The empty promises began in 1997 when the Kyoto Protocol demanded governments stop subsidizing all ‘greenhouse-gas-emitting sectors’. Posturing world leaders dutifully queued up to pay lip service, establishing a now familiar tradition. While attending various climate summits, each would (re)commit to the eradication of fossil fuel subsidies, implore others to follow suit, and then, as if nice sounding words were all it took to cleanse the world of greenhouse gases, return home and do nothing. President Obama claimed in 2012 that a hundred years of subsidies to the oil companies was over - he lied. In 2020, annual global subsidies to the fossil fuel industry were estimated at $500 billion, and following a blip between 2013-16, are on the rise again. But why? How did governments, whose raison d'être is to keep their citizens safe, come to prop up an industry that puts lives at risk? And how great a threat does it pose? It began so well... Once upon a time it actually made sense. Indeed, when fossil fuel subsidies were first implemented they were endorsed by progressives for their equalising influence. Whether direct financial transfer, preferential tax treatment, or government infrastructure spending, it didn’t matter, they did what all subsidies do: reduced prices, in this case, the price of energy. By doing so, they gave those mired in poverty access to electricity, heating, and ultimately the components needed for a dignified life. There was also the added benefit of securing national energy supplies, as supporting indigenous production reduces dependency on foreign imports, which cannot always be guaranteed. Securing the energy supply was securing the country’s future - another easy sell. Noble-sounding as these justifications may be, the refining of green technologies mean they hold diminishing credibility, especially in the developed world where 80% of all historical carbon emissions have been emitted. A recent report by the International Renewable Energy Agency (IRENA) has shown that ‘onshore wind and solar PV power are now, frequently, less expensive than any fossil-fuel option’, and ‘the costs of new solar and wind installations’ - previously the greatest obstacle to its widespread adoption - ‘will increasingly undercut even the operating-only costs of existing coal-fired plants’. Besides some relatively isolated instances, the claim that subsidies expand energy accessibility by reducing costs, although still made by its advocates, is no longer true. Just last year, UN secretary general, António Guterres, declared, unequivocally, that fossil fuel subsidies only serve ‘to boost hurricanes, spread droughts, melt glaciers, (and) bleach corals’, and instead of using taxpayers’ money to ‘destroy the world’, the same finances should be redirected towards renewables. A 2019 report from the International Institute for Sustainable Development (IISD) substantiated these demands, claiming that it would only take 10-30% of current fossil fuel subsidies to be swapped for the balance to be tipped, decisively and irrecoverably, in favour of green energy, triggering its ‘rapid global rollout’. Speed is crucial, too, for although the transition is already underway, progress has been slow relative to what’s required. This swap could be the shot in the arm renewables need to take them from ‘viable and competitive’ to the only choice. Even without transference, the elimination of fossil fuel subsidies would significantly reduce emissions, such is the industry's reliance on them. Indeed, in some areas, certain subsidies are allowing for its entrenchment and even expansion. Consider, for example, the federal tax break that allows oil producers in the US to deduct almost all the costs of constructing and drilling new wells from their taxes, by far the most costly part of the process. By lowering the amount of upfront cash-flow required by producers, (the buy-in, so to speak), new and expanding enterprises are incentivised to drill more wells than would otherwise have been financially feasible. And once established, each well can then produce oil for up to 40 years. Through this process, known as ‘carbon lock-in’, fossil fuel production accelerates and greenhouse gas emissions increases. Meanwhile, the distorted market makes it harder for new, green energy to compete. A paper published in the journal, Nature, in 2018 offers statistical support for why subsidies should be eliminated, suggesting that it would reduce emissions by ‘five hundred million to two billion metric tons of carbon dioxide per year by 2030’. For context, that amounts to roughly a quarter of the energy-related emission reductions pledged by the Paris Agreement signatories, which few are on the path to meeting. The real cost Alarmingly, the amount of subsidies are far higher when the negative externalities caused by burning fossil fuels are also considered. Using a somewhat loosened definition of what constitutes a subsidy, a study by the International Monetary Fund (IMF) found that $5.2 trillion was spent globally on subsidies in 2017. That is $10 million per minute and 6.5% of global GDP. In addition to conventional subsidies, the financial or tax support aimed at lowering the cost of fuel, the report included the indirect, often hidden costs of burning fossil fuels, primarily the spiralling healthcare costs and constant need for climate change adaptation. By including these numbers, the true damage inflicted on society is shown, allowing better informed future decisions. For instance, the IMF estimates that if subsidies were scrapped the number of early deaths from fossil fuel air pollution would be halved. Alternatively, if left ignored, the Universal Ecological Fund predicts that in America, economic losses from extreme weather combined with the health costs of air pollution will reach at least $360 billion annually over the next ten years and cripple economic growth. Click here to browse our agricultural and environmental economics job listings Vested interests Which leads to the obvious question: why not simply just stop them? The answer, in short, is lobbying. To borrow the words of Catherine Howarth, chief executive of ShareAction, ‘these companies have mastered the art of corporate doublespeak - by boasting about their climate credentials while quietly using their lobbying firepower to sabotage the implementation of sensible climate policy and pouring millions into groups that engage in dirty lobbying on their behalf’. During the 113th Congress (the 5th and 6th years in Obama’s Presidency), the oil, gas, and coal companies spent a combined $350,587,282 on lobbying and campaign contributions, the efforts of which, according to the research group, InfluenceMap, were ‘overwhelmingly in conflict with the goals of the Paris agreement and designed to maintain the social and legal license to operate and expand fossil fuel operations’. Between 2016-2019, Shell, ExxonMobil, Chevron and Total spent over $1 billion on lobbying ‘designed to control, delay, or block binding climate-motivated policy’. To gauge its success one need only look at the inclinations of the current US administration. But things must change. Politics must better insulate itself from dirty money - the consequences of not phasing out subsidies are too dire. As Chief Economist at the International Energy Agency, Fatih Birol, has said, failing to do so will mean countries fail to reach their climate targets - and down that path lies certain catastrophe. Once upon a time, it made sense for countries to support these industries, it was progressive, humane. That time, however, has now passed. Header Image Credit: Glovatskiy on Shutterstock (licensed image - copyright)
The continued existence of fossil fuel subsidies in a time of their almost universal condemnation reveals something about the governments that rule us, something pernicious, but also something all-too-predictable. Like no other area, they expose a gulf between rhetoric and action, a disconnect so stark that, if the risks it posed were less catastrophic, would almost be comical. Back in reality, though, the cognitive dissonance, cynicism, or whatever its cause, serves only to warm our planet and threaten all life.
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INOMICS unveils its A-Z of economics terms
But there’s always more we can do, and we felt the time was ripe to expand our help section to try and give even more value to young economists who are just starting out in the game. So without further ado, we’re proud to unveil our new A-Z of economics terms. Our A-Z is simple - we have professional economists write accessible but in-depth overviews of some of the most important economic terms that you will need for your studies. Starting out, we are focusing on microeconomics terms, but soon we will be expanding to macroeconomics, environmental economics, and every other type of economics you can think of. They aim to offer an insight into exactly what the term means, put it into context to make it easy to understand, and give a brief insight into where the term has been used and where you can find more academic information on the concept. First, head to inomics.com and take a glance at our header navigation. Hover your mouse of the section ‘Insights’ and you’ll see a drop down menu with the option listed ‘Economics Terms A-Z’. Give that a click and you’ll be taken to our list of all economic terms, handily listed by the first letter of the term, making it easier to find exactly what it is you’re looking for. And if you go further and click on an actual term, you’ll be able to see all the information about that term, including links through to any related definitions which we think help explain certain concepts which have been referred to. Let’s have a look at one example, adverse selection (long picture incoming): As you can see, this definition of adverse selection includes a brief, one or two sentence definition at the top, followed by a longer, more in depth definition with examples. Then some further reading is recommended which can help to expand your knowledge even more, and finally, a ‘Good to Know’ section which offers tips on how to avoid common potholes when using a term and explains some of the more tricky aspects a definition may have. Right at the bottom of the page we recommend some related terms which may be useful knowing. Watch out, too, for some of INOMICS' very own video explanations which will be appearing with some of the definitions in the coming weeks! So there you have it! INOMICS’ new Economic Terms A-Z is a godsend for anyone currently studying their economics degree and needs an accessible but thorough overview of tricky economics terms. Written by professional economists with experience at doing stuff like that, it’s a great addition to our Advice section, which offers economists tips in their studies and jobs. Confusing term getting you down? Head to INOMICS for an explanation!
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The assumption that individuals maximize utility is a cornerstone of microeconomics. It is used as a basis to explain market behavior and to predict how people act and react in particular situations. Individuals are assumed to be perfectly rational, capable of calculating how much utility they will obtain from any combination of goods and services, and choosing a combination where utility is maximized, subject to their budget constraint. In most economic modeling, an individual’s utility is described as a continuous, monotonic, and concave function of consumption. That is, the utility function U(X), where U stands for utility and X for consumption (X can be a vector of goods and services consumed), is continuous over the space of X. Its first derivative with respect to X is positive (“more is better”) and its second derivative with respect to X negative, representing the law of diminishing marginal utility. The individual will, in most cases, be limited in consumption by their income such that spending on goods and services X cannot exceed a maximum level M. The individual’s maximization problem can be posed as \begin{gather*} \max_{X}U\left(X\right)\\ \text{s.t.: }XP\leq M \end{gather*} where P is the corresponding vector of prices for the goods and services X. Figure 1 depicts a simple two-dimensional case where the individual chooses between combinations of items X1 and X2 (item X2 might also represent “all other items” in order to study the individual’s choices of X1 compared to alternatives). The items’ prices P1 and P2 and the budget M determine the set of choices the individual can make. They could devote their entire budget to X1, purchasing QX1 at a cost of P1QX1 = M, or they could do the same for X2, purchasing QX2 at a cost of P2QX2 = M. All affordable combinations of X1 and X2 are found in the grey shaded triangle which is limited by the budget line P1X1 + P2X2 = M running between the points (QX1,0) and (0,QX2). A set of indifference curves is drawn in the graph as well. Indifference curves are defined as combinations of X1 and X2 that give the individual a fixed level of utility (hence the individual is indifferent between such combinations). Due to utility increasing in X, indifference curves further from the origin (0,0) represent higher levels of utility. The individual’s utility is hence maximized at the point where the budget line is tangential to the “highest” indifference curve IC at the point (qX1,qX2), resulting in utility Ū. This means that the person will choose to buy qX1 units of X1 and qX2 units of X2; this mix is the optimal choice. On the indifference curve IC’ the individual would obtain even higher utility U’, however this is not attainable given the individual’s current budget M. Figure 1: A budget constraint with standard indifference curves Non-economists may balk at the idea that individuals calculate budget lines and indifference curves in order to make their consumption decisions. This need not be the case for the theory still to have traction. It is sufficient for the economist if individuals act as though they were maximizing utility. Utility maximization need not be a conscious or explicit process. What is important for an economist is to be able to observe behavior and then explain what is observed. Decisions that are consistent with utility maximization allow individual preferences to be summarized through utility functions, which is convenient for the analyst. Economists tend to value observing what people do (“revealed preference”) more highly than simply recording what they say they do or will do (“claimed preference”). Insofar as the future state of the world is uncertain and decisions are made under uncertainty, individuals can be assumed to maximize expected utility. This is the utility to be gained from each possible state of the world, weighted by the probabilities of the various states of the world being realized. A utility function can also be used to describe the individual’s attitude toward risk. For example, a risk-averse individual will tend to prefer lower but more certain levels of consumption over potentially high but very uncertain levels of consumption. In this case, the utility function will be strictly concave. Solving the utility maximization problem There are two main methods for solving a utility maximization problem, which students of microeconomics will become very familiar with. The first is the graphical method, explained below. The second is the Lagrange method, which is explained in the linked article. To solve utility maximization using the graphical method, it’s helpful to start with some logic. We already know that the best indifference curve is the one that is the highest attainable curve given the budget constraint. In Figure 1, this is shown as the point (qX1,qX2). At this point, the budget line is tangent to the indifference curve. Why is this? If the indifference curve is too far to the left, it is an affordable but undesirable product mix. The consumer could benefit by consuming a bundle of goods on indifference curve IC instead. Meanwhile, it’s already been established that indifference curve IC’ is not feasible because it’s too expensive for the consumer. So, any indifference curve that is best must be tangent to the budget line, like the curve IC. A curve that is tangent will be as high as possible (as it only touches the budget line at one point), and guarantees that the individual must use their entire budget to reach it. This fact allows us to construct an equation that we can solve. Because we know that the best indifference curve is tangent to the budget line at the point (qX1,qX2), we know that both must have the same slope at this point. So, all we need to do is set the slope of the budget line equal to the slope of the best indifference curve and solve. The slope of the budget line is simply the price ratio between goods X1 and X2, or how much more of X2 the individual could buy if they gave up one unit of X1. Recall from algebra that the slope of a line graphically is the “rise” over the “run”, or in this case, P1 / P2. Also note that the budget line is downward-sloping; this is because to afford more units of one good, some of the other must be given up. The slope of the indifference curve is equal to the ratio of marginal utility between the two goods, also known as the marginal rate of substitution. This is because the curve measures how much of X2 the individual would be willing to give up to have one more unit of X1 and still be at the same level of happiness or utility (hence the term “indifference”). If we set the price ratio (the slope of the budget line) equal to the ratio of marginal utilities for this individual (the slope of the indifference curve), we can solve for the utility-maximizing point. Setting these equal to each other yields the following equation: \begin{equation*} \frac{\mathit{P}_{1}}{\mathit{P}_{2}} = \frac{\mathit{MU}_{1}\left(\mathit{x^*_1},\mathit{x^*_2}\right)}{\mathit{MU}_{2}\left(\mathit{x^*_1},\mathit{x^*_2}\right)} \end{equation*} This equation can be solved by plugging in the prices of each good on the left-hand side, inserting the marginal utility on the right-hand side, and solving. This yields the optimal product mix, which can then be re-inserted into the budget constraint to find the individual’s utility-maximizing consumption decision. Remember that the marginal utility is the first derivative of the utility function, so MU1(x*1,x*2) is the first derivative of U(X) with respect to X1. See the exercise to practice this concept. The Lagrangian method is another, very common method used by microeconomists to solve constrained optimization problems. Check out our linked article to learn this method as well. Further reading Two economics Nobel laureates, Daniel Kahneman (2002) and Richard Thaler (2017) are both known for criticizing the assumption of individual rationality in economic theory and for offering plausible alternative behavioral insights. See their joint paper, “Anomalies: Utility maximization and experienced utility” (Journal of Economic Perspectives, 2006) for an excellent discussion of the limited human capacity to reason about personal well-being, in particular when time passes between consumption decisions and consumption itself. Good to know While modern behavioral economics throws individual rationality and the idea that people always maximize utility into doubt, the theory of utility maximization can also be applied to decision-making in organizations, where one might reasonably expect choices to be made with more calculation and deliberation. The theory is also widely applied in welfare economics where government decisions are justified based on the idea of maximizing a social-welfare function, which is basically an aggregate representation of people’s preferences in society. Practice solving a utility maximization problem Exercises for you <use xlink:href="/themes/custom/venice/images/icons.svg#launch-18px"></use>
Utility in economics refers to the level of happiness or satisfaction of individuals. Individuals derive utility from the consumption of goods and services, and seek to maximize their utility under any given budget.
