Archive for March, 2013

Mar 04 2013

A TED Talk overview of issues in economic development

Over the next three weeks I will be covering issues in Development Economics with my year 2 IB students. I have often used TED Talks to inspire our class discussions, and this year I decided to compile a “best of TED” playlist to guide us through the IB topics in development.

Day 1 – The Nature of Economic Growth and Development and Measuring Development:

Days 2 and 3 – The role of foreign aid

Days 4 and 5 – The Role of Domestic Factors:

  • Hans Rosling: Religions and babies | Video on TED.com – Hans Rosling had a question: Do some religions have a higher birth rate than others — and how does this affect global population growth? Speaking at the TEDxSummit in Doha, Qatar, he graphs data over time and across religions. With his trademark humor and sharp insight, Hans reaches a surprising conclusion on world fertility rates.
  • Hans Rosling: The magic washing machine | Video on TED.com – What was the greatest invention of the industrial revolution? Hans Rosling makes the case for the washing machine. With newly designed graphics from Gapminder, Rosling shows us the magic that pops up when economic growth and electricity turn a boring wash day into an intellectual day of reading.
  • Ernest Madu on world-class health care | Video on TED.com – Dr. Ernest Madu runs the Heart Institute of the Caribbean in Kingston, Jamaica, where he proves that — with careful design, smart technical choices, and a true desire to serve — it’s possible to offer world-class healthcare in the developing world.
  • Andrew Mwenda takes a new look at Africa | Video on TED.com – In this provocative talk, journalist Andrew Mwenda asks us to reframe the “African question” — to look beyond the media’s stories of poverty, civil war and helplessness and see the opportunities for creating wealth and happiness throughout the continent.

Micro-finance

  • Jacqueline Novogratz on escaping poverty | Video on TED.com – Jacqueline Novogratz tells a moving story of an encounter in a Nairobi slum with Jane, a former prostitute, whose dreams of escaping poverty, of becoming a doctor and of getting married were fulfilled in an unexpected way.
  • Jessica Jackley: Poverty, money — and love | Video on TED.com – What do you think of people in poverty? Maybe what Jessica Jackley once did: “they” need “our” help, in the form of a few coins in a jar. The co-founder of Kiva.org talks about how her attitude changed — and how her work with microloans has brought new power to people who live on a few dollars a day.

Days 6 and 7 – The Role of International Trade:

Day 8 – The role of Foreign Direct Investment (FDI)

Days 9 and 10 – Conclusions and Data Response Question practice

3 responses so far

Mar 04 2013

Monopoly prices – to regulate or not to regulate, that is the question!

Competitively Priced Electricity Costs More, Studies Show – New York Times

The problem with monopolies, as our AP students have learned, is that a monopolistic firm, left to its own accord, will most likely choose to produce at an output level that is much lower and provide their product at a price that is much higher than would result from a purely competitive industry.Regulated Monopoly A monopolist will produce where its price is greater than its marginal cost, indicating an under-allocation of resources towards the product. By restricting output and raising its price, the monopolist is assured maximum profits, but at the cost to society of less overall consumer surplus or welfare.

Unfortunately, in some industries, because of the wide range of output over which economies of scale are experienced, it sometimes makes the most sense for only one firm to participate. Such markets are called “natural monopolies” and some examples are cable television, utilities, natural gas, and other industries that have large economies of scale. (click graph to see full-sized)

Government regulators face a dilemma in dealing with natural monopolistic industries such as the electricity industry. A electricity company with a monopoly in a particular market will base its price and output decision on the profit maximization rule that all unregulated firms will; they’ll produce at the level where their marginal revenue is equal to their marginal cost. The problem is, for a monopolist its marginal revenue is less than the price it has to charge, which means that at the profit maximizing level of output (where MR=MC), marginal cost will be less than price: evidence of allocative inefficiency (i.e. not enough electricity will be produced and the price will be too high for some consumers to afford).

Here arises the need for government regulation. A government concerned with getting the right amount of electricity to the right number of people (allocative efficiency) may choose to set a price ceiling for electricity at the level where the price equals the firm’s marginal cost. This, however, will likely be below the firm’s average total cost (remember, ATC declines over a WIDE RANGE of output), a scenario which would result in losses for the firm, and may lead it to shut down altogether. So what most governments have done in the past is set a price ceiling where the price is equal to the firm’s average total cost, meaning the firm will “break even”, earning only a “normal profit”; essentially just enough to keep the firm in business; this is known as the “fair-return price”.

