Economics Student Handbook by Dr Steve Byrd

IFY Economic Studies Student Handbook Composed By

Dr Stephen Byrd PhD, MBA, FITOL, FICM

Economic Studies Week 1

2 3 4 5 6 7

8 9 10 11 12 13 14 15

Student Handbook

Topic A: The Economic Problem Positive and Normative Economics B: Economic Systems C: Production Possibility Frontier F: Determination of Demand H: Determination of Supply J: Price Determination in the Market System K: Interrelationship between Markets G: Price Elasticity of Demand I: Price Elasticity of Supply L: Market Failure M: The Functions of Price D: Externalities E: Cost Benefit Analysis N: Production in the Short Run

O: Objective of Firms P: Production in the Long Run & Economies of Scale Q: Growth of Firms Market Structures R: Perfect Competition S: Monopoly T: Oligopoly Revision TERM 1 END OF SEMESTER EXAM

5th Edition 1 4 37 1 5 6 7 8 9 10 14 16, 17 13 15 58 38, 39 (Pp. 271-275), 40, 41 42

4th Edition 1

39 (Pp. 275279)

55 43 44, 53 45, 54 47, 48

2, 41-43 1 4 5 6 7 8 9 11, 16, 21 15 19-20 22 46-48

Notes to Students: ď&#x201A;ˇ ď&#x201A;ˇ

All reading should be completed before the Week number listed. The weeks may change, but you will be informed well in advance

Page 2 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

50, 52

53 18, 54 56

Economic Studies

Student Handbook

ECONOMICS – the science that deals with the production, distribution and consumption of goods and services, and with the theory and management of economies or economic systems BASIC ECONOMIC PROBLEM: Resources = scarce; wants = unlimited FREE GOODS – resources available in unlimited quantities ECONOMIC GOODS – resources are limited in quantity – SCARCITY Production Possibility Frontier (PPF) (Also called PPCurve, PPBoundary, Transformation Curve) PPF = the different combinations of goods which can be produced if all resources are fully and efficiently used. ECONOMIC RESOURCES – FACTORS OF PRODUCTION  LAND – also includes natural resources on, below, above and sea o NON-RENEWABLE RESOURCES – coal, oil, gold, etc which will never be replaced o RENEWABLE RESOURCES – forests, soils, water, fish  LABOUR – The working force of an economy (Western economies – very scarce, due to people and cost)  CAPITAL – all resources used in the production of goods and services, i.e. machines, materials, offices, factories, roads, etc. o WORKING or CIRCULATING CAPITAL – raw materials, semi-manufactured and finished goods: circulate throughout an economy until they reach the final consumer Page 3 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

o FIXED CAPITAL – factories, offices, machinery, roads and bridges, etc  ENTREPENEURS – Individuals who organize companies to produce goods and services, take related risks (different from ord. workers) GENERAL LABOUR – individuals; small firms. Workers do all jobs. Features:  Convenient;  complete;  takes higher levels of knowledge As technology progresses:  work may become too complicated  require too high a level of education/training  if large equipment required, may be inconvenient and inefficient  materials or processes may be too far away SPECIALISATION – Labour tasks are divided Advantages:  higher level of skills, smaller range;  cost effective to provide special tools;  efficient way to produce more, using more people;  workers can do the work they are best suited to; Disadvantages:  boring;  feeling alienated from the process, management Example: Ford Motor Co. OPPORTUNITY COST – relates to choices and lost opportunities; the value of the next best choice given up in making a choice Page 4 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Normative statements  Contains a value statement or opinion  Whether something is desirable (good) or undesirable (bad) Positive statements  Indicates a fact  Shows no opinion about whether something is good or bad

Page 5 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

An economy can produce both agricultural goods and manufactured goods. It faces the production possibility curve A* M* shown in the diagram. What would most satisfactorily explain a change production from (A1, M1) to (M1, A2)?

Page 6 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

[1]

Economic Studies

Student Handbook

Microeconomics â&#x20AC;&#x201C; Basic 1

Page 7 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

[1]

Economic Studies

Student Handbook

Economic Systems ECONOMY: a social organization making decisions about:

 WHAT is to be produced;  HOW production is organized and run; and  FOR WHOM the production takes place

Planned or Controlled Actors: Government, Consumers, Workers Motivation: For the common good

Market Economy

Actors: Consumers, Producers, Owners of Private Property, and, the Government Motivation: Individuals maximize personal gain or utility; Producers to maximize profits; Gov’t maximize social welfare All Factors of Prod’n, Most Factors of Prod’n owned by except the workers are individuals; Gov’t to protect their rights owned by the State and interests All resources allocated Free Enterprise: All businesses are free by the State – to buy / sell at ? Workers can work “Planning Mechanism” where they want. People can open their own business. Consumers buy as they like and can afford. Competition: None Competition: People choose to buy where they like. Businesses are forced to respond. Mixed Economy Resources allocated both by government through the planning mechanism; and, by private sector through market mechanism

Economic Systems ECONOMY: a social organization making decisions about:

 WHAT is to be produced;  HOW production is organized and run; and  FOR WHOM the production takes place

Page 8 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Planned or Controlled Actors: Government, Consumers, Workers Motivation: For the common good

Student Handbook

Market Economy

Page 9 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Companies’ (or individuals’) actions have costs + effects, both within the companies and outside. SOCIAL COSTS = the total of all those costs. PRIVATE COST = the cost to the company. EXTERNALITY or SPILLOVER EFFECT = the outside effect of activities EXTERNAL COST or NEGATIVE EXTERNALITY = bad effect, i.e. pollution EXTERNAL BENEFIT or POSITIVE EXTERNALITY = benefit, i.e. inoculation Prices and costs generally do not reflect the effects of EXTERNALITIES. Government intervention: Regulation: i.e. Gov’t rules on how much pollution allowed. Easy to understand; cheap to implement. But: often difficult to determine how much should be allowed; do not necessarily discriminate between different costs of reducing the externalities. Also, the losers are not compensated and the polluters are free to pollute up to their regulated allowances. Extending Property Rights: property rights are not fully allocated. Effects of externalities can be far-reaching, even to different countries. Gives those who are injured the right to sue. Gov’t does not have to try to assess the cost of externalities. Also has problems: externalities that occur in different countries; degree of proof required to win in court; fairness of awards vs. perceived costs to different parties; may take a long time to win. Taxes: Gov’t assesses the cost to society, taxes the externalities. Shifts the cost to the consumers. Page 10 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Permits: Gov’t determines how much of an externality should be allowed in society, divides those effects into units, then issues permits which than be traded and sold between companies. Public Goods: Public goods = consumption by one doesn’t reduce amount available for another (non-rivalry); no one excluded from the benefit (non-excludability). Eg: Defence; judiciary and prison system; police service; street lighting In Free Market economy, unlikely to be provided by the private sector. (Private goods = consume by one, not available for another) Merit Goods: underprovided by the economy / people think there should be more available to more people: i.e. health care and insurance Demerit goods: overprovided by the economy / people think there is too much: i.e. drugs; cigarettes; alcohol. Produce negative externalities Equity: Free market will not lead to equitable distribution of resources This leads to allocative inefficiency – Government intervention: Direct – government do it; Gov’t Subsidy – costs shared with consumers

Page 11 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Cost Benefit Analysis Easy to analyze private costs and benefits May not be so easy to analyze the costs and benefits of Externalities Analyze social (ALL) costs and benefits to assist policymakers in making economic decisions Problem: may not be easy to place a value on Externalities The example: 5 million travelers save 30 minutes, for a cost savings of 2.5 million hours per year. What is the value of that time? In UK, in PRC? Also need to look at Costs and Benefits across time

Page 12 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Market Failures and Externalities Principle of Economics #7: Governments can sometimes improve market outcomes. Markets do many things well. With competition and no externalities, markets will allocate resources so as to maximize the surplus available. However, if these conditions are not met, markets may fail to achieve the optimal outcome. This is also known as "market failure".

Externalities In previous analysis, we assumed that all goods consumed or produced have been private, in the sense that one individuals consumption or production of a good does not affect the other. When our actions impact on those not directly involved, an externality exists. As one individual's behaviour increases or decreases, another's satisfaction or profit changes as well. It can have a positive or negative effect on a third-party not directly involved with the buyer or seller of the transaction. These costs (or benefits) are not included in the cost curve faced by the decision makers. Examples of externalities:

   

A A A A

smoker annoys others with second hand smoke. gardener delights a neighbour with his beautiful garden. pulp mill pollutes the air and water in town. perfume wearer gives a friend an allergic reaction.

Negative Externalities When economic agents not directly involved, negative externalities can exist, such as pollution. A free market tends to over-produce the good which produces a negative externality, and under produce those with positive externality. If we include costs borne by everyone, then we get social costs, which are the total costs of production no matter who bears them. We say that the total cost is equal to private costs plus external costs. Negative externalities result in a lower free-market output. In order to make the market produce the optimal amount, we must impose a tax. This is called "internalizing the externality", and forces those involved to account for external costs. There are also externalities in "consumption", when consumption has costs for persons other than those actually consuming the product. Examples of these are cigarettes and second-hand smoke, and drinking alcohol and car accidents.

Positive Externalities Not all externalities are negative. Some create benefits to those not directly involved. Such is the case with "technology spillover", where new inventions benefit those beyond the inventors. Some have argued that governments should subsidize research and development, since it will have positive externalities to everyone else. Another method is to allow patents to give monopoly rights to new inventions for a period of time, and encourage such activity. Without this method, there could be an under investment in research. Positive externalities in production means that social cost is less than private cost, and more of the good should be produced than will occur in a free market. There may also be positive externalities in consumption, such as education. In this case, the social value is greater than the private value

Page 13 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Page 14 of 406

Student Handbook

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

ECONOMICS – the science that deals with the production, distribution and consumption of goods and services, and with the theory and management of economies or economic systems FREE GOODS – resources available in unlimited quantities ECONOMIC GOODS – resources are limited in quantity – SCARCITY An ECONOMY is a social organization which makes decisions about:  WHAT is to be produced;  HOW is the production to be organized and run; and  FOR WHOM is the production to take place WANTS and NEEDS BASIC ECONOMIC PROBLEM: Resources = scarce; wants = unlimited ECONOMIC RESOURCES – FACTORS OF PRODUCTION  LAND – also includes natural resources on, below, above and sea o NON-RENEWABLE RESOURCES – coal, oil, gold, etc which will never be replaced o RENEWABLE RESOURCES – forests, soils, water, fish  LABOUR – The working force of an economy (Western economies – very scarce, due to people and cost)  CAPITAL – all resources used in the production of goods and services, i.e. machines, materials, offices, factories, roads, etc. o WORKING or CIRCULATING CAPITAL – raw materials, semi-manufactured and finished goods:

Page 15 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

circulate throughout an economy until they reach the final consumer o FIXED CAPITAL – factories, offices, machinery, roads and bridges, etc  ENTREPENEURS – Individuals who organize companies to produce goods and services, take related risks (different from ord. workers) General labour – individuals; small businesses. Each person does all jobs. Features:  Convenient;  complete;  takes higher levels of knowledge As technology progresses:  work may become too complicated  require too high a level of education/training  if large equipment required, may be inconvenient and inefficient  materials or processes may be too far away SPECIALISATION – Labour tasks are divided Advantages:  higher level of skills, smaller range;  cost effective to provide special tools;  efficient way to produce more, using more people;  workers can do the work they are best suited to; Disadvantages:  boring;  feeling alienated from the process, management Example: Ford Motor Co. Page 16 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Production Possibility Frontier (PPF) (Also called PPCurve, PPBoundary, Transformation Curve) PPF = the different combinations of goods which can be produced if all resources are fully and efficiently used. OPPORTUNITY COST Demand: The quantity of goods or services that will be bought over a period of time at any given price The Demand Curve – Go over Price: If all else remains the same, as prices rise, people will demand less, and, if prices go down, people will demand more

Income: As Incomes rise, the demand curve moves outward Rising prices may shift demand for other (replacement) goods Other factors that affect the Demand Curve:  Population changes  Changes in fashions and tastes  Changes in laws (seatbelt laws, smoking laws)  Advertising Demand of Individuals or entire Markets are shown the same way Market Demand: add together all Individual Demand Curves CONSUMER SURPLUS – (above price level) The more that is available, the less value consumers place on it. (A gain to consumers)

Supply: The quantity of goods or services that will be produced and sold over a period of time at any given price Price: If all else remains the same, as prices rise, producers will supply more, and, if prices go down, producers will supply less The Supply Curve: Costs of Production: If production cost rises, producer tries to pass on cost in higher prices to the consumers. Higher prices cause fewer consumers to buy. Reduced

Page 17 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

sales and reduced profits cause less producers to produce. So, a rise in costs will generally cause the Supply Curve to shift up and to the left. PRODUCER SURPLUS: (below price level) At any given price level, some firms receive a higher price than the lowest price they were willing to supply the market  Price of other goods  Goals of sellers change  Government legislation  Future expectations Price Determination in the Market Buyers and sellers come together to buy and sell goods, and the Market Price is “struck” EQUILIBRIUM PRICE is where Demand equals Supply – where the Demand Curve and the Supply Curve meet. If Market Price is below Equilibrium price, Demand exceeds Supply – EXCESS DEMAND If Market Price is above Equilibrium price, Supply exceeds Demand – EXCESS SUPPLY Changes in Demand and Supply: Changes in prices lead to movement along the Demand or Supply Curves. Changes in any other factors will lead to shifts in the Demand Curve or Supply Curve. These shifts will create a new Equilibrium Price Market Clearing: For many different reasons, Market Price very often does not equal Equilibrium Price – there could be excess Demand or excess Supply at any time. And, economists cannot agree on how much markets will tend to move towards marketclearing prices. Page 18 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

If FREE MARKET FORCES push prices to equilibrium point, this is called stable equilibrium. In some cases, FREE MARKET FORCES may not be strong enough to push price to equilibrium – unstable equilibrium. Interrelationships in the Markets So far, Price affected by Supply and Demand – a Partial model. Now: how events in 1 market lead to changes in another – General model. Goods that are used together (Examples: Mobile phones and SIM cards; DVD’s and DVD players)  in supply of “A”   in quantity demanded for “A” and

a  in price   demand for “B”,   in price Complementary goods – JOINT DEMAND Goods that can replace one another (Examples: Beef or pork; rice or noodles)  in supply of “C”   in price and decrease in quantity

demanded   in demand for “D”   in price of “B” Substitute Goods – COMPETITIVE DEMAND Goods needed to produce other goods (Examples: Cars need steel; bread and cakes need flour)  in demand for finished good “E”   in demand for

needed good “F”   in price of “F” DERIVED DEMAND Goods demanded for 2 or more different uses (Examples: Land, for housing or growing vegetables; grain, for feeding animals or making bio-fuel)

Page 19 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 in demand for Good “G” for one use   in supply

available for and  in price of the good supplied for the different use COMPOSITE DEMAND One good supplied for producing 2 different goods. (Examples: beef and leather both come from cows) If demand for 1 good rises, the price will rise. Producers will increase supply of the source product, leading to a rise in supply of the other product, and price will lower JOINT SUPPLY

Price Elasticity of Demand Elasticity = Effect on quantity demanded by a change in price.

Elastic = Change in Price causes a larger change in Quantity Inelastic = Change in Price causes a smaller change in Quantity A wide variety of things can affect Elasticity of Demand, but according to economists, the two factors that most determine Elasticity are probably: 1.

Substitute Goods – more tend to create higher price elasticity  Noodles / rice, corn, potatoes, etc; if price of noodles rises a bit, a larger group of consumers shift to rice, corn, potatoes, etc. So, price elasticity for noodles is high.  Salt has few substitutes – a rise in the price of salt will have little effect on total demand. Price elasticity for salt is low.

Time – Several times in recent history, the price of oil has risen sharply. In those times, price elasticity for oil was low – there was little people could do to replace it. However, over time, people could change their driving habits, taking Page 20 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

public transportation, buying more efficient cars, causing demand to fall in response to the higher prices In general:  Necessities – lower PED; luxury goods – higher PED  Low-priced goods – lower PED; high-priced goods – higher Percentage change in quantity Percentage change in price

PED Price Elasticity of Demand =

Alternative Calculation (percentage not known)

PED = OR

Quantity Quantity Quantity Quantity

Price Quantity

÷ X

Price Price Price Price

Quantity Price

PED Value Elasticity -0Perfectly Inelastic 0–1

Inelastic

Unitary Elasticity

1–∞ P. 55 – Table 8.1 illustration

∞

Elastic Perfectly Elastic

Perfectly Inelastic: No matter price , Demand remains same – vertical Unitary Elasticity: Any  in price offset by equal and opposite  in demand Perfectly Elastic: Any amount demanded at that price or less – horizontal IMPORTANT: Elasticity along Straight-line Demand Curves can be different! Page 57, Figure 8.2 – Elasticity at any given point “B” along a Distance Demand Curve calculated as follows:from “B” to the Quantity axis

Point A is Perfectly Elastic Point C is Perfectly Inelastic

Price

Distance from “B” to the Price axis

A = ∞ = Elastic B = 1 Unitary Elasticity

Page 57, Figure 8.3

C = 0 = Inelastic Quantity

Page 21 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Income Elasticity of Demand – How demand changes with change of consumers’ Income?Q / I OR Q X I OR I X Q Q I Q I Q I Cross Elasticity of Demand – How demand for a good changes %  in quantity demanded of good X with a change in the price of another good? %  in price of another good Y Q of X

P of Y

Q of X Q of X P of Y P of Y Substitute goods – a positive Cross Elasticity of Demand. Increase

P of Y

OR Q of X

in price of one leads to increased demand of the other. (Noodles/Rice) Complementary goods – a negative Cross Elasticity of Demand. Price increase in one leads to decrease in demand for the other. (Sand/Cement) A final point: Price Elasticity of Demand and effect on spending / income Quantity Purchased X Price = Total Expenditure (like income) For Inelastic products, a rise in prices results in a rise in total expenditure For Elastic products, a rise in prices results in a drop in total expenditure An example: Original Values New Values

Qty Dem 5 5 5

Price 10 10 10

Qty Dem 4 2

Price Total Price Elast.Expend. 0.5 50 14 0.50 56 % Δ P ≥ % Δ in Q - Inelastic, TE rises 14 1.50 28 % Δ P ≤ % Δ in Q - Elastic, TE drops

Price Elasticity of Supply – effect a change in Price has on Percentage change in quantity supplied Percentage change in price

quantity supplied. Quantity Quantity

Price Price

Price Quantity

Elasticity of Supply is affected primarily by two factors:  Substitute Goods – Goods that the producer can produce as alternatives  Time – Over time, producers can shift to producing other goods PES elasticity is analyzed as follows: Page 22 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Quantity Price

Economic Studies PES Value

-00–1 1 1–∞ ∞

Student Handbook

Elasticity

Response to Change in Price

Perfectly Inelastic Inelastic Unitary Elasticity Elastic Perfectly Elastic

No response in Supply Less than proportionate response %  in Q supplied = %  in Price More than proportionate response Producers will supply any amount at given price

Planned or Controlled Market Economy Actors: Government, Actors: Consumers, Producers, Owners Consumers, Workers of Private Property, and, the Government Motivation: For the Motivation: Individuals maximize common good personal gain or utility; Producers to maximize profits; Gov’t maximize social welfare All Factors of Prod’n, Most Factors of Prod’n owned by except the workers are individuals; Gov’t to protect their rights owned by the State and interests All resources allocated Free Enterprise: All businesses are free by the State – “Planning to buy / sell at ? Workers can work Mechanism” where they want. People can open their own business. Consumers buy as they like and can afford. Competition: None Competition: People choose to buy where they like. Businesses are forced to respond. Mixed Economy Resources allocated both by government through the planning mechanism; and, by private sector through market mechanism Companies’ (or individuals’) actions have costs + effects, both within the companies and outside. SOCIAL COSTS = the total of all those costs. PRIVATE COST = the cost to the company. EXTERNALITY or SPILLOVER EFFECT = the outside effect of activities Page 23 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

EXTERNAL COST or NEGATIVE EXTERNALITY = bad effect, i.e. pollution EXTERNAL BENEFIT or POSITIVE EXTERNALITY = benefit, i.e. inoculation Prices and costs generally do not reflect the effects of EXTERNALITIES. Government intervention: Regulation: i.e. Gov’t rules on how much pollution allowed. Easy to understand; cheap to implement. But: often difficult to determine how much should be allowed; do not necessarily discriminate between different costs of reducing the externalities. Also, the losers are not compensated and the polluters are free to pollute up to their regulated allowances. Extending Property Rights: property rights are not fully allocated. Effects of externalities can be far-reaching, even to different countries. Gives those who are injured the right to sue. Gov’t does not have to try to assess the cost of externalities. Also has problems: externalities that occur in different countries; degree of proof required to win in court; fairness of awards vs. perceived costs to different parties; may take a long time to win. Taxes: Gov’t assesses the cost to society, taxes the externalities. Shifts the cost to the consumers. Permits: Gov’t determines how much of an externality should be allowed in society, divides those effects into units, then issues permits which than be traded and sold between companies. Public Goods: Public goods = consumption by one doesn’t reduce amount available for another (non-rivalry); no one excluded from the benefit (non-excludability). Eg: Defence; judiciary and prison system; police service; street lighting Page 24 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

In Free Market economy, unlikely to be provided by the private sector. (Private goods = consume by one, not available for another) Merit Goods: underprovided by the economy / people think there should be more available to more people: i.e. health care and insurance Demerit goods: overprovided by the economy / people think there is too much: i.e. drugs; cigarettes; alcohol. Produce negative externalities Equity: Free market will not lead to equitable distribution of resources This leads to allocative inefficiency – Government intervention: Direct – government do it; Gov’t Subsidy – costs shared with consumers Cost Benefit Analysis Easy to analyze private costs and benefits May not be so easy to analyze the costs and benefits of Externalities Analyze social (ALL) costs and benefits to assist policymakers in making economic decisions Problem: may not be easy to place a value on Externalities The example: 5 million travelers save 30 minutes, for a cost savings of 2.5 million hours per year. What is the value of that time? In UK, in PRC? Also need to look at Costs and Benefits across time Economic Efficiency and Market Failure

Page 25 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Rvw: 3 Basic Economic Questions: What it produces (goods and services); How well it produces them; and, For whom it produces. Judge an economy by how well it answers those questions. Efficiency is only achieved MARKET EFFICIENCY – if producing on the PPF – Competition can create For MARKET EFFICIENCY, there must be… PRODUCTIVE EFFICIENCY – production achieved at the lowest cost Can be achieved if there is… TECHNICAL EFFICIENCY – the maximum quantity of output (products) with the minimum of inputs (resources) ALLOCATIVE / ECONOMIC EFFICIENCY – resources used to produce goods and services that consumers most wish to buy. STATIC EFFICIENCY – at 1 point in time / allocating resources differently. Company produce more if it used less labor and more capital? Country produce more if it reduced unemployment? DYNAMIC EFFICENCY – effects over a period of time. If a company distributed less profit and used the money for capital investment; if an economy directed its resources more to investment and less to consumption. MARKET FAILURE / INEFFICIENCY –  Lack of competition in the market  Externalities – actual prices and profits do not represent true …  Information failure – products bought infrequently  Factor (F.ofP.) immobility – products, worker skills, worker locations Page 26 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Inequality: Wages; Wealth and its related earnings; Pension earnings; Other components of income. The Role of the Market Adam Smith; An Enquiry Into the Nature and Causes of the Wealth of Nations; attacked protectionism, economic restrictions, legal barriers Free market system where the “invisible hand” of the market would allocate resources to everyone’s advantage

The Actors: Consumer – all powerful, free to spend, choose to allocate their resources to maximize their utility Firms – servants to the consumers, motivated to maximize their profits (Revenues – Expenses), if they fail… Owners of Factors of Production – maximize their rate of return on capital The Function of prices in the Market  Rationing (explain classic) – Price does it  Signaling – the price does it  Incentives – the Price (demand) (supply) Maximizing behavior Judging the Market Market Stabilization Price fluctuations (irregular rises and falls) can also lead to market failure Prices may be too high, making it impossible for some to buy it Prices may be too low, causing producers to stop producing Large fluctuations – may be difficult to identify the “signal” Price Controls Maximum pricing (draw curve, price below equilibrium) lead to excess supply Minimum pricing (draw curve, price above equilibrium) lead to excess demand Page 27 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Buffer Stock Scheme – large fluctuations in commodities (agriculture or mining products to be resold) come for different reasons: seasonal, bumper / failed crops; etc. Commodities tend more inelastic (near vertical curves), so shifts in D or S can lead to large changes in prices, little change in quantities Buffer stock scheme has elements of Maximum and Minimum pricing and deals with the “Supply Side” (later – 2nd term).  Gov’t sets “Intervention Price”  If Market Price lower, Gov’t buys, increasing demand, pushing up price  If Market Price higher, Gov’t sells, increasing supply, pushing down price Taxes – Other actions Gov’t can take:  Indirect taxes – paid to sellers, when Indirect Taxes

goods are bought

o VAT, Ad Valorem – based on Consumers pay

price

o Excise Tax – based on, charged per unit

Producers

o Tend to reduce Supply, push S curve up and to the left  Subsidies (money given out by the government) o Reduces overall producer costs, pushing S curve down, to the right

Page 28 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

The amount of tax burden shared by each side depends on Elasticity (See P. 76, Figs 11.4 & 11.5)

Subsidies

Consumers

 S = Perf Elastic / D = Perf Inelastic –

S2 Producer

Consumers  S = Perf Inelastic / D = Perf elastic – Producers

Page 29 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Production in the Short Run Short Run: at least one Factor of Production cannot be changed Long Run: all Factors of Production can be changed, technology remains unchanged Long Long Run: technology changes Production Function: Formula to calculate Production (output) based on the amounts of Labour and Capital (inputs) used: Q = L + C Law of Diminishing Returns: (Short run) excess inputs lead to inefficiency Total Product: quantity of total output based on given inputs over time Average Product: quantity of output per unit of input Marginal Product: addition to output by an extra unit of input Ss review Table 46.1, Figure 46.1 – each curve declines, first MP, AP, TP Returns to Scale: What happens in long run, as firms increase all inputs?  Increasing RtoS: Greater efficiency – change input leads to greater TP 

Constant RtoS: change input lead to equal increase TP



Decreasing RtoS: lower efficiency – change input leads to lower TP

Total Revenue (TR) = Total Quantity (Q) x Average Price Average Revenue (AR) = Total Revenue (TR) ÷ Total Quantity (Q) Marginal Revenue = Additional receipts from selling one additional unit Cost (in Economics) = Opportunity Cost = materials + owners’ time + earnings on cash + cost of buildings and equipment + goodwill Fixed Costs: generally costs of capital, do not change in the relevant range Variable Costs: materials, other costs, that change with changes in output Total Cost (TC) = Fixed Cost (TFC) + Variable Cost (TVC) Average Cost (AC) = Total Cost (TC) ÷ units of output (Q) Marginal Cost (MC) = cost of one additional unit of output (ΔTC÷ΔQ) Profits = TR – TC

Review AVC, AFC, ATC, MC (p 322)

Page 30 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Summary MC, AC curves “U” shaped – bottom is where diminishing returns set in MC, AC curves mirror images of MP, AP When MP starts decreasing (efficiency), MC starts rising MC crosses the AC, AVC curves at their lowest point (p 322), where costs are neither rising or lowering, so it should equal the MC Objectives of Firms Control – important to know who controls  Small businesses – single/few owners  Large companies o Shareholders elect Directors o Directors appoint Officers/Managers o May be a separation, with different interests o Workers with Trade unions o State through legislation and regulations o Consumers through organizations Managerial Theories  Assumes a separation (divorce) between Ownership and control  Owners are interested in the company having profit  Managers interested in their own: working conditions; salaries and benefits; power; etc. and will work for company’s profit too Behavioral theories – decision-making by different groups that compete for power. Each group has its own minimum goals, and they go from there. Neo-Classical economics – Short-run Profit Maximization  Assumed owners or shareholders most important

Page 31 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Firms may not always have profits. Predicts they will continue to operate as long as they cover their variable costs  Adjust Prices and Output based on the Market  P 331 – continue to produce, even possibly thru Period 4 – then, Period 5, would not produce. Short Run Profit Maximization – Where a firm should produce Maximum level of profit: where TR–TC is greatest

Add: profit a company expects to make included as a cost: Normal Profit Abnormal / Economic Profit – profit above Normal Profit Add in TR to show Break Even Points

Page 32 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

P 345 shifts in cost and revenue curves Rises and falls in the curves / changes profit maximizing levels Firms don’t do this calculation – but if they’re maximizing profits, they should be at the level where MR = MC / As long as MR from one unit is greater than MC, they will produce one more.