An allocation of resources is Pareto efficient if it cannot be modified to increase the wellbeing of one individual without diminishing the wellbeing of any other individual. If it is possible to reallocate resources and improve the welfare of one person without harming anyone else, this reallocation is called a Pareto improvement, and consequently the initial allocation was not Pareto efficient. Sometimes we distinguish between Pareto efficiency in the allocation of resources and pareto efficiency in the production of goods and services. The concepts are very similar. Pareto efficiency in consumption (i.e., in the allocation of resources) means that no one can be made better off without making someone else worse off. Pareto efficiency in production implies that we cannot increase the production of one good (or service) without decreasing the production of another good or service. Let’s look at an example to better understand what a Pareto efficient allocation is: suppose you’re walking together with a friend along a beach when you discover two beautiful seashells laying there. You decide to keep one for yourself and give the other to your friend, so that each of you has one seashell. Is this allocation Pareto efficient? To answer this question let's consider whether we can reallocate resources to improve your welfare without harming your friend. If we want to increase your welfare, we have to give you your friend's seashell. But this means that we have to take away the seashell from them and their wellbeing will decrease. So, taking away your friend’s seashell makes them worse off and is not a Pareto improvement. Similarly, it is not a Pareto improvement if we take your seashell to give it to your friend. Given that we can not reallocate the resources in this example without making someone worse off, the initial allocation was Pareto efficient. What if instead of picking up both shells, you only pick up one and leave the other on the beach? Is this Pareto efficient? For simplicity, let's assume that no one else would come to pick up the seashell and also no other living being would use it. Can we reallocate the resources and improve efficiency? In this case, the answer is clearly yes. If instead of leaving the seashell on the beach, your friend picks it up, his or her wellbeing will increase without reducing the wellbeing of anyone else. This means that the initial allocation was Pareto inefficient - and leaving a seashell on the beach is not Pareto efficient. Importantly, Pareto efficiency does not tell us anything about the fairness of the distribution of resources. For example, suppose that the entire wealth of a country is given to just one single citizen, while all the other citizens do not obtain anything. Is this allocation of resources Pareto efficient? Yes, it is. Why? In order to see the answer, think about whether it is possible to reassign the resources in a way that the wellbeing of one person increases without making anyone else worse off. Is this possible? Obviously not. If we want to give something to the other citizens, we have to take resources away from the rich person. That is, in order to increase the welfare of another individual, we have to reallocate it from the rich person, and this means that their utility will decrease. Since we can’t make anyone better off without harming the rich person, the initial distribution was Pareto efficient. Coming back to our seashell example, an allocation in which you decide to keep both seashells that you found is Pareto efficient as well. Sometimes, the analogy of a cake is used to explain the difference between equality (or equity) and efficiency. The size of the cake can be measured by efficiency. If we can increase the size of the cake and people can have more cake, this clearly is an efficiency improvement. The size of the cake however does not tell us anything about how the cake is being distributed. To decide who should get what is difficult as this usually involves some judgment about what is fair or just. What would be a fair way to split the cake? Should everyone receive a piece of equal size? Should the person who made the cake get a larger piece? Should we give a smaller person a smaller piece? As you can see, there are many considerations that have to be taken into account when deciding on how to distribute the cake and asking three different people might get three different opinions. Yet, if someone invents a new technology that can convert the same amount of ingredients into a larger and equally tasty cake, then no one would object to doing so. Evidently, Pareto efficiency is a concept that is less controversial than fairness. What seems fair or just to one person does not necessarily seem fair to another person. For these reasons, economists usually focus their analyses on efficiency. Further reading In the seashell example used above we said that an allocation in which you keep both seashells and your friend has none is Pareto efficient. What happens if your friend gets jealous of you having two seashells while they don’t have any? Beckman, Formby, Smith and Zheng (“Envy, malice and Pareto efficiency: An experimental examination”, Social choice and welfare, 2000) used an experimental approach to analyze the role that envy and malice play in economic decisions. The authors found that envy and malice are strong motivations that can lead to reduced support for Pareto efficient outcomes. Good to know What would Vilfredo Pareto have to say about Robin Hood, who stole from the rich to give to the poor? He clearly would disapprove of such a reallocation of resources based on efficiency considerations. To increase the welfare of the poor, Robin Hood is willing to decrease the welfare of the rich, which means that the reallocation is not a Pareto improvement. Of course, Robin Hood would probably not use Pareto efficiency as an argument to justify his deeds.
Pareto efficiency (or Pareto optimality) is an important efficiency concept in welfare economics used to evaluate or compare different allocations of resources. It is named after Italian economist Vilfredo Pareto (1848–1923).
One of the most basic ideas in economics is that the consumption of goods and services changes our level of satisfaction or happiness (also referred to as utility). Often, we measure this change in satisfaction in monetary terms. If, for example, we want to know how much the wellbeing of a person changes if we give them a book (for free), we can simply ask this person how much he or she is willing to pay for the book. Suppose we ask a student (let´s call her Ann) what the highest price she would be willing to pay for a particular book was and her answer was €15. This means that Ann’s increase in happiness when we give her the book is the same as the increase in happiness she would experience if we gave her €15. In the special case when consumers consume just one unit of a good, the marginal utility is the same as the maximum price the consumer is willing to pay for that good. However, we do not consume just one unit of most goods and services, but several units. Some examples include the number of cups of coffee we drink each day, the number of text messages we send, the number of megabytes we stream, the liters of gasoline that we fuel our car with, and so forth. Each additional unit that we consume (e.g. each additional cup of coffee we drink) changes our wellbeing. This change in wellbeing from one unit to the next is what we call marginal utility and for many goods and services it is not constant from one unit to the next. Law of diminishing marginal utility Consuming additional units of a good or service increases our wellbeing, but the change is not necessarily the same for each unit. For instance, let's say you consume three cups of coffee. The first cup you might enjoy a lot; it wakes you up in the morning and gives you a lot of energy to help start the day. The second cup you might also enjoy, but probably a bit less than the first one. Then, the third cup might not increase our overall wellbeing at all. At this point, you feel that you’ve had enough coffee. This property, that the marginal utility decreases with the number of units we consume, is called the law of diminishing marginal utility. For many goods and services, the law of diminishing marginal utility holds, although in some cases the change in utility might decline faster than in others. But, for certain types of goods, the change in utility might be almost the same for each unit or not decrease at all. One clear example is fresh, uncontaminated air – as you consume more clean air, the utility it adds to your life remains roughly the same. Marginal utility can also be negative if our wellbeing decreases after some point. The 5th cup of coffee, for example, might actually make us anxious and feel unwell. This holds true of many other goods, such as desserts (too sweet), streaming service subscriptions (too many monthly charges), etc. How to calculate marginal utility As explained above, marginal utility is the change in total utility if we consume one more unit. Suppose we want to calculate the marginal utility that the 3rd cup of coffee gives to an individual who gains the following total utility from consuming this (see below) number of coffees: Nr of cups of €2 coffee 0 1 2 3 4 5 Total utility (measured in monetary units) 0 5 7 8 8 5 As we see from the table, the first cup of coffee increases the total utility of our individual by the same amount as if we gave them €5. It is the difference in total utility between consuming 1 cup and zero cups of coffee: <m:omathpara><m:omath><m:r>Marginal</m:r><m:r> </m:r><m:r>Utility</m:r><m:r> (</m:r><m:d><m:dpr><m:ctrlpr></m:ctrlpr></m:dpr><m:e><m:r>MU)</m:r></m:e></m:d><m:r> </m:r><m:r>of</m:r><m:r> </m:r><m:ssup><m:ssuppr><m:ctrlpr></m:ctrlpr></m:ssuppr><m:e><m:r>n</m:r></m:e><m:sup><m:r>t</m:r><m:r>h</m:r></m:sup></m:ssup><m:r> </m:r><m:r>unit </m:r><m:r>= </m:r><m:r>Total</m:r><m:r> </m:r><m:r>utility</m:r><m:r> from </m:r><m:d><m:dpr><m:ctrlpr></m:ctrlpr></m:dpr><m:e><m:r>n</m:r><m:r> </m:r><m:r>units </m:r></m:e></m:d><m:r>- </m:r><m:r>Total</m:r><m:r> </m:r><m:r>utility</m:r><m:r> from </m:r><m:d><m:dpr><m:ctrlpr></m:ctrlpr></m:dpr><m:e><m:r>n </m:r><m:r>- </m:r><m:r>1 </m:r><m:r>units</m:r></m:e></m:d><m:r>. </m:r></m:omath></m:omathpara> <m:omathpara><m:omath><m:r>MU</m:r><m:r> </m:r><m:r>of</m:r><m:r> 1</m:r><m:r>st</m:r><m:r> </m:r><m:r>cup</m:r><m:r> </m:r><m:r>of</m:r><m:r> </m:r><m:r>coffee </m:r><m:r>= </m:r><m:r>Total</m:r><m:r> </m:r><m:r>utility of</m:r><m:r> 1 </m:r><m:r>cup </m:r><m:r>- </m:r><m:r>Total</m:r><m:r> </m:r><m:r>utility</m:r><m:r> of 0 </m:r><m:r>cups </m:r><m:r>= 5 - 0. </m:r></m:omath></m:omathpara> We can compute the marginal utility of the other cups of coffees as follows: Nr of cups of €2 coffee 0 1 2 3 4 5 Marginal utility 0 5 2 1 0 -3 Let's say the price per cup is €2. How many cups will a rational individual consume? The change in total utility of the first cup is equivalent to €5, while the price is €2. Thus, the marginal utility exceeds the price of the good and a rational utility maximizing person will buy the first