Acknowledgment The auto wld like to expess her mense gtte o Pee Rock-Lacox, wo ade al te agas n t bok, an o o oeed contess and ost elfl sggstns o veen veens s n both the agas and n e text.
1B Economics in a Nutshel Noema Press e-mail: noemapress@gm noemapress@gmacom acom oyrgt© 205 lle Tragakes emal ele.nsell@gmacom All rghts reserved o art o this blcatio may be reodced or transmited in any orm or by a ny means wto the rior writen ermission o te aor an ubliser
Diagrams digtize as scalable vector gra (SVG) iles using lnscae lnsca e on Trisqel Bot lnscae an rsquel ae ree/libre soware, soware, available a nkscaeorg and r�u r�ueel.l.nfo nfo Cover hotos are rom Wikimeia ommons Design by evelonet Athens Greece rine and bound by yosho, Athens Grece oema (v6µ is te Greek word for meaning tought, concet ercetion
ISBN 978-96093-5931-3
11
Introduction This shot gudeboo s iended to help yo revew al te topics of he syabs before tests ad exams. I s ot a extbook ad cano be sed as suc t sod e used as a sppee s ppee to you extbook, whee you wi fid oe i-dep expaations o syabs syab s topcs.
Key to symbols I the iterests of brey and to ae cause-ad-effect reaioshps cear, the oowig sybos are soeties used
nceases
U
decreases
=
teefore folows tat
0
advatage posite characterstic psitve consequence
disadvaage negative characteristi, negative conseuece
ipoant poit to note
blue bod words and phases
syabs tes and coceps
Not This boo
coers a te topics i te 1B Ecoocs sylabus in sary or ncudes key denitos diagras ad heories you need to ow contains a gossay of ipotant ters You ca se o reiew he an poits o eac opc as you coer n cass ad i yor stdies of ecoocs reiew quicly ad horoughy beore ests and exas ake sue yo ave coveed a te topics i te syabus tat yo wi be exaed on on Note aso tat HL aeria appears against a igt peac bacgroud the nuberig of topcs i this book foows te nubeing of the ecoocs syabus diagras se geen ies to sow an iitia station ad bn ines to show any change wit te excepio of exteraity dagas whee een ies sow he socia optu re ies sow te sboptia (sociy ineffcient) exteraity outcoe de o aret aiure ad be ines sow the pocy ocoe
Contacting the auhor
If you hae ay qestions o reqie any caications I you ae spoted ay errors you wod ie to repo, I yo ave ay ohe coets, pease write to the athor at ieutse@gaico
lll
Contents Foundations of economics Economics as a social sciece Central themes
1 1
1
3
Mcroeconomics
1.1 omptitiv markets: Demand and supply 1 Eastcity 13 Govrnme intevetio 14 Mat falr 15 eoy of the rm ad mare srctres (HL only) 151 Production ad coss . Rveues 153 Proft and goals of rms 154 Peret competio competio .55 Monopoly 156 Monopolisc competition 5.7 Oligopoy 158 Price discriminaion
3 8 14 19 25
5 27 8 30 3 35 35
37
2 Macroeconomics
39
1 lvel of overall coomic activity activity Aggregate demand and aggegate suppy 3 Macroeco Macroeconomic nomic objectives objectives .31 Macroecoomic objcives Low uemploymnt 3 Macroecoomic objecives Low Low ad stabl rat of ifato ifato 33 Macroecoomic objcives 3 conomic growth 34 Macroeconomic objecives 4 Equty in the distribution bution of icoe 4 Fisca policy 5 Monetay poicy 6 Supply-si Supply-side de policis
39 4
3
International economics
31 3 33 34 35
Intenaiona ade Intenaiona xcange rates he alanc alancee of paymnts coomic intgration Terms of of trade trade
4
Development Developme nt economics
48 48
5 54 55 58
59 61 63 63 67 71 74 75
41 Economic developme development nt 4. Measrig developmnt 43 h role o o domestic factors 44 h role o nternatoal trad 45 he role o foreign foreign direct nvest nvestmet met (F) 46 he roles of oreign oreign aid and ultiateral devlopmnt devlopmnt assistance 477 h rol of internatioa debt 4 48 he balace etwen etwen marks and ieventio
Glossary
77 77 79 81 84 88 89
91 9
Microeconomics SL tems (cor) Mcroeconomics H tems Macroeconomics S terms (core) Macroeconomics H terms Intrnatoal coomics SL trms core) Internatoal ecoomics L terms evelopmen coomics S terms core)
94 95 97 99 99 1 11
ndex
1
lV
FOUNDATIONS OF ECONOMICS Economics as a social science social scence = any dsciplne tha studies aspects of human society including economic economics, s, anthropology, socioogy, poitl sciene psychology
The socal scentific method same as e sc1ent entc met od and cosss o he f oIIow stes: h'1s s he same 2. Idetify important vaables needed to answer he qestion qestion Mae obseratos abot a uestion of interes 3 Formuate a hypothess about how te varables are relaed.
4. Coduc tests to see f the hypohesis s suppoted by the data
If the data suppot the hypothess, then the hypthesis s acepted no refuted and ca be sed i buldn theores
6. If the data do no sppo sppo t hypothesis ths i rejected and a searh beQins for a new hotess.
Some features of the method of Ecoomics Eonomists bid modes in order to simpliy the compexities of the real word and highlght he more mportan relaionships between variabes May of te relatioshps inluded in modes are based on hypotheses tha are suppoed by emprical data.
The ceteris pabus assmption is very important in conomics It means hat wen we sdy ecoomic theoy we change only oe vaable a a ime in order to be abe to sdy te varabes effects n the assumption that al ohe vaabes remai costant ad uncagig.
Posite ess nomatie statemets somethingg that s, was or wi e; it may be posite satemet= a statement abot somethin
tue or false ex "the rate o naon is % (hs may o may n n be re}. Positve staements are used o describe events and make hypotheses and teoies. omaive stateme a staement abot something tha ogt to e expressing a
subjetive opnion or or vale jdgmen it cannot be true or false; ex the rae of inflaton is too high is based o an opiion of wha s oo high Normaive saements ae used to determine the oals of economic polices
A imporant assmptio in ecnomics s that of aonal ecoomc decisio- decisio- mak mak decisionmaers (cosmers, ms wokes and al esorce owners beve according to heir best selnterest ad ty to ge more rather han ess (more benets rom consumon more prot from prodtion hgher wages and more iome from selling labor ad other resouces, and so on)
Factors of productio and scacty f rere rere in uts used to rduce ll oods and services that eo le need an want; there are for es of resoures l l all natual resorces tha are above the groud (ex forests, itl (also known as l )= machines, tools rvers agricltural and fish in the sea ad al natral resources that eqipment factores all constcton t difes from the other three are under the ground (ex oil natural gas minerals) because is itse a rue acr o prodction ao all human effor o wrk that goes into prdcing goods and
sevices ex the work work done b teacers bulders, law ers lmbers
rui= rui = the hma efort used to organze the other three fators as well as ris-takin , iovato iovato mana emen
at= at = the conditon of being limted in relation to the needs and wants of human beigs factos of podcton are r while human needs and wans are infne sine there ae not enugh resorces to poduce everythng needed and wanted b y hman beings g oods and sevices are aso sarce
hree basc questons Sarity fres all eonomies egardless o their orm o organizaion, to aswer thee basic questons Wat o poce?
What gods and serices will be podced by the available resouces, and n wha quatites will they be poduced?
How to pouce
Wha factors o prodcton will be sed to podce the goods and seies and in wha combinations and qanttes
For whom o produce
How wil te goods and sevices produed be dibuted among ther potentia user who will get what and n what quantities
Choce ad oppotity cost he scaity of resorces means tha coices ae to e made: the uestos wha to proce ad how to pouce involve choces tat relate to resre llati (explained below) below) (The uestion f w t t rou invoves choes choes that relate to iome ditriui ditriui se seee p 55) rere lati= lati = assigning paruar resources to the production of paticular good goodss and serices lt f rue= rue = to many resores are assgned to the prodction of partular goods and servces servces there is erut eru t ueralat ure= ure = too few resoces are assigned o the prodctin of partiula gods and servies there is drdt
reaocatio of esouces changing the allocato of
resouces and hence he ombinaton and quantties o goods and serces prodced, so that diferent amous f esorces are assgned to each good ad serice misaocaio of esoces assigning the wrong amount of
resources to the prodction prodcti on of paiclar goods goods ad sevies, oerallocaio uneralocao resultng in or
the value the next best altenatve that s sacriced as a result of making a choice his conept is r t e, u i eette he and ie mt e e oru x f yo choose to stdy for yor exams the beause opportunity cost of yor choe s he sacrice of what you mosy prefered to do nstead of sudying f sociey hooses to produce good A the oppotnityy cost of this hoce s the sacrife oppotnit sacrif e f the most most refer re fered ed altern alternaive aive ood ood that could have been been roduced r oduced wt th e same same resources resources 1
T producio possi poss ibi l ties cre (rontier) (PPC o PPF) PPF) hw h axi qa qa f w g, x a a a yl ( w g f g x aglal a afa g a a y a y wih i availal a lgy. T a i a a h y y • i ly; l eploe all all all eiciely, ha h i wa If ih h ii hl y will a a i ii h a i : a h h y av fl axi ly i ig ifily
Poction poiiie mode
(units)
40
20
d
· · · · · · · · · · • · · · · · · ,. · · · · C
,
10
0
T w fllwig D scrciy scrciy i i i : i i a ai ai f unattaable ag i g. scrciy scrciy t is ecessry o mke choces: y a a fll ly a i f h i i f i; x i a ay h Coice gves ise o oppouiy cost I i l ia i f g w aig f g
•
30
4
6
8
10
potaoes (tons)
A i a h y 3 yl a 6 f a. A y 2 iy a 8 f a T v f i a i y a The sacrice 1 icyce i r gai 2 f a 0 bcyces e e opponiy cos iag h qaiy f a y 2 . T v v f i a i ivlv a relocio of esoces. esoces.
Central themes
The teat to sstainablity
Economic gowth versus economc development A ai gal gv a wl ecoomc growh (gw Y i gw i w ay aiv ecooic deelopmet (a aa f livg i a la f a y a q i a Hw w a i vl? Wa fa v vl f ig? U wha w ha ii i vl vl a la? Wa f li ha gw aa i vl?
Evial sstblity h f a a a a i way a a qay y h qaiy f avaial f f gai i a y a h f il fl a w l a y aivii a y a aal ilig f will a lf h glal lia a a y Ia q a Wha k f aivi la ai aiailiy? ailiy? gw aily aily la aia v? Wa f li a aialy a v via ga a i?
How much shold govenments ntevene n makets
conomc eicienc vess eqty: eqty : conflicti conflicting ng o consstent consst ent ojectves
All i i h w w w hgh a x x f gv aivii a comand meod (w h gv aivii i ahiy a a aw a glai ha al i i-a ilg a ai y a iva aivi a h mke meod (w al i ii-ak ia i a a i i a. Ia qi a Wa a fi a iavaag f gv vi i a? Wha a fi a avaag f fly fiig a w gv ivi? w a wa w ay hl gv iv i a?
coomic iciec h f il way a avi wa a equiy ( a f g fai ally i a elty iome disito) a w ia i jiv Ia qi a wha ii a ffiy a qiy ahv? Wa i f lii a aa f ahvig ga ffiy a wa ii f ahivig ga qiy? A ffiiy a qiy fliig jiv a lv? A h a i wi ffiy a qiy a i a l ah h? A h ii a a h?
2
microeconomics
1.1 COMPETIT COMPETITVE VE MARKES: DEMAND AND SUPPLY Competitive markets copetive ae a mae where e pce f a good service or factor of productio is determined trough e e iteractios o any sal buyes and seles, so tat no oe ca inuence the rice
market = any arrangeet hat alows buyers and selers to cme
ogeer ad mae an exchange (ex a pysical meeting place as a is maket o o a so, o classied ads, inernet, ec
Demand g
(0) = the uantity of a good tha buyers (consumes re l l o buy at vaious rices over a time prod ceeris paribus The law of dead aw of dead= dead= a law stating tat tere is a egative causal reaionship between pe (P) and quaiy (Q of a good deanded:
the higher the rice the owe e quatty deanded te lower the rice the greater e quanty demanded demanded The aw of demand s lustrated by the a r r wic is dowward soing
nval d d k and niviua and = the demand of a single buyer ake dead e demads o al he buyers in a maret found by addig up al the ndvidual deands fo each pce In a market with wo buyes, make demand, D D o uyer 1 + D of Buyer 2. D of Buyer 1
Be 2
rk n
;
Wh h n i n Consumers derive n fom buying/consumig goods an seces The addiional beefits derived from buying/cosung one more uit of a good are called a aiina (MB). As we buy more ad moe units of a good e margial beneis we enjo decease (ex te moe sodas you drik the less befis you get fom eac additonal soda theefore MBU) Since MB as Q consmed , cosumers will be willig to buy more and more units of a good only i its ice falls eefore as P, Q demanded, and vice ves. F h d v l k B v
At P 4 market Q = 2 + = 3 a P = 2 are Q = 3 + 4 7
a cha n dan) A ovement along the demand cuve fo a good can be caused nl h According According to the an, if P, Q and there is an uward movement (b = ) if PU, and tere is a downward movemet (a� b). b) . The change n Q due to te change i P is caled a an
h n n A sht of the demand curve or a good can be caused n h h n-p dn an (see beow) A rigward sh indcates a increase n demand and a efward si indcates a decease in demad The chage n Q due d ue to te shts in D is called a a i an.
Deand cve sowng canges in deaded
ead cve sfts: cages n dead
p
p
4
-
p
+
=
2 - --- - - -- -, : - - --
2 -"-----
Om 01 0
3
Q
0
1
7
Q
Q
P1 ------�-
,
Qz
Q
-c f (cu f c hf)
Demnd chan chan es and the the demand demand curve sts ts in res onse to fou a aos cages I the Cnges n ases ad pefeeces When tastes ad prefereces o Cages n e be of buyes (deogapc cages number of buyers in a arket increases, D iceases (shis (shi s rgt; if te conuers chage in fvor of good, D inceases (shits rig if number of bu ers deceases deceases D decreases decreases sts e rereces ca e a ainst a ood D deceases shifs le e Cnges coe The efects o D depend on whete te good s Cages n pces o elaed goods The ecs on depend on whether te related goods ae oal dema () oal demadd or the good icreases as consuer icme sbses goods that saisfy a simiar eed ex ea and fish as P ncreases; most goods ae ora as icoe rises increases (i sbses of good A (ex meat) icreases D for good B (ex fis) ceases (shifs (sis rig as income fals, D falls (sifs ef) right} as P of good A falls, D or good B fals sifs lef) (ii eio = demand or the good decreases as consume noe (ii lns = goods tat are used ogther, ex tenis balls and ncreases e lowerpice goods ie used cars used clothes teis rackets as P of good A ncreases D r good B decreases (shifs margarin (as oposd to butter) butter) as icoe rises, D falls (sifs (s ifs left) lef ; as P of ood A decreases, D for ood B incrases shfts ri ht as icome icome falls, D iceases sis r 3
· Supply Undersadig s y = e quantty of a good at selers (rms are ng are ng d bl to produce and sel a vaios ces ver a ime peiod cetes paribus h ly y= y= a law staig that ee is a positive casal casa l rlaionsip between d iy (Q) f a god suppied: te higer the price, the higher the quantity supplied; he lower te pice the lower the quantty spplied. Te law of supply is illustrated by the u uy cue ue whch s upward slopig Wy h ly uv ud g The price at which the rm sels s good determines the reveue of the irm (the money it receives rom its sales) As he price of a good increases the rm receives more reveue producto of the god becomes moe protable thereore it is i rms' ierests to icrease he quanity tey produce The reason fo greater greate r rotbility ht pe d revee nree rm re better abl to cove te higher costs of poduction that arise frm icreased quanity produced Therefore as P Qsppied Qsppied and vice vesa
dvdl uy d k y ndiv ndivda ly= he he spply f a single sel (rm) ak spy spy the supplies of all the sellers in a arke fod by adding up al he idividual sppes or each price a market wih wi h two sellers, maket sppy S= S= S o Seller + S of Selle 2 lr P
f el
+
p
S1
:/
2-
0
Q
0
1
3
M ply p
S2
41 ·
+
=
m
= · / / / : Q
O
Q
A P= P= 4 market Q= 2 + 3= 3= 5 a P= 2 market Q= Q= 1 + 1 =
cve ad a sh of the s I ce
Mv ng y hg i id) A movement alog e supply curve for a goo ca be cased ly by hng n ric f t gd According to te l y, if P , Q Q and there is a upward movement (b a); a) ; if PU ad here s a owward movement(a b) The change in Q due to the cage i Pis calle a ng in tiy pied.
h uy g uy A shift of he suppy cue or a good can be cased ny by a hage he nn-ri deeia sly (see below) A ightward shi ndicates a icrease in spply ad a lefward shft ndicates a decease i suppy he chage cha ge in Qdue Qdue to the shits n S s called a change n supply. Sppl r sifs: ages i sppl
ply c c hng ang n led led
s
Q
Q
No-ce deemnans o s (cases o s cve sfs)
Su I cha es and the s I cuve shifs n res ose o v n c Chg i d e) If prices o facors Chg drt ( ( tax o spedng to buy goods and seces of podctin(labor, podctin(labor, lad, capital etrepenership) increase S paid indirecty o the government); if a indirec tax ncreases S alls fals shfts left ; if factor rices decrease S icreases shi r t shits le if a idr idrec ec tax falls S increases ss ht Chg h b n h If the nuber of Chg ii dy dy((= payment by e governe to rs n oder to irs i a maket icreases S increases(sits increases(sits right if te nmbe lower costs and pric, ad a d icreas icreasee suppy suppy i a sbsdy n he product of rms a arke fals S decreases(sts decreases(sts ef) a r icreases S iceases sif sifs s r . f a sbsid U S sifs e Tehngi hg f hee is a echlgil improve S Chnge ee If is expect e futue rce of their prduct to ncrease they supply less in the arket i the present so hey ca sel icreases(shifts right if there is tecnologca worsening (less (less likely to occr) S ecreases (shfts left) more i te ture at the hghe price S falls (sifts let. If rms expect the ice to all the su s u I mre in the resent S rises sis ri ht Cg i ed gd The efects n suppy depend wheher the elated goods ae n () jn y= y = when two o more goods ex bute and skim milk, are derived from a single prodct (whole milk it is not possible to prodce e of oe ex btter, who producing f the other ex skim ilk If the price o btter rises, Q of btter produced ncreases (upwar mvement along the buter S crve and S of skm mlk increases(S cve for skm milk shis right) If the prce o btter falls Qf Qf btter produced decreases (downward movement alog te butte S cue) cu e) ad S o f sim mil lls (S cve fo skim mlk shits let) (i) c ctive uly uly whe two goods se the same esources ex oions and potatoes grown o the same agrcutual ad t s not possbe to produce e o one without poducng ss of the other. I the pice of potatoes inceases, the Q o potatoes poduced icreases upward movement alog the potato S cuve) ad the the S of onons falls (S cve or onos shits left I the price o potatoes decreases, te Qof Qof potatoes fals dwnward movement alon the otato S cue ad the the S of oios increases S ce fo oios shts i ht 4
Market equilbum E Mat quilibum
Marke equibrium s a posin o balan bw dan an spply,
an ocs whn quatty dmadd i qua qua t quaty qu aty ud. u d. In daga s pn o al s wh wh h D a S cvs coss ah oh ining quibrium ric ric P, a quiibium quatty quatty O A vy pc pc oh an P, s mart diqulibrium
p
s
I P> P xcs su = srus srus Q dmandd < Q upd I P < P xcss dma = srag srag Q dmadd Q ud In a pv ak w h s no nn w os spp an an P an O wll alwas sl a lb vals If s a soag soag ss an wll ns a o P If s a sps ss spl wll ns a P o P
D
Chngs n
Ma lbr an ang onl hr s a ang (sh) n an (D n sppl s ppl(S asg as g ro ay non- nans An sh s las o ss an or ss spply slg slg n a nw a ilb Cagg quibium quibium du t cag in upy
Changig mart quiibrium du cag in dmad
p
p
Pz - -
S2
p3
P1
z
Dz
Q3
Qt
Q
Q
Q3
As D" D1 D2 D2 P an O (o P2 an 0) As 1 J P P an O PJ a OJ
Q
Q
Q
As ro S1 o S Pan O "(o " (o P an 02) As S o S1 o SJ P P a O PJ an OJ
Te role of e prce mecam Rs n
Rouc aocation ass nn s sus duct s c os an svs carcit carc it cic and ruit t t(s (s p PPC modl: scarcty, coc ad ooty cos Rsos a scarc = li n an n lan o ppl's ns an b
wans t o cii mut ma ccs on ow o bs alcat sos o avo s was carcit ans pon ano o os h PPG n ) A cic s b a on ow an sos o ala ba (sbozng oo) o o gns(sbolzng gns (sbolzng fns; tis is a cic anwrg
B2
81
-------------�---
h wat o poduc d how to poc qstos of rsoc aocato.
Sa ans ha a o o o o ba pon nssaly nvolvs lss gn pn (an v vsa. Ev o nvolvs an pty cst (= val val o n bs alnav ogon sa): ovng o a o b nvolvs an nas n ba oon oon o B2 B1 wh an ppon os 2 2(gns (gns ogon). Sgnag ad ncetv ncton o c n eoc aocao
s mn aks aks play a cal ol ol n allcag scs o h poin o spci gos T ny s nialy a P an 0 Spos D" o D o 2( 2( a hang n n a nonp nan) A nal p P h s ss ss an(= 02 0 2 0 0 bgins " ang as () a sgnal o ps an onss ha h s a soag; sng P pvs noaon ab soag os an nss; an () an inctv t rducr t prduc mr , lang o an wa ovn along S v 0 sppl nass) bas s gar wllngnss an abl o po as P"; an an inctv cumr t bu Q t ta a 2 lang an wa ovn ang D2 (0 (0 an ass bas o nss low wllngnss an ably b as P" nw a lb lb sls a p P an an O souc allocaon as , as so ss w an o o ron s an bo no oo o s oo OJ> 0 5
PPC G
guns
Pc as a sga and ncetve n eoce aocato p
Q1
QJ
Qz
Q
· Market eficecy Consumer ad roducer surplus, surplus , socia surlus and alocative eficenc C p r p rp n loa n r p
osmr srpls the benefit receved by consumers who buy a good a a lower price than the price hey are willing o pay =th aea under the demand cuve p to te equilbium price, Pe shown by the blue area In a free compitive maket consumer surpus is maximm
S=MC
produces es who sell a good a a produce srls= srls = he bene received by produc higher price tat e price ey are willing o receive he area above he suppy crve up to te eqilibrium price, Pe shown by the orange area. n a free compei compeitive tive make poducer surpus s maximum =
he sum of producer and consume surpus n a free compeitive maket social surplus is maximm.
ociia srs oc
lo bes alocaton of resources from sociey's pont of view occring occr ing n a ee, competiive marke {wih {w ih no externalities; see p 19). rn beef (MB MB)) th t bnfi t cumer fm numng one more uni of a good, e qua o he demad cue r MC te extra cost to produes of prodcng one more n o a o e al o he su I ce
DMB
Qe
Q
ib r o e e b p { be nl b b {MB MC MC
HL topcs on demad, supply ad market equl equlbrum brum Demand
Qd bP, where
linear saighline) emand D) uve is given by Qd quantiy demanded dependent variable
P prce {independent variable
a Q nteet {he poin on e horizontl axis cu by the demand cuve
li n lot e demand equation Q Q where wher e d is in g of apples and P is in€ in€ Step 1: abel the verical axis of your grap as P {E) and e horizonta axis Q kg ppls) Step 2: To fn wo points on he D cue in the simples way set P =0 =0 Qd 1. 1. is is the Q ep the point on the orizonal or or axis cut by the demand cuve) givig the poin t (120) Sp 3 se d =0 =0 0 =1 -2P 2P 12 P 12/2 6. h the ee te the e r i t y the rve) giving he pont (0 These are he endponts of e curve {the gee line).
• b e slope of te D cuve defned as 6/P wher b is a ositive number
on n
=
Alernativey you can set P {or equal to any reasonable vaue (withi he range of e D cuve and sove Ex se se P1 d d1212-21 21 d =12 =12-2 -2 Qd10. You ave now found te point (1
7
10
12
5
Q (kg of apples)
Shing te ema ve
Any parallel shift in the demand cuve, due to a change in any n onpre determinant appeas as a cange in in the eqation Q -b If a eases, te D ve ss g; a eeases he D ve shts et
In the demand eqaon eqa on Qd1 , the of apples demanded increases by 3 kg at each price Fid e new demand equaon and plo i Step 1 Since Sin ce a 1 n he inia eqatio, a =1 =1 + 3 3 15 in he new eqaon which becomes becomes Q Step 2 o pot te ew D curve smply sh he nial D cve s skg) kg) o he righ If he of a les demande decreases b 5 at eac eac rice, t ne deman e uaio is Q 7 ad ss 5 nis k to he lf Ci pn n the demand eqaon Qd Qd b e seepness of e cuve is determined determined sope · 6Q 6Q 6= 6=chang changee in he he by h value of"· b which is the sope dependen variale divded by cange in e independen variable):
C i sp p o
largr b e o p Given Q 1 , suppose canges canges o 4 The new demand curve given by Q Q1 - ecomes lar as sown in the dagram Note tha the sope here s n o r raer than f axes dn rb 6
12
Q
Supply A linear supply S) cue is given by where quani upplied (deende variable
prc idepeden varable
(e poit o e oizota axis cut by he ply cue
the slope o the S cue deined as / / whr i a oiive uber
ot an uv an v v
o a p Plot te supply equation where s is in kg of apples and P is in€ Step 1: abe the vetical axis o you graph as and he horizontal axis o ap) Step 2: set P= P= 0 � Qs 2. Tis s te Q ntercep (te pont on the horotal horot al or axis cut by the supply cue) givig e point (2,0). Step 3 f you ow set 0 (as you did with the D cue) you will ind tat P < 0 (a negatve nuber), which is ot in e permissible range o the S cure. o get around this you can set equal o aother vau > 2 that you foud above) So let let Q= 8 � 8= 2 + 3P 6 3P P 2, so you have the pont 82) You now ave two points that you can join together to nd te S cure
p ()
J
3 2
1
f the value of in Qs + dP is egaive for example, s 6 3P e seig P 0 wil gve yo whi is not n ot i th pissibl p issibl rg of e S cue Here you can se 0 to e tercpt 0 = 6 3P P P 2, or the pont 2) (Noe Ths i s o sown te diagra)
2
5
8
Q (kg of apples)
i r Ay parallel shit i te supply curve de to a change i any nonprice deeminant shows as a change i · i the quatio Qs . ia e hi t; ca u I e supply equaton the of apples supplied supplie d icreases icreases by 3 kg at each prce Fid the new supply equatio and plo t Step : Since c 2 in the inita equation c= c= 2 3= 3= 5 in the new equa equation tion wic wic becomes + Step 2 o plot the new S cue siply sif the nial S cure 3 uits (kg) o the right If the a of a les su ied decrea decreases ses b 3 at each rice, the new su e uatio s ad S shit 3 uts k to the the ef ef Changes te slope and steepess of te curve
Ca o h ul v In he supply equation + te steepness of the cure is determined by the vale of "' whic is te o d d ( change in he dependent variable ivided by change in the th e independnt variabl)
Th lagr h vau o op, h a uv 3
Given suppose 3 chages o 2 he new suppy cue, give by becomes as shown in h diagra
2 1
As i the D cue, the slope is u ovr rather than ove o va o a o h a n varal Market e uilbm Soving equatos to fi eqiibm P and Q Give the demand cue Qd 12 2P and e supply cure Qs 2 + 3 where d and and Qs are in kg o appes and P is in
0
2
5
8
Q
oin an r o i a p
€ calclate te equilibrium price ad quaty
6
Step 1 Sice Sice at eqiibrim Qd Qs 2- 2 2 3P Step 2 Solving for for P: P= 10 Step 3 Substuing P P 2 nto the deand deand (o supply) equation Qd122(2) Qd12-4 Q=Bkg
3 2 1
o not forget th abels abels fr ad kg for Q
2
5
8
0112 Q (kg of apples) apples)
Calcatg excess ema sng e example a ove
Calcatg ecess sppy sig te eampe aove
Ex dad aises for fo r any P Pe= €2 were d > s s Supposing P = 1 use tis value or P o solve or d and Qs d 2-2P 2-2P 2-2 10 g s= 2 3P = 2 + 3 5 kg xcess demandQd demandQd Qs Qs g
x ppy arises for ay Pe€2 wee d Q Supposing P P €3 use tis value for P to solve for d and s: s s 2 33) 2 9= 9 = Qd 12-23) -23) - 6 6 xcess supply= Qs- Qd 11 11- 6 5 g This excess uply can be seen as the oae doted ine above
is excess demad ca be see as the rown dotted line above. 7
1.2 ELASTICITY Price elasticity of demand (ED) PED and how to calcuae i
Accordig to e aw o demad, an cease in P gives rise to a decrease in O demaded ad vce vrsa Now we ask, given a cage in P does 0 demaded chane a ot or a litle? The concet of PED addresses this uestion. Calcatig ED PED= PED = responsiveess eess o Odemaded The vaue of PED to changes i P =% =% chage in O Suppose the pice of pias increases fom $4 per pia o Because of the aw of demand $ per pizza an the quati quat ity demand demandeded fals from 2 pzzas demanded divided by% cage n P statig te iverse relatoship beween P and 0, to 1 pi z zas. C e PED r izzas ED has a 6 wee _ negative vale: as P n OU and vice O 15 15-- 2 -5 ' versa. 6 6 %0 � -2 ½ ½ 2 4 However, PED is teated as if it %P PP -4 O O!O - O 4 4 were postve (absolute value) 0 = intial Q value P P P PED measres resosveness Note tat weeas the value o PD is egative, t s P nitia P value treated as i it were ositve. o Q alo a ive cve. xlOO
x O
p
p
-
Price elastic and rce inelastic demad Pice eastic demad PED > 1:
Steepess of the D cue and ED
% 0 >% >% P the percetage change i O demaded demaded is geater tan the pecenage change in P (the change in OiOis o orionatel ar er than he ca ca e i P . Pice neastc demad PED %0 <% <% P= the percentage change in Odemanded is smaler tha te percentage cage i P te change i O O s ro otonatel smaller than te chan e i P PED is measured etwee wo poits on a D cuve In a dagram with two itersecting D cuves the fatte cve has the more eastic D o the same 6 is more elastic than snce tan or <
p
<
Q1 Q2 Q3
1
Vrl PED long a straightlie egaivelysloped D curve ilustrating the law of demand PD chages along n g te legth gt h o the cuve, cotinuously aling as PU and on. I the ohwest par of the D cuve PED 1, the southeas pa PED 1 and a he dpoint of the D curveve PD = 1 Why ED differs fro the soe The slope of the D cuve= QP By cotrast, PED= 0P//P0 = • QP 0 PED slope x /Q The slope of a straight lne s aways consta thereore PD a constant number x PQ which isi s contnuously cagig decreasng) as P ad o alon the D cuve. herefore herefore PD as P and o.
Vl
Q
S ecia cases of constant unchan n ED Peectly neastic deand Peectl Peec tlyy elastic demad 0 PED 0 PED :
the percentage change i 0 the percentage change in 0 is ero o mater how hig P rses, emanded esulting from a cage i P is deanded does ot espod is situato infnely large; tis is a special case used in mQ gdemaded ht be approached n n cases o drug economic theory o llustrate demad n addico. peect compeitio (L topic see p 3 When demand s pefectly ieastic he Whe demad s efecly elasic, te demand cuve is veca emand cuve is ozoal e li dad: Peecty eastic demad: demad : ED
ni ls dd the percetage change 0 demaded is equal to e percetage chage i P (cange n Q is poportionately equal to cage in P) ths is a theore theoretitical dea tat is ulikele ly to e oud ofen i the real world deand s uit elastic e demad cve s a rectagular hyperola ED =
Uit eastc demad: ED
0
i -- -
Q
D
D
8
Q
The determinans of PED
Number ad closeness of sstittes sust gs wo o more goods that satisfy a similar eed Te moe cose substitutes a good has, the ore elastic its demand the geater its PED Ex i P o appes consumers can switc to oter ruis (substitutes to apples) high resposiveness (drop) of Q o aples dmaded. But if P of gasolie cosumers cosu mers have few altrnatves low sponsiveess drop) o Q of gasoine demanded. Aes ve rice·eastic D; asoline has rceinelastic D Degee of ecessity ecessity a good tat tat is necessa necessa o a consumer to b contrasted wit a xy = a good tha is not essential) The more m ore ecessary a good te less elastic s demand = the lower its P. x food is a necessiy necess iy peope canno lve witout� if P of food , te Q of food demanded wl drop y only a lttle P for ncessities < PE for lxures =
=
=
nc sn g ater the popoion f ncome spen on a good e more elastic The greater Thegre its demad he greater its PED Ex Comparing teevisons to ce ceam since a teevison takes up a large popoion of consuer income tan an ce cream, a n i the P of tlvisions tlvisio ns will be el more strogly by consmers a an i te P o f ice cream leading leading o a greaer rsponsiveess drop) n n the Q of of televisions demanded PED or televisions > P or ce cream Time he more im a consume has h as availae o make a decso to buy a good, th moe elasic e demad. x if P o gasolne , over a so time tere will be a small dop n Q demanded, but over ogr periods consmers ca switch o other foms of tansporation an cars, or can buy moe feefciet cars c ars � large drop in Q dmaded
Applications of PED 1: ED ad oa revenue of fim TR P x Q a irm's total eai tot otaa evee TR eai s from sellin ts out t As P chan es TR ma or , or sta ncha ed, depedi o PED: PE> PE P i eastc a of D cve P ad TR cae i o ooste oste dectios dectios > 1 (ce ( ce eastc D) � ¾AQ >¾AP� P ad TR chag chagee P ooste dectons if P R. Reason ifi f P, Q propotonately more� snc te P % decrease in Q is ager than he% incease i P, TR f R Reason if P prportonaely more� snce te % crase in Q is arger tan he% decease i P =
� D E > 1 P=
te diagram, P is in the eastic e astic pa of te D cuve Whn P P TR = P x 01 yellow+ oage areas ar eas Wen P to P2, R P2 x 02 yellow blue areas Since blue orange, or ange, TRU as P
P pice easc D� ¾Q ¾P� P ad R cae n the same diecton f P TR Reaso i P Q propoioatey lss sice the% icease in P s larger tha the % decrease n Q, TR .� TR Raso if PU prporioately less snce te if % decrease in P is larger than% increase Q TR.
�
D
Q
i ilsc c: c : R cg s cin c in
l P<
z--
In e diagram, P is in the ineastc part of te D cve Wen P = P1, R P1 x 01 yelow+ yelow+ orang areas. ar eas. Whn P to P2 R P x 0 yelow plus lue areas Sce lue orange, R as P
=
D
Q2 Qt
Q
== sc ) ¾ ¾P so te cange in P has an equa (ad opposite) efect on TR as the chage n Q herere r is ucag. In both diagras orage area blue aea s R ris sig·ln w = t lastci gut h ng t c =
p
,S S., �D Q Q
Q
p - .....�.�. · ·PE· PE O
Q
PED i ltn TR
Roe of PED to ims makg icg decsos f a firm wants to increase its it s tota revenue it must kow te PED for its roduct since icreasing o decreasig its P will have a dfee ipact o R depending on te PD, and o were o th D curve it is cated
Pz .__ ·: • eo,1
Thereor Thereore, e, fallig PED along the D cuve affecs te irms R R icreases icreas es as he fim lowers its P fro P1 o P2 P2 being at te mipoit of the D curve, where PD ). At P wee PED= , TR is maimum; if P fals elow P2 R begins o decrease decrea se snce ere PE< .
'
=
D
TR
Summay of PD and R change n opposite diectons as P R R PE P and TR change change n the same direction as P, TR P< : P and TR change == : chan es in P eave TR uncan ed
Q
Q
9
Applications of of PED 2: PED PED for prmay commodties an manufacte ocs
Most prmary commodites hve ow P iestc demnd) becuse tey do ot have close substutes, and tey ae necessities. aufactur aufactured ed poducts sally re not as necessay as primay goods ad tey geealy do hve substutes, de d e to roduct diferenttion; ion; heef heefoe oe the ve h er PED moe elasic si c deman demandd
r d r ru= ru= goods arising from te fctor of production l, ncldg al agricultral podcts s well s ising foesy and extacive roducts ex ol and meras from the eath
Applicatons of PED 3: PED and idirect axes
dr x x txes on s endin to bu acular oods, ad ndiectl to te overnment tro e seller of the ood When an ndrect tax s mposed on a good, te frm's supply cre shfts o e lef hc hc is eivlent to a upward sht) ith ith the veical dference bewee te wo suply cuves= tax er ut. After the tax s mosed ql h h rr n q dd hile rd h h Te derence P - P tax per pe r unt t goverment o m te tax s e digrams sow evene per unt, and the yello are (P P x total tx colleced= totl goverment revene om he lower the PED e he moe neastc he D (he steepe he D crve) e greae he goveen reveue Reson: as P id b te consmr consmr te moe elasic sic the D the the smaller te res onsiveness dro i Q demnded, demnded, ad so the the ii her the he tx revenue =
= p
diec t wh easc deand
Idec tax with ineastc deand p
s
Pe
HL opic Appications o PED 4: 4: PED an tax incence
n the cse o n indirec tax on a good f ED< PS the ncdece of te tax te tax urde is greate o n consmes tha on prodces f PD> P the incidence of he tx is reaer on rdcers to be ex laned more fl o 5
Cross pice elasticy of demand (XED} XED an how o inepret t
If tee re two goods X and Y a chage n the rce of oe may led to chnge i dead fo te other. Given a cange i te price of good Y P ow and how mc ll demand for ood X (Ox) cane? The cocet of XD addresss tese stos. m E == resposveness of demand h m t E good X to canges i pice ofo f good Y= % f XD 0 X and Y are s (p 3) If X 0 X and Y are ln ln(p(p 3 chg in Ox dmndd ddd y % O nd hn hn in t m dirtion. n ii oppost irtios. Ox d P n change n P x Deskops and laptops f f P of destops Q x fee and sgar te P of cofee , Q demded o cofee (due to e w of demanded ofo f destops (due to the aw of � _ a demand) ad consmers swtch to buyng more ded) nd consumers tereore so uy less _ ' wee laptos D fo lptops (D cure shfts right) suga D or sugar (D cuve - - c uve sifs let) 6 T u l n r u Ox Ox O x Ox Ox Qx ntl O value P P P P P LP P inta P vle XD involves r and hece . x
y
p
� -D1
The meang of a zeo XD
If XD XD 0, tere s no resonsveness of good X o te pce of good Y: e goods are unelted Ex otdogs nd soes
ppes nd pes are lkely to ave higer XD tan les and ice crem
D
Q
e greater the absoute value of he negaive XD he greater the oeentarity of X and
tes blls nd racets have a ger X tn mil d cerel
he P of pas by 15% an t Q bought of otdogs by 10% Clcul t XD nd detiy h h reliohp eeen pz d hotdogs Q• 10% = 2/3 X ' P 1515%% E utu.
e P of ps ps by 10% and the Q boght of coes by 5% Clcuate he XD and ideny he reionshp be pzzs nd cokes XED Q - % 1/2·' P 0% E r l =
Q
he greate the vaue of he ostve XD te greae he sbstitutabi sbstitutabiy y o X and Y:
Calcaing XED
·
2
10
Applications of XEO: XEO : impicaons for busnesses The cse o complements
The case of substutes
Knowedge by a im of the XED o complementay prodcs prodced by other rms can be seful becase f a complemnt's price rses, r ses, this ay result in a dop in demand o the im's prodc whle a decrease in the compements price could esul in geaer demand fo the prodct Such informaon can ead o collaboaton between rms, such as charte ghts and hotels where both may gai om a lower prce Infoation on XED can aso be seul in pedicng efecs of ndiet axes on specic poducts E gasolne taxes lower the demand o cas especaly espec aly age cas (gasoline and cas are complementary goods
• nl i in b bu u pd PepsCo produces both epsi and 7U. If t lowes its price fo epsi, what will happen to s saes of ?U i a fall in � a lage al in sales of 7P; an ncrease in P a large ncrease n sales of 7P i i l a change i P = a small impac on saes of 7U • R i p rd Addas and Nike are wo firms prodcing substitute prodcts Knowedge o XEO or their poducts alows Adidas to predic changes n its sales due to changes in Nike prices, and vice ves vesaa • Merges etween etween ms producin producingg susie susie podts
wo rival frms producing substitutes wth a high XEO my want to ege(= jon tother) to liminae comtition bewen hm thouh this ma b illeal Income elasticty of demand (YED) YEO and a nd how to iterpet it
esses these qesfons and howmuc howmuchh does demand chan ne e The Chanes ncome Iead to chanes deand How, and The concet o f YED add ddesses YED can be used to distnish between wo diferent diferen t sets of oos YED responsiveness o demand for good X to chges in income (i) is postve or negave: • (abbreviated as Y) % change in Q nr (p 3) as income D for he good (D shifts right) if if YEO> 0 (positive)= nr demanded divded by % change in Y income , D fo he good (D shts ef) 6 1 6 • if YED< YED< 0 (negatve) iri d (p ) as income for the good (D shts lef)) if _ income , D fo th good n (D shits ight wheere 6Y 6Y 1 6Y wh i : i i d iir. y (i) Y l h rr rr h Q • Q< % Y Y Ex medicnes are a if YO< the good is a niy (p 9) becaus% Q< Q inital Q value necessity, so if income , hee wl be a proportionately ll llrr l i ii Y Y Y (relatively mall ftwad sht of ) Y initial Y value • f YO> = the good is a (p 9) becaus becausee % > % l Y x band-name clothes are a lxury (for many consmers, so if income , there will be a proportonaely r ll YEO involves i r (eativey large leftward shift in D and hence u : i l Y l hi iin infeioror goods YED YED<< ! nrl goods YD nessies YEO lxries YEO =
I I I
YED
�
Ca Ic a f g YEO
I
: 0
Income increases from $000 to 1200 pe onth, and the number of seaks bought per month increases from to 7, the uantity o chicken increases rom to 9, while he nmber o hodogs boght alls from 15 o 1 Calclate he EO for each of he thee goods, and identiy wha type of goo each one is
1
incom by 20% steaks by [(7-) [ (7-) / ] 00 0% chicken by [(-8) / 8] x 100 1.5% hotdogs by (12-5) / 15 x 00 -0%
=
YED
YEO or steas steas 40% / 20% 2 normal luxuy ED or chcken .5% I 0% 0 0= = normal necessity YED or hotdogs 20% / 20% 100 inferior, necessity
Applicatios o YE: Impicatons o poducers and the econom Iplcaios or prodces
Ipicios or e ecooy
roducers may be interesed n knowing he YE of their product as ths Pary poducs ( goods arising from the facor of producion l, which include agicltre and food usualy have a ow YO aecs how rapidly demand for it wil grow as comes change I a growing economy with increasing incomes, the industies oror goods and (ood s a necessity) while u p sualy have sevices with high YEDs will experence the most apid increases in hgherer Y Os and servces as a gop have he highest of all hgh demand and his information on s useul fo new ims making a decision (YED) These These difeing eing ED values have meant tha in many on which line of prodction to go ino, as well as or exising rms countries around he world thee is a change n the structure of economies ove time cotries usually begin with vey large primary planning investmens or he future In an economy that is expeencing expeencing recession and alling incomes incomes goods sectors but with economi growh and growh in incomes impoant as he and services with negative YEOs YE Os (iferior goods) may experience rapid manufacuring and sevces become inceasingy impoant growh Ex in Geece, Geece, which has had a vey deep ongoing recession, pimary sector shnks shnks n rative ative imporance. hs changing srctu vely more rapd growth in manufactuing and even there has been a mao gowth in inexpensve fast food restauans (an is the reslt of relatvely infeior good as consues with falng incomes swtch o thes thesee and fase growth o seices, whie he he prmay seco experiences awa rom ordina estaurans a norma ood slowest rowth of al L i i r ll p ow Ys or priay producs, sometimes forming the bulk of expors of poor contres in combinatin wih higher YDs fr manufactrd products foing the bulk of o f exports of moe developed coutries have imporant imporant impications for the vlue vlu e of exports and impos of less economicl develo ed countries in some some cases ormin a brrier to thir dvelo ment os els du to deerioatn f see 7 . 11
Price elasticty of supply supply (PES) ( PES) PES and how to calcuate it
Accordig o the law of supply a incras n P gies rs to an icreas n Q suplied, ad vce versa Now we ask, gie a cag P, dos su�ied chae a lot or a ittle? Th cncet of PES addresses tis uesto responsness of Q suppied to chages i P %chage i O Cau suppied dvided by %chang i P Suppos te pic of pias increases from $4 pr p r pizza to $6 per pizza and th quantity supid icrases fro 2000 pizzas to 2,400 Q tQ O = & _ •• % 1 PES piza. p as Caulae e o = Q whre int tal al O O v Q = in valu alue e 1 ' O 400000 400 P P P-- P ¾O P inital P al 60004 P 64 2 4000 ¾P P 4 4 PES measres v of Q a a e rve :
Price elastic and
ice neasi neasic c su
ri l l uppy teeness of he cuve nd P 1: ¾P percetge chge i pled grete than th an the ercenta erce nta e ca ca e i P chan i O o oionael lar er e r than the ca in P ri l uy < PES < ¾ ¾P perctag cange in supled is smalle a the P2 ecenta e cha cha e i P cha e i O ro oionatl sal ththa a cha e i P PES is measured ewe ewe two tw o pois on th S cu I a dagra wih wo interscting interscti ng S cues the flatter curve has the more elastc S is more elastic an S sinc as P chags than for S Yo ca se if suppy is elasic o iastc by just just ooking a the S cue. If the QQ QJ Q S c crosses the eical axis (x S) PES >1 (elasic supl) If t S curv crosss the oriontal axis (x S) PES <1 (nlastic suppy). As P O O fo S and O = - for S. I
S eca cases of constant ncan in
y a y S : t prcentag chang i supplied rsulting fro a cang in P is fiiteyy large this is a spca case sed i fiite conoic thoy to ilstrate world supply in ternatioa ternatio a trad (s p 64) PES hoonta S cuve ly i pply ES 0
PS
U li li uply s zero; no maer how high P rises, suppied is eual o h perctag cag n P dos not espnd x original antiqu furnr (chag in O is propoionately qual to has such a zo resonsivnss change in P ths is a theortica idea that is ulkely to b foud ofe ofenn ii h ral world PES = 0 vetica S cu v PES = S cuve cuts h orign Prly ia ppy P 0 lai y y l pply PES 0: the percentag chang i O suppied
PS : t prcntag cang i O supplied
s
- s s
Q
Q
The determinats of PES
Tim Te longer the tm priod a prodcr has to rspond to rice
changes th mo astc te supply. n a shot priod of time h roducr changes may be nable o obtan al cssay rsources r sources ad tcholoy ii ord to increas outut i respose to a pric incras As ore e asses it becoes easie to do so threor resonsieness PES icases. Miy ruc he more uckly ad easi ecessa sourcs can e movd from one type of rodction to anot anothr hr whr thy are needed t mor lastic t suppy. A
Q
U apaiy irm If s have achnes equiment, or labor that are not bing fully usd then it is easir to xpad production n th vnt that price icreases icreases simply by akig us of the idl sources, ad therefor or elasic the lv.. suolv Abiiy k f a fr ca sore stocks easly and inxpnsily, thn in e event of a pc ncrease it is ore likely to hav aalabl stock that can be sold i the makt ad th ore elasic the suool
lcatos o PES 1: PES or prma prma commodites ad mauact mauacted ed roducts
pmay mm mm ( pr) pr) = goods arsig rom t factor of productio a ost prima comodtis ha a low PES (inlastic
supply and lowr than the PES o anufactured roducts aily bcas they nd ore time than manufacturd products to b producd or extractd (mie (mied). d). gcultual podcts podcts need to go throug teir natura natur a growing ime. Fresty needs needs an especially ally long ti fo rs to grow and othr ria oducts x minerals, re uire a Ion ie and hi h costs costs for x !oration io t ath drillin and minin . icatos of PES 2 2 PES ad tax tax icidece
te cs of an idirect tax o a good, if PES < PED the icidec of h tax (the tax brde is gratr on producers han o cosumers; If PES > PE the ncidence of the tax is reaer o consues to e e exex lained o 5 12
Summar of elasticiies Price e asticy o demand = ED E rmu ibe ue
Q Q _ ¾P tP Tough PED is negatve, ve, it is treated as if it were positive (absole value
PED< 1 PD 1 PD= 1 PD PED
0
W h men
H iere i U e nge in Q is propoiona propoionaely ely ielastc demad smaler than chane i P cnge in Q is propoonately elasc demand laer tha chaqe in P Specal cae
cange in Q is proportiona proportionaely ely eual o chane in P Q does not hange a all in esose o hane in P Q has an an ifinitey large response respo nse to canqe in
Cross-pice elastcty of demand XED XED fomua
or two goods X and Y Qx %tQx Q %y Py Py
Pobe Po be vaue
XED >O XD
ncome e astc o demand YD Poee value Po E r YED 0
Q ¾t Q % LY
YD > 0 YED YED >
Prce e astct o supp1 PES PS fomua
Poble ae
PES Q Q %LP P
PES > P PES = ES =
What th mean
positive XED If P of good X then D o good Y ngtiv XD I of god X then D of ood Y J zero XE D of good is nhaed as P anqes =
What th mean
gasolne cgarettes, food expensive holdays, yachts
unit elasti demad
oncept use i ecoomc
peretly elasti demand perectly elasti demand
oncept use i economc teo cocept used i eoomi theo
theory
ow to nteret t
goods X ad are sbstitutes god X d comemes goods X ad are unrelated
How to nteet t
xame
orages and peas, laptops and desktops g d o tes bll and enis raes omputes ad shoes, pizzas and penls xampe
inferior good
used ars, sed cothes
nomal good
new ars, ew cotes
neessty
ood, mediines
lxuy
expesive ars ad lothe, mav sevices
ow to nterret t Ua cae
Exampe
negative YD if income then D fr r ood positive YD f income then D for ood hange n D is propoioately smaler than chane in icome change n D s propotioately propotioa tely large than ane an e i inome
What t mean
Eme
change in Q is propoionatey smaller than chanqe in P smaller change in Q is popotionately lae than hanqe in P
inelastic suppy
elastic suppy
Speca cae
hange in Q is popoionately ea to ane in P Q does no ange at all in response to hane in P Q as an nnitey large response to chaqe n P
ni elastic suppl supplyy
peectly inelast supl perectly eastic supl
oil and gasolie, some ariltral rodcts any good that an be produed ickl conpt sed in econoic theo oncept sed in economic t heor heor
concept sed in economic theo
Summary o determats
Fmember the diffeee diffeee eween eween te on-rce eternant of deman an ly, ad the etemnant PED and PES. erma a Noprce . det erm t s o demad ad spp1 I Detemnant o emad ft the D crve I 3
hanes i tastes and reerees haqes in nome normal and an d iferor qoods) qood s) haes in the ume of bers hages in prices of eated eate d goods (cmpements and sbstitutes) Detemats o PED ad PES
Determnant o PD how f D eatc o nelatc 91
numbe and loseness of substitutes deree of neessi rooton of inome sent on the ood time
Detemnant o V h the S crve ( 4)
anes in osts of faors of rodution anes anes in te number of irms i te maret canes in eectations canges in an idirect ta
haes in a sbsid chanqes in technolo chages in prices of elated goods ot supply and ompeitive sply
Detemnant o PS how S eatc o neatc neat c ( 2
mobii of fatos of roduton unused aai abilitv to store stocs ime 13
1.3 GOVERNMNT INTERVENO INTERVENON N
Indirect taxes indict ( ci t) taxes on sending sending to buy paicula goos and servces, pa nrectly o te governent by the seller
Wh
overnments overnme nts im ose indirect taxes
Indirect taxes provde governments wth revenus neded to nance varos overent ex endturs Indct taxes on goods tat are harful (ex cigaretes) can be used o decease consu on of hose oods.
