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Economics - Coggle Diagram
Economics
Microeconomics
Chapter 1: Central Problem of Economics
Choice
Resources have alternative uses
Choices must be made to achieve the highest possible level of satisfaction
Choices to make:
What and how much to produce
How to produce
For whom to produce
Scarcity
Limited resources
Land
Labour
Capital (factories/machines/tools)
Entrepreneurship
Unlimited wants
Desire for higher levels of consumption leads to unlimited wants
Wants are satisfied by consumption of goods and services
Opportunity cost
Next best alternative forgone
Free goods (air, dead leaves) have no opp cost as it can satisfy all existing wants so nothing is given up
Law of increasing opp cost
As more of one good is produced, larger and larger quantities of alternative goods are sacrificed
Production Possibility Curve
Shows all the different maximum attainable combinations of goods and services that can be produced in an economy when all available resources are fully and efficiently used at a given state of technology
Points inside curve are attainable but inefficient
Points outside are preferred but unattainable
Illustrating CPE
Scarcity
Combinations outside the PPC cannot be obtained although the economy may desire it
Choice
All combinations of goods on or bounded by PPC are attainable, but the economy can only have one of the alternatives
Opp cost
Negative slope of PPC, increasing one good decreases the other
Law of increasing opp cost
Concave PPC (relative to origin), each additional unit of capital goods produced requires the sacrifices of more and more consumer goods and vice versa
X: 10, 20, 30, 40; Y: 18, 30, 40, 45
Constant opp cost, straight line PPC
Illustrating economic growth
Actual growth
Outward movement of point inside PPC
Potential growth
Increase in production of both goods
Outward shift of PPC
Increase in production of one good
Pivotal shift of PPC
Current consumption vs economic growth
Choosing to produce more consumer goods leads to less economic growth, smaller outward shift in PPC
Choosing to produce more capital goods leads to larger outward shift in PPC
Economic growth
Increase in an economy's level of output or GDP over time
Actual growth
If economy is not fully utilising its resources, actual growth is achieved by encouraging greater use of existing resources or utilising resources more efficiently resources
Potential growth
Increase in quantity of available resources
More intensive exploration to discover new mineral deposits
Greater investment of resources into capital goods
Encourage population growth to grow workforce
Improvement in quality of available resources
Upskilling workforce
Irrigation/fertiliser application
Improvement of technology
Framework for economic decision making
Information
Perspectives
Intended Consequences
Costs
Unintended Consequences
Benefits
Changes (internal/external)
Constraints
Chapter 2: Theory and Applications of Demand and Supply
Demand and Supply
Demand: quantities of a good/service that consumers are willing and able to buy at various prices over a given time period, ceteris paribus
Supply: quantities of of a good/service producers are willing and able to offer for sale at various prices over a period of time, ceteris paribus
Demand and supply curves
Demand curve
Law of diminishing marginal utility
As more and more units of a good/service are consumed, additional utility a consumer derives from successive units eventually decreases
As marginal utility falls, willingness to pay decreases so price decreases
Law of demand
There is an inverse relationship between price and quantity demanded of a good, c.p., resulting in negative slope of demand curve
Demand curve represents the maximum price consumers are willing and able to pay for each quantity of a good/service
Supply curve
Law of supply
There is a direct relationship between price and quantity supplied of a good, c.p., resulting in positive slope of supply curve
Supply curve represents the minimum price at which producers are willing and able to supply at each quantity
Equilibrium price and quantity
The supply curve and demand curve intersect at a point which corresponds to the equilibrium price and equilibrium quantity
Quantity demanded=quantity supplied at equilibrium price
Surplus and shortage
Surplus
When price is above Peq, Qs>Qd
Signals to producers to lower prices to increase Qd, Qs will decrease
Shortage
When price is below Peq, Qs<Qd
Signals to producers to increase prices to increase Qs, Qd will decrease
Total revenue/total expenditure
Area (0PeEQe)
Consumer surplus
Difference between what buyers are willing and able to pay and what they actually pay
Producer surplus
Difference between what a producer is willing and able to put up for sale and the actual price charged
Shifts in vs movements along S and D curves
Change in quantity demanded/supplied (caused by price)
Movement along curve
Change in demand/supply (caused by non-price factors)
Shift in curve (right or left)
Factors affecting demand
Consumer Income (see YED)
Inferior goods (public transport)
As income increases, demand for inferior goods increases
Normal goods (car)
As income increases, demand for normal goods increases
Prices of related goods (see CED)
Substitutes (coke and pepsi)
Increase in price of substitutes cause increase in demand
Complements (burger and fries)
Increase in price of complement leads to decrease in demand
Tastes and preferences
Fashion/trend
Advertising
Government policies
Seasons/Festivals
Demographics (market size, age, gender)
Consumer's expectations (expected income, prices, demand)
Factors affecting supply
No. of producers (intuitive)
Cost of production (intuitive)
inputs (raw materials), state of technology, efficiency, government policies
Prices of related goods
Competitive supply (corn and wheat)
Joint supply (beef and leather)
Supply shocks
Climatic conditions
Abnormal circumstances
Producers' expectations
Simultaneous shifts
either change in Peq or Qeq will be indeterminate
Elasticities
Cross elasticity of demand (CED)
dor of demand to changes in price of related goods
Positive cross elasticity
Strong substitute CED>1
Weak substitute 0<CED<1
Negative cross elasticity
Weak complement -1<CED<0
Strong complement CED<-1
Income elasticity of demand (YED)
dor of demand to changes in income
Positive income elasticity
Income elastic (YED>1)
Luxury goods
Income inelastic (0<YED<1)
Necessities
Negative income elasticity
Inferior goods
Factors affecting YED
Nature of the good
Level of income of customers (affects what is perceived as necessities/luxury/inferior)
Price elasticity of demand (PED)
degree of responsiveness (dor) of quantity demanded to changes in price (dQd/Qd)/(dP/P)
Elastic (|PED|>1)
change in price results in more than proportionate change in quantity demanded
Inelastic (0<|PED|<1)
change in price results in less than proportionate change in quantity demanded
PED is always negative since increase in quantity demanded leads to decrease in price
Factors affecting PED
Availability of substitutes (number and closeness)
