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Welcome to ECON 372:

Comparative Economic Systems

By: Dr. Jacqueline Khorassani

Week Three Lecture SlidesSource: Chapter 1 & 2

(pp 15-)

Marietta College, Spring 2011

Notes1. Exam 1: Wednesday, February 92. Team 1 paper is on Japan, Sweden

and France and is due on Monday, February 28

3. No class on Monday, January 244. On Wednesday, January 26, expect

an in class assignment on last Friday’s class + the first 15 slides on Week 3 (this week) lecture slides. 2

The 9 criteria for evaluating economies

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4

5. The degree of dynamic efficiency Is efficiency sustainable over

time? Are there policies in place to

increase efficiency in the future? Involves collection of efficiency

related time-series data

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The 6th criterion Macroeconomic stability

– Stability in the following variables over time (10 years in your paper)

Output Employment Prices Exchange rate volatility (value of

currency) What else?

The 7th criterion Economic security of individual

– Income Per capita Distribution Poverty rate

– Employment Unemployment rate/underemployment

– Health care % of population with health insurance Infant mortality Life expectancy

– Others? 6

8th criterion The degree of income or wealth

equality? – What is the difference between

income and wealth? Which one is flow? Which one is stock?

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8

One measure of income distributionLorenz Curves

% of national income

% of population

45o

Perfect income equality

100

100

Nation’s curve

50

20

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Measure of income distribution Gini coefficient= area between

the Lorenz curve and the 45 degree line/total area under the 45 degree line– If =0 complete _______– If =1 complete _______

Equality Inequality

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Quintile Another measure of income inequality What is it?

– Here is how it is constructed 1. Obtain income data for every household in

a given year. 2. Arrange the data in a list ranging from the

household with the lowest income to the household with the highest

3. Divide the list into equal fifths (or "quintiles").

4. Divide the income share going to the top quintile by the income share going to the bottom quintile.

The higher the quintile ratio, the _______ the inequality.

Higher

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The 9th criterion Degree of economic freedom EFI = Economic Freedom Index

Takes a value between 1 (free) to 5 depending on 10 sub indexes having to do with– Corruption, trade barriers, tax rates,

efficiency of law enforcement, regulatory burden on business, restrictions on banks, labor market regulations, informal market activities.

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Another way to measure the 9th criterion

Brazil Latin America & Caribbean Countries

OECD Countries

Steps to launch a business 17 11.4 6.5

Rigidity of employment index (0 to 100)

56 40.3 35.8

Hiring cost (% of salary) 26.8 15. 9 20.7

Taxes as percentage of gross profits of a mid size company

71.7 52.8 45.4

Steps to comply with licensing and permit requirements for on going operation

19 16.3 14.1

Source: World Bank, 2005

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HDI: Human Development Index Takes a value between 0 (bad) to

1 depending on– Per capita income– Life expectancy– Adult literacy– Education enrollment

Which of the 9 criteria are reflected in this index?

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Let’s look at Tables 1.1 and 1.2, Pages 18 and 19.Who is doing better than us (USA) in different area?–Why?

Chapter 2 Objectives?

– Focuses on Market Capitalism How it can achieve efficiency When it fails to achieve efficiency

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Theorem: A complete, competitive, full information general equilibrium is efficient.

1. Complete?– There is a market for anything that is

useful– Does this hold in the US?

2. Competitive?– No barriers to entry and exit across

all markets– Homogeneous products – Does this hold in the US? 16

Theorem: A complete, competitive, full information general equilibrium is efficient.

3. Full information? Suppliers and demanders in all

markets have every piece of info they need to have in order to make the best decision

Does this hold in the US? 4. General equilibrium?

In all markets, quantity demanded = quantity supplied

Does this hold in the US? 17

What does efficiency mean? In consumption

–Can’t make someone better off without making someone else worse off. This is called ________ optimality.

In production– Operating on PPF

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What is PPF?

A curve that shows various combinations of 2 goods a nation can produce efficiently with a given amount of resources and technology

Goals?– To show trade offs, choices, efficiency in

production, increasing cost

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Production Possibilities Frontier

Assumptions1. Only two goods are produced 2. Fixed amount of resources that are fully

employed3. Given technology4. Producers and resource owners have full

information.5. Maximized output given what is available

▪ Can not produce more of something without giving up some of the other things.

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Production Possibilities Frontier (PPF)

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Roses

Guns

100

10 20 30 400

9580

60

AB

C

D

E

* I

* U

PPF

Production Possibilities Frontier (PPF)

Why is PPF downward sloping?– Can’t produce more guns without

giving up some roses Why is PPF bowed out?

– Why does the cost of producing 10 additional guns go up as we produce more guns?

– Increasing cost– All resources are NOT equally productive in

both lines of production22

Let’s start with PPF

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Good x

Good Y

A *

B *C *

*M

PPF

What is point A?What is point M?How can we move from A to B?

Increase efficiencyEmploy unemployed resources

How can PPF shift outward?

What was efficiency in consumption? Can’t make someone better off

without making someone else worse off (Pareto Optimality)

Social indifference curve– Shows the combination of two

goods that make the society equally happy, given that all members of the society have the same taste.