Indrec taxes be used to improve i mprove the alloco of resources when tere are ne aive externaltes see 19 . Indrec taxes can be used to reduce the quanty of impos nto a coun tarfs; s 64
The dieence between specfic and ad valoem taxes pc t = te tax s a specc amount iposd per unt of the good and results in a paallel shif of the S curve to the le or upward the verica dstance beween he itial S cue, S, and he aer-tax S cuve, S tax s eual to te aount of he tax per unt. pci t
d lrm the tax s a prcentage of te pce of the good and esus in a new S cuve "S + tax' tha s steepe tan the orgnal S curve because he aount of tax ncreases as P icreases d lorm s s
p
s
Q Q
Market outcomes and eects of an ndirect tax on stakehodes stakehode s Effects of a specific tax
The nta qulru beore he tax) at and Ater the tax M outo new equlbriu O s ower at 0 • new equiibriu P wc w c i h pd by t onu m is higher at P • new P receve by the t he produce is lower at Pp Ects o old: • consumers lose they pay a higer P and buy a lower O roducers los they receve a lower P ad sel a lowe O their revenues fall from P x 0 to P x 0) • workers lose: ess is produced erefore some lose ther jobs • the governent gains tax revenue yellow saded aea tax per unit x 0 (the new quanti produced and sold) • society loses: there is resource isallocaton (underallocaton and unerproductonn snce 0 < 0) an welare unerproducto welare loss = brown trange An ad valore tax as same maret outcoes and effects on stakeoders
Q2
Qi
Q
HL topcs on indiect taxes Efects o ndirect taxes sn inear demand and su In a free mare with no govenent interventon dead is given by Qd = 2P, ad supply by Q -8 where Od ad Os ar uts of good Z per ay and is in $. he government government imposes an indirect tax on good of $3 per unit Usng ths inforato calculate the aret outcomess and effects o stakehoders of this tax outcome
I unctons Mrkt outcomes de to an ndict tax
s
: 6 5 1=4 3 2 4
Mat otcoms Fid qbm and Q efo th tax ) plt D ad S cuvs a thi pit o intersecton (i) mathematically using te and S equations 6 2P = -8 4P $ Q u
l
12
6 (t)
Fid e- ulbrim Q pid by onum c) ad vd by podrs p) ii plot w S cuve b shitng S upward by $3 ax pe unit) nd the new pont of ntersecton () mathematicaly using the rule after-tax Os c + (P t) wee t tax per nt atrtax Os = -8 + 4 (P ) rta Q - 4 sng the equaion and the new S equation equation 16 2P 2 4P Q ut New prce pad by b y consumers c (= ew equbium P) New rce ecved bv oducr (= Pc t 6 14
Ects on stakholdrs Cosum ndtur: rodur vnu Befe e x 4 x 8 i = 32; 32; fe f e e x 6 x 4 i 24 Befe e x: 4 x 8 i 2 e e x 3 x i 12 Pe ee eee e dcasd b S0 12 -32 -2 e e ex eie e dcasd $ 2 - 32 - Govm ta rvu ee x eee eee x e i x e f 3 x 4 = 12. Te ee aid o rvu llow a Cosum surus( e e ue e P pi y osum suus, rodur suus and wlar loss e): du to a indirct ax � 32 16 e e e x (84)x8i P(S} 2 2 2 Ae e x 8 (86)x4i 2x4 8 4 (lu tagl) 2 2 2 =
=
=
=
=
=
=
e p eee eee y 12 ( 4 - 16 = - 12) onsumrs ar wose o odu srlus ( e e e e P eeie y pe): (42) 2) x 8 i 8 efe e x (4 =
2
2
s
Pc= 6 5 P1 4 Pp= 3 2
4 12 8 i 2 (orag tiagl) Afe e x (32)x4i Q Ql 2 Pe p eee y 6 ( 2 8 6) oducs are wors o Wla loss ewei ) eef y iey ese f ee ii efe e e y [(PPp) x ( ()] )]// 2 = [(63) x(84)] / 2 (3( 3 x ) ) 2 ro iag Ne wefe [pe-x e p+ pe p] i [e x e p (e) pe p (e) ee x x eee (yew)]: e pe p efe ef e e x 24 (= 16+ 8); e pe p fe e x 6 ( 4 + 2) ee x eee efe 24 12 = 6 w e row ia soci is wos o =
=
=
=
=
=
=
=
Tax incdece tax icdence
e i ei e e t, ie e Te iiee f iie xe i y e ewee e I D PES ax incd s same o osums ad per py pi f e x Hwee e e pi roducs y e p eee y e elave szes of PED d PES. I ED > E ta incdc s gratr o roducrs I ED < E, a incdc s ratr on cosumrs E E sam tax incdc incdc PE PES: roducrs a mo I D onumers a mor i eqy ei e' i e eli oe' i e ei e' iiee iiee pe' iee iiee pe' iiee p pe' e' iiee iiee (PP) x (ee) (P Pp) x (P P) x (ee) (PPp) x (e) (PP) x (ee) (PPp) x (e) (e) p =
p
s
s
s
Pc
D
Qz
Q1
Q
Q2
Q2Q1
Q
The group with w ith the owe espsiveess t pie (ower pie elastiy) pays the large sae f e tax= has a hihe taxicdee taxicdee
Subsidies
= pye y e ee i i e e pe iee ppy
sbsiy Wh ovenments rnt rn t subsdes
ie e e iee ' eee ee e (ex ie i fe iie e e ppo pi i ii (ex si i e ee e ie we e pie ff piu iie e e we eie fo ue ue ex ie ep we epe
iie e e ege op o o eie e iee e eie f ie ex ei e e e we e pie piu i e e e e i ex e ee 64 ue e ipe u p e e i f ee we ee e pi piiie ex exea eai ie ee 2122) 15
Market outcomes outcomes and eecs of a subsid o sakeholdes
A subsidy results in a parallel shif of he S curve to the gt or downward e vertcal ditance betwee the iitial S curve S and the atersubidy S curve, "S t subsid = sbsdy pe unit Te iitial equlbium (befoe the subsidy) i at and 0 Afer te subsdy Mrtt ucmes Mr ucme s • new equlbium is higher a 0 • ne equlbrium brium P ich i ch d te csme, is lower atat P • new P received by the poducer poduc er is higer at P Eects n shdr • cosumer gan: tey pay a lower P ad bu a igher 0 • podcers gain receve hige P and sell a igher i gher evenues evenues ) • orkers gain more is poduced hereore some nemployed nd jobs • te governmen loses it ust pay the ubidy bold red rectangle subsidy per uit x 0, w w negative efects o the goveent budget • ociety loes i) high-cot produce are proected by e igher price, leading to ieficiency; (ii) governmet spendig on the ubsidy has opporunity costs; (ii ) there is resource isallocatio overallocaton and ove roducto ince 0 > 0 ad welfare loss ss bron trian le
Eects of a subsidy p
S wrh subidy
c
p
Qt
Q2
HL topics on subsides Efects of subsides usin linear deman an su
I funcions
In a fee market wi no goveret intevetion, M c d id P(€) demand is given by Qd Q d 6 ad upply by Qs s 4P, wee Od and Os are n uits of good Y pe 8 day ad P i in € he goveent ipoes ipoes a subidy on P p= 7 good f €3 er n Usi this infoatio calculatet e the arket outcoes and efects o stakeholder o thi 6 subsidy 5 P c= 4 Mrket m 3 Fd ulim nd Q ee h sd 2 ) plot D and S curve and find thei th ei pint f interecti terect ion; R i) matheaicaly usng the th e D ad S eqato: eqato: 0 16 2P -2 4P €6 Q uts Q (units) 4 6 8 12 16 Fd d i Q d cr c) d rcd rdcr ) ii) plot ew S curve by sifing S downwad by €3 ( subsidy per unit); nd th new new pont of intesection;n ; R ii) atheatically, using the rule after-subsidy Os c + d (P + s) here ss subidy per uni after-subsidy after-sub sidy Os= Os = 2 + 4 (P + 3) rsu rsud d Q · P sng the D equation ad te new S equation: equation: 62P = -8 + 4P € Q Ne rice aid cosumers c 4 = e e uibiu P e ice received b roduce $7 Pc s €4 €3 €3 Ec d roder revee: Consme expedtre: Before sbsdy: €6x 4 unts €24 afer subsidy €4x 8 units €32 efore te subsi s ubsidy €6 € 6x4 uits €24; aer the th e subsidy: € x 8 units = Cosuer ex ex enditure ' b €8 €32 -€24 - €24 €6 Producer evenue b €32 €56 - €24 Gmn d d ovenent ove nent s edn subsid er unxnumber of units sold €3 x 8 = €24 d rd r d c r us (= area uder D cue and above P paid by rdcr s d d t id cnumes): €)xx4 unis � €4 P(C) efoe te bsidy (€8 €) s 2 2 8 €4)x8unit 4x8 32 8 €8 € ( . ' Af ter thesu bs dy. Pp= 7 € €116 6 Couer surplus increased by €12 (= €16 €4); css r 5 r he i in cosuer cosuer ur ur lus i shadd u u c 4 dc sl = area above S cue der P received y 3 roduces) 2 Befoe the subsdy dy (€6 - €5)x 4]4] 2 4 / 2 €2 (€7 €5)x8units 2 x8 16 € Af ter the b .dy 2 2 € €88 Q uni) 4 6 8 12 16 Produce urluu increased by €6 ( €8 €2); dcs d cs =Ql Q2 e n n roduce ur lus s shaded rr 3 x4) / = 6 n rnl Pc) x (0 0)] / 2 [(7 4)4)xx (8(84)] 4)]// 3x Wlr cn e calculated by [(P Pc)x t he oss to scet of ote that welfare los arise becaue the gai in cnsumer ad poducer uplus of €18 ( €12 + €6) is smaller than the overnmet over nmet s endi o the suid €24 . Therefo Thereforere €24 €1€188 €6 elfare los, how how the c c SU SI
16
Price controls price contols= contols= governme intevention i the market involving the settig of ce celings (maxmum ces) or ce foos mimm ices,
ths peventng the th e market from reacig a market-cearing market-cearing equilibrium prce
Price celngs (maximum pices) below the e ilibim rice of the maret, resulti resulti i a shota e Pice ceil a maimm rice on a ood set b te ovemment tat is below ice ceing ad welae efecs Wy govenmets mose ce ceigs p he maximum P tha ca be legally caged P s below eqilbim bim P(Pe) it is se by govenments govenment s to make some ecesses aordable to poor peope: • food ce cools(ceilings) fr paticular food products (bread mik weat rice and oe staples) • ent contos (celings) whch specify a maxmum re tat ca be caged fr specifc housing
Pel • - • ,
Conseqeces of ce ceigs o e maket ad e ecoomy:
• Soages ecess demad Te pice celng does ot et P adjst to ts equilibrim value Pe, and resus in a soage (= excess demad), sice at ed (Qd (Qd> > Qs) Pl Q demanded> Q sppled • No-ice atong mecaisms Snce price o longer fulfils fulfi ls s signalig ad icetive fnctions methods ote ta prce are eeded to at io( disbute) the good to buyers, sch as waiting lies rs-come first-seved, avoritism(ex avoritism (ex selli e ood to frieds) • Unegon/aalel maes Sice there are usatised buyers at Pl some people buy the good a P and ilegaly e-sel it at a igher prce C C ri i r • Cosmes onsmes who buy the good a the lower P gai those who want to buy it bt cano due to e soage ose. Tis can be seen from te welfare analysis wich sows e gan by consmers o a poio of prodcer srpls due to th e ower P paid (the ble area) ad te loss of a poio of consme surpus de to welfae oss(the oss(the cosmer srpls part of te brown saded aea). • Wokes Some workers lose their ·obs due to lower ot ut rodced.
D Qs
Qe
Qd
Q
shoage
• Ieficie esoce alocaton Underalocation of resorces ice ess s produced tha Q e • Weae osses fo sociey Welfare loss brow saded riage, sice oly Qs o the good s poduced ad cosumed, rather ha ha Qe Also, he ble saded area is a gai gai i cosmer srpls(due to the fal in in rice from e to Pl at the epense of oducer su lus
• oces Podcer ose because ey sell a lower Q(Q) Q (Q) a nd becase they eceve a owe P (Pl) rather rather ta Qe, and than e Ths ca be seen from fr om te weare aalysis sowig the loss of e ble ara of o f prodcer srpls o cosmers cosmers ad the loss of a potion o producer srps de o welfa e oss • G G There ae ae o ecoomc ecoomc gais gais or losses losses bt the overnment ma ain oliticall rom increased o uari
Prce floos mimum ices maret reslti in as ls ri l l a minmum rce on a ood set b the ovenment that is above the e ulibrium ice of te maret Wefae eects o a ice oo ice oo n The mimum P tat can be egally charged, p p s s P! is above te equilbim P (Pe) This is doe by govemes to Pn - - - - · -
• suppot suppot farmers farmers'' icomes icomes by iceas iceasng ng e pice they receive for teir pducs • sp sppo po the wages wages o lowski lowskille lledd worers worers by ncreasng them above their maket equilbi leve
e
D
Qd
Qe
Qs
Q
Q
Q
Q
Q
riuul ri l u h n • uru ( ( e prce prce loor does ot ot let P adjst adjst to is • eicent esce alocatio Moe s podced ta cosmers wat, so ee is resorce overallocation. equlbium value Pe, Pe , ad resus i a srpls(= excess supply) since at Pf, Q demaded < Q supplied(Qd supplied(Qd Qs). • Welae osses o society Welfare loss is sown by the • Inefcie fms The ige pice provided by te oor allows rms with bow saded area Afte te pice loor is imposed, cosumer srpus s redced to area a(ude a(ude he D cuve hig costs of poducton (ieficie frms) o suvve and no ty to cut costs. up to P) ad rodce suplus icreases o inclde • Goveme meases to dsose e sls ovemens buy the b+cd+e+f (abve e S ce up o P!) Social srpls srpls, as his is the only way te pice oor can be maitaied at the appears to av increased, oweve rom ths ota it is hige a equilibrium prce his ivoves bdget expenditues wt necessay to sbtrac govermet govermet spedig to buy the oppotunity costs. ovenments mus te decide what o do with it: sore it excess spply, eqal o te red bold ecage The ne (ivolvng sorage costs) export it(reqiig it(reqiig sbsidies to cover e higer weare loss is the brown shaded area rce; destro it wic involves waste of e resources sed to rodce i rull ri l • Te goveme loses a mst pay f e prchase of te srpls • Cosmes lose as they pay a higher price fo a lower qaity ot of its budget, and may additoaly have to pay sorage costs or prchased; this ca also be see in the weare aalysis above sbsidies sbsid ies on epo eposs of te surplus quantity tis t is can also be seen i • oces gain because ey eceve a hgher price and sell a te weae analysis abov lager qantity tis can aso be seen i the welfare analysis • Staolds o cotis lose if te eces spply s above epoted eadng to icresed global supply and hece lowe global • Woes gai because more output is produced there re there prices hing h ing farmers in outres where tere tere are o price oors. will be a ncrease in emlome 17
Minmum wa es nu wage a inimm price price of labor usally set by the governet to protect low-skild wores and ensure they can achieve a mimum stad stadard ard of consumpto i is a applcatio of a minimm price in the labor arke
h
=
Wage
S oa
The wage s th price of abor The D cuve shows the dead or labor by rms ad he ce shows he suppy of labor by wokers The minimum wage, Wm, does ot alow the price of labor o adjust to it s equilibium value, We, and eslts in a surplus o labo (excess (excess supply, sice at W, Q of labor deaded< of labor suppie (Qd< Qs) This T his excess exce ss supply of abo is nem d
D IO labr
Q e
Q f lbr
Qs
sns o n s h oo ss i s r skhlds • I wrrs wrrs ome wokers may accept to work work r wages wages beow beow • Worers Those who eceve the miimum wage beneft however the legal mmum those who becoe uepoyed de to the minim wage lose Misoon s so os s o o The price of labor labor • Fis Firms hirng skilled ed abo a payig the minim wage works as a igna ad incentive in the labor arket; the minim minimm m may be worse off u to higher costs of prouco wage my pevet the efficet et allocato of aor resouces resouce s ons rs rs Higher Highe r coss of prodcti of rms that pay the • ons Mi Milo loon on o o o i podu mkt Fi in nim wage mea a eward hf f the cves of ther uskled labor have higher productio costs de to the miimm products resulting i a higher P a lwer Q poduced therefre wae ths a affect resorce allocatio i the roduct ake. ake. cosumers are worse off
HL Topc o prc cotrol Pie eiin s Gve the demand fuction Qd 10 2P ad supply fnctio Qs 2 + 2P, where P s in$ and Q is 1000 kg (a) alclae te exess ded (shoage) eslting from a price ceiin ceiingg of S2; (b) calclate ate te change n consme expediure expediure and and fr revee
(a) To find the shotage, substite substit e the ceilig price price n the deman and supply equatios Qd 10 10- 2( 2(2 2 6; Qs 2 + 2(2) 2 hortae Q Q-Qs -Qs 6000 kg kg 2000 g 4000 k =
=
=
=
=
(b o calculate he chage i cosumer expendiure ad rm eveue, nd euilibrum d Q before the price celing: euilibrum etig Qd s 10- 2P 2 2P 2 4P P 3; Q = 1010- 2P 10-2(3) 4 q = d qr = . =
r n
=
P(S) 5 4 Pe= 3 Pc:2 D
3
Qs
6
8
Qd
Qe
9 10 (kg)
Consumer expeditre expeditre before th e price ceilg P paid x Q purchased S3 x 4000 kg 1 Cosmer expeditre afer rice ceiling P paid x Q prchase $2 x 2000 kg Cosuer ex eniture 8 $000 $12,000 $000
Note tha Q purchased is the Q h s pdd at the ceiling price, ot Q demanded.
=
=
=
Fi revenu the sam amoun as cosmer expendue, because P ad Q e he sae fo rs ad
cosumers both befre ad afer the price ceilng s mposed
Pe fs Given he dead dea d fncion Qd 10- 2P and suppy funtion Q 2 + 2P, where P is and and Q is in 1000 kg, calcuate (a) the excess suppy (surplus) (surplus) resultig fom a prce oor of$4 of$4 (b) the hage in consue expediture expediture () the chage i r revenue (d) governmet expedire needed o purchase the surpls
lo
P(S)
D
(a) o o d th suplus sbstitte the oor price i he demand ad spply eqaions: Qd 10 2() =2 Qs Qs 2 2() 6 urplus Qs - Qd 6000 kg -2000 kg 4000
=
2
•
3
4
=
=
6
s
7
8
9
W
10kg
(c) o calcuate the change change in ir ir reveue compare rm reveue before and after the price loor Reveue before the pie foor is fond usig the euilibri P and Q you found above ( is the sae as cosumer cosumer expenditure ir revenue aer the price oor pie received x qatty sod $4 X 6000 kg $2000 hereore r revene sd 1 ( S24000 $12000).
Cosumer epeditre before the price loor pice pai x qatity purchased S x 4000 g 1.
(d) Government expenditure expenditure to prchase the surpls price oor x aout of he srplus S4 x 4000 kg 1. 1 .
=
Cosuer ex ediu ediure re l b $00 S12,000 $4 $4000 000 .
Consmer epediture afer the price oor price pad x quany purchased $ x 2000 kg 8
5
=
(b) o calclate the chage in onse expediture d equibru P ad Q bere the pie oor is imposed setig Qd Qs 10- 2P 2 + 2P 12 4P P 102P 10 10- 2(3 2(3 4; therefore qli P = nd = 400 .
1
18
= t h e f a i l u r e of h e ar k et t o a l o cat e r e sor c es ef f i c i e nt l y , r e su i n g gi i n over a l o ca i o n nder a l o cat i o n or no al o cat i o of r e sour c es es the production of a good or seice relative to wha is socialy most desiable ; posihe aiekeetfefactlsbtoeneachii)eeor negat ieeec eecfect encstst)beuse for thrd paiesesnwho scsarcenobeepartofs a ransac� ion andwhose insteress sare no taken nto gaccont a l o ca e beuse s intsfor nsue bnsarsisi ngfrom additoal We eereaistye e MPBerniMSC Ali in w eenai bene h o ext S = MP MP = M consumpt o of an addi t i o nal uni t of a good ad S MPG MSC benefgintslossi ebene isng(ro)m)cnsumpt addionalon ttar arketequi ilndinibdiru,wher ,nwherg heee D is S, si t y a s B B ooan anaddi addi t o nal ni t of good l l c v f i c i ny = ddi t i o al r i e s s rcostsgtnolr lpdus arsing rom podctio of qat Qopt irteyprandesetPops thtehesocisocialayl yooptiimumu anraddgnloasocinialtcso a sgood additiona rricceefe (frhoe"bhese poi quat ofviyeandawndofwhat best is D MPB MSB costadditsiotnalo scuniet of ara good ising from prodctio of a imostew desrablble fro socisociety's point of Negis roducd e eerelavieesto eheearsociae oalwtiysuertherelfore es re>sour cs oo nQmQopt rseandiandPPpshwshowwthehe se eoudo bybesthe) uchs e eerenaltivees:o tthehhee sociraketl oaiwasumnde nde orles<esour ces oo outcResr oe ocude ibsatlhoecatioensoerealocaton owuder aloaton leadslitetois rdced h er e deadwe h loss f societ brown shaded trian le dcin greater tha privaea e coss, thereforen socMSCa costcurvseoflieprsoabove dctionMPCare curv. •• VerDemand icalcal disfenotnoretnceafectebectedweentheeMSCfoe andaDnd MPB MPC cuMSB vesB vale of extenal coss MS •• QWelfarQopt th(deeadwei mareeg hoverossal oiscatcattheesbreosorsownrshaded ces tootruch is roduced duced e l o ss i a ng e • hene xampllhee pre oarducte extioenrofalgoods xamp goocostdss byiclsdienofg polfossisslitiofnelofs ceadieangarto rariverbson, laemiemes,issietocnssn, M M and negaive effecs on huan health. Nge eernl nsuin ns nser ers sfectsseo oeheresthersefres n s< prMSBivatecuconspt ionocrweMPBates ce negat v e e e l i e s el •• VeSupplicyalisdidifnotnoteenc eafncectbeedwee wtheeerefMPB anda=ndMPGMSB= curMSCves alue of external costss o r e S •• QWelfarQopt : t(hdeeadwei marmareghoverloss)al oicats theesbrreosorsowrshadedt ces tootuch riuchngleis. produced duced.. e l o ss shaded • alxamplth eefsetsoi no-g (csigoker aret escospt ion), wherheaethextcareercostal costs ses iclofucarde segatsnigve s and i n cr e ased gasoline (a fssil fue) where extenal costs iclde ollution of cea air. dricia sfor third pareteiesnthbene s r sc e t h ei pr o duct o n act v i t i e s ar e s ie eernl =dcM benef ereMPGore and MSC < C crvMSCes valvaculuee oliesexbeeronalnwalMPCbeecitse • Ve c al di f e r e ce et w e een en MS M •• QmDemad Qopis otheafarfectkeetd nder tndehererfarleocatD esesMPBresororMSB cesded tootanglalitnglle eis prodced dced •• WeExaplfareelsossresear(deadwei eadchweibgprhtivloatss)ses)rismhselebradsowntoshaded shadevel opment of) newraininegchnolor worogikees sha bene t h e who e of soci e ( e r ed e cho o g gy y sp l o ver s M M providedby ed by a fi which bene oher is once the worker chages job sue su e s r e e e e bee s s e e p i a e onsumpt i o i s benec s enl nsu i n f o r h i r d pa t i e s t h er e o r e > MSB c v e l e s aboe MB cue M M • Vertcaca dif ererece etween w een MSB and MSC cr v e es s val u e of ex ext t e r a al l bene i t s s ot hafefmarcedketthnde ereforf orael ocatoScatMPCes re=sorMSCceses too litle is prodced odced � .:r:rnal benefits ••• QmWeSupplarQopteislootaf ss ( d eadwei eadwe i g ht l o s ss s s h e br o wn s shade haded d t r i a ngl e • nep Exapoeyment s cosumpt cosumpt i o n of edcat o n e ads t o b bee ee t s f s soci oci e t y i n c u di n g l o we wer r ncreasedits arrseoductfromivcosumpt ity lower icronimofe healrates,thhicarghere economic growth = M similar exteral benef 1.4 MARKET FAILURE markt failu
Externalities exenaiy exena
MSB
Poi
(MPC PC))
SC)) (MSC
Qpl
Externalit Extern alit dia rams: points to note M
wfae loss
Ne ativ ativee extenalities moston of extena costs o societ Negaive extenaliy
lm
roducs ipos xtra coss
�' ; 1
soiy: MS M
MSB MB
Q
exteaites eato of extea beets or societ Postve exteaites
MSC MC;
o1
p
MS MB
l
Q
19
Q
How to correc! draw an exernali dia ram wihou emorzi : hree ues an how o use hem
he les Prouct Prouctn n externaiy: he cuve splts int two consupton extenaliy: extenaliy: the D curve spits into two Supply relects ss deand reflects eeis Negativ Negativee externality Qm > Qop posiive exteraly Qm < Qopt he poin of the welfae loss triange ala s looks toward Qo t.
H se he les 1 Draw a deand and supply diagram diagram and lael the axes "P and Q 2 For a proucion exteality exteality raw two two cues; cu es; fo a consumpio consumpio extemaliy daw wo D cues In ech case nd the wo correspondng correspondng equilibrum qantities on the Q axis 3 In a negative xtenality, sin Qm > Qopt, lael the arger quantity Qm and and the smaller quantity Qopt; n n a positive externaity the larger qanty qanty is Qopt and the smaller qantiy Qm 4. Qm corresponds to pivat costs and benes, bene s, teefore to MPC in a production externaiy and to MS in a consupon extemality whle Qopt oresponds to socal costs an beneits and so to M o MB; yo can now label all te cures. 5 Find the rian le hat hat oints towad Qo Qo t and shade it this is welfare welfare loss
Merit and deme oods mert goods goods wose consumption creates ost cnsuin eeaities are socially desirable but dervie y the arke ad de rcsued requre government government olicies olicies to inrease teir provsion (poction) and consmption x eucaion, ealth care, inrastrcture inrastrcture roa roas s sanitation sewera sewera e s stems
Gve s s (based on the use f gvernen athory to make decisions decisions see s ee p ) include incl ude reglations, islatio adveisi , edin, ad direct overent visi
ee t gs = goods whose consutin creaes egave ee s eetes are socially uesirable bt are vve y h arket ark et v vse se require require goveen policies to redce their provis (prodction) and cosu ion x ci arees, asoie as a s f for cars .
Makt-bas l les es use methods that hange relaive pes (suc as ie taxs and ssies) ss ies) an therefor thereforee change te te inceves facin ecisi ecisiaker akerss and ee their their behavio.
I the a ams elw elw the the e ln es e rese resett he esu vee ies ce cett he etenali a aes incle egisaton reglaions reglaions and avertizig that aim at irecy reducing emissions and/or enviroent damage x pose resticions o eissions Limit te amont of outpt produced orce irms to install non-polting n on-polting technoogies • Ban danger dangerous ous sbs sbsta taces ces (ex (ex asbest asbests) s) Cea Ceate te potecte potecte areas forbid forbiding ing ndstrial ndstrial o agricultura agriculturall activities activities Res Restri tricti ctins ns o logg logging, ing, fishin fishingg and hnting hnting • Nega Negative tive advet advetising ising to to inence inence consume consumers rs o avoid avoid prchasing prchasing prodcts of ighy pollting rms ark-bas es es chage he rce ceives faced faced y rms e e ta t t cuse cusess the supp supply ly curve curve o si sitt ar causing P to increase and Q to fall; if he tax s exactly eual o he value o the external cost MPC will reach MSC and te externaliy s eliinate the new equiibriu is gven by B esuling in Qopt and Popt and welfae loss s elinated
Eauaton of lgsaton, rgulatio an artzg
0 Simpler to implement copared to aret-based policies 0 Efecive in a least paally achevng their objectives 0 In some cases are ore appropriae than market solions. Involve costs of monitoring and enfrcement Are ieffcien as they o o ifferentate beween frms wih hgher or lowe costs of reducng pollution/envronmenta ham Do not provide incentives for switcing to cleaer techoogies Face ncoplee nowledge o exent of damage done by various ollutants and and therefore on how uch to restric aciviies Ealaton of arkt-as pos
0 Ca internalie the extenality make proucers pay fr the extenal cost 0 reaer eficiency (ower cos) in reucing pollution than gorn gultin 0 he ost efcient poicies are (a) taxes on emissions an (b) tradale perits Frms that can reduce emssions at a lower cost ict ta ess essis is (polltants) (polltants) also cause causess he he sppl spply face te icentive to lowe emssions nd (a) pay a ower tax or cre to sif f war eang to Qopt and Popt tis wos (b) sell permits or a proit ms facing high costs of redcing by ceatng icentives f irms to educe eissions and shi to en emissions can (a) pay the tax o (b) by permits Te reslt i s a echges= tecnoogies that reuce negative environ enta efects) echges reducton of emissions at a lower overall cost to society. in orde to avoid paying the tax The ore te poltants eted eted the 0 axes on emissions and tradable ermits create inc entives o greate the tax, teefore the greater the incentives to switc to clean swtch o cean tehnolgies technologes. Ex the ta ta on carbon emissions o fossil fuels 0 A switch to ceane technoogies cuses MSC t o shit to the egatve ru etral etraly y right, redcing the se o the the extenalty and welfae oss ie t r esss Fo both taxes a tradale perits culies in dentifying p the most harmfu poltants and the value of external costs MC MPC + In the case o taxes, difficultes in identiying te value of tax tha wi eua the vale of he harm (e extenal cs) [ For tradable permits tere are diicultes in determining the crrect amount amount of overall permissile plution (the cap o f cap ad trade scees) For tadale permits there are ifficultes n determining how to distibute the permits among rms D MPB MP B For both indirect taxes and tradabe permits here are dificltes in ensuig compliance an enorcement. Q Qopl Qm arbon taes are often preferred o tradable permits beause • Tr Traaa al l e em ms s de shemes) shemes) a maximm • the theyy ake ake energ energyy c c mor mor preict preictbl bl permissible amount of a pacular pollutant s determined, and permits to tey can be s sed ed fo fo al fossil fossi l el el emi emissio ssions ns emit tis poltant are distrbute to rms by te governmeto teyy are are easier easier to to design, design, implem implemet et and and enforc enforcee iernational body), which can be boug ht and sold in a market These ofer • te Tradable permits may be prefere becase caron axes te ncentve to switch to c ea ehgies. ehgies . Ex uopean Uno Unonn • cannot canno t set a lim limit it to te p permissib ermissible le ev evel el of ca carbon rbon Emissions Traing System coverng power and eat geneaton oil are gss (since they are a nirect tax see p 6) efinees metals, ul an a e, and ener ntensve inusties. =
20
Negative consumptio extealities: oly respnses Evaluatin f egsation, advesng ad educai Command approaches i i lgiti, tizig uatig t bi t i t bi f 0 Si t i kt-b ii. tt t MPB cve shs owad MSB ig Qt a Pt 0 Efti t i i uig f g • Lgti, , x k kgg i bi ; ; iki ikigg iig iig;; ig gt xt • Ngti Ngti tiig ig t g g '' f f x fig fig 0 I it t kt t (x b t g f kig big kig i bi • Et Eti i f x gig gig t t bi bi tt t t (t fi f ii) A ik t u t t qui qui MP eave consmption eternay: eisaion advesn edcaton uik t t t t MS) Q uik t Qt ii t xtit Aiig ti f tit t f it it f t bjt S = MPC = SC Dfuti i f t uig tt t guti big f Pm opt D MPB
Qo Q
Q Marke-based plices g ti f i u A idiec tax the gd causig te negave exernaiy u t u if frm C t C+tax ig P t i Q t f I f t tx i xt t t t xt "MP + tx i itt MP t t Qt t xtit f iit g P i g Negave cnsu exterality: ndrec tax
M + ta S
Pc
=
MPC
MSC
=
MP
Q
Qopt Q
0 ii ii xtit = k f f t xt t 0 b fit t gt gti bu t b t i i uig i iti f u t t If g ig t iti PED 1 ) b)) t tx i i g tx t b t b gt iig uti g
Difti i ig f t xt t Difti i tiig t i t t tt i b q t t xt t If t g tt i x i iti PED < tg f i Q tg i i P, t tx i ik ut i git i Q , t b ti i iitig xtit It x g 56) ftig tg, ti uig t it t q it ubtitt t b
Pm
vauai f market-ased licies
Positive production extealties extealties:: olic esoses Cmmand araces i t it iig i Diect gvermet rvs i t t R&D t t f ti g tgi, ut i ft f g t C curve wad te C curve(= i gt ub ub ) ),, ig ig t t i i iu iu qtit qtit Qt i i P P
vaua direct enmen vsin a susides
Psive dct exealty diec gveet prvsi ssidy p
A ig fti i ig t t & i t
S= MPC with govemn pris r subsidy
m t
Qm
Ql
aketased aketas ed icies ag iti b u • Pvs f subsdies b t g t it fi uiiti giti it R&D) ti t ft f shn he MC curve ward e MC cuve "S it gt i i ub ubi i t t i i t tu u qti qti Qt Qt
Q 21
Difiti i tiig t u t xt bit Difiti i tiig t i f t ubi t f tt u b t i ii i t t f xt bfit [ I f gt f tt uit t Diiti b gt i tig i tu tiit f t titi tt t f bi fig) b t b T g gt t ti t i t tiiti u i f ubt t iti it ti t t gu
Positve consum ion exeales: poic resposes Commad apoaches inle legislt, vetising n eutin tt Evauao of legslato advetg ad edao s t t nuenng te bev nsues t ese e s 0 ile t ieen te MPB v ss owar SB eg t n 0 Efetve est tlly inesing en te g • Legsti Legsti fing fing inese inese sut sutn n ex kng iy iy sl usg te stve exenlty eselly i te ses ws eutin ulsy ll ile king euti ulsy. • Ave Aveizng izng n euti euti eu euging ging suti suti ex e egi ging ng ets t vinte tei le; eging e ek-s � Avetzg n etn le e likely t iese Positve onsumpton extealy: legslaton, advezg, eduato en t te equie level ( lkely t s l te wy t ) kely t e s nly tly elinte te extely. � Avetng n etn ve tty sts s uns e ivete e bjtves � Diltes le n eneent legsltin (ex ilen wine unes y be set ut wk te tn t s) � Inese in e es ige ssibly king gs ble lw-e gus st teee be b e use tgete wit sbsiies ee gvenet visn (ex ee D= MPB eutn elt e evies). Q Q Q • Diet gve gveet et visi visi, , ex euti euti elt e e instute instute Evaluaton o dret dret gveet povso ad subsdes (len wte sulies sewege syses) wi s te eet 0 Ae gly efetve nesng te sule n shfg te 5 cue o "S wh govee rov so o subsdy nsue n e eee vey eting tese eng e silly tu tu qntty t te we e extenlities. f sues (see g belw). 0 ubses n/ fee gveet vis e key ts i kig tese b t ll (ex ee euti ee elt e Make-based olces nge e etives is nsues: seves) visn subsies by te gvenent wt wt te eet eet sitg te 5 ue to S w govenmen rovson o subsdy esltng e � Duties i esg te vlue e extenl benets silly tiu qtty te we ie ses � Duties i eeining te t gveet vsn n/ subsiy tt will be equl te extenl beneis. Postve cosumpto extealy � Otunity ss gvenen seig iet visin dre goverme rovso o subsdy n/ subsy Dues e by te gveen kng es n wt t s by w u view te vey ny eting ls n e gvenent bge S with govenment prov1so subsdy
Qm
Qopt
Common access resources ad the threat to sustaiablty comon access esouces = ntul esues wtt
susaabty= susaabty = te use ul eses t te tt llws te t eue eselves us esultg evinenl esein ve te s t fuue gnetns wl be ble t se te t ssy tei ees n wnts Aises e et sstaable develomen "Develent w ees te nees te eset witut ising e bility te genets t ee te wn ees (ntn iss)
wnesi t e te in ket ve n e wnesi noexludable teefe be use eely by b y nye tey e no (ele be exle using e beuse t s ssbe ge e te se) yet y et valous (tei use by ne esn kes te ess vilbe use by see else). x ests ves lkes te es sil qulity biivesty eve te zne le
The lack of a pricing mechanism fo common access esouces and te threat to sustanabiy Te unique nte ess esues nely tei oecludaby sing being eely vilbe se by ye wi e gee w te rvary s t te se by e ees vlblty tes ses seus te t sstinbility. e et ises bese sie tese eses n be eely use tey y be overused deeed (= eue qutity) n degaded ( eue in ulity) Example 1 A est wit n wes n be use by yne
xample 2 Fs n ens ves lkes ve n wes wn tees se s tbe n leng ln gultue Ts n be se by b y ye s ses treat to sustaabe ses hrea o sustaable se o foress i tees e e w se of fs esoues s e se se t tey n e quikly t ew tees gw ests bee deeed (ee eue eseves ey bee depleted (ee i in qutity) wile te envet is degaded (eue i qulity) e t qutty) wile te es ives les e degraded lss tl b f est nils lss bvesty glbl (ee quty) s tei esyste s sute. sute. win. n bt exes esues e bein bei n use use ssa levin be ewe lwequ esues use by utue enets enets 22
Use of fossil fues as a treat to sustainabiity
Te use of fossil es in production (a eergy input for indus and agriculture and consumpion (an enegy npt for the se of as and eating systems) creates negative exteraites of enormous propotios These exteralities can be see as resuing rom overuse, depleton and degradaton of common access resorces (cean ar oceans ivers, sea life), givig rise to exteral costs that incude clmate cage, depletion of the ooe layer, acid rain, and a vast amou of ealth probems ad related eah cae costs You can se a negative proucto exenalty diagram or a negave n xiy diagam to lusrate ad explai te threats o susainability osed b use of ossl fuels. E va
Poverty as a theat to sustanablity
economcaly ess develoe contries, poverty ofte leads people o se ope access resouces nsstanably as hey k n t xtrl lw in High poplation gowh ees addiional pessures on nsstainable resorce use Exampes include deforesation (cig down foest to cear land or agriclue or to obtain frewood soi degradation (depleto o the soil's nutrients) as farmers canot afford nps to maiain sol fertly ad as tey move to new pasture lands for thei aias; soil erosio as peole ove to ra le ads o moutais
uar10n of governmen responses to treats t0 SUStana . bTt
L i There Th ere are man inds of legisaion/reglations that can be used to deal with threats to susainability posed by egatve prodction and consumpton externalites externa lites See p 20 - 21 for a ist of exampes and evalati evalation. on.
f n nli nli or tecnoogies tat reduce negative enviomental effects (due to negative exteraites, ex wind and soar power, biofuels and geothermal energy. According to the Word Bak, both private and public fudg or cle technologes all ar ar so of wat is needed
Carbo axes are taxes on emissions of cabon doxde arising fro t us of fossil fs T ighr t missions t grat the amoun of tax paid thus creatng nentives f frms to switch to cean techoogies. Ex Denmark Filad, France Ireland, Poland and Swede ave mplemented carbon taxes See p 0 for dagram and evaluatio
a ad tae schemes( schemes( = tradble pe pet t)) involve seting a maximum aont o polnt (uslly crbn dioxd) t cn b id, nd disribting permis to frms to rease the polluta (by a government or international body; he permits n te be traded i a make Ex European Union Emissions rading Sysem. See p 20 fo dscusson and evaluaton.
in f hr ui Man couties subsidze fossil u prodction or consumpio, esltng n lowe costs of poducto of fossil fuels for fims and lowe pices for consumers thus enco encoraging raging their prodcto and consmption Sc subsdes sould be elminated. The World Bak estmats tat globa subsides fr peleum producs ar nearly ten times global nding for eeg R&D.
Govenen Goven en ubid ubide e for te evelopmen of clea tecnooge
Goverments may povide subsiies to government agencies o private frms at coduc R& fo te developmet of clean tecologes Tis has the efect of increasing the spply of cean tecnologies and lowering teir prce to buers buers of these tecnologies (see p 16) wie at at te same tme reducng te use o tecnologies based on fossi fuels and therere redcig te size of negative production externaities
Need or ineraiona colaboaon Negative enviromenta exteralities (both o producion and cosmpton) extend far beyond ational boudares and ereore require intenaional collaboraton or teir solutio Ozone depleio and gloal climate chage fo example are globa isses r which all coutes, o a greater or lesser degee are re sponsibe hee caot be a solutio to such sses n e absence o effectve nternaional aeemens Ex e Kyoto Proocol.
Lack of public goods pt a good tat is r (ts use by one makes it ess availabe fo use by others others)) and excldae (peope can be exclde e prevented fom using it by carging a price rivate goods iclde an good good tha can be sold in a market fr a price ex cas comptes hoses educaio, ealth care sics, cs, i. goods tha ar prodcd by privat fms or by th govr govrnmnt nmnt for whch a pice i chaged Wh
go d at is n (s se by one pi d = a god does ot make it les l es avalable for use b oers) and n n ecldal (it n i r i and erefore exclude people from sng te good) Ex atoal dns t polic forc lhtouss, knowlde strt ls
e of market falue: te free der oem
r dr dr prl = occus when peope se a good witout paig r i; t is close relaed to non excdabili. When it is ot possibe to exc excde de people from using a good (ex a ighthose by cagng a pce fo t ey take a "ree ride, e. tey use it wtout having to pay for is use
l d en k i becase o the free ide problem Since s not possbe o cage a price or the good private frms will not produce it even tog it may be socially desrabe ad consumers may have a demand fo it Firms wl not podce t because who a price it wll be impossbe for them to cove teir costs Pbic goods ae therefore a type of market failure because te market (ie ate frms) fail o prodce t a all
ili d goods that are non-ivalrous but are excludable; the fee ider problem does o od because it is possible o exclude ers by carging a price Ex oll oads (whoever is not willng or able to pay te toll wil be excluded fom is se
Drect rovision o ublc oos by te overnment
Since the market ails ai ls to allocate ay resorces to the prodctio of public goods, and snce public goods are socaly desiable tey are directly provded by the government ad financed (paid fo) by govenment ax revenues. In view of the oppounity costs of government speding ad he many compeing ses of govermet fuds governments ace he difficultes of deciding wha partcua public goods to provde ad in wat qantities. Politcal pessures pes sures on e goverment ma also come into play result ig in coc coces es made on olitcal rate rate ta (or n addition to) eoomic grunds
23
Summay of dierent kns of goods base on valry and excdability no-ivalous
rivalous
excludabe
no no excldabe
private priva te goods
quas-pblc oods
goods with o without positive and negative trnalitis (both prodction ad consumpion) sod r a ric mrit goods (as ong as thy ar prodcd by the markt) and dmeri goods Ex cas bicvcs cloths ducation, ducatio n, asoie etrol n acess resoces natual rsorcs that ar not ownd ow nd by anyone, not sold n markets markets and not having a rc thir lack o a pric maks thm sbect to overuse ie unsustaiable se), depletion and degradaion Ex forsts rivrs laks forsts, soil qualy, sh in the oceans
= goods that do not fall neatly into the othe three categories; often bt not lways) have large ositive rnalitis and so may povidd by th th govrnment x n-crowded toll roads musms and pblic swimmn ools tha chare etrance fees, cable c able TV ubi ub i socialy desirabe goods not produed by private rms bcaus it is not possibl to charg a rc sbj sbjct ct to he ree der problem: eol s thm wtho having to pay; since hey are socially dsiabe they are prodced by the government and povided free of charge Ex natonal dfns roads strt lihtin, lihthouses
HL topic Asymmetric information asti nra a type of market failure occrring when one party to a transacion (buyer or seller) has more information than he othe paty leading to allocaive inficiency
When seles ave moe information tan buyers x Sellers of used cars know more about th car's conditon than the buy sllrs of food and medcines or n geeal, geeal, ites iortant to human halth) know mor abo th prodcts thy ar sllig than byers slrs of gal and mdical svcs lawyrs and doctors) kow more abot the nature o the sevice hey are rviding rvi ding than byrs. In a free nregulated markt, thes knowldge asymmetres usaly rsult in an underalocaton of esorces o the producion o he good o sevic bcas byrs try to protct thmslvs against th risk of prchasingg a good or sevice that is not in ther best intee prchasin inteests. sts. Possble overe resposes Lesaton and reulaons
0 Halth and safety standad and qality controls protect consumers aganst the risks of purchasng inferor or dangerous roducts. Are tme-consuming processes casng delays in conomc activity Large opportunity coss n trms of implmntation implmntation and monioring rovison o ormaon to consmers
0 Ex normaion about th quality of mdical svices nutrtion infoaton on ood rodcts, inforaton on halth haards of products hlp consumers make nform nformed ed purchasing decisons Infomation colecton s comlcated and ostly; may be inaccrate o information s impossible to provide to buyers ex specialized legal or medical knowedge) censre
0 Rquirement hat profeional have a lcene (docor lawyr) May b usd to rstrict th nmbr of rofssonal in a market and create oopoly power
Wen byes ave more informaton tan sees Arises most ofen in the case of byers o insrace, leading to two kinds of problems: 1. Te probem probem o advese seection th byr of health insurancee knows more abut the condion of his/her health that the insuranc slr; this rslts in an unrallocation of rsorcs to health insurance, as sllers ty o potect themsves agaist highrisk (.. unhealthy) insurac buys and aso rsults in high prices for health insurance insurance olces olces Goenment responses t adese seecton n nsace 0 Corrction of undalloaton of sourcs to halth insurance by covering veryon in a oplation through social health insrance or dirct governen rovision of halth car svcs at a zerlow rice Opponiy costs of spending from th govrnmn budgt or social insrance bdge 2 h p m the buyer of insurance insurance changes changes his/hr bhavor aftr the purchase of insranc increasig he chancs o risky bhavior x th purchas of car th nsranc may make th buyr lss areul about lockng his/her ca. Resposes o moal azd n nsance @ h problm is sally dalt with by th sellr of insuance who may orc th buyer to shar in th paymnt of damages (x if the car i stoen the owne mt pay a pat of the cost of replacing h car) this decreases the car owners risky behavor � Uneual effects on lowncome versus hih-income peope
H topic t opic Abuse o monopoly powe sels ; it is tpe of market falure bcause it reslts in monopoy power = he ability of a fim to influence the pce o the good that it podcs and sels; underallocation cation of rsourcs rsourcs to h producion o the good n question and hece in allocative inefcency and welfare loss an underallo stuctres xcpt perfct perfct competion competion i n in onopoly ower is discssd at lngth on p 3 • 34 It s associatd with all arket stuctres and is ndsrable from th oint of vw of soci soci bas it rsults n
Possibe overnment es onses to monopol powe see p 34 egslaon may inclde anti-monopoy laws ntended o prevnt h
ormation of monopolies or o break p monopolies thus encouraging com etitve behavior Gt ofen used in he case of na nall to brng abot a outcom that is mor monopoes (se p 33 - 34) to avorable o consuers, eanng ower prics and higher quanties than wold rsu n a rvte ure ld mono ol 24
Naonalizaon the transfer of owrship from th private to the Na pbic secor the opposite of pvaza vazatto o see 61 ), as a
atrnativ to in rl n i see 3 rad lberalzaton = remoal o barriers to trade see 63) rslting in larg quantits f impos ntrng a count, whch wh ch crae cometiton fo esting irms hat mst now compe wh out fom aboad
1.5 HL TOPIC THEORY OF HE H E FRM AND MARKET STRUCTURES STRUCTURES 15 Production and and costs costs
Distncton betwee the short ru and the Ion un in microec microeconomics onomics shot run = ped f me we at last o acto o octo is ix i d er r re e h fixed actos o ouco (iuts) p ps) re re ey ged ged i qy e perd e, l ee , re e r d
log u ped e we al acto actoss o roucon ae vaable i ; ere re ed r varable factors of produco producon n (puts) ar prd p re ged qy esy er perd e r e e eer e
un:: 1s ' . h'g re re rns po dc f10nn the s ho rt un otall pu TP ota e l y p pded
anal poct MP = dd p pred y eage c AP = qy p prded erge y e re p e : e dd re p, e r � A M r p r ip a o miishi eurs eurs re re are p e are dded e p e p, e rg prd e re p r rees ree d e egi ; dg re r te so run we e e ip ed. E pzz rer ke w e d wrkpe re fed er e r re k d p ireie eee eee e re e e pr f e wker r ree e p w l wl eeul ee eQe e errwd w fm h bass o costs o oucton n the so un
Calculations Calcul ations ad diagrams based based o oal, average ad marginal produc daa
Te , rg d erge prd re e ee gee Y re ge d "l prd d U pe d re reed e er re p r e e ew g e r fr A d ge e e A d w e wer re w d e e e ee , d e eg Total podc T s
Uts of rbe pt abor
Magal podct MP uts
0
0
.
2 5
1 2
2 3
2 2.50
9
3 4 5
4
3
15 15
6
1
7
0
14
8
-
12 14
erage product (uits
3
2
2.80 250 2.14 .7
e e e pe e e pe = H/r • ree ree e e ur ure e ee eeper • eg eg we we e e e eg ge er, • eq equ ull zer zer w we e T T d • i eg egi ie e we we l l
Total ouct (T) Umts
of Ou1pt
TP
nit of Laor (vaable pu}
ainal a aveae uct (P, AP) nts of Ou1pl
The MP uve ntesets the P cuv at th maximum o AP
he MP uv uvee ilutte il utte the l o mnisn etns
M
Uns Lr (varible In)
ntroducg costs o rod ct1o pye ey de expct cos g pye y fr prd prd p r e prd pye r ee wge pad wrker conomc oss oss e ep d p e we we reer we e ecoomc costs
cos= = g red e r e e r plici cos prd p wed we d y y e r r e prd E e e redd r wk p e' w e re re re e ed r g e-wed ud; ud; de de e e eepreer ed e r Al prd re oount coss ee p 1 1 I e e f ep , ppruy re e e e e ere w red e e f , , p re e ed e
Costs o rouction n the short un fxed cost d var wi p up ree r deee, ed re ; ey e pd ee we p zer ey pper rzl le ye f re pye re ree TFC l ed i o y w p: p ree re
ree re re er we p er pye wge r ere reed TC e C otl costs e ed d re reed C e e e e e T d V e TC TFC + TC 25
Fied coss vaiable costs a tota tot a costs costs
TC
ava costs er unt of o ut Q
Avra s A AV A) and maia os ) ss MC
average xed costs (AFC AFC))= total fxed costs per unt of outpu (Q):
TFC
AC
ATC AVC
average vaiable co (AVC (AVC tota vaabe ss per un o outpu Q)
V
AVC avag total cot (ATC total costs per unit f output (Q):
TC Q AC C AC AVC. AVC. Note tat ·st as C= TFC + VC, so also A margnal costs (MC) (MC) the extra costs of producng an addtoal ut of outpu (Q) C
AC op (Q)
AC
The ATC cuve is the vetca sum s um of te AC and AC cuves Therefore the dee wn A ad AV s equa t A ote that e v s he AV and an d A ues a hi mii miimm mm p
The relationship relationship betwee the odct ces ces ad the cost curves curves the sho sho r Te sho-u ost ost cuves owe their shape to h law dimn dim ns shn hn us whch explai wy te poduct cuves ad the cost curves are miror images of each oter: When the margia product of o f labor increases, this meas that he extra otput produced by ac additiona unt o labor is icreasg and that theefore the exta cost of producing eac additoal unt of output MC) is aling When dmiisng returs set n, ad the marginal prodct of labor begs o fall this eans that te exra output produced by eac additional unt of labor s decreasig, ad at eefore the extra extra cost of producng eah addtional unt of output MC s sig.
Raohi Rao hi wn hu pd ad s s AP,M
of labor
MC
AVC
The same ideas accout fo e relationsip beee the AP ad AC cues. Therefore when MP is maximum MC is mimum ad we AP s maxmum, AC s minimm (AFC is igored because ixed coss are costant MP itesects itesect s AP at its maxmum ad MC ntesec ntesects ts AVC at s miimum
Q'
Caclatig sho-r costs I the tabe below, you are given data o tota product (TP o Q) ad toa cost (TC) Calculate (a) TFC (b) C ) AC (d) AC e) ATC and (n MC The answrs are show bod a oal fxed Total Total cot ) Avrag fxd Aveage total aga Avage vaale produc (TP or)
o (TC)
0 2
50 50
5
50 50
150 300 450
50 50 50
600 750 900
9 2 14 15
£
varale cos (VC)
£
TCTC+TVC
£
co (AFC) ACTC/
cost (AVC) AVCVC/
ost (ATC) ACACAVC
cost (C) C C C/
£
£
£
£
.
.
50 200 350
500 650 800 9 50
25
75
00
75
0 5.56 47 3.57 3.33
60
50
70 5556
50 3750
50
547
53.5 53 .57 7
574 6333
50 75 50
60
a) TFC TF C s fud hrough e nformation nformati on i he C coum. Se C c) Use he formula AC FCQ f mula AVC A VC= VC/Q £ 50 we P= P= 0 = £ 50= xed cost and is onstant for al leels d) Use e fmula e) Use te ormua ormua ATC AC+ AC (aternatively ATC C/Q) of ouut f ormla MC C/O (n Use the formla (b Sine TC= C C C C C TC You should e abe to gaph al of e aove ces he os cuves follow e same general saps sown n te corespondng dagrams
Prodctio i the log r: r : rets to scale n the lo ru, l l factors of rodction iuts ae varial . What haens to otut in the o ru ven a chae n al nts? Ex: n o u prdued ee are two iputs labor (workers) and captal up u pdd up upu u poded pod ed s upu w a a uns wh ieasn rus macnes, whch ae double afer a perod of me w deras uns o sale to sal um wes nme o manes o cae 1000 Perod 0 3 1000 1000 Period 2 20 2000 2300 1700 na rn al al as nps ncrease output ncreases n the same propoton: nputs dobed and output also double doubledd nrasn erns o sale as nuts crease, output increases moe than in roporto nts doubled ad outut more tha oubed dasin rus o a as iputs ncrease oup ncreases less than propoion inputs dobed and uput less than doubled 26
Costs of prduction in the long run run:: ecoomies and disecooes of scale Eln n l L In the shoru a irm faces a shoru AC cure, or SRAC SRAC (descried above). We it increases its sie by iceasing all its inputs i te lng ru ts SRA TC shts to te right A rst, tis rigtward shft is also downward; ater it is rightwad and horizonta and eve later it rigward rig ward and pward Te pattern traced out by these ghtward shifts of a seres of o f SRAC cures provides e or L tl a cost cue showng the reatoship ewee aveage cos o a firm and quantity o output t prodces as it icreases in size by vaig all its inpts (in te long n is made u of a series of sortrn avera e total cost cost cre
Long-run aveage total ost ue ue (RA TC) costs
L SRATC1
. ,
-
Ts
RAT2
SRAC3
-<
economies _. _. disecooies ostat retus of ale o ae o ale p (Q)
Expaii! the shae of the th e RA C re eoomes o sa sae= creases n the sie of a rm i te log r) ead to aing ut uu li v ct ct conomics of scae aise becase arger firms ae eter abe to take advanage o: Spec Specaiza aizatin tin of labo labo o maagem maageme e eading ng to greater greater efciecy ciecy • fficiecy of larger larger machnes machnes ta can e e aforded aforded by arger frm • Spread Spreadig ig of mareing mareing advertisig ad ad R&D (research and deelopmen deelopment)t) costs over arger uantities o outpt Idivisibiites of macies or prodcio processes they canot be "divded "divded into smaler sizes for se y smal firms • Blk buying of npts, npts, or yng age qaities of inputs inputs by laer rms that need large pples ofeed at lowe pices per uit • owe owerco rcost st inancing or borrowig borrowig at lower lower ierest ierest rates rates ad bter terms, terms, often avaiale avaia le for larger fims reduction ad costs in aing AC due to correspond to ri i i as inputs doble outpt more thn doubes� cost cos t e unit of o ut ATC must be falli
dseooes o sale ireases i the sie of a frm i te log ead to ising osts e nt o pt = n n v v f a rm ecomes too age a ge tere may be ana anageme gemet t probems ems de o o poor coodi coodinaio naionn and and moniong monio ng of fims actvites Communia Communiation tion diffi diffiulties ulties resuling resuling n ieffiie ieffiies s ow woer woer moral moralee and mivato vato i they they are are a unimpoant part of a very arge firm
Firms need ot always expeence ecoomes or disecoomes diseco omes o scae in i n e event of onstan experece ce costat costs erns to scale tey will expere e n of ot constant averae coss.
th Ion ru Incrasing AC due to iseonomes o sale correspond to eeasig etus to sale otion: as ips doube output ess than doubes cost er n out ut ATC ms be rsin
1.5.2 Revenues R X Q
n w ifn v i Sch rms are fo ud ony i pei p 30) Sch For these rms = AR MR.
margnal evenue (MR marg (MR extra reveue arisig from te sae of one moe uit of outpt R H
average revee AR ) revee per it of oput AR R/Q Sice TR / = P � AR P
tota revene R R
P = AR= AR= TR / $
n wi v Such rms are fond in (p 3 l p p 35) ad py p 35 MR = sIoe of TR cre � when TR 1s maxm, MR 1s zero
MR= 1R/ $
R$
.
0
R R $
R$
MR R/ $
0
1
5
8
8
8
2
0
7
5
3
6
3
8
4
5
0
0
2
5
0
0
6
3
8
-
-
TR (SJ 20
15
T
0
5 0
1
4
p (Q
O
1
2
3 4 s
6 7 ou1put(Q}
P,A M($) 8
P,AR MR
6 4
=
Ql1,>�-
------- -------
-
Q
-4
27
1.53 Profit and goals of firms i = = otal eveue eveue TR) mius ecmic sts exici+ im lcit costs ecoomc rot ma be ositve zero o ne ave bm r sv r, aising when total revene bm TR > economic coss; i is ro over and and above al
normal prof= prof= zero ecoomi ot, asg when toal reveue R eoomc osts ss egve eoo pro arising we toal revenue R < ecoomic costs
The impotance of normal pofit
rma pi pi arsng whe economic prof is zero, is e amou of reveue requied by a frm to just keep it i business The firm hat earns zero economic pro wil no sh down because is revene is sfcen o cover al of is costs, incldng its implcit coss whch cover paymen or he enrepreneurship enrepreneu rship ha s used i e rm as wel as he opporny coss of all oer selfoed facrs o producio (ex rena icome sacred hrogh the use i te rm of a selfowed buildig).
