Microeconomics Level 1. 0930Course objectives 0940Introduction to economics 1040 COFFEE 1100What...
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Transcript of Microeconomics Level 1. 0930Course objectives 0940Introduction to economics 1040 COFFEE 1100What...
0930 Course objectives0940 Introduction to economics1040 COFFEE
1100 What markets do: supply, demand, and equilibrium
1145 Group work1215 Review of group work1300 LUNCH
1400 Market failure, and government intervention1445 Group work and TEA
1510 Review of group work1530 Cost benefit analysis1600 Lessons from Level 11610 Test1645 End
COURSE OBJECTIVES
This course has three objectives• to provide an overview of the scope
and methods of economics• to offer a self-contained introduction
to key themes in microeconomics• to equip participants to proceed to
Level 2
COURSE OBJECTIVES
• Economic analysis aims to be rigorous, but it need not be technical.
• No prior knowledge of economics or mathematics is assumed.
Basic Concepts
• Stocks and Flows• Goods and services
Share of National Output, percentage
Agriculture Industry Services
UK 1965 3 46 51
1997 2 30 68
France
1965 8 39 53
1997 2 27 71
Basic Concepts
• MICROECONOMICS: detailed study of decisions made by consumers, producers and their interaction in specific markets
• MACROECONOMICS: big picture – emphasizes interactions in the economy as a whole.
Basic Concepts
• POSITIVE ECONOMICStries to explain behaviour
• NORMATIVE ECONOMICS prescriptions based on value judgments
Basic Concepts: The Production Possibility Frontier
Maximum quantity one good that can be produced, given quantities of other goods being produced
A
B
C
D
E
F
G
.
GOOD 1
GOOD 2
A, B, C efficient
(on the frontier)
D, E inefficient
(inside the frontier)
F, G unattainable
(outside the frontier)
Basic Concepts
COMMAND ECONOMY central planner issues orders
FREE MARKET ECONOMYwhat, how & for whom decided by prices, incomes, wealth
DEGREES OF GOVERNMENT INTERVENTION
Hong Kong- China - Denmark - UK - USA -Cuba
Scale of government(spending as % of national income)
1880 1930 1960 1990
Japan 11 19 18 32
USA 8 10 28 36
UK 10 24 32 41
Germany 10 31 32 45
France 15 19 35 52
Sweden 6 8 31 50
TOOLS
NOMINAL & REAL VARIABLES
1970 1982 1991Unit labour
costs100 406 589
Real unit labour costs = (Unit labour costs / Retail prices) x 100
Real unit labour costs
100 93 82
Retail prices 100 438 720
Tools: Interpreting the data
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Bus fare
Bus Revenue
It appears that higher bus fares cause higher revenue…
Tools: Interpreting the data
+++
++
+
+
+
+
Bus fare
Bus Revenue
… but it might not be true
Low tube fare
High tube fare
Suppose the two clusters are from two different time periods – what might that imply?
Tools: Interpreting the data
Bus revenue depends on bus fares
But it also depends on other things• incomes• price of other modes of travel• reliability (relative to other modes of travel)• relative comfort • relative perception of safety
Market
• DEMANDquantity buyers wish to buy at each price
• SUPPLYquantity producers wish to sell at each price
• MARKETarrangement to exchange goods & services
• EQUILIBRIUM PRICEthe price at which market clears(i.e. quantity demanded = quantity supplied)
Market
Demand curve
quantity
price
EquilibriumQuantity
EquilibriumPrice
PRICE ADJUSTMENT
Equilibrium price clears market
Supply curve
Market
The demand curve shows the relation between price of a good and quantity demanded of that good.
But how does demand change when ‘other things’ change?
DEMAND IN MORE DETAIL elaborating on the ‘other things’
How does DEMAND for a good vary when
1 price of a related good changes?– substitutes – complements
2 consumer’s income changes?– normal goods– inferior goods
3 tastes change? – role of fashions and fads, culture
COMPARATIVE STATICS(effect of changing the ‘other things’)
Suppose income rises, increasing demand
Quantity
Price
Demand: low income
Equilibrium price rises
Equilibrium quantity rises
Demand : high income
Supply
SUPPLY IN MORE DETAIL elaborating the ‘other things’
How does SUPPLY of a good vary when
1 technology improves?
2 input prices change?energy, labour, capital
3 regulation imposes extra costs?
COMPARATIVE STATICS
Suppose technical breakthrough raises supply
Quantity
Price
Demand
2 but equilibrium price falls
1 Equilibrium quantity rises...
Supply rises
COMPARATIVE STATICS
An important difference
• If demand shifts, equilibrium price and quantity move in the SAME DIRECTION
• If supply shifts, equilibrium price and quantity move in OPPOSITE DIRECTIONS
SOME EXAMPLES
Third world farming• What is the effect of better irrigation & fertilizer?• What happens to price? To quantity? • To revenue?
Computers• The price of a personal computer has been falling.• Which is shifting, demand or supply?
Introduction to EconomicsGROUPWORK
1 Are the following statements positive or normative?
(a) Higher tax rates cut revenue from tobacco taxes(b) Poor countries got an unfair share of world income(c) Smoking is antisocial & should be discouraged(d) Airbus needs public support(e) Airbus deserves public support(f ) Airbus is a good investment for Britain
GROUPWORK
2 The price of crude oil increased from $2.90 to $9 per barrel in 1973, in a coordinated move by OPEC members.
(a) How did the OPEC members manage to raise the price? Show using a supply-demand diagram for the oil market.
