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SCHOOL OF MANAGEMENT
D I S T A N C E
L E A R N I N G
2015/16
MAN4100M
Business
Economics
MODULE STUDY BOOK
M B A
MBABEUKSB152015 MAN4100M
Bradford MBA
Contents
Introduction to Business Economics
7
7
9
12
15
16
PART I: MICROECONOMICS
17
19
Introduction
Objectives
Diminishing marginal returns
Scarcity and choice
Opportunity cost
Production possibility frontier
Summary
Unit 2: Issues Relating to Demand
Introduction
Objectives
The demand curve
Price elasticity of demand
Consumer surplus
Summary
Unit 3: Production and Output Decisions
19
20
20
21
22
22
26
27
27
28
28
32
40
42
47
Introduction
Objectives
47
48
48
49
51
Shutdown point
Deriving the firms supply curve
The supply curve
57
58
58
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Elasticity of supply
Costs of production in the long run
Returns to scale
Economies of scale
Economies of scale at work
Motives for growth
Summary
References
Unit 4: Markets in Action
61
63
63
63
65
66
67
69
71
Introduction
Objectives
71
71
Equilibrium
Disequilibrium
Labour markets
Market failure
Summary
References
72
75
77
78
81
82
83
83
83
84
84
91
91
92
95
95
97
99
102
104
105
107
Introduction
107
Objectives
Economic targets
Main macroeconomic policy tools
108
108
108
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Contents
Inflation
What causes inflation?
Tackling inflation
Unemployment
What causes unemployment?
Healthy balance of payments
Exchange rates
Healthy economic growth
What causes economic growth?
Circular flow of income
Summary
109
109
110
111
112
115
115
116
117
118
122
References
124
125
Introduction
Objectives
Keynesian theory of national income
Keynesian solution to unemployment revisited
The multiplier
Problems with Keynesian theory
Keynesian view of inflation revisited
Economic policy tools
125
126
126
129
130
130
132
133
Monetary policy
Money, banks and money supply
Demand for money
Money market equilibrium
Updating the Keynesian model
Supply side policies
Summary
References
134
134
136
136
142
144
148
150
151
Introduction
Objectives
151
151
152
152
154
Terms of trade
Exchange rates revisited
Floating or fixed exchange rate?
155
155
160
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161
163
164
165
165
167
168
169
171
175
Unit 1
Unit 2
Unit 3
Unit 4
Unit 5
Unit 6
Unit 7
Unit 8
175
178
183
188
191
194
196
200
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Introduction to
Business Economics
Your Module Leader
Dr Simon Rudkin
An active researcher in the fields of supermarket impact, oligopolistic
competition and regional linkages, Dr Rudkin graduated from the
University of Manchester with his PhD in 2008. With work experience at
the University of Manchester and at Xian Jiaotong-Liverpool University in
Suzhou, China prior to coming to the University of Bradford he has a wide
range of international academic teaching experience.
Recent publications include a novel model of local shopping as an
alternative to a monopolist supermarket in Economics Letters, and a
review of the distributional impacts of a new supermarket on fruit and
vegetable consumption in a poor neighbourhood of Leeds, West Yorkshire
in Environment and Planning A. These are being extended to consider
other industries, such as Chinese online shopping, and full dietary
diversity.
Keen to consider how applied economics can help answer questions in
various fields, Dr Rudkin has also this year completed working papers on
fiscal competition, the role of China in South-East Asia and the ethics of
large corporations dealing with the crises self-regulation may create.
A fellow of the Higher Education Academy with an active interest in new
teaching technologies, he has undertaken research into breaking down
silence culture with tablet computers, considered how collaborative wikis
can aid learning and sought new ways to bring live elements into
established teaching materials.
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Part I: Microeconomics
This part develops the central theme of economics. We examine the
functioning of markets by analysing how firms and consumers make
decisions to buy and supply goods. We then place the organisation within
its market environment to understand the determinants of its performance,
and in turn explore the application of economics to decision making and
strategy.
enable you to analyse and critically assess both theory and the
application of theory.
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Assessment criteria
A written assignment of 2,000 words, based on both microeconomics and
macroeconomics. Assignments must be submitted by 12 January 2016.
To view the assignment questions, go to the Business Economics
Blackboard site and click on Assessment in the left hand menu. You
should see a folder named Distance Learning Assessment. Click on this
and you will see the assignments.
Assignment
The assignment contributes 100 per cent of the assessment for this
module. For guidance on completing assignments see the Effective
Learning Service (www.bradford.ac.uk/management/els/)
Assignment aim
The aim of the assignment is for you to show your understanding of the
economic concepts covered in the module and your ability to apply the
economic concepts in a meaningful, insightful and balanced way. The
assignment emphasises the durability and the wider application of the
range of economic techniques you have studied and shows how
economics can be used to aid decision-making and problem-solving in a
business context.
The best practice for the assignment is doing the activities and review
activities that have been set in this Study Book. Wherever possible, it
would be helpful to think how you could develop your answers to the
questions and seek out supporting arguments.
what you are going to look at in the reports, you can identify and define
any terms and significant issues, and say how you propose to examine
them. This has two effects: it compels you to discipline yourself and
address the question in a relevant fashion; it also shows the reader that
you are in control of the subject, and that your report is not just going to
meander aimlessly until it has filled a respectable number of pages. The
report should not be a magical mystery tour.
In the main body of the report, you should unfold the main arguments in a
coherent sequence, bringing relevant evidence to bear on the points you
are making. In economics, this section of the report normally requires you
to show your understanding of the relevant theory relating to the topic
under discussion and the ability to apply the economic concepts in a
meaningful, insightful and balanced way. Rarely will this section produce
any clear-cut outcome. Rather this section will highlight your
understanding of the economic toolkit and, more importantly, your ability to
use it to analyse a wide range of complex and strategic issues, and devise
appropriate strategies to deal with the situation in the question. Your ability
to use economic theory to think around a problem, reveal the different
options/choices that can be made and evaluate the relative effectiveness
and appropriateness of these strategies under different circumstances is a
strength of economics and a skill you need to show.
You should also consider what you yourself may be able to add to the set
of issues under discussion. Often this is not easy but it may be possible to
point to problems in the theory, the discussion or debate, for example,
ambiguity in the use of economic concepts or the limitations of the existing
evidence.
Finally, there is the conclusion. Here you draw together the main
elements of the reports in a summary fashion, stating the conclusion (if
any) you have reached. These points may help:
While there is no single blueprint for the ideal report, the following
guidelines should be helpful.
The report should answer the question set, in your own words (that is,
without plagiarising anybody else), and employ accurate grammar,
spelling and syntax.
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The report should make good use of a range of economic concepts and
apply them broadly in a logical and balanced manner.
Credit will be given for answers that adopt a critical or original approach
to the questions and that are written with clarity and fluency.
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11
Textbook
Throughout the module, you will need to refer to the module textbook:
Begg, D. and Ward, D. (2013) Economics for Business 4th edition.
Maidenhead: McGraw Hill.
The textbook forms an essential part of your study. It is vital that you read
the chapters specified at the beginning of each unit to familiarise yourself
with the concepts and issues to be covered. A word of warning at this
stage: dont spend too long studying the material in the textbook; a quick
reading should be sufficient.
12
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through each unit, you will be directed to read specific pages or analyse
particular cases, tables and diagrams.
Activities and review exercises have been provided to help you test your
understanding, and guidance has been provided in Appendix B at the end
of the module so that you can assess your responses. Completion of the
exercises is absolutely essential if you are to develop a good
understanding of economics. Reading the textbook and the Study Book
will not be sufficient to establish a clear grasp of the concepts and issues
covered. You should try wherever possible to consider your own personal
experience and provide examples from your own business environment to
amplify your answers. You will need to interact with the material and
become involved. This requires a commitment to active study.
A word of warning: the units in the Study Book are of unequal length.
Some units such as those on scarcity and choice are quite brief. You are
advised to break up the study of longer units and allow a little time for
concepts to sink in before moving on to the next stage.
Model answers to the activities, where applicable, are provided in
Appendix B.
Assessment issues You are urged to put any general queries about
the assessment here, since the reply provided by the tutor may also
answer queries from other students.
13
materials for each live online tutorial are outlined in the Study Book. You
will be given details of the times and dates of these tutorial sessions once
the module has commenced.
If you have never used the Blackboard Collaborate virtual classroom
platform before, it is essential that you familiarise yourself with the platform
and test your computer setup before you attend the first tutorial. To test
your sound settings, please go to the Blackboard Collaborate Support site
at http://bit.ly/1etRu2Y. For further support materials and information about
Blackboard Collaborate, please see the Blackboard Collaborate Support
site at http://bit.ly/1jBpgUc.
Formative assessment
You will be provided with an opportunity to submit two pieces of work that
your module tutor will assess and give you detailed feedback on. The two
opportunities for formative feedback relate to issues discussed in Units 2
and 7 (see relevant units in the Study Book for further details).
Please note: none of your answers to these formative tasks will count
toward the final grade they are optional exercises that allow you to test
(and receive feedback on) your understanding of key concepts/theories
and ideas.
Multiple-choice questions
After completing each unit in the Study Book you can test your basic
knowledge and understanding of the main economic ideas by tackling the
15 multiple-choice questions. These are available online in Blackboard.
Internet resources
The World Wide Web provides a very useful resource. You will find it
particularly useful when you want to analyse business organisations or
when you wish to read informed opinion regarding macroeconomic issues.
Sites well worth checking out include:
http://econlinks.com/
www.economist.com
www.ft.com
www.euromoney.com
The Bradford University School of Management library and your local
library hold publications and databases relating to industries, organisations
14
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and economic trends. The internet also gives you the possibility to access
libraries elsewhere.
Additional textbooks
Sloman, J., Hinde, K. and Garratt, D. (2010) Economics for Business
5th edition. Harlow: FT/Prentice Hall.
Sloman, J. and Jones, E. (2011) Economics and the Business
Environment 3rd edition. Harlow: FT/Prentice Hall.
Griffiths, A. and Wall, S. (2011) Economics for Business and Management
3rd edition. Harlow: FT/Prentice Hall.
Bradford MBA
15
reference) and no access date included. This is simply to increase the flow
of text in the grey boxes.
16
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PART I:
MICROECONOMICS
Unit 1:
Introduction to Economics
Key reading:
1. Begg, D. and Ward, J. (2013), Chapter 1
Key audio/video:
1. An Introduction to MBA Business Economics (Blackboard > Module Site
> Module Materials > Unit 1) Activity 1.1
Other:
1. Unit 1 lecture slides and audio (Blackboard > Module Site > Module
Materials > Unit 1 > Lecture slides and audio)
2. Unit 1 multiple-choice questions (Blackboard > Module Site > Formative
Exercises > Multiple-Choice Questions > Unit 1) Activity 1.6
Introduction
Think of something you like; a good example is chocolate. Imagine now
you are in a shop and they will allow you eat as much as you like and
there will be no charge. How much would you take? What considerations
would you give in deciding? As a business trying to meet these needs,
how does your company decide how much to provide to the market? What
other goods are sold? How do you decide how many resources to allocate
to each product?
In economics we recognise that there is a lot more to the market than
simply price and the availability of goods. Consumers want a range of
products, and in greater quantities than the market can provide. The basic
economic problem is thus that consumers have essentially infinite wants
but resources are limited; someone, or something, must decide how to
allocate resources. No matter how much money you have, or how
developed a nation is, these issues persist. Our discussion is phrased in
terms of happiness rather than money, because it is the utility we get as
individuals that matters. A great example of this is the child who plays with
the box rather than the present on their birthday; they value the box more
than the toy despite what the market says the prices should be.
This unit develops a theoretical framework that will enable you to
understand the problem of scarcity over choice, and answer the questions
posed above.
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19
Objectives
By the end of this unit, you should be able to:
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20
In the figure the second unit brings almost as much happiness to the eater
as the first, u2 u1 u1. As the quantity goes up this is no longer true, the
22nd piece only increases the utility by u4 u3.
What about the workers? They arrive fresh and ready to work and can
produce the first unit quickly, soon getting into a rhythm and producing
more. However, over time they will inevitably tire, or become bored, and be
able to produce less and less. In the extreme they will need sleep and be
unable to produce any more. From your own work you will know there are
times when you are more productive than others, but you receive the
same wage for each unit of time so there is no financial reason not to
assume the same output per unit wage.
Economics begins from the idea that returns, whether happiness from
consumption, the output of labour or otherwise, diminish.
21
Opportunity cost
Read: Begg and Ward (2013), pp.528
Resources can only be allocated once, and some wants will not get the
inputs they need. The alternative uses for the resources are termed the
opportunity costs as the economy loses the chance to enjoy the gains that
those uses of the resources would have brought. A government spending
on education cannot then use that same money to spend more on
transport. The opportunity cost in this case might be a new high-speed
railway. When you choose to spend time watching television then the
alternatives, such as reading a book, are the opportunity cost.
Recognising that resources have alternative uses and decisions impact on
what we can, and cannot, do is a key part of economics. It is essential to
addressing the basic economic problem.
22
households and businesses. The curve represents the PPF and the PPF
demonstrates the various combinations of capital and consumer goods
that could be produced. Any point along the PPF represents a full
utilisation of resources and a very efficient economy.
Figure 1.3: Production possibility frontier
Consumer
goods
b
c
x
d
a
Capital
goods
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23
The PPF can be used to examine the concept of opportunity cost. Take an
individual firm that has diversified its production and produces good A and
good B.
Figure 1.4: Production of good A and good B
Good A
a1
a2
b1
b2
Good B
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25
Summary
Read: Begg and Ward (2013), Summary, p.25
In this unit we have introduced three of the most important concepts in
economics; diminishing marginal returns, the basic economic problem and
opportunity cost. Each of these will appear prominently in all of the study
units that follow. As economists we recognise that decisions must be
driven by happiness; there will necessarily be winners and losers.
