Economics
Unit 7:
Utility:
Total utility: the overall satisfaction that is derived from the consumption of all
units of a good over a given time period
marginal utility – the additional utility derived from the
consumption of one more unit of a particular good.
When price of good decrease, the marginal utility/P will increase
Change in price of good cause movement along demand curve
Assumption:
- Marginal utility theory assumes that consumer ranking their wants and
assign value of satisfaction gained from consuming good.
- Law of diminishing marginal utility
Indifference curves and budget lines
Indifference curves show combination two goods that give consumer equal
satisfaction or utility.
Slope downward represent fall in quantity consumed of one good is accompanied
by increase consumption of other good for the same level of satisfaction
The slope of the indifference curve represents the extent to which the consumer
is willing to substitute one good for another. when consuming large amounts of
good Y, the consumer is willing to give up rather more of this good/ The rate at
which the consumer is willing to substitute one good for another is known as the
marginal rate of substitution.
Budget line graph
If price of X has fall, more can be purchasing this level of income. The graph shows
good x’s price fall by halve, which means they can buy twice the original amount.
As price X is fall relative to Y, they will substitute X for Y. Substitution effect of
price change. Fall in price of good X allow consumer have more money to spend
on other good, real income increased  Consumer may buy even more of good
X. Income effect
If the price of good X increases, this means that consumers have less spending
power. The loss of spending power is represented by a new budget line B2. less of
good X can now be consumed with the same level of income.
- A movement along I1 to point E2. This is the substitution effect
- A shift downwards to a lower indifference curve I2 moving from E2 to E3.
This is the income effect, so-called because the consumer has less spending
power due to the increase in price of good X
Income effect has been eliminated by removing the reduction in real income
through including an imaginary budget line that is parallel to the new budget line
but at a tangent to the original indifference curve.
Show a fall in price level of Good X
- Substitution effect has move from E1 to E2 due to drop in price of good X
- Income effect is positive as they have more real income, which move from
l1 to l2, higher indifference curve
Good x is inferior good:
- As real income increase, consumer will buy more expensive, quality good
instead of X. Which cause income effect to be negative, but can’t outweighs
the substitution effect
For Giffen good, demand fall as price fall and increase as price increase. Such as
staple food as rice and wheat flour. As price of staple food increase, real income
decreased.
Income effect will greater than substitution effect
Limitation:
- When there is two good and income is fixed when there are hundreds of
products they can choose from
- Consumer act rationally
- ‘indifference’ implies that consumers are willing to accept any
combination of the two goods as represented by an indifference curve.
However, consumers express their wants and needs in terms of preference
or rank order, and not indifference
Efficiency and market failure:
Economic efficiency: scarce resources are being used in the ‘best’ possible way.
Most wants are being met with those scarce resources.
Productive Efficiency: firms produce at the lowest cost, making best use of
resource
Allocative efficiency: produce combination of good and services that are most
wanted by consumer. Give maximum satisfaction at their current income.
represents the additional benefit derived from the consumption of one more unit
of a particular good
At X, more of both good can be produce with the available resource – productive
inefficiency.
At Y produced the maximum amount of product with the available resource –
productive efficiency
Firm will produce at the lowest cost to stay competitive, this will lead to
productive efficiency
Allocative efficiency exist price of product is equal to marginal cost of production.
Cost of producing one more unit of output. The seventh unit cost 8 dollars but
only valued at 5 dollars by the consumer, same applied for fifth and sixth output.
Competitive market can lead to allocative efficiency, firm will produce products
that are most desirable by the consumers relative to cost of production.
There are two motivations:
- to make the greatest possible profit will push firms to produce such
products  highest possible demand and revenue
- in competitive markets will be forced to produce those products most
demanded by consumers. If firms do not produce these goods, other firms
will step in and do so. This can cause business to close
Pareto optimally:
- impossible to make someone better off without making someone else
worse off
- can be represent using PPC curve, on the line, its impossible to increase
output of good X without reduce good Y  state of pareto optimally
- any point in PPC, possible to increase of good X without reduce good Y 
pareto inefficient
Dynamic efficiency:
- Resources are reallocated in such a way that output increases relative to
the increase in resources.
- achieved when a firm meets the changing needs of it market by introducing
new production processes
- Investment will be high initially, the payback after the investment like
research, technology will come later
- A long-run concept
- Will shift the LRAC curve down when being dynamic efficient
Market failure:
- Market failure exists whenever a free market, left to its own devices and
totally free from any form of government intervention, fails to make the
best use of scarce resources.
