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Welcome to ECON 372: Comparative Economic Systems By: Dr. Jacqueline Khorassani

Marietta College, Spring 2011. Welcome to ECON 372: Comparative Economic Systems By: Dr. Jacqueline Khorassani. Week Four Lecture Slides Source: Chapter 2 & Jackie (pp 25 -39). Notes. Exam 1: Wednesday, February 9

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Welcome to ECON 372: Comparative Economic Systems By: Dr. Jacqueline Khorassani

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  1. Marietta College, Spring 2011 Welcome to ECON 372: Comparative Economic SystemsBy: Dr. Jacqueline Khorassani Week FourLecture Slides Source: Chapter 2 & Jackie (pp 25-39)

  2. Notes • Exam 1: Wednesday, February 9 • Team 1 paper is on Japan, Sweden and France and is due on Monday, February 28 • On Monday, January 31, expect an in class assignment on last Friday’s class + the first 15 slides on Week 4 (this week) lecture slides.

  3. 27th Milton Friedman Lecture Sunday January 30, 2011 7:30pm McDonough Auditorium Topic: Regulation and Technological Change: The Case of Electricity Dr. Lynne Kiesling Senior Lecturer Department of Economics Northwestern University Free and Open to the Public

  4. This is an opportunity to collect more bonus points • 2 points for attending • 2- 5 points per question • 2-10 points for summarizing the talk

  5. Social Indifference Curve • Assumptions • Only two goods are consumed. • Fixed taste. • All members of the society have the same taste. • More is better.

  6. Social Indifferent Curve • Why is it downward sloping? • If increase both happiness goes up • Why is it bowed in? • Why are we willing to give up fewer roses for 10 additional guns as we consume more guns? • Diminishing utility Roses A 95 B 50 40 C Indifference Curve 0 10 20 30 Guns

  7. Social Indifferent Curve • Do we like D better than B? • Yes, on a higher indifference curve • Do we like F better than B? • No, on a lower indifference curve Roses A 95 D * B 50 Indifference Curve 40 C *F 0 10 20 30 Guns

  8. Social Indifference Map • Can a society’s indifference curves cross each other? • If indifferent between A and C • If indifferent between A and B • Then must be indifferent between B and C (not true, because B and C are on different indifferent curves) • Given no change in taste indifference curves can not intersect Roses A* B* I1 C* I2 Guns

  9. Social Indifference Map • Indifference curves of a society are parallel to each other. Roses I3 is better than I2 why? I3 I2 I1 Guns

  10. PPF and indifference map The highest indifference curve we can reach given what is available = efficiency in production and consumption. Why? Efficiency in production = maximizing out put , given resources and technology Efficiency in consumption= Can’t have more of both goods=can’t make someone better off without making someone else worse off • Is B better than M? • Is C better than M? Roses B 95 C 80 M 0 10 20 30 40 Guns

  11. How does this model relate to distribution of income? • Consumption efficiency has nothing to do with distribution of income • If one person gets it all, it is still efficient as long as to make some one else better off you have to make this person worse off by taking something away from him.

  12. How do market supply and demand in a competitive market related to efficiency?

  13. Let’s look at supply and demand in a completive market • If the maximum amount of output is sold  efficient At P = 100, how much is sold? At P = 50, how much is sold? At p = 70, how much is sold? Which one is efficient? This result is achieved under competitive, full information general equilibrium. P S 100 70 50 D 50 Q 30 80

  14. Definitions • Marginal cost = increase in total cost as a result of producing one more unit of a good = MC • Marginal revenue = increase in total revenue as a result of selling one more unit of a good = MR

  15. What is the profit maximization rule in a market economy? • As long as producing one more unit of a good adds more to your revenue than to your cost (as long as MR> MC) produce more • If producing one more unit of a good adds more to your cost than to your revenue (If MC>MR)  produce less • Profits are maximized when you produce the quantity of output at which MC = MR

  16. In the short run, when you have at least one fixed input of production • MC eventually increases as you increase production • Why?

  17. Example • Output = shirts • Inputs • Labor (L) • Capital (K, sewing machine, which you only have one) • If you keep on hiring more workers and don’t buy any more sewing machines, new workers can not produce as many shirts for you as the old workers but you pay them the same wages as your old workers  you cost per additional shirt goes up. • MC of additional shirt goes up

  18. How is the price and the quantity of output determined in a competitive market? What is MR for this firm? $10 P P =ΣMC S MC $10 P =MR D 20 2 Quantity Quantity Market Firm 1

  19. Monopoly • What is it? • Extreme case • One producer produces a unique good or service for which there are no close substitutes in the market • Has power to control the price.

