HS 151: Economics

Lectures: Jan 30 & 31, 2012

Overview of topics
Jan 30
Market economy: laissez faire, welfare state,
market equilibrium
Economic problems and how market solves it
The invisible hand
Globalization and its consequences
Jan 31
The economic role of the government: efficiency,
externalities, public goods, equity
A 4-minute video!
Chapter 2, pg 25-39

Growth of the Mixed Economy

Laissez faire: let do; leave us alone
An environment in which transactions and
economic decisions between buyers and sellers
are free from state/government intervention
(e.g. regulations, taxes, tariffs, etc.)
Welfare state
Market directs the economic activities, while the
government provides socioeconomic protection
(e.g. pensions, health care etc.) to its citizens

Mixed Economy
Mixed Economy:
Mix of both the state & the private sector
Means of production are mainly under private
ownership
Government/State influences the economy
through fiscal and monetary policies
Mixed economy as opposed to capitalism and
socialism?
India: Industrial Policy Resolution, 1956

The market economy

Market: is a place where buyers and sellers
interact to determine prices and exchange
goods and services
Market economy: is an elaborate mechanism
for coordinating people, activities and
businesses through a system of prices and
markets
It functions remarkable well! (no central
intelligence or computation required)

Market Equilibrium
Market equilibrium represents a balance
among all the different sellers and buyers
The market finds the equilibrium price that
simultaneously meets the desires of buyers
and sellers.
By matching sellers and buyers, the market
economy solves the three problems of what,
how and for whom (see next slide)

The role of markets in solving the

three economic problems
What: goods or services will be produced is
determined by consumers (not by votes!)
through their purchase decisions
How: things are produced are determined by
competition among producers by meeting
price competition and maximizing profits
For whom: things are produced depend on
the supply and demand in the market for
factors of production
See Figure 2.1 (pg 29) for a nice
illustration of these mechanisms

The invisible hand

Coined by Adam Smith (1723-1790)
in Wealth of Nations (1776)
Self-regulating nature of the
marketplace
Individuals, while trying to maximize
their own gains in a free market,
constitute an invisible hand which
promotes the interest of the society
at large

Critique of the Invisible Hand

The remarkable efficiency property of Invisible
Hand will be destroyed if there are:
Market failures (allocation of goods and
services by free market is NOT efficient)
Examples: public goods, monopoly

Externalities (a transaction spillover; a cost or

benefit NOT transmitted through prices)
Examples: pollution (negative externality)
More on EXTERNALITIES and MARKET FAILURE in next class

Globalization
Combination of economic/financial integration,
technological diffusion and greater access to
information
global village (Mcluhan, 1992)
weightless economy (Quah 1996)
A borderless world in which people, goods,
ideas and images would travel

What are the major components of

globalization?
1. Trade openness increase in
national output of exports and
imports (financial crises?)
2. Increase in global competition
slicing up the production process
outsourcing (job insecurity?)
3. Increase in job opportunities for
men and women (gender
inequality?)
4. Growth of ICTs cell phone and
internetfacilitates social ties &
creates social capital (Digital
divide?)

Globalization and the Digital Divide

Population Penetration (%
(millions) Population)
Asia

3,879

23.8%

Middle
East

216

31.7%

Africa

1037

11.4%

North
America

347

78.3%

Europe

816

58.3%

In Africa, women are less

likely than men to own or
use a cell phone
Source: World Bank, 2010

Internet usage, 2011

Source: www.internetworldstats.com

Global trade has grown since 1990

Source: World Bank, 2012

Distribution of global income

Distribution
of World
Output
(2011)

GDP growth
(1996-2005)

Projected GDP
growth (2012)

United States

18.6%

3.2

1.8

European Union

17.9%

2.3

0.2

Japan

5.7%

1.0

1.5

Other advanced

8.2%

3.8

2.8

China

15.8%

8.1

8.0

India

5.7%

6.5

6.9

Africa

3.3%

4.5

0.2

Middle East

3.5%

4.5

0.1

Source: The Conference Board Global Economic Outlook, 2012

http://www.conference-board.org/data/globaloutlook.cfm

Global Poverty (1970-2015)