- When the interaction of supply and demand doesn’t lead to productive or
allocative efficiency  no efficient allocation of resource
Private costs and benefits, externalities and social costs and
benefits
Externality:
- Concept of when people who are not involve with the transaction of good
and services that are affected by the decision. Those people are call third
parties
Negative externalities occur when the consumption/production of a good
produces a cost to society which is greater than that incurred by an
individual consumer/producer. This is sometimes described as a
negative ‘spill-over’ effect.
*****
A positive externality is where the side effects provide unexpected benefits to
the third parties
Private cost: Cost incur by the business who carry out an action either as
producer or consumer
Private benefit: Receive directly by those who produce or consume service
Example: A airplane business, private cost for producer is cost of operating the
airplane, private cost for consumer would be ticket cost. Private benefit for
producer would be revenue gain, for consumer would be able to travel to places
External Cost and benefit:
- Consequences of externality arise from particular action
- Fall on the third party
Social costs = Private costs + External costs
Social benefits = Private benefits + External benefits
When private cost doesn’t match social cost or private benefit doesn’t match
social benefit  distort the efficient allocation of resource. Market cant produce
at best allocation of resource
When social benefit exceed private benefit  positive externality
A market is not efficient when there is externality
Negative production externality:
-
External cost is shown as MEC
Marginal social cost is shown as MSC
Marginal private cost is the supply curve of the firm
Marginal private benefit = marginal social benefit so is equal to demand
Optimum level output is when the marginal social cost is equal to
marginal social benefit. However, the actual output is at Q1 is where
marginal private cost equal marginal private benefit
- Xyz is the deadweight welfare loss due to overproduction
Positive production externality:
- Marginal social cost will be lower than the marginal private cost
- Assuming no consumption externality. MPB = MSB
- Socially optimum output is at MSB = MSC
- Business will produce at Q1 where MPC = MPB, which there is
underproduction
Negative consumption externality:
- The marginal social benefit is lower than marginal private benefit due to
the marginal external cost
- Optimum level output is at Q when MSB = MSC
- However business will produce at Q1 where MPC = MPB, result to
overconsumption
Positive consumption externality:
- MSB is greater than MPB due to the positive marginal external benefit
- Optimum output is at Q when MSB = MSC, but output at Q1 when business
produce at MPB = MPC.
Asymmetric information:
- When buyer doesn’t have information that the seller has and vice versa
Two types:
- Hidden characteristic, when one party know more about a situation than
the other. Outcome is called adverse selection. Example: Buyers of used
cars may end up purchasing more low-quality cars in the market, reducing
the market for good quality vehicles.
- Hidden action, when one party take action that other party can’t observe
which affect both of them, known as moral hazard. Apply in the case of a
bank loan where the person who has obtained the loan takes a bigger risk
in setting up a business.
Cost benefit analysis:
- takes a much wider view than a financial appraisal.
- Take into account social cost and benefit
4 stages
Identification:
- Identify all relevant cost and benefit of project, include external, private
cost and benefit
- problems when it comes to identifying external costs and benefits.
Putting monetary value:
- Putting monetary value on cost and benefit
- Easier if there are already market prices available
- However, for other variables, its difficult to assign value such as time
Forecasting future:
- estimate costs and benefits over many years
Decision making:
- results of the earlier stages are drawn together to aid decision making
- If value of benefit exceed cost, then project is worthwhile
- Project with highest benefit: cost ratio is most likely to go ahead
Types of cost, revenue and profit, short-run and longrun
production
As number of workers goes up, marginal product goes down due to law of
diminishing return. Adding more worker is in a short-term way for increase output
Rising marginal cost and average variable cost is indication of diminishing return
As output increase, AFC decrease and AVC will increase. Eventually, it will
outweighs the effect of AFC falling, causing ATC to rise
To increase 100 to 200 goods, relatively less labor and capital require per unit
output, this is increasing return to scale
Increasing amount of capital and labor is need to produce 100 more of goods, gap
increase indicate decreasing return to scale
Economies of scale:
- LRAC slopes upwards after the minimum point. beyond a certain size, a
firm’s costs per unit of output may increase as the scale of output
continues to increase. This situation is one of diseconomies of scale.
