econ ppt 2
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TRANSCRIPT
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Microeconomics
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Markets
What is a market and how does it work to allocate resources in an economy?
How do governments intervene in the market?
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What factors influence market
structure?
Number of Firms
Barriers to Entry
Homogeneous or
Heterogeneous Product
Market Power/Consume
r Sovereignty
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PerfectCompetition
Oligopoly MonopolisticCompetition
Monopoly
Market Structure: Number of Firms
Small & many Large & fewSmall & many
One & largeRelatively
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PerfectCompetition
Oligopoly MonopolisticCompetition
Monopoly
Market Structure: Barriers to Entry
None High Relatively low Very High
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PerfectCompetition
Oligopoly MonopolisticCompetition
Monopoly
Nature of goods: Homogeneous or Heterogeneous
“Identical” Both Similar “Unique”
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PerfectCompetition
Oligopoly MonopolisticCompetition
Monopoly
Market Structure: Market Power/Consumer Sovereignty
Very high Low High Very low
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PerfectCompetition
Oligopoly MonopolisticCompetition
Monopoly
Market Structure: Examples
Agriculture Cars Restaurants,books, clothing
Post Office, water & electricity
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Monopolistic C
ompetition
Many Buyers
Similar products
Many Sellers
Advertising & branding
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Perfect C
ompetition
Many Buyers
Identical products
Many Sellers
Price drives decisions
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Monopoly
Many buyers
No close substitutes
One seller
Immense power
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Oligopoly
Many buyers
Product requires
high production
costs
A few large sellers
Tendency to collude
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A market is any situation or place that enables the buying and selling of goods and services and factors of production. A market may be a physical location (a street market), it may also be a virtual one (internet buying and selling) or a national one (the market for teachers or doctors). Triple A
Markets exist when buyers and sellers interact. This interaction determines market prices and thereby allocates scarce good and services.
What is a market? 13
Buying and selling is fundamental.
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The Supply & Demand Model
Supply and Demand Model
Law of Demand
Law of Supply
Equilibrium Price and Quantity
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The intersection of demand and supply is the goal that every seller want to achieve.
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Demand
A schedule (curve) that shows the quantity of a good that consumers are able and willing to buy at a certain price during a specified period of time.
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Higher the price less peoplewould buy.
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+Change in Quantity Demanded
Movement along the demand curve
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Law of Demand
• Demand falls
Price Rises •Demand rises
Price Falls
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Why Does Demand Rise when Prices Fall?
More
Buyers Income
Effect Substitute
Effect
This is cheap!
I am richer!
I will switch to this product!
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Three important factorsTo effect demand
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Determinants of Demand: Price
Price • Increase or decrease in in
price level
Increase or decrease in the quantity demanded• Movement along price
curve
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Determinants of Demand: Non-price
Non-Price• Change in factors other
than price that influence demand
Increase or decrease in Demand• Rightward or leftward shift
or the Demand Curve
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D e te rm in a n ts o f D e m a n d
T – consumers’ tastes and preferences
O – other goods (complements and substitutes)
E – expectations of future incomes or prices
I – income
S – size of the market (number of firms)
S - special events or circumstances 21
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+Change in Demand
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Movements versus Shifts
Change in Quantity Demanded
Change in Demand
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Veblen Goods (HL Extension)
A “show-off” good Price Increases Demand
Increases
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Giffen Goods (HL Extension)
Essential inferior good Price Increases Demand
Increases
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Expectations (HL Extension)
Price Falls
Consumer expects further
price falls
Purchase delayed
Fall in quantity
demanded
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Exceptions to the Law of Demand (HL Extension)27
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Supply
A schedule (curve) showing how much of a product producers will supply at each of a series of prices over a specific period of time.
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Law of Supply
• Supply falls
Price Falls •Supply rises
Price Rises
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Why Does Supply Rise when Price Rises?
Suppliers want
to sell more New suppliers
enter market
I can make more profit!
I can make a profit!
