Economics Microeconomics
September:
The Basic Economic Problem:
Opportunity cost- Cost of the next best alternative.
Economic goods- Scarce resources
Free goods- Resources that are not scarce
Resources are scarce but the wants are finite. This causes economics agents to make choices: they must allocate scarce resources between competing uses. Therefor the basic economic problem is one of scarcity and choice.
There are limited resources on earth and therefore these are known as Scarce Resources.
There are four factors of production which are resources used in the production process. These are land, labour, capital and enterprise. They also all have associated costs or rewards.
Land- All natural resources (rent).
Labour- The physical and mental work of people (wages).
Capital- Imputs that help to create consumer goods.
Enterprise- The human capital involved with organizing factors of production and taking risk (profit).
Entrepreneurs--- taking risk---rewards
A positive statement is something that can be tested. Normative statement is instead based on opinion or subjective values.
CELL:
Capital, Enterprise, Land, Labour
Opportunity cost:
Opportunity Cost can be illustrated by using Production, Possibility, Frontiers that show the effects of making an economic choice.
OC= the cost of the next best alternative forgone
Work-leisure choices- The opportunity costs of deciding not to work an extra ten hours a week is lost wages given up.
Production possibility frontiers:
Opportunity cost can be illustrated by using Production Possibility's Frontiers that show the effects of making an economic choice.
A PPF shows the maximum possible output combinations of two goods or services that an economy can achieve when all resources are fully and efficiently employed.
Opportunity cost: The opportunity cost of producing more of one good is the amount of other goods that must be given up. The slope of the PPF represents the opportunity cost of switching from producing one good to producing another
If it’s a straight-line opportunity cost is the same.
Capital goods are used to make consumer goods and services. Capital inputs include fixed plant and machinery, hardware, Sofware, new factories and other buildings.
Consumer durables- Products that provide a steady flow of satisfaction/ utility over their working life. (washing machine or phone).
Consumer non- durables- Products that are used up in the fact of consumption (drinking coffee).
Consumer services- haircut or a ticket to a show.
Free Market Economy:
A free-market economy is characterized by minimal government intervention in economic activities.
In such economies, prices are determined by supply and demand forces in the marketplace.
Private individuals and businesses own and control the means of production and make economic decisions.
Competition is a central feature of a free market economy, which is believed to drive innovation and efficiency.
Key examples of countries with free market economies include the United States and Hong Kong.
Mixed Economy:
A mixed economy combines elements of both market and command economies.
In a mixed economy, the government plays a role in regulating and overseeing certain economic activities, such as healthcare, education, and infrastructure.
Private individuals and businesses still operate freely in markets for goods and services, but the government intervenes to address market failures and ensure public welfare.
Many developed countries, including the United Kingdom and Canada, have mixed economies.
Command Economy:
A command economy is characterized by extensive government control over economic activities.
In such economies, the government owns and controls the means of production and determines what goods and services are produced, how they are produced, and for whom they are produced.
Prices are often set by the government, and there is limited room for individual decision-making in economic matters.
Historically, the Soviet Union and North Korea were examples of command economies.
Shifts in PPF:
Causes of an inward shift on an economy's PPF- Natural disasters, large scale net outward labour migration, Destruction/ loss of factor inputs caused by civil war, A trend decline in the productivity of inputs perhaps caused by a persistent recession which causes net investment to be negative.
Specialization- When an economy concentrates on a specific product or task. Specialization happens at all levels of economic activity.
Division of Labour- Where production is broken down into many separate tasks.
Division of labour can raise output per person as people become proficient through constant repetition of a task. This is called “learning by doing”. This gain in productivity helps to lower the supply cost per unit.
Production- Volume of output over a given period
Productivity- efficiency of production, output achieved with a given number of inputs.
Unrewarding repetitive work that requires little skill can lower motivation and eventually causes lower productivity. Workers may take less pride in their work and quality suffers. Dissatisfied workers become less punctual at work and the rate of absenteeism increases.
