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!

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.

State of the World Economy

Just an article from The Economist about the future of the world economy. Worth a read. Print it out, highlight it...etc.

Here's the link:

http://www.economist.com/blogs/freeexchange/2011/09/world-economy?fsrc=nlw|pub|09-28-11|publishers_newsletter

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.  

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.