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Friday, 30 December 2011

Top 10 Posts This Year

Today is a very special day, not just because it is New Year's Eve eve, but because it is the blog's five month anniversary with my first post being on purchasing power parity! Below I have compiled a list of the top 10 posts so far. If these are popular, I am assuming they have been most helpful to you guys, so please have a look at all 10, and good luck with your revision.

10. Trade Unions posted on 16th November

9. Oligopoly Case Study  posted on 16th October. Although it was a few months ago, the case study can still be used as an example.

8. Word of the Day: Economic Growth on a PPF posted on 3rd August

7. Notes on Supply Side Economics and Crowding Out posted on 16th October

6. Word of the Day: Backward Bending Supply Curve  posted on 25th August

5. Negative Externalities posted on 16th September

4. Monopoly posted on 23rd August

3. Word of the Day: Elasticity posted on 13th August

2. Perfect Competition Long Run Equilibrium posted on 11th August

1. Perfect Competition Short Run Equilibrium posted on 10th August

It seems perfect competition is the most popular, not surprising because even I had difficulties with this one.

Keep looking out for more revision notes to come soon!

Tuesday, 27 December 2011

The World Tonight on Boxing Day!

Merry Christmas to everyone!!! Hope that you all got what you wished for, but also that you've have been busy revising for January exams!

The World Tonight had a special report on the global economy and the free market. Listen here from 7 minutes  30 seconds. Listen out for case studies and recent news to back up your arguments in the exam.

Wednesday, 21 December 2011

LSE video - The Crisis in Greece

The LSE interviewed Dr Daphne Halikiopoulou - research at the LSE- regarding the crisis in the eurozone. Watch the video here, for an insight into Greece and their economy.

BBC Radio 4 - The World Tonight

'The World Tonight', a BBC Radio 4 programme, yesterday, touched on the UK economy, discussing the following:

  • Slowing growth and rising unemployment
  • The importance of moving the economy from services to manufacturing
  • Case Study: Starbucks: increasing training opportunities, education in management, job creation and career pathing 
  • Vicious circle: 
    • Manufacturing declines à Training and development of people to go into this sector declines à Manufacturing declines further
  • Euro sovereign debt crisis
  • The look into the future in 2012
Listen from 0:11:40 to 0:28:00 for the programme on 20/12/11 on this link: BBC R4 The World Tonight

Tuesday, 13 December 2011

Recent inflation figures!

Once again, the new inflation figures have come out for November and the CPI has fallen 0.2% from the previous month. The RPI also fell from 5.4% to 5.2%.
Reasons for the slight fall in inflation include:

    • Supermarket food prices (bread and vegetables) - price war
    • Transport costs - fuel prices fell
However, the rate at which prices are rising is still twice that of the rate of increase of wages, making society worse off. Wage rises are not keeping up with inflation, thus in real terms, salaries are falling.

Thursday, 8 December 2011

What does the UK's economic growth tell us about the impact of cuts?

This blog was created to help you find resources for your exams, as well as providing specific exam revision notes, so below is the link to an article that talks about government cuts and their impacts on society.

http://www.rsablogs.org.uk/2011/adam-lent/growth-data-impact-cuts/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+rsaprojects+%28RSA+blogs%29

 
Make notes about what you read, and notice that the view of Adam Lent conveys that government cuts have not yet stifled growth.

Wednesday, 7 December 2011

Phillips Curve



·     The Phillips curve shows the short run trade off between unemployment and the rate of inflation (see July's post).



·     As unemployment falls, inflation rises. Both demand-pull and cost-push inflation can rise due to low unemployment.

·     Demand pull: When more people are in employment, more people have more spending money. Thus consumption increases, leading a shift of the AD curve to the right and a rise in the price level.

·     Cost push: Low unemployment means there is a smaller pool of labour for employees to choose from. This increases trade union bargaining power for higher wages (see here) and thus increases wage inflation. Because it costs firms more to produce the same level of output, they raise the price of the goods they produce to pass on this extra cost to consumers, contributing to a higher rate of inflation.

