Samenvatting Economie voor politicologen Universiteit Leiden jaar 1 Bachelor Politicologie blok 3.

Lecture 1: The core of the market economy, a spontanous order
 

Opportunity costs: the value of the good service or time lost to obtain something else

Microeconomics studies individual decision-making units, such as a consumer, a worker, or a business firm.  

Macroeconomics studies the economy as a whole or its aggregates

Aggregate: a collection of specific economic units treated as if they were one unit.

Economic problem: the need to make choices because wants exceeds means

Economic problems for individuals

• Limited income forces people to choose what to buy and what not 

• Necessities and luxuries as types of wants 

Economic problems for society:

• Scarcity of economic resources: land, labor, kapital, entrepreneurial ability (KANO)

• Many ways to distribute: goods and private or government services

Production possibilities model

• Assumptions:

  • Full employment of resources

  • Fixed resources

  • Fixed technology

  • Two goods: consumer and capital goods

• Creates a negative curve downwards

Law of increasing opportunity costs: as production of a good increases, the opportunity cost of producing an additional unit increases. 

Budget Line: shows various combinations of two products a consumer can buy with a specific money income.

Economic system: a particular set of institutional arrangements and a coordinating mechanism for producing goods and services.

Two types of economic systems:

• Command system 

  • Government owns most of the production

  • Economic decisions are made by a central governing body

  • Failure because 

    • Coordination problem: output targets

    • Incentive problem: no adjustments for surplus or shortage

• Market system

  • Production is privately owned

  • Markets and prices are used to direct and coordinate economic activities

  • Freedom of enterprise

  • Freedom of choice 

  • Private property

  • Self interest is the most advantageous outcome 

  • Competition is the present in the market 

  • The market brings buyers and sellers together

  • Technology and capital goods promote efficiency 

  • An active but limited government

The invisible hand from Adam Smith 

• Unity of private and social interests

• Efficiency

• Incentives

• Freedom

The circular flow model

• Resource Market 

  •  Households sell resources -

  • Firms buy resources 

      -     Product Market 

• Households buy products 

• Firms sell products 

      -     Real flow of resources and products corresponds to the money flow in the opposite direction.

Lecture 2: Principles of Economics vraag en aanbod 

There is a market for supply and demand

they determine price and quantity

There is a difference between a local, national and international market

Demand: demand is a schedule or curve that shows the various amounts of a product that consumers will buy at each of a series of possible prices during a specific period

•  The Law of Demand states that, all else equal, as price falls, the quantity demanded rises, and vice versa.

• Individual demand: demand curve of a single consumer

• Market demand: sum of all demands

  • Determined by: 

    • Consumers tastes

    • number of consumers

    • income

    • the price of related goods

    • expected prices

  • Movements along the demand curves are changes in quantity demanded

    • Can happen because of a higher price

Supply:

• A curve showing the amounts of a product that producers will make 

• The Law of Supply states that, all else equal, as price rises, the quantity supplied rises, and vice versa

• Market supply: all individual supplies from a specific product

  • determined by:

    • resource price

    • technology

    • taxes and subsidies

    • prices of other goods

    • expected price

    • the number of sellers

Market equilibrium:

• a competitive market will make no one able to set a price

• Equilibrium: the balance point 

  • Equilibrium price: the price at which quantity supplied and quantity demanded are equal

  • Equilibrium quantity: is the quantity demanded and supplied equal

• A price above the equilibrium price would create a surplus: a situation where quantity supplied exceeds quantity demanded

• A price below the equilibrium price creates a shortage: Demand exceeds supply

A price ceiling protects the buyers from too high of a price. creates a shortage 

A price floor protects the sellers from a race to the bottom. creates a surplus, minimum wage

When supply increases: price drops quantity rises (RIGHT)

When supply decreases:  price increases and quantity drops (LEFT)

ceteris paribus: If all else stays the same . 

Government sets prices distort resource allocation and cause negative side effects

Demand: Willingness of the buyer to pay for a economic service or good at a certain price 

Quantity demanded: the exact number of goods at a certain price 

Price elasticity of demand: a measure of the responsiveness of the quantity of a product demanded by consumers when the product price changes

• Responsive consumers with price changes are elastic products

• with no response from consumers products become inelastic

Price elasticity is measured with the price elasticity coefficient 

% change in demand / % change in price 

• Elastic when Ed>1

• Inelastic when Ed<1

• Perfectly (in)elastic demand: can be any amount at a given price/does not depend on the price 

Price elasticity of supply: a measure of the responsiveness of the quantity of a product supplied by sellers when the product price changes.

