Word of the Day

A positive statement

A statement that can be proven to be true or false. A positive statement does not contain any bias and is simply a fact or a false fact. For example, if I say that paper is not made from wood, this is a positive statement because one can test what paper is made from (the statement will inevitably be made untrue since paper is made from wood, however that doesn't mean the statement is not a positive one).

In economics, it is useful to identify a positive statement from a normative statement.

A normative statement

A statement that is based on opinion and cannot be proven true/untrue. For example, 'fiscal policy is more effective than monetary policy at increasing aggregate demand', is a normative statement because it contains one's view and cannot be tested (because fiscal and monetary policy are frequently used hand in hand).

Production Possibility Frontier and Long Run Aggregate Supply

The PPF shows the combination of capital and consumer goods that can be produced within the economy. The PPF shows what the economy can produce. If the economy is producing inside the PPF, point X, it is in a recession. Unemployment is high and the economy is not producing at it’s full productive capacity.

When the economy is producing on the PPF, point Y, it IS producing at its full productive capacity. It is also producing on the LRAS curve, point V on the supply/demand diagram. Real national output is YFE and the price level is P1. Full employment of resources has been achieved, which means that the labour force is fully employed, see Word of the Day. The only way to increase output is by increasing investment in capital goods (which increases consumer goods) thereby increasing LRAS. If this happens, economic growth is occurring in the long run. See Word of the Day. LRAS1 moves rightward to LRAS2 and thus SRAS1 shifts rightward to SRAS2. Real national output in the economy has increased from YFE to YFE2. Assuming AD remains unchanged, the price level falls from P1 to P2.

Word of the Day

Full Employment

According to Beveridge's definition, which is perfectly acceptable to use in the exam, full employment is when 3% or less of the labour force is unemployed.

According to the free market definition, full employment occurs when ASL = ADL

Full employment also occurs when the economy is producing on the LRAS curve, see PPF and LRAS. This is because when there is no spare capacity, all workers willing and able to work are working.

It does not mean that all members of the working population are in employment, frictional and structural unemployment is always occurring.

Stock Markets take a heavy dip

The FTSE 100 and Dow Jones dropped heavily yesterday (Friday) due to the uncertainty bought about by US economic growth and it's debt ceiling, and Spain and Italy's unmanageable public finances. There are fears that Italy and Spain may need bailouts as well, which is why investors sold these stocks.  Spain has the fourth largest economy in the EU, however its bond yields (interest rates on government bonds) remain high at 6.4% and in Italy, 6.3%. Greece, Ireland and Portugal had levels of above 7% when they desperately seeked bailouts by the IMF and European Union, highlighting the risk that Italy and Spain face. Have a look at this video to learn more.

The FTSE 100 fell by almost 3.5%, it's lowest fall since the collapse of Lehman Brothers in September 2008. The Dow Jones fell by 4.3%, Japan's Nikkei fell by 3.7% and Hong Kong's Hang Seng fell by 5%. 

Only time will tell what will happen, how investors react to markets will influence economies in the way they want because speculation is a powerful tool. If things continue the way they are, the EU may have to start preparing more bailout packages. As for the USA, someone once told me that when America sneezes, the whole world catches a cold.

Conditions that affect Supply and Demand

Demand

These following conditions cause demand to fall and shift leftwards:

• Low prices of substitute goods (goods that perform the same function as each other and can be used as substitutes for one another, for example, a computer and a laptop). If substitute goods are cheaper, then demand for the original good will fall because consumers are buying the substitutes (assuming everything else remains constant – ceteris paribus).
• High prices of complementary goods (goods that are bought with each other, for example a printer and printer ink). If complementary goods are sold at high prices, consumers may decide the purchase is not worth it, ceteris paribus.
• Low personal income. This leads the household with lower disposable income for spending, therefore demand for goods and services may fall.
• Tastes and preferences for the good changes.

The reverse of these factors will cause demand to rise and shift rightwards.

Supply

The following factors cause (short run) supply to fall and shift leftwards:

• High costs of production
• Wage costs
• Rent prices
• Commodity/raw material costs
• Cost of borrowing (higher interest rates)
• Higher taxes
• Corporation tax
•  VAT
• Excise duties
• Lack of subsidies/grants

These factors can cause firms to leave the market, thus resulting in a fall of supply.

The opposite of the factors above can cause supply to increase and shift rightwards, along with the addition of technical progress.

Word of the Day

Law of Diminishing Marginal Returns

States that when a variable factor of production is added to a fixed factor of production, the result will be an increase in marginal output. However after a certain point, the marginal returns will eventually start to fall. The law only operates in the SHORT RUN

When more and more labour (variable factor) is added to machinery and equipment (fixed factor), the marginal product of labour will fall because the workers are getting in each other's way. They are not any less hard working or motivated.
The LoDMR is also the reason why the AC curve falls and then increases.

Before point A, average costs fall as output increases because the addition of variable factors cause an increase in marginal output. Also, the average variable cost (AVC) curve falls slightly , accounting for the fall in average total costs.

After point A, AC rises due to the LoDMR because variable costs to rise.
Remember AC = AVC+AFC  therefore if AVC rises, AC rises. (AFC - average fixed cost)
The spreading of fixed costs become insufficient in the short run.

Great Perfect Competition Video

Okay, so here's a really good video on Perfect competition.

The first diagram drawn shows abnormal/supernormal profits.
Second diagram drawn shows normal profits.
Third diagram shows subnormal profits.