Sectors of industry:
Primary- Raw materials are extracted and food is grown
Secondary- raw materials are transferred into goods
Tertiary- Finished goods available for sale/production of services
The four functions of money:
A medium of exchange- To buy and sell goods.
A measure of value- a unit of account. This can be affected by high inflation.
A store value- links the present and future value. This can be negatively impacted by very high inflation.
A method of deferred payment- credit and borrowing- the accepted way, in markets of settling a debt.
Forms of money:
Cash- Notes and coins, a perfect medium of exchange, but affected by inflation.
Money in current accounts- Cash on demand and debit cards but there is not a perfect medium of exchange as they can be declined.
Near monies- Assets that fulfil some but not all the functions of money but are not a medium of exchange for example an (ISA)
Non money financial asset- All financial assets can be turned into money (house).
Utility- Maximising agents' economic welfare is often referred to or measured by the concept of utility: the satisfaction or benefit derived from consuming a goof or set of goods.
Consumer- want to maximise their purchasing power
Workers- Want to maximise their own welfare at work.
Firms- Want to maximise the utility of ownership.
Governments- are assumed to want to maximise the economic welfare to their citizens.
Neo-Classical Theory- A theory of economics which typically starts with the assumption that economic agents will maximise their benefits and act rationally.
Homo economicus is based on the idea that people are rational and self-interested and make descions based on maximizing their own utility or satisfaction.
Margin- Assumes that all decisions are taken in isolation.
Margin Benefit (MB)- This refers to the additional benefit gained from producing or consuming one more unit of a good or service.
Marginal cost (MC)- This represents the additional cost incurred that comes from making or producing one additional unit.
Demand- The quantity of goods or services that consumers are willing and able to buy at a given price in a given time period.
Derived demand is the demand for a factor of production used to produce another good or service.
Composite demand is where goods have more than one use.
Veblen goods- People will by item when they are scarce.
Giffen good- low-income, non-luxury product for which demand increases as the price increases.
Causes of shifts in the Demand Curve:
Changing prices of a substitute goods
Changing prices of a complements
Changes in the real income of consumers
Seasonal factors
Social and emotional factors
Interest rates
Market shocks (recession, commodity prices(oil)
P-Population
I-Income
R-Related goods
A-Advertising
T-Tastes
E-Expectations
S-Seasons
Other factors can also cause demand for a product to change these are called conditions of demand.
The law of diminishing marginal utility explains that as a person consumes more of an item or product, the satisfaction (utility) they derive from the product.
Consumer surplus- the difference between how much buyers are prepared to pay for a good and what they pay.
Supply:
Supply- Shows the quantity of a goods that suppliers are willing to sell at any given price.
When supply is affected by price changes, this is known as movement along the curve.
P-Productivity
I-Indirect Taxes
N-Number of firms
T-Technology
S-Subsidies
W-Weather
C-Cost of production
These conditions can cause a shit in the supply curve to the left or the right.
Price determination:
Equilibrium means a state of equality or balance between market demand and supply.
Prices where demand and supply are out of balance are called points of disequilibrium.
Equilibrium price- Where planned demand equals planned supply.
Price has three important functions in allocating resources in a market.
Rationing- Prices serve to ration scarce resources when market demand outstrips supply.
Signalling- Prices adjust to demonstrate where resources are required, and where they are not.
Incentives- Price acts as an incentive for buyers and sellers-buyers and sellers behave rationally and will want to maximise utility.
Allocation of recourses
R-Rationing
S-Signalling
I-Incentive
Producer and Consumer Surplus:
Consumer surplus- is a measure of the welfare that people gain from consuming goods and services.
Producer surplus is the difference between two price levels
Midpoint= Allocative Efficient
Price Elasticity of demand- The responsiveness of change in quantity demanded in relation to a change in price.
What factors determine PED:
Number of close substitutes for consumers
Price of the product in relation to total income
Cost of substituting between different products
Brand loyalty and habitual consumption
Degree of necessity/ luxury
S-ubsitutes (number of close alternatives)
P-ercentages of income
L-uxary/ necessity
A-addictive/ habit forming
T-ime
Elastic only irritates skin
Elastic- Opposite, inelastic same
Income Elasticity of Demand:
Income Elasticity of Demand- The responsiveness of change in quantity demanded in relation to changes in income.
