Rowville Secondary College

Economics

Mr Desler (Careers Room- next to Room 27)desler.marcus.a@edumail.vic.gov.au

Do Now Activity – List 10+ eco. terms

Learning intention:Review the work covered in Head

Start last year

Success CriteriaYou have answered or can now

answer all the questions from Chapter 1 with confidence

Success in VCE Economics

= achieving your best

1. Keep notes and handouts organised (a workbook for any class notes and exercises done and a folder with plastic sleeves for handouts and tabs/dividers to separate work into topics)

2. Keep notes neat with headings and subheadings, bullet points (some students retype the powerpoint slides from class)

3. Prepare summary notes from the textbook ??4. WORK ON A CONSISTENT BASIS (a bit most days – 35+ minutes

- not a lot one day and nothing for 6 days)5. DO THE MAJORITY OF THE TASKS GIVEN TO YOU6. Make effective use of class time7. Review the day’s lesson in the evening (look at the class

slides / read the textbook(s)8. Have some interest in current events / affairs affecting

Australia9. Do the review questions given to you before an assessment

(SAC)

Housekeepingles apply i this classroom, in particular:

• Punctuality • Prepared (bring all stationery)• Respect for others (listen when

someone is speaking) • Effort all the time in the

classroom !• No phones or iPods etc. except

when I say • Water bottles only (no other drinks

or food – eat before you arrive)

Unit 3 Area of study 1

What is economics ? Economics looks at how limited

resources are used to produce goods and services which are then distributed to people to satisfy their unlimited needs and wants

How can we as a society organise ourselves and use the resources available to maximise people’s standard of living

Microeconomics

Examines a particular part or section of an economy

A particular market (car, housing, fruit & vegetable)

A particular industry (agriculture, manufacturing, tourism, retail etc)

A particular sector of the economy (household sector, business sector or government sector)

MacroeconomicsTakes a look at the economy as a whole and how it is progressing (the ‘health’ of the economy)

Overall changes in prices (inflation) Jobs growth The level of unemployment Level of trade with other countries (imports and

exports of goods and services) Interest rate movements by the RBA (Reserve Bank) Changes in ‘national production’ – Gross domestic

product (GDP)

Standard of living

Material Non-material

Material standard of living An individual’s access to and consumption of

goods and services (as a country this can be improved by increasing gross domestic product (GDP) – the total value of final goods and services produced in an economy over a certain period of time)

Non-material living standards

Quality of life (level of happiness / health / friendships / family connections / amount of leisure time available / freedom / crime / pollution / equality of opportunity / crowding and congestion / stress etc)

LIVING STANDARDS

Material vs Non-material

Material and non-material living standards can be in conflict with one another – often to pursue one means

to reduce the other

Resources (factors of production)

Resources – inputs used by business to produce goods and services

Types of resources: Human resourcesThe physical and mental efforts of people in

the production of goods and services Entrepreneurial / Enterprise resourcesThe risk taking and management skills and

organisation of individuals who set up and operate a business

Factors of production (resources) Capital resources

Plant, machinery and equipment used in the production of final goods and services for consumers

Natural resourcesThe gifts of nature which a country

possesses eg: solar / minerals underground / soil / forests / oceans / rivers / climate

Classifying goods and services

Collective goods and services Goods and services produced or provided

mainly by Government for the use / benefit of all in society

Producer goods and services Goods and services required by businesses to

create final goods and services for consumers

Consumer goods and services Final goods and services that are purchased

by individual households

Why needs and wants are unlimited

NEEDS AND WANTS FROM

HOUSEHOLDS (individuals)

BUSINESSESGOVERNMENT

OVERSEAS COUNTRIESCaused by an increasing population,

materialistic attitudes of society, intense advertising by businesses, planned obscelecense of products, re-occurring needs (food)

Relative scarcity (the basic economic problem) The imbalance between our unlimited

wants and the limited resources that are available

Our society cannot produce everything it needs and wants

Can only produce a certain level of output (GDP)

