HOMEWORK 3

HOMEWORK 3

What are the two types of market failures?

Market failures are often associated with time-inconsistent preferences, information asymmetries,[6] non-competitive markets, principal–agent problems, externalities, or public goods. The existence of a market failure is often the reason for government intervention in a particular market.[9][10] Economists, especially microeconomists, are often concerned with the causes of market failure and possible means of correction.[11] Such analysis plays an important role in many types of public policy decisions and studies. However, some types of government policy interventions, such as taxes, subsidies, bailouts, wage and price controls, and regulations, including attempts to correct market failure, may also lead to an inefficient allocation of resources, sometimes called government failure

2. What gives rise to the first type of market failure?

Some have argued that governments should subsidize research and development, since it will have positive externalities to everyone else. Another method is to allow patents to give monopoly rights to new inventions for a period of time, and encourage such activity. Without this method, there could be an under investment in research. Positive externalities in production means that social cost is less than private cost, and more of the good should be produced than will occur in a free market.

3. What does the second type of market failure gives rise to?

When economic agents not directly involved, negative externalities can exist, such as pollution. A free market tends to over-produce the good which produces a negative externality, and under produce those with positive externality. If we include costs borne by everyone, then we get social costs, which are the total costs of production no matter who bears them. We say that the total cost is equal to private costs plus external costs. -

4. What are the two types of spillovers?

The two types of spillovers are knowledge spillovers and technology spillovers

5. What are spillover costs?

Spillover costs are basically the costs that are paid by people who do not agree to the action causing the cost.

6. What are spillover benefits?

Spillover effects are the external outcomes of economic activities which can affects those people which are not directly involved in this process. It is quite natural and realistic. For example, the war of Amercian-Afganistan is badly affecting the economy of Pakistan

7. What are the economic consequences of both spillover costs and spillover benefits? Support your explanation graphically.

Economists call effects on those not involved in a market externalities, and externalities vary along two dimensions. First, externalities can be either negative or positive. Not surprisingly, negative externalities impose spillover costs on otherwise uninvolved parties, and positive externalities confer spillover benefits on otherwise uninvolved parties. (When analyzing externalities, it's helpful to keep in mind that costs are just negative benefits and benefits are just negative costs.) Second, externalities can be either on production or consumption. In the case of an externality on production, the spillover effects occur when a product is physically produced. In the case of an externality on consumption, the spillover effects occur when a product is consumed.

8. How does the government correct for both negative externalities and positive externalities?

Positive externalities are benefits that are infeasible to charge to provide; negative externalities are costs that are infeasible to charge to not provide. Ordinarily, as Adam Smith explained, selfishness leads markets to produce whatever people want; to get rich, you have to sell what the public is eager to buy. Externalities undermine the social benefits of individual selfishness. If selfish consumers do not have to pay producers for benefits, they will not pay; and if selfish producers are not paid, they will not produce. A valuable product fails to appear. The problem, as David Friedman aptly explains, “is not that one person pays for what someone else gets but that nobody pays and nobody gets, even though the good is worth more than it would cost to produce

1.What is the purpose of the circular-flow model and products?

One of the main basic economic models is the circular-flow model, which describes the flow of money and products throughout the economy in a very simplified way. The model represents all of the actors in an economy as either households or firms (companies), and it divides markets into two categories:

    markets for goods and services

    markets for factors of production (factor markets)

2.What do firms need in order to produce goods and services?

In economics, factors of production are the inputs to the production process. Finished goods are the output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function. There are three basic factors of production: land, labour, capital. Some modern economists also consider entrepreneurship for a factor of production

3.Who are the owners of the factors of production?

If you are equating market economy with capitalism (which is not accurate, but still common),
then the answer you probably want is that ownership is in private hands.
Most big companies are publicly-held corporations. There is no single owner; the stock may be widely distributed.
Much of the stock in the U.S. is owned by pension funds, which nominally act on the behalf of workers. That means you could say that workers own many of the means of production, even if they have no control over them.
Much of the rest of stock is owned by mutual funds. But mutual funds don't actually exercise any control over the companies whose stock they hold. Thus they may be legal owners, but they don't behave like owners.
 Then there are the sovereign wealth funds where foreign governments buy stocks and other assets:

4. What are the of factor resources owned by households?

Households own all the factors of production, that is land, labor, capital. These factors of production are sold to the firms to produce goods and services through factor markets. Firms make use of these resources and provide goods and services to the household through product markets. However the exchange of goods and services and factors of production takes place with the help of the financial flows that move in the reverse direction. As the households purchase goods and services from firms it is their consumption expenditure which in turn becomes income or profits for the firms. On the other hand when firms buy factors of production from the households they pay factor payments in the form of wages, rent, interest.

