, popular attitudes and national institutions.
social structure: family – less focus on family, more focus on individual
tribal loyalties – can result in conflict and civil war which hinder development
popular attitudes: enterprise – acceptance of risk-taking / possible business failures
innovation – new methods, as opposed to traditional methods in production
personal advancement – advancement of the individual and their higher income/wealth
discipline – acceptance of discipline of the workplace (punctuality etc)
national institutions: land ownership – ownership is an incentive to improve land and crop yields (a portion of the crop is not being given away as rent to a landlord as in subsistence farming)
style of government – democratic government
banking structures – acceptance of banking and lending
administration – an honest and transparent public service, no bribery/corruption
education/training programs – acceptance if are against traditional beliefs
(eg education of women)
• problems of measuring development:
-statistical/data collection errors
-broadness of definition of development
...
3.3 Macroeconomic models
• aggregate demand – components: Aggregate demand (AD) is the total amount of goods and services (ie real GDP) that will be purchased at each general price level (GPL).
AD represents total expenditure:
= consumption + investment + government spending + net overseas exports
= C + I + G + (X – M)
The AD curve is “downwards” sloping:
-As GPL rises, the real spending power of a given nominal income decreases AD is reduced
-If GPL rises, local prices are less competitive and so M↑ and X↓ AD is reduced
-As GPL↑, real value of savings↓, so to maintain real wealth people may cut back on spending AD↓
-If people borrow to maintain spending, interest rates↑ so C and I fall AD is reduced
• aggregate supply: The total supply by the business/firms sector
There are 2 time frames that apply to aggregate supply (AS) – short-run and long-run.
This is due to the “time-lag” between the adjustments of resource markets and those of goods and services markets.
short-run aggregate supply (SRAS):
Where goods and services markets have adjusted to equilibrium, but resource markets have not.
(Many resources are subject to long-term contracts, so prices cannot change until end of contract.)
ie Resource prices are assumed to be constant in nominal terms.
long-run aggregate supply (LRAS):
Both resource markets and goods and services markets are assumed to have attained equilibrium.
∴ LRAS is a vertical line at the “full employment” level of real GDP, as any increase in GPL is matched by an increase in resource prices real profit is constant and so production is unchanged.
• full employment level of national income: where LRAS is along x-axis (real GDP) –see above
• equilibrium level of national income: (short-run equilibrium?)
• inflationary gap & deflationary gap: ???
• diagram illustrating trade/business cycle:
Business cycle stage Boom Downturn Trough Upturn
-Consumer confidence
-Consumption very high decreasing low increasing
-Business confidence
-Sales & profits
-Investment very high decreasing low increasing
aggregate demand very high decreasing low increasing
Unemployment low increasing very high decreasing
Inflation high decreasing low increasing
Economic growth strong slowing low/negative increasing
Trade balance worsens: X↓ M↑ improves: X↑ M↓ strongly positive worsens: X↓ M↑
tax receipts very high less very low more
welfare & u/e payments low more high less
budget position good/surplus likely worsens bad improved
fiscal policy contractionary:
T↑ G↓ expansionary:
T↓ G↑ expansionary:
T↓ G↑ contractionary:
(T↑) G↓
monetary policy tight:
interest rates↑ loose:
interest rates↓ loose:
interest rates↓ tight:
interest rates↑
3.4 Demand-side and supply-side policies
• shifts in the aggregate demand curve / demand-side policies:
AD`: increased AD
AD``: decreased AD
fiscal policy:
Fiscal policy is government budgetary policy:
If tax↓ and government spending↑, AD increases
-increases C (more after-tax income to spend)
-increases I (more incentive to invest)
If tax↑ and government spending↓, AD decreases
interest rates as a tool of monetary policy:
The changing of the money supply, and so interest rates, affects the level of AD.
[This is often left to the central bank of a country: eg Reserve Bank of Australia, US Federal Reserve.]
If interest rates↓, AD increases
-increases C (more after-interest income to spend, more desire to borrow to spend)
-increases I (less costly to finance projects)
If interest rates↑, AD decreases
consumer expectations:
If expectations improve, AD increases.
-C increases due to better job security (strong economy)
-I increases due to strong current and predicted sales/profits
If expectations worsen, AD decreases.
overseas sector / exchange rates:
Appreciation is when the exchange rate for the local currency increases and buys more overseas currency.
Depreciation is when the exchange rate for the local currency decreases and buys less overseas currency.
If local currency depreciates, AD increases.
-X increases as price of exports is lower for overseas customers – demand for exports increases
-M decreases as the price of imports is increased – demand for imports decreases
• shifts in the aggregate supply curve / supply-side policies:
SRAS (only?) will shift when the costs of productive inputs change – eg wages, raw materials, electricity, oil
When production costs increase, SRAS decreases. When production costs decrease, SRAS increases.
Factors which shift the potential output (productivity) will shift LRAS, and so also shift SRAS.
These factors are changes in the quantity and quality of resources, and technological improvements.
Quantity and quality of resources: for example:
Land – clear/reclaim land for use, discover minerals, increase access to fishing/hunting
Labour – employment of women, immigration, more education/training, improved health
Capital – increase in savingsincreased used of capital, invention of new capital/R&D
Enterprise – increase number and quality of entrepreneurs
Technological improvements: (in both physical and human capital)
“Microeconomic reform”: (the above + policies to increase productivity)
Labour
tax reform – (increase indirect tax and) lower income tax to increase incentive to work and enterprise
welfare reform – tighter rules take away the disincentive to work of generous welfare
industrial relations reform – productivity-based wage negotiationsincentive to be more productive
– less union power as unions raise cost of labour
– less wrongful dismissal laws
Enterprise
tariff reduction – increases import competition, local firms more efficient/productive
privatisation / increased competition – private firms more profit focused, more efficient/productive
less government red tape – will increase business and enterprise activity
key industry reform – lowers the cost of business inputs: financial sector, transport
infrastructure – improvements in infrastructure eliminate bottlenecks and inefficiencies
• strengths and weaknesses of these policies:
The strength and validity of these policies can be measure against the macroeconomic goals of government: full employment, economic growth, price stability/low inflation, external balance.
Demand-side policies:
Can achieve full employment, economic growth and external balance (increase AD), but at the expense of price stability – increased GPL inflation.
[Fiscal vs monetary......]
Supply-side policies:
Can achieve all goals (increase LRAS/SRAS) – in case of employment, the natural rate is decreased and thus more employment.
3.5 Unemployment and inflation
• full employment and underemployment:
full employment: Full employment is not 100% employment. It is the level of unemployment consistent with the rate of natural unemployment (frictional, structural, seasonal, (hardcore) –see below). This does not include cyclical unemployment.
