THEME 1: intro to markets and market failure

ceteris paribus

(latin) “all other things remaining constant”

→ focus on the majority when observing the effect of one variable

normative statement

Information based on a value judgement

→ e.g. minimum wages should be increased

positive statement

information based on a fact

→ e.g. if prices decrease, general demand will increase

model

simplified version of a complex economic function that can be tested

value judgement

a subjective opinion

scarcity

excess of want over availability of resources

opportunity cost

next best alternative that is forgone when making a decision

economic agent

someone who makes economic decisions

e.g. firms, individuals, government

specialisation

producing what a worker, firm or country is best and most efficient at

division of labour (+ discussed by who?)

when productive processes are is split so each stage is carried out by different workers

→ idea discussed by adam smith

medium of exchange

e.g. money

a system used to overcome the inconvenience of the barter system

free market

economic environment with no government intervention, and the market decide how resources are allocated

mixed economy

an economic environment where governments only intervene when necessary, and most resources allocated by the market

command economy

an economic environment that is fully run by the government

which individuals advocated for free, mixed and command economies?

free: friedrich hayek

mixed: adam smith

command: karl marx

4 factors of production

capital, enterprise, land, labour

consumer goods

goods that cannot be used to produce another good

capital goods

goods that can be used to produce other goods

renewable reosurce

a resource that can/is being replenished as it is used

→ e.g. solar energy

non-renewable resource

a resource that cannot be replenished, or replenishes too slowly, as it is used

→ e.g. coal

production possibility frontier (PPF)

a graph that depicts the maximum productive potential of an economy when its resources are being fully used

→ also shows:

opportunity cost

allocation of resources

economic growth or decline

OPPORTUNITY COSTS: importance for CONSUMERS

• maximising utility → weighing the benefits of choosing one thing over another especially with price changes

• allocation of their time → consumers must have a work-life balance

SPECIALISATION AND DIVISION OF LABOUR: pros for FIRMS

• higher productivity and output → they become skilled by repetition → increasing output per worker

• time saving → no time wasted switching between machinery, tools and tasks

• cost effective → each worker does not need full set of equipment → then benefit from economies of scale

SPECIALISATION AND DIVISION OF LABOUR: pros for CONSUMERS (trade)

lower prices → reduced costs bring down prices

increased quality → skilled workers make less mistakes and produce at higher standards

SPECIALISATION AND DIVISION OF LABOUR: cons for FIRMS

• workers become demotivated and bored → repetitive tasks can decrease worker morale

• structural unemployment→ if demand for the product decreases, workers lack transferrable skills

• disruption risks → if one part of the process breaks down, the whole process stops

SPECIALISATION AND DIVISION OF LABOUR: cons for CONSUMERS (trade)

• over reliance on imports → if each country is specialised in one field, they rely on others for basic commodities

• structural unemployment → if demand for the product decreases, workers lack transferrable skills

OPPORTUNITY COSTS: importance for FIRMS

• resource allocation → what to produce and how to allocate it to maximise profit

• investment → deciding when to invest

• specialisation → goods with lowest opportunity costs (lower prices) receive more demand

OPPORTUNITY COSTS: importance for GOVERNMENTS

• public sector spending → must decide where to spend their government budget

• taxation decisions→ whether to increase or decrease taxes (both have pros and cons)

COMMAND ECONOMY: pros

• directly provides public services

• reduces inequality→ wages and prices are controlled by the gov.

• prevents monopolies

• focuses on full employment → gov. creates jobs and allocates them to workers

COMMAND ECONOMY: cons

• inefficiency → no competition leads to no innovation

• limits individual freedom

FREE MARKET: pros

• high efficiency and low prices → due to competition

• consumer decides → they decide how resources are allocated due to their spending decisions

• supply and demand as the price mechanism → resources allocated automatically

FREE MARKET: cons

• market failure → market can fail and leave to severe recessions

• negative externalities → ignores environmental damage, no public goods, information provision

• high inequality → education, healthcare, etc. are out of reach for the poorer individuals and the wealthy get wealthier

• monopolistic power → monopolies exploit consumers with very high prices

role of the government in a mixed economy

• providing public and merit goods

• correcting market failures → through taxation, subsidies, etc

• regulation of monopolies and work environments

• income redistribution → through progressive taxation, benefits, etc.

• macroeconomic stability → trade, balances, etc.

merit good

goods that would be under-provided by the free market, such as healthcare and education

externality

a cost or benefit of a transaction that affects a third party not directly involved

public goods

goods the state provides, because a free market would not otherwise supply them

market failure

when the free market fails to allocate resources efficiently, requiring state correction

“invisible hand”

adam smith’s idea that self-interest in a free market can lead to positive outcomes without state direction