MICROECONOMICS

THE ECONOMIC PROBLEM

Scarcity
-Free goods: We have enough for everyone. There were more free goods in the past
than now.
-Economic goods: They are scarce. They will run out at some point

Wants and needs

Everyone has needs, such as food or water, but there are infinite wants.

Basic economic problem

Resources are scarce but wants are infinite. The basic economic problem is that we
need to allocate resources to competing uses. Economics is the study of this
allocation of resources. When we chose between different options, such as between
a pair of shoes or a hoodie, the one left behind is the economic cost of choice or the
opportunity cost.

What is an economy?
It is a system which attempts to solve this basic economic problem. Economists
distinguish three parts of this problem:
-What is to be produced? Resources need to be allocated into different things
-How is production to be organized? Materials, location, workers/automation…
-For whom is production to take place? What proportion of the benefits does each
person get (gov, workers, ceo..)

An economic system needs to provide answers to all three questions.

Factors of production
They are:
-Land: Not only the area but also the resources underneath. Owners of land can also
rent it.
-Labour: The workforce of the economy. The value of a worker is called its human
capital.
-Capital: The stock of tools, factories, offices, resources, etc. used in production.
Two types:
-Working/circulating capital: stocks of raw materials, semi-manufactured and
finished goods waiting to be sold.
-Fixed capital: It wont turn into a product. It is used to make working capital into
finished products.
-Enterprise: Entrepeneurs use the factors of production to make money. They risk
their money and assets, but have a chance of making a profit.
PPFs
The production possibility frontier shows the different combination of goods that can
be produced from a set of resources. If we are on the PPF, all resources are fully and
most efficiently used.

Q A ·D A and B are efficient output as they lie on the PPF

D
C is inefficient, as not all resources are fully or
B most efficiently utilized.
⑧
F is not possible (in the long run) as it lies beyond
·L the PPF.

The PPF in the market system

Assuming that the consumers want more X than Y, point B is productively efficient,
as efficiency is maximized, but it is allocatively inefficient, as consumers want more
X. There will be more Y being produced than consumed, and this will result in a price
fall of Y. There will also be a shortage of X, and as a result, the price will rise. This
higher profit will cause more firms to start producing X, as it's profitable, which will
lead to more X being produced. The market system will produce a movement until it
gets to A. Assuming that consumers are all satisfied at this point, point A is
allocatively efficient, called the optimum allocation of resources.

TYPES OF ECONOMIES

In an economy, there are various actors. The individuals (consumers and workers),
groups (firms, trade unions, families, etc.) and the government (may range from a
local council to the european commission).

The allocation of resources

There are two main ways in which resources are allocated:
-The market mechanism: It allocates resources through bringing together buyers and
sellers who agree on a price for what is being sold.
-Planning: Resources are allocated through administrative decisions.

Types of economies
(Next page)
Types of economies
There are three main types:
-Free market economies: Markets allocate resources through the price mechanism.
An increase in demand leads to an increase in price. The quantity of products
consumed depends on income, which depends on the market’s value of an
individual’s work. There is a limited role for the government, which limits itself to
protection using the legal system. In this economy, consumers have many options to
chose between, and companies are pushed to improve and innovate and be more
efficient through competition.
-Planned or command economies: Associated to a socialist or communist system,
the government owns scarce resources and sets production targets and growth rates
according to its own view of people’s wants. Markets prices play little or no part in
informing resource allocation decisions. Products are mass produced with little to no
variation, and there is not much innovation in products, as there is no need to do so.
There is also a tendency to inefficiency, but citizens are safer, as healthcare, food, etc
is provided.
-Mixed economies: Some resources are owned by the public sector (government)
and others are owned by the private sector. The government intervenes in markets to
avoid market failure. Nearly all economies in the world are mixed.