cup at a price of €2. What about the second cup? The increase in utility is the same as the price of the cup. This means that our individual is indifferent. They are unsure whether to buy the second cup of coffee or keep the money, since both yield the same amount of utility. A rational consumer will buy or consume a unit of a good if the marginal utility of this unit exceeds the price he or she has to pay for this unit. It is valid to assume that the customer does purchase the second cup here since it does not lower their overall utility. However, they would not purchase the third cup, since they would be giving up €2 to receive only €1 worth of utility. In many applications we assume that goods are perfectly divisible and we will have a particular utility function given. In these cases, the marginal utility is simply the derivative of total utility. Let’s consider an example: suppose we have an individual with utility function <m:omath><m:r>u</m:r><m:r>(</m:r><m:r>q</m:r><m:r>) = </m:r><m:r><m:rpr><m:scr m:val="roman"><m:sty m:val="p"></m:sty></m:scr></m:rpr>ln</m:r><m:r>(</m:r><m:r>q</m:r><m:r>)</m:r></m:omath>, where q denotes the number of units the person consumes of a particular good. For this utility function, marginal utility <m:omath><m:r>MU </m:r><m:r>= </m:r><m:f><m:fpr><m:ctrlpr></m:ctrlpr></m:fpr><m:num><m:r></m:r></m:num></m:f></m:omath><m:omath><m:f><m:num><m:r>∂u</m:r></m:num></m:f></m:omath><m:omath><m:f><m:num><m:r>/</m:r></m:num><m:den><m:r></m:r></m:den></m:f></m:omath><m:omath><m:f><m:den><m:r>∂q</m:r></m:den></m:f></m:omath><m:omath><m:f><m:den><m:r> </m:r></m:den></m:f><m:r>= </m:r><m:f><m:fpr><m:ctrlpr></m:ctrlpr></m:fpr><m:num><m:r>1/</m:r></m:num><m:den><m:r>q</m:r></m:den></m:f></m:omath>. This is the marginal utility of the qth unit. If we want to know what the marginal utility of a specific unit is, for instance the 3rd unit, we simply compute the value of MU for <m:omath><m:r>q </m:r><m:r>= 3</m:r></m:omath> and obtain <m:omath><m:r>MU</m:r><m:r>(</m:r><m:d><m:dpr><m:ctrlpr></m:ctrlpr></m:dpr><m:e><m:r>3) </m:r></m:e></m:d><m:r>= </m:r><m:f><m:fpr><m:ctrlpr></m:ctrlpr></m:fpr><m:num><m:r>1/</m:r></m:num><m:den><m:r>3</m:r></m:den></m:f><m:r>.</m:r></m:omath> Marginal utility and the law of demand The marginal utility is the change in wellbeing of consuming one more unit and is equivalent to the maximum willingness to pay for this additional unit. The law of diminishing marginal utility tells us that the change in wellbeing decreases as we consume more and more units. This means that the willingness to pay for one additional unit also decreases as we consume more units. Thus, there is a negative relationship between the quantity consumers want to consume and the price they are willing to pay for that quantity. Put differently, the higher the price, the lower the quantity demanded. This is what we call the law of demand. Further reading Marginal utility is a central concept in neoclassical economic theory and so is the idea of diminishing marginal utility (sometimes also called marginal value). Is there any empirical evidence of the law of diminishing marginal utility? Yes, there is. “A Test of Diminishing Marginal Value“ (Economica, 2006) by authors Horowitz, List and McConnell confirms in an experimental setting that there is strong evidence of diminishing marginal value. Good to know In our discussion we have focused on the marginal utility of a good and argued that for goods the law of diminishing marginal utility holds: the more units we consume the less our wellbeing increases. What about "bads"? How does the marginal utility (in this case with "bads" causing disutility, which is negative marginal utility) change as we consume (or have to consume) more and more units of the "bad"? For example, suppose there is a large construction site next to your apartment that creates a disturbing noise. How much would you be willing to pay for a few hours of quiet each day? Maybe for the first few hours not that much as you may spend the time cleaning instead of studying, going to the supermarket, etc. But as the number of hours that you suffer increases you may be willing to spend more and more money to have a few moments of peace. This is what is called the law of increasing marginal disutility. While marginal utility is supposed to be decreasing with consumption, marginal disutility is increasing according to economic theory.
Marginal utility in economics is the change in wellbeing (or change in total utility) that a person experiences if they consume one additional unit of a good or service.
The story of the prisoner’s dilemma is as follows: two criminals are arrested on suspicion of having committed a crime, let's say a bank robbery. The police do not have enough evidence to convict them for the robbery, but they have smaller charges on each of the two. The prisoners are being held captive in separate cells of a prison without any possibility of communication. The general attorney offers both prisoners the same deal: if they betray their accomplice (or 'defect' as it is called in the table below) by testifying as a witness they can go free and will not have to serve any prison sentence whatsoever. However, it is not that simple. Should the other also testify, meaning that they both implicate each other, each will serve 2 years in prison. If only one testifies while the other remains silent, the one who does not testify (the silent one) will be sentenced to 4 years in prison, while the one who does testify will go free. In the case that they do not betray each other, that is, that both remain silent and cooperate, they cannot be proven guilty of the bank robbery and both will be sentenced to 1 year in prison for the minor crimes. In this two-player game, each player has two options: cooperate with their partner in crime and remain silent, or testify and betray their accomplice, i.e., defect. The prison sentences represent the payoffs of each decision and these payoffs of course depend on whether each accomplice accepts the deal offered and defects, or remains silent and cooperates. The following payoff matrix describes the possible outcomes of the game. Player 2 Cooperate Defect Player 1 Cooperate -1,-1 -4,0 Defect 0,-4 -2,-2 What is the equilibrium of this game? To answer this question, we first have to find the best responses of the two players. Suppose player 2 cooperates and remains silent. In this case the best option for player 1 is to defect and betray his partner as he would receive a sentence of 0 years, instead of the 1 year he would get if he remained silent. Now suppose that player 2 defects and betrays her partner. The best response of player 1 is again to defect as this would lead to a sentence of 2 years for each of them, far preferable to the 4 years he would have to serve if he kept quiet. For player 2 the situation is identical (the game is symmetric), which means that her best response is to defect and betray player 1. Thus, in the unique Nash equilibrium of this game both prisoners will defect and accept the deal they were offered by the general attorney. As both implicate each other, each of them has to serve a 2-year prison sentence. In this game “defect” is the dominant strategy and “cooperate” is the dominated strategy. A strategy is dominant if it leads to a higher payoff no matter what the other player(s) do. A strategy is said to be dominated if under no circumstances it is optimal for a player to use it, as in it yields a lower payoff than any other strategy regardless of the other players’ strategies. In the prisoner’s dilemma it does not matter whether the accomplice decides to remain silent or betray his or her partner. In both cases the other player maximizes their payoffs by defecting. This result is interesting in so far as both prisoners would be better off if they cooperated and remained silent, as in this case each would only be sentenced to 1 year. Yet, the fact that our players are fully rational and only think about maximizing their own payoff (or utility) this outcome cannot be reached. Even if the accomplice remains silent, each prisoner has an incentive to deviate and betray the partner to reduce their sentence. A lot of research in game theory has focused on finding ways in which cooperation can be established in the prisoner’s dilemma. One way out of the dilemma is to consider a repeated game in which the players meet not only once, as in, there are multiple rounds. In the repeated prisoner´s dilemma where the final round is not specified, betraying an accomplice will have a negative impact on a criminal´s reputation and will make future cooperation harder. For example, if the involved criminals are part of a gang, going free by betraying a fellow gang member may no longer be a dominant strategy given the future consequences. Possible strategies in the repeated or iterated prisoner´s dilemma include tit-for-tat and grim-trigger strategies. If players play a grim-trigger strategy, they start with cooperation in the first round of the game and then cooperate until one player defects. If someone defects, all players will defect from this point in time onwards. Following this strategy, cooperation can be sustained as long as players care sufficiently about the future. If players play tit-for-tat, they also start with cooperation in the first instance. A player cooperates if the other player cooperated in the previous period and defects if the other player defected in the previous period. <11an>limit:2;categories:Jobs|Courses|Programs|Conferences;countries:France|Germany|United Kingdom|Italy;disciplines:Economic Thought & Methodology (JEL B)</11an> Further reading Theoretically cooperation is not possible if the players know exactly how many rounds will be played, because everyone will want to defect in the last round and by backward induction this also means that in the other periods all players will defect. In experiments cooperation occurs even in the finitely repeated prisoner´s dilemma. Embrey et al. (The Quarterly Journal of Economics, 2018) show that in experiments a player cooperates as long as the others cooperate until a certain threshold round. The more experienced the players, i.e. the more often they have already played the game, the earlier they start defecting. Good to know Game theory in general and the prisoner´s dilemma more specifically have been used in the 1950s and 1960s to analyze conflict during the period of the cold war. The US and the USSR were the two players, who could choose between not attacking the other nation (to cooperate) and being the first to strike (to defect). That the conflict never escalated can be (partially) explained by the negative consequences an attack would have had on potential future cooperation, because none of the two parties wanted to start a war.
The prisoner's dilemma is a well-known game in non-cooperative game theory that highlights how the individually rational behaviour of 'players' can lead to an outcome that is suboptimal for all involved. It is a game that is often used to analyze the possibility of cooperation in situations where self-interested individuals interact strategically.
