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Revision and Consolidation. Microeconomics Price mechanism and resource allocation. Scarcity. [limited resources, unlimited wants]. Significance of resource allocation. [How can society’s welfare be maximised?]. Mkt Mechanism. Govt intervention. Merits / Demerits of each mechanism.

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Revision and consolidation

Revision and Consolidation

Microeconomics

Price mechanism

and

resource allocation


Revision and consolidation

Scarcity

[limited resources, unlimited wants]

Significance of resource allocation

[How can society’s welfare be maximised?]

Mkt Mechanism

Govt intervention

Merits / Demerits of each mechanism


Revision and consolidation

Market Mechanism

How it works

  • Market forces of dd & ss

  • price changes

  • guide movement of resources

Market efficiency

Market failure

Show how it can be efficient

Sources of market failure

Methods to resolve


Jjc 2006 a explain why the lcd tv market has expanded so rapidly in recent years 10
JJC 2006a. Explain why the LCD TV market has expanded so rapidly in recent years. (10)

Demand + Supply

3 reasons

???

Expansion of market

  • Supply Factors

  • Increase in number of suppliers (rising dd, rising profits)

  • Improvement in production methods

  • Demand Factors

  • Rising Y (underlying assumption?)

  • Improved functions

  • Advertising

Graph to illustrate effect on eqlm qty with both DD & SS increasing


Revision and consolidation

PJC 2006Economic theory stresses the importance of efficiency in the allocation of resources.a. Explain how, in theory, output and price should be determined in an industry to achieve efficient resource allocation. (10)

Which theory?

What makes efficient resource allocation?

Demand-supply

Social welfare is maximised


Price output determination

P1

D1 = MPB1

Q1

Price-output determination

Pte eqlm coincides with the socially optimum outcome

Price

New MPB

= MSC

S = MPC

Net benefit

New eqlm where MPB = MPC

also where MSB = MSC

MPC

P0

= MSB

D0 = MPB0

Q0


Resource allocation by px mechanism
Resource allocation by px mechanism:

Individuals, by pursuing their self-interests, maximises the welfare of the society

i.e. MPB = MPC and MSB = MSC

 adjusting the level of output produces no net addition / reduction to welfare

 point where welfare is maximised

Above analysis rests on the assumptions of

  • perfect competition

  • perfect information

  • absence of external costs / benefits


Revision and consolidation
PJC 2006b. Discuss the difficulties of achieving an efficient allocation of resources by both the market and government. (15)

  • Market Failure

  • Market power

  • Externalities

  • Public & merit (demerit) goods

  • Government failure

  • Problems of pure command economy

  • Weakens competition

  • Political pressure / self-interest

  • Policy decisions based on imperfect information


Resource allocation by px mechanism1
Resource allocation by px mechanism:

Maximise social welfare only if:

  • perfect competition

  • perfect information

  • absence of external costs / benefits

    When these conditions are not satisfied, resource allocation by px mechanism fails to maximise social welfare and market failure is said to have occurred.


Market failure
Market Failure

Definition and examples of each type of mkt failure

Why each type of mkt failure leads to welfare loss

Graphs to illustrate welfare loss


Market power
Market Power

Definition and examples of market power

Why market power leads to welfare loss

Mkt power in pdt mkt:

firms raise prices and sell a lower quantity

Graph to illustrate welfare loss


Externalities
Externalities

Definition and examples of externalities

Why externalities leads to welfare loss

Negative externalities:

Crs/prs in deciding how much of a good to buy / produce consider only their private benefits and costs, ignoring the external cost borne by the 3rd party.

Graph to illustrate


Public goods
Public goods

Definition and examples of public goods

Why public goods leads to welfare loss

Non-excludability

 free riders  absence of paying customers

Non-rivalry

 MC = 0  inefficient to charge a price

Together

pte prs unable to ss the good

 non-provision if left to the market


Govt failure
Govt Failure

Definition

  • When government intervention in resource allocation leads to a deepening of existing market failure or the creation of a new failure

    Some sources of government failure

  • Problems of pure command economy

  • Weakens competition

  • Political pressure / self-interest

  • Policy decisions based on imperfect information


Resource allocation through central planning
Resource Allocation through Central Planning

Central Planning

Government collects data, estimates how much of each good people need and issues instructions to managers of factories.