Neo-Keynesian – Long-run Profit Maximization  COST PLUS PRICING – average total cost, based on full capacity, plus a profit.  Assumes consumers do not like frequent price changes  Will continue to produce even with losses

Page 33 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Production in the Long Run Review: Short Run Cost Curves  AFC downwards  ATC starts moving up where diminishing returns set in Economies & Diseconomies of Scale and average costs In long run, all FofP are variable (can add factories, etc) Draw LRAC Curve –  Long run costs fall as output increases – economies of scale  At some point, LRAvgCost stays the same – constant returns to scale o

The optimum level of production

The center section of curve

Minimum Efficient Scale (MES) is the beginning of the lowest point

 Later, LRAC’s begin to rise – diseconomies of scale Sources of economies of scale – Larger companies  Technical Economies / Diseconomies: In production process: can’t use equipment to maximum efficiency (indivisibility). Also, may be more productively efficient  Specialization: Employ more specialists – greater efficiency (in small firms, specialists are an indivisibility)  Buy larger quantities (bulk); use more employees efficiently; etc.  Financial economies: More sources of financing, lower costs Sources of Diseconomies of scale  Mainly due to problems with management  As firms grow, more difficult for management to control company’s activities – Centralized / Decentralized Movements along and shifts in the long run average cost curve LRAC Curve: boundary, represents the

Attainable

Page 34 of 406

Dr Stephen Byrd PhD MBA FICM FITOL Output

Economic Studies

Student Handbook

minimum attainable average costs Increases in production lead to movements along the LRAC Curve Downward shifts in the LRAC Curve caused by:  External Economies of Scale: savings from growths in its industry: better roads; lower training costs (more qualified workers); gov’t programs, etc  New technologies Upward shifts in the LRAC Curve caused by:  Taxation  External Diseconomies of scale: generally industries expand too quickly Relationship between the SRAC and LRAC Curves Short run – AC fall at first (econ of scale); rise (dim rnts) Long run – all factors are variable; economies and diseconomies of scale

Growth of Firms Mergers and the Growth of Firms LL: ProdInLR: to reach level where EconOfScale SetIn Large firms: Economies of Scale, or, high barriers to entry. Smaller firms: lower barriers; operate at MES, lower costs (before diseconomies of scale, productive inefficiency); offer localized service, etc No direct correlation between size and efficiency Reasons for growth:  Take advantage of economies of scale  A better ability to impact its market  Risk reduction Methods of growth: Page 35 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Internal Growth

 External Growth – Merger; Amalgamation; Takeover – all involve the joining together of 2 companies Reasons / Motivations for Merger, Amalgamation or Takeover:  Cost and time – cheaper and quicker – after budgeting the cost for internal growth, a firm may find stock of a company on the open market  Asset Stripping – Buy large company, keep some assets, sell the rest  Rewards to Management – mergers result in a larger company, quickly, and often, managers use the chance to improve their compensations Types of Mergers  Horizontal Merger – 2 firms, the same industry, same stages  Vertical Merger – 2 firms, same industry, different stages o Forward integration – supplier merging with a buyer o Backward integration – a buyer merging with its supplier  Conglomerate Merger – 2 firms, different industries Notes about Mergers Not clear that mergers increase economic efficiency Productive efficiency may incr if average costs fall (economies of scale) But, sometimes the economies of scale are losses of jobs Allocative efficiency may incr if wider range or better quality product But, mergers tend to reduce competition in the market Asset stripping controversial

Perfect Competition Remainder of 1st term on different models of competition in the market, and how firms might make decisions under those conditions Assumptions about Perfect Competition: Page 36 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Large number of sellers in the market, change in output of one firm will have minimal effect on market (draw enlarged Supply/Demand) Low barriers – easy (freedom) for firms to enter and exit the market Perfect knowledge – buyers, sellers, about prices (if one firm increases prices, its demand will go to zero), so firms must accept the market price Price takers – many buyers, sellers; none big enough to influence market Homogeneous product – no branding, products are identical (Relatively few industries like this - agriculture) So, each seller’s Demand Curve is perfectly elastic – horizontal (=AR=MR)

SRAVC and LRAC are the lowest points where a Firm would sell. In short run, Firm will stay in business as long as it covers AVC. So in the short run, MC (includes Normal Profit) above SRAVC is the Firm’s Supply curve Short run equilibrium is where D = MC Short run profit maximization – Firm produces at H (along D Curve) and G is abnormal profit Long Run Equilibrium – in long run neither losses nor abnormal profits:  Losses: leave the industry (fig 53.7), pushing industry’s S Curve in, left, increasing prices Page 37 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 If abnormal profits (knowledge fully available), other firms follow, push S Curve out, right, pushing down prices Competitive pressures force: no losses, no abnormal profits – equilibrium AC = MC, (from before) D = AR = MC, (intuitively) MR = MC, so, AC = AR = MR = MC In the long run, costs will be the same – perfect knowledge New technologies, special operating methods will be available to all Even if high-efficient personnel push down costs, they will demand more pay So in the long run, costs will remain the same

Monopoly

The only producer / supplier in an industry – IS the industry Barriers: Government; resources; competitive practices; cost – Natural Monopolies minimum costs EconOfScale: purchasing; marketing; technical; managerial / specialization; financial. Examples: telephone; rail; water; etc. Some monopolies may be regional or local monopolies Monopolies remain if barriers to entry remain high Can charge higher price (may not maximize profits) Profit likely to be Abnormal (higher than PerfComp) Efficiencies: Natural monopolies productively efficient – lowest possible costs Allocatively inefficient – high prices / abnormal profits ProdEff and AllocEff are forms of Static efficiencies Monopolies provide Dynamic efficiency: abnormal profits put into R & D … Other firms innovate jump over monopoly (good / economy) – process of creative destruction Page 38 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Monopolies can avoid innovation: keep their abnormal profits Market failure –– the government may intervene:  Taxes – no incentive to reduce costs;  Subsidies – to reduce prices, no way to know right price;  Price controls – can force down costs, no effect;  Nationalize / Privatize; Deregulate; Break Up; Reduce barriers to entry Downward-sloping Demand Curve (draw) is industry’s, monopolist’s – can only increase sales by reducing price Consumer: monopolists must produce products consumers want, and are willing to pay the monopolist’s price Average Revenue at different pts on D Curve (D = AR) Q 0 1 2 3 4 5

TR 0 8 12 12 8 0

8 6 4 2 0

8 4 0

8 12 12 8 0

10 8 6

2 0 0

Short run profit maximiser – produce at the level where MR = MC (graph) Price: Drop a line down from D through MR = MC point Abnormal profits: rectangle from D Curve down to AC Curve Area above is “Consumer Surplus” Monopolist can Price Discriminate: some consumers willing to pay more; split market; keep it split without spending too much money  1st Degree Discrimination: different price to each consumer  2nd Degree Discrimination: by volume  3rd Degree Discrimination: can separate consumers into 2 or more groups Other: No Supply Curve Page 39 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Increase output only where Elasticity is ≥ 1 (above mid-point)

Oligopoly Characteristics:  Relatively few Suppliers in the industry (could still be many small ones)  Firms are interdependent (actions of one affect others – i.e. sales) Most markets are Oligopolistic – imperfectly competitive In addition, according to “Neo-classical” theory:  There are barriers to entry  There are abnormal profits Characteristics (compared with Perfect Competition):  Non-price competition – means they compete in different areas, not just on price – marketing strategy looks at all 4 P’s, and Brands  Price rigidity – fewer price changes, even if costs change  AC Curve more “L” shaped than “U” shaped  Collusion – oligopolists acting together Neo-class theory on Oligopolistic firm’s market D (draw, start with Price):  A price rise by one firm results in lost sales, others will not follow (up)  A price drop = smaller reaction, others follow, so no big Q increase (down) Review: So, from the market price:  Increases in price results in Price Elastic reactions  Decreases in price results in Price Inelastic reactions So the Demand Curve is “Kinked” Draw in MR curve (kinked and broken)

Monopolistic Competition Page 40 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Imperfect Competition / Monopolistic Competition Assumptions:  Large number of buyers & sellers  No or Low barriers to entry

Same as Perfect Competition

 Short-run profit maximizers  Different goods Firms not Price Takers / Downward sloping Demand Curve Different products / substitute goods / higher elasticity In the Long Run:  They will produce (quantity/output) where MR = MC;  Price is at Average Revenue (same as Monopolies)  If abnormal profits: o More firms enter the market – Supply increases o Price goes down, so MR & AR both decrease, until AC = AR (tangent) So, in Monopolistic Competition, MR = MC; AR = AC

Page 41 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Typical Exam Questions

Constant RtoS: change input lead to equal increase TP



Decreasing RtoS: lower efficiency – change input leads to lower TP

Review AVC, AFC, ATC, MC (p 322)

Page 42 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Page 43 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Add: profit a company expects to make included as a cost: Normal Profit Abnormal / Economic Profit – profit above Normal Profit Add in TR to show Break Even Points

Page 44 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Page 45 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

The optimum level of production

The center section of curve

Minimum Efficient Scale (MES) is the beginning of the lowest point

Attainable

Page 46 of 406

Dr Stephen Byrd PhD MBA FICM FITOL Output

Economic Studies

Student Handbook

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Internal Growth

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Monopoly

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

TR 0 8 12 12 8 0

8 6 4 2 0

8 4 0

8 12 12 8 0

10 8 6

2 0 0

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Increase output only where Elasticity is ≥ 1 (above mid-point)

Monopolistic Competition Page 52 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Imperfect Competition / Monopolistic Competition Assumptions:  Large number of buyers & sellers  No or Low barriers to entry

Same as Perfect Competition

Page 53 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Purchasing power parity (PPP) is an economic technique used when attempting to determine the relative values of two currencies. It is useful because often the amount of goods a currency can purchase within two nations varies drastically, based on availability of goods, demand for the goods, and a number of other, difficult to determine factors. PPP solves this problem by taking some international measure and determining the cost for that measure in each of the two currencies, then comparing that amount. An economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power. The relative version of PPP is calculated as:

Where: "S" represents exchange rate of currency 1 to currency 2 "P1" represents the cost of good "x" in currency 1 "P2" represents the cost of good "x" in currency 2 In other words, the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency. For example, a chocolate bar that sells for C$1.50 in a Canadian city should cost US$1.00 in a U.S. city when the exchange rate between Canada and the U.S. is 1.50 USD/CDN. (Both chocolate bars cost US$1.00.)

Read more: http://www.answers.com/topic/purchasing-power-parity#ixzz1F7C8mTeu The Big Mac Index is an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries.

The Human Development Index (HDI) The first Human Development Report introduced a new way of measuring development by combining indicators of life expectancy, educational attainment and income into a composite human development index, the HDI. The breakthrough for the HDI was the creation of a single statistic which was to serve as a frame of reference for both social and economic development. The HDI sets a minimum and a maximum for each dimension, called goalposts, and then shows where each country stands in relation to these goalposts, expressed as a value between 0 and 1. Page 54 of 406 Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

The education component of the HDI is now measured by mean of years of schooling for adults aged 25 years and expected years of schooling for children of school going age. Mean years of schooling is estimated based on duration of schooling at each level of education (for details see Barro and Lee, 2010). Expected years of schooling estimates are based on enrolment by age at all levels of education and population of official school age for each level of education. The indicators are normalized using a minimum value of zero and maximum values are set to the actual observed maximum values of the indicators from the countries in the time series, that is, 1980â&#x20AC;&#x201C;2010. The education index is the geometric of two indices. The life expectancy at birth component of the HDI is calculated using a minimum value of 20 years and maximum value of 83.2 years. These are the observed maximum value of the indicators from the countries in the time series, 1980â&#x20AC;&#x201C;2010. Thus, the longevity component for a country where life expectancy birth is 55 years would be 0.554. For the wealth component, the goalpost for minimum income is $163 (PPP) and the maximum is $108,211 (PPP), both observed minimum observed during the same time series. The decent standard of living component is measured by GNI per capita (PPP US$) instead of GDP per capita (PPP US$) The HDI uses the logarithm of income, to reflect the diminishing importance of income with increasing GNI. The scores for the three HDI dimension indices are then aggregated into a composite index using geometric mean. Refer to the Human Development Report 2010 Technical notes [388 KB] for more details.

Page 55 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

The HDI facilitates instructive comparisons of the experiences within and between different countries.

Page 56 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Demand: The quantity of goods or services that will be bought over a period of time at any given price Law of Demand: If all else remains the same, as prices rise, people will demand less, and, if prices go down, people will demand more The Demand Curve – Diagram

Downward sloping – inverse / negative relationship: as price decreases, quantity demanded increases, and, vise versa Demand of entire Markets shown the same way Market Demand: add together all Individual Demand Curves Determinants of Demand (factors that affect Demand)  Price (movement along the demand curve)  Prices of other goods (with, or, instead of)  Incomes  Changes in fashions and tastes  Population size or structure  Advertising  Expectations of consumers

Changes in any of these will cause Demand Curve to shift, either inward or outward

 Changes in laws CONSUMER SURPLUS The area above price level and to the left of the Demand Curve. The amount that consumers who were willing to spend more, don’t have to spend. The benefit to consumers of having markets. (The more quantities are available, the less value consumers place on it.) Elasticities Elasticity = Effect (responsiveness) on factor “Y” by a change in factor “X” Price Elasticity of Demand (PED) = Effect on quantity demanded by change in price, or, responsiveness of quantity demanded to price changes

Elastic = Change in Price causes large change in Quantity Demanded Inelastic = Change in Price causes small change in Quantity Percentage change in quantity Percentage change in price

Demanded Page 57 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Price Elasticity of Demand =

Page 58 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Alternative Calculation (percentage not known)

PED =

Quantity Quantity

Price Quantity

÷ X

Price Price

1 1–∞ ∞

Response to Change in Price No response in quantity demanded

Inelastic

Less than proportionate response

Unitary Elasticity

%  in Q demanded = %  in Price

Elastic

More than proportionate response

Perfect Elasticity

Consumers demand ∞ Q at that price

Determinants of PED: 3.

Availability of substitute goods tends to increase PED  Noodles & rice, etc; if price of noodles rises, consumers shift to rice, etc. So, price elasticity for noodles is high.  Salt has few substitutes, so a rise in price will have little effect on total demand. Price elasticity for salt is low.

Price Price

Quantity Price

PED Value Elasticity -0Perfect Inelasticity 0–1

Quantity Quantity

Time tends to increase PED  Oil: when price rises, with nothing to replace it, people buy more. But over time, people change driving habits, buy more efficient cars, take public transportation, causing quantity demanded to fall

Necessities tend to have lower PED

Low-priced goods tend to have lower PED

Luxury goods tend to have higher PED

High-priced goods tend to have higher PED

Page 59 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

IMPORTANT: PED along straight Demand curves can be different!

Point A is Perfectly Elastic Point C is Perfectly Inelastic

Distance from “B” to the Quantity axis Distance from “B” to the Price axis

Price

PED at any given point “B” =

A = ∞ = Elastic B = 1 Unitary Elasticity C = 0 = Inelastic Quantity

PED is important because it affects total spending (expenditure) on the product, and therefore total income (revenue) received by the firm. This helps determine whether a company’s total income (revenue) will increase or decrease when they raise prices. Total Expenditure (TE) = Q x P Inelastic products: rise in price results in increase in Total Revenue Elastic products: rise in price results in decrease in Total Revenue Example: Original

Qty 5 5 5

Price 10 10 10

New

Qty 4 2

Price PED 14 14

Page 60 of 406

0.50 1.50

TE 50 56 28

%ΔP ≥ %ΔQ - Inelastic - TR increases %ΔP ≤ %ΔQ - Elastic - TR decrease

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Supply: The quantity of goods or services that will be produced and sold over a period of time at any given price Law of Supply: If all else remains the same, as prices rise, producers will supply more, and, if prices go down, producers will supply less The Supply Curve – diagram Upward sloping – positive relationship: as price increases, quantity supplied increases, and, vise versa Supply of entire Markets shown the same way Market Supply: add together all Individual Supply Curves Determinants of Supply (factors that affect Supply)  Price (movement along the supply curve)  Costs of Production  Price of other goods  Technology  Producers’ Goals  Government legislation  Future expectations

Changes in any of these will cause Supply Curve to shift, either inward or outward

PRODUCER SURPLUS The area below price level and to the left of the Supply Curve. The low prices that producers who were willing to sell, don’t have to sell so low. The benefit to producers of having markets (some firms receive a higher price than the lowest price they were willing to supply the market) Price Elasticity of Supply – effect a change in Price has on quantity supplied. Percentage change in quantity supplied Percentage change in price Page 61 of 406 Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Quantity Quantity

Student Handbook

Price Price

Price Quantity

Quantity Price

-00–1 1 1–∞ ∞

Elasticity

Response to Change in Price

Perfectly Inelastic Inelastic Unitary Elasticity Elastic Perfectly Elastic

No response in Supply

Page 62 of 406

Less than proportionate response %  in Q supplied = %  in Price More than proportionate response Producers supply ∞ Q at that price

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Price Determination in the Market Buyers and sellers come together to buy and sell goods, and the Market Price is “struck” EQUILIBRIUM PRICE is where Demand equals Supply – where the Demand Curve and the Supply Curve meet. EXCESS DEMAND: Market Price below Equilibrium price, Demand > Supply EXCESS SUPPLY: Market Price above Equilibrium price, Demand < Supply Changes in Demand and Supply: Changes in prices lead to movement along the Demand or Supply Curves. Changes in any other factors will lead to shifts in the Demand Curve or Supply Curve. These shifts will create a new Equilibrium Price Market Clearing Price: Equilibrium price. For many different reasons, Market Price very often does not equal Equilibrium Price – there could be excess Demand or excess Supply at any time. Stable equilibrium – where FREE MARKET FORCES push prices to equilibrium point. Unstable equilibrium – in some cases, FREE MARKET FORCES may not be strong enough to push price to equilibrium. Consumer / Producer Surplus – Review Interrelationships in the Market How events in 1 market lead to changes in another COMPETITIVE DEMAND / Substitute Goods – Goods that replace each other Examples: rice and noodles; beef and pork Page 63 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

An increase in price of one good “C” leads to a decrease in quantity demanded for that good (movement along D). This leads to an increase in demand for the substitute good “D” (D shifts out) and an increase in price (movement along S)

JOINT DEMAND / Complementary Goods – Goods that are used together Examples: cement and sand; DVD’s and DVD players A decrease in price of one good “A” leads to an increase in quantity demanded for that good (movement along D) This leads to an increase in demand for the complementary good “B” (D shifts out) and an increase in price (movement along S)

Page 64 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Cross Elasticity of Demand (CED) – How demand for good “X” changes with change in price of another good “Y” %  in quantity demanded of good X CED = %  in price of another good Y P of Y Q of X P of Y Q of X OR / OR Q of X X Q of X P of Y P of Y Substitute goods (noodles and rice) have a positive CED. Increase in price of one (rice) leads to increase in demand of the other (noodles) Complementary goods (sand and cement) have a negative CED. Increases in Price of one (sand) leads to decrease in demand for the other (cement)

Page 65 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

DERIVED DEMAND – Goods needed to produce other goods Examples: Cars need steel; bread and cakes need flour An increase in demand for finished good “E” (D shifts out) results in an increase in demand for good “F” (needed to produce “E”) (D shifts out) and an increase in price of “F” (movement along S)

JOINT SUPPLY – One good supplied for producing 2 different goods Examples: cows supply us with beef and leather Increase in demand for finished good “G” (D shifts out) results in an increase in the price (movement along S).

Page 66 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Producers will increase supply of the resource, leading to an increase in supply of the other product “H” (S shifts out), and price will decrease (movement along D)

Page 67 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

MARKET FAILURE / INEFFICIENCY If the market does not achieve these efficiencies, there is Market Failure Some specific Market Failures:  Lack of competition in the market  When prices and profits do not represent true costs to society – Externalities  Information failure – products bought infrequently  Factor immobility – products, worker skills, worker locations  Inequality: Wages; Wealth and its related earnings; Pension earnings; Other components of income. When Market Failure occurs, governments step in to correct the failure Market Stabilization Price fluctuations (irregular rises and falls) can also lead to market failure Prices may be too high, making it impossible for some to buy it Prices may be too low, causing producers to stop producing Large fluctuations – may be difficult to identify the “signal” Price Controls Maximum pricing (price below equilibrium) lead to excess supply Minimum pricing (price above equilibrium) lead to excess demand Buffer Stock Scheme – large fluctuations in commodities (agriculture or mining products to be resold) come for different reasons: seasonal, bumper / failed crops; etc. Commodities tend more inelastic (near vertical curves), so shifts in D or S can lead to large changes in prices, little change in quantities Buffer stock scheme: Page 68 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Gov’t sets “Intervention Price”  If Market Price lower, Gov’t buys, increases demand, pushes up price  If Market Price higher, Gov’t sells, increases supply, pushes down price

Taxes – Other actions Gov’t can take:  Indirect taxes – paid to sellers, when Indirect Taxes

goods are bought

o VAT, Ad Valorem – based on Consumers pay

price

o Excise Tax – based on, charged per unit

Producers

o Tend to reduce Supply, push S curve to the left Subsidies (money given out by the government)  Reduces overall producer costs, pushing S curve to the right The amount of tax burden shared by each side depends on Elasticity (See P. 76, Figs 11.4 & 11.5)

Subsidies

Consumers

 S = Perf Elastic / D = Perf Inelastic –

S2 Producer

Consumers  S = Perf Inelastic / D = Perf elastic – Producers

Page 69 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

The Market Review: Demand and Supply, Interrelationships between markets, and, Elasticities – together called The Market Mechanism The Role of the Market Adam Smith: Advocated: Free market system where the “invisible hand” of the market would allocate resources to everyone’s advantage Opposed: protectionism, economic restrictions, legal barriers

The Actors: Consumer – all powerful, free to spend, choose to allocate their resources to maximize their utility Firms – servants to the consumers, motivated to maximize their profits (Revenues – Expenses), if they fail… Owners of Factors of Production – maximize their rate of return on capital The Function of prices in the Market  Rationing (explain classic) – Price does it  Signaling – the price does it  Incentives – the Price (demand) (supply) Maximizing behavior Judging the Market Review: 3 Questions: What to produce; How to produce; and, For whom to produce – all deal with the Basic Economic Problem, and an economy is judged by how well it answers those questions. Efficiency is only achieved MARKET EFFICIENCY – if producing on the PPF – Competition can create

Page 70 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

For MARKET EFFICIENCY, there must be… PRODUCTIVE EFFICIENCY – production achieved at the lowest cost Can be achieved if there is… TECHNICAL EFFICIENCY – the maximum quantity of output (products) with the minimum of inputs (resources) ALLOCATIVE / ECONOMIC EFFICIENCY – resources used to produce goods and services that consumers most wish to buy. STATIC EFFICIENCY – at 1 point in time / allocating resources differently. Company produce more if it used less labor and more capital? Would a country produce more if it reduced unemployment? DYNAMIC EFFICENCY – effects over a period of time. If a company distributed less profit and used the money for capital investment; if an economy directed its resources more to investment and less to consumption.

Page 71 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Short Run: at least one FofP cannot be changed Long Run: all FofP can be changed, technology remains unchanged Long Long Run: technology changes Production Function: Formula to calculate Production (output) based on the amounts of Labour and Capital (inputs) used: Q = L + C Law of Diminishing Returns: (Short run) excess inputs lead to inefficiency Total Product: quantity of total output based on given inputs over time Average Product: quantity of output per unit of input Marginal Product: addition to output by an extra unit of input Ss review Table 46.1, Figure 46.1 – each curve declines, first MP, AP, TP Returns to Scale: What happens in long run, as firms increase all inputs?  Increasing RtoS: Greater efficiency – change input leads to greater TP 

Constant RtoS: change input lead to equal increase TP



Decreasing RtoS: lower efficiency – change input leads to lower TP

Review AVC, AFC, ATC, MC (p 322)

Page 72 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

(a)

(b)

Output

Total Revenue

(c)

Total Cost

(d)

(e)

Profit

Marginal Revenue

(f)

(b) - (c)

1 2 3 4 5 6 7 8 9

£25 £50 £75 £100 £125 £150 £175 £200 £225

£35 £61 £81 £96 £110 £125 £148 £180 £220

(g)

Marginal Additional Cost Profits (e) - (f)

-£10 -£11 -£6 £4 £15 £25 £27 £20 £5

£25 £25 £25 £25 £25 £25 £25 £25 £25

£35 £26 £20 £15 £14 £15 £23 £32 £40

-£10 -£1 £5 £10 £11 £10 £2 -£7 -£15

26 20 15 14 15 23 32 40

Total Revenue and Total Cost Marginal Revenue and Marginal Cost

250

200

150

30 Total Revenue

100

Total Cost

Marginal Revenue

Marginal Cost

0 0

Short Run Profit Maximization At an output of 7 unit, Profit is at the maximum, so the Firm will produce at 7 units - to maximize profits. Notice that at an output of 7 units, Marginal Cost is rising, but not yet equal to Marginal Revenue, and beyond 7 units, Marginal Cost exceeds Marginal Revenue. So, Profit Maximizing Level of Output can be determined using MR and MC curves, where MR = MC, and at any output beyond that point, MC exceeds MR. Increases in Costs or Revenues With these graphs, it is easy to see the effect of changes in Costs or Revenues If Costs increase, Total Cost and Marginal Cost Curves both shift upwards, Firm produces less. If Prices increase, Total Revenue and Marginal Revenue Curves shift upwards, Firm produces more.

Page 73 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Control – important to know who controls  Small businesses – single/few owners  Large companies o Shareholders elect Directors o Directors appoint Officers/Managers o May be a separation, with different interests o Workers with Trade unions o State through legislation and regulations o Consumers through organizations Managerial Theories  Assumes a separation (divorce) between Ownership and control  Owners are interested in the company having profit  Managers interested in their own: working conditions; salaries and benefits; power; etc. and will work for company’s profit too Behavioral theories – decision-making by different groups that compete for power. Each group has its own minimum goals, and they go from there. Neo-Classical economics – Short-run Profit Maximization  Assumed owners or shareholders most important  Firms may not always have profits. Predicts they will continue to operate as long as they cover their variable costs  Adjust Prices and Output based on the Market Short Run Profit Maximization – Where a firm should produce Maximum level of profit: where TR–TC is greatest (Review FC, VC, TC Graph)

Page 74 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Add: profit a company expects to make included as a cost: Normal Profit Abnormal / Economic Profit – profit above Normal Profit Add in TR to show Break Even Points

Rises and falls in the curves / changes profit maximizing levels Firms don’t do this calculation – but if they’re maximizing profits, they should be at the level where MR = MC / As long as MR from one unit is greater than MC, they will produce one more.

Page 75 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Tutorial Tutorial P.332 Question 2 Units Output 10 15 20 25

(a) (b) (c) (d)

Fixed Cost 10 10 10 10

Variable Cost 10 15 20 25

Total Cost 20 25 30 35

Total Revenue Produce 30 10 25 0 22 -8 20 -15

Shut Down -10 -10 -10 -10

Produce Produce Produce Shut Down

P 344, Q1 Output 1 2 3 4 5 6

TR 10 20 30 40 50 60

TC 8 14 20 30 50 80

Profit 2 6 10 10 0 -20

MR -10 10 10 10 10

100 80

40 20 0 0

Page 76 of 406

MC -6 6 10 20 30

35 30 25 20 15 10 5 0

MR -MC --

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Units Output

Fixed Cost

Variable Cost

Total Cost

Total Revenue Produce

Shut Down

Units Output 10 15 20 25

Fixed Cost 10 10 10 10

Variable Cost 10 15 20 25

Total Cost 20 25 30 35

Total Revenue Produce 30 10 25 0 22 -8 20 -15

Shut Down -10 -10 -10 -10

(a) (b) (c) (d)

Page 77 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Produce Produce Produce Shut Down

Economic Studies

Student Handbook

Review: Short Run Cost Curves  AFC downwards  ATC starts moving up where diminishing returns set in Economies & Diseconomies of Scale and average costs In long run, all FofP are variable (can add factories, etc) Draw LRAC Curve –  Long run costs fall as output increases – economies of scale  At some point, LRAvgCost stays the same – constant returns to scale o

The optimum level of production

The center section of curve

Minimum Efficient Scale (MES) is the beginning of the lowest point

Page 78 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Sources of Diseconomies of scale  Mainly due to problems with management  As firms grow, more difficult for management to control company’s activities – Centralized / Decentralized Movements along and shifts in the long run average cost curve LRAC Curve: boundary, represents the

minimum attainable average costs

Attainable

Increases in production lead to Output

movements along the LRAC Curve Downward shifts in the LRAC Curve caused by:  External Economies of Scale: savings from growths in its industry: better roads; lower training costs (more qualified workers); gov’t programs, etc  New technologies Upward shifts in the LRAC Curve caused by:  Taxation  External Diseconomies of scale: generally industries expand too quickly Relationship between the SRAC and LRAC Curves Short run – AC fall at first (econ of scale); rise (dim rnts) Long run – all factors are variable; economies and diseconomies of scale

Tutorial: U 49, P 325, Q 1

Page 79 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Mergers and the Growth of Firms LL: ProdInLR: to reach level where EconOfScale SetIn Large firms: Economies of Scale, or, high barriers to entry. Smaller firms: lower barriers; operate at MES, lower costs (before diseconomies of scale, productive inefficiency); offer localized service, etc No direct correlation between size and efficiency Reasons for growth:  Take advantage of economies of scale  A better ability to impact its market  Risk reduction Methods of growth:  Internal Growth  External Growth – Merger; Amalgamation; Takeover – all involve the joining together of 2 companies Reasons / Motivations for Merger, Amalgamation or Takeover:  Cost and time – cheaper and quicker – after budgeting the cost for internal growth, a firm may find stock of a company on the open market  Asset Stripping – Buy large company, keep some assets, sell the rest  Rewards to Management – mergers result in a larger company, quickly, and often, managers use the chance to improve their compensations Types of Mergers  Horizontal Merger – 2 firms, the same industry, same stages  Vertical Merger – 2 firms, same industry, different stages o Forward integration – supplier merging with a buyer o Backward integration – a buyer merging with its supplier Page 80 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

ď&#x201A;ˇ Conglomerate Merger â&#x20AC;&#x201C; 2 firms, different industries Notes about Mergers

Not clear that mergers increase economic efficiency. Productive efficiency may increase if average costs fall (economies of scale). But, sometimes the economies of scale are losses of jobs. Allocative efficiency may increase if wider range or better quality product. But, mergers tend to reduce competition in the market. Asset stripping controversial.

Tutorial P. 419, Q 3 (a) Horizontal (b) Vertical, forward integration (c) Vertical, backward integration (d) Conglomerate

Page 81 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Market Structures Remainder of 1st term on different models of market structures, and how firms might make decisions under those conditions Influences on firms’ size and behaviour:  Pricing  Supply  Barriers to Entry  Efficiency  Competition Determinants of Market Structure  Barriers to entry / Freedom to enter and exit  Nature of the product – homogenous (identical), differentiated?  Control over supply/output  Control over price Direct relationship with different levels of competition

Assumptions about Perfect Competition: Large number of sellers in the market, change in output of one firm will have minimal effect on market (draw enlarged Supply/Demand) Low barriers – easy (freedom) for firms to enter and exit the market Perfect knowledge – buyers, sellers, about prices (if one firm increases prices, its demand will go to zero), so firms must accept the market price Price takers – many buyers, sellers; none big enough to influence market

Page 82 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Homogeneous product – no branding, products are identical (Relatively few industries like this - agriculture) So, each seller’s Demand Curve is perfectly elastic – horizontal (=AR=MR) SRAVC and LRAC are the lowest points where a Firm would sell. In short run, Firm will stay in business as long as it covers AVC. So in the short run, MC (includes Normal Profit) above SRAVC is the Firm’s Supply curve Short run equilibrium is where D = MC Short run profit maximization – Firm produces at H (along D Curve) and G is abnormal profit Long Run Equilibrium – in long run neither losses nor abnormal profits:  Losses: leave the industry (fig 53.7), pushing industry’s S Curve in, left, increasing prices  If abnormal profits (knowledge fully available), other firms follow, push S Curve out, right, pushing down prices Competitive pressures force: no losses, no abnormal profits – equilibrium

Page 83 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

AC = MC, (from before) D = AR = MC, (intuitively) MR = MC, so, AC = AR = MR = MC In the long run, costs will be the same â&#x20AC;&#x201C; perfect knowledge New technologies, special operating methods will be available to all Even if high-efficient personnel push down costs, they will demand more pay So in the long run, costs will remain the same

Page 84 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Review:

Perfect Competition: Best prices for consumers (allocatively efficient); productively inefficient (not lowest costs); only Normal profits (no abnormal); no innovation (not enough profit, and, no incentive) Monopoly

The only producer / supplier in an industry – IS the industry Barriers: Government; resources; competitive practices; cost – Natural Monopolies can minimize costs through Economies Of Scale: purchasing; marketing; technical; managerial / specialization; financial. Examples: telephone; rail; water; etc. Some monopolies may be regional or local monopolies Monopolies remain if barriers to entry remain high Can charge higher price (may not maximize profits) Profit likely to be Abnormal (higher than Perfect competition) Efficiencies: Natural monopolies may be productively efficient – lowest possible costs (Other non-natural monopolies may not be productively efficient) Allocatively inefficient – high prices / abnormal profits Productive and Allocative Efficiencies are forms of Static efficiencies Monopolies provide Dynamic efficiency: abnormal profits put into R & D … Other firms may innovate, jumping over monopoly (good for the economy) – process of creative destruction Monopolies can avoid innovation: keep their abnormal profits Market failure –– the government may intervene:  Taxes – no incentive to reduce costs;  Subsidies – to reduce prices, no way to know right price; Page 85 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Price controls – can force down costs, no effect;

 Nationalize / Privatize; Deregulate; Break Up; Reduce barriers to entry The market / industry downward-sloping Demand Curve is the monopolist’s also. Monopolist can only increase sales by reducing price Consumer: monopolists must produce products consumers want, and are willing to pay the monopolist’s price Demand Curve is the Average Revenue curve (D = AR) MR Curve has a steeper slope than the AR Curve Profit maximizing level – where MR = MC Profit maximizing quantity: vertical line from D through MR = MC point Price: horizontal line from D to y axis Abnormal profits: rectangle from D Curve down to AC Curve Area above is “Consumer Surplus” Monopolist can Price Discriminate: some consumers willing to pay more; split market; keep it split without spending too much money  1st Degree Discrimination: different price to each consumer  2nd Degree Discrimination: by volume  3rd Degree Discrimination: can separate consumers into 2 or more groups Other: No Supply Curve Increase output only where Elasticity is ≥ 1 (above mid-point)

Tutorial: P 355, Q 1 P 356, Q 2 Page 86 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Q 0 1 2 3 4 5

TR 0 10 17 21 22 20

10.0 8.5 7.0 5.5 4.0

10 7 4 1 -2

Page 87 of 406

Student Handbook 15 10 AR

0 -5

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Page 88 of 406

Student Handbook

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Page 89 of 406

Student Handbook

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Static Efficiency Static efficiency occurs at a point in time and focuses on how much output can be produced now from a given stock of resources, and whether producers are charging a price to consumers that fairly reflects the cost of the factors used to produce a good or a service.

Dynamic Efficiency Dynamic efficiency occurs over time. It focuses on changes in the degree of consumer choice available in markets together with the quality of goods and services available. For example â&#x20AC;&#x201C; the opening up of the market for parcel deliveries has had an impact on price and output levels (these are changes in static efficiency). However we have noticed the entry of new suppliers into the market, an increase in the level of capital investment and improvements in the quality and reliability of services in local, regional, national and international parcel deliveries â&#x20AC;&#x201C; this represents an improvement in dynamic efficiency. Dynamic efficiency also refers to the rate of technological advancement in a particular market or industry â&#x20AC;&#x201C; this is linked to the investment made by suppliers in new capital and research and development.

