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NSS Understanding and Interpreting the Economics Curriculum Session 1 Microeconomics part of the NSS Economics Curriculum 7 April 2009(Tue) Agenda Topic A Topic B Topic C Topic D Basic Economic Concepts Firms and Production (Max. 10 mins. Q&A) Market and Price Competition and Market Structure (Max. 10 mins. Q&A) Break (15 mins.) Topic E Efficiency and Equity and the Role of Government (Max. 10 mins. Q&A) Elective 1 Q&A Session (A) Basic Economic Concepts Economics as a social science Study of human behaviors Based on the postulate of constrained maximization Use examples to illustrate the scope of economic analysis Methodology of scientific study NOT required (A) Basic Economic Concepts Scarcity Choice and opportunity cost (i) The source of economic problems : scarcity Unlimited wants and limited resources Meaning of scarcity Relationship between scarcity and choice Relationship between scarcity, competition and discrimination Difference between scarcity and shortage (A) Basic Economic Concepts Free and Economic goods Meaning of goods Definition free goods and economic goods Examples of free goods and economic goods (A) Basic Economic Concepts (ii) Choice and opportunity cost Economic decisions involving choices among alternatives Concept of cost in economics Relationship between choice and cost Definition of opportunity cost Explain why only the highest-valued option forgone count as cost (A) Basic Economic Concepts Identify / calculate the cost involved in choosing an option : out-of-pocket cost and implicit cost Explain whether / how cost changes under different circumstances Is Sunk Cost required? • The term is NOT required but students should be able to explain why past expenditure, that is not recoverable, is not a cost. (A) Basic Economic Concepts Interest as the cost of earlier availability of resources Explain why interest is the cost of earlier availability of resources Is inter-temporal choice required? Yes Explain how interest rate, present consumption and saving are related [Relationship between interest rate, investment and money demand are required (to be explained in the Macro section)] [Calculation of present value is NOT required] (A) Basic Economic Concepts The three basic economic problems (i) What to produce? How to produce? For whom to produce? Meaning of each economic question illustrate with examples (A) Basic Economic Concepts (ii) How society tackles the basic economic problems • By society’s customs and tradition • By government decisions • By the market mechanism (N.B. Illustrations by examples only. All theories on types of economic systems NOT required) Examples of each of the above methods in tackling economic problems (A) Basic Economic Concepts (iii) Private property rights and its importance in a market economy Meaning of private property rights exclusive right to use exclusive right to receive income, and right to transfer Explain why private property rights is important in a market economy : Clear delineating of private property rights is the perquisite for the use of price mechanism in market exchange, which ensure resources to be allocated to the highest-valued users. (A) Basic Economic Concepts Specialization and exchange • Exchange as a condition for specialization • Explain why exchange is a “necessary” condition for specialization (A) Basic Economic Concepts Circular flow of economic activities (i) Consumption of households and production of firms (ii) The relationship among production, income and expenditure • Stretch a well-labeled circular flow diagram in a closed economy. • Relationship among (the value of) production, (factor) income and expenditure (A) Basic Economic Concepts Normative vs. Positive statements • Distinction between positive statements and normative statements • Normative statements : Involve value judgment ; Disagreement cannot be settled by appealing to facts • Positive statements : Do not involve value judgment ; Refutable by facts - Disagreement can be settled by appealing to facts • Examples of normative and positive statements (A) Basic Economic Concepts • Value Positive analysis normative policy suggestion • From the standpoint of maximising social gains, should the illegal practice of reproducing discs be firmly suppressed so that only the higher-priced original discs can be found on the market? Explain. (HKALE 1994 Q8) (B) Firms and Production Ownership of firms • (N.B. Firm as a unit that makes decisions regarding the employment of factors of production and the production of goods and services) • To give the meaning of firms (B) Firms and Production (i) Forms of ownership • Public ownership • Meaning of public ownership: ownership by government or its agencies with the right to own, control, use and dispose of property (e.g. government departments and public corporation) • Examples of organizations or institutions in Hong Kong operating under public ownership. (B) Firms and Production • Private ownership: sole proprietorship, partnership and limited company • (N.B. Classification of partnership NOT required) • Classify a private firm into sole proprietorship, partnership, private limited company and public limited company • Key features (including legal status, liability, number of owners, etc.) of different forms of private ownership • Documentation involved in setting up business units NOT required • Advantages and disadvantages of different types of ownership NOT required (B) Firms and Production (ii) Limited and unlimited liability • Meaning of limited liability • Identify types of ownership that the