Pot maxmzaton as a goa of ms
Sandard economic heory assumes ta rms ar drve by ter goal o maxmize prot were ro is iterpreed to mea . There ae two methods There methods used o maximize os te R R ad e MR :: Usig te R , pr s maximum maximum at lv sig he R rt s maximum at v u w R t u w R Is s
1 : msw1'th no. f uence ove ce CI a cuI a o1 -maxmz outtu t and amount o f o tf
You a given daa on Q TR and C Fnd ro-maximzng levl of oupu oupu Q, nd T R M Q and (b) by usig e he amout of po earned a) by sig the R TC R TC mehd and s $) ($) $) {$) 9 MR= MC mehod In bot cases verify your rests grapically. (c) How you ell 9 7 3 -6 7 1 tha his m has no ifluence ver price? 7 1 2 5 14 (a) Calclate Calclate TRTC for eac eve o outut (shown i bold); dentify the largest 21 4 3 value which is (If TRTC te same value twice, chose he one corespodig 2 7 28 o he large Q) This gives a oupt level of Q* = uits, u its, and to pt 7 7 2 () Calclate MR and MC (ow n bold) nd wr ty re eual MR= MC , 42 6 9 3 7 correspodng to ouut f · is cant d prot rom MR MC ae) 7 6 7 55 49 (c) The rm as no inece ove pce because MR is constant a P . When TR RC< 0, te rms make a loss Note ta boh ar araches aches ive he idetcal idetcal resuts R • m v c) TR C 60 TR 0 0 30
20 0 0
5
6
R ) 20 0
u are give data n Q and C nd prt-maxming evel o outu Q, ad he amout of rot earned (a) by sig he R TC mehod and (b) by sing the MR MC mehod. boh cases verify yr esus grapically (c ) w c yo l ha tis rm has ha s some ifluence over pice a) Calculae R, ad R-TC or eac level of Q (sow n bold) ideify te largest TRTC TRT C which is (f TR-TC he same value wice choose e oe correspoding to e larger Q). Ths gives giv es an outpu level of Q 4 s ad $7. b) Calculae MR and MC shown i bold) d where tey are eual: R= MC correspondig to ouut of Q= 4 us (canot d rot from MR C alne) c) irm as some so me fuence fuence over rce because becau se Ps falig ad TR is i s oliear Noe hat bot aroaces ive ive te denia esuls
25 2
TRR T
2
6
uits
Q
s 1 2 3
4 5
p
$) 11 1 9 7 6
T $ ($
7 6
18
9 13 15
2
17
28
21 28
0
10
0
R- $
M $)
C $ )
.
10
7 7
8 6
2 2
4
2
2
.9
5 0 39 9 0 7 2 4 28 55 - Wen TR TR RC< 0 the rms make a oss
7 1 6
M MC rt m i v ) MR, C(S)
20 0
-5
28
4
s)
7
5
5
MR
a roft -maxm -maxmzg zg out ut and amount o po1 : frmsw1th th.. f uence ove ce a cuI CI
30
2
MC
0
(S ) 35
4
u v ) M MC ii u
s
R mia w u v ) R
MC ($)
s) MR
Understanding why MR= MC gves rse to maximum prot Considr th darams abov, shown th MR =MC thd of prot axmzaton (for frs bot wt nd wout unc ov P). For ny < *, MR> MC, mag tt th xtra rvnue of or any , MC MR mng tht th xtr cost of roducg roducg o o unt of outu s gatr than cost f oducg o mor unt of outut s grt tn th rvu obtad from that that sam ut thrfor t s wothwl for th frm to rouc mor sam unt thrfor th frms shoud roduc ss A whr MR= MC t s no ossb or th r to chn ts outut v to rov ts oston trfor roft s axmd
Alternatvee oals of ims Alternatv Growh maximizaion Frs ay b trsd n mxg growth
trms of th quntty of outu roducd rthr than rofts rofts gv u som s om roft or th sk o or growt growt Advntgs of gatr growth cud chvt of gtr cooms of sca hnc owr vrg costs gar dvrsfcaton nto other roducts gratr markt owrabty to nuc c c d ower rsk of tak-ovs by ohr frs
Maageal t maxmizato Lrg s ru by grs who ar not owrs y try o mxmz tr rson uttysasfacto utty sasfacto by gvg thmsvs argr bts suc as hghr h ghr sares us of uxurous coany cars and xns ccounts a of whch wh ch ay work to rduc rofts
g bvor rms v Sasfcg Ths s an arnatv to axzg
any dffrnt gos som of o f whch ay confct nd th my not wt to "mx· yhgot yhgot rvnu gowth agra uty that coud gv rs to a sgncant scrfc of somhng s. y may rfr a stratgy tha maks comromss og dffrnt objctvs d cvs a sasfaoy oom wth sct o th m otant oas
Rvn maxmzato Frms ay b trst trstdd n xmzng rvusTR rvus TR P x rthr than rofts for svra rasos such as th rsson of succss of a frm wth g ss nd h rtv s ht rvnus ca b asudas asudas comard wh ofts
veu maxmaon P, M
D
T s maximm a Q* wre M= 0 c b sn dgrm
27; ths ads to a ghr d owr P thn th cs of rof mxons mxons 3.
Q MR
Copoae soa esposbiy Ths vovs avodac o acvs
tht my ad to ngtv roducto xrnatssuch s outo outo or vront dgradato or oth undsrab acvtssuch acvtssuch as us o chd abor o azardous wokg condtons of whc may cat ngtv mg wth cosumrs Such r bhavo s couragd by cosums who rfr to buy goods and srvcs fro soca! rs osb rms
Summary of prodct, cost revene and profit terms Poct tems to roductP vrag roductA roductA mrgna roductM roductM
tota quantty of outut outut roducd by frm tota roduct ut of abo ut =xra rodut roducd by dton unt of bor
TP / unts of bor TP / unts of abor
Cost tems ct costs xct costs coomc costs
scrfcd ncom or th us of fctor of roductonnut roducton nut tha s owd by h fr or us n roducton ayt o oy by a frm to b b ctor of rductonut for us n roducto xct costs + mct costs
tota ixd costsC costsC =costs that do not v v wth outt tot vrb costsVC costs that vay wt outut tot costsTC costsTC TFC TVC outut TFC/ TFC/ vrag xd costsAC costsAC = xd costs r unt of outut vrg varb varb costsAVC varb costs r unt of outut outut VC VC// tota costs r un of outut vrg to costsATC costsATC outut AC AVC=TC/ TC/ mgna costsMC costsMC =xtra =xtra cost of oducng o mor unt of outut TC/ og ru avrag tota costLRATC} costLRATC} cu= cost cuv showng th rtosh btw vag cost o a rm ad h quatty of outut t roducs s t cass n s by vyg ts nuts n t ong run
Revene tems tot rvnuTR avag vnu AR rg rvuMR rvuMR
c x quntty quntty P x TR/ P toa rvnu r ut of outut xtr rvnu rom th s of n n xtr unt of ouut TR/
Pofit tems conoc rft bnorma roft norm roft oss
=tota rvnu mnus conomc osts ostv conomc roft zr conomc roft ngv cooc rot
TRTC R C whn R C TRTC TRTC whn TR =TC TR C whn R C C
oa rot t mout of rvu d to k a r busss whch just covrs ts xct nd ct costs cudng aynt for ntrrnursh 29
1.5.4 Perect competiton Assumptions of the model Assumptions mod el Tee i a a mr o sma ms, each of whch acts There is do o ad x, o at any fm cn freey ad ide edeU ad is nable to infuence infuence the rice of its oduct. exs an idst without restrictos of a kind Al rm sel a omoos om oos (o dia dia od o tha it i not not There is t t imaio, imai o, o hat al rm and coumers coumers have all necea iformation o rce ad o ut o make decisos osible to dit uish te roduct of deet rduce rducers. rs. Tere is eect resouce mo so so tat resouces factor of rdctio cn be moved !reel ad wihout wihout cot from oe r to anoher anoher The peecty compettive irm as a prce take pic ke= ke= a rm tat ell all the output it wats at te P deermied in the maret the rm has no abilty to inlence becae of it mall size ad becase it sell a homogeeos prodct teefe the t he demand ce cng the r i peety eastic at Pe determied y D and S. S.
, )
e m
D =P =AR R
Pe
maret/ dusty
s
I te maet indsty) demad (D) ad supply (S determine an equilibrum price e. hs price i accepted by each individual irm i the industy If a r tries t increase its pice i will loe al cstomer t oher rms, ice the prodct tey all ell i idetical. While te firm ould lower its pice below e it wold be fooish to do o sice t ca el all t wants at Pe
D
Q
Q
The reveue cuve facig e perectly competitive rm c e sen o p 27 nde 'Revene f ms with no no iuence over pice whe it was notd that AR MR. Since te demad ce faci the rm is efectl elatic horizonta a Pe follow hat P AR MR
Sho-un prot maximization in perfect competition competition (MR MC method) In the shot ru, the peectly competiti competitive ve rm may make aboma o o omal om al poit p oit or loss. l oss. =
How to d d t otmaxm otmaxm or ossmimi) ulum ad amou am ou o o o or oss o e m: . Fid Q wer weree MR MR MC this is O if te im earns abnormal or 2 Draw a line upwad to P ( ) or to ATC (whicever s hgher) norma rot rot and 0 if it mae a loss ATC by Q poduced poduced 3. Compae P with ATC to d which is larger P >ATC" aomal 4. Multiply the veical dfeence between P ad ATC or 1 ) to fid tota aoma prot o toal loss (Qn ro P A " ormal orma l oi < AT oss Abnoml rofit (ostive econoic roit) , rv o
Loss av oom o
Noml rofit (zeo ecoomic rot
r MC vus ot __ __
p v o
MC
D=MR D P-
ATC
p- '
A
Qn
Qn
Q
Qioss
>A im makes aoma pof; A frm mas ero aorma
Shutting down n the short run : beakeven pice an shutown price rea-eve pe pe the price at whic te rm makes normal pro ie P miimm AC meaning that P ( reveue pe uit)=cost uit)=cost pe uit st-dow te ice at wich the rm will sut down i te sor s or it s where P miimm AC Braev ee ad s-d s -dow ow rie I te shot ru, a ossmakig fim ries to minimie nimie its osses. osses. Since i is i the a t leat one ied nput, ad hereoe as fixed ost If it ht h t e omto o run it ha at down its loes will eal it ied coss I it can mae losses smaller tha it ied cot by cotnig o produce i sould contiue to prodce t MC Remember tat te diferece beeen ATC and AVC AC At P ( bre-eve ri where the rm earns nomal proit, P i icient to AVC cove al of AC and all o AC (ie all of AC) break-even pice At (where the rm is maing a lss) is suicient to cver al of AVC ad a loss-makig fr ll produce poon of AFC he frm wl rodu bease s oss fxed costs. shtwn p At (were the t he irm again i maing a lo scient cient to cover cover only on ly AC ad los-making fr wll not podue noe of AC AC t irm ndirt wee po duc ducig ig ad no rodig becaue i oth cae los ie cot cot ti ti i he sudow p p loss P is cover only a pa o AVC and At P (where te irm agai i maig a loss noe of AFC te im wl o od becaus for an PJ loss loss fxed costs costs e m l su dow if s ow . oit t of mimm A hutdow ic icee The efecl com ettive rms so- so-u u s s is c o h oi 30
In long-u long-u equibrim al fms ea nomal poft zero economic proit) Fm ama in run nmal l The firm T makt pice
he frms in the indsty are initially accepting accepting price P1 detemined detem ined in the market, earnng abnormal prois (green area) in te shot un. Wen the idtry goe into the long run, outsder rms attacted by profits enter the ndust causing the market suppy cuve to sif to the right ad te prc to fall Market spply inceaes nti the new pply curve S2 give a pice of P2, where w here the abnormal proft are elimiated; al rms ustry arn rmal t whr = mnmm mn mm ATC
revenues, COSIS
P2 0
Q2 Q1
price, evee.
Q
Q
rm ru nmal ri n n n T m T mark t price S2
he rm in the indty are iitially acceptng prce P detemined in the market, makng loses (red area in the ho h o When the indty ind ty goe into the ong run some of the los-makig rm leave te indtry, caing cai ng the spply ce to shit to the lef and the price to incease arket spply deceases dec eases ntil the new spply curve S gves a prce o P2 where the losses hae been eliminated among the remaining rms n the idustry al man im ern orml roi were mnimum ATC
SI
COSS
P2
0 = MR
Pz
1
:
=
Q
Q
Nt te te iffeece beween the sutdown sutdown ic i t t st rn ad in te Ion run: Ln w i is were P mni mum ATC If fals Ln uow is were mnmm AVC. If P falls below ti evel, te m wil mae losse larger arger than it e sts below this level, te frm has o reasn o ntine to prodce a i and so is better of sto i rouction and closin dow s 30 the Ion run al its n uts are variable and it can leave the idust The break break--even pri pri ce ce,, were P minmum ATC and te rm makes ormal profit is the same in te o ru and in the ong run Note that the break-even rice and the Ion -run shut-dow rice are the the same.
Poductve and alocative efciency perect competiton po tiv ny = producing a the owest posible cost u potiv u w uin uin aks la at minim m ATC allativ iey prodcing the combnaton o goods ad sevces that conumers mostly want us we P MC =
nu qlim in m ut an aat iy T m T mat price, revenues osts
pce
T im nr qibum ar nrma i snce P Ais Ais euilibrim alows the rm to aiv t riv iiy p Q s wr ATC is minmum minmum an alaiv e sn C
D R
Pe
the pefectly pefec tly omeitive market euiibrium occurs whre MB= MC, and a u
P
DB Q,
Q
Q
Q
sum of cosume ad poducer surpls) s maxmm Idcatg alocatve effcency (as
explained on p 6)
he gnicance of thse eiciecy conditions s
that here s no resouce wste Productive and alocatie efciecy i he so -u
he peecly competitive rm alway achieve allocative eiciency eicie ncy bot in the sho and long un becae since P M pro aximizato occurig at M meas tat P = M where pro is maximm. maxim m. However, the im i m that earns abnomal pro n the shor run does ot achieve productive eiciency, eicienc y, since prodction takes place at were A i not minimm You can check hese point by examining the dagram above. E va
ar10 of eec t compet 0
Acieement of prodctive efiey n the lg ru) means that e s n esrce wate in duction e Aciemt f aloative eiceny meas tee s n rouce wate n account f roducn oods ot wate/vae b oie oie ! ecause of the above eficiencies peect competition becomes a standard or assessig te extent of neficieci neficiec i n other markt strctues ompettion leads rms to lowe ther costs o prodctio ad hiher-ot fims are forced out of the maket @ onme beneft from low prices aring from competito and lak of abormal ofis in the Ion rn. onme dcide what ad how muc wll be produced, bcae te maket espods immediately to change i consumer tates and preferece, and alo becaue frms have no power to inece oumr trouh dvriin l ood r homoo 31
The model s base nralstic assumpins ad there are few if an real-word real-word makes ta aratl aratl dscribes ecase f the small e o firms hy ant gow arge eough to enio nm al see 7. As ms open and close niosly her may may be a waste of resoures involved as facto of prduction mve om om one rmndust to aoter (tis is assumed awa bv te mode. Homogeeous prodcts ma tha onsmers annot enjoy ay prodct vaie. Since firms do not earn abnormal prots n the long run, they are nlikel to enae in reearc for new roduc develoment e model cannot guarantee that there will not be any ai pui puinn mpn (see p 9, in whch case if these occr (as ( as they are likely o allocative efcency will no o b cived
1.55 Monopoly Assumptions of the model Thr is a g d i th arkt. sngl frm resents h tir markt or ndust Uderstanding barers to enty Barries o nt ar im otat fatures of bot Lage is f s causng average coss o all as output increases i the long un (p 2); enty of nw frms is difcult dif cult as enterig o a smaller scale woud mean high average sts, igh ries and and thereoe abii o o com ete with th th eisn i Nal n where a sigle firm can cover the needs of a entire arkt a a lowr avrag cos tat two or mor fis (s p 33); w frms ar strongl disouraged disouraged fom eteng due to vy low avra costs costs of the natural natural moo olist Badig wich ivolves adveising to ceae a uiue product image and name, atracting cosumr loyalty rs may be uable to break nto arkts wi song brads due to consumer loyalty owad the alead exsi roducts
h frm prodcs a good ta as s (if here wer close substitutes substitutes would ot be a oo ol
Legal barriers, created by legislatio incud patents ( rights give t is to be soe poduer of a ew pdut or a ped o im) gh gh ( ghts o auos o b sol rodcrs o writt wo) and rade barrs rstrict i s s 64 Aggessive tactis methods used by xistig firms o o prvent outside fis from etering such as by lowig pice o mak it difclt for a new rm to copte, or by threateig nw rm by a takove. Conto of ecessary esues involves ownersip or control of ssential esources invove in productio such such as corol of oil eseves o diamond mies
The monopoist' monopoist's demand and revenes n eation eati on to price easticty o demand (PED) Te monopoliss evues ad rv cuvs wr elad o p 27 ("Revues o ms with iu over rice') Se t t follows that e dd The R and MR us ae ae sow sow hr i lato to PD D d MR PED nlis d rd l D I the upper let potio of the D cuv PD >1 a th midpoint of te D cuv PED 1, and a th botom rig potio PED 1 (p 8 9 nd p 27 27 Whe PD 1, MR is positive positiv e (R incrases) Whe P 1 MR 0 (TR is maxmum) Whe PD < 1 MR is negatve (TR decreases) This means that l wl nt rod i o D u wr PED < 1 (TR dereases) Ths ca be seen from th pro maximizing conditio conditio MC MR sice MC is always positive, it canot be equal to MR at any negative MR valu. Anote way to see this is to note hat as Q producd icreases T icreases, but if TR decreases (as it dos w MR 0 = oft ut b ai , whic rm wl not ace Monopolist proft maxmzato The onopolst faces the same cost cues as th prfectly compeitiv (or any oher) m What dffers dffers is the shap of th D = AR AR and MR cves, which are added to the cos cuves to nd protmaimzing equilibrium 1 Find profi-m profi-maimi aimiig ig Q ( ( O) by MR MR MC 2. Fid the the correspoding P ( P) by drawing a veical i o the D = AR cue and across to he veca axs. 3 Dra Draww a line fro e poit of ATC to the veica ais 4 Prot (posiive ive econoic econoic or abnoral profit since P > ATC) is found by (P ATC ATC)) x O = gree area
Monopolist revenue maxmzato Revene maimzato is an alterative goal to proit maxiiaion, wic ma at ims be pursued by ims (see ) Revene is maimized at the level of output whee R = corresponding to maxmum total 1 ind oss-mnmiig Q (= ) by MR reveue (R) (as seen n the diagram o p ). 1 id revenue maximizig Q (= (= Q) at the the point . where MR 2. Find the corrspodig P ( ( P) by (= P) b drawing a drawing a vrtical lin lin to the D = AR cu 2. Find the corresponding P (= and across to th vetical axis veica ie to te D = AR cuve d aross to 3 Contiue the veical lie upward upward to ATC te vertical axis and draw a i rom the point of AT to th The dagram also shows rot-maimng Q vetcal axis. (Q) ad P (P), fond by e MR MC rule 4 Los Losss is found by (ATC P) P) O O Th uii ha a lw red area ad g a i-ar.
Moopols loss mimaio Th monopolis may also mae a loss (egative economic prot) this happes whe P < ATC) Loss is iimzed t same way tha profit is maimized:
Hw li n ls
How the moopos maxiizes profi
s
pric eeues oss
h is i ve
prce s s cs
Q
Q
32
Q
Shor-run ad log eqiibrm in monopoy Because o hgh bi o , new fims cannot ene the maket even if the monopolis s eaning abnoa pots(positve pots(positve economic prots. Theefore continues to ean abnomal profits n he long un. h h- qii i i IfI f the monopolist is making a loss loss(negative economic prof) in the shotrun it may choose o shut down i th e long un o it may contiue to operae if it is subsidized by the government(in government(in the even that it is a natural monopoy see elow)
Natral monopoly nl l = a monopoy with economies of scae so lage tha when it poduces output hat satsfies he demand of an ente mare it s scae(alling aveage costs); costs); it s thereore not in society's society 's nteest to break it up ecause wo o moe ims sill experencing economies of scae(alling oducin the same level of of out ut woud do so at hi her ave ave e costs he demand cuve of he natural monopolst ntersects its TC cue a a N poin where average costs are stl alling(it alling(it s stll expeiencng economes of price, scale The reasoning s tha the frm is eaning at least nomal prof cost where P ATC it canno produce any O greate than o•, because if it did, P(given P (given by the D cue would be lower than AC and he im woud be making a loss Theefore must produce produc e a O less than O* but then t hen it is experencing economies of scale. If his fm were split up into two or or moe A ms each one would have substantialy highe average coss. hereoe it is not in societys inerests o split it up atral monopolies usualy have hgh capal costs and include includ e mainly pubic utliies such as wate Q* Q eectricit and natua as com anies.
Price ad o i price, evenues ot Pm P i
The in pefect competiton has ouput O pc and pice Ppc, detemined d etemined by the ntesection of demand and the MC cuve(which cuve(which in pefec pefe c competition is the S cuve) The monopolist has its outpu etermined by R= MC which is Om sold at price Pm
.
Theefoe the monopolis has hih i Theefoe i d d u han he pefectly competiive frm D
Ths result maes monopoly undesabe rom consumers point of view
Q
Effcenc in moo o & i p
pice revenue c
S
du & i, pie evee
MC
M
Pm
pie eue cs
M
Ppc - D
Q
(soc (s ocia iall op tm mu u))
Q
Q Q M
Q
he highe pice and lower uantity poduced by the monoplist have efecs on consume and producer surplus: • Lower O at at Om � esouce misallocation esults esults due o ower poduction than the social optmum level(Op), level(Op), eadng to wlfare loss(bown aea) and alocave ineffciency; • Hghe P at Pm consume surpus decreases by the aount o the geen aea taen by produce supus the monopoist ans at the ex ense of consumes
Qpc
Q
he poftmaximing poftmaximing monopoist st canno acheve poductive poductive and allocative effciecy it is poductively ad alocatively : • Poductive inefciency at the poin o poducton Om ATC is • Alocative inefcie inefciency ncy at the poit of poducti poduction on Om Om P > M; this shows that the vaue consumers attach to the last unit of the good(= good(= P) is greater than what it costs to poduce it( MC). The monopolist faces an additonal type of neficiency arsng fom its lac of competitos, competito s, makng ess caef to keep costs as ow as possible -ie means hat he monopolists C may be highe than necessa it may poduce at a point such as X, rathe than at point a, which is on its ATC cuve Xneficency may arse from poo management inefcient worers and a ack of concern about keepng costs low, all of which ae due o lac of competition.
Q
Postve caracterisics of moo o Rsach Due to its abnormal prois in te ong
run te onopolist has funds to cary ou D eading to new oducts and ecnolo ies ies benetin consumers and soci . Ecooms of scal ue to ther arge sze monopoistic ms ae in a position to achieve ach ieve age economes of scale involvig low avera e oss in the Ion un leadin leadin to ower rces or conumes. 33
Possbl lowr prcs du to tcnoogica inovaos he development and use of new technolgies may lead o lowe costs nd hence to lowe ices en·o ed b consumes Nata moools n the event that a m is a naural naural monopoy, it can achieve ecoomies of scale so age d average costs so low that it s i societ s inteest o mnain it as a mono ol .
Evaluatin
onoo ow o we te abiit to inuence price due to a downward he ineciencies of onopoly and oigopol lead o govement efors t oro and l e degee o oo owe aiming to bring slopig demand cuve, leadng to resource misalocaton and wefare wef are loss o o onooies ono oies nd olgoo ol gooe e exercis a ces and qaities more in line lin e wit copeive markets markets and to t o lmit ondeabe aon o oo o ower resource misalocaion and welfare oss ree nreglated nreglated monopoies are as a le legal; onopoies are alowed to exs mainly f they are naal oool oool in wic case tey re re lted te oenmnt tis a ies to oth ll d rte owned ono oies =
Lecuslaon to lim moopoly power
Leaon roong oeo Most counries ave egsltio egsltionn is essenta since greaer copetitio is in the nteess of laws tat: consers and sociey, eading to greater quantities produced and lower prices do not peri foration of onopolies (ecept natural while moopoly ower leads to alocatie ineficiency and welare loss . onopoes) I Vage laws allow or diffeen inerpetations of o f anticompettive beavior. do not perit colo (ageeens to x rices and I ere are diferences beween contries and changes oer time on h ow share otpt) among oligopolstic rms see p 36) uch moooly ower is too mch and on how arg mergers shold be reglae mergers (agreements beween rms to joi depending on politcal iews iews together) posing lis on te se of the merged firm, here ae diferent degrees o enforceent o aws. to aoid excessive monopoy ower I here are aor dfcuies in inding evidence o colusion i oligopol Natonalzato= transfer o fir ownersip fro the rvate to the publ or Tade iberalizato = te reoval of trade restrictions (taifs governent sector quotas, see 6 so tat iorts iorts can enter feely nto a count Governet ownersip allws the th e goverment to regulate natral ncreased impors into a count ncrease copetiton faced onopoies forcing te to loer rices and increase anties rodcd in by domestic rms wit foreig poducers; domesc irs wit a the nteress o consers redcig allocative inefciency and welare loss sbstantial degree o moopoy oer are orcd to ower prices tus facing reduced onopoy ower I Govern Governen en ownersip oen leads to ineiciencies and iger igerhan han necessaryy costs of prodction as govenments necessar govenments ae no driven by the goa to t o I necient doesc firs ay g o of bsiness, wt a aximie rofis corresondi increase increase in i n neome neoment nt
•
•
•
n n Average cost picig s a method used by goernents to orce natral onoolies to produce were P ATC, gen by te ines inesection ection of D wit ATC, esultng ng in i n quanttyQac and prce Pac where the r earns noral prot since = = ATC. The regulated monopolis roduces a arger Q and sels it at a lower P than the nregulaed onopolst who akes abnormal rot (P > AC). Since P= P= AC te monopolst earns noa prot and so does not make any loss (tat would requie subsidies by te goveren) Since P s lower andQ andQ is higher consumer srplus increases I Prodctive efciency is not acheved (podction is not at inimm AC) Alocative efciency is not achieved ( MC) so tere s welfare oss Since the ir is guaranteed a pice = = AC, i has no incentve incentve to t o kee ts costs as ow as ossbe he folowing inforaton shos the rotaxizing izing or loss imizing equilibrium of three rms: r X r Y Z
nis 170 350 420
$)
12 20 27
AVC ($
2 4 7
( Explain whch rm is mang abnormal prot, nora profi or loss. (b For each fir, calculate its otal amont of roi or oss (c) lain whether or not te t e loss-akig fm shold sht down down Using e inforation beow a) calcuate the fir's break-even price and sutdown price () nd the corresponding lee of outt of each. n $ 17 5 5 5 20 6 7 5 24 8 5 29
AT
Pacp - - - - - - - - - - - - - - Q
=
You s calclae C ATC ad AVC ATC AVC ni ( $ ) ( $) $) $ 22 .40 3.40 5 17 3.33 25 6 7 29 414 3.43 8 425 362 34 (a) Breakeen P $414 min ATC Shtdown P $333 n AVC (b) The fir breaks een aQ aQ 7 nits i shuts down atQ atQ= 6 nits
e, reven coss
Q
(a) Fir has AC= AVC +AC= 7 2 = $9 Since P = $12 P > ATC tereore im X makes anoral ro r Y as AC= AVC +AFC= 17 + 4= $21 Since = = $20 P < ATC, tereore i Y ae a o Fr has ATC AVC AFC= 20 7 = $27 Since P $27 $2 7 P= ATC erefore i ae nor o (b) irm A as rot per unit= PAC= PAC= 12 = 9= 9= $3 rofit per unit x uits of output 3 x 70 anor o Frm B has oss per unit= AC - P= 2 20= 20= $1 oss er nit x units o outpt 1 x 350 lo irm C has eo anora o o o (c Fir Y old ol d o o down beca because use P > AVC (20 > 17) 17) t is cvering its varable costs plus a oro of xed costs so loss < xed sts f it shuts down loss wll e ual its ixed costs
AFC($)
7 17 20
Aerae o r
34
=
sing the data below, caculate ig P and andQ Q (a) poft-aimiig and (b) (b ) reenue-maximizing mizing P andQ: MC MR ni ( $ ) ( $ ) $) 4 1 8 8 2 7 3 6 3 4 6 4 4 5 2 5 5 4 0 6 7 6 3 -2
(a) rotaimiig g Q is where MC MR 4 so it is 3 uits, at P 6 () Revene-maxing Q is where MR= 0 so it is 5 units, at P $4 =
=
=
Te ir tat aizes revenue as a lower P and hgerQ tan the frm that maies roit
1.5.6 Monopolistc competition Au f h d
freedom freedom o etry nd ext i the idusty thee ae o (o Thee aes.large umber of firms, eah of whih ats indepedently I lThee ofThee the otiisshdct o w) bai eotrshes; to enpodt s Ex esauats, hidesses, i i i eah i m t i e s t o make makei i t s pdt pdtdi di f e et etf f om omot aes fuishoes ue, supemaket an be idies,feetloataitoed easaess by appeaae, tosumes ase, olo siitzfeomsqualthitye basi pakag g bad g sees (sh as fdyl on--pr prce comeio waat eas aess bybyosumes s of on ood eodes lothi s
Prdu da, -
ad dad rv
Podut eetatio ais uibe ovi al y impot aofta sed by smssupeito oeat e moopol y powe The dowwd m monopol sti ompetitio theefoe song demd cve whee a es Theodued moedibfosmes ed podt i y ove i t s sbst i t u t e s i v a f ms, t h e eat e t h e moo ol owe of a f m i e ad uat i t demaded ae i n vesel e a t e d. o-- rce cometion opettion =mes ompetawayitionbet nfombetwheee o Moopol esiompet aly ompet itive ms se both pie fice podut ms ocometion ats ofaothust o ad opi i t The more successful e o bet w ee f i ms o a a st o mes o e geae e moooy e ms by loweig the tthheoubasih s rodc o fatosdeetton othe than pie o-rce-cometio owe ad te owe the eiae o e om etion ie of the odut i
Prf axza ad za h h h ru
Pof maxiistmiiompet aio aditioloaess mieimsme atios moopol ik.eThea moopol easo yisfothatitseah fpai im la behaves ow podut , po duett-omaxipodt dig feeveletofaouttioput ad The m i pitheegee ae Qaeaad P Toal poft s show by loOlssmi imP1 iig Tolevelal oflossospshow ut ad pib theThe ae ad e ed aea. Nra rf h g ru
price,
L ii M
revenues,
costs Pn
s A TC TC_. _. P1os os,. ,. -
D
D
Q
Efy
moopol og uistei libimtof:ms i ompet ot sahieevethepodut ve miig eoutfpdoitey pof t axi , otQe ahi is o oeveatalmlonatimive eATC do siQe,eP at> MC, the poiditatmaxiigmthatitgoooutflitpieey,of the good is beiwantng podued o what osmes
thatbypothet maxi miatio i fat iThe avolimdvpo esagams olaty pat Pabove adof Qfsuggest dei s i o s m wheeas i os o . odut dieet et atiom avy ivolves deisios assumes eaity, thee may be oe baies o e tha the mode •
price,
revenues,
ue to fee ety ad exit, i ii t er orm ot. New pof msaeposiattvate eoomi ed io industpotes, andeaning abomal ap e pat of h e maket shae of exi s t g ms veo fahenATC g eahuve existsoigPmATCshifs lTheef et utSomeoleit tshmsteaget exioft emai lossmak gmsidustto iieease s ausitheg theve makefaishae n i g g eahsofPm shiATCts igh ti it is tage to the ATC uve Criticsms of the model
iiti
Q
L lii pice,
veues
Pe --
D Q
Podut diiesfedoes etiaottioaladlow taal he pesee ofiwha aey leive e, aseiany moopol y si s at t h e dst s ot possible to add up demad ves tPodut di f e et i a i o pesupposes eseah ad deve o pmet (R& b he labkleoYetabomal ts i tihsetloomet g isugges s thaotthissome is otR& ossi ms ipofmoool tio do a •
1.5 7 Oliopol e ut' h d
A
Thee is a of lthe r, eah o whih s awae of Fiodut ms selexl eias the a podt ex oil o iri thee he esee t he ot h es gh Thee is the ete haee hidst y akig it diilt o ew fims to umbe atios of eah oe aetalr, of thdue e othtoesthe small (
Irdd ad h da r ud
The iittsedepedee of how msitiexolgetopos itys makes thbehave em havelikterie ea amebeh so thTheiat eah iemitbehai ies t pedi t thehematoosonof li tvali imseti adivesto base ow at i o s on i v al s t o of hess st at o e ads et e icetve o coude ake a ageemet o x pies ad e nceve o comee ims e the etive to ompete wh eah o h e o t h e pupose of apt i g pa of t h e v a f ms' make shae shae. beweethethmaket em betwee hemselves o as o lmit ompetitio 35
Game theory: theory : strategic interdependence interdependence and the ncentve ncentvess to t o compete o to colude gae theory a mathematial tehnque sed to analye the behavo of iterdependet decisiomakers who se stategic beavo; one su game s based o te pr isoner 's diema= a game showig ow two ational decision-makers who ry to make temselves as well of as possie
by sng strategi behavior end up becomig worse of Game theory is very useful to demonstrate impotant eatures of the behavior of oligopolsti firms Suppose tere re t fir, nd B, d the eh hve wo pricig sraeges 'high prce" ad low price ere are our possib possible le outomes • The frms rms begi in otcome 4 wee wee ue to price competiton they both use te low prce stategy ad ear low proits o $20 million each
: h i l
Firm A high price
1
• ey realie realie that if tey tey r u u ad fix prie prie at a igher level level they ca be at outome 1 where tey both make igher profits of $50 millio eac.
hig i
• While olludig udig they fae fae a dilemma Eah oe thnks that that i it breaks the agreemet and lower lowerss prie, will make the igher profit o $70 million while the riva will make $30 million (otomes 2 and . Each also thinks that doest lower prce, te rival will ad wil beat it to the iger profits.
Firm B
• Theeore tey both break te agreeet and end up in box 4 agai wee they are both wose o eanin lower rofs of $0 millio ea
$50
ow price $70
mlon $50
mon
low pi
$70
miio
Ke
ois deostrated b te isoes dema ae: • Th Thee fir firms ms s sow ow statec beavio, as eah bases its ations on what i t
• Bot becoe ose o as a resul of prie competiton o gesses the ote wl do cuting prces in an a n efo to apture pa of the rivals market share • The irms sow statec tedepedece= as eah one ties to guess what te other wil do, te ations o one affet outomes ot ony for itself • h her ere eor oree price opetitio s stroy avoded as it may b aso for te oter lead to a pce a = a situaion wee frms retaliate against eac oer by loweig prces to the poi that they may ed • e frms ae ae ii i i whh are the ceive ceive to ompete ompete up makig losses. ie com etition ad te ientive to ollude b xn the rice
The concentration ato cc r r i a measure used to determie the degree of ompetion i an indsty, ad wheter firms ave too muh w w it measres the peentage of outpt p rodued by te arges frms in the th e indstr. x A fvefirm concentration ratio of 45% means that the largest fve firms poduce 4% of indst output a sevefrm ratio of 80% meas tat te top seve fims are responsbe for 80% o output. e h h ccr cc r i h lw h p pin in n h i h r f f l r A industr s eld to be oigopolistic if the four largest irms are responsble for 40% of outpt Te onentraio ratio sers from some lmitatons it canot account for te reative sizes of the largest fims possible ompettio fom imports te degee of ompettio of the industy n gobal markets.
lui lui= = collusio between ms leadig to the foma ton o a catel = = an agreement between frms with the objective to maximie profits by behavng as if tey ee a oopoy and restriting competition betwee them usaly by fxig pces at a hige leve ad imiting otput; arels are formed by collsve oigopolie. Te poft-maximizig otput is split betwee betweenn the carel members possibly by se of histocal market shares or some oer rule) The monopoy dagam sows profitmaxmiation by a cael Cates ae ilegal n most on tries beause their member beve like a monopoy with signifiant oopoy poe leadig to iger pries and lower outpt tha wat arises in more competitive mar kets and sbstantial wefare loss. Ex Orgaization of Petroem Exportig Coutres (PEC), omposed of tiee oi- odin outres that restrit oil out ut leadin to a hi her h er oi rie
Fr lli i p pic enes coss Pn --
D
Q
• Cate membes membes fae te te nentive nentive to ceat ceat on the ael ael by secretl secretlyy • It is imprtant mprtant to to have a domnat domnat firm in te te atel tat tat takes on a lowerng their prce is way capturing ivals market sare. leadershp role makig it ease to resolve dfferenes and arrve at agreemets agreeme ts lak of a doiant f rm can ea d o cate breakdown • Cea Ceatig tig by oe oe or more more rms may lead lead to a price price ar ar nvolving nvolving retaliatoy prie cuts, making all the frms worse of ad leading to • he larger te umbe o irms i an an industy that that are oinig the arel beak-down. arel the more diicult t s to reac an ageemet ad the easie • Der Derig ig osts osts of podcti podction on amog catel members members may lead to for the agreement to break down disagreements as ger-cos fims want to ix a higher price and • Durng recessios wit fallig sales and profts frms have a vice versa. reae iceive to heat b loweri rces Tacit collusion
l= l = coo eratio between firms i oli o ol to restric com etition and ix rces hu l i h= h= a fom of tait colluson were dominant irm in the ii pc form of tct cllsion lsion where firms agree informally industry sets a prce ad also iitiates prce changes; te emainig to se a prie ta s lower tan the profit-maximzing pre so as o discoura e ew frms fom enter into e ndst rms ace t te leade leaders rs rce becomi becominn efet efetive! ive! rie-t rie-takes akes 36
No-colusive oli o ol
h kid dd
h kind kin d dd u d Olgopolisic firms ofte do no collude, ye there is still price stability price rigiditie) in oligopolistic markets Te kik kiked ed demand crve shows how tis can appen Suppse there are two firms, Y ad Z podng outp Q and selling t at price P* • Y asks if I raise my pice aove P' wa will Z do? Most likely Z will ot rase ts price becase by mantaining mantainin g a lwer prce tha mne, i wll be able to captue a large part of y market share� y D appeas elatc whe P > P*, because as my P propoionaely more m TR Therefore sould nt raise my prce abov . • Y asks, if I lower my pice below below P*, wa wil Z do? Most likely Z wil lowe lowe its prce prce too, to avoid losig market sha to me� my D is inelastic whe P < P P because a my P P propotionately less my TRU e hul lw ri w • Z asks the the same questions as and tries to gess Ys respos resposes. es. Zs reasonng reasonng is the same as Ys. r l d ri r lwr l wr As both (o al) irms in the industry reason ths way, r d i n e rms prof-maxmize b the ue MR = MC he broke pat of MR (de to te knk in D alo alows ws ims with differ different ent csts Ms o rofitm rofitmaximize aximize at he same Q and P P l l h h d The model explains why r i p i (price rigidites) in oigopoly evn thog the firms do ot collud he model shows that irms ri ir basig their actions o guess abot what thei rivals will do The model shows that he irms avod lowering prices to gan market share e h d p ti, as his can ead to lower revenues and prots as wel a o price was ri i l • Fear of price price was leads oligopolstic rms to compete compete with eac other other o the basis of on on rce factos. • Impora Imporant nt non-price non-price facto factoss are ew ew podcts podcts and poduct differetiato advertisin nd brandi .
o moopoy becase of: igh bar igh barre rers rs to et etyy sign si gnca cant nt monopo monopoly ly power power abnormal abno rmal prof profits its n the the long long u alocative aloc ative and produc producve ve inefcency cency igherr prices ighe prices and lower oput oput tha compe competiv tivee rms pssible X-ineciency X-ineciency de de to lack lack of price competit competition ion in oligopoly oligopoly eed or government government polices ensring o abse o monopoly monopoly power power larg la rgee econo economi mies es of of scae scae abil to car out &D, eadin to new roducs and tecno tecnolo lo ies
1.58 Price dscminaton rie driian selling a prodct at diferent prices to different consumer groups, were the prce diferences are not due to diffeence in costs o roductio
Lii h d The model canot explain how e fims go to the point of e kink (bend) in the D cuve, wee they prodce utpu Q t pre P. The model does no hold i periods ifation (a isig overall price evel), whn firms increase their prices de o higher costs and/o increasig demad
• Oligopoisti Oligopoistic irs ea abormal (posit (positive ive economic) c) proits, ts, offering offering them e resorces or research and deveo ment, adverisin and brandin • Product dieretia dieretiation tion adveis adveising ing and branding ng lead to grear grear moopoly moopoly ower ad abit to nece rice, and reaer abnormal rofis.
Siiarie Oigopoly is simia
• • • • • • • • •
Dencs Olgopoly differs from moopoly because • it conssts conssts of several several firms ather ather than oe oe (o single single domnant domnant)) • frm use strategc behavior • rm strive strive or major or prodc prodc differe differetiation tiation (if products products are ot homogeneos) • frms face face sron srongg non-prc non-prcee compet competio io • fr frm m have igh igh adver adverisin isingg and branding branding costs costs • frms may behave collsiv collsively ely (like (like a moopoly moopoly ad yet avoid detction becase hey are not a single rm hus h us escaping laws protcting cosumers agais abuse of monopoly power
Ex hols ofer lower prces for f or witer and midweek says arlnes ncres thir prices as the date o travel approaches; hairdressers ma offe hgher prices or women than me cinmas ma offer wer rces for childre and older eo eole le
Conditos Condito s that mst be satisfed or rice isciminaton t t take lace
The rm mus ave some moopoy power (ability (abili ty to iluce price); a peectly competitive competitive rm beig a price aker, ca caot ot ractice rice dscrimiation.
Of two consmer groups, the ist has a lower PED than e secod he wo MR cuves (MR1 and MR) are added together to give total MR, whch whc h he fim euaes with its M o maimie prot. Ths gves Q*, which te irm divides beee the to goups by eqatig MC=MR=MR=MR givig otputs 0 ad 02 ad prces P1 and P2 gve by the D crve) Group , wh te lwr , ir ; Grop , with te w di n hihe rne nd
p
e firm ms be abe to separate consumer grops so hat there is o possibiiy of esale (buying at the low price ad re-selling at te hgh rice . Se aratio cn be b time a e, eder, eo ra hical location.
l
p
r
p
r + r MC
P1
Q
37
Q2
R
Q
Q*
Comparison of market structures Marktt trtr ar h i r r i ra akt p Mark p..
Monopolistc competton
Perfect competition Assumptons of the model
.
mny sm ms omogeneous oduc o bes o e eec omo eec esouce mobly
.. .
my ms, vg ses deeed oduc o o low bes o e
Olgopoly
.. . .
few lge s omogeeous o dfeeed oduc g bes o e m edeedece segc beo
Monopoly
sgle o domne m oduces good w no cose subsues g bes o e
Characterstics Number of firms
any
few
r ia
Size of firms
r
r
Barriers to entr
r
i
Tpe of product
ir
(x ) r r (x r)
Product variet
( r)
Degree of monopol power and demand curve
r; rz (r kr)
r; r (r r kr)
r: r a (r r akr); r r k r r r r r i r r ra r /r
Degree of ndependent acton
r r r r r
pe of competiton faced
r r ( r r r i)
-r r r rrr
Shrtr qiii L prt
ir rrr r r r r a x r
r
r
r
L pr a L tpt I I t r
r P r a r rk rk rr r r r k r r r
r P a r a r i r k r r P r Q k r r i r
r P r a r r r r r r i
r P r Q ar i r r r r
Productive and allocative effcienc i th
ir a i r rk rr; ( ik ) rr k r r
Economies of scale
z
i i
r z r r r r
At t research and deelopment
i r r r i r r
, r r r r i
r ra r r i rr r r
38
r r r rrr; rrr; r r r r rk r ar r r r rrr
r ar r r ir
macroeconomics
2.1 THE LEVE OF OVERA OVERA ECONOMIC ACTIVIY
The circla flow of income model
Th circulr low of ncome model pvds a vv pan lashps n h ar. The ccl c cl ow o ncoe cloed ecooy(= ecooy(= o oreig de) ih o govemet govemet o inncl rke s shw by h ow ls blw Cnss, wh sl ars ars pdn n rs v icoe rs er ow e) d spnd all hs by ds ad sv; hs spnd s comer exedtre nd s ql h qany h d and srv bh s s spv p knwn as h le o ot loer ro e) Fs by h s pdn ss nd s h pd ds ad svs h
Pme = coe come ret we o cl itees etrereehi rof
Fcos o poduco lnd
income flow= ex exendure low vale of ot fow
rcr flow of incoe mode
-.1 1 - a c� � to _ s p di n . - _ r - - _ - _ _� � L - -L ' . - I I 1 -T - - - - ' - - - ' - • t consumer = vale exen �die L . d� consumer inme
,
J
f
_ _, _ _ • - - - .. _
r
FIRMS
CONSUMERS
- - - - _,
Leakage
,
goods a n er yjjc y
1
v v stm tm nt spndin g
svi �- · txs iprt sdn
ormn spdn p sp
The c lo of ncome in n oen ecoomy( th oegn tde) wh governent nd fnncl mkes lds lekges ed d econs geen.
ekge = ny ha lvs h l w
hh pd h l lly l jns:
Ijeco o
y ha ns h l lw
Injecon Injec
Lees e ed necons: ekges: nectons:
If te m o ecio > the o ekge � rlar w rws b pd ds and svs h y ws plym h o econ on < te of ekge a w shrns pd d ad ad svs n h n s sson nploen
sav S) s ) p spnn M
vsn spndn ) vrnn spndn G) p spdn X)
Distngushing beween GDP and GNI (GNP)
GN GNP GNP h n vd by h sdns ny n a GDP h l vl l nl d d ) ya adlss wh h rs prdn wd by h sds pdd wh h bndas a ny n a ya dlss a ld wh ws h os o od od GDP val p) s lly d GN vd by h rsdns ) bs s pd sally ws ass nnal bndrs hr vd y b r ss hn val p pdd
NI D + cor come receied fro rd - fcor coe en rod
G + ne fco ncome fom brod co ncome sen bod s kely to cde
co ncome eceved om bod s kely to nclde
n vd y d dn n h by lv wkn abad knw as remnces prs lnl pns as a i) ad abad ad s h wn as of reron
•
n wk wk wn dsly sn hr lvs bak h etnces prs lnanal pas p dsally s bk h h ny ot eo)
G s b asr h vl p prodd by a n ha G G). G G s b s o h and b h sdns nr.
Distingisng btwn nomnal an l valus n Nomnl GDP/ GDP/GN GN ar ss p ad cen pces ps prvl a ny vn n)
s
Rel G GGNI a ass p nd n s cos pces ha pval n pl y hr l
valss na h n p val p v v has v
ves mus wys e sed to mke omprsons over e, n d aa pr hs
p nd n wh h nln r hs
stngising btw total a p apia vas ol e c c oon o ot nd nd pvd n da h sz n n ny Pe ci P prvds ndn h p rspdn ah psn n h ppan ava Per ct pvds d hw h n s vd by h prs n h ppa n ava ad i ereoe eer indicor of tdd of lig e c c1 GD =
39
to G poton
The three ways to measure economic activity! Economic activit s measured by use GDP and NI (G NP)gures. NP)gures. These measure are impan r: • •
undersandng hw an enmy's upu and nme hange (grw r shnk)ver shnk)ver me makng mparsns wh her enmes/unre and rmulang pes aheve mpran enm bje ves (ex lw unempymen lw and abe rae nlan)
Yu an undersand he ways measure GDP yu remember ha incom ow = xpndi xpnd itu ow vau of outut ow ow All hree apprahes ead he same reus aer adjusmens r sasal errrs Measuring GDP by the expenditue approach: approach:
Measuring GDP by the nme apprah apprah
Adds up a pendng buy al nal gd and sees se es whn whn a year. year. here are ur mpnens spendng
Adds up al nme earned by he ur r prdun in he urse prdung al upu whn a yea Rnt earned by and Wages earned by ao I ntt earned by caita oft eaed by ntnuh
Conumtion ndin (C) Al spendng by numers nume rs buy gds and eves nvtmnt ndin () Al pendng by rm buy apa gd plus a prvae nsrun Governent spendin spending g (G) Al spendg by he gvernmen nludng labr ss and nrasruure (rads arprs prs e) X-M)) xo (X)t xo (X-M (X)- mo (M) A spendng by regner buy exps mnus al spendng by dme nsumers buy mpr C ++ G XM GD GD,, whee GDP Is a measue f enoi ativity.
Ths apprah alws mparns he reave nrbun G and GDP
Rent + wages + interest + proft= natonal ioe
M Measuring GDP by the output appoah
Adds up he vaue eah gd and see (xQ)prdued n he enmy whn a year, hus banng he value all nal gd and eve whh equa D The value gd and sees alulaed r eah se n he enmy suh as gds n he agruura ser gd n he manuaurng ser erves n he heah er 0 eduain ser 0 nane ser e. 0
•
National inome is another measre of
conomic actvit actvit and an d an be used alulae DP aer erain adjumens are made ma de hs apprah allws mparsns he reave nme hare ar prdun ( ex labrs share)and nrbuns n rbuns hee nanal nme (and hene GDP)
•
•
Ths apprah alws mparsn he reave nrbun eah er GD
Evaluating the use of nationa ncome statstic statsticss Nanal nme as are ued alulae GDP NI/ GNP (and nana nme) bu are n alway aurae as a bass r makng mpasns ver me and and beween unres and r arrvng a a nlusns abu andards lvng n deren unre beaue beaue (o I) ma undrtimat undrtimat tandad o ivin cau th d n nude upu sld n he undergrund (nrma)enmy (nrma) enmy (ex unrepred nme a plumber) d n nude upu ha s n sld n markes (ex d grwn r wn nsumpn) d n ake n aun mprvemen n qual gds and seres (ex mprved mpuers) d n ake n aun andard lvng ars ( levels eduan healh le expeany)
GDP (or GN) ay
ovtimat tandad of ovtimat ivin beause thy d n ake n aun he vaue negave exernaes ha redue sandards vng (ex pun) d n ake n aun he derun naural resure (ex res wldle si qua)
(o I) ma ov ov o undtmat tandad of vin cau th dsregard wha upu nsss (ex hgh mary gds upu and lw mer gds upu r he reverse) disregard he dsrbun nme (ex hgh nme inequaly r lw nme nequay) dsregard derng pre evels n deren unres (ex $100 upu ranslaes n mre upu n a lw pre unr han n a hgh pre un)
Some of these defiienes are paly orreted though the flowing
h Human v v opmnt I ndx (HI HI)) whh measures sandards lvng n hree dmenns per apa nme healh and and eduanal aanmen (see p 80) PPP)) xchan r at he use uch an ow a (PPP at whh rre r derng pre levels n deren unres (see p 79) he use n meaures wh whih ih ake n aun envrnmenal desrun (see belw)
he meaning and ignificance of green GDP n s a measure P ha ake n aun envrnmena desrun arsng m prdun and nsumpn aves aves Sne GDP des n nsder envrnmenal desrun n < In general n
vau of nv nviionmnta dtruction
Green DP s sgnan beaue () () rre he serus serus deeny nvennally measured measured GD whh negles he he val ue envrnmenal desrun utn utn fom fom oduction odu ction mthod that do do natu natua a ouc and hav mao nativ (nvionm nta) nta)xnait xnaitii and (i)raes awareness piy makers and and he pub he mprane can tchnoo tchn ooi i ha mnmze envrnmenal damag e and may even nrease he quany and qualy naura resures (naura apal)
40
The business cycle ccl shotem utuations icreases ad deceases) n ea GDP ove time onsisng of four ases: cc cc ad
i = = the level of rea GDP podued when the eonomy is on its ong-erm ong-er m gowt rend where yia nemployment and nemploymet = the atura rate NRU ; also know as l as l m m
Whereas real GDP n most eonomies typially teds to iease over log periods of time, t ctuates a lot over shot periods. A dstintio n therefoe be made between m c c ,, nvolvg a cylia pate of increases and derases in real GDP, shown b the ne in the f re
-m w ( ( l ) ) wih ions out the c clical ctuations shown shown b he w line ine in the re
h u ui i cyc
Real GDP
t Time (Years)
Sh-- m lc Sh lc show in the business cle diaram above, pial onss of for hases: peak cnc oh a temporay rea GDP (negaive growth) uemploymet (ylil (ylil se seee p 48) 48) eporary maximm of ra raee of inflation (disiatio or een deaton; see p 5); if the miimum o real GP rea GD otratio lasts two or more qarters it is known as rcion
expansion
rea GDP , nemploymen yical) rate of inflaio
The rm wt trn {in the diaram above s e leve of real GDP known as nil tt or f mlmn { 44. Th bu cycl ad olcy
mdi m di ci (sc (sc and moneta, see p 5859) aim prima primaily ily at redcig th shoterm shoterm ftuations o the busness yle ontratonary policies ty to weake the expansion in fation) and expasiona expa siona policies ty to reduce the size o the ontaion cylcal unemployment) slope(steepess) of he long-term grow ted by Spy-de oces(see p 6) am at easng the slope(steepess) nres the rae of ecnomc ecnomc owth and en en the eve of otetial otetia l otut.
Distingushng between a decrease GDP ad a decease n GDP owt Decease GDP GDP falls, for ex, fom 15 bilio in oe year to 3 billion n the nex year( ngatv
w) w)
Decease i GDP w the rae o growth of GDP fals, for ex from 3% in one
year o 2.7 % i the next note tee s positive gowth i both years meaig hat in boh years GDP ireases, bt in the seod year it inreases at a lower rate
Cc d e m e aa cm acco
HL topics on calcuating measres of economic economic acivity The followig figues are taken from Meland's aiona icome acounts
lm ors lm
cm m m E m < Icm Cm < Cm cm m ce a 00000
00 $ 3.5 2.53
775 2.87 .95 372 281 -1.9 1.5
Cacli ma e e c Nomial Nomi al GDP I+ G + XM 28+ 95 95+ + 75+ 75+ 287 35= $35.88 Ccli GNI GDP nomina) nomi na) + iome fom aboad aboa d nome set abroad 3588+ 3588+ 253 372 $3469 l Ateatively GNI GDP nomin)+ net iome from aboad= aboa d= 3588 +() () 469 ill Ccli ic ic df The iomatio in the table tels us that te year 2 is the ae ya otie tha he f s oe ype of ric d used to onvert int o ea GDP (see p 5). ominal GDP into mi DP mi 88 a 00 · 100 $ illn pc dflo 0 The same method method an be used to ove mi cme into al a l icm using a pie deflatr 41
2.2 AGGREGATE DMAND AND AGGREGAT SUPPLY Aggregate demand (A) The dierence between mcro demand and macro a Mcro demand(0) = the quantty of a single product that consumers are wling and able to buy at deren r, over a secfic me erod cees paibus. The negaive elatonship betwee ice ad quany s due o o dimnshng dimnshng marginal benets see 3
AD)) = he amount o real outpu(goods outpu(goods and seices) hat Macro aggegate demand (AD
ll ur n an economy(consumes, economy(consumes, fims, governmen and egnes) ae wng and abe to buy a dee possbe r r ll n a yea ceteris paibus. he AD uve has a negative sloe (s downwad sopng) indicating a egtive eaonshp between the price level and ea oupu or GDP (equal to ea income). his s due o ve dieent acos acos han micro demand D ; these factors factors ae ex ex laed below.