As consumers have no alternative to the monopolist's product (except not buying) the monopolist, as opposed to a firm in perfect competition, can charge a price above marginal costs. Remember that in perfect competition there are so many buyers and sellers that no one can influence the market price, and firms have to price at marginal costs. If a firm in perfect competition decides to price above marginal costs, it will not sell anything, because the consumers have plenty of other alternatives. The lack of alternatives for the consumers in a monopolized market allows the monopolist to charge a higher price, because there will still be consumers interested in buying the good even if the price is above marginal costs. The monopoly price The monopolist is a profit-maximizing firm and will therefore charge a price that maximizes its profits given the market demand. How does the monopolist maximize profits? Profits are the difference between total revenue and total costs. When the monopoly decides how many units to sell it will compare the change in total revenue from selling one additional unit, i.e., the marginal revenue, to the increase in total costs, i.e. the marginal costs of this unit. The marginal revenue of a monopolist is lower than the market price, because to sell more units the monopolist has to reduce the price for all units. As long as the marginal revenue exceeds the marginal costs, producing one additional unit will increase total revenue more than total costs which means that the profit increases. At the unit where the marginal cost of production equals the marginal revenue from selling that unit, the monopolist will cease production. This is because beyond this point, selling more units will decrease profit. The monopolist is able to do this because it has price-setting power. In contrast, a perfectly competitive firm (which is a price-taker) produces units until its marginal cost of production equals the set market price. If a firm in a perfectly competitive market attempted to sell units at the monopoly price (a higher price point at which marginal revenue equals marginal cost, or MR = MC), it would fail to sell any units at all. This is because consumers could simply buy from the firm’s competitors, who sell at a lower price that is equal to marginal cost P = MC. Consequently, the monopolist maximizes its profits at the quantity where marginal costs are equal to marginal revenue (MR = MC). At this point it doesn't make sense for the monopolist to increase or to decrease the quantity. Mathematically, the monopolist maximizes profits <m:omath><m:r>π </m:r></m:omath>with respect to its quantity produced, where Taking the derivative with respect to quantity q and setting the derivative equal to zero, we obtain the following first-order condition: The first two terms on the left-hand side are the marginal revenue and the last term is the marginal cost of the monopolist. Therefore, we obtain the result that at the optimal quantity the marginal revenue (MR) has to be equal to the marginal costs (MC): Let us look at a simple example. Suppose that a monopolist produces at constant marginal costs equal to 2, i.e., <m:omath><m:r>C(</m:r><m:d><m:dpr><m:ctrlpr></m:ctrlpr></m:dpr><m:e><m:r>q) </m:r></m:e></m:d><m:r>= 2</m:r><m:r>q</m:r><m:r> </m:r></m:omath>and faces market demand <m:omath><m:r>q </m:r><m:r>= 8 - </m:r><m:r>p</m:r></m:omath>. We first solve this last equation to get p = 8 - q. Then, the monopolist maximizes profits <m:omath><m:r>π </m:r><m:r>= p*q - C(q) = (</m:r><m:d><m:dpr><m:ctrlpr></m:ctrlpr></m:dpr><m:e><m:r>8 - </m:r><m:r>q)</m:r></m:e></m:d><m:r>q </m:r><m:r>- </m:r><m:r>2</m:r><m:r>q</m:r><m:r> </m:r></m:omath>by taking the derivative with respect to q and solving. The solution for this example shows that the optimal quantity of the monopolist is equal to 3 and the price (which we find by plugging back in into the demand function) is equal to 5. For any quantity below 3, the monopolist can increase its profit by increasing production. If the quantity exceeds 3, the profits begin to decrease as the quantity increases. This is shown in the table below: Price 0 1 2 3 4 5 6 7 8 Quantity 8 7 6 5 4 3 2 1 0 Profit <m:omath><m:r><m:rpr><m:scr m:val="roman"><m:sty m:val="bi"></m:sty></m:scr></m:rpr>π </m:r></m:omath> -16 -7 0 5 8 9 8 5 0 The price that the monopolist charges is higher than the market price in perfect competition (which is equal to marginal costs) and the monopoly quantity produced is lower than the quantity sold in a perfectly competitive market. This means that there are some customers who would be willing to buy the good at a price above marginal costs, but lower than the monopoly price. However, this is not possible in this monopolist’s market. Therefore, there are unrealized gains of trade. The consumer surplus is lower than the consumer surplus in a perfectly competitive market. This loss in consumer surplus is not fully compensated by an increase in profits, which means that there is a deadweight loss. This situation is depicted in the graph below. The deadweight loss, shown in red, is created by the failure of the market to include customers who want to buy above marginal costs but below the monopoly price. The monopoly price, pm, is the price at which marginal revenue from the next unit sold is equal to marginal cost. This produces a quantity qm that is less than the perfectly competitive quantity. If the market were perfectly competitive, the price would be p* and the amount sold would be q*. Figure 1: Deadweight loss from a monopoly market How much the monopoly price will be above marginal costs depends on the price elasticity of demand. If demand is inelastic, which means that a comparatively high increase in the price will cause a small reduction in the quantity demanded, the monopolist can charge a higher price. In the case of an elastic demand the monopolist would lose too many customers by increasing the price and therefore has less ability to charge a high price. The possibility to charge a price above marginal costs is what we refer to when we talk about the market power of a monopoly. The market power of the monopolist can be measured by the Lerner index which is defined as Where <m:omath><m:r>ε i</m:r></m:omath>s the price elasticity of demand. The Lerner index takes a value between 0 and 1, where 0 means that the firm has no market power and has to charge a price equal to marginal costs. The closer the Lerner index is to 1, the more market power the firm has. The higher the absolute value of the elasticity of demand (the more elastic the demand), the lower the market power of the firm. This index shows what we discussed earlier, that the monopolist is able to charge a higher price in markets in which demand is less price-elastic. Why do monopolies exist? There are several reasons why some markets are and remain monopolized. In some markets barriers to entry make it difficult for potential competitors to enter. For example, if one company controls the access to an essential resource, competitors without access to the resource cannot compete in the market. In some situations the government intentionally creates monopolies, as e.g. in the case of patents. A patent grants a temporary monopoly status to the patent holder; patents encourage innovation by guaranteeing that the inventor can earn high profits from the invention for a time. Besides this type of intentional monopoly, the nature of production in an industry may be such that total costs of serving customers are lower if only one firm manages production. If this is the case we call the resulting monopoly also a natural monopoly. An example of a natural monopoly is the utility industry. Utilities such as sewage and electricity are much more efficient if only one firm supplies them and is able to connect them to the local network. If market forces alone were allowed to run the industry, it could result in multiple redundant utilities competing with each other, which would be inefficiently expensive to set up (due to high barriers to entry). Moreover, with only one firm supplying the utility, it’s easier to maintain as there is only one network and not several. Alternatively, because of the high barriers to entry, it’s possible that the first firm to provide the utility service would force all others out of the market and prevent their entry, resulting in monopoly prices and an inefficiently low number of people being served. Thus, governments usually regulate utility industries to ensure they do not charge monopoly prices and fail to serve all customers. Thus, natural monopolies may still be improved in an overall welfare sense if there is some regulation. Further reading As pointed out above, the problem with monopolies is that when the quantity exchanged in a market is lower than it would be under perfect competition, overall welfare is reduced. Therefore, governments are interested in knowing how to regulate a monopoly and reduce the resulting welfare loss. One economist who extensively studied market power and regulation is Jean Tirole. For his work Jean Tirole won the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel in 2014. Good to know Pure monopolies are rare, but there are several examples of markets with dominant firms that control a decisive part of the market share. Examples include the market for diamonds (De Beers), eyewear (Luxottica), operating systems (Microsoft), and others. How much market power these firms have does not only depend on their market share, but also on other factors such as e.g. the price elasticity of demand in the market. Therefore, when competition authorities try to determine whether a firm is becoming too powerful and might abuse this power, they do not only take into account the market share of this firm, but rather focus on the possibility of the firm to charge a price above marginal costs.
A monopoly in economics describes a market in which there is only one firm and it does not face any competition. A monopolist is a firm that offers a unique product or service without close substitutes and therefore does not have any competitors. This means that the monopolist has access to the entire market demand and each customer interested in buying the product can only choose whether to buy from the monopolist at the respective price or not to buy at all.
Top Economics Think Tanks and Research Institutes in the US
Click here to browse our economics job listings 1. National Bureau of Economic Research (NBER) Cambridge, Massachusetts The NBER is a non-partisan organization which conducts research into all topics within economics, and disseminates its findings to academics and policy makers. They have a particular focus on quantitative methods, especially the development of statistical measures and the use of quantitative models. 2. Peter G. Peterson Institute for International Economics (IIE) Washington, District of Columbia Another non-partisan research institution, the PIIE focuses on the study of international economic policy, particularly in identifying policy approaches and practical ideas about how the forces of globalisation can be made to be beneficial for people around the world. 3. Brookings Institution Washington, District of Columbia A long-established institution which conducts research into public policy issues in the areas of economic studies, governance studies, foreign policy, metropolitan policy, and global economy and development. <11an>limit:2;categories:jobs|courses|conferences;countries:United States;disciplines:General Economics (JEL A)</11an> 4. Resources for the Future (RFF) Washington, District of Columbia An environmental policy advice organization which conducts research and analysis to provide information to help policy makers craft better policies regarding the use of natural resources and the environment. 5. Public Policy Institute of California (PPIC) San Francisco, California This California-based institution seeks to provide advice in the arena of public policy, including regarding topics such as climate change, correction and criminal justice, economy, governmental reform, health care, higher education, political engagement, and water. 6. American Enterprise Institute Washington, District of Columbia A public policy think tank which advises law makers in Washington in the areas of economics, foreign and defense policy, health care, education, politics and public opinion, poverty studies, and society and culture. 7. W.E. Upjohn Institute for Employment Research Kalamazoo, Michigan This highly specific think tank conducts research in the causes and effects of unemployment in order to assist and support the unemployed, and disseminates their findings to government and to the public. 8. Levy Economics Institute, Bard College Annandale-on-Hudson, New York A public policy research organization providing advice to US policy makers and business leaders, particularly by providing macroeconomic models and analyses of the US economy and other world economies. 9. Urban Institute Washington, District of Columbia A research institution dedicated to reducing hardship among the most vulnerable people in society and promoting opportunities for all, through research into topics such as beginning and end of life, criminal justice, income and wealth, and nutrition. 10. Center for Economic and Policy Research (CEPR) Washington, District of Columbia Originally established in Europe, this research institution branched out to the US to continue its mission to promote high quality economic research and to disseminate its findings to decision makers. The center's network still extends across Europe, bringing together researchers from around the world.
Think tanks are important institutions in the modern world. As the world becomes more globalised, think tanks which can undertake research and advocacy work at a transnational level become essential players in the global scene. Seeing as economics doesn't happen in a vacuum - each country's economic situation affects the political situation of every other country - they are also crucial to the profession (or at least, line of academic study) of most of the readers of this website. But which ones are the ones you should be following? Which think tanks conduct the most groundbreaking, critical economic research? And which one would be the best one to work for, if you ever had the chance to get your feet in the doors of such prestigious institutions? We've taken a look at the best ones in the United States, so you don't have to do the legwork yourself.
