Copy of HL Economics Notes

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TABLE OF CONTENTS Unit 0 Microeconomics: Unit 1A​ - Unit 1B​ - Unit 1C Part 1​ - Unit 1C Part 2 - Macroeconomics Unit 2A - Exam Techniques Unit 0 Economics - social science - Study of society and the way individuals interact within it - How does society allocate resources in order to fix the basic economic problem Normative vs. Positive statements - Normative - opinion based - “Should” - Value judgements - Positive - can be (dis)proven - Doesn’t have to be true Models vs. theories - Models - Very precise - Oft. expressed mathematically/diagrammatically - Link different variables - Theories - Not as precise as models = usually expressed through words Ceteris Paribus - All other variables within an economic model remain constant Production Possibility Curves/Frontiers Assumptions: - Only two goods produced - Resources are fully employed and used efficiently - Quantity and quality of resources is fixed - State of technology is unchanged “​Curve represents​ maximum potential level of output​ if an economy uses all of its resources as efficiently as possible. Represents​ all different combinations of 2 goods at max. production​ when all available resources are used ​efficiently​” Two types of PPC/PPF: 2 very different goods - resources can’t be easily transferred - Opportunity cost will vary depending on where shifts occur because: - The first few resources transferred from A → B may be nonessential to production of A and therefore opp cost wouldn’t be that high - However as more resources that may be more important to production of A are transferred to B, opp cost will increase - Curved PPC 2 similar goods - resources easily transferable - Opportunity cost doesn’t vary as much because resources are equally utilised by 2 goods - E.g. grades for literature and grades for maths - Resource: Time spent studying for either subject - Straight line PPC Long term growth → IQIQFOP (Increased quantity/quality of FOPs → new curve formed) Short term curve → Better use of existing resources (e.g. reducing unemployment) → Point moves out ( from inside curve to onto curve) Factors of production and factor payments - Land - rent - Labour - wages - Capital - interest - Entrepreneurship - profit Needs vs. Wants - Need = Something we need in order to survive - Want = something we desire - We have unlimited wants and limited resources ⇒ basic economic problem Economic systems​ - determine how resources are used - Answer 3 basic economic questions: what, how, and for whom Public sector → govt answers qus and owns resources Private sector → private households sell FOPs to firms, firms sell back goods Public goods → non-rivalrous, non-excludable, non-profitable → provided by govt (e.g. streetlights) Merit goods → underprovided and underconsumed by private sector - often subsidised/provided by govt (e.g. education, healthcare) Economic goals: economic efficiency, economic growth and innovation, economic freedom, economic security and predictability, economic equity (not necessarily equality), other (e.g. environment) Free market Mixed economy Planned economy Economic questions Who​ → private sector How​ → price mechanism For whom →
​ willing and able to buy Who​ → Private and public sector How​ → Price mechanism and govt planning For whom​ → willing and able + general public (subsidised/free) Who​ → government/state How​ → Govt. planning For whom​ → general public (usually free/subsidised) Characteristics -No government intervention -All resources privately owned -Main motive = profit - decides what is produced -Most efficient method decides how to produce -Self interest theory, capitalist -Price mechanism/’invisible hand’ handles allocation -Private and public sector both own and control resources to produce g/s’s -Public and merit goods provided -Public sector answers all 3 questions -Planners employed to answer these questions using input/output analysis -Fixed prices -SOE = state owned enterprise Advantages -Quick response to consumer wants -Wide variety -Innovation and incentive -Economic freedom -Consumer sovereignty -Economic growth and innovation Adv over free market: -Provision of public g -Creation of jobs -More merit, less demerit g -Laws -Safety net Adv over planned: -More economic freedom -Narrower gap between rich and poor -Access to basic g/s’s -Less externalities as social costs are considered -Merit goods and public goods provided Disadvantages -FOPs only employed when profitable → unemployment -Unprofitable g/s not produced (no public g’s) -Overproduction and overconsumption of demerit goods -Underproduction and underconsumption of merit goods -Externalities - social costs ignored -Evident gap between rich and poor Closest examples Singapore, Hong Kong, Most markets are Norway, New Zealand mixed but some are govt dominated (e.g. N.Korea) and some are consumer dominated (e.g. Hong Kong) Economies in Transition - Former communist countries → capitalist market economies - E.g. Serbia, Cuba, Vietnam, China - Usually experience (in SR) - Decline in output → less GDP/capita - Money moving out of country to more stable economies - Unemployment - More crime/corruption - Massive rise in inflation - More inequality and poverty - LR: - Economic growth - But still fragile and easily thrown into crisis Communist Countries 1. Problems with inconsistency a. Planners lack detail about workplace b. Managers understate potential, overestimate resources i.
Planners scale up output potential to accommodate ii.
Managers exaggerate more and cycle continues c. Delays d. Hoarding of resources e. Planners don’t build slack into plans i.
Small problem causes knock-on effects -Less economic freedom -Ineffective allocation → shortages and gluts -No incentive to innovate - no variety - no efficiency -Hard for planners to collect info as economy grows North Korea, Cuba, Iran, Burma, Liberia 2. Problems of inappropriate success indicators and rewards a. Quantitative rather than qualitative → quality suffers b. Prices do not take D/S into account - set by govt 3. Both of the above result in a. Inefficiency in allocation of resources b. Managers conceal info How to transition to market economy: 1. Price liberalisation a. Using price mechanism and profit motive b. Usually leads to inflation 2. Trade liberalisation a. Can bring competition b. Allows resources to be allocated on basis of comparative advantage → economic efficiency increases c. Currency must be convertible i.
Often a fixed exchange rate to avoid depreciation 3. Removal of subsidies a. Avoid artificially low prices → prices ‘jump’ 4. Privatisation a. SOE → private firms b. Large enterprises lose state subsidies = find out production was inefficient, equipment was outdated, and output is unsellable c. Success depends on management expertise → always under threat of takeover d. Unemployment increases as they hire excess workers 5. Creating a supportive political and institutional environment a. Consistent policies are required b. Easy access to finance through a stable financial and banking system c. Encourage new enterprises 6. Reform of the financial sector a. Creation of a central bank b. Commercial banking institutions c. Framework to oversee activity in financial sector d. Market for govt to sell bonds to finance expenditure that is beyond their income Success depends on - Extent and pace of reform - Degree to which financial stability is achieved - Degree to which external stability is achieved and whether a commitment to press ahead w process of reform exists - Degree to which there is foreign investment - Political (in)stability Why privatise - Less govt involvement → wide share ownership → benefits to consumers - Lower prices - Wider choice - Better quality - Increased initiative - Generates govt revenue Problems - Public sector monopolies could be replaced with private sector monopolies - Some natural monopolies are better left with public sector - Negative externalities - Watch-dogs and regulators needed to police actions of privatised monopolies Unit 1A Microeconomics - Demand, Supply, Elasticity and Government Intervention in the Price Mechanism 1.0 Types of Markets A market = any set of arrangements by which buyers and sellers come into contact to trade goods and services 4 main market structures Perfect competition - unattainable Monopoly - unattainable Monopolistic competition - realistic (imperfect competition) Oligopoly - realistic (small number of firms own large share of market) Structure​ shapes ​Conduct w
​ hich affects C
​ ompetition 1.1 Market Forces - Demand As b increases - the slope becomes flatter Demand = The quantity of a good or service that consumers are willing and able to purchase at ​any given price​ in a particular period of time. Quantity demanded = The quantity of a good or service that consumers are willing and able to purchase at ​a specific price​ in a particular period of time. - Can be individual (one consumer) or represent a whole market (all consumers in that market for that g/s) - Can be for firms - purchasing FOPs (factor market) - or households - purchasing the g/s’s made by the FOPs (product market) Effective Demand - willingness and ability to purchase g/s at a given price (​backed by purchasing power) LAW OF DEMAND Consumers buy g/s to maximise utility (because we assume consumers are rational). Consumers buy more as price falls and less as price increases, ceteris paribus. (inverse relationship) Caused by price factors: - The income effect → Change in quantity demanded due to a change in price which causes a change in purchasing power/real income. S​ ize depends on proportion of income spent on good (more income spent on a good the bigger the fall in demand when real incomes fall) - The substitution effect → Change in quantity demanded due to a change in price causing consumers to switch to an alternative substitute products (​Size depends on number and closeness of substitutes, if the good becomes relatively more expensive and it’s easier to access substitutes demand will fall more due to price increases) The amount by which quantity demanded changes is dependent on the size of the income and substitution effects Price factors cause an ​extension​ or ​contraction​ of demand (movements up/down and a​ long​ the demand curve) - change q
​ uantity demanded​ not ​demand Non price factors: Cause an actual shift in the whole demand curve (outward/inward) - change ​demand​ not quantity demanded 1. Change in incomes/purchasing power a. Affected by i.
Purchasing power post tax ii.
Availability of loans/taxes iii.
Interest rates of loans/credit balances b. When goods are normal goods there is a ​positive r​ elationship between purchasing power and demand c. When goods are inferior goods there is an ​inverse​ relationship between purchasing power and demand 2. Change in expectations of future price or availability 3. Change in price and availability of substitutes 4. Change in price and availability of complements 5. Change in population size or distribution 6. Changes in the law 7. Attitudes towards the product a. Peers b. Advertising c. Fashion/tastes 1.1 Market Forces - Supply As d increases, the slope becomes flatter Supply: The quantity of a good or service that producers are willing and able to offer at a​ ny given price​ in a particular period of time. Quantity supplied: The quantity of a good or service that producers are willing and able to offer at a​ specific price​ in a particular period of time. LAW OF SUPPLY Producers will supply more as prices rise - ceteris paribus (and vice versa). Positive/direct relationship between quantity supplied and price because Firms aim to maximise profits As prices rise, new firms enter the market attracted by chance of increasing profit Price factors cause extension/contractions along the supply curve Non price factors​: Cause shifts in the supply curve 1. Costs of production a. Wage rates b. Loss of productivity 2.