- Economies of scale can only accrue to a firm in the long run.
- firm’s output is rising proportionally faster than the inputs, which means
that the firm is getting increasing returns to scale
Technical economies:
- advantages gained directly in the production process through more
efficient production methods
- Example: Increase speed of transporting so that no idle and flow production
faster
Purchasing economies:
- Bulk buying, buy large amount of cheaper average total cost
Marketing economies:
- Promote product at larger amount of air time, transport and warehouse
cost can be reduced where customer require service on large scale
Managerial economies:
- Expert can hired to manage more operation
Financial economies:
- Better and cheaper access to loan from bank
Diseconomies:
- a firm can expand its scale of output too much, with the result that average
costs start to rise
- problems of management co-ordination of large complex organizations and
the effect that size and poor communications, worker not feeling valued
Price taker:
- competitive market the firm has no control over the price of its goods
- firm’s demand curve will be horizontal and its revenue will depend entirely
on the amount of goods sold
Price maker:
- If the firm chooses to increase output, price will fall; if it decides to reduce
output, price is expected to increase.
- firm’s demand curve is its average revenue curve.
Profit:
- What left when revenue deduct total cost
Normal profit:
- Minimum return business must have to stay in business
Supernormal profit:
- Signal for other business to enter
Subnormal profit:
- Profit earn is less than normal profit
Different market structures
Perfect competition:
- Firms are price takers and there is perfect information for all firms in the
market
- Many firms, freedom of entry into the industry with all firms producing
identical products.
Imperfect competition
Monopolistic competition:
- Monopolistic competition is where there are many firms and freedom of
entry
- firms have some control over the product and its price. Firms are price
makers.
Oligopoly:
- few firms and they have market power to erect barriers to entry to deter
competition from new firms.
- Product are wide ranging
- Firms are price makers as they have some control over price depending on
the market power of competitors.
Monopoly:
- Single seller in market
- Price maker
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Barrier to entry:
Legal barrier:
- Under license by government
Market barrier:
- Advertising and branding from large company
Cost barrier:
- High fixed cost
- Economies of scale allow to lower average cost.
- Predator pricing: eliminate new firm enter a business by cut price
- Limit pricing: eliminate firm about to enter by setting low price
Barrier to exist:
- Some cost like research cant be convert back to money
If cost is higher than revenue, the firm is about to exist industry. As long as price
revenue cover the average variable cost, the firm would make a loss equal to fixed
cost. Called shutdown price. Only hope is market price will rise to increase
revenue.
Where the revenue is lower than costs in the long run, firms will leave
the industry. If many firms leave, the effect will be a reduction in the
overall market supply. This will raise the market price, giving the rest of business
opportunity to produce and make normal profit.
Supernormal profit is only in the short run. Its existence act as an incentive for
new firm to enter the market. Absence of barrier of entry will make them enter
easily and increase total supply. Market price will fall and supernormal profit will
diminish. When it goes, new entry will stop, and existing one will be covering
their cost
model of perfect competition is the most efficient market structure in the long
run
Monopolistic competition:
Successful advertising will shift the demand curve to the right and will reduce the
price elasticity as consumer will feel there are less close substitute.
large number of competitors using a combination of price competition and nonprice competition to try to increase their market power. If there are few barriers
to entry, then their success will only be temporary.
In the short run, the profit-maximizing firm will be seen to make supernormal
profits. However, new firm will join which will shift the demand to the left. This
will happen until all industry are making normal profit.
Firms operate above the ATC point so its inefficient. firm is not allocatively
efficient as P > MC.
Oligopoly
Total output is concentrated in few firms
Decision taken by firm are independent, Firms must decide their market strategy
to compete with close rivals
High barrier of entry
Product may be differentiated or undifferentiated
Concentration ratio is sum of the market share percentage held by the
largest specified number of firms in an industry. It ranges from 0% to 100%,
and an indicates the degree of competition in the industry. Low concentration
ratio in an industry would indicate greater competition among the firms in that
industry. *****
It is calculated by adding together the total sales for each of the specified
number of largest firms in the industry. (E.g. a 4 firm concentration ration
takes the sales of the largest 4 firms) That sum is then divided by the total
sales of the industry and converted to a percentage. (2)
***n
Are price maker, but it could lead to price war. They should only start price war if
cost of production is significantly lower than competitor
Suppose a firm increases its price. This will not be followed by all firms as they
have little to gain since their revenue is likely to fall. If price is reduced, there will
be the same reaction from all firms. Again, revenue will fall.
