A2: Unit 3 - The demand for labour and the elasticity of labour

Demand for labour:

•     Derived demand: Demand for labour. Not wanted as an end product but rather for the process. Rise in demand lead to increase of workers.
•           Aggregate demand for labour: Demand for labour depends on level of economic activity. If economy is growing and firms +confident for continuous growth > employment levels increase. If economy is declining; firms –confident therefore fall in employment levels.
•        Individual firm’s demand for labour: No. of workers that firm employs also depends on:
• Price of Labour: Rise in wage rates > rise in labour productivity = raise unit labour costs; contraction in demand for labour.
•    Productivity: Output per worker per hour increase, more attractive labour becomes.
•    Price of other factors of production: If capital becomes cheaper, e.g. firms may substitute some workers with machines.
• Supplementary labour costs: E.g. increasing employers National Insurance contributions will lead to a fall in demand for labour.

*Change in last 3 factors will lead to a change in the quantity of labour demanded at given wage rate.

•           Marginal productivity theory of labour: Demand for workers depend on Marginal revenue product; cost of taking on additional unit of labour = MRP; establishes equilibrium quantity of labour employed. Whereas Marginal product of labour is number of extra units of output a firm gains from employing an additional worker.  
• Short run; firm takes +1 workers > out rises at first (because increasing returns due to benefit of division of labour)
•    After x amount of employment reached, marginal product tends to fall because of onset of diminishing returns.
• MRP is the addition to firm’s revenue from employing additional worker. Calculated by multiplying workers marginal product (MP) by marginal revenue (MR): MRP = MP * MR

•        *With perfect competition in product market; firms become price taker. Price of output does not change if it sells more > marginal revenue = price. Firms can sell all its output at the ruling market price. Assuming perfect competition in labour market; firms can recruit workers at constant wage rate.
• The marginal revenue product of labour curve. Shows marginal revenue product and equilibrium quantity of labour employed; or basically the quantity of labour demanded at each wage rate.

• Shifts in demand curve for labour: Demand curve for labour will shift right if MRP of labour increases due to increase of marginal product of labour and/or marginal revenue.
 
•   E.g. Demand for car assembly workers increase if productivity of car assembly workers rises > perhaps from +training and/or price of their output rises due to rise in demand for cars.
•       Measuring MRP: In reality is difficult because hard to isolate the contribution to output made by individual worker (work tends to be done in teams).

 

The elasticity of demand for labour:

•           Elasticity of demand for labour:  measure responsiveness of quantity demanded of labour to changes in the wage rate; formula:


•   Elasticity of demand for labour = % change in Q of labour demanded / % change in wage rate
• E.g. elasticity of demand for labour = 5, wage rate +10%; demand for labour would fall by 50%
• E.g.2 If demand for labour -10%, wage rates +100%, elasticity of demand = 0.1 (inelastic.)
•          Factors determining elasticity for labour:
• Time: Long run easy to substitute labour for other factors of production vice-versa. Short run; firms may not have time to re-organise operations therefore employ same no. of workers even if wage rates increase. Elasticity of demand for labour will be higher in long run.
•    Elasticity of demand for the product: Labour is derived demand > collapse in demand for e.g. tin > collapse in demand for tin miners. If elasticity of demand for product is low, reduction in demand for it will have little effect on employment in industry.
• Availability of substitutes: Easier to substitute other factors of production of labour; more rise in real wage rates will lead to a firm replacing labour with machines. E.g. relatively easy to replace production line workers with automated capital equipment. If a lot of good substitutes then elasticity of labour will tend to be high.
•   Proportion of labour costs to total cost: Larger proportion of labour cost to total cost; higher elasticity of demand for labour. Because +wage bill > +impact on total costs.
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AS: Unit 1 - Maximum and Minimum pricing, Zero Pricing

In this post we will learn:

1.  Maximum pricing / Price ceilings
2.  Minimum pricing / Price floors
3. Zero pricing

 

Maximum prices

 

Maximum prices may be defined as a price ceiling whereby price of a good or service is not allowed to exceed. It usually below the free market equilibrium price (Pe).