·     The trade-off illustrates the difficulty faced by policy makers and the government are faced with choosing the most suitable combination of inflation and unemployment rather than completely eliminating/reducing one of them.

·     The Phillips curve is still debated among many economists as they feel it does not hold. One of the criticisms of the Phillips curve is that in the 1970s (use this as a case study in the exam!!), inflation and unemployment were rising at the same time and there was no trade off. This was called stagflation/slumpflation (see Word of the Day in August).

The Phillips Curve relates to the quantity theory of money, so, if you have forgotten why, refresh your memory by clicking here!

In the long run, there is NO trade off between inflation and unemployment, shown in the diagram below. 



NRU is the Non-accelerating inflation Rate of Unemployment. This means that it is the only rate of unemployment that the inflation rate does not change, the natural rate of unemployment. It is also known as the equilibrium level of unemployment.


Sunday, 4 December 2011

Negative Externality

There is a great video for those of you who are unsure about negative externalities conducted by my favourite person when I was studying my A-Levels, Paj Holden! To watch the video, please click here.

Please also look at my post on negative externalities as this will also help you.

Speculation


·     One of the factors that affect economic growth (see here), speculation is when the buying and selling activities of firms and individuals (known as speculators) affects the price of goods and commodities around the world.

·     Speculation can also influence the price of world currencies.

·     Before the crisis in 2007, the value of the pound rose significantly because interest rates were high prompting speculators to buy the pound because rewards for saving were greater.

·     Speculation can affect economic growth because of something known as the ‘speculative bubble’, relating to asset prices. Click on this link here for a more detailed analysis. Rapid growth of assets prices such as housing (e.g. 2007), commodities (gold, silver..) and shares/bonds can lead to a bubble because people speculate that the price will continue to rise so they buy more of these assets. When the price is above the real value of the asset, people will start to sell and the bubble bursts, leading to a collapses in business and consumer confidence and ultimately a recession.

Wednesday, 30 November 2011

Autumn Statement

Following the Chancellor's Autumn Statement yesterday, I found this excellent summary available on the BBC for you guys to read. It explains the key points and breaks down what he discussed into sections of the economy. Click here to view it.

There are also many pages on the FT from yesterday's statement. There are videos and interactive graphics so do look at them. The FT would have a more critical analysis of the issue and critique some of the policies and schemes introduced so read them to develop a better evaluation for the exam. Click here for it.

Sunday, 27 November 2011

The Andrew Marr Show

This morning the Chancellor, George Osborne and the shadow Chancellor, Ed Balls, were on The Andrew Carr show talking about the economy and the government's fiscal position. The Chancellor outlines the new schemes that are being introduced to help small medium sized businesses and Britain's position in the Eurozone crisis.

Here is the link for BBC iplayer to watch it:

http://www.bbc.co.uk/programmes/b01803z5

Next week Nick Clegg is on the show, so for those of you who are still interested in what he has to say, watch the show next week as well. Alternatively, I will post up the iplayer link next week as well.

Thursday, 24 November 2011

BBC programme called 'Your Money and How They Spend It'

There is a really good programme by the BBC's political editor, Nick Robinson. It concerns itself with the fiscal policy of the UK in the past and the future. It describes the government's decisions in the allocation of resources and how the government spends our money. The programme is on the link here and is broadcast every Wednesday at 9pm on BBC2.  The issues discussed include:


  • Politics
  • UK's budget
  • Ageing population
  • Winter fuel allowance
  • Pensions
  • NHS
  • Financial crisis 2008
  • Tuition fees
  • Inequality
  • Infrastructure spending
Please watch it, there are case studies that you can use in your exam and some statistics that, if you learn, will make your exam answers different than others. It is also useful to know about previous governments' fiscal policies. The extra knowledge that you will receive will definitely be beneficial.