owners could enjoy limited liability (B) Firms and Production (iii) Shares and bonds as sources of capital • (N.B. Classification of different types of shares and bonds NOT required) • Key differences between shares and bonds • Shares: Holders are owners; returns – dividends • Bonds :Holders are creditors; returns – interest • Advantages and disadvantages of issuing bonds and shares in raising capital • Advantages and disadvantages of buying bonds and shares from a small investor point of view (B) Firms and Production Types/stages of production • Primary, secondary and tertiary production and their inter-relationship • Meaning of primary, secondary and tertiary production • Examples of different types of production • Classify an given industry into primary, secondary and tertiary production • Describe their inter-relationship • Recognize the contributions of each types of production to HK’s economy (B) Firms and Production Types of goods and services produced (i) Goods and services • Production involves production of goods and / or provision of services (ii) Producer and consumer goods • Meaning of producer and consumer goods • Examples of producer and consumer goods (B) Firms and Production (iii) Private and public goods • (N.B. Modeling regarding public goods NOT required) • Definitions of private and public goods • Examples of private and public goods • Is the concept of impure public goods required? Yes (B) Firms and Production Division of labour (i) Types: simple, complex and regional • Meaning of simple, complex and regional division of labour • Examples of simple, complex and regional division of labour (B) Firms and Production (ii) Advantages and disadvantages • Give advantages and disadvantages of division of labour (iii) Limitations • Recognize the limitations of division of labour (B) Firms and Production Factors of production (i) Human resources • Labour: supply, productivity, mobility and different methods of wage payments • Labour supply (measured in terms of man-hour) • Factors affecting labour supply (e.g. wages, population, population structure, etc.) • Meaning of average labour productivity • Calculate average labour productivity • Factors affecting labour productivity (e.g. education, training, capital endowments, etc.) (B) Firms and Production Factors of production (i) Human resources • Labour: supply, productivity, mobility and different methods of wage payments • Meaning of geographical and occupational mobility • Factors affecting labour mobility (geographical and occupational) • Advantages and disadvantages of different methods of wage payments (B) Firms and Production • Entrepreneurship: risk-bearing and decisionmaking • Special role of entrepreneur : risk-bearing and decision-making (B) Firms and Production (ii) Natural resources • Land: supply • Recognize that supply of natural resources could not be changed by human efforts (B) Firms and Production (iii) Man-made resources • Capital: accumulation and depreciation • Meaning of capital accumulation (involving giving up present consumption for future consumption) and its relationship with interest rate • Meaning of depreciation (B) Firms and Production (iv) • • • The features of (i) to (iii) in Hong Kong Describe the features of (i) to (iii) in Hong Kong Remarks: In the existing CE syllabus, ‘Classification’ is one of the subtopics under factors of production. The restructuring of the subtopics implies ‘classification of factors of production’ in the NSS Econ syllabus is not as important as the existing CE syllabus • Discussion of factors of production is limited to those areas stated in the syllabus (B) Firms and Production Production and costs in the short run and long run (i) Definition of short-run and long-run • In terms of fixed and variable factors of production. • Meaning and examples of fixed and variable factors of production (B) Firms and Production (ii) Law of diminishing marginal returns Illustration by total product, average product and marginal product schedules only. • State the law of diminishing marginal returns • Transform MP to AP and TP, AP to MP and TP, TP to MP and AP (numerically) • Illustrate the law of diminishing returns by total product, average product and marginal product schedules • [Relationship between law of diminishing returns and U-shaped MC NOT required] (B) Firms and Production (iii) Cost of production • Fixed and variable costs • Meaning and examples of fixed and variable costs • Total, marginal and average cost of production • (N.B. General relationship between total, marginal and average cost curves NOT required. Relationship between short run and long run cost curves NOT required.) • Transform MC to AC and TC, AC to MC and TC, TC to MC and AC (numerically) (B) Firms and Production (iv) Economies and diseconomies of scale • Internal economies and diseconomies of scale • External economies and diseconomies of scale • (N.B. Economies and diseconomies of scale illustrated by average cost. Further classification of internal and external economies and diseconomies of scale NOT required) • Meaning of internal / external economies and diseconomies of scale • Illustrate internal / external economies and diseconomies of scale by average cost (B) Firms and Production • Possible reasons leading to internal / external economies and diseconomies of scale • (Further classification of internal / external economies and diseconomies of scale NOT required) (B) Firms and Production (v) Expansion and integration of firms • Types: vertical, horizontal, lateral and conglomerate • Motives • Meaning of each types of integration • Examples