Capacity Building For Knowledge Production

At The University Of Mandalay
 
Module 1:Theories and Concepts in Social Sciences And Development
 
Workshop 4 : Introduction to Economics
 
June 11 -13, 2018
 Convened by:

Professor Franque Grimard

  

Workshop 4 : Introduction to Economics

1. Introduction to Microeconomics
2. Introduction to Macroeconomics
3. Introduction to Development Economics
 
June 11 -13, 2018
 Convened by:

Professor Franque Grimard

1. Introduction to
microeconomics
PROF. FRANQUE GRIMARD, MCGILL UNIVERSITY (MONTRÉAL,
CANADA)
Plan of the presentation

 What is Economics about?

 Introduction to the key concepts in micro

 Scarcity of resources

 Opportunity cost and incentives

 Preferences

 The supply and demand model

 The labor market

 Market imperfections

 Theory of the firm and value chain

What is Economics about?
 Economics is the study of choices under scarcity of resources.
 It is the study of all forms of choices, from the individual point of view to the
social choices.
 An economic choice could be any decision that implies the sacrifice of another
option or activity. It is not confined to financial or spending decisions.
 Example : sitting here right now is an economic choice
 Some recurrent questions in Economics:
 What, how, and for whom do we need to produce?
 What are the tensions between individual and social choices?
 What is the optimal allocation of resources?
Key concept : The scarcity of resources

 A widely used definition of Economics:

“Economics is the study of the use of scarce resources to satisfy unlimited human
wants.” (Ragan, 2017)

 Resources are anything that could be used or traded in order to satisfy the needs.
 Scarcity is the fact that resources are available in a limited quantity, even
renewable resources.
 Unlimited needs refer to the willingness to accept an additional quantity of a good
or a service if no sacrifice is needed to obtain it.
An (extreme) illustration of unlimited
needs
The Brunei sultan’s palace “contains 1788
premises. The whole palace contains 200,000
square meters of space. The mosque of the
palace can accommodate up to 1500 people,
while the banquet hall can provide space for over
5000 guests. The palace even has a helipad, 5
swimming pools and more than 250 bathrooms.”
And this is just his palace!

Source: Istara Nurul Iman (the Palace) website

Economic decisions and incentives
 Economic agents’ decisions are based on a cost-benefit analysis.
 There are many types of agents: individuals, households, firms, governments, interest groups, etc.
 An agent makes its decisions according to marginal values: she considers the cost and the benefit for
her from an additional unit of a good or a service.
 Fictitious example with movie tickets:

Number of unit(s) 1st 2nd 3rd

Benefit 8,000 Kyat 7,000 Kyat 5,000 Kyat
Price 7,000 Kyat 7,000 Kyat 7,000 Kyat
 A rational consumer will choose to buy only two movie tickets because the marginal benefit from
consuming a 3rd ticket is lower than its marginal cost.
Economic decisions and incentives
(cont’d)
 Agents react to incentives: these are generally put in place by policymakers in
order to change marginal costs and benefits.
 Example: The introduction of a carbon tax in Singapore in the Budget 2018 increases
the marginal cost of driving a petrol-powered car. (The Straits Times, February 2018)
 Prices are also a form of incentives.
 The recent increase in the minimum wage (K600 per hour set on May 14th) could
incentivize firms to reduce the overtime hours. (The Myanmar Times)
 If the price of beans decreases, households are incentivized to buy more beans.
Key concept : The opportunity cost

 The agent’s cost-benefit analysis is a result of scarcity: because of scarcity,

choices must be made.
 Decision-making implies the existence of costs.
 In Economics, the opportunity cost corresponds to the next best alternative that is
given up by making a certain choice.
 Examples:
 The fact that you are sitting here implies an opportunity cost, which is, for
instance, the time that you do not spend on another productive activity.
 When an individual buy a movie ticket, he renounces to 7,000 Kyat that he could
save or spend on something else.
Key concept : Preferences

 On the benefit side of the cost-benefit analysis, agents have preferences over
different options.
 They represent, in an ordinal way, what an individual like or not and “by how
much”.