The AD curve has a negatve slope (there s a negatve relatonshp between the prce level and real GDP because of of three factors factors:: wah (weah (weah value o al assets owned, ncuding proety savngs stocks bonds, etc) If he price evel inceases real value o wealth U eople ee poorer sending on output U there s an uwad movemen aong the AD curve fom a o b on AD
h ar dmd u Pric lvl
intest at effect f he price level ncreases consumes and
ms need more money or their ransacions demand or money neres rae cost o borowng consumer and firm spending U due to ower borrowing hee s an upwad movemen aong he AD cue rom a o b on AD movemen ir riinl rd f he prce evel increases expos become more exesive to foregners quay o expos(X) demanded by oreigners Also mpots(M) mpots(M) ecome reavey cheaper o domestc esidents quanty o imorts (X - M) there is a upwad movement along he AD curve rom a to b on AD n he even that he ice eve deceases the opposie o he above processes wi occur and there wi be a downwad movemen aong he AD cue from b o a on AD
ADl
AD2
R r u h h rh rm 1 2 dr dr u u h h l rm r m O
Determnants of AD (causes of AD shifts) AD has our componens: um d m m (rm) d rm d d (alu (alu mnu u m) he deemnans o AD whch can cause shits n the AD cue are groued under each of he four components Consumption spendng increases. This happens whn: consumer confdence mpos cosumers become
•
•
•
•
•
more omisic about he utue o he economy nterest rats all onsumer borowng borowng inceases (expansionary (expansiona ry moeary oicy see p 6) wlh nr(e sock make or house prices rse) consumes eel wealthier rl m a ll disposabe ncome ncea nceases ses (expasionay (expas ionay iscal pocy p 58 or makebased supplysde poly p 6) houshold indebtdness (debt) decrases consumers ee more comfoabe abou heir spending
Goernmnt spendng increases his happns when •
•
lal rr o he government change spending on various actvities ncreases (ex educaton healh care nrastucure nrastucur e defense, ec) m rr of the governmen change change the government neases s spendng on various acvies (expasionary (expas ionary fsca poicy p 58 or evenionis onis suyside polcy)
Inestmnt spendng ncases his happens when •
•
•
•
•
bsiiness confidnc mpos= frms become moe optmisc bs
aout the uture o he economy r ra ll irm boowing increases(expansonary moneta policy policy see p 6) hl mrm ur invesmen spendng increases un taxes all eax eax pots ncrease(expansiona ncrease (expansiona iscal policy 58 or marketbased supysde supysde poicy p 6) corporate ndebtednss (dbt) deceases ms ee moe comfotabe abou invesment spending
Net xport spending (X-M) ncreases his happns when •
•
•
•
m rd r brd ra demand or a country's exports increases u h r l (depreciation see 67) exports become cheaper o foregers and mots become more expensve o domestic residens exports incease and mports decrease net expos( X M) increase rd r rd dr dr((= ewer estritions on mpos in oher oher counies see p 64) = a couny's expos ncrease dm rd r r (= more estrictons on mports rom other countres) mpos a net exports ( X M) in
42
Equilibrium in the sho un and changes n sho n equibium In the AD-AS ml the intesection f AD and SRAS deermine -r ilum in he economy which in trn indicaes lum p(rl p (rl } shown as Y a the lim lim vl pl'
-r lrim Price lv
In macroeconomics you must alays refer to the ri or vg ri , or g l(not ·pice")
SRAS
' pl
his eqilibrim can chae only hg hg( ( r caused by any o he eerminans of AD or any of he facors ha inunce SRAS (see p 42 43)
AD Y'
Chgg h im g i
Real GDP
Chgig -ru liri lirim m g SRAS Price
Price
l
leve
SRAS, SS2
SRAS
pl3 ph
ADJ
:ADl
D2 3
Yl
Y1
Y2
Y
Y
P
GDP
As AD fom AD1 to AD � price level and real GDP As AD U from AD1 o ADJ� price level U and eal GDP
As SRAS om SRAS to SRAS � price level and real GDP As SRAS om SRAS SRAS to SRAS price level and real
Atenative AD-AS models 1: Monetais/new classal model
This mode is based o the assumption tat when prodct and esource makets are fee to wok compettvely accodin to demand and suppy, produc pices and esouce prices wil b exible in the upwar a downward drectios an the economy will be able o move ino the g , when resource pices chae to match caes in the pice leve
Long run aggegate spply (LRAS)
ll mlm t t il output where cyclcal uemployment i zero and unemployment oyment euals the natual ate occuri occu ri when the economy s g irm lg r h uv(L uv(L r h h l e RAS cue ad og-u equbum uu (= (= l mlm u} because in the lo rn resouce Price LRAS pices chane aon wih he prce evel theefore in l m esource prices lv A remai constan Tus, as the price eve ncreases or deceases, rm iil and fims face no incentive to chane te qantity o otput they produc Therefoe te quantity o output podced he long s independet o the pce eve
Long-run equilbrium the monetarst/new casscal model
onun eqilibim occrs at the leel o potenal oup, Yp or ful employme outpt where A and SRAS eect the LRAS cve.
Iflatioay and defaionay (ecessionary) gaps
Yp
Rea1 GDP
A ecoom s hr ilm m difer rm I ilm. There ae two ossibiiies: a dation dationaa a or an iationa A li g occrs whe shorn equilirum P Ye) is (= ri g ru irim irim (< i () () less than poeta GDP GDP(Yp) (Yp) u iu ggrg m g i i h hr I g h m wi u ( ( fll mploymen RA A1 v output). o see se e why cosier he follown
A Ye
Ra GD
Suppose he ecooy e cooy is nially a poin a a oru eqilibrium eqilibrium producin Y. Due to decee i AD AD1 � AD) i oves to pont whee the pce level has ale, real GDP is lower at Ye a there is a d d lti lti g g he economy can remain at y ony i the shot un the lon rn waes and other resource prce wil fal to match the fal in the price leve RA RA ncreases, ncreases , i.. .. shs rht from SRAS to SRAS where the economy s at poit back at lon un equilibum aan g h l AD s l h ri w GDP 4
Inln : sn quibum GDP Y> nil GDP Y) c
LRAS
SRAS
A inn occurs whe shoru euiibrium Ye is geatr gea tr tan ponta ponta p due d ue eess r mand n nan nan p cn nly ss s s n s rn n ng n e enmy w rn ni (= full emp oymt otput) o see why, cosidr t ollowg Sppos the coomy is itially at poi a log-r eulbim producig otpu otpu p. ue to a ncras A � A2 it movs o poit poit y wher te price level is hige, eal is greatr a gap . The ecoomy ca rmai at y e ad tr is a inflatoay gap. oly i t short In th log r wags ad other rsourc prics ris to match t icrease i he prce level = SAS deeases, ie shis ef from SAS to t o SAS2 ad h coomy is at oit z at log ru euiliium oce agai
A Y
Y
eal
n e ln rn nly ec an incs n D is us incs h ic ll w n n e GDP.
-
I he motaisUew-classical mode, lcns u c ny n s n n n h nmy macly ns ngn qubum nd l mymn ni ni u because because of the assumpto assumpto of fll wag-pric lxibility. lity. Terere logr euilirum always occurs at ful employmet otput.
Changes in long-ru eqibium I the moetarsew moetarsew classical cal mod Io r e ilibim ca chan chan e a cnn AS, leadig to icreasg potential outpt w cns LRAS nd n , leadig to cages coomic growt) or dcreasig poetial otput (egatie grow growh h oly in prc levl (as sow also abov. see p 54 on causes of growth. Cin n un qim qim nsn n uu Cn ln n qlrim nin n c RAS l LRS1 S2 l SRAS SRS
SS
I
A SRAS1
ADI
Yp
p
1
ea
Alternativee AD-AS models 2: Keynesian moe Alternativ Kynsin Tis model is based o th assmptio tat e s n ln rn, bcause wages ad ohe resouce resouce prices) as well as the prce level d l esy
Price leve
The three secios of he Keyesian AS cuve
) iznl scn occus bcause bcause o two factors a wage-pr wage-prce ce dwward exb exby y Wages do ot fall easily (they ar inexble dowwrd) because of wage cotracts, mmum mmum wags ad upoplaity ty of wage cuts. Te T e pric lev also dos ot fall easily it is also iexible dowward) ecause if wages do ot fall a drop i poduct prices would cut ito rms' proits, wich irms wsh to avod. sa aiy wen e ecnmy is n ecs ecssin sin At low lvls of ouput, w th omy is i rcssio tere is plymt pl ymt f d ot resorces so if rms dcid to icrease outp ad ad demad more resorces there is o pward pressure o wags ad the price level there they do ot icreas.
AS vercal
r
uw sin sn occurs becase of rs bnks (shages) ht appar as outpt crass and approaches ful employet or
potetal outpt (p, causig caus ig resorce prces to icease As frms' costs f prodctio ris, firms rais prodct prics so the pre lvl begis to rise
Yp m Real GDP
ii) e a s n occus becase mimm y u (m) is reached maig that all rsoucs are employed t thir maximum maximum extet ad it s terefore ot possibl for otput to icrase frter Ay ffo to cras outp byod ths poit rslts oly i icreases i h price levl 45
Equilibrium in the Keynesan model Euilibrium i this t his mode is iven by te intersection of the A ad eyesia AS cures. Tere are tree possible eqiibrim eqiibrim positions F oym m: il il (Y (Y s rehd v
AS
Do g GDP Y< oeil GD(Y
g i GD Y> o GD (Y
vl
P lv
A
AD A
p =
Y,
Real GDP GDP
Ke concusio concusions ns arisn from he Ke nesn model ine resoure prices ad product pres are inexble downwad, the eonomy annot move ito te o run is downwad, eans tat the eco omy rei Idiiely ck n (cssy (cssy gp sd y sfe agreate e, and terefore requres expnsionay demad-side olies sal and/or monetay) to ome ot of of te ecession
Weres i te moetisUnew classil modl expsiona expsiona poicies are always nflaioay(leadn nflaioay(leadn to a higer pce leve due o the upward slopin RAS uve nd the veil RAS crve), in te Keynesian mode e ie ie o a y i i h i ev wh h ecoomy s csso {the orizonta part of te uve Increases in A become iflaton only as te eonoy a roaes full em o men! out
Shifs in aggregate supply over the ong tem and economic gowth Over the g a lo period of time the LRAS d t Keyesian AS uves sit, indiatn t op Y hg sy he hi ae he gh iiig omic growh( growh( owt i real ; see p 54) ators sitn te cues nclde •
•
•
ss i y o rs o rodo ex an inease te amounts of capial oods o the amount of lbor vs n y o crs o oo ex a imprvement imprveme nt in labor quality de to more edcaion edcaion ad slls ehlogcl chags wih could nvove iprovemets in te qlity of capita oods sc as informaton tecoloy)
•
i h r o eoyme, ex a fll stral nemployment is similar to inrease in labor quatity mrvme s i ciy mean btter se of sae mrvmes resorces ad lowe osts of poduction sial chags, ex reduction i bueauracy, or redction i overnmen reuation of the pivate sector or ecoraemet o iresed ompetition ompetition w may irease effciey(lower effciey(lower osts of production, allowi firms' output to increase.
I h v h h o h v c, h cuv h o h l iiig giv c grwh grwh ge gowh i h ye d
Logm gowh i h moiw sl Pr lv
e eve
RA2
RA1
A
A 2
_
_
Y
l GDP
Y
Y l GD
oh s ptn uu ss ro Y Y ig coic grwh. See or mor informion on rowt)
46
HL topic The Keynesan mulpler mule a ltipie efet on AD and hene on rea GDP( real inoe) due to mule t o a age in spending •er hge n ea D mI hange han ge in e muilie iiil ange n sening intil hnge n se seg g
Keynesia
fraction of addtional in inome ome used to consme consme(by) (by) domestic products ++ ncome(Y) (Y) that goes oward sav ng (S) argina argi na rensy sv( sv( )) I l faction of additional ncome eermie he se inome(Y) (Y) paid as taxes( taxes ( gin prensiyy ( ( )) I fration of additonal inome eges from mg ensiy m m(( )) I fraion of aditonal inoe (Y) spen on morts M) he seng w (see rar w + + + + mel 9) margal proesty t csue (M (MPC)C/ C/Y Y
=
=
=
Understanding the multpler
Beause sendig sendi g ne v isi s he nme anhe any change in spendng leads to a hain reation of inome hanges and futher spending anges so that the nal hange in inome( inome( GDP) GD P) is greater thn the ntial change in spending Ex Te govenment nreas nreases es spendng on shoo supplies by $100 he elers of schoo spplies reeivin reeivingg the $100 of me spend this depend depending ing on er argina argina propensiies: assung MPC 0 75(and MPS + MP MPM 0.5) 75% of $100 = $75 is spent on nsum n sum of goods and sevices and the remainng remainng 25% of $100 $1005 leks out of the spening ow, gong towad saving axes and bying bying mpots he selles sel les of $75 of goods an sevies spend his nme acordng to the same marinal propensities since the MPC = 075, 75% o $75 $5625 is spent on nsmn nsm n of goods and sees and te reaining 5% of $75 $1.75 goes toward saving taxes and buying impos te same process contines ad innitu ntil additional ncoe creaed reahes zero The hain reacton of consption spending that began from a initial chnge in goenent spending reslts in an nease in inoe( GDP) gee h he n hge i sendig 1 - m Ie I · - -- Since 1 MPC = MS MPT MPM mu� - mu� 1 1 S+ S +T T+ + =
=
=
he sale te tota of eakaes, the bigge te MPC and the lager the muilier Te muliplier works in exacly te te sae way for deeases n sening seni ng ml mle e deease deease n AD an re The mtler mtle r n relaton to njectons and leakages leakages n the crcar flow o ncome mode
Injeins in he spenng w Injeins w ine a hnge n spendig
Leges rm he sening w e he n he mle m le hge e > ni hnge i senig se nig saving taxes doestic does tic spending on ipos ipo s
nvestmen spendng govemen spending foreigners' spending on expos Imoance of the mutpe
Sine any ncrease ncrease or decrease in sending has a multplied effect on rel GDP it is imotant o polcyakes to know te size of th mutpier Ex T troika" of lenders to Greee (th IMF, ropean Central Bank and ropan Coission) underesiated te size of the multplier in Greece wit the reslt that when astety easres wee iposed (decreases in governent spnding and ineases ineases in taxes), the reslting resl ting derease in Greeces real GDP was ch greater tan expe expeted, ted, leading to a recession that was mh ore or e serious tan anticipatd. Calcatng the eects of njectons on on eal GDP sng the mtper mtpe r
In Meryland te MPC 0.8 and re GDP $335 bilon If nvestent spending als by $0 $075 billon ae he hge i rea n he n vue rel re l . =
=
MPC 0.8 teefore ltiplier /(1 08) =5. all in real GDP= 5 x 05 bin. nal vale of rea GDP 3345375 9 bln The sme bem old be expressed n tems of o f te MP MPSS + MP + MPM = 02 ulip ulipier ier = / / 02 02 The res of the solton is sae as above =
=
=
=
he mact o the mltler sng a Keynesan AD-AS dagam
If nvestent spening nreases by 10 bllion and the MPC= 0.75 s that the ultiplier is 4, AD will increase increas e by by b( 10 x ) at every prce level he bin nrese n nil nrese n A biin (eq he nrese n nvestmen nvestme n seng) s a adinl l l ue he mle m le s h 1 + l
The multipr and shifs shifs n AD crv
=
The fnal inease n rea GDP depens n whee he Keynesn Ave A ve A shs sh s If AD inease in the orizontal pa the change n real GDP wil be the sae as the t he nge nge in AD = 40 bilion But if AD increases n the upward sloping slopin g o veil veil par of the AS urve, ur ve, the inrease in real GDP will wil l be salle than the increase in AD. Te ll utiplier efect is felt on ral ral GDP only in the horiontal part of he AS cue, where he prce evel i constant 47
Y1
2
J
' <40b lY=40b
OJ R
2.3 MACROECONOMIC OBJECTVES 231 MACROECONOMC OBJECTIVS : LOW UNMPLOYMN uplet= ub o o i h abo oc wo ar acivy ookig wok bu do no hav a jo uplet= = = h um o unmoyd o xssd s ng o o up f npd pp up1 K 0 T f onsss o o num o o wo oyd us h num wo umoyd. udp= udp = o wo oyd, bu who () wok - whn hy woud wok u-m or (i) wok d s o ow sk v wh hy w d x n gn woking s w) dn p p o wihou o wo n nudd o umoym gus us hy o ivy skig o s w s o who udmoyd y ou s uy oyd in o uoy igus
Diiculties in measurng unempoyment
um o n s usu n stimate o "u "u un o us: • dos o nud discouragd woks, o o who woud • dos o ud o woking h undgound (ugsd) oomy o wok u gv u ookg us hy oo • dsougd o hidd unoym) msus umoy s n g ov ouy's who • ous undoyd woks s uy oyd woks, ouion, whs h unoyn vy dir dn ouo gous o odng dng o dn gions i v hy r wokng o y dog o h ou dn hni ou s dn dn ou s d nd dos o uiz skis so o hdd un o mn
Consequences ofunemloment ofunemloment
Economic consqucs @ loss of al outpt ( GDP) si w o wokg o
odu ouu us C dig o us s 2 54) @ oss of govrnmnt tax vnu du o oss o om xs sn umoyd v o o om wok bfits h govnn mus @ h cost o nmploymnt bfits y o h unmoyd @ loss o incom o umoyd wos @ ncrasd qualty n t distiuton of incom and mor o si h umod su a oss o ino
Oveview oft oft es and cases ofnempo ment Cyclca unmploym unmploymtt
oug i diony gs du o nsu AD
nds
0 crasd omlssss s sg ovy oud o
ndd osus o kuy nd oss o h homs mor amly radown du o h s o nsng ovy nd y o mk nds
Natura unmpoym unmpoymt t
oug wn h onomy odus on ouu ( u oymn ouu) Ion un uum w unm unm o = i q n pn pn + su suu u npn p i n f
h
. � I b k
n dd
T pes and caus causes es o unempo ment
Cycca nmploymnt( nmploymnt( = dmad-d cnt unmplymt) unmplymt)
usd y ig AD downwd oon) s o h usss y doy g) s sous sous y o h ooy s n n sson ( o uoyn, sng s og s h ong) AD s ouu s o oy v (Y) dmd o s y umoym sus c AS
ADI
YI
Psona and socal consus 0 casd cim ats 0 casd stss ls dig o oo h 0 casd dbtd dbtdss ss s o oow mo o k
Y
Ra GD
p n p duss
dd
Evalatng olicies to deal with unem lo ment
Nd xpasioay dmandsid poicis o sh AD o h gh d m h doy g D ss o h v o on ouu (u moym ouu) s 9 6 o vuion o nsoy s d moy os os)) pansonay fiscal pocy T T n u h onoy ou o d sso ms ms dy on h ooy 0 i y 0 ossi oii 0 owdg ou Eps p n . ) uk o m o o n o owdig ou 0 nv d sson s ) s s no ow %; (ii) nks y unwing o d d s d osums y unwg o oow
48
Frctioal unemployment is short-term, and aects workes who ae in betwee jobs, sch as when a woke s ed, o volutaly eaves a job seach of a bete one.
S pyt s also h-te afectng wokers with obs that change accodng o seasons Ex workes i the ost idsty lose thei job dig some winte moths
Need nteventoist suppyside meases {see 61) to ovde
nomato beween job seekers and emloyers thogh the creaio o job centes and emloyen agences 0 edces he tme wokes send nemoyed ootty coss o govenment sending negative eects n the govenmet bdget wh conal conal Need terveions spplysde measures see 6) as wh emloymet Inoaon shold be ovded o job avaablty dng vaos seasons thogho the t he yea 0 � ame as ctnal nemloymen
Srua unemployme unemployment nt has three ma ases and s seos as t s ogterm: 1. Cha Chages ges he demad for palar abor skis
de to: tehologal hage Fo examle comter technology led to a do the demand or yss who became scaly emoyed, whe inceasing the demand o comter secalists. •
D2
Q
2 hanges the geographia loaio of duses and ms ms and oten ete ndstes someimes heefore jobs
recate o othe egos n a coty o othe coties oten i search o owe search owe labo costs or othe avoa avoabe be codiions (sch as lower axes The wokes who are e behd become stctaly nmloyed. 3 Labor maet igdties ae actors that do o alow the labo maket to work eey accodg to deman and sy, ths esulting in nemloyment {as well as higher labo costs fo s); they nclde
•
•
taining ogras f workes seekng ew skls gans and low nterest loans o yong workes seekng traiig ad eang gans to ms hat oe oheob trang govenmen hng and tang o wokes oviso o o sbsidies sbsidies to wokers to he them elocate oviso o sbsidies o tax incentves to ms m s to encoage them to move to hgh emloyment regos
ages i he sue o he eoomy nvovg gowth o some ndstes and decne o others o examle agcte in may cotres s declning in imotace over tme ad agcltal workes become stctaly eectve n edcng emoymet nemloyed, whie ohe ndsties {n maactg or ootty costs o govenmet seding sevces) gain i moance moance Ths ca be shown an ad negatve eects eects n the govemet bdget bdg et D dagam o the odct odced by the declg ndsty As D alls Q sied als and wokers o longe needed by Maebased suppysde meases {see 6) wold iclde the decnng indsy ose jobs edcng mmm wages n deessed egons so ims ca be p atacted by low lo w wage costs s loweg emoymet benes to make lowaying obs moe attactve to neloyed wokes edcg labo oecon in oder o make hirg ease {de to lower P1 costs o ing) x lowe comesaton ayments P2 - - - ·
•
seee 6) consstng consstng o Need inevenons sppysde measures se
0 mght edce emloymen � incease woke nsecy lead to moe eqal ncome dstibtion lead to greate ovey as workes ose otecton ma ot always be efectve edcng nemloymet Need nterventois suppyside meases see 6) ex sbsdes to amiles es to hel them the m elocate to lowemloymet egons ego ns sbsdes to ms to ndce them ove o ecoomcaly deess ed regons efective in edcing nemoymet ooy costs o govenmet sedig negatve eects on the govenmet bdget. Need marketbased supplysde polies consstng o abor market reoms see 62), sch as
edcng the oe o abo ions redcig nem oymet benefs redcg labo oecion redcg or elimag g the minmm wage
whch egotate hghe tha elbim wages leadig to nemloymen ply whch may edce wokes' incentive to wok he above abor mae eoms a pi w whch make dfct ad costy o fms o e wokes, de o long noce eiods and high 0 may lowe nemloymet withot ay negaive eec on the comensato Ths Th s makes ms moe elcant o he new new govenmet bdget wokers ths t hs casng casng emloymet cease woke nsecty i w llt l lt leading o a excess excess sly o ea to moe eal ncome dsbon abor and hence emloymet {see dagam 8) ea to eae eae ove as wokers lose oecto oecto
Maretbased suppysde poles canot dea wth cyclcal nemloymet, which is de o insicen AD Howeve interveoist spplyside polies can he edce cyclical emloyment becase hey have deadsde eects leadng to ceases n A { 6).
Demandsde poies canot geeally dea wth natal nemloyment ctona/seasonalstcta) A imoat exceon s expasonay fisal poly nvovig govenment spendig o ageted seos ew techology deveomen nfastcte edcato health cae) whch ae the same as cea cea ntevenonist slysde olces and ca hel edce sct ra emoymet 6) 49
2.3.2 MACROECONIC OBJECTVES 2: LOW AND SABLE RATE OF INLATON enerall ic evel deflato a utaied decreae in the enera inlat on = a utained increae i the eeral ric eve inlat inlatio for exam e, 7% in 2010 folowed b 5% in 11 11 d snfat on on= = a fal i the rate of inlatio
How infaion and deflation are measued sum p i d (CPI) a meaure o the cot of vig of the tyica hoehod and ho th change over tme; the comare the cot of uying a d bast o ds ad svis from one year to the next By cacuatig the vaue of te ame aket from year to ea the offer an etmate of how ice chane o averae from ear to to ear ear..
Why he CPI s inaccurae as a measue of nflation and defaon
Th CP s basd n d bs ds d srs valud t se is � diferet income grou conume dferent � the quaity of roduct may mrove over time ut the canot cominato of goo a evice tha hoe icuded accout for thi the aket � tre may e regiona vaiatio i rice ich te cnot � conumer chage their coumtion atte over accou for time deending on change in reative rice change in � coumer make increaing ue of dicount tore an ae whch tate and referece ad the intrducton of ew roduct the cannot accou fo
The aket of good ad ervice i revied eriodcay eriod cay (rogy evey ten year) ut eve o it i no oie to fy eove thee robem
Othe ways o o mease prce evel changes T r (dig) re l l
T pdr pe d
Soe roduct grou aicuary food and and energy (oi) have rice that are highy voatie (fucuate a ot over hot eod) ad may e mieading aot the infation tred whe incuded in the . order to get a more accrate icture of here iation i ation headed, ecoomit comute the core o unelyng ate of nfaton hich excue nfaton excue thee roduct gou
he pd p ind () meaure chage in the average rice o factor of rouctio ad therefore meaue rice evel change from the eetve of roducer rather rathe r than conumer Since the meaure rice evel change at eay tage i roducto it i e i redictig change in fure ifatio (meaured y the )
T GDP da (HL p s p 4) he deator i another ye of rce idex that i ued to convet nomina into rea t i a meaue of the average eve of rice of a goo roduce i an ecoomy (i.e. a good incude i ) he defator ad dier from each other in that • the deator cont o f rice of a good and evice rduced dometicay incudng ome that ae not uchaed y dometic coume namey al caita goo good caed y the goverment and exot the excude e xcude rice of good and evice ot urha urhaed ed y conumer, ut icude rice rice of o f imoed conume good e defato and ave dierent ue he deator ed to covet nomina nto rea • The i ued to cacuae change i the cot of iving of coumer.
Consequencess of a hih nflaon ate Consequence
A w d stbe at at n is ot a pbm e m, ecaue ecoomic activitie e ca e carred out moothy and the oie negative eect of inatio are vey imited. oever a hg rate of iation ead to to sev pblem pblem � Rdibution eects ato give rie to oer ad iner: Loses occur for hoder o ca for aver for ender ad for eoe receivng xed ncome or wage ecaue the ea vaue (urchaing ower) of their money fa Gans occr for orroer, and for aye of fixed ncome or age ecaue the rea rea vaue (urchaig ower) of their ayment fa Some of the oe an gain may e avoided avoided throg (a) aymen of interet to aver ad eder that i at eat a high a he rate of ination o () iceae i incme or wage hat ae at eat a high a the rate of iation here may eut easd nalt m dst buon dstbu on a te eaty wo are n a etter otion to make invetment in aet with riing rice (ex re a etate, god) gan reative to oer income gou igh ination ead to een lose ecaue the rice mechaim i uabe to ffl it ignaig and ncentive functio eective
Uneany he iabiity o redict fture rice and rice eve cange caue uncetaiy amog im wih cannot accuratey edict ture revenue and cot of rouctio ad may terefore have a negative efect o o invstment, invstment, and therefore ecnomic e cnomic groth. � es savng Snce aver face a o o their aving ( they do ot receive a igh eough rate of iteret), the incentive to ave i reduced Men os igh rate of iation mean that frm mut contiouy rit or ih ne meu cataogue rice it rce ae and rice advetizeme hich icreae their cot of ouction amag t omtitvs omt itvs igh inatio mea that a county' exort ecome more exenive to freigner a therefore are ikey to fa, hie iot ecome more attractive a they are cheaer reave to doetc good. et exo (X-M fa decreae uttig a doar doar eue o rea additio a trade defcit may e created (o ceae) uttig a doad reure o the vae of the currency (ee 2) 50
Types and causes of inflaton Tere are to main types and causes of ifaton deand-pul ifaton and cost-push laton. n-ll ifin is caused by an icrease in AD hece a rightward shift in the AD C-- inli is cause by a decease n C SRAS ence a letward shift in the SAS curve cue fom AD o AD hs may reslt rom a chage in ay of the comonents of AD, wich are I G, and X-M X-M (see (see 4 43). fom SRAS1 o SRAS2, resuing om iceases in coss of rodctio or supy shocks (see I he ne/new lil e ie n lw l n n 43) nra n h v wl i r . C iflin i l le e (Note: In his model h u, a increase n AD AD causes an icrease icrease oly n the price eiu enll ifi because i leve as rea GDP remains remai ns constant a otetal otetal outpt; see p 5) eas o a fall i real GDP a the sae time tha the rice evel s icreasig. Tis is also know n h Kn n a n n i n rin ( h hznal as stgao (=stagnato nflao) f u) n r in a ie n e wih wi h n nr h v. The pri ce leve begins to increase oly as he ecoomy Notice hat he eynesa moel is no aproaches full empoyment out out poental out) Yp. If AD coines to ncrease apopriate to llustra llustrate te cospush ifation beyond Y the rice evel ises very apily whle rea GDP respods ess and ess as maxmum capacity out (Y) s aproache n-u i i lain n/nw i i lv
Costsh no Moears/new clssc mode
in dl
i lv
i lv
A
l2 ·
l2 __ __
l
AD2 AD1
A
AD
ADl
Y1
Y2
Ra GDP
Y
Y
Yp YJ Rea GP
Ra GD
Y2
While the two types of iation ae theoetcally distict, in practce may be dicult o sigush whc whc s which
E va uamg po to dea w"h . fa 0 · po r1es
n-l nfn Need nin dd-i ie ie to sift AD to te let
Crry fi li li U U (see p 89) 0 can be efective i addressng address ng igh a risig iflaio 0 G U imacts directy o the ecoomy snce G is a comoent of AD (= (= + I + G + XM) � time elays � ossible olitical olitica l inteeece, politcally popular Cry y nr n � C (see p 6) 6) 0 quicker o imleme 0 no oitcal iteerence � highe iterest raes may affect AD ater log time lags -i i (ee 66) hat ieae LRAS from RAS to RAS (hece potential output om Y1 to Yp2) ca be used to eal wt ndl d costush nfato Such policies: ower iflatoay pessures rice evel can al bot wit a constant AD a with icreasig AD (see iagams) acheve economic growt ee a lo time o take efect have ambgous efecs on uemloymet (see 6) may icrease icome icome iequalities iequalities and overty see p 6)
Cost sh Cost sh naton
ostpush ilaton is far more ificult to address addr ess because tere tere is o single or obvious policy cy that is i s approrate � Crn endi liie are ote se, howeve wie they ca ower inflaion ey ake the eesso eee. 0 Sly th e disadvantage of tme Slysde oces are more appropriate but face the lags The aporiate oicy eends on the case o increased costs If cost-push is de to risig wages olicy shold aim at i w nre (b ar m m see 6) If costpush is de to risig pofits caused by excessive moopoly owe, poiciess shoul y o poicie w f fr fr (i i iie see 6 ) iie If costpush is de to a dereciatng crrecy (wic causes impo prices o rse for domestc buyers) olicies shol t y to rd ndn n (rd in in,, see p 64). If cost-push is de to inceasg oil rices olices sould try to u i n ex icentives to roduce alterative ener sources l-i l m wr i ) Price lvl
LRAS1
ll
LRAS2
p,
ph pl .
pl2 D
Yp1
51
Ra GD
Y
Y
Consequences o deflation Dati occurs infrqnty bcause of such factrs as infreuenty alling wages, tus making it difficult fo irms wr prics, lgplsic lgplsic rs' far f pce wars and the general avidanc of rs t lowr prics as this cuts into hir profits When deation occurs, i can hav sous osuncs Bncis n/n ss Delaton causs the real value f debt t incres aking i r difficult fr browrs t repay thr lans, therere lading t ore bankuptcies If ankruptces are widspread anks suffe osses on teir lans, incrasing the risk a banking r inancial csi Oher onseqs Delaton gives rs to redisbto ees (thouh hes are h exa ppsit t thse of inatin), as well as ncy nc y and mn oss. o ss.
Cyclia unempoymnt and a delaoary spira
As th pric levl alls cnsumrs and frs avod spendng as they wat fo prices o fal futhr Therefr a daina spiral ay set in pc levl falls spding s postponed D fals pie level falls furer spnding is again pstpnd � D fals fuher This pocss rsults in a depning recssion and h unmomnt
In contrast to natio delation esults n an movm o omivss, sinc lwr x x prcs man m an that a cous xos ecoe mo atractive t reiners AD rea GDP
T es and causes o deflaion
Poces for deflation
Datin may b caused by a l i bad" deation ecause real eaus of th dangrs f dflaion, conomic poicy ais at GDP fals) by an nrease n SRAS gd daton cuse rea GDP achiving a low and stale rate o nflaon about 23%) an nt ncreass). Howeve, no dlation is eve ally good ecause egardlss 0% ination as this is cnsidrd to be dangerously clse to o th cause the risk of a dfatinary spiral and banking criss ak i datin. Deatin reqies xpasoay deand-sde tentill dan us. os sca and nta
HL topics on unemployment and inflation Calcuating he unempoyment rate
In the 1 quar of 2013 Greeces popuation was 077 mi llin of which 49% wr n h labr frc and 145 illion were oking fo a job ut unale to find on Culat h unmlom r
S Find th nume f pepl in he labr frce: 1077 x 09 5.28 miion S
Sep 2 culate the unemplynt rate numbr f unmpled peopl/aor frc x 100 .45/528 x 100 27 27.46% .46% =
Consrucng a consumer prce index The people of Mrland cnsue thre thre gods pizas hotdogs and boks h seond oun blow shws th uantities of each god cnsu by th ypical faily ach yar thse ae th wights th gods i th baskt). h next 4 columns sow he price f ach god in cnsu 200 202, 2003 and 2004 a ue of b s ket in each yer VI Q
p izas
hodog ooks
55 78 42
Pn 2001
Pn 2002
$10
$12
$3
$4
15
17
Pin 2003
1 $5 8
n 2004
200
10 $5 $6
2002
550
$660 $312
$23 4
$630 $1414
$714
$1686
2003
605 $390 $756 $1751
2004
$550 390 62 1612
val o h as h o ou as r each yea, ultiply Q of each gd by its P and sum up For 2001 55x0 + 78x3 + 42x5 550 234 + 630 $1 h last ur olumns abve shw th results all fur years =
=
() ssui s is osu ie n ) o h s v o s a ---- 1 In gera,I o ---- va o s n s
Threfo
Y C
1 10000
1924
12383
11400
Caculaing the rae of ination
Caluae Meylad's a of iaion in 2002, 2003 ad 2004 (a) sn h vaue o he aset yo alated aove:
) usn e CPI yo osuted osuted aoe
rat of aion n 2002 2002 [(16861414/1414] x 100 = 1924 % Using th sa mthd at inflatin in 2003: 385 % rat o inflation i 200: -94%
2002: 2003 2004
11924100/100 X 100 = 94 %* [(123.8311924/11924 X 100 385 % (1140012383/12383 X 100 = 794%
• Note that this is simpy equal to 119.24 -100; it is not ssay t efo he acuatio wh cuag he atio rt aiv to th bs
Notice that th esults fo a) and (b) are idential.
Disingishing between nflation, nflation , delation ad dsnflation
Notice that ilion il ion occurred in 2002 and 2003 2003 is isl lo o ocurred in 2003 and o ccued in 200 52
Relationships between infaion and unemoyment: Te Phllps cre (SRPC) AD-AS -n l shows a ive eatshp bewee ila il a ad umply idag a adf w t wo: the ighe ighe e ila ila rt h l h umplyet ate ad v v il t rl 970s poliyake usd ddd os o brig te t e ecoom o a poi o e SRPC were th wad to b SRP upoes a fx SRA uv, ad so al vees alg SRC r by g i AD. - l (SRPC) Inl
- li li n -rn AD-AS l En En n-i li l i A m m AD o 2 = ral ut 1 = n e f oit o poit n- i D fom AD to D3 eal u n n r l n ) S (x f p ADAS l n SR
e
'
Y
l ili n) n SRC
Yz G
i n
n he l pc shoks o h ry 90 SR l causg - - inl inl see 5 which which cam t b w w as li sho fr "g ad iltio, iltio, eferig e ferig o rec ad i ha cc toeth W tuh la l a l n (as ea DP el) Hir inl n r n wr wrn n ) SRP sis outad out ad ad o rgt Simlly, RAS 1 e SRPC sift iwr ad to te left T n i r ) I te a 90s Mil Fdm gd t h lg u wg d ll ter far rie hag o a ages i e prie lee hr is a bwee bwee iao d umply T ln-n l )) s ia a te atual rate of elom NRU, dg ta in nn l n li.
n n e e
T l n l-n -S l I t iag below te rical RPC aa te R r spd h eal L c a potal ouput p we mply mply R upo t omy i lg lg quliim, x o he LRPC ad RAS cves d 1 om D to r, wt w d oer f i i tee is a ili i ADS modl t pt wle e e mve up RPC o pt wh il il 1 d emplym (uemplyt < NRU. n rn wa to ee he iceae i he pi ll RAS deceaes to SRS mvg te ecm t t RC hft t RC2 ( ( w v t lao ec e o LRPC LA at o .
S LRPC
I
A-AS P LRAS l
LRPC
plJ
pli
-S - S 11
U
p
V
I n i n r r w l hfr dig t t od of da poliies lwe emplm vel bel he NR ill ol as as iatio sow by a ovemet up th RC m t t 53
2.33 MACROECONOMIC OBJECTIVES OBJECTIVES 3: ECONOMC GROWTH i r = growt n real GDP over a period of ime usually expressed as a percenage cange i rea GDP it s oe calcated in te(pe peo i te popltio po pltio
Using dagams dagams to ilustate ilu state ecoomic growth
L iiti PC r i r Increase possibilties r
LAS1
LRAS2
/b •a
Yp1
Te economy moves from nside te PPC to closer o the PC, idicatig greaer aal t prodced due to: • lower unempoyment gr grea eae err p pdu duct ctiv ivee ef efc cency e ncy (producng a a ower cos cos ie with wit h fewer resources) see 2 for more details
The economy's PPC shifts outwad, outwa d, indicating an icrease i rdi bitt i bi i de to larger quantiy of resources better quality of resorces improved ecnology
The econoys RAS cve sifs otward indcating a icrease in otntal tt(Yp) tt (Yp) or ful empoyment output due to • large quaty o esorces • better quality of resources • imprved tecoogy • he remaiig facors facor s lsted on p 46 * Te Keynesian AS cve can also be used.
ital for economic rowth I I in ha aital(= aital(= the vestmet atal cpta(= aother
Te m ortace of investment i te teee t Invstmt n physc capita a produced actor of poduction icluding machines, factories tools roads teecommicaions etc) results n a lrgr quntty of capt good, as well as in i i itl if these embody(inclde embody(inclde ecnologial mprovemets(ex mprovemets (ex more or bette machines oads elecommuncatos
skils, knowledge, eduato and good ealth that ae acqired by people ad make the more prodctive results in an iprovd alty of t abo foc due o greater edcation, skils knowledge and health(ex health(ex bildng more schools ad hos als
term f "ld d ps all aura resources suc as biodiversity, sol so l qality, the ozone ayer ec) eslts n a grat antty of natal esouce(renewabe ad impovd ty o atur esoucs (x plantig more oress iproving soil quality)
e impotace o poductivty or ecoomic gowt
rtii o labor( oupu pe worker increases as a result o nvestmets in physica uman and atra capital because these investments alow each worker to podce more outpt per hour o work n w i. =
Te conse uences o ecoomc owt ofte de Stadads o iving my not prove if otpt increases involve 0 Ipovd tandds of lvig or the ppulation may rest
military goods or if the eeds eeds of the poor {educaion, ealth ealth care infastrcture) infastrctu re) are negected o i f icome distibt distibtion ion s highly equal Un due to tecnoogical chage and especally se of ippropt tchnologs(see p 81 � Hig nftio may res grw is lined with A(dema A(demand nd pll, or risng input costs SRASJ(costpush SRASJ(costpush maket-oreted coe dstto may wos i i s based on maket-oreted sppy sde polcies(see p 61 or o he gowh of indusres tha dot employ much abor lr r ici ce cc(e cc(eee p 1) may may relt if gowth s based o increased domestic AD eading to moe mpots � very oen results from gowth based o techologes and prodcto methods as wel as se of hghly poluting techologes consum ion ex cars wit numeos ne ave environmental exernalties
fom more output prodced especially if tis ivolves mert goods production(edcation, production (edcation, health care, infrasttre) 0 Low unmpoynt ay result rom ew job creation at ofen accompanes nceased otpu pduced Low nfto may esult rom increases i poteial outpt (rgward shif o the RAS cve see p 51 0 Icom dsttio my mpov based on polcies tha redstribute income (ex hman capital ceai transfer tra nsfer payments to protect vnerabe groups, progressive aes, etc see p 56 l l r ici ic i i crr crr cc(sep cc(sep 71) may eslt if gowh s based o growh grow h of epos reslt om growh ased on t rr cold reslt om he se of polluto-ree technologes and prdctio methods meth ods (crrelyy moe the (crrel th e exception on ha the rule)
HL topc Cacatng te rate o ecoomc gowt Meryads real GDP grew rom 34 345 5 billio in 205 to 35.31 billion in 206 Its poplation grew from 21 million o 27 million ove the same period. Calculate growh i i (a real GDP; (b) real GP per capita(c) capita(c) Explain wy one on e growh rae s positve and the oter is negaive (a) (35.31 [(35.31 375/ 3475 X 10 .1 . 1 % (b 20 2055 eal GP GP per capita = 375 375 billion/ 21 millon lon $ 206 real GP per capita capit a 3531 bllion/ 21 milo $; (1627189 16469.19)/ 16469.19)/ 166919 x 10 = % growt in eal GDP per capita (1627189 (c Te opation grw faster han rea GDP casing growh in real GDP per capita to be egative even togh growth i rea GDP was w as positive =
54
2.3.4 MACROECONOMIC OBJECTVES 4: EQUTY N THE DSTRIBUTON DSTRIBUT ON OF INCOME
Dierence between equality and equity n ncome dsribuion
Why e market system does not resut n an e utabe e ual dstribtion of income
qaly= eveoe eceives an qual an i qaly= qity qity eveone gets a ar ant f in whee fin may be ierpreted in difere diferent nt ways(e ways (e ncoe ccording to the aont of wok doe o acoding o abilities, o accodig o eeds, o accodng o the picile o eual) Whn it r quy in in itriu h ul al n i i itrtriin iin
a marke syste te amont of incoe eceived s i acordace with owneshp and sale of factos of poducto see e irlr f f n p 39) But oesip is higly eual: eual: some peole peole ave more factos of poducio o sel ta oes ex land or caita n addto to abo, while sll othes ay have one to sel(ex sel (ex e old, e ve yog, e sick, the uemployed). Teefore te make syse distrbes ncoe e all .
How income neualt s measure: measure: ree inicators of ncome inealit (or euait) euait) i) I har f nt nt th li he olaio may be divided io ten eqal pas, eac beng 10% of te popuatio( d d ino five eual as each beig 20% of the oulain oulain( ( qu quntls ntls)) Daa ae peseed n the pecentage o total icome in the ecoomy eceived by each part Eamle i % of icome
Pt % 23 %
2nd
3r
% 3.3%
% 4.6%
% 5.4%
% .3%
n btin i n bl a qiil
Quintii es Quint
% of income
6th
% 99%
%
%
12.7%
1 4 4..7 %
8h
1% 83% 3%
Rih % 21.5%
tl 1000%
Poores 20%
2 20%
3 20%
4 20%
Rches 0%
Toal
.6% =23+3.3
100%
17%
7%
398%
1000%
nd
rd
) Loez rve Tis s a sual reeseation o ncoe sares eceived by percentages of te popuation Te lu lne in e diagram s the ie of t n quit qu ity= y= each decile receives 0% of toal ime o each itile eceives 20%. Te grn in in is a Loen cue based o he ntile daa above above (Cumlaive meas tat eac poin is the su of al pevios icome saes; ex poi b sws that 5.6% of ncome 56% 100%) s received by 0% o the poulation(e poulation(e wo pores uintiles) T r line is aoher Loez cre of a economy w ratr nq ity n icoe distbuton. on.
Te fe away a oez curve s om t e o peec equaiy, te
th
r Cumulative % of income
15.6%
r ual h iriti iriti f in.
umultve% populto
i h ni int Tis is a nercal n ercal repesenation of te orez cve.
r i iin iin umtve % me
G oefiie= oefiie= � Y (see diagam) and vaes fro Oto 1. Y+Z If e Gni coefficient 0 tee is pefect incoe eqality. eqality. If e Gini coeicien= coeicien = 1, ee is maxum possible icome ineualiy
The oe te Gii oece te geaer te ncoe equalty.
z
uive% oulto
Pove absoute verss relave over y= y = e inability of a cosume or famiy o saisy saisy basc pysical eeds(e, ood cothing seer, etc) due to o incoe absoue povety povety a easure of e nber of eople in a poplati wh an ncoe leve belw a preded "povety line ha is te iimu icome necessa o satis basi h sica eeds
elative povey= a measre of the numbe of pepe i a poulatin wih an income leve belw a predefied evel that canges oer te ad is defind as a percetage of socie's edian icom; ovey s "relative to othe peoles incomes eflecs the dea at people should be able t afod a lifest le ical of teir socet socet
Causes o ove • • • •
y l do no allo people o satis satisyy thei basic pyscal needs nlynt deprives peole o incoe and and tros people into poverty even if ey eceive uemplyet uemplyet benes as these t hese are ofen uite low a f han a meas peope peope lac kls, knoledge ad educaio or good healt ey ey ave ow poductvity o icomes iinati i inatinn on he basis of race, gede age etc in e jb are are nemployment o lower wages for te same work lii a i rit g uatn halth r in fratr utr) contibute o povey as peoe o w iomes ae heavily deendent o merit goods provided/sbsidid by he government can rib ribe e t oet th th ove c cle/tra see 8 55
ig tn which ay include poor nuito ig evels of alcoholis stess low poductivity ow icme leves f t hh a a an uatin uat in w ha capa low earning poenta hihr ity ( ( early deaths) a prb such as alcohols ige crie ates which lowe e ality of le and buden the govenme bdget with exta exped expedres res
Distingushng betwee direct and dect taxes i t axes on income ad wealth paid drectly to he nrct taxes = taxes o speding to buy goods and sevices paid gvernme (ex personal icome i come taxes corporate income taxes idirectly to the goverme through the sellers (ex sales taxes, vaue welth taxes taxes added taxes VA taifs
Progressive, propo1ona a d regressve taxes pogressive axes the perceage of
come paid as ax (average tax rae) c as icome increass c I 1000 2000 3000
proporonal taxes the percentage of income
paid as tax (average tax rate) i ct as icome incrases
p t r 10% 100 15% S 300 20% S 600
pn r t t 10% 10% S 200 30 10%
egessve taxes th prcntage of
ncome paid as tax (average ax rate) as icome increases
t R ta a i 0% 100 7% 40 5% 150
Persoa ncome taxes are ll rri ad t t ppinal ppinal Idirec taxes are lw ee eei i (ex a tax o $10 $10 pad to buy a good is a larger fracto o a low ncome tha of a high icome).
Methods to pomote equity (equalty) Positive and negatve eects o efficency In ncome distrbuton in resouce alocaton Thse methods ca be highly highl y successfu i redistributing income, but have both positive ad ngative eects o effcency i resource allocaon. Pogressve axes ae an mpoan ehod sed to make
More equal icome dsributo helps people on very low incomes acuire human capal they become moe employable uemployment ad utput (geaer ecoomc growth) use of resources improves More eqal icome disributon allows peope to escape he poverty cycle/trap (see p 78) use of resources improves improves rogressve ncom taxes act as atomat sab sabzes zes,, reducig he size of busiess cycle uctuaions (se p 59) uemployment or iation use of resources impoves ! Hg tax rates may reduce the ncentive to work uemployment use of resources wrses
Governents se tax evees to provde me goods
Mrit gods have p pt ti t i trali (see p 19), 19), involving uderalocation of resources (allocative neiciency); this is a least partly corrected he goverme provision ado subsides of merit goodss increa good increase se alloative al loative efciency improves Oppotunity coss o government spendig ! Neative efects o the overnmen's bdget staers ers,, reducig the Unemployment beets act as atomatc sta sie of bsness cycle flctatons (see p 59) uemploymet o ination use of reources improves ome (ex unempome beefits, chld subsidies received by paes) may redce the ncentie o work uempoyment ! Oppotuny costs of government spending NeQtve efecs on the overments budet nimum wages may lead to unemploye rice controls i geeral lead o alocative inefciency ad welfare dadwih losses
rii ri i ul. The more progressive a ax sstem s (ie te moe apidly the average tax rate ncreases as incom inco m increases) th greater the income redistibuto achieved increasigly arger propoios (factios) of income are taxed away as incomes incomes ise thus decreasig the icome derences btween rich and poor e resutig ax reveues ca be used to povde mer goods ad transfer payments (see (s ee below)
irl r t icluding education health care ad infrastructue (cean waer sanation, sewerage etc) makig them available o peope o ow icomes who would ohewse be uable to have access o them. overnes se ax evees o povde tansfer payments
( trasfers of icome from taxpayers to vuneable groups who aee people in need) a need ) icluding unempoyment beefits, chid alowances pesons ousing beets student gras
Gr ri crl ex r l to suppot Gr icomes of farmers ad low-silled workers (minimum wages), ad i i to make food es more ffordable
HL topic Calcuatos of magna and average ax aes I R = tax ad taxable income x 100 i t R R ta rae alied to income i the hihest tax bracket Merylad's persoal icome taxes are calculaed based o the ollowng: Income ackes (annal coe)
Magna tax Rate MTR
$0 - $15,0 $15,000 00 $1500135,000 $350060000 $60001 or more
0% 15% 25% 45%
Individual A as income of $32700 and ndivdual B has income o $75200 Wha is (a) the amount of tax paid ad () ( ) te average and margial tax rates of each one? Indvdal A: tax pad= (0 x $15000) (05 x $7700) $ 7700) 0 + $2655 $2655 $2655 Aveage tax ae (AT) 2655 32,70 x 00 = 81% (M) = % l : t (0 x $15000) $15000) + (015 x $20000) + (0.25 x $25000) (0.5 x $15200) 0 $3000 $6250 + $6,84 = $090 Aveage tax ae 16,090 / 16,090 / 75,200 x 10 4% Margna tax rate %
rgressve ve taxaton MR < AR n progressve taxato MR > AR; I proporonae axaon MR A R i rgress 56
Oveview of macroeconomc polces Supply-se polces
Demand-sie polces Man ocus: on the demand sde of the economy
Man cs on the spply sde o the econoy
Man objectve to eminate o educe shot-tem economc fluctuatons, e. recessonay deflatona) and natonay gaps, and ence to acheve low unemployment cyclca) and a low and sabe ate of nflaon; also known as se e eet
Man oectve o pomote ong tem economc gowth and ence ncease potenta output
pulate (ncease o decease) aggeg aggegate ate Man method use: manpulate demand AD)
Fscal polcy
I a recessonay gap, the govenent ses expansonary polcy G spendng o ncome taxes decease C o bsness taxes decease = 1 AD
Man meo se ncease aggegae supply (LRAS o Keynesan AS)
Inervenons suppyse polces
Marke-orene spply-se poces
Based on goveen neventon n te economy nended to decty ncease the poductve capacty of the economy
Base on nstuional chanes n the economy nene o eveop ee competve makets tha ncease effcency n podcton and n the allocaton of esouces
Monea pocy
I a ecessonay gap, the cena ban ses expansonary (easy monetary) pocy money supply = nte nteest est ae U cost of boowng U and
Man polces •
A
G spendng U o ncome taxes ncease C U o bsness axes ncease = U =ADU
Man poces •
•
I an nfatonay ap the govenent ses conactona polcy
nvesment n human captal
I an nfaonary gap te cena ban ses conactona (gh monetar) pocy money supply U = nteest ae cos of boowng = and U
nvesment n eseach and deveopment (R&D) leadng o e deveopmen of new technologes
•
• •
•
nvesment n nfastucte ndustal polces
polces to encoage competton labo maet em polces ncentve-elated polces
= AS (LRAS or Keynesan AS) hence potenal oupu
=AS (RAS Keynesan AS) hence poeal oupu
ADU
e ese ese les e slse ees (e lee enes etl uu) u u) Expansonay fscal fsca l polcy tha ncludes nclu des nceased govenment spendng on specc aeas such as human captal development, development, o nfastuctue o R&D wll cause not only A to ncease but also AS LRAS o eynesan eynesan AS) and poental output, becase these ae the same as cean types of ntevenonst suplysde polces Addtonal demandsde demandsde polices wth suppyside effects ae cuts n busness axes whch ncease nvestment hnce the quantty of captal goods casng RAS o eynesan AS and potental ouput to ncease
57
Soe sppyse poces have demand-se eecs (.e. nfuence A) Inteventionst upplysde polces such as govenmen nvestment n human human captal, nfastuctue and R& wl cause not only AS LAS o eynesan AS) and potental output to ncease nceas e bt lso AD because ey nvolve nceases n govenment sendng sendng (G), whch s s a component of AD Futhe, maketbased suppysde polces that cause nvestment ) to ncease ex cuts n taxes on pots) wll aso esult n AD nceases snce nvestment s aso a componen of AD
DEMAND-SID POLCES Tese are polices tat manipulate (increase o decrease) aregate demand (AD), aimin to t o elmiate o reduce shot-term economic fuctuaios, or inflaionary ad deationarecessionay gaps; also kown as dmd dmdmnagmn mnagmn There are two types o demand-side demand-side policies sa pliy ad mey iy. iy .