Degree of necessity
Proportion of income
Price elasticity of supply (PES)
dor of quantity supplied to changes in price
Always positive since increase in quantity supplied leads to increase in price
Inelastic (PES<1)
Elastic (PES>1)
Factors affecting PES
Spare capacity (unused manpower/resources)
Nature of production
Degree of factor mobility (how fast you can move resources and increase productivity)
Length of production period (Crops take a while to grow so a few years needed to adjust, supply is price inelastic)
Ease of accumulating inventory
Time period (most goods elastic in long run and inelastic in short term)
Limitations
Ceteris paribus assumption
Demand elasticities neglect cop
Lack of perfect information
Government intervention
Tax
Direct tax
Indirect tax
Specific (fixed amount)
Upward parallel (leftward) shift in supply curve
Vertical distance between S0 and S1 is the tax amount
Ad valorem (percentage)
Supply curve pivots about origin
Purpose of indirect tax
Raise tax revenue
Reduce consumption of undesirable goods
Subsidy
Artificially lower costs
Downwards (rightwards) shift in supply curve
Consequences of subsidy
Producer income increased
Lower price for consumers
Higher quantity exchanged
Transfer of income from taxpayers to producers
Allocation of resources to subsidised industries
Strain on govt budget
Price control
Price floor
Legally established minimum price above the market equilibrium price
Purpose
Protect producer income
Create surplus to store for future shortages
Minimum wage to reduce poverty and inequality
Effects
Change in expenditure depends on PED
Creates surplus (unemployment in the case of min wage)
Decrease in consumer surplus
If govt buys up excess
Producer surplus increase
Revenue increases
Excess not bought
Black market, goods sold illegally below minimum price
Price ceiling
Legally established maximum price below market equilibrium price
Purpose
Keep price of good affordable to majority
Prevent exploitation by suppliers during times of shortage
Stabilise prices
Effects
Shortage (rationing)
Consumer surplus increase
Producer surplus decrease
Decrease in expenditure/revenue
Quantity control
Quota
Chapter 3: Market Failure & Government Intervention
Market Failure
The free market does not always allocate scarce resources efficiently in a way that maximises society's welfare
Marginal Private Benefit/Cost
MPB: the benefit consumers gain from consuming an additional unit of a good
MPC: the cost producers incur from producing and additional unit of a good
Demand and supply curves can be used to represent MPB/MPC respectively
Marginal Social Benefit/Cost
MSB: benefit to society from the consumption or production of an additional unit of a good
MSC: cost to society from the consumption or production of an additional unit of a good
Social Welfare is maximised when MSB=MSC
Below Qm, MSB>MSC, more resources can be allocated to production and consumption of the good
Above Qm, MSB<MSC, less resources can be allocated to production and consumption of the good
At Qm, MSB=MSC in the absence of market failure
Causes of Market Failure
Externalities
Marginal External Benefit/Cost
MEB: benefit to third parties from the consumption or production of an additional unit of the good
MEC: cost to third parties from the consumption or production of an additional unit of the good
MSB=MPB+MEB
MSC=MPC+MEC
Negative externalities
External costs cause a divergence between private and social costs so MSC>MPC
MSC intersection with MSB is the socially efficient quantity Qs<Qm
Left-pointing triangle bound by Qs and Qm represents deadweight loss
Cost is incurred by third parties due to the production or consumption of a good without compensation
Positive externalities
External benefits cause a divergence between private and social benefits so MSB>MPB
Right pointing triangle bounded by Qs and Qm represents deadweight loss
Production or consumption of a good generates external benefits for third parties without compensation
Solutions
Negative production externalities
Taxes
By imposing a tax such that Tax=MEC at Qs, there will be an upward shift in the MPC curve such that Qs becomes the new market equilibrium quantity, externality is internalised
Limitations: Lack of info, impractical to have different tax rates depending on pollution levels
Regulation
Require by law that producers equip factories with emission reduction devices and enforce by conducting checks and imposing fines/suspensions
Limitations: lack of compliance, high administrative costs, blunt instrument, unsustainable
Total ban on product
Only when MEC is large such that MSC is much higher than MSB so there is a net welfare gain from imposing the ban
Tradable/marketable permits (quota)
Government places a cap on the total permissible level of pollution based on estimates of what level is socially efficient
Firms are issued permits which allow a certain amount of pollution, permits can be traded between firms
Advantages: efficient distribution of permits, incentive to reduce pollution
Limitations: lack of perfect information, compliance and admin
Negative consumption externalities
Taxes
Regulations
Positive consumption externalities
Subsidies
By giving a subsidy such that subsidy=MEB at Qs, there is a downward shift in the MPC curve such that Qs becomes the new market equilibrium quantity, externality is internalised
Limitations: Lack of info, opportunity cost for government budget
Unintended consequences: inefficiency, budget strain
Direct provision from government
Government provides goods and services with positive externalities, may not be free
Limitations: inefficiency, poor service standard, budget
Public goods
Public goods are goods and services that have the characteristics of non-excludability and non-rivalry in consumption
The free market fails to allocate any resources to produce such goods that can enhance the welfare of society
Characteristics
Non-excludability
Consumption of a good or service cannot be limited to paying consumers
Non-rivalry
The consumption of a good or service by one consumer does not reduce its availability to another consumer
Non-rejectability
Inability of a consumer to refuse the consumption of a good once it is produced
Solutions
Direct provision by government
Free market will not provide public goods, government has to provide them to enhance society's welfare
Government's objective is not to maximise profits but social welfare
May be provided by government or outsourced to private company with cost born by government
Limitations
Lack of information
Lack of public funds
Political Pressures
Implications
Free ridership
Due to non-excludability, people can free-ride on a good by receiving benefits of a good without paying
No price signals
Market will not provide good due to lack of price signals arising from free ridership
No user charge
Marginal cost of providing a public good to an additional consumer is 0. Since Peq=MC, so producers cannot profit and the market does not provide the good
Information failure
Imperfect information
Incorrect information