Thursday, 17 November 2011

Energy in the 21st Century - Commodity Markets


'Cheap resources underpinned economic growth for much of the 20th century. The 21st will be different'. http://www.mckinseyquarterly.com/A_new_era_for_commodities_2887?srid=520

Read the short article about the future for commodities to give you a better overview of the commodities market. You might need to register to read the full article, but if you don't want to register, I have posted up a summary below.

  · Research from McKinsey Quarterly shows that in the past eight years, prices have risen to levels not seen since the 1900s.

  · Price are very volatile – similar to that of the oil shock in the 1970s.

  · The future oil prices look set at remaining high and volatile because of two factors:
o Global supply is changing. If oil reserves begin to decline, prices will shoot up, until a factor such as new reserves being found, affects the price and they begin to drop.
o Inelastic supply. This means that OPEC for example, can charge high prices because they know that demand from Western countries particularly, will not decrease so much. To refresh your memory on elasticity, click here.

· Demand for energy, food, water and raw materials will rise exponentially as three billion new middle-class consumers will arise in the next 20 years.
o In India, calorie intake is predicted to rise by 20% within the next 20 years and per capita meat consumption is set to rise by 60%
o Demand for infrastructure will rise

  · Through the 20th century, demand rose between 600-2000% for some commodities, however the reason prices did not rise so dramatically was due to improvements in exploration and extraction techniques enabling new reserves and sources to be found.

· Climate change and rising carbon emissions illustrates the rise in resource usage.

· For the future, outlook for supply increases in bleak because it is becoming harder to find new reserves of raw materials and freshwater in the short run.
o Supply is increasingly becoming inelastic in the future
o The marginal cost for resources is increasing as they are depleted faster and costs of extracting in unconventional methods/locations rise. For example, tar sands, the alternative to pure crude oil, requires separation from sand, using up more energy and water.
o In Uganda, water shortages have led to higher energy prices in a country already trying to develop. This has led to burning wood for energy à deforestation à soil degradation à food supplies fall.

·  A future solution includes trying to increase productivity from natural resources by, for example, improving mining recovery rates, making households more energy efficient (home insulation, solar panels…etc) and reusing wastewater.  

·  If you want to find out more, check out this live stream of the event ‘Resource Revolution: Meeting the World’s Energy, Water, Food and Material Needs’ that you catch watch on Thursday 24th November through this link:

http://www.chathamhouse.org/livestream-mckinsey

Wednesday, 16 November 2011

The Quantity Theory of Money


The quantity theory of money

·       Explains that a rise in the money supply leads to excess demand, leading to a rise in prices, inflation. To put it simply, too much money chasing too few goods.

·       The quantity theory is a special case of demand pull inflation.

·       The Fisher Equation of Exchange provides evidence for the quantity theory of money.

MV = PT
M = money supply               
The total amount of money in circulation in the economy at any given time.

V = velocity
The number of times the money circulates around the economy at any given time. V is influenced by methods of payments such as cash, bank overdrafts, credit or debit. Methods of payments are limited therefore V remains constant.

P = price level

T = total transactions
The measure of all the purchases of goods and services in the economy. T remains constant because the theory assumes money is a medium of exchange, not a store of value, therefore people spend quickly any money they receive.
If V and T remain constant, they cancel each other out and thus a M = P. This means that a rise in M will create a rise in P, therefore explaining the theory.
Criticisms

Keynesians generally reject the theory because….

1. There are too many assumptions that the theory relies upon. They don’t believe that people quickly spend any money they receive. Instead, people hold money balances if share prices/bonds are likely to fall for example, thus V and T cannot remain constant.

2.  If there is spare capacity in the economy, Keynesians believe that real output and employment will increase, not the price level. However a counter-argument for that would be the Phillips Curve (more on that to come!).

3. If M has increased, the effect it can have on P is limited if V balances out the increase in P. Reflation of the economy can further limit the effect of a rising money supply on the price level.

