\begin{equation*} \epsilon_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 demand is generally negative because people tend to demand more (less) of an item as its price falls (rises). Precisely how sensitive demand is to changes in price depends on many things. Some factors include the type of item being sold, the availability of substitutes, the type of buyer, and the time period considered. For example, basic food items such as bread tend to be price-inelastic: people adjust their demand in response to changes in price less than proportionately to the changes -1 < ϵbread < 0. This means that if the price of bread goes up 10%, quantity demanded will fall by less than 10%. On the other hand, let’s consider the rise in price of a particular type of bread (“special bread”). If other types of bread that represent good substitutes for it do not change in price, then people may respond by reducing consumption of special bread. This could happen in (potentially greater) proportion to the change in price, i.e. ϵspecial_bread ≤ -1, or result in the purchase of other bread to replace it (see cross elasticity of demand). Demand for special bread would then be said to be price-elastic. Whenever the quantity of an item demanded changes by at least as much, or disproportionately more, than a change in its price ϵA ≤ -1, the item is price-elastic. Tourism is one sector of the economy where items (transport, accommodation, food) tend to be very price-elastic: if holidays reduce (increase) in price then more (fewer) people will go on holiday. Indeed, the demand for any goods and services that are not necessary for daily life tends to be price-elastic. Of course, what is considered a necessity for one person may not be necessary for everyone else in the economy. This is relevant for sellers of items in the market who often try to group their customers by price sensitivity and practice price discrimination (offering different prices to different groups) wherever it is profitable. The demand curves for four standard theoretical cases of price elasticity are shown in the graph below. In the first case, the demand curve D1 is linear and downward-sloping. This implies that the price elasticity of demand for the item is negative ϵ1 < 0. However, note how price elasticity itself is not the same all the way along the curve. At high prices and low quantities, any change in price is small relative to the current price. Meanwhile any change in quantity demanded is large relative to the current quantity demanded. Demand is then price-elastic ϵ1 < -1. But at the other end of the curve where prices are low and quantities high, any change in price is large relative to the current price, while any change in quantity is small relative to the current quantity demanded. Thus demand is price-inelastic -1 < ϵ1 < 0. It is not unreasonable to expect that the price elasticity of demand for an item depends in part on where the current market equilibrium lies. This in turn is determined by supply too and is therefore not shown in this graph. The remaining three cases are less realistic but they form important benchmarks for demand theory. The second demand curve D2 is horizontal at a price of p2. In other words, the item is only demanded at a fixed price of p2. Any quantity of it is demanded at this price. The idea is that buyers are so sensitive to any change in price that quantity demanded will suddenly reduce to zero should the price go up. Inversely, demand will become infinite should the price go down. This is known as perfectly price-elastic demand ϵ2 → -∞. In practice, perfect price elasticity is improbable for any item. The third and vertical demand curve D3 represents the other extreme: quantity q3 is always demanded, irrespective of the item’s price. People simply do not react to price changes: demand for the item is perfectly price-inelastic ϵ3 = 0. Finally, demand curve D4, the only nonlinear example here, is special in that quantity demanded evolves exactly in proportion to any change in price. In this case, demand for the item is unitary price-elastic ϵ4 = -1. If the price decreases by 5%, quantity demanded rises by 5% such that total revenues from sales remain unchanged. Another key feature of cases 2 to 4 is that price elasticity of demand is constant in all of them, i.e. ϵA is the same at any point on the corresponding demand curve. Unrealistic perhaps, but music to the ears of theoretical economists! Figure 1: Various price elasticities of demand In rare cases, demand for an item can increase in response to a price rise. For such items the demand curve will slope upwards and the price elasticity of demand will be positive ϵA > 0. The phenomenon of conspicuous consumption is one such case: goods or services that are bought in part to display the wealth of the owner or user. More wealth can be shown off at higher prices! For more on this, see the article on normal and luxury goods. Another case is where price is a signal of quality, particularly for luxury items. If a higher price means the item has improved in quality then more of it may be demanded. Naturally, this only holds as long as buyers can distinguish between true and false signals of quality. Price elasticity is a static theoretical concept. Therefore there is no time dimension in the definition of price elasticity. However, in practice, it is important to consider the time frame for responses to changes in price. People may not change their purchasing behavior in the short term; if they simply fill the supermarket shopping trolley with the same goods every week, then short-term demand will be price-inelastic. In the long term however, demand for items is more sensitive as people become aware of price changes and are better able to adjust their buying decisions accordingly. <11an>limit:2;categories:Jobs|Courses|Programs|Conferences;disciplines:Financial Economics (JEL G)</11an> Further reading For a good appreciation of why price elasticity matters and an empirical overview of consumer sensitivity by food category in the United States for the entire period 1938 to 2007, see the study by Andreyeva, Long and Brownell, “The impact of food prices on consumption: a systematic review of research on the price elasticity of demand for food” (American Journal of Public Health, 2010). Good to know Governments have a keen interest in price elasticity of demand in order to judge where they can raise revenue through consumption taxes. In most economies, the government taxes tobacco products quite heavily. Some argue that this is done to discourage smoking for a healthier society. But the reality is that demand for cigarettes is price-inelastic: most smokers are addicted and will continue to purchase their regular dose regardless of price hikes through tax. The more price-inelastic an item, the greater its potential to provide juicy tax revenues. Of course, this introduces deadweight loss into a market, but it can be worth it if there is also a reduction in negative externalities (for example).