5. In the form of what do households receive money income or payment from firms?

Spending patterns vary by age, region of the county, the size of the household, and income, among other things. Some things are purchased infrequently, others on a regular basis. The Bureau of Labor Statistics conducts the Consumer Expenditure Survey to quantify some of these observations. The seven major categories in the Survey are food, housing, apparel and services, transportation, health care, entertainment, and an "other" category that is mostly taken up by personal insurance and pensions, but also includes personal care products, reading, education, tobacco products, cash contributions, and miscellaneous items. Although the dollar amounts vary with every Survey report, some trends have been in place for many years.

6. What do households spend their income on?

Spending patterns vary by age, region of the county, the size of the household, and income, among other things. Some things are purchased infrequently, others on a regular basis. The Bureau of Labor Statistics conducts the Consumer Expenditure Survey to quantify some of these observations. The seven major categories in the Survey are food, housing, apparel and services, transportation, health care, entertainment, and an "other" category that is mostly taken up by personal insurance and pensions, but also includes personal care products, reading, education, tobacco products, cash contributions, and miscellaneous items. Although the dollar amounts vary with every Survey report, some trends have been in place for many years.

7. What does the financial system consist of?

A financial system can be defined at the global, regional or firm specific level. The firm's financial system is the set of implemented procedures that track the financial activities of the company. On a regional scale, the financial system is the system that enables lenders and borrowers to exchange funds. The global financial system is basically a broader regional system that encompasses all financial institutions, borrowers and lenders within the global economy.

8. What does the government’s ability to borrow money depend on?

Government debt is one method of financing government operations, but it is not the only method. Governments can also create money to monetize their debts, thereby removing the need to pay interest. But this practice simply reduces government interest costs rather than truly canceling government debt,[3] and can result in hyperinflation if used unsparingly.

9. What is the importance of a viable financial system?

There are multiple components making up the financial system of different levels: Within a firm, the financial system encompasses all aspects of finances. For example, it would include accounting measures, revenue and expense schedules, wages and balance sheet verification. Regional financial systems would include banks and other financial institutions, financial markets, financial services In a global view, financial systems would include the International Monetary Fund, central banks, World Bank and major banks that practice overseas lending.

10. Why do firms want to produce goods and services?

In business, products that are sold, traded or otherwise provided to consumers or other companies can be classified as either goods, which are tangible, or services, which are intangible. Most countries measure their economies on the production and consumption of both physical goods and intangible services. Some companies provide both goods and services, and others provide only one or the other. Firms produce goods and services primarily to make profit and to circulate money into the economy.

11. What are the types of reward or payment received by the different factor resources?

Payments made of scarce resources, or the factors of production in return for productive services. They are also categorized according to the services of the productive resources being rewarded. As wages are being paid for services of labor, interest is paid for the services of capital, rent is paid for the services provided by the land and profit is for the factor of payment to entrepreneurship

12. What do governments pay to households for using their resources?

13. What does all expenditures by the households, government, firms, and the rest of the world equal to?

14. What does GDP stand for?

Gross Domestic Product. The total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports. The GDP report is released at 8:30 am EST on the last day of each quarter and reflects the previous quarter. Growth in GDP is what matters, and the U.S. GDP growth has historically averaged about 2.5-3% per year but with substantial deviations. Each initial GDP report will be revised twice before the final figure is settled upon: the "advance" report is followed by the "preliminary" report about a month later and a final report a month after that. Significant revisions to the advance number can cause additional ripples through the markets. The GDP numbers are reported in two forms: current dollar and constant dollar

15. What do households do with the portion of their income that they do not spend?

16. What are imports?

An import is a good brought into a jurisdiction, especially across a national border, from an external source. The party bringing in the good is called an importer. An import in the receiving country is an export from the sending country. Importation and exportation are the defining financial transactions of international trade.

17. What are exports?

The term export means shipping the goods and services out of the port of a country. The seller of such goods and services is referred to as an "exporter" who is based in the country of export whereas the overseas based buyer is referred to as an "importer". In International Trade, "exports" refers to selling goods and services produced in the home country to other markets.

18. What similarities and differences did you find between the assigned pages and the instructor’s prepared video?

The pages assigned gave more information on the subject where the videos give a more vivid and illustrated idea of what the concepts are about. They are both informative.

