economics session1
TRANSCRIPT
8/9/2019 Economics Session1
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Anke N Richter, CFA LSBF - Economics
ECONOMICS
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Anke N Richter, CFA LSBF - Economics
ECONOMICS - INTRODUCTION
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Anke N Richter, CFA LSBF - Economics
Economics Definition
• Economics: is the social science thatstudies the production, distribution,and consumption of goods and
services• The term economics comes from the
Ancient Greek οἰ κονομία (oikonomia,"management of a household,administration")
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Economics Basics
• Key assumption: scarcity of goods
• Types of market participants: – Households: maximize consumption
– Businesses: maximize profit
• Market participants offer production factors on themarket : capital, labor, land
• The challenge for households and businesses toreach their goals while resources are scare
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Economics Basics
• Economics looks at some key questions:
• Production: how could input factors be usedefficiently for production and which goods should beproduced
• Distribution: how to distribute the goods betweenhouseholds and how to distribute the income for theproduction factors
• Coordination: of plans of households andbusinesses to produce and consume (planed ormarket-based economy)
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Anke N Richter, CFA LSBF - Economics
Areas of Economics
• Microeconomics – Production theory
– Market and Price theory
• Macroeconomics – Growth, Inflation, Unemployment
– Monetary/Fiscal Policy
• International Trade
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ECONOMICS – ECONOMIC SYSTEM
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Economic system
• An economic system is defined by the way a society decidesand organizes the ownership and allocation of economicresources
• Market based economy: private ownership and free allocation
over the market
• Planned economy : usually limited ownership and coordinationvia gov’t plans
• Mixed economy: most economies today have elements fromthe market and planned system, however, the degree varies
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Market-based coordination
• Adam Smith (1723-1790): concept of invisiblehand – Pursuit of self-interest by individuals will lead to the
most efficient allocation of resources for the whole
economy – Central view of free market economist
• Market coordination over price• Function of price
– Signaling: where are resources required? – Transmitting preferences – Rationing
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Mixed economic systems
• Based on believe that the market is notalways leading to the best results (marketfailure)
• Gov’t intervention is required• Various schools of thought:
– Ordoliberalism: gov’t needs to create the framework for the
market to work (legal framework, competition laws, fiscal
discipline, limited gov’t intervention) – Active intervention in various areas by the gov’t (EU agriculture
policy)
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ECONOMICS – MICROECONOMICS
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Demand and Supply
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Demand and Supply
Price
QuantityDemand
Supply
P
Q
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Demand
Demand: quantity of a good or service thatconsumers are willing and able to buy at a givenprice in a given time period
Marginal Benefit: benefit from consuming anadditional unit of a good or service. It is the most aconsumer is willing to pay for one more unit of agood
Principal of Decreasing Marginal Utility: additionalutility from consuming each additional unit of agood decreases as more units are consumed
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Supply
Supply: the quantity of a product that aproducer is willing and able to supply ontothe market at a given price in a given timeperiod
Marginal cost: addition to total cost fromproducing one additional unit of output
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Consumer and Producer Surplus
Price
QuantityDemand
SupplyConsumerSurplus
Producer
Surplus
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Efficient Resource Allocation
Efficient resource allocation happenswhen marginal benefit equals marginal
cost for the last unit produced andconsumed
The sum of producer surplus andconsumer surplus is maximized at thatquantity
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Competitive Equilibrium
Equilibrium in a competitive market: where supplyand demand meet
The quantity supplied at the equilibrium price equals
the quantity demanded at that price
The equilibrium changes over time with shifts indemand and supply
There is a ST and a LT equilibrium
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Obstacles to Efficient Allocation
Price controls – ceilings, floors
Taxes and trade restrictions
Monopolies – restrict quantity
External costs and external benefits
Public goods – national defense
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Externalities
Externalities:arising from production and consumption of goods andservices for which no appropriate compensation is paid
Externalities cause market failure if the pricemechanism does not take account of the social costsand benefits of production and consumption
Negative: air pollution
Positive: vaccination
Internalization of external effects: pricing ofexternal effects (carbon emission trading),intervention required – market fails
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Public and private goods
Private goods –Excludability: not everybody has access
–Rivalry: consumption reduces good –Rejectability: does not need to be consumed
Public goodsNon-excludability: “free-rider” problem