YED
Inferior v Normal good
Example;
Normal good- Fresh vegetables Inferior good- Tinned vegetables
A normal good will always have a positive income elasticity because quantity demanded and income either both increase or both decrease. An inferior good, however will always have a negative elasticity because the signs on the top and bottom of the formula will always be opposite.
Cross elasticity of demand (XED):
Cross elasticity of demand measures the proportionate response of the quantity demanded of one good to the proportionate change in the price of another. For example, it is a measure of the extent to which demand for pork increases when the price of beef goes up.
Substitutes:
Substitutes are products in competitive demand.
With substitutes, an increase in the price of one good (cetirus paribus) will lead to an increase in demand for a rival product.
The value of XED for two substitutes is always positive.
Complements:
Complements are products in join demand
A fall in price of one product causes an increase in demand for the complementary prod uct.
The value of XED for two complements is always negative.
XED
<0 (negative)
Complements
>0 (positive)
Substitutes
0
Unrelated goods
Price elasticity of supply (PES):
Definition- measures the proportional change in quantity supplied due to a proportional change in price.
If supply is elastic, producers can increase their output without a rise in cost or a time delay.
If supply is inelastic, firms find it hard to change their production in a time period.
Factors determining PES:
Time scale
Spare capacity
Level of stock
Barriers to entry market
Indirect and direct taxes:
January
Why does the government impose taxes on society- Governments put taxes on society for lots of different reasons. Firstly, taxes are a primary source of revenue to fund public services and infrastructure such as education, healthcare, defence, and public safety. Secondly, taxes are used to redistribute wealth and help with economic inequalities by collecting more from those with higher incomes and providing support to those in need.
Difference between direct and indirect taxation-
Direct Taxation:
Definition: Direct taxes are directly on individuals and these taxes cannot be given to someone else. The person on who the tax is must pay it
Examples: Income tax, corporate tax, property tax, and wealth tax are examples of direct taxes.
Indirect Taxation:
Definition: Indirect taxes are put on goods and services and the tax can be shifted from the person who pays the tax to someone else. The final consumer often has to pay the tax.
Examples: Value Added Tax (VAT), goods and services tax (GST), excise duties, and customs duties are examples of indirect taxes.
Difference between progressive, regressive and proportional taxes-
Progressive Taxation:
Definition: In a progressive tax system, the tax rate increases as the taxable income of an individual rises. Higher-income individuals pay a higher percentage of their income in taxes compared to lower-income individuals.
Example: A progressive income tax might have different tax brackets, with higher rates applied to higher income levels.
Regressive Taxation:
Definition: In a regressive tax system, the tax falls disproportionately on lower-income individuals or households. As income increases, the percentage of income paid in taxes decreases.
Example: Sales taxes are often seen as regressive because everyone pays the same rate on purchases regardless of their income, and this can represent a larger proportion of income for lower-income individuals.
Proportional Taxation (Flat Tax):
Definition: Proportional taxation, also known as a flat tax, imposes the same tax rate on all individuals or entities, regardless of their income. The tax burden is proportional to income, meaning everyone pays the same percentage of their income in taxes.
Example: If there is a flat income tax rate of 10%, everyone, regardless of income level, pays 10% of their income in taxes.
What is meant by a “Pigouvian tax”- A Pigouvian tax is put on things that cause problems for others, like pollution. The goal is to make the people and businesses doing these things think about the wider impact. By adding the extra cost of these problems to the price of things, Pigouvian taxes want to make sure that what people and businesses do is good for everyone. This way of doing things helps the economy work better and helps take care of the environment by stopping harmful actions and encouraging better choices for everyone.
Indirect taxes and subsidies:
Ad Valmore tax- Increases in proportion to the value of the base tax (the price of the good).