The economy can only expand at a certain rate Need to make choices as to what should

be produced and what needs to be forgone or not produced

The basic economic problem

Unlimited needs and wants by people

Limited resources available

to produce goods and servicesSCARCIT

Y•Most goods and services have a price because they are scarce (the scarcer the item, the higher the price)•Scarcity restricts living standards of a nation because we can’t have everything we want•Countries with access to more resources or use them more efficiently can have higher standards of living compared to other countries

Scarcity leads to making choices Choices need to be made about what

goods and services will be produced with our limited resources

Choice on the best use of our limited resources leads to the notion of ‘opportunity cost’

Opportunity cost is the benefit forgone by not using resources for there next best alternative use (cost can include $ lost, time lost etc)

Time to smell the roses

Choices Opportunity cost Limited resources Unlimited needs and wants Collective goods and services Consumer goods and services Producer goods and services Scarcity Labour resources Natural resources Capital resources Households Businesses Overseas countries Government

Living standards Material living standards Non-material living

standards People’s behaviour Models &

calculations/equations The BASIC ECONOMIC

PROBLEM Social Science Microeconomics Macroeconomics Individual markets,

sectors, industries The economy as a whole

Show the connections between the terms & concepts below in a mind map – you have 25 minutes

Production possibility diagram A ‘PPD’ shows the possible

combinations of goods & services & the concept of opportunity cost faced by a nation in deciding what choice of goods and services will be produced.Good

s

Services

A

B

C

Points on the PPF C: a combination of goods and services which

is not attainable by the economy at present

A: the various combinations of goods and services which are possible if the economy is operating at full capacity (using all it’s resources)

B: a combination of goods and services which is not using all the resources available in the economy (under-utlilisation of resources)

How can a nation increase it’s production possibility frontier ?

Increasing skilled migration (labour resource increases)

Improvements in productivity levels of employees

Improvements in technology to increase efficiency and productivity

Increases in foreign investment (more capital resources)

Discoveries of more natural resources

Types of efficiencyAllocative Efficiency An efficient allocation of resources is the

best combination of goods and services produced so that living standards are maximised which is a particular point on the ‘PPF’.

Technical Efficiency A technically efficient allocation of resources

refers to an economy operating at maximum productivity & output (operating at the lowest possible costs) which is any point along the ‘PPF’.

Types of efficiencyInter-temporal Efficiency Having the right combination of resources

used for production of consumer items and resources being used for production of capital goods & infrastructure to improve future production and assist future generations

Dynamic EfficiencyA country is dynamically efficient if it is able to change production to take advantage of new technology to benefit it’s society (change from using labour to machine based production or from fossil fuels to renewable energy sources

Factors that influence the decision-making of households, businesses and government

Households Income levels interest rates fashions & fads advertising in the media traditions & customs (culture) state of the economy – boom or recession

influences household confidence and thus spending choices

pressure groups in society (Greenpeace, Consumer action groups like ‘Choice’, political parties) can influence household spending choices

Factors that influence the decision-making of households, businesses and government

Businesses Government policies and laws interest rates state of the economy affects business

confidence and whether they invest and expand Number of competitors locally and overseas resources available and their price people’s fashions and tastes influence what

businesses produce technology available for use Pressure from trade unions (organisations that

represent employees on pay and conditions) Changing demographics (an ageing population)

Factors that influence the decision-making of households, businesses and government

Government State of the economy affects government spending

(in a ‘downturn’ governments will spend more to stimulate the economy)

amount of tax revenue available for use pressure groups in society influence governments Employer associations (represent employers)

pressure governments for business-friendly policies

society attitudes to issues and where tax revenues should be spent

opposition political parties Changing demographics (an ageing population)

An economy: a system that exists to organise

the production of goods & services, the distribution of incomes as well as the distribution of goods & services based on consumer expenditure.