2.4 FSCAL POCY Fs l s ie te vmnt taxes e man a f vm rv r r vm u yps gvm nt u gvm v v • di (many and idir t • u ditus spedin for governmn tss (see p 56 governmnt's t's day-to-day • ss gs sv provded by he overnmet su peationswaes peations waes of government government workers supplies, subsidies) • it ital al pnit spending on public nvestmes oads as rasporation and postal sevices, elecric water • gvmwd riss called rvtt arpots public ospitals and scools etc) • sr pymt ex unem lo ment beneits see 6 trasfer of ownershi from overnment o rivate owers
The bud et otcome gv ug = a plan relating govement revene o overmet overm et spendin usually for a peiod of a year ge ovement revens are equal o ovement s endi , over he eriod of a ear
g u g u overment evenes> gvenmt spedng ove the peod of a year ug iit overnet reveues < overnmnt spendi spendi over te eriod of a ear usall made ossibe b overme borrowi
Fiscal policy an short-term demad maagemet Of the four omponents of areate demandAD) demandAD)C, C, G, X-), scal poly ca • directy chae gvrme snng (G, as te ovenment increases or decreases ts ow expenditures • idrctly hage nsumin ig (C) y cangi personal icome taxes as taxes 1 C and as axes C • idirectly chane vsm snng (I) by chanin business taxes taxes on prois) as taxes , IU, and as taxes , R ry R ry// d dllai gp gp : equiibrium real GDP at Y poteial output Yp (= ful employment output) due to isuicient AD The overment uses pans pansiionar iy to incease AD to AD2 by • increasing G, or • decreasig persoal ncome taxes� consumpio or • deceasing bsiess taxes investmet . I al cases AD1 , aimig o close clo se the dflai dflaina na gap. pnsinry piy Ms/n Ms/nw w lasia l asia m LRAS
Y poteial output Yp Yp Inflonar gap: gap: equibrium real GDP at Y full eployment ouput du e to too muc AD The ovenment uses rtny rtn y py p y to decrease AD to AD2 by: • deceasin G or • nceasn pesonal income taxes cos umption U or • ncreasin busness taxes investme all cases ADU A DU aiming to lose te nfaionary ap riny ly Mnaisw l modl LRA l
level
R
A2 AD1
p
Y1
Ra GD
Y
Ensiy iy yn ml i lvl
ri lvl
A02
p
l G
nty ply Kysn mdl mdl
A
A01
Y
P
p P
E ls g t mars/w si m as AD eal GP 1 a the price level . rsls g t Kyns mdl as AD � � eal GDP 1 but the pce level remains constant in e orizotal ange of he AS curve, where te ecnomy is in ecession ad eins to rise ol wen otetial output Yp is a roaced. 58
Ep slt sg t metis/w assl m as AD U real GDP ad he prce evel U. Epee rslts sng eynsia mel as AD � � eal GDP but the pce lve falls only in the veical and upwa up wad d slopn pats of the AS cuve, ad remais costant in te horzotal ae were te economy is n recessn
The role of automatic stabzers
automatc stablizers= automat stablizers= f n h ooy h h of ono fon (ony nd on gp) wtho w thout ut a ovmt aco h ng h onoy; o pon orssv icom axs nd umomt bt. bt. Poessive icome axes I a ecessiona a, G nd no f o od y h gon f popoony o pog y g dpo (- (-) ) no o f popoony g o w o o o pd A f n wod wo pog
Uemome benefis In a recessiona gap, npoyn n gonn
pndng o npoyn oy n h py opnng fo h o o no d pndng o h poyd poyd A hn wod who h h npoyn n
I a iatioar a G d o n no popooy pog y ng dpo (-) no o popooy ng on wh no o pnd AD n h wod who pog y
I a iflatonar gap npoyn f gonn pndng on poyn oy f nd h py on on (d) n n o d pndng of h nwy poyd A n hn wod wo h noyn n
Fscal polcy and ts mpact on poteta otpt and long-tem economc growth
F poy nndd py ho dnd ngn oo o ff on ong gowh hogh drect and dec eecs o poea outu Fiscal oic 's indrec eects o oetia ou
poy poy y nnng ow of non ( nfony gps) nd ow of npoyn ( dony/ony gp) fo ono noen noen nog p nn nog no g h podon of o p good h nd deo n nd hnoo on hn oo n on o nd ono owh sa o icys d1ec efes on oenal ot Govermet spendg o phsica capa ad Govenme sedng o ma Govemen provso of icetives o sach a eveomt (R&D) n caia pdng o do inves ow gh
nf (od ho ) d nw nng d hh poon hnoog n n qny nd po y of h o fo pon op n y of p good pon op
f- po p n nd nd dop y f on o
Evaatn fscal oc Strengths of fiscal picy
Waksss of fiscal poicy
@ g p o o h onoy o p dng of hoo hop 0 Epon poy f n png p ng an onoy o of dp on (wh ony poy y no wok p 6) @ pno poy n po op dg o ono gowh ( o) @ Go pndg h d p o ggg dnd n on o o nog pndg y n hg ng n h n o ow on onfd
wok wh jo g (dy) nong dy n ng don n pnon nd fo fo h f o f Th po onn: n nd n n go pndng g pop y ndn po no ono o w w ny pf po y odd pnony poy y nfony f oo ong (A ) pnoy poy y n g dg d nd gonn d nno d nny ( n on ony y poy) Cowdng o ( ow o n o-ph non on wo wo p 51)
Crowdng ot (a possble weakness of scal pocy)
Crowding out
Whn gonn o pnony poy on d o oow n od o py o nd gonn pnd whh n o T T n n d o ow nn nd opon pndg pnd g d oo h hgh hgh o of oowng whh py o h pnony ff of nd gon pndng on A A o A2 d o n G G d A J o A d o d d n C nd Thfo h pnoy f of nd gonn pndng dd
Price leve
G+
AD1
2.5 MONETARY POLICY
ADJ
AD2
Real GDP
d n n y hngng h ony ppy Monear poic d o y n whh dn
The roles of a cental ban nclde beng:
a ake to e govemet nag h gonen' depo and oowng d k pyn fo h gonn a anke to commecal as hod dpo f h d nd o h n h n h hy n fnd
•
a regao of commercial ans: h fy of h
o nng y
esponsle o deermig nees aes ond
. on poy •
esponsle o exchage ate pocy
In ny on h n nk ndpndn of h gonn n ode o en h oy poy no fnd y po fo non o fo o h G nd noe o o on 59
How interest rates are detemined ee= payment for money that has been borowed ae o ee payment for borrowed moey over a ceain time period, expressed ee over a ceai ime me eod a a ercenta e of the borrowed amoun; he • ice" of moe seices The ate of interest interest is detemined detemined in a moey mae mae where te supply ee moneyy (Sm) is fixed at a level decided upon by the central bank (and rae of mone is tereore vertical), vertical), ad he he demand for money (Dm) shows te negative ve elationship beween the qantiy of money demanded and the rate of nteest (r) The equlibrium rate of interest is determined by the intersection of Sm and Dm, and the initial equilibrium interest rate is r, given by Dm fl o wer e ae o nere it and Sm If te central bank wishes to ower inceases te supply of money (Sm shifs to Sm2) and the interest st at atee als fom to 2 o ae he a e o nee the eqilbim intere central ban deceases te supply of money (Sm shifts to Sm3) and te eqilibim interest ate rses fom r to
How ee rae are deemned SMJ SM S
O Q o moey
Moetay polcy and an d sho-tem demad managemet
f the fur components o o aggregate demand (AD) (C, , G, X-M), monetay poicy can influence onmo eg () and veme v eme eig (I) by agig agig e moey y ad ee ate. Interest rates deermie deermie the cos of borrowing: ng: the igher the interes interes rate, te iger iger the cost of borowing boro wing and the lower te amout amou t of consumption and investment spending nanced by orrowig he lowe lowerr the th e interest rae the lower the cost of borowng and and he igher the t he amot ofof consumptio and ivestment spening financed by rrowng (dea a ga, ga , tere is nsufficient AD for a recssiona (dea the economy to reach potential output p ( ull employment output)
n an aoa ga ga tere is too muc AD for the economy to be at potential output Yp ( full employmet output)
o see te efects of expansona monetay policy, see te diagams on p 58 ey are e ame a e ae o eaoa a poly
To see the efects of contractionary monetay policy see the dagams on p 58 (ey ae e ame a i te ae o oraioa ial oly)
The central ban uses ensonar (ay monear) oiy to incease AD from AD to A aiming aimin g to cose the recessonary gap by increasing the money supply and loweing the interes t rate consumption spending and nvestment spending A
he central bank uses coationa (g moea) olcy to decease AD from AD to AD aiming to close the inationay gap by deceasing he he money supply and increasing he inteest rate consumption spending and investment spending U AD
Eee Ee e elt g t e mo ea eaew ew aia aia moe: as AD real GDP and the price evel .
Expctd ul ug h moat/w clacal model:
as ADU eal GDP and te price level U
Eee el ng e Keyea mode as AD real GDP but te price level remans constant in he orizontal range of te AS cue where he economy is in recession recession and begins to rise oly when potentia output (Yp is approaced.
xpctd ul g h Kya mo as AD eal
GDPU but the pice evel falls only in the veical and pward sloping pas of te AS curve, and emains constant in the hoontal ange, whee the econom is in recession
In some countries, rate tan focs on te goals of low unempoyment and low and stable inaton central banks attempt to acieve a at ae o nfaon that usaly varies beeen 1% and %, egardless of te rate of unemployment Based on oecasts of inlation, monetay policy is used to acieve the inflaton target contractionay con tractionay policy is used if forecasted ination is igher than te targ e and expansionay policy if forecasted ination is ower tan te target Wereas iation targeting usualy permits the achievement of a low and stabe inflaton rate this may sometimes be be achieved a e o o h nem lo men men,, as unem lo ment is i ored we te cetra bank makes its olic decisions. ons.
Evaluat oeta ol Stng of ontay pocy
0 here are o politica constrants, as the cenral bak is ofte independent of the govenmet, and monetay olicy does not involve te goverment budget (government spending and tax revenues) 0 nterest rates can be adjusted incrementaly (n smal pas), smal l or euent cange cangess making it more flexible and suitable to small 0 s quicke to implement compared to fiscal policy @ t do ot in g dfit nd t 0 There is no crowding out
Wakn o montary polcy
� There are some time lags (deays) ogh o as seious as in scal policy � It may not be effective in a deep recesson becase (i) even if te inteest rate falls to ve low leves, banks may be too eau to lend and firms/consmes may be too eau to borow (due to ow conidence) (ii) interest ates cannot fall beow beow ero even thog more expansion expansion may be necessay May e inationay if epansioy poliy lt too long ( AD incres too much) � Poblematic in costpus ination makes recession wose see 51 51
60
2.6 SUPPLY-SIDE POLCES hese are polices that aim at increasing aggregate spply spply (LRAS or Keynesian AS) thus achieving long-term economic growh and hene gowth in potential output. There are two types of supplysde policies inteeost and marke-bsed marke-bsed.. Before reading this section yo shoul revew the factors that lead to long-term economic growth shown as rightwar shts n the RA or eynesan AS cuves cuves (see p 46 54). 54).
nterventionist supplyside policies Inereonst supplyse pol polces are based on government itevention n he economy ntended to directly direct ly increase the producive capaciy
of the economy
Four main categoes of tevetiost supply-sde poces Investment in human capital
Ivestment n ifrastrctur
Involves government speding on training retraining and education, and improved access to health care seices leading to a bettertaned and healthier workforce thus inceasng the povt of the labor fore (see p 54) leading to economic growh and an increase in potential output At the same time the ncrease in government spendng rests in an increase in AD
Involves government spendng on fastructue = a type of physicl capitl ex roads, power supples, habors airpots sanitaton, water supplies ies whch increse increse prod pr odiv iv (p 54) leading leading to econom economc c growth and an increae in potential otput. At the sam e time, the increse in governmet spendng reslts in an ncrease n AD
Ivestmen n ew techology
Idstrial poles
Involves government spending o research ad development (R&D) leadg to ew technoogy which ncreases the uality of pysia apital, tus increasing the prouctiviy (p 54) of the labor force (workers working wth bette capital pdce more output) This resuts in economc growth and an increase in potential otput At the same time the incease in government spending gves rse to an increase in AD
Involve government policies policies intended to promote specic idusres olcies include: tax redctions tax exemptions low-i terest loans subsides and grants for idustries that ae held to be important t o support growh These polices lead to an increase in nvestment y irms in these ndustries resulting resulting in economic growth and an increase in potential otput as wl as an increase in AD A so incde support for inat insres in dveloping countries (see p 65)
. t supp1 Eva uat'g .teent',os ,os supp1s'de poI'ces
SreQhs of eentiois slsie olicies
0 Povide drect suppor of aeas impoat fo grow (human capita nfrastructre, R& growthoriented ndstres) 0 Create new jobs and redce strctura unemployment 0 Put a downward pressre on inflation, due to the increase in prodctive capacity and and R (s p 1) potential otput 0 Result n economic growh and an increas e n potential 0 Result in improved equity in income distribtion nvestments in huma apital are boadly boadl y distibted, icreasing ob oouniies for al
Wenesses o iee ios ss ssee oles � Need a long tme t take effect Government spendng has opportunity costs � overnment spening may lead to a buget defict increasing the pulc debt overnment pening may lead to an oveszed and poibly inefficient government sector ! he government may make poor choies on wha t industes to sppo leading to neffciency neffcie ncy n the alloation of resources
Marketbased supplysde poicies M artase spsp -sie oiies are base on nstitutonal changes in the economy intened to develop free competitive maets that ncrease effcency in prodction iprove the alocation of resources and lead to economic grwh (increases in potenta outp)
Three man categores of marketbase suppyse suppyse poces 1 Poicies encourgig copeo
Are based on he he idea that greater competiion c ompetiion creases eficency in poduction ad improves resorce alocaton potentia output increases: Pri ri zio transfers ownershp from the government to pivate
Atimoopoly reulion tres to prevent the formaion of monopolies
owners Private ownership of frms rms become pit maximiers (thus wishing to cut osts), bureaucracy decreases, nproductive workers workers are red eficiency improves potentia output increases
(sngle sellers n a maet with high barries to entry and thereore no competition), or to brea up existing monopolies nto several firms, on the grounds that monopoies are ineicent an sell a lower amon of otput at a higher pic than compettve indstries eiciency mproves poteia utput icreases Tre ibelio removes or lowers barrers to trade (taifs otas and others, see p 63), allowing more impots to enter enter into a contry which ncrease competition between domesic producers and foegn producers whose goods are enteing the omestic market efciency improves potential utput increases
Dereguo elminates or lowers the amont of govement regultion of a ndusty (e reglato of pices quantit of otput produced which are sed to protect firms from competition) thus exposing irms in the industry to greater competition. ncreased compettion greater eficiency (and uality improvements) potential outpt increases (Ex airlines, banks and other financial institions teecommunicaions for which deregula deregulation tion has meant that new rms can enter reviosl potected industres).
61
2. Lao arke efos Also ow as i eas easg g abor abor akt flexibi ly o eduin ed uingg lao la o ae rigidies, hs a edd o as as omp ompo o lao lao mas, allog wages o deed y spply ad demad o lao, o lowg lao oss o ms ad ladg hm o h moe lao; hs pols may also d sa ploy ( a o ase o sal mployme s lao make gds s p 49) poal op ass: Redig ao nio powe po we ss ow wages wages baus baus lao uos o goa hg hg wag wag ases w whh employs abo ss all s h mo lao, poduo eases sal mploy alls poea op ass
boisi g o reding iniu wages es Is low wags boisig wags o sld wos lao ss all ad sa poym alls poal op ass
Redig nempo n empoyme yme beeis ay sl asd asd mpoym as d omes o mployd woks hs asg hm o s poym ad ak o a o sal ploym alls oeal op ass
Reducig job se set t mas ase ad ess osly o s o wos (y dg wok ompesao, heo m mss may e wos mo easly lao oss all ad sal plo yme als poal op ass
3. Incetive-related polices
A pols volvg ax s, dd o ase nvs o pop o wok ad o ms o vs As hos wod as, ad as vs ass h s gowh op poal op ass Cuts ersoal icome taxes ma a peopl's a-ax
oms as asg hem o sh o wo oe hos wokd eas, quval o a as h qay o abo � poal op ass Cus n busess taxes mea ha ms aeax pos
as lavg hm wh mo ds o ves i apal goods o o gag sh ad dvelope ass ass vesm ad mo hooga povms poal op ass
Cs i taxes on aa a a gais = axes on pos o sos ad bods ad o e ees es ncoe nc oe ma ha peope have a gae gae o as ve o sav h om o phases o soks ad ods o savgs dposs as se s e hy wil ave o pay lowe axs o ei savgs asd savigs mas a a moe uds avaal o vsm y y s mo apal goods ao ad mo sah ad dvlopm ad w hologes � poal op ass
Evaluating market-based suppy-sde polcies Streqths of market-based sly-sde sl y-sde olces
0 povd y podo mag lowe oss o podo @ poved alloao o sos s s s ade o avalabl sos as h s lss so was (x labo esos 0 ao o ew obs ad edo i sa mploym weaknesses
@ mpov pod qay de o asd ompo ewe ms 0 dowwad pss o ao a o d o e eas AS (s p 51 (s 51 0 eoom owh o a a as s pona op
o arke t·based UPY•'de oI',ces
0 Spplysd polis geea ed a log me o ak olicies encoragig coetio: rvatizaio s 0 pva ms a lely o sell a hgh ps ad pode low qas opaed o h gove whh s o h pl s
g espeally low om popl (x wa sppls, saao, aspoao) ds o o om 0 asd mploym may sl as pva s lay o wos d o os-savg ladg o a wosg dso 0 h may egav s o h vo as pva po-od s ay less od ao ssaale soe se ad avoda o gav podo xals x als he om o polo ad voal dgadao d gadao Deregulato 0 as asdd poym may sl (d o o os savng, h a wosg dso o o ss 8 0 ay o alays h pbl s (x aa deeglao e Ued Sas ld o he gloal aa ss Trade ibealizao ls s s s dow slg sl g asd eployme 0 lly o hav om losses o so saholds, as lss Labo arke reos 0 lowe soa poo s lly o sl, wh ass woe sy loe ages ages ad om a lly o sl hh ase povy ad al alss ome dso 0 loe 0 as o do o mpoym s h ss a loss o a mpoa auomatic sa sabb i e dd o smooh o h
aos o h sss yl s p 59) Incetive-eated Incetive-e ated policies policie s 0 ome ax s ay v v lg ds o mo lse (m away om wo ah ha a ds o wo o 0 s sess axes apal gas axes ad axs o s o may wos dso o o as os o hs axs a
pad y g o as 0 s axs a lad o a la de de ad bl deb
62
internatonal economs
3.1 INTERNATONAL RADE
Free tade free tade
=
ntenaia rae th no venme nervon impi rstricins any ki impts pts
The beneits of trade
ntetiona rae s ale ale aboad and i (urcass f abrd or rous ns d ontrie: 0 i li Fe ae(wit no 0 G i Abl pr o and rvic fro t ce ns h ne se vlable n t be ld a ee latin f rrcs ll q Reucs n 0 B e 27 T ii 0 Abity q alable doecaly c imed us incsg e g f firs t sel o oe nte ins the sze of e mas and o d t n be ocd doeal. llows hem t ce r as w in sie 0 b bii q oe exang 0 I i s dc ne a cur fm d dei fis pre grar coetitin, ic fc thm t ty edd o py f imo ee 6 s uie hen nr d lwer e ot f don r h ease onu de. Greae Iese ome m t G ch he neai lss ffii is (ith hig css f f ut) r frced t lo xhane f god ad e allo e idea and tchnly s thi t t o bines A "ege fo growth D t os r Lower prices for consumes With grter coition an fis la to reater eic ow ow oe e ai ai uer al an e fin oe
he World ade Organizaton Organizaton (WO) functos an ojectves •
•
h WTO s n innl rna with th k b jcie t ro fe d m ie arnd th d. It a oiatng frum ecouagn ls a egotion eee is eme nte usuall in civ ade lbezo (= e te ton e e
•
•
oes e of tdi le at ll emer nris mst follw e rdn c h. hlps t st s t dispus en cnti, wh ay r i e coe f i ag by isig b ie nd the ai d ba WO rl.
HL topics Absolute and comparative advatage he theo of absoute advatae l l a cury s i e u gd l i ue with r ft! n oth o o r ore oe e peiliz i pron f w or xo s n wih e n lt dvg e l nse n in of t te aantge aantge ro of e an Th PP w R wth Clyla i pution f biks. l A a e bo re ll en·o er rdcto rdcto an n ion an ieae i alciv fenc .
he th theo eo
coptive dvge t ha copaative advatge i pdio o a o i i d ower o cost he Woodad 1 3/1 1234 3 i i nis sle n ug 2 / 4/ xo t o n whh e (= grter grte r cpa l 2 vnt e wil eo eased to nd su i th o n h tl h oui pbilitie of Wodlan and heepland ucig lme ol ol pltd as PPs in h digram Alhg Wolnd an ate advage in rouion o both lbe o, e 3 coie c l bet o td bcuse e ife PC Cnte Cnt e hol le p expt of o f o . no rer i an an nption e an inceae llctiv efie efie =
Soces of coptve dvtge e hae difrnt ctr edowets
nal eor, fcrs o proucin tchology). E e Ui St lg frie ins aprpri f giltur ark re, UK have exense accss a ia fr si
Limitations Limita tions of o f the theo
4
arative avata e
i i i • fe e no ade pe xe fos f pdcion nlgy • fll len perfec mpti • a ibalancs X M al t t e e tranprttin cs f hs d no hold, her y t l =
0
0 Risk excessve speciato If i cil to
, e boe leable e on h rol s fl i lobal or ti s r a l i lobal re f i ex o wh an le t ei l 84 . Iii r M lon nte peali n p ) b ould li o ii i podtio of mufcre gds nd ss p 88) Scizatn cdin t art art ant e oe o allo e o ve hir econies. econies. Tee Tee ar evrl rget y sti t ect i wi he t l 5 63
Trade protection
= gvenmet gvenmeti ntettnln tde nvvg thee mpstnf n f trade baies nteded t lmt the qntty mps nd ptect the dmest c ecmyintevent m fein gn cmpet Quoa estctnn n the qty mps Subsdy Ta x n mped gds (dect Quoa the gvenment ims t wepyment csts fbypdct n nd ptce
Tade potection
Tarifs
Quotas
p
Q1
QJ
Q•
Qz
Subsdies
s
Q
Befoe th tar s mposed:
SSwSwd wlD =ddmest ccSde cves spp y Pwcsmes wl d prcend Prece wld pdvbyed by pdces 010202= dmes cc OO dem sppm bnded ed dmest de 000 m p p s Ae te taif s imposed SP += w dd sppl ypplsstti P pd by wl p c e cnsmes d ece v ed by pdces 03= dmest dmestcc OO demnded spped 0 m s w
w
o. o -
s
Q
Beoe te qota s mposed
SSwnd wD =lddmest cce S nd D cves sppl y Pw cnsmes wrld pced Pece pdvbyed by pdces 00= dmest dmescc OO sppl ed demnded 0Aer 0-- 0theota mpiss imposed SP= dmest pcnsmes ce wtchsppl qtdyece plPsvpqt ded byby pdces 03 = dmest cc OO demnded spplied dmest 04 -0 -0 m s t o.
Eects on stakeholders Qotas
aifs
Beore the sbsdy is ganted
SSwSwnd wlD =ddmes ccve S nd D ces sppl y wwcsmes wld pceend Pecepdvedby by pdces 00= dmest cc OO demded spplied dmest 0Aer-0 - 0the= sbsdy mpts s ganted S,P dmest dy ved by P=pdces pce wc tsppl h(cnsmes sbsy wdythsbs Pstece l py Pw) 030= dmest icc OO sppl sppl ed dmest demded 0 - 0 m ts Subsdies
0 Doestic roducers an from al tpes o otecto because 0 p dced m 0 t 03 nd 0P ece pdced m 0 t 03 nd O pdced m 01 t 0 d I ved mPwWok t P a an o al P ece v ed m Pw t P P ece v ed f m Pw t P o o oon a:dmest a: dmestc empment de t ncesedpdct cesed pdctn mo do lom 0Pwbght J mo nd on om 0Pwbght ndo sme Po bee ndun te the sbssmedy 0 0 t 0 p d t P 0 t 04 P p d t P Govenmet unaected n evees 0 Govemet gais t evenes Government loses mst py sbsdy sped n g de t t h e qt the Domestc ellw ectsociety le oses thee is el t the ectnle tlned eebsd brow ee s Domestc socety loses thee Domestc socety loses thee ineicency n producton since hghe nmsepto ontshecehghhegheP cst nms enptod on tshencehghhegheP cst e ct e d by e ct e d by cst ms e ptected by the hghe P allocatve ececy, shw by welfe alocative ineicency, shwn by wele aocatve ineiciecy shwn by wele sssbow lssslsbown tiages (bd) (cnsme aea (bcd) (csme lspl sssbown tangle (b) (cnsme spl bcd; sp l st de t t h e t f bcd; emi n sssme tdee thte sbs dy l st de t t h e qt pdce spl s gi n ed = gvemet pdce spl s g ed = pdce spl g ed t h e ; net oss evee ged c net oss b+d) sbs gvemet spedng lst b+c+d, sce qt evenes ( c) e sl l ten b epn cties b etdyyloss= b} Frte esults o tade potection dmestHiclydo o o pod o d t cstpepdct o on d mped ipts th eceive de ptectn e sd t h g he p c es t h ee e n ces n g ms' e highecst he csts dpdct iyy(de t the bve) me eps lesscmpet ss cmpettive Loss of expot competitiveness thehi he ct l oeig pouces lose the eps t the ptectedct ecoomy loses de t glbl esce mslltin sme pdctn mves m me meeecent pdcers bd t ess ecRsk ent global dmest c pdces s t etltebbybesmtpsi bpss ng thethwn of retaiato and tade was trde ptecti c led the ctiest Potetial d t l e sm pment e tdetdeestbctiess fo copton tde esticts m edt as e e tetepepeeeededbybygvenment s mps nbecse g tde bthee sbecse sep becse theypvi eylypvi dhee tq evenes. ep g c e s e s ss s get t Quotas e Sbsidies e sly peeed by ecnmsts becse thee s n wele lss csmes csmes wh whevees. emn nected bybysbsi sbsidies w+1
q
1
•
•
•
•
•
•
64
Adminstative bariers Adminstratve barrers= barrers= a vaiey o obstacles to imports imposed by govenments s a fom of tde poection iended to liit the qatiy of
mports and poect domestic podcers fom foeig copeition. May iclde complcated beacatic pocedres ad a vaiety of unecessay packaging, heah, sfety, and envrnmental standards wth which imports ms comply i ode to e admted io the conry. Kown asa asa type of 'hddenn potecton ecase i is not always obvous that th ey are imposed f th ppose of restrictng imports 'hdde
Arguments . favor of trad e protect1o: a eva uaf0 @ Inant industry agument An idusry tha s just begnig to be set up is unable to compee i intetional makets agnst well estblished rms that have expeience and econome of scale, d must theeore be protected util hey grow and mature" One of the stoges arguments i fav favor or of tade potecio. @ Divrsication o dvoping contis May dvelopng conties specaize i podctionexpo of a arow age of goods, with negatve ve effecs on heir ecoomes (see p 84). Ptecio o a varie of idsties ca el hem diversi divers i se se 88 @ Nationa scrty outries wat to be selfsfficient i prodcio of defese goods when hreateed, ad so oten potet idsies oduci deensereled oods @ Hath saty and nvonmnta standads Such sandads are essetial o the otecto o cosmes ad a d he envime @ Tas as sorce o govenment evene May contries especially deveopig oes, ely o taifs as a ma soce of overmet evenes @ Mans o ovcoming a tra dct A trade defit arses when he vale of expos < the vaue va ue of impors which may eate baance o ymnts diicltes (see p 71 73) The use of tarfs and qotas esticts imorts and therefe redces the size o f the tade defici @ Ant-m Ant-mng ng tars = tarfs imposed y an impoig contry on goods dumped y other county to rise the pce to predmping levels ( = sellig goods (exports) i intetioal maets at a pice lowe ha verae cost of rodction it is aaist WTO ues) @ Protcton o domstc dom stc jos Ths is a commo amet ad refes to he dea that protecto of idsries ids ries allows doestic poducto poduct o to incease, ince ase, thus ceatig addtoal domestic jobs while loss of protection protectio n alows cheap mports o ete that foce domestc fms to sht down thus leadin to rete rete unemoment.
It may e diffclt to select which whichparicur paricur industes o potect, ie. whch oes have he poential to grow and ecome eficet prodcers. Also proected idsries rsk o eve becomng ver eficie Furt Further her once he dus duses es grow and mae, may e diffcult to eliminte eliminte the potection fo olitcal reasons ! he prolems ae simlar o the aove: how to chose which idstries to protect how to avoid ineffciency due to dependece of idstries on potection; how to remove potecto wen wen the indsties ar wll dveloed ! he dager is that his can be sed as a argment to exed protecion to ndust es that ae very idiectly eate to prodcio or deense, d ma become a tve of hidden rotect May e sed as an excse to keep mpos ot as in the case o admiistative baiers" see above a e of hdden h dden rotectio � This occs de to neective ax sysems reuirg reform o redce deendence on is The contiued se o tafs may delay such needed ax eforms. � allig impos man hat exports ae allig in ote couies this polcy may nvie retalation fom the affeced contries. his should hereoe be used ony as a shoterm emegency measre, and othe olices shold be used to edce the tade dect see 73 � It is very difficult to prove that a coty s dumpig, and can e a very og tme to do so In the meatime mpoig cotes may e dvge of this og tme dely d ely o impose antidmpig tarfs ad ain at he exense of the exorin co. � heap impos cold be due to lowe coss of podction i othe contries which is an impoant jstiction jstiction or tade Thereoe rade potecio shifts production fom low-cos efficiet pdcers to highcos nefficie ones, nd shold be avoided s it cobes o global alocative ieficenc and vites retaliato. i
HL topic Calculations of the eecs of aris, quotas and subsidies Calcuatons of he efecs o taiffs Calcuating efes of a ar I te mae for pooes n Merylnd, the fee trde ittion is shown in gen. . . Merylnd imposes a riff of M4 per uit of potatoes, how in D h l i i h p s The sppy cure is Sw+t appeaig i bown (MS) C C h h h i i i d h i Beoe 20 units podced afte 50 uits poduced pdction y y 30 units C h h i i h h i Beoe 100 nits ater 0 nits cosumption . y 30 uits (70 - 100 - 30) Cl Cl h h h h n f s ) h trif. Beoe00-20 Beoe 00-20 80 nits ate 70-50 20 uits Q of by 60 its (20-80= -60) Cl h i iv iv ih h Pw+ = 7 + 4 = M$11 M$11 Cl h h n h Beoe 7 x 100 = M$700 ate 1 x 70 = M770 Expenditue M$70 770-700) Cl h chn in d v h Before: 7 x 20 20 M$140; afer: 1 x 50 50 M$50. Reveue y M$410 550140) Cl h h v v D Taiff evenue taiff pe nit x Q of M M$4 x 20 20 units = M80 9 Cl h v f ln. ln. 100 20 units of Vlue of X before x 100 100 20) x 80 M$60 Vaue o X fter fter 7 x (70 (70 50 ) ptate M$140 Vl of X lo lo $40 (140 - 60 - 4) 1 C h d h i 4 x (0 20)] / 2] 4 x 30) / 2 = M$60; area b = 4 x 100 100 70) / 2 (4 1. Cl h h h l S Area a 4 PS inceases y the amont of the doted lue shape x 30) / 2 2 M$60. otal welare loss area a + are b 60 + 60 M$120 11. C h h (CS) since P received by poduces icease fom Pw o Pwt Gai o PS [(Pwt Pw) x 0 - re of tingle Pwt tingle a S falls by the amou o the dotted ed shape sice P paid by consumers rises fom Pw to wt Loss of S (Pwt Pw) x 0] + aea of tingle [11 7) x 50 · 60 200 · 60 M$14 tingle [11 [11 7) x [11 70 60 280 60 M$340
65
Calcuations o the eects of qotas l
In he marke for extiles in Merryland he free trade siuto s show i g. Merryland mposes a quoa of 2030 uis
s
1 D r r v cpiv dvg dvg or iv ivg g tt? It has a omparatve disadvanage sine is domesi pie Pd > Pw 2 w h w spy c () ng Meyl tr te t
The suppy uve, q is sown i brw brw
3. Clc th o t c c t
Q puhased by osumers aer the quota domesi poduto afer the quoa quoa 1820 2030 3850 nis shown in 4 Clcl th hng i t ip (M) t t 400- 910 3790 nits Q of M aer 200 is( is(= uoa) Q o M before 400Q of M by 1760 nits(2030 nits(2030- 39 3900 = 16 160) 0) Cclt te cg c pnitr e Beore 5 x 400 M$23500; aer 8 x 3850 3850 M$3080 onsmer expenditure by MS7300 30800- 23 50) =
8
� s.
0
91 180
85 47
t l
Cct w t t u(assumig u(assumig quoa revenues are aken aken by orign expoers). aea a= [3 x(1820 x(1820 910) / 2 3 x 910) / 2 M$365 x(4700- 3850)] / 2 (3 x 850) / 2= 2= M$1275; area b 3 x(4700area = = 3 x(3850 x(3850- 1820) MS6090 Toal welare loss a + b + 1365 + 1275 690 MS8730 =
Cct t cg r v t t t. Before: 5 x 910 MS4550 aer 8 x 820= MS14,560 MS14 ,560 Reveue by M$10010 14560- 4550)
=
=
Epn ly ct t gvrt gvrt bug. Assumig te quoa revenues go g o to foreig foreig expoes(the most mos t ommo rie) here are no efes on the govement budge. Clc v ttl er eryl yl t by ps Vaue of X ee 5 x(4700 x(4700 90) 5 x 390 MS18950 M S18950 Vaue of X aer 5 x qoa qoa 5 x 2030 = MS10,150 MS10, 150 Value of X lost M$8800(1015 M$8800(101500- 1895 189500 880 8800) 0) =
uo rv r by ptr clt t t t t t on potr xpores gai quoa reveues (85) x 2030 3 x 203 MS6090. xpores xpor es lose expors MS8800 (see queso 8 aove Ne loss loss MS2710 MS2710 60 609090- 8800 210 =
s�
=
rwng t dig udes soeies have dffuy drawig a quoa diagam bu it is very easy one you realize ha is similar o a tariff diagram Look a he wo dagrams a top of p 64 1 raw a ariff diagram 2 he w+t line drawn at Pw+ in he ariff diagram) beomes a doed line a Pq(i Pq(i he quoa diagam) 3 In your quoa diagram diagram he poin were he ure is u by by he Pq lie, draw q as a line li ne parllel o . (The horioal dieree beeen and q is he amoun of he quota.) Your quoa diagram is omplete
Cacations Cacat ions o o the efects of sbsdies
t t y
Meryland's mrke fo apples free tade siuatio is sown i gr subsidy o MS5 per ui of appes s graed
s
D y v co v vatg vtg l? has a omparive disadvantage beause beause is domesi prie, Pd > Pw Pw Drw t w suppy v tt td t biy. biy. he ew supply uve, s, is shown i bwn bw n Clct t pc civ by rcr te by w g. he P reeved by produers is Pw subsidy/ui ws 9 5 M$14 Clct te cge n tiy mp ( u t t biy Befe: 780-140 780-140 640 nts nts aer: 8080- 280 280 500 units Q of M by 140 nits nits(5 (50000- 640 640 140 140)) Wht he chg ch g i er pt t bsy here is o age sie P pad ad Q bough ae e same Cc cg dcr v o by Beoe 9 x 140 140 M$1260 er 14 x 280= 280= M$3920 Reveue y M$2660( 3920 - 1260 1260)) Cc Cc t gvrn gvrn bgt. Govermett speding o Goverme o sbsidy subsdy/unit subsdy/unit x Q rded 5 x 280 MS1400 he are of e reta e otlied ied n bold b 66
pe
Ccl Cclt t t vl ot ot( ( lt by e apples to erryland
Value of X befoe: 9 x (80 (80- 140 140)) 9 x 640 = M$5760 Value of X aer: 9 x(780 x(780- 280) 9 x 500 MS4500 Value of X los los= = M$126 M$12600 45005760= 26) Aleaively vale of X los Pw x fall i M M 9 x(2 x(280 80 4 40) 0) = 9 x 140 MS260 =
Cacuate he welfare loss e to te sbsidy sbsidy
Welfare loss loss area a [sbsidy/unit x(280 x(280 -140)] / 2= (5 x140) 2 M$350
3.2 EXCHANGE RATES Freely floating exchange rates exchage rate = the value o one currency epressed in erms of anoher; can e hough o as he "price' o a currency
eel loaig excage ae= ae = an exchange rae hat is deermined enirely y demand demand and supply o he curency, wh no governmen inervenion
How eely foating foating exchange rates rate s ae deemined Freely loating echange raes are deermined y demand and supply n the cuec make (= marke where currencies are bought and sold)
Te special elaosp beween demad and sly of cuences Buying and sellng of currences nvolves he drec echange o ne ne currency or anoher In order o acquie or uy a currency such as Indian rupees one must give up or sel anoher currency such as US dollars. Simlarly o uy US dolars one must sel Indian rupees.
The demand or Indian rupees s euivalet o he suply o US dollars The demand for for S dollars s equivalen he supply of Indian rupees
Demand ad s I of ceces Consider wo counres Inda and he nied Saes.
The market fo India rupees
¼..
Demand fo dia ees arises when Unied Saes residents consumers s e govenmen anks and other nancial instiuons and o on) wsh to mae paymens o ndia in orde to: • uy ndian goods and sevces (mpo) rm India • uy stocs and onds (make inancal nvestmens) in India • mae in i i i in India India (see (see p 88) • ravel o India To demand uy) Indan upees US residens mus supply (sell) S dolas.
S rupees
D rpes
n ee aises when resdens n Inda wish o make paymens o he Unied Saes or he same reasons as aove and o which hey demand S dollars): • uy US goods and seices impo) rom the nied Saes uy socks and onds make inancial invesments) in he United States make foeig diec vesmes in the nied Saes s see ee p 88) ravel o the United Staes Indian rupees ae suppled (sod) ecause S dolas are demanded ought)
he eqlbim excage ae o dia ees s deemined b e inesecon ines econ o o Sad Sad D a e*.
Q ee
Noe o he axes ae labeled he hozonal axis measures he of ees The veical axis $/ee, measures the pice o rupees in erms o$ .e. he number o$ tha mus e paid o uy 1 rupee Noice ha ees aea e deominao
Chan es n exch exchan an e aes cuec aecao an incease in the value o a curency in a e may occur occur due o an increase in demand or decrease in supply suppl y o a currency
cuec deecat a decrease in he value a curency in a feel floang excange ae ssem; may occur due o a decease in demand o an incease n supply o a urency
¥ eii e i i i ¥
¥ ee e o r dd ¥
½
½
s
e2
e1
ez
s
D2
D f
Q of¥
¥ aeciaio due o a decease i sul of¥
½
¥ drii e ee in l ¥
½
S
e2 - - - - -
e
1
e
D
s,
D
Q�
Q�
e i l dim ¥ r i e er e lel e e axs Y n e e ie n 67
Causes of exchange rate changes
decrease) n te demand or o r supply of a crrecy Exchange ates change weneve there s a change (icrease or decrease)n Imagie a country called Merryland wose curency s the Mryad $ (M$). The M$ appeciats wh hr is: An ncras foreign demad demad for Myand's Myand's exos D fo
increases D curve or M$ sifts rq M$ appreciates A dr i rrd dd mr S of M$ falls sice less foegn excage eeded to pay for mports is demanded)= demanded)= S curve of M shifs eft= M$ aecates ecates A d rd Merrylands D fo f o impors falls = S f M falls (since ess foreig excange needed to pa y or impots is demanded demanded S cue of M shifts lt= lt= M$ arciaes A w lin t i lnd ln d rlv r Merlands expos become more compeitive aboad= D fo expos increases = D cuve for M$ shifts right M$ appreciaes; also Merylans D fo ipos alls alls S o M$ shifs let M$ appreciates An creas n Meyad ist rats Meryad becoes ore attractive to foreign nan nancial cial investos buyng bonds in Merland D for increases = D curve for M$ sifts rht appreciates A i n v i rrd r rd ii di di nvt see p 88) 88) r finil nv)= nv)= D fr M ncreases D cue cu e for M$ shits rht rht areciaes Cucy secuation byig o selling currencies to mke a prot Exctaons o M$ areciaion speculatos by now to sell ate at te igher excange rate rate D or M inceases inceases D or M sifts rt = M$ appreciates noe ts ma be a selfflfillin selfflfill in process Cnl k n MS (see p 69) 69) D for M$ ncreases= D curve for M$ shifts riqht M$ appreciaes
Evalatin Evalat in onseqees onseqees o exhane rate aes Ariin of e M makes: • Merryads expos more expensve to foreigers ore foeign currences mus be given up per M$) M$ ) • Merryands ipors less expensive (the M $ ca by more more of foegn currencies)= t t nr nr ppecation cases net expots (X-M) to decease
h M$ depreciates he her is
A dr in fr dd lnd rt= D for
M$ deceases D cuv for f or M$ shits let M$ deeciates de eciates A ira in rad dand d and f = S of M$ increases (since ore foeig excange needed to pay pa y for impos is demaded) S cue of M$ si sifs fs rght M depreciates A i i rd Meads D fo ipos rses rses S of M$ iceass more foeig excage eeded to pay for iports is deanded) deanded) S cue of M shifts rit M$ depeciates A hhr ifli r in rd rliv h ri Merrylands exports becoe ess copeitive abroad abroad D fo expots falls= falls = D cuve fr M$ M $ sifts let= M$ dprecaes also D for ipots increases increases S ce of M sifts riht ri ht M$ derecates A dcrease n Meryla teres ates Merlad becomes less Me ryland = attractive to foreig financial invesors bying bods i Meryland D or M$ decreases decreas es cve fo M$ shifs ef e f M depreciates A dr i i iv ld rd di iv (s di (see ee p 88) i iv) iv) D or M$ = D crve fo shts let = depecates deceases= deceases Cuecy scaion scaion xc xctations tations o M$ drciaton speculators sel M now to buy later at e lower lower xcage ate S of M increases S cuve of M shifts ght M$ deprecates (ote tat ths ma be a selfffiln selff filn roces rocess s Cnrl Bn nvn ln M$ (see p 9 S of M inceases S curve of M$ shifs rt M deprecaes rn of te M akes • Meryands expos less expesive to foeignes ess fegn i currencies s be given p per M$) = i • Merlands impos ore expensive (te M can buy less of foreig forei g currecies) imos decease Depeciato cases net expots X- o increase HL stdents note n ote te MrshallLerer condiio and J-cuve, 73
Cosuncs o nflation 0 Arciato et exports X aggegate demd shifts Drcato net xpots X) '= aggegate deand sifs
eft dndl il . 0 Ari Ari mpots less expensve impoted inputs (x il) ceaper so rms coss f prduction prduction . ni
rgt ddll li li riin riin= = imprs more expensive ipoed nputs (ex oi ore costl, rms css f rduci oiore = h 1
Cons ueces o unm o mn!
Ari Ari net expots (X-M) = = aggregate demand sifts left l i
xpotsX-M) X-M) 1 aggregate deand sifts 0 rin net xpots r t= l
C h Arin Arin= = net exprts XM) aggregate demand sifts 0 rin ne expos X-M) ' aggregate deand sifts rigt rigt iv c c t d wh left left nv n d rwh Drin Drin impted ipts more cosly cosly hge osts of 0 Arn Arn ipoted ipts ceaper ceaper lower costs of production decrease SS SS iv n d h production icrease SRS= SRS= itv fc n d rwh Net effect on rowth deeds o whch of the efects s stroner Net efec on rowth deends on wich of te fects is stroer Cn d n Arn Arn= = net expos (X-M) tade defcit trade 0 i net xpots (X-M) tade defici trade sr lus1 HL noe te Marshal-erne codio and Jcuv Jcuv 73 sr lus C i d see rii = value of foeig ebt oe dificlt or debto countries 0 A vale of oreig debt . easier for idebed countries t re a thei debs to re I teir debts a serious roble for some less develo ed countries 9 C r hd Cr are t frm higer iprt pces and igher inflation Cr bene fro lower import prices and lowe inatio F tha depend o mpored inputs lose as costs o production 1 Fi that depend on iported iputs bene as costs of prodcio i/wrkr i expot idsties ad impo-competing ndustries lose F/w n export indstries ad ipor-competig industries ga i r ri i ex otn to Mer land lose fom ewer ex orts Fi i ex oin to Mer ad an fro more ex ots 68
Government intervention: Fixed exchange rates id hn r r a exchage rate fixed by a couys goverment or central bank a a certain evel in terms of aother currency currency(sch (sch as the US o€ , hence no eritted to ad·ust ad·ust to crrenc crrenc deand and su ; re uies constant central bank intevention to maintain he he xed level dvlui a decrease in the vale of a currency in a d rvluti rvluti an increase in the vale of a currency in a id r t t achieved through the governent or central hn r t achieved through the government o cental bank whch decdes decdes u on a new ower excha e ate for the currenc bank which decdes u on a new hi he excha e rate for for the curenc How the fxed rate is mantaed
Suppose Merryland's crrency, the M$, s xed agais the€ at the rae of M$1 €3 Inially Inial ly the M$ ae s at equiibrum at poi a Suppose foreigners' demand or Merylads expos J so D for M$ shfts ef e f from D to D2 = at the t he xed rate of€3 there is excess exc ess S of M eqa to a-b n a fee foatg syse he exchage rate woud all o deteied by D ad S at point c.
M$ make maket:t: M$ ixed agat aga t he€ he € a M$1 =€3
¾s
,
S2
S1
3
But at the ixed rate of be brt k t (hece to poi a) a ) M$ m mtt dre t t dt dt l (hece (hece to poi b) to aintain the xed ate o€3. o€3. Wih freey loaing exchage ates, the exchange rate adjuss o chages i D and S wth ixed exchange ates, o S are made
Q of MS
o adjut i order to aitan the xed ate.
P ri M$ S M$ i : The cetral bank can buy M$ in the oreign exchange market • The governent ca se s e olces to liit impots (i) contractionary by sellig reserves of regn exchange( foreg exchange fscal a monetary policies = real GD and incoes = hed by the cetral bank) D for M$ and shifts rght ipos and(ii and(ii tade protecto poicies(tafs poicies(tafs quotas etc.)= The cental bank ca increase interest raes = fiancial capal ipos As A s ipos S of M$ ad shifs eft • The goverment can mpose exchage contros( s attracted to Meryland D for and shifts righ contros( imits on the The governent o Meryland can borrow from abroad amount of foeign exchange tha can be bought by doesic fuds ow ow ito Mr land D or and shifts shifts ri h resides = S of M$ ad shifs eft
Policies inceasing D fo M$ D o M$ ce sit ig to D
• • •
Hoeve, each tee · ha d.Iadvantae Policy Ceral ban buys in freign exchage arkets
Cetral ban ncreases interest rates The goverme of Merlad borrows from abroad Government liits ipots throgh contractionay polices Government liits impots thogh trad protection easurs /government imposes exchange contros
sadvantaes
Central bak evetaly runs out o reserves of foei exchane to sel Hghe ierest rates cause recession i the ecoomy Reayet costs burde the ecoo n the future(see future(see91 91 Contractiona policies case recsso Lead to resource isallocaio and isks ofretaiaton of retaiaton Lead to resource isallocatio
I the opposite sation s ation if foregners' D or expots had icreased so D or M$ icreased the D or M$ ce wold sht o the right A the fixed rate of €3 there would wo uld be exe o M$ eadig o apprecation in a fee-oaing syste Appropate poicies o maintai the t he ixed rate woud icude cetral bank saes of M(by M(by buyig foeg exchange) so that S of M$ o lowering he ntees rate so that D for M$ . ir ni d r r rr th as thee are fewer egative cosequeces of policies
Government ntervention Managed exchange rates d nd lat) lat) exchange rates deterined largely by currecy D and S but where t er b
intervees a tmes b bu i ad selln forei n exchan e to avoid shar shortter uctuations and ifluence the value of the exha e rate Most econoically developd coutres today have aagedexchag aaged exchag Some econoicaly less devloped coutries peg ( x) their
raes Exchange rates are determied manly by aket frces with peiodic intevention Ieveio takes takes the fo of cental bank bying and selln of eseve crrencies, ad sometimes iterest rate chan es.
currency to the S$ ad oat together toget her with the US$ To maintain the pegged vale of thei crency, these counres use the t he olces discussed above in connection with xed exchan e ates.
Distincio bewee ovevalued ad ndevaled crences ovevalued crrenc a curecy whose value is mantained hger than deaed rren rren a curecy whose value is aintained
is market equlibrum level may occur i xed o managed exchage rate sstes 0 akes mports ess makes expors ore expensive expensive expensiv e was used by less hurtig export export idustries and he economy developed countries in the worsens the crrent account baance past to speed up and creates baance of payments ndstrialzato based o difficltes see see p 71 7) mpots of cheap raw cheap impots create unfar aterias ad capital goods copetition fo domestic producers (part of impo sbtto the above lower doestic employe polcies see p 85) and ecooc owth 69
lower than its market equilibri level may occr in xed or maaed exchane rate sstems creates an uair competitve 0 makes expos less expensive to foreigners advatage fo domestic industries, sed by some countres to and so is kown as a "dirty oat proote growth of expo invites retaliation through industres copetitive devaluaios(one devaluaios(one 0 prmotes eploymet country devalig ate anothe) in export industries makes impos more expensive 0 promotes ecoomic causig cost-psh inflaion growh
Comparing ad ctrasting exchage rate sysems Freel fexible oatin no eed fo the central bank or government to inteene no eed fo he central ban to hold oreign curency reseves automatic correction of current account imbalances: a trade deict (ith excess S o the curency) through deprecation a trade suplus (ith excess D of the curency) through appreciation(see appreciation (see p 72) freedom for polcy-makes o use moetay(and moetay (and fscal) policy to deal with domestc problems(iation problems(iation unemployment) withou having t respond to the eed to maintai a fxed exchange rate thee is usualy a smooth adjustment to extenal shocks(barng shocks(barng sdden and abru t exchan e rate chan es
uncerainy over over future exchange rates for frms, mporers and expoers and iestos negativey afecting investment the volume of trade and the voume of investmets large, sudden suddenexchange exchange rate chages may create nstablty, someimes even leadng to nacial cises requiring MF inteeto (see (s ee p 90) if there is inatio, the curecy depreciates(since depreciates (since X ad M ) but depreciato ay ead to impoed cospush infation reducng expot competitiveness and lowering economic growth there may be urrecy speculation
Fxed exchange ates
high degee o ceaity ove future exchange rates for rms imporers ad exporers, and nvestors, with positive efects on ivestent the vlume o trade, and the volume of investments iation is kept low though scal policy; since thee cannot be depeciatio depec iationn when whe n there is ination a hgh inflato inflato rate would create a lrge excess S of the currency(since currency(since X . and M ) which woud require maor iteventons wth negative efects(see efects(see p 69) theefre sca sca poicy is used to contro inatio less room for currency speculatio, as the exchange rate is fixed (xcept whe currency revaluatio/devaluation is expected, and seculation ma hasen the revaluation or devauation
need for costant iteveto by the central ban ban to maintain the xed excange rate need f e cetral bank to hod foreig curecy reserves to be abe to inerene with purchases of the domestic curecy curec y when necessay loss of netay polcy to deal with domestic probems since inteest ates mus be used o mainain the exchange rate in the evet o age and persstet current accout decits there must be contractionary scal poicy to limit impos wh negaive efets on the economy since ecession results or becomes eve deeer
HL tpics Echage rate calculats Caculate the vaue of a curency in tems of anothe Give the exchange rate £ 1 = US .65 calculate te value o 1 US$ i terms of£. 1 S$ 1 = = 0.61 65
iven the exchange rate € 1 Canada 1.44 caculate the vaue of 1 Canadian i terms of€ Canadian 069 44
Caculate the pice o a good n deent curreces usng us ng exchage exchage rates Give the£ - US exchange rate above calculate the pice in £ of 5 Give books that cost US$15 each. Total cost o boos in US$ 5 x US$15 US$75. Sice US$ =£ =£ 061 = 061 x 75 £4575
iven the Canadin n -€ exchange rae above calculae the th e price in € of 7 pas that cost Canadian $10 each. otal cost of pizzas in Canadian $ 7 x $0 Canadian Canadian $70. Sice Canada $ $€069 = 69 x 70 70 €830
neret and ca cu ate c hanges n a curenc s va ue ro a set of data Average anual exchage tes:£ pe US$*
2007 008 009 201 201 202
52 567 667 673 .69 656
In whch years did the£ the £ appreciate?
In which years did the $ depreciate?
201
201
In whch years dd the£ the £ depreciate?
In which years did the $ appreciate?