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c. Maintenance Government intervention/legislation a. Legislation may change production practices Size and nature of an industry Change in weather Random shocks/unpredictable events Price and availability of related goods a. Joint/composite goods Changes in tech Changes in taxes/subsidies on producers Change in number of firms Change in price of a substitute FOP in production 1.2 Demand and Supply functions ​calculations​ - H
​ L Plotting demand curve: The x-intercept: Where the demand curve meets the x-axis. QD where P = zero. (a) The y-intercept: Where the demand curve meets the y-axis. Price where QD = zero. All consumers have been driven out of the market. (a divided by b) If the value of ‘​ a’ in the demand function changes, then the demand curve shifts to the left or to the right​, parallel to the original curve. If the value of ‘b’ changes in the demand function, then the slope of the demand curve will change. The slope of the demand curve is ‘-b’. I​ f ‘b’ gets smaller, then the slope of the curve gets steeper and if ‘b’; gets bigger, the curve will be flatter. Plotting supply curve: The x-intercept: Where the supply curve meets the x-axis. QS where P = zero. (c) 2nd point to plot: On an IB exam you will be given a range of prices. Choose one of those prices and sub it into the supply function formula for P. Solve for QS. If the value of ‘​ c’ in the supply function changes, then the supply curve shifts to the left or to the right​, parallel to the original curve. If the value of ‘d’ changes in the supply function, then the slope of the supply curve will change. The slope of the supply curve is ‘+ d’.​ If ‘d’ gets smaller, then the slope of the curve gets steeper and if ‘d’; gets bigger, the curve will be flatter. Equilibrium​/Market Clearing Supply function = Demand function Gives you equilibrium quantity, substitute into any equation for equilibrium price Calculating excess demand/supply Input given price into both functions and see which one is larger (excess) Taxes Specific Use the linear functions for the original demand and supply 1. Take the supply curve and change P to (P - tax) 2. Multiply out brackets 3. Equate new supply curve with demand curve for new equilibrium price 4. Substitute equilibrium price in either equation to get equilibrium quantity 5. Use the linear functions for the original demand and supply 6. Take the supply curve and change P to (P - tax) 7. Multiply out brackets 8. Equate new supply curve with demand curve for new equilibrium price 9. Substitute equilibrium price in either equation to get equilibrium quantity Subsidies 1. Use the linear functions for the original demand and supply 2. Take the supply curve and change P to (P + subsidy) 3. Multiply out brackets 4. Equate new supply curve with demand curve for new equilibrium price 5. Substitute equilibrium price in either equation to get equilibrium quantity 1.3 Price Determination Equilibrium/Market Clearing Where demand and supply curves meet - no shortages/surpluses When demand ​≠ supply → disequilibrium Almost impossible to attain equilibrium but all suppliers try to get as close as possible S​o, I​ ​’m R
​ e​ ady S​ignalling I​ncentive R​ationing Also: Pardon me, are you Aaron Burr S​ IR 1. Increase/decrease in either demand or supply 2. Creating a shortage or a surplus 3. Increase/decrease in price that consumers are willing to pay 4. Signals​ to producers that consumers want to buy more/less 5. Rational producers will have an i​ ncentive t​ o produce more/less 6. Will allocate more/less resources to that good/service (​rationing​) 7. Market will eventually clear at a new equilibrium E.g. 1. Demand curve shifts to the right due to a better advertising campaign 2. Excess demand at original price 3. Shortage 4. Price begins to rise 5. Acts as a s​ ignal​ to producers to change the behaviour, i​ ncentivises b​ oth groups 6. Producers produce more 7. Consumers consume less 8. Change in allocation of resources, good is rationed for consumers willing and able to buy and is more expensive 9. Demand contracts (opp for fall in demand) E.g. Increase in supply due to good harvest of fruit 1. Supply shifts right 2. Excess supply at original price 3. Surplus of good 4. Prices fall 5. Signals producers and consumers to change behaviour and incentivises both groups 6. Producers supply less 7. Consumers buy more 8. Allocation of resources changes 9. The now cheaper good is available to more consumers. FOP shifted to markets where prices are rising (opp for fall in supply) FUNCTIONS OF PRICE 1. Rationing/allocative device a. Rations consumer and producers according to those who have the willingness and ability to pay b. Producers allocate more FOPs to produce g/s in markets where prices are rising and out of markets where prices are falling 2. As a signal a. Prices reflect market conditions b. Consumers and producers change their behaviour in response to signals provided by price 3. An incentive/disincentive for producers a. Increase in price creates incentive for firms to shift resources from one industry to another where high price is found and for new firms to join that industry b. Decrease in price creates disincentive for firms to remain in an industry or for new firms to join it 2.0 The interrelationships between markets Complements Goods which are consumed together and will yield higher utility for the consumer when consumed together. (JOINT DEMAND) Substitutes A pair of goods that are considered by consumers to be alternatives to each other. (COMPETITIVE demand): As price of one rises, the demand for the other rises as well as its prices Derived Demand Many goods are demanded only because they’re needed for the production of other goods Composite demand When a g/s is demanded for 2+ uses (e.g. milk to cheese, yoghurt, butter)
Joint supply Two goods where the production of more of one leads to the production of more of the other. An increase in the quantity demanded for one good in joint supply will cause an increase in the quantity supplied for another Market Efficiency: Consumer and Producer Surplus Making the best possible use of resources State of allocative efficiency (where resources are allocated) No one can become better off in terms of increasing their benefits from consumption without someone else becoming worse off (marginal benefit = marginal cost) State of productive efficiency When g/s are produced using the fewest resources possible (point o
​ n​ the PPC) Consumer Surplus Excess/extra amount consumers would be prepared to pay for a good ​above​ what they actually pay (equilibrium) On graph - area above equilibrium but below demand curve Producer Surplus Excess/extra amount producers receive a​ bove​ the price they’d actually be willing to accept to supply a good On graph - area below equilibrium and above supply curve Community surplus = Consumer + Producer Surplus Maximised at equilibrium 3.0 Elasticity When measuring change in: New - Old Old 1. Elasticities of Demand a. Price elasticity of Demand (PED) b. Cross elasticity of Demand (XED) c. Income elasticity of Demand (YED) 2. Elasticity of Supply a. Price elasticity of Supply (PES) Price Elasticity Of Demand Brand elasticity vs market elasticity Brand - substitutes involve other brands Market - substitutes are different goods Measures the responsiveness of changes in quantity demanded of a product to changes in price % change in quantity demanded % change in price If PED>1 → demand is p
​ rice elastic​ (1% change in price will cause >1% change in QD) Firms shouldn’t raise prices as this will have a negative effect upon sales revenue If PED<1 → demand is p
​ rice inelastic Firms should raise prices as this will have a positive effect upon sales revenue PED is always a negative figure so we take the absolute value. Perfectly price inelastic → Price changes have no effect on QD (consumers continue to purchase same quantity of goods when price increases) Perfectly price elastic → Consumers buy all g/s at a given price Unit elastic → % change in P = % change in QD Total revenue doesn’t change as prices change FACTORS AFFECTING PED (SPLAT) ● S​ubstitutes ○ Number, quality, availability of information on, closeness, attractiveness of substitutes ● P​roportion of income spent on G/S ○ If it’s a small proportion of income - tends to be more price inelastic ● L​uxury vs. Necessity ○ Necessities - inelastic ● A​ddictive properties of a good/whether it has habit forming properties ● T​ime for consumers to find substitutes Real life situations - Inelastic - Cigarettes - Insulin - Elastic - Sports cars - Private fountains Uses of PED - Help firms determine pricing policy to maximise sales revenue - Help government estimate impact of tax on sales - Help firms decide whether they need to differentiate their products from rivals PED VARIES/CHANGES AS THERE IS MOVEMENT ALONG AND DOWN A STRAIGHT LINE DEMAND GRAPH Exceptions - Perfectly price (in)elastic curves and unit At high prices and low Q % change in QD = relatively large, and %change in P = relatively small Large PED figure - price elastic demand At low prices and high Q % change in QD = relatively small and P = relatively large Small PED figure - price inelastic demand 2. ​Income Elasticity of Demand (YED) Income is a non price factor - causes shifts YED = Measure of the responsiveness of quantity demanded to a change in income alone. % change in quantity demanded % change in income If |YED| > 1 → Income elastic (small change in income = large change in QD) Luxury good If |YED| < 1 → Income inelastic (large change in income = small change in QD) Necessity If YED = + → Normal good If YED = - → Inferior good If YED = 0 → Changes in income will have no effect upon the QD of a particular good (e.g. toothpaste) Main determinant of YED - extent to which it is a necessity or a luxury Same good can be seen as a luxury or necessity for different income groups (e.g. Bread is a luxury for low income groups but a necessity for high income groups) Uses of YED 1. Determine which goods to produce/stock a. In recession demand for inferior goods may rise and d for normal goods in a boom i.