Commodity Well-being level

Meat 
Alcohol 
Fruit 
Rice 

 Therefore, we can see economic decisions as an arbitrage between opportunity

costs and preferences.
 From preferences to utility

 By attributing a value to different options, one can Utility

classify preferences with a cardinal measure. In
Economics, we often call this classification the utility.
 The utility function is the relation between the number
of units of a good consumed and the utility level that a
consumer gets from the consumption of these units.
 Standard utility functions have the feature of
increasing at a diminishing rate: the utility one gets
from eating a 3rd apple is less than the utility she got
from the 2nd one.

Number of Unit(s)
The consumer’s optimization problem
   consumer, when making a choice, selects the best
A
option among a set of options that are available and
affordable to him.
 A consumption bundle is affordable to a consumer if it
respects its budget constraint.
 In a binary comparison (simple case with 2 goods), the
budget constraint is a straight line that represents the
different bundles that the individual can choose if he
spends its entire budget.
 All of the bundles that lie under the budget constraint
(including the line itself) are said to be attainable.
 With 3 goods, the budget constraint takes the form:

Source: economicsdiscussions.net
 The consumer’s optimization problem
(cont’d)
 As we said earlier, economic decisions are the result of
an arbitrage between preferences and opportunity
costs.
 In an utilitarian context, economic choices correspond
to the intersection of an indifference curve and the U
budget constraint.
 The indifference curve is the set of bundles for which
the consumer is indifferent. In other words, the
consumer does not prefer a bundle to another one that
lies on the same indifference curve, which means that
the utility level is constant along an indifference curve.
There is an infinity of IC’s, one for each possible level
of utility.

Source: economicshelp.org
 The supply and demand model: The demand
for a good or a service
 The demand and supply model establishes two links
between the quantity of a product and its price.
 The first relation, called the demand, represents the
link between the quantity demanded by the consumers
and the price of the product.
 The demand curve represents the sum of the quantity
demanded by all of the individuals at every price level.
 The relation is negative because, ceteris paribus, the
more the price is high the lower the quantity demanded
of the commodity.
Why is the demand curve negatively
shaped?
 Substitution effect:
When the price of a good increases, ceteris paribus, its
relative price (its opportunity cost) is higher. The
existence of substitutes - some other goods that can
replace it - makes it possible to change consumption
choices upon an increase in the price of a specific good.
 Income effect:
When the price of a good increases, ceteris paribus, it
reduces the quantity one can buy under the same budget.
Consumers cannot afford the same quantity as before, so
they will likely choose to reduce their consumption of
the good and of its complements.
Source: economicshelp.org
The supply and demand model: The supply
for a good or a service
 The supply is the relation between the quantity offered
by the producers and the price of a good or a service.
 The relation is positive because, ceteris paribus, the
higher the price, the higher the quantity offered.
 This is due to the fact that, the higher the quantity
produced, the higher the marginal cost. Indeed, the
bigger the firm, the more complex it is to coordinate all
of its activities (human resources, marketing,
administration, etc.).
The supply and demand model: The market
equilibrium
 Putting both the demand and the supply curves in the
same graph, we obtain the market equilibrium. Surplus
 The equilibrium is defined as a price and a quantity such
that supply equals demand. It is a situation in which the
market clears: there is no shortage nor surplus.
 It is the best possible allocation for both consumers and
producers: the producers sell all of the units they are
willing to produce and the consumers all pay a lower
price than the one they value the good at.
Shortage
Changes in the equilibrium

 Some events or changes in the market can induce a shift in the equilibrium.
Graphically, this represents a shift in one of the curves.
 On the demand side: changes in preferences, changes in the prices of substitutes
or complements.
 On the supply side: changes in the costs of production (new technologies, changes
in the prices of inputs or wages), entry or exit of new firms.
 Some government interventions could induce distortions in the market.
 Example: Setting a minimum wage, a floor price, a ceiling price, or production quotas
could induce a non-efficient equilibrium.
Some government interventions