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In a market, sellers who offer a good or service interact with buyers who do not possess the good and want to acquire it. At each price the sellers decide how many units they want to offer or supply at this price, and the buyers decide how many units they want to buy or demand. The quantity supplied will be higher the higher the market price of the good, whereas the quantity demanded will be lower the higher the market price of the good. At the price at which these two quantities are identical, i.e., at the price at which the quantity demanded equals the quantity supplied, the market is in equilibrium. In equilibrium there are no buyers who would like to buy the good but cannot find a seller, and there are no sellers who would like to sell the good but are unable to find a buyer. This means that at the equilibrium price, the sellers are able to sell exactly the quantity they want to sell at this price and the buyers are able to buy exactly the quantity that they want to buy at this price. If we know the demand and supply in a particular market, we can easily find the market equilibrium by looking for the price at which the quantity demanded is equal to the quantity supplied. For example, suppose that in the market for pencils the market demand is given by the linear demand function <m:omath><m:ssub><m:ssubpr><m:ctrlpr></m:ctrlpr></m:ssubpr><m:e><m:r>q</m:r></m:e><m:sub><m:r>D </m:r></m:sub></m:ssub><m:r>= 10 - </m:r><m:r>p</m:r></m:omath> and the market supply is equal to <m:omath><m:ssub><m:ssubpr><m:ctrlpr></m:ctrlpr></m:ssubpr><m:e><m:r>q</m:r></m:e><m:sub><m:r>S </m:r></m:sub></m:ssub><m:r>= 2</m:r><m:r>p </m:r><m:r>- </m:r><m:r>2.</m:r></m:omath> In equilibrium the number of pencils that the sellers want to sell has to be equal to the number of pencils that the buyers want to buy, i.e., quantity supplied has to be equal to the quantity demanded, or <m:omath><m:ssub><m:ssubpr><m:ctrlpr></m:ctrlpr></m:ssubpr><m:e><m:r>q</m:r></m:e><m:sub><m:r>D </m:r></m:sub></m:ssub><m:r>= </m:r><m:ssub><m:ssubpr><m:ctrlpr></m:ctrlpr></m:ssubpr><m:e><m:r>q</m:r></m:e><m:sub><m:r>S</m:r></m:sub></m:ssub></m:omath>. For the demand and supply function of our example this means <m:omathpara><m:omath><m:r>10 - </m:r><m:r>p </m:r><m:r>= 2</m:r><m:r>p </m:r><m:r>- </m:r><m:r>2.</m:r></m:omath></m:omathpara> Now we only have to solve <m:omath><m:r>p</m:r></m:omath> to find the equilibrium price which is equal to <m:omath><m:ssup><m:ssuppr><m:ctrlpr></m:ctrlpr></m:ssuppr><m:e><m:r>p</m:r></m:e><m:sup><m:r>* </m:r></m:sup></m:ssup><m:r>= 4.</m:r></m:omath> To find the corresponding quantity, we plug the equilibrium price <m:omath><m:ssup><m:ssuppr><m:ctrlpr></m:ctrlpr></m:ssuppr><m:e><m:r>p</m:r></m:e><m:sup><m:r>* </m:r></m:sup></m:ssup></m:omath>back into the supply or the demand function and obtain <m:omath><m:ssup><m:ssuppr><m:ctrlpr></m:ctrlpr></m:ssuppr><m:e><m:r>q</m:r></m:e><m:sup><m:r>* </m:r></m:sup></m:ssup><m:r>= 6.</m:r></m:omath> Thus, in our market for pencils the equilibrium price is equal to 4<m:omath><m:r>, </m:r></m:omath>and at this price the quantity exchanged is equal to 6 units. This result is also shown in the graph below. The market equilibrium in a perfectly competitive market corresponds to the point of intersection of the supply curve and the demand curve. On the x-axis we have the quantity <m:omath><m:r>q</m:r><m:r> </m:r></m:omath>of the good or service (in our case pencils) and on the y-axis the price <m:omath><m:r>p</m:r></m:omath> of the good. The green line represents the demand curve and shows the quantity demanded at each price (for the graph below the demand function is the same as in the example <m:omath><m:ssub><m:ssubpr><m:ctrlpr></m:ctrlpr></m:ssubpr><m:e><m:r>q</m:r></m:e><m:sub><m:r>D </m:r></m:sub></m:ssub><m:r>= 10 - </m:r><m:r>p</m:r><m:r>)</m:r></m:omath>. The blue line represents the supply curve (also taken from the example above <m:omath><m:ssub><m:ssubpr><m:ctrlpr></m:ctrlpr></m:ssubpr><m:e><m:r>q</m:r></m:e><m:sub><m:r>S </m:r></m:sub></m:ssub><m:r>= 2</m:r><m:r>p </m:r><m:r>- </m:r><m:r>2) </m:r></m:omath>and shows the quantity supplied at each price. At the equilibrium price <m:omath><m:ssup><m:ssuppr><m:ctrlpr></m:ctrlpr></m:ssuppr><m:e><m:r>p</m:r></m:e><m:sup><m:r>* </m:r></m:sup></m:ssup><m:r>= 4</m:r></m:omath>, the quantity demanded is equal to the quantity supplied <m:omath><m:ssup><m:ssuppr><m:ctrlpr></m:ctrlpr></m:ssuppr><m:e><m:r>(</m:r><m:ssub><m:ssubpr><m:ctrlpr></m:ctrlpr></m:ssubpr><m:e><m:r>q</m:r></m:e><m:sub><m:r>D </m:r></m:sub></m:ssub><m:r>= </m:r><m:ssub><m:ssubpr><m:ctrlpr></m:ctrlpr></m:ssubpr><m:e><m:r>q</m:r></m:e><m:sub><m:r>S </m:r></m:sub></m:ssub><m:r>= </m:r><m:r>q</m:r></m:e><m:sup><m:r>* </m:r></m:sup></m:ssup><m:r>= 6)</m:r></m:omath>. Figure 1: Competitive market equilibrium The market equilibrium is also called the competitive equilibrium, because it describes the allocation of goods and services in a perfectly competitive market (see the term for Perfect Competition). In a competitive market where buyers and sellers are price takers, the equilibrium price (and thus marginal revenue) will be equal to marginal costs and each firm makes a profit of zero. The intuition behind this result is that in a perfectly competitive market without barriers to entry, firms will enter as long as they can make a positive profit. As the number of firms increases the market price decreases because new firms introduce excessive supply that cannot be sold at the original market price. Then they must lower prices to sell their stock. This decreases profits until they reach zero and firms have no incentive to enter the market anymore. Figure 2: New equilibrium after a shift in demand Excess demand and excess supply If the market price is not equal to the equilibrium price, the quantity demanded is not equal to the quantity supplied. If the market price is too high (i.e. higher than the equilibrium price), many sellers want to sell, but only few buyers are interested in buying. This means that the quantity supplied exceeds the quantity demanded - a situation called excess supply. Coming back to our example: at the price <m:omath><m:r>p </m:r><m:r>= 6</m:r></m:omath> per pencil, the quantity that sellers want to sell is equal to <m:omath><m:r>2(6) - 2 = 10,</m:r></m:omath> while the quantity demanded is equal to 4 and there is an excess supply of <m:omath><m:r>10 - 4 = 6 </m:r></m:omath>units. So what will happen in this market? There are many sellers who would like to sell at the market price of 6, but are unable to find a buyer. Some of them will start lowering the price in order to be able to sell, because it is still better for them to sell pencils at a price of 5 euros (for example) than not sell anything at all. Sellers will continue to lower their price until the market price reaches 4, the equilibrium price. At this point sellers have no incentive to further reduce their price, because at the price of 4, they can sell exactly the number of units that they want to sell at this price. Conversely, if the market price is too low, many buyers will be interested in acquiring the good, but few sellers will want to sell the good. This implies that the quantity demanded exceeds the quantity supplied and we call this situation excess demand. We can illustrate this situation using our example demand and supply equations. If the market price is equal to 2, the quantity demanded is equal to 8, but the quantity supplied is only equal to 2. The price is so low that it is not profitable for the sellers to sell more than 2 units. This implies that some customers who want to buy the good cannot, because there is no seller who wants to sell to them at the market price. Consequently, the sellers, knowing that there is enough interest in their pencils, will increase their prices until the market price reaches the equilibrium price. In equilibrium, when the quantity demanded equals the quantity supplied, there is neither excess supply nor excess demand. Whenever the market is not in equilibrium, either because the market price is too high (excess supply) or too low (excess demand), the forces of supply and demand will cause prices to adjust and the market price will move towards the equilibrium price. Further reading In the description above we focused on the market equilibrium in a single market. We ignored that in reality there are many markets, one for each good or service that people want to trade. For this reason, what we described in the above article is also sometimes referred to as “partial equilibrium”, because it refers to the equilibrium for only one good and the rest of the economy might not be in equilibrium. General equilibrium theory, on the other hand, takes the interaction between different markets into account and studies how the forces of supply and demand tend to move the economy as a whole towards an equilibrium. The equilibrium in general equilibrium theory is also sometimes called Walrasian equilibrium, named after the French mathematician and economist Léon Walras (1834-1910) who was the first to study and formalize this idea (see Walras, L., “Elements of pure Economics”). Good to know Are the prices we observe when we enter a store competitive equilibrium prices? Not always. First of all, many markets are not perfectly competitive (i.e. some firms or consumers have market power and therefore the prices in these markets are not the prices we would expect to see in a perfectly competitive market). Second, the equilibrium price of a specific good or service depends on many factors (e.g., the price of related goods, i.e. complements and substitutes, the income of the consumers, the costs of the producers, tastes, expectations, and so forth). Many of these factors affect the supply or demand function and change frequently over time. Therefore, the market prices of the goods and services also fluctuate over time and the prices we observe in the shops might be above or below the equilibrium price. But, the situations of excess supply or excess demand are only temporary, and as we know that the prices will move towards the equilibrium price, we expect that the prices we observe will fluctuate around the equilibrium price.
A market is in equilibrium if at the market price the quantity demanded is equal to the quantity supplied. The price at which the quantity demanded is equal to the quantity supplied is called the equilibrium price or market clearing price, and the corresponding quantity is the equilibrium quantity.
Many games in life have a Nash equilibrium of some type, and learning the Nash equilibrium can help economists predict human behavior (at least, when people behave rationally and selfishly in an economic sense). For example, the foundational Prisoner’s Dilemma features one Nash equilibrium. Other games may not feature one, however, particularly games with an unlimited set of possible choices. Put simply, a Nash equilibrium describes a situation in which each person acts optimally given the actions of the others, so that no one wants to change his or her action. The concept is named after the American mathematician John Nash (1928-2005) who formally developed the concept in the 1950s and won a Nobel Prize in Economic Sciences for his work. In many situations we are confronted with different options and have to decide which one to choose. The payoff (or utility) that we obtain from each option depends both on our own decision and on what others decide. For example, if I can commute to work either by car or by metro, how comfortable the car ride is depends on traffic. Meaning, how many others decide to commute by car affects my utility. A situation is a game when two or more decision makers (or players) decide between two or more options, and the players' decisions also affect each other’s payoffs. In a game, each player takes into account the immediate effect of his or her decision on his or her own payoffs and how the other players will react. As we assume that players are rational and their objective is to maximize their own payoff, we know that every player will play a "best response" to the strategy of the others. An action is the best response if it gives the player a higher payoff (or at least the same payoff) than the payoff that he or she can get by choosing any other possible action. The (Nash) equilibrium of a game The Nash equilibrium of the game corresponds to a situation where no one has an incentive to change his or her strategy given the strategies of the others ‒ i.e., when everyone is playing their best response. This implies that in a Nash equilibrium, the actions that people take coincide with the actions that the others think they will take. Given that everyone correctly anticipated what the others would do and everyone chose the best alternative considering the strategies of the others, no one can gain by deviating from their current strategy. In other words, everyone is happy with the decision that they took in view of the others' decisions. An example (coordination game) Let's consider the concept of Nash equilibrium with the help of an example. Suppose there are two friends, Alex and Blake, who decide to meet in the park. Both of them enjoy playing basketball, but neither of them wants to be the one to bring the ball from home to the park. Each of them can choose between two options: either bring a ball from home or not bring a ball. The payoffs in this game could be the following: if no one brings a ball, everyone receives a payoff of zero. If both bring a ball, then everyone gets a payoff of 1. If only one brings a ball, the person who brings the ball gets a payoff of 1, while the other one gets a payoff of 2. We can write down the actions and payoffs in form of a payoff matrix: In each of the four cells displaying the payoffs, the number before the comma corresponds to the payoff of player 1, in our case Alex. The second number describes the payoff of Blake. This means that if both Alex and Blake bring a ball everyone gets a payoff of 1, and so forth. Now let us find the Nash equilibria of this game. To do so, we check what is the best response of Alex for any action of Blake. If Blake brings a ball then Alex gets a payoff of 1 if he also brings a ball and a payoff of 2 if he does not. Consequently, his best response to Blake bringing the ball is not to bring a ball. If Blake does not bring a ball, Alex obtains a payoff of 1 if he brings one and a payoff of zero if he does not. Hence, his best response to Blake not bringing a ball is to bring a ball. Now we can repeat this exercise to find the best responses of Blake and we see that she should bring a ball if Alex does not and should not bring one if Alex does. This means that this game has two Nash equilibria (in pure strategies). In the first Nash equilibrium, Alex brings the ball. In the second one, Blake brings the ball. Why are these action profiles Nash equilibria? Because when Blake does not bring a ball and Alex does, neither is incentivized to change their decision given the decision of the other. That is, because Blake does not bring the ball, Alex brings it himself. Why is both of them bringing a ball not a Nash equilibrium? Because if Alex knows that Blake is bringing a ball, it's not in his best interest to bring one himself. This means that in this situation he can gain (increase his payoff) by changing his strategy. Mixed-strategy Nash equilibrium The game described above is called a coordination game and has two pure Nash equilibria. A mixed strategy equilibrium is a Nash equilibrium in which one or more players randomize. This means that they play each strategy with some probability. In symmetric games (as the one described above) where each player has the same possible actions and the same payoffs associated with each action, the focus is often to find the symmetric mixed-strategy equilibrium. In a symmetric mixed-strategy Nash equilibrium each player assigns the same probability to a particular action. For the symmetric mixed-strategy Nash equilibrium of the game described above, each player assigns a probability of ½ to each strategy. Put differently, if each of them tosses a coin before leaving and takes a ball if the coin shows heads and leaves the ball at home if the coin shows tails, this strategy would be a (symmetric mixed-strategy) Nash equilibrium. Note that in this equilibrium it is possible that they will have 2 balls and it is possible that they will have no ball at all depending on the outcome of the coin tosses. Yet, if Alex knows that Blake will toss a coin to decide what to do, his best response is to toss a coin as well. Further reading Nash equilibrium is not the only solution concept for non-cooperative games. Depending on the information that the players have, how often they interact (i.e. how many time periods) or whether the players choose their actions simultaneously or sequentially, different solution concepts exist. Many of these solution concepts are refinements of the Nash equilibrium as e.g., the Subgame Perfect (Nash) equilibrium or the Bayesian Nash equilibrium (see e.g. “Game Theory: An Introduction” by Steven Tadelis, 2013). Good to know The movie “A beautiful mind” is based on the life of the American mathematician John Nash, who suffered from schizophrenia. His dissertation on non-cooperative games for which he obtained his PhD from the University of Princeton was only 20 pages long.
Nash equilibrium is an important equilibrium or solution concept in non-cooperative game theory. A Nash equilibrium is a strategy profile (i.e. a strategy for each player) in which each player is playing the best response to the strategy of the other(s).