Firms that produce normal goods with high YED tend to perform better overall as incomes rise over time 2. Help firms plan production (e.g. in recession, increased production of inferior goods) 3. Help firms establish any potential changes in demand (due to swings in the trade cycle) 4. Help government analyse how output of an economy may change as living standards improve 3. Cross Elasticity of Demand XED = Measures the responsiveness of the QD for one product as a result of a change in the price of a related product % change in quantity demanded of Good A % change in price of Good B If XED is positive → Two goods are substitutes If XED is negative → Two goods are complements XED = 0 → No relationship between 2 products | XED < 1 | → Not very closely related (steep curve) | XED > 1 | → Close relationship (shallow curve) 1. ​Price Elasticity of Supply % change in quantity supplied % change in price Measures the responsiveness of changes in QS to a change in price If PES>1 → supply is ​price elastic​ (1% change in price will cause >1% change in QS) If PES<1 → supply is ​price inelastic Special curves: Perfectly price inelastic (PES = 0) → Producers will supply the same quantity of g/s whatever the price they are sold for. Occurs over a very short period of time for supply of most goods Perfectly price elastic (PES = infinity) → Producers will supply more and more g and s at one particular price Unit Elastic (PES = 1) → % change in price = % change in QS Factors Affecting PES - FLATS 1. F​actor mobility a. Ease of transferring resources between goods 2. L​evel of capacity a. More unemployed workers/machinery = more elastic 3. A​vailability of resources a. E.g. Availability of skilled labour 4. T​ime to produce goods a. E.g. flowers are price inelastic in supply b. Short run - some firms may be able to supply a few more goods for sale but QS will only increase a little and soon run out c. Long run - firms can obtain more FOPs and expand infrastructure 5. S​torage possibilities a. Perishable or not Importance of PES - Profit incentive to make supply as price elastic as possible so that firms can respond quickly and maximise sales revenue and profit. They will shift production away from g/s where prices are falling to avoid losses and increase output for goods whose prices are rising - PES affects firms that produce primary sector goods differently (can’t respond immediately) - Wait to see if price change persists before responding - Experience large fluctuations in revenues - PES = important consideration for governments because, by increasing mobility and flexibility of resources, resource allocation becomes more efficient Real world examples Concert tickets (fixed quantity) - perfectly inelastic Singing performances - relatively elastic 4.0 Government Intervention Taxes 1. Direct a. Levied at the source on the income of firms and households and is paid directly to the government. 2. Indirect - Tax on expenditure/consumption - Additional costs on producer - 2 types - Ad valorem - Amount of tax levied varies according to value of good purchased (percentage of price) - Curves diverge - Specific - Amount of tax levied does not change with value of goods (set amount - Curves are parallel Why does government impose taxes? - Source of government revenue and can be used to fund public/merit good provision, etc. - Excise taxes discourage consumption of demerit goods (depends on PED) - Can redistribute income - Can improve the allocation of resources by correcting negative externalities The incidence of tax / the burden of tax If demand is perfectly price inelastic - all tax borne by consumer price elastic - all tax borne by producer If supply is perfectly price inelastic - all tax borne by producer price elastic - all tax borne by consumer 1. Tax yield Government wants to maximise tax yields through Imposing taxes on goods where demand is relatively price inelastic Widen the tax base (i.e. tax more goods to discourage consumers from switching to purchase non taxed goods instead) Quantitative Calculations - Specific Tax 10. Use the linear functions for the original demand and supply 11. Take the supply curve and change P to (P - tax) 12. Multiply out brackets 13. Equate new supply curve with demand curve for new equilibrium price 14. Substitute equilibrium price in either equation to get equilibrium quantity 2.
Subsidies = A grant/assistance given by government to encourage supply of a g/s. Increases supply curve (shifts right) Greater production and consumption (can improve or worsen the allocation of resources, depending upon the allocative efficiency before subsidy) Why does the government offer subsidies? -
Increase revenues and incomes of firms Make goods affordable (reduce gap between rich and poor) Encourage production and consumption of merit goods Support growth of infant/particular industries Encourage exports (appear cheaper) Improve allocation of resources by correcting positive externalities Consequences - Consumers extend demand due to fall in price - Producers gain higher income and produce more goods - Government may have to cut spending elsewhere - More workers likely to be higher to produce more (unemployment decreases) - Society worse off - over allocation of resources to subsidised good - Foreign firms who compete with firms who have been domestically subsidised not as competitive. Quantitative Calculations 1. Use the linear functions for the original demand and supply 2. Take the supply curve and change P to (P + subsidy) 3. Multiply out brackets 4. Equate new supply curve with demand curve for new equilibrium price 5. Substitute equilibrium price in either equation to get equilibrium quantity 4.1 Government Intervention: Maximum and Minimum Prices Government intervenes on either: ● Grounds of equity ● Grounds of efficiency Maximum (low) price controls Max price/price ceiling Price control imposed on a g/s by government and must be b
​ elow​ free market equilibrium to be effective. E.g. Rent controls UK government imposed max prices in UK housing market in early 1900s (grounds of equity) Created shortage Used first come first served, waitlists, coupons, favouritism (​Non price rationing systems​) System was cancelled because ● Black markets ● Lower quality properties ●
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Less people sell/rent houses People are forced to accept low quality houses or whatever they get because it’s better than nothing Minimum (high) price controls A price control imposed by government and the price charged by sellers cannot be below that price. Set when govt belows there’s been an abuse of market power and prices are too low. Creates surplus E.g.Agricultural goods - help producers increase their income Farmers Price Controls: Type of Price Control Price Ceiling Impacts in Market Impact on Stakeholders 3. Non-Price Rationing Consumers: - Waiting in line - Partly gain (area c), - Distribution of coupons partly lose (area b). CS or ration cards benefit was a + b, now - Favouritism it is ​a + c​. Those able to 4. Decreased Market Size buy the cheaper good 5. Allocative Inefficiency are better off, those 6. Rise of Parallel Markets unable to are worse off 7. Shortage Producers: - Worse off. Sell a smaller quantity (Qs) at lower price (Pc). Revenue falls from Pe x Qe to Pc x Qs. Indicated by loss of producer surplus (area c and d) from area​ c + d + e t​ o only area e. Workers: - Worse off. Fall in output means some workers are likely to be laid off causing higher unemployment or underemployment. Government: - Partly gain: popularity among consumers - Partly lose: Fall in corporate tax revenue and income tax revenue from unemployed, increased unemployment benefit expenditure. Price Floor Taxes and Subsidies 1. Surpluses Producers: 2. Government Measures - Better off. Receive to Dispose of Surpluses higher price and since - Store it (additional cost) Gov buys surplus, - Export overseas at a revenue increases from subsidised price Pe x Qe to Pf x Qs (additional cost) - Producer surplus - Use it as aid for increases from d
​ +e t​ o ​d developing countries + e + b + c + f (no revenue generated) Consumers: 3. Productive Inefficiency - Worse off. Must pay a 4. Allocative Inefficiency higher price for good. 5. Negative Welfare - Consumer surplus falls Impacts from a​ + b + c​ to just a​ .​ Workers: - Better off. Employment increases due to increase in production Government: - Worse off, as they must purchase surplus and may have to pay to store it Type of Govt Intervention Reasons to implement this policy Impacts on Stakeholders Indirect Taxes
1. Government Revenue 2. Discourage consumption of harmful goods 3. Redistribute income 4. Improve allocation of resources by correcting negative externalities Consumers: - Worse off. Price increased to Pc and Q available decreased to Qt. Consumer surplus reduces from​ a + b + c + d​ to just a​ ​. Producers: - Worse off. Revenue falls as Qs is smaller and production costs have increased. Producer surplus falls from​ e + f + g + h + i ​to just h
​ + i Workers: - Worse off. Output falls to Qt and therefore less workers needed ---> unemployment Government: - Better off ---> additional revenue - Area of government revenue is b
​ + c + e + f Society: - Worse off. Underallocation of resources. - Shown through welfare loss of d
​ + g Subsidies 1. Encourage consumption and production of goods that are socially beneficial 2. To support a particular producer/industry 3. Address a balance of payments deficit 4. To make certain necessity goods more affordable Consumers: - Better off. Price decreased and Qs supplied increases. - Consumer surplus increases from a​ + b ​to d + e + f + a + b Producers: - Better off. Revenue rises as Qs increases and costs decrease - Producer surplus increases from h
​ + d t​ o h + b + d + c Workers: - Better off. Increase in output results in more employment Government: - Worse off. Budget is negatively impacted - May have to reduce expenditures in other areas, raise taxes or run a budget deficit - Govt expenditure = ​b + c + d + e + f + g Society: - Worse off. Overallocation of resources to production of goods. - Welfare loss = g​ Unit 1B Microeconomics - Market Failure Examples 1.0 What is market failure? IOS: Misallocation of resources Theoretically the (purest) free market should efficiently allocate resources all the time, however realistically this isn’t always possible. Types Of Market Failure: - Externalities - Negative (of production and consumption) - Positive (of production and consumption) - Non provision of public goods by private firms - The under provision/consumption of merit goods “ over provision/consumption of demerit goods - Common access resources and threat to sustainability (CARs) - Free goods like air (if air is polluted, everyone is impacted) - Open fields that aren’t owned - everyone competing to use the field before anyone else can (before the grassland is destroyed) - Asymmetric information -