4. Reverse causation: Inflation causes an increase in the money supply, not the other way round. Cost push inflation occurs and the money supply adapts (by rising) to finance a higher price level set for consumers to pay.

Normal Good

A normal good is one where, as incomes rise, demand for the good rises. For example, my demand for clothes and shoes would rise if my income rose.

In contrast to a normal good, is an inferior good, where notes on that can be found here.

Trade Unions


A collective association of workers whose aim is to improve the pay and conditions of member workers.

Aim to:
·     Improve real incomes
·     Working conditions
·     Pensions
·     Security
·     Unfair dismissal
·     Counter monopsony power
·     Protect against discrimination

Trade union membership has declined to less than 30% of all those employed in the UK (2007). Reasons for this include:

·     Membership is considered to be a waste since the economy was in a boom creating less of a need to bargain for higher wages

·     Tougher employment laws

·     Little evidence for significant mark-ups in wage levels bought about by trade unions

·     You become less employable if you belong to a trade union

·     Changes to the labour market: decline in jobs in heavy industry to more service sector based, shifts towards shorter employment contracts and more people working part-time/flexible hours

·     Some employers restricted trade unions in their work place

Unions influence pay by:

Ø     Collective bargaining
o      negotiate pay levels above the current levels that exist. This is only effective if the union has control over the total labour supply available in the industry.
Ø     Closed shop agreementemployer and union agree that all workers be part of the union
o      Pre-entry: workers must join the union before starting employment
o      Post-entry: non trade union members get the job but have to join to keep the job. This prevents free-riders benefiting from the mark up bought by the union on wages
o      This was considered to be a labour restrictive practice and is now illegal in the UK


Pre-entry closed shop

The diagram below briefly displays a pre-entry closed shop agreement made by unions.




S1 shows the supply for labour in the market before the closed shop agreement. Supply shifts to the left and becomes more inelastic because the increase in wages has minimal effect on employment if the workers have already been employed by the firm. Employment still, however, falls from L1 to L2 when wages rise from W1 to W2.

Perfectly competitive market

To refresh your memory of the PC market, click on the revision notes of the PC market in the short run and long run.



This diagram shows the effects of a trade union in a perfectly competitive market. The equilibrium wage rate is W1 where the number of workers employed is L1. The effect of the trade union is that wages are pushed up to W2 à the acceptable wage rate for union members. The supply curve becomes W2XS. From W2X, the supply curve is perfectly elastic. Along XS, the curve is upwards sloping because more workers are attracted to higher wage rates. The employer wishes to hire L3 workers but the number of workers willing to work at the wage rate of W2 is L2. Thus there is excess supply of labour, causing classical unemployment between L2- L3

This diagram argues that the trade union causes unemployment, however one can counter-argue, as in the Keynesian view. It is unrealistic to assume that demand conditions remain unchanged because higher wages would normally increase demand for output, thus increasing output and increasing demand for workers to produce more output.

This diagram can also be used to explain the effect of the National Minimum Wage, as well as trade union mark-ups.

Look out for more on the effects of trade unions in a monopsonistic market soon! (To prepare yourself, you could read Word of the Day)

Monday, 14 November 2011

Case Study for Supply Side Economy

A new government scheme has been launched today to tackle our sluggish economic growth. 'Business Link' (for more information and research, visit their website) has started a new scheme called 'My New Business' to give advice to potential entrepreneurs. Could this be a potential supply side policy aimed at shifting our LRAS curve rightward?

Read this short article which explains the potential benefits the scheme will bring to our economy. Click here.

To find out more about supply side policies and supply side economics, see my notes posted here!

Wednesday, 9 November 2011

The New Global Economics

On Monday 14th November, one of a two part programme will be on at 8:00pm about the future of the global economy. The show will be broadcast by Martin Wolf, the chief economics commentator of the FT, where he'll discuss the short and long run effects and how things will be changing in the world.