The price elasticity of demand for an item A ϵA measures how the quantity of the item demanded qA changes in response to a change in the item’s price pA.
The economic theory of production divides costs into two main categories, fixed and variable. Fixed costs, or overheads, cover expenses that do not depend on the level of output in the short term: the cost of purchasing or renting land, buildings and machines, and the cost of running them. Variable costs depend directly on the level of output and include the cost of inputs that vary with output, such as raw materials and hours of labour. Figure 1: Returns to scale as quantity increases Average costs, or unit costs, are simply the total of all fixed and variable costs, divided by the level or units of output. As shown in the graph, unit costs are relatively high at low levels of production, which is due to fixed costs. As output increases, average costs fall as the outlays for land, buildings and machines are spread over more units. The entity is said to be experiencing increasing returns to scale: it is good for it to grow (between 0 and q1 output in the graph). However, unit costs will not decline indefinitely as machines suffer wear and tear and need to be repaired or replaced, and more buildings and land are required for greater production. Unit costs may settle at a minimum amount for a range of output levels. No further cost savings can be made simply by varying output: the returns to scale are then constant (between q1 and q2 output in the graph). Eventually, it becomes difficult to manage very large levels of output and unit costs start to rise: the entity is now experiencing decreasing returns to scale (beyond q2 output in the graph). Economies of scale may not be due solely to production costs. Insofar as the entity is producing items for sale, conditions in the market for the items also determine economies of scale. It will only be profitable to increase production as long as there is sufficient demand for the item and/or the competition allows for it. This interdependence with the market makes it difficult to pinpoint the optimal size of an entity for efficient production. Although economies of scale make intuitive sense in theory, they are difficult to measure and judge in practice. A degree of risk is involved in decisions made by individuals and organisations about growing capacity through new investments in capital (i.e. fixed costs). Investments can increase production at a lower unit cost but whether or not positive returns (and thus true economies of scale) are achieved also depends on sales and revenue. It is seldom easy to know whether “small is beautiful”, “big is better” or “too many cooks spoil the broth”. Further reading George Stigler won the Nobel Prize in Economic Sciences in 1982 for his contributions to the study of market processes and industry structures. In “The Economies of Scale” he contends that an organisation’s optimal size can be deduced most easily by observing an industry over time, classifying each organisation in the industry by market share and determining within the distribution where market share is increasing and where it is decreasing (Journal of Law and Economics, 1958). Good to know In the digital era of the Internet and Big Data, increased computing power and lower data-processing costs create plenty of opportunities to achieve economies of scale. The emergence of Big Tech (firms such as Amazon, Facebook and Google) is clear evidence of this. Yet even the scale of these giants is limited by demand in their respective markets and, increasingly, by government regulations aimed at constraining their power.
Economies of scale are the savings that occur when an entity grows in size and can produce output more efficiently or at lower cost. Here, the word “entity” can refer to individuals, organisations or even entire nations.