Information about production process isn’t released to public - E.g. Used cars - E.g. Insurance companies The abuse of monopoly power Government failure 8 types It is usually the government’s job (unless it is a pure free market, which doesn’t exist) to correct this misallocation of resources: - Providing g/s’s themselves (public/merit goods) - Subsidising private sector firms to supply such goods - Implementing indirect taxes - Use a cap and trade system/tradable permits - Positive/negative advertising to develop ‘perfect information’ - Laws/legislation - Supporting international action on an issue 1.1 Externalities IOS - When a private economic transaction affects third parties (spillover effects due to the parties involved in the transaction)/side effects Costs - Private costs/internal costs - borne by individual economic units (consumers and firms) - involved in transactions (e.g. wages) - Private benefits/internal benefits - enjoyed by individual economic units (consumers and firms) - involved in transactions (e.g. sales revenue) - External costs - any costs beyond private costs - External benefits - any benefits beyond private benefits - Social costs = Private costs + External costs - Full costs of an activity - borne by society - Social benefits = Private benefits + External benefits - Full benefits of an activity - gained by society SB = PB + EB SC = PC + EC However,​ both of these (SB and SC) are misallocation of resources and are therefore classified as externalities and market failures. If ​SB > PB → Positive externalities or​ PC > SC - If ​SB>PB​ is the case, this good or service should be consumed more (underconsumption) - Vaccines aren’t consumed as much as they should be due to lack of perfect information - suboptimal consumption. - Positive consumption externality - If ​PC>SC​ is the case, this good or service should be produced more (underproduction) - Insufficient resources/funds. - Positive production externality If ​PB > SB → Negative externalities or​ ​SC > PC - If ​PB>SB​ is the case, this good or service should be consumed less (overconsumption) - Second hand smokers are impacted by smokers. - Negative consumption externality - If ​SC>PC​ is the case, this good or service should be produced less (overproduction) - Paint production pollutes rivers, but producers are able to sell for low prices which means that demand increases and this overproduction continues. - Negative production externality Marginal cost = the additional cost to the total cost of producing one more unit of output Marginal benefit = the addition to total benefit of consumption of one more unit If MC > MB it is not rational to pursue an activity, if MB > MC it is. Marginal Private Costs = MPC (the normal supply curve - free market mechanism) Marginal Private Benefits = MPB (the normal demand curve - free market mechanism) Marginal Social Costs = MSC (true supply curve) Marginal Social Benefits = MSB (true demand curve) Social optimum → MSC = MSB or equilibrium = ​Pareto Optimal Pareto optimal - market is functioning at best level of output (no one can be better off without making someone else worse off) Negative Externalities OF PRODUCTION Solutions 1. Tradable Permits (​Presentation​) Annual tradable permits that allow firms to have a certain bracket of CO2 emissions (can be sold if limit isn’t reached (to other firms) or bought if limit is exceeded (from other firms) a. Incentivises greener production b. Firms have financial incentive to reduce pollution as they can sell their permits Example - 1990 US. Sulfur trading scheme to prevent sulfur emissions. (Cut SO2 levels by 40%) - eventually reduced permits to gradually reduce emissions. Short term - firms will find ways to cut down emissions Long term - may innovate new methods that are more environmentally friendly and thereby the permits may not be necessary. *
The graph should show the supply curve shifting left over time as the government should annually decrease supply (prices increase) The demand increases over time due to economic growth EXAMPLES → EU emission trading scheme was designed to reduce heat trapping emissions to help European countries meet their Kyoto protocol commitments. Cons - Big firms/monopolies may pay for permits and pass off costs to consumers - Cheating 2. Legislation and regulation (​Presentation​) a. Could make firms less competitive internationally b. Less firms would want to set up in the country c. When you set minimum standards companies will only meet the bare minimum i.
Need a system that incentivises rather than simply controls d. Need people to regulate/monitor 3.
Taxes a. Problems - hard to quantify per unit externalities i.
Has to be imposed on emissions instead of output in order to incentivise producers to produce better 1. If this happens MSC would shift as producers would produce better OF CONSUMPTION Solutions 1. Negative advertising 2. Taxation Rise in price causes contraction of demand which brings equilibrium closer to optimal quantity 3. Legislation and Regulation E.g age restrictions Positive Externalities Production 1. Training increases skill other firms benefit 2. Investing in research 3. Complementary industries 4. Bring business to surrounding stores 5. Transport links may be provided to nearby businesses 6. Tree farms have the side effect of oxygenating the atmosphere to everyone’s benefit 7. A new school will raise property values in the area, even for those with no children 8. A company with good training will benefit all companies who eventually hire those workers 9. Research and development by one firm can benefit other firms who use the advancements 10. Software companies create technologies that inspire others to new creations by imitation a. E.g. gaming ”When there are positive externalities, the market equilibrium of P1 and Q1 results in too little produced at too high a price. Social costs are much less than social benefits at this point, so society can benefit from increased production. This is the p
​ otential welfare gain​ (shaded yellow).” The optimal output is at P* and Q* where MSC=MSB/pareto optimal 1. Subsidies Cons - opportunity costs Political difficulties if other firms want subsidies HOWEVER - this is an incentive for firms to want to have positive externalities 2. Legislation and regulation 3. Government provision/state provision of good Consumption 1. Additional years of education a. Educated workforce b. More skilled workforce c. Less crime/loitering - more productive society 2. Healthcare e.g. vaccination a. Diseases won’t spread b. Longer life spans c. More productivity 3. Use of condoms a. Prevents spread of disease b. Prevents overpopulation 4. Fitness/use of a gym a. Anybody who has to look at you/date you b. Less burden on healthcare system c. Less obese 1. Positive advertising 2. Subsidies CONS - Producers can become lazy Opportunity cost PROS - Lower COP Lower prices 3. Legal requirements Legally mandated behavior - E.g. school age -
E.g. required vaccinations 1.2 Public vs. Private Goods Non excludable → you can't prevent someone from using a good if they haven’t paid for it Free rider problem Rivalry → Only one person can use it at a time Subtractability → It gets used up by one person using it Public goods have to be nonrivalrous and nonexcludable Collective/club goods → non rivalrous but excludable Common pool resources/ common goods → rivalrous but non excludable Goods can switch categories - for instance a hammer is a private good when in store but becomes a common pool resource in a household wherein everyone can use it Failure to provide public goods (e.g. in free market system) → market failure Solutions 1. Direct provision a. Decision of which to provide is a normative issue 2. Contracting out a. Funded by government and provided by public sector Merit Goods Create positive benefits and are underproduced by free market Underprovision/underconsumption → market failure Demerit Goods Oversupply/overconsumption → market failure 1.3 Common Access Resources Non excludable but rivalrous Examples ●
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Common pasture lands for cattle Water sources that become depositories for toxic waste Forests that are clear cut for the lumber, or to make way for farmlands Oceans and lakes that are overfished The atmosphere, which is infused with pollutants from industry Problems → Tragedy of the commons A dilemma posed when common resources are used or degraded rapidly by private individuals who enjoy the short-term benefits of the resources, but are ignorant or neglectful of its long-term depletion. Free rider problem Those who benefit and draw from a resource, but do not have to pay for it. Such goods are ‘free’ to consumers because they are non-excludable. As such, producers are not able to charge a market price for them. Solutions 1. Extension of property rights a. Give someone rights over resource - they now have incentive to use it sustainably (set long term and short term goals). Works well in theory and on small scale 2. Carbon Taxes a. Tax imposed on producer based on their emission if they burn fossil fuels in production b. However, accurately estimating externalities is a challenge, and evasion and avoidance on the part of producers and consumers is an issue. 3. Regulation/legislation 4.
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a. Complete bans b. Solid caps c. Quotas d. Fast and easy to administer e. Takes time and money to enforce Producer subsidies a. Subsidies for development of green technology/innovation b. Subsidising firms that produce sustainably incentivises Advertising a. Consumers can see the negative/positive impacts and buy less/more International Cooperation between governments a. The Montreal Protocol (1987) b. The Kyoto Protocol (1997) c. The Paris Agreement (2016) Tradable Permits/Cap and trade system (explained earlier) 7.
Problems with Tradable Permits 1. Cap and giveaway a. Free permits to polluters i.
They can raise prices and make a lot of money 2. Offsetting a. If a firm reduces emission (e.g. by planting trees) they get more permits which offset i.
People can also cheat b. For example, in Indonesia a lot of heritage and environment was destroyed to plant palm trees and they got permits for this 3. Distraction a. Cap and trade creates a false sense of progress which makes us as a society complacent 1.4 Asymmetric Information Imperfect information (one or more parties in the transaction doesn’t/don’t have the same amount of information as others) Asymmetric information exists when buyers and sellers do not have equal access to information. It usually results in the underallocation of resources in the production of goods and services (for producers to protect themselves) Situations 1. Moral hazard a. Someone takes a risk but doesn’t face full costs of that risk b. E.g. After taking an insurance policy someone behaves more riskily (under-allocation) c. E.g. 2 Polluters dumb waste into CAR like rivers and consumers are unaware and therefore (overallocation) 2. Adverse selection a. Buyers know more about themselves than sellers (e.g. when buying insurance or renting an apartment) i.
Therefore suppliers under allocate to protect themselves and their goods ii.
Or suppliers spend more money screening consumers which increases their prices 3. Sellers have more information than buyers about good or themselves a. Sometimes they limit information and choice available to consumers i.
E.g. Used car salesman knows history of car ii.
Seller of a plot of land knows chemical plant will be built next door but doesn’t disclose iii.
Pharmaceutical companies may not release all info about potential side effects 4. Safety in the workplace a. Employer attempts to hide potential risks from staff to attract employees i.
