Archive for 2. Microeconomics

Market Failure – Brief Slides

A satiric picture of how free markets can result in failed markets.

Voicethread Slide: Click Here

Reasons For Market Failures

  • Positive and negative externalities: Market will fail if it excludes the externalities involved.
  • Lack of public goods: If the price is very low, there would be short in supply of the product for the market. So the supply of the product would not be efficiently allocated to the customers
  • Under-provision of merit goods
  • Over-provision of demerit goods
  • Abuse of monopoly power: If only one firm has a monopoly on a product, it will prevent other firms from joining in the market. As a result, no other firms will join in, therefore the firm increases the price of the product. As price goes up, customers will not buy the product of the firm, therefore decreasing in supply demanded. This results in high price with low supply allocated to the market.
  • Inequality
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Externalities in Real Life

Global Warming is an example of negative externality.

BBC News: Noise pollution on the increase

BBC News: Schoolies week in Australia causes binge drinking worry

Externalities are costs (negative externalities) or benefits (positive externalities), which are not reflected in free market prices. For example, as a result of manufacturing of products, the CO2 levels in the atmosphere increase and therefore results in global warming. So global warming is an negative externality.

In the class, we have looked at the videos about real life externalities. In the videos above in the links, they reported the negative externalities caused by noice pollution and binge drinking.

In the first video, some teenagers were having a party at the house where the sound-proof system was poorly installed. As a result of this boisterous party, neighbors had to suffer a noise pollution. This is one of the negative externalities. The another is that the policemen had to go to the reporter’s house to find out what the problem is and go to problem-making teenager’s house for warning. Boisterous party of teenagers had negative externalities of upset neighbors and the time of the policemen. Some might say that it is policemen’s job to solve these kinds of problems, however, in the video over 300% of calls to police office increased because of the noise pollution. So, it has cost policemen’s time to solve other problems. So the policemen would not have time to stop other crimes from happening. Overall, teen’s noisy party has cost the society a lot, more than their upset neighbors.

In the second video, it reported that teenagers binge drank after their examination as a ceremony. Teenagers were having fun, however, it has cost the society some negative externalities. For example, policemen and volunteers were patrolled in order to prevent some teens from alcoholic poisoning. It has cost policemen’s and volunteer’s time and energy in keeping eye on these teens. Also, the teens probably littered and did not pick up the trash at the beach. This would also cost the local government money for employing people to clean the mess.

In sum, there are many externalities to what we do. This is not limited to economic transaction. There could be externalities from anything we do. In my opinion about the teenager’s binge drinking, the government should just give disadvantages to the teenagers for drinking. For example, if a student gets caught drinking, he/she can be sent to do 30 hours of service hours in alcoholic addiction support center as a punishment.

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Commentary: Worst cocoa shortage for 40 years fuels chocolate price rise fears

Daily Mail Reporter: Click Here

This article reports a shortage of cocoa, the worst for 40 years. Ivory Coast, the major exporter of cocoa, has experience the worst harvest in years due to El Nino phenomenon. As a result, “the price of cocoa in London rose to 2,055 pounds a ton this week, the highest since 1985.” The major chocolate bar producers will have inevitable choice of raising the price of their product. In addition, the demand from a new market such as China and India has increased by 3 percent. Also putting the upward pressure or price, the price mechanism explains this.

The surge in price of cocoa is due to the theory of price mechanism. There are several factors that affect demand and supply. Natural disaster affects supply curve to shift leftward. As illustrated in the diagram, there has been a sharp decrease in the supply of cocoa (S1 to S2). The price of cocoa has surged significantly. To make matter worse, the demand has increased 3 percent (D1 to D2) due to China and India’s high demand. This increased price even higher (P1 to P2). China and India’s change in taste has affected the demand curve to shift rightward. The consumer’s change in preference also affects the demand curve. Also, the increase in demand by China and India could be said that the market size for cocoa has increased.

Notice the steepness of demand curves. They are steep compared to other demand curves such as those of luxury goods. As cocoa do not occupy a large portion in people’s income, this sudden surge in price do not affect people’s consumption of cocoa to decrease significantly. In other words, these demand curves have income inelastic quality. There is another factor making chocolate to have inelastic quality. It is its addictiveness. Many chocolate lovers will have difficult time cutting off their chocolate consumption just because of the increase in price. The elasticity theory states that higher the addictiveness of the product, there will be low elasticity of the product.

The supply will not be able to react fast as demand to sudden increase in price. The theory for supply states that when the price of a product goes up, the suppliers are willing to supply more of the product to make high profit. However, the supplier will not be able to increase the number of their product supplied in the market. There are several obstacles preventing suppliers to supply more in short period of time. As there has been a sharp decrease in cocoa produced, suppliers will have difficult time finding cocoa. Also, the suppliers might have storage of cocoa; however, the suppliers did not expect this sudden decrease in cocoa. So the supplier would not have a lot of cocoa in their storage to satisfy the shortage in the market.