(a) Caculate Caculate the% change in the vaue o the US in 2072012 656 520 x 10 2615% appeiaon of te .52
(b) Caculate the% the% change in the vaue of the£ i 20072012. () id the vlu vlue e of£ in tems of US$(£ US$(£ price) in 07 and 2008,2009, 2008, 2009,200, 200, 2008,2009,200, 2007 £ = 50 50 = 923 US$ 202£ = 0656 = 524 US$ 202 202 ·54 Appecation of one currency always (ii) x O O = -20 75% depeiaio or the implies deprecation of the other currency. 1.923 • These figures show the amout of£ that must be given up up(sod) (sod) to buy 1 US$ hey also sow the amount of£ that can b e bought by givig up (selling) US$ In he peiod 20722, an increasing amount of pounds was needed to get US$ thereore he £ has been losng its vaue relatve t the US$. US$ . t the same time, US$ can get an icreasing amount of£ therefoe the S$ has h as been inceasig its value relative to the £
Lnear demad ad supply fctios lt e b ee Gven demand and suppy functos Qd Qd 1 -3P and Qs -2 +4P, whee Qd ad s are in millions of M$(Meryland's M$(Meryland's currency) currency) fid the equilbrium exchange exchange ate of the M$ in tems of€ ad the eqilibrium quatity of M$ Since at equlbrium Qd Qs 12 3P = 2 2 +P +P � 4 = 7P � P = 2 2 pe M1(ie M$ is woth€) woth€) To nd equiirium Q subsitute =2 ito the o S equatio and solve = 2 2 (2 (2)) = ili M
iri
¼
s
4
½
D 6
70
12
MS (millions)
3.3 THE BALANCE OF PAYMENTS The strucue of te balance of a ments b o ym= ym = a rcod of al transactions btw rsids of a couty wi rsidens of al o countris cosisng of al payments ig io h county fro aboad(Iows) aboad(Iows) and al paymets leavig a country t o go aboad(oulows) aboad(oulows) ovr a priod of m, usually a ya; it conssts of h u u he ou ad e ou, ou, wich in e ourse of a ear add u o zo m ay item of h balance of paymnts involvg a uu o cou= cou= a xcss of credits ovr debits any of the + three acconts meanin that inows fom abroad outows oin abroad s n flow of unds ino a count etered wi a lus b m= m = any tem of the balace of paymens involvig a e on a acou acou an excess of dits ovr ov r credis in any of the ouow ou ow of funds from a cout , enter enterdd with a mius - si n three accounts meanin that outflows oi abroad inlows from aroad Componen tsof ba I ace of aymen
s accoun s
Th currnt ccot is mae of four ites goods(a credit since . lc o i goo: vaue of exports of goods(a fr om aroad mius vale of impors i mpors of good goodss(a payme s received from debi snce payments are made to foeges foeges bc o r i
t o or t o crt cco . B o d svi val of exos o svics (a rdit sinc paymnt is received fm abroad) mius value of impors of servis (a debi sinc aents fo es ar mad o foreins . Iom: rcips from aboad(creds) aboad(creds) minus paymnts abroad debits of rnts irst a rofts debits . Cun rcets from abroad(crdits) abroad(crdits) mius aymets abroad(debits) abroad (debits) of ims incding pesions rmittaces rmittaces( ( mony se hom bv worers livin and orkin abroad ad its h ai ou consiss of wo itms, ad is usualy less importan a e currn and fnacia accounts . C C sr: iow (cedits minu minuss oows (dbits (dbits of a varety of iems including det forgiveness(whe forgiveness(whe a foreign dbt is cacelled non-l non-life ife isuranc claims and ivestm rants . io i o-ou o-i nows (crdits) mins ouflows(deits ouflows(deits of payments for pucas of atural resources that ave not bee produced(ex produced(ex land, shing shi ng ighs ighs forestry rs ad rchase of itaile assets ex covr covrts ts aents aents
Meyad's Baae f paymes, 2012, bi $ c o t in goo(goods expors mns impors
-21 B o d in svs(srvcs svs(srvcs expors mnus mpors 5 +3 . I Iom om(inows (inows mns otows) 4 . Cu rs (inow (inowss minus otows 17 (I) alae on cu aoun( aoun(= 123+ Cial sf(inf (inflows lows mins outlows ows . anaion i oodud no-iaa a(inflows a (inflows mis ouflows) (II) Bn on ou ou((=1+2) + 2)
3 -5
12 4 2
ic ivsm(inlows ivsm(inlows minus ouflows) . Pooo nvm nvm(nows mius oflows)
3. R Rrv rv t t (Il alan on iaa acoun( acoun ( 123)
+8
(IV) Eor an omiion
1
ALANCE(llllll+V
0
Te overal baace of e balace of paymes is aways 0 becase te sm of cedits( is aways alanced y the sm of debits(· over a year: M30 � -M30 +5+3+3+124+2+1 � 2145 he balance o crrnt acco is always balanced by te sum of capial accou plus acial al accoun baacs pls rrors and omissios • 7 blo � + $7 bil o( -2 1 1)
il il ou consists of hree iems ilos(credits (credits mus ouflows ouflows(debits) of funds Dc vt ilos used for investmets in i n pysca capita, includig factoris and buidngs /O usal undrak b /O bmuio muio ooo ooo see 88 oo ooo o vsm vsm nws nws(credits (credits mnus oows(dbs) oows(dbs) of here is a dici o un ou o 7 bio bio(debits (debits funds used or investmets iana cital socks ad bods bods crdis y M17 bilio), du maly to a ( ( X> M Rv oeign excange hld by th etral bank tha is bought or sold to inuence te vale of the cotry's exchange exchange rae in a There is a dii o l l aou o $ bi o xed x ed or managed exchange rat e system. Foreig exchag is boug (debis credits by M2 billio) (debis wen he cental bank oms oms uy to lower its value (an ouow of domestic rrny rrny thereoe a debi debi orign exchage is Tee s a urpus o inaial acou o S 1 blion so d when the central central bak bak buy doms ic uy in order to (credits> debs by M18 billion ncrease its vale(an vale(an inow of e domesic cency therefore a credit) 2012 the Merrylad centr central al bank bough $ bl lion lion(by (by selig rros n omsio om sio iclded o account or or ms that have not bee esee asses o mae p for e sorage of creds eeded to brng ncluded or for errors forcin a zero overall alance about a ero balanc in the balance of amnts
The balance of a ments in reaton to exca e rates W ovr c o lc o w q o zo A cuecys cuecys exchang rae is aways determed by curecy D and S (this is te also or fxed exchange rates r ates wher D S is forcd(see forcd(see p 69 Notce tha D o o a uy giv o i(ow o moy o o a ouy) d o a cuc c ucyy gv i o bis (ou (ouow ow o f mo om h oun ice fo an iv excha e ra ra D for he currnc S of e currc it folows tha ris dbi
Ct= l otg xcg r How qual ebi a rly oaig hg a ym n a frely oatig sysem, te eilirim exchage rae is determied by maket foces(D ad S for the crrency Looing a the€ market a e D or€< S of€ meaning at credts debit in the eozone and so market orces psh the vale of e€ downwad to* wee D or€ S of€ and cedits= debis e, D for€> for€> S o€ meanng tht cedits > deits, and so market forces ps the€ upwad to e, wee again S D and creds= debits n he erozoe. erozoe. Teefore mare forces esure tha debs wl always be eual to cedits at e eilibim exchage rae
¾
s
D
Q of£
71
How credits are made o equal debits n a fxed exchange ate syste
xed excge re system, sce te excge rte cot cge te evet of excesss D or excess S of e curecy, exces curecy, e cetr bk or goverme cge D d/o S of te currecy to me te prodce te desred (fixed) rte (see p 69)
If te exchge re s xed t level wee D < S d ceds < debs te cetrl bk mus buy te currecy (sell freig excge) or rise te iterest rte (to trct foreg ficl cptl) D for te curre cy n to te pot wee D = S ece credts = debts. T a
f e excge rte is ixed t level wee D > S d cedts > debits te cetrl bk sells te currecy (buys reg excge) or owers te iteest rte (foeg leves) S o te crrecy icil cpitl leves) to te pot were D S d credits = debts T a i u
creates e ssing ceds.
ceaes the mssng mss ng debs
The interdependence of the curent account and fnancial accout gog te cptl ccot d errors d omssos (fo splcty d becuse tey re relvely impot) it ollos fro te bove t t tee s close reltiosip bewee te curet ccot d te fcil ccou srpls i oe ccot plies decit i te oter f tere re excess creds oe ccout ( srpus) ere mst be excess debits te oter ccout ( defct). Curent accont imbalances imbalances ad efects on on exchan Cuent account deicit and t e excange rate A cuent accont deicit esus n a downward pressure on e excange ae because: Te M s iitly t equiibriu t e Suppose tere is decrese i ded or Meryld's expos D r te M$ flls D o M$ curve sifs le to D2 t e1 tere is excess S of M$ d exports (credts) ports (debs) otg cges te cptl d icil ccouts to crete te ecessy out of missg credts e excange rae as to e2 expos (X) icese d impots (M) decrese X credts)= debts) s restored
Cuent accoun splus and ncreasing excange rae
Cent accoun defct and falng excange rate
¾s
e ates Cn a a a a a A an an l l a ar r excange ae becase: Te M$ is iitlly t equlbriu e f ere s crese i ded fr Meryds expos expos D fo te M icreses D for M cve sfts rig g to D2 t e1 tere s excess e xcess D for M d expos (credts) mports (debits). f otg cges te cpt d c ccouts o crete te eessy ot of mssig debits, te excange ae nceases o e2 expots (X) decese d mpots M icrese X cedit= debis) s estored
¼s
s
s
D2
Q
Q
HL Topics he balance of paymets Caulat mts o baanc o aymns aymns Use te lowg oro o outy Y to peset its blce of pye ts (00 bilio d ill i te ssig figures pyets
Fll i te mssg fgures below
Country X Balace of paymes, 2010, billio$ Expots of goods mports of goods Blce of tde i goods xpots of sevces mpots of sevces Blce of tde i servces come urret rsfers Blce o crret ccout pitl trsfers sctios i o-prodced ocl ssets Blce o cpitl ccout Direct ivesmt Poolio iveste Reserve ssets Blce o ficil ccout Errors d omssos Blce
05 -40 34 4 - +3 +3
7
Blce o cpl ccout xpots of seices lce pitl trsfers Blce of tde services eseve ssets rrors d omissios Blce o curret ccout urret trsfers Drect vestmet coe lce o ficil cco xpos of goods ports of good goodss Blce Bl ce of trde i goods mports of services oolio ivestmet rsctios i o-produced o cl cl ssets
l i e aaan la r : -3 48 -3 -3 -4 8 0 0 - 9 47 -8 8 -87 -87 72
-8 9 -8
4 - 7
40 -3 4 -3
Implications of persistent curent accont deicits A curent account defict that persists ove long periods of time can can pose serous probems to an conomy. It indicates that a county is i moe to buy from aboad (debits) than t s earning fom selling abroad (credts) This excess of debits over credits must be balanced by cred is inflows n he combned nanca and caita accounts acc ounts Persisten current account deficits ma result in: 0 Hghe nees raes to attact financial 0 Inceased borrowng fom abad leading to hgh idebtedness idebtedness( ( = high debt invesments (needed as creds) whch are levels) with its own se o problems (see p 9) • poo ieaona credt atngs make it dificult o get more oans in the future contractionary as they lead o recession • ir a o loa tat use up funds with aernave uses inin the 0 Conractionary fiscal policies, to lower incomes economy (investments meit goods provsion) i.e. oppounty costs and hereore impos which also lead to recession • i o aa a r ou needed or domestc production since the abiliy o impo is i s limied 0 Depeciaion of e curency may result (fo • iran hi nr s to aract nancal capital reasons explained above, p 72) eadng to cost-push • r u u aa iv, as future generatons wl have o reply he loans inflaton du to higher coss o impoed inputs 0 Lowe economc growh i the uure in view of the above actors includng 0 ncreased sale of domestc assets to oreigners contractionary moneary and scal olicies inerest payments with oppounity costs (socs eal esae, facories) whch may lead to loss and lower possibilities toto imo im o needed inputs of conrol of a count over is assets
Methodss to Method t o reduce cent accont deicits and evaluaton Expediurre-sw Expediu e-swtcig poices poices polices that switch consumtio pendterecing policies polices that reduce expenditues away from impors and oward domestcally produced goods. and aggregate demand, lowerng mpos and a nd increasing expos. nclude wo main polices Include contactonay sca and oeay polces wth wo eects tade protecon poces (tarifs quotas etc) = impors U AD decreases = lower incomes = D fo impos decreases lower AD at of inlaton falls foreign D for expos inceases tade decit (XM) hence curen account decit ae reduced tade deci (X-M) hence curen account decit ae reduced 0 prices of poteced goods consumption of protected goods U higher ineres rats attract nancial capital creating needed credits 0 increased ineiciency of rms in the nancal account 0 greater domesic and gobal resource misallocaton 0 contractionary sal and moneay poicy lead to recession = eal 0 ris of retaiaion by other countres GDP decreases and unemployment increases iain expos cheaper mpors more expensive 0 higher inerest ates curency appreciation expots decrease trade deci (X-M) hence curren account decit are reduced impos ncrease trade decit and curent account balance wosen wo sen 0 increased exports AD demand-pull ination (this paly cancels the eects o expenditurereduc expenditurereducng ng poices) iher imort rices = costush inflation Sppy-- side poces Market-based supply-sde polces incuding poicies to incease competiion (p 61) and abor market refoms (p 6) as well Sppy as inteventionis Sside polices (p 61) all o which am to sht the LRAS curve o the right and lower inflaionay pessures in the economy thus increasin exo cometitveness and leadin to rowh in exots ower inflation rms oe compeitive in inernational markets 0 need a lng time o be efective expos tade deicit (XM) and current account dec are educed 0 see p 61 61 - 62 f more details on the the eects o supply-sde poicies see 61 - 6 for more details on the eects of supply-side policies
•
•
•
•
Implications of of persisen persisen curen accon suluses A current account surplus hat persiss persiss over lon perods can pose some probems probems to an economy It indicaes hat a country is dn l l u r aa aa (debts) than it is earning from sellng aboad (cedits) (cedi ts) his excess of credits over debits mus be balanced by debits debi ts (outflows) in the combined nancial and ca ital accounts Hi raes may result from arge volumes o 0 ower consmpon ad ece owe standads o lvng than ex os and a id ex ot rowth ex China necessa since X < M therefore consum on dca = alr a i ii i B ;; 1 da lare larerr a i Note hat an a aa a o valao will lead to a al ra povided PED + PED >1 J trade blance Is a graphca repesentaton of the effects o he arshallLerner condition (X·M) In shot periods of time (about six months or most manufactured products) ( PED PED < 1, therefoe depreciaon nially leads l eads to a larger trade decit, shown n he diagram. After six onths o a year ED + d url PED 1 thereore with depreciation the trade decit stas to shrink and eventually becomes a rade surplus. (X = M) 0 --------+-----, im im P for mpos and D for expos are low over sho perods of time because consues and poducers need ime o learn about and adjust to ( < price changes o to discover alternaive producs or they may have pro rde deici contracual a reements. 73
3.4 ECONOMIC INTGRATION economi c Inegaon Inegaon growng conoc rlons nd coopron bwn conrs rsng rsn g fom td or ohr grns th nk h nos toghr pfnt trade agreent pfnt agreent= = ccordng o h Wod Trd Orgnzon (WTO), n grn bwn o or or conrs o gv prfrn ccss o pcr producs (ccss w ow o no rffs or ohr oh r rd rd pocon); ofn ncds ddon ssus byond trd sch s srvcs nvsn nd nc propry rghs hy y b br or rgon grmns nd hy ay nvov re tade aeas or custos nons
tradng boc boc wo or or conrs th hv grd to rdc or mn d bes bwn th to nourg e d baea tade agement baea agement n grn bwen wo cones o rdc or n rd bs o o ncorg fr td btwn thm egona gade ageen n gmn btwn seve con ts n geograpc geograp c egon to rduc or nt rd rd brrs o ncorg ncorg fr rd bn h mea trad agreeme n n grn bwn any contes m aond e wo wod d s a ndr th drsh drshp p of h ord rade ganaon to rduc or n trd tr d brs to ncorg fr rd btwn th
T rad'mg blocs
Free tade aeas
s grop of ntrs ht hv grd o rduc or mnt td t d brrrs o chv fr rd bn th. Ech ounry rns h rgh o mpose s own rd brrs owrd non-brs Ex NAFA (Noh Amrcn r rd Agrn A f ad aa
Customs uions
A csoms non s hgh or of ntgron thn fr trd r bcs n ddon o f d bwn brs hr s so comon rd pocy (coon rd brrrs owrd non-brs Ex SACU Souh Afc Cstos non
Commo makes
A coon makt s hghr or of ngrton thn cstos non bcus n n ddton o r rd nd comon rd pocy towrd nonbrs hr s so fr ovn o bor n d cp bn th brs Ex EEC Eropn Econoc Comnty bf ths bm h Euopn non
Evaluaig tadi bocs Trdng bocs or sr dvtgs s fr td: 0 ncrsd coptton ong prodcrs du o grr mpors forcing nfcnt nfcn t prodcrs prodcrs to cos down nd ownng prodcton coss (cncy pvs 0 Lowr prcs for onsrs ncresd prodc vty nd povd qu 0 Provd oppouns for rms o xpnd no rgr rks 0 ncrsd nrn or xtrn xtrn nvsmn by frs ht wn o bnf fro fro h rg sz 0 ncrsd xports o brs of h trdng boc 0 Grr conoc growh 0 provd octon of rsourcs 0 Rducd hoss du o gr grrr conoc con oc ngrton 0 H opc By gowng n s du to xpnson no rg mrs rs y bn fro conomis of sal 0 opc Possb bns from ade creai creai = th rpcn o hgr-cos dostc prodcs by owr cos pod prodcts d o h foron of trdng boc Ex Cynd s n nffcn nffc n producr of or coprd coprd o Rocknd but bcus of trfs on or t procs s hgh-cos or producrs Cynd nd Rocknd thn o trdng boc nd n fs on or _ Cynd's dosc producon of or fs nd s rpcd by orcos pors fro Rocknd
Yt rdng bocs so fc numb of dsdvngs oss of non onoy pcary n hghr vs of ntgraton Ovr h sho rm ncn s y go o o bsnss rsng n gr npoyn ncrsd povy povy nd grtr nm nets ne ts rdng bos on sn s s an rnv to ulttr ulttr grns ndr th WTO y mt th ro of h WTO s foru o ngo ngo gob fr rd rd Th brkup of h gob conoy no grdng bocs rhr gob fr trd through utr (WTO) grmns my ncrs nfcncy n gob rsorc ocon Dvopng cons h sgn prrnt rd grns grns wh rg contrs (x S) or conty grops x E) unb o ngo s ffctvyy s y wod f hy ngod oghr s group und h WTO ffctv f ber conrs r no s v of conoc nd chnoogc dvopmnt th rtvy ss dvopd countrs y b t dsdvng s thy y be unb o cop wh h mo dvncd nd oftn ow-cos prodcs of dvopd cons (s p 87 for or on cono cy ss dvopd conts). topc Possb osss fo rae dveio h rpcn of or cos mpod poducs by b y hghr-cos pos du o h formon of rdng boc. Ex Woond hs rf on bcks nd pos brcks fro Cynd hch s or-cost bck producr hn Rocnd Wnd hn fors rd grn wh Rocknd nd ns rfs on pos fro Rocknd nnng he on pors fro Cynd whch now bco or xpnsv Thror Woond ns to or fro Rocnd h hhr-cost roducr roducr
Monetay union mona non non brs of coon mrkt dop coon crrncy nd coon cntr bnk sponsb for ony pocy or h brs Ex th Eurozon conrs h dopd h uro fr gvng up hr non crrncs whos coon onry pocy s h rsponsby of t Europn Cnr nk (EC)
Evauatng moneta union @ o rsk and ncrnty rsng ro exchng rte chnges s contres hv h s curncy bntng rs cnss porrs xpors dng o grtr conoc cvty 0 o rnscons coss or costs drvd fro hvng o conv on crncy no nor 0 Thr s prc rnsprncy mkng t fr sr o copr prcs nd coss cross countrs 0 gh vs of nvsn nvsn d o c of xchng r sk 0 Encourags ffos o nn ow nfon r for xpo copvnss snc hr s no possby for crrncy dprcon @ ghr rs of cnomc growh du to of h bov 0 A strong nnc n wod frs du o h mch rg sz of th combnd conos of h mmbr sts 74
! oss of h by to condct monty pocy n ccordnc wth domsc nds (o d wth nfton or rcsson and npoyn oss of on xchng rat nd h by of cons own crrncy o pprce/dprc (rv/dvu) to d w rd bncs oss of conoc sovrgny s h rsponsbts of non govrnmns nd non cnt bnks r kn ov by suprnon bods th oovr y b ncd (x h Euopn Cnr Bn) Th sng on ony y pocy pcs dfrnty on ch conty dpndng on whr s n th busnss cyc on pocy y oo xpnsonry/conrconry for so countrs Wtho common sc pocy s nky h onty non cn work 1f ongon xpncs rcsson cny coctd x vns cod fnnc fnnc ncss nvstns n hos rgons
3.4 HL TOPIC TERMS OF RAD rae average prie of expors divided by the average pre of mpots times 100; it is the ratio of two index numbers imes 00: erm o rae iex ex of avea aveage ge expo expo pice x 1 term of re (oT exx o averae impo pe e
Understanding Understandi ng the terms of trade
Improvement the tems of tade= tade= the vale of te oT ineases due to a increase in average expo pces o decrease in aveage mpo prces (or both) A ToT improvement ncates tat tat te same amount of mpots an be bouht wi a smaler amoun of exports; or that more impos can be ouht with he same amont of exots.
eteioato te tes o trae= trae= te value of e ToT ereases ue to a decrease in average expo prices or increase n average import pices (or bo bott h A ToT deterioration ndiaes that a larger amount of o f expots is requred to buy b uy the same amount amount of impos, or that the same amoun amountt o exots can bu onl onl a smaler amount of imos.
Calcuations sn the terms of trade
Rocklan's averae expot and import ries are shown below nx v ex e n e
2011
20
98.72
0000
9
0000
3 0543
0427
Causes of changes i the tems of tade Causes te sot tem
•
•
•
1 What is the bae year? 2012 (index nmber 100) Calcuate the erms o trade for eah of of the years 20: 98.72 / 97.3 X 00 0122
04 10975
202 0000 203 05.43 / 10427 100 101 204: 097 / 17 X 100 043 3. In wih yea(s did the ToT improe? n 2013 a 2014
057
4 I wih ear s id the ToT deeoate 1 Causes
• ae I ema ema on o nions ions f global deman demandd or a pailar prodct increases (perhaps de o a change in onsmer tastes) prie pri e of the prodct nreases= nreases= ToT mprove for expoing ountries and deteriorate for impoing • ountes. ount es. If gobal demand alls the opposite wil ocr ne i upply oio If gloal spply of a product inreases (perhaps de to favorabe weather onditions afetng agricltre or decreases in the lobal prie of oil prie of te • pouct fal To T deteoate fr expoing countries and imprve for impoing ounes If gloal spply dereases the opposite will our canges elatve flaton ates I a ounty experience hge ination rates eative o other ontries= pries of exports inrease= ts ToT improve and oT of countes that impot fom te hig inflation ounty deeriorate. cages eatve excage ates Crreny epreciaio o evauation impo prices rise= ToT To T deteriorate Appreiation or revaluaon imot rces fall ToT improve
e lon ter ce pvy I producivty (output (output per nit of labor input) increases spply inreases (S ue shits right) pries pr ies of expots fal ToT eteorate fr f r expotin cnties tecoogca ipoveets Simlar efets as prucivy nreases, since tehnologial advanes advanes ae oten the ause of podutivity ireases; ireases; supply inreases (S curve shits shi ts right) prices of expos = ToT deeriorate for expoting counttries canges ioe eves Over ong perod of time nomes tend to increase leaig o demand inreases but e efects on countries ToT depend on income elasticities of demand (YDs or expos and impots may commodities, often produed an expoted by developing develop ing ountries, are income inelastic YED<1) while manufacred oods and seices, oten prodce and expoed by deveope deve opedd ountries ountries ae income elastic (YED>1) (YED>1) (see p 11 11)) Since D an hene P of income elasti goos rise faster an ad P of icme i cme ineat oods, contries expog goods with a hig YE experiece ToT mprvements wile countries exportng goods with low YDs expeience deteroatng ng ToT see p 76 fo more deails)
Consequeces of canes cane s in te terms of trade Eects of changes n the terms of trade on the t he cuet accout Points to note: Sine e trade bance i the most most impotant pa of the current accont, tis examines te efecs of ToT changes on the rae aae a ae ae aae aae value o expor expor expo r eveue) eveue)-- vale of mpo mpor expere). The effets effets of hages in the ToT on a cuntys trade balance epen o e ue o cae in e To o ne re r e ae y e lol em e ToT an baane of trade ange in e same direcio: oth improve or oth eteriorate ppoe lo o ee fom o 2 P om P to P2 an from to 2 (P Q)
e o age o a rae balne o mprove mpro ve o oh eeoate
For expo oe P mean o mpove, and x Q) means expo evenues rae lane mpove (trade (trade deficit OR trade surplus ) For impo orie P means o eeoae and (P x Q) means mpo expenires ae aae woe tade decit OR trade surplus ) ppoe gloal all from o 3 P to P and to Q (P x Q) or expoing ntries, o eeoe and ae e woe or im oin o in cutries o m ove a a e l m ove 75
QJ
Q1
Q2
Q o
TT hg hg i gl u the efects on the balance of tade de ed o the P of the ood tha s x od r r m oed. e 5 d r m 5 52 52 P to P a an to If P< 1 (ex primay commodiy) % i Q ¾U in P P x Q) Q) U r eig nrs: since P o deteorate; and x Q ( exp revenes) U trade balance woses mog n: since PU o improve; and P x Q ( impot expedites) U tade alance impoves D h TT e rd h i If PE > 1 (ex manufactured good)=% Q ¾U in i n P (P x Q) F g since sinc e P o deteiorate bt P x Q ( expo revenes) = trade balance imoves F mog : since sinc e P o imrove bt P x Q ( import expedtes) = = trade balance deteriorate D h T bl r h
Wh g 5 hage h TT hg he r a d ED p
QJ
Q1
Qz
Q
TT h h e e eh h eects on the trade balace de ed o the M hl-Lrr d 73 Di/l imor rces = TT r l= l=mpot mpot ces U = TT m D + EDm = = r bn me (trade det U D + Dm = = re an we (tade deficit U OR trade surpls ) OR trade surpus ) h M-L d hd D + Dm )= r h h M-L de h D + Dm )= tre I h bl m ade deic U O tade s ls a wr tae defci O trade s ls l s
Effects of shot-erm luctuatons in e tems o trade o deveo n couties
To f develong cotes cotes whose expots expo ts are domnae by ma commodties tend to tat tat mch moe a the o of trie triess that ex ot manfactred manfact red odcts becase ofof nl nl D 5 mmd mmd P P11 and PS PS11 see Inelasic dmd pri goods p
Elastic d aufacr gs gs
sc sppy pria gds gds
Elstic spp afatrd ds
p
, 1
P2 ---
Pz P
i
,
D
As S shits along the cuve, price uctuaios are are larger fo rima oods with inelastic PE< lar e ToT cuat cuation ion 0 uctating revees of podces leadig to cetaiies with negative effects on investmet investmet 0 lctuatng govenment evenes, leadig to nstable govemet spendig, inaproprae ae scal olcies olcies and dficlties in deb debtt e e a men mentt
D,
As shifts along the S cuve pice fctatios ae a e larger fo pimay oods wih inelastic S PS< 1 lar e o uctuaios 0 ctang expo revenes revenes peventig longterm l ongterm planning plannin g of necessay impots of inputs fo ms and food for consumers 0 o imovements whe prices rise prevet effots to omote long term dvesiicatio o the economy istead elp mantain dependence on commodi ex orts see 88 on the advanta es of divesicato divesicato
Efects o long-tem deeroraon i the ems o ade o developing countes
Wh dl izi rma mmi mmie e ha x rl rl di TT ma • w m dmd (ED) m r m • Th Thgl gl gr gr shift the mu mu (see p 1 ) As icomes grow ove ime a lage opoio opoio S crve crve to he ight leading to a fal n pie of of income is spet o goods ad sevices with income elastc demand (Y>1) ad agricltal poducts (impotant pmay commodities) a reatvey smaler propotio o primay commodities wth icme inelastic demand • M w lgi im (YE<). (YE <). ith demad for primay commodiies growing less raidly pes of tese dg m r d commodites also ncease less apdy, .e. prices of commodites fa relative to countes leads o highe ces than the prices of r f manufactred goo Countries that exo mainly priay commodites ad agricultal poducts whose makets are oganied impo mafactured mafactured goods theefoe face deteiorati oT moe com eitivel Cnsqenes of deteorating tems tae
A o deteioaton ove a ong peiod of tme means a county ust keep expotg moe to maintain the same quatty of impo ts iceasig ootn cost of imots is leads o • nceang difclis to imo ecessa nts The eed o keep expong primay commoities makes t nts for oto otonn • Growing ad pesisent baance of rade defcs dificlt to psue dvesication ower economic gow and redced possiblties fo economc • Increased need to boow to finance ade deficits eading to development growing indebtedess • Reduced expot eaigs i agicure leadng to greater al here is global edstibution of output and income ove the log tem w owing income inequalities between povety ad income ieqalities developed and less developed counties outpt ad income • owe incomes ad more povety leadig to owe ow e governet ae tansfeed from ontr A to other countes c ountes as A must evees, reducng the goveme's abiit to roie met goods give up more and more of its otp otput ut in the fom of expots in and nace economic developmet excane for te same Q o imots •
76
development economics 4.1 ECONOMIC DEVELOPENT Th aur f gwh a economic growth = ncreses in real GD ea output
economic developent pocess where icreases re GDGN per nd/or real GNI (re income) over time; tis is often cpi occur longside decreses in poverty, increased employment mesured in p ap tems (per person in the populaton) opportuitie lower ncome ineqaliie increased access to merit goods in order to determne how output or income e changing on including education, health care and inrastucture (snitton and clean ater spplies) incresed gender equity ll generlly leding to improvemens in a average per person economic growth my be negative, involvin decreases decre ases in rel GP or el G OUton's standard of livin Wheres economic gowth occus in a single dimension (increaing rea GDP or GNI), em devepme s muidmea oe as t incudes chne in mn diffee diffeent nt es of economic nd soci ife
Sources of economic growt in economcay less deveoped deveoped countre countress (ELDCs) The most impont sources of economic growh in economcally ess eveloped contries (ELDCs) re the folowing: Ieae ua pa apial Increased qantiies of machines, tools, equipment roads and tansportation sysems, telecommunictios l of which are p of physica physica cpital and are ofte i so supply in DCs increse te poducvty of labor (ouput per uit of labor) and terefore mke economic growh possible
Impveme apppae eh Tehnologil chnge improves the qulity of physical capi contributin contributingg to incresed bo productiviy However Howe ver to be ueful to ELDCs the tecnology mst be ppopae o local conditions relting to e envionmet clmate, quantities of labor spplies and levels of skills see p 8).
eae a hma apal Improvements i he leve o helth and edcaton, which are oten reltively low in ELDCs increse the quntity of mn capil (see p 54) lso raising labor labor pduiv p duiv and making econmic growh possible.
Ial hae coomic growth requires the deveopmen of institutions alowing a market economy to function well including effcient effcient nd fir legl system nd tax ystem bnking system proection of propety rigts ad protection gainst wdespread corrution see see 838. 838.
The "curse of natura resources Wheres in theory primy commodities (ex ol ntural gas, metals mnerls timber) cn make an impotnt contribtion to economic grot in prctce s oserve that mny contries tt ve major resources of suc commodies (ex Congo Mexico, Nigeria Sout Africa Venezuela) ve ot ot been growing as rpidly s countries that are resouce-poor resouce-poor (ex Hong Kong srel Jpn, Tiwan). ne impont actor actor beind ths my be tt relince on commodities commodities did no encourge effors to acheve early dvesfcao of the economy into manufcturing (p 88), wie lso burdening te economy with vola of ep evee (p ) deeai erm ade (p 76), rade dei and e a e (p ) need for borrowing and h leve le ve de (p 91. Resorcepoor contries, being forced o diverfy their ecoomic civiies and rane of exots erl o were more liel to void these diicltes
How economc rowth reates to economic deveo ment Gowt n otput d incme per cpit cpi t (economc gowth) sugget tha growth offers greae pabl for ncreases in consmptio of good ad sevices nd improvements improveme nts in livng sandards oweve gro w i output d ncome per capa capa is a aveae ve he ppa ppa ence evelng evelng nothing about about ow e ieaed u upu pu ad me ae d dbed bed f the benefit benefitss of gowh re concentrt concentrted ed n few hghincome groups, whle te te bulk of the poplation remins witout ccess to basic sevices (merit g ood without access to em lo ment o ouities livin i s alid id conditions in sev sevee ee ove economic row rowhh wll not lea leadd to economic develo ment om ow h ma ead o eoom devel me i: • economic gowth gowth eas to a orsening orsening distriion of of income, often he he esult wit witin in urbn urbn ares ares improv improvemen ements ts in infrstruc infrstructure ture are o market-base supply-side polcies nd trade lierl iztion (see p 8) concentted in the formal secor, wit neglect of e infrmal sector of urbn slms (see p 8 there e ow lees of government nvestmen nvestme n n hmn capital so that large pa of the popltion are e iot aete access o edction nd ther theree is discrm discrminat ination ion aganst aganst social social goups goups on the heath care grouns of relgion, ethncity gender race, etc there is wiespea introction o captalntensive technoogies leading to the poor live in remote geogaphicl res h limited unemploym unemp loyment ent (see p 81 ccess to growing economic actvity improvemets i infrastruture (clen wter sitatio are concentrted in • he poor are caugt in a povety trap/cycle (see p 8 uran area, with eglect of rral ares where mny of the poor poor lve he oo have no access to credit see 82
Countryy grous accordng to Countr t o ter eve o economc deveopment deveopment Countie around e wold re dvided nto rou s b he Word Bn ccordi to e a ia me G level ma mre de velped urie ma u rie ) mi e deveped e () are divided no ree groups i "low ncome·, i ower middle income ad ii u er mdde income cnsist of one rou refeed to as i h income ncome leves re djsted eac year to account for inftion owever lai e y ime eve o deemne er level o f eom devepme a e h mead he mltidimension nture of development mens that a low-ncome count my have greter chievemens in res ote tan income (edcation health income equlity geder eqity ty etc than higincome county county Tis probem is partialy addresse by use of the uma eveopme de (I p 80)
Dversty of economicay ess deveoped coutries Cs) DC difer enormus! from ech other wit es e to teir natral resources clmate humn nd c il resources isto
e of olitical s stem e ree of oliical stbilit 77
Common characteiscs of economicay economicay less developed counties (ELDCs) n spite o the great divesiy beween economicaly less developed countries ere are several caractestics tey share in comm on on (tough it m ay ay be danerous to eneralize as tere are ofen excetions) ow vs f P NI ct Wie there ae vey large gh h ts n populain gwh ELDCs ave igher variatons in GD and GNI per capita btween ELDCs temselves bihrates than EMDCs and tis contributes to moe apid overall teir leves of outpt and income are ow and in some ses population on growth Tis ma have negatve efects on growth and extremey low Moreover, the income pr capita gap (or difference) development: the more children in a family, the less income is beween ELDCs and EMDCs on o n average as been growing in absolute available for eac chld; mothers mothers wth lack of acce access ss to health care terms For the incom e gap to close poor countries must achieve higher sufer poor healh from fro m many bits there may be environm ental ental rates of growth than rich countres This has been been occurring in ceain degradation as populaton pressures ead to unsustainable resource regions ex East Asia) but other egions are alling behind (ex Africa) use suc as clearng foests to use land for agricuture (see (s ee p 23)
Low lees of heat and euca
H lv v Low levels of output and incom e translate into hg poverty levels Roughly one in ve hoseholds in te world live in e v (ess tan US$12 US$12 per person per day), and one in three live in oer povert (less than S200 per person per day.
Levels of ealth ae ow de to several factors incuing poor access to ealth care sevices and medications manutrition on accont of povey wich does not allow families to buy suicient amounts of food with essential nurents lack of access to lean water supples, and lack of appropriate sanitation Levels of edution are also low, due to such Hg lvs f uepe upt ack of factors as insufcent educatonal facilities, lack o access to em ploym ent ent opportunities result in ig rates of unem ploy ploym en en and scoos low proity proit y attaced attaced by parents to education especially in underemploym ent ent where worers are occupied for only a pa of e te case of girs, and the need to send children out to work to m e. tm e. nemploym ent ent is oen 20% or more of the labor force. supplement suppleme nt family fa mily income g ic inuit Whereas all countries in te world have w lv lvlsls pscl cap n tcno log hys hysical ical income inequalities, these tend to be lager in ECs, were w ere the poorer capita tends to be limited in qantities, n relation to very abundant groups of te population oten ave mu smaler shares of tota income labo supplies Com pared pared to ric countres the amount of physical (eadng (ead ng to a relatively high gn oeicient see p 55) 55) Tis is an capita available per worer may be as little as onetwentieth In m porant im porant reinder o why wh y measures of incme incme per capita reveaing addition te level of technoogica development tends to be low as nothing about distribution are on teir own, inadequate measures of te physica capita avalabe oten conssts of relavely rela vely sim ple m ple economic development. machines and equipment
arge agrira (ad prmary) eo
The share of te primary sector including agriculture, in i n total outpu and the poporton of workes in ths secor, is high, often as uch as 30% or more compared to 13% in many EMDCs. In general, th lower the per capta incom e e eans tat in some EDCs tee is a the larger is this sector This m eans eavy reiance on agrcutural (and prmay) pduct exports w a 85).). whole range o reated diiculties (p 84 - 85
Da oom e s Tese involve e si ultaneous ultaneous existence of wo diferent d iferent systems tat m m
coexist in an economy, sc as • a ormal ormal (register (registered ed and regulate regulated) d) and and informal (unregistered, unregulated) urban scto • a technolog technologcally cally advanced agrc agrcultua ultuall sector sector based on the use of odern and adanced nputs side-bysde wi subsistence agricuure based on labor and simple toos • ve ric ric hgly educated educated people people sidebyside debyside ve poor illiterate and/or and/o r uneducated eole
ow v o roductiv ow levels of ealth and education mean there ae low levels of hum a a caitl In combnaton wth low leves of pyscal capital, these factos afect rucivity (output (outp ut per unit of labo inpt) inpt) wic wic is aso ow ow Low poductvity poductvity n turn translates into low rates of economic growt
rg urbn inom l l scor n scor n nforma sector s one tatis tat is not regulated and not registered While in EMDCs this is generall llegal in poor countries it is a gray area tat is not ony permied to contnue to exist bt s ofen even encoaged to grow It is found especially in uban areas (cties) and conssts o small-scale sel-employed people in a very broad range of sevices and poducton such as sale of food, clothing and varous houseod items m ending ending of coths, cobblers barbers and household cleaners Tis secto is ofen encouraged because it absobs a large part of the oteise unemployed and underemployed wokers wo would have no alternative wok Aout onthird to onehalf of non-aiultrl workrs in s wok t sector Yet it remains higly problematic because being unegistered informal sector wokers ave no social o legal protecton and ofen live in te most squald conditions.
The povety trap povey cyce)
The Millenium
povy rap y )
Deveopmen Goals
is sown n e diagra below ow ncome and savings do not The MDG grew out of the Unied Nations The Mllennium Decaaton Decaaton of September 2000 and permit people to purcase (invest in) m achnes achnes and equpment (physical capital), m educaion and eath care (human apia) or m i proved proved agricultura inputs to presee soi ai to nurients or avoid overfishing deforestation ec (envinmental capital) Tis eads to low 1 Eradicate extreme povey and unger productvity, and in tu to low incom e growt and ence low incomes, in i n a cycle or trap cie ciev v universal pimay pimay education Te povey cycle is transmied across generations ciden are caught in the trap 3 romot gender euality and em power power women aong with !eir parents growng up in oor eath, wt lim ited educaton and imted educe cildm ortality ortality m ited possblities to live productive lives and earn higher incomes. 5 Improv maternal healt Outsde intevention, e foreign ad ando government investments in infrastructure 6 Com ba ba IVIDS malaria and other diseases b u _n ityLt_ 7 Ensure environmenta sustainability f or a" co _ o rea re kou'ot het ra . m m _ oods-rovision areessent i _ _m m _ m er i 'and - Develo a global arnership for deveopment
Te poey ap ye) --� --� , I y t I u pya pduy d u ap 78
8.
The Milnium Development Development Goals (MGs) are impoant tools in te efforts to promote econom icic development Whereas some progress as been made toward achievng the targets, the reaity remains fr behnd what had been originally oped for. One dificulty is te large sorall in funds tha rich counries ave made availble for in spite of ntia promises to the contrary p 89).
oeg ad
4.2 MEASURING DEVELOPMENT
The diculties of measuring eveopment Economic develo ment s measured b se of = vibles indicti the state of wha wha is bein esed Indicators cators low us to: mesure counts peforance wth respect to t o reching a goal • measur measuree prog progress ress de de by by cout couty y ove ove tme desi n olicies to he achieve s ecic oals sch as the MDGs co e he eormance o diferent cories cories wh ech oher Since ecooic development is ltidiensiol there is i s o single idictor t c accrtey accrte y measure t To overco overcome me this prole, develo ent be easred b ro s of n itr or b m i ni ni Stil, ndicaors hve shotcomin s Daa ma not be vible in some countri countries es lnbilit to collect accurate data relatin Deitons of some indcators ma
Single indicators GDP per caita and and GNI pe caa GDP mesres total outpt poduced in an economy ove a year; GDP per caita esues the amont of otput poduced in a
GNI easures income received by residents of n econo econoyy over a yea I pr pi easures e aout of incoe received by residents in in a year that coresponds to eac person in he population on average
year tht corresponds to each perso in the populato on veraqe + iom rv m r m m see 39 for more details MDCs GN per capit and GD per cpa re ote (thogh ot lwys) simlar because he inows nd ouows of coe re no too dfferent ro each other and tend to cacel out. n ELDCs e dfferences re sometimes greate greate due aily to (i) prf pri of union nion corporations (profs sent o the home cot) and (b) wor mes (wages of workers sent bck to their hoe contry) p ap s ir f p p pr p prsn prs n in a econoy econoy (thn GN per cpit)
pe p ee ao of sar o vn (n GDP pe cpita becse it easures o ome me eevd b ech person on vr vrg g
However even er a s m mit mitn n m f lvi l vi of oa see 40. For exmle It provdes no ndicato o the dstrbuton of coe, and It provides no idction of e oposition of otpt (ex erit goods whether ths is distributed reltvel euall eua ll or or uneuall roduction verss milita qoods roducto. I does ot ccout for acieveents in standrds of living, It does not account fo egative environental externalites, sc as attainments in evels o heath heat h nd education usustiabe resource use and environent destruction. It does ot inclde incld e ncomes eaed i the undergrond t does not nclude otpu ot sod in arkets (ex food grown fo own ecoom use.
GDP//GN e caa and GDP/ GDP GDP/GN er capta n urchasng owe aes (PPPs ) (PPPs ) Sppos tere are to onties with ideic GN per cpa a o $5000, ut with different pice leves, Country A hs low prices fo goods nd sevces and Conty B has higher prices his ens hat he GNI per capita o $5000 cn c n buy more goods nd sevices (as greter prcsing power i County A thn in Cont B eefoe t is miseadng to say tat e two coutries have identi GNI per capita, snce e GNI of Couty A is woh moe in terms of what it c buy tan the GNI of Conty B
This proble arises when mrket exchnge rtes (those explined in ar ae sed to conve local crrencies into US$ (or into other currecies. To resolve this poble, ocal currencies are coveed ino US by use of special exchnge res clled ph pw pariis (PPPs PPPs)) exhange ate hat covet loca currencies into S$ n such way that the nfece of diferent price levels across conties is elimnaed the result is GDP or GN per apita values expressed n S (PP) directly comparbe across contries
gener high-icoe coutres have igher price eves than low-ncome conries Ths ens that n ters of prhasig power US 1 ca buy ore goods and services in a low-incoe county hn in a igh-icome count. Therefore when we compare oput and icoe levels between ig- and owicome coutries, es, G and GD converted ito S$ by use of arket exchage ates exaggerate the diferences y cotast, when PPPs ae used, he diereces beween igher igher and owerincome owerincome countes ecome smaller Weve op o iom n o o per pa) s cmpr os n s v mp u s he ma hv v
Health ndcas
halh diator measures of the ste of heh of
p i measures the nmber of yers perso an expect o live o ver e t the te of her/hs bi
o tio ree ve common used heh indictors are m mesres he nber o n m measures the mbe of infan deas each yer per 1000 1000 ve bihs, women who die each year fo cses fom the me of birth unil the a e of one ear related to e nancy er 00,000 live bihs
hese mi eve me rovide n indicaton o o ma fctor fctorss ha reveal foration bout bout cont cont ·s leve of develo ent l f p p hh sve such s iunizton ad ad ess o e popio l cr sv clding doctors, hos tals, ad medons revention of of comnable diseases ex mli, tuberclosis Ace to uient od in terms of boh caores and essenta The qualiy of he evoment, iclding polluton levels and ntients, and absece of malntrtio ade uate ua te nfrstuctre sewer e, clen wter su lies • ve eio h w there is a close corretion corretion beween levels of eduction and evels of health Generlly, te higer cout's ncoe leve, the higher he life expecancy and the lower the nfat ad maternl oaliy. owever tere re y exceptons to this, as any contres hve chieved r lh oms wh w iom. his indicates ta oris n m m ov hh f hei lo o w w rv f o ses 79
Educatio ndcaors
uation n soe ve comonl sed dc dction tion indicators ar educatio idcators = measures of the leve of educationa atainent o a o uatio T d measues the pecentage of peole in a population above e fteen fte en wo can ead and write.
ria oo nont easrs eas rs th prntag o f cldren who re of ocil school age wo atend ate nd rima lmnta schoo.
Sond o oo o no measres the percentage of childrn of oicial scool ag who attnd sconda scoo.
M o coo cooig ig easress the easre t he nuber of years peopl aged 5 or more have atnded scool on avera e
Genraly te higer a contys income eve, the highe te vaues of the measures provided by al the indicators abov owev, as in the cas of halt ndicators tere ae ajorexceptions as a nuber of contries ave achieved ve igh litracy rats and primary scool enrollntt rtes, in spit of havng vy low incos p capita For xample, Uganda and Burundi with vey low incoes per capit ve enrolln primary school enrolent rtes at are even iger than some vey hig-income coutres e reso behind this ies in government policies that have sin led l ed out rim scoo scooll education as a ma·or dvelo en! oa tha thatt is ursued even tou h rsourcs ma b v limt limted. ed.
Oher sgle dicatos here are may udreds of indictors tt a be used to easure the wdely di eren spects of ecomc deveopent. he World Wor ld ank compiles the World Developmet Indicator o whc there re over 900. any of these can be accessed at htt /1/1da da a.worldbak worldbak..org org//data data-- cat aog og//world deveopmet -ndicator ndicatorss he idicators cove he folowing topcs Agcutur and rral develoment Aid ffctiveness Cliate chaQe Econom and owt Edcaon Enrv ad iin n Enviroment
Exta debt Finanial ctor Gnder Healt Inastrctur Laorr and social Lao soci al otectio Povt
Pat cto Pbic scto cienc and techolo oial dvlot rn dvlont
Composite indcators copos cop osii ndao= ndao = grop f sige idcators used togeter to form a ng aur o dvlop d vlopn n i v dmnion compose indicaos are sperior to sngle idicators o f economc deveopmen as ey incopor ate more oe dimenso of developme
The Huma Deveopme Idex Th un vlop ndx )) measurs dvlopment in t dnio: • T lvl lvl of a measure measuredd by oe oe indicator: life expecta expectancy ncy at birth. birth. • T vl of duo duo meas measurd urd by by two indicat indicators: ors: ean years of schooling schooling (see aove) aove) ad xpected years o scoolng (th number of yar a fveyear fveyear od child can expect t o attend scoo) T add add of livig , measured measured by by one ndic ndicator ator G p caita caita The D is an average over these tree dimnions It is prsntd as • a inde indexx number number rom O to or each each conty, conty, and and • an DI ran, ran, according according to wich wich al al oui nd o om m ig ig in r o i v h dnio dni o o ow. he s r pror to GNI or GDP) pr capita a a mar o ooic dvlopm becse i
provides infoation o acievements in three diensios siltanousy, ie heat edcation and income er capita heat
he Huma Dvlopmnt Idx (DI) i th mo widly d compo ndicator of coomc dvlopt, and is actally a mear of ma dvopm a process
defned n trms of huan freedoms freedoms incdng reedo fro hnger eedom rom preventabe preventab e diseases freedo from ignorance povey povey and want, and a nd freedom to live a fll and productive life
A comparison o GI pr capa rak nd rak across counties revels tht the two often do not go together becase: countrie countriess that attc a high importance importance o iprovig iprovigheir heir hea nd/or education outcomes by allocating allocati ng sources to t o e provision of ealth and educaio seces ave a igher HDI ank tan GN per capita rank while a low priority to thee areas appers s a lower DI tan GNI ran ac eve majo health and education Ti mans that many countries in te world can ac eve mrovmnts bv rallocatin resources in favor of rovdi srvics n ts areas
Sor oi oig g o mn vlop vlop ndx ndx ver nd above te sotcong faced by all d ators the an Dvelopment D velopment dex is lmited as a indictor of economic development in tat it does not provide ny ndication o achevements in other impotant dimesions of develoent, such s incoe distribtion acce access ss to clea clea water w ater and sanitation, employent, gende gende eqality ad others.
Addoa comosie dcaors Te dr na dx Gi lso first appeang in 20 measus t losss he InequalityInequality-adjtd adjtd un Dvopm Dvopm wome expeece o account of inequalities ties in three diensions: ndx (IHDI) i a measre tat rst appeared in 200 wic is te same as te HDI only tat in odiv od iv a measred by mternal mortality rates seep 79) 79) and adolescent addition it takes nto accont nai in eac fility rte (t higr ths ths are the lower te GIi); of the same thee diensios he HDI mpowrm measred by the share shar e of parlamenta ss ed by woen, ad "stacts from te D o ccut fo achiveents in igher educio (te higer these are the igher the GIi ); ineqaities terefore te geaer the equality, labo ma patcipaton measured by wme's paticipaton in the l abo market te lower te IHDI. te hiher tis is, the t he hiher the G. e Mti M ti dni dnion on ovy ndx (P measure povery not just n income terms but alo in trms of deprivatios expereced by poor eole in tre dimensions helt education, and livin standards masurd bv access to w ater eectrici cookin ful toit and othes
. . .
80
4.3 THE ROLE OF DOMESIC FACORS
Education and healh Edction nd helth re the building blocks of ma capita behind EMDCs with respet to chievemens in capitall (see p 4). ELDCs generly lg fr behind both edctio nd helth helth evels ho h there re exce io ioss Edution d helth re t one nd the sme tme: "goods leding to 0 fudametal 0 goals of ecoomic 0 compoet pas o 0 major soces o ma ghs vey sgncnt devellopent deve opent,, iclded i the Huma Developmet ecoomc gow hrogh (oding o the Uited the Meim Ide I dexx widely sed to ositve ther onribio o bor Ntions Delrtion of mesure eonomi Develoment Goals podcivty (otput pe uit consupion Humn Ri hts DGs, see 8 eteales 19 develo me see 80 of bor in ut, see 54 Positive externalties of education ad heat care seices
The mret ndelloctes resores fo the proviso o eduio nd helth th cre sevices; he mginl socl benes (MSB) of cosmption of edution nd helth e e greter h he mrgnl pvte beets (MP) with th e diffeence onted for by eea beefts (see p 19) Eea beefits o edcato OLDCs
Eeal bees o al
onomc gowth rising fom greter lbor produivty Redced nempoyment More foreign dret investme investmett (see (s ee p 8 8) s MCs re trted by n edued lbor lbo r fre Techoogil mprovemes de more R&D by skiled people Greter politil stbiliy which ontribues o moe growth d developme developmet t Edution of wome leds to hghe lbo fore pticption, pticption , reded bith rtes lowe poputon growth tes nd redced povety dution of women nd mohes leds to helther feme populton d hethier children
Eonomi growh, from ncesed lbo lborr podtvity podt vity Lower is of spedng diseses from lower disese brde Lower ris of o-immized people otcing disese rsig rom he immnton o poton of the poplo Improved school tendne of helther hldre d beter shool perormne A onger lie i which to se skills uired d me contribtios o soiey nd the eoomy
In view of the bove there re vey strong justios for goverment polcies to promoe cess to edcton nd heh cre servies Govermet poies my ke the fom of • provsion of shools tht re tted ed ree of hrge • ws tht me me educio educio ompul ompulsoy soy up to cei ge free immunition • ccess to govenment govenmentprov provided ided heh heh re servic services es tht re re ree of hge or hve ver low chrge Addio polies es e he provision sion of ifrstcre iclding ce we suppies nd sewege sysems, s well s efors to lmit pollution, ll of whh contrbe to t o moved heh
The experieces of contries ht hve grown nd deveoped rpidly over the t he lst severl dedes shows tht one mportn for behnd their sucesses hs bee mor nvestmens in edco (ex Chi, Idones Idones, , Soth Kore, Thild) Studies show tht in lowinome outries priority priori ty shold be given to pomotig uiversl litercy (he bility to red nd wite) which cn be hieved by nversl nversl primry shoo eduton this s in fct the secod Mllennium Development Gol (MDG p 78) oe ht three o the eigh MDGs e diey reted o improving heth (os 4, d 6 p 8)
Approrate echnology The need fo a appopriae ecoogy = tehnology tht is well sied
o contr's fctors fctors of podction this oten efers to the qunties o ao retive to utities of hysca caital vilble s well s skl evels needed in relon o sil levels vlble in dditio, tehnology must be pproprte n reltion o ont onts s geogphil, cime nd ecolo ecolo icl odios
I ELDCs wh reltive bud utities o bo se of ao-tesive techooges results i inresed employmet icesed se of locl skls, more inome fr the worers employed, reded povey nd svngs on foreig foreig exhge (de to locl podction d minenne of the e i me s o osed to el in on im oed l oods
ELOCs e ve oten hreried by rge utities of lbor i combinion with eltvely scre ities iti es of physicl cpl nd lrge prts of he lbor foce re no highly siled This mens they t hey reie tehnologes tht e lar· esve meig tehnoogies th need ge untities of lbor to rn d mintin d tht re reltvely smpe o operte Lboritensive tehnologes should be contrsed wh capa-ntesive ecnoogies which reure reltive! sml mount mount of hi h silled bo o r, mint nd o ere se o capal-esve echologies resus in greter unemployment, imited se of locl sills together wth sill reurements tht my be diffiult nd ostly to seure, redued icomes d geer povery s well s ncresed use of possbly scce oreign exchge exchge to cire costly m oed c itl e u ment
a hl s a mar a mi r an ln yet both hisorc hisorclly lly nd o the present, use s ote mde of in ro rite tehnolo es while not enou h teto s id to the develo me nd se o o rite ri te tehnolo es e of the seros errors of -- polices i the 90s nd 90s The use of inppopte tehologes s one of the drwbs of rin i i (F F) (see p 8) ws he use of mpoed cpitintensive tehologes tht contribted o rsig uemployment the t he growh of n ra rmal secto (p 8) nd deits n the n ELDCs th elies on plintesive urrent cont (p ) de to the eed to import expensve ptl eupment technoogies (p 88) Mos ew technology ogy origites in hghincome countries, which end to locte fr more resoces o reserh nd development h DCs Sne MDCs hve etively bndnt supplies of physl pl in reltion to less bund bo mch of this techology is cpitl ntensve nd nd therefore in ro rite for lbor-bund ELOCs Yet most ELDCs do do not not hve the resorces to develo their ow tehnolo es 81
Credit and mico-cedt Why credit is mpotant fo ecoomc gowt ad development Ban ki ad cedit are i otant because the : 0 povide a lik beween saves 0 provide an ncentive for ad ivestors; he savigs o oe households to save houseod are ade avalabe or because they ffer interest inestors to orrow a mens on he savin s
0 provide funds or ivestors, who ay be arers, sopowners small usnessowners to borrow and nace a for ivesents.
0 ofer a way out of poverty and te povery cycle/ cycle/tra (p 78) i poor peope wh lack savngs ca borow te can ceae a rotabe busiess
However oor eo le are usuall excuded from te ossbil of borrowin to nance a busiess ecause The credt syste ofen is ot wel Te bankng secto is often dominate dominatedd by foreign ! anks require colateral for ang anks wt an interes in lending large aounts o loans and poor people lackig ay dveloped and people do ot ave o ra hca access access to bak baches. baches. wealh borrowers and lar e cor oratios o et ave notin to oer as collaeral. As esult of he aove Poor peoe are forced to borow bor ow from ilegal mey-enderswo mey-enders wo arge extremey ig interest ates and a nd fro eplitative pawnbrokes oaii far less tan what what the eed oo sta or e ad a small busiess busiess
� Poor people's lack lack of access to sufcet reliable, ow-cos sourcs of credit is a mar btal t onomi growth nd develo ent, revenin eo e ro esca in their overt .
Te oe of o f mico-cedit: mico-cedit: an evaluato m icro cro--credt credt= = cedit (lending o very smal aounts of
The rst microcreit schemes began i te 197s, initaed by Muamad oney for shot peiods of tie to poor people who ave Yunus in anglades, who received e Nobel Peace ze n 26 fo his other access to cedit contriution to econoic developmet Eames of micro-enterises businesses fanced b microcredi careers, street vendors seasresses, itti roducts, roducts, bcvcle sos Acclshens and chalees of micocredit iclde: 0 Mcro-credit helps poor and ueployed people ecome self-empoyed n n sall usnesses It s not necessay o povide colaeral to obain a on Te borrowers vey ofte are wome wo have prve to ave the ighes repayent rates ad who use ter usiness icoe o provde fr e wel-beig of their chldre ad amily. 0 Te social satus of women boowers as prved 0 Microcred as plays a key oe in povety redcion as t esults n iher and ore sabe icoes icoes
There are ar too ew micro-credt scemes o cover the eeds of blions o poor ad so only a vey small propoion of poo po o peope ae eneiting fom tese There is a isk at mcocredt schees may ecome a substiute or adly needed governent povety-reductio polices Many micro-cedit borowers end up workg in the uran in inra ra t t , , in wic workers ae witou social potecton p 7. Microcedit has high iterest rates wic ae ecessay to cove cov e e hg cost o the oas (adiistaive costs ise we oans are vey small) but whc ay penale vey poor people stuggling to ea a decent icome xcessive borrowing ay lead to a debt ap (wee te oly way to epay is by orrowin more
Empowemen of women owemet Serios geder iequaliies in may contries casing woen to face dscrmiation at at depives e of umeros oppotuites ope to me, me, have vey niant consequences t ny fo he women themseves, t aso fo sociey the economy nd economic evel met
empowemen o women = eliminatng e discrminaton faced by gis and women wi espect to access to educaio ad health care, in the labor arket iheritance rigs and rights to to property access to cedit, and in al spheres of social and econoic ife ife with a vew to achevig geder equality so tat girs and women will ave te same oppounties availabe o boys and en to achieve their oteta to live a full full and roductve life
he major signifcnce of woens empowerment as ade it Goal umer 3 of the eight Millenniu goals (MD Gs see p 78) "roote te composite idcator "Gender Inequaiy Inde (GI, see p 8, alows geder inequalities to be gende equaiy ad epowe wome while te masured ad oitoed over tie in order o assess what proress is made n acievin this goal.
