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MICROECONOMICS 2017 PAPER - Coggle Diagram
MICROECONOMICS 2017 PAPER
1a)
Explain how
rational choices
made by
consumers and producers
lead to an
efficient outcome
. [10]
Price Mechanism
Introduction
Rational choice
(rational decision-making)
definition
involves thinking at the margin
and undertaking actions that maximise welfare
both
consumers and producers
make rational choice that maximise their self-interest
consumers maximise utility
producers maximise profit
rational
consumers and producers
will weigh the marginal benefit against the marginal cost of the decision, before deciding whether to consume or produce
an additional unit of the good
Efficient outcome
(allocative efficiency)
definition
is achieved when the society (i.e.
consumers and producers
) produces and consumes a combination of goods and services that maximise society's welfare
assumes perfect competition & absence of externalities
allocative efficiency is achieved when
MSB=MSC
the marginal social benefit is equal to the marginal social cost
P=MC
the value that society places on the last unit of the good is equal to the opportunity cost of resources used in producing that last unit
Body
Consumers
need to make
rational choices
on the quantity of goods and services to consume, due to limited income.
for consumers
the marginal benefit
(demand of the good)
is the valuation of consumers' utility derived from consuming
an additional unit of the good
the marginal cost is the price paid for
an additional unit of the good
MB is downward sloping
due to the Law of Diminishing Marginal Utility (LDMU)
states that as consumers consume more and more goods and services, they will enjoy less
additional utility
from
subsequent units
results in the price consumers are willing and able to pay for
subsequent units
to decrease
explaining the downward sloping demand curve
for a given equilibrium
Rational choice
means that at price Pe,
consumers
will consume up to quantity Qe to
maximise utility
.
consumer surplus
is maximised at area AEPe
the difference between what consumers are willing and able to pay for a good and the price actually paid
no
additional net benefit
gained from consuming the
subsequent unit
If Qd<Qe
then MSB>MSC
(price)
resulting in adding more benefit than cost after consuming
an additional unit
hence, rational consumers should consume more to increase consumer surplus
If Qd>Qe
then MSB<MSC
(price)
resulting in addition more cost than benefit after consuming
an additional unit
hence, rational consumers should consume less to increase consumer surplus
Producers
need to make
rational choices
on the quantity of goods and services to produce, due to limited factors of production.
for producers
the marginal benefit
(marginal revenue)
is the price received from producing
an additional unit of the good
the marginal cost
(supply of the good)
is the opportunity cost of resouces used in the last unit of the good
MC is upward sloping
due to the Law of Diminishing Marginal Returns (LDMR)
states that as producers produce more and more goods and services, they will suffer more
additional cost
from
subsequent units
results in the price producers are willing and able to receive for
subsequent units
to increase
explaining the upward sloping supply curve
for a given equilibrium
Rational choice
means that at price Pe,
producers
will produce up to quantity Qe to
maximise profits
.
producer surplus
is maximised at area BEPe
the difference between what producers are willing and able to receive for a good and the price actually received
no
additional net benefit
gained from producing the
subsequent unit
If Qs<Qe
then MSB
(price)
>MSC
resulting in adding more benefit than cost after producing
an additional unit
hence, rational producers should produce more to increase producer surplus
If Qs>Qe
then MSB
(price)
<MSC
resulting in addition more cost than benefit after producing
an additional unit
hence, rational producers should produce less to increase producer surplus
Rational choice
is made by both
consumers and producers
to
maximise their self-interest
market demand curve represents the maximum price consumers are willing and able to pay for a given quantity of a good
market supply curve represents the minimum price producers are willing and able to receive for a given quantity of a good
when allocation of resources is left to the free market
(price mechanism)
goods are produced up to the point where market demand matches market supply
allocative efficiency
is achieved
assuming perfect competition & absence of externalities
since demand reflects MB & supply reflects MC
at the market equilibrium point where market demand matches market supply MB=P=MC
society's welfare
is maximised
for a given price P1 below the equilibrium
there will be a shortage in the market
as Qd>Qs
quantity demanded exceeds quantity supplied
consumers will outbid one another to buy limited resources
resulting in an upward pressure on price
the increase in price signals to
consumers to decrease Qd along D
by the marginalist principle
consumers will choose to consume a good until the MB derived from consumption of the good is equal to the MC
as price increases
for a given quantity of a good
1 more item...
producers to increase Qs along S
by the marginalist principle
producers will choose to produce a good until the MR is equal to the MC
as price increases
for a given quantity of a good
1 more item...
shortage is eliminated at a new market equilibrium
at Qd=Qs where MB=MC
consumer and producer surplus are maximised
society's welfare
is maximised at area AEB
allocative efficiency
is achieved
1b)
Discuss
the view that
inefficiency
arising from public goods
is the
main reason
for the
Singapore government's spending
in various markets. [15]
Market Failure
Introduction
Inefficiency
(market failure)
definition
is the ability of the unregulated free market to achieve
allocative efficiency
, due to under-allocation or over-allocation of resources relative to the socially optimal output
is the ability of the unregulated free market to achieve
equity
, due to unequal income distribution
is corrected by
government's spending
(government intervention)
Thesis: Inefficiency arising from public goods is
the main reason
for SG government's spending in various market.