Page 90 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Page 91 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Week Begin 16 17 18 19 20 21

Student Handbook

Topic U: Introduction to Macro Economics V. Economic Growth W: Aggregate Demand & Aggregate Supply X: Consumption, Savings & Investment Y: Taxation

Z: Government Expenditure

AA: Redistribution of Income & Wealth AB: Money & Monetary Policy

24 25 26 27

AC: Inflation AD: Unemployment

28 29 30

AF: The Balance of Payments Review FINAL EXAMS

AE: International Trade

5th Edition

Pages

19 – 20

129-142

27 24 – 26 21 – 22 77, 12 78, 33 65 35, 82 31 30, 79 36

185-194 161-184 143-157 523-530 78-83 531-538 231-237 455-463 246-252 567-572 217-223 209-216 539-549 253-257

224-230

Notes to Students:  

All reading should be completed before the Week number listed. The weeks may change, but you will be informed well in advance

Page 92 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

National Economic Performance is a measure of: How the country is doing How do we judge? Four basic areas (over and over again):  Economic Growth – o the rate of change in output – GDP o RECESSION and DEPRESSION (Output shrinks over a long period of time)  Unemployment – o A waste of a resource (scarce) o Economic Growth and Unemployment linked  Inflation – o The ongoing rising of price levels o Prices of what you want to buy go up o The value of what you’ve saved (what you can use it for) falls o Inflation above about 3% starts becoming a problem o Economic Growth (GDP) and Inflation have a relationship  The Current Balance – Exports vs Imports – Surplus / Deficit o Exports: Bring money into country; give up use of products o Imports: Send money out of country; get products o Too much exporting leads to trade surpluses o Too much importing leads to trade deficits Government objectives  Economic growth – high  Unemployment – low  Inflation – low Page 93 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Current Balance – broadly balanced Trade-offs Measuring National Income

The Circular flow of Income – The Two Sector (or Closed) Model A simple diagram to show Nat’l Income 1. Land, Labour and Capital * 2. Rent, wages, interest and profits National Income = “Y” 2 3. Goods and services

Households 1

National Output = “O” 4. Expenditure on goods and services National Expenditure = “E” * = Households own the wealth of the nation

Firms

All three, “Y” “O” and “E” are equal – National Income Equilibrium

The Circular flow of Income – The Five Sector (or Open) Model

The Multiplier Effect – Injections cause larger effect Note about Savings – the Paradox of Thrift Paradox (n) – something that is contrary to common opinion Thrift (n) – managing and saving money

Page 94 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Common opinion says that saving money makes us better off… The Paradox of Thrift is that if everyone saved more, everyone would be worse off, because the leakage would cause the economy to shrink GDP is value of all goods and services produced, at market price, includes:  Indirect taxes – not really a part of output, so value is inflated  Value of imports and exports (GDP more difficult to calculate than above circular model) Gross Value Added (GVA) at basic cost = GDP – indirect taxes + subsidies (Indirect taxes – subsidies = basic price adjustment) Gross National Income (GNP) at market price = GDP + income on overseas investments – income of foreign investments in the UK GDP is most often used to measure National Income Calculations exclude Transfer Payments Gov’t payouts, student loans, second hand sales, etc (no goods or services produced) Reasons to produce National income statistics:  Help economists to understand economies  To judge economic welfare  To forecast changes and plan for them  To compare: over time; and, between countries

Page 95 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Possible errors in calculation:  Too many statistics, too many changes  Some activity may be hidden: avoid tax; illegal; informal  Self produced goods and services  The Public Sector (Government) – nothing bought or sold Problems with comparing National Income over time:  Prices change (Inflation) – must consider real, not nominal prices  Accuracy is always going to be a problem  Presentation – if calculation method changes, need to adjust  Population changes – use “per capita” for comparison  Changes in quality will throw of price comparisons  Consumption vs Investment – Investments will affect standard of living now and in the future. Drawing on investments will increase consumption  Externalities – not measured  Does not take into consideration income distribution Comparing – difficult because of the differences in economies  Purchasing Power Parities (PPP) – a typical basket of goods

Page 96 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Economic Growth is the change in potential output of the economy shown by a shift to the right of the production possibility frontier (PPF). Difficult to measure the productive capacity of an economy. Usually measured by the change in real national income – GDP The Business Cycle Economies rarely operate at full efficiency o Peak, boom o Downturn o Recession, trough, slump, depression o Recovery, expansion Ups and downs in economic performance create the shape of Actual GDP During peaks, economy operates closest to full efficiency, closest to PPF During other times, it is moving toward or away from full efficiency Recovery is not economic growth From Actual GDP, get the “Trend” “The Output Gap” Difference between Actual and Trend GDP Recovery is different from Economic Growth What causes Economic Growth? Increases, or, more efficient use of Inputs Land – includes all resources (economists say increased use of natural resources help developing economies more than developed economies) Page 97 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Labour – increases in labour force:  Demographics – younger workforce (many countries’ workforce aging)  Participation – e.g. women  Immigration – may affect output, might not effect economic welfare (more to share) Capital – must increase to sustain economic growth – investment targeted in growth industries Technological progress – increases economic growth  Decreases average cost of production  Creates new products, which consumers then buy Efficiency – the way resources are used to produce goods and services Markets promote efficiency Arguments for Economic growth  Improved standard of living  Crime reduction  Improved working environment  Improved environment  Reduction / elimination of absolute poverty Arguments against Economic growth  Problems with national income statistics  Negative externalities  Growth unsustainable  Using up of natural resources  Increased inequality Economic Growth – Comparing between countries

Page 98 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

There are problems with comparing. Often, the amount of goods that can be purchased in different countries is very different, because of the following: •

Standard of living

•

Exchange rates of currencies

•

Cultural differences

Examples: •

Levels of education and development

•

Types of housing and relative costs

•

Differences in type of food consumed

•

Different life styles

•

Governments’ control over currencies and exchange rates

Purchasing Power Parity is a method of comparing, based on: •

Availability of goods

•

Demand for goods

•

Differences exchange rates

(Parity: treating something as equal)

Calculation: Where: S = exchange rate of currency 1 to currency 2 P1 = cost of good “x” in currency 1 P2 = cost of good “x” in currency 2 Example: •

A chocolate bar in Canada costs C$1.50

•

If exchange rate between Canada and the US is 1.50 USD/CND

•

The chocolate bar should cost $1.00 in the US

But the example is a bit simple: •

There are differences between what people use in one country compared with another country Page 99 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies •

Student Handbook

So, PPP is based on a “typical” basket of goods purchased by a “typical” household during a “typical” month,

•

In different countries

The Big Mac© Index •

Compares the price of a McDonald’s Big Mac© in different countries

•

An informal way of measuring purchasing power parity

•

Also a way of measuring how much exchange rates affect a product

Human Development Index – A way to measure a country’s development Combines the following aspects: •

Life expectancy

•

Education levels

•

Income

Based on a minimum and maximum for each aspect

Page 100 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Nominal vs. Real Certain economics statistics comparison problems because of inflation Nominal: “in name only” means, as is Real: means, as adjusted for inflation Example: •

Nominal GDP: 8%

•

Inflation Rate: 3%

•

Real GDP: 5%

Page 101 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Aggregate Demand Demand for all goods and services produced in the economy Aggregate Demand Curve: relationship between Price Levels and Real Expenditure (adjusted for inflation). Output adjusted based on Retail Price Index. The higher the price levels, the less that can be purchased. Reminder: Nat’l Income (Y) = Nat’l Output (O) = Nat’l Expenditure (E) E=C+I+G+X-M National Expenditure (E) = Consumption (C) + Investment (I) + Government Spending (G) + Exports minus Imports (X – M) Analysis: anything that causes a change in any of these different components will cause a change in National Expenditure

 Consumption: Influenced by interest. Prices rise, consumers need more money to buy, borrow. Money supply limited, drive price (interest) up. In the end, consumers demand less.  Investment: rise in prices leads to rise in interest rates. Marginal efficiency of capital theory: Investment affected by chg in IR  Government spending affected by political decisions  Exports and imports: o Higher domestic prices = lower X, higher M, AD shifts in o Lower domestic prices = higher X, lower M, AD shifts out Movement along the AD Curve AD falls as prices rise, 1) because increases in IR reduce C and I, and 2) because higher prices reduce X’s and increase M’s

Shifts in AD Curve Come from anything other than changes in price levels Page 102 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Consumption: increases in C, caused by: lower unemployment rate; lower interest rates; rise in stock markets (wealth); new technologies; lower savings; lower income taxes; all lead to shift in AD Curve  Investment: Increased confidence by businesses in the economy; lower interest rates; increased company profits; fall in taxes on company profits; all lead to increases in I, shift in AD Curve  Increase in Government spending will shift AD Curve out  Imports and Exports: Fall in exchange rate – X’s more competitive, M’s less – X’s rise, M’s fall – push AD Curve out The Multiplier Effect Remember the Circular flow of money. Every time money is injected into the economy (i.e. spent on investments, increase in gov’t spending), it pays for goods and services (materials and labour), and so it returns to the households in terms of salaries and profits. Then, it can be turned back to circulate through the economy again. And each time it is re-spent, it adds to the economy. This is The Multiplier. Leakage – every time when money is in the households, some may be taken out of circulation: savings; taxes and imports Shape of the Aggregate Demand Curve: Keynesians – weak link between prices and AD (more steep)  Price levels have little effect on interest rates  IR changes have little effect on consumption and investment  The main determinant of investment is past profits Classical economists – strong link between prices and AD (more flat)

Page 103 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Changes in prices have strong effect on interest rates  Changes in IR strong effect on consumption and investment Shape of AD Curve Keynesians: Weak link between prices and aggregate demand •

Price levels – little effect on IR

•

IR changes – little effect on C and I

•

Main determinant of I is prior profits

The Aggregate Demand Curve is more steep Classicals: Strong link between prices and aggregate demand •

Price levels – strong effect on IR

•

IR changes – Strong effect on C and I

The Aggregate Demand Curve is more flat

Page 104 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Shape of Long Run Aggregate Supply (LRAS) Curve Vertical – limits to capacity and other Factors (LRAS is the PPF) LRAS shifts over time, as quantity and quality of Factors change  Technology, training and education, etc  LRAS Curve shift represents change in PPF Effect of excess Labour and changes to wage (salary) rates Classical Economists – Excess labour causes a drop in wage rate, labour market slowly clears (Adaptive Expectations); New Classicals – Labour market clears quickly (Rational Expectations). Either way, labour market functions perfectly: unemployed tend to get jobs, and the labour market moves back to relative equilibrium Therefore, the LRAS Curve is vertical Keynesian Economists – wage rates tend not to fall: highly skilled workers want to keep their high wages; labour unions fight wage cuts; minimum wage laws; unemployment benefits; mobility of workforce. So the unemployed remain out of work until some other force increases demand for labour. Moderate Keynesians – employers may temporarily push down wage rates, then wage rates will recover. So, according to Keynesians – The market will not clear (“sticky downwards”). At full employment, LRAS Curve is vertical. If mass unemployment, increased output not likely to lead to increases in price levels, so at low levels of output, LRAS Curve horizontal. Finally, LRAS slowly curves up to connect.

Page 105 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Long Run Equilibrium Output Main issue is difference in view of the labour market, and the effect on long run equilibrium output Classical Economists •

rises in unemployment lead to quick wage cuts

•

pushes output back to full employment levels

Keynesian Economists •

unemployed do not reduce wage expectations

•

remain out of work much longer

Classical Economists Increase in Aggregate Demand Economy moves to disequilibrium Temporary over-employment & over-output SRAS shifts left due to increased costs New equilibrium, higher prices

Increase in Aggregate Supply

Page 106 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Creates increased output Causes price levels to drop

Keynesian Economists Increase in Aggregate Demand •

All periods of dis-equilibrium depend on the situation in the economy,

•

specifically unemployment, and

•

the effect of unemployment on demand for goods and services (AD)

If at full employment, Shift causes rise in prices only, no output change

If in mass unemployment Shift increases output with no effect on prices

Page 107 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

If some unemployment Shift causes rising prices and increased output

Increase in Long Run Aggregate Supply If at full employment Shift causes large increase in output, and big drop in prices

If at mass unemployment Shift will have no effect at all on the economy

Page 108 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

If some unemployment Shift causes output to increase, and small drop in prices

Increases in both Aggregate Demand and Aggregate Supply Increased Investment causes AD to shift outward, Also shifts AS out Causes increased output with little effect on prices

Page 109 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Consumption = spend on consumer goods/services; Consumer goods include both Durable and Non-durable goods Marginal Propensity to Consume = measure of the change in C Change in Consumption MPC = = consumption Change in Income Y For entire economy, MPC likely positive, less than 1 (will always save). Average Propensity to Consume = average amount spent on Consumption Income

APC = consumption

C Y

In developed countries, generally less than 1 (will always save) Consumption Function = relationship between consumption and the determinants of consumption: Disposable Income, wealth, inflation, interest rate, expectations, age. Main determinant is Disposable Income. If Disposable Income rises, econ theory suggests consumption will rise. Wealth of household – 2 parts: Physical wealth; monetary wealth If household wealth rises, consumption will likely increase: Wealth Effect Wealth changes (short term) – 2 ways:  house prices;  stock values Inflation (rising of general price levels) has 2 effects on consumption: A. Speed up purchases because prices will be higher (uses up savings) B. Save more – inflation tends to reduce value of current wealth/savings Page 110 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Overall, inflation tends to reduce consumption. The negative effect of “B” is greater than the positive effect of “A”. Interest Rate and Credit (ability to borrow) If interest rate rises: home mortgage payments rise; and, purchase of durable goods (by credit) reduce – a fall in consumption Besides effect of IR on credit, government can restrict borrowing levels. Consumer Expectations: If Consumers Expect: Effect on consumption: Increased prices Spend sooner – increase consumption Increased real income Spend more – increase consumption “Booming” economy leads to increased consumption “Harsher” economy leads to decreased consumption Age: Young, old tend to consume more of income, middle-aged save

Page 111 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Saving: what is not spent – put in bank, invested, added to cash Savings: a flow concept; the accumulation of prior saving Saving Income Change in Saving Change in Income

APS = MPS =

= =

S Y S Y

Note: APC + APS = 1 Increase in savings reduces consumption, increases investment Savings Function: Determinants = Disposable Income, wealth, inflation, interest rate, expectations, age (similar to consumption) Higher earners have lower MPC’s Economic Theories on consumption and savings Keynes observed there is a primary relationship between current income and current consumption; most important: 1) short-term income; 2) availability of credit. Consumption function relatively stable; changes in wealth & IR have little effect. Based on these, Keynes believed: Increased wealth leads to stagnant economy. Redistributing income from rich to poor would increase total consumption. This has been proven wrong. APS in the West is typically very low – income has little effect on savings Life Cycle Hypothesis: Current consumption based on likely income over lifetime, not current income, e.g. manual worker vs. professional. Permanent Income Hypothesis (Milton Friedman): studied average income over lifetime, called Permanent income. Influences: Rise in wealth will increase C over life; Rise in IR lowers value of investments and wealth resulting in a fall in C over life, and, Rise in IR makes future income less valuable, lowers Permanent Income. Page 112 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Lifetime APC is 1 â&#x20AC;&#x201C; in other words, we spend everything!

Page 113 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Investment: (different from savings) Investment is the purchase of machines and equipment (capital) used to create goods and services (by business) – to create profit / return Gross Investment – the cost of all investments Investments wears down as used – Depreciation or capital consumption Net Investment – the value of investments after deducting Depreciation The rate of return on investment: Marginal Efficiency of Capital (MEC) Investment level depends on IR and MEC – more/more, less/less MEC % 20 15 10 5

Planned Investment 4 8 12 16

20 15

Planned Investment Schedule (Demand)

10 5 0 0

Investment

MEC Theory: Planned investment rises when IR falls, because …. No matter whether Investment from Retained Profits / Borrowed Factors that shift the Investment Demand Schedule: Cost of capital; Technology; Expectations; Gov’t policy Table 32.3, P 216

Year 1 2 3 4 5 6

Output 10 10 12 15 15 14

Page 114 of 406

# Machines 10 10 12 15 15 14

Invest 0 0 2 3 0 0

Ch Output Ch Invest 0% 20% 25% 0% 0%

Dr Stephen Byrd PhD MBA FICM FITOL

50%

Economic Studies

Student Handbook

The Accelerator Theory – planned Investment changes with levels of income or profits, not with interest rate. And, change in Investment is greater than change in income The Accelerator Theory: It = a (Yt – Yt-1) It = investment in any year “t”; a = “Capital Output Ratio”; Yt – Yt-1 = change in real income during year “t”, so if capital of $20 is needed to produce $4 in income, Capital Output ratio is 5 Accelerator model has limitations – simplistic:  Excess capacity, whether due to slow economic times, or for other reasons may make Capital Output ratio higher  New technologies can change output levels  Expectations can affect planned investment Still, evidence suggests investment linked to past changes in income. Most investment comes from retained profits; companies don’t necessarily consider interest. So, investment may depend more on levels of retained profits, and, new capital technologies.

Page 115 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Fiscal Policy: Taxation and Government Expenditure Taxation The Canons (general rules) of taxation  Cost of collection should be low  Amount to pay and when should be relatively clear  The method of payment and the timing should be convenient  Should be levied according to the ability to pay Regarding economic efficiency, economists argue that a “good” tax should:  Minimize losses in economic efficiency, or even increase econ efficiency  Fit together (compatible) with other foreign tax systems  Automatically adjust to changes in price levels Governments collect taxes:  To pay for government expenditures  To connect costs to externalities  To manage the economy / macroeconomics  To redistribute income Taxation Methods Direct Taxes – “levied” directly on individuals or organizations Indirect Taxes – placed on goods or services Behaviour of Taxes Progressive: AT increases as Income increases Regressive: AT decreases as Income increases Proportional: AT remains the same as Income increases Types of Taxes Page 116 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Income Tax: Personal earnings; marginal tax rates. Progressive. Pay As You Earn (PAYE) system. To Consolidated Fund,

£0 £4,895 Pers Allow. £4,896 £6,985 10% £6,986 £37,295 22% £37,296 40%

pays Gov’t expenditures National Insurance: Separate Fund, pays pensions, Jobseekers Allowance and a part of

£0 £84 £646

£83 £645

0% 11% 1%

£10,000 £1.5 mil

0% 19% 30%

National Health Service. Mildly progressive up to 645, Regressive above Corporation Tax: On company’s profits. Credits reduce tax. Progressive.

£0 £10,000 £1.5 mil

Capital Gains Tax: On gains on sale of Assets (excl. most goods & services, personal residence). Added to Personal earnings, taxed like Income Tax. Inheritance Tax: On value of assets left at death. 1st 275,000 passes tax free, thereafter taxed at 40%. Progressive. Excise Duties: Taxes levied on fuel, alcohol, tobacco and betting. Based on volume (quantity) sold. Regressive. Value Added Tax (VAT): A tax on expenditure. Different rates. Essentials like food, water, children’s clothing, books, newspapers, publications, public transport are all tax exempt. Domestic fuel (gas, electric, heating oil and coal) taxed at 5%. All other goods at 17.5%.

Page 117 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Council Tax: On domestic properties (residences) by local authorities. Properties are assessed (valued), then divided into “bands” A thru H. A is lowest rate, H is highest. Local authority then sets rates, but differences between rates fixed, highest = 3 times lowest. Regressive. Business Rates: Local authority tax on business property. See textbook for more complete analysis of all taxes

Taxation, Inefficiency and Inequality  VAT and excise duties decrease supply  Income tax leads to fall in labour  Corporation tax discourages entrepreneurs In some cases, taxes may offset the cost of externalities (sin taxes) But, in general, taxes tend to distort markets Taxes lead to economic inefficiency because w/tax, marginal cost ≠ price (so many cases of econ inefficiency make it difficult to judge taxes)

Page 118 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Goods and Services Provided by the State Produced by:

Paid for by:

Examples:

Public Sector

Public Libraries, Hospitals

Private Sector Public Sector

Public Sector

Doctors, School buildings, etc.

Private Sector Postal service

Government Spending – factors that suggest the best/optimal level:  Public, Merit goods: defense, law & order, police, education  More efficient: health care (economies of scale, drive down costs)  Equity: health care, elderly (high costs, low funds); education – help poor  Taxation level: Too high will be a disincentive, pushing businesses out In the case where State spending too much, various steps to downsize:  Privatization – Transfers mainly from 3 above  Outsourcing – buying from private sector, i.e. construction, schooling  Create Internal Market within the public sector  Create partnerships between public and private sectors  Stop funding certain things – transfers from 2 above Choosing between Public Sector and Private Sector  Productive efficiency – economies of scale  However, as we’ve learned, may also suffer from diseconomies of scale  State services tend to lack competition, choice, which can also lead to inefficiency Page 119 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Prices of services in the public sector are supported by tax revenue. Private sector pricing may make too expensive Government Borrowing / Deficit Spending: pressure to spend more and tax less. But high deficits can not be sustained in the long run Fiscal Policy and the Economy: A decrease in Taxation or an increase in Government Spending:  Will shift Aggregate Demand out  May shift Aggregate Supply out if spent on Investments  Increase Economic Growth  Decrease Unemployment  May cause Inflation  May cause Exports to reduce, Imports to increase (a net leakage) Trends in public spending in the UK  1900-1960’s – increased: defence, rebuilding  1960-1975 – increased: the welfare state  1975-1990 – decreased: Conservative gov’t  1990-1999 – recession in 1990-1992; newly elected gov’t realized public spending couldn’t be frozen forever; overall, decreased slightly

Page 120 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Redistribution of Income & Wealth In a Market Economy, Distribution of income and wealth not likely to be efficient or equitable Absolute poverty; relative poverty LORENZ CURVE Handout Law of Diminishing Marginal Utility â&#x20AC;&#x201C; the additional satisfaction from consuming any good decreases the more the good is consumed. Suggests: redistributing from rich to poor would increase combined utility by all. (ÂŁ1 means more to poor than rich) Methods of Redistribution: Taxation (Progressive / Proportional / Regressive): the more progressive, the more redistributive, and links tax with ability to pay Government Spending: social security; national insurance; (to target needs) housing grants; distribute clothing; etc. Legislation: minimum wages; equal pay legislation; sick pay, pensions, medical insurance; retraining Costs of Redistribution: government intervention benefits some people, but not everyone. Taxpayers lose use of funds paid to government. Classical economists: redistribution has a heavy cost: Taxes = disincentive; unemployment benefits & equal employment laws = higher wages = less employed; high taxes = flight of capital; etc. Free market economists: big loss of economic growth because of taxation and redistribution Supply side economists: the gap between poor and rich should be increased Page 121 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Poor would be better off if economy could grow in hands of wealthy, and that economic benefits would “trickle down” to them.

Page 122 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Measuring Income Distribution It is possible to measure how equally or unequally a price system rations by looking at the distribution of income. The table below shows that during 1978, 20% of households in the United States (groups of people living together, usually families, or single people if they live alone) had total money incomes of less than $6,391. These people received only 4.3% of the total income that households earned. Twenty percent of households earned between $6,391 and $11,955, and these households earned 10.3% of the total income earned. The rest of the table can be interpreted in the same way.

Percent Distribution of Aggregate Household Income in 1978, by Fifths of Households Households

Percent of Income

Lowest Fifth (under $6391)

4.3

Second Fifth ($6392 - $11955)

10.3

Third Fifth ($11956 - $18122)

16.9

Fourth Fifth ($18122 - $26334)

24.7

Top Fifth ($26335 and over)

43.9

Source: U.S. Bureau of Census, Current Population Reports, P-60, No. 121, "Money Income in 1978 of Households in the United States," Washington, D.C.: U.S. Government Printing Office, 1980. Data taken from cover. (Data are before taxes.)

The information in the table can be made into a Lorenz curve such as that shown below. The further the Lorenz curve lies below the line of equality, the more unequal is the distribution of income.

Page 123 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

All economic statistics have problems, and the Lorenz curve and the numbers from which it is constructed are no exceptions. Problems come from two sources: do the numbers actually measure what they are supposed to measure, and are the numbers accurate? Income distribution is intended to tell us about the rich and the poor, or about how much discrimination exists in a system of price rationing. In a system of price rationing, however, differences in the ability to use income wisely also determine how much discrimination there is. If those who receive the most income, for example, also tend to be the most capable at using that income, then the picture that the Lorenz curve shows will understate the actual amount of inequality. If rationing is not done solely by price, but by other methods as well, then looking at income data may be meaningless. In the United States, most rationing is done with price, but not all. For example, the purpose of public housing and food stamps is to prevent rationing by price. Both of these items are ignored in the data in the table. Also, one should be cautious when comparing income distributions among countries because their rationing systems can be very different. For example, comparisons of income distribution between the United States and the Soviet Union were not meaningful--although economists sometimes made them--because the Soviet Union not only relied heavily on queuing, but those with special status, such as party members, had access to stores denied to the ordinary citizen. Households differ in size and average age, but these differences are not reflected in the table above. Neither is the fact that the amount of time over which income is earned affects the shape of the Lorenz curve. Larger households tend to earn more than smaller households. People in their thirties tend to earn more than people in their twenties. Households with four or five members, with more than one person working, and whose working members are between 35 and 55 tend to earn more than other households. In a paper published in the American Economic Review in September of 1975, Morton Paglin concluded that ignoring the influence of age on earnings overstates inequality by 50%. There is also variability from year to year in how much households earn. Some people appear poor because they had an unusually bad year, and others will seem rich because they had an unusually good year. The shorter the period over which income is measured, Page 124 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

the more unequal the distribution appears. Thus, if income were measured over a decade, the distribution would be more equal than any of the yearly distributions. The other source of problems is in making the initial measurements. The data shown in the table were obtained from questionnaires given a sample of 56,000 households. Not all of these households gave correct answers. The publication containing these data had a lengthy discussion of measurement problems, but when other people use these data in a book or an article or an argument, that lengthy discussion often gets left out (as it does here).1 Despite the measuring problems, it is clear that a system of price rationing will distribute goods less equally than will alternative systems such as those using queuing or coupons. Many people consider this inequality a major shortcoming of a market economy, and most critics of market systems emphasize this characteristic. Defenders of market systems, on the other hand, tend to downplay rationing issues, and instead focus on the ability of a market economy to coordinate information and incentives. These are tasks that markets seem to perform very well in comparison to the ways other systems do them.

Page 125 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Money Characteristics of Money  A medium of exchange  A unit of account

Check your book for definitions of these

 A store of value  A standard for deferred payment Forms of Money  Cash

 Money in current accounts (in bank, can be withdrawn as cash)  Near monies – money in “deposit” accounts  Non-money financial assets (all assets that can be converted into money, i.e. houses, cars, shares) Monetary Policy Interest rate (IR): price of money lenders / savers expect to pay / receive  Nominal Interest Rate – the rate offered by banks  Real Interest Rate – the Nominal Interest Rate adjusted for inflation In the UK, the Central Bank sets interest rates Bank Base rate – basic rate upon which all other interest rates are based Changing IR can to some extent control: the amount of credit and borrowing from banks and financial institutions; and therefore the amount of money circulating in the economy Monetary Policy objectives in macroeconomics: Monetary Policy is the primary method used to control Inflation  Inflation comes together with economic growth

Page 126 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Raising the Interest will only moderate inflation – rarely reduce it Raising Interest Rate causes a drop in Aggregate Demand, as follows:  Less purchases of Consumer durable goods  Housing market – drop in purchases of homes  Wealth effects – drop in value of assets / wealth  lower spending  Government Bonds – drop in Bond prices  Savings – increase in savings  Investment – drop in investment in projects  Unemployment – Rising IR tends to lead to drop in output, which would tend to lead to rise in unemployment  Exchange Rate / Balance of payments: increase in local currency’s value  an increase in exchange rate  increase in price of local goods  less exports, more imports; less exports = lower AD  Therefore, a decrease in Economic Growth Increase in IR called “Tightening” / Dropping IR is called “Loosening” Classical Economics (LRAS is vertical): a rise in IR / drop in AD causes a drop in prices, no effect on output Keynesian – if close to full employment, a rise in IR lowers prices, but also creates a small effect on output and unemployment; if closer to mass unemployment, a rise in IR has a smaller effect on prices, mainly lowers output and increases unemployment Operations of Monetary Policy IR affects the money supply – they’re linked (market diagram for money) Page 127 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Besides changing IR, government can take steps to directly affect money supply:  Open Market Operations – sell, buy government debt (bonds)  Reserve Asset Rates – the % banks must hold (explain, include the Credit Multiplier)  Other Rules and regulations that can influence other variables, such as home sales and purchases Money Supply and the Budget Deficit  If Government borrows from the public (sells bonds) to finance the Public Sector Net Cash Requirement (PSNCR), this is just borrowing from the public to spend, so no effect on money supply, just IR  Print more money / sell gov’t debt to banking sector. Gov’t spending goes into the public, in effect increasing the money supply Limitations of Monetary Policy  Money supply not always clearly measurable  Reliable, timely data not easy to produce  The links between IR, money supply not clear  Effects often take time to work through the economy  Unexpected events

Page 128 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Inflation: rise in general price levels over a long period of time Deflation: lowering in general prices, or, slow down in economic output Measured by the “Retail Price Index” – a basket of goods, weighted average, subject to inaccuracy ... Problems during inflationary periods:  Consumers unclear what’s a fair price “Shoe Leather costs”  Less cash (more in savings) (IR higher, opportunity cost), difficult to plan  “Menu Costs” prices constantly changing (e.g. restaurants)  “Redistributional Costs” income & wealth, may result in transfer from borrowers to lenders; savers lose if Inflation > Nominal IR  Creates Unemployment and lowers Growth – increases costs of production, reduces investment – which decreases the likeliness of long-term growth Anticipated/Unanticipated: Mostly unanticipated, difficult for cons. to plan Causes of Inflation: Imported – Increases in prices of imported goods Demand-Pull – Too much spending in relation to output shifts AD. Use AD/LRAS curves to show Cost-Push – Changes in costs (supply side): any cost (wages, salaries; imports; profits; taxes) rises, pushes up SRAS, prices rise; Workers react by demanding higher salary, prices go up again; go right into spiraling effect Both these are “Keynesian” theories

Page 129 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

“Monetarists”: inflation is Demand-Pull; sustained inflation caused by increases in money supply (don’t believe in Cost-Push) Increase in Money Supply  rise in AD, directly and indirectly (Multiplier) The Fisher formulation of the quantity theory of money MV=PT M = Money Supply; V = Velocity, P = Prices; T = number of transactions Increase in M  immediate fall in V, then additional money begins to be spent  gradual increase in Y (income), V increases back to standard – gradual rise leads to Demand-Pull inflation (rise in prices, P) – P rising  Real Income come back down (adj for Inflation) V & Y return to equilibrium, P remains at higher level Monetary Transmission Mechanism (see textbook) Increase in MS  increase in AD  rise in SRAS – Shift back to LRAS. (New) Consider where costs rise (shift SRAS up) If Price levels increase when economy is below full employment – Stagflation. Workers may demand higher wages, but if MS is fixed, may not come – workers stay out of work for some time, then economy will begin to return to full employment Counter-Inflation policy: Monetary Policy: Raise IR = less spent on durable, investment; reduce wealth – lower stocks value, homes (mortgage); rise exchange rate; increase saving

This only happens if economic growth slows or reduces (not popular!) Fiscal Policy: Government spending: If Demand-Pull, government reduce spending, AD. If Cost-Push, government can: reduce (or not increase) indirect taxes; reduce (or not increase) prices in government controlled sectors (rail, post, etc.); reduce corporate taxes –– argued these steps only change money supply Exchange Rate Policy: controlling exchange rate directly or through changes in Interest Rate can affect Cost-Push Inflation Prices and Incomes Policies: To directly control / freeze prices & wages – argued this can work for some time (short) Inflation / Deflation Retail Price Index / Consumer Price Index – be familiar with how it’s calculated, and, the possibilities of inaccuracy Be familiar with the effects of inflation, and, anticipated and unanticipated Page 130 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Labour market (diagram) & Equilibrium – As more enter the market the marginal revenue product of labour declines (downward slope) Unemployment when labour market is in disequilibrium:

Cyclical / Demand-Deficient (Keynesian) – demand falls Negative output gap Classical / Real Wage – wages above equilibrium and factors keep them from going back down (“sticky downward”). Market fails to clear because: u/e benefits too high; minimum wages; unions. Unemployment when labour market is in equilibrium: Frictional – workers lose jobs, spend a short time looking for work. Structural – economy doesn’t provide enough jobs for the labour supply within a labour market: regional; sectoral; technological Seasonal – based on seasonal work Cyclical U/E is Involuntary – no choice – boom time, no cyclical u/e All other u/e is Voluntary – workers refuse opportunities for jobs. The economy is at “full employment” when there is no involuntary u/e The natural rate of u/e is the

Real Wage Rate

Workers S (Labour Force)

percentage of voluntarily unemployed EF = Unemployment (natural level

of unemployment) So, Natural rate of u/e = EF / OE

D (Firms) 0

Employment

Classicals: Short run u/e temporary, wages will fall, Page 131 of 406

Dr Stephen Byrd PhD MBA FICM FITOL Prices /

SRAS2

Economic Studies

Student Handbook

labour market will move back to equilibrium; Long run – unemployment will be Voluntary. Inflation & Unemployment using AS/AD: AD shifts out, causing rise in prices Costs will also rise, incl wages

Shift SRAS up New Equilibrium 

higher prices

Page 132 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Real Nat’l Income

Economic Studies

Student Handbook

The Phillips Curve: Relationship between unemployment and inflation Money Illusion: Workers not knowing about inflation believe prices are stable – won’t include inflation in their pay increase requests Term: “Money Wage Rate” =

Δ MWR (Inflation)

actual wages, not adjusted for inflation Unemployment: those not working Starting at 0, if gov’t increases AD, move up P Curve, lower 0

u/e, but, with

inflation. If workers don’t know there is inflation, moves back to A. If they know, they will demand more pay, stay unemployed, push P Curve out. LRPC is vertical. Increase in AD will push PC out. Natural rate of u/e = NAIRU (Non-Accelerating Inflation Rate of Unemployment) – u/e rate sustained with or without change in inflation Employment tends back to natural rate of u/e The Phillips Curve is why there is a “curve” in the Keynesian LRAS Curve Keynesians: believe that in high u/e times, it takes a long time for the labour market to “clear”, so they don’t believe in natural rate of u/e Page 133 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Unemployment

Economic Studies

Student Handbook

Neo Classicals: argue that people can see inflation coming, and immediately adapt (Theory of Rational Expectations) – SR Phillips Curve doesn’t exist. Policy steps Government can take to deal with Unemployment For Cyclical u/e, use demand policies (increase AD), but watch for inflation Classical economists (vertical LRAS) say economy will always return to full employment, so demand policies not necessary and may be damaging For other types of unemployment (voluntary), use supply side policies: Classical (real wage) u/e: Keynesians say cut unemployment benefits; pay companies to hire unemployed; give other benefits to low-wage workers. Classicals agree, and also add reducing Union power, reducing minimum wages Frictional (short term) – u/e services; reduce u/e benefits Structural: If Regional: Keynesians say government should use financial incentives for businesses to relocate; Classicals say leave it to free market forces (cheap land, labour costs); If Industrial: Keynesians say retrain workers; Classicals say lower benefits & redundancies; (some of these measures will also help frictional u/e) Another solution – reduce natural rate of u/e: increase growth rate of whole economy (assuming this will increase number of jobs): Keynesians suggest increasing investment in physical and human capital. Classicals suggest reducing tax rates; privatizing; increasing competition; deregulating.

