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Welcome to ECON 372: Comparative Economic Systems By: Dr. Jacqueline Khorassani

Marietta College, Spring 2011. Welcome to ECON 372: Comparative Economic Systems By: Dr. Jacqueline Khorassani. Week Three Lecture Slides Source: Chapter 1 & 2 (pp 15-). Notes. Exam 1: Wednesday, February 9 Team 1 paper is on Japan, Sweden and France and is due on Monday, February 28

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Welcome to ECON 372: Comparative Economic Systems By: Dr. Jacqueline Khorassani

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  1. Marietta College, Spring 2011 Welcome to ECON 372: Comparative Economic SystemsBy: Dr. Jacqueline Khorassani Week ThreeLecture Slides Source: Chapter 1 & 2 (pp 15-)

  2. Notes • Exam 1: Wednesday, February 9 • Team 1 paper is on Japan, Sweden and France and is due on Monday, February 28 • No class on Monday, January 24 • On Wednesday, January 26, expect an in class assignment on last Friday’s class + the first 15 slides on Week 3 (this week) lecture slides.

  3. The 9 criteria for evaluating economies

  4. 5. The degree of dynamic efficiency • Is efficiency sustainable over time? • Are there policies in place to increase efficiency in the future? • Involves collection of efficiency related time-series data

  5. The 6th criterion • Macroeconomic stability • Stability in the following variables over time (10 years in your paper) • Output • Employment • Prices • Exchange rate volatility (value of currency) • What else?

  6. The 7th criterion • Economic security of individual • Income • Per capita • Distribution • Poverty rate • Employment • Unemployment rate/underemployment • Health care • % of population with health insurance • Infant mortality • Life expectancy • Others?

  7. 8th criterion • The degree of income or wealth equality? • What is the difference between income and wealth? • Which one is flow? • Which one is stock?

  8. One measure of income distribution Lorenz Curves % of national income 100 Perfect income equality Nation’s curve 20 45o 50 % of population 100

  9. Measure of income distribution • Gini coefficient= area between the Lorenz curve and the 45 degree line/total area under the 45 degree line • If =0  complete _______ • If =1  complete _______ Equality Inequality

  10. Quintile • Another measure of income inequality • What is it? • Here is how it is constructed • Obtain income data for every household in a given year. • Arrange the data in a list ranging from the household with the lowest income to the household with the highest • Divide the list into equal fifths (or "quintiles"). • Divide the income share going to the top quintile by the income share going to the bottom quintile. • The higher the quintile ratio, the _______ the inequality. Higher

  11. The 9th criterion • Degree of economic freedom • EFI = Economic Freedom Index • Takes a value between 1 (free) to 5 depending on 10 sub indexes having to do with • Corruption, trade barriers, tax rates, efficiency of law enforcement, regulatory burden on business, restrictions on banks, labor market regulations, informal market activities.

  12. Another way to measure the 9th criterion Source: World Bank, 2005

  13. HDI: Human Development Index • Takes a value between 0 (bad) to 1 depending on • Per capita income • Life expectancy • Adult literacy • Education enrollment • Which of the 9 criteria are reflected in this index?

  14. Let’s look at Tables 1.1 and 1.2, Pages 18 and 19. • Who is doing better than us (USA) in different area? • Why?

  15. Chapter 2 • Objectives? • Focuses on Market Capitalism • How it can achieve efficiency • When it fails to achieve efficiency

  16. Theorem: A complete, competitive, full information general equilibrium is efficient. • Complete? • There is a market for anything that is useful • Does this hold in the US? • Competitive? • No barriers to entry and exit across all markets • Homogeneous products • Does this hold in the US?

  17. Theorem: A complete, competitive, full information general equilibrium is efficient. 3. Full information? • Suppliers and demanders in all markets have every piece of info they need to have in order to make the best decision • Does this hold in the US? 4. General equilibrium? • In all markets, quantity demanded = quantity supplied • Does this hold in the US?

  18. What does efficiency mean? • In consumption • Can’t make someone better off without making someone else worse off. • This is called ________ optimality. • In production • Operating on PPF

  19. What is PPF? • A curve that shows various combinations of 2 goods a nation can produce efficiently with a given amount of resources and technology • Goals? • To show trade offs, choices, efficiency in production, increasing cost

  20. Production Possibilities Frontier • Assumptions • Only two goods are produced • Fixed amount of resources that are fully employed • Given technology • Producers and resource owners have full information. • Maximized output given what is available • Can not produce more of something without giving up some of the other things.

  21. Production Possibilities Frontier (PPF) Roses A 100 B * U 95 C 80 D 60 PPF * I E 0 10 20 30 40 Guns

  22. Production Possibilities Frontier (PPF) • Why is PPF downward sloping? • Can’t produce more guns without giving up some roses • Why is PPF bowed out? • Why does the cost of producing 10 additional guns go up as we produce more guns? • Increasing cost • All resources are NOT equally productive in both lines of production

  23. Let’s start with PPF • What is point A? • What is point M? • How can we move from A to B? • Increase efficiency • Employ unemployed resources Good x *M B * How can PPF shift outward? C * PPF A * Good Y

  24. What was efficiency in consumption? • Can’t make someone better off without making someone else worse off (Pareto Optimality) • Social indifference curve • Shows the combination of two goods that make the society equally happy, given that all members of the society have the same taste.