Production

Incomes

Expenditure (Spending)(Distribution of goods & services)

Economic system

Three questions an economic system needs to answer

1 What and how much to produce ? (how are resources to be allocated or used) – left

mainly to the market mechanism or price system in Australia – interaction of buyers and sellers

2 How to produce ? The lowest cost method will be adopted as firms

wish to maximise profits – how much labour vs capital resources should we use ?

3 For whom to produce for ? Who will receive goods and services and incomes-

distribute evenly (or unevenly via the market ?)

Australia = a ‘contemporary market capitalist economy’ Approximately 80% of resources privately

owned & 20% are Government owned

On the whole consumers influence business decisions & production by their behaviour (what they buy and do not buy) – 80% of resources allocated through the ‘market’ – consumers sending ‘signals’ to businesses

Government also interferes somewhat in the economy to influence what and how much is produced (20% of resources are allocated by Government) because of MARKET FAILURE

Economic systems

Planned Socialism

Government control of resources and decision making on what and how much is produced

Pure Market Capitalism

Individuals own resources and consumers decide what and how much is produced. NO GOVERNMENT INTERVENTION

Contemporary Market Capitalism

80% of resources non-government owned, 20% government owned. Decision making mostly by consumers & businesses but some government interference

How does the market mechanism / price system allocate resources in the economy

In a market economy, businesses receive signals from consumers. Businesses will only produce goods and services which are most profitable for them and will choose the method of production which minimises their cost of production.

When the final prices of goods and services increase due to higher consumer demand, this indicates to businesses that there is a shortage or underproduction of that product and thus an under-allocation of resources. Businesses and owners of resources will want to re-allocate scarce resources & start producing this product or increase production of the product as there is more profit to be made from this product than other alternative uses for the scarce resources.

  If demand and the final prices of goods and services decrease , this

indicates to producers and owners of resources that there is an oversupply or overproduction of the product and thus too many resources have been allocated in this area. Profit margins on the product will be reduced and so businesses and owners of resources will no longer be prepared to allocate resources to production of this product and will look to allocate scarce resources elsewhere where greater profits can be obtained.

The operation of the market mechanism (demand and supply)

The law of demandAs the price of a good or service

increases, there will be a decrease in demand for that item as less consumers can afford the item.

As the price of a good or service decreases, there will be an increase in demand for the item because it becomes more affordable for more consumers

There is an inverse relationship between the price and the quantity demanded

The demand line shows the quantity demanded of a particular item by consumers at different prices for the item

The law of Demand (packet of Dorritos)

Price ($) Quantity demande

d1 80002 60003 40004 20005 1000

DQuantity

Price

0

Movements along the demand line (contractions and expansions)

Contraction in demand

Price

Expansion in demand

Quantity

There is a movement along the demand line when there is a change in price

Shifts in the demand line (increase in demand due to factors OTHER THAN PRICE CHANGES)

Buyers may change their demand for an item over a range of prices. This will cause a shift in the demand line

An increase in demand (D to D1) – buyers want more of the product at a given price than before over a range of prices

0

D1

Quantity

Price

D

$4$3

1000

4000

2000 5000

A shift of the demand line to the right (an increase in demand for an item over a range

of prices)An increase in demand over a range of

prices is caused by: An increase in disposable income

(wage rises, decrease in personal tax rates, working longer hours)

Increase in the price of SUBSTITUTE products

Decreases in the prices of COMPLEMENTARY products

Increase in the population or increase in the population target market for that item

A shift of the demand line to the right (an increase in demand for an item over a range of prices) An increase in demand over a range

of prices is caused by:

Increase in consumer confidence The item becomes more fashionable

(preferences & tastes change) Decreases in interest rates on loans

leaves more income to purchase goods & services

(Advertising campaigns to promote the product have been more successful or there has been less advertising on substitute products)

Shifts in the demand line (decrease in demand)

An decrease in demand (D to D2) – buyers want less of the product at a given price than before over a range of prices

0

D

Quantity

Price

D2

$4$3

1000

4000

2000 5000

A shift in the demand line to the left (a decrease in demand over a range of prices)