Macroeconomics and Monetary Economics (JEL E)
\begin{equation} \mathit{YED}_{A} = \frac{\Delta\mathit{q}_{A}}{\Delta\mathit{Y}} = \frac{\frac{\partial{q}_{A}}{\mathit{q}_{A}}}{\frac{\partial{Y}}{Y}} \end{equation} In the market for any good or service, how much of it is demanded depends to a large extent on its affordability to buyers. An item’s affordability is determined both by the price at which it is offered and by the buyers’ available budgets. While price elasticity of demand gauges the sensitivity of buyers to changes in the item’s price (it measures pricing sensitivity), income elasticity of demand considers the relationship between budgets and quantity demanded. The concept of income elasticity is used to classify goods and services into two main types: normal and inferior. A normal good or service is one whose demand moves in the same direction as income. That is, if the buyer’s income increases (falls) then the buyer will demand more (less) of the product. In this case, YEDA > 0. On the other hand, an inferior good or service is one whose demand moves in the opposite direction to income, YEDA < 0. Examples of normal items include consumer goods and services such as clothes, electronic goods, general transport services and theatre and concert tickets. Consumers generally want more as they become better off. Normal goods and services can be subdivided further into the categories of basic necessities and luxury items. Basic necessities are items whose income elasticity of demand is inelastic, 0 < YEDA < 1. That is, demand does respond positively but it does not rise or fall by as much as income in response to any change in income. As its name suggests, demand for a basic necessity is less sensitive to a change in income: the buyer needs it! In contrast, a luxury item is one whose demand increases as soon as it becomes affordable; its income elasticity of demand is said to be elastic, YEDA > 1. Inferior goods and services include food staples such as bread and shared transport such as public bus services. When income rises and thus demand falls for an inferior good or service, its consumption is typically replaced by an alternative item with a higher income elasticity of demand. For example, consumers may switch their income away from bread in order to consume more meat, or they may purchase a private car or other, more comfortable form of transport to substitute for their public-bus journeys. Figure 1: Various income elasticity of demand depictions Income elasticity of demand is often described graphically using an Engel curve (named after the German statistician Ernst Engel). This is a plot of quantity demanded graphed against income (not to be confused with a demand curve, which shows the relationship between prices and quantity demanded!). In the graph, the 45° dashed line through the origin represents proportionate responses of buyers to changes in income, i.e. unit income elasticity of demand, YEDA = 1. Along this line, if buyers’ income increases by 10% then their demand for the item also rises by 10%. The special cases of normal goods, necessity and luxury, are easily discernible in relation to this dashed line; inferior goods are recognisable by the negative relationship between income and quantity demanded. Further reading Aitchison and Brown provide further forms of Engel curves in their article, “A Synthesis of Engel Curve Theory” (The Review of Economic Studies, 1954) and point out that what constitutes a necessity for one income group in the economy may in fact represent a luxury for another income group. Hence their thesis is that Engel curves should be curves rather than straight lines! Good to know Economists are often criticized for assuming that more is always better. This may be an unfair claim. Economists tend to focus on the maximization of individual utility (read: happiness!), which need not always rise with income and consumption. At some point, consumption is saturated. This is manifested through the large gifts and donations that the rich often make to others in the form of charity. Income elasticity of demand is also very relevant in Development Economics; income elasticity tends to be higher at lower levels of economic development.
The income elasticity of demand formula YEDA is a measure of how the quantity demanded of an item A qA in a market is affected by a change in income Y on the demand side of the market:
Common examples of adverse selection include the market for insurance and the labour market In the insurance market, providers know less about their customers’ risk levels than the customers themselves, and riskier customers have a greater interest in purchasing insurance. Risky customers then dominate the insurance market, increasing the cost to providers because there are more claims from such customers. The price of insurance (the insurance premium) then rises, which also affects less risky customers, who may then choose not to purchase insurance coverage at all. Adverse selection thus leads to a smaller, less efficient market than a market in which insurance companies knew everything about their customers In the labor market, employers know less about job candidates than the candidates themselves, and unsuitable candidates are attracted to job descriptions and job adverts promising good salaries and working conditions. When such candidates apply for jobs they dilute the pool of potential employees and, in the absence of a mechanism for employers to screen candidates for their suitability, this reduces the value of employees to the employers, who in turn offer lower wages and benefits. Suitable candidates are then less attracted to the jobs. Again, adverse selection leads to a less efficient market than one in which employers had full information about job candidates. Adverse selection is potentially very harmful as it can mean that some people obtain jobs where they will do serious damage to others. A particularly dark example of this is child molesters being attracted to jobs which grant them access to children, such as schools and clubs providing activities for children. Not only do unlucky children then suffer, but trust in the market is eroded and the “right” people stop participating in the market. This is why the teaching profession is highly regulated and laws exist to enforce a thorough screening of applicants for such roles. Further reading George Akerlof is one of three economists to have won the Nobel Prize in Economics in 2001 for analyses of markets with asymmetric information. In “The Market for Lemons: Quality Uncertainty and the Market Mechanism” (Quarterly Journal of Economics, 1970) he analyzes adverse selection in the used car market where sellers of used cars have superior information about the cars’ true quality than buyers. Akerlof demonstrates how sellers of low-quality cars (“lemons”) flood the market, lowering prices and thus preventing owners of high-quality cars (“peaches”) from obtaining a fair price for their cars. Good to know The problem of adverse selection can be mitigated through the design of appropriate mechanisms to discourage unwanted players from entering the market and/or to encourage favorable players to enter the financial market. In the case of health insurance or any type of insurance, providers practice price discrimination, offering lower premia to customers who provide evidence of being low-risk, and they may also charge excess fees in the case of claims in order to share risk with the customer. In the case of the labor market, employers may initially offer a period of probation with poorer conditions (lower salary and benefits) to new employees such that only suitable candidates who are sure of passing probation apply for the job in the first place.