(b) What happened to the demand for coal and the price of coal? Show using a supply-demand diagram for the coal market.
(c) What happened to the demand for fuel-guzzling cars?
(d) What happened to supply and demand for oil eventually?
GROUPWORK
3 The following data describe price and output of a product:
(a) Plot a scatter diagram(b) “Higher prices make firms raise
output.”“People buy less when prices are higher”Does the diagram shed any light on these statements?Could both be correct? Explain.
Year Price Output
1985 100 101
1986 104 107
1987 108 112
1988 112 122
1989 118 128
1990 117 128
1991 108 118
1992 98 103
GROUPWORK
4 For each government intervention listed below, identify the possible rationale.
(a) Income tax(b) Taxation of petrol(c) Regulating gas prices(d) Banning the use of cannabis(e) Running the NHS(f ) Maintaining an army
The Role of Government
IF MARKETS ARE EFFICIENT (i.e. ‘invisible hand’ works), the government could confine attention to– Legislation and general regulation– Redistribution (taxation & transfer payments)– Macroeconomic management (stabilization)
The Role of Government
However, sometimes free markets are not efficient
These instances are called MARKET MARKET FAILURESFAILURES
When markets fail, the government may intervene for efficiency reasons
SOURCES OF MARKET FAILURE
1. EXTERNALITIES
One person's decisions/choices affect others DIRECTLY
If markets were free and unregulated• cannot be made to PAY for the HARM
you inflict on others (e.g. pollution)
• cannot RECOVER all the value of BENEFITS
you confer upon others (use of green technology)
SOURCES OF MARKET FAILURE
1. EXTERNALITIES
Individual’s optimal decision is not optimal for society
Result: OVERPRODUCE the bad things, UNDERPRODUCE the good things.
Market outcome is INEFFICIENT,Government intervenes to CORRECT INEFFICIENCY
Policy Tools: tax, subsidy, quota, artificial markets
SOURCES OF MARKET FAILURE
2. PUBLIC GOODS
Goods that we consume together, so that • no individual can be excluded from consuming • consumption by one does not leave less for others
National defence Street lighting
No one has any incentive to pay for such goods. In the absence of government intervention, too little of
these will be provided.
Government steps in to ensure right level is produced.
SOURCES OF MARKET FAILURE
3. IMPERFECT COMPETITION
If firms have market power (power to set prices above cost), markets are usually INEFFICIENT
Once again, government can intervene (say, by regulating prices)
Example: Regulation of National Grid
GOVERNMENT FAILURE
In PRINCIPLE, the government can correct market failures
In PRACTICE, the government • does not always improve matters• sometimes makes things worse
Why?
GOVERNMENT FAILURE
• INFORMATIONAL PROBLEMS• INCENTIVE PROBLEMS • RENT SEEKING & CAPTURE
Hence, must check for the possibility of GOVERNMENT FAILURE before jumping to conclusions.
MARKET FAILURE & GOVERNMENT FAILURE GROUPWORK
1 There is a tax on cars in Central London
(a) Why not leave things to the market? List the different motives for intervention.
(b) Which of these are to do with efficiency?
(c) Are there any other motives than efficiency?
(d) Is/Was there a possibility of government failure?
MARKET FAILURE & GOVERNMENT FAILURE GROUPWORK
2 If people want to watch advert-free terrestrial TV, there should be a market for this. So what is the case for the compulsory TV License?
COST-BENEFIT ANALYSIS
Usually applied to government investment decisions
– roads – channel tunnel– subsidies to start-ups, R&D
The main question:
How do we value SOCIAL costs and benefits of a project?
COST-BENEFIT ANALYSIS
STEPS IN THE PROCEDURE• check how the private sector would do it• adjust for discrepancies between
private profits private profits PLUS spillover benefits to others
private costs private costs PLUS spillovercosts borne by others
Private valuations Social Valuations
COST-BENEFIT ANALYSIS
EXAMPLE: THE JUBILEE LINE EXTENSION
PRIVATE VALUATIONS
• CostsCosts present value of construction cost(say, takes 4 years to build)
+ present value of future operating costs(maintenance, wages, electricity)
• BenefitsBenefits present value of passenger fares
Build if Net Present Value of project is positive (i.e. project is profitable).
COST-BENEFIT ANALYSIS EXAMPLE: THE JUBILEE LINE EXTENSION
SOCIAL COST BENEFIT ANALYSIS
Were any social benefits or costs missed in the above valuation?
Beneficial externalities
less congestion on roadsless pollutionhelps integrate London
Harmful externalities
vibration to houses above linecongestion near terminuses
Social cost benefit analysis should attempt to measure as many of these implications as possible.
Externalities
• economic models are deliberate simplifications of reality• ‘other things equal’ streamlines thought but its validity
needs checking• supply and demand explain equilibrium price and
quantity• markets sometimes fail to be efficient• governments could intervene to correct failure• but government action is itself vulnerable to failures• of course, governments also care about equity • social cost benefit analysis tries to measure as many
inputs and outputs of a project as possible