Production possibility frontiers help us to visualise all of these problems in
a clear and simple way. Frontiers also show the importance of getting
allocation decisions right.
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26
Unit 2:
Issues Relating to Demand
Key reading:
1. Begg, D. and Ward, J. (2013), Chapter 2
Other:
1. Unit 2 lecture slides and audio (Blackboard > Module Site > Module
Materials > Unit 2 > Lecture slides and audio)
2. Unit 2 multiple-choice questions (Blackboard > Module Site > Formative
Exercises > Multiple-Choice Questions > Unit 2) Activity 2.7
3. Unit 2 live online tutorial (Blackboard > Module Site > Collaborate)
Activity 2.8
4. Unit 2 marked formative assessment (Blackboard > Module Site >
Formative Exercises > Marked Formative Assessment > Unit 2)
Activity 2.9
Introduction
In most economies, markets are the principal ways in which scarce
resources are allocated to the production of goods and services. A market
is anywhere there is a buyer and seller. In essence, markets operate
through the price mechanism which co-ordinates the buyers and sellers.
For example, as prices rise relative to costs of production, firms offer more
for sale. In this way, the price acts as a signal to firms that scarce
resources should be reallocated from markets where profits are low to
markets where profits are high. The price mechanism is often referred to
as the invisible hand since it is the result of free market forces.
Have you ever considered why baked beans only cost 25p when they
enjoy so much popularity? Why do firms not cash in on this demand by
charging 99p? Why does a pint of beer cost 2.95 in your local pub
compared to 5.00 in a nightclub? Why does the government tax
cigarettes and beer but not apples? Why does the accountant working at
your firm earn more than the cleaner? The answers to all these questions
can be found by analysing how demand and supply interact in the market
place.
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27
In this unit you will begin to develop your understanding of how markets
behave. First, you will concentrate on the demand side of the market.
What affects the level of demand, how do consumers react to price
changes, how can firms set prices that will maximise their revenues; and
why do firms set different prices for different market segments? Once you
feel comfortable with this knowledge, Unit 3 will then introduce concepts
related to the supply side of the market. Unit 4 will then combine the ideas
from Units 2 and 3 into an integrated understanding of markets. Hopefully,
you can see that economics is a subject which builds upon itself and it is,
therefore, important to gain confidence in the ideas and issues of each unit
before moving onto the next.
Objectives
By the end of this unit, you should be able to:
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28
D
q
Quantity
time period.
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29
D2
D1
D3
q
Quantity
p0
D2
D1
q1
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q2
Quantity
30
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31
Of course, at this stage we are only focusing upon demand. You should go
back to our definition of a market. We now need to examine the role of the
sellers who supply the products if we are to establish how the market
determines price and output.
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32
p
2
p
1
Quantity
p
p
Quantity
If we examine Figures 2.4 and 2.5, we can show the relationships between
the relative changes in price and quantity demanded. Strictly speaking this
approach should be used to simplify the idea only, since the validity of the
diagrams is dependent upon the scale of the axes.
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33
Special cases
The perfectly elastic demand curve suggests even a tiny increase in price
will lead to none of the product being sold (see Figure 2.6).
The perfectly inelastic demand curve suggests no matter what happens to
price the quantity demanded will not change (see Figure 2.7).
The unit elasticity suggests a 5% change in price will lead to a 5% change
in quantity demanded (see Figure 2.8).
Figure 2.6: Perfectly elastic demand curve
Price
q1
q2
Quantity
p2
p1
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Quantity
34
Quantity
Determinants of elasticity
a decrease in price will lead to a large increase in the quantity sold and
revenue will increase.
Now at this point you might ask: well, if demand is inelastic and consumers
will continue to purchase the product even if the price increases, why dont
firms just keep on raising prices indefinitely? This is a good question and it
is worthwhile spending some time analysing the response to this question.
At this point, we could take the soft option and state it would be easier to
answer this question at the end of Unit 3. In
Unit 3, we identify how firms choose the level of output which will
maximise profits. Having selected this output, the market demand will
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35
determine the price that the firm charges. You need to remember that
profit is equal to revenue minus costs. Raising prices might increase
revenue but the traditional theory of a firm assumes the firm will aim to
maximise profits and not revenue. This will be clearer at the end of Unit 3.
So how can we answer the question without taking the easy option? This
requires a more complex response. The elasticity of demand varies along
the course of the demand curve. If we examine Figure 2.9, we note that
the demand is inelastic, at lower prices and elastic at higher prices. This
would suggest a firm could increase its prices when the price is low and,
since demand is inelastic, there will be a smaller proportionate reduction in
demand: hence, there is an increase in revenue. But as price is increased
and demand becomes more elastic there will come a point where an
increase in price will lead to a larger proportionate reduction in demand.
Think of consumers who stick with a product when prices are low and
remain loyal as prices increase, but when prices get much higher a larger
number of consumers start to look at alternative products.
Figure 2.9: The demand curve and the elasticity of demand
Price
Elastic
Inelastic
Quantity
In summary, we can assume the firm will set price at the point where
demand is just about to become elastic: that is, the firm has kept on
increasing price until the point where it cant raise it any more without
reducing revenue. Note: here we are referring to revenue and not profit.
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36
Elastic
Inelastic
Total revenue
Quantity
Price
Elastic
Unit elasticity
Inelastic
D
Quantity
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37
Price
D2
D1
D3
p2
E
p1
D3
D2
D1
q4
q3 q2 q1
Quantity
Income elasticity
Income elasticity measures the responsiveness of a change in demand for
a change in income. Income elasticity of demand can be calculated using
the formula:
YE d
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38
Cross elasticity
Cross elasticity measures the responsiveness of a change in demand for
good A for a change in the price of good B. How will a change in the price
of a competitors product affect the demand for our product?
Cross elasticity can be calculated using the following formula:
Ed A
Ed = 1
Ed > 1
Question 3: Can you find examples of firms that have products with high
cross elasticity of demand for your firms product?
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39
Consumer surplus
Read: Begg and Ward (2013), Chapter 2, pp.4954
Consumer surplus is measured for each consumer and is calculated as
the difference between the price of the product and the maximum price the
consumer would be willing to pay. So if a latte coffee costs 2.00 and I am
willing to pay up to 2.50 for a latte coffee, then my consumer surplus is
0.50. If a caffeine junky is willing to pay up to 4.00 for a latte coffee, then
his or her consumer surplus would be 2.00.
The consumer surplus for all consumers demanding a given product is
illustrated in Figure 2.12.
Figure 2.12: Consumer surplus
Price
Consumer
surplus
pe
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Quantity
40
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41
Summary
Read: Begg and Ward (2013), Summary, p.54
You should now be able to understand the theory of demand and explain
the difference between a movement along and a shift in the demand
curves. You should also have a grasp of the important factors behind
pricing decisions and how the market reacts to changing conditions. You
have examined the ideas of consumer surplus and considered ways in
which businesses might maximise revenue in their pricing policies.
Importantly, you should have a good knowledge of the concept of
elasticity, and its importance to decision making and market strategy.
42
Business Travellers
Business
2500
2413
2324
2228
2144
2047
1957
1874
1784
1693
1598
1510
1422
1334
1240
1150
1057
974
881
791
Economy
1000
976
951
927
898
875
849
826
799
776
748
726
702
677
649
627
601
575
550
523
Tourists
Business
700
680
669
650
646
619
611
591
581
570
556
529
521
502
493
469
462
445
433
418
Economy
450
440
429
422
408
401
392
382
368
361
348
339
327
317
312
297
289
278
270
259
43
Task 4: If business class tickets sell for 1000 and economy class tickets
sell for 350, illustrate the consumer surplus gained by passengers when
customers only fly in the class that is best suited to their needs: that is,
business passengers fly business class and tourists buy economy class
tickets.
Task 5: Table 2.2 provides details of Emirates prices for a return ticket
between Manchester and Dubai. Why might we see pricing like this? What
type(s) of price discrimination are being applied here?
Table 2.2: Return flight prices using Emirates Airlines from Manchester to
Dubai
Leaving
Returning
Business
Economy
Saturday 10 October
Saturday 17 October
2,411
448
Sunday 11 October
Sunday 18 October
2,391
395
Monday 12 October
Monday 19 October
2,391
363
Tuesday 13 October
Tuesday 20 October
2,391
363
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45
Unit 3:
Production and Output
Decisions
Key reading:
1. Begg, D. and Ward, J. (2013), Chapters 3 and 4
Other:
1. Unit 3 lecture slides and audio (Blackboard > Module Site > Module
Materials > Unit 3 > Lecture slides and audio)
2. Unit 3 multiple-choice questions (Blackboard > Module Site > Formative
Exercises > Multiple-Choice Questions > Unit 3) Activity 3.11
Introduction
As already identified in the introduction to Unit 1, the factors of production
are subject to a law of diminishing marginal returns. This unit provides
some of the important background understanding required for our
examination of markets in Unit 4 and competition in Unit 5. While
consumers can simply turn up at a market and demand goods, firms are
not as fortunate. In supplying goods, firms face a number of issues
concerning the actual production of goods and services. Having decided
what and where to produce, they must make important decisions
regarding how much labour and capital should be used. Should it buy
components from suppliers, and if so which firms, or should it produce the
whole of the product in house? How much will it cost to make different
quantities of output? When might the firm expand or when should it shut
down?
An important distinction made by economists is that costs behave
differently depending on the time scale. The short run is the period of time
in which the firm is unable to vary all its factors of production. In other
words, at least one factor of production is fixed. This could be particularly
skilled workers in very short supply or it could be a machine that takes a
long time to arrive often an order is made. The long run is defined as the
period of time in which it is possible to vary all the factors of production.
Production may be defined as anything which satisfies a want or a need
and, as such, covers the output of services as much as the output of
goods.
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47
Objectives
By the end of this unit, you should be able to:
understand the reasons why a firm may expand and how economies of
scale affect the firms costs.
Total product
43
43
43
160
80
117
351
117
191
600
150
249
875
175
275
1,152
192
277
1,372
196
220
1,536
192
164
1,656
184
120
10
1,750
175
94
11
1,815
165
65
12
1,860
155
45
Total product
Number of workers
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Total
product
Labour units
Note how the total product increases at first, and how it begins to tail off as
more units of labour are employed. For the purpose of this theory we need
to assume that each worker is just as good and hard working as the next
and that the production methods do not change, so that we can isolate the
relationship between the number of workers employed and output.
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This theory would suggest that in the short run a firm faces strong
limitations on its output; less flexibility gives the firm much less room for
manoeuvre than is the case in the long run which we will examine later.
Figure 3.2: Average product and marginal product
Product
Average
product
Marginal
product
Labour units
Total product
10
24
42
56
70
72
Average
product
Marginal
product
Using graph paper can you plot the total product curve, the average
product curve and the marginal product curve?
Question 2: At what point does diminishing marginal returns set in?
Question 3: Why do you think that diminishing returns set in?
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Definitions of costs
Fixed costs = Costs which do not vary with output
Variable costs = Costs which vary with output
Total costs = Fixed + variable costs
Average total cost =
Total cost
Output
Fixed cost
Output
Lets take a look at Table 3.2, note how the fixed cost remains the same
regardless of the number of workers are employed. If we plotted this
information in a graph, we would have the situation shown in Figure 3.3.
Table 3.2: Changes in costs with changes in labour
Labour
Fixed cost
Variable cost
Total cost
100
20
120
100
40
140
100
60
160
100
80
180
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Total
cost
Variable
cost
Fixed cost
Labour units
Fixed cost
200
Variable cost
0
200
300
Total cost
200
800
1,200
2,200
Average costs
Average total costs =
Total cost
Output
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Consider Table 3.3. We can deduce that the total fixed cost must be 200.
Can you see how this has been done? In Figure 3.4 we can show how the
AFC is shaped as total fixed cost is spread over a greater quantity of
output.
Table 3.3: Output and costs
Output
AVC
AFC
ATC
200
200
400
150
100
250
200
67
267
300
50
350
400
40
440
Total cost
Marginal cost
400
500
100
800
300
1,400
600
2,200
800
The first marginal cost value is a dash since we are not given the fixed
cost when output is zero. If we plot the average cost and marginal cost
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curves on the same diagram, we have Figure 3.5. Notice how the marginal
cost curve intersects the average cost curve at its lowest point. This is not
just coincidence! This is an important part of the relationship and it is
essential for you to remember this when we examine the theoretical
framework behind a firms output decisions in Unit 4.
Figure 3.5: Average cost and marginal cost
Cost
Average cost
Marginal cost
Units of output
Fixed cost
Variable
cost
Total cost
Marginal
cost
Average
cost
10
10
10
12
12
12
20
26
30
32
39
54
71
10
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54
Using graph paper can you now plot the average cost and marginal cost
curves on the same diagram? Remember, plot costs on the vertical axis
and output along the horizontal axis.
Question 2: Complete the following table.
Output
TFC
40
TVC
06
11
15
TC
60
66
AFC
AVC
ATC
MC
On graph paper can you plot TFC, TVC and TC against output; and AFC,
AVC, ATC and MC against output?
Question 3: Complete the following table which includes both revenue
and cost information and calculate the missing figures.
Output
Price
TR
10
10
10
10
10
10
MR
FC
VC
TC
MC
Profit
2
7
+1
8
+4
36
5
55
27.5 years, Hitachi will build 122 trains comprising 866 carriages. Twelve
trains are being manufactured at its Kasado works in Japan and the rest at
Newton Aycliffe. Hitachi has also been named by Abellio, an arm of the
Dutch state rail operator, as preferred bidder for 70 trains for ScotRail.
We arent going to rely on the Japanese supplier base for components.
We are going to Europeanise as much of this plant as we can, Mr Foster
[Jamie Foster, Procurement Director for Hitachi] said. The company said it
was working with 56 suppliers in Europe, 32 of them based in the UK.
