Entries Tagged 'concepts' ↓

Readers Question: the elasticity of demand for good is likely to be greater in the short run than in the long run true or false?

Elasticity of demand measures the responsiveness of demand to a change in price. See: Price Elasticity Demand 

In the short run demand is likely to be more inelastic (low = less than 1).

If people are used to buying a good, then when the price goes up, they will buy it out of habit. However, when they realise the price rise is permanent they will expend energy in looking for alternatives.

PRice Elasticity of Demand for Oil.

If the price of oil increases people with petrol cars will still buy petrol. However, over time people may increasingly start to buy cars which use alternative energy sources such as natural gas, hydrogen or solar panels. But it will take time to make the switch

Readers Question: I am studying AS level economics and I have a homework which i’m stuck on. I was wondering what are the pros and cons of the government intervening in market failures such as those resulting from the immobility of labour, negative externalities and greater income inequality, following the closure of factories.

It’s a difficult AS question. Some ideas might include:

Advantages of Government Intervention

The existence of Negative externalities lead to overconsumption. A negative externality causes a harmful effect to a third party. Therefore the social cost is greater than the private cost. However, people ignore the costs to others and so in a free market there is overconsumption. Negative externalities of a factory closing down include the costs to the rest of society in the nearby town. It is not only workers who are adversely affected but local shops.

Immobility of labour can lead to geographical unemployment. i.e. jobs are available but workers find it difficult to move to these areas. Government interevention can subsidise firms who move to areas of high unemployment or subsidise workers who move to areas of low unemployment. THis can help overcome market failure in the labour market and reduce the problem of geographical unemployment resulting from a factory closing down. Continue reading →

Readers Question: Why government, rather than private industry, is required for an effective mosquito eradication program?

An effective mosquito eradication program is an example of a public good.

If you exterminate all the mosquitos it has the characteristics of

1. Non rivalry. - When you benefit from living in an area free of mosquito’s it doesn’t reduce the benefit to anyone else. (unlike a private good where if you consume it, you reduce the amount available)
2. Non Excludability - Once provided you can’t stop anybody benefitting from it. I

If you get rid of all mosquitoes and prevent malaria, then everyone in the community will benefit.

However, in a free market the service may not be provided; this is because you will benefit even if you don’t pay and contribute to the program. Therefore there is an incentive to wait for others to pay for the program and then ‘free ride’ on the efforts of others.

A private firm will therefore, struggle to get sufficient people to pay.

This is why the government can pay for it out of general taxation. This forces everyone to pay.

This contrasts to a private good, where the benefits accrue to a certain individual and there are market incentives to pay for it.

Readers Question what is the marginal cost measured at a particular level of output defined as?

Definition: Marginal cost is the change in total cost of producing one extra unit of output.

For example, suppose the cost of producing 10 bikes is £2,000. If you produce 11 bikes and the total cost increases to  £2,150.

This means the marginal cost of the 11th bike is £150. (Note, the marginal cost is less than the average cost of the first 10 bikes)

See: Diagram of marginal cost 

I am taking advantage of the Easter holidays to write an Economics Dictionary. I am concentrating on the main economic terms with brief definitions and where appropriate examples. So far I have written A and B. Writing the dictionary has taught be a few things. These are some of the more interesting terms.

• Black Monday 

• Black Wednesday 
• Black Thursday 
• Booms 
• Beggar My Neighbour 
• Bounded Rationality Continue reading →

Readers Question: What are the consequences for Ghana if it is dependent on primary products?

Definition of Primary products: Raw materials and resources used in the productive process. Examples include: metals, agricultural products and minerals.

Advantages of Producing Primary Products

1. What Ghana will have a comparative advantage in producing
2. Important source of export revenue
3. Creates Jobs

Disadvantages of Relying on Primary Products

1. Prices are Volatile due to inelastic demand. e.g a fall in price of primary product would lead to a fall in revenue.
2. Limited resources. One day Ghana may run out of its primary products and the economy will be vulnerable to this lack of diversification
3. Discourages investment in other aspects of the economy. Concentrating on primary products does not help the long term development of an economy because there is a lack of investment in other aspects such as education. Comparative advantage can change over time

Readers Question: Outline the technique of cost benefit analysis. How can it be applied to the assessment of investment in education projects and what are its strengths and weaknesses?

See: Procedure of CBA 

Potential Benefits of Education Spending

• Increased Labour Productivity in the long run. i.e. more literate and numerate workforce should be more efficient enabling higher rates of economic growth
• Decreased Unemployment. In a modern economy it is important workers have relevant skills. Structural unemployment is often caused by a lack of skills and training. Education aims to reduce structural unemployment, especially amongst young workers.
• Higher wages for workers. More educated workforce can command higher salaries (see MRP model of wage determination)

Continue reading →

With Chinese inflation rising to over 7% many people are suggesting - Why Not Use Price Controls to Stop Food Inflation?

China and other Asian economies have seen a particular marked rise in food inflation. This creates various problems. Firstly, it particularly affects the rural poor who experience a decline in living standards. Secondly, the rise in food prices indirectly increase the cost of production for the manufacturing sector; many firms feed workers directly.

Imposing price controls enables the government to keep a lid on prices making life more affordable. This is done in countries such as India. However, the basic economic problem is that imposing price controls reduces the incentive for firms to supply more. Therefore, it can actually make the situation worse in the long term because if lower prices discourage investment, the fall in supply will raise future prices. It would be better to allow market forces to raise prices and (hopefully) increase supply.

Can Price controls ever be justified?

One case where price controls may be justified is if rising prices are caused by monopoly power. If prices are kept high by monopolies then a reduction in price will not cause lower supply.

Readers Question: How The Economies Of Scale Can Bring Benefits To The Market.

Economies of scale occur when increased output leads to lower unit costs (lower average costs)

Diagram Economies of Scale

Examples of Economies of Scale include

Tap Water - High Fixed Costs of a national network.

Continue reading →

Readers Question: What is the benefits of monopoly. Identify and explain these benefits that brings to the market.

I need examples related to the benefits too.

I have written a few posts about the benefits of monopoly’s and mergers in the past

• Benefits of Mergers
• Are Monopolies always bad?
• Does Microsoft have too much market power?

Continue reading →