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Ten Thoughts on Improving Your Economics Papers

AS and edit Master subtitle style Click to A2 Economics Revision April 2012

(1) The Importance of the Margin

Textbook economics decisions made at the margin

Marginal revenue = marginal cost (profit max output) Marginal social benefit = marginal social cost (social equilibrium)

Few businesses / people have the capacity to reach precise equilibrium points or even seek to find them But

Marginal changes in behaviour can have a big effect if enough people make them (e.g. Energy consumption) Economists increasingly interested in power of network effects Changing behaviour at the margin can have important social effects social norms can change + policies can have an impact The fundamental value of something depends on the value of the marginal unit important in lots of markets (e.g. oil, food)

2: Unintended Consequences

This is a root cause of government failure All govt interventions in a market have at least one and often several unintended consequences Easy to have the benefit of hindsight when seeing this! Reasons:

Economics is a social science about human behaviour Rational agents look for ways to offset policies that cost them Widespread information failure by state when setting policies Policies are static but markets are dynamic - markets and the agents that inhabit them move far more quickly than government Disintermediation is inevitable in a globalized world

3: Stakeholders matter!

Stakeholders are Any person or organization that has a legitimate interest in a specific project or policy decision. Check to see the source of comment in data response questions is there inbuilt bias? Identify and comment when value judgements are being made always scores high for evaluation When evaluating bring in the views of different stakeholders (see the WEESTEPS approach) Risk of government failure:

Regulatory capture / powerful lobbying for particular group i.e. policy decisions made to please a vested interest Inequitable impact between one group and another

Examples of Stakeholders

NGOs and Employees other advocacy groups (i.e. World Bank, IMF, Pressure Groups) Communities where a business is located or affected by a Prospective employees decision Prospective customers Supply chain businesses National communities Shareholders International community Creditors Competitors (and taxpayers) Government in a market Trade unions (and the workers they represent)

4: Time Periods Always Consider Them!

Be familiar with

Immediate (momentary) especially in primary sectors Short run (at least 1 fixed factor, diminishing returns) Long run (all factor inputs are variable, internal and external economies and diseconomies of scale can be exploited)

Applications of time periods in your analysis

Elasticity of supply (micro and macro (AS) supply curves) Elasticity of demand (Ped, CPed, Income elasticity) Discounting the future value of costs and benefits (CBA) Long run effects of macro policies e.g. supply-side / trade policy Long run effects of micro policies e.g. liberalising a market, nationalisation, buffer stock schemes, indirect taxes

5: (a) Demand and supply curves are often non-linear!


No reason for demand curve to be drawn as straight line


Changing elasticity of supply as output increases

5(b): Upward sloping demand and downward-sloping supply!

Upward sloping demand curve e.g. Speculation or snob-value demand

S1 S2 S2

Long run supply with economies of scale

6: Change the elasticity to build / develop / deepen your analysis!


S + tax P2 S P1

D Q2 Q1

6: Change the elasticity to build / develop / deepen your analysis!

More close substitutes higher CPED P P

S + tax P2 S P1 P1 P2

S + tax

D Q2 Q1 Q Q2 Q1


D2 Q

7: Most markets are inter-related

Changes in relative prices / rewards in one market affect resource allocation in others Key related-market concepts to revise:

Substitutes products in competitive demand Complements products in joint demand Derived demand especially in supply-chain / labour markets Composite demand factor input can be used in different ways Joint supply increased supply of one product by-products Competitive supply Q of X causes contraction in Q of Y Factor markets and the economic cycle (labour demand) Bond markets / currency markets / equity markets Macroeconomic effects of external demand/supply shocks

Also important in macroeconomics

8: Relative prices, preferences and incentives in our choices

Markets are powerful dont underestimate them especially the power of setting the right incentives Policy interventions seek to change behaviour of agents People do respond to incentives

Govt failure if the incentives turn out to be perverse Govt failure if the incentives are not strong enough (ineffective) Leads to substitution effects (changes in demand for X and Y) Agents react to changes in measured costs and benefits of their own actions A sufficient change in relative prices to make a difference Availability of alternative courses of action Enough time for agents to respond and react

Behaviour changes when relative costs & benefits alter

This requires

Examples of changes in relative prices

London congestion charge / underground fares National minimum wage / living wage Changes in relative prices of low and high carbon energy Relative prices (profits) of different crops in farming Relative price of ethical-products Relative prices and demand for exports / imports e.g. Following an exchange rate change Relative prices of legal versus illegal transactions (e.g. Incentives to engage in crime / trade in human organs) Relative labour costs in different countries (FDI decisions)

9: Expectations matter!

Expectations are hugely important in micro and macro! Expectations of the future drive current behaviour!

Housing market / property development / decisions on land use Investment decisions by businesses (expected profits) Food supply decisions expected returns from different crops Currency demand and supply speculative activity in FOREX Monetary policy / inflation inflation expectations and wages Fiscal policy / tax cuts / govt borrowing expectations of changes in taxes Rational expectations growing doubts about rationality Adaptive expectations adapting to recent experiences

Formation of expectations:

10: The cost-benefit principle

The mother of all economic ideas is the cost-benefit principle. It says that should take an action if, and only if, the extra benefit from taking it is greater than the extra cost The hard part is

Identifying the relevant costs and benefits Measuring and valuing them many things that matter to us do not have market prices or accurate valuations

Key point: Individual rationality does not always lead to a socially optimum / desirable outcome Behavioural economics questions the core rationality embedded into conventional textbook economics A cost benefit approach can be applied to most intervention issues But be aware of the limitations of cost-benefit analysis!

And help your evaluation

Most policy problems require a combination of strategies Understanding network effects they are important Understand interdependence in markets - agents can be influenced directly by what others do Understand the meaning of efficiency and equity in markets (allocative, productive, dynamic efficiency) Have the courage to challenge the conventional wisdom Let your diagrams do a lot of the hard work for you develop your analysis with high quality diagrams it will make a difference Use the data that is provided but be aware of limitations Be cautious about the effectiveness of government intervention Few policies are subject to a rigorous trial process a weakness Markets often find solutions to intractable problems in the long run if the incentives are strong enough

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