Prices will tend to stay the same and to change little over time. Price rigidity
oligopolist will be better off concentrating on non-price competition to increase
revenue.
Collusion in oligopoly:
Is an informal agreement, firms agree to a form of competitive behavior which
benefits the firms. ***
Large firm cooperative with rival, informal collusion is not illegal and usually take
form of price leadership. where firms automatically follow the lead of one of the
groups. The objective is to maximize the profits of the whole group by acting as a
single seller. Sufficient market power to determine price change
cartel is a formal price or output agreement between firms in an industry to
restrict competition. It’s illegal. By joining a cartel and agreeing prices, firms are
operating as a single seller and maximizing their profit
Monopoly:
a legal monopoly is when a firm has more than 25% of the total market; if this
share exceeds 40% then the monopoly is said to be ‘dominant’.
profit-maximizing monopolist would choose the output where MC = MR.
There is no long run or short run because there Is no incentive for business to
move away from MC = MR,
Price discrimination occurs where the monopolist chooses to split up the output
and sell it at different prices to different customers
Natural monopoly:
Where monopoly has overwhelming cost advantage
At quantity Q, firm will making supernormal profit. But if behave like a
competitive firm, it would be where price equal long run marginal cost, at Q1.
This is loss making, however government will provided subsidy as they are
providing essential goods.
Monopoly vs perfect competition
The monopoly output is lower than in perfect competition.
The price in monopoly is higher than it is in perfect competition.
The monopolist is making short- and long-run supernormal profit.
The firm in perfect competition is productively efficient, producing
the optimum output. It is also allocatively efficient, producing where price = MC.
The monopolist captures consumer surplus and turns it into supernormal profit.
Consumer surplus in monopoly is less than in perfect competition due to the
higher price that is charged by a monopolist.
The deadweight loss is the sum of the loss of the total consumer surplus and
producer surplus. It is shown by the shaded area. deadweight loss is significant
because the monopolist is gaining at the expense of consumers through
converting some of the consumer surplus into producer surplus.
Monopolist do not have the same control over costs, there may be too many
workers or capital is not being used efficiently.
Growth and survival of firms
Internal growth:
- Retain profit from business and reinvest to increase productive capacity
External growth:
- joining with others via takeovers or mergers.
- Takeover bid objective is to own 51% of the total and have control of
business
- Quicker and cheaper
Diversification:
- Sell wide range of product
Integration:
- a merger whereby two firms agree to join up with each other, or acquisition
or purchase whereby one firm takes over control of another.
Horizontal integration:
Merger of business in the same industry to reap benefit economies of scale,
reduce competition
Vertical integration:
Firms grow forward or backward of its production stage
Cartel:
A formal agreement by firms to operate collectively to raise price or limit
output to reduce competition/control the market ***
Possibility of price war where one firm break rank to capture bigger market share
If some firm have higher cost of production, resulting in fewer profit due to
agreed fixed price
Principal-agent problem
When one agent make decision on behalf of another person. The agent, through a
day-to-day involvement in the firm, has more information than the principal. This
difference is an example of asymmetric information and moral hazard. The
problem is that the principal does not know how the agent will act; the principal is
also not sure that the agent will act in the principal’s best interests.
In the case of a firm’s growth, the agent may have plans and a strategy that differ
from those of the principal. The agents may decide to act in their own interest. If
successful, the agents stand to gain prestige and enhance their own career
development. The principal is not fully aware of what the growth plans involve.
This is called the agency cost
Differing objectives and policies of firms
Why firm doesn’t operate at profit maximization:
-
difficult to identify this output
may not be long term interest of business, to avoid government regulatory
may attract new entrant into industry
damage relationship between stakeholder and firm, the firm’s workforce
and consumer as they see shareholder earn large returns
- Firm could become a target for takeover bid
Other objective of firm:
Survival:
- minimising losses to develop a revised strategy to stay in business
- limit to the time and to the scale of losses that can be tolerated. If a firm is
not covering its variable costs, then closure would be a sensible outcome.
Profit satisficing:
- reasonable or minimum level of profit, sufficient to satisfy the shareholders
but also to keep the stakeholders happy
- Worker will expect pay rise, consumer expect price fall
- Profit satisficing can also be a feature of firms that have enjoyed a high
market share over a long period of time. Complacency can lead to firms
losing focus
Sale maximization:
- maximize the volume of sales rather than the total revenue from sales.
