CHAPTER 3. Economic system Market structure Consumer price index

Transcription

1 CHAPTER 3 Economic system Market structure Consumer price index

2 ECONOMIC SYSTEM Definition: Institutions, laws, technology, tradition, ideas and attitude that mobilizing production, managing resources and operating business Main problem/focus of economy is How to satisfy unlimited wants with limited resources? In general, economist will analyze costs and benefits to improve allocation of resources. How to organize production and consumption in answering the economic question depend on the society. Society decides to establish an economic system that can ensure the best use of resources for current and future consumption.

3 Economic systems and activities Economic system will determine types of market Economic system will influence consumers and families activities related to consumption and production 6 types of economic system Subsistence Capitalism Socialism Mix economy Communism Islamic

4 Subsistence economy Before the existence of currency, all goods were produce for own needs or others (barter system) Needs are simple, life is not complicated Small community, know each other Production technique: simple because produce for own consumption As economy grows: job specialization, needs can be satisfied by goods that produced by others Goods need to be transform into different form

5 Free market economy system Also known as laissez-faire or free market There is no government intervention in economic decision (if any, very minimal) All economic problems are solved by price mechanism where demand and supply in equilibrium state. People are free to own asset and make decision Competition is very intense Example: USA

6 Free market economy ADVANTAGE Welfare of the society can be maximized Competition benefited individual and nation (increase in efficiency and lowering price) Encourage advancement of technology and innovation Efficient in consumption of goods and production factors. DISADVANTAGE Instability of economy (high and low prices due to demand and supply) Instability in income Private sectors fail to produce public goods Competition will increase price, esp. due to advertisement costs. Unequal economy growth (concentrated at the areas with higher returns)

7 Central planned economy system (Socialis) Economic problems are solved by a planning unit under the government Consumers have no choice because price is fixed by the government Government controls all the production factors. Labor costs is valued by the government Equal distribution E.g. North Korea

8 Cont. ADVANTAGE Resources are used to produce goods for the well being of the society Well planned development Consumers are protected; equal distribution of income. DISADVANTAGES Economic decision is made by a small group of people (government) centrally. This might lead to unwise decision and can affect the well being of the society People are not motivated to work harder Technology and innovation are static.

9 Mixed economy system Some of the resource allocation are controlled by the government. Combination of capitalism and socialism Government intervention in price mechanism in the market. Both public goods and private good available in the market Example: Malaysia

10 Cont. ADVANTAGE Can correct the weaknesses of the market system. Distribution can be improved. Can correct price instability through fiscal policy and production policy. Can control monopoly by government taking over or licensing Society has more choices of goods and jobs. DISADVANTAGES Weaknesses of centrally planned economy Weaknesses of free market economy

11 Comunisme Similar to socialism, but distribution is controlled by government. No individual ownership, individual use goods produced by the government No choices in the market, all being determined by government Example: China (wearing almost similar types on clothing)

12 Islamic economy system Based on Quran and Hadith (complete way of life). The basis: Allah is the absolute owner of everything on the earth and human are caliphs which are entrusted to manage all these wealth. Economic activities must follow the sharia. It is a type of worship which Allah will give reward. Individual can own assets but need to be managed properly and just pay zakat for the assets Have to balance the individual and society interests Monopoly is prohibited Competition must be just Cannot take advantage on the vulnerable/disadvantaged Can satisfy needs and wants but not unreasonably. Produce only goods permitted by Islam.

13 MARKET STRUCTURE Market is a place where buyers and sellers exchange goods and services through purchasing and selling activities. Market Perfect competition Imperfect competition Monopoly Monopolistic Oligopoly

14 Characteristics for market classification Characteristics Number of firms exist Types of goods produced Freedom/barriers to enter and exit market Pricing of goods Existence of non-price competition such as advertising, offer, gifts, etc..

15 Perfect Competition Many buyers and many sellers The firm as a price taker Firms free to enter and exit market Every firm is a price taker and has no effect on the market Each firm produces output in small quantity Each buyer uses a small portion of the market output and cannot influence market prices Price is determined by supply and demand equilibrium. This price will be taken by the firms as their selling price. o If Pf > Pm no buyer o If Pf < Pm loss There is no restriction to enter and exit market If there is huge profit, other firms can enter the market freely. Or vice versa.

16 Perfect Competition Homogeneous output Sellers and buyers have perfect knowledge Perfectness of factor mobility Output by is almost similar (perfect substitute) No firm has an advantage over the other firms o firms do not charge high prices o output will be sold at same price Non-price competition (e.g. advertisement) does not relevant because output is homogeneous, the buyers give same priority to the output Buyers know about the output Producers know where to get cheaper FOP (e.g. land) No firm will raise (lower) the price of their output because they fear of losing buyers. FOP (esp. Labor) freely move between firms to get good returns as long as there are differences in price. Mobility FOP occur until reaching an equilibrium price When the FOP and outputs at the same price, the cost of mobility equal to zero.

17 Monopoly One seller and many buyers Goods produced has no close substitute Barrier to enter and exit market Firm = industry The firm has the power to determine prices and quantity of output Buyers do not have influence on market price Goods cannot be obtained elsewhere Buyers have to use the goods even if the price is expensive Barriers to entry in the form of: o Restrictions in the form of legal protections o Capital size requirements o High technology development needed The firm is not free to shut down their operations whenever they like, even when they are operating at loss. E.g. government monopoly in providing basic needs such as supply of clean water.