In contrast to Nissans high-volume, just-in-time Sunderland operation,
which requires some suppliers to be located next to, or even in, the plant,
Hitachi, with its longer manufacturing timescales, does not need them on
the doorstep.
(Source: Tighe and Powley 2015)
Answer the following questions.
Question 1: What fixed costs are incurred by switching production from
Kosado to Durham?
Question 2: What are the likely effects on variable costs from using this
new plant?
Question 3: How do the variable costs of Nissan and Hitachi differ
according to this article?
Question 4: Train orders are known for being cyclical. Explain why it might
be better to have a larger variable cost base in an industry like this.
Activity 3.4 read and reflect answers:
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Shutdown point
Read: Begg and Ward (2013), Chapter 3, pp.6680
In the short run, the firm has already committed to the fixed costs. They
have been paid and can be left out of the short-term decision-making
about output. In the short run, the firm will continue to produce provided
that the revenue generated exceeds the variable cost. At each output
level, the surplus of revenue over variable cost makes a contribution
towards paying for the fixed costs. If the revenue is less than the variable
cost, it will be more sensible for the firm to cease production. Stopping
production will reduce the size of the loss and limit it to the value of the
fixed costs already paid. Therefore, the short-run shutdown point occurs
when the revenue cannot cover the variable costs.
Of course, in the long run the firm is operating under different decisionmaking criteria and can vary all its factors of production. In such cases, the
firm is more concerned about covering total costs rather than just variable
costs. In the long run, the firm will shut down if it cannot cover the total
costs.
Figure 3.6: Costs and revenues and output
If we consider Figure 3.6, we can see this clearly. Imagine that the vertical
axis includes both costs and revenue. If the average revenue AR1 is below
point y, then the AVC exceeds the AR. The firm is not covering its variable
costs and should cease production. At point y, the average revenue AR2 is
equal to the AVC and the firm is therefore just covering its variable costs.
This firm will continue to produce in the short run. At point z, the firms
average revenue AR3 is equal to the ATC and as such the firm's revenue
is covering all its costs and the firm will continue to produce in the long
run. Clearly the short- and long-run shutdown points differ. In the short run,
the firm will shut down to the left of point y, where it cannot cover its
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variable costs. In the long run, it will shut down to the left of point z, since
the revenue does not cover total costs.
a firms supply schedule shows the quantities that the firm is willing to
offer at each market price
since a firm is assumed to operate for profits, then it will only offer
output when the market price is greater than the cost of producing the
last unit offered
therefore, the firms supply schedule is also the firms marginal cost
curve (where MC exceeds AVC in the short run or ATC in the long run).
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p1
q1
Quantity
Any other factors other than a change in price will cause a shift in the
supply curve itself. These factors are referred to as the determinants of
supply and include:
state of technology.
S2
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q
3
q Quantity
2
59
60
Elasticity of supply
Elasticity of supply measures the responsiveness of quantity supplied for a
given change in price.
Factors affecting elasticity of supply include
time period
The time period effect on the elasticity of supply works in much the same
way as for the elasticity of demand.
Figure 3.9: Time and elasticity of supply
S
Price
p2
p1
q q q
1
Quantity
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Spare capacity
Spare capacity describes the ability of a firm to expand its output given its
existing factors of production. A firm may have the flexibility to respond
rapidly to increased demand if it carries a large stock of finished products
or has the ability to quickly expand output. It might have a large amount of
work in progress or workers without a full workload, or the capacity for
overtime, or machines that are currently underutilised. When a firm has no
spare capacity, it has little room for manoeuvre and the supply curve is
relatively inelastic. The concept of spare capacity will be looked at again
when we examine how government policy affects the supply of products in
the macroeconomics part of the course.
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Returns to scale
Returns to scale looks at the relationship between changes in the scale of
operation and the amount of output generated.
Increasing returns to scale mean that bigger firms are able to generate
greater returns than smaller ones. A large number of these will come from
the firms market power, discussed in Units 4 and 5.
Constant returns to scale occur when size does not matter.
Decreasing returns to scale occur when firms become too large. A classic
example being the costs that bureaucracy can impose on large firms
decision-making.
Economies of scale
Economies of scale explores the relationship between changes in the
scale of operation and the average costs of production. We can define it
as those aspects of increasing a firms size that lead to falling average
costs. These economies of scale can be either internal or external. Internal
economies of scale are those that arise from the growth of the firm itself.
External economies of scale are those that arise from factors outside the
individual firm, such as developments in the local infrastructure and
improved road communication links, etc.
Firms do not always find that growth leads to falling average costs.
Sometimes they can become too big and the diseconomies of scale
outweigh the economies of scale. It is important to remember that when
looking at how scale affects costs, we are looking at the overall effect of
changing scale. When a firm begins to grow it starts to experience
economies of scale but also suffers some of the disadvantages of growth.
It is why we refer to the outweighing nature of the concept.
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Cost
Economies of scale
Constant
Output
Diseconomies
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SRAC
c
q Output
2
We start on the short-run average cost curve 1 (SRAC1). The current level
of production in the short run is q1. The firm in the short run is able to
produce this level of output for an average cost of c1. If there is an
increase in demand for the product so that the firm considers the level of
production should be q2, the firm can only meet this output target in the
short run if there is an increase in the average cost to c2. (The firm may
need to pay overtime to meet the target.) However, in the long run, the firm
can increase the scale of production and moves to short-run average cost
curve 2 (SRAC2). The new target output of q2 can now be produced for the
reduced average cost c3. The firm is experiencing economies of scale,
which outweigh the diseconomies of scale.
If the firm continues to grow, it would move to another short-run average
cost curve. At some point it will theoretically reach the optimum scale of
production where the product is produced as cheaply as possible. After
this level of output the diseconomies of scale outweigh the economies of
scale. In Figure 3.12 we draw a long-run average cost curve (LRACC)
which envelops the SRACCs. This represents the theoretical view of how
average costs vary with the scale of the firm.
In practice, however, many large firms do not experience the envelope
curve as described in Figure 3.12. The firm experiences the first part of the
curve, where increasing size leads to falling average costs. However,
when the optimum scale is reached the firm finds that continued growth
leads to constant returns to scale. That is, the economies and
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SRACC
SRACC
LRACC
Output
LRACC
Output
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Summary
This unit has demonstrated some of the constraints placed upon the firm
in the short run. The firm is significantly hampered by having at least one
factor of production fixed. The theory of diminishing returns shows how the
marginal product falls as the units of the variable factor are increased
beyond a certain level. In the long run, the firm has far more flexibility and
can respond to changing market conditions by expanding the scale of
operations. Appreciating the interrelationship between the various costs
and revenue will allow us to focus in Unit 4 on how firms arrive at their
pricing and output decisions in different market structures.
Output:
Sweaters
(per day)
TFC
(/day)
Total
labour
cost
(/day)
Total
material
cost
(/day)
TVC
(/day)
TC
(/day)
50
50
50
25
33
83
10
13
15
16
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Output
(/sweater)
10
13
15
16
AFC
(/sweater)
AVC
(/sweater)
ATC
MC
TC
MC
ATC
AFC
AVC
TVC
2
3
4
5
6
Clues
1. AFC for 6 units of output is 9.
2. AVC for 2 units of output is 30.
3. Total cost is increased by 28 when the third unit of output is added.
4. ATC of 4 units of output is the same as the ATC of 3 units of output.
5. Total cost for 5 units of output is 258.
6. Total variable cost is increased by 100 when the sixth unit of output is
added.
7. Total cost increases by 8 when the second unit of output is added.
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References
Tighe, C. and Powley, T. (2015) Hitachi to open 82m train plant in
Durham this year. Financial Times, 11 January.
http://www.ft.com/cms/s/0/972f7360-89fa-11e4-9b5f00144feabdc0.html#ixzz3iERW8fGQ. Accessed 8 August 2015.
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Unit 4:
Markets in Action
Key reading:
1. Begg, D. and Ward, J. (2013), Chapter 4 and part of Chapter 8
2. DAveni, R. (2015) The 3-D Printing Revolution. Harvard Business
Review, May (Blackboard > Module Site > Module Materials > Unit 4)
Other:
1. Unit 4 lecture slides and audio (Blackboard > Module Site > Module
Materials > Unit 4 > Lecture slides and audio)
2. Unit 4 multiple-choice questions (Blackboard > Module Site > Formative
Exercises > Multiple-Choice Questions > Unit 4) Activity 4.6
Introduction
In this unit we will combine the demand and supply analysis developed in
Units 2 and 3. The purpose of which is to understand the forces that
determine the price and quantity of a product traded in a market.
Our analysis will use demand and supply curves within a single diagram
and will highlight the concept of market equilibrium. We also consider
market disequilibrium and address the forces that push a market back
towards equilibrium
While markets are often viewed by economists as an optimal resource
allocation mechanism, there are instances where markets can fail. We
consider all these factors with a specific focus on the applications to
business.
Objectives
By the end of this unit you will be able to:
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Equilibrium
Read: Begg and Ward (2013), Chapter 4, pp.8491
Consider Figure 4.1 showing the interaction of demand and supply in the
market. The point where demand and supply intersect is called the
equilibrium. This is the point at which the buyers and sellers are in
agreement about both the price and the quantity to be exchanged at this
price.
Figure 4.1: Market equilibrium
Price
S
p
Quantity
Characteristics of equilibrium
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p
p
S1
2
D2
D1
q1
q2 Quantity
In Figure 4.3, there is a decrease in demand and this leads to a shift in the
demand curve to the left (if you are struggling to see how this shift is to the
left think of how the demand curve has moved for every level of price). The
new demand D2 gives a new price of p2 and causes a contraction of
supply. The quantity of the product exchanged is q2.
Figure 4.3: Decrease in demand
Price
S1
p1
p2
D1
D2
q2
q1 Quantity
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p1
p2
D1
q2
q1
Quantity
S1
D1
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Disequilibrium
Read: Begg and Ward (2013), Chapter 4, pp.9198
In Figure 4.6, the market has supplied a level of output q2, which at the
market price p2 charged for the product exceeds the quantity demanded q1
at this price. This is described as an example of excess supply. If free
market forces operate, what is likely to happen next?
Although firms have produced q2 units of output they only receive revenue
from the sale of q1. They are left with q2 q1 units unsold. In order to clear
this excess supply, the price will need to fall. As price falls firms will
produce less and there will be an extension of demand until the
equilibrium situation is reached. The key point here is that this will happen
automatically if the market is left to its own free market devices.
Figure 4.6: Market disequilibrium
Price
S
p
D
q
Quantity
In Figure 4.7 the price p3 lies below the equilibrium. This time the quantity
demanded is q2 and the quantity supplied is q1. This leads to a shortage.
The market price will be bid up by consumers until and equilibrium position
is found.
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Labour markets
Wages in the labour market are established through the interaction of
demand and supply for labour. The demand for labour is partly derived
from the demand for the good or service. The firm also has other factors
affecting its elasticity of demand for labour, for example, proportion of total
costs accounted for by labour, the ease with which labour can be replaced
by machinery or other workers, etc. The elasticity of supply of labour is
affected mainly by the length of training required to perform a particular
task.
Compare the position of the managing director and the cleaner in your
company. Compare, for example, their wages. The managing director
requires skill and expertise that makes him or her far more inelastic in
supply than the cleaner. The cleaner performs a necessary role for the firm
but does not require much training and can be more easily replaced with
other cleaners. This gives the cleaner a weak position when wage
bargaining.
Figure 4.8: Comparing wages of different personnel
Wage
S
W2
D
S
W1
D
L2
L1 Number
of workers
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Market failure
Read: Begg and Ward (2013), Chapter 8, pp.200215
In some cases, the market does not (or would not) give society the optimal
output allocation and, in these cases, the government may intervene to
influence the market. Examples might include the provision of public and
merit goods, policies to influence the inequitable distribution of income,
minimum wage legislation, policies to tackle the uses and abuses of
monopoly power, including privatisation.
Public goods
Public goods are goods for which a supply might not be forthcoming if the
government did not intervene. It is hard to establish who would pay for
these goods at the point of use. Clearly there is a demand for street
lighting, but would a firm be willing to supply this service when it is difficult
to work out which consumers are using the service and how often? Would
the free market be able to provide a police force if left to its own devices?
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Merit goods
Merit goods are goods that can be provided by the private sector but
which are considered so important that the government intervenes to
enable a greater benefit to society. Examples include the provision of
education and health services.
Monopoly power
Inevitably, in a competitive situation there will be some winners and some
losers. In business, the winners may get increasingly powerful and may
grow in size by expanding or through company takeovers. As these firms
get bigger and more powerful, they can influence the market significantly.
As we shall see in Unit 5 monopolies are able to make more profits and
charge higher prices than firms in markets in which substantial competition
exists. The UK government has set up agencies such as the Competition
and Markets Authority and Financial Conduct Authority, and various
watchdogs to regulate monopoly power.
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Price
10p
S1
1.06
1
Quantity
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Summary
This chapter has focused on key economic ideas associated with markets.
Demand and supply, developed in previous units, have now been
integrated into one framework. The importance is now in understanding
the equilibrium price and quantity, as well as the factors that cause
demand and supply to change, thus altering the equilibrium. Development
of these important concepts include the analysis of disequilibrium, which
covers output shortages or surpluses, changes in the elasticity of demand
and supply, and a consideration of informational asymmetries. The market
framework will now be mixed with cost and revenue concepts to enable a
consideration of competition in Unit 5.
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References
DAveni, R. (2015) The 3-D Printing Revolution. Harvard Business Review,
May.
http://search.ebscohost.com.ezproxy.brad.ac.uk/login.aspx?direct=true&db
=bth&AN=102262142&site=ehost-live. Accessed 28 August 2015.