Sales maximization will lead to greater output
Revenue maximization:
- Managerial salaries and bonuses are usually based on total revenue, not
profits. Sales can be easily and regularly monitored
- The firm may produce where MC > MR provided MR > 0 since total revenue
will increase.
Price discrimination:
First degree: firm sells each unit of a product to a different consumer, charging
each the price consumer willing to pay
Example: A car dealer is likely to weigh up just what a potential customer might
be willing to pay for a second-hand car
Second degree: consumers are only willing to purchase more of a product if price
falls as more and more units are bought.
Third degree: discriminate between consumers and is based on the presumption
that groups of consumers have a different price elasticity of demand. low price
elasticity of demand need the product and can be expected to pay a higher price
for it than consumers whose demand is more price elastic.
Total revenue would be 120 by 3 x 40 = 120, total cost would be 45 x 3 = 135,
making a loss of 15 dollars. If output is sold separately for price consumer willing
to pay, total revenue would be 60 + 50 +40= 150, making supernormal profit of
15.
Price discrimination will only work where consumers have a different willingness
to purchase or have different price elasticities of demand for the product.
Other pricing policies:
Limit pricing: setting a lower short-run price to deter new firms from entering
their market. At this new price, the established firm no longer maximizes profits,
the low price act as a barrier of entry.
Predatory pricing: setting a price that is so low that the new firm has no
alternative but to match it, to force new firm out of business.
Price leader ship: All firms in the market accept the price that is set by the leading
firm, which is often the firm with the largest market share or is the brand leader.
avoiding price competition yet maximizing total profits for all firms. However
small firm, their costs are higher, matching a price decrease could result in
sustained losses and the eventual exit of smaller rivals from the market.
Firm A is the lower cost producer and price leader. It maximizes its profits at point
A where MC = MR. Its output OA is sold at price PA. Firm B’s ideal price is at PB,
but if it fixes price here, it will not be able to compete with A’s lower price
When PED = 1 , MR will be = 0 and total revenue is maximized, if PED < 1, MR will
be negative reducing the total revenue.
A firm choosing to maximize its revenue would raise output beyond MC = MR
until MR had fallen to zero
Unit 8
Government policies to achieve efficient resource allocation
and correct market failure
Negative production externality
Use tax to stop negative production
MSC = MPC + tax
The total tax paid is equal to the area P2P1yz, of which the consumer’s share of
the burden is PP1yx and the producer’s share is P2Pxz.
Cant estimate how much to tax
green tax will not be effective if the demand for the product being taxed has a
price inelastic demand
Regulation
setting standards that restrict the amount of polluted waste that can be legally
dumped.
Property right
how owners can use their assets.
If a polluting firm has property rights, then those who are affected by its
activities could pay the polluter to reduce the scale of activity. In principle the
polluter would require payment equal to the loss of profit
Pollution permit
polluting firms are provided with a permit to produce a given level of pollution.
Negative consumption externality
Specific indirect tax:
Negative consumption externalities created by one group of consumers reduce
the private benefit of others, due to external cost, MSB is lower than MPB
The market Equilibrium is at MPB = MPC, at Q
By imposing indirect tax equal to zy, the supply curve shift left market price
increase to P1 result in fall in quantity to Q1.
Optimum level output is at Q1 where MSC = MSB
impose a minimum price on products that generate negative externalities of
consumption
production quotas. This involves limiting the quantity of goods that is produced
Positive production Externality
MSC is lower than MPC. Market Equilibrium is at QP, optimum output is at MSC =
MPB at Q1, so its underproduction. Government should give subsidy equal to
external benefit to increase quantity produced to Q1. Size of subsidy is P2P1YZ
Or to increase demand of the good, by provision of information
Positive consumption externality
Equilibrium is at MPC = MPB at QP, the marginal external benefit added to MPB
to give MSB.
Government give subsidy shift supply curve to right from S to S1. Optimum
output level is at Q1 where MPB sold at price P1
Nudge theory
presenting choices in a better way, people make better decisions. achieving
beneficial economic and social outcomes without the need for regulations
Causes and consequence of government failure:
Imperfect information
lack of information about the true cost or value of a negative externality.
difficult to trace the source of the pollution.