18 Monopoly No non-price competition Because of firm and its products have no close substitute do not have non-price competition - such as advertising and promotion. Advertisement is applied only to introduce products or to maintain reputation

19 Monopolistic competition Many firms and a variety of brand name Branded goods Freedom of enter and exit the industry Influence on the price Non-price competition Large size firms No individual firm will affect the market The size of the monopolistic firms are almost the same Output produced by firms is less than output of the total market Branded goods Output is physically more or less the same (in terms of raw materials & mode of production) Firms are difference in terms of: o Brand o Packaging o Advertising style o Services o Marketing effectiveness

20 Monopolistic competition Monopolistic output has close but not perfect substitute Freedom of entry and exit into the industry Influence on price of goods Non-price competition E.g. soap, cooking oil, beverages, footwear, clothing of different brand It's easier than monopoly market Firms should be able to produce the items in a slightly different with the existing market The items should be attractive enough to compete in the market Increase in prices consumers will buy a cheaper substitute sales will decline (vice versa) Firms cannot win ALL the market, because product is not a perfect substitute. Firms producing basically similar product firms need to highlight the difference in their brand Ads, packaging, marketing towards influencing consumer perceptions and preferences of the firm's brand

21 Oligopoly Few firms in an industry Firms dominate the bulk of the market Thus, they focus on prices and output Firms influence each other (i.e. action taken by one firm can affect the other firms) Perfect oligopoly: several firms that produce goods/services in the same industry such as petroleum, cement, bus, taxi Imperfect Oligopoly : several firms that produce goods that vary in quality, design and price. E.g car manufacturing industry, computer. Type of goods Firms producing similar or nearly similar products o Perfect oligopoly - producing similar product o Imperfect oligopoly - producing different goods in terms of design and brand. Entry of new firms Not so easy. Barriers in terms of: o Capital needs have to compete with existing firms

22 Oligopoly Pricing Because each firm has influence, the market price is determined by the cooperation between firms This collaboration enables high pricing Without co-operation - market prices will not stable and tend to lower the price less profit Each firm must take into account the actions of other firms (especially in determining prices and output) to maximize profits Non-price competition The goods produced are similar or almost similar Non-price competition is important The most important non-price competition - Ads o Most effective and dynamic o Generate loyalty to the brand o Expressed the assumption that the output of a particular firm is better and the quality of other firms

23 CONSUMER PRICE INDEX (CPI) Changes in the average price of specified goods and services, which represent the expenditure pattern of an average household in the Peninsular, Sabah and Sarawak with a particular year as the base year. Price changes affect the well being of consumers. Consumers need more money to make ends meet. Price changes are measured using the Consumer Price Index (CPI) by the Department of Statistics Price Index is an index used to indicate the average changes in retail prices of basket of goods and services purchased by the family.

24 Limitations of the CPI Fixed basket of goods Differ between consumers Purchasing power Factors influencing the use of income Change in the quality of goods, new goods are produced

25 Weighted Price Index(WPI) Formula WPI = P 0 X Weightage X 100 P a CPI (W) = WPI weightage

26 Example Calculate the WPI, the CPI, Goods P 1 P 0 Weightage Price index WPI A B C TOTAL

27 The formula for calculating the CPI (i) LASPEYRES FORMULA (MALAYSIA) Comparing the cost of the base year basket of goods measured in the new year with a group of similar goods on the basis L = P (P 1, P 0, Q 0) LPI = P 1 Q 0 X 100 (i) P 0 Q 0 P1 = Price of goods in a current year P0 = Price of goods on the basis Q0 = quantity of goods on the basis (ii) PAASCHE FORMULA Comparing the cost of purchasing a new set of items assessed in the new year with a group of similar items valued at the base year. S = P (P 1, P 0, Q 1 ) SPI = P 1 Q 1 X 100 P 0 Q 1 P1 = Price of goods in the current year P0 = Price of goods at the basis year Q1 = quantity of goods in the current year

28 Example Given the price and quantity of goods for the base year and current year. Calculate the Laspeyres and Paasche Price Index. Answer LPI = 212.5% SPI = 220%. Good Price 2010 Quantity 2010 Price 2013 Quantity 2013 A B

29 USE OF CPI CPI is used to calculate the change in consumer purchasing power Percentage change in the index used to measure the rate of inflation and is also used to adjust Consumer expenses Basic wage adjustment Portray consumer purchasing power - influence the quality of life Improve financial aspects

30 Value of Money Purchasing power = the amount of goods and services that can be purchased with a sum of money. Changes in money value due to: Inflation - changes in prices Time e.g. consumers do not want to wait consumers want immediate satisfaction Risk - the uncertainty of future Change in economic situation

31 Inflation Definition Continuous increase in general price levels. Also referred to as a condition where too much money chasing for few goods/services. Excess demand (demand pull inflation) Reasons for inflation Increases in price of factors of production (cost-push inflation) Consumer perception

32 Effects of inflation on income FIXED INCOME Loss because the value of money falls, the purchasing power is also less. LENDERS Loss because the value for the amount of money paid back by the borrower has gone down BORROWER Profit for debt when value of money falls. Same amount of money can buy less

33 Unemployment The unemployment rate = Number of unemployed x 100% Number of employment Level of full employment is achieved when a low unemployment rate (2% - 4%) Effects of unemployment Economic Lesser output (G&S of a country. Low income per capita (national output is divided by the total population) Social Lost income - family instability (conflict). Lost jobs - crime, pollution (squatters)