Economic Trade-off. What goods should be produced? How the goods should be produced? Who receives the goods?

Transcription

1 Capital Goods The Economic roblem The Economic roblem How do we best satisfy unlimited needs and wants with finite resources? Economic Resources Economic Trade-off roduction ossibilities Frontier Labour What goods should be produced? K C C Land How the goods should be produced? K B K A A B Capital F Who receives the goods? C A C B C C Consumer Goods Entrepreneurship A roductively Inefficient B roductively Efficient Scarcity of Resources Opportunity Cost C Infeasible

2 emand Curves emand of a good or service that consumers are willing to buy at any given price. emand Curve Movement Inwards Shift Outwards Shift Q 1 Q 2 Q 2 Q 1 Q 1 Q 2 Law of emand: emand Inverse Relationship Causes: of Income Substitute Compliment irect Taxation opulation Size Causes: of Income Substitute Compliment irect Taxation opulation Size

3 Supply Curves Supply of a good or service that producers are willing to produce at any given price. Supply Curve Movement Inwards Shift Outwards Shift S S 2 S 1 S 2 S 1 Q 1 Q 2 Q 2 Q 1 Q 1 Q 2 rofit Motive: Supply rofits ositive Relationship Factors: roduction Costs Technology Availability of Inputs Indirect Taxation Value of Subsidies Factors: roduction Costs Technology Availability of Inputs Indirect Taxation Value of Subsidies

4 Elasticity of emand (E) E The responsiveness of the quantity demanded of a good or service to a change in the price. Formula E = ercentage Change in emanded ercentage Change in E Values Elastic emand Inelastic emand E Value emand 0 erfectly Inelastic 0 > E > 1 Inelastic 1 Unit Elastic 1 > E > Elastic erfectly Elastic Substitutability of the Good Necessity of the Good Q 2 Q 1 Q 2 Q 1 Short-run vs. Long-run E Value < -1: E Value > -1: roportion of Income % in % in % in % in Specific Market Conditions Q Q

5 Elasticity of Supply (ES) ES The responsiveness of the quantity supplied of a good or service to a change in the price. Formula ES = ercentage Change in Supplied ercentage Change in ES Values Elastic Supply Inelastic Supply ES Value Supply S 0 erfectly Inelastic 0 < ES < 1 Inelastic 1 Unit Elastic S 1 < ES < Elastic erfectly Elastic of Spare Capacity Ease/Cost of Factor Substitutability Q 1 Q 2 Q 1 Q 2 Short-run vs. Long-run ES Value > 1: ES Value < 1: Inventory Stock s % in % in % in % in Market Structure QS QS

6 XE and YE Income Elasticity of emand (YE) Cross Elasticity of emand (XE) The responsiveness of the quantity demanded of a good or service to a change in income. The responsiveness of the quantity demanded of a good or service to a change in the price of another good or service. YE = % in emanded % in Income XE = % in emanded of Good B % in of Good A Inferior Normal Luxury Negative XE (-) ositive XE (+) Good Good Good Good A Good A YE < 0 0 < YE YE > 1 Good B emand Good B emand Income Income Income Compliments Substitutes emand emand emand AN OR

7 Indirect Taxes Indirect Taxation Taxes imposed by the government upon the purchase of goods and services. Specific (Unit) Tax Ad Valorem Tax Incidence of Tax E.g. Excise uties E.g. Value Added Tax Tax Burden T A X S 2 S 1 T A X S 2 S 1 S 2 S 1 3 Q 2 Q 1 Q 2 Q 1 Q 2 Q 1 Tax per unit is the vertical distance between supply curves Absolute value of tax increases as price of product increases Consumer Incidence roducer Incidence Govt. Tax Revenue Elasticity?

8 SUBSIY Subsidies Subsidies Fixed payments made by the government to producers, to help reduce the cost and price of a good or service. Subsidy Examples Effect of a roducer Subsidy Incidence of Subsidy Rail Travel S 1 S 1 Subsidies 3 Renewable Energy Subsidies S 2 S 2 Farming Subsidies Q 1 Q 2 Q 1 Q 2 Fishery Subsidies Childcare Subsidies Vertical distance represents value of per unit subsidy Consumer Benefit roducer Benefit Govt. Subsidy Cost Elasticity?