The wrong level of tax will lead to the wrong level of production and an even
greater inefficiency in the use of resources
government must provide the right amount of goods. If it does not estimate the
level of demand accurately, then the wrong amount will be produced or funded
 inefficient allocation of resources
Unintended consequence:
undesirable intentions can create inefficiencies.
imposition of taxes can distort incentives, high income tax can create
disincentives for people to work harder and so gain more income.
pays benefits to unemployed workers. If benefits paid are too high, there may be
no incentive for the unemployed to look for work
Policy conflict:
increase existing inequality. example, a tax on energy use that aims to reduce
harmful emissions of greenhouse gases will have different effects on different
groups of people. This could be seen as unfair and increasing inequality in
society.
subsidies on the costs of fossil fuels. These encourage production and
their use in coal-fired power stations, both of which contribute increased
environmental pollution. It might keep workers in jobs but its inconsistent with
the need for more sustainable policies.
Equity and redistribution of income and wealth
Equity: Distribute resource fairly among people, there are two aspect,
Horizontal equity: people with same circumstance should pay same level of
taxation.
Vertical equity: Taxes should be fairly apportioned between rich and poor in
society
Equality: Equality is about treating everyone in the same way. Equality aims to
promote fairness, but it can only work if everyone starts from the same position
and needs the same help. It is the ideal of everyone being truly equal
Poverty: families do not have enough money or access to resources to be able to
experience a reasonable standard of living. includes not only having food and
housing, but also access to decent education, healthcare, water supply and
sanitation.
Extreme poverty: living on less than 1.9 dollars a day
Absolute poverty: when household income is below a certain level that makes it
impossible for a person or family to meet the basic needs of life such as food,
housing, water, healthcare and education.
Relative poverty: income of a household with the average income for their
country where its less than the average or 50%. Household have money to meet
basic need.
Benefit of Money raised through the tax system is then paid to low-income
persons and families in order to increase their disposable income:
Mean tested benefit: Only paid to those on low income, most in need. This can
create disincentive to work. Its call poverty trap when financially worse off when
one or more of members are working rather than living off the range of benefits
available to them.
Universal benefit: Paid out to everyone in certain category, often age-related
regardless of income. This mean they are also paying to those who are not in
needed and tend to be more expensive
Universal basic income:
unconditional cash payment made at regular intervals by the government
regardless of earnings or employment status. Reduces poverty and income
inequality while encouraging those receiving to enter or stay in employment.
Negative income tax:
a way of dealing with the weaknesses of means-tested and universal benefits.
Example: Tax rate is 25%, everyone receive annual benefit of 4000 dollars. If tax
paid is less than received annual benefit  negative income tax, they receive
the difference between tax paid and annual benefit. For high income earner,
then this is the amount of tax they have to pay.
Labor market forces and government intervention
marginal revenue product (MRP) is the extra revenue earned by the firm when it
employs one more worker
firm should continue to hire labor as long as the additional worker adds more to
revenue than to the firm’s costs.
Factor determine demand for labor:
Wage rate: rise in the wage rate will increase labour costs and is likely to lead to
a fall in the quantity of labor demanded by a firm
Productivity: If productivity increase, output increase, labor becoming more
attractive resource for firm and increase in demand for labor
Demand for product: When demand for product is higher, firm will need more
worker. Demand curve will shift right
Individual supply of labor
as the wage rate increases, more people are willing to offer their services to
employers.
Beyond a certain point, there is a trade-off between work and leisure. Individuals
may decide that they would prefer to work less and have more time for leisure.
labor supply to a firm or industry
the number of workers wanting to supply their labor increases with the wage rate
that is offered.
Elastic and inelastic supply curve
Long run supply of labor
Factor
Size of population: increase in the overall supply of labor mainly due to higher
birth rates and improved medical care for young children.
Labor participation rate: More students are continuing their studies at
university, a further cause of a declining labor participation rate or worker choose
early retirement
Tax and benefits level: High tax rate will cause disincentive to work and withdraw
from labor market
Immigration and emigration:
Perfect market:
Each firm therefore purchases labour until the value of the marginal revenue
product equals the wage rate.
When there is increase in demand for labour, employment increase from L to L1,
The wage rise from W to W1
When there is increase in supply of labor, supply will shift right, this will cause
downward effect on the wages. As the number of workers increases, so their
marginal productivity falls, as does the value of their marginal revenue product.