$700 in 1999 PPP: corresponds to $1 a day cut off

Worlds richest 1% of adults own 40% of the planets wealth

United Nations, 2006

Source: UNDP, 2005

Globalization of commodities
Case study: The sociology of coffee
(Giddens, 1997)
Next time you enjoy a cup of Nescafe, stop and
think about how more than 100 million people
involved in the coffee growing industry have
worked together to help you open your day

The sociology of coffeecontd

Country: Uganda
Around one quarter of the population earns
its living from coffee growing
However, globally commodity prices have
fallen; Between 1999-2002 the value of
coffee exports fell from $13 billion to $7
billion
So, what happens to Ugandan
coffee cultivators and farmers?

The sociology of coffeecontd

Household incomes of local communities fall;
worsening nutrition; children drop out from
school; inability to buy essential commodities
1. Terms of trade have fallen in favor of industrialized
countries
2. Coffee consumption is highly price inelastic
3. Super market prices have remained stable
4. Increases in productivity (through increased
exploitation of family labor)

Nestles trading profit rose by 15% between

1999-2000 (Oxfam, 2002)

The Economic Role of Government

(Chapter 2, Section C)

Increasing Efficiency: promoting competition,

curbing externalities and providing public
goods
Promoting Equity: using tax and expenditure
programs to redistribute income
Foster Macroeconomic Stability: by reducing
unemployment and inflation while
encouraging economic growth

Efficiency
Efficiency: use of resources so as to maximize the
production of goods and services
How can a market be efficient?
Perfect Competition: a market in which no firm or
consumer is large enough to affect price
Deviation from an efficient market
1. Imperfect competition
2. Externalities
3. Public Goods

1. Imperfect Competition or Monopoly

Occurs when a buyer or a seller can affect a
goods price
Examples include Microsoft, De Beers (diamond)
Characterized by too high price and too low
output levelsinefficiency
How does the government fix this?
Antitrust laws
Removing tariffs and regulations that uphold monopolies
Pricing and regulation in public utilities e.g. water,
electricity

2. Externalities
Spillover effects; occurs when firms or people
impose costs or benefits on others outside the
market place
Types of externalities
Negative externality: a social cost (society
pays off the costs). E.g. Pollution
Positive Externality: the free rider problem.
E.g. public goods

3. Public goods as positive externalities

Are commodities that are enjoyed by everyone
(non-rival) and from which no one can be excluded
(non-excludable)
Consequence?
Adequate private production of these goods will not
occur because the benefits are widely so dispersed that
no single firm or consumer has an economic incentive to
provide the service

Way out?
Government provision (e.g. taxes, intellectual property
rights, etc.)

How does the government pay for

public goods?
Taxes
A compulsory contribution to state revenue levied by
the government on a product, income or activity
Price for using public goods

What is the difference between tax and price?

Taxes are not voluntary; everyone has to pay for
our share of the cost of public good
Paying price for a good or service is voluntary
Example

Equity
Markets do NOT necessarily produce a fair
distribution of income- inequality
Equity: An concept or idea of fairness in
economics
How does the government achieve equity?
Progressive taxation
Taxing larger incomes at a higher rate than
smaller incomes
Transfer payments and subsidies
E.g. aid for the elderly and disabled

Equity: key to macroeconomic stability and

development
Millennium Development Goals (MDGs)
Goal: to end poverty by 2015
1.
2.
3.
4.
5.
6.
7.
8.

Eradicate poverty and hunger

Achieve universal primary education
Promote gender equality and empower women
Reduce child mortality rates
Improve maternal health
Combat HIV/AIDS, malaria and other diseases
Ensure environmental sustainability
Develop non-discriminatory trading & financial
system

A 3-minute video!

Video: Miniature Earth, 2010

Other useful web resources

Poor economics: http://pooreconomics.com/
New York Times blog:
http://kristof.blogs.nytimes.com/