Page 134 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Page 135 of 406

Student Handbook

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Page 136 of 406

Student Handbook

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Terms of Trade: the ratio of export prices to import prices, or, costs, or â&#x20AC;Ś Example: Â˝ resources allocated each Germany Italy Total Output

Freezers

Dishwashers

1,000

500

800

200

1,800

700

Germany produces more of both than Italy. But Italy is closer to Germany in producing Freezers than Dishwashers. Opportunity costs of producing Freezers: Germany

1 / 2 Dishwasher

Italy

1 / 4 Dishwasher

Therefore, Italy should specialize in producing Freezers Output after Specialization

Freezers

Dishwashers

400

800

Italy

1,600

Total Output

2,000

800

Germany

Source: www.tutor2u.com

Page 137 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

International Markets Availability, Price and Product Differentiation lead to International Trade Economic Theories on Int’l Trade: A. Smith Absolute Advantage – based on lower production cost (labour). David Ricardo Relative / Comparative Advantage (early 1800’s) even if one country produces products more cheaply; countries may be better off to specialize and trade (overall economic efficiency) – countries will benefit from trade when comparative cost of production are different Example of the value of trade:

Tom Hank

Fish Crabs Fish Crabs

Production Possibility Fish Crabs 40 -0-030 10 -0-020

Produces & Consumes 28 9 6 8

 Tom has an absolute advantage on both products  Evaluate their opportunity costs: Tom Hank 1 Fish 3/4 crab 2 crabs 1 Crab 4/3 fish 1/2 fish  Both can benefit from specializing and trading  Tom should catch fish, and Hank should catch crabs Produces & Consumes Specializing Trading Fish 28 40 fish -10 fish Tom Crabs 9 0 crabs +10 crabs Fish 6 0 fish +10 fish Hank Crabs 8 20 crabs -10 crabs Assumptions of Theory of Comparative Advantage Page 138 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Trade & Consume 30 10 10 10

Economic Studies

Student Handbook

 No transport costs (even with, may still make sense)  No Economies of Scale (EofS enhance this theory)  Two economies, 2 goods  Traded goods are homogeneous  Factors of production perfectly mobile  No tariffs or other barriers  Perfect knowledge Non-Price theory of trade For non-homogeneous goods, other things help determine trading practices, such as: design, reliability, availability, image, etc. Trade Policy Benefits of Free Trade  Efficiencies through theory of Comparative Advantage  Economies of scale  Greater choices on what to buy  Seems to enhance competition Globalisation – Integration of world economies Benefits Disadvantages Reduce prices / more affordable Put many local workers out of work Give poorer countries Destroying the environment development Reasons to justify protection  “Infant Industries” – give time to grow domestically (size, market, econ of scale, learning curve, etc) then open to foreign. But gov’t must be able to correctly pick the industries that will grow well  Protect / preserve jobs – ends up giving consumers less choices; foreign countries can retaliate, leading to further loss of choice for consumers Page 139 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

 Dumping – some countries selling goods for export at below their cost  Unfair competition (labour) – a comparative advantage (for consumers)  Terms of Trade – if a country demands too much of an imported product, gov’t could impose a tariff. Economy would lose because consumers would pay higher price. In addition, exporting country would also lose, as tariff would still restrict trade.  Others: Defence, protect populations, protect from something unsafe, etc

Protectionism: acts by

SDomestic

countries (gov’t or private) to protect industry that

World P

restrict trade

SWorld+Tariff SWorld

Methods of protectionism: Tariff: Tax (Duty) imported good

Effects of tariff: Increase Price, increase amount sold by local producers Quota: limit on the quantity

SDomestic

that can be imported. Reduced imports raise

SWorld

prices, increasing domestic

Page 140 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

supply (shaded area is windfall) Other Protection: Voluntary Export Agreements â&#x20AC;&#x201C; enforced by importers; non-competitive purchasing by governments; safety standards; etc. In all cases, economists would argue in favour of other methods

Page 141 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Balance of Payments Acct – record financial dealings between countries  Current Account – exchange of goods and services  Capital Account – flows of monetary assets re savings, investments, etc Balance of Payments will always be in balance. Since cash is not exchanged, shifts in Current Accounts are financed by loans to or from the Capital Accounts Current Account divided into 2 groups:  Visibles: trade in goods: Exports are positive, Imports are negative. Difference between visible exports and visible imports = Balance of Trade  Invisibles: Trade in services, investment income, etc. Current account is combination of these two Small, short term Current Account Deficits or Surpluses not a problem Large Current Account Deficits over the long term  Country or its people spend too much on foreign-produced goods  If too much, too long, doubts repayment, foreign lenders stop loaning  Less goods available – imports stop, domestic goods exported  If economy strong, foreign institutions won’t stop, country can benefit Large Current Account Surpluses over the long term  Can be seen as sign of economic strength … but they can:  Reduce what’s available for consumption within the country  Can cause problems between trading nations Page 142 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Exchange Rate Policy – ways to affect the Exchange Rate Fixed Exchange Rate system – one currency pegged to another Free or Floating Exchange Rate Policy – free market forces … Interest Rate – increase will tend to increase Exchange Rate Gold and Foreign Currency Reserves – Central bank has them, can sell off to attract more pounds, increase value of pound, or vise versa Either of these steps will only ever make small changes. Review the Macroeconomic effect of change in exchange rates: If Value Increases Inflation Moderate or reduce  Some imports reduce £  Decrease in AD Economic SR lower domestic Growth output and investment, lower AD Unemployment Rise because of low AD Current Balance Decrease Exports, Increase Imports, Reduce the current Balance

If Value Decreases May increase  Imports & Export £ rise  Increase in AD SR higher domestic output and investment, rise AD Lower as AD increases Increase Exports, Decrease Imports, Increase the current Balance

Theory on exchange rate policy and reducing trade deficits MARSHALL LERNER Condition: Depreciation / Devaluation of currency…  If combined PED of X and M > 1 …  Results in improvement of trade deficit  If combined PED of X and M < 1 …  Results in worsening of trade deficit Example of MARSHALL LERNER Condition: Page 143 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Assume:

Student Handbook

Exchange rate: £1 = $2 Price

Demand

Revenue

Bal. of Trade

Exports

£100

550

£55,000

Imports

£100

600

£60,000

Assume:

–£5,000

Depreciate currency to £1 = $1.80 (10%) PED

Price

Demand

Revenue

Bal. of Trade

Exports

0.6

£100

583

£58,300

Imports

0.8

£110

552

£60,720

1.4

Marshall Lerner Effect satisfied, Deficit reduces

Exports

0.4

£100

572

£57,200

Imports

0.5

£110

570

£62,700

0.9

–£2,420

–£5,500

Marshall Lerner Effect not satisfied, Deficit rises

Page 144 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Changes in any of these will cause Demand Curve to shift, either inward or outward

 Changes in laws CONSUMER SURPLUS The area above price level and to the left of the Demand Curve. The amount that consumers who were willing to spend more, don’t have to spend. The benefit to consumers of having markets. (The more quantities are available, the less value consumers place on it.) Supply: The quantity of goods or services that will be produced and sold over a period of time at any given price Law of Supply: If all else remains the same, as prices rise, producers will supply more, and, if prices go down, producers will supply less The Supply Curve – diagram Page 145 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Upward sloping – positive relationship: as price increases, quantity supplied increases, and, vise versa Supply of entire Markets shown the same way Market Supply: add together all Individual Supply Curves Determinants of Supply (factors that affect Supply)  Price (movement along the demand curve)  Costs of Production  Price of other goods

Changes in any of these will cause Supply Curve to shift, either inward or outward

 Technology  Producers’ Goals  Government legislation  Future expectations PRODUCER SURPLUS

The area below price level and to the left of the Supply Curve. The low prices that producers who were willing to sell, don’t have to sell so low. The benefit to producers of having markets (some firms receive a higher price than the lowest price they were willing to supply the market) Price Determination in the Market Buyers and sellers come together to buy and sell goods, and the Market Price is “struck” EQUILIBRIUM PRICE is where Demand equals Supply – where the Demand Curve and the Supply Curve meet. EXCESS DEMAND: Market Price below Equilibrium price, Demand > Supply EXCESS SUPPLY: Market Price above Equilibrium price, Demand < Supply Changes in Demand and Supply:

Page 146 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Changes in prices lead to movement along the Demand or Supply Curves. Changes in any other factors will lead to shifts in the Demand Curve or Supply Curve. These shifts will create a new Equilibrium Price Market Clearing Price: Equilibrium price. For many different reasons, Market Price very often does not equal Equilibrium Price – there could be excess Demand or excess Supply at any time. Stable equilibrium – where FREE MARKET FORCES push prices to equilibrium point. Unstable equilibrium – in some cases, FREE MARKET FORCES may not be strong enough to push price to equilibrium.

Page 147 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Tutorial Page 25, Question 2 Price 20 16 12 8 4 10

(a) (c) 50 Quantity (millions)

400

(a,A) 500 600

HW for Tuesday: P. 27, Q 6

Price 500 400 300 200 100

(a,B)

100 (millions) Price 100 200 300 400 500

A 500 400 300 200 100

200

B 250 230 210 190 170

300

C 750 700 650 600 550

Page 148 of 406

Ttl 1,500 1,330 1,160 990 820

D 500 500 500 500 500

Ttl 2,000 1,830 1,660 1,490 1,320

(a,C) 700

B -250 -230 -210 -190 -170

800

Quantity

Ttl 1,750 1,600 1,450 1,300 1,150

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

P. 34, Q. 2 (a) A Supply Curve shift to the left (a reduction in Supply) indicates a reduction in earnings. With less profits, producers will tend to be less willing to supply goods and services. (b) (i) furthest: 1996, 2002,1994; (ii) least far: 1984, 1978, 1972, 1975 HW for Thursday: P. 36, Q. 5 Price 5 4 3 2 1

(a) 10 15 Quantity

Price 1 2 3 4 5

A 10 12 14 16 18

B 2 5 8 11 14

C 0 3 6 9 12

Ttl 12 20 28 36 44

Ttl 17 25 33 41 49

(b)(i) 1 = 12; (ii) 3.5 = 32 (d) Greater productive efficiency would lead to greater production at lower costs. This would shift the supply curve to the right and downwards

HW for Thursday: P. 42, Q. 1 Price S

30 20 10

10 20 30 40 50 60 70 (b) Equilibrium price is 20 (c) (i) Excess demand below 20; (ii) Excess supply above 20

Quantity

(d) (i) 10 = shortage; (ii) 40 = glut; (iii) 22 = glut; (iv) 18 = shortage; (v) equilibrium

Page 149 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Interrelationships in the Market How events in 1 market lead to changes in another COMPETITIVE DEMAND / Substitute Goods – Goods that replace each other Examples: rice and noodles; beef and pork An increase in price of one good “C” leads to a decrease in quantity demanded for that good (movement along D). This leads to an increase in demand for the substitute good “D” (D shifts out) and an increase in price (movement along S)

Page 150 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Producers will increase supply of the resource, leading to an increase in supply of the other product “H” (S shifts out), and price will decrease (movement along D)

Elasticities Elasticity = Effect (responsiveness) on factor “Y” by a change in factor “X” Price Elasticity of Demand (PED) = Effect on quantity demanded by change in price, or, responsiveness of quantity demanded to price changes

Elastic = Change in Price causes large change in Quantity Demanded Inelastic = Change in Price causes small change in Quantity Demanded Price Elasticity of Demand =

Percentage change in quantity Percentage change in price

Alternative Calculation (percentage not known)

PED = OR

Quantity Quantity Price Quantity

÷ X

Price Price Quantity Price

PED Value Elasticity -0Perfect Inelasticity 0–1 1 1–∞ ∞

Quantity Quantity

Price Price

Response to Change in Price No response in quantity demanded

Inelastic

Less than proportionate response

Unitary Elasticity

%  in Q demanded = %  in Price

Elastic

More than proportionate response

Perfect Elasticity

Consumers demand ∞ Q at that price

Determinants of PED: Page 152 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies 9.

Student Handbook

10.

11.

Necessities tend to have lower PED

12.

Low-priced goods tend to have lower PED

13.

Luxury goods tend to have higher PED

14.

High-priced goods tend to have higher PED

Page 153 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

IMPORTANT: PED along straight Demand curves can be different!

Point A is Perfectly Elastic Point C is Perfectly Inelastic

Distance from “B” to the Quantity axis Distance from “B” to the Price axis

Price

PED at any given point “B” =

A = ∞ = Elastic B = 1 Unitary Elasticity C = 0 = Inelastic Quantity

Qty 5 5 5

Price 10 10 10

New

Qty 4 2

Price PED 14 14

0.50 1.50

TE 50 56 28

%ΔP ≥ %ΔQ - Inelastic - TR increases %ΔP ≤ %ΔQ - Elastic - TR decrease

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Income Elasticity of Demand – change in demand with change of consumers’ Income Q / I OR Q X I OR I X Q Q I Q I Q I Demand for most products increases as incomes rise Inferior goods: Goods where a rise in income causes a decrease in demand Price Elasticity of Supply – effect a change in Price has on Percentage change in quantity supplied Percentage change in price

quantity supplied. Quantity Quantity

Price Price

Price Quantity

Quantity Price

-00–1 1 1–∞ ∞

Elasticity

Response to Change in Price

Perfectly Inelastic Inelastic Unitary Elasticity Elastic Perfectly Elastic

No response in Supply

Page 155 of 406

Less than proportionate response %  in Q supplied = %  in Price More than proportionate response Producers supply ∞ Q at that price

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Elasticity of Demand Tutorial P 50, Q 1 Elasticity of Supply Tutorial

Review P 62, Table 9.1 Results: 1, 2 & 5 are Income Elastic; 3 & 4 are Income Inelastic Do Q P 64, Q3

(a) (b) (c) (d) (e)

Original Values Quantity Supplied Price 0 4 3 6 6 8 7.5 9 4.5 7

New Values Quantity Supplied Price 3 6 6 8 9 10 4.5 7 1.5 5

P 4 6 8 9 7

/ / / / / /

Price Calculation Elast of Q x ď ˛Q / ď ˛P = Supply 0 x 3 / 4 = Infinity 3 x 3 / 6 = 1 6 x 3 / 8 = 1/2 7.5 x 3 / 9 = 2/5 4.5 x 3 / 7 = 2/3

Sample Exam: 3. A 4. D (have one of the students calculate on board) Price Elasticity of Demand =

Percentage change in quantity Percentage change in price 5. C (have one of the students calculate on board) Percentage change in quantity supplied Percentage change in price

Page 156 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Perfectly Elastic Unitary Elastic Elastic Elastic

Economic Studies

Student Handbook

An economy is judged by how well it answers the three questions: What goods and services it produces? How well it produces those goods and services? For whom does it produce those goods and services? M________ Efficiency _____________________________

_____________________________ P________ Efficiency _____________________________ Can be achieved if there isâ&#x20AC;Ś _____________________________

T________ Efficiency _____________________

Page 157 ofA________ 406 Dr Stephen Byrd PhD MBA FICM FITOL

Efficiency

Economic Studies

Student Handbook

_____________________

S_______ Efficiency _____________________________

_____________________________

D________ Efficiency _____________________________

_____________________________ An economy is judged by how well it answers the three questions: What goods and services it produces? How well it produces those goods and services? For whom does it produce those goods and services? Market Efficiency

Economy is producing on the

PPF

Page 158 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Competition helps achieve Productive Efficiency

Production achieved at the

lowest possible cost. Can be achieved if there isâ&#x20AC;Ś

Technical Efficiency

with

Maximum outputs

the minimum inputs

Allocative Efficiency

produce

Resources used to

g & s consumers want

Static Efficiency

One-time savings that can be

Dynamic Efficiency

Ongoing savings that can be

Page 159 of 406

achieved

achieved Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

In the following sentence on price elasticity of demand, Delete the words in bold which are incorrect. a.

The price elasticity of demand measures the responsiveness of the quantity demanded / price to a change in the quantity demanded / the quantity supplied / price.

Give the formula for price elasticity of demand.

In the mid 1990s, the government in the UK announced that for every 10 per cent rise in the price of cigarettes, the demand is likely to fall by 6%. If this information is correct, what is the value of the price elasticity of demand for cigarettes?

In each of the following pairs, decide which of the two items is likely to have the more elastic demand. Give reasons for your answer. a.

Petrol (all brands) and Esso petrol

Holidays abroad and Bread

Salt and Clothing

The following table shows the quantity of a product demanded at two different prices:

16 25 14 35 Page 160 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

4. What is the price elasticity of demand from ÂŁ16 to ÂŁ14? Show formula and calculation.

The following diagram shows two demand curves that cross at a price of P0.

Which of the following statements are true? a.

Curve D1 is more inelastic and curve D2 more elastic. True / False

Demand is more elastic between P0 and P1 along curve D2 than along curve D1. True / False

For any given change in price there will be a larger proportionate change in quantity along curve D1 than along curve D2. True / False

Answer the following: a.

What is the formula for income elasticity of demand?

Which of the following would you expect to have a demand which is elastic with respect to income? (There is more than one.) i.

Flour. Yes / No / Possibly

ii.

Ready-prepared meals for the microwave. Yes / No / Possibly

iii.

Champagne. Yes / No / Possibly

iv.

Socks. Yes / No / Possibly

Designer jeans. Yes / No / Possibly

vi.

Electricity. Yes / No / Possibly

vii.

Bus journeys. Yes / No / Possibly

Page 161 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

The Nature of Production - Efficiency Productivity is an important part of a business being efficient. Efficiency can mean different things in business but there are essentially two ways we can look at it. Productive Efficiency: A business can improve productive efficiency by producing output at the lowest cost possible. If it can find a way of producing its products cheaper then it can improve its productive efficiency. Technical Efficiency: A business can improve its technical efficiency if it could find a way of using its existing resources to produce more. It may be that it could use machinery instead of people that do the same job but do it much faster without having to take a break!

Task Units of machine

 

Cost of machine per unit

Units of labour

Cost of labour per unit

Output

£20

£15

100

£20

£15

100

£20

£15

150

£20

£15

170

£20

£15

150

£20

£15

200

Cost per unit (average cost)

Complete the table calculating the total cost and the average cost. Having completed the table, which would be the most efficient combination for the firm to use? Explain your answer.

Page 162 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Questions 17 and 21 are based on the figures in the table below Fixed Capital Total Output inputs Variable input cost Costs AC (000s) (£000s) (£000s) (£000s) (£000s) Units Labour Materials 10 10 10 10 30 3 15 10 15 15 40 2.67 20 10 20 20 50 2.50 25 10 24 25 59 2.36 30 10 28 30 68 2.27 35 10 30 35 75 2.25 40 10 40 40 90 2.25 45 10 50 45 105 2.33 50 10 60 50 120 2.40

Revenue (£000s) 50 67.5 80 87.5 90 87.5 80 67.5 50

17 As output increases from 35 to 40 the firm experiences...

Optimal returns to scale Decreasing returns to scale Increasing Returns to scale Constant returns to scale

18 The Marginal Cost per unit as output rises from 30 to 35 is

A. B. C. D.

A £2.25 B £1.40 C £7.00 D £0.70

19 Not shown 20 Not shown 21 Not shown

Output (000s) Units 10 15 20 25 30 35 40 45 50

Fixed Capital inputs (£000s) 10 10 10 10 10 10 10 10 10

Variable input cost (£000s) Labour Materials 10 10 15 15 20 20 24 25 28 30 30 35 40 40 50 45 60 50

Page 163 of 406

Total Costs (£000s) 30 40 50 59 68 75 90 105 120

Marginal Cost MC

Revenue (£000s) AC (£000s) 3 2.67 2.50 2.36 2.27 2.25 2.25 2.33 2.40

50 67.5 80 87.5 90 87.5 80 67.5 50

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Complete the table below and use the information to answer questions 11 to 15

Quantity

1000

n/a

400

800

600

1600

1000

2400

1600

3200

2400

4000

3400

4800

The average cost when the level of output is 2 is: a. 680 b. 650 c. 800 d. 530

12.

The average fixed cost when the level of output is 5 a. 800 b. 600 c. 750 d. 200

13.

The average cost is lowest: a. When output is 3 b. When output is 4 c. When output is 5 d. When output is 6

14.

The marginal cost of the 6th unit of output is: a. 4,400 b. 3,400 c. 1,000 d. 800

Page 164 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies 15.

Student Handbook

The profit maximizing level of output is: a. 3 b. 4 c. 5 d. 6 Complete the table below and use the information to answer questions 11 to 15

Quantity

1000

n/a

400

800

600

1600

1000

2400

1600

3200

2400

4000

3400

4800

The average cost when the level of output is 2 is: a. b. c. d.

12.

530 650 680 800

The average fixed cost when the level of output is 5 a. 800 b. 600 c. 750 d. 200

13.

The average cost is lowest: a. When output is 3 b. When output is 4 c. When output is 5 d. When output is 6

14.

The marginal cost of the 6th unit of output is: a. 800 b. 1,000 Page 165 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

c. 3,400 d. 4,400 15.

The profit maximizing level of output is: a. 6 b. 5 c. 4 d. 3

Page 166 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Complete the table below and use the information to answer questions 11 to 15

Quantity

1000

n/a

400

800

600

1600

1000

2400

1600

3200

2400

4000

3400

4800

The average cost when the level of output is 2 is: a. 680 b. 650 c. 800 d. 530

12.

The average fixed cost when the level of output is 5 a. 800 b. 600 c. 750 d. 200

13.

The average cost is lowest: a. When output is 3 b. When output is 4 c. When output is 5 d. When output is 6

14.

The marginal cost of the 6th unit of output is: a. 4,400 b. 3,400 c. 1,000 d. 800

15.

The profit maximizing level of output is: Page 167 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

a. 3 b. 4 c. 5 d. 6 Complete the table below and use the information to answer questions 11 to 15

Quantity

1000

n/a

400

800

600

1600

1000

2400

1600

3200

2400

4000

3400

4800

The average cost when the level of output is 2 is: a. b. c. d.

12.

530 650 680 800

The average fixed cost when the level of output is 5 a. 800 b. 600 c. 750 d. 200

13.

The average cost is lowest: a. When output is 3 b. When output is 4 c. When output is 5 d. When output is 6

14.

The marginal cost of the 6th unit of output is: a. 800 b. 1,000 c. 3,400 Page 168 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

d. 4,400 15.

The profit maximizing level of output is: a. 6 b. 5 c. 4 d. 3

Page 169 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Marginal Product

70 60 50

16 18 18 10 2

Output

(from Unit 46, Question 4) Total Average Labour Product Product 1 8 8 2 24 12 3 42 14 4 60 15 5 70 14 6 72 12

Student Handbook

Total Product

Average Product Marginal Product

30 20 10 0 0

Labour

Unit 46, Q. 5 , Unit 47, Q. 2 & 4 (Unit 48, Question 1)

Given:

Cost of Capital

Labour Quantity 1 20 2 45 3 60 4 70

TFC 200 200 200 200

200

TVC 50 100 150 200

Unit Cost of Labour

TC 250 300 350 400

AFC 10.0 4.4 3.3 2.9

AVC 2.5 2.2 2.5 2.9

450

50 ATC 12.5 6.7 5.8 5.7

MC 2.0 3.3 5.0

14.0

400

12.0

350 10.0 TFC

250

TVC

200

150

Cost

Costs

300

AFC

8.0

AVC

6.0

ATC MC

4.0

100

2.0

50 0

0.0 0

Output

Page 170 of 406

40 Output

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

(Unit 48, Question 2)

Given: Capital 10 10 10 10 10 10 10

Cost of Capital Labour 0 1 2 3 4 5 6

Quantity 0 8 24 42 60 70 72

TFC 10 10 10 10 10 10 10

Unit Cost of Labour TVC 0 2 4 6 8 10 12

TC 10 12 14 16 18 20 22

AFC 1.3 0.4 0.2 0.2 0.1 0.1

AVC 0.3 0.2 0.1 0.1 0.1 0.2

ATC 1.5 0.6 0.4 0.3 0.3 0.3

MC 0.3 0.1 0.1 0.1 0.2 1.0

1.6

1.4 1.2

TFC TVC TC

15 10

AFC

Cost

AVC

0.8

ATC

0.6

0.4

0.2 0

0 0

40 Output

Output

Page 171 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Questions 17 and 21 are based on the figures in the table below Fixed Capital Total Output inputs Variable input cost Costs AC (000s) (£000s) (£000s) (£000s) (£000s) Units Labour Materials 10 10 10 10 30 3.00 15 10 15 15 40 2.67 20 10 20 20 50 2.50 25 10 24 25 59 2.36 30 10 28 30 68 2.27 35 10 30 35 75 2.25 40 10 40 40 90 2.25 45 10 50 45 105 2.33 50 10 60 50 120 2.40

MC (£000s)

Revenue (£000s)

MR (£000s)

2.00 2.00 1.80 1.80 1.40 3.00 3.00 3.00

50.0 67.5 80.0 87.5 90.0 87.5 80.0 67.5 50.0

3.50 2.50 1.50 0.50 -0.50 -1.50 -2.50 -3.50

17 As output increases from 35 to 40 the firm experiences...

Optimal returns to scale Decreasing returns to scale Increasing Returns to scale Constant returns to scale

18 The Marginal Cost per unit as output rises from 30 to 35 is

E. F. G. H.

A £2.25 B £1.40 C £7.00 D £0.70

19 Which of the following statements is NOT TRUE at an output of 30 units A. The firm is achieving increasing returns to scale B. This is the profit maximising level of output (between 20 and 25 units) C. This is the revenue maximising level of output D. Average cost is falling 20 The Optimal level of production would be at A. 20 B. 35 C. 35 to 40 D. 15 to 20 21 The Marginal Revenue curve would intersect the Marginal Cost Curve A. At an output of 20 units B. At an output of 30 units C. At an output between 20 and 25 units

Page 172 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Complete the table below and answer the questions that follow

Output (000s) Units 10 15 20 25 30 35 40 45 50

Fixed Capital inputs (£000s) 10

Variable input cost (£000s) Labour Materials 10 10 15 15 20 20 24 25 28 30 30 35 40 40 50 45 60 50

Total Variable Costs (£000s)

Total Costs (£000s)

AC (£000s)

MC (£000s)

50.00 67.50 80.00 87.50 90.00 87.50 80.00 67.50 50.00

1 As output increases from 35 to 40 the firm experiences...

Optimal returns to scale Decreasing returns to scale Increasing Returns to scale Constant returns to scale 2 The Marginal Cost per unit as output rises from 30 to 35 is

I. J. K. L.

A £2.25 B £1.40 C £7.00 D £0.70

3 Which of the following statements is NOT TRUE at an output of 30 units E. The firm is achieving increasing returns to scale F. This is the profit maximising level of output G. This is the revenue maximising level of output H. Average cost is falling 4 The Optimal level of production would be at E. 20 F. 35 G. 35 to 40 H. 15 to 20 5 The Marginal Revenue curve would intersect the Marginal Cost Curve D. At an output of 20 units E. At an output of 30 units F. At an output between 20 and 25 units G. At an output between 15 and 20 units

Page 173 of 406

Revenue (£000s)

Dr Stephen Byrd PhD MBA FICM FITOL

MR (£000s)

Economic Studies

Student Handbook

1. Perfect competition is characterized by all of the following EXCEPT A) well-informed buyers and sellers with respect to prices. B) a large number of buyers and sellers. C) no restrictions on entry into or exit from the industry. D) considerable advertising by individual firms. 2. A barrier to entry is A) an open door. B) the economic term for diseconomies of scale. C) illegal in most markets. D) anything that protects a firm from the arrival of new competitors. 3. The demand curve facing a perfectly competitive firm depends on A) market supply alone. B) market demand and the market supply curve. C) market demand and the firmâ&#x20AC;&#x2122;s supply curve. D) market demand alone. 4 Which of the following terms would best describe the elasticity facing a perfectly competitive firm? A) inelastic B) perfectly inelastic C) perfectly elastic D) elastic 5. All of the following pertain to a perfectly competitive market except which one? A) Consumers can shop for the lowest available price. B) There is freedom of entry and exit of firms in the industry. C) Consumers prefer certain brands over others. D) All firms in the industry are price takers. 6. Which of the following is the best example of a perfectly competitive market? A) diamonds Page 174 of 406

B) farming Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

C) soft drinks

D) athletic shoes

Use the diagram below to answer Questions 7 – 8

7. If the price a perfectly competitive firm is facing in the market is P2 then the profit-maximizing firm in the short run should produce output A) B

B) C

C) D

D) E

8. The short-run shut down price for a perfectly competitive firm is A) P3

B) P1

C) P2

D) P4

9. A perfectly competitive firm’s marginal-revenue curve A) moves upward to the right and then declines when MC = MR. B) is the same as the firmʹs TR curve. C) is a straight line that coincides with the market demand curve. D) is the same as the firmʹs demand curve.

Page 175 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Monopolistic Competition / Imperfect Competition Assumptions:  Many buyers & sellers  No or Low barriers to entry

Same as Perfect Competition

 Short-run profit maximizers  Goods can be differentiated Firms face a downward sloping Demand Curve, so they are not Price Takers Differentiated products and substitute goods mean they face a higher price elasticity of demand In the Long Run:  They will produce where MR = MC;  Price is at Average Revenue (same as Monopolies)  If abnormal profits: o More firms enter the market – Supply increases o Price goes down, so MR & AR both decrease, until AC = AR (tangent) So, in Monopolistic Competition, MR = MC; AR = AC

Page 176 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slides Slide 1

Economics

Slide 2

Economics Microeconomics Studies the behaviour of individual companies and consumers, in the production, distribution and consumption of goods and services

Slide 3

Economics Macroeconomics Studies the scientific theory and management of economies and economic systems

Page 177 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 4

Basic Economic Problem

Slide 5

Infinite wants â&#x20AC;˘ People desire to consume goods and services

Slide 6

Finite resources

â&#x20AC;˘ Choices must be made about how to use these resources to best try to satisfy the unlimited wants

Page 178 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 7

Student Handbook

Basic Economic Problem Goods Free Goods: unlimited quantities Economic Goods: limited in quantity

Slide 8

Basic Economic Problem • Because of the basic economic problem, choices must be made about how to allocate resources • In a modern economy this allocation is decided by ‘the market’

Slide 9

Basic Economic Problem • Economies must deal with it • Judged by how well they deal with it

Economy: social organization, decides: 1. What is to be produced 2. How it is to be produced 3. For whom it is to be produced

Page 179 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 10

Student Handbook

Economic Systems Actors:

Planned or Controlled Government, Consumers, Workers

Motivation:

For the common good

Factors of Production: Allocation:

All (except workers) owned by the State All resources allocated by the State – “Planning Mechanism”

Market Economy Consumers, Producers, Owners of Private Property, and, the Government

Individuals maximize personal gain or utility; Producers to maximize profits; Government maximize social welfare Most owned by individuals; Government protects their rights and interests All businesses are free to buy / sell what they want at prices they choose. Workers can work where they want. People can open their own business. Consumers buy as they like, and can afford. Competition: None People choose to buy where they want. Businesses are forced to respond. Mixed Economy: Resources allocated both by government through the planning mechanism; and, by private sector through market mechanism

Slide 11

Production Possibilities Basket 1 0 10 20 30 40 50 60 70 80 90 100

Slide 12

Basket 2 100 99 98 95 91 87 80 71 60 41 0

Production Possibility Frontier 120

100

0 0

Page 180 of 406

100

120

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 13

Student Handbook

The different combination of goods, or, goods and services an economy could produce if all resources are fully and efficiently used

Goods

Production Possibility Frontier

Services

Slide 14

Opportunity Cost • • • •

Choices are evaluated One choice will be selected as the ‘best’ All other choices are given up Example: You have enough money for a DVD player or an MP3 player. If you choose the DVD player, you give up the opportunity to benefit from having an MP3 player. • Opportunity cost: The benefit (of the next best alternative) we give up when we choose

Slide 15

Economic Resources also called

Factors of Production • • • •

Land Labour Capital Entrepreneurs

Page 181 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 16

Student Handbook

Opportunity Cost: Questions • From a range of alternatives you have chosen to study at university in _________ (country). • What were the other alternatives available to you when you made your choice? • What was the opportunity cost of your choice?