Please do listen to it, if you can't then listen on iplayer when convenient for you, because this programme will give you valuable analysis that you can use in your exam and possible case studies...etc. To find out more about the programme, click here.

The Credit Crunch

For those of you who are unsure what the 'credit crunch' is, and how it started, watch this simplified, but concise video that explains it.

http://www.youtube.com/watch?v=wGxmgwUWNr0&feature=related

To summarise, occurring in 2008, the credit crunch was the result of over lending to people who are high risk and thus the inability of debtors to pay back their loans. In a simplified version, banks make money through a process called credit creation, lending more than is initially deposited. They know that people will deposit money back into the bank that they borrowed from and so can afford to lend more than they have (given a low liquidity ratio: the proportion of their assets - savers' money - that they keep).

Tuesday, 8 November 2011

Code for Fiscal Stability (1998)


·     Based on the 5 principles of tax
o      Equitable
o      Economical
o      Efficient
o      Convenient
o      Flexible

Includes:

·     The Golden Rule
o      The government should only borrow to fund new social capital (capital spending, i.e. schools, roads…etc) and not current spending (e.g. welfare benefits)

·     The Sustainable Investment Rule
o      Public sector net debt should not rise above 40% of national income at the end of each financial year of the economic cycle

·     If the government stuck to the two rules, the public sector budget should, in theory, balance out over the course of one economic cycle because the government is not increasing current spending. A deficit is run on capital spending instead, thus balancing it out.

·     Aims
o      To limit how much the government borrows and for what purpose
o      Allow automatic stabilisers (see here) to smooth over the economy
o      Support the role of the monetary policy
o      Avoid an unsustainable increase in public sector debt
o      Ensure that tax revenues that are collected finance public spending as far as possible

·     Australia and New Zealand had a similar code

·     The government complied with the rules from the full economic cycle between 1997-1998 to 2006-2007, just before the recessions/economic crisis.

·     In November 2008, it was written in the pre-budget report that the code had been suspended to allow for the government to act appropriately in response to the global recession.

·     It was replaced by a less restrictive ‘temporary operating rule’ where the target was to manage public finances over the medium term. 

Please note, the Fiscal Policy Framework and the Code for Fiscal Stability should be used in the exam for demonstrating your understanding of past and previous fiscal policy used by governments. As it is no longer in use, be careful when mentioning in the exam.

Stealth Tax

An indirect tax that government's try to implement as they think people will not notice them. They can be thought of as being 'secretly' implemented.

When the UK government introduced the Fiscal Policy Framework and the Code of Fiscal Stability (1998), one disadvantage was that it didn't stop the introduction of stealth taxes. For more on the Code of Fiscal Stability, look here

Tuition fees

Hi everyone, I would first like to apologise for the inactivity on my blog.

Second, I've just read something intriguing about universities and tuition fees. This article here, from The Independent, explains that universities have appealed to the Offa (Office for Fair Access), the universities watchdog, to try and amend the agreement they made earlier this year, to try to reduce their fees.

27 universities have appealed, possibly suggesting a price war in the higher education market. Is this a case against the market provision of higher education?

This is a good example of a possible price war that is currently occurring and a good example to use in the exam.

Tuesday, 1 November 2011

UK Growth Figures

Today it emerged that the UK economy has grown 0.5% in the third quarter of this year. Economists predicted a 0.4% growth rate, beating expectations. My verdict: at least it's not negative growth!

These two articles here and here, are good readings explaining the recent ONS figures.

Sunday, 30 October 2011

Cost-Benefit Analysis (CBA)


·     A method of decision making which attempts to take into account social costs and benefits and private costs and benefits of a given project.

·     Tries to place a monetary value on all benefits arising from a project, then compares the total value with the project’s total costs.