Specific tax is tax that does not change with the value of the good, but the amount or volume purchased (a bottle of wine).
Excise duties in the UK are indirect taxes levied on three major categories of goods- alcoholic drinks, Tobacco products and road fuels
Indirect taxes and Elasticity:
When demand is elastic (PED>1) the incidence of tax will be greater for a supplier than consumer.
When demand is perfectly elastic (PED= infinity), the incidence will fall on suppliers.
When demand is more inelastic (PED<1), the incidence of the tax paid by the consumer will be bigger and the incidence of tax on the producer will be smaller. When demand is perfectly inelastic (PED=0), the incidence will fall on consumers.
Q-Question Using an example explain why the government imposes specific taxes on many goods and services.
Answer-The government imposes specific takes on society to try reducing the amount of demand on these goods and services. An example of this could be the high tax on cigarettes. This could also be known as a Pigouvian tax the government do this to reduce the negative impacts on society. For example, smoking cigarettes links directly with bad health putting more pressure on the nhs.
The more inelastic the more consumers are going to benefit the more elastic the more producers are going to benefit.
Government subsidy- Is a form of financial support offered to producers and occasionally consumers. Subsidies to producers reduce the marginal cost of supply.
Justifications for Subsidies:
Helping poorer families with food and childcare costs
Improved nutrition can lift labour productivity and reduced the burden on health services.
Drawbacks of subsidies:
Producers can be “subsidy dependent”
Subsidy can distort resources allocation
Environmental risks from excessive production
Subsidies are difficult to remove
Effects of subsidies:
Subsidies increase output and lower prices for consumers which could help families on low and fixed incomes. (Reduces inequality) They could help boost demand during periods of economic decline.
Market failure:
Market failure is when the free market fails to allocate recourse to the best interests of society, leading to an inefficient allocation of scare recourses.
Information failure- Occurs when people have inaccurate or incomplete data and so make potentially “wrong choices”.
Long- term consequences- Information gaps about long term benefits of cots of assuming a product.
Complexity- Information failure when a product is highly complex.
Unbalanced knowledge- When the buyer may know or then the seller or vis versa.
Price inforation- When consumers are unable to quickly/ cheaply find sufficient information on the best prices for different products.
Asymmetric Information- This occurs when somebody knows more than somebody else in the market.
Private and Social Costs/ Benefits:
Private Costs:
Definition: Private costs are the expenses or negative consequences incurred by an individual or a firm in producing or consuming a good or service.
Example: If you decide to buy a car, the private costs will include the actual cost of the car, insurance, fuel, maintenance, etc.
Private Benefits:
Definition: Private benefits are the gains or positive outcomes experienced by an individual or a firm because of producing or consuming a good or service.
Example: Continuing with the car example, the private benefits would include the convenience of transportation, the enjoyment of driving, and the satisfaction of owning a vehicle.
External Costs:
Definition: External costs are the negative side effects or expenses that result from an economic activity but are not borne by those directly involved in the activity.
Example: If a factory pollutes a river while producing goods, the cost of cleaning up the pollution and its impact on the health of nearby residents are external costs because the factory and the consumers do not directly pay for these consequences.
External Benefits:
Definition: External benefits are the positive side effects or advantages that result from an economic activity but are not directly enjoyed by those involved in the activity.
Example: Planting trees in a neighbourhood not only beautifies the area but also provides cleaner air for everyone. The improved air quality is an external benefit because individuals who didn't plant the trees still enjoy the positive impact.
Marginal private cost (MCP)- Cost to the producing firm of producing an additional unit of output.
Marginal social cost (MSC)- Total cost of society to producing an extra unit of output. (MSC=MPC+ MEC)
Marginal private benefit (MPB)- Benefit to the consumer of consuming an additional unit of output.
Marginal social benefit (MSB)- Total benefit to society from consuming an extra unit. (MSB=MPC+MEC)
Deadweight= triangle-Deadweight loss is an unrecoverable cost to society.
The key problem is that often, economic agents do not take account of the costs their decisions impose on others. The market fails to price negative externalities properly leading to a misallocation of recourses from a social perspective.