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Determinants of Supply: Price
Price • Increase or decrease in in
price level
Increase or decrease in the quantity supplied• Movement along Supply
Curve
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+Change in Quantity Supplied
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Determinants of Supply: Non-price
Non-Price• Change in factors other
than price that influence supply
Increase or decrease in Supply• Rightward or leftward
shift in the Supply Curve
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Determinants of Supply
S – subsidies and taxes
T – technology
O – other related goods
R – resources
E – expectations
S - special events or circumstances 34
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+Change in Supply
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Movements Versus Shift
Change in Quantity Supplied Change in Supply
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Equilibrium Price and Quantity
Marketing Clearing
Price
Suppliers obtain their
highest price
Demanders obtain their
lowest prices
All goods are sold
Quantity Supplied = Quantity
Demanded
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+Equilibrium
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Functions of Supply and Demand Interactions
Prices
Incentive for Suppliers
Provides a Rationing Function
Signaling Function for Suppliers
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+Consumer and Producer Surplus
Consumer surplus is when people are able to buy a good for less than they would have been
willing to pay.
Producer surplus is the difference between the
minimum price a producer would accept to supply a given
quantity of a good and the price actually received.
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+Consumer Surplus
Price
Quantity
D
Po
Qo
A + B = Maximum Willingness to Pay for Qo
What is paid
Consumer Surplus
A
B
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+
Minimum Amount Needed to Supply Qo
Producer Surplus
Price
Quantity
Po
Qo
What is paid
Producer Surplus
S
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+Consumer and Producer Surplus
Price
Quantity
Po
Qo
S
Producer Surplus
Consumer Surplus
D
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+
Original Consumer Surplus
Change in Consumer Surplus: Price Increase
Quantity
New Consumer Surplus
Loss in Surplus: Consumers paying more
Loss in Surplus: Consumers buying less
Price
D
Po
Qo
P1
Q1
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Price Ceilings
Price Ceiling
• Maximum (low) price to protect consumers
• Many suppliers opt out of market
Excessive Demand
• Supply does not equal demand
• Under-allocation of resources
Shortages
• Informal markets (Black market)
• Queuing and rationing
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Price Floor
Price Floor
• Minimum (high) price to protect producers and low income earners
Excessive Supply
• Supply does not equal demand
• Unemploy-ment
Surpluses
• Inefficiencies• Over-
allocation of resources
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+Price Ceiling & Price Floor
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+Disadvantages
Possible Solutions
Increase Supply
Negative Consequences
of Price Ceilings
Shortages
Provide subsidies
Expensive
Opportunity Costs
Releases stockpiles
No stockpiles
Expensive Opportunity
CostsGovernment provision
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+Disadvantages
Possible Solutions
Increase Demand
Negative Consequences of Price Floors
Surpluses
Destroy or stockpile
Expensive/Wasteful
Opportunity Costs
Export surplus and/or impose
tariffs Upset trading partners
Advertise
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Buffer stock manager sets a price band from highest and lowest
price
Buys stock in times of surplus
Sells stock in times of shortage
Price Support/Buffer Stock SchemesGovernments intervene when there are extreme price fluctuations brought about by seasons factors (agricultural products) and/or economic factors (commodities).
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+Loss in Efficiency Too High a Price (Price Floor)
Price
Quantity
Po
Qo
S
D
QL
New Consumer Surplus
PH
New Producer Surplus
Lost Consumer Surplus
Lost Producer Surplus
Price Floor
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+
New Producer Surplus
New Consumer Surplus
Loss in Efficiency Too Low a Price (Price Ceiling)
Price
Quantity
Po
Qo
S
D
QL
PL
Lost Consumer Surplus
Lost Producer Surplus
Price Ceiling
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Commodity Price Agreements
A buffer stock scheme involving several countries
E.g UNCTAD OPEC
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MicroeconomicsElasticities
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Elasticities
How sensitive is a buyer to a change in price?