Underemployment may occur when a full-time job seeker accepts a part-time job – they are now not unemployed, but underemployed. [Disguised unemployment is where firms are overstaffed – either in an attempt to produce low unemployment rates (planned economies) or to keep experienced workers. Workers in these situations may have little to do.]
• unemployment rate:
unemployment rate =
unemployed: workers who are able and willing to work but who do not have jobs
labour force: the percentage of the population of working age (over 15) who are willing and able to work (ie the number of employed + number of unemployed = participation rate)
=population × % working age × participation rate
• costs of unemployment:
-loss of foregone production in the economy; economy operates inside PPC
inefficient, lower living standards
-government budget position worsens: unemployment benefit payments increase, tax receipts decrease
other worthwhile government programs cannot be financed
The unemployed suffer large reductions in income and personal poverty.
-social costs of unemployment:
private costs (to the unemployed person): poor health, low self-esteem, boredom/isolation, financial hardship, substance abuse
external costs: family stress, vandalism/petty crime
• types of unemployment:
structural: when the structure of the economy changes
-significant loss of jobs in certain industries due to fall in demand for a product, or a shift in the geographical location of production
-includes regional u/e (result of a dominant industry in an area) and technological u/e (human skills replaced by technology)
-unemployment is reasonably long-term
frictional: due to workers entering/re-entering workforce or switching between jobs on day data is collected
-high frictional u/e during a boom (less risk in changing jobs), low in a recession (more risk)
-unemployment is short-term
seasonal: in occupations that are seasonal – have a busy working season and an off-season
eg tourism, fishing, agriculture
cyclical / demand-deficient: widespread, general u/e associated with the business cycle
-occurs during recessions, as aggregate demand (C + I + G + X – M) is too low the achieve full employment / the natural rate of u/e
[diagram – recessionary gap?]
real wage: where the price of labour (real wage) is above the equilibrium price of full employment
-due to legislated minimum wages above the clearing wage (a price floor for labour)
-due to strong union power winning high wage outcomes that flow on to other workers
• measures to deal with unemployment:
structural: quickly retrain the structurally u/e
frictional: improve the information stream from employers to job-seekers about job opportunities
seasonal: train workers in skills for employment in the off-season
cyclical / demand-deficient: government policy, [demand-side / supply-side policies]
real wage: restrict union power, remove/lower minimum wage
• definitions of inflation and deflation:
inflation: a general sustained increase in prices
deflation: a general sustained decrease in prices
• costs of inflation and deflation:
-inflation:
inequity: savers & borrowers – savings lose value; assets financed by loans gain value
exporters & importers – local exporters charge higher prices-X↓; imports are cheaper-M↑
financial asset holders & real asset holders – financial holders lose; real holders gain
price makers & price takers – price makers-monopoly/oligopoly- can raise prices; takers can’t
fixed income earners & talented / in demand – fixed incomes can’t increase, ∴real incomes↓
trade balance worsens – X↓ M↑ –see above
distorted investment, speculation – people buy existing assets, less new productive investment
lower business confidence – unpredictable prices increase riskless investment, so less employment
accounting problems – unable to predict future prices of capital equipment, so hard to plan ahead
industrial unrest – workers want wage increases to maintain real wage
less saving – disincentive to save less investment less productivity
wastage of resources – administration changes
-deflation:
......
• causes of inflation:
cost push:
Increases in costs push up prices of finished products.
Due to costs of: raw materials, wages, utilities (water/electricity/telecommunications), imported product
May also be due to monopoly/oligopoly firms making profits
demand pull:
When extreme demand (C+I+G+X–M) occurs and supply struggles to satisfy it, inflation may occur.
Widespread shortages cause prices to be bid up inflation.
Boom conditions exist, ie full employment.
excess monetary growth:
If the money supply increases (money is printed) without the quantity of goods increasing, inflation results.
equation of exchange: M × V = P × Q
M: money supply, total $ spent
V: velocity of circulation
P: average price
Q: quantity of goods
V is assumed to be constant in the short-/medium-term.
If M rises > Q rises, then P will rise (inflation)
3.6 Distribution of income
• direct taxation: tax liability targeted at one person on the basis of income
eg income tax, company tax
Incidence (person who pays the tax) is the same as impact (person levied tax – physically transfers $)
• indirect taxation: a tax imposed on spending
eg cigarette tax, petrol tax, GST
Incidence = consumer, impact = retailer
• progressive taxation: as income increases, the marginal tax rate increases (on the extra income)
-tax brackets increase with income
-the proportion of income paid as tax increases with income
eg
Tax bracket ($) Marginal tax rate
0-10000 0 cents per dollar
10001-50000 30 cents per dollar
50001+ 50 cents per dollar
∴ someone with an income of $80000 would pay:
(50000-10000) × $0.30 + (80000-50000) × $0.50 = $27000 in tax
• proportional taxation: (flat tax) the proportion of income paid in tax is the same for everyone
eg 30% of income paid whether one has income of $30000 or $200000
-marginal rate of tax = average rate of tax
• regressive taxation: the proportion of income paid in tax is less for those with higher incomes, and more for those with lower incomes
-marginal rate of tax < average rate of tax
• transfer payments: welfare payments from the government to the households sector
When combined with progressive taxation, income is effectively transferred from high income earners to lower income earners.
Section 4: International economics
4.1 Reasons for trade
• differences in factor endowments: different countries have different resources that enable them to produce certain products at lower cost
-eg Scotch whiskey, tourism from Uluru
• variety and quality of goods: trade enables a better match between wants of consumers and the products able to satisfy them, through greater variety.
Products may also be of better quality, as countries produce those products in which they already have expertise and resources.
• gains from specialisation: quality of products increases as countries can devote more resources into one area, in which they specialise
• political: trading partners often have improved international relations, and a reluctance to go to war with each other.
Trade increases cultural diversity and understanding.
4.2 Free trade and protectionism
• definition of free trade: where there are no government imposed restrictions on trade
• types of protectionism:
tariff: a tax imposed on imports
-increases price of imports making local products comparatively more competitive
-WTO preferred, as any producer willing to pay the tariff can compete openly global efficiency
quota: a number limit on the amount of imports allowed into a country
-guarantees local producers a proportion of the market
-quota allocated by import licences, which are auctioned off to highest overseas bidders
-overseas producers without licence cannot compete at all – barrier to entry
subsidy: a payment made by government to local producers on each unit produced
-gives local producers advantage over importers by effectively reducing costs of production
voluntary export restraint: a self-imposed limit on the amount of exports a country exports
-guarantees local producers market share
-usually applied when exporter faces threats of more formal protection measures
administrative obstacles:
-act as a disincentive for exporters, especially if only low volumes of exports
health and safety standards:
-local producers are unaffected, as all must abide by standards
-exporters may not wish produce an extra line of product to meet standards, especially in low volumes
environmental standards:
-see above
• arguments for protection:
Infant industry: (valid)
High initial costs (factories, training, marketing) may mean that newly established local producers will find it difficult to compete with established overseas producers. Thus protection can provide time for local producers to establish.
