Category Archives: IBHL-1 Economics

The Big Giveaway

1. Explain what is meant by the term ‘freeconomics’. 

The term freeconomics means that businesses provide goods and services for free or at a low price. This causes consumers to be more committed as they are receiving what they want at lower prices than they were before.

2. How can firms afford to make goods and services available for free?

Firms can afford to make goods and services available for free by reducing marginal costs or having other sources of income. Marginal costs are the cost of producing one extra unit for an item. An example of another source of income can be if there are advertisements and such that help the firm gain a profit. For example, Facebook is a free social networking site however the company still makes a lot of money. This happens because of the advertisements that are placed on the page. Facebook is used worldwide by people, so when other companies want to advertise their products, they pay Facebook to do so because those advertisements will be seen by many people. Since Facebook has personal information about each person and show the “likes”, the advertisements could appeal to specific people’s wants to advertise. Also, people can see how many of their other friends have “liked” a specific product and would be persuaded to buy it as well. This way, Facebook makes money from companies that want them to advertise their products and such for them, and those companies make money once consumers on Facebook have seen what they are selling. So, Facebook can afford to make its good and services for free because they are paid a lot of money by other companies to advertise their goods and services, thus making a profit. This is similar to the situations of other firms because they also have goods or services that are free but make profits from other things they provide.

3. “Anderson’s idea is that the internet, by reducing marginal costs, encourages businesses to make their money by offering free goods or services to an extent we have not witnessed before”. Discuss the extent to which doing business over the internet reduces marginal costs.

There is an extent to which doing business over the Internet reduces marginal costs. This depends on other factors that can affect the company to have different outcomes in the long run or short run. In the short run, it can reduce marginal costs as it is electronic but in the long run, it could cause more competition to arise therefore causing the marginal cost to increase. An example of this is MEGAVIDEO, a server that provides movies and television shows for viewing. MEGAVIDEO allows 72 minutes of viewing for free, but after these minutes, you must pay or wait for another 72 minutes to view the rest of the movie or show. This is advantageous to the company because most movies go over the 72 minutes, so the people will get very frustrated with waiting to finish the movie, especially if they are on a very intense or important scene. Therefore, some may be willing to pay for the unlimited service so that they do not have a limited time to watch something, which will increase MEGAVIDEO’s marginal revenue. However, it may be disadvantageous providing 72 minutes free if the people are only watching shows on it because the episode will end before the 72 minutes, therefore they will not need unlimited access as it isn’t a bother to them.

The stakeholders of this are MEGAVIDEO, consumers, and competition. In the short run, MEGAVIDEO will be winners because they are making a profit. Also, they are reducing their marginal costs because they do not have to pay for packaging and such for the movies. They simply have to upload to the server, probably just once, and once it is on their server millions of people can watch it. Therefore, they are saving a lot of time because they do not have to upload a movie more than once. Also, in the short run, consumers will be winners because they can watch the first 72 minutes which is enough time to watch a 40 minute episode. However, if they want to watch a full movie and are not willing to pay for it on MEGAVIDEO, they always have other options to view movies.

In the long run, MEGAVIDEO could be losers. This is because once other companies see that they are making a profit and reducing their marginal costs, they may follow MEGAVIDEO’s path, and this will increase competition. Once the competition increses, because consumers have many options, they may choose not to pay for MEGAVIDEO and rather use a site that is free for a longer amount of time or a site that has the same conditions as MEGAVIDEO but at a higher viewing quality.This will increase the marginal cost of the company because they will have to keep uploading more and more movies and shows so that they can be ahead of their competition which will cost them a lot of time. Also if their competition increases, their marginal revenue will start to decrease if people are not paying for unlimited use on their server anymore. Even in the long run, the consumers will be winners because they will have options available to them no matter what and can choose whatever sites or means of watching movies and shows they want.
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Coffee Shortages in Venezuela

1.Using supply and demand diagrams, as appropriate, show why there have been coffee shortages in Venezuela.

There have been coffee shortages in Venezuela because of the price ceiling that has been set. The price ceiling is set below the equilibrium therefore there is more demand than supply. Because there is more demand than supply, a shortage occurs because the supply can’t cover all the needs of the consumers.

