Theory Flashcards
Specialisation / Division of labour
- idea introduced by Adam Smith
- productivity increase
- workers won’t need to switch tasks, so time saved (DoL)
- practise = more efficient at task (DoL)
specialisation +ve
- increased productivity through better use of workers
- increased output = increased trade, increased growth
- increased allocative efficiency
specialisation -ve
- changes in fashion/taste
- poor national interdependence
- finite resources in specialised industry (e.g. oil)
Division of labour +ve
- higher productivity, saved time
- lower CoP = lower prices for consumers
- specialist machinery for already efficient workers
- higher quality of goods
-ve of division of labour
- boredom of workers, demotivated. productivity down
- risk of unemployment due to over-specialisation
specialisation of production for trade (+ve/-ve)
+ comparative advantage will be more efficient, producing @ a lower cost, so selling for a lower price
- high dependence on other countries, so problems with trade will affect all e.g. war
- overdependent on one export, and if fails the economy suffers. e.g. agriculture failing due to weather
Free market economy
- individuals free to make own choices, own the FoP (no govt involvement)
- consumers decide on satisfaction, producers on profit
- no completely free left in the world
Adam Smith
- believed in free market
- ‘invisible hand’ which allocated resources, allowing greatest good to most number of ppl
- comp in market means lower prices as firms wanted to be competitive, benefits consumer
- however, state needed to provide what free markets wouldn’t e.g laws, or public goods like bridges + roads
Friedrich Hayek
- state control leads to loss of freedom
- poor ppl in free market better off than in cmd as had freedom
- while ppl don’t make supply/demand choices w perf info, know what they need e.g. consumer knows how much food needed / producer knows how much materials needed
free market +ve/-ve
+ automatic system: if good not wanted, not produced
+ high motivation as hard work can lead to high rewards
+ productive efficiency as firms are in competition so will produce @ lowest cost
- high inequality, rich get richer, poor stay poor
- wasted resources on unproductive expenses like advertising to provide comp servce
command economy
- all FoP except labour owned by state
- no private property, everyone working for the common good
- all workers no matter job receive same wage, products standardised, prices limited
Karl Marx
- wanted to remove difference between owners and workers as 2 class system was forming
+ve/-ve command econom
+ minimum standard of living for all, less inequality
+ less wasted resources, as no competition
+ standardised products mean cost effective production
- potential over/under supply as state cant make so many decisions, so wasted resources
- less motivation for workers as same wages for all no matter what
govt role in mixed economy
- redistributes income: uses tax to move income from rich to poor, e.g benefits and provision of services (NHS/free schooling) allowing the poor to access these services which they may not have been able to afford
- creating rules: e.g. prevent abuse of monopolies, where a company w/ more than 25% market share can take advantage of consumers due to monopoly power
- supplements/modifies price system: produce public + merit goods (emergency services + transport and limit production of demerit goods (child pornography)
consumers aim to maximise…
producers aim to maximise…
govt aim to maximise…
- utility
- profit
- social welfare
PED
always -ve
changing over demand curve, elastic top half, inelastic bottom half. unitary elastic in middle.