Protection should be short/medium-term, structured and phased out over a given period of time, or else inefficiency may result.
Efforts of a developing country to diversify:
Due to comparative advantage, excessive specialisation may occur in a free trade environment. There is large risk – if the major industry in a LDC fails – wider economic problems. Diversification, through protection, reduces risk.
However, increased protection may reduce real living standards – tariffs cause price increases; subsidies mean more taxes.
Protection of employment:
Protection expands local industries, creating employment.
But this employment is in inefficient industries (thus requiring protection) and resources could be better devoted to efficient productive industries export potential, higher incomes. Inefficient industries will eventually disappear and relocate to countries of comparative advantage.
Source of government revenue:
Tariffs may be a significant source of government revenue for some LDCs. Removal may cause hardship.
Strategic arguments:
self-sufficiency (valid)
Means to overcome a balance of payments disequilibrium:
Ideally exports and imports into and out of a country should be balanced – trade balance. Removal of protection may create a flood of imports and a negative trade balance.
Instead of imposing protection, inefficient import-replacement industries could be closed, and resources reallocated to competitive export industries. The rise in exports should compensate for increase in imports.
Balance of payments problems may be solved in other ways – see Section 4.7.
Anti-dumping: (valid)
When a country has an oversupply of a product that is unsaleable within the country, it may sell the product overseas at extremely low prices (in an attempt to recover some revenue). Local producers cannot compete with these prices, and so will disappear. The local country must now import the product.
Protection should be short-term only.
• arguments against protection:
Inefficiency of resource allocation:
Protected industry will expand, and more resources are allocated to an uncompetitive and inefficient industry. National efficiency is less.
Costs of long-run reliance on protectionist methods:
-entrenched inefficiency may occur in the industry...
Increased prices of goods and services to consumers:
Tariffs, quotas and subsidies all cause prices to be artificially high above the world price.
(see diagrams above)
The cost effect of protected imports on export competitiveness:
......
4.3 Economic integration
• globalisation:
-trade: integration of goods and services markets, WTO
-foreign investment: integration of capital markets
-free movement of labour integrates labour markets
-international agreements/decisions/relations: United Nations, WTO etc
• trading blocs: groups of countries who agree to liberalise trade amongst themselves
free trade areas (FTAs): free trade between FTA members, but members still impose tariffs on non-members wishing to export into their country
eg Australia-US FTA, North American FTA (US, Canada, Mexico, Chile)
customs unions: an FTA, but with a single uniform tariff for non-member countries wishing to export into union
common markets: all of the above, also with free movement of labour (no work permits), capital and enterprise
eg European common market
4.4 World Trade Organisation (WTO)
• aims: to promote global free trade – creates multilateral trade agreements, rules which all members must follow
acts as forum to hear disputes between members:
-certain standards must be met for membership (currently 148 members)
-membership gives equal access to all other members’ markets
-all members are treated the same (but LDC given longer timeframes to comply with rules)
-total consensus (from all 148 members) must be achieved for a rule to be instated
-holds “rounds of talks”: eg the Doha Round
WTO favours tariffs (open, visible competition) over other forms of protection
http://www.wto.org/
• success and failure viewed from different perspectives:
-Low protection achieved on manufactured goods, banking, telecommunications...
-attempts to protect intellectual property, prevent piracy
-Very slow progress on agriculture, textiles -footwear and clothing (LDCs have comparative advantage), as high subsidies in EU / USA and high tariffs in developed countries...has caused some conflict
4.5 Balance of payments
-a systematic record in monetary terms of a country’s transactions with the rest of the world
-a financial document that categorises and compares money inflows and outflows resulting from international transactions
• current account: contains regular or recurring transactions whose results are felt during the current period
-consists of four sections: net goods / balance on merchandise trade
eg exports, imports
net services
eg travel, education services, telecommunications services
net incomes
eg property incomes: rent, interest payments, dividends, profits from foreign investment
net current transfers
eg gifts, (non-capital) foreign aid, pensions/taxes/refunds from overseas
• balance of trade: balance of visibles: see net goods above, tangible goods only included
= goods credits (exports) – goods debits (imports)
• invisible balance: total on net services, net incomes and net current transfers above
= service/income/current transfer credits (money inflows) – debits (money outflows)
• capital account: records international capital transfers, loans and investments; transactions are large, irregular and have long-lasting effects
-consists of 2 main sections: capital (transfers) account
-net capital transfers = capital transfer credits – debits
eg money transfer with immigration, some foreign aid
-net acquisition of non-produced, non-financial capital
eg intellectual property, patents, trademarks
financial account
-net investment = investment credits – debits
direct investment: results in control of the enterprise by foreign investors
portfolio investment: purchase of shares/bonds in overseas companies
other investment: eg offshore borrowing, lending abroad
-net reserve assets
eg central bank transactions with foreign currencies/monetary gold
-net errors and omissions
On the balance of payments: overall credits = overall debits
(see Section 4.6 –floating exchange rate)
∴ this section reflects inaccuracies in data collected; it “balances” the whole account
4.6 Exchange rates
• fixed exchange rates: where the exchange rate (ER) has a constant value in terms of overseas currency
-ER is set by government / central bank and not market forces
• floating exchange rates: where the ER is determined by market forces – demand and supply in the foreign exchange (forex) market
Demand for local currency is comprised of credits to the balance of payments (foreigners wanting to pay money into country require the local currency):
-goods & services exports; incomes, current transfers paid into country
-foreign investment, loans into country
-central bank buying local currency
Supply of local currency is comprised of debits to the balance of payments (locals wanting to pay money to overseas require foreign currency, and thus sell some of their local currency):
-goods & services imports; incomes, current transfers paid overseas
-foreign investment, loans to overseas countries
-central bank selling local currency
• managed exchange rates: ......