Slide 17

Normative and Positive Statements

Slide 18

Normative Statements • Contain a value statement • Is a statement which shows opinion • When used in economics, normative statements indicate whether something is desirable or undesirable

Example: The company has done a good job of improving their pollution record

Page 182 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 19

Student Handbook

Positive statements • A statement of what is and what exists • Is a statement that shows a fact • When used in economics, positive statements show no indication of approval or disapproval Example: The company has reduced their levels of polluting emissions by 13% over the last 12 months

Slide 20

Economic Growth Exam Question Review

Slide 21

The Circular Flow of Income A diagram to show National Income The Five Sector Model Leakage

Households E

Banking O

Firms

Investment

M Imports

T Taxes

S Saving

Government

Overseas

Government Spending

Exports

I Injection

Knowing and understanding this diagram IS required!

Page 183 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 22

Student Handbook

Circular Flow Which one of the following is most likely to increase economic activity in the circular flow of income model? [1] A Increased taxation B Increased spending on imports C Increased government spending D Increased saving

Slide 23

Circular Flow Which of the following is an injection into the circular flow of income? A Spending on imports B Taxes C Investment D Saving

Slide 24

Circular Flow

Page 184 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 25

Student Handbook

Positive Output Gap With the use of a diagram illustrate how an economy can experience a positive output gap [3]

Slide 26 Rate of Growth

The Output Gap Diagram Actual GDP Trend GDP

Time

Slide 27

Nominal vs. Real GDP In 2005, nominal GDP in the country of Uralla grew by 5%, the consumer price index rose by 2.5% and, as a result of immigration, the population increased from 1,000,000 to 1,005,000. From this information, which of the following statements about Uralla is correct? [1] A Real per capita GDP increased by exactly by 2.5% B Real per capita GDP increased by more than 2.5% C Real per capita GDP increased by less than 2.5% D Real per capita GDP did not change

Page 185 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 28

Demand The behaviour of Consumers

Slide 29

Definitions Demand: The quantity of a good or service consumers would be willing and able to buy at different given prices Law of Demand: If all else remains the same (ceteris parabis), when the price of goods go down, more people will purchase greater quantities.

Slide 30

Demand Schedule For example, look at the demand facing a single seller in a market, in this case, a tire seller. Price (ÂŁ)

Quantity demanded

Page 186 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 31

Student Handbook

Plot a Demand Curve Demand for Tires

Price

Price (ÂŁ)

Quantity demanded

20 10

Quantity

Demand Curve At a price of 30, the quantity demanded would be 15, shown as followsâ&#x20AC;Ś How would a price of 20 be shown?

Demand for Tires

Price

Slide 32

A drop in price to 20 would result in an increase in the quantity demanded to 25. a change in price results So,

in a change in quantity demanded, represented by movement along the Demand Curve.

D 0

Quantity

Slide 33

The Demand Curve The Demand Curve is downward sloping There is an inverse relationship between price and quantity demanded As price decreases, quantity demanded will rise, and the opposite is also true Market Demand:

Add up the Demand Curves faced by individual sellers

Page 187 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 34

Determinants of Demand • • • • • • • •

Price (results in movement along Demand Curve ) Prices of other goods Incomes Changes in any of these will Tastes and fashions cause Demand Population size or structure Curve to shift, either inward or Advertising outward Expectations of consumers Changes in laws

Demand Curve For example, as the Chinese economy develops, people are earning more, improving their standard of living.

Slide 36

So, more people are buying cars.

As a result, demand for tires at all prices is increasing.

A change in any other determinant results in a change in quantities demanded at all prices, represented by a shifting of the Demand Curve.

Demand for Tires

Price

Slide 35

Student Handbook

Quantity

The Demand Curve Changes in Determinants of Demand: • Change in Price: “movement along the demand curve resulting in an increase / decrease in quantity demanded” • Change in any other factor: “causes the demand curve to shift out / in resulting in an increase / decrease in demand”

Page 188 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 37

Student Handbook

Consumer Surplus Consider the Dem and Curve BCD below. At a price P 1, consumers would purchase 0 Q1 quantity. Price (£)

BC on the dem and curve represents consumers who would be willing to pay a higher price, but need not. The m arket brings them a benefit since they don’t have to pay as m uch as they would have been willing to pay

The area of the triangle P 1BC in the diagram is called the Consumer Surplus, the total benefit to consumers of a price P 1 D

Quantity Dem anded

Slide 38

Slide 39 Elasticity Effect on factor “Y” by a change in factor “X” or the responsiveness of “Y” to changes in “X”

Page 189 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 40

Student Handbook

Price Elasticity of Demand (PED) How much quantity demanded (Q) responds to changes in price (P) •Elastic: Change in P causes larger change in Q •Inlastic: Change in P causes smaller change in Q

Slide 41

Measuring the value of PED PED =

Percentage change in Quantity o Percentage change in Price

PED Value -00–1 1 1– ∞

∞

Slide 42

Elasticity

%ΔQ %ΔP

Response to Change in Price

Perfectly Inelastic No change in quantity dem anded when price changes Inelastic

Less than proportionate response to changes in price

Unitary Elasticity

Percentage change in quantity = Percentage change in Price

Elastic

More than proportionate response to changes in price

Perfectly Elastic

Consum ers will dem and any quantity at the given price

Determinants of PED 1. Availability of substitute goods tends to increase PED 2. Time tends to increase PED 3. Necessities have lower PED 4. Low-priced goods have lower PED 5. Luxury goods have higher PED 6. High-priced goods have higher PED

Page 190 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 43

Student Handbook

Measuring the value of PED PED and the demand curve A Perfectly Inelastic Demand Curve looks like this 5

D 5

Slide 44

Measuring the value of PED PED and the demand curve An Inelastic Demand Curve looks like this 5

D 5

Slide 45

Measuring the value of PED PED and the demand curve A Perfectly Elastic Demand Curve looks like this

Page 191 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 46

Student Handbook

Measuring the value of PED PED and the demand curve An Elastic Demand Curve looks like this 5

Slide 47

Measuring the value of PED PED and the demand curve A Unitary Elastic Demand Curve looks like this 5

Slide 48

Measuring the value of PED But, PED along a demand curve is also different Price drops from 7 to 6 PED = (1÷2)

(–1÷7)

= 50% ÷ –14% = –3 .57 5

Elastic Price drop from 3 to 2 PED = (1 6)

(–1 3)

= 16% ÷ –33% = – .48

Inelastic

Page 192 of 406

D 5

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 49

Student Handbook

Measuring the value of PED If a business raises prices, will it make more money?

It depends on Price Elasticity of Demand! Total Expenditure (consumers) = Total Revenue (firms)

Slide 50

Measuring the value of PED Total Expenditure & Total Revenue TE = TR =PxQ

= £6 x 3.75

= £22.25 D 5

Slide 51

Measuring the value of PED Inelastic PED and TE At a price of £6, notice the area of Total Expenditure If the seller raises the price, notice the new area of TE

Notice how the blue area is much larger than the yellow

D 5

Page 193 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 52

Student Handbook

Measuring the value of PED Elastic PED and TE At a price of ÂŁ6, notice the area of Total Expenditure If the seller raises the price, notice the new area of TE

5 D

Notice how the blue area is much smaller than the yellow 5

Slide 53

Supply

Slide 54

Definitions Supply: The quantity of a good or service producers would be willing and able to produce and sell at different given prices. The Law of Supply: If all else remains the same, as the price of a good increases, more producers will produce greater quantities.

Page 194 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 55

Student Handbook

Supply Schedule Referring to the previous example, look at the choices our tire seller would make at different levels – a Supply Schedule.

Slide 56

Price (£)

Quantity supplied

Plot a Supply Curve Supply of Tires

Price

Price (£)

Quantity supplied

20 10 0

Quantity

Supply Curve At a price of 20, the quantity supplied would be 15, shown as follows… How would a price of 30 be shown? A rise in price to 30 would result in an increase in the quantity supplied to 25. A change in price results in a change in quantity supplied, represented by movement along the Supply Curve.

Supply of Tires

Price

Slide 57

40 30 20 10 0

Quantity

Page 195 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 58

Student Handbook

The Supply Curve The Supply Curve is upward sloping There is a positive relationship between price and quantity supplied As price increases, quantity supplied will rise, and the opposite is also true Market Supply:

Slide 59

Determinants of Supply • • • • • • •

Slide 60

Add up the Supply Curves of all the individual sellers

Price (results in movement along Supply Curve ) Costs of production Changes in any Price of other goods of these will Technology cause Supply Curve to shift, Producers’ goals either inward or Government legislation outward Future expectations

The Supply Curve For example, if new technologies were introduced into China which made the production of tires less expensive… Producers producing at all price levels would choose to produce more tires. As a result, quantities of tires supplied at all price levels would increase, causing the Supply Curve for tires to shift outward.

A change in any other determinant results in a change in quantities supplied at all prices, represented by a shifting of the Supply Curve.

Page 196 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 61

Student Handbook

The Producer Surplus Consider the Supply Curve 0CS below. At a price P 1, producers would produce 0 Q 1 quantity. Price (£)

0C on the supply curve represents producers who would be willing to sell at a lower price, but need not. S

Slide 62

Those producers benefit because they can sell at a higher price The area of the triangle P 10C in the diagram is called the Producer Surplus, the total benefit to producers as a result of m arket price P 1 Quantity Supplied

Price Elasticity of Supply (PES) How much quantity supplied (Q) responds to changes in price (P) •Elastic: Change in P causes larger change in Q •Inlastic: Change in P causes smaller change in Q

Slide 63

Primary Determinants of PES 1. Availability of substitute goods tends to increase PES 2. Time tends to increase PES

Page 197 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 64

Student Handbook

Measuring the value of PES PES =

Percentage change in Quantity o Percentage change in Price

PES Value -00–1 1 1– ∞

∞

Elasticity

%ΔQ %ΔP

Response to Change in Price

Perfectly Inelastic No change in quantity supplied when price changes Inelastic

Less than proportionate response to changes in price

Unitary Elasticity

% in quantity supplied = % in Price

Elastic

More than proportionate response to changes in price

Perfectly Elastic

Producers will supply any quantity at the given price

Slide 65

Economics 2nd Term

Slide 66

Economics Definition: The science that deals with… Microeconomics … the production, distribution and consumption of goods and services, and… 2nd Term: Macroeconomics … the theory and management of economies or economic systems 1st Term:

Page 198 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 67

Topics to be covered

Slide 68

Macroeconomics • • • • • • • •

Slide 69

Introduction Economic Growth Aggregate Demand & Aggregate Supply Consumption, Savings & Investment Taxation Government Expenditure Redistribution of Income & Wealth Money & Monetary Policy

Macroeconomics (Continued)

• • • •

Inflation Unemployment International Trade The Balance of Payments

Page 199 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 70

Assessments

Slide 71

Assessments Economic Growth Essay Final Exam

10% 70%

Slide 72 Price Determination in the Market

Page 200 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 73

Student Handbook

Market Price • Buyers and sellers • Come together • A price is “struck”

Slide 74

Equilibrium Price (£)

D Quantity

Equilibrium Price (P E) and Equilibrium Quantity (QE) where Demand and Supply Curves intersect Equilibrium Price is sometimes called the Market Clearing price – at that price, all good would be sold.

Slide 75

Excess Supply Price (£) Surplus PM PE

D QD

Quantity

When Market Price (P M ) is above PE this results in excess supply – surpluses

Page 201 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 76

Student Handbook

Excess Demand Price (ÂŁ)

Shortage D QS

Quantity

When Market Price (P M ) is below PE this results in excess demand â&#x20AC;&#x201C; shortages

Slide 77

Stable / Unstable Equilibrium Stable Equilibrium: Free market forces push market price toward Equilibrium Unstable Equilibrium: Free market forces are not strong enough to push the market price to Equilibrium

Slide 78

Exam Problem Which of the following actions could cause a higher price and a lower quantity consumed? A. An outward shift of the demand curve B. An inward shift of the supply curve C. An inward shift of the demand curve D. An outward shift of the supply curve

Page 202 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 79

Slide 80 Interrelationships between Markets Goods that affect other goods

Slide 81

COMPETITIVE DEMAND Substitute goods • Increase in price of one leads to a decrease in quantity demanded • This leads to an increase in Demand for the substitute good, which leads to a rise in price

Page 203 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 82

Student Handbook

JOINT DEMAND Complementary goods • Decrease in price of one leads to an increase in quantity demanded • This leads to an increase in Demand for the complementary good, which leads to a rise in price Market for Good "A" Price

Price

Market for Good "B"

Quantity

Slide 83

Quantity

Cross Elasticity of Demand (CED) OR (XED) How demand for good “X” changes when the price of good “Y” changes

XED =

%ΔQ of X %ΔP of Y

Substitute goods have a positive CED

Complementary goods have a negative CED

Slide 84

DERIVED DEMAND • An increase in Demand for finished good “E” • Results in an increase in Demand for the good “F” needed to produce “E”, which leads to a rise in price

Market for Good “F" Price

Price

Market for Good "E"

Quantity

Page 204 of 406

Quantity

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 85

Student Handbook

JOINT SUPPLY • An increase in Demand for finished good “G” • Results in an increase in Supply of the resource “H” needed to produce “G”, which leads to a lowering of price

Price

Market for Good "H"

Quantity

Slide 86

Income Elasticity of Demand (YED) How demand for a good changes when income (Y) changes

YED =

%ΔQ %ΔY

Most goods in general have a positive YED Goods with a negative YED are called “Inferior Goods”

Slide 87 Economic Efficiency & Market Failure

Page 205 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 88

Student Handbook

Economic Efficiency EFFICIENCY •MARKET Efficiency •PRODUCTIVE Efficiency

•TECHNICAL Efficiency •ALLOCATIVE / ECONOMIC Efficiency •STATIC Efficiency •DYNAMIC Efficiency

Slide 89

Economic Efficiency •MARKET Efficiency •Production Possibility Frontier (PPF) •Competition

•To achieve MARKET Efficiency, there must be •PRODUCTIVE Efficiency

Slide 90

Economic Efficiency •PRODUCTIVE Efficiency •Producing at lowest possible cost •Can be achieved if production achieves …

•TECHNICAL Efficiency

Page 206 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 91

Student Handbook

Economic Efficiency •TECHNICAL Efficiency •Maximum output (production) •Minimum input (resources)

Slide 92

Economic Efficiency •ALLOCATIVE or ECONOMIC Efficiency •Resources are being used to produce goods and services that people most want

•STATIC EFFICIENCY •DYNAMIC EFFICIENCY

Slide 93

Market Failure MARKET FAILURE represents INEFFICIENCY •Lack of COMPETITION

•EXTERNALITIES •FACTOR IMMOBILITY •INFORMATION FAILURE •INEQUALITY / INEQUITY

Page 207 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 94

Market Stabilization Governments take action to deal with market failure

Slide 95 Market Stabilization Wide price fluctuations lead to market failure •Prices too high – consumers won’t buy •Prices too low – producers won’t sell •Make it difficult to identify the “signal”

Slide 96 Market Stabilization Specific steps governments take: •Price Controls •Buffer Stock Schemes •Subsidies •Taxes

Page 208 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 97 Price Controls Price S

Minimum Price (above the market price) results in Excess Supply.

PMin PE

Maximum Price (below the market price) results in Excess Demand.

PMax D

Quantity

Slide 98

Commodities • Mostly agriculture & mining products • Generally traded worldwide, but each economy faces its own market conditions • Large Price fluctuations for various reasons – – – –

Bumper crops Crop failures Weather and other natural phenomenon Political situations

• Steep, inelastic Supply & Demand curves • Small shifts create large changes in price

Slide 99

Buffer Stock Scheme Price S Government sets the intervention price, say P I If market price is below P I, say P B… PI

Government buys large quantities, pushing Demand curve out until it reaches P I. This creates a Buffer stock.

PB D

DI Quantity

Page 209 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 100

Student Handbook

Buffer Stock Scheme Price

Assume the same intervention price, P I If market price is above P I, say P A …

PA PI

Government sells large quantities from Buffer Stock, pushing Supply curve out until it reaches P I D Quantity

Slide 101

Taxes Price STax

Tax causes suppliers to offer less units for sale at every price

S Paid by Consumers Total cost Paid by of Tax Producers

Tax per unit

Tax is vertical distance between supply curves Tax increases prices and decreases amounts available – but at what cost?

Quantity

Slide 102

Subsidies Price

S SSubsidy

Benefits to Total Consumers cost Benefits to of subsidy Producers

Subsidy per unit

Subsidies encourage suppliers to sell more at every price Subsidy is vertical distance between the two supply curves Subsidies reduce prices and increase amounts available – but at what cost?

Quantity

Page 210 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 103

The Role of the Market

Slide 104

The Role of the Market • Demand • Supply • Price Determination

• Interrelationships between markets • Elasticities The Market Mechanism

Slide 105

The Role of the Market Consumer

Producer / Firms

All powerful Free to spend

Choose

Serve consumers

Maximize profits

Owners of Factors of Production Maximize return

Maximize utility Maximizing behaviour

Page 211 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 106

Student Handbook

The Role of the Market The Functions of Price in an Economy •Rationing •Signaling

•Incentives

Slide 107

Economic Efficiency An Economy is judged by how well it answers these three questions: •What it produces (goods and services); •How well it produces them (how well it uses resources); and, •For whom does it produce them

Slide 108 Production in the Short Run

Page 212 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 109

Student Handbook

Production in the Short Run Supply – the quantity producers would be willing and able to produce Examine the behaviour of producers Short Run – at least one factor cannot change

(generally the factory) Long Run – all factors can change – technology unchanged Long Long Run – technology changes The Law of Diminishing Returns: In the short run, too many inputs lead to inefficiency.

Slide 110

Production in the Short Run Economies of Scale: If producers are operating at lower levels of output, they can become more efficient by increasing their production levels. Diseconomies of Scale: At very large production levels, further increasing production begins leading to inefficiency.

Study Labour

Slide 111

Returns to Scale What happens to output as inputs increase? Returns to Scale

Explanation

Effect

Increasing Returns

Increasing inputs leads to greater increases in outputs

Constant Returns

Increasing inputs leads to equal increases in outputs

Decreasing Returns

Increasing inputs leads to lower increases in outputs

Page 213 of 406

Greater efficiency

Lower efficiency

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 112

Student Handbook

Production in the Short Run Total Product (TP) =

Quantity of output, based on given inputs, over time

Marginal Product (MP) = Additional output produced by adding one additional unit of input Average Product (AP) =

Slide 113

Quantity of output per unit of input

Production Calculations Each time another worker is added, output increases. But the increase in output changes as work becomes more, then less efficient.

Production Schedule Labour Inputs

Marginal Product: additional output produced by adding an additional worker. Average Product: average quantity of goods produced by each worker.

Slide 114

Total Marginal Average Product Product Product

(L)

(TP)

(MP)

(AP)

5.0

5.0 6.0

7.0

7.2

6.5

5.7

Production Diagrams Labour

Total Product Diagram of TP

At first, TP increases at a faster rate â&#x20AC;&#x201C; increasing returns to scale. Then, increases begin to slow down â&#x20AC;&#x201C; diminishing returns to scale. Labour

Output

Diagram of AP and MP MP is at its highest where diminishing returns to scale set in

Note: both curves rise, then decline, first MP then AP

MP Output

Average Product and Marginal Product

Page 214 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 115

Student Handbook

The Production Function (Cost of Production) Q= L + C Where: Q = Quantity produced

OUTPUTS

L = Labour

INPUTS

C = Capital

Slide 116

Production in the Short Run – Costs “Costs” in Economics include all economic costs facing the company and its owners: •Materials;

•Owners’ time;

•Labour;

•Earnings on cash;

•Management;

•Goodwill;

•Equipment;

•Opportunity cost;

•Cost of Buildings

•Normal profits

The These same areinunique Business to Economics and Economics

Slide 117

Production in the Short Run – Costs Costs are grouped according to their behaviour •Fixed Costs:

Costs that do not change in the relevant range; generally the cost of capital (e.g. factory)

•Variable Costs:

Costs that change with changes in outputs; includes materials, supplies and labour

Page 215 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 118

Student Handbook

Production in the Short Run – Costs Costs are summarized as follows:

Total Cost (TC) = Fixed Costs (TFC) + Variable Costs (TVC) Average Cost (AC) = Total Cost (TC)

Units of output (Q)

Marginal Cost (MC) = The cost of one additional unit of output = ΔTC ÷ ΔQ

Slide 119

Production in the Short Run Problems In lesson exercise

Slide 120

Production in the Short Run Problems Given …

Output 0 1 2 3 4 5

Complete the table, beginning with Fixed Cost

Total Total Fixed Variable Cost Cost 40 6 11 15

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

60 66

Page 216 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 121

Student Handbook

Production in the Short Run Problems Given …

Complete the table, beginning with Fixed Cost

Fixed costs remain the same at all levels of output – they’re fixed!

Output 0

40 40 40 40 40

2 3 4 5

Slide 122

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

6 11 15 60 66

Production in the Short Run Problems Fill in: Total Cost = Total Fixed Cost + Total Variable Cost

Output

Slide 123

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40 46 51 55

Production in the Short Run Problems Calculate Variable Cost: Total Cost – Total Fixed Cost

Output

Total Total Fixed Variable Cost Cost

Total Cost

20 26

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

Page 217 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 124

Student Handbook

Production in the Short Run Problems Calculate Average Fixed Cost: Total Fixed Cost รท Output

Output

Slide 125

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40.0

40 51

20.0

13.3

10.0

8.0

Production in the Short Run Problems Calculate Average Variable Cost: Total Variable Cost รท Output

Output

Slide 126

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40.0

40 51

20.0

13.3

10.0

8.0

6.0 5.5 5.0 5.0 5.2

Production in the Short Run Problems Calculate Average Cost: Total Cost รท Output

Output

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40.0

6.0

40 51

20.0

5.5

13.3

5.0

10.0

5.0

8.0

5.2

Page 218 of 406

46.0 25.5 18.3 15.0 13.2

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 127

Student Handbook

Production in the Short Run Problems Calculate Marginal Cost: Increase in Total Cost at each output level

Total Total Fixed Variable Cost Cost

Output

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40.0

6.0

46.0

40 51

20.0

5.5

25.5

13.3

5.0

18.3

10.0

5.0

15.0

8.0

5.2

13.2

Slide 128

6 5 4 5 6

Cost Calculations Output

Total Fixed Costs

Total Variable Costs

Total Cost

Marginal Cost

Average Fixed Cost

Average Variable Cost

Average Total Cost

(Q)

(TFC)

(TVC)

(TC)

(MC)

(AFC)

(AVC)

(ATC)

200

100

300

100

200

100

300

200

170

370

100

185

200

220

420

140

200

255

455

114

200

275

475

200

295

495

200

320

520

200

360

560

200

425

625

200

525

725

100

Output

Total Fixed Costs

Average Fixed Cost

(Q)

(TFC)

(AFC)

200

100

200

Slide 129

Fixed Costs Total Fixed Costs 250

200

150

100

0 0

Average Fixed Costs 250

200

150

200

100

200

Page 219 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 130

Student Handbook

Variable Costs Output

Total Variable Costs

Average Variable Cost

(Q)

(TVC)

(AVC)

Total Variable Costs 600

500

400

300

100

170

220

255

275

295

320

360

425

525

200

100

0 0

Average Variable Costs 120

100

0 0

Slide 131

Total Costs Output

Total Cost

Average Total Cost

(Q)

(TC)

(ATC)

Total Costs 800 700 600 500

400

200

300

370

185

420

140

455

114

475

495

520

560

625

725

300

200 100

0 0

Average Total Costs 350

300

250

200

150

100

0 0

Slide 132

Cost Analysis 800

350

700

300

600

250

500

200 400

150 300

200

100

MC ATC

100

AVC AFC

0 0

•MC and AC curves are “U” shaped •The bottom of the MC curve is where diminishing returns set in •MC crosses the AVC and AC curves at their lowest points, where they are stable, neither going down nor rising

Page 220 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 133

Student Handbook

Labour

Cost Analysis 350

300

250

200

150

100

MC ATC

AVC AFC

Output

0 0

MC starts rising where MP starts decreasing … … where diminishing returns to scale set in.

Slide 134

Cost Analysis Where to produce?

350

Where MC starts rising? (diminishing returns to scale set in) Even if MC is rising, if adding one more unit of output is reducing AC, it’s more efficient. So, even if MC is rising, as long as MC is less than AC, AC is falling, producer will continue producing more.

300

250

200

150

100

MC ATC

AVC AFC

0 0

The optimum level of output is the point where AC is at its lowest, and is neither decreasing nor rising. At that point, AC = MC – This is the Optimal Level of Production

Slide 135

Cost Calculations Output

Total Fixed Costs

Total Variable Costs

Total Cost

Marginal Cost

Average Fixed Cost

Average Variable Cost

Average Total Cost

(Q)

(TFC)

(TVC)

(TC)

(MC)

(AFC)

(AVC)

(ATC)

200

100

300

100

200

100

300

200

170

370

100

185

200

220

420

140

200

255

455

114

200

275

475

200

295

495

200

320

520

200

360

560

200

425

625

200

525

725

100

Page 221 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 136

Objectives of Firms

Slide 137

Objectives of Firms Firms are controlled by whom? …Small Single / few owners Businesses:

Shareholders elect Directors Directors appoint Management Trade Unions represent Workers State sets laws and regulations Consumer organizations

Large Companies:

Slide 138

Managerial Theory Firms Owners

Management

Profits

AND

•Increases in company’s value

Managerial theory

•Working conditions •Salaries & benefits •Power

assumes a separation between Ownership and Control

Page 222 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 139

Student Handbook

Behavioural Theory Firms

•Decision-making by different groups •Different groups compete for power

•Each group sets its own minimum goals •…and they “go” from there…

Slide 140

Review of Costs 350

800

700

300

600 250

500 200

400 150

300 100

200

MC ATC

100

AVC AFC

•MC and AC curves are “U” shaped •The bottom of the MC curve is where diminishing returns set in •The optimum level of output is where MC is upward sloping and intersects with AC

Slide 141

Revenues

Using cost data from “Production in the Short Run”, add revenue. Assume a selling price of 75 per unit. Output

Total Revenue

Marginal Revenue

(Q)

(TR)

(MR)

150

225

300

375

120

450

100

525

600

675

750

800

Total Revenue & Total Cost Curves

700

600

500

400

300

200

100

0 0

Marginal Revenue & Marginal Cost Curves

0 0

Page 223 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 142

Student Handbook

Short Run Profit Maximization Total Revenue & Total Cost Curves

If goal of a firm in the Short Run is to earn the maximum profit … 800

… they should produce where Sales are greater than Costs by the maximum amount …

700

600

500

On the diagramc, they should produce where TR is the greatest distance above TC

400

300

200

… about here …

100

0 0

Slide 143

Short Run Profit Maximization MR & MC Curves TR & TC Curves

Where is “here”? At this place, the tangents of both curves are parallel. It means the slopes of both curves are equal… Or, both curves’ slopes are changing at the same rate… In other words, where marginal revenue and marginal costs are equal, or, ….

120

800

700

100 600

80 500

400

300

40 200

20 100

8 8

10 10

… where MR and MC curves intersect.

Slide 144

Short Run Profit Maximization TR & TC Curves

One other detail about the TR & TC Curve diagram …

800

700

Notice where the TR & TC Curves intersect…

600

500

400

Before that point, costs exceed revenues. Only after that point do revenues exceed costs. We call that point the “Break Even Point”, where the firm is neither making nor losing money.

300

200

100

0 0

Page 224 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 145

Student Handbook

Economic Theory Theories

As we said in the first lesson, Economics is a science, and as such, there are different Classical Keynesian theories about how consumers, businesses •Long run profit maximizers •Short run profit and maximizers governments will behave under •Cost plus pricing – ATC (based •Assume owners control different conditions. on full capacity) plus a profit

•As long as firms cover variable •Assumes consumers do not like costs, will continue producing There are two main “schools ofprice thought” frequent changes •Adjust prices and output •Continue to produce even with about Economics. based on market conditions losses

Slide 146

Economic Theory Theories

Slide 147

Goals of Firms A profit maximizing company has fixed costs of £10. Its variable costs increase at a constant rate with output. The variable cost of producing each unit is £1. Explain whether it will produce: What are its choices? Units

Total Revenue

Fixed Costs

Variable Costs

Total Costs

Produce

Don’t Produce

£30

£10

£20

£10

£25

£10

£15

£25

£0

£10

£22

£10

£20

£30

£8

£10

£30

£10

£25

£35

£15

£10

Page 225 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 148

Production in the Long Run

Slide 149

Review Production in the Short Run •AFC curve is downward sloping

Average Fixed Costs Average Variable Costs 250

•AVC curve slopes downwards then upwards

120

200 100

150 80

Due to Economies of Scale and Diseconomies of Scale

100 60

0 0

Slide 150

4 2

6 4

8 6

10 8

12 10

Review Production in the Short Run •ATC curve starts moving up where “Diminishing Returns to Scale” sets in

Average Total Costs 350

300

250

200

150

100

0 0

Page 226 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 151

Review Production in the Short Run •Firms maximize profits where the distance between TR and TC are the greatest •This is the place where MR and MC intersect •One final point: Changes in Price or Costs will affect the profit maximizing level of •For example, increases in costs output will cause the MC curve to shift upwards, reducing profit maximization output

Slide 152

Student Handbook

Total Revenue, Total Cost

Marginal Revenue, Marginal Cost 800 700 120 600

100 500

80 400

300 60 200

40 100 0

20 0

0 0

Production in the Long Run • In the Long Run, all factors are variable • The curve starts out with the firm having Economies of Scale • Then the firm produces at maximum efficiency level – Constant Returns to Scale

Long Run Average Costs

• Finally the firm begins experiencing Diseconomies of Scale

Slide 153

Production in the Long Run • The maximum level of efficiency

Long Run Average Costs

• The optimum level of output in the long • run The Minimum Efficiency Scale (MES)

Page 227 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 154

Student Handbook

Attainable LRAC – lowest possible average costs a firm can achieve

Long Run Average Cost Curve

Actual cost will be inside and above the LRAC Average costs never below the LRAC Increases in production lead to movement along the LRAC

Slide 155

Long Run Economies of Scale (Large Firms) • Technical:

Use equipment more efficiently Indivisibility Source of Productive Efficiency

• Specialization:

Employ more specialists

• Purchasing:

Buying larger quantities

• Financial:

More sources of funds – lower cost

Firm may also experience Technical Diseconomies of Scale In small firm, may be indivisibility

Slide 156

Long Run Diseconomies of Scale (Large Firms) • Mainly due to management problems • As firms grow, more difficult for management to control activities • Centralization / Decentralization

Page 228 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 157

Student Handbook

Shifts in the LRAC Downward Shift: • Savings from growth in industry • Better roads & transportation • Better qualified workers – lower training costs • Government training programmes • New technologies • External Economies of Scale:

Upward Shift: • Taxation • External Diseconomies of Scale:

Slide 158

• Generally means industries expanding too quickly

Relationship between LRAC and SRAC LRAC and SRAC Curves

Slide 159 Growth of Firms & Mergers

Page 229 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 160 Growth of Firms & Mergers Long run â&#x20AC;&#x201C; reach the level where Economies of Scale set in Economists say: no direct link between size and efficiency

Slide 161

Long Run Average Cost Curve In the long run, when all factors are variable, firms benefit from increasing their size

Long Run Average Cost Curve

Increases in sales lead to lower long run average costs

Slide 162

Growth of Firms & Mergers Reasons for growth: Take advantage of Economies of Scale Better able to affect their market

Reduce risks

Page 230 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 163

Student Handbook

Advantages of different sizes Large firms:

Economies of Scale High barriers to entry (difficult for other firms to reach their size)

Small firms: Low barriers to entry

Operate at MES Some lower costs Offer better service – local

Slide 164

Methods of Growth • Internal: increasing sales • Merger • External: • Amalgamation • Takeover

2 or more companies join together

Slide 165 Reasons / motivation to choose Merger, Amalgamation or Takeover • Time and Money • Asset Stripping • Rewards to Management

Page 231 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 166

Student Handbook

Types of Mergers • Horizontal merger – Same industry, same stage of production

• Vertical merger – Same industry, different stage of production – Forward integration: manufacturer acquires its customer – Backward integration: manufacturer acquires its supplier

• Conglomerate – different industries

Slide 167

Notes about Mergers • Not clear they increase economic efficiency • Productive efficiency may increase, if average cost reduces (E of S) • Those E of S often involve loss of jobs • Allocative efficiency may increase • Tend to reduce competition in the market • Asset stripping controversial

Slide 168

Monopoly The only producer / supplier in an industry A monopoly is the industry

Page 232 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 169

Monopoly • • • • • •

Slide 170

Student Handbook

The only producer Barriers to entry high Government Resources Competitive practices No close substitutes

Monopoly Barriers: • Government • Resources • Competitive practices • No close substitutes

Slide 171

Natural Monopoly Defined: Cost of producing the product is lower (due to economies of scale) if there is just a single producer

Page 233 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 172

Student Handbook

Natural Monopoly Economies of Scale: • Purchasing • Marketing • Technical • Managerial / Specialization • Financial Examples: telephone, power, water, etc.