A shift of the demand line to the left is caused by:

A decrease in disposable income (less hours worked, increase in personal tax rates, lower wage rates)

Decreases in the population or the population of the target market

Decreases in consumer confidence (sentiment)

The prices of SUBSTITUTE products decreases

A shift in the demand line to the left (a decrease in demand over a range of prices)

A shift of the demand line to the left is caused by:

The price of COMPLEMENTARY products increases

Increases in the interest rate on borrowed funds – less discretionary income for purchases

The product is becoming less fashionable (preferences & tastes change)

(More advertising is occurring on substitute products or less advertising on this product)

Do Now Activity Fill in the blanksAustralia has a 1_______ _______ ________ economy. 2___% of

resources are 3______ owned and 4____% of decision making is done by 5_____ & ______. So the 6 m _____ m _______ allocates 7____% of resources in our economy.The 8 m____ m____ allocates resources through 9_____ sending ______ to businesses. Businesses will only allocate their scare resources to 10 p_______activities and use the 11______ cost possible in 12_____. When consumers want more of an item this indicates to businesses that there could be 13__________ of that product. Business will 14_______ _______ ________to that product because 15_______ are there to be made. When consumers reject or stop purchasing an item, this indicates to businesses that there is an 16_________ of resources to the production of the item. Businesses will take 17______ _______away from production of the item as there are 18____ _____ to be made now from the product.The law of demand says that when 19______ _____, demand 20 ______ and when 21_____ _____, demand will 22______. Movements along the demand line are caused by changes in the 23_______ of the product. The demand line may shift or move (an increase or decrease of demand over a range of prices) because of 24____________, 25_____________, 26 __________________, 27____________.

The behaviour of sellers (suppliers) in the market

The Law of supply

As prices rise, producers will supply more of the product to the market (due to greater profits being made per item)

As prices fall, producers will supply less of the product to the market as profits will be lower per item

The supply line shows the quantity sellers are willing to supply the market at certain prices of the good or service

The Law of Supply (packet of Dorritos)

Price ($) Quantity supplied

1 10002 25003 40004 60005 8000

Price

Quantity

S

0

Movements along the supply line (expansions and contractions) – caused by changes in the price of the good or service

Expansion in supply

Contraction in supply

Price

Quantity

There will be a movement along the supply line if there is a change in price

0

Increases in supply of a product over a range of prices (shifts in the supply line to the right) Sellers may decide to increase their

production or supply of a product over a range of prices (shift of the supply line to the right from S to S1)

0 Quantity

Price

S1

S

$4$2

1000

3000

3700

5000

An increase in supply at a particular price Factors which could cause this are: Decreases in the costs of production (raw

materials, energy prices, interest rate decreases)

Introduce better technology, so can produce at a cheaper cost or produce more with the same level of resources

Using the existing resources more productively so can produce more at the same cost as before

(More Government subsidies (financial assistance handouts) for the industry)

Changes in climate (favourable climatic conditions) for agricultural products

A shift in the supply line to the left (a decrease in supply at a particular price over a range of prices)

Sellers may decide to decrease their production or supply of a product over a range of prices (shift of the supply line to the left from S to S2)

0 Quantity

Price

S

S2

$4$2

1000

3000

3700

5000

A decrease in supply over a range of prices may be caused by:

Increase in production costs of the product (wage rises, energy cost increases, interest rate rises, raw material price increases)

Change in the climate (unfavourable climatic conditions)

(Reduction of or scrapping of subsidies to businesses in the industry)

Less use of efficient technology means lower production and higher costs of producing a product

Lower productivity levels of labour and capital resources

Equilibrium or market price

S

DQuantity

Price

The quantity supplied equals the quantity demanded at a particular price

The market or equilibrium price Buyers want to buy at the lowest possible

price while sellers want to sell at the highest possible price so:

In a competitive market, there will be a price where both buyers and sellers agree to and an exchange of goods and services will occur. This is the equilibrium market price. At the equilibrium price, there is no shortage or excess of a product because quantity demanded is equal to the quantity supplied and thus the goods are cleared. Both buyers and sellers are satisfied.