• distinction between:
depreciation and devaluation: floating ER depreciates; fixed ER is devalued (decrease in value)
appreciation and revaluation: floating ER appreciates; fixed ER is revalued (increase in value)
• effects on exchange rates of:
Factor Effect on demand Effect on supply Effect on ER
Trade flow
-exports increase, imports decrease
-exports decrease, imports increase
increase
decrease
decrease
increase
appreciates
depreciates
Capital flows / interest rate changes
-FI into country increases, FI overseas decreases
-FI into country decreases, FI overseas increases
-local interest rates rise (loans into ↑, loans out ↓)
-local interest rates fall (loans into ↓, loans out ↑)
increase
decrease
increase
decrease
decrease
increase
decrease
increase
appreciates
depreciates
appreciates
depreciates
Inflation
-local inflation increases (exports ↓, imports ↑)
-local inflation decreases (exports ↑, imports ↓)
decrease
increase
increase
decrease
depreciates
appreciates
Speculation
-predict that ER will appreciate
-predict that ER will depreciate
increase
increase
appreciates
depreciates
Use of foreign currency reserves
-central bank buys local currency
-central bank sells local currency
increase
increase
appreciates
depreciates
4.7 Balance of payment problems
• consequences of a current account deficit or surplus:
Deficit:
In the short-term, exports have decreased or imports have increased (comparatively)
(X-M) is more negative AD is decreased:
YE falls to YE`: less growth, more unemployment
GPLE falls to GPLE`: less inflation
Longer-term: trade deficit causes depreciation of ER
AD increases, because exports ↑ (are relatively cheaper), imports ↓ (are relatively more expensive)
X and M are re-balanced
LDCs: current account deficit means capital and financial account surplus
build up of foreign debt due to foreign investment (loans)
[indicated by appreciating ER, as D for currency increases]
increase in interest payments on loans
[ER depreciates slightly as payments are made and S increases, but overall ER has appreciated]
current account deficit worsens...(cycle) debt trap
Surplus:
Short-term: [AD increased – more growth, less unemployment, more inflation]?
Longer-term: [AD decreases as ER appreciates...X and M re-balanced]?
• methods of correction:
Managed changes in exchange rates: (very short term)
If current account deficit (depreciated ER), central bank buys local currency D ↑, ER appreciates
If current account surplus (appreciated ER), central bank sells local currency S ↑, ER depreciates
Reduction in aggregate demand / expenditure-reducing policies: (short-medium term)
-contractionary/expansionary fiscal policy (T and G); tight/loose monetary policy (interest rates)
If current account deficit, decrease AD lowers M helps rebalance trade balance, reduces deficit
Also decreases inflation, increasing global competitiveness rebalances trade
-M may also be reduced by increasing domestic savings:
Eg. superannuation, reducing government deficit (running a budget surplus)
If current account surplus, vice versa.
Change in supply-side policies to increase competitiveness: (long-term)
For deficit – increases efficiency, international competitiveness; boosts exports and import replacements
Protectionism / expenditure-switching policies: (medium-term, longer may be harmful)
Increasing level of protection reduces imports, reducing any current account deficit.
S of currency decreases, and ER appreciates.
However, may be prevented by WTO or long-term entrenched inefficiency may result.
• consequences of a capital account deficit or surplus:
Surplus may lead to debt trap, especially in LDCs
(see consequences of a current account deficit or surplus)
Surplus corresponds to current account deficit, whilst deficit corresponds to current account surplus.
4.8 Terms of trade
• definition of terms of trade: measures average export prices relative to average import prices
(price index is a measure of average price)
In the base year, X price index = M price index = 100, ∴ ToT index = 100.
• consequences of a change in the terms of trade for a country’s balance of payments and domestic economy:
Ceteris paribus, improved/more favourable ToT should increase X revenue, whilst decreasing M spending balance of trade and current account deficit should improve, ER appreciates.
• the significance of deteriorating terms of trade for developing countries:
LDCs generally have primary industry exports (minerals, food) whose PεD is inelastic.
∴ fall in price means large decrease in export revenue.
ToT worsens, along with trade balance and current account deficit
may fall into debt trap...
•
introduction to economics
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”...
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”...
notes - introduction to economics
INTRODUCTION TO ECONOMICS
1.1 Definitions
Specialization
• Populations were fairly limited until the agricultural revolution and hunter gatherers were forced to do everything for themselves.
• Once agriculture developed people were able to specialize in the things they were best at doing, productivity increased dramatically.
• This created a surplus which could be traded for goods produced by people who had specialized in other areas.
Trade
• Trading occurred in markets where people could buy things more cheaply than they could make them.
• Originally, goods were traded through barter, but this required a simultaneity of desire: you had to find someone who had what you wanted and at the same time they had to want what you had to offer.
• Time was wasted trying to find satisfactory exchanges, and money was invented which eliminated the inconvenience of barter.
o This release of wasted time led to a further increase in the surplus.
Industrialization
• The industrial revolution introduced machinery allowing further specialization:
o Division of labour: workers specialized at tasks increasing productivity.
o Economies of scale: gains from bulk buying, large scale financing, and the use of large scale machinery permitted even further gains in productivity.
• We moved from labour intense production which uses relatively large amounts of labour compared to other factors, to capital intense production where relatively large amounts of capital are used compared to other factors.
• Resequencing: there are many ways to fabricate the parts for a product, and many different ways of assembling it. By altering the sequence of actions, a firm can find the most efficient way to fabricate parts and assemble them into a final product creating further gains in productivity and reductions in cost.
Economic Sectors
• The primary sector involves the extraction of resources: farming, fishing, forestry and mining.
• The secondary sector involves the conversion of natural resources into goods: manufacturing and construction.
• The tertiary sector involves the production of services: finance and tourism
• In the private sector resources are owned by private individuals
o Consumers are grouped into households which own the resources and decide what to buy and in what quantities
Rather than specialize on their own, most people sell their labour services to a firm and receive money wages in return.
They also sell the services of other factors to firms in return for income.
• Producers expect to cover their costs with the revenue they obtain from selling:
o Profit maximization is essential otherwise the firm falls behind or is bought up by another firm which will force the first firm to maximize profits.
o Firms are the principle users of factors of production, they account for 85% of employment in most Industrialized countries (ICs).
• In the public sector production is in public hands: owned and controlled by the state which both buys and produces goods and services.
o We cannot assume that govts. always act in a consistent manner.
o Various govts. make laws, the courts interpret these laws and uphold them.
• Any govt. measures that impose large costs with few obvious benefits to the current generation are unlikely to be popular:
o Long run benefits are sometimes ignored: the planting of trees will only be enjoyed by future generations which do not have a vote today, therefore govt. will not spend money on planting trees.
o There is uncertainty about the future: it is hard to make decisions today which may have long term consequences.
1.2 Positive versus Normative Concepts
• Positive economics is based on theories which can be tested by looking at past data.
• Positive statements concern what is, was or will be: assertions about the world
• Normative economics is based on opinion.
• Normative statements often include words such as ‘should’ or ought to’ and involve value judgements about what is good and what is bad.
• Normative statements are not testable: 'ought we to be more concerned about unemployment than about inflation?'
• In democracies normative statements are often settled by voting
1.3 Ceteris Paribus
• With all other factors or things remaining the same.