Adverse selection occurs as a case of asymmetric information whenever a more well-informed market player uses information to take advantage of another player in the market who does not hold that information. In turn, this adversely affects participation in the market.
In classical economic theory, information is assumed to be complete and evenly distributed among market players: each player knows how the other players value the items being traded in the market. This simplifies the analysis of the market because the players’ actions will be certain and predictable. Market outcomes (prices and quantities) can then be easily calculated. However in reality, market players tend not to know everything about each other. That is, information in the market is asymmetrically distributed. Information is valuable, and better informed market players can take advantage of their superior information to achieve better outcomes than less informed players. For example, sellers of goods typically hold more information about the goods they are selling than do prospective buyers. Sellers can reveal information that makes the goods seem more valuable to buyers, while not disclosing any information that would reduce their value to buyers. The price of the good will then be higher than it would have been in a market with complete information. This is one reason why firms spend so much money on marketing and advertising! Other asymmetric information examples include if a homeowner wanted to sell their house, they would have greater information about it than the buyer. Asymmetric information refers to this unequal knowledge between buyers and sellers. Asymmetric information can also be present in financial markets, where insiders or large investors have access to information that is not available to the general public, giving them an unfair advantage in making investment decisions. In all of these cases, one party has more information than the other party, which can create an imbalance. Understanding the structure of information in a market (i.e. how the information is distributed: who knows what about whom) is crucial for predicting what will happen in that market. This can be more important for predicting outcomes than holding the information itself. Where there is asymmetric information, it is often useful for the less informed player to elicit information from the better informed player. A whole branch of microeconomics is devoted to the design of mechanisms (protocols, sets of rules) to reveal information about valuations that would otherwise be hidden, in order to increase efficiency in the market. An example of this is the public licensing of airwaves for mobile telephone networks. In the advent of mobile telephony, governments claimed the rights to the airwaves under their jurisdiction but they did not know how much telecommunications firms were willing to pay for them. Economists were commissioned to design auctions that would give the firms an incentive to bid up to their reservation prices (i.e. be truthful about their valuation of the airwaves). This raised billions of dollars for the public purse that may otherwise have remained within the profits of the private telecommunications firms. What was important was that governments had recognised their own ignorance and the nature of the information asymmetry, and acted accordingly. Further reading on asymmetric information Joseph Stiglitz is one of three economists to have won the Nobel Prize in Economics in 2001 for analyses of market failures with asymmetric information. For a good and very readable overview of how information affects economic outcomes, see his working paper, “The Revolution of Information Economics: The Past and the Future” (National Bureau of Economic Research Working Paper No. 23780, 2017). Good to know The labor market is full of information asymmetries. Employers usually know more about the jobs they need done than potential employees, while candidates who are applying for jobs know more about their own strengths and weaknesses than potential employers. The recruitment and selection process is geared towards revealing hidden information about candidates in order to achieve the best match for the employer. Candidates too have an interest in assessing potential employers and learning more about the jobs on offer before signing up to them. Understanding and applying the theory of asymmetric information can help you to find the job that is right for you!
Asymmetric information in economics refers to a state where market players have different levels of information about each other’s valuations of the market. As such, their information is asymmetric, or asymmetrically distributed.