Wages are reduced for all worker, but employment rise
Imperfect market
Trade union
Trade union could set an minimum wage above equilibrium wage. At this wage,
more worker is likely to work at Lc. However, job offer are less to Lu.
High labour cost could make employer go out of business
Government intervention
minimum wage is a national minimum wage. it does not take into account
variations in the cost of living in a country. very difficult for workers to survive on
the minimum wage alone unless long hours are worked.
Monopsony
single or dominant buyer,
Wage differential: An occupation that is in high demand and low supply will pay a
higher wage rate than one where there is an abundant supply of workers. Wage
difference between job. Example: pilot get pay more than cabin attendant, cabin
attendant get pay more than worker cleaner the airplane
Causes:
Bargaining: Member of strong professional organization like trade union, action
by pilot have substantial impact on airplane’s revenue
Education and training: Some occupations, especially those in healthcare, legal
services and teaching, require workers to undergo a long period of training.
Skilled and unskilled worker: Skilled worker will likely to get paid more than
unskilled one as supply for skilled is less while demand is higher. Marginal
revenue product for skilled one Is higher because it will lead to higher output
Male and female worker: men are still paid more than women in many
occupations. on average the MRP of women is lower than that of men. The MRP
is lower because there are more women in low-paid occupations that generate
low marginal revenue to a firm.
Hours of work: Part-time workers on average are paid lower wage rates than fulltime workers. there is usually a large pool of part-time workers in a local labor
market. Many part-time workers are women.
Government policy: Governments try to recruit more doctors and nurses to fill in
for the increased demand for such professionals. This shortage of supply widens
the differential between these workers and others in similar occupations
transfer earnings: this is the minimum payment necessary to keep labor in its
present use.
economic rent: any payment to labor which is over and above transfer earnings
at W, wage rates below this there are workers who are willing to offer their
services to employers, at any wage rate from zero upwards, workers will join the
labor market, until at wage W, L quantity of labor is available. Below W any
wages they get over and above what they will accept is their economic rent.
case of superstars can be explained. labor supply curve is perfectly inelastic; their
earnings consist entirely of economic rent.
workers with a perfectly elastic supply, such as many unskilled workers and
others in menial jobs, have no economic rent as their earnings consist entirely of
transfer earnings. Employers can hire an infinite supply of labor at the market
wage W
The circular flow of income
Multiplier: shows the relationship between an initial change in spending and the
final rise in GDP
Change in income / change in injection
Closed economy
Mps = 1 / marginal propensity to save OR 1 / 1 - mpc
Mpc = change in consumption / change in income
if a person receives an extra £100 of income and spends £ 70, mpc will be 0.7 and
mps will be 1 − 0.7 = 0.3
closed economy with government sector
There is extra injection, G(government spending) and extra withdrawal T (tax)
Multiplier = 1 / mps + mrt
Mrt = marginal rate of tax, marginal propensity to tax
Open economy with government sector
Most realistic model as it includes all four possible sectors (households, firms, the
government and the foreign trade sector)
C + I + G + (X − M) = Y, and
injections equal withdrawals, which is now where I + G + X = S + T + M
1 / mps + mrt + mpm
Mpm = marginal propensity to import
Saving is defined as disposable income minus consumption.
Aps = saving / income
Average propensity to save. As income rises, the actual amount saved and aps
tend to increase. The rich usually have a higher aps than those with low incomes.
Mps = change in saving / change in income
Income rise = mps rise
Apc = consumption / income
As people can either save or consume, apc will be equal to 1 – aps. The rich will
have lower mpc and higher mps.
Multiplier: 1 / 1 – MPC OR 1 / MPS
Marginal rate of tax is the extra proportion income paid in tax
Mrt = change in tax / change in income
Marginal propensity to import
Mpm = change in import / change in income
The level of national income in an economy is determined where aggregate
demand equals aggregate supply
Aggregate expenditure = consumption (C), investment (I), government spending
(G) and net exports; that is, exports minus imports (X − M)
If aggregate expenditure exceeds current output, firms will seek to produce more
They will employ more factors of production and GDP will rise.
Whereas if aggregate expenditure is below current output, firms will reduce
production.
If aggregate expenditure rise due to consumption and investment increase,
output will increase
GPD increasing
A change in the total spending on a country’s goods and services will result in
national income changing by the size of the injection times the multiplier.