Setting a minimum wage Setting a production quota

The labor market: the labor supply
 On the labor market, the price of labor is the wage.
 Workers are the suppliers: they “sell” their talents and their working force. Firms
(or governments) are the demanders: they “buy” the worker’s talents in order to
produce goods or services.
 The number of hours an individual offers to work is the result of a choice of time
allocation: The individual chooses how to allocate its time between work and
leisure. In this model, all of the time not dedicated to work is considered as
leisure.
 Working allows the individual to get a wage that he can spend or save. However,
it requires some effort so there is a trade-off between work (consumption) and
leisure.
 The wage is the opportunity cost of leisure because the individual must renounce
to its hourly wage for every hour dedicated to leisure.
The labor supply curve
 An increase in the hourly wage have two effects on hours supplied: a substitution
effect and a revenue effect.
 Substitution effect:
After the wage increase, the opportunity cost of leisure increases. Therefore, ceteris
paribus, the individual chooses to work more because the marginal benefit from working
more hours is higher.
 Income effect:
The increase in the wage increases the revenue of the individual for a given number of
hours. Since leisure is a normal good, the demand for leisure increases with the revenue.
The labor supply curve (cont’d)

 At low wage levels, the substitution effect

dominates. However, after a certain high
level, the income effect dominates.
 An example: Doctors in Québec (the second-
biggest province in Canada) have seen their
wage increase substantially in the last decade
and now work fewer days than they did ten
years ago.

Source: economicshelp.org
The labor market: the labor demand

 Labor is a variable input that is used by firms to produce Wage (Kyat)

goods or services.
 Exactly like in the goods and services market, the demand
curve is negatively shaped: the higher the wage, the lower 𝑊
  2
the quantity of labor demanded.
 Machines and other forms of capital are, in certain cases,
substitutes for labor. 𝑊
  1
 In a competitive market, labor is paid at its productivity Labor demand
level: a worker receives a wage that is equal to the
marginal benefit she brings to the firm.

 𝐻 2  𝐻 1 Hours worked
The labor market: the market equilibrium

 The equilibrium is the wage and the quantity

of labor (hours worked) such that the supply
and demand curves intersect. It is a situation in
which the market clears: there is no
unemployment nor excess labor.
 In reality, the existence of the minimum wage
generates some unemployment.
 There are also other reasons behind the
existence of unemployment such as matching
issues, accessibility to unemployment
insurance, and the increase of foreign
competition.
Market imperfections

 The supply and demand model that we have analyzed so far is built on many
assumptions that generally do not match the reality.
 Highly competitive markets: many consumers and producers
 Perfect information
 Absence of externalities
 Private goods: the good is both excludable and “rival”
 In practice, no such ideal market exists. In any market, at least one of these
assumptions does not hold.
 Imperfect competition
 Asymmetry of information
 Existence of externalities
 Non-excludable and/or non-rival goods
Imperfect competition

 When the number of agents is limited on one side, they gain some market power.
They have a higher bargaining power than the other party, which they can use for
their own advantage.
 A monopoly is a market in which there is only one supplier. It has the power to
reduce the quantity produced and charge a higher price.
 Since February 2017, Myanmar’s Competition Law prohibits actions leading to
“monopolization of a market”. (Myanmar-Norway Business Council) Monopolies are
inefficient so they are generally illegal.
 In general, some monopolies are accepted when initial fixed costs are extremely high.
We call natural monopolies such situations because no firm would be interested in
entering the market if expected profits are not high. For instance, mining, electricity, or
water systems could enter this category.
 Imperfect competition (cont’d)
 An oligopoly is a market in which there is a small number of firms producing an
identical or very similar good.
 Decisions made by one company has an impact on the results of the others. Therefore,
they all have an incentive to cooperate and the equilibrium is the result of some
strategic behaviour.
 Examples: drug cartels, OPEC, jade industry in Myanmar*
 Monopolistic competition is an intermediate case between the perfect competition
and the oligopoly.
 There is a high number of buyers and producers of slightly differentiated goods.
 Producers act, to some extent, as small monopolies over their market segment. They
can therefore slightly reduce quantities and charge a slightly higher price than on
competitive markets.

