Download Microeconomics Level 1 Dr Ken Hori HM TREASURY

Microeconomics Level 1
Dr Ken Hori
Microeconomics Level 1
1
0930
0940
1040
Course objectives
Introduction to economics
COFFEE
1100
1145
1215
1300
What markets do: supply, demand, and equilibrium
Group work
Review of group work
LUNCH
1400
1445
Market failure, and government intervention
Group work and TEA
1510
1530
1600
1610
1645
Review of group work
Cost benefit analysis
Lessons from Level 1
Test
End
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COURSE OBJECTIVES
This course has three objectives:
• to provide an overview of the scope and
methods of economics
• to offer a self-contained introduction to
key themes in microeconomics
• to equip participants to proceed to Level 2
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OUR APPROACH
• Economic analysis aims to be rigorous,
but it need not be technical.
• No prior knowledge of economics is
assumed.
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CONCEPTS & TOOLS
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Basic Concepts: Choice and Scarcity
• Economics studies Choices - made by
individuals, firms, and governments, that
govern the allocation of resources.
• Study of the allocation of scarce resources
among competing uses - labour time; land;
capital goods; natural resources.
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Basic Concepts: What, how and for whom
Four key questions:
1. What is produced? How much?
2. How are these goods produced?
3. For whom are they produced?
4. Who makes economic decisions?
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Basic Concepts: Micro vs Macro
• MICROECONOMICS: detailed study of
decisions made by consumers, producers
and their interaction in specific markets
• MACROECONOMICS: big picture –
emphasizes interactions in the economy as
a whole.
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Basic Concepts: Positive vs Normative
• POSITIVE ECONOMICS: Tries to explain
behaviour
– How would more tax on fuel affect the price and
quantity sold?
– What are the effects of joining the Euro?
• NORMATIVE ECONOMICS: Prescriptions
based on value judgments
– Who gains and loses from more fuel tax?
– Should we join the Euro?
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Basic Concepts: Market vs Government
• Market: a real or virtual place where exchange
takes place.
– Buyers and sellers meet
– A price is established
• vs Government…
– Command Economy: central planner issues orders
– Free Market Economy: what, how & for whom decided
by prices, incomes, wealth
• Degrees of government intervention:
Cuba – China – Denmark – UK – USA – HK
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Basic Concepts: Opportunity Cost
• Scarcity means that there exists Opportunity
Cost:
– What you have to give up to get something else
– E.g. cost of education:
• Time (foregone leisure)
• Fees
• Lost earnings
• For example: Production Possibility Frontier
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Basic Concepts:
The Production Possibility Frontier
GOOD 2
Maximum quantity
one good that can be
produced, given
quantities of other
goods being
produced
G
. A
B
F
D
E
C
GOOD 1
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A, B, C efficient
(on the frontier)
D, E
inefficient
(inside the frontier)
F, G unattainable
(outside the frontier)
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Is Economics a Science?
• Of course it is – the queen of the social
sciences!
• Develops theories that can be tested
against data and (in principle) rejected.
• Economic theories never hold exactly:
statistical regularities may exist.
• “Failed” economic theories can never
be dislodged by facts and evidence
alone – it takes a better theory.
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TOOLS
• Model:
– Deliberate simplification of reality
– Like a map
• Data:
– Time Series
– Cross-section
• Estimation and testing using econometrics
– E.g. people with more education earn higher
incomes. Causation? Correlation?
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Tools: Visualizing data
A scatter diagram
variable y
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variable x
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Tools: Interpreting the data
Bus Revenue
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Bus fare
It appears that higher bus fares cause higher
revenue…
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Tools: Interpreting the data
… but it might not be true
Suppose the two clusters are from two different time
periods – what might that imply?
Bus Revenue
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High tube fare
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Low tube fare
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Bus fare
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Tools: Interpreting the data
• Bus revenue depends on bus fares.