Below AP Economics teacher Jacob Clifford illustrates and explains this regulatory dilemma. Watch the video and see how he shows the effect of the two price control options on the firm’s output and the price in the market.

[youtube]http://www.youtube.com/watch?v=A2ePDt6-k8Q[/youtube]

The article above examines the differences in the price of electricity in states which regulate their electricity prices and states that have adopted “market” or unregulated pricing, in which firms are free to produce at the MR=MC level:

“The difference in prices charged to industrial companies in market states compared with those in regulated ones nearly tripled from 1999 to last July, according to the analysis of Energy Department data by Marilyn Showalter, who runs Power in the Public Interest, a group that favors traditional rate regulation.

The price spread grew from 1.09 cents per kilowatt-hour to 3.09 cents, her analysis showed. It also showed that in 2006 alone industrial customers paid $7.2 billion more for electricity in market states than if they had paid the average prices in regulated states.”

The idea of deregulation of electricity markets was that removing price ceilings would lead to greater economic profits for the firms, which would subsequently attract new firms into the market. More competitive markets should then drive prices down towards the socially-optimal price, benefiting consumers and producers by forcing them to be more productively efficient in order to compete (remember “Economic Darwinism”?). It appears, however, that higher prices have not, as hoped, led to lower prices:

“Since 1999, prices for industrial customers in deregulated states have risen from 18 percent above the national average to 37 percent above,” said Mrs. Showalter, an energy lawyer and former Washington State utility regulator.

In regulated states, prices fell from 7 percent below the national average to 12 percent below, she calculated…

In market states, electricity customers of all kinds, from homeowners to electricity-hungry aluminum plants, pay $48 billion more each year for power than they would have paid in states with the traditional system of government boards setting electric rates…”

That $48 billion represents higher costs of production for other firms that require large inputs of energy in their own production, higher electricity bills for cash-strapped households, and greater profits and shareholder dividends for the powerful firms that provide the power. On the bright side, higher prices for electricity should lead to more careful and conservative use of power, reducing Americans’ impact on global warming (since the vast majority of the country’s power is generated using fossil fuels).

Here arises another question? Should we be opposed to higher profits for powerful electricity firms if their profits result in much needed energy conservation and a reduction in greenhouse gas emissions? An environmental economist might argue that if customers are to pay higher prices for their energy, it might as well be in the form of a carbon tax, which rather than increasing profits for a monopolistic firm would generate revenue for the government. In theory tax revenue could be used to subsidize or otherwise promote the development and use of “green energies”.

Whether customers paying higher prices for traditionally under-priced electricity is a good or bad thing depends on your views of conservation. But whether higher profits for a powerful electricity company are more desirable than increased tax revenue for the government are beneficial for society or not seems clear. If we’re paying higher prices, the resulting revenue is more likely to be put towards socially desirable uses if it’s in the government’s hands rather than in the pockets of shareholders of fossil fuel burning electricity monopolies.

Discussion Questions:

  1. Why do governments regulate the prices in industries such as natural gas and electricity?
  2. Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
  3. Why, in reality, did the price of electricity in unregulated electricity markets ultimately increase so much that consumers in the market states paid billions of dollars more than in regulated states?
  4. What industries besides that for electricity share characteristics that might qualify them as “natural monopolies”? Which of the industries you identified should be regulated by government, and WHY?

262 responses so far

Mar 04 2013

“Drinking games” – Why a Budweiser / Corona merger would seriously bum out, like, a ton of frat boys

Facts: 65% of all the beer bought in the United States is produced by one of two companies: Anheuser Busch / InBev or Miller. 7% is produced by a company called Grupo Modelo. 72% of all the beer bought comes from these three companies. Much of the remaining market is shared by thousands of “micro-breweries” of varying sizes.

While there are literally thousands of beer makers in the US, technically speaking, the market is oligopolistic, since such a large share of the market (72%) is dominated by just three firms. To be classified as an oligopoly, a market must be dominated by a few large firm selling a differentiated (and sometimes a homogeneous) product. Firms are interdependent on one another and they tend to compete for consumers using “non-price competition”, which may include improving the quality of their product and offering customers a wider variety to choose from, and especially through advertising. A final characteristic of oligopoly is that high barriers to entry exist.

In the case of the beer market,  there are minimal economies of scale, since anyone with a $200 home brewing kit can technically “enter the market”. But other barriers to entering the national market for beer are significant, which explains why the market is dominated by three huge firms. Notably, brand recognition poses a barrier to entry to the thousands of small brewers in America. The brands owned by the big three firms are well-established and liked among consumers, making it difficult for smaller brewers to gain share in the market.