·     An approval technique à used to decide whether the project will go ahead or not

·     Incorporates externalities

Uses

·     Public projects: airports, roads, motorways, bridges, tunnels, dam...
·     Public health programmes: mass immunisation (e.g. preparing for swine flu, even though vaccinations were not required in mass scale, CBA could have been used to decide if this was the best option)
·     Introduction of congestions charge in London
·     Investment in environmental projects (e.g. wind farms)

Stages of CBA

1a. Calculate social costs and benefits (externalities)
  b. How likely is the outcome of the cost/benefit calculated? Uncertainties?

2. Discounting the future: Calculate the monetary value now of costs and benefits expected in the future. Monetary value falls over time (because of inflation) therefore costs/benefits will be lower. Individuals also enjoy benefits now rather than later, leading to a fall in the value of costs/benefits for the future.

3. Compare costs to benefits to determine the net social rate of return.

4. Compare the net rate of return with different projects and decide which ones should go ahead.

Price shadowing: Prices being put on economic activities where there is no market price – artificial prices. They are used to reflect the time social costs and benefits, because charged prices do no always reflect the true marginal social cost of resources.

Criticisms of CBA

·     Putting a monetary value on externalities since they are delivered and received outside the market and have no market price. E.g. impact on environment.

·     Problems choosing the rate at which to discount the future and setting shadow prices accurately

·     Not all stakeholders are taken into account when calculating costs and benefits. E.g. non human stakeholders and future generations

·     Future costs and benefits are hard to forecast due to demand and supply changes, population, inflation rate, development of new technologies…

·     The costs and benefits are different to different income groups

·     A benefit to one party could be considered a cost to another, creating the need for value judgements and sometimes bias

·     The decision made to go ahead with a project is on the basis that benefits exceed costs, therefore the costs of the project are by passed

·     ‘Impartial experts’ making wrong decisions

·     Argued to be a ‘job creation scheme’ for economists and planners and a waste of time

·     Valuing human lives, for example for a proposed new road crossing. Is there a morality to calculating the value of someone’s life?

Case Study

The CBA was used with Heathrow Terminal 5

For:
Economic growth, jobs, increase competitiveness, boost economy, transport links improved, building on Brownfield sites.

Against:
More flights à more noise, traffic congestion, more air pollution, effects of wildlife

CBA was also used when deciding whether to have a national smoking ban in public places in 2004 in the UK

Saturday, 29 October 2011

Buffer Stock Video

Hi everyone, so there is a great video on buffer stocks here, explaining clearly how the buffer stock scheme works.

Link here.

This guy is absolutely amazing, so do check out his other videos!

The break

I apologise that the site has been inactive of the past week or so. I have been busy recently so unable to have posted new resources. Please subscribe so you receive the latest updates!

P.K

Satisficing

Relating to organisational theories and growth of firms, satisficing means achieving minimum targets that are acceptable and satisfactory to all stakeholders that make up the firm, managers, shareholders...etc. 

Requires compromising

Helps resolve the conflicts that form between shareholders' and managers' objectives

Tuesday, 18 October 2011

Inflation to be highest rate for 3 years

This article here highlights that inflation CPI is expected, by city forecasters, to hit 4.9% or even as high as 5.1%. Please read the whole article as it contains information about that rate of pensions increases and past inflation, which is very beneficial to know for the exam!

Sunday, 16 October 2011

Oligopoly Case Study

News of tough economic times ahead could be one of the driving forces behind a possible price war between Asda, Tesco and Sainsbury's, among others. The supermarket market is prone to have price wars frequently, particularly ahead of seasonal periods. This article here, explains the strategies used by Asda, Tesco and Sainsbury's, yet competition is getting stronger with European supermarkets Aldi and Lidl increasing their market share (measured by the concentration ratio). Apparently there is no price war going on, yet if consumer prices get lower and lower in the coming weeks, we may have to reconsider what really is happening.

This is a good case study to use and gives you an idea about oligopolistic markets at work.

