Microeconomics Set 2 - Modern Mixed Economy

The Market Trade, Money and Capital The Government Summary
Economics I: Microeconomics
Set 2: Modern Mixed Economy
Nordhaus and Samuelson, Economics 19e, Chapter 2
Dr. Christoph Bierbrauer

Professorship for Economics
Cologne Business School
Summer Term 2016
Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Review of Central Concepts
Characterize normative and positive economic analysis

What are the characteristics of a mixed economy?
Draw the Production-Possibility Frontier and explain the
underlying idea
Explain the concept of opportunity costs by an example

The Market Mechanism
No single individual or organization or government is responsible

for solving the economic problem in a market economy
Economic activity is coordinated by prices through the markets

Prices contain information

The Market
A market is a mechanism through which buyers and sellers interact

to determine prices and exchange goods, services and assets
A price is the value of a good or service in terms of money

(Numéraire)
Prices represent the terms at which different items can be
exchanged

The Price
Prices coordinate the decisions of producers and consumers in a

market
Prices are signals that indicate changes in demand/supply

Producers adjust their production plans
Consumers adjust their consumption plans (e.g. substitution)

Market Equlibrium
A market equilibrium represents a balance of all different buyers

and sellers, respectively the equilibrium of supply and demand
If prices are too high, output/supply will increase above the

demanded level
If prices are too low, demand will increase; consumers may
suffer from supply shortages
The equilibrium price meets the desires of buyers and sellers

simultaneously

Three Problems of Economic Organization (revisited)

What commodities are produced in what quantities?
Determined by the demand of buyers in the market and the
corresponding price movements
Production is adjusted in order to maximize profits
How are goods produced?
Producers target a maximum of profits (minimum of costs),
i.e. they choose the most efficient methods of production
For whom are goods produced?
Factor markets determine wages and capital rental rates
(factor prices)
Distribution of goods depends on the distribution of income
among the population
Dual Monarchy: Tastes and Technology
Tastes of consumers:
Consumers pick a point at the production-possibility frontier
Samuelson: Euro votes
Available technology and resources:
Determine the production frontier
Prices and Markets

The invisible Hand
The invisible hand; private interest can lead to public gain when it
takes place in a well-functioning market mechanism
Adam Smith
The limits of the doctrine

Market failures
Entry barriers
Public goods

Motivation
The characteristics of the modern (mixed) economy:

Trade and specialization
The use of money (Numéraire)
The use of capital as leverage for human labor

Trade Specialization and Division of Labor
Specialization and trade - people can become highly productive

in a very narrow field of expertise
Specialization on particular sets of tasks (division of labor)

Specialization enables gains from trade

Money
Money is the medium for the exchange of goods and services
Enables trade, allows for the transformation of specialized

labor into a consumption bundle
Money is only useful, if everyone trusts and accepts it as the
medium of exchange (fiat money)
The Government/central bank has a monopoly on the issue of
money

Capital
Capital is a produced durable input and itself an output of the

economy
The per capita capital stock in Germany is approximately

145.000 Euro (Source: Eurostat)
Indirect production technology is, in general, more efficient
Some goods can only be produced when using specialized
capital inputs

Investment: Growth from Sacrifice

Government
The government
1. May increase efficiency, e.g. by healing market failures
2. May promote equity by the redistribution of income
3. May foster macroeconomic stability and growth

Perfect Competition - Efficiency
The virtues of the market are fully realized under perfect

competition (price = cost)
Market participant behavior does not affects prices

Imperfect Competition
Sources of imperfect competition, i.e. a market participant’s

behavior does affect the market price (price > cost)
Labor unions
Monopoly
Regulation of public goods

Externalities
Externalities; involuntary spillovers which may be either costs or

benefits
Pollution
A beehive
Public Goods are commodities that can be enjoyed by everyone,

no market participant can be excluded
What is the price of a public good?
The preservation of public goods such as fertile soil and clean air
are vital for the long-run survival of a society.

Equity
A market economy may produce inequalities in terms of income

and consumption that endanger the long-run stability of a
society
Examples of how the government may affect the market

outcome are:
Progressive taxation
Transfer payments

Macroeconomic Growth
Economic growth vs. the business cycle
In general, the government attempts to smooth the business

cycle:
Monetary policy (interest rates)
Fiscal policy (fiscal stimulus)
However, it is more difficult to foster economic growth:

Investment in infrastructure and education
Support of research and protection of intellectual property

Market Mechanism
Perfect competition
The invisible hand solves the problem of economic
organization (What, How, For whom)
Imperfect competition
A more realistic assumption
Market outcomes are sometimes flawed

Trade, Money and Capital
Trade enables specialization

Money allows the transformation of specialized labor services
into a diversified consumption bundle
Capital is itself an output and allows indirect production
methods

Government


Microeconomics Set 2 - Modern Mixed Economy

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The Market Trade, Money and Capital The Government Summary

Dr. Christoph Bierbrauer

Cologne Business School

Summer Term 2016

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Review of Central Concepts

Characterize normative and positive economic analysis

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

The Market Mechanism

No single individual or organization or government is responsible

Economic activity is coordinated by prices through the markets

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

A market is a mechanism through which buyers and sellers interact

A price is the value of a good or service in terms of money

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Prices coordinate the decisions of producers and consumers in a

Prices are signals that indicate changes in demand/supply

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

A market equilibrium represents a balance of all different buyers

If prices are too high, output/supply will increase above the

The equilibrium price meets the desires of buyers and sellers

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Three Problems of Economic Organization (revisited)

Dual Monarchy: Tastes and Technology

Prices and Markets

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

The invisible Hand

The limits of the doctrine

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

The characteristics of the modern (mixed) economy:

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Trade Specialization and Division of Labor

Specialization and trade - people can become highly productive

Specialization on particular sets of tasks (division of labor)

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Money is the medium for the exchange of goods and services

Enables trade, allows for the transformation of specialized

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Capital is a produced durable input and itself an output of the

The per capita capital stock in Germany is approximately

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Investment: Growth from Sacrifice

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Perfect Competition - Efficiency

The virtues of the market are fully realized under perfect

Market participant behavior does not affects prices

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Sources of imperfect competition, i.e. a market participant’s

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Externalities; involuntary spillovers which may be either costs or

Public Goods are commodities that can be enjoyed by everyone,

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

A market economy may produce inequalities in terms of income

Examples of how the government may affect the market

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Economic growth vs. the business cycle

In general, the government attempts to smooth the business

However, it is more difficult to foster economic growth:

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Trade, Money and Capital