Consumer surplus: Upper triangle 

Producer surplus: under triangle

Welfare loss due to a price floor/ceiling = Triangle downwards from price floor line 

• Substitutability: the more subtitute goods there are, the higher the elasticity

• Proportion of income: the higher a products price relative to someones income, the higher the elasticity

• The more something is considered a luxury, the higher the elasticity

• The longer the time of consideration, the higher the elasticity

Market failure: the inability of a market to produce a desirable product or produce it in the right amount 

Happens with:

• Production of public goods and services (that involve externalities)

Private goods:

• Rival

• Excludable

• Bough and consumed individually

• produced and allocated by a competitive market 

Public goods are:

• Non-rival

• Non-excludable

• Free rider problem 

• Not produced in a market 

Government provides most public goods with taxes

Market Demand for Public Goods and Optimal Quantity •

• Market demand for a private good: a horizontal sum of individual demands: quantities demanded at each price are added up. 

• Market demand for a public good: a vertical sum of individual demands: individuals’ willingness to pay (per unit) for each given quantity of a public good are added up. 

• Optimal quantity of a public good is where the marginal benefit of this good (market demand) is equal to the marginal cost of producing the good (supply).

Externalities: 

• Negative externalities are spillover production or consumption costs imposed on third parties without compensation to them

• Positive externalities are spillover production or consumption benefits conferred on third parties without compensation from them.

Lecture 3

Different types of businesses

• Corporations: are firms that pool resources of large number of people

  • resources are pooled though sale of stocks and bonds

Long term geen vaste kosten

Labour output

• Marginal product: extra production with 1 extra worker

• Average product: total/units

Law of diminishing returns: how more units are added, in the end it will decline

Arbeidsdeling, in de weg lopen daarna

First extra labour increases marginal returns, then diminishing marginal returns and too many workers lead to negative marginal returns. 

As long as marginal stays above the average, it rises

- Explicit costs: monetary payments that a firm must make to an outsider to obtain a resource.

- Implicit costs: equal to the monetary income that a firm sacrifices when it uses a resource that it owns rather than supplying the resource in the market.

• Fixed costs (TFC) are costs that do not change in total when the firm changes its output.

• Variable costs (TVC) are costs that increase or decrease with a firm’s output.

• Total costs (TC) is the sum of fixed costs and variable costs. 

• TC = TFC + TVC

• Average costs are TFC/Q or TVC/Q or AFC + AVC

Marginal cost = Change in TC / Change in Q

• The extra or cost when producing one more unit 

• controllable 

Long run production cost

• Firms enter and exit 

• New plants 

• Long run ATC curve is U-shaped because more plants does not mean more profit

Economies of scale:

• specialization

• efficient capital 

• other factors

Diseconomies of scale:

• Control and coordination problems

• communication problems

• worker alienation 

• Shirking 

Minimum efficient scale 

• Minimum efficient scale 

  • Lowest level of output with lowest possible long run average cost

  • determines the structure of the industry

4 markets:

• Perfect competition: large number of sellers, standardized product, easy entry and exit 

• Monopolistic competition: large number of sellers, differentiated product, easy entry and exit 

• Oligopoly: small number of sellers, standardized or differentiated product, limited entry 

• Pure monopoly: one seller, unique product, no entry

Pure competition:

• Very large numbers of independently acting sellers who offer their products in large markets.

• Standardized product: firms produce a product that is identical or homogenous. 

• Firms are “price takers”: the firm cannot change the market price but can only accept it as “given” and adjust to it. 

• Free entry and exit: no barriers to entry exist. 

Demand (Pure competition)

• perfectly elastic (Horizontal demand curve)

• Average revenue is equal to price 

• Total revenue = P x Q

Because the firm has to accept the market price it can only maximize profit by adjusting output. To calculate the firm compares MR and MC for each extra unit 

MR=MC (MO=MK) best number of products to make 

Pure monopoly

• Single supplier: the firm is the sole producer of a specific product.

• No close substitutes: this product is unique. 

• Price maker: the firm has considerable control over price, since it controls the total quantity supplied. 

• Blocked entry: there is no immediate competition, because there are barriers to entry. 

  • Those barriers may be economic (economies of scale create natural monopolies), technological, legal, or of some other type.