When a tax is imposed the external costs are seen to be internalised between producer and consumer.
Positive Externality:
Definition: A positive externality occurs when the benefits of an economic activity spill over to third parties who are not directly involved in the activity.
Example: Education is a classic example of a positive externality. When an individual gets educated, not only do they benefit by gaining knowledge and skills, but the society benefits from having a more educated and skilled workforce, leading to higher productivity and economic growth.
Negative Externality:
Definition: A negative externality occurs when the costs of an economic activity are imposed on third parties who are not directly involved in the activity.
Example: Pollution is a common negative externality. When a factory releases pollutants into the air or water, it may harm the health of people living nearby or damage ecosystems. The costs of healthcare and environmental damage are borne by individuals and society, even though they are not involved in the production process.
Social benefit= private benefit + external benefit
Public goods:
Non-excludability: Benefits derived from pure public good cannot be confined solely to those who have paid for it. Non-payers can enjoy the benefits of consumption at no financial cost to themselves- economists call this the “free rider” problem.
Non-rival consumption: Each party's enjoyment of the good or service does not diminish others enjoyment- in other words the marginal cost of supplying public good to an extra person is zero. If a public good is supplied to one person, it is available to all.
Private goods- Are rival and excludable, for example, a choclate bar can only be consumed by one consumer. Moreover, private property rights can be used to prevent others from consuming the good.
Private Goods:
Private goods are goods that are both rivalrous and excludable.
Rivalrous: Consumption by one person reduces the amount available for others. For
example, if you eat an apple, that apple is no longer available for someone else to eat.
Excludable: It's possible to exclude people from using the good if they haven't paid for it. For example, if you buy a ticket to a movie, you can be excluded from watching the movie without a ticket.
Examples of private goods include food, clothing, cars, and smartphones.
Public Goods:
Public goods are goods that are non-rivalrous and non-excludable.
Non-rivalrous: Consumption by one person does not reduce the amount available for others. For example, if you enjoy the benefits of a streetlight, it doesn't diminish the light available for others.
Non-excludable: It's difficult or impossible to exclude people from using the good, even if they haven't paid for it. For example, national defence protects everyone within a country's borders, regardless of whether they contribute to its funding.
Examples of public goods include national defence, street lighting, public parks, and clean air.
Quasi-public good, is a type of good that shares characteristics of both private and public goods. Quasi-public goods are excludable but not entirely rivalrous in consumption. This means that while access to the good can be restricted to those who pay for it, the consumption of the good by one individual does not significantly reduce its availability for others. Examples of quasi-public goods include highways, libraries, and cable television.
The non-rival nature of consumption provides a strong case for the government rather to provide and pay for public goods.
Examples of quasi-public goods:
Many NHS hospitals and financed by a mix of state and private companies.
Global public goods:
Security from war
The rule of law, property rights and contract enforcement
Diseases
Non use of nuclear weapons
Public Goods and the Tragedy of the Commons- A term used in social science to describe a situation in a shared-resource system where individual users, acting independently according to their own self-interest, behave contrary to the common good of all users by depleting or spoiling that resource through their collective action.
The tragedy of the commons is caused mainly by the lack of property rights meaning that the government/ community cannot protect the resource.
Public goods recap:
Non-rivalrous: Consumption by one person does not reduce the amount available for others. For example, if you enjoy the benefits of a streetlight, it doesn't diminish the light available for others.
Non-excludable: It's difficult or impossible to exclude people from using the good, even if they haven't paid for it. For example, national defence protects everyone within a country's borders, regardless of whether they contribute to its funding.
Examples of public goods include national defence, street lighting, public parks, and clean air.
Non-rejectable: The collective supply of a public good for all means that it cannot be rejected by people, a good example is a nuclear defence system or flood defence projects.
The reason on why services such as lighting and national defence need to be provided by the government is because people will not pay for these services. This is because they are non-rivalrous which means one
Problems with Environmental Taxes:
Assigning the right level of taxation: There are problems in setting the right tax so that the private cost will equal the social cost.