Consumers make bad choices as they have been misinformed or receive the wrong information from sellers
Ignorance
Consumers are ignorant to the actual benefits of a product and over/underestimate the MPB
Due to low frequency of consumption and lack of experience, a consumer may not be able to accurately assess the true MPB
Imperfect info on MPB
Consumers will consume at Q1 where MPB perceived=MPC based on imperfect information
Over/underconsumption Q2-Q1 where Q2 is the equilibrium quantity with perfect information
Divergence between actual and perceived MPB
Deadweight welfare loss of area ABC (points from Q1 to Q2)
Imperfect info on MPC
Consumers will consume at Q1 where MPC perceived=MPB based on imperfect information
Rest is the same
Divergence between actual and perceived MPC
Solutions
Education/Moral suasion
Use morality to influence and change behaviour instead of force
Limitations
Loopholes in regulation
Education is a long-drawn process
Effectiveness of education depends on consumer response
Addictive products may not be affected as much by education
Regulation
health warnings
laws protecting against imperfect information
laws protecting the ignorant (children)
The free market allocates resources on the assumption that all consumers and producers have full or perfect information about the market and products and hence are able to make optimal choices to maximise their welfare
Asymmetric information
Economic agents involved in a transaction (consumers and producers) do not have the same amount of knowledge, resulting in distortion of incentives and inefficient market outcomes
Adverse selection
Occurs when a good is mainly bought or sold by a certain segment of the more informed party that would harm the uninformed party
Knowledgeable sellers
Used car market: Used car dealers have more information regarding a car's condition than the buyer and will hide some information from buyers to profit. Buyers take this into consideration and are willing to pay lower prices. Sellers of good cars are unwilling to sell at these prices so only low quality cars are sold
Knowledgeable buyers
Health insurance market: Buyers know more about their health than sellers and may conceal certain information. Higher risk individuals more likely to buy health insurance and opt for higher levels of coverage
Moral hazard
One party has more information than the other and changes his behaviour after the transaction as the costs are borne by the other party
Effects
Reduced market size
Adverse impact on low-risk consumers
Risky behaviour from insured parties
Underconsumption by low-risk consumers
Solutions
Mandatory coverage
Laws to prevent opportunism (anti-lemon laws) to prevent sellers from selling defective goods
Equalising information (screening and signalling)
Immobility of factors of production
Resources cannot respond to incentives to produce goods and services demanded by customers or disincentives to stop or cut production, productive efficiency is not obtained
Labour immobility
Occupational immobility
Workers are unable to switch to different jobs immediately as they lack the right skills
Geographical immobility
Social ties and costs involved in moving
Capital immobility
Functional immobility
Difficult to transfer from one use to another
Geographical immobility
Difficulty of transport
Solutions
Policies to overcome occupational immobility
Retraining/reskilling
Limitations
Success/uptake rate
Funding
Policies to overcome geographical immobility of labour
Bring workers to work
Better transportation
Affordable housing
Bring work to workers
Decentralise business centres, provide incentives for businesses to relocate
Policies to overcome capital immobility
Provide incentives to invest in new capital or relocate
Limitations
High risk due to information failure (government dk where to invest)
Lack of compliance (misuse of funds)
Market dominance
Quantity supplied is restricted in order to maximise profits, resulting in deadweight welfare loss
Solutions
Prevention/Prohibition
Prevent monopolies from forming or prohibit monopolies from abusing their dominant position
Deregulation
Increase competition to keep prices competitive and improve efficiency
Price regulation
Force monopoly to charge a price equal to MC
Inequality in distribution of income and wealth
Efficient allocation may not result in equitable outcomes
Markets unable to provide for those who lack purchasing power due to income and wealth inequality
The poor are unable to gain access to essential goods and services, resulting in inequity, government must intervene to provide them
Equity is normative, some goods are universally essential while others are subject to the values of different societies (e.g. petrol)
Equity is fairness in the distribution of economic welfare
Income inequality is the extent of income disparity between high and low income households (measured using Gini coefficient)
Solutions
Progressive income tax
Limitations: Too progressive --> no incentive to work
Subsidies
Tax collected is redistributed to low-income households
Minimum wage
Limitations: increases unemployment
Training and skills upgrading schemes
Close the gap in education and qualifications
Workfare income supplements
Immediate help to the low income, does not incentivise unemployment
Causes of government failure
Definition: Government intervention results in greater market inefficiencies than would otherwise occur
Information failure/gap
Bureaucratic inefficiency
Costs of administration and compliance
Political factors
Tendency to look for short term solutions
Pursuit of self-interest
Electoral pressures
Lack of voter/political support
Unintended consequences (COE makes ppl drive more to get their money worth, worsening congestion)
Policy conflicts
Chapter 4: Firms and Decisions
Objectives of firms
Profit maximisation
Total revenue exceeds total costs by the greatest amount
Addition to total revenue from the sale of the last unit is equal to the addition to total cost of producing it (MC=MR)
Reasons why firms do not operate at profit maximising output
Lack of information and knowledge
implicit costs are hard to compute
hard for firms to gauge demand accurately and continuously
Short term profit maximisation not in the long term interest of the firm
Alternative objectives
Sales revenue maximisation
Increase production to MR=0
Increase market share
Sales volume maximisation (market share dominance)
Market share dominance can be measured in terms of output and sales revenue
Engage in extensive product development to differentiate its good
Increase market share in the short run, once good becomes PED inelastic
Profit satisficing
Shareholders seek profit while managers wish to grow the firm
Attain reasonable profits to satisfy shareholders
Cost, revenue and profit maximisation
Costs of production
Explicit costs
Costs incurred when actual monetary payment is made
Implicit costs
Do not involve direct payment of money
Involves opportunity cost
Short run
At least one fixed factor
Output can only be adjusted by changing the quantities of variable factors
Long run
All factors of production variable