• This means that we change one parameter at a time and watch how it influences the variables.
o For example: if the government cuts income taxes in order to lead to an increase in personal income, we would like to see whether consumption rises.
o If we hold everything else constant, we expect that most people will spend more money when their income rises.
o However, if at the same time there was a jump in prices and interest rates, people might not spend more money. This is why it is so important to isolate one change from another. In real life, of course, that is usually not possible and we have to make adjustments.
1.4 Scarcity
Factors and Payments to Factors of Production
• Natural resources include all the resources we use such as land, trees, water, minerals.
o In Europe, rent is the income paid on natural resources such as land
o In North America, rent is what is paid to rent an apartment and payments for using natural resources are called natural resource costs or raw material costs.
o There is some controversy about how to include environmental resources such as clean air, clean water, quietness etc. When these are polluted there is a cost, how should that be included, and who should pay for it?
• Labour is simply the number of hours of work put in by a person.
o Wages: are the costs associated with using labour and are usually paid on an hourly basis.
• Capital is defined as physical plant, machinery, equipment and buildings. It is not the money that you invest in the stock market.
o Profit: this is the return on investment in capital equipment:
We assume investments in capital equipment earn the opportunity cost rate of return (OCRR) in the market.
Anything earned in excess of the OCRR is referred to as abnormal or super-normal profit or pure profit or economic profit.
• Entrepreneurship: it is estimated that 85% of small businesses go bankrupt during the first five years. And 85% of those that survive go bankrupt in the next five years. There is a great scarcity of good management talent in the world.
o Abnormal profit is defined as the amount earned in excess of normal profit and is calculated as the difference between what you receive for selling a good or service and the cost of producing it, including the effort you had to put into it and the OCRR you could expect to earn on the money invested in capital equipment.
o We refer to the amount received as total revenue, and the costs as total costs. Thus profit is equal to total revenue minus total cost.
o Most firms maximize profits by trying to increase revenues through better marketing, and decreasing costs through more efficient systems of production.
o If firms do not maximize profits, they will either not grow anymore because there are no profits to re-invest in the business, or they will be bought out by someone else who will then force the firm to profit maximize.
1.5 Choice
Utility
• Most people are assumed to be motivated by rational desires.
• Utility: most people derive enjoyment or utility from the goods and services they consume, and most understand that the first amount of enjoyment from consuming a good is often the highest.
o As more and more is consumed, the level of enjoyment starts to decrease. This is referred to as the concept of diminishing marginal utility. The marginal utility is the enjoyment received from the next unit of whatever is being consumed, and it diminishes as more is consumed.
o Most people try to maximize total utility or enjoyment by consuming more than one good: as the marginal utility from consuming one good starts to fall from consuming more, you switch to another good where the marginal utility is higher.
For example, we do not just eat one food such as hamburger, we get more enjoyment from mixing it with other foods such as salad, potatoes and vegetables.
Opportunity Cost
• Opportunity cost: the cost of using a resource measured in terms of the sacrifice foregone in the next best alternative. When the best alternative is chosen from a range of alternatives the second best choice is the opportunity cost.
Free and Economic Goods
• Free goods involve no opportunity cost such as fresh air, but they become economic goods if opportunity costs are involved in such things as removing pollution from the air.
• Consumption goods are purchased by consumers and consist of perishable goods such as fresh food, semi-durable goods such as clothing, and durable goods such as cars.
• Capital goods also referred to as producer goods are simply capital used in the production of consumer goods.
Production Possibility Curves
• Point B on the PPF shows the maximum that can be produced with existing resources and technology, it is a point of productive efficiency.
• The negative slope of the PPF reflects basic scarcity
• The law of diminishing returns implies a convex PPF: as resources are transferred from one use to another, the increment in output becomes smaller, the opportunity cost larger.
o Resources are being released in the wrong combination
o The resources being released are less and less suited to the new use
• Point A inside the frontier is productively inefficient: more of one good could be produced without sacrificing any of the other:
o Under market systems it is called unemployment
o Under central planning it is called inefficiency.
• Point C can only be reached through:
o Trade
o The discovery of more resources
o Increased labour productivity from greater education and training
o Increased capital productivity from an increase in technological knowledge.
1.6 Rationing Systems
Basic Economic Questions
• Scarcity: although output is limited by the technology available, there may be enough resources to satisfy basic needs for most humans, but there will never be enough resources to satisfy all peoples wants and desires.
o What goods and services should be produced with the resources available?
o How can factors of production be used efficiently to produce what is chosen?
o For whom should these goods and services be produced?
• Factors of production include:
o Land or Natural Resources: not man made: land, minerals, wood, fish.
o Labour: human resources determined by population, age, skill and training.
o Capital: man made tools such as buildings, equipment, and machinery
o Entrepreneurship: undertake the risk of organizing and combining factors for production.
• In order to maximize welfare we must produce in the most efficient manner possible to get the most out of our limited resources: this will put us on the production possibility frontier. This point is defined when:
Marginal Social Benefit = Marginal Social Cost
• But how do we distribute production in such a way as to maximize utility for society as a whole?
o Marginal utility for rich people is low as they have the money to afford to buy everything: in a word they are bored from over consumption.
o Marginal utility for poor people is high because they have only limited income.
o The problem is:
If income is distributed from the rich to the poor, there is less incentive for people to work; using a dictatorial command systems such as under communism was found to lead to great inefficiency and unfairness.
Those who work hard in the market system are rewarded so efficiency is achieved, but many become losers and are marginalized.
• What is produced is largely determined by the needs and wants of people
• How it is produced depends on available resources and technology.
• For whom depends on how goods are distributed: by traditional systems, central planning (dictatorship) or the free market.
Traditional Economies
• Resources and production systems are owned by the community
• Production takes place using traditional technology
• Allocation is based on long established patterns of community sharing.
• The production possibility boundary tended to expand and contract slowly as population grew, there were climatic changes, and new tools were invented
• Advantages of traditional systems:
o Resources are protected and the systems have proven to be sustainable over long periods of time
o Losses and profits are shared by the whole community, peer pressure forces decision makers to be careful
• Disadvantages of traditional system: Growth is very slow
Central planning:
• Resources and production systems are owned by the central government which allows the govt. to determine what is produced, how and for whom.
• Enormous information is required due to centralized planning and control. Govt. planners must:
o Predict patterns of consumer demand
o Estimate technological possibilities and production capabilities
• Producers are motivated to underestimate their capability
• Advantages of central planning:
o The govt. can make the distribution of income more equal
o The govt. determines what goods are produced and can prevent production of socially undesirable goods.
o Initially higher growth rates for Russia and China would suggest that as a system of organizing economic activity, central planning is successful in the early stages of economic development
• Disadvantages of central planning:
o Requires large amounts of information: forecasting people’s desires is difficult and the lack of incentives have led to a number of problems:
Decision makers do not experience profits and losses and are not strongly motivated to make the right decisions
Incentives to falsify production information lead to poor production decisions and massive pollution,
A reluctance to change with the market in forecasting demand:
There are queues when there are shortages (quantity rationing), and stockpiles if there are surpluses.
o State owned enterprises are managed inefficiently.
o There is no incentive for individuals and firms to be innovative. With no profit motive goods are often of poor quality and choice is very limited.