Suppliers therefore are no longer allowed to charge the market price and is forced to meet the maximum price ceiling set by the government.

However this contributes to excess demand (Q2 to Q1) as suggested by the Law of Demand, the lower the price, the higher the demand HOWEVER at 'Pmax' suppliers are not willing to supply what is demanded at 'Q1' and is only willing to supply at 'Q2' thus there is excess demand.

 

Maximum prices may be imposed by the government in an attempt to prevent the market price from rising above and beyond a given amount; for example to prevent the monopolistic exploitation of consumers.

 

Impact (evaluation)

• Can result in a underground market whereby maximum prices is evaded targeting those who are prepared to paid more (to satisfy excess demand) promoting illegal criminal activity. Higher prices therefore act as a device for rationing.
• May lead to corruption and bribery in regulation
• Maximum price above the equilibrium will contribute no effect thus may be considered as Government failure (as government administration costs will exceed the 'benefits')

Minimum pricing

 

Minimum prices may be defined as a price floor whereby price of a good or service is not allowed to go below. It usually above the free market equilibrium price (Pe).

Suppliers therefore are no longer allowed to charge the market price and is forced to meet the minimum price floor set by the government.

 However this contributes to excess supply (Q3 to Q1) as suggested by the Law of Supply, the higher the price, the higher the supply HOWEVER at 'Pmin' consumers are not willing to pay what is supplied at 'Q1' and is only willing to pay at 'Q3' thus there is excess supply.

 

Minimum prices may be imposed by the government I an attempt to prevent the market price from falling beyond a given amount; for example to prevent over consuming of  a demerit good. 

 

Impact (evaluation)

• Prevents the market from working efficiently therefore may lead to further misallocation of resources.
• Minimum price below the equilibrium will contribute no effect thus may be considered as Government failure (as government administration costs will exceed the 'benefits')

Zero Pricing

This illustrates the effect of the market when a  good is produce free at the point of use. This suggests a market price of 0. For example the NHS health care (though we 'pay' for it through taxation it is free at point of use). However demand for this service will most likely lead to excess demand (Q2 - Q1) thus disequilibrium resulting in waiting lists.

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A2: ESSAY Unit 3 - ECON 3 Distribution of income made more equal solely through progressive taxation and transfers? (25 marks)

Here I have attached my essay answer for this question; it is graded an A. Remember a good essay needs a balance of knowledge, application, analysis, and evaluation. My essay isn't perfect but I hope you can benefit from it nevertheless. This is a distribution of wealth and income question where you argue government policies for a more equal distribution. Questions like these are excellent opportunities for you to include real life application! *please do not repost without credit, thanks!

Do you agree that the distribution of income should be made more equal solely through the use of progressive taxation and transfers? Justify your answer. (25 marks)

Progressive taxation is when the proportion of income tax increases as income increases thus the marginal rate of tax is greater than the average rate; this enables a more equal distribution of income. However criticism could be made for the progressive taxation policy and there are other policies which may aid in a more equal distribution of income such as the national minimum wage and government supply-side schemes to improve education and training

Firstly progressive taxation closes the wealth gap as when income increases so does the tax rate. For example in the UK the lowest band with earnings up to £32,000 are taxed at 20% whereas the highest income band earning over £150,000 are taxed at 45%. Consequently this redistributes income with more equality and gives the government higher tax revenues, some transferring in the forms of welfare spending therefore closing the income and wealth gap. However, it can be argued that it is unfair for the higher income earners to be taxed harshly only for their income to be distributed to lower income earners as welfare benefits. This may create disincentives for people to aim for high income jobs or become entrepreneurs, typically requiring greater skill and qualifications, as a large quantity of the income will be taxed away; by extension this will decrease the UK’s competitiveness and wealth compared with other countries in the long run. Thus it can be considered that progressive taxation and transfers should not be the sole instrument for a fairer distribution of income. A system of regressive taxation maybe considered for example VAT where the tax added on items is fixed (currently at 20%) for all income earners, though this may be considered unfair to the low income earners. Progressive and regressive taxation discourages the equity concept whereby distribution is fair and just as it can be argued that for example a window cleaner should not be earning as much as a surgeon thus progressive taxation can be considered as not a fair system. However equity carries a value judgement as there may be conflicting opinions on what ‘fair’ is.