 

 

 

2. Discuss the effectiveness of price controls as a policy to reduce inflation.

The government of Venezuela decided to keep price controls on items such as coffee, beans, sugar, and powdered milk to decrease inflation. This has angered coffee companies and caused them to stop supplying coffee in supermarkets as they feel that they are not making profits with the low selling prices. Instead, they have stored their coffee in warehouses in hopes that the government will change to a fair price. They decided not to supply at all because of the government’s price controls, which means that coffee shortages will occur as the demand for coffee outweighs the supply. Also, this will not stop until the government negotiates a fair price so the government and coffee companies have to come to an agreement so that citizens can buy coffee once again, companies can make profits, and the government can reduce inflation. So, the price controls have not been effective in reducing inflation and instead have angered coffee suppliers.

3. Analyse the impact of the price controls on Venezuela’s major economic targets

The price controls have not been able to reduce inflation. The government has decided to lower the prices of coffee which only caused the coffee suppliers to stop supply. The stakeholders are the citizens of Venezuela, the government, and coffee companies. By lowering the price by a lot, the coffee companies decided not to supply at all. This could lead to a black market within the country where the prices of coffee will be very high and the government will have no control over it. In the short run, the citizens are losers since they are demanding coffee but not getting any supply. Even if there is a black market, only the rich people will be able to afford it, so the poorer people will still be losers. The government are also losers because their method was not effective and they have just angered companies. Also, in the black market, the government has no say and control in the price of coffee. Lastly, the coffee companies are both losers and winners. Because they are not supplying in the supermarkets, they are not making any profit so they are losers. However, they could make a profit if they decide to sell coffee at black markets and because there is no substitute for coffee and the government can’t control the situation, the demand will be inelastic to a certain degree and they will make a lot of profit. However, is some cases, the government could intervene in the black markets within the country, which could lead to a black market outside the country. In this case, the coffee suppliers are winners. Though the coffee suppliers will make less money if they sell coffee internationally, they are not making any money within their country so it is still more beneficial. The government will loose because they can’t control the international black market of coffee. Lastly, consumers of other countries are winners because they can afford the coffee at cheaper prices, however the consumers of Venezuela are losers because they are still not receiving coffee.

In the long run however, since the suppliers and government have not found a common price, the situation can get much worse. If the government found a way to lower prices by negotiating with coffee companies and deciding on a price that suited both companies instead of angering the coffee companies, they would be able to reduce inflation. If this were to occur, most of these stakeholders would be winners because the citizens would get coffee at a fair price, the government would be able to reduce inflation, and the coffee companies would be able to make a profit and sell coffee at a reasonable price.

Theory of the Firm Vocabulary

1. Cost Theory (total, fixed, variable costs; calculating costs)

  • Total cost: fixed costs + variable costs
    • Average total cost: total cost / output
  • Fixed costs: costs that remain unchanged when output changes (e.g. rent, interest on loans, insurance)
    • Average fixed cost: Fixed cost / output
  • Variable costs: costs that vary directly with the level of output so they change according to the number produced (e.g. cost of raw materials, packaging costs, direct labor)
    • Average variable cost: variable cost / output
2. Law of diminishing returns

  • As more and more of a variable factor are added to fixed factor, output will rise initially but will l eventually fall.
  • Example: McDonalds hire three new workers that increase output by 10 burgers but adding another worker would only increase the output by 5. Adding a fifth worker will only increase output by 2. It gets cramped and there isn’t space so it because inefficient.
  • Is a short-run law
  • Graph

3. Short-run

  • The short run is the period of time in which at least one factor of production is fixed. Over this time period the firm can only expand production by using more of the variable factor.

4. Long-run

  • The long run is the period of time when all factor inputs, including capital, can be changed.
  • Economies of scale: advantages of increasing in size (e.g. greater revenue)
  • Diseconomies of scale: disadvantages of increasing in size (e.g. poor communication)
  • Graph
5. Revenues (TR, AR, MR)

  • Total revenue (TR): all the revenue earned by the business. Total revenue = price x quantity demanded.
  • Average revenue (AR): total revenue divided by number sold.
  • Marginal revenue (MR): the increase in total revenue as the result of one more sale. This is not necessarily the same as the price. It is only the same as price, if price remains constant.