Free market
• Resources and production systems are owned by individuals and the allocation of resources, what, how and for whom, is left to the forces of supply (production) and demand (consumers) operating in a relatively free market.
• Producers attempt to maximize profits, but if they are poor at predicting:
o They produce too much (surpluses) and will lose money.
o They underestimate (shortages), will miss the potential profit and a competitor will make the profit instead.
• Only those firms which can predict most closely what consumers will want will earn adequate money to stay in business.
• Advantages of free market:
o Resources are allocated by market forces and the price mechanism without govt. intervention.
o Profits provide an incentive to reduce costs and be innovative.
o The free market maximizes community surplus if there are no failures and imperfections.
• Disadvantages of the free market:
o Market failures and imperfections occur because of public goods, merit goods, externalities and lack of competitive markets.
o The system of profits and losses is thought to be unfair, substantial govt. intervention is needed to cope with income redistribution problems.
The wealthy are taxed to reduce profits
Those marginalized by the system, are supported with tax money
o The system is incapable of controlling pollution and producing sustainable growth, planning has been introduced to correct for this problem.
Mixed Economies
• Most countries in the world have moved gradually toward a mixture:
o Free markets are used to allocate resources to achieve efficiency.
o Government planning is used where markets fail to operate successfully, and to redistribute income to those who are marginalized by the market system.
1.1 Definitions
Specialization
• Populations were fairly limited until the agricultural revolution and hunter gatherers were forced to do everything for themselves.
• Once agriculture developed people were able to specialize in the things they were best at doing, productivity increased dramatically.
• This created a surplus which could be traded for goods produced by people who had specialized in other areas.
Trade
• Trading occurred in markets where people could buy things more cheaply than they could make them.
• Originally, goods were traded through barter, but this required a simultaneity of desire: you had to find someone who had what you wanted and at the same time they had to want what you had to offer.
• Time was wasted trying to find satisfactory exchanges, and money was invented which eliminated the inconvenience of barter.
o This release of wasted time led to a further increase in the surplus.
Industrialization
• The industrial revolution introduced machinery allowing further specialization:
o Division of labour: workers specialized at tasks increasing productivity.
o Economies of scale: gains from bulk buying, large scale financing, and the use of large scale machinery permitted even further gains in productivity.
• We moved from labour intense production which uses relatively large amounts of labour compared to other factors, to capital intense production where relatively large amounts of capital are used compared to other factors.
• Resequencing: there are many ways to fabricate the parts for a product, and many different ways of assembling it. By altering the sequence of actions, a firm can find the most efficient way to fabricate parts and assemble them into a final product creating further gains in productivity and reductions in cost.
Economic Sectors
• The primary sector involves the extraction of resources: farming, fishing, forestry and mining.
• The secondary sector involves the conversion of natural resources into goods: manufacturing and construction.
• The tertiary sector involves the production of services: finance and tourism
• In the private sector resources are owned by private individuals
o Consumers are grouped into households which own the resources and decide what to buy and in what quantities
Rather than specialize on their own, most people sell their labour services to a firm and receive money wages in return.
They also sell the services of other factors to firms in return for income.
• Producers expect to cover their costs with the revenue they obtain from selling:
o Profit maximization is essential otherwise the firm falls behind or is bought up by another firm which will force the first firm to maximize profits.
o Firms are the principle users of factors of production, they account for 85% of employment in most Industrialized countries (ICs).
• In the public sector production is in public hands: owned and controlled by the state which both buys and produces goods and services.
o We cannot assume that govts. always act in a consistent manner.
o Various govts. make laws, the courts interpret these laws and uphold them.
• Any govt. measures that impose large costs with few obvious benefits to the current generation are unlikely to be popular:
o Long run benefits are sometimes ignored: the planting of trees will only be enjoyed by future generations which do not have a vote today, therefore govt. will not spend money on planting trees.
o There is uncertainty about the future: it is hard to make decisions today which may have long term consequences.
1.2 Positive versus Normative Concepts
• Positive economics is based on theories which can be tested by looking at past data.
• Positive statements concern what is, was or will be: assertions about the world
• Normative economics is based on opinion.
• Normative statements often include words such as ‘should’ or ought to’ and involve value judgements about what is good and what is bad.
• Normative statements are not testable: 'ought we to be more concerned about unemployment than about inflation?'
• In democracies normative statements are often settled by voting
1.3 Ceteris Paribus
• With all other factors or things remaining the same.
• This means that we change one parameter at a time and watch how it influences the variables.
o For example: if the government cuts income taxes in order to lead to an increase in personal income, we would like to see whether consumption rises.
o If we hold everything else constant, we expect that most people will spend more money when their income rises.
o However, if at the same time there was a jump in prices and interest rates, people might not spend more money. This is why it is so important to isolate one change from another. In real life, of course, that is usually not possible and we have to make adjustments.
1.4 Scarcity
Factors and Payments to Factors of Production
• Natural resources include all the resources we use such as land, trees, water, minerals.
o In Europe, rent is the income paid on natural resources such as land
o In North America, rent is what is paid to rent an apartment and payments for using natural resources are called natural resource costs or raw material costs.
o There is some controversy about how to include environmental resources such as clean air, clean water, quietness etc. When these are polluted there is a cost, how should that be included, and who should pay for it?
• Labour is simply the number of hours of work put in by a person.
o Wages: are the costs associated with using labour and are usually paid on an hourly basis.
• Capital is defined as physical plant, machinery, equipment and buildings. It is not the money that you invest in the stock market.
o Profit: this is the return on investment in capital equipment:
We assume investments in capital equipment earn the opportunity cost rate of return (OCRR) in the market.
Anything earned in excess of the OCRR is referred to as abnormal or super-normal profit or pure profit or economic profit.
• Entrepreneurship: it is estimated that 85% of small businesses go bankrupt during the first five years. And 85% of those that survive go bankrupt in the next five years. There is a great scarcity of good management talent in the world.
o Abnormal profit is defined as the amount earned in excess of normal profit and is calculated as the difference between what you receive for selling a good or service and the cost of producing it, including the effort you had to put into it and the OCRR you could expect to earn on the money invested in capital equipment.
o We refer to the amount received as total revenue, and the costs as total costs. Thus profit is equal to total revenue minus total cost.
o Most firms maximize profits by trying to increase revenues through better marketing, and decreasing costs through more efficient systems of production.
o If firms do not maximize profits, they will either not grow anymore because there are no profits to re-invest in the business, or they will be bought out by someone else who will then force the firm to profit maximize.