9 The Theory of Competition Competition The extent to which rival firms compete with each other within a market. Objectives Survival/Growth Sales Revenue Market Share rofits erfect Competition Monopoly Factors A theoretical model that describes the conditions required for intense competition to take place between firms. Large number of buyers and sellers takers Sell homogeneous products No barriers to entry/exit A market structure where one firm exerts dominant control of the market. One dominant firm maker (Monopoly ower) Absolute product differentiation Significant barriers to entry/exit Number of Firms Extent of roduct ifferentiation egree of Barriers to Entry Availability of Information Theoretical Model Low s Efficiency Benefits High s Lower Welfare and Efficiency Miscellaneous e.g. Advertising

10 The Mechanism The Mechanism How the interaction of demand and supply determine the price and quantities of the goods that get produced. Incentive Function s provide economic agents with incentives to alter their behaviour. Rationing Function s allocate economic resources which are in finite supply. Signalling Function s signal information to economic agents about a specific market. S 2 S 2 S 2 S 1 S 1 S 1 = S 3 Q 2 Q 1 Q 2 Q 1 Q 2 Q 1 Higher price incentivises firms to provide more Higher price rations lower supply by forcing some consumers out of market Higher price signals to all agents the change in market conditions

11 ublic Goods ublic Goods Goods that are non-rival and non-excludable and likely to be underprovided by the market. Examples Goods Spectrum Characteristics Non-Excludability Lighthouse ure ublic Goods: Non-Rival Quasi-ublic Goods: Non-Rival No person can be excluded from the benefit of the good. Flood Barriers AN Non-Excludable OR Non-Excludable Non-Rival National efence rivate Goods: Rival AN Excludable Free Goods: Basic Need AN No Opportunity Cost Consumption by one person does not affect consumption ability of others. Characteristics ensure no effective demand for the good from the market. Roads/Motorways Free-Rider roblem

12 ositive Externalities ositive Externalities ositive roduction Externality ositive Consumption Externality A benefit enjoyed by third parties as a result of the production/consumption of a good or service. Renewable Energy MC MSC s do not reflect social cost Merit Goods MB MSB ositive spill over effects Under production of good Under consumption of good MC MSC MC = MSC rivate Costs/Benefits External Benefit External Benefit Social Costs/Benefits RI SOC A E B B SOC RI E B A B Misallocation of Resources Market Failure Q RI Q SOC MB = MSB MB MSB Q RI Q SOC

13 Negative Externalities Negative Externalities Negative roduction Externality Negative Consumption Externality A cost imposed on third parties as a result of the production/consumption of a good or service. Factory ollution MSC MC s do not reflect social cost emerit Goods MSB MB Negative spill over effects Over production of good Over consumption of good MSC MC MC = MSC rivate Costs/Benefits External Cost External Cost Social Costs/Benefits SOC RI B E C A RI SOC E C B A Misallocation of Resources Market Failure Q SOC Q RI MB = MSB MSB MB Q SOC Q RI

14 State rovision and Regulation Government Intervention Concerted regulatory action taken by the government designed to overcome market failure. State rovision The process of an industry or group of firms moving from the private sector to the public sector. Regulation Rules and laws enforced by the government that influence the behaviour and incentives of economic agents. rotects industries/firms in decline Loss of rofit Incentive State provision may introduce moral hazard problems for industries Controls externalities present laces too many restrictions on firms Government needs to have perfect information to identify the social optimum. Government Failure

15 Controls Controls A form of government intervention which places restrictions on what the price in a market can be. Examples Minimum Maximum S S Minimum Wage MIN Minimum Rent Controls Maximum MAX Agricultural Controls Q Q Excess Supply Q S Q S Q Excess emand Q Minimum Alcohol ricing Only Effective if. Min. Original Only Effective if. Max. Original

16 Aggregate emand (A) Aggregate emand Equation: Aggregate emand Consumption Investment Government Spending Net Exports A The total expenditure on an economy s goods and services at any given price level. C I G X-M Total spending by consumers on domestic goods and services. Spending that increases the size of a nation s capital stock. Spending set by the government to inject economic activity into the economy. Net trade component: export revenues less import expenditure. 66% of UK G8% of UK G0% of UK G -4% of UK G ependent on omestic isposable Income rofits Tax Revenue Exchange Rates Expenditure Foreign Expenditure Interest Rates Confidence Interest Rates Confidence Budget osition ebt Burden Global emand Relative Inflation Rate