• A monopolist charges a higher price and sells a smaller level of output, alos it lacks productive efficiency

Prices between monopolists and pure competition differ because 

• Economies of scale 

• X-inefficiency

• monopolies maintain entry barriers

• monopolies can lag in technology 

Price discrimination: the business practice of selling the same good at different prices while the costs are the same 

• have monopoly power 

• segregate the market

• prevent resale 

Antitrust laws: government actions against a monopoly whe:

• Anti competitive actions 

• creates substantial economic inefficiency 

• and appears to be long-lasting 

Monopolistic competition

• Large number of sellers 

• Differentiated products

• Easy entry and exit 

• non-price competition (advertising)

• Demand curve not perfectly elastic

• Elasticity increases when there are more rivals/weaker product differentiation

• Short run: MC=MR, P>ATC = profit

• long run: entry and exit so: p=ATC, will lead to a normal profit

• efficiency: productive inefficiency P>ATC, allocative inefficiency P>MC

Oligopoly:

• Few large producers 

• Homogeneous or differentiated products

• Blocked entry

• Kinked-demand model

  • An oligopolist’s rivals will ignore a price increase above the going price but follow a price decrease below the going price. 

  • The demand curve is kinked at this price and the marginal-revenue curve has a vertical gap. 

  • Price and output are optimized at the kink.

• Collusion: rival firms working together

  • reduces uncertainty and increases profits

  • with identical cost, demand and MR’s firms can use MR=MC

  • Cartel: is a formal agreement among producers to set the price and the individual firm’s output levels of a product (OPEC)

  • Is mostly not allowed: anti trust laws, also coordination problems, easy chitable, demand and costs may differ. High profits attract potential entry. 

  •  

Lecture 4: Wage determination

Firm’s demand labor

• Labor is derived demand this it depends on 

  • productivity 

  • price of the good it helps produce

• Derived demand: the demand for a resource that result from the demand for the product it helps produce 

Marginal revenue product: the change in a firm’s revenue when it employs another employee

• Change in total revenue / unit change 

marginal resource cost: change in a firm’s total cost when it employs another employee

• In a competitive market MRC is equal to the market wage rate

• Change in total cost / Unit change in labor 

Labor demand changes when:

• changes in demand

• changes in productivity

  • quantity of other resources

  • technological advance 

  • quality of labor 

• Changes in price of other resources

  • a decline in price of complementary resources increases labor demand

  • a change in price of substitute resources has an ambiguous effect on labor demand 

Labor demand can be elastic

• EW = % change in Q labor / % change in wage 

• EW > 1 = elastic 

• Elasticity of demand depends on:

  • ease of resource substitutability = more substitutability the more elastic 

  • elasticity of product demand: the greater, the more the labor demand elasticity

  • ratio of labor cost to total cost: the greater the share of labor in total cost, the greater the elasticity of labor demand 

Market supply of labor

• increases because of different job options

• labor supply and demand crosses is the equilibrium wage rate and employment

In a competitive labor market there are many employers and firms use MRP = MRC to determine employment at market wage

Monopsony is a market structure in which there is only a single buyer of a good, service, or resource.

• the employer is here the wage maker and determines with MRP=MRC

Union Models

• Exclusive unions: restrict supply of skilled labor to increase the wage rate received by union members

• Inclusive unions: include as members all workers in an industry and put great pressure on firms to agree to wage demands through the threat of a strike 

Wage differentials are the differences of wages 

• a weak labor demand will result in a low equilibrium wage 

• a low labor supply will result in a high equilibrium wage

• Members of noncompeting groups differ in their mental and physical abilities and levels of education, thus can receive different compensation

Lorenz curve and gini ratio

Lorenz curve weakens through government transfers

Income mobility 

• income changes and mostly increases till middle age 

• low and high income are not permanent conditions 

Causes of income inequality

• ability

• education

• discrimination

• preferences in market work

• risk willingness

• unequal distribution of wealth 

• luck and connections

Equality vs efficiency 

• An equal distribution of income maximizes the total consumer satisfaction (or utility) for any particular level of output and income. 

• Income distribution is important in determining the amount of output or income that is produced and available for distribution. 

• It is a tradeoff

Poverty: when someone does not have the means to satisfy basic needs

Gross domestic product (GDP): the total market value of all final goods and services produced annually within a country. 