How sensitive is a buyer when another product changes price?How sensitive is a buyer to changes in their own income?How sensitive is a supplier to a change in price?55
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ElasticitiesPrice
elasticity of
demand PED
Cross elasticit
y of demand
XED
Income elasticit
y of demand
YED
Price elasticit
y of supply PES
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Price Elasticity of Demand (PED)
P rice e las tic ity o f d em an d =P ercen tag e ch an g e in q u an tity d em an d ed
P ercen tag e ch an g e in p rice
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Range of PED values•Demand not sensitive or responsive to changes in pricePED < 1
Inelastic demand
•A proportional sensitivity or responsiveness to a change in pricePED =1
Unit elasticity
•Demand sensitive or responsive to change in price
PED > 1
Elastic demand
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Range of PED values• Not sensitive or
responsive to changes in pricePED < 1
Inelastic demand
• A proportional sensitivity or responsiveness to a change in price
PED =1
Unit elasticity
• Sensitive or responsive to change in price
PED > 1
Elastic demand
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Price Inelastic Demand60
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Price Elastic Demand61
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Range of PED62
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Extreme Cases
PED = 0
Perfectly inelastic
PED = ∞
Perfectly
elastic
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Perfectly Elastic Demand64
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Perfectly Inelastic Demand65
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Unit Elastic Demand66
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Determinants of PED
P – proportion of income spend on good
A – availability of substitutes
C– closeness of substitutes
T – time available for adjustment
T – type of good: necessity or luxury67
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Determinants of PEDIncome
• Inelastic demand
A large proportion of income
• Elastic demandA small
proportion of income
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Determinants of PEDSubstitutes
• Inelastic demand
Very close substitutes
• Elastic demand
No close substitutes
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Determinants of PEDSubstitutes
• Inelastic demand
Substitutes available
• Elastic demandNo
substitutes available
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Determinants of PESTime
• Inelastic supplyShort run = all
but one input can be changed
• Elastic supplyLong run = all inputs can
be changed
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Determinants of PESSpare Capacity
• Inelastic supplyNo spare
capacity
• Elastic supply
Space capacity available
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Practical Implications of ElasticityImpact on Total Revenue of Firms
Tax Incidence
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Impact on Total Revenue of Firms
Total revenue is the amount paid by buyers and received by sellers of a good. TR = P x Q
With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.
With an elastic demand curve, an increase in price leads to a increase in quantity that is proportionately smaller. Thus, total revenue decreases.
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Governments levy taxes to raise revenue for public projects
Critics of taxation argue that:
Taxes discourage market activity.
When a good or service is taxed, the quantity sold is smaller.
Taxation
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Indirect Tax Specific Tax76
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Indirect Tax Ad Valorem Tax77
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Tax incidence is the manner in which the burden of a tax is shared among participants in a market.
How this burden is shared depends on elasticity.
Tax Incidence
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+Tax and Relatively Inelastic Demand
TR = .25 X 200 m = 50 m
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+Tax and Relatively Inelastic Demand
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+Tax and Relatively Inelastic Demand
Price for Buyers = .35
Price for Sellers= .2 (150m X .2)
(150m X .15)
(150m X .35)
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+Tax and Relatively Inelastic Demand
Price for Buyers = .35
Price for Sellers = .25
Before Tax Buyers paid .25After Tax Buyers pay .35 Buyers contribute 15 m to Revenue (150 X .1)
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+
Buyers spend = 52.5 m
(150m items x .35)
Sellers receive
30 million
(150 m items x .20)
Govt. Revenue =
22.5m
(150 items x .15 tax
Buyers have contributed 15 m
150 m items x .1
Before the tax they paid .25 now they pay .35 on 150 m items. They pay
a higher price of .1 per item
Sellers must contribute
7.5 m
150 items x .5 to make up the tax revenue shortfall
The Money Trail
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+Tax and Relatively Elastic Demand
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+Tax and Relatively Elastic Demand
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Summary
The incidence of a tax refers to who bears the burden of a tax.
The incidence of a tax does not depend on whether the tax is levied on buyers or sellers.
The incidence of the tax depends on the price elasticities of supply and demand.
The burden tends to fall on the side of the market that is less elastic.
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Total Revenue and Price Elastic Demand87
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Total Revenue and Price Inelastic Demand88
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Some Practical Applications of PED
With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.
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Market Failure
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Market Failure
What is market failure and why does it occur?
How effectively can governments intervene to correct market failure?
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What is market failure?