Planning ahead to build an appropriate scale
Minimum efficient scale output (lowest point on LRAC curve)
EOS and DOS
Internal economies of scale
Fall in unit cop when firm increases output by expanding its scale of production
Sources
Bulk purchase
Spreading out fixed costs
Division of labour/specialisation
External economies of scale
Fall in unit cop due to growth in the industry
Sources
More firms enter to operate at a locality
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Sharing and disseminating information
Internal diseconomies of scale
Rise in unit cop when firm increases output by expanding its scale of production
Sources
Managerial difficulty
Low morale
External diseconomies of scale
Rise in unit cop due to growth in the industry
Sources
Higher input prices
Increased strain on infrastructure
Shifts in LRAC curve
When scale of production changes, movement along the LRAC curve
External economies/diseconomies of scale cause curve to shift down or up respectively
Total cost
Total cost=total fixed cost+total variable cost (TC=TFC+TVC)
Marginal cost
Additional cost arising from an additional output (dTC/dQ)
Average cost
Cost per unit of output (AC=AFC+AVC=TC/Q)
Revenue
Total revenue
Total earnings per period of time from the sale of output
Average revenue
Amount earned per unit sold (TR/Q)
Marginal revenue
Additional revenue obtained when one more unit of output is sold (dTR/dQ)
Types of economic profit
Normal (TR=TC)
Subnormal (TR<TC)
Supernormal (TR>TC)
Factors affecting profit, price and output
Demand changes cause AR and MR to change, affecting equilibrium price and output
Changes in fixed costs cause change in profit but not equilibrium price and output (AC shifts, MC still intersects minimum)
Changes in variable costs cause equilibrium price and output to change (MC and AC shift)
Strategies and Decisions
Market Structures
Monopolistic Competition
Differentiated goods (independence)
Little to no BTE
Many small firms (can start after 3 yrs of working)
Imperfect knowledge
Oligopoly
Homogenous or differentiated product
High BTE
A few dominant firms (roughly <50)
Imperfect knowledge
Perfect Competition (imposssible)
Many small firms and consumers
Horizontal demand curve
Price taker
Homogenous product
No barriers to entry and exit
Producers and consumers have perfect knowledge of the market
Monopoly
Single seller
Imperfect knowledge
High barriers to entry and exit
Substantial internal EOS
Monopoly able to charge lower prices than new entrant
Control of essential raw materials and wholesale/retail outlets
Legal barriers (patents/copyrights)
Brand loyalty
Unique product
PED inelastic
Non-price strategies
Marketing
Efforts taken by a firm to promote its product, usually advertising but can include free gifts, samples and lucky draws
Innovation
Effort by a firm to come up with new, improved or differentiated products, raising market power as demand for products increases and products become more PED inelastic.
Can also apply to production process to raise productivity or lower costs
Growth
Expansion
External
Mergers and Acquisitions
Horizontal integration
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Side effects
Debt from financing acquisition
Poorer product quality
Diseconomies of Scale
Benefits
Increase firm's capacity and market share rapidly
Cost rationalisation (no need for duplicate factors)
Internal
Increase in scale of production
Generally inferior to merger
Diversification
Mergers and Acquisitions
Conglomerate integration
Firms from different industries merge for risk diversification (risk spread out)
Vertical integration
Firms in different stages of production (forward and backward integration)
Side effects
Risk from entering unknown market
Benefits
Economies of scope
Protection from competitors
Revenue advantages
Capture market share and increase market power
PED inelastic --> Pricing power
Larger revenue enables non-price competition like product development and promotion
Cost advantages
Increase IEOS
Cooperation/Collusion
Situation where firms in a market cooperate to jointly fix prices or output
Big firms may cooperate in the area of R&D if costs are high and the pace of technical change is rapid by pooling knowledge and agreeing on technical standards
Cartel
Formal collusive agreement, causing oligopoly to behave like a monopoly
Agreement sets monopoly price and allocates the output among members usually according to market share
Tacit collusion
Unwritten agreement
Following the pricing policy of a recognised leader, usually the firm with largest market share
Pricing Strategies
Predatory pricing
Selling products below average cost in order to force competitors out of the market
May start price war in oligopoly, quality of goods drops
Price rigidity
In an oligopoly, rivals will match any price decrease initiated by any one firm but will not match price increases according to kinked demand theory
Raising prices causes more than proportionate fall in Qd
Lowering prices causes rivals to lower prices so as to preserve market share, less than proportionate increase in Qd
Limit pricing
Setting prices slightly higher than average cost but lower than that of potential rivals, creating an artificial entry barrier and preventing new firms from entering the market
Price discrimination
Charging different prices for the same product to different groups of consumers, not due to differences in costs
Conditions
Price setter with a degree of monopoly power
Different markets wth different PEDs
Separate markets and prevent resale
Benefit
Improve equity by making good/service available to lower income groups
Reinvestment in R&D, innovation, lower costs and lower prices, benefiting society
Costs
Fall in consumer surplus for consumers with price inelastic demand, producers profit at the expense of these consumers
Decision to shut down
Short-run
If AR>AVC, continuing production can help to cover some of the start up capital
If AR<AVC, shut down temporarily to avoid incurring further losses until conditions are more favourable
Long run
Shut down permanently and leave the industry if TR<TC
Other influences on firm behaviour
Behavioural economics
Technological disruption
Corporate social responsibility
Impact of Firms' Strategies & Decisions on Efficiency and Consumer Welfare + Government Intervention
Efficiency
Allocative Efficiency
Output level where society's welfare is maximised (P=MC)
If P>MC like for price setters, firm is allocative inefficient and society would benefit from production of additional units of the good
Dynamic Efficiency
Firms invest in technology so productivity and product quality increase over time
Innovation is used to erect barriers to entry, reduce costs and increase revenue, helping to retain supernormal profits in the long run
Productive Efficiency
Achieved when a given level of output is produced at the lowest cost (any point on LRAC)
X-inefficiency
Large dominating firms may become complacent and inefficient without competitive pressures as cost controls become lax. COP is higher than necessary so AC and MC are higher than on LRAC and LRMC curves.