In the Planet Money podcast below, we hear the story two of these “big three” beer makers. Anheuser Busch / InBev is attempting to merge with Grupo Modelo, a transaction that would reduce the “big three” to the “big two”, which would give the new single firm a truly dominant position in the market, and increase the two-firm concentration ratio from 65% to 72%. The podcast explains how competition in the market for beer benefits consumers, and how a decrease in competition will harm consumers. Below, I will provide a graphical analysis of the situation.

As the podcast explains, the competition between the big three beer producers has several benefits for consumers, not least of which is the huge variety of beers available across the three firms, each trying to capture a larger share of the market by offering consumers beers that appeal to their diverse tastes. In addition, however, the nature of competition in oligopolistic markets tends to result in stable prices over time. Here’s why:

Imagine Anheuser Busch / InBev, which wishes to raise its price from P1 to P2 in the graph below. If AB/InBev raises its prices, while Modelo and Miller keep theirs unchanged, the demand for AB/InBev’s beer is likely to be highly elastic, meaning that even a small price increase will cause the quantity demanded to fall dramatically (from Q1 to Q2). Due to the high elasticity of demand above P1, such a price hike will lead to lower revenues for AB/InBev. Conclusion? A price hike is a bad idea.

graph 1

So what if AB/InBev decides to lower its prices? The graph below shows that at any price below P1, demand will most likely be highly inelastic, because a price cut will most likely be matched by Modelo and Miller, who would have to cut their prices to avoid losing a significant number of consumers to AB/InBev. If all three firms lower their prices, then each firm will see hardly any increase at all in their total sales. A price decrease by AB/InBev will set off a “price war” and the firm will see its revenues fall.

graph 2

What we end up with is what is known as a “kinked” demand curve for AB/InBev’s beers.

graph 3

The firm has almost no incentive to raise or lower its prices, since a change in either direction will cause revenues to decline. Therefore, beer consumers enjoy stable prices, and the firms choose to compete through product differentiation, innovation and, of course, advertising!

So how would a merger between two of the big three beer makers change the situation in the market? What if just TWO firms controlled 72% of the market instead of three? The fear is that AB/InBev, once it owns Modelo, will be less interdependent on the actions of Miller. In other words, it will care less whether Miller ignores its price increases or matches its price decreases. Since there will be fewer substitutes for the gigantic firm’s dozens (or hundreds?!) of beer brands, demand for them overall will be more inelastic. This would give AB/InBev more price making power, and essentially make the market look more like a monopoly.

graph 4

When a firm has monopoly power, as we can see, a large increase in price (from P1 to P2) leads to a relatively smaller decrease in sales (from Qt to Q2). If AB/InBev and Modelo were to merge the firm would be able to get away with raising the price of all of its beer brands, as consumers are less likely to switch to the competition, since a big chunk of the competition would be owned by the firm itself!

The amount of competition that exists in a market has major bearings on the consumers, as this podcast demonstrates and our graphs illustrate. With just three big firms making 72% of the beer in the US, it may not seem like that big a deal if two of them merge. But even the loss of one firm in a highly concentrated market like beer could lead to higher prices for dozens of the top selling beers in the country; hence the US government’s hesitance to give AB/InBev a green light in its plan to acquire Grupo Modelo!

Discussion Questions:

  1. How can a market with thousands of individual sellers be considered oligopolistic?
  2. Why is “brand recognition” considered a barrier to entry into the beer market?
  3. Explain why prices in oligopolistic markets tend not to increase or decrease very often.
  4. Why is “non-price competition” so important for beer makers in the US? What are some forms of non-price competition that they practice?
  5. What is meant by the statement that “monopoly price is higher and output is lower than what is socially optimal.” Would this apply to the beer market if the AB/InBev and Modelo merger were to proceed?

3 responses so far

Mar 04 2013

Lesson Plan: Sources of Economic Growth and Development

Introduction: In order to understand the goals of economic development, it is useful to examine the characteristics of more economically developed countries and compare them to those of less economically developed countries. Before beginning the assignment below, watch the following TED Talk by Swedish Professor of world health Hans Rosling:


Resources: Use the following websites to find the required data for the assignment below.

Part 1 – Development Data:

Using the two websites above, locate the following for TWO COUNTRIES, one from the list of countries with “high human development” and one from the list of countries with “low human development”. Use the tables below to fill in the data for the two countries you have chosen.

