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Introducing

Economics
ECO1101
Course Instructor: Chin Phaik Nie
Today Lecture
Economic Systems
Price Mechanism
Positive and Normative Economics

Introducing Economics
Economic Systems
Totally
planned
economy
Classifying economic systems
Totally
free-market
economy
Totally
planned
economy
N. Korea
Cuba Poland France
UK
USA
Mid 1980s
China Hong
Kong
Classifying economic systems
Totally
free-market
economy
Totally
planned
economy
N. Korea
N. Korea
Cuba
China
Poland
Poland France
France
UK
USA
USA
Mid 1980s
Late 2000s
China Hong
Kong
Cuba
China
(Hong
Kong)
Classifying economic systems
UK
Totally
free-market
economy
[I] The Command Economy
all economics decisions are taken by
the central authorities. For example:
socialist or communist
the state plans the allocation of resources at
3 important levels:
consumption and investment
allocation of resources between current
consumption and investment for the
future
[I] The Command Economy
matching of inputs and outputs
plan the resources required by each
industry and firm
plan the output produced by industry
and firm
distribution of output between
consumers.

Advantages of a command economy
high investment, high growth
stable growth
social goals pursued
low unemployment
Problems of a command economy
problems of gathering information
expensive to administer
inappropriate incentives
shortages and surpluses

[II] The free-market economy
Base on demand and supply decisions

Advantages of a free-market economy
transmits information between buyers and sellers,
economy functions automatically
no need for costly bureaucracy to coordinate
economic decisions
incentives to be efficient as competition between
firms keeps prices down
competitive markets responsive to consumers
Problems of a free-market economy
competition may be limited: problem of market power, a few
giant firms may dominate an industry
power and property may be unequally distributed
the environment and other social goals may be ignored.
some socially desirable goods would simply not be produced
by private enterprise
ethical objection encourage selfishness, greed, materialism
and acquisition of power
Macroeconomic instability: periods of recession with high
unemployment and falling output & periods of inflation.
[III] The Mixed Economy
A market economy where there is some government
intervention. Government may control the following:
relative prices of goods and inputs, by taxing or
subsidising them or by direct price controls
relative incomes, by the use of income taxes,
welfare payments or direct controls over wages,
profits, rents, etc
the pattern of production and consumption, by the
use of legislation, by direct provision of goods and
services, or by nationalisation.
Macroeconomics policies


Price Mechanism
price respond to shortages and surpluses
shortages, P increases
surpluses, P decreases
equilibrium price : demand = supply
response to changes in demand and
supply
act as both signals and incentives

How does the price mechanism acts as signals and incentives
a change in demand
a rise in demand signaled by a rise in price
a rise in price acts as incentives for firms to
increase the supply

a change in supply
a rise in supply signaled by a fall in price
a fall in price acts as incentives for demand to rise
Goods Market
D
g


shortage
(D
g
> S
g
)
P
g


S
g


D
g

until D
g
= S
g
The price mechanism:
the effect of a rise in demand
Goods Market
D
g


shortage
(D
g
> S
g
)
P
g


S
g


D
g

until D
g
= S
g
Factor Market
S
g


S
f


D
f

until D
f
= S
f

D
f
shortage
(D
f
> S
f
)
P
f


The price mechanism:
the effect of a rise in demand
Attempt Question!
Q: Can you think of any examples where prices and wages
do not adjust very rapidly to a shortage or surplus? For
what reasons might they not do so?
A : (1) Many prices set by companies are adjusted relatively
infrequently: it would be administratively too costly to
change them every time there was a change in demand. For
example a mail order company, where all the items in its
catalogue have a printed price, would find it costly to adjust
prices very frequently, since that would involve printing a
new catalogue, or at least a new price list.
(2) Many wages are set annually by a process of collective
bargaining. They are not adjusted in the interim.


Attempt Questions!
Why do the prices of fresh vegetables fall
when they are in season? Could an
individual farmer prevent the price falling?
Because supply is at a high level. The
increased supply creates a surplus which
pushes down the price. Individual farmers
could not prevent the price falling. If they
continued to charge the higher price,
consumers would simply buy from those
farmers charging the lower price.


Attempt Questions!
If you were the owner of a clothes shop, how would
you set about deciding what prices to charge for
each garment at the end of season sale?
You would try to reduce the price of each item as
little as was necessary to get rid of the remaining
stock. The problem for shop owners is that they do
not have enough information about consumer
demand to make precise calculations here. Many
shops try a fairly cautious approach first, and then,
if that is not enough to sell all the stock, they make
further end of sale reductions later.

Attempt Question!
The number of owners of compact disc players has grown
rapidly and hence the demand for compact discs has also
grown rapidly. Yet the prices of discs have fallen. Why?
The costs of manufacture have fallen with improvements in
technology and mass-production economies.
Competition from increased numbers of manufacturers has
increased supply and driven prices down.
Budget-priced CDs of original analogue recordings cost less
to produce (there are no new studio costs).
In the early 2000s, the advent of copying CD tracks from
the Internet has reduced the demand for CDs. This change
in demand has further compounded the fall in price.
A. A rise in the price of the good and a fall in the
price of factors used to make it.
B. A rise in the price of the good and a rise in the
price of factors used to make it.
C. A fall in the price of the good and a fall in the
price of factors used to make it.
D. A fall in the price of the good and a rise in the
price of factors used to make it.
Assume that there is a fall in demand for
a good. Ceteris paribus, this will result in:
Q
A. Rise.
B. Fall.
C. Stay the same.
D. It depends on why the supply of good X has
risen.
If there is a rise in supply of good X,
what will subsequently happen to the
price of a factor used to make good X?
Q
Positive Economics
A statement of FACT
unemployment is rising

Normative Economics
A statement of VALUE
(ought or ought not to, good or bad,
desirable or undesirable)
the government ought to reduce the
unemployment

Attempt Questions!
Which of the following are positive statements and which
are normative?
(a) Cutting the higher rates of income tax will
redistribute incomes from the poor to the rich.
(b) It is wrong that inflation should be reduced if this
means that there will be higher unemployment.
(c) It is incorrect to state that putting up interest rates
will reduce inflation.
(d) The government should introduce road pricing to
address the issue of congestion.
(e) Current government policies should be aimed at
reducing unemployment.

Answers
(a) Positive. This is merely a statement about what would
happen.
(b) Normative. The statement is making the value judgement
that reducing inflation is a less desirable goal than the
avoidance of higher unemployment.
(c) Positive. The statement is making a claim that can be
tested by looking at the facts. Do higher interest rates reduce
inflation, or dont they?
(d) Normative. It is expressing the value judgement that the
government ought to address the problem of traffic
congestion and that road pricing is the best way.
(e) Normative. It is saying that the government ought to
direct its policies towards reducing unemployment.

A. Unemployment is higher this year than last.
B. Unemployment will rise.
C. Economists predict that unemployment will rise.
D. Raising taxes will cause unemployment to rise.
E. The government should cut taxes and therefore
reduce unemployment.
Q
Which one of the following is a
normative statement?
THE END
Please try to End of Chapter
Questions in the text book,
page 28, Q1 to Q8.
Reference: Chapter 1 in
Sloman text book and 8 docs
in Facebook ECO1101

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