Work: Micro-economics
Navigation: Home Page Comment Education Videos
Micro-economics
1. Argue the case that the advantages of a Planned Economy outweigh those of a Market Economy.
A planned economy has the advantage that it can allocate resources towards where they are most needed. Expenditure can be devoted to essential public services, such as health and education (Associated Press 2007). In contrast, merit goods and public goods are more likely to be under-provided in a market economy (Anderton 2008:130).
There is a wide availability of doctors in countries such as Cuba (Associated Press 2007). Also planned economies, such as Cuba, (Wall 2003:329) tend to have low rates of income inequality. This means that societies in planned economies are more equal and cohesive. Supporters of planned economies would also argue that life expectancy in Cuba is strong. Life expectancy was 77, in 2007, the second highest in Latin America (Associated Press 2007).
Supporters of a market economy would argue that a market economy allocates resources more efficiently; according to what consumers are willing to pay for goods. However, market economies can be seen as wasteful. A pure-market economy does not direct spending. Therefore, money can be spent on gambling which arguably could be better allocated towards health expenditure.
Also, it not clear that a market economy allocates resources more efficiently than a planned economy. A private monopoly is acceptable in a market economy. But it could over-price essential products to consumers such as water services (Sloman 2007:123).
2. Why is opportunity cost a more important concept than accounting cost?
Accounting cost only measures the actual cost. This could be the cost of labour. An electrician could be paid £20,000, a year, by an electrical contracting company. This is the accounting cost or the cost to the company. However, if the electrician were instead self-employed then the earnings for the year could be £25,000. This shows that the electrician is forgoing £5,000 of (lost) earnings by being employed by a company. Opportunity cost is a more useful concept as it shows the amount of money that is forgone. The accounting cost is only showing the cost that the company paid to the electrician. This is not what he was capable of earning if he was employed in his best available alternative employment; in this case as a self-employed worker (Begg et. 2005:89).
3. Under what circumstances might the “law” of demand prove incorrect?
There are cases where if price rises then demand also increases. Expensive branded trainers have been criticised for encouraging ‘conspicuous consumption’ whereby consumers are attracted to the appearance of the product (Begg. et. al. 2005:76). The price can be increased, for such trainers, and they may encourage a feeling of exclusivity which could increase demand.
Another case is where a consumer is in serious poverty. Under normal conditions, a price rise would lead to a fall in demand. But an individual in poverty may spend more money on an inferior good, such as white bread, which goes up in price (Begg et. al 2005:75). This good may be a significant part of their disposable income so they are relatively poorer after the price rise. Other items of food expenditure are sacrificed to pay for the additional spending on ‘white bread’. Let us say £5 was spent on food, including £1 for a loaf of bread. If the loaf of bread increases to £2, then the consumer buys the new loaf for £2 and spends the remaining £3 on other food.
4. Define the term “price inelastic” and recommend an advertising and pricing strategy to a firm seeking to achieve such a status for its product.
Price inelastic is when demand is not fully responsive to a change in price.
An advertising campaign would aim to make the product ‘price inelastic’. It would aim to make the product desirable so that the consumer would continue to demand it; despite an increase in price. An advertising campaign for a car would aim to make the car indispensable so that consumers would not want to buy an alternative car. If such an advertising campaign were successful in terms of making the car, price inelastic, then the firm should raise its price as its revenue will increase despite the price rise.
5. In the light of the recent proposed reforms of the funding of universities in England, what factors are likely to determine price elasticity of demand for Higher Education?
The availability of substitutes affects the price elasticity of demand (Wall 2003:245). Substitutes, in this case could be alternatives such as apprenticeships. If prospective students thought that apprenticeships were a good alternative to higher education, in terms of providing training, then demand for higher education would become more price elastic.
Another factor is the amount of money spent on education compared to income (Wall 2003:245). If higher education is a small proportion of income then the price elasticity is relatively inelastic. However, with the rise in fees then the expectation would be for the elasticity to become more elastic. Prospective students could look for alternative types of training.
With the fees being deferred until after graduation then perhaps there should be no change in elasticity. With the income threshold for repayment increasing from £15,000 to £21,000 then perhaps the elasticity should become more inelastic as graduates are perhaps less likely to pay the loan back; and less likely to consider alternative forms of provision.
