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Microeconomics Level 1

HM TREASURY. Microeconomics Level 1. 0930 Course objectives 0940 Introduction to economics COFFEE 1100 What markets do: supply, demand, and equilibrium Group work Review of group work 1300 LUNCH 1400 Market failure, and government intervention 1445 Group work and TEA

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Microeconomics Level 1

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  1. HM TREASURY Microeconomics Level 1

  2. 0930 Course objectives 0940 Introduction to economics • COFFEE 1100 What markets do: supply, demand, and equilibrium • Group work • Review of group work 1300 LUNCH 1400 Market failure, and government intervention 1445 Group work and TEA • Review of group work 1530 Cost benefit analysis 1600 Lessons from Level 1 1610 Test 1645 End

  3. COURSE OBJECTIVES This course has three objectives • to provide an overview of the scope and methods of economics • to offer a self-contained introduction to key themes in microeconomics • to equip participants to proceed to Level 2

  4. COURSE OBJECTIVES • Economic analysis aims to be rigorous, but it need not be technical. • No prior knowledge of economics or mathematics is assumed.

  5. INTRODUCTION TO ECONOMICS CONCEPTS & TOOLS

  6. Basic Concepts • Stocks and Flows • Goods and services

  7. Basic Concepts • What, how and for whom • Markets versus ‘command economy’

  8. Basic Concepts • MICROECONOMICS: detailed study of decisions made by consumers, producers and their interaction in specific markets • MACROECONOMICS: big picture – emphasizes interactions in the economy as a whole.

  9. Basic Concepts • POSITIVE ECONOMICStries to explain behaviour • NORMATIVE ECONOMICS prescriptions based on value judgments

  10. Basic Concepts: The Production Possibility Frontier Maximum quantity one good that can be produced, given quantities of other goods being produced A, B, Cefficient (on the frontier) D, Einefficient (inside the frontier) F, Gunattainable (outside the frontier)

  11. Basic Concepts OPPORTUNITY COST OF A GOOD What we could have had instead

  12. Basic Concepts COMMAND ECONOMY central planner issues orders FREE MARKET ECONOMY what, how & for whom decided by prices, incomes, wealth DEGREES OF GOVERNMENT INTERVENTION Cuba -China- Denmark-UK- USA - Hong Kong

  13. Scale of government(spending as % of national income)

  14. TOOLS MODEL Deliberate simplification of reality like a map DATA Time Series Cross-section

  15. TOOLS NOMINAL & REAL VARIABLES Real unit labour costs = (Unit labour costs / Retail prices) x 100

  16. Tools: Visualizing data A scatter diagram

  17. Bus Revenue + + + + + + + + + Bus fare Tools: Interpreting the data It appears that higher bus fares cause higher revenue…

  18. Bus Revenue + + + + + + + + + Bus fare Tools: Interpreting the data … but it might not be true Suppose the two clusters are from two different time periods – what might that imply? High tube fare Low tube fare

  19. Tools: Interpreting the data Bus revenue depends on bus fares But it also depends on other things • incomes • price of other modes of travel • reliability (relative to other modes of travel) • relative comfort • relative perception of safety

  20. WHAT MARKETS DO DEMAND, SUPPLY & PRICE ADJUSTMENT

  21. Market • DEMANDquantity buyers wish to buy at each price • SUPPLYquantity producers wish to sell at each price • MARKETarrangement to exchange goods & services • EQUILIBRIUM PRICEthe price at which market clears (i.e. quantity demanded = quantity supplied)

  22. Market Supply curve price Equilibrium Price Demand curve Equilibrium Quantity quantity PRICE ADJUSTMENT Equilibrium price clears market

  23. Market The demand curve shows the relation between price of a good and quantity demanded of that good. But how does demand change when ‘other things’ change?

  24. DEMAND IN MORE DETAIL elaborating on the ‘other things’ How does DEMAND for a good vary when 1 price of a related good changes? • substitutes • complements 2 consumer’s income changes? • normal goods • inferior goods 3 tastes change? • role of fashions and fads, culture

  25. COMPARATIVE STATICS (effect of changing the ‘other things’) Suppose income rises, increasing demand

  26. SUPPLY IN MORE DETAIL elaborating the ‘other things’ How does SUPPLY of a good vary when • technology improves? • input prices change? energy, labour, capital 3 regulation imposes extra costs?