of each types of integration • Give some possible motives behind each types of integration • Methods of integration (e.g. takeover, merger, consolidation, etc.) NOT required (B) Firms and Production The objectives of firms: (i) Profit maximization with given price and marginal cost schedule • Meaning of profit as the difference between total revenue and total cost • Profit-maximizing choice of output for individual firms with given prices and marginal cost schedule • The marginal cost schedule as the supply schedule of individual firms • (N.B. Long run supply NOT required) (B) Firms and Production • Price taking assumption • Explain why the marginal cost schedule is the supply schedule of individual firms • Shut down point, break even point, LR supply NOT required • Graphical relationship between MC, AC, AVC and supply curve NOT required • Long run supply ; monopoly does not have a supply curve NOT required (B) Firms and Production (ii) Other objectives: market share, provision of non-profit making services, corporate social responsibility, etc. • Illustrate with examples 10 Minutes Q&A (C) Market and Price Law of Demand State the law of demand Explain phenomena by using the law of demand (full price / relative price) [Note: The change highlight the importance of law of demand] (C) Market and Price Individual demand (i) Factors affecting individual demand (ii) Complements and substitutes, superior and inferior goods (N.B. Giffen goods NOT required) Meaning of complements and substitutes, superior and inferior goods (N.B. Giffen goods NOT required) (C) Market and Price Explain how price, price of related goods, income, price expectations, weather, etc. affect individual demand (C) Market and Price (iii) Individual demand schedule and importance of the ceteris paribus assumption (iv) Difference between change in quantity demanded and change in demand Distinguish between change in demand (caused by changes in exogenous variables) and change in quantity demanded (caused by changes in price, an endogenous variable) (C) Market and Price Market demand (i) Horizontal summation of individual demand curves Meaning of horizontal summation Add up the individual demand curves / schedules horizontally to obtain the market demand curve / schedule (Graphically or numerically) Explain under what condition market demand could be obtained by horizontal summation of individual demand (C) Market and Price Market demand (ii) Factors affecting market demand similar to those points mentioned in the section about individual demand One of the additional factors: number of consumers in the market (C) Market and Price Individual supply (i) Factors affecting individual supply Explain how price, price of related goods, cost of production, technology, price expectations, weather etc. affect individual supply Give the meaning of joint supply and competitive supply State the law of supply (C) Market and Price (ii) Individual supply schedule and importance of the ceteris paribus assumption (iii) Difference between change in quantity supplied and change in supply Distinguish between change in supply (caused by changes in exogenous variables) and change in quantity supplied (caused by changes in price, an endogenous variable) (C) Market and Price Market supply (i) Horizontal summation of individual supply curves Add up the individual supply curves / schedules horizontally to obtain the market supply curve / schedule (graphically or numerically) (ii) Factors affecting market supply Similar to those points mentioned in the section about individual supply One of the additional factors : number of sellers in the market (C) Market and Price Interaction between demand, supply and price (i) Definition of equilibrium: no tendency to change (ii) Equilibrium price and quantity Find the equilibrium price and quantity graphically Find the equilibrium price and quantity, given the demand and supply schedule (C) Market and Price (iii) Effects of change in demand and/or change in supply on equilibrium price and quantity Explain the effect of change in demand and/or change in supply on equilibrium price and quantity, with the aid of diagram(s). (C) Market and Price Consumer and producer surplus (i) Marginal benefit to consumers, maximum willingness to pay, consumer surplus, demand curve and their relationship. Definition of consumer surplus Show consumer surplus on a (supply-) demand diagram (C) Market and Price Marginal benefit is roughly the same as maximum willingness to pay Marginal use value is NOT required because there are some technical complications in defining marginal use value Methods in extracting consumer surplus are NOT required (C) Market and Price (ii) Marginal cost of firms, minimum supply-price, producer surplus, supply curve and their relationship. Definition of producer surplus Show producer surplus on a supply-(demand) diagram (C) Market and Price (iii) Illustrate consumer surplus and producer surplus in a demand-supply diagram. (N.B. Concepts of utility, marginal rate of substitution, and indifference curves NOT required.) (C) Market and Price Functions of prices (i) Rationing function: existing supplies are distributed to users with highest value. Exchange without production ; prices would direct existing supplies to highest-valued users (C) Market and Price (ii) Allocative function: Demand is derived from marginal benefit, and supply is derived from marginal cost, and then price and resources allocation are determined. Resource deployment through changes in relative prices. Changes in relative price lead to changes in quantity of the goods produced, which