Impacts of firms' strategies & decisions on efficiency and consumer welfare
Price and output
Collusion results in higher prices so consumers are adversely affected
Competitive oligopolies price rigidity ensures consumers enjoy low prices even if costs have risen
Price discrimination may reduce consumer surplus
Predatory pricing and price wars may benefit in the short term until competitors exit
Variety and quality of products
Innovation actually improves variety and quality
Advertising and branding only give the illusion of improvement
Government policies towards market dominance
Reasons for government intervention
X-inefficiency
Dynamic inefficiency
Allocative inefficiency
Worsened equity
Objectives of government intervention
Improve consumer welfare and equity
Promote economic efficiency
Ensure big firms remain viable and innovative
Policies
Increase competition with competition/antitrust laws
Prevent formation of monopolies/cartels
Prevent the abuse of dominant position (predatory pricing)
AR/MR shift left and become more price elastic
Antitrust laws may be a blunt instrument as some mergers are to reduce costs through joint production
Regulation
Regulate prices by marginal cost pricing (P=MC)
More common for natural monopolies (small market or high fixed costs, MES is very large)
Reduction in supernormal profits disincentivises R&D
Public ownership
Government runs the firm but has no incentive to keep the firm profitable. P=MC for allocative efficiency and equity improves
Macroeconomics
Chapter 5 Part 1: Introduction to Macroeconomics and Standard of Living
Importance of macroeconomy
The continuous cycle of production and consumption within an economy enables us to satisfy our material wants
Macroeconomic goals
Internal goal
Domestic price stability (low, stable inflation rate)
Full employment
Economic growth (Non-inflationary, sustainable, inclusive)
External goal
Favourable balance of trade position (X-M)
Macroeconomic problems
Price instability (High inflation or deflation)
High unemployment
Negative, slow or inflationary economic growth
Persistently large balance of trade defecit
National income accounting
Purpose
To track the economic performance of a country
Indicate the overall standard of living of the people in the country
GDP
Market value of all final goods and services newly produced within the geographical boundary of an economy in a given period of time (one year)
Real vs Nominal GDP
Real
Measured at constant/base year prices
Effects of price changes removed
Nominal
Effects of price changes not removed
Measured at current market prices
Real GDP = Nominal GDP/GDP deflator x 100
Growth in real NI (% change) = growth in nomination NI (% change) - inflation (%)
National income --> household income --> purchasing power --> consumption of goods --> material SOL
GNI/GNP
Market value of all final goods and services newly produced anywhere in the world from resources belonging to residents of a country on a given time period (one year)
Net factor income from abroad (NFIA) = factor income from abroad (FIFA) + factor income paid abroad (FIPA)
GNI=GDP+NFIA
National income: Y=PxQ
Difficulties
Ommisions in measurement
Illegal activities
Unreported activities
Non-marketed activities
Double counting
Difficulty in obtaining reliable, complete information
Comparison of standard of living over time and space
Material well-being
Quantity and quality of goods and services available to residents for consumption
Measured by real GDP per capita
Non-material well-being
Intangibles/quality of life (working hours, stress level, pollution level)
Standard of living refers to the level of well-being or welfare enjoyed by an average person or resident of a country
Comparison
Limitations to using national income statistics
Inter-temporal comparison
Non-material
Changes in negative externalities
Pollution, congestion, destruction of environment not counted
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Changes in disamenities
Longer working hours/stress also not counted
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Material
Changes in population
GDP per capita ofc u need to look at population lah
Changes in composition of NI
Industrial machines and military goods (capital goods) are not consumed by consumers and do not contribute to standard of living
Changes in price level
If prices go up but output is the same living standards don't actually increase its just inflation. Use real GDP/GNI not nominal since it keeps price constant
Changes in distribution of NI
GDP per capita is only an average, does not account for income disparity
Gini coefficient and Lorenz curve are better measures of income distribution
International comparison
Material
Different currencies involved
Comparison cannot be made using different currencies, must standardise (to USD)
Fluctuation in market exchange rate
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Differences in population
Differences in composition of NI
Differences in distribution of NI
Different sizes of the non-monetised sector
Less developed countries have more farming communities, where housewives, unpaid family workers and subsistence farming are all not counted in GDP
Differences in availability and reliability of data
Greenland and Africa + inaccuracy for bigger countries
Non-material
Differences in negative externalities
Differences in disamenities
Other indicators
Human Development Index (HDI)
weighted average of GNP per capita, life expectancy and educational attainment
Net Economic Welfare (NEW)
adds leisure and non-marketed activities and subtracts costs of pollution and disamenities from GNP
Chapter 5 Part 2: Circular Flow of Income and AD/AS Model
Circular flow of income
Firms
Factor incomes (wages, rent, interest, profit)
Households/Consumers
Consumer expenditure on goods and services (C)
At equilibrium
national income = national expenditure = national output
J=W
Governments
Government expenditure (G)
Injection into the circular flow
Taxes (T)
Withdrawal from the circular flow
External/Foreign Trade
Imports (M)
Withdrawal since money leaks out of local economy
Exports (X)
Injection since people overseas are creating income for domestic households and firms
Withdrawals (W) = Savings (S)+M+T
Injections (J) = Investment(I)+X+G
The Multiplier
The multiplier is defined as the number of times national income expands as a result of an initial injection
An injection generates income for individuals employed by firms producing demanded goods and services. They then spend a proportion of the additional income on induced consumption and the rest is withdrawn as savings, taxes and import spending. Increase in induced consumption creates income for individuals employed in other sectors, repeating the cycle until increase in income becomes negligible.