SPECIALISATION AND THE DIVISION OF LABOUR

Specialisation
It is when we concentrate on a product or a task

The division of labour

It occurs when production is broken down into many separate tasks, where each
person on each task is specialised in it. It makes production more efficient

SMITH, HAYEK AND MARX

They are three writers who have profoundly influenced thinking about economic
systems.
-Smith: His book explained how the invisible hand of the market would allocate
resources to everyone’s advantage. The selfish pursuit of profit could lead to an
economy where benefit is maximized. He is advocate for free market economies and
losses-faire governments, which leave markets as much as possible to regulate
themselves. He also said, though, that the government should protect people from
poverty.
-Hayek: He said that a big control of the economy by the state lead to loss of
freedom. He said that free unregulated markets were better than regulated markets,
as the liberties of the individuals are maintained.
-Marx: He said that there was a big gap between fortunes and workers, and that it
should be eliminated. He said that it was inevitable that one day the poor would rise
up in revolution, and a new democratic society would arise. He supported command
economies.
DEMAND

Functions of prices
-The price mechanism: It provides the main methods through which scarce resources are
allocated between competing uses in all modern economies.
-The signaling function: Prices signal what is available
-The incentive function: Prices create incentives for agents to behave in ways consistent
with their self-interest. The rising cost of a good may:
-Result in a firm expanding production and maximizing profits
-Result in a consumer contracting demand due to high prices

Demand
Demand is que quantity of goods and services that consumers are willing and able to buy
at a given price in a given time period.

Demand is affected by price, income, confidence, price of substitutes, etc.

Individual and market demand

Each of us has an individual demand, of goods we want or need. Market demand is more
general.

Types of demand
-Derived demand: This is demand for the output of the product. A firm buys a machine
because of what it does, not because they want to sell it.
-Joint demand: this arrives when two goods are complements, such as a printer and
cartridges. If you buy one you buy the other
-Composite demand: This is for goods with multiple uses, such as water
-Competitive demand: The demand for goods that are competitive. These goods are
called substitutes.

The demand curve

It represents the relationship between the price P

of a product and its demand. If its downwards

=
sloping, the lower the price the higher the demand, Pu
ti D
and the higher the price, the lower the demand. &, Q2 ①

Utility and demand

Utility is a measure of the satisfaction that we get from purchasing and consuming a good
or service. There are two ways to analyze utility.
-Total utility: The total satisfaction from a given level of consumption
-Marginal utility: The change in satisfaction from consuming sn extra unit of. a good or
service.
Upward sloping demand curve
Caused by:
-Giffen goods: these don’t have a substitute. The higher the demand, the higher the
price.
-Goods with snob appeal: The snob effect is a phenomenon where the demand for a
good by individuals of a higher income is inversely related to those of a lower
income. These goods confer status to the buyer, and they are called Veblen goods.
-Speculative goods: For stocks, for example. The higher the price, the higher the
demand, as people expect to make money out of it
-Quality goods: customers believe that the higher the price, the higher the quality,
and the higher the quantity demanded.

Exceptions to the law of demand

-Ostentaneous consumption: Some luxury product’s satisfaction if having them due
to their price and of the envy that having them provokes to other people
-Speculative demand: The consumer can not only be interested in the satisfaction
that come from having the product, but also because of the potential rise in its price
leading to capital gain or profit.

CONSUMER SURPLUS

Getting value for money

-Value is what we get from consuming a good or service
-Price is what we pay for it

The private marginal benefit is the gain in satisfaction that we get from consuming an
extra unit of a product. As consumption rises, we asume that the marginal benefit
falls.