  20. Now suppose a firm buys all of the little firms in a the market MC P P =ΣMC S MC $10 P D 20 2 D Does monopoly produce 20 units? Market Firm 1 = monopoly

  21. Monopoly is facing the same demand but S = MC If monopoly wants to sell one unit, it can charge $20 What is MR of the first unit? $20 If monopoly wants to sell 2 units, it can charge $18. What is MR of the 2nd unit $16 Why? MR = ΔTR/ ΔQ MR = 16/1 P =MC 20 S 18 D MR 1 2 Market

  22. How should the monopoly maximize profits? Find the quantity of output from intersection of MR and MC Charge the highest price it can charge for this much output Monopoly produces less and charges more than a competitive market Consumers are not consuming the maximum amount  no efficiency in consumption P S =MC 15 D MR 10 Market

  23. How likely is efficiency in production under monopoly? Not Likely Why? Monopoly charges a higher price  can afford to be less efficient and more wasteful than a competitive firm. Under monopoly, production is below capacity  we don’t reach our PPF. Monopoly P S =MC 15 Competitive 10 D MR 10 20 Market

  24. Question • How are natural monopolies different from unnatural monopolies?

  25. What is economies of scale? As the firm gets bigger AC drops We can have one firm producing 30 units or We can have 3 firms each producing 10 units Which one is potentially more efficient? One firm This is a cause of natural monopoly Examples? What should government do? (Rachel) Allow monopoly to exist but watch it. AC Average cost Economies of scale $30 $12 Quantity of production 30 10

  26. What about unnatural monopolies? • There is a short range of economies of scale • We can have one firm producing 30 units or • We can have 3 firms each producing 10 units • Which one is potentially more efficient? • three firms • Examples? • What should government do? (Rachel) • Remove the barriers to entry • Sherman Act, Clayton Act, FTC Act in the US • PP31-32 AC Average cost $40 $30 Q 10 30

  27. natural & unnatural monopoly • Natural monopoly enjoys economies of scale • Unnatural monopoly is created by artificial barriers to entry • Existing firms and/ or government make it difficult for new firms to enter

  28. A power plant may be an example of natural monopoly

  29. There is no huge fixed cost involved in arts and crafts not a natural monopolies

  30. What are externalities? • Costs or benefits of market activity to non-market participants • Examples of external costs • Pollution • Examples of external benefits • Scientific research • Problem: When externality is present, even a competitive market does not result in efficiency • Optimal amount of good is not produced

  31. Example of external cost A chemical plant pollutes the river The factory may not be producing the optimal amount of the chemical good

  32. Why not? Let’s look at external costs • The cost of pollution must be added to cost of production  MC goes up • There is over-production • What is the role of government? • Define Property rights better • Nobody owns the river • Coase Theorem • PP34-35 • Provide information • Internalize cost • Sell emissions permits • Taxes S = MC (social) P S =MC (private) External cost Competitive 10 D Q 15= optimal 20 Over production n Market

  33. Example of external benefit Production of flu vaccines The optimal amount of vaccine may not be produced

  34. The external benefits must be added to demand • There is under-production • What should government do? • Subsidize consumers • D goes up…why? • Subsidize producers • MC goes down…why? • Produce the good • Problems? Let’s look at external benefits P S =MC (private) Competitive MC-subsidy 10 D + external benefit D Q 25 = optimal production 20=under-production Market

  35. What is a public good? • Examples? • Education? Roads? Bridges? Clean air? National defense? • A public good has two characteristics • Non excludability • Non-payers can’t easily be excluded • No rivalry in consumption • My consumption does not significantly affect how much of the good is left for you

  36. Does a market economy produce the optimal amount of public good? Why or why not? • If I can benefit (can’t be easily excluded) without paying, will I pay voluntarily? • No • Who will pay? • ??? Good question!!! • Free rider problem • Everyone will hope that others will pay and she will benefit without paying

  37. Market economy produces less than optimal amount of public good, why? So, maybe we need a government to collect taxes and produce the optimal amount of this good or service P S Actual Demand (including the free riders demand) Observed market Demand Q Current=30 Optimal= 60

  38. Does government always produce the optimal amount of public good? • No • Suppose this public good is clean air • Optimal = 60 (society as a whole desires 60 units of clean air) • Do we all vote on this? • No, we elect representatives and they vote.

  39. What affects our representative's votes? • May be their own self interest • Who paid for their campaign expenditures? • Who is more likely to help them to get re-elected? • Special interest groups • And may be the special interest groups prefer 30 units of clean environment. • They are the big corporations who pollute the environment

  40. What if politicians have public interest in mind? • They may still vote for 30 units of clean environment. • Why? • Because they really think that is what the general public wants or that is the best for the public • Some voices are louder than others • Big corporations lobby • Cleaner air = higher unemployment

  41. Public Choice School • Studies biases in collective action • Even in the most democratic systems • the optimal (efficient) amount of public good may not be provided by government. • Result • Neither government nor the private sector supplies an optimal (efficient) amount of a public good.

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