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Unit 5:
Market Structures
Key reading:
1. Begg, D. and Ward, J. (2013), Chapter 5
Other:
1. Unit 5 lecture slides and audio (Blackboard > Module Site > Module
Materials > Unit 5 > Lecture slides and audio)
2. Unit 5 multiple-choice questions (Blackboard > Module Site > Formative
Exercises > Multiple-Choice Questions > Unit 5) Activity 5.10
3. Unit 5 live online tutorial (Blackboard > Module Site > Collaborate)
Activity 5.11
Introduction
In this unit we examine the firm and how it responds to competition in the
marketplace. We will analyse the pricing and output decisions of firms
within three different market structures. The analysis will also allow us to
make an assessment regarding profitability and efficiency in the allocation
of resources. We shall build models for the three market structures:
We focus first on how perfect competition and then monopoly works; then
we compare the two market structures focusing upon price, output, profit
and efficiency. Finally, we examine oligopoly and examine the ways in
which this market structure forces firms to compete.
Objectives
By the end of this unit, you should be able to:
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Profit maximisation
Read: Begg and Ward (2013), Chapter 5, pp.104112
Economists assume that firms are in business to make profits for their
owners (shareholders). A stronger assumption is that firms seek to
maximise profits. In this unit and throughout this module we will also
assume profit maximisation. But if you are interested in alternative
assumptions for a firms behaviour then take some time to read
pages 189199 of Begg and Ward (2013).
If firms are profit maximisers, then they will produce an output where
marginal revenue equals marginal cost. The textbook provides a long but
accessible explanation for why marginal cost must equal marginal
revenue. However, a concise approach is to acknowledge that the firm
must maximise profits when the profit from the last unit is zero, i.e. all
profits have been extracted and equally where marginal cost equals
marginal revenue.
Market structure
Figure 5.1: Continuum of market structure
Perfect
competition
Monopolistic Oligopoly
competition
Monopoly
Figure 5.1 shows a continuum of market structure. Note that the perfect
competition (PC) is at the opposite end of the continuum to monopoly. In
between lies monopolistic competition and oligopoly, both market
structures where the firm faces imperfect competition. In this unit, we will
not analyse monopolistic competition.
Perfect competition
Read: Begg and Ward (2013), Chapter 5, pp.112119
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Price
MR=AR=D
D
Output
Market
Output
Firm
Figure 5.2 shows the interaction of market demand and supply that gives a
market price of p. The individual firm will charge this price for its product
since it is a price taker. The firm faces a perfectly elastic demand curve.
You should remember what this means from Unit 2. If the price is 50p for
example, then the firm will receive 50p for each product sold. This means
the firm will have an average revenue (AR) equal to 50p. Selling one more
unit will provide the firm with an extra 50p so the marginal revenue (MR)
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will be 50p also. The firm faces a perfectly elastic demand curve and, at
this market price, price is equal to average revenue and marginal revenue.
The obvious question to ask at this stage is why doesnt the firm just keep
on producing more and more of the product if it can sell an infinite amount
at the market price? The answer to this question allows the economist to
draw together some of the work covered in Units 2 and 3. So far the
perfectly elastic demand curve is just focusing on the demand and
revenue situation faced by the firm. Profit is the difference between
revenue and costs and so we need to introduce the cost curves we
identified in Unit 3. We do this, as in Figure 5.3, by introducing the average
cost (AC) and marginal cost (MC) curves.
Figure 5.3: Output, price and cost
Price
MC AC
MR=AR=P
q1
q2
q3
q4 Output
86
to produce. The shaded area in Figure 5.4 shows the level of abnormal
profit earned by the firm in the short run.
Figure 5.4: Output and profit
Price
MC
AC
MR=AR=D
q3 Quantity
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The key point to remember is that the firm maximises profit by producing
at the level of output where MR = MC.
Of course, not all firms will be able to make a profit. Some firms will find
that nobody wants to purchase their goods, they may be unfashionable. In
these cases, a firm will minimise its losses in the short run by producing
where MR = MC.
If we now go back to the theoretical model of perfect competition we are
developing, in the short run the firm is making abnormal profit. Other firms
will see this abnormal profit since they have perfect information and so
resources are reallocated in the market to increase the output levels of this
profitable good. The individual firm is powerless to prevent this happing
since there are no effective barriers to entry. Other firms enter the industry
and this causes the market supply curve to move to the right. This will
force down the market price and will continue to do so until normal profits
are earned again by the now expanded number of suppliers. Note that this
is the free market at work. The price acts as a signal to firms and the
resources are reallocated accordingly.
Consider Figure 5.5. Note that the supply curve moves to the right. This
new supply S2 gives a new equilibrium price of p2 and in diagram b this
gives a new perfectly elastic demand curve at this price. In diagram c,
MR = MC at the same point as AR = AC and so the firm is earning normal
profit. The firm will continue to produce at this point until the next change
takes place within the market.
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S1
S1
S2
S2
P1
P1
P2
P2
D
D
(a)
Quantity
(a)
Price
Quantity
Price
D1
MR=AR
D
D21
MR=AR
MR=AR
D2
MR=AR
(b)
Quantity
(b)
Quantity
Price
MC
AC
Price
MC
AC
AR=MR
AR=MR
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(c)
Quantity
89
MC
AC
Price
D=MR=AR
q Quantity
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Consumer sovereignty
The perfectly competitive market structure, operating in the way we have
described suggests that the market responds to the wishes of the
consumer. The consumer dictates how a societys scarce resources
should be allocated and the market responds positively and efficiently to
the consumers wishes. Consumer sovereignty has been likened to
casting votes in the economic ballot box. The more that a product is
demanded, the more votes it receives.
Efficiency
An economist might refer to efficiency as productive efficiency or
allocative efficiency. A firm is efficient when it is producing at the bottom
of its AC curve. This is known as productive efficiency. By referring to our
perfect competition diagrams, we can see that perfect competition is
productively efficient in the long run. Allocative efficiency refers to the
resources being allocated efficiently, and occurs when the firm is charging
a price equal to its marginal costs. This concept also requires the firm to
be earning normal profits. If a firm is earning abnormal profits, then by
deduction, more of the product needs to be supplied to the market to force
down prices to the level where normal profits are earned. Therefore, we
can state that the firm in perfect competition is allocatively efficient in the
long run.
It is important to remember that we must not confuse efficiency and
profit. They are related and in general everyday life we know that
efficiency can lead to profit. But, a firm that isnt efficient can also be
profitable and so the distinction is important.
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Monopoly
Read: Begg and Ward (2013), Chapter 5, pp.119126
Definitions of a monopoly can vary from a market where the consumer has
no discernible choice of supplier to the UK governments definition that a
monopoly is a firm with over 25 per cent of the market. For the purpose of
our analysis, we shall take a monopoly to be a firm that faces no direct
competition. We shall assume that there is one seller and many buyers, no
close substitutes exist and the monopolist has highly effective barriers to
entry.
A monopolist can control either the price of the product or the amount sold.
It cannot do both since it cannot control the market demand. The demand
curve facing the firm is the market demand curve. If the monopoly firm
wishes to sell an extra unit of the product it can do so, provided it lowers
the price. If price is lowered, the marginal revenue falls more steeply for
the firm since all the products sold to date need to be sold for less. In
numerical terms, if the firm lowers price by 1p it sells one more unit per
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month but the marginal revenue falls by more than 1p since the eight
products sold by the firm originally have reduced revenue by 8 times 1p.
This is shown in Figure 5.7.
Figure 5.7: Monopolies and the demand curve
Price
AR=D
MR
Quantity
AC
p1
c1
AR=D
MR
q1
Quantity
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The shaded area denotes the abnormal profit. In the short run, the
monopolist can earn abnormal profit. If this is perfect competition, then
other firms would enter the market. This cant happen in monopoly since
the firm has effective barriers to entry. Therefore, the monopolist can earn
abnormal profit in both the short run and the long run.
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Oligopoly
Many markets in the real world cannot be characterised as either perfectly
competitive or monopolistic. Instead, many markets are characterised by a
small number of large suppliers. For example, food retailing is usually
dominated by a small number of supermarket chains, and retail financial
services is controlled predominantly by a small number of banks. Since
many of these markets are very important to us as consumers, and also as
potential sources of employment, it is clearly important that we have an
understanding of these markets. The theory of oligopoly helps us here.
The theories of perfect competition and monopoly assume away the
existence of competitive rivalry between firms (why?). In contrast, the
theory of oligopoly focuses in on competitive rivalry between firms and,
as a consequence, is a major source of economic ideas on strategic
decision-making.
Consider a market with only four major suppliers. If one firm decides to
change the product that it offers, the price it asks for its product, or the
amount it is willing to supply, then this will have a major impact on its
competitors businesses. As a consequence, economic theory aims to
model the behaviour of a firm as a reaction to the expected behaviour of
its rival. If you play chess you will know precisely what is being referred to!
Read: Begg and Ward (2013), Chapter 6, pages 136156
An oligopolist at work
Oligopoly means competition between the few. Although price competition
can occur, a feature of the oligopoly market is non-price competition. The
oligopolist always needs to take the likely reaction of competitors into
account when making decisions. In many ways, the oligopolists might be
considered as incredibly powerful: they are often household names; they
advertise frequently; they have impressive business premises and
locations; they tend to attract graduates with good salaries and pension
plans; they have executive boxes at important sporting occasions, etc.
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But, and it is a big but, they face incredible competition and live in a
ruthless business environment.
The oligopolist has a strange looking demand curve. It is referred to as a
kinked demand curve. It is really made up of two demand curves. A
relatively elastic demand curve to represent the demand faced when
prices are increased and a relatively inelastic demand curve to
demonstrate the demand faced when price falls (Figure 5.10). The
demand curve dd denotes the effect of a price increase by the firm. Note it
is relatively elastic. The demand curve DD, represents the demand faced
by the firm if it were to decrease price. Note the relatively inelastic nature
of this demand curve. Where the two demand curves intersect is the
starting price for the firm. This point z can be represented on a slightly
different diagram to highlight the workings of an oligopoly market
(Figure 5.11).
Figure 5.10: Oligopolists demand curves
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If the firm in oligopoly starts off at point z, the price charged is p1 and the
output is q1. If the firm increases its price then a relatively large reduction
in demand will occur. The competitors of the firm will leave their prices
unchanged and so only the customers with strong brand loyalty will
remain. If the firm lowers its price then its competitors would follow suit
and so a relatively large reduction in price would lead to a relatively small
increase in demand. Quite clearly, faced with this scenario, the firm would
not wish to engage in price competition.
Price rigidity
Another means of explaining why oligopolists tend not to compete on price
can be found by adapting our earlier diagrams. When we covered
monopoly earlier in the unit we identified that the marginal revenue curve
slopes more steeply than the demand curve. In Figure 5.12, there is a
marginal revenue curve which corresponds to the relatively elastic
demand curve and one which complies with the relatively inelastic demand
curve. There is also a vertical discontinuity which exists on this marginal
revenue curve, denoted by points a and b. We could mathematically
explain this but we will invoke the principle of opportunity cost and the
notion of what we could more usefully do with our time!
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When we consider the price rigidity diagram, Figure 5.12, MC1, MC2 and
MC3 denote one firm with three different levels of efficiency. To begin with,
the firm with MC1, charges a price p1. When the firm increases efficiency,
the MC falls to MC2and then MC3, but the firm will still charge the same
price since the MC crosses the MR in the vertical discontinuity area. The
firm becomes more profitable by increasing efficiency. In the oligopolists
marketplace, characterised by cut-throat competition, increasing efficiency
becomes one of the most reliable forms of competing. Research and
development becomes integral to the success of the firm.
The more the firms in oligopoly can co-operate, the more the firms should
have a chance of being profitable. With less the co-operation, then there is
more chance that all firms will suffer. In a risky market situation, is it
surprising that firms diversify to spread the risk? Consider the amount of
diversification in the electrical and white goods markets. Consider the
incredible number of new products being launched. Is the consumer still
sovereign amidst this vast amount of product choice?
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have been paid: the women have bought nappies, rice, sugar and sacks of
maize meal half the weight of a bag of cement. In front of the main doors,
young men stand in the hot sun selling tomatoes and onions; five kwacha
a kilo (approximately 40 pence). On the street outside, makeshift stalls
tout plastic-weave shopping bags, cellophane-wrapped Bibles, pens and
herbals potions. In the car park, women sit on the tarmac selling avocados
and dried kapenta fish, a type of sardine. It is, in miniature, a scene typical
of the street-side bustle that has long been the African shopping
experience.
The supermarket, however, is a newer phenomenon both to Lusaka,
the capital of Zambia, and to Africa. Serene, air-conditioned and well
stocked, it is an experience urban Africans are becoming increasingly
accustomed to as South African retailers advance north across the
Limpopo river. The trend is being felt from Lagos to Luanda, Maputo to
Kampala, and it is radically altering the shopping habits of the burgeoning
middle class. Where the supermarkets have led, other international brands
have followed: from Barclays to KFC and Nandos. According to forecasts
by McKinsey, Africas consumer-facing industries will grow by more than
$400bn by 2020. All want the same thing to tap into the aspirations of a
new generation.
Before supermarkets arrived in Lusaka, Anga Kasanda, a 37-year-old
account assistant, used to do her shopping at the sprawling open-air
Soweto market. Packed with people and ripe vegetables, the place is full
of sweat, noise and dust. Now she rarely goes. In the Shoprite on Cairo
Road, one of Lusakas main highways, Kasanda browses shelves of Italian
(rather than Egyptian) pasta. Every location you go, theres malls ... I can
say thats development, she tells me. Its changed the perspective of
people. For her, its the basics that have made a difference: being able to
get hold of electrical appliances such as a steam iron, and being able to
do an entire shop under one roof. For millions of Africans, following a
decade of strong economic growth, it is these seemingly mundane things
that have helped to raise living standards. Its revolutionised the way
people are shopping, she adds. We dont want to go backwards.
(Source: England 2015)
Question 1: Why might oligopoly supermarkets be welcomed by
consumers when theory tells us that perfect competition amongst small
stall holders is better?