17 Aggregate emand Curve A Curve Graphical representation of the aggregated demand for goods and services produced within a country at any given price level. A Curve Movement Inwards Shift Outwards Shift A 2 A A 2 A 1 A 1 Y 1 Y 2 Y 2 Y 1 Y 1 Y 2 ownward Sloping Curve Average Inverse Relationship Causes: Consumption Investment Government Spending Exports Imports Causes: Consumption Investment Government Spending Exports Imports

18 Short-run Aggregate Supply Curve SRAS Curve The aggregated supply for all goods and services produced within a country at any given price level over a limited period of time. SRAS Curve Movement Inwards Shift Outwards Shift SRAS SRAS 2 SRAS 1 SRAS 1 SRAS 2 Y 1 Y 2 Y 2 Y 1 Y 1 Y 2 Upward Sloping Curve Average rofits Causes: Labour Costs Raw Materials Costs Oil Causes: Labour Costs Raw Materials Costs Oil

19 Long-run Aggregate Supply Curve LRAS Curve Keynesian AS Curve LRAS Curve Movement LRAS Curve Shifts Keynesian Movement Keynesian Movement LRAS LRAS 2 LRAS 1 LRAS 3 AS AS 2 AS 1 AS 3 Y FE Y 2 Y 1 Y 3 Y FE Y FE2 Y FE1 Y FE3 erfectly Inelastic Curve Causes: Three hases: Causes: Full Employment Change in quantity and/or quality in factors of production. Inward Migration Elastic Intermediate Spare Capacity Close to Full Capacity Change in quantity and/or quality in factors of production. Research + evelopment Fall in Capital Stock Inelastic Full Capacity Technological rogress

20 Economic Growth Economic Growth An increase in the real G of a country over time. Macroeconomic Equilibrium Short-run Growth Long-run Growth LRAS SRAS LRAS SRAS 2 SRAS 1 LRAS 1 LRAS 2 SRAS SRAS 2 1 = A 2 A 2 Y FE A Y 1 = Y 3 Y 2 A 1 Y 1 Y 2 Y 3 A 1 In the Short-run A Curve Expansion only A and LRAS Curve Expansion A SRAS ositive Gap (Y 2 -Y 1 ) Full Employment of In the Long-run Actual G otential G increases in LR A SRAS LRAS Unsustainable Growth Sustainable Growth

21 G Business Cycles Business Cycles escribes the process of economic expansion and contraction that economies experience over time. A Growth C Recession A period of increasing economic growth without any evidence of inflationary pressure. A B + C - A B + C - A B + C - Long-run Trend A period of declining economic growth with negative growth in 2 successive quarters. B Boom Trough A period of rapidly rising A sustained period of low economic growth exhibiting inflationary Time economic growth with the possibility of pressure. + ositive Gap - Negative Gap deflationary pressure.

22 Macroeconomic Objectives Macroeconomic Objectives olicy goals set by the government which represent a strong and stable economy. Macroeconomic Stability Objectives Conflict How to decide? Sustainable Economic Growth Low Stable Inflation The UK government often faces a trade-off when setting economic policies. Low Unemployment Competitive Trade osition Sign of a strong and robust economy Very difficult to achieve all objectives! Higher Econ. Growth Inflation Rises Unemployment Falls Loss of Competitiveness Exploitable olicy Trade-off Uses economic data and forecasts to determine the primary objective to achieve.

