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Types of market: Perfect Competition Markets
Goods and services are exchanged voluntarily at a price fixed by the market as a result of the free operation of the laws of supply and demand. In this situation, not a single company has enough power to influence the price; so all companies compete on equal conditions.
Types of market: Imperfect Competition Markets
One or more companies have the power to influence price, to a greater or lesser extent. The smaller the number of companies is, the greater their influence on the price. Hence, imperfect competitive market models are classified by number of companies participating in the market.
Market classifying criteria
Number of firms in the market
Price taker capacity
Products are homogeneous or not
Level of competition
Transparency
Entry and exit barriers
Entry barriers
These are the costs that a newcomer company in the market would have to bear, due to the entry in a certain market.
Common entry barriers:
Cost advantage by competitors
Product differentiation
High capital investments needed
Exit barriers
These are the costs that a company would have to bear, due to the exit from a certain market or the losses caused by not recovering part of what was invested.
Perfect competition market evolution
Growth: If sellers make non-traditional profits (higher than usual ones), new producers or sellers enter the market, imitating already established companies.
Surplus: As new vendors enter, the supply of goods increases. Because they are undifferentiated products, excess supply is created, and sellers lower prices so that surpluses can be sold. As a result, profits go down.
Maturing: As a result of oversupply, the period of non-traditional profits comes to an end and some companies exit the market to engage in more profitable activities. The rest of the companies adapt their production processes, or look for other formulas that will allow them to continue in the market. In this situation, too, companies imitate each other, and prices fall again.
Stabilization: More companies are leaving the market; the few that remain are recovering customers, and they are starting to reap profits again because supply is down and price wars are over. The income that companies get during this period is called normal income because it allows them to pay the expenses and the employee has a minimum reward.
Comparing a monopoly and an oligopoly
In a monopoly, there is only one firm. There is no competition and transparency, the entry and exit barriers are high, and there is a full pricing power. In a monopoly, firms invest in marketing and advertising trying to differentiate their products.
In an oligopoly, there are a few firms. The competition is very high and there is no transparency. There is a homogeneous product and both entry and exit barriers too. There is a high pricing power. In an oligopoly, there is a big risk of collusion, meaning that there could be secret agreements between the competitors.
Adam Smith
1. Free operation of the market.
2. Self-interest is the engine of the economy.
3. Defends private property.
4. Against the intervention of public bodies.
Market failures
Market failure is the economic situation defined by an inefficient distribution of goods and services in the free market. In a market failure, the individual incentives for rational behavior does not lead to rational outcomes for the group.
The main market failures are:
1. The instability of economic cycles
2. The existence of public goods
3. Externalities
4. Imperfect competition
5. The unequal distribution of income
Economic cycle
The Economic cycle is the fluctuation of the economy between periods of expansion (growth) and contraction (recession). Factors such as gross domestic product (GDP),
Interest rates, total employment, and consumer spending, can help to determine the current stage of the economic cycle.
Economic expansion
The economic activity grows (GDP-Gross Domestic Product ) together with the employment rate.
Economic recession
The economic activity falls down together with the GDP and the employment rate.
Economic policy: Public Bodies Intervention
Refers to the actions and tools used by the Public Bodies to intervene in the economic activity and push it in one direction. The direction can be towards growth or towards slowdown.
Intervention→ Public consumption and production of goods and services to foster the economy and accomplish the lack of private demand. These ideas belong to John Maynard Keynes (1883-1946), English economist.
No intervention→ Let the markets run freely, so they go over the crisis situations. These are liberal ideas defended by Hayek (1899-1992), Friedman and others.
Externalities: Internal and external costs
Internal costs→ These costs are linked to the use of the productive resources such as: salaries, rents,interests,… and also are taken into account.
External costs→ These costs are assumed by citizens not linked to the firms as a consequence of the firm’s activity and getting no payment for it at all. Pollution is a major example.
Externalities
Externalities are consequences derived from economic activity that affect people other than those who carry out the activity in question, and are not reflected in the prices of the goods and services produced.
External cost→ The cost of an economic activity that falls on people other than those who carry it out
External benefit→ The benefit of an economic activity received by people other than those who carry it out
Advantages of free competition
1. The search for more efficient ways of producing goods, brings out more innovation and technological progress.
2. Opens public access to a wider variety of goods and services due to price reduction practices.
3. Permits a better value for money since prices go down while salaries can remain the same.
4. Makes it easier for new firms to enter in the market so new employment is created.
Taxes
Equity principle→ The public expenses that make possible the corrective action of the State must be financed by all its citizens according to their economic capacity.