  25. Social Indifference Curve • Assumptions • Only two goods are consumed. • Fixed taste. • All members of the society have the same taste. • More is better.

  26. Social Indifferent Curve • Why is it downward sloping? • If increase both happiness goes up • Why is it bowed in? • Why are we willing to give up fewer roses for 10 additional guns as we consume more guns? • Diminishing utility Roses A 95 B 50 40 C Indifference Curve 0 10 20 30 Guns

  27. Social Indifferent Curve • Do we like D better than B? • Yes, on a higher indifference curve • Do we like F better than B? • No, on a lower indifference curve Roses A 95 D * B 50 Indifference Curve 40 C *F 0 10 20 30 Guns

  28. Social Indifference Map • Can a society’s indifference curves cross each other? • If indifferent between A and C • If indifferent between A and B • Then must be indifferent between B and C (not true, because B and C are on different indifferent curves) • Given no change in taste indifference curves can not intersect Roses A* B* I1 C* I2 Guns

  29. Social Indifference Map • Indifference curves of a society are parallel to each other. Roses I3 is better than I2 why? I3 I2 I1 Guns

  30. PPF and indifference map The highest indifference curve we can reach given what is available = efficiency in production and consumption. Why? Efficiency in production = maximizing out put , given resources and technology Efficiency in consumption= Can’t have more of both goods=can’t make someone better off without making someone else worse off • Is B better than M? • Is C better than M? Roses B 95 C 80 M 0 10 20 30 40 Guns

  31. How does this model relate to distribution of income? • Consumption efficiency has nothing to do with distribution of income • If one person gets it all, it is still efficient as long as to make some one else better off you have to make this person worse off by taking something away from him.

  32. How do market supply and demand in a competitive market related to efficiency?

  33. Let’s look at supply and demand in a completive market • If the maximum amount of output is sold  efficient At P = 100, how much is sold? At P = 50, how much is sold? At p = 70, how much is sold? Which one is efficient? This result is achieved under competitive, full information general equilibrium. P S 100 70 50 D 50 Q 30 80

  34. Definitions • Marginal cost = increase in total cost as a result of producing one more unit of a good = MC • Marginal revenue = increase in total revenue as a result of selling one more unit of a good = MR

  35. What is the profit maximization rule in a market economy? • As long as producing one more unit of a good adds more to your revenue than to your cost (as long as MR> MC) produce more • If producing one more unit of a good adds more to your cost than to your revenue (If MC>MR)  produce less • Profits are maximized when you produce the quantity of output at which MC = MR

  36. In the short run, when you have at least one fixed input of production • MC eventually increases as you increase production • Why?

  37. Example • Output = shirts • Inputs • Labor (L) • Capital (K, sewing machine, which you only have one) • If you keep on hiring more workers and don’t buy any more sewing machines, new workers can not produce as many shirts for you as the old workers but you pay them the same wages as your old workers  you cost per additional shirt goes up. • MC of additional shirt goes up

  38. How is the price and the quantity of output determined in a competitive market? What is MR for this firm? $10 P P =ΣMC S MC $10 P =MR D 20 2 Quantity Quantity Market Firm 1

  39. Monopoly • What is it? • Extreme case • One producer produces a unique good or service for which there are no close substitutes in the market • Has power to control the price.

  40. Now suppose a firm buys all of the little firms in a the market MC P P =ΣMC S MC $10 P D 20 2 D Does monopoly produce 20 units? Market Firm 1 = monopoly

  41. Monopoly is facing the same demand but S = MC If monopoly wants to sell one unit, it can charge $20 What is MR of the first unit? $20 If monopoly wants to sell 2 units, it can charge $18. What is MR of the 2nd unit $16 Why? MR = ΔTR/ ΔQ MR = 16/1 P =MC 20 S 18 D MR 1 2 Market

  42. How should the monopoly maximize profits? Find the quantity of output from intersection of MR and MC Charge the highest price it can charge for this much output Monopoly produces less and charges more than a competitive market Consumers are not consuming the maximum amount  no efficiency in consumption P S =MC 15 D MR 10 Market

  43. How likely is efficiency in production under monopoly? Not Likely Why? Monopoly charges a higher price  can afford to be less efficient and more wasteful than a competitive firm. Under monopoly, production is below capacity  we don’t reach our PPF. Monopoly P S =MC 15 Competitive 10 D MR 10 20 Market

  44. Question • How are natural monopolies different from unnatural monopolies?

  45. What is economies of scale? As the firm gets bigger AC drops We can have one firm producing 30 units or We can have 3 firms each producing 10 units Which one is potentially more efficient? One firm This is a cause of natural monopoly Examples? What should government do? (Rachel) Allow monopoly to exist but watch it. AC Average cost Economies of scale $30 $12 Quantity of production 30 10

  46. What about unnatural monopolies? • There is a short range of economies of scale • We can have one firm producing 30 units or • We can have 3 firms each producing 10 units • Which one is potentially more efficient? • three firms • Examples? • What should government do? (Rachel) • Remove the barriers to entry • Sherman Act, Clayton Act, FTC Act in the US • PP31-32 AC Average cost $40 $30 Q 10 30

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