The availability of grants and bursaries is another factor. The more generous these are then the more inelastic demand is likely to be. Generous bursaries would discourage a movement towards alternatives such as apprenticeships.
The student’s subject choice and the potential graduate premium are relevant. The graduate premium is the difference between a graduate’s income and a non-graduate’s income. An economics graduate may enjoy a larger premium compared to an arts graduate (Machin and Vignoles 2005:93). The elasticity may be lower for an economics graduate, with a potentially higher graduate premium. The potential alternative, i.e. an apprenticeship, is less attractive to an economics student compared to an arts student.
6. Is “normal” profit a good thing?
Normal profit is a ‘good thing’ as it provides enough profit for an entrepreneur to stay in business over the long term. A ‘normal profit’ for an independent food shop would provide enough money for a shopkeeper and to provide for his family. It could also be perceived as acceptable because the consumer is obtaining a ‘fair price’ for a good.
Normal profit is unlikely to be enough to pay for a substantial innovation. A large investment by a pharmaceutical company cannot be funded through normal profits. Monopoly or abnormal profits would be appropriate in this situation as they would be able to pay for substantial research investment.
7. Giving examples, explain why goods may exhibit negative income elasticity in the short run but positive income elasticity in the long run.
Negative income elasticity can be identified, initially, with leisure related goods such as rail fares. Incomes could rise, but the demand for rail fares could fall as people are working more rather than taking railway trips. If real wage rates increase, then the reward for working increases, in preference to taking leisure (Anderton 2008:468).
However, in the longer run if people have more income, they may feel more able to take railway trips rather than work. As income rises to a sufficient level then the demand for railway fares could also rise. Consumers who are purchasing leisure activities may exhibit this pattern of behaviour (Anderton 2008:468).
8. When faced with the income/leisure choice, what factors other than real wage might influence the decision of an individual member of the labour force?
If the demand for leisure is higher, than the demand for income, then the consumer will demand leisure.
The prospects for future income could determine demand for leisure. If the future prospects for income are significant, then the individual can afford to take the ‘leisure choice’.
The level of savings: if the individual has access to savings then the individual can demand leisure rather than work.
If other members of the household work and provide income then this can be used to support leisure activities.
9. Can a market in which Minimum Efficient Scale is relatively large exhibit monopolistic competition?
Monopolistic competition is characterised by many buyers and sellers which are relatively small. Therefore it would be unlikely that a market, in which Minimum Efficient Scale is relatively large, would exhibit monopolistic competition.
Industries where Minimum Efficient Scale is relatively large include aircraft and motor car manufacture (Begg 2005:107). These are large manufacturing industries where economies of scale are needed to significantly reduce the long-run average costs of production (Begg 2005:107). The shoe industry, certainly in the past, where there was a large number of manufacturers, would have exhibited a market closer to monopolistic competition (Anderton 2008:364). Such manufacturers could operate on a relatively small (minimum efficient) scale.
10. Why do economists persist with the profit maximising assumption in spite of managerial theories of the firm?
The profit maximising assumption is useful for economists as it provides the basis for predictions. It helps to forecast what will happen in certain market situations (Anderton 2008:367). For example, the consequences of a price change, in an oligopolistic market such as UK food retailing, can be predicted. A price cut will be followed as other large oligopolistic competitors do not want to lose market share and profitability. The reverse is also true that if an oligopolist wanted to raise prices then competitors will not follow. They will allow the ‘price raiser’ to lose their own market share.
Managerial models of the firm, such as profit satisficing, are less clear about predicting the outcomes of situations (Anderton 2008:333). It is unclear what level of profit is ‘satisfactory’. Managerial models of the firm may explain real-world situations i.e. that a company may be willing to ‘satisfice’. However, they do not offer predictive models.
References
Anderton, A. (2008), Economics: Fourth Edition, Causeway Press: Harlow
Associated Press, (2007), Despite hardships, Cubans live long lives
Begg, D., Fischer S. and Dornbusch R., (2005), Economics, Eighth Edition, Mc-Graw Hill: London
Machin, S. and Vignoles, A. (2005), What's the Good of Education? : The Economics of Education in the UK, Princeton University Press, Oxfordshire
Sloman, J., (2007) Essentials of Economics: Fourth Edition, Prentice Hall: Harlow
Wall, N., (2003), Complete A-Z Economics Handbook, Second Edition, Hodder Arnold: London