Consumer surplus P
It is a measure of the welfare that people gain
from the consumption of goods and services,
or a measure to eye benefits they derive from surplus
~consume
the exchange of goods. [6
It is the difference between the total amount
that consumers are willing and able to pay and
what they actually end up paying.
Market
price
the level of consumer surplus is the area under E]
the demand curve and above the ruling market
price.
In the diagram to the right, the consumer is
willing to pay 6 pounds for 5 units, but ends
up paying 3 pounds for 15 slices. 3 18 Q
PRICE ELASTICITY OF DEMAND

What is it?
It measures the responsiveness of demand after a change in the good’s own price

To calculate the coefficient of price elasticity of demand:

% change in Q demanded
% change in P

Numerical values
-Perfectly inelastic: PED=0
It is an extreme case where consumers are willing and able to pay any price

P,----.
&

? === Si

⑥ R

-Inelastic: PED=between 0 and 1

The percentage change in demand is smaller than the percentage change in price

jit, 2,0
e

-Unit elastic: PED=1

A change in price has a proportional change in demand.
P

=
2,01 D

-Perfectly elastic:PED=infinity
There is one price consumers are prepared to pay.

·
P,

8. Q2
D

-Elastic: PED is bigger than one

Demand responds more than proportionally to a change in price

=
-8,92 Q
Factors that determine PED
-Numer of close substitutes available to customers
-Price of product in relation to total income
-Cost of substitutes
-Brand loyalty
-Degree of necessity/luxury

Usefulness of PED
Firms can calculate the PED of their products to predict:
-Effects of a change in price
-Effects of a change in indirect tax on price and quantity demanded

Firms can also use it for price discrimination, which is where the supplier decides to
choose different prices for the same product on different segments of the market.

Surge pricing
It is when demand out-strips available supply. Uber, for example, rises prices when
there is a lot of demand.

Limitations of elasticities
-May be inaccurate or incomplete
-Elasticities vary between regions/times
-Rival producers may change their market strategies from time to time

CROSS-PRICE ELASTICITY OF DEMAND

What is it?
It measures the responsiveness of demand on good X following a change in the price
of related good Y

Substitutes, complements and unrelated products

-Substitutes are products in competitive demand. An increase in the price of one
good will lead to an increase in demand of the rival product. the value of XED is
always positive
-Compllements are products in joint demand. A fall in price of one product causes an
increase in demand for the complementary product. The value of XED is always
negative.
-Unrelated products have zero XED. The change in the price of one has no effect on
the demand of the other.

Formula
-
% change in Qd of X
%change in P of Y
Graphs
-There are two types of substitutes:
-Close substitutes: A small rise in price -Weak substitutes: A large rise in price
of X causes a large rise in demand for y. of X leads to a small rise in demand for Y

P D
Ouf
I
D

P. R
.....
*
-0.
- - - -

41 ---

i :
!
P. -
-
- -

i.
8, 2 x2
D of] & A
-There are two types of complements:
-Close complements: A small fall in. -Weak complements: A large fall in price
price of X leads to a large rise in. of X leads to a small rise in demand for Y
demand for Y
Po Pot
A
↑P, --
P.
-------
I

I
i "" B

Q
·Do Y !, a2 Do Y

INCOME ELASTICITY OF DEMAND

What is it?
It shows how responsive the demand for a product is to a change in (real) income.

Formula
% change in Qd
% change in real income

Different types of goods

-Normal goods: YED is positive
-Luxury goods: YED is bigger than 1
-Necessities: YED is between 0 and 1
-Inferior products: YED is negative. They are counter cyclical, as their demand varies
inversely to the macroeconomic cycle.
SUPPLY

What is it?
Supply is the quantity of a good that a producer is willing and able to supply onto the
market at a given price in a given time period.

The law of supply

It is that as the price of the product rises, business expand supply to the market
The reasoning towards this is mainly the profit motive. This is why the supply curve is
upwards.

o
Causes of shifts in the supply curve
-Changes in cost of production
-Lower costs mean that firms can supply more
-Higher costs means that firms can supply less
-A fall in the exchange rate. Imports will be more expensive.
-Advancements in production technology will cause an outwards shift
-The entry of new producers will cause an outwards shift
-Taxes, subsidies and government regulations

Joint supply
It is where an increase or decrease in the supply of one good causes an increase or
decrease in the supply of a by-product

PRICE ELASTICITY OF SUPPLY

It measures the relationship between change in quantity supplied and a change in

price. When supply is elastic, producers can increase production without a rise in
cost or a time delay. When supply is inelastic, firms find it hard to change their
production levels in a given time period.