A price in the market which is lower than the equilibrium price

300 450200

Price

Quantity

D

S

Expansion in supply Contraction in demand

As sellers raise the price to ‘clear’ the market

$2

$4

When there is a low price for a product (below the equilibrium price)

At a low price for the product there will be a shortage of the product because the quantity demanded at that price will far exceed the quantity available (supplied) in the market as profits for suppliers will be low.

This will cause buyers to be unhappy and allow suppliers the opportunity to increase prices and thus produce more profit. Production of the item would increase as profitability of the item improves, thus there would be an expansion in supply and a contraction in demand as prices rise until the equilibrium price is reached which is the natural market position where there is no excess or shortage of the product.

When the current market price is above the equilibrium price

300 450200

Price

Quantity

D

S

Expansion in demand

Contraction in supply

As sellers lower the price to stimulate demand

$6

$4

When there is a high price for a product which is above the equilibrium price When the current market price is higher than

the equilibrium price, there will be an excess of the product in the market as the quantity supplied at the high price will be much greater than the quantity demanded by buyers. Sellers would be very dissatisfied and would need to clear the excess stock in the market. They would reduce their prices causing a contraction in supply as profitability on the item decreases and an expansion in demand due to the price decrease until a situation where demand and supply of the item in the marketplace is equal (the equilibrium price).

Changes to the equilibrium price and quantity when there is an INCREASE IN DEMAND (factors other than price)

S

DQuantity

Price

D 1

As demand increases there will be an initial shortage of the product, causing the price to increase with a corresponding expansion in supply until a new equilibrium is reached

Changes to the equilibrium price and quantity when there is an DECREASE IN DEMAND (factors other than price)

S

D 2Quantity

Price

D

As demand decreases there will be an initial surplus of the product, causing the price to decrease with a corresponding contraction in supply until a new equilibrium is reached

Changes to the equilibrium price and quantity when there is an INCREASE IN SUPPLY (factors other than price)

S

D Quantity

Price

S 1

As supply increases there will be an initial surplus of the product, causing the price to decrease with a corresponding expansion in demand until a new equilibrium is reached

Changes to the equilibrium price and quantity when there is a DECREASE IN SUPPLY (factors other than price)

As supply decreases there will be an initial shortage of the product, causing the price to increase with a corresponding contraction in demand until a new equilibrium is reached

S2

D

Price

S

Quantity

The role of relative prices in allocating resources in Australia’s economy

Relative prices: The price of one item compared to the price of

another. Changes in relative prices will influence the behaviour of consumers and businesses.

What would happen to resource allocation in the economy in the situations below: The government gives households a $1000

rebate to install solar panels The government places a 20% tax on ‘alcopops’ The government introduced a carbon tax of $23

per tonne on Australia’s 500 top carbon emitting businesses on 1st July 2012

The government places a 20% tax on ‘alcopops’

The relative prices of other alternative alcoholic drinks will become cheaper in comparison to ‘alcopops’. This would cause consumers to reduce their demand for alcopops and increase their demand for wine as it is now relatively cheaper. As the demand for wine increases, it’s price will start to rise also. The increase in demand and price for wine sends signals to businesses to redirect their scarce resources away from the production of alcopops to instead the production of wine as now greater profits can be made from wine.

The government gives households a $1000 rebate if they install solar panels

The price of solar panels …………………………………………..