Leads to over allocation of labour to that company as workers were lured in under false pretences Solutions
1. Regulation a. Laws and rules on quality standards/safety b. Laws to punish use of insider information c. Can lead to too much government intervention (unwieldy bureaucracy) and there are opportunity costs in ensuring standards are met 2. Provision of information a. Government can provide information b. But how does the govt collect and ensure accuracy (sometimes internet is a big source to spread the info) 3. Licensing a. To ensure suppliers meet standards b. Or to limit supply of people offering service (increasing price) 4. Sellers protecting themselves by offering range of options a. Sellers protecting themselves by offering range of options i.
Deductible amounts on insurance claims. Diff options on insurance policies 1.5 Abuse of Monopoly Power Monopoly power exists when a firm is able to influence or increase the price they receive to a price above the competitive market equilibrium. Monopolists and other imperfect competitors will restrict output to increase prices. Market equilibrium → MSC = MSB (quantity = Qc, price = Pc) Allocatively efficient Qm = not allocatively efficient Monopolists produce MR = MC Profit maximisation But here MSB ≠ MSC Community surplus decreases, DWL occurs How do monopolies abuse power? ● Marketing barriers ● Product differentiation / brand loyalty ● Control over retail outlets ● Economies of scale allow for cost advantages ● High capital / start-up costs ● Imperfect knowledge (like a secret recipe) ● Pace of change ●
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○ E.g. Apple constantly releasing iPhones before competitors can catch up Sunk costs ○ Costs which cannot be recovered if the firm goes out of business Natural cost advantages (like prime location or ownership of resources Mergers / takeovers Aggressive tactics or intimidation Solutions Potential Solutions: 1. Legislation a. Antitrust or anti-combine legislation (maximum % of market that can be controlled) 2. Regulation a. Regulatory agencies track the pricing and production decisions of monopoly firms 3. Natural Monopolies a. Can be granted in certain industries where one firm can keep costs lower than competing firms could (i.e. public utilities or MRT). 4. Nationalisation a. Transferring ownership of a monopoly from the private to gov’t/public sector. 5. Introducing competition a. Subsidies or tax breaks b. Government firms entering market to compete Negative Externalities Examples Industrialisation - Pollution - Climate change - Wiping out species Explorers/settlers - Wiping out species - The Moa - The Quagga Externalities - Climate change - Solutions - raising awareness - Most of economy is based on fossil fuels (oil, coal, natural gas) - To sustain dependency on fossil fuels we’re turning to different sources - E.g. fracking for natural gas - Offshore drilling for oil - Poisons rivers - Shell takes oil from underground wells - mining, extraction, upgrading - Negative impact on habitat, animals, inhabitants, the whole race in the long run - Negative externalities - Almost everything we do (including all modes of transportation) release carbon dioxide into the atmosphere - Ice caps melting, ozone thinning - By 2020 you’ll be able to sail over the North Pole - Temperatures are rising - Because it seems abstract and it takes very long, people are more focused on small individual actions and disregard the concept of global warming - Pollution in China - Policy - green growth - government changed plan for renewable energy - India has vast reservoir of coal - it’s cheap - Poverty means people are moving to use of coal - Electricity consumed by a US citizen = 34 of an Indian - Palm oil plantations
- Many people buy foods with palm oil in them - Palm oil plantations kill wildlife -
Consumption of beef - Cows produce methane (breathe into the atmosphere) - Every molecule of methane = 23 molecules of CO2 - Nearly all of the methane comes from livestock in the US Unit 1C Part 1​- Microeconomics - Theory of the firm Total Profit = TR-TC Avg. Profit = AR - ATC Marginal Profit = MR - MC Profit maximisation MR = MC Short run and long run Markets can operate in the short and the long run. SR → Time period in which one or more input(s) in the production process is fixed (this input is usually land or capital) LR → Producer has flexibility over all production decisions All inputs in production process are variable in the LR No fixed costs Law of diminishing marginal returns = “As more of a variable input (labour) is added to a fixed input (capital) in the production process, the resulting increase in output (or MP) will eventually begin to diminish.” Short run concept. Product Curves Product → The output of the good X axis → variable input, Y axis → output Total product = Overall quantity of output that firm produces. (how much output a firm can produce according to the law of diminishing marginal returns) Marginal product = The change in output resulting from employing one more unit of a particular input (for example, labour). MP​L​ = ​Δ in TP Δ in QL Average product = Units of output produced per unit of a factor of production while keeping other factors of production constant. The higher the average product, the more productive a factor of production is and vice versa. APL = ​TP QL Where MP is maximum - diminishing returns set in When AP and MP meet, AP is maximised (as then MP begins to drag it down as it is an average), therefore, max AP - m
​ aximum productivity. Productivity and cost curves are mirror image curves TC = TFC + TVC Total expense incurred in reaching a particular level of output - economic cost Accounting costs​ = A direct payment made to others in the process of running a business =TFC + TVC (Explicit costs = out of pocket costs/directly made to others in course of running a business) Accounting profits = TR - explicit costs Economic costs Opportunity cost of using the firm/owners’ resources in the business rather than elsewhere Explicit + Implicit costs (opp cost) Implicit costs = opp cost of using firm/owners’ resources in the business Economic profit = TR - (explicit costs + implicit costs) EP = 0 → “normal economic profit”, both alternatives are equal EP > 0 → supernormal profit, better off already EP < 0 → economic losses, could be better off Total Cost Total cost = total expense incurred in reaching a particular level of output/economic costs of production TFC = Total Fixed Cost Costs that do not vary with the level of output. Cannot be varied in short term TVC - Total Variable Cost Average Fixed Cost - AFC AFC = TFC/Q ​or ​AFC = ATC - AVC Average Variable Cost - AVC AVC = TVC/Q​ or​ AVC = ATC - AFC Average Total Cost - ATC ATC = TC/Q ​or A
​ TC = AFC + AVC Marginal Cost The cost added by producing one additional unit of a product or service. MC = △TC/△Q ​or​ MC = △TVC/△Q / Space between ATC and AVC = AFC Decreasing MC - specialisation Bottom of MC - diminishing returns set in as the next unit of input is added AVC = MC → lowest point of AVC = max productivity ATC = MC → lowest point of ATC = economic capacity/capacity output Financial limit of business π = profit Returns to scale = how the output of a business responds to a change in factor inputs Increasing​ returns to scale % change in output > % change in inputs Decreasing​ returns to scale % change in output < % change in inputs Constant r​ eturns to scale % change in output = % change in inputs Envelope Curve = LRAC curve Productive efficiency = production takes place at the lowest costs
(increasing returns to scale) - As more inputs are added, output increases more than proportionately lead to economies of scale - a fall in long run avg. costs of production as output rises (diminishing returns to scale) - As more inputs are added, output increases less than proportionately leads to diseconomies of scale - a rise in LR avg. costs of production as output rises Minimum efficient scale - lowest level of output where LR avg. cost is lowest A firm may not always operate here because they also need to accommodate rising demand (constant returns to scale) Optimal level of production - As more inputs are added output increases proportionately output range over which production cost are at a minimum In a monopoly is more to the right with no diminishing returns to scale U shaped LRAC curve → firms experiencing economies of scale and then diseconomies of scale Downward sloping LRAC curve → firms enjoying economies of scale over a high range of output L shaped LRAC curve → shows firm reaching minimum efficient scale of production and thus experiencing constant returns to scale Economies of scale Internal - within firms/as a result of its growth - Marketing - Purchasing - Technical economies of scale - Indivisibility of machinery - Specialisation - Financial economies of scale - Bulk buying - Risk bearing/diversifying - Managerial External - due to growth of industry Diseconomies of scale - Result of decreasing returns to scale - Control, Coordination, Communication Revenues and Profits - Total Revenue = P*Q - Marginal revenue = difference in total revenue that comes from s​ ale​ of one additional unit of output - MR = △TR/△Q - Average revenue (revenue per unit of output sold) -
AR = TR/Q Price Takers (e.g. perfect competition) take the price that the industry demand and supply decides - AR = MR = D = Price - Because price is constant, total revenue increases at a constant rate. This means that the change in total revenue (or MR) will always be constant and equal to the price. Price Makers (e.g. monopoly) create their own price - D = AR = Price - MR decreases by twice as much as price because when you reduce the price on a product, you have to reduce it on all units sold - (describe this using a table with quantity, price, total revenue, and marginal revenue as the columns.) ​Use this link to explain​. - Revenue is maximised when MR = 0, or when MR meets the x​ ​ axis. It is also when the PED of the D curve = 1. Above this point PED>1 (elastic), below this PED<1 (inelastic) - Have to draw line up to price line (D) at any point to see price. (e.g. MR = MC gives profit maximising quantity but have to draw line up to D to see profit maximising price) Total Profit = Total Revenue - Total Costs Average Profit = Average Revenue - Average Total Costs Marginal Profit = Marginal Revenue - Marginal Costs Revenue is maximised when MR = 0 Profit is maximised when Marginal Profit = 0 (MR = MC) Price Taker Graph Break even price → ATC minimised/ATC meets MC - Zero profits/normal profits Shut down price → AVC minimised/AVC meets MC - Just covering the firm’s average variable costs. If price is lower than this, the firm would make less losses by shutting down as it would only have to pay fixed cost In the LR - all costs are variable and therefore a firm will shutdown when the price they receive is less than minimum AC. Perfect Competition AR = Demand curve MC (above intersection with AVC)= Supply curve Allocative efficiency​ is at equilibrium (therefore at AR = MC) Price taker will always be allocatively efficient as MR and AR are the same thing and they want to maximise profits (which is at MR = MC) and so they will also have AR = MC and therefore be allocatively efficient However price makers will never be allocatively efficient as MR and AR are not the same and therefore you cannot be at profit maximisation (MR = MC) and equilibrium (AR = MC) at the same time and they’d choose to produce at profit maximisation. Productive/technical efficiency ​is where AR = min. ATC Price takers will always be productively efficient in the long run (not necessarily in the short run), due to easy entry and exit to market always leading to breakeven price. Characteristics 1. There are a large number of firms and a large number of buyers, none of whom have any more power in the market than the rest. 2. All firms produce a homogeneous product. 3. All firms are price takers. The only thing they can control is quantity. 4. There is freedom of entry and exit in the market. 5. There is perfect resource mobility. 6. Perfect information It is possible for the firms to make supernormal profits in the short run, but in the LR, sharks would enter the industry (possible because perfect info and freedom of entry/exit) If they made losses, firms would leave the market (possible for same reasons are above) Therefore LR equilibrium is the min. ATC Allocative efficiency = suppliers are producing the optimal mix of goods and services required by consumers. ( = equilibrium with no shortages or surpluses (Supply = Demand or P = MC). In perfect competition, this is also profit maximisation point. Productive/technical efficiency = Produces its product at the lowest possible average cost. This is where the price is equal to MC at minimum ATC/breakeven price Unit 1C Part 2​ - Microeconomics - Theory of the firm Monopolies = price takers Characteristics: 1. No competition - the firm is the industry. 2. Lack of competition means firms can maximise profits and make abnormal profits both in the SR and in the LR. 3. Price makers - they can set price or QD, not both. 4. Barriers to entry - allow firms to make abnormal profits. 5. Imperfect information - firms may conceal information like predatory pricing practices, or price discrimination. 6. Non-homogenous products - difficult for other firms to copy. Examples​: Natural - PUB (water in SG) SMRT Not natural - Luxottica - sunglasses Monsanto - GMOs (genetically modified organisms)
Previously: De Beers - diamonds Monopolies create barriers to entry to prevent new firms from entering the market when they’re making supernormal profits. These barriers allow them to maintain market power. 1. Innocent barriers a. Natural advantages that existing firms have over new entrants (natural monopolies usually have these barriers): E.g. i.