Formula
% change in quantity supplied
% change in price

Coefficient of PES
It is always positive because an increase in price is likely to increase the quantity
supplied to the market.
Measurement
-PES > 1: Price-elastic supply: A change in price creates a bigger change in quantity
supplied.
-PES = 1: Unit-elastic supply: A change in price has a proportional change in
quantity supplied.
-PES < 1:Price-inelastic supply: A change in price creates a smaller change in
quantity supplied.
-PES = 0: Perfectly inelastic supply: A change in price has no effect on the quantity
supplied onto the market.
-PES = infinity: Perfectly elastic supply: A firm can supply any quantity at the same
market price.

Price-elastic Unit-elastic Price-inelastic

P P &
S
S
Pz -- Be a --- *

i !
2 ----
-

S
P ---- !
"
P a

i
---
--

! "
Q Q2 Q a,P2 Q ①, Q2 Q

& Perfectly inelastic & Perfectly elastic

S

PL--------
· S

i
1, ------

Q ① Q2 Q

What determines supply elasticity?

-Factor substitution possibilities: Can labour or capital inputs be switched easily
when there is a change in demand?
-When factor substitution is possible and can be achieved at low cost, supply will
be elastic
-When factors are highly specialized, substitution may be harder and thus supply
will be inelastic
-Spare production capacity available: When there is spare capacity, business can
expand output easily to meet rising demand without upward pressure on costs
-Stocks (inventories) available to meet demand
-A low level of stocks makes supply inelastic in the short term
-When stocks can be released onto the market, supply is elastic
-The time frame allowed
-Momentary period (fixed supply)
-Short run (inelastic supply)
-Long run (elastic supply)
-Artificial limits on supply: e.g. the impact of patents that limit which firms can supply
a product.
Momentary supply (price elasticity = zero)
An increase in price from P1 to P2 does not lead to a change in supply.
&
momentary supply

P2 --------- -
8

1, ---------- 8

Di D2
Qu D

Short run supply

An increase in price from P1 to P2 does lead to a short term expansion in supply from Q1 to
Q2. In the short run, price will be P3.

&
momentary supply
shortrun supply
P2 --------- -
8

Pl

are a

Long run supply

The initial increase in price will lead to a increase in output to Q3, and price will be less than the
initial increase at P4.
&
momentary supply
shortrun supply
P2 --------- -
8

Pl long run
supply

=
MARKET FAILURE
It occurs when freely-functioning markets, operating without government intervention, fail to
deliver an efficient or optimal allocation of resources. This is usually caused because the
benefits that the market confers on individuals or firms carrying out a particular activity
diverge from the benefits to society as a whole Therefore, economic and social welfare may
not be maximized. This leads to a loss of economic efficiency.
Some causes of market failure are externalities, imperfect information, pure public goods,
monopolies, etc.

Complete and partial market failure

Complete market failure occurs when the market does not make a product at all, while
partial market failure occurs when the market does not supply the products in the quantity
demanded or at the price consumers are willing and able to pay.
EXTERNALITIES

Externalities and market failure

They are a major cause of market failure and are likely in every market.
They are spill-over effects from production and consumption for which no
appropriate compensation is paid/received. They lie outside the initial market
transaction/price. They can cause market failure if the price mechanism does not
take account of the social costs and benefits of production and consumption

Private external costs and benefits

-Private costs are the costs faced by the producer or consumer directly involved in a
transaction
-Private benefits are the benefits for the producer and/or consumer directly involved
in an economic transaction.

The existence of externalities created a divergence between private and social costs
of production and the private and social benefits of consumption.