As cocoa are considered inelastic, it is expected that there will not be a sharp decrease in demand. However, if the El Nino weather phenomenon continues to affect the supply of cocoa, it is inevitable that there will be a decrease in demand eventually. Then the suppliers will have to lower the price of cocoa, which will settle the new price or equilibrium point for cocoa.

To evaluate, there will be a slight impact on chocolate industry. If the El Nino phenomenon stops in near future, it will actually have positive impact on chocolate industries. As price increase, chocolate industries will see an increase in their revenue with same amount of demand. However, if the El Nino phenomenon does not stop affecting the supply of cocoa, then chocolate industries would experience a decrease in their revenue. The demand will decrease because the price of cocoa starts to become a large portion of people’s income.

In conclusion, the impact on chocolate industries depends on the duration of this surge in price. If this is just a temporary phenomenon, it will have positive impact on chocolate industries as cocoa are income inelastic. However, if this surge in price does not stop, the chocolate industries will have negative impact on their revenue. Also, the supply of cocoa will decrease, decreasing the availability of chocolate for many consumers.

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Reflection on the 3rd Data Response

I thought I did very well on this Data Response, but I got a 5 for IB grade. For the first question, I did fairly well, however, I missed out some of the points that IB wanted. For the second question, it was a disaster. I have mistaken PED graphs for YED graphs, this was the major reason why I did so poorly on this Data Response. Next time, I think I should practice diagrams more before the test.

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Elasticity: Hovis Case Study

bread

News Article: Click Here

Premier Food’s Hovis has experienced some significant decline in its bread sales. This is mainly because of

  1. Increase in price of bread.
  2. Rival companies keeping the low price.

Hovis’ increase in price of bread was said to be inevitable. They simply could not maintain the price as the production cost were exceeded the selling price. Consumers have turned their back on Hovis for following reasons.

  1. Whenever there is an increase on price of a product, the demand decrease. It’s the law of demand. (The degree of its decrease is determined by its elasticity). So the consumers started to buy less of their bread.
  2. Usually, bread are told to be inelastic. However, in the article it reported that there are 2 other rival companies selling bread. This has made a substitution effect for Hovis’ bread. Therefore, it has made the bread elastic.

It’s simple. There are other companies selling low-price bread, but Hovis rose its price. No consumer would leave a cheap bread to the side and buy Hovis’ expensive bread.

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Advice for JAL

ja-704j-japan-airlines-jal-boeing-777-246-er

Just like British Airline, Japan Airline is in a big mess of deficit. Due to global economic recession, the demand for high service, high price seats went down as well as Japan Airline’s profit went down. Here are some of my advice for JAL:

  1. They should cut off high price seats such as business class and 1st class seats. Due to global economic recession, the demand for those seats have went down. Conversely, the demand for lower price seats such as economic seats went up.
  2. They should lower the price as much as possible. As the demand for high price seats went down, Japan Airline must make the seats available for a low price in order to ‘survive.’
  3. They should lower the labor cost. This might lower the quality of airline service, however, it is inevitable during the recession.
  4. They should get rid of unprofitable air-routes. By getting of those unprofitable, money-eating routes, it will significantly help Japan Airline financially. Instead, they should look for cheaper, but effective routes.

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Data Response: “Cheap Flights – Europe”

ryanair-Irish-budget-airline

a) In the article, it suggested that European air travel’s price are getting elastic due to the global economic recession. It has introduced British Airway, which aimed for high price and inelastic part of the service to gain profit. However, as the demand for high price seats went down, they tried switching their plans to aim for low price and elastic part of the service. So this suggests that European air travel price are getting elastic.

b) Ryanair used to aim for low price seats in order to gain a lot of travelers in their aircraft. The low price seats are usually very elastic. Therefore, if Ryanair lowers the price by just a little, there are tremendous increase in amount of demand. As the global economy went through recession, lots of travelers wanted low price seats for airlines. So the Ryanair has become the most profitable airline by the tremendous increase in demand for low price seats.

c) Ryanair was able to offer seats on some flights for under 10 pounds because of their unique plan. Ryanair had an unique plan in minimizing costs included in a flight service. The airline provider has only one kind of aircraft, the Boeing 737, that minimizes the service costs. It only landed on minor cities, where it cost less than in major cities. Also, they can fly two times than the ordinary airline because their airline gets their aircrafts back into the sky only 20-25 minutes after it has landed. Also, as they covered the cost for the flight, they lower the price for an empty seat right before take off. This has really helped lower the price for seats.

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