ΔY=kΔJ, where k is the multiplier
k=1/(1-MPC)=1/MPW
Marginal Propensity to Consume (MPC)
Marginal Propensity to Withdraw (MPW)
MPW=MPS+MPT+MPM
Marginal Propensity to Tax (MPT)
Progressiveness of tax system
Marginal Propensity to Save (MPS)
Social security system
Attitude towards thrift
Interest rate
Income level (richer ppl can afford to save)
Marginal Propensity to Import (MPM)
Attitude towards imports
Openness of economy
Singapore's multiplier
Although MPT is relatively low, MPM and MPS are high due to lack of natural resources and CPF and lack of pensions and unemployment benefits
Autonomous vs Induced Expenditure
Autonomous
G, I, X assumed autonomous, kickstarts the multiplier process
Induced
Varies with income, increased consumption due to increase in income
AD/AS Model
Aggregate Demand (AD)
Total level of expenditure on all domestically produced goods and services by households, firms, governments and foreigners
AD=C+I+G+(X-M)
Consumption
Factors affecting consumption
Wealth
Economic outlook/consumer confidence
If households believe the economy will grow strongly, they expect better job opportunities, wages and higher dividends, consumption increases and vice versa
Income
Causes for change in income
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When income increases, households have higher purchasing power and they will spend a proportion of the additional income on consumption.
Availability and cost of credit
Investment
Types of Investment
Foreign direct investment (FDI)
Investment in capital goods by foreign firms
Residential housing
Production or sale of residential housing is an investment as it can generate welfare for a prolonged period
Business investment
Fixed capital
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Working capital
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Factors of Investment
Marginal efficiency of investment (MEI)
Expected rate of return on investment
Factors affecting MEI
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Interest rates
Businesses usually take out loans to fund investments, if interest rate is lower than MEI, firm will invest and vice versa
Government
Types of government spending
Recurrent expenditure (operation of publicly provided services)
Fixed expenditure (infrastructure)
Factors affecting government spending
Budgetary considerations (tax, borrowing, reserves)
Microeconomic factors
Correcting market failure
Macroeconomic factors
boosting AD, output and employment during economic downturn
spending on physical capital (infrastructure) and human capital (training/education) to raise future productive capacity
reduce spending to curb AD, income and hence imports to deal with trade deficit
Political factors
Increased spending near elections for popularity, and on supporters and swing voters
Net Exports
Factors affecting net exports
Income of foreign country affects demand for exports
Domestic income affects expenditure on imports
Price competitiveness of exports
Exchange rates
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Relative inflation rates
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Non-price competitiveness of exports and imports
Protectionism
AD curve
Downward sloping because of the inverse relationship between pries and real national output
Change in general price level causes movement ALONG the AD curve. As GPL rises, wealth, interest rate and international trade effects causes consumers firms and foreigners to buy less domestic output
Shift in AD curve
When AD falls (due to CIGXM) AD curve shifts left and vice versa
Aggregate Supply (AS)
Supply of all firms within an economy
Shape of AS curve
Horizontal (Keynesian) range
Large amounts of excess capacity and significant demand deficient unemployment
Upward sloping (intermediate) range
Production is close to full capacity and bottlenecks in resource supplies appear. Firms have to use increasingly less suitable resources resulting in rise in cop. Prices rise in order for firms to produce more.