Question 2: What are the likely effects of allowing the growth of
supermarkets in Africa?
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Summary
There are such a large number of different firms operating in the
marketplace that we place them into a market structure. Economists
examine the price, output, efficiency and profitability of firms in each of the
different market structures. Understanding the context of a firms strategic
decision-making allows us to make much more sense of an ever-changing
market situation that all firms face. Firms do not always behave in the way
our theoretical models would suggest; take, for instance, the assumption
concerning profit maximisation.
As a general rule of thumb, it would appear that the more competition in
the marketplace the better. This is hardly a surprising revelation. Most
people in the street would be able to make this same assertion! We do,
however, now have as economists a theoretical underpinning to this
general rule of thumb.
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References
England, A (2015) Africas supermarket shopping revolution. Financial
Times, 24 July. http://www.ft.com/cms/s/0/6c0f2576-30b3-11e5-8873775ba7c2ea3d.html#slide0. Accessed 26 August 2015.
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PART II:
MACROECONOMICS
Unit 6:
Introduction to
Macroeconomics
Key reading:
1. Begg, D. and Ward, J. (2013), Chapters 9 and 10
Other:
1. Unit 6 lecture slides and audio (Blackboard > Module Site > Module
Materials > Unit 6 > Lecture slides and audio)
2. Unit 6 multiple-choice questions (Blackboard > Module Site > Formative
Exercises > Multiple-Choice Questions > Unit 6) Activity 6.7
Introduction
The macroeconomic environment is ever changing. New policies or
agreements are continually being made (for example, the current
negotiations over the Trans-Pacific Trade Partnership), adjustments to key
economic variables (for example, interest rates) are announced, and
almost daily some evidence is reported about the present state of the
economy. But what does all this indicate? For firms, it is the recognition
that not only must they respond to internal change and to changes in
trading relationships, but also to the changing macroeconomic
environment in which they operate. For example, what are the implications
of high or unstable exchange rates? What are the implications of
increasing world trade flows and international competition? How does
monetary/interest rate policy affect the well-being of firms? Similarly, as
individuals, we must recognise the importance of the macroeconomic
environment to our everyday well-being. Our ability to gain employment or
our potential for a sustained increase in our standard of living are both
factors influenced to some extent by macroeconomics.
In this unit, we introduce some of the key macroeconomic concepts and
introduce a conceptual framework which we will develop in Unit 7.
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Objectives
By the end of this unit, you should be able to:
Economic targets
Read: Begg and Ward (2013), Chapter 10, pp.247271
Every government, regardless of its political persuasion, aims to achieve:
low inflation
low unemployment
Each government may differ in the priority attached to the objectives and
indeed in the methods and policies used to achieve them. The main
difficulty for the government is that it is hard to achieve all these objectives
at the same time. Reducing inflation may very well lead to increased
unemployment and slower economic growth. Reducing unemployment
may be at the expense of rising inflation and increased difficulties with the
balance of payments.
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Inflation
Inflation means the general rise in prices. It is expressed as an annual
percentage increased and is calculated using the consumer price index or
the retail price index (RPI). The products that are priced every month are
weighted in order to represent the importance in terms of spending. Quite
clearly, an increase in the mortgage rates or cost of electricity is far more
important to a households outlay each month than a doubling in the price
of a box of matches. Inflation means that the pound in your pocket is worth
less than it was a year ago in terms of what that pound will buy.
Cost-push: this type of inflation may result from an increase in the price
of a raw material or component. Or it might arise from an increase in the
price of a factor of production such as higher labour costs or an
increased cost of machinery or higher council tax. An increase a the
firms costs that is not matched by increased productivity leads to
increased costs of production. Firms respond by pushing up prices to
maintain profit margins.
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Tackling inflation
Inflation can be tackled in a number of ways depending on the economists
view about what caused the inflation in the first place.
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Unemployment
Unemployment may be defined as the difference between the number of
people willing and able to work at the prevailing market wage and the
number that have jobs. To classify as unemployed for the purpose of
government statistics, an individual must be entitled to benefits.
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cost of the money allocated to tackling the social problems that arise from
greater unemployment. Not only does the government have to allocate
vast resources to the problems that unemployment brings, it also loses out
on the extra tax revenues it would have received had the unemployed
been working instead.
In addition to these financial implications, society has lost out on a vast
amount of goods and services that would have been produced if everyone
had been working. These extra goods and services would have enhanced
the standard of living and contributed to government popularity. Think
about the production possibility frontiers at this point.
Unemployment affects everyone, not just the unemployed. Think of the
opportunity cost and the effects on income tax if there was less
unemployment. Or, consider how tax revenues could be switched to
reducing the length of hospital waiting lists and teacher-pupil ratios.
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Exchange rates
A high exchange rate means imports are relatively cheaper and exports
are relatively more expensive. If imports are cheaper, then firms face lower
costs of production (for example, cheaper raw materials) and this may be
good for reducing cost push inflation. But, cheaper imports and more
expensive exports may be bad for businesses that are competing in the
world marketplace and reduced demand for domestically produced goods
could lead to unemployment. A low exchange rate means imports
become relatively more expensive and exports become relatively cheaper.
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GDP: gross domestic product is the value of all the goods produced
within a countrys borders by domestic firms.
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income method
expenditure method
output method.
an innovative approach
Put these factors together for your country and compare the result with the
combination of factors enjoyed by the Germans, French and Japanese.
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Spending
Labour
Wages
Goods and
services
Firms
Firms produce goods and services, which they sell to households. The
households supply labour and other factor inputs like land and capital to
firms in return for income, which they then spend on the output produced
by firms. In this example, quite clearly we can identify that:
Income = Output = Expenditure
There is no pressure for national income to change. The money just
continues to flow around the economy. This simple diagram also suggests
that there are three different methods of calculating national income:
income method, output method and expenditure method. All should give
the same answer, since they are just alternative ways of looking at the
same thing.
If we begin to make the model more realistic by accepting that consumers
save, buy imports and pay tax, we can include the role of financial
institutions, the government and international trade. This can be
demonstrated in Figure 6.3, which has a number of important points to
examine before we begin to tie up the loose ends of the circular flow.
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Households
Spending
Income
Firms
Government spending
Investment
Exports
investment expenditure
government expenditure
export expenditure.
savings
taxation
import expenditure.
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Summary
In this unit, we have introduced the macroeconomy and the clear idea that
much of what happens in the economy is interconnected, and that there
will always be a number of important consequences for any given change
in government policy. You should have a reasonable grasp of the
interdependence of the governments economic objectives. The next unit
will build upon this introductory work and extend our understanding of how
different economists believe that the governments objectives should best
be achieved.
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Sales 20,000
Wages 10,000
Profit 10,000
Sales 16,000
Wages 8,000
Profit 8,000
Sales 50,000
Wages 15,000
Profit 15,000
Wheat 20,000
Sales 36,000
Wages 10,000
Profit 10,000
Iron ore 16,000
Bakery
Sales 170,000
Wages 40,000
Profit 80,000
Flour 50,000
Oven Factory
Sales 70,000
Wages 24,000
Profit 10,000
Iron 36,000
output method
income method
expenditure method.
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References
Noble, J. and Wigglesworth, R. (2015) China seeks to allay renminbi slide
fears. Financial Times, 12 August. http://www.ft.com/cms/s/0/8405dc0440a0-11e5-9abe-5b335da3a90e.html. Accessed 8 August 2015.
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Unit 7:
Evaluating Government
Economic Policy
Key reading:
1. Begg, D. and Ward, J. (2013), Chapters 11, 12 and 13
Other:
1. Unit 7 lecture slides and audio (Blackboard > Module Site > Module
Materials > Unit 7 > Lecture slides and audio)
2. Unit 7 multiple-choice questions (Blackboard > Module Site > Formative
Exercises > Multiple-Choice Questions > Unit 7) Activity 7.10
3. Unit 7 live online tutorial (Blackboard > Module Site > Collaborate)
Activity 7.11
4. Unit 7 marked formative assessment (Blackboard > Module Site >
Formative Exercises > Marked Formative Assessment > Unit 7)
Activity 7.12
Introduction
Regulating the macroeconomy is based on a firm belief that governments
are best placed to intervene in the running of the economy. Obviously, this
is a controversial view in its own right, and some economists argue that
the economy is best left alone to be regulated by the market. Whatever
your view, governments do play an important role in regulating the
economy in order to achieve their stated objectives.
In this unit, we examine the government policies that are used to regulate
the economy. We assess how realistic the theoretical arguments are likely
to be in practice. We start by developing the Keynesian model of how the
economy works and discuss some of its limitations. We move on to
examine how the government can use a combination of demand and
supply side policies to best manage the economy. This will require the
introduction of an aggregate demand and supply framework so that we
can assess the impact of government policy.
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Objectives
By the end of this unit, you should be able to:
investigate the Phillips curve and how its apparent breakdown with
stagflation gave support to the monetarist criticism of the Keynesian
approach to managing the economy
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At point yx, the planned injections and planned leakages are in equilibrium.
There will be no pressure for national income to change. At yz, planned
leakages exceed planned injections and at yy, planned leakages are less
than planned injections.
Consider point yz in more detail. Planned leakages are greater than
planned injections. Remember planned injections are drawn as a
horizontal line since the injections are assumed autonomous. If planned
leakages exceed planned injections, there will be less total expenditure in
the economy on goods produced by domestic firms. Firms find that they
sell less and their stocks of unsold goods start to accumulate, with firms
investing in effect in their own stock. Firms react to this situation by laying
off workers and so national income starts to fall. As national income falls
so does the ability to save, pay tax and buy imports. Income will fall until
the planned injections are equal to planned leakages again at point yx.
Keynesians point out that the economy has returned to equilibrium but that
this equilibrium has a level of unemployment attached.
Pre-Keynesians believed that unemployment would only occur if there was
a situation of disequilibrium. For Keynesians, equilibrium occurs when
Total planned expenditure = Total income/output
And when
So, what is the main idea here? This demonstrates that Keynesians
believe that national income changes to restore equilibrium in the
economy but that this equilibrium can have a level of unemployment
attached. Therefore, if left to its own devices the economy does not give
full employment, and it becomes the governments responsibility to
intervene.
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If you can answer these three questions then you are already some way
towards understanding the next part of the Keynesian model. At yy the
planned injections exceed the planned leakages in the economy. Spending
increases, firms find their stocks become depleted so they take on more
workers to increase production. National income increases and so does
the ability to save, pay tax and buy imports. National income will increase
until the planned leakages are equal to planned injections and the
economy is back in equilibrium at yx.
If unemployment exists at yx and we want it to fall then the government
should increase autonomous injections until we have full employment
equilibrium at yfe. This is demonstrated in Figure 7.2.
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The multiplier
The increase in government expenditure will increase national income by
an amount greater than the value of the injection. The multiplier stems
from the idea that if the government injected 40 million, say, by giving the
unemployed lots of money, then they would spend it which creates income
for someone else which is spent etc. If the governments injection raised
national income by 200 million, then the multiplier would be 5.
Injection times multiplier = Change in national income
40 million 5 = 200 million
If the government knew the size of the multiplier and the increase in
national income required, then it would know how much to inject. However,
this is easier said than done! The multiplier raises national income by an
amount that will generate additional leakages so that planned injections
equal planned leakages again at equilibrium.
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interest, but this might reduce private sector investment if interest rates
increase too much (financial crowding out).
2. What would happen if a lot of the extra spending in the economy goes
on imported luxuries from abroad? The extra jobs made available by the
injection may be created in foreign countries as a result. In the UK, for
example, there is a high marginal propensity to import; consumers
spend a lot of the countrys increasing income on imported goods.
3. What would happen if in the face of higher domestic demand, firms
cannot increase output quickly enough? The result would be inflation.
Firms might not have sufficient spare capacity to increase output and
may not be willing to undertake the extensive investment required to
meet the new demand unless they have the expectation that the new
level of demand will be long term and sustained.
4. There are crude elements in the Keynesian tools themselves. Working
out the amount to inject, understanding the extent of time lags and the
general difficulties of gathering up-to-date and accurate statistics mean
that the goalposts keep changing.
5. In a dynamic world economy, the success of domestic government
policy relies on the co-operation and complementary policies of
international competitors and trading partners.
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expansionary policy
reduce taxation or increase government expenditure
decrease interest rates in the economy
contractionary policy
increase taxation or reduce government expenditure
increase interest rates in the economy.
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Monetary policy
Monetary policy generally involves:
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Retail deposits
Wholesale deposits
M4
65bn
1472bn
574bn
2106bn
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risk selection deciding who to lend money to, and monitoring the
risks taken through regular screening
Many regulatory issues are raised, especially given banks are able to
create money and that lending to failed projects can exposed depositors
to risks of losing their money. The financial crisis, and bank funding of
subprime loans, meant many savers suffered exactly the loss of funds that
they should be protected against.
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raising the interest rate, so that the market then determines supply.
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Balanced budget
Budget surplus
Budget deficit
National debt
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Consider Figure 7.6. The aggregate demand curve, AD, gives the total of
all goods and services demanded at various price levels. Put another way,
the AD curve shows the relationship between the total amount of
income/output that will be purchased and the price level. The AD curve
slopes in the way that it does for three main reasons.
1. The interest rate effect. This suggests that as prices increase the
interest rates in the economy will increase since all lenders will have
add an inflation premium to the loan to compensate for the loss in real
value of the loan. As interest rates increase, the demand for interestsensitive goods will fall. Hence, there is a reduction in income/output.
2. The wealth effect. Inflation reduces our purchasing power and we feel
less wealthy. We respond by spending less, which reduces
income/output.
3. Substitution of foreign goods. The more inflation in an economy, the
less competitive the economys goods become vis--vis foreign
competition. Consumers switch from domestic to international
producers. This reduces domestic production, and GDP falls.