However, in these troubled economic times, it’s increasingly unclear whether GDP remains an appropriate measure. After all, it ignores inequality, still rampant across the Western world; it doesn’t take into account the earth’s dwindling natural resources; and it fails to recognise the rapidly deteriorating environment. With such glaring omissions, should it really be trusted to measure the success of our economies, and by proxy, the quality of our lives? Here we take a closer look at the measurement’s history, the charges it faces, and its future, all in an attempt to better answer the question: is it time to bin GDP? Its birth Russian-born economist Simon Kuznets first developed GDP, initially known as Gross National Product (GNP), in the early 1930s. His design came at the behest of the US government which, during the Great Depression, was seeking a more accurate measurement of economic output to guide its interventionist governmental policy. As economist Kate Raworth describes, 'GDP enabled President Roosevelt to monitor the changing state of the US economy and so assess the impact and effectiveness of his New Deal policies'. A few years later, as America readied itself to enter the Second World War, GNP was again of use. In his book, How to Pay for the War, John Maynard Keynes explained how important aggregate economic statistics like GNP are for converting an industrial economy into a planned military one. Knowing what was available for a country to mobilise was essential to any credible war planning. Interestingly, in the 1934 report Kuznets delivered to US Congress, he warned against the use of GDP as a measure of economic welfare, and placed emphasis on maintaining a clear distinction between the quantity and quality of growth. Economic welfare, he claimed, could only be ascertained if personal distribution of income is known – something GDP does not calculate. In his own words: ‘goals for more growth should specify more growth of what and for what’. His recommendation fell on deaf ears. Economist Moses Abramovitz was something of an anomaly, when in 1959, he cautioned ‘we must be highly sceptical of the view that long-term changes in the rate of growth of welfare can be gauged even roughly from changes in the rate of growth of output.’ Such admonishments did little to slow the GDP fan train, which further gathered pace during the Cold War, as growth was seen as the best means of judging which economic ideology - the central planning of the Soviet Union or the free market of the west - could churn out more stuff. Its confirmation as the buzzword of 20th-century economics came in 1999 when the US Commerce Department heralded it as one of the ‘great inventions’ of the last 100 years. Only more recently, particularly since the financial crisis, has criticism of the measurement begun to mount, showing signs that maybe, ninety years after conception, it’s running out of track. The charges it faces One of the most regular criticisms GDP faces centres on what it doesn’t measure - the list is lengthy. Among the most conspicuous absentees are volunteer work and unpaid household labour, the latter perhaps a legacy of its wartime origins. Still, that these are not considered as ‘contributing’ towards the wellbeing of the economy is contentious, and sets a worrying moral tone for any society created using GDP as its yardstick. It's perhaps no coincidence, that it's women that have traditionally carried out these activities. A further concern is what actually contributes to GDP. Take, for instance, crime. Few in their right mind believe that crime is a signifier of a healthy, progressive society. Yet, when it comes to GDP, crime can be very helpful indeed. Consider the scenario: inequality is spiralling, concentrating wealth in the hands of a diminishing few, while increasing the number of those with very little. The disparity then prompts an increase in crime, as it so often does. And yet, for GDP this bears no burden; in fact, it's beneficial. To a growth fundamentalist, only concerned with growth, a smashed window is not seen as violation of basic social rules; it's seen as an opportunity for a glazier to make a new window, turning a profit and paying tax in the process. This logic holds for much crime and extends to the employment of police, lawyers, judges and prison guards that are tasked with dealing with it. The same logic also applies to catastrophes, which are another excellent means of boosting GDP. World War 2 helped drag the US out of an economic crisis, and countless natural disasters - like the Japanese earthquake in 2011 - have boosted economic growth in all corners of the globe, often increasing both production and employment. The environment foots the bill In our age of climate deterioration, the relentless pursuit of GDP growth also comes at a great environmental cost, one that, in the developed world, far outweighs the benefits it brings. The conversion of trees into lumber, of farmland into shopping malls, and most devastating, of fossil fuels into CO2, all underpin GDP growth, contribute to global warming, and are anathema to a sustainable way of living. If the planet is to be preserved in any recognisable state, reliance on GDP as a gauge of progress, welfare, or even health of the economy, will have to be tempered. The question is, do we have alternatives at hand? Thankfully, yes we do. Genuine progress indicator (GPI) is one of the leading candidates to replace GDP and differs in that it also takes into account social and environmental factors. Perhaps unsurprisingly given the above, it therefore defines what we currently consider ‘healthy’ economic growth completely differently. An illustrative example is Canada’s oil-rich province, Alberta. According to a study by the Pembina Institute, between 1961 and 2003 it experienced GDP growth of 500%. During the same time period, GPI performance steadily fell, responding to growing inequality, rising household debt, and an increase in greenhouse gas emissions. Exactly how different the governance of the province would have been if GPI had informed policy instead of GDP is obviously an unanswerable question. It’s safe to say, though, it would have diverged radically. The Index of Sustainable Economic Welfare (ISEW) has also sporadically been used, and includes inequality, crime, pollution and volunteer work in its estimates. How much traction these metrics will gain remains to be seen. What can be said with more certainty is that the management of the world's economies needs transformation. Climate catastrophe threatens all life, and inequality in much of the Western world has been on the rise for decades - GDP accounts for neither. Our measuring stick for progress fails to address two of the biggest problems we face. It makes no sense. It's high-time we heeded economist, Joseph Stiglitz’s, call - made now over a decade ago - to put an end to 'GDP fetishism'. We need metrics that speak to the needs of the twenty first century, not ones that exacerbate them.
Gross Domestic Product, or GDP, is the market value of all goods and services that a country produces in a given year, adjusted - to make it comparable to previous years - for inflation. In many ways, though, it's transcended this rather prosaic definition. It's become the barometer of a country’s progress, an indicator of a land’s prosperity, and the ultimate yardstick for assessing living standards. When growing (at expected rates), politicians refer to it as proof of the success of their policies. And when rates are not met, or, god forbid, GDP growth slows, it’s weaponised by those for whom it’s politically expedient. It has the power to both elect governments and bring them crashing down. In the theatre of politics, rarely is it anywhere but centre stage.
Whenever a firm increases the number of units it sells, this will affect the firm's revenue, because the quantity sold is higher and revenue is equal to the number of units sold times the price they were sold. In a perfectly competitive market, each firm acts as a price taker and can sell as much as it wants to at the market price. This implies that the marginal revenue in a perfectly competitive market is equal to the market price. For example, if a firm is selling orange juice at €2 per glass (and it can sell as many glasses as it wants to at this price), then any additional glass of orange juice that the firm sells increases total revenue (TR) by 2 and thus, marginal revenue is equal to 2. That is, if the firm increases quantity from 10 to 11 glasses, total revenue increases from 20 to 22 and the change in total revenue is equal to 2: MR = TR (11 glasses) – TR (10 glasses) = 11 * 2 – 10 * 2 = 22 – 20 = 2. If the market is not perfectly competitive, the marginal revenue is not necessarily equal to the market price. Consider a monopolist who faces the entire market demand. In order to sell more units, the monopolist would have to decrease the price for all units (not only for the additional unit that it wants to sell). This means that total revenue could increase by less than the market price if the next unit lowers the sales price by too much. To be more precise, selling one more unit will increase total revenue by the price at which the good is sold minus the revenue that the monopolist loses from selling all units at a lower price. Total revenue is a quadratic function which is maximized at the point where marginal revenue is equal to zero (at quantity q *). Mathematically the marginal revenue is the derivative of total revenue with respect to quantity, i.e. \begin{equation*} \mathit{MR} = \frac{\mathit{dTR}}{\mathit{dq}} = \mathit{p(q)} + \mathit{q}*\frac{\partial\mathit{p(q)}}{\partial\mathit{q}} \end{equation*} where TR is total revenue <m:omath><m:r>TR </m:r><m:r>= </m:r><m:r>p</m:r><m:r>(</m:r><m:r>q</m:r><m:r>)</m:r><m:r>q</m:r></m:omath>. The first part of this derivative p(q) is positive, because when the quantity sold rises total revenue increases by the price at which the extra unit is sold. The second term of the derivative will be negative, because to sell more units, the price per unit must decrease. Multiplied by the total number of units q, this measures the total loss in revenue due to the lower price. The figure shows the marginal revenue curve and the total revenue curve for a monopoly with linear market demand. The left panel (a) shows the marginal revenue curve (MR) and the demand curve (D). In the case of linear demand, marginal revenue is also a linear function, and its slope is twice as steep as the slope of the demand function. This means that if inverse demand takes the form p = a - bq, then the marginal revenue function is MR = a - 2bq. The right panel (b) shows marginal revenue (MR) as well as total revenue (TR) (and average revenue (AR)) in the case of a linear demand function (D). Total revenue is a quadratic function that reaches its maximum where marginal revenue equals zero (at quantity q^*). Keep in mind that marginal revenue is not the same as average revenue AR, which is the revenue per unit, i.e., \begin{equation*} \mathit{AR} = \frac{\textit{Total revenue}}{\textit{quantity}} = \frac{\textit{TR}}{\textit{q}} \end{equation*} Marginal revenue is an important concept in economics, because together with marginal costs it determines the equilibrium quantity and price in a perfectly competitive market. A firm maximizes its profits when it produces the quantity at which the marginal revenue of the last unit produced is equal to marginal costs of that unit. That is, profit maximization requires MR = MC . If marginal revenue exceeds marginal costs <m:omath><m:r>(</m:r><m:r>MR </m:r><m:r>> </m:r><m:r>MC</m:r></m:omath>), selling one additional unit increases total revenue more than total costs. Therefore, profit will increase if it sells this unit. (Remember that the profit of the firm is total revenue minus total costs). Consequently, a profit- or utility-maximizing firm will produce this additional unit. If marginal costs exceed marginal revenue <m:omath><m:r>(</m:r><m:r>MR </m:r><m:r>< </m:r><m:r>MC</m:r></m:omath>) total costs increase more than total revenue for the next unit produced, and it is better for the firm not to sell this unit. When <m:omath><m:r>MR </m:r><m:r>= </m:r><m:r>MC </m:r></m:omath>the firm has no incentive to either increase or decrease its quantity as both would lead to a reduction in profits. Therefore, firms stop producing where MR = MC, but before MR < MC. Further reading In economics, we usually assume that the firm's objective is to maximize profits. But, some economists following Baumol (see e.g. “Business Behavior, Economics and Growth”, 1967) argue that under certain conditions firms seek to maximize revenue rather than profits. Baumol argues that the managers of a firm, in contrast to the owners and shareholders, are more interested in maximizing sales than profits because there is a direct link between the salary and reputation of a manager and total revenue. Good to know What determines the wage that you can earn? According to economic theory, your salary will depend on how much the total revenue of your employer increases by hiring you. This theory can be used to explain why some football clubs are willing to pay huge sums for players that they expect to contribute considerably to the success and fame of the club. For example, in Summer 2019 Eden Hazard transferred from Chelsea to Real Madrid for €150 million. This large sum reflects not only Eden's expected contributions on the field, but also new merchandising opportunities and brand recognition for Real Madrid. Test whether you understood the concept of marginal revenue... Take a quiz <use xlink:href="/themes/custom/venice/images/icons.svg#launch-18px"></use> Exercises for you <use xlink:href="/themes/custom/venice/images/icons.svg#launch-18px"></use>
Marginal revenue (MR) measures the change in total revenue that occurs when a firm increases output by one unit, i.e., it is the extra income (or revenue) generated by selling one additional unit.