The price elasticity of demand (PED) How the quantity demanded by

buyers changes when there is a change in the price of a product

% change in quantity demanded PED=

------------------------------------- % change in

price

Price elasticity of demandWhen demand is relatively elastic (PED

> 1) The quantity of a product demanded by

consumers changes MORE THAN proportionally with a change in the price. The actual total revenue (sales) for the business will increase when there is a price decrease but total revenue will decrease when there is a price increase

A 7% decrease in price causes a 15% increase in demand for the product or visa versa

D

P

Q

7%

15%

Types of goods and services that would display a HIGH price elasticity of demand (PED > 1) – VERY ELASTIC DEMAND

Non-essential (discretionary items) in the household budget tend to be fairly elastic

More expensive items (a high proportion of income spent) tend to display a higher elasticity of demand

(holidays / dining out / housing / luxury cars) Products which have CLOSE SUBSTITUTES tend to

display a high price elasticity of demand

(If the product has no complementary products but is a stand alone item, then it may display more price elasticity (fresh flowers ? , take away food ?, petrol ?))

The price elasticity of demand

Demand is of ‘unit elasticity’ The quantity demand by consumers

changes in the same proportion as the change in the price (a 5% drop in price will cause a 5% increase in the quantity demanded and visa versa)

P

Q

D

8%

8%

The price elasticity of demand

Demand is relatively inelastic PED < 1)

The quantity demanded changes less than proportionally than the change in the price

(eg: a 15% drop in the price causes an 8% increase in the quantity demanded by consumers and visa versa)P

Q

D

12%

5%

Goods and services that may display inelastic demand (PED < 1)

Items which are essential (non-discretionary) Cheap items in the household budget (small

proportion of income spent) (milk, bread, cereal, rent, school costs, etc) Items which do not have substitutes tend to

display inelastic demand (Products which complement other items may

display fairly inelastic behaviour) (Addictive products such as cigarettes, alcohol

and poker machine gambling) (Products which have significant ‘branding’ in the

marketplace – a strong brand name and presence)

Price elasticity of supply (PES)

Refers to how the quantity supplied changes when there is a change in the price of that product

% change in the quantity supplied

----------------------------------------% change in price

PES =

A high PES – a large price elasticity of supply – supply is VERY ELASTIC

There is a larger proportional change in the quantity supplied then there is a change in the price (PES > 1)

Q

SP

15%

5%

A low PES – supply is inelastic (small price elasticity of supply)

Refers to a smaller proportional change in the quantity supplied compared to the change in price (PES < 1)

S

Q

P10%

4%

Factors that determine the ‘PES’ for certain products

Products that can be more easily stored /stockpiled (durable items) for longer time periods tend to have a more elastic supply (stock can be placed on the market quickly if prices rise)

Businesses that have spare capacity or where resources can be moved easily into or out of the industry in response to price increases or decreases show a greater PES

Products that can be produced quickly tend to have more elastic supply (production period is short)

Price elasticity of supplyElastic supply Products which are

stockpiled (durable) Industries operating

below full capacity Industries where

resources are easily moved into or out of production when prices change

Can be quickly produced

Inelastic supply Products not able to

stockpiled or stored over a period of time

Industries operating at full capacity

Industries where resources are not easily moved into production to respond to price rises

Take a long time period to produce

Market structuresThe structure of a market or industry is determined by the following criteria: Number of sellers and their market share The degree of similarity of the products sold

(are they identical or very different in their characteristics)

Ease of entry and exit into & out of the industry for sellers

Their are four basic types of market structures Perfect competition Monopolistic competition Oligopoly Pure monopoly (no competition)

Perfect competition

Lots of buyers and sellers in the market. Prices are determined purely by the market

forces of supply and demand – businesses are ‘price takers’ (consumer sovereignty exists)

All products are the same – quality and features (no product differentiation)

There are no barriers for sellers to enter or exit the market

Buyers and sellers have all information available to them and make rational decisions

Resources are easily mobile and can be moved to where they can be used most profitably

Buyers and sellers try to maximise their own well being

Monopolistic competition Many buyers and sellers (like perfect competition) Buyers and sellers are well informed about

products and resources available respectively There are very little or no barriers to enter or exit

the market Products are similar in nature but sellers will try

to differentiate their product from other sellers Products may be differentiated based on:• Physical characteristics (size, taste, texture,

quality)• Location (close to consumers)• Services (offer extra benefits beyond the product

itself – longer warranties or after sales service)• Image (link the product to a concept / idea)