Supply Side Economics


Supply side economic policy is a set of government initiatives that aim to improve the economic performance of markets and industries. Policies tend to be more microeconomic because they focus of individual economic agents. Policies aim to:

· Increase competition within markets
· Increase efficiency within markets
· Increase the economy’s potential production – PPF/LRAS (see here for more)

Supply side fiscal policy

· Creating personal incentives to improve economic performance of the supply-side of the economy
· Since 1979, supply-side fiscal policy had been used by Labour and Conservative governments
· Supply-side economists believe that high levels of government spending, taxation and borrowing lead to crowding out (see below) of the public sector.

The intended effects of supply-side policies are shown below:



It is the free market view that supply-side policies should be used to increase efficiency and competition within markets.

Crowding out

Resource crowding out

Assuming there is no spare capacity in the economy and full employment of all resources, resource crowding out is when employing more labour and capital in the public sector sacrifices the use of the same resources by the private sector. Resource crowding out does not happen when there is spare capacity in the economy because government spending can be seen as ‘picking up the slack’ of the private sector. The private sector can be stimulated and crowding in can occur.

Financial crowding out

Increasing taxes to facilitate for high levels of government expenditure reduces the spending power of private sector firms.

Monday, 3 October 2011

Cyclical Unemployment

Unemployment caused by deficient AD.


Equilibrium is at point X with real national output level at YFE and price level P1. A collapse in business/consumer confidence can shift AD1 to AD2. Thus lowers output from YFE to Y2, and lowers the price to P2. Since less output is being produced, firms employ fewer workers, shifting ADL1 to ADL2 on the diagram on the right. If wages are flexible (as free-market economists believe), the rate of unemployment is E1 at real wage rate W1. If wages are ‘sticky’ (as the Keynesian economists assume), the rate of unemployment drops further to E2, and real wages remain WFE.  

Saturday, 1 October 2011

Externalities and market failure


An externality is when a public good (properties of public good: non-excludable and non-rival) is “dumped” on to third parties outside the market, see here for more. They occur from the consumption and production of goods and services. Those receiving the externalities are not compensated for in any way.

Externalities can be a form of market failure because market failure occurs when the wrong quantity of a good/service is provided at the wrong price.

A negative externality is when the…

marginal social cost  >  marginal private cost

The extra cost borne by society resulting from the last unit of output consumed/produced is greater than the extra cost to the individual/firm.



The socially optimum level of output (where MSB=MSC) is Q1, and price P1. The privately optimum level (where MPC=MPB) of output is Q2 and price P2.When there is a negative externality, the market produces at the privately optimum level at point X, therefore there is over-production. The shaded area represents the welfare loss and the MEC.

If a firm, a factory for example, produces electricity, they also create a negative externality which is pollution. If the firm fails to recognise and act against reducing the pollution, market failure occurs. The incentive function of price breaks down (see word of the day) because the firm is only charging consumers for the output of the good produced in the factory and not the output produced as a negative externality. Therefore the good is under-priced, over-consumed and over-produced.

A positive externality is when the…

marginal social benefit  >  marginal private benefit

The extra benefit borne to society resulting from the last unit of output consumed/produced is greater than the extra benefit to the individual/firm.



If a factory produces a positive externality, for example increased fish stocks in a lake that result from more warm water being discharged into it, fisherman are able to exploit the fish without having to pay the factory owner. The fisherman free rides. Market failure occurs because the good is under-priced and under-produced.

See here for more on public goods and the free rider problem.


Public Good

A good that possesses the following characteristics:


  • Non-excludable: You cannot stop anyone from using the good.
  • Non-rival: If you use the good, it is equally available to others who want to use it as well.
Examples: Street lights, national defense

How public goods are a form of market failure

If a public good is provided to a market, e.g. national defense, the social benefits are greater than the private benefits, creating a positive externality (notes on positive externalities can be found here, as are the notes on merit goods which cause positive externalities of consumption, or you can take a look at separate merit goods notes. Also, you can take a look at negative externaility if you want, only try not to confuse yourself! See here). This means that people know that the benefits to them if they join the army is that the country can be at an advantage during war. However this is the same benefit people will receive if they don't join the army, so people are inclined not to join the army because the cost is too high (risk of death) and there are mutual benefits to those who have joined with those who haven't. This is called the free-rider problem. People benefit from goods/services that they haven't paid for. This is market failure because there is no market incentive for people to join the army, or for the private sector to provide national defense.