The problem with central planning

No price mechanism to signal the changes in cr preferences and demand

No way for govt officials to keep track of all the thousands of local conditions and millions of individual desires within a country

Outcome

Resource misallocation – too much of a good is produced while acute shortages appear in others


Resource allocation through central planning1
Resource Allocation through Central Planning

Other problems with central planning

In the absence of competition:

  • little incentive for firms & workers to raise productivity

  • limited innovation and poor quality control

    Nationalised industries in mixed economies also suffer from these same problems


Political pressure self interest
Political Pressure / Self-interest

Govt reluctance to raise taxes on fossil fuels /

subsidies on oil

  • Effects of extracting and burning fossil fuels on the environment and health

    Agricultural subsidies + tariffs on imported products in many developed countries

  • Distorts price signals

  • High price for consumers, over-production

  • Cheaper to import from developing countries which enjoy CA in agricultural production


Decisions based on imperfect information
Decisions based on imperfect information

Pigovian taxes / subsidies

  • correcting externalities require a tax (subsidy) equivalent to the marginal external cost (benefit) to get prs/crs will internalise this external cost (benefit)

  • in reality, it is difficult to estimate the actual value of external costs (benefits) – e.g.?


Revision and consolidation

VJC 2006“Scarcity is a problem faced by all economies.” In the context of the Singapore economy, comment on how efficiently the price mechanism allocates resources and how well it resolves the problem of scarcity.” (25)

Scarcity and allocation of resources

What is scarcity?

What has it got to do with resource allocation?


Revision and consolidation

VJC 2006“Scarcity is a problem faced by all economies.” In the context of the Singapore economy, comment on how efficiently the price mechanism allocates resources and how well it resolves the problem of scarcity.” (25)

Price Mechanism

Based on dd- ss

Motivated by self-interest

Decides what, how and for whom to produce?


Revision and consolidation

VJC 2006“Scarcity is a problem faced by all economies.” In the context of the Singapore economy, comment on how efficiently the price mechanism allocates resources and how well it resolves the problem of scarcity.” (25)

Does it solve the scarcity problem?

What makes efficient resource allocation?

Social welfare is maximised

Thesis: cr sovereignty

Anti-thesis: Mkt failure



Resource allocation in a single industry

P1

D1 = MPB1

Q1

Resource allocation in a single industry

Price

New MPB

= MSC

S = MPC

Net benefit

New eqlm where MPB = MPC

also where MSB = MSC

MPC

P0

= MSB

D0 = MPB0

Q0

Coffee outlets


Resource allocation across industries
Resource allocation across industries

Individual prs & crs, whose actions are guided only by their self-interests, help to maximise society’s welfare.

Resources, guided by the invisible hand, are channelled to the production of g&s which are desired by society.

Total satisfaction is maximised

Consumer sovereignty:

Consumers, through their money “votes”, dictate what goods should be produced.

E.g. Demand for coffee increases

  • px of coffee ___ , profits of firms _____

  • forms the incentive for firms to ____ production

  • increased competition for workers, retail space and other fops bids up px of these factor i/p

  • rising costs (e.g. rental) force bubble tea joints which face falling dd to ___ production and ___ their claim on the resources

  • resources move into the coffee retail industry


Resource allocation
Resource allocation

Price

Price

Resources channelled away from declining industries to produce goods which are desired by society.

Bubble Tea

Coffee joints

Quantity

Quantity

Price

Retail space

Quantity


Resource allocation by px mechanism2
Resource allocation by px mechanism:

Individuals, by pursuing their self-interests, maximises the welfare of the society. No coordination is required!

i.e. MPB = MPC and MSB = MSC

 adjusting the level of output produces no net addition / reduction to welfare

 point where welfare is maximised

Above analysis rests on the assumptions of

  • perfect competition

  • perfect information

  • absence of external costs / benefits


How efficiently the price mechanism allocates resources1
How efficiently the price mechanism allocates resources

Market Failure

Definition and examples of each type of mkt failure

Why each type of mkt failure leads to welfare loss

Graphs to illustrate welfare loss

Note:

Choose examples in the Singapore context



How well it resolves the scarcity problem
How well it resolves the scarcity problem:

Reliance on price mechanism

Profit-motive spurs adoption of more efficient methods of production and other cost-cutting measures

Firms more responsive to changes in dd and cost conditions, producing g&s in dd

  • more o/p can be produced with a given amount of resources

  • outward shift of PPC

  • reduce scarcity BUT can’t eliminate it

  • Graph?


How well it resolves the scarcity problem1
How well it resolves the scarcity problem:

How to produce

An increase in the price of labour relative to capital

  • firms adopt more capital-intensive method of production to minimise their cost

  • cost-minimising behaviour guides firms to substitute relative less scarce resources for scarcer resources.


How well it resolves the scarcity problem2
How well it resolves the scarcity problem:

For whom to produce

The goods will be distributed to the people who are willing to pay the highest price

 determined by availability of income

 helps to reduce scarcity problem for high income groups but does little to help the low income groups


How well it resolves the scarcity problem3
How well it resolves the scarcity problem:

Reliance on price mechanism

Profit-motive spurs adoption of more efficient methods of production and other cost-cutting measures

Firms more responsive to changes in dd and cost conditions, producing g&s in dd

  • more o/p can be produced with a given amount of resources

  • outward shift of PPC

  • reduce scarcity BUT can’t eliminate it

  • Graph?