EconomicsNotes

Posts

Inequality, Part One: the greatest market failure?

Income inequality arises when different consumers have different incomes, and different people have different talents. It could also arise because of the source of income or the value of the talents. For instance, employees might have different incomes from each other because of different marginal labour products, different factor returns to their labour, or different elasticities of labour. People might have different skills for which there is a greater or lesser need and employers, or the purchasers of labour might have different demands. Equally, entrepreneurs often take greater risks than others, and thereby expect and receive greater rewards than those who do not take risks. There might be different factor returns to capital or land, which result in various levels of profit, dividend, or rent, for those who do not live by the return to their labour value. A functional market would bring all these diverse groups together as suppliers and consumers and would matc...

How great a challenge does the growth of the People’s Republic of China pose for the world economy?

The PRC became committed to a policy of managed marketisation and globalisation in 1987, which was termed ‘capitalism with Chinese characteristics.’ In the decades since, economic growth has lifted more people from poverty than at any other time in history, contributed to the development of global growth, and added a third engine to global markets after North America and Europe. As China is resource-poor, its spending of surplus dollars gained in trade on African and South American markets has also lifted those areas for the first time from the dependency and postcolonial malaise identified by the Brandt Commission in 1980. Western Europe, and particularly Britain, have benefitted from Chinese investment and tourism, and have reached a position of trade balance as European and British products have been sold to the Chinese middle classes. The immediate ‘challenges’ of such growth have largely been to western institutions and wages. In the longue durée , China’s growth, and that...

Should economically less developed countries fix their exchange rates or let their currencies float freely?

An exchange rate represents the value of one currency in terms of another. Central banks can attempt to ‘fix’ these rates by declaring a value at which the currency will be exchanged. They can then defend this rate against market speculation, should there be any, by manipulating interest rates, using currency controls, or buying and selling currency on the international markets. No one country can ‘hold out’ against the markets however, even if it is the biggest in the world, for very long, as exchange markets can mobilise more money than exists in any one country at any time. Therefore, countries which fix their rates either do so at a realistic level, and allow their currency to be traded, or use another currency internationally to that which is used domestically. In addition, some countries use a foreign currency for trade, and simply make any trade in their currency outside their own borders illegal. The reasons for which a country might choose to fix its exchange rate are ...

Is a market economy the best way to allocate resources?

1. The market economy relies on the price mechanism at heart. This is the original idea now associated with Adam Smith that an automatic allocation of goods and services will happen in each market when demand and supply are allowed to find their own equilibrium. The price mechanism is held to indicate, or signal, to producers and consumers which market is ‘up’ or ‘down.’ In the system, consumers are believed to seek to maximise their utility, and suppliers are expected to maximise their profits. The price is their incentive to do so, and their decisions inform the allocation of resources by producers. This system has been held to rest on the ideas of consumer and producer surplus (which are different from the idea of transfer earnings and economic rent, though they could explain it too.) Firms are assumed to seek maximum profit, which is the greatest gap between total costs and total revenue. Since in competitive markets firms have very little to no control over prices a...

Should a firm which produces a product with a positive income elasticity of demand and positive cross elasticity of demand lower the price of the product?

1. Income elasticity of demand assesses the degree to which a change in income will affect the demand for a good. Positive income elasticity of demand suggests that a rise in income will result in a rise in demand, and a fall in income in a fall in demand. If a firm is a price-maker rather than a price taker (that is, if it is not operating under conditions of perfect competition) then it might choose to reduce price to make its product affordable. This suggests that the good would have a positive price elasticity of demand too, because otherwise, a fall in price could result in a loss of revenue. A positive cross elasticity of demand indicates that a good has substitutes which could experience a fall in demand if the good is reduced in price. This implies, but does not prove, that the good itself would attract customers from the substitute. This would allow for a rise in revenue, the capture of greater market share, and, possibly, the development of economies of scale as l...

To what extent do specialisation and the division of labour address the basic economic problem?

1. The basic economic problem illustrates the difficulty caused by the fact that economic goods are limited and subject to resource constraints but wants are unlimited. A choice therefore must be made, which gives rise to opportunity cost. Specialisation seeks to lower costs and thereby improve productivity by increasing the quantity and quality of output from firms. It does this by concentrating individuals or economic enterprises (or occasionally whole economies) on particular parts of the production or supply chain. This is often accompanied by the division of labour, in which individual workers or small teams of workers focus on particular aspects of the production process for a good or service. If correctly carried out, specialisation increases output and efficiency, leading to gains in terms of welfare and pareto efficiency for societies (shown by the outward movement of a production possibility curve.) It can also lead to lower costs, and possibly to production ...