Public goods
is a source of
market failure
as
public goods are
non-rivalrous
&
non-excludable
which are not usually supplied in the free market
there is a need for government intervention
non-rivalrous goods
mean that consumption by an individual does not reduce the quantity available to others.
as supply of a public good is not depleted by an additional consumer
the marginal cost of producing for an additional consumer is zero.
since in the free market, rational producers will produce up to P=MC
hence consumers are required to pay the marginal cost of their consumption which is zero.
however, in the private market with profit-maximising firms
goods will not be supplied for free
1 more item...
non-excludable goods
mean that it is impossible or very costly to exclude non-payers from enjoying the good.
as individuals who do not pay for the good enjoy it equally as those who pay for it
there will be no incentive for individuals to pay no matter the valuation of their utility
1 more item...
therefore, when left to the free market, there will be little to no provision of public goods
(missing market)
, resulting in allocative inefficiency.
eg.
in the market for streelights
an individual's use of light does not reduce the amount available for others
it would be unfeasible to charge each individual separately based on the amount of light they use
eg.
in the market for defence
an additional individual in the population will not decrease the amount of protection to the country
toursits who enter the country will receive the benefits of defence even without payment.
is
directly provided
by the
government
therefore, with government intervention, there is allocation of resources to the production of public goods, correcting allocative inefficiency arising from public goods.
eg.
streetlights are important for the safety of commuters and motorists
provided by public agencies (eg. LTA) which is funded by the government using national reserves (which is financed through taxes)
Antithesis: Inefficiency arising from public goods is
not the main reason
for SG government's spending in various markets.
Merit goods
is a source of
market failure
as
merit goods are
underconsumed/underproduced
due to
positive externality
&
imperfect information
positive externality
arises as
since in the free market, rational producers and consumers are self-interested
they choose to ignore the positive externality and only seek to maximise their private net benefit
1 more item...
imperfect information
arises as
since in the free market, consumers are not fully aware of the full benefits of consuming merit goods
they underestimate the marginal private benefit of consumption of merit goods
1 more item...
positive externality
is
subsidised
by the
government
therefore, with government intervention, there is allocation of resources to the production and consumption of merit goods, correcting allocative inefficiency arising from merit goods.
eg.
indirect subsidies in the production of healthcare (eg. subsidised services at polyclinics & 60-80% subsidised class B and C wards in restructured hospitals)
with a subsidy equal to the MEB
cost of production decreases
1 more item...
quantity of healthcare increases from Qe to Qs
internalising positive externality
1 more item...
eg.
direct subsidies in the consumption of education (eg. personal edusave funds & bursaries)
with a subsidy equal to the MEB
disposable income increases
1 more item...
quantity of education increases from Qe to Qs
internalising positive externality
1 more item...
imperfect information
is
educated
by the
government
therefore, with government intervention, there is allocation of resources to the consumption of merit goods, correcting allocative inefficiency arising from merit goods.
eg.
public health campaigns providing information of benefits of health screening
consumers are able to more accurately valuate their MPB
demand curve increases and shifts right from MPB0 to MPB1
quantity of healthcare increases from Qe to Qs
eliminating deadweight loss, correcting underconsumption of healthcare.
Income inequality
is a source of
market failure
as
since in the free market, the needs and wants of consumers with insufficient dollar votes may not have any impact on the market demand
hence resources are allocated based on dollar votes with the free market equilibrium output Qe (where D0=S0) is less than the socially optimal output Qs (where D1=S0).
deadweight loss of area ABC is incurred, resulting in allocative inefficiency & inequity.
is
subsidised
by the
government
therefore, with government intervention, there is allocation of resources to the lower-income households in consumption of merit goods & necessities, correcting allocative inefficiency & inequity arising from income inequality.
eg.
direct subsidies in the consumption of healthcare (eg. CHAS & COMCARE)
with subsidies, consumption of healthcare becomes more affordable to the lower-income households
demand curve increases and shifts right from D0 to D1
quantity of healthcare increases from Qe to Qs
correcting underconsumption of healthcare & acheiving greater equity.
eg.
direct subsidies in the consumption of necessities (eg. GST vouchers & U save with higher rebates for lower-income households)
with subsidies, utility bills are cheaper
disposable income increases for lower-income households
1 more item...
quantity of necessities increases from Qe to Qs
achieving greater equity.
