The Ten Principles of Economics

PART 1:

Principle 1: PEOPLE FACE TRADEOFFS: To get something one has to sacrifice other thing. For example, a country can spend its maximum resources for its defence but at the same time, it has to sacrifice the maximum spending for the country welfare. A society also faces tradeoffs between the Efficiency and Equity. The government generally tax rich people so that it can get the money from them and use it for the welfare of the poor people; this brings the equity but reduced the efficiency. (Mankiw,2003,p.5)

Principles 2: THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT: Since we do tradeoffs, the people generally find out the cost and benefits that their action going to incur. For an action, one has to sacrifice something. For example: I have come here to do post-graduation but I had to sacrifice my server administrator job. A cost that given up to get something known as the opportunity cost. My opportunity cost is server administrator job, money, and time, which I had given up for the post-graduation. (Mankiw,2003,pp.5&6)

Principle 3: RATIONAL PEOPLE THINK AT THE MARGIN: (Refer appendix (a)) One always does small changes in their plan of action to achieve maximum benefits from the process. (Mankiw,2003,p.6) This small change known as the marginal changes as it take place around edges. For example: A student who is enrolled for 1 year of education, if he/she add one more year to its study, they will be able to apply for permanent residency which incur as additional benefits but with this come the additional costs of college fees, time etc. Comparison of marginal benefits and marginal cost will be able to help you in taking the decision.

Principle 4: PEOPLE RESPOND TO INCENTIVES: Behaviour of any person or firm changes according to the environmental variables like benefits or cost changes. For example: If the cost of the orange increases then the consumer will shift towards apples, as cost of orange is high. (Mankiw,2003,p.7)

Principle 5: TRADE CAN MAKE EVERYONE BETTER OFF: Trade is taking place between the products that countries own not between the countries. (Chapter 1,p.4) (Refer appendix (b)) Trading between parties makes goods cheaper. For example: Trade between country A and country B will help both the countries to get goods of one another and help them to expertise in what they are good at producing.

Principle 6: MARKETS ARE USUALLY A GOOD WAY TO ORGANIZE ECONOMIC ACTIVITY: Market Economy is the concept where a centralise judgment planner is substituted by judgement of millions of households and firms. The place where the households and firm can communicate with each other for services and goods is known as market and it is taken place under the influence of the price and self-interest, which helps them to take decision. For example: Taxes that impose by the government always change the goods price and decision of producer and consumers. (Mankiw,2003,p.9)

Principle 7: GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES: When a market fails to distribute the resources efficiently, it is known as market failure, which decreases efficiency. Government impose some rules to improve the market.(Mankiw,2003,p.11) For example: When the Australian government, impose carbon tax on the emission of the carbon, which will makes the firm to emit less carbon, which results in less pollution. (Kirk,2010)

Principle 8: A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS AND SERVICES: The living standard in the country is depends upon the country producing capacity. In country where, more goods and service are produced in a unit time there standard of living is high as compared to the people with less productivity. For example: Living standard of a U.S. citizen is better than living standard of Mexican and Nigerian citizen as a U.S. citizen earn more than those two citizen. . (Mankiw,2003,p.12)

Principle 9: PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY: Inflation is the state in which the price level increases in the economy. Inflation occurs when the supply of the money, which is under the hood of government, increased drastically in compare to the accessibility of services and goods in the markets.(Chapter 1, p.6) When the government produce high quantity of nation’s money, than it has lose its value. For example: When in Germany the average price of the commodity is tripling every month so the production of money is also tripling every month. .(Mankiw,2003,p.14)

Principle 10: SOCIETY FACES A SHORT-RUN TRADEOFF BETWEEN INFLATION AND UNEMPLOYMENT:

Policy that are making, to reduce the inflation led to increase in unemployment and policy to reduce unemployment led to increase in inflation this properly describe in Philip curve. This concept ends in 1970 when inflation and unemployment co-existed at their maximum peak. (TEN (10),p.3) The relationship between the inflation and unemployment is temporary. (Mankiw,2003,p.14)

Answer 2: The study, which deals with the choices made by an individual and business, the way in which this choices are communicate with each other in a market environment and the effect of the government on them, is known as Microeconomics. Example: Study of people behaviour of buying more laptops?

The study, which deals with the performance of the global economy and the national economy, is known as Macroeconomics. Example: Government rule and taxation on particular goods. (McTaggart,Findlay,andParkin2007,p.4).