1.5 Choice
Utility
• Most people are assumed to be motivated by rational desires.
• Utility: most people derive enjoyment or utility from the goods and services they consume, and most understand that the first amount of enjoyment from consuming a good is often the highest.
o As more and more is consumed, the level of enjoyment starts to decrease. This is referred to as the concept of diminishing marginal utility. The marginal utility is the enjoyment received from the next unit of whatever is being consumed, and it diminishes as more is consumed.
o Most people try to maximize total utility or enjoyment by consuming more than one good: as the marginal utility from consuming one good starts to fall from consuming more, you switch to another good where the marginal utility is higher.
For example, we do not just eat one food such as hamburger, we get more enjoyment from mixing it with other foods such as salad, potatoes and vegetables.
Opportunity Cost
• Opportunity cost: the cost of using a resource measured in terms of the sacrifice foregone in the next best alternative. When the best alternative is chosen from a range of alternatives the second best choice is the opportunity cost.
Free and Economic Goods
• Free goods involve no opportunity cost such as fresh air, but they become economic goods if opportunity costs are involved in such things as removing pollution from the air.
• Consumption goods are purchased by consumers and consist of perishable goods such as fresh food, semi-durable goods such as clothing, and durable goods such as cars.
• Capital goods also referred to as producer goods are simply capital used in the production of consumer goods.
Production Possibility Curves
• Point B on the PPF shows the maximum that can be produced with existing resources and technology, it is a point of productive efficiency.
• The negative slope of the PPF reflects basic scarcity
• The law of diminishing returns implies a convex PPF: as resources are transferred from one use to another, the increment in output becomes smaller, the opportunity cost larger.
o Resources are being released in the wrong combination
o The resources being released are less and less suited to the new use
• Point A inside the frontier is productively inefficient: more of one good could be produced without sacrificing any of the other:
o Under market systems it is called unemployment
o Under central planning it is called inefficiency.
• Point C can only be reached through:
o Trade
o The discovery of more resources
o Increased labour productivity from greater education and training
o Increased capital productivity from an increase in technological knowledge.
1.6 Rationing Systems
Basic Economic Questions
• Scarcity: although output is limited by the technology available, there may be enough resources to satisfy basic needs for most humans, but there will never be enough resources to satisfy all peoples wants and desires.
o What goods and services should be produced with the resources available?
o How can factors of production be used efficiently to produce what is chosen?
o For whom should these goods and services be produced?
• Factors of production include:
o Land or Natural Resources: not man made: land, minerals, wood, fish.
o Labour: human resources determined by population, age, skill and training.
o Capital: man made tools such as buildings, equipment, and machinery
o Entrepreneurship: undertake the risk of organizing and combining factors for production.
• In order to maximize welfare we must produce in the most efficient manner possible to get the most out of our limited resources: this will put us on the production possibility frontier. This point is defined when:
Marginal Social Benefit = Marginal Social Cost
• But how do we distribute production in such a way as to maximize utility for society as a whole?
o Marginal utility for rich people is low as they have the money to afford to buy everything: in a word they are bored from over consumption.
o Marginal utility for poor people is high because they have only limited income.
o The problem is:
If income is distributed from the rich to the poor, there is less incentive for people to work; using a dictatorial command systems such as under communism was found to lead to great inefficiency and unfairness.
Those who work hard in the market system are rewarded so efficiency is achieved, but many become losers and are marginalized.
• What is produced is largely determined by the needs and wants of people
• How it is produced depends on available resources and technology.
• For whom depends on how goods are distributed: by traditional systems, central planning (dictatorship) or the free market.
Traditional Economies
• Resources and production systems are owned by the community
• Production takes place using traditional technology
• Allocation is based on long established patterns of community sharing.
• The production possibility boundary tended to expand and contract slowly as population grew, there were climatic changes, and new tools were invented
• Advantages of traditional systems:
o Resources are protected and the systems have proven to be sustainable over long periods of time
o Losses and profits are shared by the whole community, peer pressure forces decision makers to be careful
• Disadvantages of traditional system: Growth is very slow
Central planning:
• Resources and production systems are owned by the central government which allows the govt. to determine what is produced, how and for whom.
• Enormous information is required due to centralized planning and control. Govt. planners must:
o Predict patterns of consumer demand
o Estimate technological possibilities and production capabilities
• Producers are motivated to underestimate their capability
• Advantages of central planning:
o The govt. can make the distribution of income more equal
o The govt. determines what goods are produced and can prevent production of socially undesirable goods.
o Initially higher growth rates for Russia and China would suggest that as a system of organizing economic activity, central planning is successful in the early stages of economic development
• Disadvantages of central planning:
o Requires large amounts of information: forecasting people’s desires is difficult and the lack of incentives have led to a number of problems:
Decision makers do not experience profits and losses and are not strongly motivated to make the right decisions
Incentives to falsify production information lead to poor production decisions and massive pollution,
A reluctance to change with the market in forecasting demand:
There are queues when there are shortages (quantity rationing), and stockpiles if there are surpluses.
o State owned enterprises are managed inefficiently.
o There is no incentive for individuals and firms to be innovative. With no profit motive goods are often of poor quality and choice is very limited.
Free market
• Resources and production systems are owned by individuals and the allocation of resources, what, how and for whom, is left to the forces of supply (production) and demand (consumers) operating in a relatively free market.
• Producers attempt to maximize profits, but if they are poor at predicting:
o They produce too much (surpluses) and will lose money.
o They underestimate (shortages), will miss the potential profit and a competitor will make the profit instead.
• Only those firms which can predict most closely what consumers will want will earn adequate money to stay in business.
• Advantages of free market:
o Resources are allocated by market forces and the price mechanism without govt. intervention.
o Profits provide an incentive to reduce costs and be innovative.
o The free market maximizes community surplus if there are no failures and imperfections.
• Disadvantages of the free market:
o Market failures and imperfections occur because of public goods, merit goods, externalities and lack of competitive markets.
o The system of profits and losses is thought to be unfair, substantial govt. intervention is needed to cope with income redistribution problems.
The wealthy are taxed to reduce profits
Those marginalized by the system, are supported with tax money
o The system is incapable of controlling pollution and producing sustainable growth, planning has been introduced to correct for this problem.
Mixed Economies
• Most countries in the world have moved gradually toward a mixture:
o Free markets are used to allocate resources to achieve efficiency.
o Government planning is used where markets fail to operate successfully, and to redistribute income to those who are marginalized by the market system.