• But it also depends on other things:
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–
incomes
price of other modes of travel
reliability (relative to other modes of travel)
relative comfort
relative perception of safety
• “Ceteris paribas”
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DEMAND, SUPPLY & PRICE
ADJUSTMENT
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Market
• DEMAND
quantity buyers wish to buy at each price
• SUPPLY
quantity producers wish to sell at each price
• MARKET
arrangement to exchange goods & services
• EQUILIBRIUM PRICE
the price at which “market clears”
(i.e. quantity demanded = quantity supplied)
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Market
Supply curve
price
Equilibrium
Price
Demand curve
Equilibrium
Quantity
quantity
PRICE ADJUSTMENT
Equilibrium price clears market
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Market
• The demand curve shows the relation
between price of a good and quantity
demanded of that good.
• But how does demand change when
‘other things’ change?
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DEMAND IN MORE DETAIL
elaborating on the ‘other things’
How does DEMAND for a good vary when
1
price of a related good changes?
– substitutes
– complements
2
consumer’s income changes?
– normal goods
– inferior goods
3
tastes change?
– role of fashions and fads, culture
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COMPARATIVE STATICS
(effect of changing the ‘other things’)
Suppose income rises, increasing demand
Price
Supply
Equilibrium
price rises
Demand : high income
Demand: low income
Equilibrium quantity rises
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Quantity
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SUPPLY IN MORE DETAIL
elaborating the ‘other things’
How does SUPPLY of a good vary when
1
technology improves?
2
input prices change?
energy, labour, capital
3
regulation imposes extra costs?
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COMPARATIVE STATICS
Suppose technical breakthrough raises supply
Price
Supply rises
2 but equilibrium
price falls
Demand
1 Equilibrium quantity rises...
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Quantity
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COMPARATIVE STATICS
An important difference
• If demand shifts, equilibrium price and
quantity move in the SAME DIRECTION
• If supply shifts, equilibrium price and
quantity move in OPPOSITE DIRECTIONS
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SOME EXAMPLES
Third world farming
• What is the effect of better irrigation &
fertiliser?
• What happens to quantity? To price?
• To revenue?
Computers
• The price of a personal computer has been
falling.
• Which is shifting, demand or supply?
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Introduction to Economics
GROUPWORK
1
(a)
(b)
(c)
(d)
(e)
(f )
Are the following statements positive or
normative?
Higher tax rates cut revenue from tobacco taxes
Poor countries got an unfair share of world
income
Smoking is antisocial & should be discouraged
Airbus needs public support
Airbus deserves public support
Airbus is a good investment for Britain
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GROUPWORK
2
(a)
(b)
(c)
(d)
The price of crude oil increased from $2.90 to $9
per barrel in 1973, in a coordinated move by OPEC
members.
How did the OPEC members manage to raise the
price? Show using a supply-demand diagram for
the oil market.
What happened to the demand for coal and the
price of coal? Show using a supply-demand
diagram for the coal market.
What happened to the demand for fuel-guzzling
cars?
What happened to supply and demand for oil
eventually?
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Real Oil Price
(1997 = 100)
400
300
200
100
0
70 74 78 82 86 90 94 98
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GROUPWORK
3
The following data describe
price and output of a
product:
(a) Plot a scatter diagram
(b) “Higher prices make firms
raise output.”
“People buy less when
prices are higher”
Does the diagram shed any
light on these statements?
Could both be correct?
Explain.
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Year
Price
Output
1985
100
101
1986
104
107
1987
108
112
1988
112
122
1989
118
128
1990
117
128
1991
108
118
1992
98
103
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GROUPWORK
4
For each government intervention listed below,
identify the possible rationale.
(a)
(b)
(c)
(d)
(e)
(f )
Income tax
Taxation of petrol
Regulating gas prices
Banning the use of cannabis
Running the NHS
Maintaining an army
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Why Intervene?
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The Role of Government
• IF MARKETS ARE EFFICIENT (i.e. ‘invisible hand’
works), the government could confine attention to
– Legislation and general regulation
– Redistribution (taxation & transfer payments)
– Macroeconomic management (stabilisation)
• However, sometimes free markets are not
efficient.
