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IGCSE Economics – Co-operatives

May 4, 2017 Leave a comment

Showed this video on co-operatives to my IGCSE Economics (Unit 4 of CIE syllabus) class today and found it most useful in demonstrating the characteristics and examples. Remember the following characteristics about co-operatives:

  • share responsibility for the success or failure of the enterprise
  • work together
  • take decisions together
  • share profits (and losses).
  • The three most commonly found cooperatives are farming, production and retail.

Advantages

  • Limited liability
  • Workers in worker co-operatives take business decisions and share profits.
  • Members of consumer co-operatives enjoy profit dividends or lower prices

Disadvantages

  • Many consumer co-operatives have been forced out of business by larger companies.
  • Worker co-operatives may be badly run.

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Categories: Micro Tags:

A2 Revision – Pareto Efficiency

October 19, 2016 Leave a comment

In the A2 exam there is usually one multiple-choice question on Pareto Efficiency and part of an essay.  The idea of Pareto Efficiency is named after the Italian Economist Vilfredo Pareto. For a given set of consumer tastes, resources, and technology, an allocation is Pareto-efficient, if there is no other feasible allocation that makes some people better off and nobody worse off. See also a previous post – Pareto Optimality and the perfect wave.

fig15-01

The figure above shows an economy with only two people, Susie and David. The initial allocation at A gives David QD goods and Susie QS goods. Provided people assess their own utility by the quantity of that they themselves receive, B is a better allocation than A which in turn is a better allocation than C. But a comparison of A with points such as F, D or E, requires us to adopt a value judgment about the relative importance to us of David’s and Susie’s utility. It is important to note from the figure the following:

  • If you move from A to B or A to G it is a Pareto gain – A to B both Karen and John are better off. A to G Susie is better off, David no worse off.
  • If point B or G is feasible then point A is Pareto-inefficient – more goods can be consumed
  • A move from A to D makes David better off and Susie worse off. However we need to make a judgment about the relative value of David’s and Susie’s utility before we can comprehensively state that David is better off. Therefore the Pareto principle is limited in comparing allocations on efficiency – it only allows us to evaluate moves to the north-east and south-west

fig15-02

Therefore, we need look at the economy as whole and how many goods it can produce. In the Figure above the frontier AB shows the maximum quantity of goods which the economy can produce for one person given the quantity of goods being produced for the other person. All points on the frontier are pareto-efficient. David can only be made better off by making Susie worse off and vice versa. The distribution of goods between David and Susie is much more equal at point C than at points A or B. Note that:

Anywhere inside the frontier is Pareto-inefficient – some can be made better off without making the other worse off.

The economy should never choose an inefficient allocation inside the frontier. Which of the efficient points on the frontier (A, B, C) is the most desirable will depend on the value judgment about the relative value of David and Susie utility.

Source: Economics by Begg

Categories: Micro Tags:

A2 Revision – Marginal Utility Theory

October 9, 2016 Leave a comment

With the A2 exam not far away I thought it appropriate to post something on Marginal Utility. This is usually a multiple-choice question and part of an essay.

Consumers buy goods to derive satisfaction, or utility. Each unit purchased gives satisfaction (utility) and Marginal Utility is the satisfaction derived from the consumption of 1 more unit. Under normal circumstances the amount of satisfaction from each unit consumed will fall as more units are consumed e.g. when you finish a run your first drink will give you more satisfaction than your second and your second drink will give you more satisfaction than your third etc. – hence we get diminishing marginal utility see Table below. This is the basis of the normal demand curve, which slopes left to right – downwards.

The theory assumes that the RATIONAL CONSUMER aims to MAXIMISE SATISFACTION (or utility) by equating the MARGINAL UTILITIES yielded by the expenditure of a last money unit (cent or dollar) on each commodity purchased. The consumer is this is EQUILIBRIUM when the following formula is achieved:

  • MU of A   =     MU of B    =     MU of C       Etc.
  • Price of A       Price of B        Price of C

This means that the LAST unit of money spent provides the consumer with the same SATISFACTION (or UTILITY) irrespective of the good on which it is spent.

Examples

A consumer has $35 to spend. Price of X = $10 and Price Y = $5. What combination of X and Y maximize total satisfaction?

Quantity Bought Marginal Utility X Marginal Utility Y
1 30 15
2 20 12
3 15 10
4 9 8

 

  • MU of X   =     MU of Y
  • Price of X       Price of Y
  • 20   =   10
  • 10         5

Here the consumer buys 2X and 3Y

TOTAL UTILITY in this example = 30+20+15+12+10 = 87. (Note that TOTAL UTILITY is otherwise irrelevant to the calculation).

When the PRICE of a good falls, more will be bought (since the M.U. ÷ price formula is disturbed – and a LOWER M.U. {i.e. MORE BOUGHT} will restore equilibrium). Similarly, when the price of a good RISES less will be bought. This emerges from the LAW OF DIMINISHING MARGINAL UTILITY which states that as successful and equal quantities of a good are consumed, total utility increases but at a DIMINISHING RATE (i.e. MARGINAL UTILITY is FALLING – and can eventually become NEGATIVE.

Limitations of marginal utility theory 

  1. Unit of measurement – difficult to find an appropriate unit of measurement of utility.
  2. Habit and impulse – consumer spending on a particular product maybe habit forming or on impulse and therefore does not consider the marginal utility
  3. Enjoyment may increase as consumption increases – in some case utility may increase from further purchases of an item. A collector of memorabilia may obtain greater satisfaction from consuming an additional item – collecting a set of stamps etc
  4. Quality and consistency of successive units of a good – there is the assumption that all goods are homogenous but if successive can of soft drink are not the same then the marginal utility may change and be more or less than the previous one
  5. Other things remain constant – assumes that all factors affecting individuals’ satisfaction remain the same. However over time there maybe changes in income and the quality of other products as well as development of new products.
Categories: Micro Tags:

Indifference Curves and Giffen Goods

September 23, 2016 Leave a comment

New to the A2 CIE syllabus is indifference curves and my A2 class recently had a multiple-choice question concerning indifference curves and giffen goods. A giffen good occurs when a rise in price causes higher demand because the income effect outweighs the substitution effect.