Government intervention helps women. We need more of it
These aren’t easy questions, the rancorous nature of current American politics evidence of their polarising nature. Nevertheless, as social expectations are raised, they require constant reappraisal, for certain injustices necessitate government intervention. Research has shown that gender equality, especially, is reliant on an active, intervening state to provide things the market has historically failed to offer and that are vital to progress - namely parental leave and childcare. The case for placing both in the custody of the state is compelling, and ultimately, if gender inequality is to be taken seriously, necessary. Here’s why. Historic prejudice The labour market has rarely been a friend to women. Reflecting regressive social mores, it has, for most of its history, viewed the female condition as unsuitable for the dog-eat-dog world of work - too sensitive, too fragile - while pregnancy itself carried great disruptive potential, an ever-present, ticking time-bomb. These sentiments continue to find expression in the hiring process - men preferred to women in a phenomenon economists call ‘statistical discrimination’. The preference presumes that women are more likely to quit work on account of starting a family. And being ‘more likely’ to quit, they are paid less - globally women earn 24% less than men according to Oxfam - as businesses safeguard themselves against future losses. In turn, unfair remuneration makes women actually more likely to quit, and the circle is complete. A similar logic makes women less likely to get promoted, explaining their relatively few numbers in positions of high authority. The material ramifications of this are dire, to say nothing of the ethical injustice. UN unemployment and poverty statistics are all skewed unfavorably towards women, and mothers have it particularly bad. Despite progress having been made - 39% of the global workforce are women and there’s been a haphazard re-examination of caregiving roles in society - the restrictive breadwinner/homemaker dichotomy generally persists, economic prejudice feeding social expectations and vice versa. It’s possible for politics to help disrupt this stubborn feedback loop; intervention can check female economic prejudice and address outmoded social norms - if the will is there. America provides a cautionary tale of when the opportunity is passed up. The American experience The self-styled home of freedom and opportunity - along with Suriname, New Guinea and the Marshall Islands - doesn’t have a national law on paid parental leave, preferring instead for the market - rarely known for its compassion - to adjudicate. As a result, in 2013, it was estimated that just 12% of American workers were covered by paid parental leave policies. Forbes recently reported that 25% of women in the US return to work just 2 weeks after giving birth. And many others, left overwhelmed and with little recourse, simply leave their jobs rather than return when expected. In the words of the legal team, A Better Balance, while still thought of a the primary caregivers women are effectively ‘forced to choose between their job and a healthy pregnancy’. Those who do return to work post-pregnancy then encounter further problems. As ethnographer, Kristen R. Ghodsee, has observed, ‘many professional women get completely derailed after taking time out of the labour force’ - the quickening pace economies change, and the absence of any mechanism to help ease the return, makes it increasingly difficult to re-enter the workforce after a period of inactivity. Child care then poses further problems, for in the US it costs, on average, $15,000 per child per year. Federal provision does not exist. This means that for a large number support is unavailable, and an oftentimes a career-damaging return home is left as the only option. An American Progress study found that in 2016 alone, an estimated 2 million parents made career sacrifices due to problems with child care, and mothers were 40% more likely than fathers to report that child care issues had a negative impact on their career. It’s perhaps unsurprising, therefore, that a New York Times survey recently revealed 64% of Americans had fewer children than they would like, citing the prohibitive cost of childcare - so much for the benevolent invisible hand. The Swedish model Sweden, so often a beacon of progressiveness, offers an alternative. Witnessing American plight, it was clear to Swedes that the key to this fight was comprehensive governmental intervention, specifically, intervention on behalf of young families. One mooted solution was state-sponsored paid maternity leave that guaranteed job protection. Although certainly a positive step, some were left unconvinced it went far enough, and actually feared it may further incentivise businesses to overlook women when hiring. To ward against this, Sweden has legislated that parents of both sexes are entitled to 480 days of paid parental leave at 80% of their salary, plus bonus days for twins, and, most significantly, they must share it - each partner must take at least 90 days of those 16 months. Click here to browse our economics job listings Not only is this offer more generous, it addresses the social and economic issues that conspire to straitjacket women. It reframes the traditional expectations of both mothers and fathers, equalising the roles they’re presumed to adopt in parenthood. This, by extension, also encourages a more fundamental reassessment of societal gender roles which, regardless of identification, many find restrictively narrow. And financially speaking? Well, it’s just a better deal for both parents. Given toddlers are far from self-sufficient, and workplace pressure can be unremitting, Sweden also recognised further measures to protect the careers of young parents - particularly mothers - were needed. They guaranteed affordable childcare for all. The Education Act of 2011 confirmed that parents need only ‘spend [between] one to three per cent of the family’s income on childcare’, depending on income, with the state footing the rest of the bill. The results have been clear: 80% of Swedish 1-5 year olds now attend preschool, mothers (and fathers) are able to continue their careers unencumbered, and the country itself has been ranked the best place for women to live by U.S. News. The irony apparently lost on them. Generous parental leave and quality child care will not end structural injustices faced by women, but they’re imperative first steps. Their imposition directly targets the so-called ‘statistical discrimination’, and removes key obstacles that discourage the hiring of and investing in women. They are a start, a basis from which a broader program of reform can be built that mitigates the free market’s prejudice - gender quotas, improved education, and further legislation all have parts to play. If government intervention can be called upon in other moments of perceived crisis - not least to prop up banks - why not also for the crisis of gender inequality? As America has proven, parental leave and childcare are not safe without government enforcement. Their provision needs to be taken in-house, guaranteed and made accessible to all. For any further advice - just ask the Swedes.
The jostling between market and state, and the territory that each occupies, lies at the heart of political discourse. It's the major fault line around which political parties form and debates rage. Despite their uneasy relationship, between them they generally make available all that we need, be it food, a home, healthcare, employment, or education, at varying - and often questionable - quality and cost. The demarcation between the two, rarely ever static, differs widely across states, and speaks to the values of the society in question. What, for instance, can be said of a country whose privatised higher education is financially off limits to its poorer citizens? Is it right to leave the market responsible for people’s health? And what of the provision of childcare?
Some resources are plentiful while others are rare. We tend to think less about the air that we breathe than about how we are going to spend our time on any given day. That is because breathable air is in apparent abundance while the number of hours in a day is clearly limited. Our decision to breathe is not a conscious one and is thus somewhat uninteresting for an economist. On the other hand, a whole branch of economics exists to understand and explain our choices of time allocation: how many hours we choose to work and how many hours we choose to play are of fundamental importance to the labor market. It is not just people’s time but also their skills that are in limited supply. Economists are typically concerned with the efficiency of any allocation: how can the most be made of such scarce resources? While mainstream economics focuses on the preferences and decisions of individuals in society, evaluating the fair allocation of scarce resources requires aggregation of preferences in order to judge the utility of an allocation to society as a whole (see welfare economics). Thus, not only the efficiency of an allocation but also its equity, or distributive fairness, is relevant to the study of scarcity and choice. Indeed, the issue of equity is central to the debate on free-market versus planned economies. The scarcity of a resource in a particular context can be quantified and hence judged objectively. Traditionally, economists have also studied people’s choices over scarce resources as though they were taken through simple, objective and rational calculation. Of course, people’s decision-making is not purely rational; it is affected by emotion too. The fast-developing subfield of behavioral economics applies insights from human psychology to enrich economists’ understanding of choice at a more subjective level. <11an>limit:3;categories:Master's Programs;disciplines:Economics</11an> The basics of supply and demand tell us that the price of a rare item will be higher than that of a common one. Marketing teams often apply the concepts of scarcity and choice along with ideas from psychology to make money. If marketers can create the impression that an item is in scarce supply, then some people will be willing to pay more for it, or to bring forward their purchases. Mind games about scarcity are played out through campaign statements such as “Buy it while it lasts!”, “Last chance to order!” or “Limited offer!” precisely in order to influence consumer choice. Further reading For an interesting discussion about the scarcity of a clear definition of economics and how economists have chosen to present their discipline over the years, see Backhouse and Medema's “Retrospectives: On the Definition of Economics” (Journal of Economic Perspectives, 2009). Good to know Perhaps the most important and pressing issue of our time, that of climate change, is essentially a problem of scarcity and choice. As the very air we breathe comes under threat and our rivers begin to run dry there has never been a greater urgency to consider economics in the search for practical solutions. The subfield of environmental economics deals with emissions targets and permits, carbon taxes, and subsidies for renewable sources of energy. It will surely be one of the most in-demand areas for economists to work in the years to come.
Where there is scarcity, choices must be made! Scarcity refers to the finite nature and availability of resources while choice refers to people’s decisions about sharing and using those resources. The problem of scarcity and choice lies at the very heart of economics, which is the study of how individuals and society choose to allocate scarce resources.
The theory of comparative advantage states that as long as countries have access to resources in different proportions (i.e. at differing relative cost) then they will all gain from engaging in international trade with one another. To realize these gains from trade, they each need to simply devote resources to the industries where domestic production is most efficient and then trade to receive other goods that satisfy domestic demand. Seen in this light, limiting trade between economies results in a deadweight loss. Economists, ever in search of efficiency, therefore tend to agree that free trade agreements are a good thing and that trade barriers are to be avoided. Nevertheless, trade barriers are becoming commonplace around the globe as many governments take a protectionist stance to their economies. While countries as a whole do tend to gain from free trade, as more countries participate in the world economy, competition in production intensifies, leading to losses for certain groups within countries. Wages and jobs in particular industries can come under pressure. In theory, this loss of a less efficient industry at home can be ameliorated by retraining and reallocating people and jobs to more productive areas of the economy. Yet trade barriers can have a more immediate effect because retraining takes time. Trade barriers are hence favored by many citizens and politicians looking for a quick fix. Over time, this results in countries propping up inefficient domestic industries with subsidies and tariffs, creating yet more deadweight loss. <11an>limit:3;categories:Master's Programs;disciplines:Economics</11an> A prime example of this is the trade dispute that began in June 2018 between the US and China and their governments’ discussions regarding tariffs on imports. The decision by the British electorate to leave the European Union can also be explained in part by an aversion to the free movement of people; exiting the bloc effectively erects a non-tariff barrier to trade on labor as a factor of production. Within the European Union there are no tariffs on goods and services exchanged. Even so, non-tariff barriers to trade persist through variations in the national rates of tax, differing technical standards of production, as well as the bias of national governments in favor of local firms. The European Union also maintains strict food and drugs safety standards, imposing licenses for the import of non-EU products in these sectors. The arguments for and against trade barriers typically boil down to a classic discussion about economic efficiency on the one hand and distributive justice on the other. Reducing barriers improves efficiency and thus creates a larger economic “pie”. But, distributive justice may justify keeping some barriers or rules in place to ensure the pie is shared in a fair way. Further reading Paul Krugman was awarded the Nobel Prize in Economics in 2008 for his work on New Trade Theory, which explains why trade intervention can make sense when markets are imperfect. For a refreshingly critical view of economists’ unequivocal advocacy of free trade, see his article, “The narrow and broad arguments for free trade” (American Economic Review, 1993). Good to know Trade barriers within the discipline of economics itself are few and far between. Students of economics have a comparative advantage over their peers in more traditionally national subjects such as law and medicine, as legal and health systems tend to be specific to each country. Indeed, economic principles can be applied virtually anywhere. This facilitates international student exchange between economics departments during studies. And as a graduate of economics, the international job prospects are good, not least in import and export industries, where a sound knowledge of trade barriers is a must! Video Summary Want more examples? Watch our short video on Tariffs and Trade Barriers:
Trade barriers refer to the obstacles that are put in place by governments to limit free trade between national economies. Trade barriers are thus essentially interventions in markets that happen to operate internationally. Trade barriers include tariffs (taxes) on imports (and occasionally exports) and non-tariff barriers to trade such as import quotas, subsidies to domestic industry, embargoes on trade with particular countries (usually for geopolitical reasons), and licenses to import goods into the economy.
Dress Code for Economic Conferences: What to Wear and What to Avoid
Having previously helped thousands of INOMICS users find the right economics conference for them, it seemed only polite to give some general guidelines about what’s appropriate to wear once there - we know you economists are a particular bunch! Hopefully this advice will allow you to check one small thing off your (very long) checklist, and allow you to focus on the more important aspects of attending an academic conference: the networking, presenting, and possibly - fingers crossed - even having fun! So, let's get serious. Check out our conference listings The basics It’s quite likely that you’ll be traveling prior to the conference and might not have access to an iron. This one should keep in mind. Moreover, remember to pack clothes that work for both standing and sitting (there will be a lot of both, economists really can talk) and won’t be completely wrinkled after a few hours. With this in mind, avoiding linen is probably a good idea, unless, perhaps, your conference is taking place on a tropical island. In which case, lucky you! Bringing some back-up options is always a good idea in case one of your items of clothing gets a wee bit dirty or, god forbid, you have an accident. Wearing dark colours is normally a good idea as they are universally flattering and hide wrinkles and spillages well. Finally, pack some layers; you might be in a room with an air conditioner for one talk and in a veritable sauna the next, and you don't want to be distracted by being too hot or too cold. Smart is better than casual Broadly speaking, it’s always better to dress up rather than down. While “business wear” can mean a full suit for some folks and jeans and a nice top for others, it’s better to be the only guy with a tie than the only one without. No matter what time of year, shorts are never a good choice, as they come across as too casual. For women, skirts and dresses are fine, but nothing too tight or short, as this can seem unprofessional. A nice blazer or scarf can dress up a plain outfit. Be aware of what you’re wearing on top though – as a general rule you shouldn’t show any cleavage, as it can be distracting or even offensive, and it’s better just to err on the conservative side. Dressing for presenting If you’re presenting for the first time, remember that your presence can be nearly as important as your presentation. In order to seem professional and poised, avoid large jewellery or busy prints, and make sure your hair is not hiding your face. Women can wear heels, but make sure you’re comfortable walking and standing for an extended period of time. Aside from this, whatever you're wearing you should try and be as confident as possible when presenting. Squaring your shoulders, standing straight and having your legs at shoulder width apart is a body position that suggests confidence and authority. Doing something like this makes you look assured and assertive, which is just as important as looking smart. Do some practice runs with some economists friends in the days leading up to build up confidence. It's always a good idea. Simply ask Finally, if you’re unsure of the basic dress code for a conference, don’t be afraid to ask. Some disciplines are generally more formal than others (finance versus computer programming, for instance), so generalities only go so far. The conference organisers should provide you with guidelines, but it’s perfectly fair to bring it up if it’s unclear. Moreover, don’t feel pressured to completely let go of your personality in favour of a professional wardrobe. As long as you feel comfortable, you’re more likely to come across as confident. Interpret our suggestions as they make sense for you, and just remember to bring a few extra options for surprise occasions like extra dinners, unexpected weather changes or other unforeseen circumstances. Go on. Knock 'em dead.
While you may be used to the daily routine of graduate school or teaching, presenting at a conference, or even just attending one, can be a whole different activity. The preparatory checklist is long enough as it is, without having the added conundrum of worrying about your appearance. If you’re in business school, perhaps you’re used to ironing your button-down shirt and slacks every day, but most academics cringe when they hear the term 'business casual'. But fear not. We, the gracious folks at INOMCS, are here to help.