Oligopoly

A few only large sellers with a large market share and maybe a few (if any) other firms with low market share

Moderate competition or perhaps even low levels of competition if only 2 or 3 firms exist

Products could be the same or differentiated Price collusion or price fixing can occur if

their are only a small number of big firms Often difficult for businesses to enter the

market (high costs of setting up and of production and / or barriers created by existing businesses)

Monopoly Only one seller of the product No competition so seller is a PRICE-MAKER

(sets the price) Product differentiation is not important Very high barriers to enter the market (firm

often owns the resources or Government gives firm the right to be sole producer or costs of production are too high for other potential businesses to try and enter the market)

Eg Postal services, South East Water, Melbourne Ports Authority, Metro (Melbourne train service)

High levels of competitionBenefits Keeps prices and thus inflation low Makes firms produce products efficiently otherwise they will

not survive (resources are used efficiently and to their maximum potential)

Firms must provide a quality product to the consumer to be competitive

Goods and services are produced that consumers desire -consumer sovereignty (thus maximising their satisfaction and standard of living

Problems Price wars can force many smaller businesses to fail Businesses often cut costs to try and survive leading to

issues with safety for workers and / or customers Money is often spent on advertising distorting consumer

knowledge and not allowing them to maximise their welfare

Problems with having little or no competition

Prices of goods and services can be higher than what they should be

Lower product quality Lower customer service Businesses are more inefficient (leads

to lower production than is possible, inefficient use of resources – lower GDP – and thus lower living standards)

Firms may restrict supply in the market leading to shortages in order to keep prices higher

Market Failure Occurs when a free market is unable to allocate resources efficiently or when resources are allocated in a way that does not maximise society’s satisfaction or welfare (living standards).

There is market failure when socially desirable goods and services are under-produced (public goods) If left to a free market, many desirable and essential

goods and services would not be produced or very little would be produced and / or the prices for these products would be very high. This because many socially desirable products are PUBLIC GOODS. Public goods are non-excludable and non-rival (one person’s use does not lessen another person enjoying the product). You cannot exclude non-payers from using the product.

Exs: education, health, roads, street lighting, recreational areas (parks & pools), transport services, defence services law and order

Businesses don’t want to produce these goods and services because of the ‘free-rider’ problem of people accessing the product without paying for it. Therefore businesses make less or lower profits than what they should. There is a disincentive to produce the product.

Socially desirable products

How can governments promote these products

Spending through the budget (money collected from tax revenues)

Payment of government subsidies to producers and rebates to consumers (rebates for water tanks, LPG conversions for vehicles, private health insurance, subsidies to private schools and hospitals and some agricultural industries)

Govt laws to force people to consume a product (minimum school leaving age)

There is market failure because of ‘externalities’

Occurs when a person or business is engaged in an economic activity (production or consumption) that affects the well being of a 3rd party who is not involved in the activity

Externalities can be either: Positive – the 3rd party receives a benefit Negative – the 3rd party incurs a problem

or cost

Negative externalities Causes market failure because firms do not pay

for the social costs that they inflict on other businesses or people through their actions. Therefore they continue to create these social costs as they are not added into business production costs. Peoples’ standard of living decreases and so resources have not been used efficiently.

Governments reduce negative externalities by: Laws to reduce or stop pollution

(noise/air/outflows into waterways) Subsidies or rewards for pollution reduction Proposed carbon tax to be introduced (1st July

2012)

There is market failure because of market power (weak competition)If competition is weak

Prices are higher, firms don’t produce and thus use resources efficiently and often restrict their output

Government can promote competition by: Deregulating markets (removal of government

restrictions for competition) Financial markets (early 1980s), Labour markets (early

1990s), aviation market (1990s), certain agricultural products (1990s onwards), etc

Reducing tariffs on imports (more competition from overseas forcing our businesses to be efficient in their resource use to keep production costs down to compete)