Suppose you have a very low income and eat two basic food stuffs rice and meat. Meat is a luxury and is much more expensive than rice. If rice increased in price, your disposable income is effectively reduced significantly therefore, you buy less meat, to compensate for less meat you buy more rice to gain enough calories. Source: www.economicshelp.org

Griffen good and indifference curves

indiff-giffen

  • Good B falls in price – hence budget line moves from: 50 A – 30 B to: 50 A – 60 B.
  • The move from point J to point K is the substitution effect which = +16
  • The move from point K to point L is the income effect which = -20
  • These make up an overall move from point J to point L is the price effect (substitution effect + income effect) = -4

As income effect is negative, substitution effect positive and overall price effect negative Good B is a giffen good.

Summary of income and substitution effects of price changes

sub-income-effect

Go to eLearn Economics for more notes on Indifference Curves.

Income and Substitution Effects with Indifference Curves

June 8, 2016 Leave a comment

New to the Cambridge A Level Economics syllabus this year in Indifference Curve analysis and I have just covered this with my A2 class. Below are some notes that I’ve put together and a very good video from economicsfun on YouTube.

Income and Substitution Effects with Indifference Curves

Any price change can be conveniently analysed into 2 separate effects – the INCOME EFFECT and the SUBSTITUTION EFFECT.

Income effect of a price change: – when there is a fall in the price of a product, the consumer receives a real income effect and is able to buy more of this and other products in spite of the fact that nominal income is unchanged. If the consumer buys more of the good when the price falls it is a Normal good. If the consumer buys less of the good when the price falls it is seen as an Inferior good.

Substitution effect of a price change: – when there is a rise or fall in the price of a product, the consumer receives a decrease or an increase in the utility derived from each unit of money spent on the product and therefore rearranges demand to maximise utility. This is distinct from the income effect of a price change. For all products, the substitution effect is always positive such that a fall in price leads to an increase in demand as consumers realise an increase in the satisfaction they derive from each unit of money spent on the product.

Remember for normal goods, both the income and substitution effects are positive. But the income effect can be negative: if a negative income effect outweighs the positive substitution effect, this means that less is bought at a lower price and vice-versa. This good is therefore known as a Giffen good.

Giffen goods are generally regarded as goods of low quality which are important elements in the expenditure of those on low incomes. A good example is a basic food such as rice, which forms a significant part of the diet of the poor in many countries. The argument, not accepted by all economists, is that when the price of rice falls sufficiently individuals’ real income will rise to an extent that they will be able to afford more attractive substitutes such as fresh fruit or vegetables to makeup their diet and as a result they will actually purchase less rice even though its price has fallen.

Categories: Micro Tags:

Income and Substitution Effects with Indifference Curves

March 29, 2016 Leave a comment

New to the Cambridge International Exams A Level Economics syllabus is indifference curve analysis. This was part of the old Oxford and Cambridge A Level Economics course back in the 1990’s. Below are some notes which might be of assistance to those teaching this course.

Income and Substitution Effects with Indifference Curves

Any price change can be conveniently analysed into two separate effects – the income effect and the substitution effect.

Income effect of a price change: when there is a fall in the price of a product, the consumer receives a real income effect and is able to buy more of this and other products in spite of the fact that nominal income is unchanged. If the consumer buys more of the good when the price falls it is a normal good. If the consumer buys less of the good when the price falls it is seen as an inferior good.

Substitution effect of a price change: when there is a rise or fall in the price of a product, the consumer receives a decrease or an increase in the utility derived from each unit of money spent on the product and therefore rearranges demand to maximise utility. This is distinct from the income effect of a price change.  For all products, the substitution effect is always positive so a fall in price leads to an increase in demand as consumers realise an increase in the satisfaction they derive from each unit of money spent on the product.

Note for normal goods, both the income and substitution effects are positive. But the income effect can be negative; if a negative income effect outweighs the positive substitution effect, this means that less is bought at a lower price and vice-versa. This good is known as a giffen good.

Showing income and substitution effects on a diagram

A Normal Good

Indiff Curves - Noraml Good

The graph above shows the effect of a fall in the price of Good B that increases the amount that can be purchased to 70. Hence the budget line moves from: 45 A – 37 B to: 45 A – 70 B.

To find the substitution effect, you must find a point where the new level of prices is effective but the consumer is no better or worse off than before. Therefore a line ZZ is drawn parallel to the new budget line (45A – 70B) and therefore has the same slope. This line then gives the same relative prices as implied by the new budget line. The consumer will be no better or worse off if he is consuming on his original indifference curve I1. Drawing the line ZZ at a tangent to the indifference curve I1, the consumer would consume at point K if prices had changed but income had not. The movement from point J to point K is therefore the substitution effect of the price change.

To find the income effect you have to find the movement between two points where income has changed but the same relative prices are effective. The movement from point K to point L is the income effect of the price change.

Summary

  • Good B falls in price – hence budget line moves from: 45 A – 37 B to: 45 A – 70 B.
  • The move from point J to point K is the substitution effect which = +13
  • The move from point K to point L is the income effect which = +10
  • These make up an overall move from point J to point L is the price effect (substitution effect + income effect) = +23
  • As both effects are positive Good B is a Normal good

Go to eLearn Economics for more notes on Indifference Curves.

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