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If the government decides to expand demand, you can see the effect on
the economy in Figure 7.9.
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The increase in AD shifts the demand curve to the right. This has the
effect of increasing national income/output and hence employment but at
the expense of higher prices. Whether the reduced unemployment is worth
the higher prices is difficult to establish.
If the government decides to go for supply side policies then this picture is
changed somewhat.
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Note that the national income/output has shifted to the right; hence, there
is greater employment which has resulted from a more efficient supply of
goods and services. There is reduced unemployment without inflation. Is
this too good to be true? Possibly, say the Keynesians. What if the
problem in the economy is mainly lack of demand, as in a recession; who
will buy the output? Keynesians suggest an integrated approach that uses
both supply side and demand side together. Consider such an approach
by expanding demand as much as supply will allow. This is shown in
Figure 7.11.
Figure 7.11: Supply and demand side
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Note that the new AD2 and AS2 gives a greater income/output but without
inflation. The new income/output is y2. But lets now deepen the analysis
still further. Consider the three scenarios described in Figure 7.12.
1. A situation where there is substantial spare capacity in the economy.
2. The intermediate zone, where some spare capacity exists.
3. A situation where no spare capacity exists.
Figure 7.12: Aggregate supply curve and spare capacity in the economy
In the section of the diagram where substantial spare capacity exists, firms
would find it easy to increase supply to meet increasing demand resulting
from expansionary government policy. This increase in income/output
would reduce unemployment without creating inflationary pressure. This
can be seen clearly in Figure 7.13. If there is little or no spare capacity in
the economy, then supply is very inelastic. An increase in aggregate
demand would lead directly to inflation since firms increase prices rather
than output. If this situation existed in the economy, the Keynesian
approach to unemployment would be unsuccessful.
The intermediate zone is perhaps the most realistic situation for the
economy to be in. Here spare capacity exists for some firms and
industries, while other firms and industries are at full capacity. Expanding
demand would lead to an increase in income/output and employment. It
would also lead to some inflation.
Figure 7.13 suggests that the governments demand side success is very
dependent on firms abilities to increase output. If supply side policies are
used in the economy, then the supply of output at every price will move to
the right. This is shown in Figure 7.14. Note that the new AS2 joins the
previous AS1 in the area where no spare capacity exists.
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The final diagram in this model (Figure 7.15) brings the demand and
supply side policies together. Pay particular attention to the intermediate
area. If you ignore for a moment the other parts of the diagram, do you
find something familiar about what is left? You should notice that the
intermediate zone is the same as the basic AD and AS diagram in
Figure 7.8.
If demand side policy is to be used, it should be in conjunction with supply
side policy. Perhaps the government could target expenditure at areas of
the economy in which substantial spare capacity exists. In addition, since
imports will inevitably increase as incomes go up, government expenditure
could be targeted at export firms to avoid balance of payment difficulties.
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Summary
In this unit, we have only touched on a number of issues that need
considering when examining how the government can influence economic
activity in the economy. You should now be developing an understanding
of how the Keynesian model of income allows an explanation of both
unemployment and inflation. The role of changing national income is
fundamental to an understanding of why Keynesians identify a role for
positive government intervention in the economy. We have also examined
the use of fiscal and monetary policy and some of the issues surrounding
each of these policies. Understanding demand side and supply side
policies becomes crucial to an understanding of how modern economists
approach the task of achieving economic objectives.
In Unit 8, we focus upon the UK and its role in the international
marketplace.
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References
Donnan, S. (2015) US economy: The case (in charts) for optimism.
Financial Times, 5 June. http://www.ft.com/cms/s/0/6985393a-0b92-11e58937-00144feabdc0.html#axzz3iu16FL1r. Accessed 8 August 2015.
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Unit 8:
Economics of the
Global Economy
Key reading:
1. Begg, D. and Ward, J. (2013), Chapters 15 and 16
Other:
1. Unit 8 lecture slides and audio (Blackboard > Module Site > Module
Materials > Unit 8 > Lecture slides and audio)
2. Unit 8 multiple-choice questions (Blackboard > Module Site > Formative
Exercises > Multiple-Choice Questions > Unit 8) Activity 8.12
Introduction
It is impossible to talk about a countrys economic well-being and future
prosperity without setting it into the context of the global economy.
International competition, multinational enterprises, trade agreements and
the drive for integration have immeasurably changed the economic
landscape. Our aim is to put many of these issues into focus, and to
develop an understanding of many of the key concepts in the international
economy the balance of payments, exchange rates and comparative
advantage. We move on to show the benefits to be gained from
international trade and the cost of protectionist policies. Further, we go on
to question the extent of international trade and globalisation. Is it really as
far reaching as we think? Finally, we assess the importance of these
issues for the future competitiveness of the economy and firms in general.
Objectives
By the end of this unit, you should be able to understand:
terms of trade
how exchange rates are determined and the influence they exert on the
economy
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Balance of payments
Read: Begg and Ward (2013), Chapter 15, pp.382385
The balance of payments is the difference between a countrys imports
and exports. It is helpful to consider where the money goes in establishing
whether a payment is for an import or an export.
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The investment earnings and transfers takes into account the net
earnings arising from overseas assets owned plus the transfer of funds
to and from the UK.
Terms of trade
The terms of trade are defined as the average price of exports divided by
the average price of imports expressed as an index. If the terms of trade
rise (export prices rising relative to import prices), they are said to have
improved, since fewer exports now have to be sold to pay for imports.
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If we now put the demand and supply of pounds together we are able to
determine the exchange rate. This is shown in Figure 8.3.
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If British goods become very fashionable in the US, then there would be
an increase in demand for pounds. The demand curve would shift to the
right. This would cause the exchange rate of the pound to increase. The
exchange rate increases from p1 to p2. This is shown in Figure 8.4.
Figure 8.4: Increase in demand
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The Americans demand less pounds. The demand curve for pounds shifts
to the left. This reduces the exchange rate of the pound and the price of
pounds decreases from p1 to p2 as shown in Figure 8.5.
Figure 8.5: Decrease in demand
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160
would just keep on demanding them because the exchange rate wont
change it is fixed. In this situation, the UK would run into balance of
payments difficulties. The exchange rate would not fall as it would with a
floating exchange rate system, so the government would need to intervene
to maintain the value of the pound. The government would do this by
buying up any excess pounds on the foreign exchange market, so
reducing UK reserves of foreign currency. This could not carry on
indefinitely since eventually the UK would have no foreign currency
reserves left. If the situation persisted, the government would have to bring
in expenditure reducing or expenditure switching policies.
EMU timetable
1 January 1999 establish fixed exchange rates between currencies and
a single monetary policy to be framed and implemented by European
System of Central Banks (ESCB).
1 January 2002 ESCB put euro notes and coins into circulation and
withdrew national banknotes.
1 April 2002 The changeover to the euro was completed. The
independent European Central Bank and the ESCB took over
responsibility for monetary policy and interest rates.
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Freedom would still exist in fiscal policy and member states could
pursue independent budgetary policies.
One fit monetary policy limited given a continuing business cycle and
structural disparities between EU members.
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The removal of tariffs alone may give an impression of a free market but
various tax differences may provide equivalent distortions.
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Can the UK afford not to be a member of the full EMU since it has gone
ahead anyway?
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Multinational corporations
Read: Begg and Ward (2013), Chapter 16, pp.413425
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Summary
In this unit, we have outlined how all economies benefit from international
trade. It is easier to see the advantages when countries have an absolute
advantage. It is more difficult, but still true, when we use the principle of
comparative advantage. You should have demonstrated how comparative
advantage works and discovered a real sense of achievement since it is a
difficult concept to explain. Firms and industries that rely on international
trade are affected significantly by the exchange rate and we have
examined what determines the exchange rate and how the exchange rate
influences the demand and supply for imports and exports.
In addition, we can identify trends in world trade and understand the
growing reliance on trade within the EU.
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References
Jones, C. (2015) Mario Draghi casts himself as guardian of monetary
union, Financial Times, 16 July. http://www.ft.com/cms/s/0/6ed110be2bd9-11e5-8613-e7aedbb7bdb7.html - axzz3j5r6YvEd.
Accessed 8 August 2015.
Beattie, A. (2015) Free Lunch: Trans-Pacific opacity. Financial Times,
27 May. http://www.ft.com/cms/s/3/afd460bc-fe38-11e4-be9f00144feabdc0.html#axzz3iu16FL1r. Accessed 8 August 2015.
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Unit 9:
Revision and Assessment
Key audio/video:
1. Concluding MBA Business Economics (Blackboard > Module Site >
Module Materials > Unit 9) Activity 9.1
Other:
1. Unit 9 live online tutorial (Blackboard > Module Site > Collaborate)
Activity 9.2
This module has introduced you to key economic ideas and then related
them to business. Economics is split into two areas: microeconomics and
macroeconomics. Microeconomics covers markets and competition;
macroeconomics covers the economy level topics such as inflation, GDP,
interest rate policy and fiscal policy.
In terms of assessment, microeconomics and macroeconomics are
covered by written assignments. You will find the assignment questions on
Blackboard during December. Guidance on answering economic
questions is also provided. Further information relating to a summary of
the module and approaches to answering economics questions can be
found in the talking head video.
169
of the tutorial (Blackboard > Module Site > Module Materials >
Collaborate). Your tutor will also go through some of the basic issues that
you need to address in the assignments. In order to get the most out of the
session please ensure that you come prepared with any questions or
queries that you may have.
Question 1: How does the change in exchange rates impact upon the
industry in question?
Question 2: How might this change in the exchange rate affect the growth
of the country being studied?
Question 3: How do changing exchange rates impact on your business
and what steps can you take to minimise risks?
Your tutor will also go through some of the basic issues that you need to
address in the assignments. In order to get the most out of the session
please ensure that you come prepared with any questions or queries that
you may have.
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Appendix A:
Module descriptor
Module Title: Business Economics
Module Credit: 10
Module Code: MAN4100M
Academic Year: 2015/6
Teaching Period: September intake programmes
Module Occurrence: A
Module Level: FHEQ Level 7
Module Type: Standard module
Provider: School of Management
Related Department/Subject Area: School of Management
Principal Co-ordinator: Dr Simon Rudkin
Additional Tutor(s):
Prerequisite(s): None
Corequisite(s): None
Aims
To educate students in the workings of the market environment within
which organisations operate. To provide students with the opportunity to
use and apply economic concepts, constructs and frameworks in support
of business problem appraisal and decision-making. To enable students to
critically evaluate business problems and collect data in the construction
and presentation of appropriate business solutions.
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Study hours
Lectures:
Seminars/Tutorials:
Laboratory/Practical:
0.00
0.00
0.00
Learning outcomes
1. Knowledge and understanding:
On successful completion of this module you will be able to...
a) Analyse how markets work and how market forces affect organisations,
including an understanding of micro level market forces and competition
and macro level effects stemming from national and international
economic policies and changing business environments.
2. Subject-specific skills:
On successful completion of this module you will be able to...
a) Apply economic concepts to economic sectors or industries in order to
enhance your understanding of opportunities and threats in those
sectors or industries;
b) Analyse economic business problems, collect data and construct
business assessments;
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Mode of assessment
Assessment type: Coursework
Percentage: 100%
Description: Individual assignment (2,000 words)
Supplementary assessment
As Original.
Outline syllabus
Scarcity and choice. Resource allocation and markets: demand and
supply/cost analysis; intervention in markets. Market structure and
competition: structure, conduct and performance of companies and
markets; market concentration and public competition policy. The
determinants of national output/income and fluctuations in growth rates.
Key economic variables: output, employment and inflation. Government
fiscal, monetary and supply-side policies. Exchange rates and the balance
of payments. Globalisation, international trade and international
investment.
Version No: 8
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Appendix B:
Model Answers to
Activities
Unit 1
Activity 1.2
At point a, where all resources are used to produce capital goods there will
be an extremely unhappy electorate with little choice of home-produced
consumer goods to purchase. Consumer goods would have to be
imported; in short, a very unbalanced economy would occur. At point b,
there are consumer goods galore. A materialists paradise! But if all the
resources are used to produce consumer goods, then what will be used to
produce capital goods when current machinery becomes worn out? Can
the country import all the capital goods it needs? Would that provide a
balanced economy?
The answer to question 2 is inconclusive. It is not really possible to say
which is the better combination; they are both theoretically as good as
each other. No information is given regarding the quality of the capital and
consumer goods vis--vis the foreign competition. More resources may be
allocated to a sector either because it is extremely efficient or to make up
for its relative weakness.
Activity 1.3
Question 1: Diminishing marginal returns mean that as more of a
particular good is produced the process is less efficient and more units of
the other product must be given up to allow a unit increase in output. For
example, land can be used to graze cattle, but who will produce fertiliser
for crops. With only cattle the land never gets chance to recover in the
same way and so is less use for cattle as well. Similarly if the land is only
used for crops, the crops slowly suck nutrients from the soil and
production becomes harder. By combining the two outputs the economy
can produce more of each item and rotate fields to keep them productive.
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Unit 2
Activity 2.1
Scenario 1: If there is an increase in the price of a complementary good,
then the demand curve will shift to the left. In Figure 2.3 this is a
movement from D2 to D1. This is because the complementary good will be
demanded less at the higher price and, since the products are jointly
demanded, your product will face a reduction in demand as a result.
Scenario 2: If there is a decrease in the price of a substitute good, then
the demand curve for your product will shift to the left since consumers will
purchase the cheaper substitute product instead. This is a movement from
D2 to D1 in Figure 2.3.
Scenario 3: If there is an increase in consumer incomes, then we would
expect the demand curve to shift to the right since consumers can afford to
purchase more of your product at every price. For a normal good, this is a
movement from D1 to D2. However for an inferior good, the demand curve
for your product would switch to the left as consumers use their higher
incomes to purchase alternative products. This is a movement from D2 to
D1 in Figure 2.3.