Key player, which are present in the market environment, are the producer, consumer and the government. Decision of the producer to produce goods, entering or exiting the market comes under the microeconomics, which is the individual decision of firm.(OECD,p.34) A firm will always take a decision to maximize its profit. Regulations made by the government, affect firm decision, as unnecessary restriction will increases firms cost and decreases its productivity, which results in the firm loss comes under macroeconomics. (Loayza,p.6)

PART 2:

Answer 3:

Supply curve: A supply curve is the curve, which shows the relationship between the price of the goods and the quantity supplied when all the elements acting on the producer scheduled sales remains the same. Supply curve is upward sloping. (McTaggart,Findlay,andParkin2007,p.66). In Figure-1, as the price is increasing the supply of the apples are also increasing for 0.40 supply was 1,000 and for 0.60 supply was 2000. This implies that it follows the law of supply.

Price ($ per pound)

Apples per day (pounds) supplied

0.40

1000

0.60

2000

0.80

3000

Figure-1 Source: Collins Karen

Demand curve: A demand curve shows the relationship between the price of the goods and the quantity demanded when all the elements acting on the consumer’s schedule buying remain the same. Demand curve is downward sloping. (McTaggart,Findlay,andParkin2007,p.62). In Figure-2, as the price is decreasing the demand of the apples are increasing for 0.80 demand was 1,500 and for 0.40 demand was 2,500. This implies that it follows the law of demand.

Price ($ per pound)

Apples per day (pounds) demanded

0.80

1500

0.60

2000

0.40

2500

Figure-2 Source: Collins Karen

Equilibrium of a market: When two opposite forces balance each other, this state is known as the Equilibrium state. Market equilibrium is the state when the buyer and seller both of them are satisfied with the price of the commodity. Condition that satisfies the equilibrium is that, when the demand of the quantity is equal to the supply of the quantity. (McTaggart,Findlay,andParkin2007,p.70). In Figure-3, the intersection point of the demand curve and the supply curve is the equilibrium point where the apples demanded is equal to the apples supplied.

Price ($ per pound)

Apples per day (pounds) demanded

Apples per day (pounds) supplied

0.80

1500

1000

0.60

2000

2000

0.40

2500

3000

Figure-3 Source: Collins Karen

Answer 4: A chemical equilibrium is the state at which the rate of the forward reaction is equal to the rate of the reverse reaction. (Refer appendix (c)) This simply tells us that the rate of forming of the products is equal to the rate of forming of the reactants. (sparknotes,2009)

For example: N2+3H2 ⇄ 2NH3

The reaction shows us that when hydrogen reacts with nitrogen they form the ammonia gas, NH3. During the first interaction between the nitrogen and hydrogen in the chamber, ammonia is generated. When the concentration of ammonia increases the ammonia gas start to breakdown into the nitrogen and hydrogen. When the rate of forming of ammonia is equal to the rate of decomposition of the ammonia then that state is known as the equilibrium state. (Refer appendix (d)) (Chemistry Explained,2010)

When we contrast the concept of the chemical equilibrium to the concept of the economics they are the same as both the equilibriums need one condition to satisfy quantity demanded = quantity supplied, (Refer appendix (e)). At the equilibrium, the forward reaction, which is to equivalent to the quantity demanded in economics, is satisfied by the reverse reaction, which is equivalent to the quantity supplied in economics. In economics for quantity demand, there is always supply of goods, which is never ending process as in chemical reaction at equilibrium state it is also a never-ending process.

Equilibrium is very important in economics because if there is no equilibrium than there will be shortage or surplus of the goods which will results higher price for goods or lower price of goods, which will make both the consumer and producer unhappy as at the equilibrium stage the price that a seller will be happy to sell its good and a buyer is happy to pay for it. (McTaggart,Findlay,andParkin2007).

Answer 5:

D’

TCS S=MC

Price

P* E(D=S)

S’ D=MB

TPS

Q*

Quantity

Graph 5(i)

For resource allocation we have to prove MB (marginal benefits)=MC(marginal costs) and maximum welfare = Consumer surplus + Produces surplus.

In the Graph 5(i), We have supply curve S, which also represent marginal cost, and demand curve D, which also represent marginal benefits. The intersection of the curve D and S is the equilibrium that is where demand = supply which also means the marginal benefits = marginal costs. At this point the P* and the Q* is the price and quantity that will be our competitive outcome.