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Social Indifference Curve Assumptions

1.Only two goods are consumed.

2.Fixed taste. 3.All members of the society

have the same taste.4.More is better.

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Social Indifferent Curve

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Roses

Guns10 20 300

95A

Indifference Curve

50

40

B

C

Why is it downward sloping?If increase both happiness goes upWhy is it bowed in?Why are we willing to give up fewer roses for 10 additional guns as we consume more guns?

Diminishing utility

Social Indifferent Curve

Roses

Guns10 20 300

95A

Indifference Curve

50

40

B

C

D *

*F

Do we like D better than B?Yes, on a higher indifference curveDo we like F better than B?No, on a lower indifference curve

Social Indifference Map

Can a society’s indifference curves cross each other?

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Roses

Guns

I1I2

• If indifferent between A and C• If indifferent between A and B• Then must be indifferent between B

and C (not true, because B and C are on different indifferent curves)

• Given no change in taste indifference curves can not intersectA*

B*C*

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Social Indifference Map

Indifference curves of a society are parallel to each other.

Roses

GunsI1I2

I3

I3 is better than I2 why?

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PPF and indifference map Is B better than M? Is C better than M?

Roses

Guns10 20 30 400

9580

BC

M

The highest indifference curve we can reach given what is available = efficiency in production and consumption. Why?1. Efficiency in production =

maximizing out put , given resources and technology

2. Efficiency in consumption= Can’t have more of both goods=can’t make someone better off without making someone else worse off

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How does this model relate to distribution of income? Consumption efficiency has

nothing to do with distribution of income– If one person gets it all, it is still

efficient as long as to make some one else better off you have to make this person worse off by taking something away from him.

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How do market supply and demand in a competitive market related to efficiency?

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Let’s look at supply and demand in a completive market

If the maximum amount of output is sold efficient

P

Q50

D

S100

70

50

30 80

At P = 100, how much is sold?At P = 50, how much is sold?At p = 70, how much is sold?Which one is efficient?This result is achieved under competitive, full information general equilibrium.

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Definitions Marginal cost = increase in total

cost as a result of producing one more unit of a good = MC

Marginal revenue = increase in total revenue as a result of selling one more unit of a good = MR

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What is the profit maximization rule in a market economy?

1. As long as producing one more unit of a good adds more to your revenue than to your cost (as long as MR> MC) produce more

2. If producing one more unit of a good adds more to your cost than to your revenue (If MC>MR) produce less

3. Profits are maximized when you produce the quantity of output at which MC = MR

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In the short run, when you have at least one fixed input of production MC eventually increases as

you increase production Why?

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Example Output = shirts Inputs

▪ Labor (L)▪ Capital (K, sewing machine, which you only

have one) If you keep on hiring more workers and

don’t buy any more sewing machines, new workers can not produce as many shirts for you as the old workers but you pay them the same wages as your old workers you cost per additional shirt goes up. MC of additional shirt goes up

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How is the price and the quantity of output determined in a competitive market?

Market Firm 1

P P

D

S

P

MC

$10

220

=ΣMC

What is MR for this firm?$10

=MR

Quantity Quantity

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Monopoly

What is it?– Extreme case

One producer produces a unique good or service for which there are no close substitutes in the market

Has power to control the price.

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Now suppose a firm buys all of the little firms in a the market

Market Firm 1 = monopoly

P P

D

S

P

MC

$10

220

=ΣMC

MC

DDoes monopoly produce 20 units?

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Monopoly is facing the same demand but S = MC

Market

P

D

S =MC20

1

18

2

If monopoly wants to sell one unit, it can charge $20 What is MR of the first unit?$20If monopoly wants to sell 2 units, it can charge $18.What is MR of the 2nd unit$16Why?MR = ΔTR/ ΔQMR = 16/1

MR

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How should the monopoly maximize profits?

Market

P

D

S =MC

Find the quantity of output from intersection of MR and MCCharge the highest price it can charge for this much outputMonopoly produces less and charges more than a competitive marketConsumers are not consuming the maximum amount no efficiency in consumption

MR

10

15

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How likely is efficiency in production under monopoly?

Market

P

D

S =MC

Not LikelyWhy?Monopoly charges a higher price can afford to be less efficient and more wasteful than a competitive firm.Under monopoly, production is below capacity we don’t reach our PPF.

MR

10

15

10

20

Monopoly

Competitive

Question How are natural monopolies

different from unnatural monopolies?

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What is economies of scale?

Average cost

Quantity of production

As the firm gets bigger AC dropsWe can have one firm producing 30 units orWe can have 3 firms each producing 10 unitsWhich one is potentially more efficient?One firmThis is a cause of natural monopolyExamples?What should government do? (Rachel)Allow monopoly to exist but watch it.

$30

$12

10 30

ACEconomies of scale

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What about unnatural monopolies?

Average cost

Q

There is a short range of economies of scaleWe can have one firm producing 30 units orWe can have 3 firms each producing 10 unitsWhich one is potentially more efficient?three firmsExamples?What should government do? (Rachel)Remove the barriers to entrySherman Act, Clayton Act, FTC Act in the US

PP31-32

$30$40

10

AC

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