Public goods can be a form of market failure if the price mechanism breaks down. If the provision of street signs and road signs requires people to pay (i.e market provision), some people will pay and some people won't (free rider problem). Businesses providing road signs will not check who has and hasn't paid because too many people are benefiting from them (due to the properties of a public good, see above). Thus by the creation of a positive externality, the private sector does not see it profitable to continue providing road signs, leading to market failure.

Solution

Government provision of public goods financed through taxation. This ensures everyone pays for it and everyone benefits from it.

Thursday, 29 September 2011

Monetary Policy

Involves the use of interest rates (see Word of the Day) and quantitative easing (changes to the money supply) to achieve the government's policy objectives. Expansionary monetary policy involves decreasing interest rates and increasing the money supply to increase AD and contractionary monetary policy is the opposite; interest rates are increased to deflate the economy and reduce AD.

Monetary policy is set by the Monetary Policy Committe (MPC) who have meetings every first Thursday of each month to set interest rates. The MPC has 9 members, if you want to find out more, click here.

Changes to AQA exams!!!

This post is for everyone on the A2 AQA exam board. There have been changes to the exam and the new exam will require (some) maths. This link here should lead you to the document explaining what the new questions will want you to do. It seems like pretty basic stuff so hopefully you should all do fine! Just wish they'd introduced it on the year of my exam!

Wednesday, 28 September 2011

Inferior Good

A good whereby demand for the good decreases as income increases. It goes against the normal law of demand where increasing income should lead to higher demand. An example of this type of good is demand for public transport. As income rises, more people can afford to buy and use cars, thus demand for public transport should fall.

Tuesday, 27 September 2011

Merit Good

A merit good is one where the marginal social benefit is greater than the marginal private benefit of consumption. Merit goods lead to market failure because the wrong quantity of goods is sold at the wrong price. The diagram below explains more.

Consumption of a merit good leads to a positive externality. Remember that social benefit maximisation is when MSB = MSC and private benefit maximisation is when MPB = MPC. Therefore if the free market were to provide merit goods, it would provide at Q1 to maximise private benefit. However, the socially optimum level of consumption is at Q2 thus leading to under-consumption and under production of merit goods (hence market failure).

Marginal External Benefit is MSB – MPB. It is the extra benefit incurred from producing the positive externality.

Wednesday, 21 September 2011

Video on Comparative Advantage and PPF

There is a fantastic video which thoroughly explains the comparative advantage using the PPF curve. Using and linking the two in your exam can show the examiners your ability to use micro and macroeconomics in one argument. The link is here. Enjoy!

To learn more about PPF, click here and here. To learn more about comparative advantage, click here!

Public Bad

A good that people want to remove (e.g. rubbish). Society would rather pay to remove the good rather than leave it there.

Tuesday, 20 September 2011

Global Economy


For those of you who have been watching the news recently, you should know that there is fear that the global economy could double-dip which the USA in serious risk. Below is a summary of the main uncertainties the global economy faces.

The IMF says…

· There is sluggish economic growth
· Governments need to rethink their policies
· The UK growth forecast needs to be reduced (and George Osborne said so too). Economic growth in the UK has been revised to a mere 1.1%
· Deficit reduction plan needs to be delayed

Eurozone

· Italian credit rating degraded
· Protests in Greece
· 40% of our exports go to the eurozone.

All advanced economies are facing tough times.

The UK government should focus more on capital spending (spending on infrastructure). This will stimulate the economy because infrastructure provides the correct conditions for business and enterprise to flourish. It will create jobs in the short run and long run, and should increase economic growth in the long run.

It's good to be on the ball with all the latest economic news.