PED factors affecting
- substitutes available (pepsi + coke)
- time (more time = easier to find sub, so SR goods inelastic, LR elastic)
- necessity (if need, inelastic as no matter price still need)
- total % of expenditure (small % means inelastic as change in price wont do much)
- addictive
PED and revenue
- elastic demand curve
decrease price = increase rev
increase price = decrease rev - inelastic demand curve
decrease price = decrease rev
increase price = increase rev
YED values
YED<0, inferior good, increase income decrease demand
YED>0, normal good, increase income increase demand
YED>1, luxury good, increase income big increase demand
YED>1, elastic YED<1, inelastic
significance of YED
- so businesses know how sales will be affected by income of population
- economy improving, incomes rising, can impact type of good being produced
XED values
XED>0, substitutes, increase in price of good B means increase demand for good A (coke + pepsi)
XED<0, complementary, increase price B decrease demand A (DVD + DVD player)
XED=0, unrelated, no impact
larger number, stronger relationship
significance XED
- firms can be aware of comp and those making complementary goods
- know how price changes by other firms will affect them
factors affecting PES
- time: immediate term, supplier can only sell how much they already have despite price, supply inelastic. in LR, can increase production, all factors elastic, so elastic
- existing stocks can be used to make more elastic
- if working below full capacity, can produce to full capacity so more elastic
- availability of FoP, labour may need skills so cant increase
- ease of entry, costs of start up equipment etc, inelastic supply
- substitutes availabilities
price mechanism
A - allocate scarce resources efficiently
R - ration scarce resources by encouraging/discouraging consumption/production
S - signalling excess demand/supply, and the need for ↑ / ↓ resources
I - incentivising producers to ↑ / ↓ output to maximise profit
price mech local scale context
COVID in UK, trade stopped so virus didnt spread. decreased supply on store shelves, but ↑ demand, so price ↑
rationing function - only those who can afford/really want it will buy it
price mech national scale context
- housing north vs south UK, rationing function in London, houses price up so only wealthy/ who need most will buy.
- high house prices offer incentive for firms to allocate resources to this market, incentive function, as profit to be made
price mech contect global scale
- 1973, OPEC restricted supply of oil on MASSIVE scale due to geopolitical factors.
- prices of oil ↑ ↑ ↑ globally, due to high value.
- rationing function, high prices deferred consumers who didnt value oil as highly.
- allowed those who needed most to access, market therefore returned to equilibrium
PED perf elastic/PES perf inelastic - tax
supplier pays all the tax
PED perf inelastic/PES perf elastic
all tax passed onto consumer
why consumers may not behave rationally
- influences of other people
- habitual behaviour
- consumer weakness at computation (do things they know they shouldn’t e.g soda) (don’t make comparisons of prices so buy more expensive, e.g. multipack not always cheaper but ppl assume it is)
under provision of public goods
- non rivalrous non excludable, so underprovided by private sector due to free rider problem
- market cant make sure enough of these are produced
- e.g streetlamps
information gaps
- economic agents dont always have perfect info, dont always make rational decisions, so resources not allocated to maximise welfare
- consumers dk quality of used cars
govt int: indirect tax +ve/-ve
+ internalises externality, market produces closer to/at social equi, social welfare maximised
+ raises govt rev, can be used to solve externality in other ways
- hard to know size of externality, so hard to target tax (imperfect info)
- black market creation
- if inelastic, tax wont reduce output
govt int: subsidy +ve/-ve
+ welfare maximised, closer to social optimum output
+ other positive impacts like encouraging small businesses, ↑ equality, encourage exports
- govt have to spend lots, high opportunity cost
- hard to work out size of externality (imperfect info)
- once implemented, hard to remove
max and min price
- max price put on +ve ext goods, like food. lack of food will have bad effect on NHS
- min price on -ve ext goods, like cigarettes. higher price will discourage consumption
max/min price +ve -ve
+ max price means goods will be affordable, min price means producers get good price. help to reduce poverty, can ↑ equality
- can lead to black markets. max prices may lead to illegal bribes etc
- hard for govt to know where to set prices
max price eg
manhattan rent controls, so that rent is affordable for all
price caps on milk, toilet paper, medicine, petrol etc in venezuela (EVAL: caused black market, goods no longer in supermarkets as firms cant make profit)
min price eg
- scotland, min price on alchohol. targets cheapest drinks aiming to cut down binge drinking. (EVAL - bad effect on poverty for ppl who are addicted)
tradable pollution permits +ve
+ as govt limits number of permits, guaranteed pollution fall
+ govt can ↑ rev by selling permits, and fining firms who exceed
+ encouraged investment to green tech
+ encourages efficiency, firms choose whether to cut pollution/buy permits
tradable pollution permits -ve
- expensive to monitor and price
- raised costs for businesses, likely passed onto consumers
state provision of public goods +ve -ve
+ corrects market failure by providing important goods which wouldn’t have been provided otherwise
+ benefits for themselves, e.g. providing healthcare means healthy workforce so improved econ growth
- expensive, high opportunity cost
- may produce wrong combo of goods
- corruption / conflicting objectives
provision of info +ve -ve
+ helps consumers act rationally
+ best if used alongside other policies, e.g. demand ↑ elastic in LR so help find taxes become ↑ effective at reducing output
- expensive for govt to do, opportunity cost
- govt may not have all info
- consumers may not listen
regulation +ve -ve
+ helps overcome market failure
+ prevents exploitation of consumers, ensures symmetric info
- expensive to monitor, opportunity cost
- firms may pass on costs to consumers
causes of govt failure: information failure
- any decisions the govt makes will be based on some data, but wont always have perfect info.