6. Profit, sales & revenue maximization

  • Profit maximisation: Companies that are trying to create the biggest gap between their costs and revenue to increase the profit. (companies like Tiffany don’t want to increase sales by reducing costs but rather just get the most profit from their good) A firm will maximize profits where MC=MR.
  • Sales revenue maximisation: it means earning the maximum possible revenue from the quantity sold. This will not be the same as profit maximizing as the additional units will have a higher cost and may therefore be less profitable to sell. Sales revenue is maximised where MR=0.
  • Sales volume maximisation: it means selling the maximum possible number of units without incurring a loss. Sales volume is maximised where AR=AC. The firm might be able to sell more than this, but the diagram shows that on all units of output beyond this, AC is greater than AR and, therefore, a loss would be incurred.
  • Graph

7. Perfect Competition (elements of)

  • Perfect competition is considered as the ideal or the standard against which everything is judged.
  • Perfect competition is characterized as having:
    • Many buyers and sellers. Nobody has power over the market.
    • Perfect knowledge by all parties. Customers are aware of all the products on offer and their prices.
    • Firms can sell as much as they want, but only at the ruling price. Thus sellers have no control over market price. They are price takers, not price makers.
    • All firms produce the same product, and all products are perfect substitutes for each other, i.e. goods produced are homogeneous.
    • There is no advertising.
    • There is freedom of entry and exit from the market. Sunk costs are few, if any. Firms can, and will come and go as they wish. There are no barriers to entry such as licenses.
    • Companies in perfect competition in the long-run are both productively and allocatively efficient.
8. Shut down and break-even price
Where MC meets AVC (average fixed cost) is the shut down price. This is because they can’t meet their costs therefore must shut down.  Where MC meets ATC is the break even price.
9. Monopoly (elements of, model, theory)

  • Model: Monopoly is the opposite of perfect competition. In the literal sense, it exits when one single firm or a group of firms acting together control the entire market for that good or service and no substitutes are available. This is a situation of pure monopoly. Economists focus more on the degree of monopoly power that exists rather than absolute monopoly power. A market concentration ratio is used to measure the degree of concentration within that industry or group of industries. The five firm concentration ratio is used commonly to indicate the proportion of the industry’s output produced by the five largest firms.
  • Theory: In perfect competition, as there are many firms competing against each other, no one controls the price; therefore they are price takers. However, under monopoly there is only one firm in the industry. So there is no difference between the demand curve for the industry and and the demand curve for the firm. As the monopolist is subjected to the normal demand curve, to sell more, the price must be lowered. However compared the other markets, the monopolist’s demand curve is probably more inelastic as close substitutes are not available even at higher prices.
  • Assumptions about the Model
    • One firm
    • Price Setter
    • Barriers to entry
    • Some monopolies are considered Natural Monopolies i.e. barriers to entry are very high and the firm enjoys economics of scale where it can produce at a lower cost than many small firms combined e.g water supply, gas, electricity
  • Pros
    • natural monopolies can gain economies of scale
    • abnormal profits used for Research and Development
  • Cons
    • anti-competitive behavior & predatory pricing
    • high prices for lower output
    • productively & allocatively inefficient
10. Oligopoly (elements of, model, theory)

  • Definition/Model: Oligopoly is when a few suppliers who provide the same product dominate a market. Petrol companies and the soap and detergent industry are good examples. Each firm has to be concerned about what the others in the industry will do.
  • Assumptions about the model
    • three or four large companies dominate the industry, but small companies do exist
    • firms are interdependent, all will watch what the competitors do and act accordingly
    • there are barriers to entry, this means it is difficult for other firms to enter the industry;
    • non price competition, as companies cannot compete by prices, therefore they have to compete with the service they offer
    • the oligopoly must be collusive (collusion)
    • advertising
11. Monopolistic competition (elements of, model, theory)
  • Definition/Model: Monopolistic competition is made up of a large number of small firms who produce goods that are only slightly different from other sellers.
  • Assumptions about the model  
    • Large number of firms: Each firm has a small share of the market
    • Independence: because of the large number of firms in the market, every firm is unlikely to greatly affect the other. When making decisions firms do not have to think about how its rival will react.
    • Freedom of entry
    • Product differentiation: This makes it different from perfect competition. This is also why each firm has a down ward sloping demand curve.
  • Examples
    • Petrol stations, restaurants, hairdressers.
  • Theory
    • Monopolistic Competition in the short-run
      • Graph
      • In the short run firms are able to make abnormal profits.
      • Profit maximized when MC=MR
      • In monopolistic competition the AR and MR curves are more elastic because more substitutes are available.
    • Monopolistic Competition in the long-run
      • Graph
      • In the long run new firms can enter the market. Other firms are attracted by the abnormal profits and they will be competed away until there are just normal profits.
      • This means that the demand for the product of each firm will fall and the AR will shift to the left.
12. Advertising and Branding