Vertical (Classical) Range
Economy has utilised all available resources, operating at full employment/potential output, any rise in AD will only lead to higher prices
Shifts in AS curve
Vertical shift
Cost of production
As COP increases, AS falls and the AS curve shifts up
Supply shock
Positive supply shock implies increase in AS which causes the AS curve to shift down and vice versa
Horizontal shift
Change in productive capacity caused by change in quantity of resources
Size of labour force
Land and natural resources
Investment in private capital stock
Investment in public infrastructure
Both
Change in cop and productive capacity cause by change in quality (productivity) of resources
Investment in human capital
Improvement in technology
Macroeconomic equilibrium
The equilibrium level of national income and real national output occur at the intersection between the AS and AD curves
Types of equilibrium
Near full employment equilibrium
AD cuts intermediate range
Spare capacity present but limited
Full employment equilibrium
AD just cuts vertical range
No cyclical or demand-deficient unemployment
Above full employment equilibrium
AD cuts vertical range
Increase in price with no increase in real national output
Under full employment equilibrium (recession)
AD cuts horizontal range
Excess capacity, unemployment
Chapter 6: The National and International Economy: Macroeconomic Aims
Economic Growth
Actual & Potential Growth
Actual Growth
Expansion or increase in an economy's level of output or real GDP over time
Achieved by a rise in AD and/or AS
Measured by rate of growth of real GDP over time as a % change on the nation's real income over time
Important terms and concepts
Slowdown in economic growth
RNO/GDP continues to expand at a slower pace
Negative economic growth
Contraction in economic output over time
Associated with economic recession
Accompanied by unemployment
Cyclical fluctuations
Periodic changes in the value of economic activity
Technical recession
Economy contracts over 2 consecutive quarters
Hard vs soft landing
Hard: Sudden sharp or severe contraction in output
Soft: Gradual slowdown of economy such that there is no major rise in unemployment
Benefits
Consumers
Higher material living standards as a result of increased consumption
Producers
Increased levels of revenue and profits
Government
Create jobs and reduce unemployment
Increased tax revenue to invest into potential, sustainable and inclusive growth
Costs
Demand pull inflation if potential growth does not increase in tandem
Structural unemployment caused by rapid innovation and technological changes leading to mismatch of skills
Environmental pollution (-ve externalities) due to rapid industrialisation, urbanisation and careless management
Depletion of natural resources such as non-renewable resources and over-use of renewable resources
Worsened income inequality as rapid economic growth widens income disparities, threatening social and political stability
Current vs future consumption tradeoff
Causes and Policies
Actual growth too fast
Contractionary fiscal policy
Decrease government spending/increase tax
Contractionary monetary policy
Increase interest rates to discourage consumption and investment
Appreciation/revaluation of exchange rate
Make imports cheaper and exports expensive
Supply side policies
Improve quantity/quality of resources such as relaxing immigration policies/training programs
Slowdown/negative actual growth
Expansionary fiscal policy
Increase government spending/reduce direct tax
Expansionary monetary policy
Reduce interest rates to encourage consumption and investment
Depreciation/devaluation of exchange rate
Make imports more expensive and exports cheaper
Protectionism like tariffs to maker imports more expensive
Potential Growth
The increase in the productive capacity of the economy, which is the maximum output the economy is capable of producing given available resources and state of technology.
Importance of achieving both
Actual growth must be in tandem with potential growth for the economy to grow at an uninterrupted rate
If potential>actual growth is too slow and causes demand-deficient unemployment
If actual>potential prices rise as the economy overheats and experiences strong inflationary pressures
Sustainable growth
Rate of growth which can be maintained without creating other significant economic problems, particularly for future generations. It implies a positive and stable growth rate over an extended period.
Rapid growth today may cause environmental problems for future generations
Depletion of resources
Finite resources extracted at rapid rates may lead to future generations having insufficient amounts
Trade off between goods currently produced and produced in the future
Environmental pollution
Negative externalities like air, water, noise pollution, traffic congestion brought about by industrialisation
Measurement of sustainable growth
Green GDP (GDP - Net Natural Capital Consumption)
Environmental consequences of growth factored in such as resource depletion, environmental degradation, protective and restorative environmental initiatives
Traditional measure of GDP is inadequate
Natural resources are poorly represented in GDP
Insufficient weight given to future benefits of protective and restorative projects
Positive externalities arising from forests etc. and negative externalities like pollution unaccounted for
Depletion of resources not accounted for
Policies to achieve sustainable growth
Prevent depletion of resources (Prevent overfishing, reduce dependency on fossil fuels)
Reverse climate change (Switch to renewables, regulation on greenhouse gas emissions)
Inclusive growth
Economic growth that is distributed fairly across society and creates opportunities for all
Rapid economic growth resulting from strategies which emphasise specialisation in capital, knowledge, skill or technology widens income disparity
Focuses on productive employment for all sectors of society rather than on income redistribution
Policies to achieve inclusive growth (SG)
Inclusive growth program
Aims to catalyse industry redevelopment, promote inclusive growth and ensure sharing of productivity gains with workers through higher wages
Companies provided with funding to enhance productivity and upskill workers while sharing gains of growth with them
Strengthening social safety net
Alleviating cost burden of lower/middle income groups to facilitate social mobility through tax rebates/GST vouchers/subsidies in healthcare and education
Full Employment and Unemployment
Labour Force
People who are willing and able to work
Labour productivity
Output produced per man-hour
Unempl*yment
The situation where people in the work force (willing and able to work) are unable to find employment
Must be of legal working age, physically and mentally able and actively looking for a job
Types of unemployment
Demand-deficient/cyclical unemployment
Caused by lack of AD in the economy to maintain full employment (Y<Yf)
During recession, AD falls, businesses suffer poor sales and may retrench redundant staff, causing them to become unemployed. Once economy recovers, AD increases, output rises and firms start hiring, lowering cyclical unemployment
Policies
Same as slow/negative actual growth (cos root problem is AD low)
Structural unemployment
Caused by mismatch of skills as job seekers have a different set of skills than what is required by employers
Causes
Technological advancement
The skills needed to perform jobs or the location of jobs change. People made redundant in one sector cannot immediately find jobs elsewhere due to lack of skills or unwillingness to move
Policies
Supply-side policies
Retrain existing workforce to fit into other available jobs in the economy
Restructure economy to create new jobs to replace old job loss
Protectionism
Frictional unemployment
Temporary unemployment experienced by fresh graduates/those in-between jobs
Causes
Lack of information