Consumer welfare effects: Producers may pass on a tax to the consumer if the demand for good is inelastic.
Effectiveness of a tax and unintended consequences:
Effect of tax depend on the elasticity of demand
Problems in setting the tax rate at the right level to archive aims.
How much tax revenue is raised:
Does an indirect tax generate substantial tax revenue.
How is tax revenue used
Consequences for equity:
Who are the main winners and losers
Dose a tax have a regressive impact on lower incomes
Subsidies effective meeting their aims:
Will they achieve desired stimulus
Is subsidy sufficient
Will subsidy affect productivity:
Subsides for investment and research can bring positive spillover.
Firms may be depended on state aid.
Maximum price- This is a legally imposed maximum price (or price ceiling) in a market that suppliers cannot exceed. A maximum price is introduced to prevent prices rising above a certain level.
March:
A maximum price crates a shortage of Q1 to Q2 in the market meaning many consumers will not be able to access housing or food despite the lower prices as existing suppliers have now left the market or are simply not willing to supply at such a low price.
Minimum prices:
Some goods, such as cigarettes and alcohol have significant negative externalities.
Arguments for a minimum price:
Reduces negative externalities from heavy alcohol consumption
Pubs may benefit from higher minimum prices in supermarkets
Arguments against a minimum price:
Minimum price is a tax on responsible drinkers.
Regulation:
Regulating negative externalities- Can be more effective is demand is unresponsive to price changes- Regulations can be gradually toughened each year (this will help stimulate capital investment)
Disadvantage of regulation- High costs of enforcement- Regulation can lead to unwelcome unintended consequences.
Trade Pollution Permits:
Externalities caused by pollution can be reduced using trade pollution permits. (Firms are legally allowed to pollute but governments put a cap on how much they can pollute)
Definition: Trade pollution permits is a system where companies can buy and sell permits that allow them to emit a certain amount of pollution, within an overall limit set by the government.
Example: Imagine there are three factories in a city, each allowed to emit 100 units of pollution. The government sets a total cap of 300 units. Factory A finds a way to reduce its emissions and only needs 80 units, so it has 20 extra units. Factory B needs more permits because it's difficult for them to reduce pollution, so they buy 20 units from Factory A. Factory C, on the other hand, has outdated equipment and needs 120 units to operate, so it buys 20 units from Factory A and 20 units from Factory B. In this way, the total pollution stays within the limit, but each factory has flexibility in how they manage their emissions.
Evaluation:
Is it cost-effective?
Compare the cost of reducing pollution through trading permits to other methods.
Check if it encourages industries to find cheaper ways to reduce pollution.
Is it fair for everyone?
Make sure the costs and benefits are distributed fairly among different groups.
Check if vulnerable communities are protected and decision-making is transparent.
Effective enforcement may not be possible.
Pollution is an international market failure that requires an international solution.
State provision of Public Goods:
Information failure:
Information failure occurs because one party to a transaction does not have the information that is available to make a decision.
Policies for addressing information failures
Compulsory labelling on products (cigarettes).
Improved nutritional information on food and drinks.
Dangers of gambling addiction.
Pollution permit
Legally go to school until 16
Anti-competitive practices are illegal, such as collusion. (price fixing)
Public choice theory
Rent seeking
What is meant by Government Failure:
Government failure occurs when an intervention leads to a deeper market failure or even worse a new failure may arise
Government failure can happen if a policy decision fails to create enough of an incentive to change people's actual behaviour.
Examples of causes of government failure:
Political self-interest (public choice theory)
Regulatory capture
Information gaps
High enforcement/ compliance costs
Policy myopia (short term)
Damaging effects of red tape (excessive regulation)- inc barriers to market entry
The law of Unintended Consequences:
Examples:
Bank bail outs- raises the problem of moral hazards (banks take excessive risk (2008 QE)
Windfall Tax on North Sea oil and gas led to huge fall in investment and exploration- casing UK imports to rise.
Note
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