  • Advertising definition: The presentation of a product, idea or organization to convince individuals to buy, support, or approve of it.
  • Branding definition: Creating a name, symbol or design that identifies what differentiates this produce from others. How consumers perceive a branded product will be enough for goods to be sold at a very different price.
  • Multiple branding definition: Marketing two or similar and competing product by the same firm under different and unrelated brands. This could be effective on the barriers to enter a market for new firms.
13. Forms of collusion

  • Formal Collusion
    • Cartel definition: Limited number of competing firms, which are selling a similar product, decide to collude rather than compete.
      • When the cartel acts like a single monopolist and maximises profits, it is most successful.
      • Profit maximisation for the cartel graph
      • To maximize profits, MC is equal to MR and there is a optimum price.
    • Reasons for a cartel
      • geography: productive capacity or pre-cartel market share
      • cartel members want non-price competition so that they can gain optimum quantity.
  • Informal or tactic collusion
    • Priceleadership definition: This is when one firm sets a price that is accepted as the market price by the other producers. There is no formal or written agreement.
14. Price discrimination

  • Definition: charging different prices for the same/similar good to different consumers
  • Price discrimination occurs in an imperfect market, when a sale from the same supplier, of an identical good or service is charged for a different price for different consumers. Price discrimination is used to profit the discriminating firms. But, the price discrimination has to be for different consumers, in different markets.
  • Stakeholders:
    • Winners:
      • Suppliers (able to set a higher price to those able to buy it at that price)
      • Poorer consumers (able to buy the good/service at a price they can afford. If price not that low, they wouldn’t have been able to buy it)
    • Losers:
      • Richer consumers (have to pay a higher price for the same good, but not a big loser because they are still able to pay for the good/service)

15. The kinked demand curve theory

  • Asymmetrical reaction : asymmetrical reaction to the change in price by one firm.
  • eg. a decrease in price by one firm will lead to a decrease in price by other firms to protect market share.
  • Elastic part of graph (top part of graph) – to increase price at the elastic part of the graph would not be effective as not many other firms would increase their price (because price is high)
  • Point at kink : point showing discontinuity (how good changes from elastic to inelastic)
  • Inelastic part of graph (bottom part of graph) – Price War! Constant competition of price (if one firm decreases price, other firms fallow

China and India Making Inroads in Biotech Drugs

In class, we recently looked at the article China and India Making Inroads in Biotech Drugs. Cancer drugs and medicines are very expensive and not available in every country at an affordable price. China and India, two of the worlds LEDC’s are copying US’s cancer drugs at a cheaper price without patent. This is angering the US because while they spend millions researching and creating the product, China and India are just copying their hard work and not giving them any profit from that.

There were three basic economic questions in this article. Firstly, what drugs are considered beneficial for all, thus, patents could be violated? Secondly, how could US Biotech companies keep cost competitive with India/ China? Lastly, who will benefit from cheaper drugs? Who will lose?

Some definitions that came up in this article were price discrimination, law of demand, allocation, tradeoff, and opportunity cost. Price discrimination is when the price of a good differs. This is shown as the drugs are sold at a much higher price in the US than in China and India. The law of demand states that as price goes up, quantity demanded goes down and vice versa. This is shown in this article because as the price of the medication in India and China go down compared to the US, the demand for those drugs increase. Allocation is the process of distributing something, in this case money. In this article, the poor people need to decide how to allocate their money so that they can afford the drugs. Allocation shows tradeoffs and opportunity costs because if they do choose to spend their money on the drugs, they are giving up something else that could have been bought with the money spent on drugs.