Social cost = Private cost + External cost

Social benefit = Private benefit + External benefit

When negative externalities exist, social costs exceed private cost. This leads to
over-production and market failure if producers do not take into account the
externalities

When positive externalities occur, social benefits exceed private benefit. This can
also lead to market failure

Marginal social, private and external costs and benefits

-Marginal private cost (MPC): Cost to the producing firm of an additional unit of
output
-Marginal external cost (MEC): Cost to third parties from the production of an
additional unit of output.
-Marginal social cost (MSC): Total cost to society of producing an extra unit of
output. MSC = MPC + MEC
-Marginal private benefit (MPB): Benefit to the consumer of consuming an additional
unit of output
-Marginal external benefit (MEB): Benefit to third parties from the consumption of
extra unit of output
-Marginal social benefit (MSB): Total benefit from consuming an extra unit.
MSB = MPB + MEB
 How do economists value externalities?
A key aspect of externalities is the difficulty of assigning values
-Shadow pricing: e.g. the external cost of road congestion can be calculated by
multiplying the number of hours lost by the average wage e.g. 1m lost working hours x
$12 average hourly wage = $12m lost
-Compensation: estimate the cost of ‘putting right’ an externality e.g. include the cost
of installing double gazing in houses affected by increased road noise from a new
motorway. If 200 houses are affected each with $5000 double glazing cost, increased
road noise is estimated at $1m
-Revealed preference: How much people are willing to pay to avoid an externality e.g.
if 200 householders are willing to pay $2000 each to avoid noise, the externality is
valued at $0.4m

POSITIVE EXTERNALITIES

What are they?

They occur when production and/or consumption creates external benefits on third
parties outside the market. They create third party spillover effects. The result is that
social benefit of production/consumption is greater than private benefit.
These benefits may be in the form of lower costs, increased revenues or increased
utility.
They are associated with merit goods and services

Examples
-Positive production externalities:
-Flood defense projects
-Bee-keeping and pollination
-Positive consumption externalities:
-Healthcare
-Education

Graphs:
-Positive externalities in consumption: -Positive externalities in production: The
They cause social benefit to be greater. social marginal cost of production is less
than private benefit. than the private marginal cost of production
B
2+ loSS B
2+
MPC
We
Ifave MpC

-
MSC
Pre-

..... am welfare loss

ii.MSA
-....

MSB
MPB

D &
Subsidizing consumers
A subsidy reduces the marginal private cost of consumption and ought to lead an
expansion of demand towards the desired social optimum.

tfirs subsidy per unit

e ~ MD with consumer subsidy

= MPB
external benefit

Q2 is the socially optimum level of consumption

Externalities in production and consumption

L B
+ MS

--------- MPC

Sin this diagram there are also

---------- negative externalities, as a Qn]

!
MSB

MPB
a a, Q

NEGATIVE EXTERNALITIES

What are they?

They occur when production and/or consumption impose external costs on third
parties outside the market for which no appropriate compensation is paid.

Examples
-Negative production externalities
-Air pollution from factories
-Damage to the environment from industrial ocean fishing
-Negative consumption externalities
-Effects of passing smoking
-Noise pollution from events such as sports matches and concerts
Graphs
-Negative externalities in production: These. -Negative externalities in consumption:
occur when social cost is greater than private. These are caused when the private
cost when producing something. benefit is greater than the social benefit

- -Yes,
MSC MSC

t
MPC
-----
B

welle -
we
Ifare

a - - -

MPB

PUBLIC GOODS

What are they?

They cause market failure due to missing markets. Their main characteristics are:
-Non-excludability: The benefits derived from pure public goods cannot be confined
solely to those who have paid for it. Non-payers can enjoy the benefits of consumption
at no financial cost to themselves. This is called the free-rider problem.
-Non-rival consumption: Each party’s enjoyment of the public good or service does not
diminish others’ enjoyment. The marginal cost of supplying a public good to an extra
person is zero. If a public good is supplied to one person, it is available to all.
-Non-rejectable: The collective supply of pure public goods for all will mean that it
cannot be rejected by people, an example being a nuclear defense system.