Scenario 4: If there is a brilliant advertising campaign by your main
competitor, then your demand will shift to the left. This is a movement from
D2 to D1 in Figure 2.3.
Scenario 5: If your product is decreased in price, then you will experience
an extension of demand. This means there will be a movement along the
original demand curve itself. See Figure 2.1. Price is a movement along
the line, all other factors, such as substitutes, income, etc, are movements
of the line.
Activity 2.2
When the demand curve is in the elastic region, a decrease in price will
increase total revenue. Note how in this region the total revenue is
increasing. When the demand curve is in the inelastic region, a decrease
in price leads to a decrease in total revenue. When we have unitary
elasticity, the total revenue will remain constant.
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Activity 2.3
Question 1: Relate income elasticity to a product/market of your choice.
Question 2: Price inelastic; unitary price elasticity; price elastic demand.
Question 3: Examples of products with close substitutes.
Activity 2.4
Question 1: Razors and blades, games consoles and games, train travel,
electricity.
Question 2: First degree.
Question 3: First degree extracts the greatest consumer surplus, but is
unlikely to be profitable. It would be very difficult to organise and
consumers may not wish to participate in such a market.
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20
40
60
80
100
Demand Functions
1200
1000
800
BE
600
TB
TE
400
200
0
0
20
40
60
80
100
Task 2: Business class for business is the least elastic, while the economy
class demand from tourists is the most elastic. This is because quite often
business class travellers must actually make the journey as a means to an
end. Tourists, by contrast, might like extra comforts of business class but
their willingness to pay is constrained. Low prices in economy can tempt
passengers to fly, and this is the lowest priced set of tickets offered.
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20
40
60
80
100
A similar imposing of the consumer surplus triangle onto the TE graph will
give the second part of the answer. Although the total surplus is much
smaller it still means there will be a large number of consumers who feel
they have got a good deal.
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Task 5: This question features two parts and relates to the demand data
from Table 2.
(a) Weekends are always more popular as children are not at school and
it is easier to book a solid week off work. With a greater potential
demand prices will be higher. It is also possible that other events
cause weekend demand, and any well-reasoned argument is
welcomed here.
(b) This is an example of third degree price discrimination because
passengers are being differentiated by the day that they want to travel.
There is no difference in quantity, which is always one ticket, and as
such there is no opportunity for first, or second, degree price
discrimination here.
In reality airlines use frequent flyer rewards as a means to obtain seconddegree discrimination and get someway towards first-degree. There are
also revenue management models in place, which mean that if you were
to check the prices today you could find they are lower (not enough people
on the plane) or higher (the plane has limited-to-no seats left).
Task 6: Again this task has been split into subparts for consideration.
(a) Manchester to Dubai in first class may suffer a little bit if passengers
choose to travel to Heathrow to board the rival flight. However, if the
appeal of the regional airport is that there is no need to travel to
London, then there will be very limited effect. Manchester to Dubai and
London Heathrow to Abu Dhabi are not strong substitutes.
(b) London Heathrow to Abu Dhabi is a much closer substitute for the
London Heathrow to Dubai route and so there will be a lot more
competition faced. Emirates would look to dampen this by talking
about the other facilities offered, such as the on-board spa. It may also
talk of the convenience of having more flights.
(c) Economy class tickets are a more competitive market as passengers
are often looking for the lowest price. Here again Emirates will seek to
create differentiation. However, it should also be noted that for those
who are closer to Manchester, the extra cost of getting to London
might make the new Abu Dhabi flight less of a substitute. Etihad, as
sponsors of Manchester City football club, also has flights into
Manchester, which would be more of a substitute.
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Unit 3
Activity 3.1
Question 1:
Labour
Total product
Average
product
Marginal
product
10
10
10
24
12
14
42
14
18
56
14
14
70
14
14
72
12
Activity 3.2
Output
Fixed cost
200
200
200
200
400
200
300
500
200
600
800
200
1,200
1,400
200
2,200
2,400
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Total cost
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Activity 3.3
Question 1:
Total
output
Fixed
cost
Variable
cost
Total
cost
Marginal
cost
Average
cost
10
10
10
12
12
10
12
22
10
11
10
20
30
10
10
26
36
10
30
40
10
32
42
10
39
49
10
54
64
15
10
71
81
17
10
10
90
100
19
10
Question 2:
Output
TFC
TVC
TC
AFC
AVC
AC
MC
40
40
40
46
40
46
40
11
51
20
5.5
25.5
40
15
55
13.3
18.3
40
20
60
10
15
40
26
66
5.2
13.2
Question 3:
Output
Price
TR
MR
FC
VC
TC
MC
Total
profit
10
10
10
10
+1
10
20
10
15
17
+3
10
30
10
24
26
+4
10
40
10
34
36
10
+4
10
50
10
53
55
19
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Activity 3.4
Question 1: New plant construction and associated planning permissions,
the creation of necessary networks and the set-up of new suppliers will all
be fixed costs that will be sunk before any production can take place. Land
and machinery might have resale value and so these two are merely fixed
costs.
Question 2: Variable costs will fall as a result of the move because there
is no shipping of finished trains from Japan. Components may be cheaper
or more expensive depending on the relative cost of buying in Japan and
shipping to Europe against the cost of sourcing in Europe.
Question 3: Nissan runs its car plant with high variable costs, importing all
of the items needed to assemble the finished car. Hitachi does not have
these shipment costs and so can enjoy lower variable costs.
Question 4: In this case the demand for trains picks up as the economy
picks up and the ridership increases. In the UK there was a long period of
not ordering new units in the period surrounding rail privatisation, but that
was a unique time. For Hitachi its investment indicates a confidence that
the initial order for the IEP and the ScotRail order are only the first of
many. Should there be a downturn then the company will be left with a
plant that is underutilised and not generating any payback on the large
fixed costs. Whether Hitachi goes past the shutdown point is questionable,
but it is usually considered that keeping the fixed cost base small in
cyclical industries is wise.
This case actually opens up a discussion about government funding and
the role that the state plays in making sure people can travel during times
of economic downturn. Such questions are avoided here.
Activity 3.5
Situation 1: If there is an increase in the cost of raw materials, the supply
curve will shift to the left since it now costs more to supply each unit of
output at each price.
Situation 2: If there is an increase in the price of the product, then there
will be an extension of supply on the original supply curve.
Situation 3: An increase in productivity will cause a shift in the supply
curve to the right since more can be supplied at every price than before.
Situation 4: An increase in wages causes the supply curve to shift to the
left since it now costs more to produce each unit of output than it did
before.
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Activity 3.6
An example that could be given to outline this situation at work is a
scenario in which house prices are increasing rapidly. In the initial period
the market supply has great difficulty in adapting much and the price of
rented accommodation will remain high. In the short term, there is a little
more flexibility since extra rooms may be made available for rent by letting
parts of large houses or taking in lodgers. In the longer term, landlords will
enter the market and adapt houses for renting and new housing may be
made available, which gives the consumer more choice. The supply curve
will become steadily more elastic as the time period becomes longer.
Activity 3.7
Consider fixed and variable inputs in the short run; ability to expand all
inputs in the long run.
Activity 3.8
Figure 3.10 summarises how economies of scale should work in theory. At
first, the expanding firm will experience economies of scale. After it
reaches a certain size, the firm will experience constant returns and after it
has grown larger it will find that the diseconomies of scale become far
more significant. Figure 3.10 is a simplified diagram and should only be
used as a starting off point. Figure 3.11 is a more detailed and informative
diagram.
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Output
TFC
TLC
TMC
TVC
TC
AFC
AVC
ATC
MC
50
50
50
25
33
83
12.5
8.25
20.75
8.25
10
50
50
20
70
120
12
6.2
13
50
75
26
101
151
3.8
7.8
11.6
10.3
15
50
100
30
130
180
3.3
8.7
12
14.5
16
50
125
32
157
207
3.1
9.8
12.9
27
Working out the above table is not easy, particularly the last column where
we work out the MC. You do this by dividing the change in total cost by the
change in output.
Question 3: This is a fairly searching question. You have done well if you
completed the table in less than ten minutes.
Output
TC
MC
ATC
AFC
AVC
TVC
114
57
27
30
60
142
28
47.3
18
29.3
88
189
47.2
47.3
13.5
33.8
135
258
68.8
51.6
10.8
40.8
204
358
100
59.7
50.7
304
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Unit 4
Activity 4.1
See Begg and Ward (2013), section 4.6.
Activity 4.2
An increase in demand for doctors requires a substantial increase in
wages in order to attract a small increase in the number of doctors. This is
because doctors are relatively inelastic in supply and many years of
training are required before an individual can qualify as a doctor. A nurse is
also a skilled worker, but the wage increase is smaller since nurses can be
trained on the job and, therefore, more people can quickly enter the
market for nursing. Nurses are relatively elastic in supply vis--vis doctors.
Activity 4.3
This activity hinges entirely on the fact that a subsidy is a negative tax. So
where the taxes in the notes cause the supply curve to shift left, a subsidy
will cause it to shift right. By introducing the subsidy the government is
enabling suppliers to bring their goods to market at a lower price than they
otherwise would have done.
Question 1: In this case a subsidy is applied to the price. This causes
supply to shift right with the difference at every quantity being equal to the
per unit subsidy.
To illustrate this we assume that the subsidy is 100 and that the original
price was 2000. The quantity of solar panels installed at this price is
5000. When the subsidy is implemented the quantity rises and the price
falls, we shift right along the existing demand curve. The new price is
1980 and the new quantity 5400. This means that there will be more solar
panels in operation, good news for the environment, and that consumers
will be paying a lower price. Consumer surplus increases, which is good
news for the economy. We do not know whether profit increases, but
certainly 80 from the subsidy is not being passed on to the consumer.
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Question 2: Here we use the same diagram but show what happens
when the demand curve becomes more inelastic. To make the illustration
we zoom in on the interesting area around the equilibrium. One of the
Figure 7: Elasticity and the subsidy in the double-glazing market
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great features of the diagrams is that they can be drawn with no intercepts
so there is no need to worry about scale relative to zero.
Figure 7 shows the results as demand becomes increasingly inelastic the
reduction in price becomes larger, but the gain of quantity becomes
smaller. However, in all cases the subsidy is effective at increasing the
quantity.
Question 3: For this question we just use the information to calculate that:
Activity 4.4
This relates to the Harvard Business Review article The 3D Printing
Revolution. This considers the effect 3D printing is having on markets.
Question 1: 3D printing allows firms to reduce their fixed costs as it is
more flexible than the traditional injection moulding technique; the same
printer can make any number of products while moulds must be tailored
for the precise details of the product. There is also a slower printing
process to consider, and this will also raise the cost of each unit. Overall
variable costs rise and the supply curve will shift to the left. Prices will rise
and the quantity will fall. This corresponds to Figure 4.5 in the main text.
Question 2: 3D printing is heralded for its ability to create a product that
can be easily tailored to customers needs. As a result demand is likely to
rise as the product will make each customer happier, and therefore willing
to pay more. An increase in demand will cause the quantity to go up, as
well as the price. Whether the increased quantity is enough to cancel out
the lower quantity from the supply shift is questionable, and is something
that any good answer should discuss. Ultimately it will depend on the size
of the shifts and the elasticities of the curves.
Question 3: As supply becomes more inelastic the change in price
becomes smaller for any given vertical shift of the curve.
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Unit 5
Activity 5.1
The firm is making a loss since D = MR = AR is below AC when MC = MR.
Firms will move out of the industry and so the supply curve S2 will shift to
the left. This will cause an increase in market price and the price will
increase until the surviving firms are making normal profit.
Activity 5.2
Perfect competition is not very realistic. The problem with the assumptions
is that they all need to be true at the same time for a market to be perfectly
competitive. Clearly, consumers dont have perfect knowledge and
freedom of movement from seller to seller is not as straightforward as it
might sound. However, the theory is still extremely useful because it allows
an economist to compare other kinds of market structure with a market
operating free of imperfections. We are able to make meaningful
comments about monopoly power, pricing and output decisions, efficiency
and profit, if we have a yardstick to compare them with.
Activity 5.3
The monopolist is neither productively or allocatively efficient. The
abnormal profit earned by the monopolist in both the short and long run is
paid for by the consumer.
Activity 5.4
In this activity you are expected to discuss the issues surrounding the
Eurostar investment by the United Kingdom, French and Belgian
governments.
This was a large investment in a market of which no one truly knew the
size. Competing with airlines and cross channel ferries meant that rail
would have a battle to establish itself. Eurostar invested heavily in
promotion as well as helping the governments pay back the initial
infrastructure investment. By enabling an operating profit there was money
available to pay back these fixed costs.
Had the governments permitted competition then no company may have
been able to get past the short-run shutdown point and then there would
have been no return on the significant investment of building the tunnel.
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Activity 5.5
There are many ways of competing on a non-price basis: location,
sidelines, advertising, free gifts, special offers, happy hours, opening
hours, loyalty cards, product range, diversify product into top, mid, bottom
of range, etc.
Activity 5.6
Question 1: Supermarkets have power in the market when dealing with
suppliers, indeed this has caused a large amount of concern around the
world because many believe that this power is wielded too much. However
from the perspective of the consumer being able to obtain lower prices,
and impose standards, it is welcome.
Supermarkets also need to compete with each other and attract customers
to their marketplace. This means they offer low prices and better facilities
to make shopping easier. By contrast perfectly competitive stores are
compelled to take market size as given and so will not try to attract
consumers. This is something which is the subject of a large literature,
including Rudkin (2014) amongst others.
A wide academic literature studies supermarket competition both
theoretically and empirically, with supermarkets often shown to offer higher
utility to their shoppers than other retail formats. An empirical set of papers
consider these results and what they mean for health, access to fruit and
vegetables.
Question 2: Clearly the public in the article like supermarkets, but there
are many consequences of allowing supermarkets to grow unchecked.