The stakeholders in this article are the rich and poor patients, pharmaceutical companies, researchers, governments, NGOs, and the Indian and Chinese manufacturers. Though there is no solution that benefits both sides together, there is a possible solution benefiting a few of the stakeholders. The solution is that we can wait 20 years after the product is produced. Once the 20 years are up, the poor people will be able to gain access to these drugs as the second buyers. The first buyers will be the people that are able to afford those drugs in the 20 years. The reason for this solution is that since the pharmaceutical companies are producing the goods and the researchers are finding ways for this to happen, we should side with them since they are the ones putting hard work into the drugs. However, if India and China do not wait for this and keep producing cheaper drugs, US companies will refuse to make newer advances and this will mean that after 20 years, only this cure will remain and no newer improvements or treatments will be produced. In this situation the winners are the rich patients since they will be able to afford the medications as soon as they are out, pharmaceutical companies and researchers because they will be able to gain a profit, and the rich governments (US) because their country will be able to afford medications. The losers will be the poor patients because if anything happens in those 20 years, they will not have treatment as they can’t afford it, the NGOs because they are non governmental, and the Indian and Chinese governments and manufacturers because they will not have treatments for 20 years. In this case, the winners will benefit as they get cures and can possibly make profits while the losers will have costs since many people will be dying in the 20 years they cant afford the drugs. Even if India and China copy the US drugs, they will still have costs because no further advances will be made to the drugs. Looking at this, we can see that the winners such as the US government, pharmaceutical companies, researchers, and rich patients have comparative advantage.

Store Analysis

As you enter 7-11, the first thing I noticed was that the entrance faces away from the cashier. This can be a way for the store to make sure the customers look at the whole store before they decide to exit the shop.

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When you enter, the first thing you see are things that are necessary at times but are not edible items. This makes customers decide to roam around the store to find food or drinks if that is the reason they came to the store. This can be another way for the store to make sure you look around.

 

 

The aisles are not that wide or narrow which allows at most two people to go at the same time. This way, people may not feel overwhelmed by aisles that are too narrow where they can barely walk through or too wide.

 

The last thing I noticed was that after a customer passes and pays at the register and is walking towards the exit, they pass the sweets. The sweets are colorful and attract many customers so they may be kept there to make the customers buy even more items or for those who didn’t buy anything, buy a few things.

 

Hypothesis: I think that 7-11 wants its customers to buy a few things. When a customer first enters, they are faced in the opposite direction of the register so this can cause them to want to look at the whole store. As well as this, there are also other incentives to stay in the store. Lastly, when you are exiting after paying, there are even more items that most people want to buy. All of these facts show that 7-11 stores want quite a few items bought.

Do You Suffer From Decision Fatigue?

a. Decision fatigue:

Decision fatigue is when you get very tired from making so many decisions that you start making poor ones. The more choices you have to make, the harder they become and then you start looking for easy way outs, leading to poor choices such as recklessness or acting impulsive instead of thinking through the consequences of the decision.

Ego depletion:

Ego depletion is a term used to explain one’s will power or self-control. When they have to use their self- control, it makes it harder to control themselves later on. For example, if someone were told not to eat chocolate, because they are controlling themselves at that time, they would be weaker if they were asked to do something else later on.

b. I think that the most interesting example was about glucose. Our bodies and brains get energy from glucose which is the sugar found in many sweets and foods. When experiments using lemonade mixed with sugar or diet sweetener was used, they realized that it tasted the same as glucose but didn’t have the same effect on the brain. This meant that people were able to have more self-control, which improved decision-making. Through this experiment, skeptics and researchers found out why glucose was able to cause ego depletion. When glucose is low in the body, the brain works on some parts and doesn’t on other parts. This can cause irrational and quick decision making instead of paying attention to the long-term consequences of a decision. This is the reason why dieting is hard test of self-control. Dieters need a lot of self-control not to eat and as they resist certain foods, it takes out their willpower, but to regain their willpower, they need glucose and need to eat, which makes dieting such a hard task. This is an interesting example because it is easily relatable.

c. This relates to economics because all businessmen and economists have to constantly make decisions. Each day companies and people need to come up with ideas on how they are going to make a profit, which is their main goal. As they make more decisions, it could be possible that they suffer from ego depletion or decision fatigue, which could cause loss to the company. However, if they are careful about the choices they make and are always aware of the long-term consequences, their company could be very successful.

d. In the past year, I have tried to go on diets but realize that they never work for me. Every time I use self control to resist eating something, the more tired I get and the less I am able to make decisions and think straight. When this happens, it can cause decision fatigue and the decisions I make can be very silly because I am too tired to make up my mind. Also, after dieting, I am no longer able to have willpower against the food I wasn’t able to eat before which causes ego depletion. The same goes for shopping. If I have shopped for a very long time, by the end of the day, I can’t make any more decisions and my judgment starts to become worse and worse. Through this article, I think that I have learned to use my self-control to a certain point. I should use it when necessary, but should not push myself too much so I can still make good decisions.