implies a change in resource deployment (N.B. Graphical analysis NOT required) (C) Market and Price Price elasticity of demand (i) Arc elasticity (N.B. Point elasticity, cross elasticity and income elasticity NOT required) Calculate the (arc) price elasticity of demand (the average price and quantity method) (ii) Relationship between price elasticity and total revenue State and explain the relationship among price change, price elasticity and total revenue (C) Market and Price (iii) Factors affecting price elasticity of demand Explain how the price ranges, availability of substitutes, degree of necessity, time, durability, proportion of total expenditure spent on the good, number of uses, etc. affect the price elasticity of demand. Second law of demand is NOT required but students need to know time for adjustment is a factor that affects price elasticity of demand (C) Market and Price Price elasticity of supply (i) Arc elasticity (N.B. Point elasticity and cross elasticity NOT required) Calculate the (arc) price elasticity of supply (the average price and quantity method) (C) Market and Price (ii) Factors affecting price elasticity of supply Explain how factor mobility, flexibility of production, time, etc. affect the price elasticity of supply (C) Market and Price Market intervention (i) Price intervention: price ceiling and price floor Meaning of (effective) price ceiling, and (effective) price floor Effects of the imposition of (effective) price ceiling / floor on (money) price, quantity transacted, consumer surplus, producer surplus, etc., with the aid of diagram(s) (C) Market and Price (ii) Quantity intervention: quota Illustration of quota by a kinked supply curve Meaning of quota Effects of the imposition of quota on price, quantity transacted, consumer surplus, producer surplus, product quality, etc., with the aid of diagram(s) Single (homogenous) product is assumed Quota on imported goods (of a price taking country) is covered in Topic J (C) Market and Price (iii) Unit tax and unit subsidy Determination of the share of the tax burden/subsidy between producers and consumers Effects of the imposition of unit tax / provision of unit subsidy on price, quantity transacted, consumer surplus, producer surplus, etc., with the aid of diagram(s) Show share of the tax burden/subsidy between producers and consumers on a demand-supply diagram Relationship between elasticity of demand-supply and distribution of tax burden / subsidy (C) Market and Price (N.B. Graphical illustration of price ceiling, price floor, quota, unit tax and unit subsidy and their impact on price and quantity) (D) Competition and Market Structure Perfect competition and imperfect competition (monopolistic competition, oligopoly and monopoly) (i) Definition of market Any arrangement that transactions take place (D) Competition and Market Structure (ii) General features • Number of sellers • Number of buyers • Nature of product • Ease of entry • Availability of information • Price taker/price searcher Examples of monopolistic competition, oligopoly and monopoly (D) Competition and Market Structure (iii) Sources of monopoly power Natural monopoly, high set-up cost, legal entrance restrictions, public ownership, etc. (D) Competition and Market Structure (N.B. The four different forms of market structure are theoretical constructs. Actual examples may only be approximations of the above constructs. General analysis with marginal revenue and marginal cost curves NOT required.) 10 Minutes Q&A Break (E) Efficiency, Equity and the Role of Government Efficiency (i) Condition for efficiency: maximization of total social surplus; marginal benefit equals marginal cost. The terminology “Pareto condition” NOT required “Inefficiency” is possible in a partial analysis (“It is always efficient when all constraints are considered” – NOT required) (E) Efficiency, Equity and the Role of Government (ii) Deviations from efficiency: • Deadweight loss • Price ceiling, price floors, taxes, subsidies and quota The effect of price ceilings, price floors, taxes, subsides and quotas on consumer surplus, producer surplus, and efficiency, with the aid of supply-demand diagram(s) Meaning of deadweight loss and indicate the deadweight loss on supply-demand diagram(s) The above list that lead to deviations from efficiency is NOT exhaustive (E) Efficiency, Equity and the Role of Government (iii) Divergence between private and social costs (benefits): market versus government solutions, illustrated by examples ONLY Examples that involve a divergence between private and social costs (benefits) Explain the problem of divergence between private and social costs (benefits) • [over-production/consumption ; • under-production/consumption] (E) Efficiency, Equity and the Role of Government (iii) Divergence between private and social costs (benefits): market versus government solutions, illustrated by examples ONLY Explain how the problem of divergence between private and social costs (benefits) could be solved by government solutions (e.g. taxes/penalties, subsidies, etc.) Explain how the problem of divergence between private and social costs (benefits) could be solved by market mechanism [The term Coase Theorem NOT required] (E) Efficiency, Equity and the Role of Government (N.B. Graphical analysis with illustration of consumer surplus and producer surplus in a demand-supply diagram only. The terminology ‘Pareto condition’ NOT required) (E) Efficiency, Equity and the Role of Government Equity (i) Efficiency and equity in a market economy Explain why a free competitive market is efficient Recognize