Explaining a quota
Initial market equilibrium price and qty at Pe and Qe respectively.
A quota is a limit on the quantity produced imposed by a government through legislation that is set below the market equilibrium qty. For eg. COE limits number of permitted new car ownerships each month
After quota implemented, supply shifts leftwards and becomes perfectly inelastic at Q1. It now becomes illegal to produce Q1.
Consequently, market equilibrium output decreases to Q1 and the market equilibrium price increases to Pq.
Thus the price mechanism is displaced, and the output is no longer determined by the free market.
Explain why public goods lead to market failure
(non excludable, non rivalrous)
A good is nonrivalrous in consumption when consumption of the goods and services does not reduce the amount available to others.
For example, providing national defence for one citizen does not diminish the quantity of national defence provided to other citizens in a country
Thus MC of serving an additional unit is zero
Since the efficient provision of public goods require consumers to pay price equal to MC, price is set to zero (P=MC=0)
No profit-maximising firm will provide goods at price of zero, and any non-zero price will discourage users from enjoying the public good
Thus allocative inefficiency results as free market will not provide for public goods
A good is non-excludable in consumption when it would be impossible or very costly to exclude non-payers from consuming the good once it is provided.
This results in the ‘free rider’ problem because no rational consumer will have incentive to pay, and thus producers find it difficult to collect payments to earn revenue
For example national defence is not supplied by the private sector even though it is highly valued
Many citizens would simply opt to be free riders and private producers will not be able to collect payment
Thus lack of profitability leads to non-provision in the free market
Thus market failure
How does supply side address demand-pull inflation
Quantity and quality of FOP increase/New tech
> same amount of resources but greater productivity
> increase in productive capacity
> maximum output that can be produced when all FOP fully employed
> LRAS rise
> reduce competition for scarce FOP
Explaining market failure
Define MPC and MPB
Rational consume up to Qp MPC=MPB
explain 3rd party and MEC
Due to presence of MEC, MSC>MPC
Socially optimal at Qs MSC=MSB
Since disregard MEC, Qp>Qs = overconsumption
Social welfare that could have been gained rep by area ABC (deadweight loss)
Hence allocative inefficiency > market failure
Explaining price mech
State shift (DD/SS)
Shortage/surplus at current eqm price
State upward/downward pressure on price
Consumers constrained by budget > increase/decrease quantity demanded
Higher/lower prices > profitability affected accordingly > producers increase/decrease quantity supplied
Process continues until new eqm P and Q where shortage/surplus eliminated
(For shorter questions just state “market will adjust” after saying pressure on price)
Short run and long run shutdown condition
Shut down if TVC>TR or earning subnormal because AC>AR
Will incur FC even if shut down, but can avoid incurring further TVC
a. Shutdown > Avoid TVC and limit loss to TFC
b. Don’t shut down > Loss would be TFC + TVC that TR fails to cover
Considering a and b, rational loss-minimising decision is to shut down
Long run must make at least normal to stay in industry.
All FOP are variable in the LR
Better to earn nothing (and incur zero losses) than to stay and incur losses - in line with profit-max objective
Explain multiplier effect
AD increase > firms draw on inventory to meet unanticipated rise in DD
Unplanned fall in inventories > signal to increase output levels next production cycle to ensure inventories at optimal level
Firms demand more factor inputs (including labour) and pay out more factor income
As RNY increases, income-induced consumption increases (C) causing another round of AD increases
Multiplier effect is triggered and cycle of increase in income increasing spending repeats
But each round of consumption becomes smaller due to leakages in tax, savings, imports
Eventually new RNY eqm reached
Explain Theory of CA
Country is said to have CA in production of a good or service if it can produce at a lower opp cost than another country.
Trade benefits all if they specialise in G&S where they have CA
Assumes 2 countries, 2 goods, resource endowment, divide resources equally, constant returns to scale, perfect mobility of FOP, transport costs nil and free trade
(Example of Thai rice and SG Pharma)
Devote all resources to one good = more efficient + world output increase
Export specialise, import non-specialty > exploit differences in opportunity cost and consume a combination of goods beyond what they could produce on they own
Consume beyond PPC > material SOL increase since higher qty and quality of G&S
Dynamic gains: trade spur competition spur r&d drive innovation cause increase in prod capacity and more movement of capital resources increasing qty of resources available > PPC shift outward parallel
How globalisation helps efficiency and equity
ON EFFICIENCY:
Trade flows
increase competition by increasing number of producers
check local market power by making local markets more contestable
attempts to amalgamate to form monopolies and exploit consumers may be checked by imports of cheaper products
incentivised to be more allocative, productive, dynamically efficient to compete
ON EQUITY:
Specialisation
Increase SOP
reap iEOS
Import cheap inputs + competition thus r&d
Lower prices
Affordability increase
Equity
Benefits of globalisation
FTA: more resilient to external shocks and protectionism by diversifying export markets
Trade creation: consumption shifting from high cost producer to low cost producer increasing consumer surplus for country + better X for low cost producer
Explain tariffs
Dd and Sd are domestic DD and SS
Mkt eqm at Pe and Qe before free trade
Free trade
Perfectly elastic world SS at Sw
Domestic producers cannot charge above Pw if not consumers switch
Country imports as much goods as they want (Pw perfectly elastic )
At Pw, Qd is Q2 of which Q1 is supplied by domestic producers
Q2Q1 is imported
Increased consumer welfare due to lower prices
Domestic producers adversely affected (fewer units, lower price)
UnE rise
Tariff raise SS to SSw+tariff, P raise accordingly
Qd of imports decrease by Q2Q4
At Ptariff, domestic production increase by Q1Q3
BUT
Consume less, surplus fall A+B+C+D
Producers gain A, Govt collect C, DWL B+D
