Revision and Consolidation

1. Revision and Consolidation Microeconomics Price mechanism and resource allocation

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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.

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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.?

19. 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?

20. 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?

21. 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

22. How efficiently the price mechanism allocates resources

23. 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

24. 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

25. 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

26. 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

27. 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

28. How well price mechanism resolves the problem of scarcity

29. 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?

30. 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.

31. 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

32. 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?