– These instances are called MARKET FAILURES
• When markets fail, the government may
intervene for efficiency reasons
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SOURCES OF MARKET FAILURE
1. EXTERNALITIES
• One person's decisions/choices affect others
DIRECTLY
– Can be negative or positive
• If markets were free and unregulated
– cannot be made to PAY for the HARM
you inflict on others (e.g. pollution)
– cannot RECOVER all the value of BENEFITS
you confer upon others (use of green technology)
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SOURCES OF MARKET FAILURE
• Then individual’s optimal decision is not
optimal for society!
• Result:
– OVERPRODUCE bad things
– UNDERPRODUCE good things
• Thus the market outcome is inefficient.
– Government intervenes to correct inefficiency
• Policy Tools: tax, subsidy, quota, artificial
markets
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SOURCES OF MARKET FAILURE
2. PUBLIC GOODS
Goods that we consume together, so that
• no individual can be excluded from consuming
• consumption by one does not leave less for others
National defence
Broadcast signals
No one has any incentive to pay for such goods.
In the absence of government intervention, too little or
none will be provided.
Government steps in to ensure right level is produced.
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SOURCES OF MARKET FAILURE
3. IMPERFECT COMPETITION
•
•
•
If firms have market power (power to set
prices above cost), markets are usually
inefficient.
Once again, government can intervene
(say, by regulating prices)
– Example: Regulation of National Grid
Is monopoly always bad?
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GOVERNMENT FAILURE
• In principle, the government can correct
market failures.
• In practice, the government
– does not always improve matters
– sometimes makes things worse
• Why?
– Informational problems
– Incentive problems
– Rent seeking
• Hence, must check for the possibility of
government failure before jumping to conclusions.
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MARKET FAILURE & GOVERNMENT FAILURE
GROUPWORK
1 There is a tax on cars in Central London
(a)Why not leave things to the market? List the
different motives for intervention.
(b) Which of these are to do with efficiency?
(c) Are there any other motives than efficiency?
(d)Is/was there a possibility of government
failure?
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MARKET FAILURE & GOVERNMENT FAILURE
GROUPWORK
2
If people want to watch advert-free terrestrial
TV, there should be a market for this. So
what is the case for the compulsory TV
License?
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COST-BENEFIT ANALYSIS
Usually applied to government investment
decisions
– roads
– channel tunnel rail link
– subsidies to start-ups, R&D
The main question:
How do we value SOCIAL costs and benefits
of a project?
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COST-BENEFIT ANALYSIS
Steps in the procedure:
• Check how the private sector would do it
• Adjust for discrepancies between private and social
valuations
Private valuations
Social Valuations
private profits
private profits PLUS spillover
benefits to others
private costs
private costs PLUS spillover
costs borne by others
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COST-BENEFIT ANALYSIS
Example: The Jubilee Line Extension
Private valuations:
• Costs
+
• Benefits
present value of construction cost
(say, takes 4 years to build)
present value of future operating costs
(maintenance, wages, electricity)
present value of passenger fares
Build if Net Present Value of project is positive
(i.e. project is profitable).
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COST-BENEFIT ANALYSIS
EXAMPLE: THE JUBILEE LINE EXTENSION
Social Cost Benefit Analysis
Were any social benefits or costs missed in the above
valuation?
Externalities:
Beneficial externalities
Harmful externalities
- less congestion on roads
- less pollution
- helps integrate London
- vibration to houses above line
- congestion near terminuses
Social cost benefit analysis should attempt to measure
as many of these implications as possible.
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•
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Economic models are deliberate simplifications of reality.
‘Other things equal’ streamlines thought but its validity
needs checking.
Supply and demand explain equilibrium price and
quantity.
Markets sometimes fail to be efficient.
Governments could intervene to correct failure…
…but government action is itself vulnerable to failures.
Of course, governments also care about equity.
Social cost benefit analysis tries to measure as many
inputs and outputs (private and social) of a project as
possible.
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