Non-rival consumption
Usually public goods are not provided by theprivate sector but require gov’t intervention
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Market Mechanism
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Market Equilibrium and Shocks
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Price Ceiling
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Price Ceiling
Long-Run Impact:
– Price does not promote efficient allocation
– Long waiting period to purchase
– Sellers discriminate
– Sellers take bribes
– Sellers lower quality
– Often leads to a black market
• Examples: rent control
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Price Ceilings/Black Markets
A black market is economic activity thattakes place outside the legal system
– Black market prices > ceiling prices
– Example: Currency in countries with fixedexchange rates
Black markets are inefficient
– Contract enforcement costs
– Prices increase along with legal risk
– Quality deteriorates
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Demand/Supply of illegal Goods
Expected penalties on sellers and consumerswill shift demand and supply:
Penalties on sellers supply decreased
Penalties on buyers demand decreased
Price factors compensation to sellers in for
potential penalties
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Price Floors
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Price Floor
Long-run effects: Excess supply of the good
Substitution in consumption away from the
price controlled good
Example: minimum wage
Excess supply of labor increasedunemployment
Producers substitute capital for labor
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Elasticity of demand and supply
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Price Elasticity of Demand
As the price of a good increases usuallydemand (quantity) decreases
– Elastic demand: Percentage increase inprice leads to a larger percentage decreasein demand
– Inelastic demand: Percentage increase in
price leads to a smaller percentage decreasein demand
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Anke N Richter, CFA LSBF - Economics
Price Elasticity of Demand
Elastic
Price
DD
D
D
PricePrice
Quantity
InelasticPerfectlyInelastic/Elastic
Elastic
Inelastic
Quantity Quantity
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Determinants of Demand Elasticity
Necessity of the product
Availability of substitutes
Switching cost
Relative amount of budget spent on theitem
Time since price change
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Calculating Elasticity of Demand
price elasticity of demand
% change in quantity demanded
% change in price
change in valuewhere % change
average value
If price elasticity = 0, not elasticIf price elasticity between 0 and 1, inelastic
If price elasticity = 1, % changes are equally
If price elasticity >1, elastic
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The price increases from $7 to $9, quantitydemanded decreases from 12 to 8 units.Calculate and interpret the demand elasticity
% change in demand: (8-12)/10= -40%
%change in price: (9-7)/8= 25%
price elasticity= =-40%/25%= -1.6
Demand Elasticity – Problem
Absolute value greater than 1, so elastic
- 3
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Cross Elasticity of Demand
Cross elasticity
% in quantity demanded% in price of substitute or complement
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Cross Elasticity of Demand -substitutes
Price of coffee went up 12% and demand fortea increased 9%
Cross Elasticity > 0: tea and coffee are substitutes
0.759%
Cross elasticity of demand12%
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Cross Elasticity of Demand - complements
Price of scones went up 20% and demandfor tea decreased 13%.
Cross elasticity < 0: the goods are complements
=-0.65-13%
Cross elasticity of demand20%
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Income Elasticity of Demand
The sensitivity of quantity demanded tochanges in income
Normal good: Income↑ Demand↑ Elasticity > 0
Necessity: 0 < Income elasticity < 1
Luxury good: Income elasticity > 1
Inferior good: Income↑ Demand↓ Elasticity < 0(e.g., bus travel, camping holidays)
%change in quantity demandedIncome elasticity
%change in income
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Income Elasticity of Demand- Example
Income went up 7% and annual demand forcars went up 15%. Calculate the incomeelasticity of demand and determine the type ofgood.
Because elasticity > 1, cars are luxury goods
- 2
2.14Income elasticity of demand15%
7%
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Elasticity of Supply
elasticity of supply
% change in quantity supplied% change in price
When > 1, then supply is price elasticWhen < 1, then supply is price inelasticWhen = 0, supply is perfectly inelasticWhen = infinity, supply is perfectly elastic following a change in demand
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Elasticity of Supply
The price of oranges increased 11.11%, andorange growers increased quantity supplied
by 9.09%
= 0.81 =9.09%
Elasticity of supply inelastic11.11%
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Determinants of Elasticity of Supply
Availability of resource substitutes
Spare production capacities
Ease/cost of substitution
Time of production process
LT vs ST
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Elasticity on a Straight-line Demand Curve
The slope of the
price-demandline ≠ priceelasticity
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Price Elasticity of Demand and TotalRevenue
• Greatest total revenue (P × Q) at the pointwhere elasticity = –1
• Inelastic range: Price increase will increase totalrevenue; percentage decrease in quantitydemanded < percentage increase in price
• Elastic range: Price increase will decrease totalrevenue; percentage decrease in quantitydemanded > percentage increase in price