Job seekers do not know who is hiring and prospective employers do not know who is interested in filling existing vacancies
Expectations mismatch
Job seekers have certain expectations that need to be met and will not always accept the first job offered, will be worsened by unemployment benefits, parental support and mindset of job seekers
Policies
Provide job information to improve efficiency of labour market
Moderate job expectations
Solve transport issues by improving transportation system affordability and quality or decentralising workplaces
Others
Seasonal unemployment
People not needed year round (fruit pickers)
Diversify economy
Underemployment
Employment of workers with high skill level in low wage jobs that do not require such abilities
Disguised unemployment
Farmers inviting relative to work on farm who does not contribute much to production
Measuring unemployment
Unemployment rate = (Unemployed/Labour force) x 100%
Consequences of unemployment
Consumers: Reduced levels of consumption and lower SOL due to decrease in income (prolonged unemployment may result in workers losing touch of their skills, becoming unable to gain employment; loss of self esteem; social cost
Producers: Reduced levels of profits and investment due to low consumption (Poor business sentiments/social instability drives away investors)
Government: Economic growth, SOL threatened, budget deficit
Full employment
Non-zero, low rate of unemployment that is compatible with price stability (Enough jobs to match job seekers)
Inflation and Deflation
Price stability
General price level in an economy increases at a low, stable, expected rate (no high inflation/deflation)
Inflation: sustained increase in general price level of an economy over time
Deflation: Sustained decrease in general price level of an economy over time (-ve inflation)
Measuring inflation
Consumer Price Index (CPI)
Measures the average level of prices of a basket of goods and services consumed by a typical household
Comprises
Basket of goods and services to represent typical household consumption
Base year as a reference point for comparing prices over time
Weights to take into consideration the relative importance of each item in the basket of goods by % of total expenditure
Uses
Measure of inflation
Cost of living
Wage adjustment
Limitations
Doesn't apply to households whose consumption patterns diverge from that of a typical household (create specific indices for different household types like by income or race)
Expenditure patterns change in the long run so computation of CPI has to be periodically updated
Change in quality of goods and services often unaccounted for
Inflation Rate = (CPI2-CPI1)/CPI1 x 100%
Degrees of inflation
Mild inflation (<=2%)
Creeping/Moderate inflation (6-7%) so tuff
Hyperinflation (Prices rising so fast that money ceases to be a medium of exchange)
Disinflation: price levels rise at a decreasing rate
Core and headline inflation
Headline inflation
Measure of the total inflation within an economy including food and energy prices
Core inflation
Excludes volatile food and energy prices since inflation is not a measure of price fluctuations or price instability
Consequences of high inflation/deflation
Costs of high inflation
Consumers
Erodes internal value of money, increases cost of living, reduces material living standards
Discourages savings and increases consumption
Income Distribution
Winners: Variable income earners, debtors, firms (demand-pull)
Losers: Fixed income earners, creditors, consumers, firms (cost-push)
Shoe-leather costs
Opportunity cost of time and effort spent trying to counteract the effects of inflation
Prodcuers
Discourages investment due to uncertainty
Menu cost: cost of updating prices more frequently
Governments
Hinders economic growth and employment
Saving and investment discouraged
Cost-push inflation leads to simultaneous rise in GPL and contraction in output (stagflation)
Worsened balance of trade as exports become more expensive and imports become relatively cheap
Capital flight as businessmen and foreign investors lose confidence in local currency
Greater M and capital flight lead to decrease in supply of currency, lower X leads to decrease demand for currency, both lead to weaker currency
Severity also depends on whether inflation is anticipated which is more likely with a low and stable inflation rate
Benefits of low inflation
Opposite of high inflation
Harmful vs benign deflation
Harmful
AD falls
Prolonged
Benign
AS rises
Not prolonged
Costs of harmful deflation
Adverse effects on economic growth and employment
Postponing consumption and investments
Consumers delay consumption in anticipation of falling prices so businesses suffer losses and have no incentive to invest
Cost of purchase of inputs at earlier date with higher prices possibly higher than sales revenue leading to widespread business closure
Reduction in overall economic activity leads to deflationary spiral with high unemployment and low income
Increased unemployment and fall in SOL
Revenue falls but workers resist cuts to nominal wage, employers must retrench workers to maintain profitability, decreasing income and affecting material SOL
Causes and policies
Demand-pull inflation
Arises when there is excessive AD that outpaces AS, leading to a rise in GPL with little to no increase in real output
Caused by:
Excessive spending (caused by optimism in a booming economy)
Excessive money supply (caused by availability of cheap and easy credit)
Policies
Same as actual growth too high (cos its p much the same thing)
Cost-push inflation
Arises when AS falls due to persistent increase in cop for reasons not associated with AD, leading to rise in GPL
Types of cost-push inflation
Imported inflation
Rising prices of key imports
Importing from countries experiencing inflation results in rise in COP shifting AS upwards (decrease in AS)
Weak currency
If importing country's currency gets weaker, importing country has to spend more even if exporting country's price is stable
Policies
Keep import prices from decreasing
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Provide alternatives
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Wage-push inflation
Wages rise faster than labour productivity, unit cop increases, AS shifts up (decreases)
Policies
Freeze wage
Clamp down labour unions
Raise labour productivity (upskilling)
Profit-push inflation
If a firm or group of firms holds too much market power, when costs rise, prices rise far more than what is required to offset the increase in cost
Price ceiling
Deregulate to increase competition among firms
Negative supply shocks
Unexpected events increase COP and thus AS shifts up
Policies
Temporary price control
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Preparation for shocks
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Statutory cost-push inflation
Rise in indirect taxes on goods and services
Cost of living increases because firms pass part of the higher indirect taxes to consumers through higher prices and firms cut back on production (AS decrease, curve shifts up)
COE and ERP
Increase the cost of transportation and cop of firms that use many vehicles
Multi-causal inflation
Inflation caused by shifts in both AS and AS
Wage-price spiral
Inflation expectation drives workers to demand higher wages, increasing unit cop with no improvement in productivity, AS shifts up. Firms cut back on hiring so the government boosts AD by spending more on infrastructure or cutting taxes, AD shifts right. Output barely changes, GPL increases significantly
Policies should include demand management and supply side policies (abit risky to decrease AD while AS is shifting up since unemployment gets worse)
Deflation
Causes
Harmful deflation caused by persistent fall in AD below full employment level
Benign deflation due to rise in AS (increased output, lower prices OR fall in cop)
Policies
Stop people from postponing consumption by changing inflation expectations (deliberately creating inflation)