Slide 173 Monopolies •Can remain if barriers to entry remain high •Can charge higher price •May not have lowest possible costs –May not maximize profits

•Likely to have abnormal profits

Slide 174

Monopoly Average and marginal revenue under monopoly

Page 234 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 175

Student Handbook

Revenues for a firm facing a downward-sloping demand curve Q (units)

P = AR (£)

TR (£)

MR (£) 6 4 2 0 –2

–4

Slide 176

Revenues for a firm facing a downward-sloping demand curve Q (units)

P = AR (£)

TR (£)

MR (£) 6 4 2 0 –2

–4

Slide 177

Revenues for a firm facing a downward-sloping demand curve Q (units)

P = AR (£)

TR (£)

MR (£) 6 4 2 0 –2

–4

Page 235 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

AR and MR for a firm facing a downward-sloping D curve Q P =AR 8

Slide 178

(units ) 1 2 3 4 5 6 7

AR, MR (£)

(£) 8 7 6 5 4 3 2

0 1

Quantity

-2

-4

fig

AR and MR for a firm facing a downward-sloping D curve Q P =AR TR 8

Slide 179

(units ) 1 2 3 4 5 6 7

AR, MR (£)

(£) (£) 8 6 14 4 18 2 20 0 20 -2 18 -4 14

(£) 8 7 6 5 4 3 2

0 1

Quantity

-2

-4

fig

AR and MR for a firm facing a downward-sloping D curve 8

Slide 180

Elastic Elasticity = -1

AR, MR (£)

Inelastic

0 1

Quantity

-2

-4

fig

Page 236 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 181

Monopoly

Slide 182

(£)

Profit-maximising price and output

Profit Maximizing Level

24 20 16

12 8 4 0 1

Quantity

-4

Slide 183

(£)

-8

fig

Profit Maximizing Level

20 16

12 8 4 0 1 -4 -8

2 3 4 5 Profit Maximizing Break Even Points Level of Output

Quantity

fig

Page 237 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 184

Student Handbook

Profit Maximizing Level

Costs and revenue (£)

0 1

Quantity

-4 fig

Slide 185

Profit Maximizing Level

Costs and revenue (£)

Profit-maximising output

0 1

Quantity

-4 fig

Slide 186

Measuring Maximum Profit MC

Costs and revenue (£)

0 1

Quantity

-4 fig

Page 238 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 187

Student Handbook

Measuring Maximum Profit MC

Costs and revenue (£)

AR 0 1

Quantity

-4 fig

Slide 188

Measuring Maximum Profit MC Abnormal profit = £1.50 x 3 = £4.50

Costs and revenue (£)

6.00 ABNORMAL PROFIT 4.50

AR 0 1

Quantity

-4 fig

Slide 189 Monopoly Comparison of monopoly with perfect competition (a) same industry MC curve

Page 239 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Perfect Competition & Monopoly

Slide 190

(same MC curve) £

MC Monopoly

AR = D MR O

Slide 191

Perfect Competition & Monopoly £

(same MC curve)

MC ( = supply

under perfect competition)

Comparison with Perfect competition

P1 P2

AR = D MR O

Slide 192

Oligopoly

Page 240 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 193

Student Handbook

Characteristics of Oligopoly •A few major firms in the market • Could still be many smaller suppliers •Firms are interdependent –Actions of one firm can affect others •There are barriers to entry •There are abnormal profits

Slide 194

Characteristics of Oligopoly •Price rigidity –Fewer price changes, even when costs change

•Non-price competition –Compete in different ways: 4 P’s; Branding

•Firms watch each other and act together –Sometimes “collusion” •AC curve more “L” shaped than “U” shaped

Slide 195

Oligopolist’s Demand Curve •If one Oligopolist increases price –No other firms will follow –Price raising firm will lose customers –(High PED)

•If one Oligopolist lowers price –Other firms will follow –Price raising firm will not gain many customers –(Low PED)

•Hence, Oligopolists are interdependent

Page 241 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 196

Oligopoly “Kinked” demand curve theory

Slide 197

Oligopolist’s Demand Curve Current price and quantity are the starting point of the demand curve

Q1 fig

Slide 198

Oligopolist’s Demand Curve If aOligopolies firm in oligopoly are raises its price, the price elastic above others will notprice. follow. the market

Page 242 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 199

Student Handbook

Oligopolist’s Demand Curve IfSo a firm in oligopoly oligopolies are lowers its price, the price inelastic below others will follow. the market price.

D O

Slide 200

Oligopolist’s Demand Curve Price elastic above the market price. Price inelastic below the market price.

The Kinked Demand Curve

D O

Slide 201

Stable price under conditions of a kinked demand curve MC2

When costs rise oligopolies still will not raise prices.

MC1

D = AR O

Page 243 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 202

Student Handbook

Oligopoly Collusion: •A secret agreement •Between two or more people / companies •To get some advantage

Cartel: •A group formed especially to regulate price and output in some industry

Oligopolists sometimes form cartels

Slide 203

Oligopoly If no Collusion or Cartels:

Game Theory

Slide 204

Oligopoly Example of oligopoly

Page 244 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 205

Student Handbook

Market shares of the largest brewers 1985 (%) Bass Allied Lyons (Carlsberg) Grand Met (Watneys) Whitbread Scottish and Newcastle Courage Others

2002 (%) 22 13 12 11 10 9 23

Scottish–Courage Interbrew UK Coors Carlsberg–Tetley Diageo (Guinness) Others

100

Slide 206

27 20 18 12 7 16 100

Market shares of the largest brewers 1985 (%) Bass Allied Lyons (Carlsberg) Grand Met (Watneys) Whitbread Scottish and Newcastle Courage Others

2002 (%) 22 13 12 11 10 9 23

Scottish–Courage Interbrew UK Coors Carlsberg–Tetley Diageo (Guinness) Others

100

27 20 18 12 7 16 100

Slide 207

Introduction to Macroeconomics

Page 245 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 208

Student Handbook

National Economic Performance A measure of how the economy is doing 4 basic areas to judge • Economic Growth • Unemployment • Inflation • Current Balance (Trade)

Slide 209

National Economic Performance A measure of how the economy is doing • Economic Growth – Rate of change in national output – GDP – RECESSION, DEPRESSION

Slide 210

National Economic Performance A measure of how the economy is doing • Unemployment – A waste of a resource – Linked to Economic Growth

Page 246 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 211

Student Handbook

National Economic Performance A measure of how the economy is doing • Inflation – Ongoing rising of general price levels – Prices of what you want go up – Value of savings goes down – Some inflation is ok, too much is bad – Linked to Economic Growth and Unemployment

Slide 212

National Economic Performance A measure of how the economy is doing • The Current Balance – The balancing of Imports and Exports – Exports bring money into the economy – Imports send money out of the country – Exports lead to trade surpluses – Imports lead to trade deficits – Linked to Economic Growth and Inflation

Slide 213

National Economic Performance A measure of how the economy is doing 4 basic areas to judge • Economic Growth • Unemployment • Inflation • Current Balance (Trade)

Desired outcome Increasing Decreasing Keep low Balanced

Trade-offs

Page 247 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 214

Student Handbook

The Circular Flow of Income A diagram to show National Income

1. Factors of Production 2. Rent, wages, interest & profits  National Income “Y” 3. Produce goods & services  National Output “O” 4. Spending on goods & services  National Expenditure “E”

The Two Sector Model

Households

Firms

Y, O and E are equal – National Income Equilibrium

Slide 215

The Circular Flow of Income A diagram to show National Income The Two Sector Model The Five Sector Model Leakage

Households E

Banking O

Firms

Investment

M Imports

T Taxes

S Saving

Government

Overseas

Government Spending

Exports

I Injection

The Multiplier Effect

Slide 216

Paradox of Thrift Paradox (n) – contrary to common opinion Thrift (n) – managing and saving money Common opinion – saving is good for everyone The Paradox of Thrift – if everyone saves, the leakage would cause the economy to shrink, making everyone worse off

Page 248 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 217

Student Handbook

Measuring National Income • Gross Domestic Product (GDP) most often used • GDP = the value (at market price) of all goods and services produced in the economy • GDP also includes Indirect taxes

Slide 218

Measuring National Income Other measures: • Gross Value Added (GVA) at basic cost GVA = GDP – indirect taxes + subsidies • Gross National Product (GNP) at market price GNP = GDP + income on overseas investments – income of foreign investments in the UK

Slide 219

Measuring National Income All calculations exclude Transfer Payments: • Government payouts • Student loans • Second hand sales • Any other transfer payments where there are no goods or services produced

Page 249 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 220

Student Handbook

Reasons to produce National Income statistics: • • • • •

Slide 221

Help economists to understand an economy To judge economic performance To judge economic welfare To forecast changes and plan for them To compare: over time; and, between countries

Possible errors in calculating National Income statistics: • • • • • •

Slide 222

Accuracy Too many statistics Too many changes Hidden activities: avoid tax; illegal; informal Self-produced goods and services The Public (Government) sector – nothing bought or sold

Problems with comparing National Income over time: • • • • • • •

Prices change (Inflation) Presentation – calculation methods change Population changes – use “per capita” Changes in quality affect price comparisons Consumption / Investment Externalities – not measured Income distribution not considered

Page 250 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 223

Student Handbook

Problems with comparing National Income between countries: • Basic differences in economies • Income distributions • Use exchange rates that compare standards of living – Purchasing Power Parity (PPP) – A typical basket of goods • Different living conditions / costs

Slide 224 The Multiplier Effect • Assume an injection takes place – enters the economy – continues circulating – each time it adds to national income • Injections add a much more to the economy than the value of the initial injection • Same is true in reverse

Slide 225

Economic Growth

Page 251 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 226

Student Handbook

Economic Growth The change in potential output Production Possibility Frontier diagram • Economic Growth v. Recovery The Output Gap • GDP growth rate • GDP trend • Positive, Negative Output Gaps

Production Possibility Frontier Combination of goods and services economy could produce if all resources fully and efficiently used

Goods

Slide 227

A = Inefficient B = Maximum efficiency B A

Services

Slide 228

Business Cycle Diagram Notice the gaps between Actual GDP and Trend GDP Rate of Growth

These are called Output Gaps Actual GDP Trend GDP

Time

Page 252 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 229

Student Handbook

What Causes or Creates Output Gaps? • Economies rarely operate at full efficiency • Ups and downs in economic performance create the shape of Actual GDP • During peaks, an economy operates closest to full efficiency, closest to the PPF • During other times, it is moving toward or away from full efficiency • Recovery is not economic growth

Slide 230 Rate of Growth

Business Cycle Diagram Economy is probably using all its resources fully and efficiently – Point B on the PPF diagram

Actual GDP Trend GDP

Economy is not using all its resources fully – Point A on the PPF diagram

Time

Production Possibility Frontier Combination of goods and services economy could produce if all resources fully and efficiently used

Goods

Slide 231

A = Inefficient B = Maximum efficiency C = Impossible given the current resources … Only if new resources are introduced … = a new PPF … = Economic Growth

Page 253 of 406

C B A

Services

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 232

Student Handbook

What Causes or Creates Economic Growth? • Increases in Inputs • New efficiencies in use of Inputs

Slide 233

What Causes or Creates Economic Growth? “Land” • Increase in use of natural resources • New discovery of natural resources

• Tends to help developing countries more than developed countries

Slide 234

What Causes or Creates Economic Growth? “Labour” Increased labour force leads to Economic Growth: • Demographics – e.g. younger workforce • Participation – e.g. women in the workforce • Immigration – Might affect output – Might not affect economic welfare (more people)

Page 254 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 235

Student Handbook

What Causes or Creates Economic Growth? “Capital” • Must increase over time to sustain Economic Growth • Investments should be targeted to growth industries

Slide 236

What Causes or Creates Economic Growth? Technological Progress Increases Economic Growth in two (2) ways: 1. Decreases average cost of production 2. Creates new products which consumers then buy

Slide 237 Efficiency The way resources are used to produce goods and services Markets promote efficiency

Page 255 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 238 Economic Growth Arguments for • Improved standard of living • Crime reduction • Improved working environment • Improved environment • Reduction / elimination of absolute poverty

Slide 239 Economic Growth Arguments against • Problems with national income statistics • Negative externalities • Growth unsustainable • Using up of natural resources • Increased inequality

Slide 240

Problem with comparing Often, the amount of goods that can be purchased in different countries is very different, because of the following: • Standard of living • Exchange rates of currencies • Cultural differences

Page 256 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 241

Student Handbook

Problem with comparing Examples: • Levels of education and development • Types of housing and relative costs • Differences in type of food consumed • Different life styles • Governments’ control over currencies and exchange rates

Slide 242

Purchasing Power Parity A method of comparing, based on: • Availability of goods • Demand for goods • Differences exchange rates (Parity: treating something as equal)

Slide 243

Purchasing Power Parity Calculation:

Where: S = exchange rate of currency 1 to currency 2 P1 = cost of good “x” in currency 1 P2 = cost of good “x” in currency 2

Page 257 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 244

Student Handbook

Purchasing Power Parity But the example is a bit simple: • There are differences between what people use in one country compared with another country • So, PPP is based on a “typical” basket of goods purchased by a “typical” household during a “typical” month, • In different countries

Slide 245

Couldn’t it be made easier?? Isn’t there something that everybody uses?

Slide 246

The Big Mac© Index • Compares the price of a McDonald’s Big Mac© in different countries • An informal way of measuring purchasing power parity • Also a way of measuring how much exchange rates affect the same product

Page 258 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 247

Student Handbook

Human Development Index A way to measure a country’s development Combines the following aspects: • Life expectancy • Education levels • Income Based on a minimum and maximum for each aspect

Slide 248

Human Development Index A way to measure a country’s development Combines the following aspects: • Life expectancy • Education levels • Income

Slide 249

Human Development Index

Page 259 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 250

Student Handbook

Nominal vs. Real Certain economics statistics have problems in comparing, because of inflation Nominal: “in name only” means, as is Real: means, as adjusted for inflation Example: • Nominal GDP: 8% • Inflation Rate: 3% • Real GDP: 5%

Slide 251

Aggregate Supply

Slide 252

Aggregate Supply The supply of everything produced within the economy Measured at different price levels

Page 260 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 253

Student Handbook

Aggregate Supply – Long Run Produce as much as resources will allow Factors of Production have Limitations: resources; capacity; labour; etc. (Production Possibility Frontier) So, the LRAS Curve is the outer limit of what economy can produce

Slide 254

Shifts in LRAS • Likely shifts over time – Technology – Training & Education • Shift of PPF represents shift of LRAS

Slide 255

LRAS Curve Outer limit of what can be produced On a diagram, a portion of LRAS Curve must be vertical

Price Levels LRAS

0 Output

Page 261 of 406

Real

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 256

Student Handbook

Shape of LRAS • All economists agree on the previous • Disagree in the area of Labour: – Excess Labour / unemployment – Changes in wage rates

Slide 257

Shape of LRAS Classical Economists: • • • •

Labour market functions perfectly Excess labour leads to drop in wage rate Unemployed tend to get jobs Market moves back to relative equilibrium – Adaptive expectations – clears gradually – Rational expectations – clears quickly • Classical LRAS vertical

Slide 258

Classical LRAS Curve Price Levels

LRAS

Labour market clears Vertical

0 Output

Page 262 of 406

Real

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 259

Student Handbook

Shape of LRAS Keynesian Economists: • Labour market does not function perfectly • Wage rates tend not to fall – Skilled workers keep their wage rates – Labour unions fight drops in wage rates – Minimum wage laws / Unemployment benefits – Workers can move around • Moderate Keynesians: wage rate may temporarily drop

Slide 260

Shape of LRAS Keynesian Economists: • Unemployed tend to remain out of work for longer periods of time • Market will not clear – “sticky downwards” • This affects Aggregate Demand • Too many out of work – “Mass Unemployment” • Stay unemployed until some force pushes demand for labour back up

• When they begin returning, increased output unlikely to lead to higher price levels

Slide 261

Keynesian LRAS Curve Price Levels

Full employment – Vertical Mass unemployment – Horizontal

When workers begin returning to work, price levels will 0 Output slowly rise

Page 263 of 406

LRAS

Real

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 262 Rate of Growth

Business Cycle Diagram Actual GDP

Positive Output Gap

Trend GDP

Negative Output Gap

Time

Slide 263

Aggregate Demand

Slide 264

Aggregate Demand The demand for everything produced within the economy • Relationship between: – Price Levels – Real Expenditure (adjusted for Inflation) – Adjustment based on Retail Price Index

Page 264 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 265

Student Handbook

The Aggregate Demand Curve Price Levels

At higher price levels, lower quantities of G&S will be purchased

Slide 266

Real Output

Aggregate Demand Reminder: National Income (Y) = National Output (O) = National Expenditure (E)

Slide 267

Aggregate Demand Components of the Circular Flow diagram: E National Expenditure C Consumption I Investment G Government Spending X Exports M Imports

E = C + I + G + (X â&#x20AC;&#x201C; M)

Page 265 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 268

Student Handbook

Aggregate Demand E = C + I + G + (X – M) Analysis: anything that causes a change in any of these different components will cause a change in National Expenditure

Slide 269

Consumption (C) Influenced by Inflation and the Interest Rate (IR) • If prices rise… • Consumers need more money to buy… • So they borrow… • The supply of money is limited… • Borrowing increases the demand for money… • So the interest rate (the Price of money) rises • In the end, consumers buy less

Slide 270

Investment (I) Influenced by Inflation and IR • Companies borrow money for Investment • Rises in prices lead to rises in Interest Rate • Marginal Efficiency of Capital Theory • Investment affected by changes in IR

Page 266 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 271

Student Handbook

Government Spending (G) Affected by political decisions Changes in Government Spending affect AD

Slide 272

Exports (X) and Imports (M) Influenced by Inflation • Higher domestic prices lead to: – Lower Exports (our goods too expensive) – Higher Imports (their goods are cheaper) • Trade Deficits

• Lower domestic prices lead to: – Higher Exports (our goods are affordable) – Lower Imports (their goods too expensive) • Trade Surpluses

Slide 273

Movement along the AD Curve • As Price levels rise, the quantity of G&S purchased falls because: – Increases in IR reduce C and I; and, – Higher prices reduce X’s and increase M’s

Page 267 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 274

Student Handbook

Shifts in the AD Curve From anything besides changes in price levels… • Consumption: increases in C are caused by: – Lower IR – Lower Unemployment rate – Rises in the stock market (the wealth factor) – New technologies – Lower savings – Lower income taxes

Slide 275

Shifts in the AD Curve From anything besides changes in price levels… • Investment: increases in I, caused by: – Increased confidence by businesses in the economy – Lower IR – Increased company profits – Fall in company taxes

Slide 276

Shifts in the AD Curve From anything besides changes in price levels… • Increases in Government Spending (G)

Page 268 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 277

Student Handbook

Shifts in the AD Curve From anything besides changes in price levels… • Imports and Exports: A fall in the Exchange Rate – Exports become more competitive abroad – Imports become less competitive at home – Exports (X) rise – Imports (M) fall

Slide 278

The Multiplier Effect Recall the Circular Flow of Income diagram: Every Injection into the economy… • Pays for goods & services… • Purchases more materials & labour… • Returned to households: salaries & profits • Circulates through the economy again and again… • The Multiplier Effect

Slide 279

Leakages Money taken out of the circular flow • Savings (banking sector) • Taxation (government sector) • Imports (overseas sector)

Page 269 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 280

Student Handbook

The Shape of the AD Curve According to Keynesian economists… Weak link between prices and aggregate demand • Price levels – little effect on IR • IR changes – little effect on C and I • Main determinant of I is prior profits The Aggregate Demand Curve is more steep

Slide 281

The Shape of the AD Curve According to Classical economists… Strong link between prices and aggregate demand • Price levels – strong effect on IR • IR changes – Strong effect on C and I The Aggregate Demand Curve is more flat

Slide 282

Equilibrium Output

Page 270 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 283

Student Handbook

Long Run Equilibrium Classical Economists • rises in unemployment lead to quick wage cuts • pushes output back to full employment levels

Keynesian Economists • unemployed do not reduce wage expectations • remain out of work much longer

Slide 284

Long Run Equilibrium Classical Economists What happens when Aggregate Demand increases Price Economy moves to disequilibrium Temporary overemployment & overoutput SRAS shifts left due to increased costs New equilibrium, higher prices

Slide 285

Levels

LRAS

0 Output

AD1

Real

Long Run Equilibrium Classical Economists What happens when Aggregate Supply rises Creates increased output Causes price levels to drop

Price Levels

LRAS LRAS1

0 Output

Page 271 of 406

Real

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 286

Student Handbook

Long Run Equilibrium Keynesian Economists • All periods of dis-equilibrium depend on the situation in the economy • Specifically unemployment • And the effect of unemployment on the demand for goods and services (AD)

Slide 287

Long Run Equilibrium Keynesian Economists What happens when Aggregate Demand rises Price Levels

LRAS

If economy is at full employment Shift causes rise in prices only, no output change

0 Output

Slide 288

AD1

Real

Long Run Equilibrium Keynesian Economists What happens when Aggregate Demand rises Price Levels

LRAS

If in period of mass unemployment Shift increases output with no effect on prices AD

0 Output

Page 272 of 406

AD1

Real

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 289

Student Handbook

Long Run Equilibrium Keynesian Economists What happens when Aggregate Demand rises Price Levels

LRAS

If in period of some unemployment Shift causes rising prices and increased output

0 Output

Slide 290

AD1

Real

Long Run Equilibrium Keynesian Economists What happens when Aggregate Supply increases Price Levels

LRAS

LRAS1

If in period of full employment Shift causes large increase in output, and big drop in prices

0 Output

Slide 291

Real

Long Run Equilibrium Keynesian Economists What happens when Aggregate Supply increases Price Levels

If economy is not at full employment Shift causes output to increase, and small drop in prices

LRAS LRAS1

0 Output

Page 273 of 406

Real

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 292

Student Handbook

Long Run Equilibrium Keynesian Economists What happens when Aggregate Supply increases LRAS

Price Levels

If at mass unemployment Shift will have no effect at all on the economy

LRAS1

AD 0 Output

Slide 293

Real

Shift in Both Aggregate Demand and Aggregate Supply Increased Investment shifts AD outward, Also shifts AS out Causes increased output with little effect on prices

Price Levels

LRAS

LRAS 1

0 Output

AD1

Real

Slide 294 Consumption and Savings

Page 274 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 295

Consumption (C) Spending on goods and services over a period of time

Savings (S) Income which is not spent

Slide 296

Consumer goods Durable goods They last (are used) a long time Usually more expensive Often bought on credit

Non-durable goods When consumed they’re gone

Slide 297

Consumption and saving • Two formulas to help understand consumption and saving in an economy: Average Propensity to Consume (APC) Marginal Propensity to Consume (MPC)

Page 275 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 298

Consumption and saving • APC =

• MPC =

Slide 299

consumption income change in consumption change in income

C Y

= ∆Y

∆C

Consumption and saving (example) Disposable Income Consumption APC = MPC =

Slide 300

Student Handbook

Year 1 Year 2 £100billion £110billion £80billion £85billion 0.8 0.77 0.5

Consumption Function – Determinants of consumption Disposable Income Wealth Inflation Interest Rates Availability of Credit Expectations Unemployment Taxation Technological Development

Page 276 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 301

Student Handbook

Determinants of consumption and saving Wealth • If a household’s wealth increases, C increases – the wealth effect • Two main ways wealth increases:  Increase in house prices  Increase in the stock market (shares)

Slide 302

Determinants of consumption and saving Inflation – Affects C in two opposite ways:  A. Increases C: consumers make big purchases sooner, to avoid higher prices  B. Decreases C: consumers save more, because inflation is reducing the value of what they’ve saved

Slide 303

Determinants of consumption and saving Interest rate (IR) • Households often borrow to consume, especially durable goods • Higher IR increases cost of borrowing, so households reduce consumption • Higher IR increases monthly payments (homes, other debts) so consumers have less money to spend

Page 277 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 304

Student Handbook

Determinants of consumption and saving Availability of credit • Governments can limit borrowing: the amount that can be borrowed; the number of loans – reduces consumption • When limits removed, households can increase borrowing, increase consumption

Slide 305

Determinants of consumption and saving Expectations (“consumer confidence”) • When consumers have positive view of the future economy, consumption increases • When consumers have a negative view of the future economy, consumption decreases

Slide 306

Determinants of consumption and saving Unemployment • Decrease leads to increased consumption Taxation • Decrease leads to increased consumption Technological development • Leads to increased consumption Age • Young consume more / Older consume less

Page 278 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 307

Save / Saving Income not spent is saved

Savings Ongoing accumulation of previous amounts saved – a flow concept

Slide 308

Savings • Two formulas: Average Propensity to Save (APS) Marginal Propensity to Save (MPS)

Slide 309

Savings • APS =

saving income • MPS = change in saving change in income

= =

S Y

∆S ∆Y

Note: APC + APS = 1 Increase in savings increases investment Increase in savings reduces consumption Higher earners have higher MPS, lower MPC

Page 279 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 310

Student Handbook

Savings Function – Determinants of savings Disposable Income Wealth Inflation Interest Rates Availability of Credit Expectations Age

Slide 311

Economic Theories on Consumption and Savings Keynes noted:  Primary relationship between current income and current consumption  Most important: 1) Short-term income 2) Availability of Credit  Consumption function relatively stable  Changes in wealth & IR have little effect

Slide 312

Economic Theories on Consumption and Savings Based on this, Keynes believed:  Increased wealth leads to stagnant economy  Redistributing income from rich to poor would overall increase total consumption

Page 280 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 313

Student Handbook

Economic Theories on Consumption and Savings Life Cycle Hypothesis:  Current consumption based on likely income over one’s lifetime  Not current income  Example: Compare manual worker with professional

Slide 314

Economic Theories on Consumption and Savings Permanent Income Hypothesis:  Milton Friedman  Permanent Income: Average income over one’s lifetime, not current income  Rise in wealth increases C over life  Rise in IR lowers C over life – it lowers value of investments and wealth – lowers Permanent Income  Lifetime APC = 1

Slide 315

Investment

Page 281 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 316

Student Handbook

Investment Additions to the capital stock of the economy i.e. factories, machines, offices etc.