But what of people's lives? With records being broken, and figures heralded as ‘the best ever’, you'd be forgiven for presuming people’s lives were improving in parallel, that the numbers translated into more than just useful soundbites. For most this is yet to happen. In explanation, economist, Joseph Stiglitz, has denied that the nation’s economic health has experienced a marked improvement, claiming ‘neither GDP nor the Dow is a good measure of economic performance, for neither tells us what’s happening to ordinary citizens’ living standards’. Indeed, if one looks to more tangible metrics - life expectancy (falling and among the lowest in the developed world), disposable income (on the decline), and household debt (skyrocketing) - a vastly different picture of American life emerges: one of stagnation, uncertainty and strife. It’s with this picture that young Americans, in particular, most identify. Instead of prosperity, millennials (Americans born between 1981 and 1996) anticipate economic future of precariousness, Trump’s creation of ‘the greatest economy… in the history of the country’ having no recognisable bearing on their reality. Optimism, the characteristic for which they were once known, is fading, and in its place has grown a shrewd pragmatism, accompanied by an acceptance that the US economy, regardless of its supposed merits, is deeply flawed. Whoever is experiencing its much touted ‘improvements’, it’s not them. <11an>limit:2;categories:Graduate / Traineeship|Internship|Junior Industry Position|PhD Candidate;countries:united states;disciplines:Economics</11an> Broken promises Remember, this was the generation that were told a college education was everything, the ticket to a comfortable life. Having held up their end of the bargain - becoming the most educated generation ever in the process - they’re now finding out the social contract to which they committed was sold on false pretences. High on the list of grievances are tuition fees - they are eye-watering. Having risen a further 25% in the last decade, they average $48,510 and $21,370 per year for private and public institutions, respectively. No one, of course, can afford this outright, and as a consequence, student loan debt has become the second highest consumer debt category, behind only mortgage debt. Added to the stagnating real wages graduates face when entering work - median purchasing power has been static for 40 years - and the rising cost of living, and you have a demographic cohort with a collective debt in excess of US$1 trillion, the highest in history. With respect to tuition at least, the accumulation of debt is not inherently bad, presuming the interests that stand to be gained are of appropriate size. Primarily, and rather obviously, this interest has typically been a job - ideally, one that's fulfilling and well paid. Nowadays, though, these are in short supply. The problem isn't an actual lack of jobs, although figures on this are nothing to celebrate; it’s the quality of jobs relative to the skills of the applicant. Millennials have been struck by underemployment, ‘the underuse of economic capacity’, or, in other words, lots of history grads working in Starbucks. According to data from the New York Fed, in September 2019, 34% of college graduates were underemployed, working in jobs that do not require a college degree. Among those more recently graduated, aged between 22-27, the rate was as high as 41.3%. And this is no post-recession fallout, either. In fact, these figures have remained relatively stable over the past 25 years. No cyclical fluctuations, as one may expect, and no identifiable long-term trends. It’s perverse. Students spend billions of dollars every year to earn degrees, and over a third of them add no value to the workforce. Ambition blocked Underemployment is also by no means the sole preserve of graduates, as the 2019 GenForward Survey, conducted by the University of Chicago, has shown. Using a nationally representative sample of 18-34 years olds, the survey reported the extent to which young people feel their aspirations are stymied. Many, for instance, believe they’re denied ‘access to good jobs, either because they are unavailable in their area or because they cannot get to them by driving or using public transportation’. A full 44% of Latinxs, 39% of African Americans, 31% of Asian Americans and 29% of whites subscribed to this sentiment, claiming that decent employment existed inaccessibly elsewhere. Moreover, those working were commonly found to dislike their jobs, large numbers citing ‘just to get by’ as their reason for being there, despite a majority strongly desiring a career-driven path. Even then, second jobs for around 25% was still needed to actually ‘just get by’, given inadequate pay. Far from exploiting the gig economy for its flexibility - its supposed redeeming quality - the data strongly suggested participation was the result of necessity, of the lack of an alternative. Candidates must listen Relative to their parents, the future for millennials is one of ‘lower earnings, fewer assets, and less wealth’, so concludes research from the Federal Reserve. The median income for 25-34 year olds has fallen in every major industry but healthcare since 2008, contributing to millennials owning just 4% of real estate value, when at the same age baby-boomers owned 32%. This is far from the picture Donald Trump describes. It’s a picture populated by physicist waiters, engineer baristas and sales people who boast an extraordinary knowledge of international relations. Ultimately, it’s picture in which talent is being squandered. With millennials on the verge of overtaking baby-boomers in number, and thus becoming a potentially election-defining voting block, candidates for President should really be taking note. Header Image Credit: Alvaro German Vilela on Shutterstock (licensed image - copyright)
The US economy is improving, so we are told. With the financial crash receding into the distance, almost out of sight, things are looking up, the future is finally brightening. Unemployment reached a 50-year low in 2019, falling to 3.5%, while US employers have added almost 5 million jobs in just two years. These are ‘the best economic numbers our country has ever experienced’, the President declared at Davos, with characteristic humility. And bombast aside, his sentiment is not without foundation, the US economy is posting some good numbers. In addition to jobs, GDP has been growing at close to 3 percent annually, and the Dow Jones has increased by 49% is the last 3 years - all of which is great election fodder for the coming campaign. Democrats should be wary.
Economic Development, Innovation and Growth (JEL O)
\begin{equation*} \eta_A = \frac{\Delta\mathit{q}_{A}}{\Delta\mathit{p}_{A}} = \frac{\frac{d{q}_{A}}{\mathit{q}_{A}}}{\frac{d{p}_{A}}{p}} \end{equation*} Price elasticity of supply is generally positive because firms are motivated to supply more (less) of an item as its price rises (falls). Precisely how sensitive supply is to changes in price depends on several factors. The most important is how long it takes sellers to adjust the amount of the item they can offer for sale. This is not just about the ability to ramp up production when more of the item is demanded. It is also about how feasible or costly it is for the seller to store items when demand falls. The more complex the production process, the greater the dependence of sellers on other markets. Greater interdependence also increases the seller’s responsiveness to price changes. In markets for physical goods and the local provision of services, public infrastructure is also a significant factor in the price elasticity of supply. The supply curves for five standard theoretical cases are shown in the graph below. In the first case, the supply curve S1 starts at the origin (0,0), and is linear and upward-sloping. This implies that any change in price is met with a proportional change in quantity supplied. Therefore the price elasticity of supply is unitary η1 = 1. If the item’s price increases by 10%, so too does its quantity supplied. As with the price elasticity of demand there are two extreme cases for the price elasticity of supply: perfect elasticity and perfect inelasticity. The horizontal supply curve S2 represents perfectly price-elastic supply: the elasticity tends towards (positive) infinity η2 → ∞. In theory, this means that if its price increases above p2 then an infinite amount of the item will be supplied. But, if its price drops below p2 then none will be supplied. Clearly, this is unlikely to happen in practice. However, in industries with flexible production and factor markets with spare capacity, the price elasticity of supply can be very high. One example is the market for coffee-to-go. In this market, new entrants are very quick to take advantage of increased consumer willingness to pay, and leave the market quickly when conditions deteriorate. Figure 1: Various price elasticities of supply At the other extreme, the vertical supply curve S3 indicates that supply of the item is fixed at a quantity of q3, whatever its price: supply is perfectly price-inelastic η3 = 0. This is the case, at least in the short-term, for items with longer, less flexible production processes. Indeed, producers of such items are unable to react quickly to price changes. The remaining two cases are the supply curves S4 and S5. The former represents relatively price-inelastic supply 0 < η4 < 1. This can be seen by interpreting the graph: as the price increases, quantity increases only slightly. The latter shows a price elasticity of supply greater than unity η5 > 1. In contrast to S4, as the price increases, the quantity according to curve S5 increases by much more. Economists distinguish between short-run and long-run supply curves due to the difference in their price elasticities. In the short run, supply is often assumed to be price-inelastic because the short run is defined by there being at least one fixed factor of production. In the long run, all inputs are variable and therefore supply tends to be more price-elastic, reflected in a flatter supply curve. Further reading The market for housing is a good example to gain an understanding of what can influence the price elasticity of supply. Using urban variation across the United States, Green, Malpezzi and Mayo uncover some key determinants of supply price elasticity in their article, “Metropolitan-specific estimates of the price elasticity of supply of housing, and their sources” (American Economic Review, 2005). Good to know The combination of price elasticity of demand and price elasticity of supply is what determines the respective sizes of consumer surplus and producer surplus in a market. In general, the less price-elastic demand (supply) is, the greater the consumer (producer) surplus. This is particularly relevant information when it comes to market interventions because it allows one to calculate which side of the market stands to gain most (or, more commonly, lose least) through a tax or other regulation on supply.
The price elasticity of supply for an item A ηA measures how the quantity of the item supplied qA changes in response to a change in the item’s price pA
Markets for goods and services have varying numbers of sellers, ranging from one (monopoly) to infinitely many (perfect competition). Oligopoly lies somewhere in between. In practice, industries with between two (duopoly) and six major players are considered to be in oligopolistic competition. Examples of oligopoly include the markets for mobile telephone networks such as Deutsche Telekom, Orange, Telefónica and Vodafone in Europe, the market for large passenger aircraft like Airbus and Boeing, and the market for soft drinks like Coca Cola and PepsiCo. The theory of oligopoly originated in 1838. French polymath Antoine Augustin Cournot observed a market for mineral water, which had two firms competing for market share. Realizing that neither firm could ignore the other’s supply of water in the market, Cournot analyzed the market as a game in which the quantity supplied by one firm q1 is a direct function of the quantity supplied by the other q2, i.e. reaction function q1*(q2) as shown in the graph on the left. Assuming that each firm sells an identical or homogenous product, faces identical costs and that the firms act simultaneously, equilibrium quantities supplied in the market are determined where the reaction functions cross q1*(q2*) = q2*(q1*). This was the first formal representation of a Nash equilibrium. It was over a century before John Nash published his general proof. In Cournot equilibrium, both firms make a positive profit and the market is supplied with more of the item at a lower price than in monopoly, but less of the item and at a higher price than in a perfectly competitive market. Figure 1: Nash equilibrium comparison between Cournot and Bertrand market scenarios Forty-five years later in 1883, another French professor, Joseph Louis François Bertrand, contended that Cournot’s analysis of oligopolistic competition was unrealistic since firms more commonly compete not on quantity but on price in the real world. Under the same assumptions of identical products or services, identical costs and simultaneous decision-making, Bertrand demonstrated how price competition in an oligopoly would instead result in zero profits for the firms, where prices would be set equal to marginal cost, just as in perfectly competitive markets. For this reason, firms in an oligopoly have an incentive to differentiate their products to a certain extent in order to profit from different buyers’ individual preferences. Some buyers will then not consider the products offered by each firm as perfect substitutes, rather they will be imperfect substitutes in consumption. The graph on the right shows the reaction functions of two firms in a duopoly where they offer similar but not fully identical products and compete on price. Note how in this situation, if one firm increases (decreases) its price, this prompts the other firm to raise (lower) its price as well. This contrasts with the Cournot case, where if one firm increases its market share (quantity), the other responds by reducing its supply in the market. As with Cournot, the Nash equilibrium in the Bertrand duopoly with product differentiation is at the point where the reaction functions cross and prices are set at p1*(p2*) = p2*(p1*). In real oligopolies, firms compete both by varying price and by varying quantity supplied. It may be argued that firms with long production processes, as in the case of passenger-aircraft manufacturers Airbus and Boeing, make strategic decisions about quantities supplied in the market rather than their prices (which can be adjusted later) and thus come closer to Cournot competition. On the other hand, market leaders that can vary their production at short notice, such as drinks manufacturers, are more likely to compete directly on price and hence fit the Bertrand competition model better. And in order to avoid suffering from zero profits, Coca Cola and PepsiCo do their utmost to convince us that their drinks are not identical! Further reading Jean Tirole won the Nobel Prize in Economics in 2014 for his for his analysis of market power and regulation. For a comprehensive treatment of oligopolistic competition, see chapter 5 of his text book, “The theory of industrial organization” (MIT Press, 1988). Good to know Rather than slaying each other in vicious price wars, firms competing in oligopolistic markets are often tempted to collaborate in pricing strategy and to coordinate supply in the market, in some cases merging their operations into a single entity. While this can sometimes benefit the industry and lead to better products, market concentration, the formation of cartels and price-fixing can be detrimental to the consumer. See the article on antitrust policies for further details.
An oligopoly is a market in which there are only a few sellers of the item being traded. The decisions of one seller thus affect the decisions of the other sellers in the market. Sellers compete strategically in the market by taking each other’s interests and actions into account.