The nature of public goods is that it is hard to protect property rights.

The free-rider problem

If the provision of public goods were left to the market mechanism, there would be
market failure. This is because of the free-rider problem. A public good is one where it is
impossible to prevent people form receiving the benefits of the good one it has been
provided, so there is little incentive for people to pay for consumption of the good. A
free-rider is someone who receives the benefit but allows others to pay for it.

Quasi-public goods
It is a near-public good, as it has some of the characteristics of a public good.
They are:
-Semi-non-rival: Up to a point, more consumers using a park, beach or road do not
reduce the space available for others. But eventually, beaches become crowded as
parks.
-Semi-non-excludable: It is possible but difficult or costly to exclude non-paying
consumers. E.g. fencing a park or building toll booths on congested road routes.
Public goods, market failure and free-riders
With public goods, private sector markets may fail to supply in part or in whole the
optimum quantity of public goods.
Public goods are not normally supplied by the private sector, as it is hard to make a
profit. It is therefore up to the government to decide what output of publuc goods is
appropriate for society.
Because public goods are non-excludable, it is difficult to charge people for
benefiting once the product is available. The free-rider problem leads to under-
provision of a good and thus causes market failure.

Global public goods

They benefit every country, irrespective of which ones provide them. Some examples
are security from war, the rule of law, eradication of smallpox, etc.

MERIT AND DEMERIT GOODS

Merit goods
These are goods that the government feels that people will under-consume, and
which might be subsidized or provided free at the point of use. Unlike public goods,
merit goods can be rival, excludable and rejectable.
They exist because there are positive externalities in consumption, leading to an
under-consumption of the good in a free market. This is because the free market
demand curve is to the left of the demand curve if all benefits were to be taken into
account.

="
MP? loss
welfare arising
from under-consumption

M)B
marketdemand would be higher
Q
if consumers had better
information
Q, Q2

Demerit goods
These are thought to be bad for you, as consumption may lead to negative
externalities. The social cost of consumption is higher than the private cost. The
government may decide to intervene in the market for these goods and impose
taxes.
L+B MP
loss
welfare

I
Pr

i
----

------
MPB

02
"Ma
INFORMATION FAILURES/GAPS

What is it?
Information failure occurs when people have inaccurate or incomplete data and so
make potentially wrong choices/decisions.

In competitive markets, it is assumed that there is perfect information, meaning that

both consumers and producers have full and correct information on the prices,
benefits and costs of the goods and services being sold. If this is not the case, there
is imperfect information.

There are many causes of information failure:

-Long-term consequences: Information gaps about long-term benefits or costs of
consuming a product
-Complexity: Information failure when a product is highly complex
-Unbalanced knowledge: Then the buyer knows more than the seller or viceversa
-Price information: When consumers are unable to quickly/cheaply find sufficient
information on the best prices for different products.

Asymmetric information
This is caused when there is unbalanced knowledge between the buyer and the
seller. For example, landlords know more about their properties than tenants, doctors
have more knowledge about drugs and treatment, or used car sellers knowing more
about the vehicle quality than the buyer.

GOVERNMENT INTERVENTION

Government intervention to correct market failure

Governments try to correct market failure in a number of ways, some of which are:
-Indirect taxes: The government can put taxes on production and/or consumption of
certain goods or services that may be causing externalities. Less goods would be
manufactured and/or sold. The level of tax needs to be set so that negative
externalities are eliminated and the marginal private cost equals the marginal social
benefit.
P Se/MSC
In the diagram to the right, we can see how
the current level of production is Q1, but the
optimal level is Q2. As a result, the price rises
S.
/MPC
P-
-------

a.----"
from P1 to P2, as tax is imposed. The output
tax
and price are now located where the marginal
social cost meets the marginal private benefit,
D/M
MSB
which is the level where we want to be in.
=