  27. COMPARATIVE STATICS Suppose technical breakthrough raises supply

  28. COMPARATIVE STATICS An important difference • If demand shifts, equilibrium price and quantity move in the SAME DIRECTION • If supply shifts, equilibrium price and quantity move in OPPOSITE DIRECTIONS

  29. SOME EXAMPLES Third world farming • What is the effect of better irrigation & fertilizer? • What happens to price? To quantity? • To revenue? Computers • The price of a personal computer has been falling. • Which is shifting, demand or supply?

  30. GROUPWORK

  31. Introduction to EconomicsGROUPWORK 1 Are the following statements positive or normative? (a) Higher tax rates cut revenue from tobacco taxes (b) Poor countries got an unfair share of world income (c) Smoking is antisocial & should be discouraged (d) Airbus needs public support (e) Airbus deserves public support (f ) Airbus is a good investment for Britain

  32. GROUPWORK • The price of crude oil increased from $2.90 to $9 per barrel in 1973, in a coordinated move by OPEC members. (a) How did the OPEC members manage to raise the price? Show using a supply-demand diagram for the oil market. (b) What happened to the demand for coal and the price of coal? Show using a supply-demand diagram for the coal market. (c) What happened to the demand for fuel-guzzling cars? (d) What happened to supply and demand for oil eventually?

  33. GROUPWORK 3 The following data describe price and output of a product: (a) Plot a scatter diagram (b) “Higher prices make firms raise output.” “People buy less when prices are higher” Does the diagram shed any light on these statements? Could both be correct? Explain.

  34. GROUPWORK 4For each government intervention listed below, identify the possible rationale. (a) Income tax (b) Taxation of petrol (c) Regulating gas prices (d) Banning the use of cannabis (e) Running the NHS (f ) Maintaining an army

  35. WHAT GOVERNMENT DOES Why Intervene?

  36. The Role of Government IF MARKETS ARE EFFICIENT (i.e. ‘invisible hand’ works), the government could confine attention to • Legislation and general regulation • Redistribution (taxation & transfer payments) • Macroeconomic management (stabilization)

  37. The Role of Government However, sometimes free markets are not efficient These instances are called MARKET FAILURES When markets fail, the government may intervene for efficiency reasons

  38. SOURCES OF MARKET FAILURE 1. EXTERNALITIES One person's decisions/choices affect others DIRECTLY If markets were free and unregulated • cannot be made to PAY for the HARM you inflict on others (e.g. pollution) • cannot RECOVER all the value of BENEFITS you confer upon others (use of green technology)

  39. SOURCES OF MARKET FAILURE 1. EXTERNALITIES Individual’s optimal decision is not optimal for society Result: OVERPRODUCE the bad things, UNDERPRODUCE the good things. Market outcome is INEFFICIENT, Government intervenes to CORRECT INEFFICIENCY Policy Tools: tax, subsidy, quota, artificial markets

  40. SOURCES OF MARKET FAILURE • PUBLIC GOODS Goods that we consume together, so that • no individual can be excluded from consuming • consumption by one does not leave less for others National defence Street lighting No one has any incentive to pay for such goods. In the absence of government intervention, too little of these will be provided. Government steps in to ensure right level is produced.

  41. SOURCES OF MARKET FAILURE 3. IMPERFECT COMPETITION If firms have market power (power to set prices above cost), markets are usually INEFFICIENT Once again, government can intervene (say, by regulating prices) Example: Regulation of National Grid

  42. GOVERNMENT FAILURE In PRINCIPLE, the government can correct market failures In PRACTICE, the government • does not always improve matters • sometimes makes things worse Why?

  43. GOVERNMENT FAILURE • INFORMATIONAL PROBLEMS • INCENTIVE PROBLEMS • RENT SEEKING & CAPTURE Hence, must check for the possibility of GOVERNMENT FAILURE before jumping to conclusions.

  44. GROUPWORK

  45. MARKET FAILURE & GOVERNMENT FAILUREGROUPWORK 1 There is a tax on cars in Central London (a) Why not leave things to the market? List the different motives for intervention. (b) Which of these are to do with efficiency? (c) Are there any other motives than efficiency? (d) Is/Was there a possibility of government failure?

  46. MARKET FAILURE & GOVERNMENT FAILUREGROUPWORK 2 If people want to watch advert-free terrestrial TV, there should be a market for this. So what is the case for the compulsory TV License?

  47. COST BENEFIT ANALYSIS

  48. COST-BENEFIT ANALYSIS Usually applied to government investment decisions • roads • channel tunnel • subsidies to start-ups, R&D The main question: How do we value SOCIAL costs and benefits of a project?

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