• To avoid double counting GDP ignores intermediate goods altogether and secondhand goods 

GDP=C+Ig+G+Xn

• Add up all that was spent to buy total output in a certain year

• Personal consumption + gross Private domestic investment + government purchases + Net exports 

Nominal GDP: measured in terms of the price level at the time of measurement (i.e., GDP that is unadjusted for inflation).

Real GDP : measured in terms of the price level in a base period (i.e., GDP that is adjusted for inflation)

Economic growth is the expansion of real GDP (or real GDP per capita) over time.

Increases through

• Inputs of resources

• productivity of inputs 

Main ingredients for economic growth:

• Supply factors

  • Increases in the quantity and quality of natural resources -

  • Increases in the quantity and quality of human resources 

  • Increases in the supply or stock of capital goods

  • Improvements in technology

• Demand factor: households, businesses, and government must purchase the expanding output. 

• Efficiency factor: the economy must achieve economic efficiency and full employment.

Real GDP = Hours of work x labor productivity

• Labor productivity consisting of:

  • Technological advance

  • quantity of capital

  • education

  • economies of scale and resource allocation 

Institutional Structures 

• Strong property rights 

• Patents and copyrights 

• Efficient financial institutions 

• Free trade 

• A competitive market system 

Productivity accelerates trough

• Microchip/information technology 

• New (start-up) firms 

• Increasing returns (firm’s output increases by a larger percentage than its inputs) 

• More specialized inputs 

• Spreading of development costs 

• Simultaneous consumption 

• Network effects 

• Learning by doing  

• Global competition

Is growth sustainable?

Antigrowth:

• environment

• economic wealth is not a good life 

• no evidence that is solves sociological problems 

pro growth

• increases standard of living

• helps poverty 

• improves working condition

• human imagination solves environmental issues

Marginal costs/profits: cost/profit that one product adds

Lecture 5: Business cycles, unemployment and inflation 

Downward Price-level Inflexibility: 

• Fear for price wars

• Menu costs 

Discretionary fiscal policy

• Not discretionary: No influence in the market 

• Discretionary: Spend more or less

Expansive policy:

• Government pays more

• Reduces taxes

burden of public debt

• the annual interest charge accruing on the bonds sold to finance the debt is the primary burden of the state debt 

Lecture 6: Money and Banking 

Functions of money

• Medium of exchange 

  • An item that sellers generally accept and buyers generally use to pay for goods and services

• Unit of account 

  • A standard measurement unit in terms of which prices can be stated and the relative value of goods and services compared

• Store of value 

  • An asset set aside to purchase items in the future

Components of the money supply 

Two definitions of the US money supply M1 and M2

• M1: currency in the hands of the nonbank public, all deposits

• M2: is a broader definition of money including saving deposits, time deposits and money market mutual funds

Near-monies are certain highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into currency or checkable deposits

Federal reserve vs European Central Bank

• European bank combats inflation, fed also combats unemployment rates

• Federal reserve also needs to:

  • issues currency

  • sets reserve requirements and holds reserves

  • lends money to banks and thrifts

  • provides the banking system with a means for collecting checks

  • Acts as a fiscal agent for the federal government

  • supervises banks

  • controls the money supply and thus the interests rates

  • independent part of the government 

    • protects the fed from political issues

Crisis of 2007/2008

• Mortgage default crisis

• Causes: 

  • Government programs that encouraged home ownership

  • Declining real estate values

  • Bad incentives provided by mortgage-backed bonds

Fractional reserve banking:

• A bank only needs a fraction of money that it lends available

• calculable with reserve ratio: Commercial bank’s required reserves / commercial bank’s checkable-deposit liabilities

• Balance sheet 

  • Assets = liabilities + net worth 

• Necessary transactions 

  • Create a bank

  • Accept deposits

  • Lend excess reserves

Giral money is created with debt acceptance 

Money multiplier:

• The money multiplier is the multiple of its excess reserves by which the banking system can expand checkable deposists and this the money supply … 

Monetary Policy and interest rates:

Monetary policy

• Open-market operations: buying obligations 

• Changing the reserve ratio: influences the ability of the commercial banks to lend (zelden)

• Discount rate: change the interest rate the federal banks charge on the loans they make to commercial banks 

Fishers equation

• M x V = P x T 

advantages of monetary policy

• quick and flexible: easy to change and more subtile 

• Political neutrality

There is one review session in this course

This Course is given in Dutch 

Exam consists of 10 open questions

Good luck!