Slide 317

Gross and net investment • • • •

Slide 318

Capital stock wears out, losing value over time This is depreciation (or capital consumption) Gross investment is the value of investment Net investment is Gross investment minus depreciation

Marginal efficiency of capital • Firms invest to make profit (a return on capital) • Rate of return on investment is called marginal efficiency of capital (MEC) • Investment (I) depends on IR – firms only invest in projects where MEC > IR

Page 282 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 319

Student Handbook

Marginal Efficiency of Capital and Interest Rates (IR) • An increase in IR leads to a decrease in investment • A decrease in IR leads to an increase in investment

Slide 320

Planned investment schedule 25

Interest rate %

20 15 10 5 0 0

Planned investment $billions

Slide 321

What causes shifts in planned investment? • • • • •

Cost of capital goods Technological change Government policy Business expectations for the future The Accelerator Theory

Page 283 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 322

Student Handbook

What causes shifts in planned investment? Cost of capital goods • If cost of capital goods rises, MEC will fall • So, increase in cost of capital goods leads to reduced investment, and investment schedule shifts inwards

Slide 323

What causes shifts in planned investment? Technological change • New technology makes capital equipment more productive, so MEC will rise • So, technological improvements lead to increased investment, and the investment schedule shifts outwards

Slide 324

What causes shifts in planned investment? Government policy • Governments make decisions regarding the business environment, which affect firms decisions to make investments • Government policy that encourages greater investment causes the investment schedule to shift outwards

Page 284 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 325

Student Handbook

What causes shifts in planned investment? Business expectations for the future • Managers base their estimates of MEC in part on their expectations • Positive expectations lead to increased investment, shifting the investment schedule outwards • Negative expectations …

Slide 326

The Accelerator Theory • Planned investment depends on the rate of change in real output • If real output increases, firms need more capital, so investment increases • If real output decreases, a firms’ capital equipment is enough, so no new investment

Slide 327

The Accelerator Theory • So, in periods of rapid economic growth, investment will grow quickly (accelerate), and in periods of economic slowdown, investment will decrease quickly (decelerate)

Page 285 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 328

Taxation

Slide 329

Fiscal Policy • • • •

Slide 330

Policies used (adopted) by government To control and direct the economy Taxation Government Spending

Canons/characteristics of taxation  Cost of collection should be low compared to the yield of the tax  Timing of collection and the amount should be clear and certain  Timing and means of payment should be convenient  Taxes should be set according to an individuals’ ability to pay

Page 286 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 331

Student Handbook

Canons/characteristics of taxation • Modern economists have added some additional characteristics (canons): Leads to the least loss of economic efficiency Compatible with foreign tax systems Automatically adjusts to changes in the price level

Slide 332

Reasons for Taxation • • • •

Slide 333

Pay for government spending Correct market failure (Externalities) Manage economy Redistribute Income

Methods of Taxation Direct tax • A tax levied directly on an individual or organisation Indirect tax • A tax on a good or service

Page 287 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 334

Student Handbook

Tax systems Taxes can be classified by behaviour: • Progressive • Regressive • Proportional

Slide 335

Tax systems Progressive • The proportion (%) of income paid in tax rises as income rises Example • A shopkeeper earning £10,000 pays £1,500 (15%) of their income in tax • A nurse earning £25,000 pays £5,000 (20%) of their income in tax • A lawyer earning £50,000 pays £12,500 (25%) of their income in tax

Slide 336

Progressive tax system

Total tax paid (T)

Progressive

O Total income (Y )

Page 288 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 337

Student Handbook

Tax systems Regressive • The proportion (%) of income paid in tax decreases as income rises Example • A shopkeeper earning £10,000 pays £2,500 (25%) of their income in tax • A nurse earning £25,000 pays £5,000 (20%) of their income in tax • A lawyer earning £50,000 pays £7,500 (15%) of their income in tax

Slide 338

Regressive tax system

Total tax paid (T)

Regressive

O Total income (Y )

Slide 339

Tax systems Proportional (flat tax) • The proportion (%) of income paid in tax remains the same as income rises Example • A shopkeeper earning £10,000 pays £2,000 (20%) of their income in tax • A nurse earning £25,000 pays £5,000 (20%) of their income in tax • A lawyer earning £50,000 pays £10,000 (20%) of their income in tax

Page 289 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 340

Student Handbook

Total tax paid (T)

Proportional tax system

Proportional

O Total income (Y )

Slide 341

Taxation in the UK Income tax • Largest source of government income • Tax on an individuals income • Tax allowance: a minimum amount allowed before paying any income tax; any income earned over that limit (tax threshold) is known as taxable income • Taxable income is then split into tax bands

Slide 342

Taxation in the UK National insurance contributions (NIC’s) • A tax to pay for social welfare i.e. pensions and unemployment allowances • Collected from an individuals income

Page 290 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 343

Student Handbook

Taxation in the UK Corporation tax • Tax on company profits • 28% of profits paid in tax • Companies can claim tax allowances to lower their tax payment i.e. investment allowances

Slide 344

Taxation in the UK Capital gains tax • • • • •

Slide 345

Tax on profits from sale of assets (Excludes most goods, services and residences Gain (profit) is calculated Added to personal income Taxed like Income Tax

Taxation in the UK Inheritance tax • A tax on the value of assets left by someone who dies • The first £250,000 is not taxed (tax allowance) • Amounts above tax allowance are taxed at 40%

Page 291 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 346

Student Handbook

Taxation in the UK Excise Duties • Taxes on fuel, alcohol, tobacco and betting • Based on volume (quantity) sold • Amount of tax prescribed by law

Slide 347

Taxation in the UK Value Added Tax (VAT) • A tax on expenditure • Added to the cost of products • Some goods have no VAT, such as food, water, children’s clothes, books and public transport • Home heating fuels (gas, electric, heating oil and coal) are taxed at 5% • Other goods taxed at 17.5%

Slide 348

Taxation in the UK Council tax • By local governments to pay for local services i.e. garbage collection, traffic management, street cleaning etc. • Based on the value of an individual’s home: the higher the home’s value, the higher the rate

Business rates

• By local governments • Based on the value of business property; the higher the value of their property the more they pay

Page 292 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 349

Student Handbook

Incentive effect Tax can have an effect on incentives • Income effect, is where tax reduces incomes and so people choose to work more • Substitution effect, is where tax reduces incomes and so the opportunity cost of leisure is reduced and therefore people choose to work less

Slide 350

Government Expenditure

Slide 351

Government Expenditure • Governments in most countries spend money in many different areas • In the 20th Century in the UK, government spending (as a % of GDP) rose from about 12% in 1900 to about 40% by 2000

Page 293 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 352

Student Handbook

Types of Government Spending Produced Paid for by: by: Examples: Public Public Public libraries, Hospitals Sector Sector

Slide 353

Private Sector

Public Sector

Doctors, School buildings

Public Sector

Private Sector

Postal service

Government Expenditure • Three largest areas of G in the UK: Social protection: unemployment allowance, pensions, etc. Health care: UK’s National Health Service (NHS) Education: schools and colleges

Slide 354

Government expenditure • Other significant areas of G:  Social services  Transportation  Industry, agriculture, employment and training  National defence  Public order and safety i.e. police, fire services  Housing and the environment  National debt interest payments

Page 294 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 355

Student Handbook

Government Spending Factors affecting government decisions: • Public & Merit Goods: economy doesn’t provide • Efficiency: Health care – reduce costs • Equity: – Health care, elderly: high costs, low funds – Education: help poor

Slide 356

Public goods • Goods that can be used by everyone • Being used by one person does not reduce the amount available for others • No person can be excluded • Examples: national defence, police, street lighting and prisons

Slide 357

Merit goods • A good good, e.g. defence, police, courts, education • create positive externalities i.e. health care and education • Underprovided by the market: – benefits will not be felt for many years

Page 295 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 358

Student Handbook

Demerit goods • A good that is overprovided by the market • Consumption of demerit goods creates negative externalities i.e. alcohol & cigarettes

Slide 359

Provision of public and merit goods • Markets under-provide public and merit goods (Market Failure) • Government can intervene to correct:  Directly provide: government provides goods free of charge e.g. roads or education  Subsidised provision: government pays part of the cost, e.g. university education or medicine  Regulation: provided by private sector, and government forces people to buy e.g. car insurance

Slide 360

Government Spending If government spending is too high: • Privatization • Outsourcing • Internal market within public sector • Partnerships between public and private • Stop funding certain programs

Page 296 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 361

Student Handbook

Reasons for Public v. Private + Productive efficiency / economies of scale – Governments tend to be inefficient – Lack of competition, choices + Price of government services supported by tax revenues – Private sector pricing may be too expensive

Slide 362

Fiscal policy The use of government spending, taxation & borrowing to affect aggregate demand in an economy

Slide 363

Fiscal policy • In the 20th Century, UK has generally had a higher level of government spending than tax revenues (budget deficits) • This represents borrowed funds, known as the public sector net cash requirement (PSNCR) • The total level of money borrowed is known as the National Debt

Page 297 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 364

Student Handbook

Fiscal policy • Some times tax revenues are greater than government spending (budget surplus) • So government can repay some of the borrowed money – a negative PSNCR • The national debt then decreases

Slide 365

Fiscal policy • Every year in March UK government presents the Budget • The Budget shows plans for government spending, taxation and borrowing (fiscal policy) for the coming year

Slide 366

Fiscal Policy and the Economy Decrease in T or increase in G: • Shift Aggregate Demand out • May shift Aggregate Supply out • Increase Economic Growth • Decrease Unemployment • May cause Inflation • May reduce Exports, increase Imports (a net leakage)

Page 298 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 367 Redistribution of Income and Wealth

Slide 368

Income and Wealth In market economy, distribution of income and wealth not likely to be efficient or equitable Can create poverty: •Relative poverty – below average •Absolute poverty – unable to provide basic needs

Slide 369

LORENZ CURVE

Page 299 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 370

Student Handbook

Income Distribution • If income of 20% lowest earning households represented 20% of national income, and... • If income of 20% highest earning households represented 20% of national income, and so on... • Income would be evenly distributed between the different groups

Slide 371

Income Distribution On a table it would look like this: Household Earnings

Percent of National Income

Lowest Fifth

20.0%

Second Fifth

20.0%

Third Fifth

20.0%

Fourth Fifth

20.0%

Top Fifth

20.0%

Slide 372

Income Distribution

% of Income

On a graph, it would look like this: 120%

100%

80%

60%

40%

20%

0% 0%

20%

40%

60%

80%

100%

120%

% of Households

Page 300 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 373

Student Handbook

Income Distribution • In a free market economy, income among households will always be different • It is much more unevenly distributed between the different groups • For example…

Slide 374

Income Distribution in the USA Household Earnings

Percent of National Income

Lowest Fifth (under $6,391*) Second Fifth ($6,392* - $11,955*) Third Fifth ($11,956* - $18,122*) Fourth Fifth ($18,122* - $26,334*) Top Fifth ($26,335* and over)

4.3%

10.3% 16.9%

24.7% 43.9%

* Earnings per year. Source: U.S. Bureau of Census

Slide 375

Income Distribution

% of Income

On a graph, it looks like this: 120%

This red curve is called the LORENZ CURVE

100%

80%

60%

40%

20%

0% 0%

20%

40%

60%

80%

100%

120%

% of Households

Page 301 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 376

Student Handbook

The LORENZ CURVE â&#x20AC;˘ Shows the difference in income distributions between different groups in society â&#x20AC;˘ As the distance between the line of even distribution and the LORENZ CURVE increases, it means income is becoming more unevenly distributed

Slide 377 The LORENZ CURVE

Slide 378

Redistribution of Income and Wealth Law of Diminishing Marginal Utility: Additional satisfaction decreases the more the good is consumed Suggests: Redistributing from rich to poor would increase overall combined utility in an economy

Page 302 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 379

Student Handbook

Redistribution of Income and Wealth Methods of redistributing: Taxation: Progressive taxes Government Spending: social security; national insurance; housing grants; distribute clothing; etc. Legislation: minimum wages; equal pay laws; sick pay; pensions; medical insurance; retraining programs

Slide 380

Redistribution of Income and Wealth Costs to economy of redistribution: Benefits some but not all Taxpayers lose use of funds paid

Slide 381

Redistribution of Income and Wealth All economists oppose redistributing income and wealth Classical economists: Taxes are a disincentive Unemployment benefits and equal employment laws create higher wages which means less people employed High taxes create flight of capital

Page 303 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 382

Student Handbook

Redistribution of Income and Wealth All economists oppose redistributing income and wealth Supply-side Economists: Gap between poor and rich should be increased Poor would be better off if economy could grow in hands of wealthy, and benefits would trickle down to them

Slide 383

What effects will these changes have on distribution of income? Income Tax

Sales Tax

Basic Rate %

High Rate %

VAT%

1977

1987

1997

17.5

2007

17.5

Slide 384

Money and Monetary Policy

Page 304 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 385

Money • • • •

Slide 386

Student Handbook

A medium of exchange A unit of account A store of value A standard for deferred payment

Forms of Money • Cash • Current accounts: Money saved in banks, that can be immediately withdrawn as cash • Near Monies: money saved in “deposit“ accounts, that require notice to be withdrawn • Non-money financial assets: all assets that can be converted into money i.e. houses, cars, shares

Slide 387

Monetary Policy Interest Rate • Nominal Interest Rate • Real Interest Rate

Page 305 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 388

Student Handbook

Monetary Policy In the UK, the Central Bank sets the Interest Rate • The Bank Base Rate – the basic rate • Banks base all their other interest rates on this rate – Savings accounts – Bank loans Changing the Interest Rate can affect: • The amount of borrowing from banks • The amount of money circulating in the economy

Slide 389

Monetary Policy The primary method used to control inflation • Inflation comes with economic growth • Raising IR only moderates inflation, rarely reduces

Slide 390

Monetary Policy Raising Interest Rate causes drop in AD: • Less purchases of Durable Goods • Less purchases of homes • Less wealth – Drop in value of assets – Drop in Government Bond prices

• Less investment in new projects

Page 306 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 391

Student Handbook

Monetary Policy Raising Interest Rate causes (cont’d): • Less output, which increases Unemployment • Exchange Rate / Balance of Payment – Increase in demand for local currency – Increase in local currency’s value – Increase in Exchange Rate – Increase in price of local goods – Decrease in Exports – Increase in Imports – Decrease in Expenditure, decrease in AD

Slide 392

Monetary Policy • “Tightening” Monetary Policy – increase IR • “Loosening” Monetary Policy – reduce IR

Slide 393

Effectiveness of Monetary Policy in controlling Inflation Price

Classical Economists:Levels A rise in Interest Rate Causes a drop in AD Which causes a drop in Price Levels No change in output levels Effective Policy

LRAS

AD1 AD

0 Output

Page 307 of 406

Real

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 394

Student Handbook

Effectiveness of Monetary Policy in controlling Inflation Keynesian Economists:

Price Levels

LRAS

Depends on economy If near full employment Rise IR  drop in AD Leads to drop in Price Levels, and… Some drop in Output 0 Mostly effective Output

Slide 395

Real

Effectiveness of Monetary Policy in controlling Inflation Keynesian Economists:

Price Levels

LRAS

Depends on economy If closer to mass unemployment Rise IR  drop in AD Little effect on Price Levels, but a big drop in Output… And a big increase in Unemployment 0 Output Ineffective

Slide 396

AD1

AD AD1

Real

Operations of Monetary Policy Interest Rate will affect the Money Supply A raise in Interest Rate Causes a drop in the money supply

Rate of Interest

Page 308 of 406

Money

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 397

Student Handbook

Operations of Monetary Policy Other steps to affect Money Supply: Open Market Operations • Selling or buying government debt (bonds): – Selling bonds removes money from circulation in the economy – Buying bonds injects money into the economy

Slide 398

Operations of Monetary Policy Other steps to affect Money Supply: Reserve Asset Rates: – When money is deposited into savings, banks then lend the money, creating Investments – But banks must hold some money in reserve – The percent banks must hold in reserve

• Reducing RAR increases lending • Increases money supply + Credit Multiplier

Slide 399

Operations of Monetary Policy Other steps to affect Money Supply: Rules and regulations that affect banking credit policies, by influencing things such as home sales or purchases, etc.

Page 309 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 400

Student Handbook

Operations of Monetary Policy Money Supply and the Budget Deficit: To finance PSNCR: • Government may sell bonds • Borrowing to spend • No change to Money Supply • Just affects IR

Slide 401

Operations of Monetary Policy Money Supply and the Budget Deficit: To finance PSNCR: • Government may print more money • Increasing the Money Supply

Slide 402

Limitations of Monetary Policy • Money Supply not always easy to measure • Data not easy to produce • Link between IR and Money Supply not always clear • Unexpected events

Page 310 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 403

Inflation

Slide 404 Inflation Inflation – A rise in general price levels over a long period of time Deflation: – A lowering of general price levels, or – A slow down in economic output

Slide 405 Inflation Measured by: The Retail Price Index • A typical basket of goods • A weighted average calculation • Subject to inaccuracy

Page 311 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 406

Student Handbook

Problems during Inflationary Periods Consumers unclear about what’s a fair price – “Shoe Leather costs”

Slide 407

Problems during Inflationary Periods Consumers have less cash – Put more in savings – Interest rate is higher – Must consider the opportunity cost

Slide 408

Problems during Inflationary Periods “Menu Costs” – Prices of everything are constantly changing – Difficult to plan on what to buy

Page 312 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 409

Student Handbook

Problems during Inflationary Periods “Redistributional Costs” – Transfer from borrowers to lenders – Savers lose if Inflation rate is greater than Nominal Interest Rate

Slide 410

Problems during Inflationary Periods Creates Unemployment and lowers growth – Increases costs of production – Reduces Investment • Which decreases the likeliness of long-term growth

Slide 411

Problems during Inflationary Periods Anticipated / Unanticipated Inflation – Inflation mostly Unanticipated – Difficult for consumers to plan

Page 313 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 412

Inflation The Causes of Inflation

Slide 413 The Causes of Inflation Imported Inflation – Increases in the prices of imported goods • Consumer goods • Raw materials

Slide 414

The Causes of Inflation Demand-Pull Inflation:

Price Levels

Too much spending in relation to output Causes AD to shift out

LRAS

0 Output

Page 314 of 406

Real

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 415

Student Handbook

The Causes of Inflation Cost-Push Inflation:

Price Levels

LRAS

Costs increase SRAS shifts in Results in higher price levels

SRAS 2 SRAS AD

0 Output

Slide 416

The Causes of Inflation Cost-Push Inflation:

Price Levels

Workers seek wage raises, increase costs again They spend more, pushing out AD Results in higher price levels

Slide 417

Real

LRAS SRAS 3 SRAS 2 SRAS AD AD2

0 Output

Real

The Causes of Inflation “Monetarist” Economists: Inflation is Demand-Pull Sustained (long-term) Inflation Caused by increases in the money supply Causes AD to shift out, directly and indirectly (the Multiplier effect)

Page 315 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 418

Student Handbook

The Causes of Inflation â&#x20AC;&#x153;Monetaristâ&#x20AC;? Economists: The Fisher Formulation of the Quantity Theory of Money MV = PT M = money supply V = velocity P = prices T = number of transactions

Slide 419

The Causes of Inflation MV= PT An increase in M Causes an immediate fall in V Then, additional money begins to be spent Causing a gradual increase in incomes V increases back to standard This results in slow rise in P (Demand-Pull inflation)

Slide 420

The Causes of Inflation MV= PT As prices rise, real income (adjusted for inflation) begins to fall V and income return to equilibrium Finally, P remains at higher levels Together, this is called the Monetary Transmission Mechanism Increase in MS leads to increase in AD Leads to rise in SRAS, shift back to LRAS

Page 316 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 421

Student Handbook

Stagflation Rising costs shift the SRAS up Which increases price levels If economy is below full employment: Stagflation – workers can’t pay higher prices Workers may demand higher wages, but If MS is fixed, they may not get raises Workers will stay out of work for some time Then, begin returning to full employment

Slide 422

Counter-Inflation Policy • • • •

Slide 423

Monetary Policy Fiscal Policy Exchange Rate Policy Prices and Incomes Policy

Counter-Inflation Policy Monetary Policy: Raising Interest Rate causes: – Less spending on Durables, Investment – Lower values of stocks, homes (wealth) – Raising of the exchange rate – AD shifts inwards (diagram) – Succeeds when economic growth slows »Not popular

Page 317 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 424 Counter-Inflation Policy Fiscal Policy: Demand-Pull Inflation: – Government will reduce spending – Causes AD to shift in (diagram) Cost-Push Inflation: – Reduce or not increase indirect taxes, prices in government sectors – Reduce Corporate Taxes – Argued – only change money supply

Slide 425 Counter-Inflation Policy Exchange Rate Policy: Cost-Push Inflation:

• Controlling the exchange rate – Directly – Indirectly, through changes in Interest Rate

Slide 426

Counter-Inflation Policy Prices and Incomes Policy: Directly control or freeze prices & wages Some say this can work for a short time

Page 318 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 427

Unemployment

Slide 428 Real wage rate

The Labour Market SWorkers

DFirms O

Slide 429

Employment

The Labour Market The demand for labour is downward sloping Marginal revenue product (MRP) â&#x20AC;&#x201C; the value of labour to firms As more workers enter the market, MRP of labour declines

Page 319 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 430

Student Handbook

Types of Unemployment Cyclical Classical Frictional Structural Seasonal

•Considered Involuntary •Workers have no choice •(In boom times, there’s no

cyclical unemployment)

•Considered Voluntary •Workers refuse opportunities for jobs

Slide 431

Unemployment when the Labour Market is in Disequilibrium Cyclical / Demand-deficient unemployment: • Demand for labour declines • Happens when the economy is in a Negative Output Gap period

Slide 432

Unemployment when the Labour Market is in Disequilibrium Classical / Real Wage unemployment: • Wage level above equilibrium • Factors keep them from going down (“sticky downward”) • Market fails to “clear” because: – Unemployment benefits too high – Minimum wages – Unions

Page 320 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 433

Student Handbook

Unemployment when the Labour Market is in Equilibrium Frictional unemployment: • Workers lose jobs, • Spend a short time looking for work

Slide 434

Unemployment when the Labour Market is in Equilibrium Structural unemployment: • Economy doesn’t provide enough jobs • Types of Structural Unemployment: – Regional – Sectoral – Technical

Slide 435

Unemployment “Full employment” means … … when there is no involuntary unemployment … in other words, when there’s no cyclical unemployment … in other words, when economy reaches the highest positive output gap

The natural rate of unemployment is the percentage of voluntarily unemployed

Page 321 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 436

Student Handbook

Real wage rate

Natural Rate of Unemployment

S(Labour

Workers

Force)

Natural Rate of Unemployment =

QEQF 0QF

DFirms O

Slide 437

Employment

Unemployment According to Classical economists: • Short run unemployment is temporary • … Wages will fall • … Labour market moves back to equilibrium • In the long run, unemployment will be Voluntary

Inflation and Unemployment Analysed using AS/AD Model Price Levels / Inflation

Slide 438

SRAS2 SRAS1

P3 P2 P1

AD2 AD1 O

Page 322 of 406

Real output

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 439

Unemployment

Slide 440

Relationship between Unemployment and Inflation? • A.W. Phillips studied the rate of growth of money wages and unemployment from 1861 – 1957 • Money Wages = wages not adjusted for inflation

Slide 441

Results of study

Page 323 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 442

Student Handbook

The Phillips Curve • Findings indicated that when raises were high, unemployment was low • Growth of money wages linked to inflation … … in inflation times, workers seek higher raises • There is a trade-off between inflation and unemployment

Slide 443

The Phillips Curve Wage growth % (Inflation) There is an inverse relationship between inflation and unemployment. If a government wants to reduce unemployment, it will have to accept a trade-off of higher inflation.

2.5%

1.5%

Slide 444

PC1

Unem ployment (%)

The Phillips Curve • Problem: • In the 1970s, inflation and unemployment were rising at the same time – ‘stagflation’ • Was Phillips Curve theory wrong? • Or, was the Phillips Curve moving? • Or, …?

Page 324 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 445

Student Handbook

The Phillips Curve Long Run Phillips Curve

Inflation

3.0%

2.0%

ToAssume counteran the inflation rise in unemployment, rate of 1% but very government high unemployment once again at injects 7%. Government resources into the takes economy measures â&#x20AC;&#x201C; thetoresult reduce is a unemployment short-term fall in unemployment by an expansionary but higher fiscalinflation. policy (pushing AD to the right) The long This higher Phillips fuels Curvefurther is vertical There is a run fallinflation in unemployment, but atatathe natural expectation rate ofinflation. higher unemployment. inflation and Theso the cost of higher Expectations process continues. Augmented Phillips Workers expecting higher inflation seek Curve. higher wages. If granted, costs rise, firms start to reduce the labour force, and unemployment moves back up.

1.0% 4%

Slide 446

PC2

PC1

PC3

Unemployment

The Phillips Curve Wage growth % (Inflation) An inward shift of the Phillips Curve would result in lower unemployment levels associated with higher inflation.

3.0%

1.5%

PC1 PC2

Slide 447

Unem ployment (%)

Natural Rate of Unemployment is also called

Non-accelerating Inflation Rate of Unemployment Or the NAIRU The unemployment rate that is sustained with or without a change in inflation Unemployment tends to return to the Natural Rate of Unemployment

Page 325 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 448

Student Handbook

Economic Theory • The P curve helps explain why there is a curve in the Keynesian LRAS curve • Keynesians: in high unemployment times, it takes a long time for the labour market to clear • They don’t believe in the natural rate of unemployment

Slide 449

Economic Theory • Neo-Classicals: people see inflation coming • Immediately adapt (Theory of Rational Expectations) • Do not believe in Short Run Phillips Curve

Slide 450

Unemployment Policies Cyclical (involuntary) unemployment: • Use Demand policies (increase AD) – But need to be careful about inflation • Classical Economists (vertical LRAS): – Economy will return to full employment – Demand policies not necessary – Warn they may be damaging

Page 326 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 451

Student Handbook

Unemployment Policies Other types of Unemployment (voluntary) – use Supply Side policies:

Classical (real wage) unemployment: • Keynsians: Reduce unemployment benefits, pay companies to hire unemployed, give other benefits to low wage workers • Classical Economists: agree, add reducing Union power, reducing minimum wage

Slide 452

Unemployment Policies Other types of Unemployment (voluntary) – use Supply Side policies:

Regional Structural unemployment: • Keynesians: Government provide financial incentives for business to relocate • Classicals: Leave it to the free market forces (cheap land and labour costs are incentive enough for businesses to relocate)

Slide 453

Unemployment Policies Other types of Unemployment (voluntary) – use Supply Side policies:

Industrial Structural unemployment: • Keynesians: Government provide worker retraining programmes • Classicals: Lower benefits and redundancies

Page 327 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 454

Student Handbook

Unemployment Policies Anther solution: Reduce the Natural Rate of Unemployment

Increase growth rate of the entire economy: (assumes this will increase number of jobs) • Keynesians: Increase investment in physical and human capital • Classicals: Lower tax rates; privatizing; increasing competition; deregulation

Slide 455

International Trade Trade Policies and Exchange Rate Policies

Slide 456

International Trade Reasons for International Trade Availability – some goods only produced in certain countries i.e. oil, diamonds Product differentiation – provides more choice for consumers Price – some countries can produce goods relatively cheaper than others (absolute and comparative advantage)

Page 328 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 457

Student Handbook

International Trade Economic Theories: Absolute Advantage • Adam Smith • Based on lower production (labour) costs

Slide 458

International Trade Economic Theories: Relative / Comparative Advantage • David Ricardo • Even if one country has absolute advantage • Countries can benefit from trade • Based on Opportunity Costs • Countries specialize and trade

Slide 459

Example of the Value of Trade

• • • • • •

Tom gives up 40 fish to catch 30 crabs His opportunity cost for 1 fish is 3/4 crab And his opportunity cost for 1 crab is 4/3 fish Hank gives up 10 fish to catch 20 crabs His opportunity cost for 1 fish is 2 crabs And his opportunity cost for 1 crab is 1/2 fish

Page 329 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 460

Student Handbook

Example of the Value of Trade Tom

Hank Crabs

Crabs

35 30

25 20

15 10

5 0 0

Fish

0 0

Fish

Tom is more efficient at producing both â&#x20AC;&#x201C; he has an Absolute Advantage Evaluate Opportunity Cost: Fish: Crabs:

3/4 Crabs 4/3 Fish

2 Crabs 1/2 Fish

Tom and Hank should specialize and trade

Slide 461

Production and Consumption Without Trade Tom Quantity of fish Quantity of crabs Hank Quantity of fish Quantity of crabs Both together Quantity of fish Quantity of crabs

Slide 462

Production 28 9 Production 6 8 Production 34 17

Consumption 28 9 Consumption 6 8 Consumption 34 17

Production and Consumption after Specialization and Trade Tom Quantity of fish Quantity of crabs Hank Quantity of fish Quantity of crabs Both together Quantity of fish Quantity of crabs

Production 40 0 Production 0 20 Production 40 20

Page 330 of 406

Consumption 30 10 Consumption 10 10 Consumption 40 20

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 463

Student Handbook

Example of the Value of Trade • With specialization, both Tom and Hank are better off • And together they are more productive as an economy • Based on comparative advantage

Slide 464

International Trade Assumptions of Comparative Advantage: • No transportation costs • No economies of scale • Two economies, 2 goods • Goods are homogeneous • Factors of production perfectly mobile • No tariffs or other barriers • Perfect knowledge

Slide 465

International Trade The Non-Price theory of trade: For non-homogeneous goods, other things determine trading practices: • Design • Reliability • Availability • Image

Page 331 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 466

Student Handbook

Trade Policies Countries benefit from free trade: • Efficiencies (Comparative Advantage) • Economies of scale • Greater choices • Enhances competition

Slide 467

Globalisation Process of integrating world economies Benefits: • Price affordability • Give poorer countries a way to develop Disadvantages: • Puts local workers out of work • May destroy the environment …Controversial…

Slide 468

Protectionism Reasons for Protectionism: • “Infant industry” • Protect or preserve jobs • Dumping • Unfair competition

Page 332 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 469

Student Handbook

Protectionism Methods of protecting local industry: • Tariffs • Quotas • Subsidies • Administrative Restrictions • Embargoes

Slide 470

Globalisation Protectionism Restricting trade to protect local industry Tariffs: • Tax (Duty) on imported goods Quotas: • Limits on the quantities of imported goods allowed in the country

Slide 471

Globalisation Protectionism Restricting trade to protect local industry Subsidies: • Direct payments to local producers Administrative Restrictions: • Rules designed to make trading more difficult Embargoes: • Complete ban on trading

Page 333 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 472

Student Handbook

Protectionism Price

Tariffs: Tax (Duty) on imported goods

PD PWT PW

Assumemarket Normal international conditions price forlower is any Domestic (unlimitedgood supply) Local producers will sell 0Q L and Q LQ I will be imported The loss of Q LQ D could destroy local producers To protect its industry, the government imposes a tariff SWorld Local producers will sell 0Q LT + Tariff and Q LTQ IT will be imported SWorld Local producers will gain sales, and at higher prices DDomestic And government gains tax revenues on imported goods Finally, remember consumer Quantity surplus and produce surplus SDomestic

QLT

Slide 473

QD QIT QI

Protectionism Price

Quotas: A limit on quantities imported SDomestic

PD PQ PW

SWorld

Assume the same international situation Government acts again, imposing a quota to protect local industry Reduced imports raise the price in the market Local producers gain sales (at higher prices) And the shaded area represents a â&#x20AC;&#x153;windfall profitâ&#x20AC;?

DDomestic 0

Slide 474

QLQ

QD QIQ QI

Quantity

Protectionism Price

Subsidies: Direct payments to local producers SDomestic SDomestic +Subsidy

PD PS PW

SWorld

Again, assume the same market situation Government makes direct payments to local industry Subsidies lower production costs, pushing the Supply curve out to the right Local producers gain sales from importers, at prices higher than the world price

DDomestic 0

QD QS QI

Quantity

Page 334 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 475

Student Handbook

Protectionism Administrative restrictions: • A series of rules or laws • Makes importing extremely difficult • Examples: registration; inspections; quarantines; etc.

Slide 476

Protectionism Embargoes: • Complete ban on imports • Can be against a company or a country • Can be on one product or all products • Examples: oil; high-technology products; etc.