Monopoly Oligopoly Monopolistic Perfect competition

competition
*See https://www.globalwitness.org/jade-story/
Asymmetry of information

 In most realistic cases, agents do not possess all of the information available to
other parties.
 Adverse selection occurs when a party has an incentive to lie about its “type”
before engaging in a contract (ex-ante).
 A risky borrower says he will pay back his loan and might not.
 A car dealer can lie about the quality of some vehicles.
 Moral hazard is when the level of effort provided is not observable and cannot be
monitored (ex-post).
 Will an employee work hard enough on a constant basis?
 Once insured, a car driver might decide to drive less carefully.
 Possible solutions: monitoring, proficiency signals, collateral
Externalities

 Some economic decisions have consequences on other parties that are not implied
in the transaction. In Economics, such impacts on other markets are called
externalities.
 In these cases, prices do not adequately reflect social costs or social benefits. If
the externality is negative, there is an overproduction of the good while a positive
externality leads to underproduction.
 A typical example of a negative externality is the decision to drive a petrol-powered
car. It generates a negative externality on other citizens because of both pollution and
increase in traffic jam.
 Education is considered to have a positive externality on society. The fact that a person
gets a degree has not only positive returns for the person itself, but also for the society
through the increase in the total stock of knowledge and in production in general.
Classification of goods
 Private goods have two important properties that make them tradable on markets:
exclusivity and rivalry.
 Exclusivity is a feature of a good for which a system (such as a price) can prevent
an individual from having access to it.
 Rivalry means that the consumption of the good by one individual reduces the
quantity available for others.

Excludable Non-excludable

Common-pool resources
Rival Private goods (roads, fish in the ocean)
Club goods Public goods
Non-rival (internet, toll bridges) (army, air, public art)
Classification of goods (cont’d)

 The main problem with non-private goods is the existence of free riders. When
some agents can use the good without paying it, no one has an incentive to pay for
its provision.
 Public goods therefore cannot be efficiently provided by the private sector
because firms cannot make profit out of selling these goods. These are cases for
government intervention in providing the good that is paid by everyone through
taxation.
 With common-pool resources, the private equilibrium leads to overexploitation of
the resource because of the “tragedy of the commons” (G. Hardin). Individuals do
not take into account the social cost of nondurable exploitation.
Tragedy of the commons
 Common resources such as land, forests or mines are subject to an
overexploitation. Private individuals, especially in rural areas, might cut trees or
extract minerals in order to cook, sell the resource, etc.
 However, social costs of degradation of the environment and ecosystems are not
fully taken into account by private agents.
 Overexploitation of resources is a complicated problem. Typical solutions
proposed by economists to manage common resources are either the imposition of
restrictions (or specific taxes) by the State or privatization of the resource (clear
property rights).
 In countries like Myanmar where property rights such as land titles are not always
clearly defined, other options must be employed by institutions in villages.
Tragedy of the commons (cont’d)
 Elinor Ostrom, the economist who classified common-pool goods as non-excludable and non-rival
goods, won the Nobel Prize in Economics in 2009 for her work.
 Her theory was about the idea that collective actions, without the need for a government, could lead to
efficient use of common-pool resources under certain conditions. That is a promising avenue for a
country like Myanmar.
 Clear definition of the common-pool resource and effective exclusion of external parties;
 Appropriation and provision of common resources that are adapted to local conditions;
 Collective-choice arrangements that allow most resource appropriators to participate in the decision-making
process;
 Effective monitoring by monitors who are accountable;
 A scale of graduated sanctions for resource appropriators who violate community rules;
 Mechanisms of conflict resolution that are cheap and of easy access;
 Self-determination of the community recognized by higher-level authorities;
 Larger common-pool resources: organization in the form of multiple layers of nested enterprises.
The problem of the firm