In D’ES’, (TCS) for the consumer surplus, P*ED’ represent the total consumer surplus that is maximum consumer benefits and for the (TPS) producer benefits it is the P*ES’ represent the total producer surplus that is maximum producer benefits. Because P* and the Q* is the competitive outcome as E is the point of equilibrium. P*ED’ and P*ES’ is congruent as D’P*=S’P* and angle D’P*E=S’P*E (P* is the mid-point of S’D’)

In Graph 5 (i), we have proven that marginal benefits= marginal cost is the efficient outcone. Any government intervention like tax or subsidy is harmful to economy because as Taxes in the economy makes the buyer to pay more and seller to get less. Therefore, it will make the producer to produce less that is that will lead to the underproduction of the product. Subsidies that are given to producer by the government lessen the cost paid by the buyers and seller receives the high price. Therefore it will lead to produce more so over production.

D’

TCS S=MC

D”

S”

Price

P* E(D=S)

D3

D2

S’ D=MB

TPS

Q1 Q* Q2

Quantity Graph 5 (ii)

In Graph 5 (ii), competitive outcome is P* and Q*. It shows that D2D”E, is the part which we are losing (Dead weight loss) as Marginal Cost<Marginal Benefits, firm is producing Q1quantity, that is firm is under producing left of Q* firm will produce less quantity. It shows that D3S”E, is the part which we are losing (Dead weight loss) as Marginal Cost>Marginal Benefits, firm is producing Q2quantity, that is firm is over producing, right of Q* firm will produce more quantity. In both the cases we are deviating from the competitive outcome so it is inefficient. (McTaggart,Findlay,andParkin2007,pp.114 & 116).

PART 3:

Answer 6: When some of the free market is not able to allocate the resources proficiently then it is a market failure. (Mankiw,2003,p.151). It can be, the resources are under allocated so goods are under produced and vice-versa. The Pollution problem resulting to global warming is example of market failure.(Market Failure,2010)

To overcome this situation the government can comes with some rules and regulation. For example: Australian government impose the tax on the carbon emission known as carbon tax. There is a belief in this step that, to avoid the extra tax or money to pay the people will choose to emit less carbon, which will result in the reduction in the national emissions. (Brook Barry,2009)

Answer 7: I think governments tend to interfere in economic activity more than what economic theory recommends because there is always a debate between the efficiency and equity. Efficiency is a concept telling us, what is the maximum amount of output a society gets from its scarce resources. Equity is dealing with the equally distribution of the economic outcome fairly among the society. (Mankiw,2003,p.5).For this thing to explain, I am taking example of Australian Government. The government introduces the mining tax and provide an argument, that the Australian people are the candidate to receive maximum share of the profits generated by the mining. This mining tax come into action, as the mining company pay royalties to state government, which is 40% of their profits, in 2001, but in present they are paying less than 20%. (Mining Tax)

Answer 8: A fundamental right of every personal, to manage their individual property and labour, is known as Economic freedom. An individual person is free to consume, produce, work, and do the investment in their way, in economically free society and protection of the freedom is by state. Movement of goods, capital, and labour is free in the economically free society. To measure index of economic freedom we measure ten modules of economic freedom on the scale of 0 to 100, 100 being the maximum freedom. The 10 modules score is totalled and average is taken out for the every country, which is index of economic freedom. Economic freedom modules, which are used for the measurement of economic freedom index are, freedom of business: free to operate the business, freedom of trade, fiscal freedom, spending of government, freedom on monetary, freedom of investment, freedom in finance, property rights, freedom from corruptions and labour freedom.(2010IndexofECONOMICFREEDOM)

Four countries that have moved up the scale in 2010: New Zealand, Switzerland, Japan, Sweden.

Four countries that have moved down the scale in 2010: Hong Kong, Singapore, India, United States. (RankingtheCountries,2010)

Answer 9: Australia stand on the third position in the Economic Freedom Index scale of 2010. Its overall score of 82.6 in 2009 remain unchanged in the 2010 as it did not move up or down in the scale of index. Good macroeconomics policies help the Australian economy to survive the recent financial crisis. (Australia,2010) For further improvement in the Australian business environment, we can use supply chain intelligence in the business (DysonEvelynLaurel), use of the business excellence framework, (BusinessExcellence,2010) improving the environment.

PART 4:

Answer 10).