23 Inflation Inflation A persistent increase in the general price level of an economy over time. emand-ull Inflation Cost-ush Inflation Consequences SRAS SRAS 2 SRAS 1 Shoe and Leather Costs Menu Costs A 2 Reduction in Incomes A 1 Y 1 Y 2 Y 2 Y 1 A Savers/Lenders Negatively Impacted A Curve Expansion SRAS Curve Contraction However ulls up from to High Confidence Causes: Expansionary olicy Export-Led Growth High Costs Higher Wages USH Causes: Higher of Raw Materials High s Higher Cost of Capital Borrowers ositively Impacted Reduction in Value of ebt

24 eflation eflation A persistent decrease in the general price level of an economy over time. Bad eflation Good eflation Consequences SRAS SRAS 1 Consumption eferral SRAS 2 Reduction in Business Investment Increase in Value of ebt Y 2 A 2 A 1 Y 1 Y 1 Y 2 A Borrowers Negatively Impacted A Curve Contraction Employment SRAS Curve Expansion Employment However Savers/Lenders ositively Impacted Increase in urchasing ower

25 Unemployment Unemployment The number of people of working age without work, but are actively seeking employment opportunities. Cyclical Unemployment Seasonal Unemployment Frictional Unemployment Structural Unemployment Unemployment caused by a downturn in the economy. Unemployment caused by peak business periods ending. Unemployment caused by workers moving between jobs. Unemployment caused by a long-term decline in an industry. LRAS SRAS LRAS SRAS LRAS SRAS 2 SRAS 1 LRAS 2 LRAS 1 SRAS SRAS 1 1 = 3 1 = A 2 A 2 A 1 A 1 A A Y 2 Y FE Y FE1 = Y 3 Y 2 Y 2 Y FE1 = Y 3 Y FE2 Y FE1 emand for Goods + Services emand for Labour Only short-term as demand returns for the next peak season. Only short-term as workers make themselves available to work again. Full Employment Natural Rate of Unemployment

26 Balance of ayments Balance of ayments A trading account which records all the transactions made between one country and the rest of the world. Current Account Measures the balance in trade with the ROW. Balance of ayments Must balance Financial Account Measures the balance in trade of financial assets with the ROW. Goods + Services CA FA Financial Assets eficit Surplus Investment Income Stock + Bonds Transfers (Aid) CA FA Currency Reserves Surplus eficit Surplus (+) eficit (-) Surplus (+) eficit (-)

27 Trade Balance Trade eficit Trade Balance in Goods + Services Trade Surplus Import expenditure exceeds export revenue. Net trade position of a country with the rest of the world in terms of goods and services. Export revenue exceeds import expenditure. Net Exports (X-M) Ceteris aribus EXORTS = INFLOW Net Exports (X-M) Ceteris aribus OUTFLOW = IMORTS Good indicator of the competitiveness of a country with the rest of the world.

28 Monetary olicy Monetary olicy olicies set by the Central Bank which involve changing the money supply and interest rates to create price stability. Bank of England: Bank Rate Change Inflation below Target Expansionary Monetary olicy Inflation above Target Contractionary Monetary olicy Savings Rate Value of ebt Exchange Rate Bank Rate Cut LRAS SRAS Bank Rate Rise LRAS SRAS A Curve Impact A 2 Inflation Rate Y 1 Y FE = Y 2 A 1 A 2 Y FE = Y 2 A 1 Y 1 CI Inflation Target 2%

29 Fiscal olicy Fiscal olicy Changes in taxation, government spending and borrowing that are designed to influence A in the economy. Government Budget A plan detailing the revenue and expenditure a government anticipates over a given period of time together with details of any borrowing requirements. Surplus Taxes Spending National ebt Falls Expansionary Fiscal olicy Reduction in taxes and/or increase in govt. spending Increase in A LRAS SRAS Contractionary Fiscal olicy Increase in taxes and/or decrease in govt. spending ecrease in A LRAS SRAS Balance Taxes Spending No change in National ebt A 2 eficit Taxes Spending National ebt Rises Y FE Y 2 A 1 A 1 A 2 Y 2 Y FE

30 Supply Side olicy Supply Side olicy olicies designed to increase the quantity and/or quality of an economy s factors of production. Interventionist SSs Government policies which generate supply side improvements. Free Market SSs olicies which provide markets with more freedom, resulting in supply side improvements. Supply Side Improvements Increases the long-run productive potential of the economy Examples: Examples: LRAS 1 LRAS 2 Education and Training Reduction in rogrammes Corporation Tax Infrastructure rojects eregulation Securing Intellectual roperty Rights Labour Market Reforms Y FE1 Y FE2 A Supply side policies often involve long time lags!