Example: multiplier is 2.5, if their spending rise by 500b, the nation income will
rise by 1250b.
consumption function indicates how much will be spent at different levels of
income.
C = a + bY, where C is consumption, a is autonomous consumption (that is the
amount spent even when income is zero and which does not vary with income), b
is the marginal propensity to consume and Y is disposable income.
For example, if C = $100 + 0.8Y and income is $1000, the amount spent will be
$100 + 0.8 × £1000 = $900
savings function is the reverse of the consumption function and is given by the
equation: S = –a + sY
S is saving, s is the marginal propensity to save, Y is income and a is autonomous
dissaving (that is, how much of their savings people will draw on when their
income is zero; this amount does not change as income changes). sY is induced
saving (that is, saving that is determined by the level of income)
if S = −$200 + 0.2 × $4000 = $600.
average propensity = saving / income = 600/ 4000 = 0.15
apc = 1 – 0.15 = 0.85
Investment that is undertaken independently of changes in income is known as
autonomous investment. For example, a firm may buy more capital goods it is
more optimistic about the future or because the rate of interest has fallen.
Induced investment is illustrated by movement along the expenditure line. This is
because induced investment is investment that is influenced by changes in
income
Accelerator theory:
investment depends on the rate of changes in income (and therefore consumer
demand), and that a change in GDP will cause a greater proportionate change in
investment.
If GDP is rising, but at a constant rate, induced investment will not change. This is
because firms can continue to buy the same number of machines each year to
expand capacity. However, a change in the rate of growth of income can have a
very significant influence on investment.
The table shows that when demand for consumer goods rises by 25% (from 800
to 1000) in the second year, demand for capital goods rises by 200% (from 1 to 3).
However, an increase in demand for consumer goods does not always result in a
greater percentage change in demand for capital goods. For instance, firms will
not buy more capital goods if they have spare capacity or if they do not expect
the rise in consumer demand to last
Economies do not often operate at the full employment level of national
income. At any particular time, they may be producing where total
spending is above or below that needed for national income to equal
potential output.
inflationary gap will occur if aggregate expenditure exceeds the potential output
of the economy. In such a situation, not all demand can be met, as there are not
enough resources to do so
Excess demand will drive up the price level
Graph shows that an economy is in equilibrium at a GDP of Y, which is above the
level of output, X
Distance ab represent inflationary gap
government may seek to reduce an inflationary gap by cutting its own spending
and/or raising taxation in order to reduce aggregate expenditure.
equilibrium level of GDP may also be below the full employment level. In this
case, there is said to be a deflationary gap. Graph shows that the lack of
aggregate expenditure results in an equilibrium level of GDP of Y, below the full
employment level of X. There is a deflationary gap of vw.
deflationary gap is increased government spending financed by borrowing.
1. The economic ideas of John Maynard Keynes were formulated in the 1930s.
In October 1929, the United States stock market crashed, followed by the
Great Depression.
2. The traditional economic model of supply and demand couldn’t be used
because it did not show factors like total consumption in an economy.
Keynes instead invented The Keynesian diagram.
3. Unemployment is bigger, The horizontal axis usually represents national
income or real GDP. The vertical axis often represents aggregate
expenditure or total spending in an economy.
4. National income is the total income by the country. "Determination" often
refers to finding the value of a variable or solving a problem based on given
conditions. In the context of Keynesian economics, "National Income
Determination" refers to the model that aims to determine the equilibrium
level of national income where aggregate expenditure equals national
income.
5. 45-degree line is a line of reference and shows all those points where
aggregate expenditure and output are equal. It indicates that vertical axis
measurement is equal to horizontal axis measurement.
6. If expenditure is less than income or level of output, then there will be
unsold good in the market. If expenditure is greater than level of output,
this will emptied all the shelves of goods, and firms will produce more
output to meet the expenditure, could also cause inflation.
7. It could shift upward or downward, factor such as tax, investment, export
import, consumer confident, government policy…
8. Consumption is a function of disposable income. It depends on various
factors such as income levels, consumer preferences, expectations, and
government policies. consumption function indicates how much will be
spent at different levels of income.
9. Autonomous consumption and expenditure are independent of income
levels, while induced consumption and expenditure depend on income
changes. Similarly, autonomous saving is the portion of savings that is not
influenced by changes in income, while induced saving depends on income
fluctuations
10.Autonomous components remain constant regardless of income changes,
whereas induced components vary based on income levels.