econ - micro y1

• Market failure


  Occurs where the free market fails to allocate scarce resources at the socially optimum level
• Reasons for market failure

  • Externalities (negative and positive)
  • Merit and demerit goods
  • Public goods
  • Common access resources
  • Income inequality
  • Monopoly power
  • Factor immobility
• Externalities


  Negative impacts or positive impacts on third parties as a result of production or consumption
• Merit and demerit goods


  Goods or services that are either worse for us than we think or better for us than we think, due to imperfect information
• Public goods


  Goods where there is a free rider problem, so firms will not supply them
• Common access resources


  Resources that are over-consumed and over-produced due to negative externalities
• Income inequality


  Can be a source of market failure on grounds of equity (fairness)
• Monopoly power


  Occurs when there is only one dominant seller, leading to higher prices and lower quantities than socially optimal
• Factor immobility


  Occurs when factors of production (e.g. labour) cannot respond to changes in demand, leading to a misallocation of resources
• Minimum price


  A fixed price or a price floor enacted by the government usually set above the equilibrium market price
• The government is saying the equilibrium price in the market is too low, so they want to raise it by implementing a minimum price
• Price floor


  The lowest price that can legally exist in the market
• Reasons for governments to use minimum prices

  • To protect producers from price volatility, especially farmers and producers of primary commodities
  • To solve market failures by raising price, discouraging consumption and production of goods/services that do harm to society
• Impact of minimum price

  1. Price increases

  2. Demand contracts

  3. Supply expands

  4. Excess supply (surplus) created
• Excess supply created


  Burden on producers as they have high costs but can only sell the lower quantity demanded
• Government intervention to address excess supply


  Intervention buying - government buys up the excess supply
• Cost of intervention buying

  Price of minimum (pmin) multiplied by the quantity of excess supply (qdqs)
• With intervention buying


  Producer revenue increases (pmin * qs)
• Without intervention buying


  Producer revenue only increases by (pmin * qd)
• Minimum price creates a deadweight welfare loss
• Impact on stakeholdersof government intervention


  • Consumers - higher prices, lower affordability, regressive effect
  • Producers - protected from price volatility if there is intervention buying, but may struggle without it
  • Government - concerned about cost of intervention buying, unintended consequences like black markets
• Production possibility frontier (PPF) or production possibility curve


  Very useful tools to illustrate the ideas of scarcity and choice in economics
• PPF/PPC


  • Shows the maximum possible production of two goods or services that can be produced with a given level of factors of production
  • Shows the various combinations of two goods and services that can be produced with a given level of factors of production
• Macro PPF


  • Shows the maximum possible production of all goods and services that can be produced with the level of factors of production in the economy
  • Shows the various combinations of all goods and services that can be produced with given factors of production in the economy
• PPF/PPC


  • Can show concepts like opportunity cost and efficiency
• Opportunity cost


  The cost of producing one good in terms of the other good that must be given up
• Concave PPF/PPC


  Illustrates the law of increasing opportunity cost
• Linear downward sloping PPF/PPC


  Illustrates constant opportunity cost
• Productive efficiency


  • Using all factors of production to their maximum level to get maximum production
• Productively efficient point


  Any point on the PPF/PPC curve
• Productively inefficient point


  Any point inside the PPF/PPC curve
• Allocative efficiency


  Whether what is being produced is satisfying consumer demand
• Pareto efficiency


  Nobody can be made better off without making somebody else worse off
• Pareto efficient point


  Any point on the PPF/PPC curve
• Increasing production on a PPF/PPC

  1. Use factors of production better

  2. Reallocate factors of production

  3. Shift the PPF/PPC curve by increasing quantity and/or quality of factors of production
• Supply


  The quantity of a good or service that producers are willing and able to produce at a given price in a given time period
• Law of supply


  • There is a direct relationship between price and quantity supplied
  • As price increases, quantity supplied increases
  • As price decreases, quantity supplied decreases
• Price changes


  We move along the supply curve
• Price increases


  Quantity supplied increases (extension/expansion of supply)
• Price decreases


  Quantity supplied decreases (contraction of supply)