Easier access to imports might make shoppers happy, but there are
knock-on effects for domestic suppliers that lose market share and for the
employees who work at those firms. Cheaper goods can mean people
consume more of what they like, this can just as easily be high fat snacks
as fruit.
In the developed world there was often a two-tier system in which the
more wealthy had access to the big format stores, while the poorer
neighbourhoods were left with no real access to supermarkets. This has
been addressed in the latest wave of development, but is something which
can have lessons for the developing nations.
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Again there is a large literature for those who are interested, but certainly
we should not just look at prices and product ranges when deciding if a
retail format is good, or whether market growth should be encouraged.
Reference
Rudkin, S. (2014) Supermarkets versus local shopping: Welfare
implications of provision mode. Economics Letters, 124(3): 396398.
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Unit 6
Activity 6.1
Where does the money come from that is injected into the economy?
What if the increase in spending is on imported goods? What if supply
cannot keep up with the increased demand in the economy?
Activity 6.2
A low exchange rate increases the price of imports and reduces the price
of exports. Exporters are pleased because they find it easier to compete in
the world marketplace. Domestic producers are happy in that they can
now compete more favourably with imported substitute goods. But, the
firms that rely on imported raw materials face an increase in their costs
and this could fuel inflation. In addition, there will be an increase in the
price of imported food and this would add to inflationary pressure.
Generally, however, the low exchange rate should move the balance of
payments towards a surplus.
Activity 6.3
Question 1: A country enjoying economic growth has several advantages:
firms are doing well from high consumer spending, giving them the
profitability to carry out future investment
Underdeveloped countries feel that no matter how quickly they grow, they
only fall further and further behind in comparative living standards. This
can be explained using a numerical example.
Country A: National income = $100 billion
Country B: National income = $5 billion
Country A: Economic growth = 2%
2% of $100 billion = extra $2 billion increase in national income
Country B: Economic growth = 10%
10% of $5 billion = extra $500 million increase in national income
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Question 2: In the first part of the essay, briefly outline the main economic
objectives and briefly explain why each is important. For the second part
of the essay, take a scenario such as high unemployment and outline how
tackling this problem may lead to other problems, such as inflation and the
balance of payments imbalances.
Activity 6.4
Question 1: By helping its domestic firms to export more China is
increasing the amount of funds flowing into the economy. Also by
devaluing its currency, the renminbi (RMB) will buy less units of other
currencies. For example Burberry has reacted to the news by reducing the
size of its Chinese operation, noting that the same RMB price now means
it is selling for fewer pounds. This means fewer imports. Exports are
injections into the flow and imports are withdrawals. Increasing the former
and reducing the latter mean there will be more funds circulating in the
Chinese economy.
Question 2: Injections into the circular flow can also be achieved through
promoting investment and government spending. China has long had
policies to achieve both of these, with infrastructure to reduce the cost of
business being a major focus of policy. Withdrawals also include taxation
and savings, so a similar effect to reduced imports could be achieved by
reducing taxation or reducing the incentive to save.
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Unit 7
Activity 7.1
If you can answer these three questions, then you are already some way
towards understanding the next part of the Keynesian model. At yy the
planned injections exceed the planned leakages in the economy. Spending
increases, firms find their stocks become depleted so they take on more
workers to increase production. National income increases and so does
the ability to save, pay tax and buy imports. National income will increase
until the planned leakages are equal to planned injections and the
economy is back in equilibrium at yx.
If unemployment exists at yx and we want it to fall, then the government
should increase autonomous injections until we have full employment
equilibrium at yfe. This is demonstrated in Figure 8.
Figure 8: Keynesian model
Activity 7.2
The UK government has no problem financing the injections into the
economy because it discovers a massive gold mine underneath Wembley
football stadium, which generates massive revenue for the government.
UK firms have substantial spare capacity and extra consumer spending
goes on British produced goods and services. The UKs international
competitors are supportive in their economic policies, and the computer
revolution allows quick and accurate up-to-date statistics on the UKs
economic performance. Not a lot to ask for!
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Activity 7.3
Expansionary policy is more popular. It is easier to find ways of increasing
spending on worthwhile projects. It is harder to find ways of making
cutbacks.
Activity 7.4
Question 1: Independence was championed as a way to take control of
the economy out of the hands of politicians and place it with experts.
When there are elections coming governments will be tempted to buy
votes, while immediately after an election they will take the chance to
recoup the give-aways. By handing control over to the Bank of England
the UK government led by Tony Blair sought to establish greater economic
credibility and ensure that future interest rate decisions would be made
based on economic fundamentals. Of course, the MPC must still react to
the economy, which can be shaped by any number of government policies.
Question 2: Demand is rising as the economy recovers and real wages
start to go up. This will inevitably bring about inflation and the MPC will be
keen to use interest rates to control any increase. Interest rate rises do
risk slowing the recovery however, and so far most developed nations
have avoided implementing rate rises for many years.
Activity 7.5
A balanced budget is one in which tax income is equal to government
expenditure.
A budget surplus refers to a situation in which generated tax income
exceeds government expenditure.
A budget deficit is a more familiar situation in which government
expenditure exceeds tax income.
The national debt is the accumulation of past budget deficits and is the
money that is owed to creditors by the government.
The PSNCR is the sum of central government borrowing (CGBR), local
authority borrowing (LABR) and the nationalised industries borrowing
(NIBR). National debt is accumulated central government borrowing over
the years. In the UK the PSNCR has replaced the PSBR as the main
measure. The PSBR was the same thing but had a slightly different
method of calculation (you do not need to know the intricacies of this).
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Activity 7.6
Reducing government expenditure would be very difficult. More
realistically the expenditure growth should be reduced. Taxation should be
increased but this is both unpopular and it can affect incentives to work.
Increasing interest rates would cut down consumer spending financed
from credit and cut back investment expenditure. The reduction in
investment may very well be counterproductive. In any case, increased
interest rates should only be used in a supporting capacity since some
firms will continue to invest even if interest rates are high as their
expectations of future demand and profitability are more important.
Activity 7.7
Question 1: Keynesian influence of the Obama government. Price stability
follows from the monetarist position that inflation is the real enemy and the
thing that must be controlled. However the link between inflation and
unemployment means that the Federal Reserve might not look at
unemployment being created if a reduction in inflation was possible. The
dual mandate ensures that a balance is struck.
Question 2: Should interest rates rise then people will borrow less and
therefore have less money to invest in new projects that would generate
flow around the economy. This would lead to reduced incomes for others
and hence reduced consumer confidence. Further the reduced investment
limits the expansion of the production possibility frontier and slows
economic growth as a result.
Question 3: Productivity pushes out the PPF, and does so without
requiring any additional inputs to the production function. As such, an
economy can grow with a given level of unemployment provided it can
increase its productivity. Productivity also helps make exports more
competitive. Many of the developed economies are now experiencing a
period where unemployment has become static and policies to promote
productivity are being implemented. Naturally this coming before
unemployment has been eliminated is causing some concern amongst
certain commentators and is part of a wider debate about whether growth,
or full employment, should be the goal.
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assumptions. They state that V is not constant, it can change due to the
speculative demand for money. In addition, Keynesians suggest that
monetarists have got the direction of causation the wrong way around,
rather than M determining P, it is changes in PY that cause the M to
change to accommodate the level of spending taking place in the
economy. Furthermore, even if the M could cause an increase in PY then
the effect on P could be marginal if Y changed. In short, Keynesians argue
that the simple relationship between M and P identified by monetarists
needs to be replaced by a more realistic, and more complicated,
relationship.
Keynesians believe inflation is caused by cost-push and demand-pull factors.
Modern government is best advised to consider that inflation can be caused
by a variety of factors all of which vary in importance at different times and,
therefore, the solution to inflationary pressure should include a combination of
approaches as part of an integrated anti-inflationary policy.
Question 2: Start by outlining the Keynesian view on what causes
unemployment. Before explaining how the Keynesian solution would work,
you need to explain how it is possible to have equilibrium and unemployment.
Having explained the Keynesian solution to unemployment, you should outline
the difficulties with this solution. Then update the Keynesian solution by
examining demand and supply side policies together.
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Unit 8
Activity 8.2
Question 1: European Union members benefit from removal of barriers to
trade, enshrined in the notion of freedom of movement of goods and
labour. Since the founding days the growth of the finance sector has
added freedom of capital movement and therefore access to some of the
worlds largest financial centres in London and Frankfurt. The European
Union also generates a large amount of legislation designed to break
down barriers to trade and open up markets for competition.
Question 2: Trading into the European Union (EU) from outside is very
difficult as there are many barriers imposed in the form of tarrifs and
market size limitations. Perhaps the most well known is the limit that the
EU places on imports of cars, particularly from Japan. By restricting
Japanese firms to just 10% of the market, the EU has encouraged these
firms to locate within Europe, the UK being a large beneficiary from this,
such that the cars are European made and not imported. The EU also
legislates to protect local specialties, which helps producers win export
orders and fight competition from imports. Examples of protected goods
include Champagne, Stilton cheese and the Melton Mowbray pork pie.
Activity 8.3
The US consumers demand less pounds. The demand curve for pounds
shifts to the left. This reduces the exchange rate of the pound and the
price of pounds decreases from p1 to p2 as shown in Figure 9.
Figure 9: Decrease in demand
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Activity 8.4
If the UK decreases its demand for US goods, that will decrease the
supply of pounds to the foreign exchange market. This has the effect of
increasing the exchange rate of the pound.
Activity 8.5
If there is increased demand from the US for UK products, the demand for
pounds will increase. This will cause the exchange rate of the pound to
increase. As the exchange rate increases UK exports become more
expensive and imports become cheaper. If UK exports become more
expensive then the world demand for UK products will start to fall. The
demand for pounds will shift to the left causing downwards pressure on
the exchange rate of the pound. The exchange rate is self-equilibrating in
a floating exchange rate system.
Activity 8.6
Question 1: Quantitative easing involves buying government bonds; with
Greek bonds being very low rated selling any is good. There will also be
benefits from improved spending that follows. Should the easing not
include Greek bonds, it will still generate funds that can be used for Greek
benefit.
Question 2: Banks need cash to repay depositors, but often most of their
money is lent out to borrowers; therefore, bank liquidity when things go
wrong is a real issue. When the government provides assistance to banks
to help them function then this is known as emergency liquidity assistance
(ELA. This became really important for Greece as people tried hard to get
their money out of the banks as collapse loomed. Thanks to the ELA,
banks were able to resume trading after a shutdown period, but with heavy
caps on the amount of each withdrawal.
Question 3: A single currency operates with a single central bank and at a
value which all national members understand. It should therefore bring
these benefits.
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Activity 8.7
Question 1: Expenditure by UK households would increase. Some of this
increase would be spent on imported goods. The effect on foreign firms
producing these products would depend upon the level of spare capacity
that exists.
Question 2: Increasing taxation would reduce expenditure and so foreign
firms would sell less in the UK and this could lead to unemployment.
Question 3: Increasing interest rates would reduce expenditure in the UK
and this would have an adverse affect on foreign firms. But, higher interest
rates can lead to a higher exchange rate, and this makes imports into the
UK cheaper and hence more attractive.
Activity 8.8
This section of the textbook considers the geography of international trade
and highlights the trading blocs that have formed, such as the North
American Free Trade Area (NAFTA) and the European Union (EU). Trade
is overseen by a range of bodies, such as the World Trade Organisation
(WTO) and the General Agreement on Tariffs and Trade (GATT). Section
16.3 presents a review of the EU seeking to highlight how countries have
gained from membership and being able to specialise according to
comparative advantage. For example it suggests the Greek benefit is
between 9% and 16% of GDP. Looking beyond the EU it is shown that the
collective bloc becomes the biggest single trading entity in the world, with
a share of 15.1% putting it ahead of China (13.3%) and the United States
(10.8%). These figures are though from 2011 and the picture continues to
change.
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Activity 8.9
Question 1: The advantages for the UK of having a large multinational
sector are that it provides investment, employment and growth, and, given
that many multinationals export, it contributes to the balance of payments.
A disadvantage of having a large multinational sector is that the economy
is vulnerable to these businesses deciding to leave. The recent debate
about EU membership and the benefits to MNCs of the UK as a member
has raised the spectre of such an event occurring. In addition, by having a
large multinational sector within the economy, and with multinationals
being such significant employers and investors, they may be able to exert
control over the host state. Such control might, for example, take the form
of requesting additional subsidies to help with expansion, otherwise
businesses will look to expand elsewhere. Finally, much of the profit
earned by multinationals does not remain in the country but flows back to
the multinationals country of origin.
Question 2: If the multinational was looking to expand overseas to reduce
costs, then it would be more likely to consider a vertically integrated
structure. If the multinational was looking to expand overseas to grow,
then it would probably be considering a horizontally integrated structure.
Question 3: The location of multinational corporations (MNCs) in
developed rather than developing economies, even when they are
pursuing low costs, is due to the fact that many MNCs are seeking workers
with skills, which they are more likely to find in developed markets. Hence
it is cheap skilled workers, which are the target of the MNC. Also
developed countries are more likely to offer a better transport,
communications and financial infrastructure.
Question 4: When the product reaches its mature phase, that is, the
phase when cost considerations become more important and the domestic
market becomes saturated with competition, then the business will have to
consider how to reduce costs to maintain profits, and how to continue to
sell more of the product. An answer to both of these questions might be to
locate production overseas in lower-cost production sites that give access
to new consumers.
Question 5: As considered in the answer to question 1, the main
advantages are to employment, growth, investment and the balance of
payments. In addition, a further advantage, especially to less developed
economies, might be the possibility of some technology transfer from the
MNC to the host state. The disadvantages could include the uncertainty of
MNC investment, the control and influence of the MNC over the host state,
as well as the environmental and social impacts that an MNC might have.
These problems might be significant in developing economies, where the
MNC is less restricted by environmental regulations and social restrictions,
such as worker rights.
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