eco1101 economic concepts, issues and tools

8/12/2019 ECO1101 Economic Concepts, Issues and Tools

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Today Lecture

Economic Systems

Price Mechanism

Positive and Normative Economics


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Introducing Economics

Economic Systems


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Totally

planned

economy

Classifying economic systems

Totally

free-market

economy


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Totally

planned

economy

N. Korea

Cuba Poland France

UK

USA

Mid 1980s

China Hong

Kong


Totally

free-market

economy


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Totally

planned

economy

N. Korea

N. Korea

Cuba

China

Poland

Poland France

France

UKUSA

USA

Mid 1980s

Late 2000s

China Hong

Kong

CubaChina

(HongKong)


UK

Totally

free-market

economy


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[I] The Command Economy

all economics decisions are taken bythe central authorities. For example:socialist or communist

the state plans the allocation of resources at3 important levels:

consumption and investment

allocation of resources between currentconsumption and investment for thefuture


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[I] The Command Economy

matching of inputs and outputs

plan the resources required by eachindustry and firm

plan the output produced by industryand firm

distribution of output between

consumers.


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Advantages of a command economy

high investment, high growth

stable growth social goals pursued

low unemployment


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Problems of a command economy

problems of gathering information

expensive to administer

inappropriate incentives

shortages and surpluses


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[II] The free-market economy

Base on demandand supplydecisions


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Advantages of a free-market economy

transmits information between buyers and sellers,economy functions automatically

no need for costly bureaucracy to coordinateeconomic decisions

incentives to be efficient as competition betweenfirms keeps prices down

competitive markets responsive to consumers


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Problems of a free-market economy

competition may be limited: problem of market power, a fewgiant firms may dominate an industry

power and property may be unequally distributed

the environment and other social goals may be ignored.

some socially desirable goods would simply not be producedby private enterprise

ethical objection encourage selfishness, greed, materialismand acquisition of power

Macroeconomic instability: periods of recession with high

unemployment and falling output & periods of inflation.


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[III] The Mixed Economy

A market economy where there is some governmentintervention. Government may control the following:

relative prices of goods and inputs, by taxing orsubsidising them or by direct price controls

relative incomes, by the use of income taxes,welfare payments or direct controls over wages,profits, rents, etc

the pattern of production and consumption, by theuse of legislation, by direct provision of goods andservices, or by nationalisation.

Macroeconomics policies


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Price Mechanism

price respond to shortages and surpluses

shortages, P increases

surpluses, P decreases

equilibrium price : demand = supply

response to changes in demand andsupply

act as both signalsand incentives


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How does the price mechanism acts as signals and incentives

a change in demand a rise in demand signaledby a rise in price

a rise in price acts as incentives for firms to

increase the supply

a change in supply

a rise in supply signaledby a fall in price

a fall in price acts as incentivesfor demand to rise


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Goods Market

Dg shortage

(Dg> Sg)

Pg

Sg

Dg

until Dg = Sg

The price mechanism:

the effect of a rise in demand


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Goods Market

Dg shortage

(Dg> Sg)

Pg

Sg

Dg

until Dg = Sg

Factor Market

SgSf

Df

until Df = SfDf shortage

(Df> Sf)

Pf

The price mechanism:

the effect of a rise in demand


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Attempt Question!

Q: Can you think of any examples where prices and wagesdo not adjust very rapidly to a shortage or surplus? For

what reasons might they not do so?

A: (1) Many prices set by companies are adjusted relatively

infrequently: it would be administratively too costly tochange them every time there was a change in demand. Forexample a mail order company, where all the items in its

catalogue have a printed price, would find it costly to adjustprices very frequently, since that would involve printing a

new catalogue, or at least a new price list.(2) Manywages are set annuallyby a process of collective

bargaining. They are not adjusted in the interim.


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Attempt Questions!

Why do the prices of fresh vegetables fallwhen they are in season? Could an

individual farmer prevent the price falling?

Because supply is at a high level. Theincreased supply creates a surplus which

pushes down the price. Individual farmerscould not prevent the price falling. If they

continued to charge the higher price,consumers would simply buy from those

farmers charging the lower price.


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Attempt Questions!

If you were the owner of a clothes shop, how wouldyou set about deciding what prices to charge for

each garment at the end of season sale?

You would try to reduce the price of each item aslittle as was necessary to get rid of the remaining

stock. The problem for shop owners is that they donot have enough information about consumer

demand to make precise calculations here. Many

shops try a fairly cautious approach first, and then,if that is not enough to sell all the stock, they make

further end of sale reductions later.


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Attempt Question!

The number of owners of compact disc players has grownrapidly and hence the demand for compact discs has alsogrown rapidly. Yet the prices of discs have fallen. Why?

The costs of manufacture have fallenwith improvements in

technology and mass-production economies. Competition from increased numbers of manufacturers has

increased supply and driven prices down.

Budget-priced CDs of original analogue recordings cost less

to produce (there are no new studio costs). In the early 2000s, the advent of copying CD tracks from

the Internethas reduced the demand for CDs. This changein demand has further compounded the fall in price.


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A. A risein the price of the good and afallin theprice of factors used to make it.

B. A risein the price of the good and a risein theprice of factors used to make it.

C. Afallin the price of the good and afallin the

price of factors used to make it.

D. Afallin the price of the good and a risein theprice of factors used to make it.

Assume that there is a fall in demand fora good. Ceteris paribus, this will result in:

Q


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A. Rise.

B. Fall.

C. Stay the same.

D. It depends on whythe supply of good X hasrisen.

If there is a rise in supply of good X,what will subsequently happen to theprice of a factor used to make good X?

Q


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Positive Economics

A statement of FACT

unemployment is rising


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Normative Economics

A statement of VALUE

(ought or ought not to, good or bad,desirable or undesirable)

the government ought to reduce theunemployment


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Attempt Questions!

Which of the following are positive statements and whichare normative?

(a) Cutting the higher rates of income tax willredistribute incomes from the poor to the rich.

(b) It is wrong that inflation should be reduced if thismeans that there will be higher unemployment.

(c) It is incorrect to state that putting up interest rateswill reduce inflation.

(d) The government should introduce road pricing toaddress the issue of congestion.

(e) Current government policies should be aimed atreducing unemployment.


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Answers

(a) Positive. This is merely a statement about what wouldhappen.

(b) Normative. The statement is making the value judgementthat reducing inflation is a less desirable goal than theavoidance of higher unemployment.

(c) Positive. The statement is making a claim that can betested by looking at the facts. Do higher interest rates reduceinflation, or dont they?

(d) Normative. It is expressing the value judgement that the

government oughtto address the problem of trafficcongestion and that road pricing is the best way.

(e) Normative. It is saying that the government oughttodirect its policies towards reducing unemployment.


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A. Unemployment is higher this year than last.

B. Unemployment will rise.

C. Economists predict that unemployment will rise.

D. Raising taxes will cause unemployment to rise.

E. The government should cut taxes and thereforereduce unemployment.

Q Which one of the following is anormative statement?


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THE END

Please try to End of ChapterQuestions in the text book,

page 28, Q1 to Q8.Reference: Chapter 1 in

Sloman text book and 8 docsin Facebook ECO1101

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