Slide 477

Protectionism Economists would always argue against protection, favouring market forces

Page 335 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 478

Balance of Payments In business and international trade, money never exchanges hands

Slide 479

Balance of Payments A financial record Financial dealings between countries Composed of two accounts: • Current Account • Capital Account

Slide 480

Balance of Payments Current Account • The value of goods and services exchanged Capital Account • Flows of monetary assets, including savings and investments

Page 336 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 481

Student Handbook

Current Account Divided into two groups: Visibles + Invisibles = Current Balance

Slide 482

Current Account Visibles: • Trade in goods • Exports are “positive” • Imports are “negative” • The “Balance of Trade” = difference between visible exports and visible imports

Slide 483

Balance of Payments Account Will always be “in balance” • Goods and services (current account) are “paid for” with increases in a liability (capital account) • Investments in foreign companies (capital account) are “paid for” with increases in a liability (capital account)

Page 337 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 484

Example – UK Balance of Payments Account Import goods from China Export goods to China Purchase a China factory Due to Investors Balance of Payments

Slide 485

Student Handbook

Current Acct -10 million +7 million

-3 million

Capital Acct -10 million +7 million +25 million -25 million -3 million

Current Account Surpluses: • More exports than imports • Lending money to foreign countries Deficits: • More imports than exports • Borrowing money from foreign countries

Slide 486

Current Account Theories • Small, short-term Current Account deficits or surpluses are not a problem • Large, long-term Current Account deficits or surpluses could be a problem

Page 338 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 487

Student Handbook

Current Account Theories Large, long-term CA deficits (from imports): •

•

Slide 488

If economy strong, foreign institutions will continue, and country can benefit, but… If too high, and for too long a period, foreign institutions may begin to doubt repayment, may stop selling (lending money)

Current Account Theories Large, long-term CA surpluses (from exports): • •

•

Slide 489

Can be seen as economic strength, but… Reduces what is available for domestic consumers Can cause problems between trading nations

Exchange Rate Systems Fixed exchange rate system • Our currency “pegged” to another country’s Free / Floating exchange rate system • Free market forces (demand and supply)

Page 339 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 490

Student Handbook

Ways to affect Exchange Rate Interest Rate • Increase in interest rate… • Will increase exchange rate

Slide 491

Ways to affect Exchange Rate Gold and Foreign Currency Reserves • Held by Central Bank • Selling them in the market attracts more domestic currency, increasing the value Any of these steps only make small changes in a country’s exchange rate

Slide 492

Ways to affect Exchange Rate Interest Rate Gold and Foreign Currency Reserves • Both policies affect the world demand for our country’s currency • Both policies only make small changes in a country’s exchange rate

Page 340 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 493

Student Handbook

Effect of

Increases in Exchange Rate Can reduce or moderate Inflation • Decrease in Exports • Increase in Imports • Decrease in AD

Slide 494

Effect of

Increases in Exchange Rate Can moderate or reduce Economic Growth • Decrease short term domestic output and investment • Decrease in AD

Slide 495

Effect of

Increases in Exchange Rate Can increase Unemployment • Decrease in AD

Page 341 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 496

Student Handbook

Effect of

Increases in Exchange Rate Can decrease the Current Balance • Decrease in Exports • Increase in Imports

Slide 497

Economic Theory and Reducing Trade Deficits by Exchange Rate Policies MARSHALL LERNER Condition: Effect of Depreciating currency… If combined PED of X and M > 1 … • Trade deficit will decrease (improve) If combined PED of X and M < 1 … • Trade deficit will increase (get worse)

Slide 498

Example of

Marshall Lerner Condition

Page 342 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 499

Oligopoly

Slide 500

Oligopoly Two examples of oligopoly

Slide 501

Market shares of the largest brewers 1985 (%) Bass Allied Lyons (Carlsberg) Grand Met (Watneys) Whitbread Scottish and Newcastle Courage Others

2002 (%) 22 13 12 11 10 9 23

Scottish–Courage Interbrew UK Coors Carlsberg–Tetley Diageo (Guinness) Others

100

Page 343 of 406

27 20 18 12 7 16 100

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 502

Student Handbook

Market shares of the largest brewers 1985 (%)

2002 (%)

Bass Allied Lyons (Carlsberg) Grand Met (Watneys) Whitbread Scottish and Newcastle Courage Others

22 13 12 11 10 9 23

Scottish–Courage Interbrew UK Coors Carlsberg–Tetley Diageo (Guinness) Others

27 20 18 12 7 16

100

Slide 503

100

Oil prices

$ per barrel

Actual price

35 Iraq invades Iran

Iraq invades Kuwait

Revolution in Iran

25 20

Impending war with Iraq

OPEC’s first quotas

World-wide recovery

First oil from North Sea World-wide slowdown

15 10

Cease-fire in Iran-Iraq war

New OPEC quotas

Recession in Far East

Yom Kippur War: Arab oil embargo

5 0 70

Slide 504

72 74

80 82

88 90

Oil prices

$ per barrel

Iraq invades Kuwait

Revolution in Iran

Impending war with Iraq

OPEC’s first quotas

30 25

Actual price Cost in 1973 prices

35 Iraq invades Iran

94 96

World-wide recovery

First oil from North Sea World-wide slowdown

15 10

Cease-fire in Iran-Iraq war

New OPEC quotas

Recession in Far East

Yom Kippur War: Arab oil embargo

5 0 70

72 74

80 82

88 90

Page 344 of 406

94 96

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 505

Oligopoly A profit-maximising cartel

Profit-maximising cartel

Slide 506 £

Industry D = AR

Profit-maximising cartel

Slide 507 £

Industry MC

Industry D = AR Industry MR

Page 345 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 508

Oligopoly Price leadership (assumption of fixed market share)

Slide 509

Price leader aiming to maximise profits for a given market share ÂŁ Assume constant market share for leader

AR = D market

AR = D leader

MR leader O

Slide 510

Price leader aiming to maximise profits for a given market share ÂŁ

MC l

AR = D market

AR = D leader

MR leader O

Page 346 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 511

Oligopoly Game theory

Slide 512

Profits for firms A and B at different prices

X’s price £2.00

£2.00

Y’s price £1.80

Slide 513

£1.80

£5m for Y £12m for X

£10m each

C £12m for Y £5m for X

£8m each

The prisoners' dilemma Amanda's alternatives Not confess Not confess

Nigel's alternatives C Confess

Confess

A Each gets 1 year

Nigel gets 3 months Amanda gets 10 years

Page 347 of 406

Nigel gets 10 years Amanda gets 3 months

D Each gets 3 years

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 514

Oligopoly A decision tree

Slide 515

A decision tree Boeing –£10m (1) Airbus –£10m

Airbus decides

B1 Boeing +£30m Airbus +£50m Boeing decides

(2)

Boeing +£50m (3) Airbus +£30m

B2 Airbus decides

Boeing –£10m Airbus –£10m

(4)

Slide 516

Oligopoly Kinked demand curve theory

Page 348 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Slide 517

Economic Studies Kinked demand for a firm under £

Student Handbook

oligopoly Current price and quantity give one point on demand curve

Slide 518

Kinked demand for a firm under oligopoly £

Slide 519

Stable price under conditions of a kinked demand curve £

MC2

MC1

a D = AR

Q1 MR

Page 349 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 520

Perfect Competition

Slide 521

Perfect competition Short-run equilibrium of firm and industry (profit maximising)

Slide 522

Short-run equilibrium of industry and firm under perfect competition P

ÂŁ

D = AR = MR

AR AC

D O

O Q (millions) (a) Industry

Page 350 of 406

Qe Q (thousands) (b) Firm

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 523

Optimum position for a loss-making firm

Perfect competition

Loss minimising under perfect competition

Slide 524 P

AC P1

D1 = AR1

AR1

= MR1

D O

(a) Industry

Slide 525

Qe Q (thousands)

Q (millions)

(b) Firm

Short-run shut-down point P

AVC D2 = AR2

AR2

= MR2

D2 O

O Q (millions) (a) Industry

Page 351 of 406

Q (thousands) (b) Firm

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 526

Short-run supply curve of the firm

Perfect competition

Slide 527

Deriving the short-run supply curve P

ÂŁ

MC = S a

P2 c

D1 = MR1 D2 = MR2 D3 = MR3

D2 D3 O

O Q (millions)

(a) Industry

Q (thousands)

(b) Firm

Slide 528

industry PerfectThecompetition supply curve

Page 352 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 529

Deriving the industry short-run supply curve P

Student Handbook

S a

D1 = MR1 D2 = MR2 D3 = MR3

D2 D3 O

O Q (thousands)

Q (millions) (a) Industry

(b) Firm

Slide 530

Long-run equilibrium Perfect competition

Slide 531

Long-run equilibrium under perfect Profits return Supernormal New firms enter competition to normalprofits P

£ S1 Se LRAC

AR1

ARL

D O

O Q (millions) (a) Industry

Page 353 of 406

QL Q (thousands) (b) Firm

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 532 ÂŁLong-run equilibrium of the firm under perfect competition (SR)MC (SR)AC

LRAC

DL AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

Slide 533

Long-run industry supply curves

Perfect competition

Slide 534

Various long-run industry supply curves under perfect competition S1

Long-run S

(a) Constant industry costs

Page 354 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 535

Student Handbook

Various long-run industry supply curves under perfect competition S2

P b

Long-run S c a

D2 D1

(b) Increasing industry costs: external diseconomies of scale

Slide 536

Various long-run industry supply curves under perfect competition P

S1 S2

a c

Long-run S

Slide 537

Market Structures

Page 355 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 538

Student Handbook

Market Structures • Type of market structure influences how a firm behaves: – Pricing – Supply – Barriers to Entry – Efficiency – Competition

Slide 539

Market Structures • Degree of competition in the industry • High levels of competition – Perfect competition • Limited competition – Monopoly • Degrees of competition in between

Slide 540

Market Structure • Determinants of market structure – Freedom of entry and exit – Nature of the product – homogenous (identical), differentiated? – Control over supply/output – Control over price – Barriers to entry

Page 356 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 541

Student Handbook

Market Structure • Perfect Competition: – Free entry and exit to industry – Homogenous product – identical so no consumer preference – Large number of buyers and sellers – no individual seller can influence price – Sellers are price takers – have to accept the market price – Perfect information available to buyers and sellers

Slide 542

Market Structure • Examples of perfect competition: – Financial markets – stock exchange, currency markets, bond markets? – Agriculture? • To what extent?

Slide 543

Market Structure • Advantages of Perfect Competition: • High degree of competition helps allocate resources to most efficient use • Price = marginal costs • Normal profit made in the long run • Firms operate at maximum efficiency • Consumers benefit

Page 357 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 544

Student Handbook

Market Structure • What happens in a competitive environment? – New idea? – firm makes short term abnormal profit – Other firms enter the industry to take advantage of abnormal profit – Supply increases – price falls – Long run – normal profit made – Choice for consumer – Price sufficient for normal profit to be made but no more!

Slide 545

Market Structure • Imperfect or Monopolistic Competition – Many buyers and sellers – Products differentiated – Relatively free entry and exit – Each firm may have a tiny ‘monopoly’ because of the differentiation of their product – Firm has some control over price – Examples – restaurants, professions – solicitors, etc., building firms – plasterers, plumbers, etc.

Slide 546

Market Structure • Oligopoly – Competition amongst the few – – – – – – – – –

Industry dominated by small number of large firms Many firms may make up the industry High barriers to entry Products could be highly differentiated – branding or homogenous Non–price competition Price stability within the market - kinked demand curve? Potential for collusion? Abnormal profits High degree of interdependence between firms

Page 358 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 547

Student Handbook

Market Structure • Examples of oligopolistic structures: – Supermarkets – Banking industry – Chemicals – Oil – Medicinal drugs – Broadcasting

Slide 548

Market Structure • Measuring Oligopoly: • Concentration ratio – the proportion of market share accounted for by top X number of firms: – E.g. 5 firm concentration ratio of 80% - means top 5 five firms account for 80% of market share – 3 firm CR of 72% - top 3 firms account for 72% of market share

Slide 549

Market Structure • Duopoly: • Industry dominated by two large firms • Possibility of price leader emerging – rival will follow price leaders pricing decisions • High barriers to entry • Abnormal profits likely

Page 359 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 550

Student Handbook

Market Structure • Monopoly: • Pure monopoly – industry is the firm! • Actual monopoly – where firm has >25% market share • Natural Monopoly – high fixed costs – gas, electricity, water, telecommunications, rail

Slide 551

Market Structure • Monopoly: – High barriers to entry – Firm controls price OR output/supply – Abnormal profits in long run – Possibility of price discrimination – Consumer choice limited – Prices in excess of MC

Slide 552

Market Structure • Advantages and disadvantages of monopoly: • Advantages: – – – –

May be appropriate if natural monopoly Encourages R&D Encourages innovation Development of some products not likely without some guarantee of monopoly in production – Economies of scale can be gained – consumer may benefit

Page 360 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 553

Student Handbook

Market Structure • Disadvantages: – Exploitation of consumer – higher prices – Potential for supply to be limited - less choice – Potential for inefficiency –

X-inefficiency – complacency

over

controls on costs

Slide 554

Market Structure Price

Kinked Demand Curve

£5

Kinked D Curve

D = elastic

D = Inelastic 100

Page 361 of 406

Quantity

The intention of this slide is to demonstrate the principle of the kinked demand curve. The slide starts with the vertical and horizontal axes. A demand curve appears – relatively elastic and a price of £5 and q 100 appear. The explanation at this point would imply asking students what would happen if the producer increased price but nobody else in the industry followed? Hopefully students will see that the demand would fall significantly. By this stage students should be aware of the impact on total revenue as a result of this action. The next assumption rests on the firm facing an inelastic demand curve; in this case the firm believes that firms will follow suit in reducing price – the effect is to lead to only a small gain in sales – total revenue would again fall. Assuming the two characteristics would suggest a kinked demand curve and price stability existing in the industry with the likely outcome being nonprice comptition.

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 555

Monopolistic Competition

Slide 556

Monopolistic Equilibrium competition of the firm:

short run

Slide 557

Short-run equilibrium of the firm under monopolistic competition ÂŁ

MC AC

Ps ACs

AR = D

Page 362 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 558

Monopolistic Equilibrium competition of the firm:

long run

Slide 559

Long-run equilibrium of the firm under monopolistic competition ÂŁ

LRMC

LRAC

PL ARL = DL

MRL

Slide 560

Monopolistic competition Comparison with perfect competition (long run)

Page 363 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 561

Student Handbook

Long run equilibrium of the firm under perfect and monopolistic competition ÂŁ

LRAC

P1 P2

DL under perf ect

competition

DL under monopolistic

competition

Slide 562

Demand The behaviour of Consumers

Slide 563

Page 364 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 564

Student Handbook

Demand Schedule For example, look at the demand facing a single seller in a market, in this case, a tire seller. Price (£)

Slide 565

Quantity demanded

Plot a Demand Curve Demand for Tires

Price

Price (£)

Quantity demanded

20 10

Quantity

Demand Curve At a price of 30, the quantity demanded would be 15, shown as follows… How would a price of 20 be shown?

Demand for Tires

Price

Slide 566

A drop in price to 20 would result in an increase in the quantity demanded to 25. a change in price results So,

in a change in quantity demanded, represented by movement along the Demand Curve.

D 0

Quantity

Page 365 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 567

Student Handbook

Slide 568

Determinants of Demand • • • • • • • •

Demand Curve For example, as the Chinese economy develops, people are earning more, improving their standard of living.

So, more people are buying cars.

As a result, demand for tires at all prices is increasing.

A change in any other determinant results in a change in quantities demanded at all prices, represented by a shifting of the Demand Curve.

Demand for Tires

Price

Slide 569

Add up the Demand Curves faced by individual sellers

Page 366 of 406

Quantity

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 570

Student Handbook

Slide 571

Consumer Surplus Consider the Dem and Curve BCD below. At a price P 1, consumers would purchase 0 Q1 quantity. Price (£)

The area of the triangle P 1BC in the diagram is called the Consumer Surplus, the total benefit to consumers of a price P 1 D

Quantity Dem anded

Slide 572

Supply

Page 367 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 573

Student Handbook

Slide 574

Supply Schedule Referring to the previous example, look at the choices our tire seller would make at different levels – a Supply Schedule.

Slide 575

Price (£)

Quantity supplied

Plot a Supply Curve Supply of Tires

Price

Price (£)

Quantity supplied

20 10 0

Quantity

Page 368 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 576

Student Handbook

Supply Curve

A rise in price to 30 would result in an increase in the quantity supplied to 25. A change in price results in a change in quantity supplied, represented by movement along the Supply Curve.

Supply of Tires

Price

At a price of 20, the quantity supplied would be 15, shown as follows… How would a price of 30 be shown?

40 30 20 10 0

Quantity

Slide 577

Slide 578

Add up the Supply Curves of all the individual sellers

Determinants of Supply • • • • • • •

Page 369 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 579

Student Handbook

The Supply Curve For example, if new technologies were introduced into China which made the production of tires less expensiveâ&#x20AC;Ś Producers producing at all price levels would choose to produce more tires. As a result, quantities of tires supplied at all price levels would increase, causing the Supply Curve for tires to shift outward.

A change in any other determinant results in a change in quantities supplied at all prices, represented by a shifting of the Supply Curve.

Slide 580

The Producer Surplus Consider the Supply Curve 0CS below. At a price P 1, producers would produce 0 Q 1 quantity. Price (ÂŁ)

0C on the supply curve represents producers who would be willing to sell at a lower price, but need not. S

Slide 581 Price Determination in the Market

Page 370 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 582

Student Handbook

Market Price • Buyers and sellers • Come together • A price is “struck”

Slide 583

Equilibrium Price (£)

D Quantity

Slide 584

Excess Supply Price (£) Surplus PM PE

D QD

Quantity

When Market Price (P M ) is above PE this results in excess supply – surpluses

Page 371 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 585

Student Handbook

Excess Demand Price (ÂŁ)

Shortage D QS

Quantity

When Market Price (P M ) is below PE this results in excess demand â&#x20AC;&#x201C; shortages

Slide 586

Slide 587

Page 372 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 588 P

Rail Travel Market

D QE

Shortage

Slide 589 P

Rail Travel Market

P1 PE

D QE

Shortage

Slide 590

The Demand Curve Increases in: incomes, population, adverts, etc

Price (ÂŁ)

ÂŁ10

D 100

150

Quantity

Increases demand, causes the demand curve to shift outward, results in increased quantities demanded at all prices

Page 373 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 591

Student Handbook

The Demand Curve Changes in Price

Price (£)

£10

£7

D 100

150

Quantity

Increase in quantity demanded as represented by movement along the demand curve

Slide 592 Price (£)

£10

£7

D Change in price

100

150

Quantity

Movement along the demand curve

Slide 593 Price (£)

£10

D 100

150

Quantity

Shift out

Page 374 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 594 Price (£)

£10

D1 50

100

Quantity

Shift in

Slide 595 Price (£)

£10

D2 50

100

150

Quantity

Slide 596 Price £

£4

200

300

Page 375 of 406

400

Quantity

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 597

Student Handbook

The Supply Curve Decreases in costs of production, advances in technology, etc

Price (£)

£5

100

Quantity

Producers will increase the quantities produced at all prices, increasing supply, causing the supply curve to shift outward

Price (£)

Slide 598

Quantity

Price

Slide 599

Quantity

Page 376 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 600

Demand and Supply Practice Questions 3 minutes for each question

Slide 601

1. If there were a decrease in the general income level in the UK, the likely result on the market for foreign holidays would be: A. an increase in price and increase in quantity B. a decrease in price and decrease in quantity C. a decrease in price and increase in quantity D. an increase in price and decrease in quantity

Slide 602

Page 377 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 603

Slide 604

4. If the government gives schools subsidies on education, this will most likely result in: A. An increase in price and increase in quantity B. A decrease in price and decrease in quantity C. A decrease in price and increase in quantity D. An increase in price and decrease in quantity

Slide 605

5. In the diagram below, Consumer Surplus is represented by: A. BEC B. EDF C. AEB D. AED

Page 378 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 606

6. When the supply curve shifts outwards, what is the effect on equilibrium price and quantity? A. Price increases, quantity decreases B. Price decreases, quantity increases C. Price increases, quantity increases D. Price decreases, quantity decreases

Slide 607

7. When the government taxes suppliers for the goods they sell, what effect does it have on the market? A. The supply curve shifts outwards B. The demand curve shifts outwards C. The supply curve shifts inwards D. The demand curve shifts inwards

Slide 608

8. Which of the following would be most likely to cause an inward shift of the demand curve for ski equipment? A. The coming of summer B. The coming of winter C. An increase in the price of ski equipment D. An inward shift of the supply curve

Page 379 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 609

1. Demand for a good is zero at £200. It then rises to 50 million units at £100 and 75 million at £50. a) Draw the demand curve for prices between £0 and £200. b) Shade the area of consumer surplus at a price of £60. c) Is the consumer surplus larger or smaller at a price of £40 compared to £60? Explain your answer.

Slide 610

3. If there were a decrease in the price of DVD players, the likely result on the market for DVDs would be: A. an increase in price and increase in quantity B. a decrease in price and decrease in quantity C. a decrease in price and increase in quantity D. an increase in price and decrease in quantity

Slide 611 Interrelationships between Markets Goods that affect other goods

Page 380 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 612

Student Handbook

Slide 613

Price

Market for Good "B"

Quantity

Slide 614

Quantity

DERIVED DEMAND • An increase in Demand for finished good “E” • Results in an increase in Demand for the good “F” needed to produce “E”, which leads to a rise in price

Market for Good “F" Price

Price

Market for Good "E"

Quantity

Page 381 of 406

Quantity

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 615

Student Handbook

JOINT SUPPLY • An increase in Demand for finished good “G” • Results in an increase in Supply of the resource “H” needed to produce “G”, which leads to a lowering of price

Price

Market for Good "H"

Quantity

Slide 616 Elasticity Effect on factor “Y” by a change in factor “X” or the responsiveness of “Y” to changes in “X”

Slide 617

Price Elasticity of Demand (PED) How much quantity demanded (Q) responds to changes in price (P) •Elastic: Change in P causes larger change in Q •Inlastic: Change in P causes smaller change in Q

Page 382 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 618

Measuring the value of PED PED =

Percentage change in Quantity o Percentage change in Price

PED Value -00–1 1 1– ∞

∞

Slide 619

Student Handbook

Elasticity

%ΔQ %ΔP

Response to Change in Price

Perfectly Inelastic No change in quantity dem anded when price changes Inelastic

Less than proportionate response to changes in price

Unitary Elasticity

Percentage change in quantity = Percentage change in Price

Elastic

More than proportionate response to changes in price

Perfectly Elastic

Consum ers will dem and any quantity at the given price

Slide 620

Measuring the value of PED PED and the demand curve A Perfectly Inelastic Demand Curve looks like this 5

D 5

Page 383 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 621

Student Handbook

Measuring the value of PED PED and the demand curve An Inelastic Demand Curve looks like this 5

D 5

Slide 622

Measuring the value of PED PED and the demand curve A Perfectly Elastic Demand Curve looks like this

Slide 623

Measuring the value of PED PED and the demand curve An Elastic Demand Curve looks like this 5

Page 384 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 624

Student Handbook

Measuring the value of PED PED and the demand curve A Unitary Elastic Demand Curve looks like this 5

Slide 625

Measuring the value of PED But, PED along a demand curve is also different Price drops from 7 to 6 PED = (1÷2)

(–1÷7)

= 50% ÷ –14% = –3 .57 5

Elastic Price drop from 3 to 2 PED = (1 6)

(–1 3)

= 16% ÷ –33% = – .48

Inelastic

Slide 626

D 5

Measuring the value of PED If a business raises prices, will it make more money?

It depends on Price Elasticity of Demand! Total Expenditure (consumers) = Total Revenue (firms)

Page 385 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 627

Student Handbook

Measuring the value of PED Total Expenditure & Total Revenue TE = TR =PxQ

= £6 x 3.75

= £22.25 D 5

Slide 628

Measuring the value of PED Inelastic PED and TE At a price of £6, notice the area of Total Expenditure If the seller raises the price, notice the new area of TE

Notice how the blue area is much larger than the yellow

D 5

Slide 629

Measuring the value of PED Elastic PED and TE At a price of £6, notice the area of Total Expenditure If the seller raises the price, notice the new area of TE

5 D

Notice how the blue area is much smaller than the yellow 5

Page 386 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 630

Student Handbook

Cross Elasticity of Demand (CED) OR (XED) How demand for good “X” changes when the price of good “Y” changes

XED =

%ΔQ of X %ΔP of Y

Substitute goods have a positive CED

Complementary goods have a negative CED

Slide 631

Income Elasticity of Demand (YED) How demand for a good changes when income (Y) changes

YED =

%ΔQ %ΔY

Most goods in general have a positive YED Goods with a negative YED are called “Inferior Goods”

Slide 632

Price Elasticity of Supply (PES) How much quantity supplied (Q) responds to changes in price (P) •Elastic: Change in P causes larger change in Q •Inlastic: Change in P causes smaller change in Q

Page 387 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 633

Student Handbook

Primary Determinants of PES 1. Availability of substitute goods tends to increase PES 2. Time tends to increase PES

Slide 634

Measuring the value of PES PES =

Percentage change in Quantity o Percentage change in Price

PES Value -00–1 1 1– ∞

∞

Elasticity

%ΔQ %ΔP

Response to Change in Price

Perfectly Inelastic No change in quantity supplied when price changes Inelastic

Less than proportionate response to changes in price

Unitary Elasticity

% in quantity supplied = % in Price

Elastic

More than proportionate response to changes in price

Perfectly Elastic

Producers will supply any quantity at the given price

Slide 635 Elasticity Practice Problems

Page 388 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 636 Elasticity Exercise a) b) c) d) e) f)

Slide 637

Original Values Quantity Price 100 5 20 8 12 3 150 12 45 6 32 24

New Values Quantity Price 120 3 25 7 16 0 200 10 45 8 40 2

PED Value -0.5 -2.0 -0.3 -2.0 0.0 -0.3

Elasticity Inelastic Elastic Inelastic Elastic Perf. Inel. Inelastic

Exam Problem Assuming the price of cigarettes increases by 10% and the quantity demanded decreases by 3%, what is the price elasticity of demand? Comment on the results. [5 marks] PED = %Î&#x201D;Q %Î&#x201D;P [1] = -3% 10% = -0.3 [2] The PED for cigarettes is inelastic.

Slide 638 Economic Efficiency & Market Failure

Page 389 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 639

The Role of the Market

Slide 640

The Role of the Market • Demand • Supply • Price Determination

• Interrelationships between markets • Elasticities The Market Mechanism

Slide 641

The Role of the Market Consumer

Producer / Firms

All powerful Free to spend

Choose

Serve consumers

Maximize profits

Owners of Factors of Production Maximize return

Maximize utility Maximizing behaviour

Page 390 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 642

Student Handbook

The Role of the Market The Functions of Price in an Economy •Rationing •Signaling

•Incentives

Slide 643

Slide 644

Economic Efficiency EFFICIENCY •MARKET Efficiency •PRODUCTIVE Efficiency

•TECHNICAL Efficiency •ALLOCATIVE / ECONOMIC Efficiency •STATIC Efficiency •DYNAMIC Efficiency

Page 391 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 645

Student Handbook

Economic Efficiency •MARKET Efficiency •Production Possibility Frontier (PPF) •Competition

•To achieve MARKET Efficiency, there must be •PRODUCTIVE Efficiency

Slide 646

Economic Efficiency •PRODUCTIVE Efficiency •Producing at lowest possible cost •Can be achieved if production achieves …

•TECHNICAL Efficiency

Slide 647

Economic Efficiency •TECHNICAL Efficiency •Maximum output (production) •Minimum input (resources)

Page 392 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 648

Student Handbook

Economic Efficiency •ALLOCATIVE or ECONOMIC Efficiency •Resources are being used to produce goods and services that people most want

•STATIC EFFICIENCY •DYNAMIC EFFICIENCY

Slide 649

Market Failure MARKET FAILURE represents INEFFICIENCY •Lack of COMPETITION

•EXTERNALITIES •FACTOR IMMOBILITY •INFORMATION FAILURE •INEQUALITY / INEQUITY

Slide 650

Market Stabilization Governments take action to deal with market failure

Page 393 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 651 Market Stabilization Wide price fluctuations lead to market failure •Prices too high – consumers won’t buy •Prices too low – producers won’t sell •Make it difficult to identify the “signal”

Slide 652 Market Stabilization Specific steps governments take: •Price Controls •Buffer Stock Schemes •Subsidies •Taxes

Slide 653 Price Controls Price S

Minimum Price (above the market price) results in Excess Supply.

PMin PE

Maximum Price (below the market price) results in Excess Demand.

PMax D

Quantity

Page 394 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 654

Student Handbook

Commodities • Mostly agriculture & mining products • Generally traded worldwide, but each economy faces its own market conditions • Large Price fluctuations for various reasons – – – –

Bumper crops Crop failures Weather and other natural phenomenon Political situations

• Steep, inelastic Supply & Demand curves • Small shifts create large changes in price

Slide 655

Buffer Stock Scheme Price S Government sets the intervention price, say P I If market price is below P I, say P B… PI

Government buys large quantities, pushing Demand curve out until it reaches P I. This creates a Buffer stock.

PB D

DI Quantity

Slide 656

Buffer Stock Scheme Price

SA Assume the same intervention price, P I If market price is above P I, say P A …

PA PI

Government sells large quantities from Buffer Stock, pushing Supply curve out until it reaches P I D Quantity

Page 395 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 657

Student Handbook

Taxes Price STax

Tax causes suppliers to offer less units for sale at every price

S Paid by Consumers Total cost Paid by of Tax Producers

Tax per unit

Tax is vertical distance between supply curves Tax increases prices and decreases amounts available â&#x20AC;&#x201C; but at what cost?

Quantity

Slide 658

Subsidies Price

S SSubsidy

Benefits to Total Consumers cost Benefits to of subsidy Producers

Subsidy per unit

Subsidies encourage suppliers to sell more at every price Subsidy is vertical distance between the two supply curves Subsidies reduce prices and increase amounts available â&#x20AC;&#x201C; but at what cost?

Quantity

Slide 659 Production in the Short Run Calculations

Page 396 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 660

Student Handbook

Production in the Short Run Problems Given …

Output 0 1 2 3 4 5

Complete the table

Total Total Fixed Variable Cost Cost 40 6 11 15

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

60 66 Unit 39, Question 3

Slide 661

Production in the Short Run Problems Fixed costs remain the same at all levels of output – they’re fixed!

Output

Total Total Fixed Variable Cost Cost

40 40 40 40 40

2 3 4 5

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

6 11 15 60 66 Unit 39, Question 3

Slide 662

Production in the Short Run Problems Fill in: Total Cost = Total Fixed Cost + Total Variable Cost

Output

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40 46 51 55

66 Unit 39, Question 3

Page 397 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 663

Student Handbook

Production in the Short Run Problems Calculate Variable Cost: Total Cost – Total Fixed Cost

Output

Total Total Fixed Variable Cost Cost

Total Cost

20 26

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

66 Unit 39, Question 3

Slide 664

Production in the Short Run Problems Calculate Average Fixed Cost: Total Fixed Cost ÷ Output

Output

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40.0

40 51

20.0

13.3

10.0

8.0 Unit 39, Question 3

Slide 665

Production in the Short Run Problems Calculate Average Variable Cost: Total Variable Cost ÷ Output

Output

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40.0

40 51

20.0

13.3

10.0

8.0

6.0 5.5 5.0 5.0 5.2 Unit 39, Question 3

Page 398 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 666

Student Handbook

Production in the Short Run Problems Calculate Average Cost: Total Cost รท Output

Output

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40.0

6.0

40 51

20.0

5.5

13.3

5.0

10.0

5.0

8.0

5.2

46.0 25.5 18.3 15.0 13.2

Unit 39, Question 3

Slide 667

Production in the Short Run Problems Calculate Marginal Cost: Increase in Total Cost at each output level

Output

Total Total Fixed Variable Cost Cost

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

40.0

6.0

46.0

40 51

20.0

5.5

25.5

13.3

5.0

18.3

10.0

5.0

15.0

8.0

5.2

13.2

6 5 4 5 6

Unit 39, Question 3

Slide 668

Production in the Short Run Problems

Output 0 1 2 3 4 5

Total Total Fixed Variable Cost Cost 40 6 11 15

Total Cost

Average Average Fixed Variable Average Marginal Cost Cost Cost Cost

60 66 Unit 39, Question 3

Page 399 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 669

Student Handbook

Production Calculations Production schedule

Each time an additional worker is added, more output can be produced.

Slide 670

Labour Inputs (L)

Total Marginal Average Product Product Product (TP)

(MP)

(AP)

Marginal Product: additional output produced by adding an additional worker.

5.0

5.0 6.0

7.0

Average Product: the average quantity of goods produced by each worker.

7.2

6.5

5.7

Production Diagrams Labour

Total Product TP increases at a faster rate until about midway – increasing returns to scale.

Then it begins to slow down – diminishing returns to scale.

Labour

Output

MP is at its highest where diminishing returns to scale set in

Note: both curves rise, then decline, first MP then AP

MP Output

Average Product and Marginal Product

Slide 671

The Production Function Q= L + C Where Q = Quantity produced, OUTPUTS

L = Labour, and C = Capital

Page 400 of 406

INPUTS

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 672

Student Handbook

Production in the Short Run – Costs “Costs” in Economics include all economic costs facing the company and its owners: •Materials;

•Owners’ time;

•Labour;

•Earnings on cash;

•Management;

•Goodwill;

•Equipment;

•Opportunity cost;

•Cost of Buildings;

•Normal profits

The These same areinunique Business to Economics and Economics

Slide 673

Production in the Short Run – Costs Costs are also categorized by their behaviour

Slide 674

•Fixed Costs:

Costs that do not change in the relevant range; generally the cost of capital

•Variable Costs:

Costs that change with changes in outputs; include cost of materials, supplies and labour

Production in the Short Run – Costs Costs are summarized as follows:

Total Cost (TC) = Fixed Costs (TFC) + Variable Costs (TVC) Average Cost (AC) = Total Cost (TC)

Units of output (Q)

Marginal Cost (MC) = The cost of one additional unit of output = ΔTC ÷ ΔQ

Page 401 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 675

Student Handbook

Cost Calculations Output

Total Fixed Costs

Total Variable Costs

Total Cost

Marginal Cost

Average Fixed Cost

Average Variable Cost

Average Total Cost

(Q)

(TFC)

(TVC)

(TC)

(MC)

(AFC)

(AVC)

(ATC)

200

100

300

100

200

100

300

200

170

370

100

185

200

220

420

140

200

255

455

114

200

275

475

200

295

495

200

320

520

200

360

560

200

425

625

200

525

725

100

Output

Total Fixed Costs

Average Fixed Cost

(Q)

(TFC)

(AFC)

200

100

200

Slide 676

Fixed Costs Total Fixed Costs 250

200

150

100

0 0

Average Fixed Costs 250

200

150

200

100

200

Output

Total Variable Costs

Average Variable Cost

(Q)

(TVC)

(AVC)

Slide 677

200

Variable Costs Total Variable Costs 600

500

400

300

100

170

220

255

275

295

320

360

425

525

200

100

0 0

Average Variable Costs 120

100

0 0

Page 402 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 678

Student Handbook

Total Costs Output

Total Cost

Average Total Cost

(Q)

(TC)

(ATC)

Total Costs 800 700 600 500

400

200

300

370

185

420

140

455

114

475

495

520

560

625

725

300

200 100

0 0

Average Total Costs 350

300

250

200

150

100

0 0

Slide 679

Cost Analysis 350

800

700

300

600

250

500

200

400 150

300 100

200

100

ATC 50

AVC AFC

•MC and AC curves are “U” shaped •The bottom of the MC curve is where diminishing returns set in •MC crosses the AC and AVC curves at their lowest points, where they are stable, neither going down nor rising

Slide 680

Labour

Cost Analysis 350

300

250

200

AP 150

100

MC ATC

AVC AFC

0 0

Output

•MC starts rising where MP starts decreasing

Page 403 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 681 Monopolistic competition

Slide 682

Monopolistic competition Characteristics / Assumptions • Large number of buyers & sellers • No or low barriers to entry • Short run profit maximizers • Goods can be differentiated • So firms are not price takers • Downward sloping Demand Curve

Slide 683

The same

as Perfect Competition

Monopolistic competition Equilibrium of the firm: short run • • • • •

Short run profit maximizers Produce where MR = MC Firms are not price takers Products can be differentiated Firms will have short run abnormal profits

Page 404 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies Slide 684 £

Student Handbook

Short-run equilibrium of firm in monopolistic competition MC AC

Ps ACs

AR = D MR Q

Slide 685 Monopolistic competition Equilibrium of the firm: long run

•More firms will enter the market •Demand Curve (AR) will shift inwards –Marginal Revenue Curve will follow

•Reach long run equilibrium: MR = MC AR = AC

•In the long run no abnormal profits

Slide 686 £

Long-run equilibrium of firm in monopolistic competition LRMC LRAC

ARL = DL

MRL O

Page 405 of 406

Dr Stephen Byrd PhD MBA FICM FITOL

Economic Studies

Student Handbook

Slide 687

Monopolistic competition Comparison with perfect competition (long run)

Slide 688

Long run equilibrium perfect and monopolistic competition ÂŁ LRAC P1 P2

DL under

perfect competition

DL under

monopolistic competition

fig

Page 406 of 406

Dr Stephen Byrd PhD MBA FICM FITOL