 

The National Minimum Wage must also be considered; in the UK the NMW is currently at £6.31 per hour for those who are aged 21 or over. Higher income will suggest higher tax revenues and national insurance contributions for the government. This policy suggests that all workers must be paid a bare minimum of £6.31 (a substantial increase since the introduction of the national minimum wage at £3.60 per hour in 1999) and therefore closes the income gap. Additionally the national minimum wage will further encourage more unemployed workers to work at the increased going wage rate thus will reduce workers falling into the unemployment trap (whereby benefits outweighs thus erode any motivation to go to work). As illustrated in the diagram above, the national minimum wage will increase wages from ‘W’ to ‘NMW’ however this illustrates there is trade-off between higher wages and employment, as firms are unwilling to hire more than ‘Q1’ at the ‘NMW’ wage rate and as more workers are willing to work at the ‘NMW’ rate results in excess supply as illustrated. Therefore higher wages can only be achieved at the cost of unemployment (Q2 to Q1).  However this will also give firms incentives to raise the productivity of employees if they must pay the minimum wage. A high minimum wage can also cause price inflation as it increases the costs to firms who then may pass on the higher cost in wages to higher prices for consumers thus results in cost-push inflation.

Government supply-side schemes promoting education and training may also be considered. For example, the government may implement training schemes to improve teaching which will lead to better education and in the long run a more educated population with greater skills and qualification which will reduce likeliness of different wages arising from very skilled and unskilled workers thus resulting in a more equal distribution of income. Other government schemes may also be considered, such as awareness campaigns illustrating the positive spill overs of merit goods such as education which will encourage people to work harder, for example in the long run better education will suggests a more prestigious high status job in the future which will also benefit the economy and contribute to economic growth.

Overall progressive taxation can be considered strong instrument in the fairer distribution of income and wealth. However this policy does not follow the concept of equity and therefore can be considered unfair. Furthermore it may cause disincentives for people to work harder for higher income jobs as a larger percentage will be taxed away thus will decrease the rate of growth of the economy and therefore weakening the international competitiveness in the long run. Thus cannot be considered the sole policy to distribute income more fairly. Other policies such as the national minimum wage can be considered as it immediately minimises the income gap in the short run. Furthermore it will encourage unemployed workers to find work however as the supply of labour increases with the higher wage rate, the demand of labour from firms will be reduced due to higher costs thus promotes unemployment. Cost push inflation may also occur if the pressure for higher wages gets passed onto to the customers by higher prices. Education and training supply-side reforms may perhaps be the best way to distribute income more fairly as it gives the opportunity of ‘unskilled workers’ to be trained thus allows more job opportunities which may enable access to better paid jobs in the long run resulting in a more equal distribution of income, though it must be considered that supply-side polices are a long run phenomenon. Overall, the best solution to a more equal distribution of income may be the combination of several policies simultaneously.

AS: Unit 1 - Shifts in demand and supply

In this post we will learn:

1. How and why there are shifts in demand
2. How and why there are shifts in supply

Shifts in the demand curve

Analysing the diagram:

Given that the original equilibrium demand curve is 'D' at price 'P' and quantity 'Q'

• Reduction in demand
• The demand curve will shift left (D to D1)
• Price will reduce from 'P' to 'P1'
• Quantity demanded will reduce from 'Q' to 'Q1'
• Increase in demand
• The demand curve will shift right (D to D2)
• Price will increase from 'P' to 'P2'
• Quantity demanded will increase from 'Q' to 'Q2'

Causes:

• Change in prices or related goods
• Substitutes
• If price of a substitute increase then demand for this good will increase
• If price of a substitute decrease then demand for this good will decrease
• E.g. If the good is butter and the price of margarine increases, then the demand for butter will increase. Similarly if price of margarine decreases, then the demand for butter will decrease.
• Complements
• If price of complementary good increase then demand for this good will decrease
• If price of complementary good decrease then demand for this good will increase
• E.g. If this good is DVD players and the price of DVDs increases, the demand for DVD players will decrease. Similarly if price of DVDs decreases, the demand for DVD players will increase as they are consumed together.
• Change in income
• Normal goods
• If income increases then demand for normal goods will increase
• If income decreases then demand for normal goods will decrease
• Inferior goods
• If income increases then demand for inferior good will decrease
• If income decreases then demand for inferior good will increase
• E.g. Transportation, if income increases you are more likely to drive your car. If income decreases you are more likely to take the train. In this case car is the normal good and public transport is the inferior good.
• Change in taste
• Change in expectation

Shifts in the Supply curve 

 

 

Analysing the diagram:

Given that the original equilibrium demand curve is 'S' at price 'P' and quantity 'Q'

• Reduction in supply
• The supply curve will shift left (S to S2)
• Price will increase from 'P' to 'P2' 
• Quantity demanded will reduce from 'Q' to 'Q2'
• Increase in supply
• The supply curve will shift right (S to S1)
• Price will decrease from 'P' to 'P1'
• Quantity demanded will increase from 'Q' to 'Q1'

Causes:

•  Change in technology
• Better technology will increase efficiency / productivity
• E.g. new machine which can produce 5 times more goods will lead decrease average costs
•  Change in supplies
• Cheaper supplies
• E.g. cheaper source of oil will decrease average costs (therefore shift S to S1). Conversely natural disaster may increase price of oil thus increase average costs (therefore shift S to S2)

 

AS: Unit 1 - The economic problem and the PPF

In this post we will answer 2 questions.

1. What is the economic problem?
2. What is the production possibility frontier?

What is the economic problem?

Right so lets get straight to it!

The economic problem is scarcity

Yep that is pretty much the economic problem; not so difficult right? But lets go in a bit more detail. 

Scarcity means there is only a limited amount of resources available to produce the unlimited demands of goods and services people desire. So basically in the world we live in, there are infinite 'needs' (necessities) and 'wants' (desires) and we cannot satisfy all of them, therefore we have the economic problem of scarcity.

 

SO! Basically there are 3 fundamental questions

• WHAT should we produce?
• HOW should we produce it?
• For WHOM should it be produced?

The purpose of economic activity is to increase economic welfare. Increasing production will enable economic welfare to increase (assuming production actually consumed and not just sitting around).

Here are some quick terms you'll need to know (most is probably common sense)

• Depletion - Using up scarce resources
• Degradation - e.g. Pollution and destruction of natural environment
• Consumer goods - Goods brought for consumption, e.g. food
• Capital goods - Goods brought by firms to produce other goods, e.g. machinery

The production possibility frontier (PPF)

This diagram illustrates possible combinations of product X and product Y an economy can produce when all the available economic resources are being used.

Say initially economy is producing at point A; this means at X1 output of product X, there will be Y1 output of product Y. However say the economy wants to increase output of product Y to level Y2, they cannot achieve this without decreasing the level of output of product X to X2. 

This is because the economy is operating at productive capacity, it cannot increase production of one product without decreasing production of another. This is called an opportunity cost where the loss of other alternatives when one alternative is chosen.

There are opportunity costs everywhere and you encounter them everyday. For example, you have £1 and you want to buy bottle of coke and a notebook; however you cannot afford both. You will then use a value judgement to decide which to get. Say you chose the notebook, the opportunity cost of the notebook was the bottle of coke.

The 'Guns vs Butter' model is a good example of the PPF applied.

This diagram is a fairly simple diagram, however as the course is synoptic - we can still use this diagram in A2 economics as well (as a low level diagram) so it is good to remember!

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