Government bodies to promote competition and investigate a lack of competiton or breaches in competition laws (Competition & Consumer Act) and ACCC (Australian Competition & Consumer Commission)

Markets & the lack of competitionTypes of ‘anti-competitive’ behaviour which is

illegal as per the Competition & Consumer Act (2010) and monitored by the ‘ACCC’)

Price fixing by 2 or more businesses Predatory pricing – where a business deliberately

undercuts a smaller business to drive the small business out of the market

Market zones – where businesses agree with each other to have only certain areas where they sell

Exclusive dealing – where businesses only buy their products from a certain firm and sell their products to a certain business

There is market failure because of asymmetric information

When buyers or sellers have more information than the other party (usually sellers) or when one party does not have access to all the information they require to make a rational decision about resource use

Insider trading on the share market The used car market The property market The food market (artificial ingredients) Education (parents do not have full information

about the performance of all schools ? – My Schools website ?)

The liquor and tobacco market

Government action to stop asymmetric information

Pass laws requiring full disclosure (labelling on food products, Product Disclosure Statements (PDS) for financial investment products, RWC for used cars)

Govt ad campaigns to inform consumers

Making certain activities illegal (insider trading on shares, winding back car odometers)

There is market failure when undesirable goods and services are produced

Examples of undesirable or dangerous products are alcohol, cigarettes, vehicles, pornography, prostitution, gambling, drugs, firearms etc

Government reduce these problems by: Putting production and / or consumer taxes on

certain products Outlawing or restricting the product Government inspectors to ensure businesses

are abiding by the law in relation to a product Age restrictions on certain goods and services

There is market failure when income is distributed very

unevenlyIn purely free markets, income is distributed very unevenly. Those who own resources earn much more incomes than those that do not own resources.

Income inequality also exists because of: Inheritance of wealth Occupational skills Educational opportunities Geographic location Sickness / disabilityGovernment can reduce income inequality by: Having progressive tax rates Welfare benefits to poorer households (income &/or means

tested) Access to cheap or free govt services (health card, education

subsidies etc) Setting a minimum wage (Fair Work Australia) Superannuation co-contribution scheme for lower income workers

Government failureWhen government intervention does NOT lead to a more efficient allocation of resources Eg: Tax laws – negative gearing on property

investments (wealthy people buy property to reduce tax often pushing up house prices)

Pork barrelling in marginal electorates (promising big spending in certain electorates if re-elected)

The obsession with spending on roads rather than public transport – should be a balance ??

Over-regulation of the labour market (too many laws for employers to follow when employing people ? – is a disincentive for businesses to employ people ????)

Government intervention to stabilise economic activity

Try to avoid massive ‘booms’ (lots of spending by households and business) and recessions (very little spending by business and households)

Aim for strong but sustainable economic growth

Influence / regulate economic activity through MONETARY POLICY (RBA) and BUDGETARY POLICY

Can you answer this question

Why is climate change considered to be a failure of markets ????

Hint: ‘Externalities’

Market failure occurs when the market does not use resources as efficiently as it could and so household’s standard of living is not maximised. Climate change refers to a rise in average global temperatures which could lead to more severe weather events (floods, cyclones, droughts) which could in turn affect the economy of Australia significantly. The predicted rise in temperature has been caused by man-made activity, notably carbon emissions into the atmosphere. These carbon emissions are a negative externality as it has and will impact on Australia’s population in an adverse way through rises air pollution and temperatures. These carbon emitters (both business and households) have not had to pay in the past for the social costs that they are creating through their activities and so they continue to emit carbon through their activities. However, this has changed somewhat with the introduction of a carbon tax on 1st July 2012 with the top five hundred largest carbon emitting businesses now paying to some extent for the negative externalities they create ($23 per tonne of carbon emitted rising by 2.5% in real terms in 2013/14) which may motivate some businesses to reallocate their scarce resources to devising ‘cleaner’ methods of production.