that even if resource allocation is efficient, there is an issue of (income) distribution (E) Efficiency, Equity and the Role of Government (ii) Measuring income inequality: income distribution, Lorenz curve and Gini coefficient (N.B. Construction of the Lorenz Curve and Gini coefficient NOT required). Interpretation HK’s situation (E) Efficiency, Equity and the Role of Government (iii) Sources of income inequality: human capital (e.g. skill differentials), discrimination and unequal ownership of capital etc. Detailed analysis of the labour market (e.g. labour demand curve =MRP curve) NOT required (E) Efficiency, Equity and the Role of Government Policy concerns (i) Equalizing income or equalizing opportunities What is ‘fair’ / ‘equity’ ? Equity is not the same as income equity but here we limit our consideration to only two commonly considered ethical principles : equalizing outcome or equalizing opportunities (A philosophical exploration of the general concept of equity is NOT required) (E) Efficiency, Equity and the Role of Government Policy concerns (i) Equalizing income or equalizing opportunities The normative choice of a different principle would affect the policy choice (E) Efficiency, Equity and the Role of Government (ii) Disincentive effects of taxes and transfers Explain why some instruments that aim at equalizing income (e.g. taxes and transfers) may have disincentive effects (E) Efficiency, Equity and the Role of Government (iii) Trade off between equity and efficiency Discuss whether there is a trade off between equity and efficiency Discuss how much redistribution is desirable IF there is indeed a tradeoff between equity and efficiency 10 Minutes Q&A Elective 1 Monopoly pricing (i) Simple monopoly pricing: Determination of price and output Efficiency implications (N.B. Graphical and numerical illustration with given demand, marginal revenue and marginal cost curves) Elective 1 Relationship between P and MR under simple monopoly pricing (numerical illustration) Show the relationship between demand curve and MR curve graphically Determination of profit-maximizing output and price graphically / numerically Elective 1 Explain why simple monopoly pricing is said to be inefficient illustrated with the consumer surplus, producer surplus and deadweight loss Compare the output, price and the efficiency implications between a simple monopoly and a perfect competitive market Elective 1 (ii) Price discrimination Meaning of price discrimination Types: First, second and third degree price discrimination Conditions for different types of price discrimination (N.B. Price and output determination NOT required) Elective 1 Illustrated with examples Price and output determination (and hence efficiency implications) NOT required Elective 1 Anti-competitive behaviours and competition policy (i) Major forms of anti-competitive practices Elective 1 Horizontal agreements among competitors: agreements to restrict prices and output price fixing: an agreement between firms to fix or raise price to restrict competition and earn higher profits collusive bidding/bid rigging: (i) firms agreeing to submit common bids, thus eliminating price competition; (ii) firms agreeing to submit the lowest bid by rotation and thereby each getting a certain amount of contracts Elective 1 Horizontal agreements among competitors: agreements to restrict prices and output market division: in products and locations customer allocation sales and production quotas Elective 1 Vertical agreements between buyers and sellers resale price maintenance (RPM): a supplier specifying the minimum or maximum price at which a product must be re-sold to customers by downstream firms, hence maintaining profit margin; tie-in sales : the sale of one good on the condition that another good is purchased exclusive dealing : sole distributor Elective 1 Mergers: horizontal mergers, vertical mergers and potential competition mergers Elective 1 (ii) The impact of anti-competitive practices (N.B. Graphical analysis NOT required) Explain some possible impacts of anticompetitive practices (e.g. higher price, lower output, lack of choices to consumers, reduce the number of competitors, etc.) Elective 1 (iii) Justifications and concerns for competition policy Justifications (1) Providing a legal basis for the investigation and sanctioning of anti-competitive conduct (2) Strengthen institutional framework for regulating competition and for its advocacy, and hence promoting market discipline (3) Improve the business environment and promote a level playing-field for business Elective 1 (iii) Justifications and concerns for competition policy Justifications (4) Improve transparency through delineating what constitutes anti-competitive conduct (5) Without such regulatory regime, in the long term there might be an adverse effect on our relative competitiveness, especially in sectors with high entry barriers. Elective 1 Concerns Concern 1: Do we need a competition policy? Arguments against the implementation of competition policy (1) Increase the cost of doing business (2) No need to interfere with normal business operations in a market place that already works well (3) There are alternative ways to enhance competition without introducing a new competition law Elective 1 Concern 2 : Cross-sector competition law or sector-specific competition law? Concern 3: Scope of behavior to be covered by competition law Concern 4 : Any exclusions or exemptions? Concern 5 : Criminal or civil offence? Consultation Document on Competition policy http://www.edlb.gov.hk/edb/eng/papers/compete/index1.html Q&A Session