Location ii. EOS/cost adv. 2. Deliberate barriers a. Attempts by monopoly/government to create barriers i.
Legal barriers ii. Marketing/Extensive advertising (e.g. De Beer) iii.
Patents/licensing iv. Control over outlets v.
Mergers/acquisitions (e.g. Luxottica) (threat of these keeps out new firms) vi. Face pace of change - (e.g. Apple) vii.
Product differentiation viii.
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Control over supplies High capital costs Risk (high sunk costs because of non-transferable capital) Imperfect knowledge Natural Monopoly Usually in industries with large EOS - E.g. utility industries, goods with significant sunk costs, goods with relatively small demand LRAC: If it would cost one firm a total of $320m (40 dollars each), two firms a total of $560m ($70 each), and 8 firms a total of $1200m ($150 each) in the long run to build 8 plants. A natural monopoly is one that arises as a result of high FC/startup costs/require unique raw materials or tech LRAC shape due to EOS Monopolist - can make abnormal profits producing between q1 and q2 Same curve for individual firm and industry as monopoly is the industry IF another firm entered demand would shift left and both firms would be unable to make even NORMAL profits Firms never produce in the inelastic portion of their AR curve because then MR is negative Profit max output → MR = MC Profit max price → MR = MC and up to the price line (or AR) Equilibrium output → MC = AR (Allocative efficiency) A monopoly will never produce here if they are profit maximising because AR and MR are not the same and profit max is at MR = MC SR - Can make abnormal profits and loss LR - Can make abnormal profits but not losses Advantages Disadvantages EOS Higher prices, lower output Can lower MC → possible that producers will produce at higher output and lower price Higher levels of investment in research and development Allocative inefficiency Can never be allocatively efficient as they want to maximise profit (where MR = MC) and allocative efficiency is where MC = AR. As MR and AR are different lines this will never happen.
Avoids wasteful reproduction (natural) Productive inefficiency To be productively efficient, firms must produce at an equilibrium where demand (P=AR) is equal to supply (MC) at the minimum ATC. However, a monopoly will never produce here because they choose to produce where MR = MC rather than where AR = MC Dynamic efficiency Dynamic efficiency as firms have more incentive to innovate to raise barriers to entry and maintain abnormal profits (DEBATABLE) Dynamic inefficiency Dynamic inefficiency as there are barriers to entry + imperfect information so they can get away with not using new tech (DEBATABLE) Can increase wages Producer welfare increases at expense of consumers Internationally competitive Shortages and glutes No incentive to innovate Abuse of monopoly power Slow/inflexible response to change Policies to regulate monopoly power 1. Subsidies a. Natural monopoly → govt may provide subsidy to encourage greater output and lower prices b. However, this subsidy is likely to be subject to regulation and government oversight/conditional 2. Anti-trust legislation/fair competition a. Protects consumers from anti-competitive behaviour 3. Price controls (​ enforced by government) a. Socially optimal price/MC pricing (P=MC rather than MR = MC) i.
Socially optimal price is also allocative efficiency (MC pricing) ii. Usually paired with subsidies so that monopoly doesn’t leave b. Fair return price (P = ATC) i.
Normal profits 4. Subsidies to smaller firms a. Government may subsidies smaller firms to help them become more competitive in a monopoly market - making it a ​contestable market Oligopoly 1. If a firm raises the price above P1, other firms will probably not follow suit and the firm who raised the prices will lose demand and revenues as demand is elastic above P1 2. If a firm lowers its prices below P1, rival firms will probably follow suit and therefore market share will remain unchanged (consumers stay where they are), but they all lose revenues - therefore demand is inelastic below P1 3. Due to the shape of the MR curve, if MC rises, it’s possible that MR=MC could occur at the same price and output → further explains price rigidity in an oligopoly Can make abnormal profits and losses in the short run Can make abnormal profits in the long run due to barriers to entry but some new firms may be able to enter the market and these profits may decrease Can’t make LR losses because they would leave the market Market structure - several large firms control supply of a g/s Action of one firm has significant impacts on market - mutual interdependence Behaviour depends on how they assume other firms will behave Characteristics 1. Few firms dominate the industry (usually between 2-10) a. Concentration ratio is high (CR​4​=80% means the top 4 firms own 80% of market share) 2. Some markets produce near identical goods (like steel and petrol), whereas others produce highly differentiated goods (e.g. shampoo and soft drinks) 3. Usually distinct barriers to entry (e.g. branding, EOS) 4. Interdependent firms - anticipate potential reactions of rivals before considering any major action 5. Firms are price makers BUT prices are quite rigid Mutual Interdependence - Key characteristic of a monopoly Firm considers anticipated reactions before embarking on a major course of action Firms either collude with rivals or compete with them - strategic thinking Collusion - Formal or informal (tacit) - Agreement to limit competition and/or raise prices - Strategy to avoid competition - Illegal in most countries Example: “Price fixing in air travel – British Airways and Virgin 2004-06 In 2007, British Airways was fined £270m for illegal price fixing arrangements with Virgin on long haul flights. The two companies met to agree and collude on the extra price of fuel surcharges in response to rising oil prices. Between 2004 and 2006, surcharges on air tickets rose from £5 to £60 per ticket. The £270m fine compares to an annual profit of £611m for BA.” Formal collusion Openly agree on price they’ll charge - May be agreement on market share or marketing expenditure - =C
​ artel Higher prices and lower output Usually illegal because it is against the interest of consumers Cartel - Association of manufacturers/suppliers that maintain high prices and restrict competition -
- Maximise joint profits as if firms are collectively a monopoly Difficult to maintain because there is always an incentive to cheat - By producing more output or reducing prices - cartel member can increase share of cartel’s profits - However if all members cheated the cartel would cease to exist as the cartel would not make monopoly profits and there’d no longer be any incentive for firms to remain in the cartel Informal (tacit) collusion Charge the same prices without a formal agreement - Firm decides to follow pricing strategy of dominant firmin industry/one of the main competitors - Price leadership Non-collusive oligopoly Price vs. non-price competition Strategies 1. Predatory Pricing a. Prices set deliberately low b. Below avg. costs in some cases (below breakeven) c. Eliminates new firms from an industry d. Established firms can do this due to EOS 2. Limit pricing a. Prices set below short run profit max level to deter new entrants b. But not necessarily below breakeven c. Take a long run view towards profits 3. Cost plus pricing a. When setting prices: firms add % figure to their costs to make a profit (add a percentage of their costs so that they make some profit) b. Ignores demand conditions in the market Fear of price wars = best deterrent of extensive price competition in an oligopoly Non price competition Most common type of competition in non-collusive oligopolies due to fear of price wars 1. Advertising 2. Branding, packaging, special features 3. Publicity, sponsorships 4. Free delivery, guarantees 5. Differentiating the good/service Game theory Understands how all individuals are rational and therefore will act strategically Success depends on choices made by others Prisoner’s dilemma Can be represented by a payoff matrix In this case the optimal solution for both parties would be to not advertise, they would both make $50m. However, both have an incentive to cheat: E.g. Coke If Pepsi advertises, Coke is better off advertising as well - or they’d lose $10m. However, if Pepsi doesn’t advertise, Coke is still better off advertising, as they’d make $80m The same applies for Pepsi, whichever decision Coke makes, they’re better off advertising. Therefore, the Nash equilibrium is where both firms advertise. It is more stable than the optimal (where both don’t advertise), as in optimal - either firm can benefit more from changing their decision. At the Nash equilibrium, each firm benefits most from staying where they are. Monopolistic competition Characteristics 1. Fairly large number of firms 2. Firm size, relatively small compared to industry size - no firms actions will have a great effect on the market/any of its competitors a. They are able to act independently - no mutual interdependence 3. There are low barriers to entry and exit 4. Firms produce ​slightly differentiated products a. Good/service is perceived to be different from other goods in some way b. Leads to small degree of monopoly power i.