Macroeconomic goals
SG government adopts expansionary fiscal policy with supply-side effects to promote long-term sustained economic growth.
eg.
government's spending in building infrastructure (eg. Changi Airport Terminal 4)
During the last two decades, the corporate world has witnessed a significant rise in the number of
mergers and acquisitions
, including
cross-border
ones.
2) Discuss the
factors
that influence a
firm's
and
government's decision
on whether a
merger
should go ahead.
Firms and Decisions
Introduction
Mergers and acquisitions
is when a firm combines with or takes over another firm
horizontal integration
in the same stage of production.
vertical integration
in a different stage of production,
forward integration
1 more item...
backward integration
1 more item...
conglomeration
that is not directly related.
Firm's decision to merge
Thesis 1: Potential
benefits
for
firms
to
merge
Revenue advantage
With merger
greater market share
increase D
1 more item...
stronger market power
decrease PED
1 more item...
increase supernormal profits
more resources to conduct R&D
1 more item...
Cost advantage
With merger
horizontal integration
larger scale of production (movement along LRAC to MES)
1 more item...
vertical integration
securing raw materials at lower cost
2 more items...
cross-border merger
firm in DC takes over another firm in LDC
1 more item...
Antithesis 1: Potential
costs
for
firms
to
merge
Revenue disadvantage
With merger
cross-border merger
cultural difference
1 more item...
stronger market power
depends on
1 more item...
Cost disadvantage
With merger
produce beyond MES
IDOS
2 more items...
unwilling to agree on overlapping processes
limited IEOS
2 more items...
merger with another that is non-performing requires the 'rescuer' firm to spend more
incur higher cost (eg. marketing, staff training, improving image to salvage reputation)
1 more item...
consolidation
incur costs to compensate retrenched workers
1 more item...
aim to
maximise profits
by
increasing revenue
decreasing cost
decision is based on
weighing marginal benefit against marginal cost
if MB>MC
profits will increase
merger will take place
if MB<MC
profits will decrease
merger will not take place
to merge
MB>MC
increase profits
cross-border merger
level of corporate tax rates
level of restriction on profits
other drivers
challenging market conditions (i.e. recession & greater competition)
merger can quickly increase market share & profits compared to organic expansion
cross-border merger
can have greater outreach to global market
when other firms have merged (especially in an oligopoly market structure with strong mutual interdependence)
if merger can offer lower P due to greater IEOS, other firms will follow suit to match the P cut
however in the long run P cut leads to price war
decrease profits
1 more item...
Government's decision to merge
Thesis 2: Potential
societal benefits
for
government
to approve
merger
cost-savings (i.e. IEOS) passed on to consumers
decrease P
improves inequity
depends on
challenging market conditions (i.e. recession & greater competition)
if not
1 more item...
higher supernormal profits to conduct R&D
process innovation
decrease COP
decrease P
1 more item...
product innovation
increase Quality
depends on
challenging market conditions (i.e. recession & greater competition)
if not
1 more item...
degree of dominance after merger (i.e. oligopoly market structure with non-price competition)
likely to conduct R&D to avoid price competition
1 more item...
cross-border merger
can have greater outreach to global market
boost export competitiveness
increase X
increase AD
1 more item...
depends on
challenging market conditions (i.e. recession & greater competition)
likely to reap benefits of globalisation
1 more item...
Antithesis 2: Potential
societal costs
for
government
to approve
merger
stronger market power
decrease PED
greater ability to increase P
widen gap between P and MC
1 more item...
less competition
lack of incentive to conduct R&D
limited dynamic efficiency
increase BTE
supernormal profits concentrated within a few firms (i.e. minority)
worsens inequity
aim to
maximise social welfare
by
achieving microeconomic goals
allocative efficiency
productive efficiency
dynamic efficiency
distributive efficiency (equity)
achieving macroeconomic goals
economic growth
lower unemployment
decision based on
weighing marginal social benefit against marginal social cost
to approve merger
firms' motive
to improve competitiveness
not to exert greater dominance
challenging market conditions (i.e. recession & losing export competitiveness)
cross-border merger
can have greater outreach to global market
political drivers to have low foreign share
merger can quickly increase market share & profits compared to organic expansion