Potve consmpto extenates o edcatio fo wome ducatio of wome is peraps e sngle os impotat oute to ter empowemet. Te signicance o wmens educat on fo econoic develoome can be seen in the ve imorant extena benes it rovdes (osive consmton eternalites; 19) Imoved eath and nion of chden dcted woe are Hge iiaon women i he labor ore and ighe mre knowedgeable about good heat and utrition praci ces fo their income Educated wome are ar ore lkely o ave a job, makng chldre, ad so aise ealther childre beter use of huan resources, ad therefore a higer faiy icoe. i
moved edcation o children ducated women are fa ore likely to appeciate the iporance of educato an so suppor educato for chldre especialy grls wose eduction is often neglected
0 Lower bih rates and owe olaon row Wome wo wok are likely to ave fewe chldren hus povig e welbeng o each cild in the faiy as te icoe avaiabe per child ncreases
Ir ait t a igher levels of heath and educaton of cildre ead o a oe educaed ad healtier abo force i the uture and therefore to icreased aor product productivity ivity
0 ii ra t t he higer incoes earned by wok ouside te oe mae it possible to break out of the povery cycle.
at m w n ll of the above contribute to greater ecooic gowth ad deveopent 82
Income distribution come ditrbtion tend to be more uneqal LDC tha EMDCs, but there are ve broad regional variatios within both g oup of coutrie. Among the ELDC incoe irbtion tend to be more eqal i countres i at Asa Souh Asia ad the Midde ast ad North Africa and le eqa i conres n ain Amerca an sbSaharan sbSaharan Africa (thogh there are excepio whin thee geographical geographical groupings as well.
Why a igly nequtable distrbton of ncome s a bare to economic growth and development
A hil eual distibutio di stibutio of income measre as a hih i coeficie ca act as a barer to rowt ad develoment becae: due o ve low ncmes o many people it leads to lowe may reult in ower savings he ecoom parly becae people o eman for goods ad services prodce locally epriving the ve low incomes have ohg to save an patly becuse very hgh local ecooy of oppotie to incease ocal employment icome people ofe pen large amouns of money on expenve iporte ivesent and income, ad hence economic growth luxu good; by b y contrast, midle-ncome peope save the most i ivolves cocetaton of a large poion o total income the hans of a ew people euig eui g i exesive politca poer and govemet poicies that avo their own inerests i nerests rather than policies to comba povety.
i involves great greater er ovety ovety which is aociated aociate d with ower amounts of ha caital as vey poor po or people have low level of educaion ad health leadg to lowe ecoomic growth
it means that a larger popoion of the poplatio the vey poor) have no access o credt as hey lac colateral, resulng i ower ower investmet ad fewer oporitie to break ot of the povety ccle
0 it i more likely o geerae poitical iabilit ue to
widesprea issatiaction, leading to owe ecoomic growth
nfrastructue inasucture = phyical capal esltig fom invetets n socially a economically ecessary goods ad servces usually udeaen by
governmets they clu clude de transpoatio systes (roads railways, pos airpots), clean cle an wate spplie sewerage yte elecommnication inclin tee hone ad eer stems electrici a s
Te roe of infastctue n ELDCs
frastructre la s a ve im oat roe in both ecoomic rowth and develo ment i ve man wa s Fo exam le 0 nergy systems increae the rage of proucto mehod tha ca be 0 Reliable tanspotaion systems make t possible to powered by electricity or g reti i greate worke poductivity hey ead ranpot good and ervice o maket they ower cot of to reduced inoor inoor pollution aisig ro the burng of pollutig utig fel hey traporting thee improve ieratonal copetitiveess impove geder eqality by freeing women' and girl ime otheie pen throgh ower costs, ad a d allow easer access to schools schools ad collecg firewood ad caring water healh cae eice 0 Clea water supplies and seweage sysems improve the heath of the popuatio redcing pevenable illese, ad cotributin to im roved tadards o liv
0 Telecommca Telecommcaion ion permit eae ea e an ater commicatio commicatio improvig prodctiviy, prodctiv iy, and allowng di ecoomy (see p 88 to divvesicaton of the ecoomy vario activte cldi mafactrin and finacia erice erice
. EDC EDCss Ca enes face d b1 'nras tru ture n 0 Govenments un ino financng dculs
Govermets ote charge ve low prices (below cost) r ervice provided (electriciy water, ec) i order to make them aoabe to the poo which eut i isciet evenues ! Low revenues mean poo quay and manenance
sufcet bdget resorces and low evenes means many seices are i poor codition.
0 Thee s oen a msalocation o resouces between deen types of inasuctue.
Too many reources may be spent ceai types of sevces fr which thee i low deand ad ot eouh on servces that are badly eeded I i r r rl i t or example the e e of capita-inenive podctio podctio method a oppoed to labortensive reslt in higher pocton costs and lower employet
Low evenus means ack o o access y oo po po
Envomental degadaon ad unsusanale dveopment
Due to ow revee governments g overnments ote do o prove sevices to reote rral areas and urban lum.
Cotrucion may volve hgh emssions of polltats o may locae in ecologcally eitve area or there may be wateful use of wate uaita andls ool dese satation, etc
Additonal domestic factors ha aect aect economic gowt and development The topics i th ecion ("Aitioal oetic ator are not i te explictly the curret ylabus ylab us bt may be seul seu l or a broae destadig o development isses ad for aswerig HLP2 quetions on economic evelopment
Ineectve taxaton systems
The bulk of evenues neee by govermet to make ivetmet n n health ecato ratructre and oher area ipotat or ecoomc growh ad developmet come from taxes. Yet tae a a hare of D colected in ELDCs on the whole are abot ha ha the eves fond n MDCs art of this diference is due to low leves of icoe i coe in LCs ot of which goe o af consmpion need among peope on ow come bt in aditio tax revenues ae low due to he folow Coupon I ax colection, involvg rbes of tax athorties to ower the amonts tha mst be paid in taxes 0 Privileges and tax exemptions ofered o high coe people who exercise a lo of polical inlence ove the overnent
Ii l invovng compicated pocedre ad a lo of breacrac reli i iecieces ad tax evaion. 0 Very low popey taxes which o average are lower tha in MCs also de to political inence of high-income gops 83
The legal syste and property ight ightss The law and jusie jusie insitions mus be efien and fair w laws proecting human ights gover governing ning economic activiies and ensuring tha prope ights ar sure y rig invove laws a ensue lega ights o ownersip and sal/tansfer of ownersip om one ownr o anothe egaly secured prope s ve impoan fo a marke economy econ omy o be able fncion well we ll as in e absnce of is there is uneainy over the se of pope, creatig a serious dsinenive for eonoic aciviy such as:
� Lower investmen vesment is less likely o be nderta ndertaken ken if prope propey y righs re not secur as thre is a sk of oss of h bsiness and the value of the investmen.
I Rdcd cc cd Sue propey ighs mean at e prope can be sed as olatera thus inreasig accss to lons for investment investme nt uroses
! ack of bnts hd ps nseure propery rights to grcultal land m y result in the land remaining fallow, nstead o being rentd ot to lndless farers
Lak of poltial stablty olitical insabiiy is assoated wi s evens as requen elecions frequent cabine hanges demonsaions, sries, riots ehni or eligious tensions and ivil war A stable governmet which does ot display the above araeristis is ver ver impoan bease eates e ates favorable condtions for growh and developmen. olial insabilit resuls in 0 bsence of eective poicy-maing by he govenme govenme and instabilit, freqen anges and ak of coninuy in he forulation of eonomi poicies.
Oflow of financial capial to other contries (= caital flight) wih depives e ounr of resorces fo growth and developmen
Lower domesti nvestmen de uncetainty over uture economi poicy and he poiia siuaon
0 Lower nvesmnt by milatea poraions as ese reqire some ein over eonomic icy and h poiial siuaion.
Corruption Corrpion incldes su ativiies as bbes, extotion nepotis fraud and ohers t s monitoed by ranspareny nernaiona () whih ranks ontries around he world eve year arding o local perepio perepions ns of orrptio orrption n Hig orruption leves hold ba grow and deelo pmen beause 0 Mny paymnts w lk a ax, reducing onomic activiy beause it s a disinentive for investmen
0 Mci urc oten results as soialy ndesirable proets my be seleted over imporant merit goods
I My yn wrk i rgriv sine payments are a igher fration of incomes of he por po r than inomes of the rih.
I vr uny wd as nsstanable proets g throg de to te payment p ayment of brbes or o r oter vors
I Mn Mnyy g iv ivee ndivd r r govn govn whh wold use tax ta x revenues o provide soial seies, meri goods goods etc; bibes invove money pad tha is lost o socie
kn eadng o disillusionment i the ount and its
h e's cidence nd t us her gvn i
instions and o disegard of legal insiuions
4.4 HE ROE OF INERNAONA RAD m c cmc v c e-speaization on a naow ange o prods any ELDCs tend to spealize n the prodution and expot of a narrow range of prodcts, whih are sally y di di (= goods arising rom e fator of prodtion ld sh as agiculral prodcs fossl fuels mineals mineals etc Suc specialiaion has dangers and osales I nig vb chng cndn cndn wd dnd d y wih determine y determine prie wherea whereass ounries benefi in imes of risn g prices prices hey hey can be seriously ut wen pres of heir main exports fal fal resling in lower l ower incomes incrasing nempoymen, increasing pove, diffilies i n buying neded impos curen acoun deficits and ossibl risin deb evels
Th s a lac divicaon div icaon ducin d s an inreased range of goods and services) whic has nuerous benefis that are enirely lost se p 88)
Pre oaiy o pay poduts Pima omodiies ave low PED and lo PES, leding o o igy voaile ies tha cause shoerm uuations uuat ions in xporing ntries ntrie s erms of ade see he diagrams on p 76 S sudens sude ns shold also see hese diagams to note the large la rge fctuaions n rma comodi ies) Such voatile fuating) fuatin g) pes an have seious consequencs fo contries whose expos are dominated dominate d by prima omodtes 0 Unb ig as pries f exports ctuate 0 Unb c due o tuaing prices creang netany
0 Ngv c ncny n nvn aecing eonomic rowh I Fcn i lymn whch increases as ommodit pices se and dereases whe ommodty pries fal
I Unb y o wt negative efets on t crren account and balance of aments
nbiy h gvrn cnc cnc dvlm rc and to a out its ans and deiver on essenial seies
84
Inabilty to access iternatoa markets Many ELDCs face seros probems n acessing inernatonal in ernatonal markets for thei expo Reasons for ELDCs' poor ccess to ieronl mrkes
Cnsequences of poeco o ic-cotr ic-c otr rmers or te gobal eonomy and ELDC amers
Potectio of amers: gculua odt pre oors nd/o sbsiies i hig-ncome counes Hghincome conties provide her farmers with sppor in the forms of of pice foors and/or subsdes, resulting resulti ng n lower prces ( n te case of sbsides) des) Ths is one of over-production and lower the most impotant ssues peventng EDC access to rich-conty markets • ih ri i i n n The tarf bar bares es mposed by MDCs on LDCs are mch higher than the tarif baries MDCs impose on each other. E These are ih i sometimes even higher than the tariff arres mposed y MDCs Taf esclio = a practce sometmes sed by EMDCs involving the impositon of low tarifs on raw, unproessed primary products (sch as cocoa and cofee) and h highr trf on procd fnal good (x chocolate choco late fom cocoa and processe processedd cofe cofee), e), h s preventing LDCs om dversifying into processing and manuactring of food prodcs. Hdden rade protecio Recently new forms of protecton are appearing in the orms of increasing qaliy, fod saety and envionmental standards, as well as complcated customs procedures, ntended to discorage mpos rom EDCs see p 65)
Resources are msalocated o a goa scae Oerproduction of agctura products in MC farms reults n srplses that are dmped into gol markets though subsides. esultng low prices force some ELDC fames ot o business Poduction is therefoe shifed away fm ELDC farmers and owad MDC famer ii le LDCs ofen prodce aicltal products moe eciently than EMCs thereore the aove shi in production oward MDCs nvolves nreasing ineficency. ELDCs lose expor eigs owe volmes of actura ac tura podct xpo man l owr xpor anings anings pssily eading to cren account decits an ncreasing levels of debt Gete povery o ELDC armers he aove processes reut in lower expors lowe incomes income s ower vestment geater nempoyment, and more povey
Log-term Log-ter m changes n the terms of trade Deterioraton in the terms of rade over log periods of time s an addiional intenationl tade arre to growth and development i EDCs his has been expained on p 76
Trade strategies for economc growth and developent Import sustitto i also known as un ii, is a growh and trade strategy based on strog government neention nee ntion invoving eay protection protec tion o domestic dustries throgh tari tari s s quotas ssides etc intended to relace imos wh domestic roduction ssides
Hvng egun in Latin American countries in te 1930s it was very wdespread wdes pread throghou mos ELDCs by the 1950s ad 1960s Due o its numerous poblems, i began beg an to be abandoned by the 190s and 980s
W Many newly ndependent countries i the 1950s i l resulted fm � S i consideed this to e the t he way to modernie and "cach high trade arrers ptecting domestic indsties; up with rich countries. low competition domestically de to ow levels of mpots In the 190s specalizaton in prmay commodities excessive government inteenton intee nton in the economy nclding coniderabe was viewed with skeptcsm and apid instialaton government ownershp of many key industries, price contos, tax alowances based on manuacuring was seen as the escape oute. sbsidized credit, wae ssidies Use of he t idustry argment (see p 65) expos s de to ovevaaion o rrenes (p � We gcull d oe expo oeed advantages of apid growth of of heavily protected 69) in orde to facilitate impors of capal goods needed for indstraiation industries � Capitl-nensve poduco metods, believed to fster apid growth, led to see n as the way nemployment income inequalites Protection of domestic industry was seen inequal ites poverty, pov erty, growth o the urban inrmal sector to potect domestc employment, since trade baiers limit � i i li ir ir il leaing to the quantity of imports increasing food impos s wel as rural povey. Pacing limits on impos was considered o be a way � Balance of pames probems emeged due to impots of capita goods fo to avoid current accont deficts and alnce of indsty food imports ad prof repatiation o mltinational corporaons payments difficul difficulties ties � Low aes of ecooic rowh due to the above problems
.. .
Exo romotion export pomoo = a growh and trade stategy based on strong govenment interenton intened to pomote economc growth through through the expanson o expos
Following the difcultes encontered enco ntered by impo substitton substitton policies, many ontres progessively rned oward expo promotion whch was ighly successfl in prooting rowth and development. Ex China Hong Kng, Indonesa, Malaysa, Malays a, Tawan and othes the the Asian rs
m l i: • i i i ie; ie; parclarly clarly thos thosee that that were Iie r ri & were provided, intended int ended to able to contrbte higher vale-added t the economy see p 88). foster he development of high echnoogy at he sme time hat the necessary necessar y complementay skills wee beng developed developed S f in hr nil i • I Iin in li li ri ri p 61) nclding subsdes, investment gran ts tax exemptons etc. ensurig the transfer of approprate echnoogy, ensurig echnoogy, the caring car ing out nn nn in edcation, research and development and infrastructe communicatons and tanspotaton) of , promoting trainng and skill levels o local workers, and use o domesticaly prodced prodced npus • S ra ii ii b only only in ceain areas based o the nfn i aume 85
Strengths of expo pomoion staegies 0 Te ue of appopriate appopriate labointensive technoogies technoogi esed ed to efective ue o local laor upple and did not displace labor 0 nvetmen in education and kil mprovements mprovementscontributed contributed to imprved uman captal laying te grund s or broad-baed growth, povety alleviaton and more equal incme dtriution 0 Targeing of industes or growt and expot acieved dvesicatton a dvesica aed ed on higher_ higher _ actvitie contributing o increased employment, and gher leve of skill and technoogy (see p 88 wile avoiding the danger of excesve pecialization 0 Inceased expos allowed te expansion into ew markes allowing acievemen o economies of cale. 0 Inceased expot avoided curent account decits and an d balance of paymens probems providing oregn excange for te purchase of necea imoted inuts.
Dicul es o exo omoo sateies Dicules ere is a posiiliy of reource misalocation due o strong governmn interventon in he economy Strn dependence on expors makes te economy vulnerabe to demand onditon on in impoing counte; if trading patners suffe a recessio the exporting economie ae trongly aeced Te ucce o expo promoon polices led to t erection of strong trade barriers, since the 198s in developed countrie that ae fearul o loing domeic output and job job o foreign loe-cos competitr counre Te Word Tade Oraizato (WTO WTO,, p 63 87) nd te Wasio Coeus (see below fown upon the use of ndutial policie aed on trong government intevention herefore it unlikey tat the polices of the Asian Tigers can e boadly bo adly repeated in te pesent gloa economc climae
Trade libeazaton
ade libeazao = reducton or removal o trade baer (tariff, quotas etc) aiming aimin g to aceve growth o nternational trade based on the princple o ee trade; trade; global trade lieaization lieaiz ation is i s to be pursued trough tade negotiation under te leadeship of te Word ade Orai Oraiao WO WO ee 63 and 8
e potena advanages of tade ieraztio ae te advaages o trade ee 63) Specialaton of prduction and expots 0 Greater eficiency in product productio io due to increaed compettion according accordi ng to comparaive advantag advantagee increae production and consumption esuing in greae 0 Abilty o rm to acqure needed resouces global allocatve efficiency 0 More foreign exchange avalabe needed to Opporunitie for achieving economie o scae py for impo Greater coice for consume due to increaed 0 Greater economic growh due o al of the ipo above factos Lowe pices o impoed goods due to reoval 0 Greaer potental to reduce poey and income of tade bare. inequalities due to economc gow
ere ae wo hases of ade eaizato: he eary ae rom e 1980 Trade lbealiation became increasinly popular dung te 8, when whe n t began to be used as pa of a growh and developmen tategy for LDCs ased on make-ased sul sul se oce (s (see ee p 61) 61) tese ave incuded wtdrawal of govenment inteventon from economic activite trough such polices a privatiaion, deregulaion te impositon of limits on government boowing movig toward exible excange raes reduction of esrictions on activiies of multinatona coporatns
Cosequences rade liberalization, togeter with w ith te introduction of ighy pro free-maret polcies polcies in LDC, are l conoversal olicies. Countie tat beneftted ot fom te poenta advantages o free trae were mddleincome ELDC that aleady a an indutrial ae and had aceved some versication o their economies economies . Lowncome countre dd d d ot fare as well ecaue of ther nabiity to compete in goal markes lack of acces acces of heir exports to foeign markets (see p 85 lack of wel-deveoped instiutions needed fo the efectve functoning of makes (weak popey rghts weak legal systems weak banking and credit systems weak tax ytem) low levels o human capal needed to take advantage of oppounities oered y tade Many countries have moved towad lieraizng and market liberaliaion heir tade and economies including Bal India uc weaknesses led to: Kenya Si Lanka, Vietnam Vi etnam and many oe oss of expot sare in wold ade (ex Afican counre) inability to diversify into maufacturedpoducts maufactured poducts These policie have been eavily promoted y te Wasiton Coseus (Word ank, The increang income gap (ineualities) beween rich and poor countres increasng income neualt neualte e witin ELDC inernaional Monetary Fund (IM (IM e U limited eects on economic growh in many countries government all baed n Wangton, D.C.). slow f any pogres n reducing povery even in countrie ta experened grow Poices or eective tade ad mare lberaliaion he ate ae om he ate 99s o e esent 0 ELDC govenments shoud Growing recognition of te dificuties make invetment in uman capital formation (educat on and eah eah infrastructure, and experienced y many counre n e ealy R&D for the deveopment of approprate technoogies pae of trade liberalization tat was pursue poicie or alleviain povey and mproving income distrbution accompanied by stong market market lieralizaion lieralizai on pusue reorms of lega ax and bankng systems create regulaoy ramework for gave re to a new pespective that to be promoting private ector actvities and reducing corruption, for more ee ctive unctioning eective, ad adee libera liberazato zato mu be o f mark marke. e. accomaied b ovene iervento puue moe eectve oveace (se (seee p 3 3 focused on creating the condition neceary for 0 ich counte (EMDCs) (EMDCs) hould: hou ld: market to work wel whie a te ame tme remove the rong protctio of ther farme farme focusing on alevating povey and imroving lower taiff and oter rrr to impo from LDC income distribution make funds avalabe or te provon o oei ad n order to (i) uppo povety alleviation (ii) achieve the DGs (p 8 and (ii) develop necessary institu institutions tions in ELDCs neceay for te growh of ntenationa trade (see p 9). 0 e inernatonal community should support the WTO in arrving at deciion that are fair to LDCs LDCs
.. . .
. .
.
.
86
The role of the Wod Tade oganization (WO) he WTO' fncion and objecive were oted on p 63 Poteial advantages e WO
Crtcim
@ I can help in the proces of global trade lieaization I can help in reolvig dagreement and differece ewee adig paner avoiding dispues tha res in trade wars. I can povide a frum where all participating counre can voice er opiions and argue in faor o their ierests. By acievig rade lieaization, it can elp achieve a bete alocatio of resorces gloaly I can help counes aond te wold acheve loe cos (throg removal of rade ariers loe pices fo coume and greater coice o coume @ f purued ogeer wit wit approprate polcies for ELCs t can elp acieve economic growth higer inome and redced pove
Te Uuguay Rond tha ended n 194, e lat ound of negoiaions where agreemetss wee reached has agreemet h as een criicied for farg he Intere EMDC: 0 Tere relted larger tarif redctions in ELDC to the benet of EMDC reltig in poorer contries facing sustantial higer arifs o heir expors compared o EMDC 0 Noig wa done ao tari ecalation (see p 85 huing ELDC export 0 Tere was no ageement o reductio in sppo eceived y EMDC farmer wic ceate rade barrers fo ELDCs Agreement nt on intellecal proprty ight made it moe coly for ELDC to t o acquire 0 Agreeme new tecnology. 0 No requiremet tha multinatonl corporaon (MNCs) buy er pple locally wa impoed, eliminan elimi nangg a poten potenial ial oce of bene benei i for ELDC ELDC at ho MC (ee p 88 Te next ound of negotiations, he Doha Rond" was begu in 21 t nce 28 it ha been apparent ha WTO mebe staes ae nable to eac ageemen i key aeas including agricltural poection arifs on indria prodcts, and on-arif barres as a form for gloal 0 Thi failue has ceated mch pessimism on e WTOs ole asa rade negoiations negoiations and as give rse to e proliferation of egi nd ble rde geemes ome of ic do ot vr e rde grw d deveme neress Ds (se below
Re onal and bilatera preferentia tade a reements eore readg thi ecio you sould review e el dg bls (p 74). Thi ecion consider el consider rde a eemen fom the ecific er ectiv ectivee of EDCs order for paicipatig conries o enjoy the bees of free or freer trade ofeed by egioal and bilaeral rade agreemes while miniizig potential cos, cos, they mus have smila eves eoom nd echogi deveopme nd simi mke ize.
The falre of he WTO to concude a new rond of rade negoiaon (ee above has relted in a ve rapid grow of regional ad bilaera trade advat e o the enes enes of fee tade a reements b coures seeki o take advat
Such imilariies creae condiio for a cpetit If one paty o the agreement ronger the weaer pary wll be uale to compee i economically or technologically ronger due o he greater eficiencies, eficienci es, economies of scae, and echnologcal sperioriy of he ronger pary In ch iuations the weaker pay may sffe rm cloure increaed nemploymet increaed povey increaed i ncreaed icome icome ieqalitie, lower expo, greaer blance of paymen dificultie, an lower posibilitie or row and developmet developmet
Real rade agreeen
Thee are ally formed beween contries tha are in regiona groupigs geographaly geographaly close o each each oe fo exampe ASA AS A in southeast Asia MRCOSUR n an America, CAIS n Centra Ameica and many more he great impoance of regional rade agreements fo DCs i ta ey ofe em a way o of th e diema of how o nese he bee s ee de ee p 63 wie exps d ey e bees vdig he bsles de eed by pes les ones (ee p 8). he advantage advantage or all paicipating paicip ating conr conres es are greae e moe the condio condio for r mei oted aove, are met
0 Risks arse hen e condtin for for mpei ae not me potentily resuig i the mers egve eecs ned bve 0 Risk arie hen e rde agreemens encourage exceive exceive pecaao (see (see p 8 and preve preven n o dicorage diverificaio of producion ad exports 0 Frer rik are noed on p 86 nder Conequences· of trade liealization
ier de geemes Thee usally invove e hgicme ury MDC and oe ownome u ELC). One or oth o the wo panes in te ageement ageem ent may e a grop of contrie ci g s a ui ch a the Eropean Unon (E) May of ese agreemens are between partners tha are n eoraicall close to eac oer ilateral trade agreemes: ae o iees o LDCs ecaue ey an gai ace o the EMDC market ovecoming at leas some of e arrier impoed by MDC oen come wit conditions ha e EMDC wi provide the ELDC with or f eign eign d (ee p 89) in fd or fd upo of varo growth and deelopmen objectives ex ex bilding of choo, infasucre det eie and moe.
B atera agreemets are commony citicied or creaing major riks or ELD C: 0 Tarf redction o he import of EDCs from EMDCs are ofen grea greaer er than thoe required by lager WTO ules ceating ris tha eve efcien ELD irms may cose down, as EMDC irms are lager techologically more advaced, ence more ecen 0 Tari redctions made by EMDCs or EDC expo may be greaer for pima commodies encouraging EDCs to ontne o specialie in rima good prodcio prodcio and expor hs makig i moe diclt or them to diversiy ther producio into proceing nd manacung 0 A a ingle EMDC (ay e or S) form any blateral agreemen wi diferet ELDC these nd themelves in competiion w each ote for he same marke ad their gow of expots may be limited 0 Bilaeral agreement preven LDC fom joiing foce foce and preenting their ineret in uiy as ey cold within e WTO greatly weakeig their bagaiig power 0 The agreements ofen impoe codtions ha are ot in hei favor (ex givng greater freedom to mltinatonal corporaions origiating i the MD). 0 Biateal agreemes can work aganst the t he efctive operation of regional agreemen among ELDC ELDC oe make both regonal and biateral bi ateral agreement) nfair comeitio ma esl in he umeos negaive efect noed above 87
Diversificaton diversiifca divers fcattio a broadeig of te rane of goods and services produced and expored; it is te oppose of speaizatn, and provides =
protection agast te dawbacs of excessive specializaton (p 84) as well as advatages for growt ad developmet Diversification of poducton ad expots oers numeros advatages to LDCs: 0 it povides oppouities fo increasig and maitainig igher expo levels in proucs enjoying sustaed reases these inds of products are manuactured goods goods (ot pra pra commodities 0 it avoids the probles of excessve specialation n prary comodities (see p 4 0 HL topic It avoids te poblems of o f log-te deterioaton i te terms of tade an sho erm luctations n te es es of trade (see p 76) Expasion io poducts wth ige vale-added (= vale which is added to unrocessed goods afer tey udego pocessig ex ocoa in te form o cocoate has a hgher vae tan raw cocoa) povides fue potential benes because it 0 creates new obs as workers ae needed to perorm te processing 0 creates new loca busiesses carying out manacturing activities 0 encourages develope of sills a tecnoogies to suppo te broader range of prodcion 0 uses locall prodced prodced prima qoods qoods as the bass of o f expanson ito rocessiq ad manacturi
Divesificato of proction and expos ay lead o loss of he beneis of specialzation in prction and expor of goods arisig f a cout's abiliy to poduce at lower eative costs than its trading paes (coparative advanage loss of improvemets in allocative eficiency risng risng from specialzaion here ay be dificltes i overcoming baers n anufactured pouts posed by EMDCs (suc as tarif escalaton
4.5 THE ROLE OF FOREIGN RECT NVESTMEN {F) and s in i ) ) nvestet by a rm origiatig i one cont (the ome count) in i faciities in i n anoter contry (the host county), caied ot by MNCs u n it porolo nvesment nancial investent ( prchase of stocs and bods) =
=
W Ms xad into ELOCs
.
expectatio of greater sales and proits avoiace of tade barriers mposed mposed by LCs by poducing wihi their boundares low costs of abo i EDCs use of raw aterias at ae localy poduced avoiding traspoatio costs ivolvemet with extactio o natua resouces tha soe LDCs possess (ex ol inerals
lil (MNC MNC)) a fim that carries ot foeig direct ivesment ths havi prouctive ivestmen in more tan one couty =
ELOC caacteistics tat attact MNCs
.
lage arkes, because of te expectato of lage sales poitical ad macroecoomic stailiy exectatos of apid economc rowh well-develoed ad well-fuconing infrastrcture (transpoation an telecommunctos systems) a welleducated ad silled local abor force low labo costs wea abo nons
a free-arket ecoomy wit ltte goverent gover ent itevetio itevet io liberalized trade (to facilitate the se o imported iputs istitutos advantageous o FOi ex welfuncioig lega system wt song popey rights favoable tx aws freedo o repatiae pots pots,, weak evironental proecton
Advantages and dsadvanages of o Ds Hw F ca beneft OCs
Wy NCs may ot ent EDCs ad may eve am tem
Tere cold be a greaer oulow oulow ate ha iow of eig exchage, de to 0 by increasing ivestent, whc may be low in EDCs due to isuficiet savngs pot epatriato (p 39), a wel as impos of inputs rere d or prodtio. prodtio. 0 by icreasing possibly low oregn exange mploye opponites may not crease sgificatly n te evnt of use of earings sice te nflow o funds for i appears as a capitalitensive technoloies and if aagerial, administrative ad tecnica staf rdit in the aial aont of the baace o are id from th o cunt payments ocal skill evels may not iprove if the iks bewee te MNC a e local 0 by providing increased employe opporunites ecoomy ae ve sal o r if podction maes use of ony nskilled abor 0 by poviding oppouities oppouities or trainin o f the local If iputs are pucase rom abroad beefis fo loca businesses d labor orce anufacturing are unlkey to maerialie 0 by biging in new tecnology, wic ca elp i Tere may ot be geaer tax eveues for the governent, de o ax breaks iversficaio o nto aufacuring and ecoomic ofeed by te govement as well as the practice of r rici MNCs lowe growth. their declared pots by byig iputs fro aflates abroad a d declarig gly inflatd costs akig pis appa lowr than ty actally ar 0 by omotng local businsss and idust by MNCs may have too uch power leadng o nappropiate poicies poicies MNC power buyig locally prodced inputs 0 by poviding te domestic goveet wt greater ove te hos couty govenment ay ead to • se of omestic budget budget fnds to buld buld infrastructr infrastructree eeded by te te C and ot ot tax revenues. by e loca popuation 0 by impoving infrastructure euired for their pa pass ss weak weak labor labor pro protec tecio io laws aws fnctoning, thus also benetg the doestic economy. pass weak enviromental protectio laws 0 by icreasing expots. MNCs ofen engage in productio meods that case serios evionenta dstrction and lad to unb ln (p 22. 0 b icrein economic rowt I view of te above, FOi is a ighly corovesa topic n e whole it is likey at it contibutes to economic growh and o ths reason LCs copete amog eac other to ake teselves attractive o NCs
Because of the merous potetially negative eects ths copetito as bee termed "the ace to the botto sggestig that LDCs col be sacrifcig elemets of economic developet, as well as sstainable deveoment, or the sake of achevin econoc rowth troh the contributions of MCs 88
4.6 THE ROLES OF OREIGN AD AND MULAERAL DEVELOPMEN ASSISANCE
Foreign aid foregn d transfer of unds in the fr of loans or grants, or ransfe of goods an seices as gifs to EDCs i orde to hep them acheve economic or social objectives ad is non-commercil the transfers dont involve buyng and selling transactons) ons) and s coceol lons involve lower than market interest rates and are iven fo long periods o ie =
ed d = condions on the borowing county imposed y bilateral ad donors (see below) requiring hat at leas a potion of the borrowed amount must be spen to impot goods and sevices from the donor county
Who are the providers provider s of a Govement of doo countre; this aid s kown as Offc Deelopment Atace (ODA ODA)), and reaches DCs in the orm : blte d ad going rom one door to one blte ELDC recpie count, o • mutlte d aid going fo donr coutres to DCs hrough internaonal organizations such as various United Naions aences, and ma others
Nongovenmen ognzo G) oganizatons concerned wit romoting objectives hat are in the publc inerest ex OXFAM Anesty nernatonal. GOs are inceasingly impotant as providers of aid; they are involved in a vey broad vaiety of deveopment effots, ncluding technical assistace for armes, education nd health sevices support for urban infrmal wokers mico-credit, rights o women human rights suainable development and any more. Tey ave a trong anti-povety perspective hey work closely with local peple, have a cear understanding of their proles and have generally earned the trust of hose hey t o help N GOs in LDCs umbe in the tens of thousands as they are mall n size and mosty povide aid on a vey sall scale
. The d"1s m,on b et ween h uan' taan a,d ad d eve opent opent a,d un d aid extended in u areas whch are experiencng emergenc situations due to crises caused by wars r natural disases and consis of dono of food, medical assstance, andd eergency relief incudig provision an of shelters and suples =
deelomen d= d= ad exended to LDCs for the uose of assistin them n deeoment
.Development aid consists of (beow marke interest rates perods); . extended(gitsor on hat do not need to be coceo coce o og ogerm on
gn
evelopment aid takes the orm of poject d aid for specfc proecs e building hospitas irigaon systems schools et pogme d aid in suppot of whoe sectos of he economy, ex education, healh care, bankig etc
repaid
W1y EMDC s are mof,va ,vated t o prov,d ea,d lil l il n Aid may be rovied to suot counries that are poltically and ideologiall friendy o EDCs such as the United Sates and he Soviet Union during the Cold War, which provided aid to their respective alies
Aid may be povided o suppot economically less developed economies that have srog economic links wih the donor country, such as trade and invesment invesm ent links if the th e recpient county experiences ences rapid growth due t o the aid the donor county is likely to benefi due o the expansion of its own arke arkess ad exos o the rcipient of aid.
Aid ay be provded prov ded out of feelings of copassion or th plight o poor people iving under vey harh conditions For
Eva luat ing the contbut contbuton on o oein in ad toeconom toeconom c develoment ment Why d eenl
0 Aid can help vey poor counries or vey poor communties wihin countries t emerge fom the poverty trp (p 78) 0 t is uite impossible to achieve the Mll on Gol MG MG
( p 78) without ad 0 According to Unied ations orgaizaions hee is srong evidence that by ncreasig investment, aid is linked wih higher growh raes 0 Aid helps in povert alleviaion through impoveents in educaton and sills reducing prevetable diseases and impoving levels of healh impoveents in infrastructure, developen of siple appropriate technologies empowering poor people by helping them nd employent 0 Aid helps hghly indebted countres obtain debt relief see 91
.
W d m be eece Pobe g from e de o donor countre:
is far less efective han utied aid becaus e it Idoes no alow recipient countries to search for low-ce upplir does no alow the o io goods that best suit ther needs someties orces them to mpo inapropriate echnologies. Ted d
obem rg o he de o recpe contre
Ue of d fnd i plce of dometc bdget fnd
defeats he oin o aid, which s o suplemen doestc budg funds ay weaken governments' efos to refm their ax systems, whch would allow for inceased doestic revenues. I Ad y o rec te
Codtol d aid granted on condiion that the recipient countries pursue paticular poicies usually marketbased supplysde polices) oces reciient countres to pursue obectives that ay be more in line with donors piorities and tha ay be inapproprate fo heir econoes ntended beefcre I l f fd due to donors' changing budget priorties, makes it dificult or recipient countries to plan paticualy if goernens are not commited t povey efective use of the funds alllleviaton eviaton and he aid funds 0 i nrfne te due to ve ae spent elsewere arge nubers of donors and acvities, mean that effecive lanning s not possible, while actvities are a rele relection ction o donor Corrpton n the case of aid is an additoal reaso reasonn why priorities. he result involves duplicatio of so me projecs with aid funds may nt reach the large gaps n others, and a significant wase of resources intended beneciaries
89
The oles of aid and trade n economic deveopment . hree st rads of t h oqh t ca ca b e d'scerned n the debate over the merts of ad versus rad e or o r economic d eveloment: Tade not aid
This pespective ocuses o he factos that lim the effectiveess of aid claimng that it is a waste o esources because it has ot succeeded i solvig the probems o LDCs i spite o vast sums havig bee spent on aid ove decades. Rather than ely on oreign aid LDCs should focus o expanding ade which provides umerous beets, through which it will be possible or them to acheve both eoomi groth ad develoet
Aid and trade
Aid fo tade
This pespective pespective cses on he i deas hat many of Ths s a reatively reativel y ewer persective accordig acco rdig o the factos that limit aid efectiveness are the which ver poor EDCs must e ofered ad oder resposibiity of donors ad that whle trade is to help them buld p ther capac to ex pot impotat it is o enough. irst, thee are difficultes Difcltes in expoig that originate i the domestic i expanding trade due to rich county potecioist economy iclde poor rasporation systems, polcies second, eve if rch countries were to weakesses in power generati generati (which icrease abandon these these policies polic ies trade wold wol d stil be nabe to production coss), nabiity to acess sufice credt sove the probems of gowth and deveopment, istitutional weaknesses in the ablity to meet because may vey poor conties have litte o hygiee ad ad technc techncal al standards complicaed expo and because soe communities ae so bureaucraic procedures al leadig to lower expors geogaphically soaed hat they are nable to get ad therefoe a iabliy to maxmize he poentas their goods to markets ue o pohibitve that tade has to ofe. Ad shold be ofered to help tasporato costs herefore aid is ecessay fr MDCs overcome sch probems Ths aid shoud be i additio to ot i place of, aid nds for povey many easos icldig achievement of the MDGs, beakig out of the povry trap fr ovey aleato etc aleviaton ec
Multilateral deveopment assistance to ELDCs y teational oganizations oganiz ations sch as the Wod Bak o o achieve achi eve development objecives muliatea l deve muliateal devell opmen ass assstance = leding to on non-concessonal ems (at maket ieest raes and market repayme periods); this should be distingushed from foegn ad (which is concessiona) Multilateral lendin cossts o: Mutaeal developmen banks, tha ed to developing outres in order to assis them Ban; others i their gowth and deve developm lopme e efforts the best known o these is he Wod Ban;
iclude the African Develo Development pment Ban Asia Developm Developmen en Bak, IerIer-Amerca Amercann Develoet Bank.
e World Bank
he Inernaiona Monetay Fund (IM IM)) that
moniors the gobal fiancial sysem and lends o governmes tha are expeiencing dificuties in makin thei iterational makin iteration al aymets
e Intenatonal Monetay Fud (IMF)
acground
Backgound
The World Bank was esablished aer Wold War I with the eto of leding to Euope for its recostructo . In the 50s i turned its aention to ledng to LDCs i orde to suppot economic groth and development Is eding the early yea rs focused on infrstructure developme (ex traspor, energy, igaton, communicatis), folowed in the 970s by a parial tr to povey alevation (ex healh, edcatio water suppies, saitaton, saitaton, employmet). Sice then o brad phases can be dsngushed in its approaches corespondig vey closely to he two phases of tade liberalizaton (see p 86):
The MF was established at the same tme as the Wold Bank after Word War II A that me, he global ecoomy had a system o xed exchangee ates exchang ate s (p ) and the Ms prpose as to ed to coutries facig baace o payments problems (iablity to mantan the xed rae due to deficits). In more ecet yeas he IMFs mai responsibilities iclude montorig the global acal sysem ad macroecoomic poicies poicies of member states, and eding to coutres coutres tha have diffcutes makig ieratonal payets through shorttem loas at market iterest rates
Maeased suppyside ocies: Suctura Adjusmn Loans
Saization polices
In the 190 the pogram of "tural adjutmet oan (L) heaviy iuenced by market-based spply-side policies, had the objective to reduce goverment iterveto ad make C ecoomies market-based Leding became niil o adoption o policies that ibeaie tade, pivatie remove pice cotrols cut govermet spending; these were the policies of the Wasngon Conensus (see p 86) SALs were sharpy criticized because of ei ambiguous eects
Lendig by the IMF t help utrie make intrnationa l paymet is aso dl o the adoption of specic policies, kow as stabiiation polces. hese polcies ae generally contractonay ad are inteded to help contries hat are unabe to ance (pay for) their crrent account deficis o able to make payments on their debs. As a ue they ncude he olowing Contractonar monea policy ie higher ntees rates the objecive s o lower aggegate demad reuce impos (hece the eed fo oreign paymes), ncrease nfows of nacial capital (hece improve abilty to make foeig paymes) Contractionar scal policy iceases in taes i mposition o fees for schools and heah cae ad cuts i govenmet spedig icldng spedig o edcaton, health cae ad ifrastructre Currency devaluatio/deprecaton to reduce imports ad increase expos Wage cuts, o reduce spending Marketbased spplyside polcies ex tade iberaiation emoval of pce cotrols etc. The IMF is more contoversal tha tha the Wrd Bank because
on gow wosenng income distiuon nceasng ovey negave eects on heat and educaton (due to cus government spendng) and on he envonment (de to negec o envonmena susanablity) and genealy, faue to omoe deveoment Deveopment of maets w govenmen inevenion
I th mid199s th Wold Bank rnd again towar d povry alevatio with a ocus on the Millenim Deveopmet Gals aog with a evsed view on he roe of governme In ths vew goverme goverme iteeo s esseta i (i) ceatig he ecessa coditos ad istitutions for makets to wok well, ad (ii) povidig spp n aeas icluding heath care, educatio infrastructre cedit gener eity, sustaiabilty appropate echology development, income redistribtio.
.
such poces ave vey serous negaive eects on empoymen povety and income dstruon.
� Both the World Bank ad IMF are criticzed for the ollog the polcy of conditonay where lending s condtional o the adoption of paicular poicies whch in efect deprive the orrowig count of cotrol over ts domestic affars the corol o ver the govering bodies of both istitutions by DCs which coto votig owe for he eative efects of the Wold Banks SALs and the IMs stabilizato oicies on economic deveome he oor ad sstaabili in EDCs 90
4.7 THE ROLE OF INTERNAONA DEB
th a have bee borrowed by the govermet ad te private sector from foreign sources ad are owed; the oreg deb = the amont of funds tha problem proble m of foeig debt arises arises aily aily becaus becausee of gover nen nen de o orei oreig g reditos redi tos
The problem of foregn debt
Goveents borow from foreign soures paly in te form gn (p 89) or o sss p 9 ad also in order to aqire foreign excange o o aon i usually aisig wen ipors of goods and sevces are greater than expors of goods ad sevces e poe o oeign iss iss o e ee o a a ur o s s
When a goverment borrows from foreig sources i must make interest payments i addition o repayen of tee borrowed amou These payments must be made in t g exchange, which ca ome from grea greater ter exos, fewer ios or more borrowiQ
How the debt roblem in ELDCs orgnated The deb probem bega bega i 197374 when OPEC (the Orgaiaio of Petrolem Exporing Couries) abrptly and massvely increased oil prices (the rst oil price shoc) Countries that were ol pores suddely sudd ely faced uge ug e io epeiures epeiure s At the th e same te, ey also had owe exo revees becase the oi price increases led to recessions de to os-sh aio, causing EMDC imports from ELDCs to fall. Te cbiatio cbiationn of lower export revenues with higer impo expenditues ed to ve siable urr ou ds ad ence to the need to borrow to pay fo e decits. decits. In 1979 1 979 here was a secod oil pie shock wose cotractiona efects were made much worse by hg interest rates initiaed by he Uited Staes o corol nflaio, and followed by oher ajo coutries leadig to a major global recesso i the early 1980s By he, the massive debt leves accumulatedd by a number of EDCs (maly in atin accumulate Aerica and sub-Sahara Africa ad become unsustaiable Almost banrupt, these coutries were foced reqest assistace for the IMF.
Te major actors ad ad er roles atat hat tme: OPEC ounes ud themselves wit huge oil expor reveues, which they deposited i arge commecial comm ecial banks aroud the world. These banks, wating to make use of te extra fuds bega ledng to to ELDCs in a prcess hat ame to be kownn as "petrodolar recycling'. kow recycling'. s encouraged petrodollar recycling, because tey saw i as an opportuity to reduce teir spen spendig dig o oreg oreg id ad deveope ssis ne. e oer aks wantig to lend as much as possible, were careess in their lending practis and did not monitor he borrowers s ndig ndi g it easy o borrow fo he banks, ad havg a free hand in ow they spet te boowed oey spent par of it unwisey (e o mata low tax ates and oor tax colecio colec io systems to suort ineficie ineficie bc c enterrises T 198s wee the ime whe mr mrkkt-bsd suplysid olcs ade their appearance (in fact suply
ter populariy was greatly increased by he nability of eandsde polces to efectively deal wih osts ifo, or sgo) These polices were the inspiratio of the t he orld Baks Srctal Adjstment Loas ad he IMFs ·stabiliaio policies see p 90 which were initiaed durig this perod ad were consdered to be the cure to he rolem ro lem of o f foreQ debt.
However as noted, these poiies had ighly damaging eecs o ECs as they worked to dee deepe pe te recessio increase nemplomet, wose povery ad come distribtio, ad cause a tremedos amount of uma sfering
Consequeces o hh level o debt . ects ts ofW0rlrldB ver ad abv e t e ec dBank and lM or· ces h evesI o de bt ave ve senous coseuences for h debed EC s ice debt repayes and payment f intees (debt Tere ae ajor oppotuiy sts of debt seiing, as te governen has less fnds available to ves n esseial nfrastucure nfrastucure educaion servcig) us be made i foreg excage ere less is o i available o impo esseial goods and srvices and inputs fo health cae ad other iporat social sevices needed for povey alleviation prodction. rivate investe may be adversely afected de o neraiy about he future of the th e ecoomy negatively afectg log term economic growt
A db ta may arise i which deb levels are so hig tha it is ecessary to go o borrowing n order to repay prior debts
Lower ecoomc growth reslts not only on accou of lower private lowe govenment investme n ha capital ad ivestmet, but also lowe reduced abili o o imo im o eeded inuts
Lower ecoomc growth affects the abilty abilt y to repay debs as with ower growth fewer fnds ae available fom which debt seici ca be ade
Debt aellaton n heavly ndebted ELDs Debt reshedui versus deb cancellatio deb resedig ( deb restuctring exteding ew lans wt loger repaye periods and a lower iterest rates wic are hen used to pay back e older oans his makes i easie or the debtor to ake te loan reaves us inerest
he Heavy Idebted Poo Countes Itatve (HIPC)
bt caclti ( debt forgiveness cancellig a porton of debts so that te t e amout tha ust be repaid is redued debt cacellaion is a sronge om of dbt relf ta debt rescheduln
This is a initiaive begun i 1996 by theWod theWod Bak ad IMF intended to help vey poor poo r countries hat are highly indebted, and was spplemented spplemented i 2005 by the ultilateal Debt Relief Iitative (MDI) i cooperation also wh te Africa DeveopmentBank DeveopmentBank Debt relief uder these programs is available for countres wit a GNI pe capita below a particlar level, and that ae in a deb trap (ve nssainable debt). Deb relief is codiioal upon (i) libeaizig er arkes, ad (i) prsig an anipovety anipov ety stategy, i.e. te fnds f nds hat become avalabe hough deb reducio mst be spent o combat tn ove v Th program are a morta Soe very highly idebted corie do ot aify for The lev of deb reducio coribtio to rovdinQ debt relie assistace. rovided for ma not be enouh. The programs are commedable for The pograms take a long te to Soe market liberaizatio liberaizatio conditons may ot be teir antipovery approach approach take eect ad contries c ontries slide more appropriate (ex charging ees or ospitals ad scoos, cutin overnment sendin on social sevices dee io debt i te meantime 91
4.8 THE BALANCE BETWEEN MARKETS AND INTRVNTON valuatig market-oiented poicies Market-oiented olicies are bas on the iea that markets marke ts ar th mot fective way for ELDC o grow and evelop.
Strenahs
Weknesses
0 Th market allocats rsourc ficinl, maximizin Market faires do not allow the market to achev allocative eficienc; social surlus throh the fnctinin of rice a sinal market failure tend to be far r romint in DCs and incentives he market fal to l ecto hath care vic and 0 Cometition bewee irm force them to be more infratructure (merit oos) that are i xtrml ho sl in LCs. efce lowen costs of rodtion at the ame time that h markt fil to rovie aaint envionmntal radation ad qual i imroved. unutainabl dvelomet whch sevee affect EDCs 0 owe cot of octon emit lowe rics which a he markt canno funcion wll when there are wak market-sorin n th ntsts o consmr a wl a irm becau of institutions sch as eectiv leal tax and fnancial bankin sctors owe int ices The market leads to the evloment of dal econom 0 he makt ncreae choc he maket leads to lae urban nformal ctor whr workes ive in 0 he market rovides incentives such as hher incoms qaid conitions and hav no social otction b h tat. and roft hat ncora conomc activit adin o h market leaves ve oor ol wiho access to credi ratr owh The market doe not hel commuitie bak out of th ovrt ta 0 Polc that cora comtition ivatization Comtitonromotn olic x rvatizaton) usuall increase drlation tc) alow rm to oerat in a ore cometitive nemloment addn to a ve lae uemloed labor force. evironmnt lowerin coss of rodction and incrain abor mark reforms lead t reatr worke necrit and lowr was allocative efcnc whn income are alread ve ow 0 olicies that romo labor markt reform encorae the rad libealization libealizationolcies olcies orce DCs to rmai xcsivl secialized workin of mand and in the labor markt lowerin and do not ecoura divrsifcation. nmoment and frms' cost of rodction rade liberalization mean tat man rms vn cin on wl be 0 Incentverelated slside olcies ex lower taxes forc to close down ue to thei iabit o comte with larer more rovide incentives to work mor and invt mor ncain technoloica avanced EMDC frm rowth. As a rsut of the above acrs lo of worker rotecton hihe 0 Trade iberaliation olcie alow m to o cii mlomt rm clor low lvl o ma catal t ov econome of cale and increase comettion leadin to al tra inabilit to acc cdit) t market ma lead to incrasin icom th bfits of incrad comttion notd above inqalites 0 Fr oatin xchan ra a ooed to xd h market can do li to alviat ovt. xchane rat) allow the marke to solve balanc o h markt ma no a to ihe economic rowth esecial i countre amnt robms automatcal b allowi xchan rate that are v oo a have reativel wak markeoi ititutio to rond to crrnc demand and spl
auaig eeioi ie Inntionit polic ar bad o the idea that ovement ineention in the econom ncesa to achive gowth and dvlomnt
Srengts
Weesses
0 Govrnmnt olice a esetial to corect marke failres 0 Governm Governmnt nt olices can be b e esined to increa increase seth th rovsion on of mt ood dcaton halth a infrartr). 0 Govement oici are nd to vntnvironmnta vnt nvironmnta eradaon and to omote sustainable develomt 0 h ovmnt can ena in R&D fo the eveome of aroiat tcholoi 0 h ovnmnt can tak action to cate nstttions tha are esential or the roer functioni of markt (rot rihts ctv tax and bankin tm etc) 0 Govrnmn olci can atmt o rlat th informal econom an ovide rotection o vlnerable worker. 0 h ovrnmnt can r u macoconomcolici macoconomc olici that aim at achivn a favorabe evironmnt (ow ination low nemloment that is favorabe o rivt invmnt 0 The ovrnment can rovie a cil et net = tranfr aments of varios knds to esre tha eole do no fal blow he ove line 0 Th overnmen can rovide come redstbton olici in favor of ls incom inqali 0 Th ovrnmet can rs industrial polcies a t of iteventoist suside olc) in suo of firm that ned aitance o row a becom omtitive low-inteest loan subiie tax break etc) 0 he overnment can rovid rade otcton for inant industre and to assis DCs diversi odction and exots 0 he overnment can itevene in foein exchane markets b fixi exchan ates and reduci unctaint r riva nvtmen.
Govenmt olce eqire e of bd fuds whch ar suall in v hot l in DC entailn ae ootuit coss in eve kind of ovrnmnt xnitur xnitur h cac o bdet funds means tha overment un h rik of rnin lar budt dficit and dbt in orr to met the dmands bi mad uon thm Th carct of bde nd alo man that it i vr ificult if at al ossible or ovrnmnt to ndak al th activiti that a ociall diabl in C (hea (h ealtlt care inrastructue ocial safet net etc Govrnmnt a ofte ineficient as the do not ace the incetv to be economical in reource u o as to euc cot and maxim roft. Excsiv bracac too man comlicad u n aminstrato) leas to her ineicici Government intevntn in ceain rms (trade rotection ric contro in th form of rice floors ca rotect iefce rouce leain to ieicece in the rivat ecor xcessiv overnmnt nteention n the mark too man or incorrct ali indral olice oveaud o uervaed xchan at xcv overnment owrsh of irm ec eads to major alocative ieficiences Macroc Macrocoomic oomic olc ma be imrudent imrudent eadin to hh h h ination ad lare ubic debts whch dicorae rivate sector activit Govements are ofen sucetbe o oliti ree b elite ros that inlunc olicmakn n thi own narrow intrt rather tha the inteess o soce Government and overnmentovidd ic ma be uscetibl to corution x brib to u cono conomic mic rojec or brb to rciv hath car erices) rulti in major allocativ inefciencies waste of resources a far distibution of oods and evices 92
Striking a balance Three peiods: peiods: three perspectives Sie the 1950s, we eoom deelopet irs becae subje o teres ts ow rg tee te e ae ee tree perods o te eah marke y a ere oreao ore ao o he aproprae roles of goverments a arets: 1950s o h 1970s
980s and 1990s
Ipot susttuto poles, olowe y epo prooto, were oth ase o sro oerme oerme inio h cooy, wth mte role or the ret
Te lerlzato poles togeter wt ret lerlto were oue o maret-as supply-se poles, ouse o lm h govn's rol favor of r ak forcs.
Lae 1990s o h prs
Te experees o the pst le to a osesus that the govrm an arks ust col ac
oher The rate etor soul e lowe to uto lrgey org to aret prples, wth te oeret o tsel to what the aret ot do.