  
The main objective of a firm is to maximize its profits. Profits are net revenues
(revenues – costs).
 Revenues are simply the sum of the quantities produced multiplied by their
respective prices:

 The firm faces many costs: prices of inputs, rents, wages, depreciation of capital,
and opportunity cost of investments (interest revenues that are not made).
 In particular, we distinguish two forms of costs: fixed costs (FC) and variable
costs (VC). Together, they form the total cost (TC).
The problem of the firm (cont’d)

   firm makes positive profits if its revenues exceed its costs, but makes losses if
A
its revenues are lower than its costs.
 If the firm decides not to produce, its revenues are null, but it must still pay its
fixed cost and makes losses:

 Therefore, as long as its revenues are higher than its variable costs, a firm has an
incentive to produce.

 In other words, as long as the price of the good it produces is higher than its
average variable cost (VC/Q), the firm should stay in the market.
The value chain
 In the production process, for most goods and services, there are intermediate
goods that a firm needs to buy from other suppliers. These suppliers could also
have suppliers for their inputs. All of these intermediaries form a supply chain.

Wheat Flour Bread

 At each step of the chain, some value is added to the good from the previous step.
The added value is the selling price minus the price of inputs at a given step.
 For example, if the price of flour necessary for a bread is K400 (and assuming it
is the only input) and the bread is then sold for K850, the added value of the bread
is K450.
 In most cases, the later the step in the chain, the higher the added value.
Marketing and design are examples of high-value-added services while natural
resources have generally a low added value.
The value chain (cont’d)
 The concept of the value chain can be applied to a product within a country and it
could also be extended to many countries through multinational firms.
 A global value chain is a combination of interrelated activities required to bring a
product from its conception to its end use. It goes from the production of fibres to
the design and marketing of clothes for final consumers.
 Policymakers need to understand their country’s positioning in GVCs if they wish
to provide better employment opportunities and upgrade in the GVCs. In general,
service-related activities generate higher value capture while agriculture and
manufacturing have low added value.

Source : Duke University Global Value Chains Center

 An example of a global value chain

Source: Meshkova and Moiseichev (2016)

Source: The Economic Times

The value chain and the Flying Geese
paradigm
 In the 1960s, Kaname Akamatsu, a Japanese economist,
tried to explain patterns of economic development in East-
Asian countries.
 His theory states that manufacturing companies move
from a country to another like migrating geese as costs of
production (wages) increase and demand changes within a
country.
 Japan is the leading goose, the Asian Tigers and China
follow, and then the other East-Asian countries come in a
V-shaped process.
The value chain and the Flying Geese
paradigm
 Akamatsu proposed that there is a technology
transfer from a leading goose to its followers.
A leader starts producing a more complex
good as firms develop new technologies and
they “pass” older technologies to the
following geese.
 The technology transfer allows the followers
to produce higher added-value goods.
 It is still unclear whether Myanmar would fit
in this model, but it is clear that the country
would benefit from such technology
transfers.
Conclusion

 Economic agents’ decisions are the result of an arbitrage between scarcity of

resources and preferences.
 Production and prices are the result of interactions between suppliers and
consumers.
 Markets are imperfect and government interventions are necessary in order to
correct them partially.
 Countries like Myanmar that still rely heavily on agriculture and manufacturing
sectors produce low added-value goods.
 Choices under constraints and agents make their decisions based on different
incentives and different constraints.
List of suggested references

 Duke Global Value Chains Center, Duke University, found at:

https://gvcc.duke.edu/
 The Economist (newspaper)
 Fatch, Walter F. (2010). Asia’s Flying Geese, Cornell University Press.
 Krugman, Paul and Robin Wells. (2012). Microeconomics, Worth Publishers.
 Mankiw, Gregory N. (2014) Principles of Microeconomics, South-Western
College Pub.