EconomicsNotes

  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...

  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...

  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 ...

  1.   Horizontal mergers occur when businesses at the same stage of the supply chain join, either because of an agreed merger or a takeover. In doing so, they could be lowering long-run average costs, and thus gain economies of scale. If the new combined business moves nearer to, or is afterwards at, minimum efficient scale, this could also improve the efficiency of the economy. Businesses could also gain several advantages, not least of which would be a lower overall debt, and a greater ability to spread risk across the firm’s operations. Ideally, an horizontal merger will result in a lowering of duplication of administration in the industry, increased productivity because of the ability to specialise and to increase the division of labour, and the creation of more secure specialised supply chains and business divisions than existed previously. Firms could gain physical economies in terms of larger offices and warehouses for the combined firm than for any single one, and...

  1.   Monopolistic competition as an idea is associated with Edward Chamberlin and Joan Robinson, who posited a realistic model of firms which operate in markets that change over time. Monopolistic competition has little to do with monopoly, except the monopoly of branding, patent, and trademark. Monopolistic competition describes a situation in which firms offer differentiated products, which do not initially have substitutes in the minds of consumers. This allows for abnormal profits, because firms can control price or supply in such a way that production occurs where marginal revenue equals marginal cost, maximising profit because firms sell at a level of average revenue above average cost.   In a monopolistically competitive market, however, barriers to entry for similar products are low and, whilst not perfect, knowledge and information cannot be fully restricted. Other firms therefore enter, with differentiated products or services that cater for the same nee...

  1.   A merit good is one with positive externalities which is excludable, but which will be under produced and overpriced in the market. The socially optimum level of such a good will therefore not be provided, leading to a welfare loss. This might be because of the nature of the good but could also be because people might not recognise the benefits which arise from use of the good. This could be because the good has a long-term advantage for people which is difficult to compute. A liberal arts degree which gives rise to a love of and familiarity with literature, poetry, philosophy, history, or art, for instance, might enrich a life, encourage mental health benefits such as patience and resilience, and allow for greater productivity and problem-solving over time than, for instance, an MBA Some industries could be subject to this type of information failure. The education, healthcare, and insurance industries are all predicated upon the possibility of future loss and fu...

1 It is sensible to be guided by analysis of markets, whilst remembering that there is always a margin of error in predictions, and that unlikely or unexpected events are not impossible. As with cyclical analysis of the economy, it is also sensible to be aware of the projected length of forecasts, and that economic analysis is often limited by assumptions about rationality and marginality which economic actors might not share. A final caveat is that the ‘map paradox’ applies; no representation is perfectly accurate because, if it were, it would be the thing represented itself and not a representation. Forecasts of trends help economic agents, governments, and monetary authorities make decisions about the allocation of resources and cash, and for example, central lending rates. In doing so, they might help eliminate waste, in the case of suppliers, which helps an economy move towards allocative efficiency. Acting because of forecasts might also reduce or eliminate decision lag, i...