Social Indicators (find and record figures for both the countries you chose below)

  • HDI ranking and value
  • Age structure
  • Population growth rate
  • School life expectancy
  • Life expectancy at birth
  • Total fertility rate
  • Education expenditures

Economic Indicators:

  • GDP per capita
  • GDP – composition by sector
  • Unemployment rate
  • Public debt
  • Stock of direct foreign investment – at home:
  • Labor force – by occupation

Part 2 – Dependency Ratio:

A nation’s dependency ratio tells us something about the ability of members of a nation’s workforce to provide necessities to him or herself and his or her dependents. Typically, less economically developed nations will have a higher dependency ratio than more economically developed countries. The lower a nation’s dependency ratio, the greater capacity for its workers to accumulate savings, which leads to investment, accumulation of capital, greater productivity, higher incomes and more economic development.

Calculation the dependency ratio: To calculate a nation’s dependency ratio, you must find demographic information on its population. You may need to do additional research beyond the two websites above to find this data.

Calculate the dependency ratios for:

      • Country with high HDI
      • Country with low HDI

Part 3 – Lorenz Curve and Gini coefficient:

The Lorenz curve is a graphical representation of the income distribution of a country. It plots the percentage of a nation’s total income (GDP) against its total population. The “line of absolute equality” is the 45 degree line, indicating a nation where each quintile (20% of the population) earns exactly the same income as each other quintile. No country is absolutely equal, therefore the line of equality is only used for comparison.

The Gini coefficient is the ratio of the area below the line of equality and above a country’s Lorenz curve and the total area of the triangle below the line of equality. A country with perfect income equality would have a Gini coefficient of 0. A country in which the top 1% had controlled all of a nation’s income would have a Gini coefficient of nearly 1.
Example: Australia’s income is distributed across its population in the following way:

      • 1st 20% – 5.9%
      • 2nd 20% – 12%
      • 3rd 20% – 17.2%
      • 4th 20% – 23.6%
      • 5th 20% – 41.3%
      • Gini coefficient = 0.352

Illustrating your countries’ Lorenz Curves: This is another activity that may require research beyond the websites provided above. Try to find data on the share of national income earned by various levels of society. If you cannot find data for the 20% ranges, use the percentage ranges you can find. Draw a Lorenz curve for the two countries you researched.

Part 4 – Conclusions:

Evaluate your findings from the two countries you researched.

    1. What conclusions can you draw about the correlation between GDP, HDI, income equality, social and economic indicators between developed and developing countries?
    2. Does a high HDI correlate with relative income equality? What about low HDI?
    3. Is a high GDP indicative of high levels of human development?
    4. What other conclusions can you draw about economic development, national income, and equality?
    5. To what extent did your country with low HD exhibit the following characteristics?
      • Low standards of living?
      • Low incomes?
      • Inequality?
      • Poor health?
      • Inadequate education?
      • Low levels of productivity?
      • High rates of population growth and dependency burdens?
      • High levels of unemployment?
      • Dependence on agricultural production and primary product exports?
      • Imperfect markets?
      • Dependency on foreign developed countries for trade, access to technology, foreign investment and aid?

    One response so far

    Mar 03 2013

    Introducing a new revision guide for the AP, IB and A level Economics exams! Now on Amazon

    Over the last year, I have been working on two new resources for IB, AP, A level and Econ 101 students. The Microeconomics and Macroeconomics Revision Guides for the Introductory Economics student represent the ultimate resource for exam preparation and subject mastery.

    The Macro Revision Guide is in its final stage of development and should be for sale by the middle of March. The Micro Revision Guide is now available now on Amazon in the US, the UK and the EU:

     Order here: Amazon.com   Amazon.co.uk  Amazon.de

    Description: The Microeconomics Revision Guide for Introductory Economics students provides a comprehensive overview of the major units covered in an introductory Micro course. The book follows the Advanced Placement and International Baccalaureate syllabuses, and includes over 200 detailed diagrams, clear explanations of concepts, definitions, examples, and a glossary with over 150 key Microeconomic terms.

    The revision guide is linked to several online resources which can be accessed for free by students reviewing for exams. Each chapter of the book is accompanied by a section on the website, www.EconClassroom.com, at which students can view video lectures published by the author covering nearly every topic from the course. The website also provides interactive flashcards for reviewing key terms and downloadable practice activities on most units.

    For more information on the Microeconomics Revision Guide for the Introductory Economics Student, have a look at the author’s website, www.welkerswikinomics.com. There you can also find links to other resources, including teacher lecture notes, a blog, and an Economics news page.

    ORDER NOW!

    Book cover preview

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