1.Why do we need to consider the definition of GDP carefully?

We need to consider the GDP carefully because it is commonly used as an indicator of the health of a country, as well as the country’s standard of living. Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a year, or over a given period of time. GDP per capita is often used as an indicator of a country's material standard of living.

2. What is the difference between how we measure total production in microeconomics and macroeconomics?

When you think of microeconomics, think of a microscope.  You are analyzing one little bit of information at a time.  In microeconomics, we tend to focus on one individual, or one firm, and how it interacts with the market.  Examples include deciding how many pieces of pizza to buy, or whether or not you should purchase insurance.  Problems generally deal with utility functions and budget constraints for consumers, and profit maximization problems for firms.

Now imagine you are standing on the moon looking at the economy on earth.  You would see huge land masses only.  This far away approach is considered a macro approach, because it aggregates all of the decisions of the individuals and firms to a regional or national level.  Macro tends to focus on government policy and the potential impacts it can have on the general economy.  Government policies include taxes, subsidies, regulations and rules.  Macroeconomics strives to understand how these policies impact the economy.

Also, in microeconomics we are concerned with things like individual salaries, purchasing decisions, exports or taxes for one product, and welfare or help for a specific demographic.  In macroeconomics we tend to think about more general terms, such as money supply, inflation, unemployment, GDP, exchange rates and trade.

3.Why does GDP include only the market value of final goods?

The dollar value of final goods includes the dollar value of intermediate goods. If
intermediate goods were counted, then multiple counting would occur. The value of steel
(an intermediate good) used in autos is included in the price of the auto (a final product).
This value is not included in GDP because such sales and purchases simply transfer the
ownership of existing assets; such sales and purchases are not themselves (economic)
investment and thus should not be counted as production of final goods and services.
Used furniture was produced in some previous year; it was counted as GDP then. Its
resale does not measure new production.

4.What is the value of GDP if the quantity and price of eye examinations produced is 100 and $50 respectively?

The GDP would be approximately $150 dollars.

5. Why does the value of total production equal to the value of total income?

Consider the new car that you just bought. Assume (only to simplify the discussion) that it was built entirely within the same country that you live in, and that you bought it in. Also to simplify, assume that it was built entirely in this year. The car being built obviously is production. But how to you value it so that it's value counts in GDP? The price that you paid is the method of valuing that would be used. That would be the value of production, how it would be counted using the expenditures approach. But if you traced that amount of money back through the production process, it all adds up to income for the factors of production along the line. The manufacturers of all the different parts receive income when they sell the parts to the automaker. Even before that, those parts were final products for somebody else that used raw materials to make the parts. The automaker, and everybody else along the line, pays wages for workers. They pay other expenses as part of the process. The companies along the way also receive profit. The total price that you paid is income for somebody along the way. The total value of production equals income.

6.What are the four components of GDP and their defining characteristics?

GDP is made up of four basic groups. The first three are types of expenditures: consumer expenditure, government expenditure and investment expenditure. The fourth component measures net exports. Net exports comprise both exports, which are items produced at home and bought by consumers overseas, and imports, which are goods produced by overseas companies but bought by domestic consumers. With the exemption of imports, an increase in every component leads to an increase in GDP. GDP is measured in one time period, usually in units of one year or quarters of a year.

7.How can GDP be measured using the value-added method?

In business, the difference between the sale price and the production cost of a product is the unit profit. In economics, the sum of the unit profit, the unit depreciation cost, and the unit labor cost is the unit value added. Summing value added per unit over all units sold is total value added. Total value added is equivalent to revenue less outside purchases (of materials and services). Value added is a higher portion of revenue for integrated companies,

1.       How do you calculate the following: Real GDP, nominal GDP, and price index?

Real GDP:

 Add a country's cumulative expenditures to arrive at nominal GDP. Nominal GDP is the actual dollar amount a country spends. GDP expenditures are made up of personal expenditures, gross private investment, government consumption, imports and exports.

Nominal GDP:

 Calculate the total consumer spending by adding up all purchases of goods and services by households. These can include food, gas and clothing.

Price Index:

 A consumer price index (CPI) is an estimate as to the price level of consumer goods and services in an economy which is used as a way to estimate changes in prices and inflation. A CPI takes a certain basket of common goods and services, for instance a gallon of gas, a loaf of bread and a haircut, and tracks the changes in the prices that basket of goods over time.