Taxes→ The financing of the State is produced, fundamentally, through the taxes that all citizens pay. Most taxes are progressive, thus the more you earn the more you pay.
Welfare
It is the state intervention to ensure the well-being of citizens. It was created after WWII, in order to address the social shortcomings. It brings universal benefits (Health + education), paid benefits (retirement), and social benefits (social canteens, social housing etc.)
GDP
The monetary value of the goods and services produced in a certain country during a certain time period.
GDP CHARACTERISTICS
1. Currency is used to measure it
2. Only legal and declared activities are included
3. Only final goods are included
4. Only the production within the national borders are included
5. Only a certain time period is measured, usually a year
LIMITS ON GDP
Black economy (not declared activities)
Activities not being traded for money
Externalities which are not included
The quality level of the products, which is not included
Wealth distribution, which is not included
NOMINAL VS REAL GDP
Nominal GDP→ It’s the monetary value of all goods and services produced by a country at current prices in the year in which the goods are produced. When studying the evolution of GDP over time, in situations of high inflation, a substantial increase in prices – even when production remains constant – can result in a substantial increase in GDP, motivated exclusively by the increase in prices.
Real GDP→ It is defined as the monetary value of all goods and services produced by a country or an economy valued at constant prices, that is, according to the prices of the year that is taken as a base or in the comparisons. This calculation is carried out using the GDP deflator, according to the inflation index (or by computing the value of the goods regardless of the year of production using the prices of a certain reference year).
OTHER INDICATORS
Green GDP→ Some economists refer to this green GDP as a modification of conventional GDP, subtracting the value (if it is downward) of the deteriorated natural resources. This accounting method seeks greater realism in knowing whether an economic activity increases or reduces national wealth.
Human Development Index→ This index is a combination of statistics from:
Life expectancy.
Education: adult literacy rate and the combined gross enrollment rate in primary, secondary and higher education.
GDP per capita.
Happy Planet Index→ It’s an alternative index of development, human and environmental well-being. The index is designed to measure the development of countries based on life expectancy, subjective perception of happiness, and ecological footprint.
GINI Index→ It measures unequal income or unequal wealth. From 0 to 100 maximum inequality.
NATIONAL ACCOUNTING It refers to the economic indicators that measure the situation of a specific country during a period of time
NATIONAL ACCOUNTING INDICATORS
Gross National Product (GNP) → The monetary value of the goods and services produced by citizens and companies belonging to a certain country in a certain period of time, worldwide.
National Income (NI) → The total income obtained by the citizen of a country before taxes and social security are deducted. Gross national income.
Disposable income per capita (DI) → The total income obtained by the citizen of a country after taxes and social security are deducted. Net national income. The amount of money that a household can really spend for their living.
GDP When things go well, GDP increases, as well as salaries and the prices.
Inflation causes and reasons
Demand inflation→ companies (forecast improvements), Public Sector (investments), Families (reduce savings and increase expending).
Cost inflation→ Natural resources go up, market pressure by monopolies which can raise prices of their products, salary increases over productivity, Interest rate raises can bring prices up since loans become more expensive for companies.
Consequences of inflation Retired people, workers, savers and export companies are the most damaged, because their salaries aren’t updated to the rate of inflation. Also, if one country has a much higher rate of inflation than others for a considerable period of time, this will make its exports less price competitive in world markets, because a high inflation rate makes the production process pricier, and thus makes the company less optimal.
Meanwhile, people in debt, states (especially with big debt) and import companies are the most profited, because they can pay back with money that is worth less than when it was originally borrowed.
Uncertainty, however, affects everyone, can make planning more difficult and it can freeze investments and the development.
Employment policy indicators
Population→ All the citizenship
Active population→ Employed and unemployed people, ages 16 to 64
Non-Active population→ People out of the labour market
Activity-rate→ active population/population x 100
Unemployment rate→ Unemployed people/ active population x 100
Occupation rate→ Employed people/ active population x 100
Employment statistics
EPA→ INE does this research quarterly in about 65.000 households since 1970.
Number of affiliates to Social Security→ Employment rate and type of contracts made
Public Employment Service→ SEPE (or Lanbide in Euskadi)