- cost and benefit forecasts are often wrong, so govt invests in system where costs higher than benefits, = welfare loss
- usually impossible for govt to get all info they need
causes of govt failure: excessive costs
- lot of money allocated by govt it used on admin costs
- social costs may outweigh social benefits once admin costs taken into account
- e.g. lot of money given to NHS spent on organisational admin instead of on medical care
causes of govt failure: unintended consequences
- some interventions cause unintended effects. consumers + producers may react to new policies in unexpected ways so may have diff effect
- e.g targets for treating patients in NHS led to a reduction in quality of care.
- black markets may be formed (from tax, regs, min prices, for cigs, alcohol)
- minimum prices impact on poor, regressive taxes.
- firms may shut down, over strict regs and tax, lead to shut down/decrease in size/relocate —> employment ↓
- subsidy, firms may become too dependant and so less productive, more wasteful
causes of govt failure: distortion of price signals
- some types of govt failure change price signals, distort free market mechanism.
- leads to keeping some firms when inefficient, so resources SHOULD be switched elsewhere but aren’t
- e.g. subsidies keep farmers in employment when they cant produce cheap enough to be competitive. means that govt helps them stay in business when they shld close down and find other uses for resources.
causes of govt failure: regulatory capture
when govt try regulate monopoly power.
- occurs when interests of society are overlooked for interests of CEOs and managers etc.
- when CEOs/managers influence the regulator, due to close contact/used to work in industry before so knows CEOs in that industry.
- means CEOs can influence regulator to reduce extent of the regulation
- working in interest of firm not of society.
- regulatory authority are expensive to maintain so if not regulating properly, can be a very large cost which outweighs benefits
why some firms want to grow
- access to economies of scale, = ↓ costs of production. sell ↑ goods = ↑ revenue. leads to ↑ ↑ ↑ profit, so ↑ motivation to achieve
- larger market share, so can influence prices and restrict other firms from entering market. monopoly power often means monopsony power, so can ↓ costs by lowering prices of raw materials
- more security, can build up assets. likely to sell goods in multiple markets, so less susceptible to changes to individual markets
why remain small?
constraints on growth:
- size of market
- access to finance
- owner objectives
- regulation
principle agent problem
- in large firms, separation of ownership and control
- firms owned by shareholders who have no part in day to day running
- CEO + senior managers control decision making
- shareholders represented by board, who decide how run. can vote people on/off. little difference as more power through buying/selling shares, i.e. if prices ↓ significantly, board encouraged to change strat
- separation = problems, differing aims
- owners want to max RoI, so SR profit max
- directors/managers want to max own benefits
THEREFORE - one group (agent) makes decisions on behalf of another group (principal).
- in theory, agent shld try max benefits for principle, but in practise, agents tempted to max own benefits.
- therefore, firms not able to profit max, but profit satisfice
- e.g. Enron Scandal - executives hid billions in debt from Board. Shareholders filed lawsuit to firm + executives when share value went from $100 to $1 in a year