At times markets fail to
allocate resources efficiently
provide goods beneficial to
society
stop production and consumption of harmful goods
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Sources of Market Failure
ExternalitiesMerit and Demerit Goods
Public Goods
Abuse of Monopoly
Power
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Positive Externalities
Third parties benefit from the production
of goods and services
Third parties benefit from the
consumption of goods and services
Negative Externalities
Third parties bear spillover costs of the production of goods
and services
Third parties bear spillover cost of the
consumption of goods and services
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Negative Production Externality95
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Negative Consumption Externality96
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Tax and Negative Production Externality97
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Tax on Producers and Negative Consumption Externality98
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Advertising to Shift Demand and Reduce Negative Consumption Externality99
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Correcting Negative
Externalities of Production
Legislation & Regulation
Tradable PermitsTax
100
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Correcting Negative
Externalities of Consumption
Legislation & Regulation
AdvertisingTax firm
101
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Positive Production Externality102
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Positive Consumption Externality103
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Correcting Positive
Externalities of Consumption
Legislation
AdvertisingSubsidies
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Correcting Positive Externalities of
Production
Subsidy
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Extension of Property Rights to Correct
Negative Externalities
Internalize Externality
Market-based Appeal
Offending Firms and third parties
monitor progress
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The Environment & Sustainable Development
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What is Sustainable Development?
The present use of resources in satisfying the needs of the economy should not lessen or limit future generations’ use of resources in satisfying needs.
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+ International Cooperation on Environmental Issues
Reduction of Global Pollution
Accountability
Assigning blame
Cost estimation
Setting appropriate costs
Method
Debate on most efficient methods
Trade-offs
Striking balance between growth &
environmental impact
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Tradable Permits
Government set a ceiling for total
emissions
Permits Issued and firms fined if they exceed limit
Permits may be resold to other
firms
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Advantages of of Tradable Permits• Disincentive for inefficient firms• Incentives to firms to reduce
pollution
Disadvantages of Tradable Permits• Heavy polluters may simply
buy permits and perpetuate the problem
• Pollution levels do not reduce
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Public, Merit & Demerit Goods
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Public Goods
• Non-Excludable• Non-rivalrous• Free riders
Merit Goods
• Merit goods are under-consumed and underprovided
Demerit Goods
• Demerit goods are overconsumed and overprovided
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• Positive externalities
• Lack of income • Lack of knowledge
Merit Goods
• subsidies• government
provision• advertising• regulation
Solutions114
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• Negative externality
• Lack of knowledge and/or apathy
Demerit Goods
• tax• advertising• regulation
Solutions115
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• inefficiencies • higher prices
Monopoly Power
• legislation and regulation
• government ownership
Solutions116
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Typical Examination Question
Questions on the Theory of Demand and Supply
1. Explain the function of prices.
2. Explain the function of markets.
3. The basic economic problems is scarcity. Explain how a market economy (or command economy) allocates resources.
4. Evaluate the consequences of price controls.
5. Evaluate the view that it is best to allow primary commodity prices to be determined purely through the free interaction of market forces.
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Typical Examination Question
Questions on Elasticity
1.Define cross elasticity of demand (or the other elasticities ) and using diagrams, explain its impact.
2.Explain why price elasticity of demand and the price elasticity of supply tends to be low on primary commodities and how this impacts price stability.
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Typical Examination Question
Questions on Market Failure1. Explain the differences between merit goods, demerit goods and
public goods.
2. Evaluate the view that governments should always intervene in markets for such goods as cigarettes and alcohol.
3. With the aid of a diagram, explain how the application of a flat rate tax (a specific/fixed amount) could reduce pollution.
4. Using an appropriate diagram, explain how negative externalities (or positive externality) are a type of market failure.
5. Evaluate the measures that a government might adapt to correct market failure arising from negative (or positive) externalities.
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Resources
Phil Holden has an excellent set of youtube videos on all aspects of markets.
Teaching Tools for Microeconomics from John Stosel is a little dated but still another excellent source of video clips on markets. This is produced by ABC News.
Paul Solman has produced a series of video clips designed to accompany Economics by Paul Samuelson. They are excellent for the IB Course. The DVD can be obtained from McGraw-Hill.
The National Council on Economic Education has produced a two volumes of student activities: Advanced Placement Economics: Microeconomics Student Activities Workbook, 3rd Edition, and Advanced Placement Economics: Macroeconomics Student Activities Workbook, 3rd Edition. Though they are designed for Advanced Placement students many of the data sets helps IB students understand key concepts. These activities are especially good for students who are more mathematically minded.
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