Week 4 Flashcards
Whats the great economic problem?
To arrange our limited resources to satisfy as many of our wants as possible.
Define speculation
The attempt to profit from future price changes is called speculation.
Define Futures
Futures are standardised contracts to buy or sell specific quantities of a commodity or financial instrument at a specified price with delivery set at a specific time in the future.
Describe a forecasting market
A forecasting market is a highly speculative market designed to allow prices to be interpreted as opportunities and used to make predictions?
How do we allocate our limited labor and capital across the industries to satisfy as many of our wants as possible?
To use our limited resources most effectively, we would like resources to flow from low-profit industries to high-profit industries.
In what cases does the ‘invisible hand’ not work
If prices dont accurately signal costs and benefits
Explain the elimination principle:
The elimination principle states that in a competitive market, profits above the normal range and below the normal range are temporary. The Profits above the normal profits are eliminated by a new entry in the market, and profits below the range can be eliminated by the exit of firms.
Explain the Ricardian rent
The result of the possession of a natural or man-made idiosyncratic, scare factor
Is tying and bundling bad?
Bundling and tying are easier to do than price discrimination as there is less information required and fewer arbitrage issues.
Extra money is spent to keep competitors out of the tied market
Potentially anti-competitive on the final product - discouraging innovation, increasing prices
Explain how markets link to one another
- Shifts in the supply and demand in one market ripple across markets worldwide. Products are interrelated.
- Entrepreneurs are constantly looking for ways to lower costs - moving resources around leads to shifts
- This links markets that seem like they are a world away
- Are these changes to stable enough or is gov intervention required?
How can we solve the great economic problem?
- Central planning
- Price system
Explain central planning:
- Central planning is unworkable
- Problems of information and incentives
- Will not solve that the price system aggregates all this information
Explain the price system
- Each user of a product will compare the value in their use with the value in alternative uses
- Each user has an incentive to give up their product if it has lower value in their use
Explain how prices are incentives, signals and predictions
- When prices rise, buyers are encourages to use less or substitute away
- It is also a signal to suppliers to provide more
- Price signals and the accompanying profits and losses tell entrepreneurs what areas of the economy consumers want expanded and what areas they want contracted
Explain the first property of the invisible hand
Cost minimisation
All firms face the same market price for a given commodity
- To maximise profits, each firm adjusts its output until P = MC
- Thus, in a comp market with N firms, they all produce where P= MC1 = MC2 = MCN
Explain the second property of the invisible hand
Balance of Industries
Define Consumer surplus
Consumer surplus is the difference between willingness to pay for a good and the price that consumers actually pay for it.
Producer surplus
Producer surplus is the total amount that a producer benefits from producing and selling a quantity of a good at the market price.
Define Pareto Improvement:
An allocation can be improved if there exists another allocation that makes at least one person strictly better off and nobody worse off
Define Pareto efficiency
An allocation is Pareto-efficiency, if no Pareto improvement is possible.
Just about efficiency, not equality or efficient.
When is government action welfare enhancing?
A re-allocation is a Kaldor-Hicks improvement if those that are made better off could hypothetically compensate those that are made wrose off and lead to a Parto-Improving outcome
Explain complements
Joint demand: Coffee machines and coffee pads
Explain Substitutes
In rival demand: Coffee and tea in the prisoner of war camp
Explain derived goods
Second good is input to first good:
Corn and fertilizer
Explain composite goods
Two goods require the same input to make it:
If more sugar is used to make ice cream less is available to make chocolate
Explain joint supply
Second good is a by-product of the first good:
Sustainably produced corn and carbon credits
Explain regenerative farming
The soil becomes healthier and the sol has a higher absorption capacity for carbon.
Whats the difference between the mandatory and voluntary carbon credit market?
Mandatory: Compliance markets are created and regulated by mandatory national, regional, or international carbon reduction regimes. The main one being the EU ETS (Emission Trading System)
Voluntary: Operating in parallel to the compliance markets, allowing companies and individuals to purchase credits for the purpose of voluntary offsets
How does Carbon Farming work?
- Farmers plant crops that reduce CO2 emissions
- The farmer sells these emissions via Rabo Bank to the factory
- Rabo provides authentic certification of this CO2 emission bought
- In this way, carbon offsetting allows for factories to attain net-zero emissions
How much CO2 is one carbon credit
One ton of CO2 or CO2eq = One Carbon Credit
Whats the main assumption behind the demand and supply model?
Markets are perfectly competitive
Why do we study the perfect competition model?
2 Reasons:
1. Understanding the model helps us to understand the deviations from this model better
2. A lot can be learnt when applying to markets which are relatively competitive as well.
Why does the invisible hand often not work well?
Prices may not accurately signal costs and benefits
Price rigidities – taxation, regulation
Information problems such as asymmetric information leads to market failure
Commodities can have externalities – public goods
Self interest does not align with social interest. Eg: sustainability
Markets may not be competitive
Long-term monopolists and oligopolists produce less than the ideal amount
Firms make above normal profits, and entry is limited. Collusion may occur which deters entrants into the market as they cannot compete with the prices set by firms who collude
Define creative destruction
Creative destruction is a process through which something new brings about the demise of whatever existed before it.
Explain the implication of the elimination principle
The elimination principle states that in a comp market, profits above the normal range and below the normal range are temporary.
The profits above the normal profits are eliminated by a new entry in the market, and profits below the range can be eliminated by the exit of firms.
Define Futures
Standardized contracts to buy or sell specific quantities of a commodity or financial instrument at a specified price, with delivery set at a specific time in the future.
Define Future contracts
Future contracts are used to buy or sell something at a future date
Define the Pareto-efficiency
Cannot make someone better off without making someone else worse off
Whats the first fundamental theorem of welfare conomics
Every perfectly competitive market equilibrium is pareto-efficient
Whats the second fundamental theorem of welfare economics
Every Pareto-efficient allocation is the perfectly competitive market equilibrium to a well-chosen initial allocation
Whats the contract curve in an edgeworth box
Where indifference curves are tangent. Any point on this curve is also pareto efficient
Explain the current energy crisis
The current energy crisis stems from the supply without Russian Gas.
Dutch gov is imposing price cap on energy.
The funds to cover this subsidy is from the taxation of windfall profits
Define Windfall profits
A windfall gain is an unusually high or abundant income, that is sudden and/ or unexpected
What are porters 5 forces
- Competitive rivalry
- Threat of new entrants
- Supplier power
- Customer power
- Threat of substitutes