Evaluation
* Evaluation
Evaluation occurs when a judgment is made. It is the weighing or measuring of factors followed by an
attempt to give relative weight to those factors. Questions that begin “evaluate”, “assess”, “critically
assess”, “discuss” or “to what extent” require candidates to show their skills of evaluation in order to
reach the highest achievement levels.
There are many ways that candidates can be encouraged to improve their skills of evaluation.
• When factors such as causes, consequences or remedies are asked for, candidates should
attempt to identify the most important ones and then to justify the reason for the choice.
• When advantages and disadvantages are asked for, candidates should attempt to identify the
most important advantage (or disadvantage) and then justify the reason for the choice.
• When strategies are asked for, candidates should attempt to assess the short term and long term
implications.
• When data is offered, candidates may question its validity, in terms of whether it is appropriate,
whether it is reliable, or whether it is still relevant.
• When summarizing a theory, candidates may question its validity, in terms of whether it is
appropriate, whether it is reliable, or whether it is still relevant.
Evaluation occurs when a judgment is made. It is the weighing or measuring of factors followed by an
attempt to give relative weight to those factors. Questions that begin “evaluate”, “assess”, “critically
assess”, “discuss” or “to what extent” require candidates to show their skills of evaluation in order to
reach the highest achievement levels.
There are many ways that candidates can be encouraged to improve their skills of evaluation.
• When factors such as causes, consequences or remedies are asked for, candidates should
attempt to identify the most important ones and then to justify the reason for the choice.
• When advantages and disadvantages are asked for, candidates should attempt to identify the
most important advantage (or disadvantage) and then justify the reason for the choice.
• When strategies are asked for, candidates should attempt to assess the short term and long term
implications.
• When data is offered, candidates may question its validity, in terms of whether it is appropriate,
whether it is reliable, or whether it is still relevant.
• When summarizing a theory, candidates may question its validity, in terms of whether it is
appropriate, whether it is reliable, or whether it is still relevant.
Glossary
Account for Asks candidates to explain a particular situation or a particular outcome. Candidates
are expected to present a reasoned case for the existence of something. For
example:
Account for the rise in unemployment shown in the table of data.
Analyse Asks candidates to respond with a closely argued and detailed examination of a
particular topic or event. A clearly written analysis will indicate the relevant
interrelationships between important variables and any relevant assumptions
involved, and will also include a critical view of the significance of the account as
presented. If this key word is augmented by the phrase “the extent to which”, then
candidates should be clear that judgment is also sought. For example:
Analyse the extent to which foreign aid promotes economic development.
Assess Asks candidates to measure and judge the magnitude or quality of something.
Candidates may offer differing assessments as long as they present the reasoning
for their conclusion. For example:
Assess the economic implications of the movement of many eastern and central
European countries from planned economies to market economies.
Calculate Asks candidates to give a precise answer, meaning there is only one acceptable
answer. For example:
Calculate the PED for a price change of $2.00 to $2.20.
Compare/Compare
and contrast Asks candidates to describe two situations and present the similarities and
differences between them. A description of the two situations does not on its own
meet the requirements of this key term. For example:
Compare the effectiveness of demand-side policies to supply-side policies in
reducing the level of unemployment.
Define Asks candidates to give a clear and precise account of a given word or concept. For
example:
Define what is meant by a free-trade area.
Describe Asks candidates to provide a description of a given situation. It is a neutral request
to present a detailed picture. For example:
Describe the main roles of the IMF and the World Bank.
Discuss Asks candidates to consider a statement or to offer a considered review of or
balanced argument about a particular topic. For example:
Discuss the view that trade is more effective than aid in promoting economic
development.
Distinguish Asks candidates to make clear their understanding of similar terms. For example:
Distinguish between normal and supernormal profit.
Evaluate* Invites candidates to make an appraisal of a situation. Candidates should weigh the
nature of the evidence available and discuss the convincing aspects of an argument
as well as its implications and limitations, and the less convincing elements within
an argument. For example:
Evaluate alternative policies designed to reduce inflation.
Explain Directs candidates to describe clearly, make intelligible and give reasons for a
concept or idea. For example:
Explain why a monopolist may charge different prices to different customers for the
same service.
To what extent? Asks candidates to evaluate the success or otherwise of one argument or concept
over another. Candidates should present a conclusion, supported by arguments.
For example:
To what extent should LDCs adopt outward-oriented strategies rather than inwardoriented
strategies to promote economic development?
What? Asks candidates to clarify the nature of something, in contrast to either a temporal
dimension (when?) or a spatial dimension (where?) For example:
What is the difference between a tariff and a quota?
Why? Invites candidates to present reasons for the existence of something. This
command word implies a powerful requirement to present a judgment. It is similar to
the invitation “account for”. For example:
Why do prices tend to be stable in an oligopolistic industry?
Tuesday, November 9, 2010
ഒരു കവിത
മാനസാന്തരം
സരസ്വതീ ക്ഷേത്രം !
മുന്പിലൊരു വടവൃക്ഷം
ശിഖരങ്ങള് അറ്റുപോയ്
ഗതകാല സ്മരണകള്
തരുണിയില് നിലംപൊത്തി
കുരുന്നുകള് വിയര്ത്തു
യന്ത്രം തന് കരാളഹസ്തം
ആധുനികതയ്ക് ഗതിയേകി
കോണ്ക്രീറ്റ് തൂണുകള്
മണ്ണിന് മരുപ്പച്ചയെവിടെ
നനവെവിടെ ..........
കുരുന്നുകള് ദാഹിച്ചു
അറിവിന് ജലം വറ്റി ..
മോന്തുവാനെന്തുണ്ടിനി
കണ്ണുനീര് തടാകങ്ങള്
പേറ്റുനോവിന് വിതുമ്പല്
മനമെവിടെ.........മര്ത്യനെവിടെ.............?
സരസ്വതീ ക്ഷേത്രം !
മുന്പിലൊരു വടവൃക്ഷം
ശിഖരങ്ങള് അറ്റുപോയ്
ഗതകാല സ്മരണകള്
തരുണിയില് നിലംപൊത്തി
കുരുന്നുകള് വിയര്ത്തു
യന്ത്രം തന് കരാളഹസ്തം
ആധുനികതയ്ക് ഗതിയേകി
കോണ്ക്രീറ്റ് തൂണുകള്
മണ്ണിന് മരുപ്പച്ചയെവിടെ
നനവെവിടെ ..........
കുരുന്നുകള് ദാഹിച്ചു
അറിവിന് ജലം വറ്റി ..
മോന്തുവാനെന്തുണ്ടിനി
കണ്ണുനീര് തടാകങ്ങള്
പേറ്റുനോവിന് വിതുമ്പല്
മനമെവിടെ.........മര്ത്യനെവിടെ.............?
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