An approprae ole for governments ELDCs Aeas tht goerets shoul e oled wt lue orreto o ret lres roso o et sees euto rstrutre pooto o R&D eeoet pope eolOY proteto o the eroet suppo o sustle deeloet
proso o a sol saety et oles to ree oe oe eqtes proso o ws poes to rote geer eulty proso o selete ustra poles sppo o sl eu se rms, a at ustes, ldQ sor or ersito
he ole of good govenance n economic development rn = the proess o goeg, whh ole the eerse o otrol a athorty; a org to e Wol Ba goo goerae "s
soyous wt sou eelopmet gee
Goo goerae ss potat eoo eeloet eeloet eause t pootes aoualy ress a trsparey o goermet ttes s esres o he oe ha that the th e goere's ojeves are lely to e arre out more eetely a eetly, whle at the sme te t t spres repet or oidee te goeret a ts ttutos o the p o tes nd nd eoo esoaers, us ag ose ee o te pae o eoom att
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GLOSSARY OF IMPORTAN ERMS
Microeconomics SL terms (coe) ad al a an idrect tax tat is a percentage of the price o the taxed good resuting in a steeper S cuve amount of tax as P
facors prouct rouctiion on( ( = sou soucs cs))= inputs used to prduce al goods ad sevices that people eed ad want ( land land ab abrr, a aiial al,,
alocation of rsoucs assigning paicular resources to the production of prticulr goods d sevices; realocaion chngig the llocto of resources ovalocaio o rsourcs too many resources ae assgned to producton cusing ovpoduction;
f ridr pob occurs whe a good is used without payment users tae a ree ride"; cosely eated to ldabil ldabilii where someone cnot be excluded rom usig good ex lgthouse)
trurship t rurship))
naloai o r = too few resources are assigned to production cusig rtn; iallcai wrong lloction of resources, causig la alcat iin
i aii an E E))= responsiveess o demand for good t changes in icome abbeviated as Y) = % chang i iQ demandd divded by % change i Y
alai i i = the best llocio of resources from society's point of view, whee MB C, or n case o exteralities, MB C
idr ax ax xc xcse ax) ax ) tax o spedig to buy goos d sevices, paid indiecly to the governmt though the sellr
a a ra = see aab i i
irir d= d= demd for the good s cosumer income , d vice vera ex ower qulity goods lie used cars used cothe: a icome1 shifts let) a income shifs right)
aal = ia aa) aa) mhines tools equipment factores ll costructio icludng Iau au a ta= ta = a tax on carbo dioxide emissios of fossl fuels
jin ppl whe two or moe goods ex butter ad sm mik ar derived fom sigle product whole milk) it is ot possile to poduce r o oe, ex butte, wthout poducing of the other ex ski ik f the pice of bute rises Q of butte produed icreses (upwrd movemet og the butte S curve) d S of sim milk icreases (S cue cu e r skim mlk shits right). righ t).
an nli= nli= techologes that reduce negative eviometal efects of poductio n a rur rur natural resources without ownership that ae no radd i a market wthout a price, ad ca therefore be used freey by ayo they th ey a -- xcluab xcluab ye rvalrous
labr abr= = all hum efort or work tht goes ito producin goods ad sevices ex the work doe by teachers builders, lawyes, plumbers)
comptitv su supp ppy= whe two goods use the same resources, ex oios d potatoes gow on the same agricutura ad the prce lan an= = ll tul resources tht e bove the gound ex forests of pottoes the Q of poaoes poduced upward movemet alog rivers aricultural lnd ish n the sea) ad al atur resources tha potato S cuve) nd the S of onos S cue f onios shifts eft) ae uder the groud (ex ol atural gas minerals)
ln( ltar d) ln( d)= ds that a usd together, ex sugr nd cofee; tenis bls ad tens rckets: as P of good A D for good U (shifts e); s o good AU for good (shifts ght)
law an l sg ht th s gtv csal reatioship bewee r ad ua ) of a goo demnded the highr the pce, he lower the quanti demanded th lower the price th geaer the quatity demanded
consumr suplus = benef receved by cosumers who buy a good
aw of supply a aw stating that there is a postive caul elationship bewee prc prcP) P) and quatyQ of a goo supplied
py= the re under at a prce lower than the price they re wiling to py= the demad curve up to the prce onsumes pay
the highr he prce the higher th quantity suppid th lowr the price th lower the quntity supplied
coss c asticity o man (XEO)= resposveess of
B the additional beets derived by arinl bnfiMB consums from buyig/cosuming an dditol unit of a good, equal to the demad cuve
demad good X to changes i price o good Y % cage iOx i Ox demaded divided by % chage an = = the quaity qua ity of a good ht buyers (cosumes) are wiin wii n and al b at variou prces prces ove a ime perod ceters pribus may ivolve indial dmand= dmand= the demad of a sge buyer or ar a the dmands of all the buyers market foud by addig up al the individua demads for each price
additioa unit o a good equal o the supply cuve
ri od goods whose consumption creates na nupn ai are socially udesrable but re overprovded by he mre d oveconsumed
margnall pria coss margna cossMP MPC C) addtoal costs to proucrs rising from poducto of a additionl unt o good
npnurhi the huma eot used to organze the othe three npnurhi fcors of productio as well as rik-akng, iovation, maagement
marginal socal bnts {MS {MS ddtonl beneits for socety arising from consuptio of n additiol uit of a good
e an= an= ha ha= = Q demanded > Q suppled
cossM SC SC)) additioal costs to socityarsing maginal socal coss
xcss supy suplus Q demanded < Q suppled xcluabl goo= good from whose consumption people can be
excluded exclud ed .e pevented from buyig buyig it) by chrgig prce
efect (cost)) f hird xtrnaly= positive efect bene) or negtve efect(cost prtes who are ot pat of a trscto trsct o nd whose ieress re ot aken ito account the maket ais to chieve llocative lloc ative eficiecy as marnal social its MSB MSB margnal soca coss MSC MSC
margnl cosMC= the exta cost to producers of poducing marg
margn marg nll p piiva va bfts MP MP= additionl benefis fr cosumrs rising fom cosumption of an addtol unit of a good
rom prouctio of n dditionl uit of good
makt au= the flure of the maket o allocate resources
efciety rsuting i ovralocato udeallocato or o allocato of resources to the production of a good or sevice relaive to wha s socialy ost desirble m os= goods whose cosumpion cretes posve cosumpo xtrnalts e soclly desible but
uderprovided by he maket ad uderconsumed
94
mnmm wage a iu pice of labor (pice r r usaly set by the goveret to potect lowsled worers and ensre they ca achieve a nmu stadard f cnsumptio; cnsumptio; is a imu price
pduce pdu ce suplus suplu s beet received by poducers who sel a good at a higher price tha the prce they are wiling to receive the area above the supply cuve u t the price receved
aiaizain the transfe of ownership from th private to the public sector (the oposte o pvati pvatiatin atin}}
gd= = a good that is rivarus ad nn-eludable pblic gd
necessity= a good that is ecessay t a csme (to be ctasted
with a that s ot essetal)
nn-excldabe gd= gd= it s ot possbe to chage a pice ad theefre exclude people fr using the good (ex a lighthouse -rivars gd its se by oe idvidual dos ot ake it less available for use by othes (ex a lighthouse) mal gd demad fr he good as smr income 1 as icme D (shifts right; as incoe shifs let
raial mc des desn-ma n-maing all eonoi e onoi deisio deisiomak makers ers (sumers, rms wrkers etc behave acrdig to their best iterests and ty to get ore rather tha less moe prof ore beefits from cosptio, higher wages, etc rivars gd= gd= its use by one idividua idividua makes it less avaiable fr use by thers scarcity= the scarcit
coditio of beg imited i relatio t te eeds ad wats of huma beigs; factors of prdcti are scarce while human eeds ad want ae nnie; ie there are not eogh resoces. gods and seices are therefre also scarce
ative sateet= sateet = a statement aout soetig soetig that ugh t be, expressing e xpressing a subjective opii or vaue dgmet ormative statemets are sed for akig ecnmic olicy
shtage see excess demand
psitve stateet = a stateet about soething tat s was o wi be; positive tive stateets are used to describe evts, and mae hyptheses ad theries
speifc a a idirect tax tat is a specfic aut per uit of te god ad reslts in a paralel sht of the crve to the let or upward:
sia srpls the sum of producer and coser cos er surlus
ppony st the sacrce o the ext best alteratve as a resut o akig a coice this cocept is cental ecnms because choie ad chice alst alst aways ivolves an scarcity ecesses choie porunity st pc celing a maxum prce o a good set by te goveret below belo w the equilbiu price of te market resutig i a shage pe elas elas demad (E responsiveness of Q deanded t chages i P % chage i Q deanded divided by % chage in P pre elasty f sppy (ES) (ES ) responsiveess Q suppied to chages i P % chage i Q supplied dvided by % chage n P
subsdy = payment by the goverment to frms i rder t lwer costs subsdy= and price ad incease supply subsies ( sbsitute gds gds= goods that satisfy a siilar need ex meat and sh aples and rages as P of god A D for good B shifts righ; as P f good A D for good (shifs let suppy ()= ()= the quatty of a good that selers (rs) are wlng ad abe se at varis prices prices over a tie period, ceteis cete is aribs aribs ay ivove ndivdal spply= spply = the sply f a single seler (rm o supply= = the splies of all the selles i a market, mark et, found by marke supply addig p al te idvidu suppies r eac price sps= sps = see excess sppy sstanabiiy = the use of natral esources at a pace ad i ways
pice fl a miium price o a good set by the overet above the eqiibrium rice of the arket, esltig a suplus pe seig opie o pie engs mamu pres r pe ls (mmm pes) usaly by the gvernet) preveting the maket fro reachig a marketclearing euilibri price pmay mmdies (or ( or prds prds= goods arising from the factor of prductin and and iclding all agicultural products as wel as shig, fresty and extractive products (ex oil ad damod damods s pvate gd= gd = a god that s rvalus and eudable
that do ot decrease the quantity quan tity or destroy te qualiy of esources avaiable for futre geneatios total reeue (TR) P Q= a
outut
rm's total earnings fom selig its
radabe perits ( cap ad rade schees schees a aximm
permssibe amunt of a paricular pollutat is determined and perits to eit this polltant polltant are dstributed to rs by govermet (or iteatioal body) which can be bogt ad sold n a arket wefae oss ( dedeg oss oss= the benets that are ost to
pvat p vatza zaon the sale of public propety by te goverent to
society de to resource isallocato
pivate rs the opposite o ataia ataiai i ) Microeconomics HL terms
abmal p positve ecoomic prot arising hen tal revenue (TR > ecooc csts it is prot ve ad abve nma nma pr aocate eiciecy= producig the
cmbiation cmbia tion of gods ad sevices that csuers mostly wan whe P MC r MB MC
f rms wth the objectve to maximie cae= a agreeent betwee frms cae
prfts while behavig as if they were a moopoly and restricting leve l competition btween them, sually by fixing pris at a higher level ad lmiting output carels are fmed by cosie oiopoes
asymetr infai infai= = a ype o arket alre occurrig when oe pary to a trasaction (byer or seller) has more fration tha the othe paty leading to allocative nefciency ber o en factors that pevet o make t vy dicult f otside irs to enter a idusty ad begi prodctin rea-een pce P where the rm makes ormal rot P
cls an agreement beteen rs t x prices ad share otput usually occus igpl concetrattio ratio= a measure sed to determie the degee of concetra
competitio an idust and whether rs have t oo ch mply pwer pwer it easres the ercetage o otput prodced by the largest rms in the indsty san es sae as iputs increase, outp ceases n the same roortio if iuts doble ott also dobes
mnmu mn mu ATC i i pefect mpet mpetiti iti
95
costs of production: production : total ost, ost , tota xe ost ost tota varb varbe cost;; avrag total ost cost ost avg x cost cost veg va cost magnal ost see p 29 al st denitins and forulas cost
r r arises when economic profit is ero i.e when toal revenue(TR) is equal to tota to ta econoic css css(TR (TR T it is he aount of revenue equired by a rm to just keep it in bsiness
csg rts to sal as inputs ncrease ouput increases
gol = a market strucure where here i s a sall nmber f large irms: sellig a homogeneous o dferentiaed product ith high barriers t enty; with inerependence aog the rms due o heir sal nuer causing the t face the cnicting objetives to cmpete or to colude
=
=
=
less than in propon if inputs duble outpu ess than doubles secoomes o sa= sa= rising csts er unit of output( rising =
average costs) hat ccur as the size f a rm increases when it varies al its inputs(in inputs(in the lng run)
conom costs the sum of explcit and implicit csts in econoics "costs refer t coomc costs =
onom c pot onom pot ttal revenue(TR) revenue(TR) inus econmc costs(explicit costs(explicit
+ implicit csts); ecnomic pro prott may be psitive zero or negative
pt mptto a market sructure where hee is a large
number f smal rms there are no barrers enty al fis sel a homgeneous prduct; thee s peect infomatn; and there is peect resource mobiliy ri i i cmpetitin between firms attrat custoers away frm the products of other irms by wering the prie he product
conoms o sa= sa= falling costs per unt output(= output (= faling
average css) a occu as the size of a rm increases when it varies all its inputs(in inputs(in the lng run) xp ost ost a ost nvlvin payet of money mon ey ade by a f t xp
obain a factor of prductin(input) prductin(input) r se in i n productn
i d dsimi simi selling a product at diferent pies to dierent cnsumer groups where the price diferences are n due to difference in costs o proton ii s s a frm f i lls where a dminant rm sets a price, and als initiates pice changes: the remaiing rms accept th leader's price becming effecively prce takers
li = cllus cllusion ion (making an agreement) between rms leading to the formatn f a at I
gme thoy a atheatical technique used t analyze behavio f interdependent decisin-makers wh use strategc behavior the pson's lmma game helps analyze behavir in ogopoy pson
pc m r r a fi hat aces a downward slpng deand curve
pce t a firm that sells all the utpu t wants a te price
imii s = a cost invovng sacriced ince r the use of a facto producion(input producion(input that is wned by the r
thus havng the abiliy to nluence its s elling price determined in the mare i has n inuence ve its selling prce p wr = a situaton where frms retaliate agains eah the by lowering pices to he pin that they may end up mang losses
ncreasng trns to sc as inputs increase, utput ncreases =
moe than in proprtn if inpus duble, utpu ore than dubles l dshig ds hig n n as mre and more units f a variable (ex abr) are added to a xed nput (ex capita) the marginal input(ex input product of the variable nput(abr) at fist increases reaches a maximu, and hen begins fal dmiishng returns ccur in the s u when at least one input is xed
sn di sn di a game in g showing how two ratinal decisionmakers wh y t make themselves as wel ff as possbe by b y using strategic behavir, end up becming ose of
=
d l rt rt arg d d rg du see p 2 fr a sumay su may f all duct denition denitionss and frus =
g u period of time whe al factrs f prducton are variable (changing) there are n fixed facts
poct rt rtat aton occurs when ims try to ae thei products ierent from hers pduct s can be diferenaed by appearane taste, clo, sie ualit, packaging, branding sevices (such as warrntes) lcation on (easy access by cnsumrs) it frms the bass f - i
=
tota cost v a cst cuve showing he ng-r veg tota relatonship beween average cs o a r and quantty utpu it prduces as increases in sie by vaying all its inputs(n the long l ong run) i is made up a series f shot-rn aveage tal cs t curves loss = negaive econmic prot total revenue (R) < ecnoic csts
l i = a market structure where thee is a large number f irms, low barries to entry, nd product diffeentiatin
d poducing at the lwest possible cost occurs whee d ks c i AC r ree r ree g e e g see p fr a sumay sum ay al revenue defintins and frmulas short u perid of time when at east ne factr f prducton is =
l = a marke srucue involvig a single firm(r firm(r ne dominant fir) i prduces a god wth n cose substitutes there are hgh barriers ent moopoy pow the ability a frm to influence the price of the
fixed(unca (uncanging) nging) and a nd all other othe r actrs are ar e variable (chngi (chnging) ng) sht--ow p sht p the price at which the firm will shut down i the shot run t is where P = inimum VG
=
god that it prduces and sels due to a downward slping demand curve i is tpe of makt r becase i results in an underalocaton of resurcs o the produtn produt n of he god in question and hence in allocave inefficency and welfare lss natural monopol monopol a r wih ecoomes o sc s large that i
satses deand of an entire marke at a level utput where it stil experiences aling average costs two o r more firms prodcing the same level of output would d s at higher aveage costs
trdpnd a characteristic of ligplistic frms strtg trdpnd
wher eby tey ty to guess what the whereby th e other will do becuse the acins one affct utcmes nt nly r themselves but also fr he others ls( ls(= rl si) si) = copeation between irms n oligoply to resrct cmpetitin and fix prices wthout a fral agreeent tx i dn the particular group bearing the burde f a tax .e. the grup paying all r a portin of a tax =
- ii cpetiton between rms on the basis of nnrice actors, thruh d di 96
Macroeconomics Macroecono mics SL tems (oe) bsle ve vey y te nber of people with an incoe level below a predefed 'povet line which is te iiu ncome ecessar to satisy as asc c pysical needs
cuet epeditues= spending by e govemt fo is dayto day operatios(wages o gvement worers, sples subsidies)
aggregate demad (AD) = the otal amout of real output(goods output(goods and services) tat a buyes i an economy(cosuers economy(cosuers rs, goverent ad foreigners) re illing and able to by at diee possible price levels, in a year ceteris paribs
neplyment cased cased y decreases i AD, leading to the downwad phase of te bsiness cycle
aggregat spply AS AS= te tota amnt real otput(goods otput(goods ad
defatiioay gap occrs wen shot-rn elbm defat elbm GP is less
serices) poduced i an economy in a ye ar at differet price levels; there are tree kinds of AS cures: s sr r ggrege sy R R) ) lgr ggreg e sy (LR (LR) and Keyesi AS
than poential GDP d ue t insfcent aggregae deand emdee emde e emoyme emoyme= = see yll emyme
m sblzers featres in in econoy tat tat liit te sie of economic uctuations(recessiona uctuations(recessiona ad inatioary gaps) i y gveme i tus stabilig the economy; te ost iotat are gressve ime taxes ad emyme
em i em ifao caused by an icrease i AD ece a rightward shi in the AD cve reslting frm a increase in any of the components of A(C, A(C, I G X-M)
enets
be bge goveent revenues ae equal to govenmet b spending ove he period of a year
cyca uempoyme uempoyme dmad-defe emlyme
deati a sustained decrease in e general pie level
demse dem es es= = poicies tat ocus o chagng A he purpose of reducing shotterm s hotterm econoc fuctuatios e. close ely and ny gs, gs, ad hece aceve low neplyent ad a low and stable rae of inaio
bge srs srs goveent revenes> governent spending over he period of a yea
erego= polcies to eiinae o lower the aont of erego= governent regulatio of a indstry(ex indstry(ex egulation of prices or quatit of otput prodced, both used to protect firms rom compeion) tus exposig ims in te indsty to greater comeion
s iess cnidece a easre o the degree of optimism of fis si regarding te future o the ecoomy
ie t taes on income and wealth paid diectly to te governent(ex personal icoe taxes, corporate icoe taxes) governent(ex
bs iess ye bsi ye shortter flcatios flcati os (ncreases and decreases) in rea GDP over ie, consistig g of four pases e, i, rg ad es
isif f lio isi lio a al in te ate of nation ex 7% i 2010; 5% in 1
def = = governmet evenues < governent sendig over bge def te perod of a year usally made made possibe y govermet borrowing
c eeies speding by th governmet on pbic investents(roads investents (roads airots ublic hositals ad scools, etc) el b a finacial istituton cocened wit h carying out moey y and exchage rate plicy as wel as reglatng comercial banks and acting as banker o both comecial baks and te governent
eci gr gr rowth i real GDP over a peiod of ie sally expressed as a pecetage change in real GDP ove ie; is ote calclated in er ters(per person in te pplaion) eey = te use of resorces in the best possibly way so that tere is o waste of resources euy e conditon of beig fair oten itepreed to ea equait" n the context of icoe ico e disrbton esy y olicy carried out by the governme governme((isl y y)) r te central ban( ban(mey liy) liy ) ntede ntededd to crease AD ad lose a ey g
sume ee a easre of te degree of opimsm of consuers regardig regardig the utue o the econoy sme ie e CPI) a easre of te cos of living of the typica hoseod ad how this changes over i e; te PI copares te cos o bying a xed basket of goods and sevces fro oe year to te nex by calcuating te vale of te sae asket fro year to year the CP ofes an estate of o pces year pces cange o average fo year to year csm spendig by consers o buy goods and seices ry ly policy caied t by te governent( governent(isl y)) or the cetral bank( y bank(me mey ly ly)) ntede ntededd to t o lower AD and close an i iy g ore e o iltin( iltin(= del delyig yig rae o i ii i) a easre of the rate of ination based on a asket o goods and seices that excludes goods with higly volatile prices(ex food and energy) order to deterine deteri ne the nderling cours of inflation ssh n n inlation cased by a decrease i SAS ence a leward shit i the SAS ce resulting resulti ng aily from ncreases n osts of prodction o supply shocks owg a possbe weakess o expansonar s s oy involvig increases in goveren speding nnced y borrowing causig a increase i interest rates that edces cosuptio and investment soendin ths ueractin te increase i AD
eenite r= r = an approach o easuing GD that adds up total spending of all buyers on all final goods and sevices within a year inldes C + I G (X - M) scl iy a type of dead-side policy by the government in orde r to order to anipuate A(by A (by chagng taxes ad/o government spending) to ahieve rice stability a low nelyment riil eml em l yme yme ueployet includig workers who are i bween bwe en jobs l emlyme ( l (= e eii ) ) t leve o eal otpt podced by the economy when nemployent is equal to atal empymet
gi e e ie ie a measure of income iequali deived from te e ve= ve = aea bewee te Loren cuve a lne of pefet icoe equaity dvded y eire area nder l ine o eec equait gvee dge a lan relating overnent revenue to
goverment spedng, usally or a period of a year gree GD GD a measre o GD that akes io accout
environmental destruction de to production o r cosption activities green GDP GDP vaue of evironenta estrucio 97
i pr )= )= the otal vale o all nal gods r and seices prduced witin te boundares f a cunt, in a year goss ntinl i GNI or GNP GNP))= he tta ncome ceived by te residents of a count in a year year regardless where he actrs of prodcin owned own ed by he esidets ae locae
id np npt = peple wthot a jo n incuded in fical unemplymen figues because hey are ot actively seekig a ob(ex "discouragd workers) as well as ndrempyed peple coued s fully empled i offcial nmploment gures come appoah an apprach measuig GP hat adds p all ncome eaned by he factrs f prduct prductin in i te curse of prducig ttal tpt whin a year incldes wages en ierest and proits
nr taxes taxes n spendng to bu gds and serces paid ndicly o the gvenmet hog te selers (ex sales taxs, VAT) inteventionst ionst supply-side supply-side policy idustal poies= a ype of intevent nteded pomte speciic idstris; nclud tax redctions, tax exmpions, lwierest loans sbsidies and grants industries tha are eld to be imprtan t sppor growth
p ppra an approac masuig tat adds p he vale va le of eac eachh god and serice (PQ) prduced in the coomy witi a year, hus baining te value f all nal gods and sces pni p( p( ul pn t pt pt ) the levl of rea GDP prodced wen e ecy is on its longerm growth tend where lial p p 0 ad employet nr npl p the inability p inabilit y to satisy basic physical needs (ex fod clthig shetr ec) de to lw inome pr p nx ( o f changes in coss of (P PI) a masue of prdction based on average prices f facos f prdctin si nce th prdction PPI masrs pice level changes at ar y sags i prodction it is sefl in predcting changes in fre f re iaton (measured by te CPI) podvty podv ty put pr work; t icrae as a rsult of investmens in physical man ad nara capital a mao cas of eoomi ow
piv = = te percetage of inco pad as tax (avag a rae) ncreases as income iceass prpo t= t= he percetage f ncme paid as ax(average ax(average tax rat) remains cstat as income inceases
nt nt= = a sustaned icrease i th general pce leve i n i= i= a polcy prsued by sme s me cenral banks fcsig on argeting a paiclar ate of nflation and cryig out oneta (manplation of ineest raes) o achiee the ageed rate policy(manplation policy i ni p= p = occrs when shn eqilibrim GDP is greate than poental GP de to excess aggregate emad i nin = money that eers he circ la of income in te m of nvestme sending gvenment spending or exprt revenes (spendng by reigners)
ea G or ea GNI a measre of outpt ad incme in terms of cnstant pices tat preval n ne paiclar yea; theeore rea values eliinat te influenc of pic level changes over ime eesso= falling real GDP over a peiod f at least tw consectv
uaers(sx cnsecutve monts) eessve a= he pecetage pecetage of ncme paid as ax(average ax(average tax rae) decreases as ncme increases
neres rae = payment for borrowed money ver a certain te prid, eatve povey= the nmber of peope wit an ncme level below a
pedened level that chages ve e, defied as a pecentage of sciey's median income pvery relative to to oter peples icome reects he idea ide a h peple soud be able afrd a lfestye typca of their scety
expressed as a percenage of the brwed aot te "price of moy sevices nves nvesttment speding by rms or the gvemen t bu y capital
gods (macnes equipment a wel a ifratrre) nl up nl up nemplyment includig wokers wh ae unemplyed on a seasoal seasoal basis ex ski insrctos in he smme
K = = an AS c wit a orizal sect(wen sect (wen th econmy is n recessin), an upwardsping ection (wen te t e economy approaches full empoyent utpt) and a vertcal secio (whe te cnomy has reaced aximm cpacty put) eakae= money ha leaves the circlar ow of come i the fm f saving, ng, taxes ad spendig o impo imposs
ln ppl ppl() () an AS cv sowig real pu produced as beig idepeden of te price evel th LRAS s vertca at ra GD where nempoyme nempoyme aa nempoyme
ru rg ppl SR AS) a AS c showing e e ttal amout f real outpt prodced n a yea to be directly relaed to te prc evel: as the pce level _ the amunt f real utpt prdced stuta empoyme empoyme uneployment ta is usaly ong-erm arsing from canging demand fo ferent labo skls (due to tcnolgical chang or structral hags in h ecoy), canges in the geograpcal lcaton f ndstries a nd labor market rigidities sppy-sie poiies= poiies= plices ta fcus the supply side of the ecoomy aiig o promoe og-erm economc gowt and hence increase pottal outp (ncrease RAS or yesian AS) ay be teventonist (invlving gover ntrvntion i te ecnmy) r maetbased (base (basedd on deveope of fee competitve makets)
Loenz uve = visual represenain of icoe shaes eceived by percenages of te popao; he rthe away a Lre cure is
fro e lie of peect eqaity he moe neual the dstributo of ncme orms the basis f compting te i coeff ien moeay poy type f f demad-sde policy detake b y te poy a type
central bak in rde o maniplate AD (by cnging iterest rates) o aciev price tabiliy d ow neplymt neplymt nl pl pl te su of r iin in and l npn l npn is te nemplyent evl of he ecny pl t t pt pt (= ll pl pl upt ) whe it is pdcing p p the value f xps mins te al of impots inl GDP(or n GNI a measre of outp and an d ncme n terms of t pi (prices a any given ment in ime) 98
tansfe paymets = transfers of ince om axpayers t vlnerabe groups who are pepl i need, ncuding nemployme befit, ild lownces, ens, hig benes nd hes deempoymen deemp oymen pepe wo are employed b wo () wrk pattie when they wld ater ok fultm and (ii) wrk at a dieent skill r lower skl level tan what thy were trained or (ex an enginer working as a waite)
npl ra ra e mbe f peope i the labor foce activey looking fo work b wih wih a b b expessed as a percetage of the labor force (= number f nmloved / labor fce x 10
Macroeconomics HL tems
r t M MR) = tax rae appled to an inivduas incoe n te hgest tax bracket
average tax ate (ATR) tax pai/ taxabe income x 10 magial popensity to cosume MP MPC C) = C/!Y = fraction of
ultilie a multipled efect on AD, and ence on real G(= rea ultilie ncome) ue o a change in spening cause by an ije
magal popensity to mpo MM) = M = fraction of aditional income() spen spe n on buying ipos ip os )
ii v a curve soing the relationship beteen te rate o f naton(ertica axis) ax is) and a nd rate o unemployen (horizonta axs); r Phll sos an inverse eatonshp; lnr nn n Phlps is vertical a the nt ae f n indicating that unempoyment is inependent of the prie levl
aditional income incom e spent to consue (buy) doestic proucts
magia popensity to save ( MS S= = S /Y = facton of aditonal
ncoe(Y) that goes toward savng ()
M fracton of additio nl ri tax (M additional nal incoe(Y) pa as taxes {T)
Internaional Internaio nal economics SL erms erms (coe)
fltii n shot fr stagnaton" and inflaton', arsng fom a flt SRAS,, wic causes a ising pce level( decease n SRAS level ( p iltin ltin)) an a all in real output
dinsv br = a varety of obsacles to impots impose din poecto intened to iit the by govements as a frm of tade poecto quantity of impots an poect omesti producers from foreign copetiton ex coplicated bueaucratic pocedures, unnecessary packaging ealh safety safety and envionna snards h i ipos must comply in order to be adite into the county
ebit t = any item in te ln f n invoving an outo of funs rom a counry enteed t a minus(-) sign
tidu i n tris taffs mposed y an mpoting ounty on tidui goos by anot county to ase the pice to pren pren levels
eprii of a curency a decease in te value of o f a curency in foati g excange ate syse may occur e to a a feey foatig decease in deand or an increase in supply o a currency
an t an exess of ebits ove crets n any of e three accunts of te ln f ns, ns , meaning at outflows going abra > infows fom abroad
appecatio of a currency an ncrease appecati ncrea se in the value of a curency n a freey loaig exchage ate syste; may occur ue to an
increase in emand or decease n suply of a cuency
baance o paments = a recor of al ansacions beween resdents
of a couny wh resens o all ote o te cunres consisting of all payments entering into into te country o aboa aboa(Inos) (Inos) an all payments eaving a county o go abro(ouos) abro(ouos) ove a peiod of tme, usually a year it consists o the un� un� the p an e fnnil n, n , wch in the course of a yea ad up to ero
ln f r in d = value of xpos o goos nus value of iports o goos
dealato = a decrease in te value of a curency cu rency in a xed echag ate syse achieved though te governent or cental
ban hih ecides upon a ne, ower exchange rate or the curency
dect inestme inestme an item in the fiancia account o he aace o ayments soing inows nus outlows o funs used fo nvesmet n pysical capita(unetaen capita(unetaen by mtiaonal cooaos cooa os,, or MN MNs s
mn sellng goods (expos) in inenationa mares at a price oe tha average cost of producton; it is against WO ules
ln f r in r vaue f expots of seices minus value o mpos of o f services
econom tegatio growing economc reations an cooperation between ountries arisng arisng om tade or oe agreemns tat lnk ln k thei econois together
bilaea tade ageemet ageemet an agreeent beteen two counes to
exchag ate ate the vaue of one currency expresse in terms o
ct = an accoun in he lne t conssting of capal transfers" and transactions non-pouce, nonnancal asses" t is usually less mpotan tha the theut ut ut and inncil
inni an accoun in the n n f f ps consstng ng of the sum of di v v nvn and eeve ae(in all cases, inflows minus ouflows)
rk a type of trang bloc where membes have fee tade beween them a comon tade polcy towad non-membes, and free movement of labo an a n capial between e members ex EEC (Euopean conoc Community, beoe hs became becam e te uropean Union)
governent or cena bank at a certan leve in tes t es f anoher currency such as te U$ o€), ence no peitte to aust to currency eman and supply equres constant central ban inteventin to mainain the xe level
ced iem any tem in te baance o payments nvolving an inflow
iposing estriions estriions of any kind on impors or expors expo rs
=
enncy of as cue otheer; an be ougght of ce" e" of of a cu be t tou pc ee p n t liminna ta btwn tad ad btw m anoth uc or limi rrirs irs to n t tm ruc barr ta ba ouraag f nour
o funds into a county, count y, entee with a us(+) sign
ixed excange ate an exchange rate xe by a untrys
fee ad = internationa tae it no govenment inerventon
r rd r a group o counres at have agreed to educe or eliminae rade barers to aceve ree ae between em eac county tais e rig to mpoe its own tae barries oad non members ex NAFTA(oh Ameican Free Trae Tra e Agement)
rr un an account n he ln f pans consistng o the su of o f te balance of rade n goods baance of trade in seces ncoe (infos inus ouos), an cuent transfes (inows mnus outlows) cusoms uni a ype of rading blo were embers have free
trade between them and common trade barriers oward non-membes; ex SAC Sout Africa Cusos Unon 99
r fli hn = an exchange rae at is etermined entirey b emand and supply of he cuency with n governen nteenin
nnt ius = a dus ha s jus sarg o be se up ad s able o compee eaoa markes wh we-esabshed rs a hav havee experece ad ecoomes of scae; s cae; oe of he sroges argumes ELDCs favor o proeco o he gouds a hese dusres us be poeced u hey hey grow ad "aure maaged exchange raes( raes( = maaged floa ) ) exchage aes a ae deermed by curecy demad ad suppy, bu wee e cera bak evees a mes orer o a vod sharp shoerm ucuaos ad o uece he vaue of e exchage ae moeary o o members of a commo c ommo are adopa adop a como currecy ad a como cea bak resposbe for moeay pocy or a he mebers ex e rozoe coues, ha adoped e euro afer gvg up he aoa curreces wose como moeary pocy s he resposby of he Europe Cera Bak(CB) Bak(CB) mulaea ade ageemet ageemet a agreee bewee may cores aroud he wod as a rue ue e eadershp of e Word Trade Orgaao WO) o reduce o emae rade barers o ecorage free rade bewee hem ovevalued cuency a cuecy whose vaue s maaed maaed gher ha s marke equbr eve may ocur fixed or maaged excange ae sysems potoio ivestmet ivestmet a em he fianc a acco acco t of he baance of paymes sowg ows us oufows of fds used ba fo acal vesmes(ex vesmes(ex buyg bos bos ad socks) socks )
rvaa io o a crease e vaue of a currecy a ie excage rate system, system, acheved roug e goverme or cera bak wc decdes upo a ew ge exchage rae tr he currecy reserve assets assets a em e aa ao of e aane o paymets sowg fows us oufows of foreg excage ed by e cetr bak, correspodg o domesc currecy saes ad purchases order o uece he vae of a exchage ae
sto buyg or seg cureces o make a prof ss payme by he govere o rs o owe oss o poduco ad prce ad crease suppy ofe used a a orm of tade poeco srus o a ao a excess of creds over ov er des ay of he hree accous ows fro abroad > oufows gog abroad ta ta a r of rade proecion vovg a ax o e vaue of mpored goods s a ype of drec tax tade lbealza lbealzao emova of mpo barrers ad rade resrcos bewee cures, orde o brg abou ee trade ade poteco govere eeo eraoa ade vovg e mposo of rade barrers eded o m he quay of mpos ad poec e domesc ecoomy from foreg ars uoas uoas sbs sbsiides compeo ex ars
prefeetial tade ageemen ageemen accordg o he Word rade Ogaao WTO, s a agre agreee ee bewe bewee e wo or more coures o gve preerea access o acuar producs access w ow or o arffs or oher rade poeco) ofe cudes cudes addoa sses beyod rade such as eces vesme ad eecua popey rgs
adig c = wo or more coures a ave agreed o reduce o dee barers bewee em em o ecourage fe rade emae d
qota a form of tade proection vovg resrco o he quay of pors
Wod Trade Ogani Ogan iat atiion a eraoa ogao voved w muera rade egoaos amed a berag goba rade w resovg rade dspues bewee member coures ad w overseeg e goba sysem of ade rues
udealed cuecy a curecy whose vaue s maed ower a s arke equbrum eve may occur fed or aaged excage rate sysems
egoa ade ageeme a agreee bewee sevea cores egoa a geograpca rego o educe o eae ade barrers o ecourae ree rade bewee e
Interaioal economics HL erms absoue advan advantage tage a couy ha s a absoue advaage advaage he produco of a good ca c a poduce w fewer resources( moe effcey a aoh aoher er couy comparative advaage a couy hs a compaave advaage he produco of a good f ca produce a a ower oppouty ot aohe cou eped tue epedt ue--reducg poicies poicies cotacoay oeay policies ad cotactoay isca polcies used o reduce esse cuen account defcis by owerg AD ad he prce eve so ha mpos ad expos expeditue--s wtchig poicies cde tade poectio poces expeditue ad depeciatio sed o educe perse cuet accout deicis by swchg cosumpo away ro mpors ad oward domescay poduced goods aco edowmens aura resouces facors of produco produco ad echoogy possessed by a couy deerme s absoue ad comaatve advatae
100
J- cuve a cuve showg showg wa happes o a couy' rade baace foowg currecy depecao(or devaua devauao o;; ay he ade Lener Lener M- codt codto o s baace woses woses(because (because he Marsall ukey o hod) bu afe a perod o me begs o mprove(whe mprove(whe e codio s sasfed sasfed)) --L M M } odio a codo pefg wa us depecatio// devaluaon o ead o a smae rade defc: hod for a depecatio I PD + PD > 1 deprecaton / devaluao smaler rade de tems o ade aveage prce of expos dvded by e average prce of pors es 100 s e rao of wo dex bers bers mes 100 trade ceton e epaceme of ghercos domec producs by oweros mpoed producs due o he formao o a radg boc dverso he repacee of owecos mpored producs by tade dverso hghercos hgher cos mpoed poducs due o e orao of a radg boc
Development ecoomics SL terms (core) arat thnology = a technology that s wll suitd to a country's factos of producton oft rfers to quantities of labor n relation o physica capita, as wll as sll lves dd dd in relato to skl levels available
a pysca caital (from nvsnts usaly by ia goveets) in social necssay ites traspotation systes (roads, railways pots, airpos) clea watr supplis sewrage systems teecomunicatios (includng teephoes), energy tc
bilater d = foreign aid going fro one donor county to o ELDC bilater recipint county
Intrnatinal Moer Fn ((M M) )= = an nternationa financal institutio that montors the global naca syste a lnds to govts perincing difcultis i akig hei internationa paymes
m da a group of sngle nicatrs us ogther to for a singe easur of developmen i sveal insions th bst know is the Humn Developen Inde know Indexx () =
concessioal ong-te los los oeg aid cosisting of loans with beowmarket interest rats, xtended for l ong peiods of ti deveopmen aid oen ad xended to LDCs for the purpose f assstig the n he eveloent eort
divfan divfan broadenng th ang f ods an svics produce an epod protcts agains ecessiv specialization and and provides advatages for growh and dvelopent dual nmy nmy two diffeent systms hat coexist n an econoy ex a foral registered ad regulated) and nforal (unrgsterd unreguated) urba sector nom deve deveopen open= = a pocess were increases i ra GD/GNI p apita occur oc cur alongsid dereaes i povety increasd mpyntt opportunities, mpyn opportunit ies, lowr ncome iqual iquals, s, icreased accss o eit goods including educatin, health car and infrastructure, all leadig to improvemnts i standards of living nmi rw rw t incrass i ral GD (ral ouput) and/or ral GNI (real income) over tie often easured in aa trs rmin a growh and tra strategy based on srong govme inteention itnded t romte m hrouh the expanion f f eo =
rin ad = trasfe of funds in the fom of loans or grants, or transfer o goods and seices as gifts o LDCs i ordr to hlp achvee econo econoic ic or soca objcties; ad is nn-mmra h achv {the transfers dont ivove comec) and s nssna l r d the aout o funds borrowd by th govrnmnt and prvat sco o forign sourcs h oblm feign eb arises many becase of governmen governmen de o oegn edios oegn dre ivesmen FD) invetment by a irm originatig in oe one country (th ho country) in prodve fcities in another country (th host count) card out by MNCs overne the procss of governn which involvs th xecise of ontro and authority; accoring to The World Bank good gvernance "is synonyus wth sund evelopment managemn
uman cpi skills knowledg euation euatio n and good heah acquired by pople that ae the oe productie
mioed credit (lendng) mioed (lendng ) of vey sall amouts f money fo shor piods of ti t i to poor people who hav no othe accss to cedit (such as though comercial banks
lnnu vmnt a )) = a st of eight goals for ELDCs merging fro th United Natios Millenniu Declaratio of etembe 2000 e eradiate etree povey an huger achiv univrsal rma ducati imprve marnal health muiatra id id foegn d by donor countries o EDCs throuh iternatoal organizations such as various Unitd Natons Natons agecies aiitae = endig to LCs by mtiatral dvpmn a interational oganizations (x World Bak) to achiev eveloent obctives o n-nsa rm (at market interst rats and rpaymt priods) to be dstinguished fo in a
mnainal ain (MNC NC a r that cars o n i ivsmn ivsmn has productive ivesent in more than t han one ounty vnma aiatin (Os) (Os ) organiaios non -vnma nonconcernd with prooting objectives hat are in the public interest, e XAM; are involved in a broad varety of developent effots x tchnical assistance or farers education and health seics, suppot fo uban informal workers microcredit rights f women human rights sustanabl devopment etc Offcial Deveopmen Asne ( A A)) foreg ai providd by governmets of door ounrs povety trp e) e) a cyce whre low incoe ad savings lead to low invstet in physical huan and atual capital, in turn lading to low prouctiviy an low inco gowth hce to low incom oce again it is ofen trasmitted from gneration to generaton
oamm ad a in uppot of whole secrs f h conomy educaion health care bankin tc conomy =
roe ad forin ad for specic projcts, ex buildig hosptals, irrigation systes schools, etc =
uhan r ari (PPPs PPPs)) hang rat that ovet loca currecies into S$ so that the ifluence of difeen price levels acoss counis is elimnated herfore GDP GN pe caita vaues xprssd in US P a rctly cmparable across cunies es cial ay n tanr aymnt of varous kid to esue that pople do not fall below the ovety line e hild bnets
humanaran a a rgn ad xnded n areas expeencing eergncy situaios due o criss causd by was or atural disastes coss of donaios of food mdical assistance, etc
tid ai onditios o the borrowing couny imposd by bi laal borow ed aount is ad donors requiring that at las a prtion of th borowed spent to ipo goods good s and srvics from the donor couty =
Hman mn Ine ! ! a mosit niatr easuring devopment easuring devopment in i n thre dis disions: ions: the lvel l vel of halth halth the level of education; and the standar standar of liing li ing imp ubtin ubtin a growth and trad strategy based on strong govermet inteention ivolvng heavy protecto of doestc idusries (through a a ua ua,, bid bid,, ec) intended to replace iports with domstc productio 10
ua ma ma r an unreglated ureistered sctor i any cities i ECs ncludes nc ludes salsae slfmpoyed popl in a broad rag of actvitis, x sal e f f foods, clothing and vaiou household its, eing of coths, cobblrs barbrs, ad household cleaners =
Wrl rl a = an internatioal acial insttutio invlved in muilatra dvmnt ia (as distinct fro g aid aid it lnds to LDCs to assst the n rowh rowh and develoment effots
INDEX A
abnormal pofit 28 absoute advatage 63 absoute povety 55 ad valorem taxes 14 admiistatve barres es 65 aggregate demand 42-43, 58, 60 deterats and sifts 2-3 scal poicy 58 moetay policy 60 egative slope of AD cve 42 aggregate sppy 4 3 46 Keyesa ad sits 546 long run (LRAS) and shifts 4, 46 o r (RA (RA and shift shiftss 43 sppyside polices 6162 aid 89 allocative eficiency 6 3 aidmpng 65 appeciation (crrency) 67 appropriate techology 81 asyetrc information 24 atomatic stabilzers 59 aveage ax rae 56 B
balace o payes 71-73 balace i 71 capital accou 7 curret accont 71 exchage ates and 72 nancial accout 7 balance balan ce o trade in goods 71 balance of trade in services 71 balanced bdget 58 barres to etry 32 bilaera aid 89 bilaea tade agreements 87 breakeve break eve prce 30 bdget decit 58 bdget surplus 58 bsness bsne ss cofdece 58 bsness cyce 41 C
capandtade scees 20 23 capital 1 5 human capital 54 natural capital 54 physcal capal 5 capital acco 7 capital expeditures 58 carbo taxes 20, 23 cael 36 cenral ban 59 ceteris paribs 1 crcua low of icome model 39 cean ecnol ecnologies ogies 23 colusio 36 omal 36 taci 36 commo access resouces 22-23 commo maret 74 coparative advantage 63 copetitive maret 3-7 eficiency 6 maret eqilibrium 5 copetitive supply coplementary goods/complemets 3 cross rce rce easticity of demad 10
compoite indicator 80 cocetraion ratios os 36 cosat returs to scae 26 cosumer codece 58 cosume price ndex 52 costrcig 52 cosume cosum e surpls 6 cosumption pedig 4243 aggregate demand shifts 42-43 changes n 4243 coractiona polcy 58 60 scal poiy 58 moetay poicy 60 core rate of inaton 50 corpoate corpo ate indebtede ss 58 corpoate social resposibil resposibility ity 29 cost-pus iflto 5 costs of prodcto 2527 economic 25 explict 25 implict 25 long run 27 opportuity 1, 25 sho un 2526 credit (balance of payments) 7 credit (bann 82 crossprce cross prce elasticity o demand 1011 applicatis compemets 10 sbsts 10 crowdig o 59 crrent accot 71 crrent acont baace 71 crrent acont decit 71 crret acont surplus 71 Jcue 73 Marshalerne codto 73 elatiosip wth th acal account 72 crret expenditures 58 cstoms no 74 cyclical nemloyment 48 D
debit (baace of paymets) 71 debt 58, 91 debt reief 91 origis of poblem poblem 91 public (gverment debt 58 deciles 55 decreasing returs to scale 26 decit (balae of payments 71 deation 52 deationay deat ionay gap 44 46 Keyesa Keyes a model 4 moetaisVew classcal mode 46 demad 3 demand ve 3 law of deand 3 maet demand 3 demanddeicient employet 48 demad mage magemet met 58 demandpl ilation 5 demadsde policies 5860 fisca policy 5859 evaluato of 59, 60 onetar policy 5960 demer goods 20 demer depeciatio (currecy 67 dereguaion 61 devalation rrec 69 102
dvlomnt i 89 dimiisig retuns 25 direc investet 71 direc taes 56 diseconomies diseco nomies of scale 27 disilato 56 disrbio of icome 556 eality 55 eity 55 measues of 55 poicies to redistrbte redistrbte incoe 56 povety 55 divesficaio 88 dual ecooy 78 dumping 65 E
economic costs 25 economic developmet 7791 domestic facors 19 oreign aid 8990 oreg debt 91 oreign direct ivesment 88 idcators and easremet 7980 ieratoal trade actos 8485 ileim Develomet Goals 78 mutilateal develoment assistace 90 relaion o ecoomc gowt 77 rade stateies 888 ecooic growh 46 4 calclaios 54 consequeces 54 producto possibilites model 54 producvty role of 54 RA ce 46 54 ecooic itegaion 4, 87 commo maret 74 cstoms non 74 oneta non 7 7 preeretal tade agreements 74 87 tradig blocs 74 7 ecoomc proft 28 ecoomes of scale 27 elasticities 813 crossprce elasticty of dead 1011 ncoe elascty of demand 11 price elastic elasticity ity of demand 8-0 price elasticity of spply 2 empowermet o woe 82 entreprenersip 1 eality (icome distbto) 2 5556 eilibrim excange rte 67 eilibrium level o otut 4446 eilibrim price and antity 5 eit 2, 5556 verss efciecy 56 excess dead 5 7 excess spply 5 7 exchage rates 6770 appreciato/depeiaio 67 cases of chage chagess in 68 coseuences of cages i 68 devauato/revaluto 69 excldable goods 23, expasonary policy 5 60 fiscal policy 58 moeta policy 60 expedtre appoach 40 expeditre low 39 exeditrereducn oolces 73
expendure-swithng poes 73 exp oss 25 expo pomoon 8586 exenl benes 19 exenl oss 9 exeles 922 egve osmpon 9 2 negtve podon 9, 20 20 posve onsmpto 9 22 postve post ve pod podcon con 9 2 F
o edowmens 63 fos o podo nnl aon 7 nn o ne nn o de nn o spls 7 eltonsp w e on on 2 fsl poly 5859 om slzes 59 von 59 longem eoom gow 59 x xge s 69, 90 ong exnge es 668 90 oegn d 89 evlon 89 vess de 90 oegn deb 9 oegn de de nvesmen 88 ee de poblem 23 ee de 63 ee de e 7 eely ong ong exnge es 6-68 70 ol nemplomen 9 l employmen 4 8 l employmen employmen lee o op op 8 G
gme eoy 36 GDP 39 GDP deo GDP pe p 39 Gn oeen 5 GNI 39 ompso w GDP 39 gols o fms 28-9 govene 93 goveme bdge 58 govemen deb 58 govemen spendg 2 geen DP 0 goss domes pod (GDP) 39 goss onl nome (GN (GN 39 H
dden employme 8 oseod debedness 58 mn pl 5 Hmn Deveopmn Idex (I) 80 mn mn nn d 9
ess o sle 26 nesng e ndos o developmen developmen 980 ompose 80 sngle 79-80 nde xes 5, 202 onseqenes 5 exeles 20-2 sos o ndsl poles 6 nt n t ndss 5 neo goods 3, nlo 50-53 oe e o 50 mesemen o 50 52 Pllps ve 53 ypes nd ses o o 5 nflo geng 60 nflonyy gp 6 nflon nfom seo 8 nomo symmees 2 nse 83 njeons 39 ees e 60 el e l bnk 59 deemno of 60 moey poly 59-60 nentonl Moey Fnd 90 neventons sppy-sde pols 6 sengs nd wekesses 6 vesmen spendng 2 3 J
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o o mke eoms 62 nd w o demnd 3 lw o dmsng erns 25 w o spply lekges 39 lne demnd nons 6 lne sppy nons 7 long n 2 3 mo 25 mo 3 long n ggege ggege sppy sppy long n vege ol ol os 27 long n elb elbm m Pllps ps e 53 long n Pll log-em logem gow end Loen Loe n e 55 M
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mp oss 25 mpo sbson 85 nenveee pes 62 ndene o xes 5 nome ppo 0 nome dson 55-56 ome elsy elsy o demnd ome low 39
mnged exnge es 69 mgnl mgn l bee 3 6 mgn os 6 26 mgnl prve benes 9 mgl pve oss 9 mgl pod 25 mg popensy 7 mgn evene 27 mgn sol benes 9 103
mgn so oss 9 mgn mgn mgn x e 56 mkebsed poles 2022, 662 86 9293 9293 blne w neenon 9293 negve exees 2022 spply-sde poles 662 de leo 86 mke elbm 5 mke l 92 bse o monopoly monopoly powe 2 symme nomon 2 envomenl ssnby 22-23 exenles 922 lk o pbl goods 23 mke ses 30-38 monopols ompeo 35 monopoly 323 olgopoly 353 pee ompeon 303 sll-ene sll-e ne odon 73 me goods 20 moed 82 llennm Deveopmen Gos 78 mnmm we , 62 monesUnew lssl model money poly 59-60 evo 60 money no 7 money sppy 60 monopols ompe ompeo o 35 eeny 35 pof mxmzo mxmzo 35 moopoy 32-3 bes o eny 32 eeny 33 ntl monopol monopolyy 33 pot mxmon 32 evene even e mxmzon 29, 32 eglon 3 moopoly powe 3 lel le l d 89 mtlel developmen ssse 90 mtlel de geemens mtnol opoons 88 mpe 7 N
nonl nome 0 mesemen 0 onlo 2 l pl 5 l moopoly 33 nemploymen en 8 l e o nemploym ong-n ong- n Pllps ve 53 egve exees 92 podon 9-20 onsmponn 9 2 onsmpo e expos 2-3 oml GDP 39 onollsve olgopoly 37 onexldble goods goods 23 2 nongovemenl ognons 89 nonpree ompeon 35 3 nonpr monopols ompeon 35 ogopoly 3 non-pe deemns dee mns o dem demd d 3 non-pe deemns deemns o sppy novlos goods 23 2 noml goods 3 nomll po 28 3 35 nom monopols ompeto 35
peect competition 31 nomatve economic 1 0
Oficial Development Assstance (ODA 89 olgopoly 35-37 collusive 36 game theoy 36 non-collsive 37 opporniy cost 1 otpt appoach 40 ovealed crren crrency cy 69 p
per capita GDP ad GNI 39 peect competitio competitionn 30-31 demad a reveue cues 30 efficiency 3 evauaton 3 prott maximizatio pro maximizationn 30 sut-dow vesus break-eve pice 30 hillips cue 53 ong rn 53 sot rn 53 portfolio investment 71 positive economcs 1 positive externalties 922 consmption 19, 22 prodction 9 21 potentia outpt 41 44 povety 55 povety cyce (tap) 78 preferentia tade agreements 74 87 price ceiling 718 price controls 178 price deat 41 pricee discriminat pric discriminaton on 37 price pri ce elasticity of demand 810 applications 9-10 determnats 9 vesus slope 8 price elasticity of supply 2 applications 12 determnats 2 price foor 1718 minimum wages 18, 62 price leadership 36 price mecanism 57 esorce eso rce allocation ad efficiency efficiency 5 price taker 30 price war 36 prices: incentives and signas 5 primay commodites 10, 1 12 76 ED 0 76 PS 12, 76 Y 1 76 prisoner's dilemma 36 private goods 23 privatization 61 prodcer price index 50 prodcer srpls 6 prodct differentaton 35 prodction possibilities cue/mode cue/modell 2 54 prodctive eicienc eiciencyy 31 prodctivity 54 profit 28 abomal 28 ecoomic 28 ormal 28 prot maximization 28 monoolstic cometitio cometitio 35
monopoly 32 oligooly 6 pefect competition 30 price discrimina discrimination tion program aid 89 progressive taxaton 56 project aid 89 propoional taxaton 56 public debt 58 pubic goods 23 purchasing power parites 79 Q
quintiles 55 quotas 64 R
rea GD 39 recession 41 recessionay gap 44 46 Keynesan mode 44 monetasVnew classca model 46 redstribtion of ncom ncomee 56 Lorenz cve 55 poicies 56 regonal trade agreements 87 regressive taxation on 56 relatve povety 55 rent 39 resee assets 71 resorce allocation 5 retrns to scae 26 revaluatio crrency 69 revenue maximzation 29 32 revenues 27 rivalros goods goods 23, 24 s
satisfcing 29 scarcity 1 seasonal nemployment 49 short run 25 43 micro 25 macro 43 shot-runn aggregate supply 43 shot-ru shotrunn illips cve 53 shotru shortage excess demand) 5 7 shtdown price 30 singe idicato idicato 80 slope 8 social safety net 92 social srpls 6 specific tax 14 speculato (currency) 68 stagation 5153 strategc interdependence 36 strctual unemployment 49 subsidies 4, 15-6 21-2 21-22 2 64 66 conseuences 16 exteaities 2-22 internaional trade 64, 66 reasons for 15 substitute goods 3 cross pice eastcity of demad 10 supply 7 law of supply 7 maket supply 7 supply crve 7 supply of money 60 supply shocks 43 supplyside policies es 6162 104
valuaton 61 62 trntionit 61 market-based 6-62 surs balance of payments payments 71 sus excess spply) 5 7 sstainablt 2 2223 sustainabe deveopment 22 T
tacit ol olsion sion 36 tarfs 64 tax incidence 15 taxes 4 1415 202, 56 calculations 1415 14 15 iect 56 idit 4 14- -1 externalites 2021 technology 23, 81 ppopiate 81 cean 23 terms of trade 75-76 calculations 75 causes of changes 75 effects o canges 7576 lng-term deterioration 76 sotterm ctuations 76 ted aid 89 total osts 25 total podct 25 tota rvene 27 tadae permits 20 23 tade creaton and diversion 74 tade lberalizaton 86 tade protection 6 4 65 dministrative barriers 65 rguments agaist 65 rguments or 65 otas 64 66 sbsidies 64 66 taiffs 64, 65 tadig bloc 74 tanser payments 56 u
nderemployment 48 ndervaued nderva ued currency 69 neploymet 48-49 calcuating 48 cases 4849 conseences 4 cyclical 48 frictional 49 atua 48 53 seasonal 49 stuctral 49 rba nformal secto 78 V
vae of output ow 39 w
wages 39 inimum 18, 62 welfae loss 14 16 17 19 33 externalites 9 onopoly 33 prce ceilingfloor 17 sbsidies 6 taxes 14 World Bank 90 World Trade Organizatio Organizationn 63 87