Indirect tax may have problems, though. These an a,

may be:
-Difficult to target: The tax would be too big or too small to correct the market
failure exactly.
-Taxes are unpopular
-Subsidies: Another way for governments to prevent market failure is through the
provision of subsidies. For example, if an asset creates positive externalities in
consumption, the owner of this asset will receive less marginal benefits than society
as a whole. To make sure that this asset can still be giving social benefits, and that
the owner can still afford to have and maintain it, it may give him subsidies.
This can be shown in the first diagram to P
the right, where there are Q1 assets available, 3/MPC
but the optimal level is Q2 assets, so the unit
subsidy

l
government gives a subsidy to achieve this level. per
Subsidies can be used to correct different types -=
of market failure, such as output of merit goods,
inequalities, factor mobility or competition. n
m
Subsidies can also have problems, such as being
difficult to target, conflictive with other policies, ①

or difficult to remove.

-Maximum prices: Prices can cause market failure when too high. The government
may judge these goods as merit goods, as they can bring significant positive
externalities in consumption. Also, maximum prices will increase the spending power
of the poor.
In the diagram to the right, we can see how P S
the equilibrium of a good is at a high price,
so the government may decide to put a
maximum price. The problem with this is that ?, ------

i
imposing a maximum price will reduce supply,

a "za
but will increase demand. There will be an
excess of demand, and those who were able
to buy the good before the maximum price
will be better off when buying it now.
Maximum prices often lead to black markets.

-Minimum prices: Some goods that create negative externalities may want to be
controlled by the government. This can be done by raising their prices to the level
where marginal social cost and marginal social benefit are equal. Alternatively, the
government may decide to put a minimum price above the free market price.
In the figure to the right, we can see

·
S
how a minimum price not only would
increase the price of a certain good,
but it would also create an excess of
supply compared to a low demand.
An excess of supply tends to create
black markets where these goods
are sold for less than their minimum
price.
 -State provision of public goods: Assume there is a market for defense. To prevent
market failure, 0A should be produced. However, there is no price on the demand
curve at which 0A would be demanded. The government therefore steps in and
provides 0A whatever the price of defense.

Pe S

B ④
8 A

-State provision of merit goods: assume this is the marker for education. To prevent
market failure, 0B should be produced. The free market, however, only produces 0A.
The government therefore steps in and provides 0B whatever the price of education.
Set Swor

8
"
A B
D

-Buffer stock schemes: The price for commodities is volatile. This is a problem for
developing countries reliant upon commodities for exports, jobs and government
income. One way of stabilizing commodity prices is by setting up a buffer stock
scheme, which is a scheme whereby an organization buys and sells in the open
market so as to maintain a minimum price in the market for a product.
There are three scenarios:

(1). In this case, the free (2) In this case, the free (3) In this case, the free
market price is within the market price is below the market price is above
minimum and maximum minimum price limit, so the the maximum price, so
price limits, so the buffer buffer stock agency needs the buffer stock agency
stock agency has no need to increase demand from D1 needs to increase
to intervene. to D2 so that the price lies supply from S1 to S2
S
within the boundaries. so that the price lies
max p 5 within the boundaries.
P
max. P 3 P

="
P---.

i
min mindz --

,
....,->
B ......, Di
'
D2
Q Q. Q2 ④ Q, Qu ①
GOVERNMENT FAILURE

What is it?
Government failure occurs when an intervention leads to a deeper market failure or
even worse a new failure may arise. In other words, an intervention creates further
inefficiencies, a miss allocation of resources and a loss of economic and social
welfare.

The law of unintended consequences

Actions of consumers, producers and government always have effects that are
unanticipated or unintended.
Well-intentioned legislation often acts against the interests of those it is intended to
serve.
People and businesses find ways to circumvent new laws, and shadow markets
develop to undermine an official policy.
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