Firms get some control over price Price maker diagram: Differentiation can mean some brand loyalty - consumers may continue to buy even if price increases slightly → producers have some level of independence when they decide on a price D curve is more elastic than monopoly or oligopoly - because of number of close competitors Short run → can make profits and losses Long run Due to low barriers to entry → new firms can enter when the firm is making abnormal profits and the market will once again settle at breakeven Firms would leave the market if there are losses, therefore they aren’t able to make LR losses LR If a firm is making SR abnormal profits, new firms enter the industry easily (low barriers to entry) Existing market is further divided between multiple firms Each firm’s individual D curve shifts left and becomes slightly more elastic due to more substitutes for consumers Continues till avg. firm is making only normal profits HOWEVER, this is only the case for the average firm Unlike perfect competition - firms can differentiate in monopolistic competition, those who differentiate the most successfully can possibly make supernormal profits in the LR, while those who differentiate least successfully may incur LR losses They are n
​ either allocatively or productively efficient They aren’t allocatively efficient because MR and AR are different curves - In perfect competition - firms end up at breakeven and since MR and AR are the same curve → this is productively efficient. As MR and AR are different in monopolistic competition, they will never be productively efficient in the SR or LR Price competition Product differentiation allows competition on the basis of price They are price takers Non price competition This differentiation also allows non price competition, however their strategies differ from oligopolies Examples: 1. Innovation 2. Quality of service (including aftersales) 3. Free upgrades to products 4. Branding 5. Exclusivity/loyalty programs 6. Sales promotions Price discrimination = Practice of charging different prices to different consumers for a product that costs the same to produce - for reasons other than difference in costs of production E.g. aircrafts Why do firms practice price discrimination? To maximise profits and steal from consumer surplus What conditions must be present in order for price discrimination to exist? - Firm must have m
​ arket power​ (must be price makers) - The more control firms have over price, the easier it is to price discriminate - Therefore - most​ commonly found in oligopolies and monopolies - Cannot happen in perfect competition - Consumers must have d
​ ifferent price elasticities​ of demand for the same product - Consumers with relatively inelastic demand are prepared to pay more than those with relatively elastic demand - Elasticity signals importance of product to consumer - E.g. coupons - consumers who collect coupons probably have higher PED than those who don’t - Producers must be able to create barriers between consumers so that they can’t buy and resell the good - Producers can separate markets in different ways: - Time (e.g. movie tickets - time of day) - Nationality (e.g. entry to national monuments is cheaper for those who are local) - Haggling - Language - Age (e.g. movie tickets for students) - Gender (e.g. lower prices at hair salons for men) - Income (e.g. government subsidised housing, financial aid for college) - Geographical distance (e.g. CDs cheaper in US than in EU because different price elasticities) NOT Price discrimination: - Hotels charging different prices at different seasons What is arbitrage and what does it have to do with price discrimination? - Arbitrage is when a good is bought in one market and sold in another - Consumer still loses(?) - Usually only able to do this for a short period What are some examples of price discrimination? -
Holiday package deals for children (families with children have higher PED) Train tickets (commuter has lower PED) Craft market Hotel All other examples above First degree price discrimination - Each consumer pays the highest price they’re willing to pay - E.g. bazaar/craft markets - haggling, shopkeepers get the highest price each consumer is willing to pay - No consumer surplus (consumer surplus becomes part of seller’s revenue, full shaded area) - Extra revenue from each good sold is the price of that shirt and therefore MR = D Second degree price discrimination - Firm charges different prices depending on how much they purchase - E.g. utility companies - e.g. electricity - High price for first few units (essential ones which would low PED) and lower prices for extra units - Some consumer surplus (solid medium blue areas) left, but most is stolen by producer (striped area is stolen consumer surplus) Third degree price discrimination - Consumers identified in different market segments - separate price in each segment because of different price elasticities in each segment
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Most common form of price discrimination E.g adult (first graph) vs. student (second graph) tickets in cinema - Students have more elastic demand for going to films due to lower incomes - Can be separated as they will need to show ID to be allowed with lower priced ticket into cinema MR curves twice as steep as their respective D curves Cinema attempts to maximise profits and therefore MR and AR curves for both markets is kinked In the case above, market A max profits at P​A and
Q​A​, whereas Market B does at P​B​ and Q​B​, the ​
whole market maximises at P* and Q* To producers Advantages -
Gain higher revenue from consumer surplus Enables producer to produce more and may lead to EOS Enables firm to drive competitors out of more elastic market by using profits from inelastic to lower prices in elastic (esp. In international trade - becomes more competitive) Disadvantages To consumers -
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Some consumers are paying lower prices than they would without price discrimination - Some may be able to purchase a product they wouldn’t have been able to previously Total output increases - more product for consumers EOS may be passed down to consumers through lower prices Unit 2A Macroeconomic objectives: 1. Steady economic growth 2. A low level of unemployment 3. Low and stable rate of inflation 4. A favourable balance of payments position 5. An equitable distribution of income Circular Flow of Income Two parallel markets (FOP market and goods market) Factor payments = rent, wages, interest, profits -
Consumer surplus is lost Some consumers pay higher prices than they would if price discrimination did not exist Factor payments = wages, rent, interest, profits In a closed economy there are no imports or exports, but other injections/leakages are still present In an open economy, all injections and leakages are present Important One part of government spending is not an injection: Transfer payments (like welfare, pensions, child allowance) As these are from tax revenue they are transfer of income rather than “expenditure” Economy in equilibrium when leakages = injections GDP, GNP, etc. Gross domestic product = the market value of all final goods and services produced in an economy over a given period of time (nationality of producer doesn’t matter) Nominal GDP: the market value of all final goods and services produced in an economy over a given period of time, ​measured in terms of current year prices Real GDP: the market value of all final goods and services produced in an economy over a given period of time,​ measured in terms of base year prices GDP deflator vs CPI Consumer Price Index only takes into account prices of g/s’s bought by consumers GDP deflator takes into account all prices Therefore: [(Real GDP) = (Nominal GDP)/(GDP Deflator)]*100% Real GDP per capita = Real GDP/Population Factors in population growth to see average output of economy per person Measuring GDP 1. Output method a. Measures actual value of goods and services produced by summing value added by all firms in an economy b. We deduct input costs at each stage of production so that we don’t double count inputs 2. Input Method a. Measures value of all incomes earned in economy b. Factor payments 3. Expenditure method a. Measures value of all spending on g/s’s in economy by summing up spending in all different sectors b. Including C + I + G +X​N Formula GDP = C + I + G + (X-M) Gross National Product (GNP) Market value of all final goods and services produced by citizens of an economy (in any part of the world) over a given period of time Gross National Income (GNI) Total income earned by a country’s FOP, regardless of where those assets are located, over a given period of time = GDP + net property income earned from abroad Net National Income (NNI) NNI = GNI - depreciation Over a year, capital stock loses some value = capital consumption - Due to: - Wear and tear - Damage - New technology making it obsolete More realistic than GNI but it is hard to accurately measure depreciation These measure: - Provide report cards of government achievement in terms of economic growth/government - Can assess govt - Help govt develop policies - Help develop models of economy and forecast future - Help firm predict future demand - Help measure living standards - Help compare economies However: - Inaccurate data collection - Unrecorded/under-recorded economic activity = informal markets - External costs/externalities - Quality of life concerns - Composition of output - If many goods do not benefit consumers, we cannot say that high GDP = higher SOL Green GDP Measure of GDP that accounts for environmental costs due to production E.g. cost of damage caused by pollution, waste disposal, cost of cleanup Green GDP = GDP - environmental cost of production The Business Cycle = Periodic fluctuations in economic activity measured by changes in real GDP Phases = boom, recession, trough, recovery Shows growth in an economy Boom/peak - AD increases - Inflationary pressure builds up - Increased demand for money → higher IR (interest rates) - → Less consumption and investment, more saving (leakage) - → (maybe) a recession Recession - Two consecutive quarters of falling GDP - → Falling AD due to less consumption and investment - High unemployment due to retrenchment - → Less spending - could cause disinflationary/deflationary spiral Trough/slump - Fall in output halts due to continued consumption spending, foreign demand for exports, and deficit govt spending - Low demand for money → low IR → more spending → boosts AD Recovery/Growth - More spending - Leading up to inflationary pressure - More employment Deflationary gaps can be caused by fall in economic growth or negative economic growth in SR and solved through demand-side policies These narrow the FLUCTUATIONS in a business cycle diagram However, supply side policies influence the trend growth line by generating long term economic growth Goal Expansion Contraction Economic growth Achieved as GDP rises Not achieved as GDP falls Low unemployment Achieved - more output, more workers needed Not achieved - less output, retrenchment Low + stable inflation Not achieved - inflationary pressure rises Achieved - inflation falls Favourable balance Not achieved - more demand for of payments position imports, current account worsens Achieved - current account improves Aggregate Demand = Total spending on all final goods and services in a period of time at all given price levels in an economy Shows relationship between APL (avg price level) and rGDP/real output AD = C + I + G + (X-M) Consumption (C) - Total spending by consumers on domestic goods and services - Durable goods - Goods that are used by consumers over a period of time - E.g. bikes, cars, houses, phones - Non-durable goods - Goods used up immediately - E.g. toilet paper, bread, newspapers Changed by: - Changes in income -
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- As incomes rise, consumption increases - ‘+’ correlation Interest rates - Higher interest rates means higher incentive to save, less to spend and borrow - Esp. on durable goods as often they may require notes and high interest rates means more expensive loans - ‘-’ correlation Changes in wealth - Wealth = assets owned - Can be changed by change in house prices and change in value of stocks and shares (possible assets) - ‘+’ correlation Changes in expectations/consumer confidence - If confident, they feel the need to save less - ‘+’ correlation Household debt - If it is easy to borrow money (easy credit) and IR are low, spending increases Investment (I) - Addition of capital stock to economies (done by firms) - Replacement investment - Expenditure in order to maintain productivity of existing capital - Induced investment - To increase output to respond to higher demand Changed by: - Changes in interest rate - Changes in levels of international income - Changes in tech - Changes in business confidence Government Spending (G) - NOT transfer payments - Depends on policies and objectives - Spending on goods and services Net exports X​N - Export expenditure - Import expenditure Changed by: - Changes in foreign incomes - Changes in XR - Changes in trade policies - Changes in relative inflation rates Demand-side policies (government) 1. Fiscal a. Expansionary i.