S

I1

P2 E2

P1 E

Price

E3 D2

P3

I2

D3 D1

Q3 Q1 Q2

Quantity ƒ 

Graph 10 (i)

In perfectly competitive grocery market, under short run, the numbers of firms are constant and each firm has certain plant size. In the Graph 10(i), D1 is a demand curve and S is the supply curve of grocery industry. E is the equilibrium point, and P1 and Q1 are equilibrium price and the quantity of grocery industry. If, there is change in demand then there is also change in the short-run equilibrium. When the demand of grocery increases (I1), the demand curve will shift towards right, D2, E2 is the new equilibrium point with equilibrium price P2 and equilibrium quantity Q2 it the point when the firm will maximize the profit by maximizing the output. When the demand of grocery decreases (I2), the demand curve will shift towards left, D3, E3 is the new equilibrium point with equilibrium price P3 and equilibrium quantity Q3 it the point when the firm will maximize the profit by decreasing the output. If demand curve shift more left than D3 than firm in grocery industry, will temporarily close down its facility or will continue to produce Q3 quantity by bearing loss.

S1

I1

P1 E1 S0

P0 E0

Price

D

Q1 Q0 Quantity → Graph 10 (ii)

In the Graph 10(ii), any price above the P0, firm in grocery industry will make economic profit and below P0, economic loss and at P0 zero economic profit. Demand curve is D. Supply curve of the grocery industry is S1, so things sold at P1 with Q1 quantity will produce economic profit and attract the other new firm. As new firm enter, supply will increase, so grocery industry supply curve will shift right (I1) to S0. As the demand is unchanged, market price will drop from P1 to P0 but quantity produce is Q1 to Q0 (increases). Therefore, economic profit of exiting firm in a grocery industry decreases but output from grocery industry increases. For the consumer: The consumer will able to get the grocery at lower price. (McTaggart,Findlay,andParkin2007,pp.234&235).

Answer 11). Using Kinked Demand Curve Model: Assumption: If the firm1 in grocery industry, increases its price than the firm2 will not follow but firm1 decreases than firm2 will also decreases its price

P MC1

MC0

Price A

B

D

MR

Q

Quantity

Graph 11(i):

In the Graph 11(i), the firm in the grocery industry having the Graph 11(i). Therefore, P is the price for the market, and D is the demand curve of the firm. If the firm increase its price P, then that firm will see that there is a greater decrease in its quantity sold because the other firm is not going to increase the price. If the firm sell, its goods below price P than there is little increase in the goods selling as other firm will also cut there price. As the demand curve is kinked so the MR, Marginal revenue is having a break AB. Maximum profit of the firm is generated at quantity Q as the marginal cost (MC) = marginal revenue (MR) i.e. intersection of MR and MC at gap AB. If there is fluctuation of MC between the A and B, the firm is not going to modify its quantity or price. If the fluctuation takes place outside the AB, so firm going to change its price and quantity. Small change in the cost is not having greater effect on price or quantity. (McTaggart,Findlay,andParkin2007,p.288).

If the two firms collude than it may happen that, they cheat or comply with each other. In the below table after applying game theory and players are two firm, firm1 and firm2 and they play for once. FIRM1: If firm 2 cheats, and if firm 1 cheats it gets 2M and if it comply than it loses 3M so 2M is better. If firm 2 comply and if firm 1 cheats it get 8M and if it comply than it gain 4M, so 8M is better than 4M. Therefore, it tells that the Firm1 should cheats.

FIRM2: If firm 1 cheats, and if firm 2 cheats it gets 2M and if it comply than it loses 3M so 2M is better. If firm 1 comply and if firm 2 cheats it get 8M and if it comply than it gain 4M, so 8M is better than 4M. Therefore, it tells that the Firm2 should cheats.

FIRM 1

FIRM 2

Cheat

Comply

Cheat

(2M, 2M)

(-3M,8M)

Comply

(8M,-3M)

(4M,4M)

(Playoffs: Firm1, Firm2)

According to the Nash equilibrium, both of them will cheat, as the cheating is the best strategy for them and earn 2M. If the game is played for the indefinitely than the both the firm will come to know that if they comply they have better result, that is each firm will going to get 4M, which is greater than 2M. Indefinite playing will give firm to get the best outcome. (McTaggart,Findlay,andParkin2007,p.303).

Answer 12). In NASH equilibrium, one company develops its best possible strategy according to the strategy adopted by another company and vice versa. Normal equilibrium where the buyer and seller both of them are satisfied with the price of the commodity. In NASH equilibrium, there is no role of price but information and strategy plays an important role but in normal equilibrium price plays an important factor to attain the equilibrium. (McTaggart,Findlay,andParkin2007).