Lower income taxes (increase C) ii.
Lower corp taxes (increase I) iii.
Increase government spending (increase G) b. Contractionary is opposite 2. Monetary a. Expansionary i.
Lower interest rates ii.
Increase money supply b. Contractionary is opposite Shape of demand curve = Downward sloping 1. Wealth effect a. APL increases, real value of wealth decreases b. Consumers save more to compensate and therefore spend less c. Aggregate quantity demanded therefore decreases 2. Interest-rate effect a. APL increases, people need more money to buy goods and services b. Demand for money increases - causing price of money (IR) to increase c. Borrowing more expensive and so C and I decrease d. Qd decreases 3. Foreign-trade effect a. APL increases, domestically produced goods become more expensive (relative to abroad) b. Exports decrease, imports increase c. X​N​ decreases d. Qd decreases Aggregate Supply = total amount of final goods and services that all industries in the economy will produce at any given price level over a particular period of time Short run: Period of time when price of FOPs don’t change (esp. price of labour - wage) Shape of supply curve Upward sloping because as, if more output is produced in SR, firms face higher costs of production and these are passed on to consumer as higher prices Changed by -
Change in wage rates Change in costs of raw materials Change in price of imports Change in govt indirect taxes Change in subsidies Long Run Aggregate Supply Neoclassical Perspective - Minimum govt intervention - Tend to prefer monetary policy - Perfectly inelastic LRAS - At full employment level of output - Asserts that potential output is based only on quantity and quality of FOPs and not on price - Neoclassical economics assumes that naturally an economy will self correct because wages will increase as prices do - In recession - producers have the power → they can pay less and wages will decrease - economy will self-correct - Vertical curve Keynesian Economists - Do not distinguish between LRAS and SRAS - Believe in government intervention - Tend to prefer fiscal policy - Keynesian economics works on basis of (downwards) sticky wages → due to contracts, etc. price increases don’t mean wage changes - Government would not let people pay very low wages - Horizontal till a certain quantity - Perfectly elastic - Because at lower levels of quantity you are simply using the idle resources we already have and therefore prices can stay the same - Then curves upwards - As quantity increases, the prices increase because resources become more scarce and therefore more expensive - Vertical - As it has reached max capacity and all FOPs are fully employed LRAS is only shifted by IQIQFOP - potential growth of PPC Factors of Production Land (all natural resources) Increase in Quantity ●
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Land reclamation Increased access to supply of resources Discovery of new resources Improvements in Quality / Productivity ●
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Technological advancements that increase access to resources or lead to discovery of new resources Fertilisers ●
Irrigation Labour and Entrepreneurship ●
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↑ in birth rate Immigration Decrease in the natural rate of unemployment ●
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Education Training Re-training Apprenticeship programmes Capital ●
Investment ●
Technological advancements that contribute to more efficient capital R & D ●
Neoclassical: Keynesian: Long run equilibrium AD = LRAS Neoclassical perspective: -
Believe that economy will always automatically move towards full employment level and is therefore where AD meets LRAS Can have temporary recessionary and inflationary gaps - Recessionary - Demand falls, workers will accept lower wages, SRAS shifts right → back to Full employment equilibrium → deflation or disinflation - Inflationary - Wages driven up as firms want good workers → repair and maintenance costs increase → SRAS shifts left → back to full employment equilibrium → inflation Keynesian perspective: - Believe that it is possible for economy to operate with spare capacity - = deflationary gap -
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Because: - Contracts - Trade unions - Minimum wage legislation - Downwards sticky wages As AD continues to increase ⇒ inflationary pressure due to scarce resources - Can lead to an inflationary gap Supply side policies 1. Interventionist a. Believes that govt intervention is necessary i.
Investment in 1. Human capital a. Retraining b. Education subsidies c. Govt hiring d. Subsidising firms to hire structurally unemployed e. Subsidised housing f. Govt projects in areas of high unemployment 2. Technology a. Subsidise R&D b. Tax breaks and other incentives to firms c. Grant patents 3. Infrastructure ii.
Additional industrial support 2. Market-based a. Believe that market forces will resolve recessionary/inflationary gaps automatically i.
Encouraging competition for higher efficiency by: 1. Privatisation 2. Deregulation 3. Reducing govt economic regulation 4. Private financing of public sector 5. Restricting monopoly power 6. Trade liberalisation ii.
Labour market reforms which make the labour market more flexible 1. Changing/eliminating min wages 2. Reducing power of trade unions 3. Less unemployment benefits 4. Less job security iii.
Incentivising 1. Less personal income tax 2. Less corp tax 3. Less capital gains tax However, there are always issues - Time lags - Ability to create unemployment - Ability to reduce inflationary pressure - Impacts on economic growth - Impacts on govt budget - Effect on equity - Effect on environment Economic Growth = increase in rGDP per capita over time - Main macroeconomic objectives When AD increases = actual growth When LRAS increases = potential Positive consequences 1. AD increases as population size and incomes growth a. Could lead to inflation (B → C) b. BUT Improvements in supply move LRAS to right allowing increase in AD without inflationary pressure (B → A) 2.
3.
4.
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Increased levels of production that occur with economic growth → less unemployment If real GDP grows faster than pop, rGDP/capita will increase (may mean higher SOL) Can contribute to leaps in tech Higher rGDP leads to higher tax revenues a. May mean more merit and public goods 6. Can increase amount of trade → higher SOL 7. rGDP rises → education and human capital often rises a. Often means higher demand for freedom and democracy Negative consequences of economic growth 1. Economic growth cannot always mean higher SOL a. Some may sacrifice leisure time to work (neglect relationships) b. Money ≠ happiness c. Obsession with money d. May lead to income inequality 2. Economic growth can lead to structural changes and therefore structural unemployment 3. Higher output of goods and services can negatively impact env a. - externalities of production b. GHG emissions c. Depletion of resources d. Higher levels of household waste Quantitative Calculations Nominal GDP = C + I + G + (X-M) Real GDP = [(Nominal GDP)/(GDP Deflator)]*100% GNP = GDP - foreign production in country + domestic production abroad Growth rate = [(new value - old value)/old value]*100% The Multiplier An initial change in aggregate demand (C, I, G, XN) can have a much greater final impact on the level of equilibrium national income. Autonomous spending is spending independent of the level of national income (G, I, X - the three injections) Induced spending is spending dependent on or directly proportional to level of national income, such as C. To the right, an initial investment can shift AD1 to AD2, but the multiplier would shift it to AD3 in the end MPC = marginal propensity to consume MPS = marginal propensity to save MPM = marginal propensity to import MPT = marginal rate of taxation MPW = marginal propensity to withdraw = MPT + MPM + MPS Determinants of multiplier - MPS - Interest rates - MPC - Tax rates - Free trade - XR - Imports - Quality domestic vs. abroad - MPM - Exchange rates - Free trade - Quality domestic vs abroad - MPT - Tax rates - Govt structure Significance of multiplier - Can magnify change in private investment - Govt can use it to see how much to spend for a desired impact - Govt can see impact of recessions in country and abroad on their own country Quantitative Calculations- Multiplier Multiplier = 1/(1-MPC) = 1/MPW = 1/(MPM+MPS+MPT) How to answer a part B: General tips on structure: - This type of question would be a part (b) on a paper 1, so you would first use the DEED method to explain the situation, and then discuss the impacts on stakeholders - The first D stands for definition, so your very first line should be defining the key terms in the question - The E stands for explanation, so you explain what is going in - The second E is for example, include a relevant example in your essay and examiners will give you higher marks, they love students who can use good examples! - The last D is for a diagram, it is good to include a diagram in all questions that you answer, it shows understanding and gives clarity to your answer 
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