Ceteris is Latin for “other things” and paribus means “equal”, so the literal translation is “other things being equal”. The concept of ceteris paribus in economics it is generally understood to mean that all other things remain equal or are held constant while dealing with the issue at hand. Video Note: In the video, “ceteris” is pronounced with a "ke". However, in many other places it will be pronounced “se". Our research says either is fine. Our narrator just found it more natural in their accent to say the former. But if you have strong feelings about Latin pronunciations do let us know. As an example of ceteris paribus analysis, one may wonder what the impact of introducing a minimum wage will be on the level of employment in an economy. A basic economic analysis of the labor market, as shown in the graph just below, might consider employers’ demand for labor D and (potential) employees’ supply of it S, quantified in hours worked per period for a particular hourly rate of pay. Demand for labor increases as the hourly wage falls since it becomes cheaper to hire workers. On the other hand, the supply of labor increases as the hourly wage rises because it is more attractive for people to work at higher wages. In this free labor market, equilibrium is where demand meets supply and h* hours are purchased by employers at the hourly wage of w* (the market-clearing rate of pay). Figure 1: Involuntary unemployment in the labor market All else equal, ceteris paribus, if a minimum wage Wm is introduced that is higher than the market-clearing rate of pay w* then employers will demand less labor and there will be a reduction in employment (total hours worked decrease from h* to hm), creating involuntary unemployment. Although there are workers in the labor market who would like to supply more hours’ work than hm at the minimum wage Wm employers are unwilling to pay for more than hm hours at the new rate. Note how this basic analysis ignores other effects of the increase in wages, such as what happens to the workers who remain in employment. Because we specified ceteris paribus, we would not be concerned with those other effects. However, extending our analysis, those still in employment now earn more per hour and may spend their extra earnings, increasing their demand for goods and services. This could end up creating more employment than the graph suggests. The workforce could also become more productive if employers choose to shed less productive employees first. This would normally make the economy more competitive with other economies, leading to greater exports. In turn, (domestic) employers will again increase their demand for labor. The above example of ceteris paribus analysis with its conclusion that “a minimum wage creates unemployment” also ignores the effects of other things that are potentially happening simultaneously. The supply of labor might be growing or shrinking due to demographic changes, or the effects of a new income-tax or child-benefit policy introduced at the same time. A more realistic economic model might attempt to incorporate some of these complexities. But, one of the core reasons we specify ceteris paribus is to simplify an analysis and focus on the effects we’re interested in. A ceteris paribus approach thus typically involves partial equilibrium rather than general equilibrium analysis and focuses on the short term rather than the medium or longer term. While this may not seem satisfactory from a practitioner perspective, there is an advantage to simplifying the world through ceteris-paribus modelling: it allows the analyst to concentrate on one mechanism at a time and to try to understand and explain causal relationships. As long as the economic analyst is careful not to overstate claims, a ceteris-paribus analysis often offers more insight than do ambitious attempts to explain everything that is happening at once throughout the whole economy. Further reading The philosopher and economist Daniel Hausman provides a critical account of deductivism in economics and how ceteris paribus has been (mis)used by economists over the years in “Economic Methodology in a Nutshell” (Journal of Economic Perspectives, 1989). Good to know Although the real world is generally too messy to test economic theories that rely on ceteris-paribus assumptions, there are ways to get around this. Behavioral economists design experiments that essentially create ceteris paribus conditions within a controlled laboratory setting. Participants in the experiments are asked to make decisions under certain conditions. The experimenter is then able to isolate the direct effects of policy changes by altering one condition at a time while holding all else equal: ceteris paribus!
When economists say “ceteris paribus” they are talking about the direct effect of X on Y while assuming that the rest of the world stands still.
Econometrics, Statistics and Quantitative Methods (JEL C)
In economic theory, free markets are beneficial to society because they allow consumers and producers to exchange goods and services for money according to their own maximization of personal utility. Both sides of the market gain at the equilibrium price; we call these gains consumer surplus and producer surplus. In a simple economy with just one market, the sum of consumer and producer surplus equates to social welfare: the market is then understood to be doing something good for society. If the government decides to intervene in a market, for example by levying a tax on an item which is being sold by producers to consumers, then this will force a new equilibrium in the market. Consider the market in the graph below, with producer supply S, consumer demand D and a free-market equilibrium of q* units sold at p* per unit. If the government introduces a simple unit tax (a certain amount of tax per unit of the item sold) to be collected from the producers, this forces a parallel shift of the supply to the left and an effective new supply curve of S’. This shift occurs because the tax increases the cost of selling the item, which reduces the amount of the item that producers wish to sell as they make less profit off of it. The new equilibrium point is where D crosses S’ at a quantity q’ and a retail or consumer price of p’cons. Although the item is sold at price p’cons this new price includes the tax and the producer only receives the price p’prod per unit. The government then receives (p’cons – p’prod)q’ in tax revenue. Figure 1: Deadweight loss produced from a tax on a competitive market Note how the new quantity q’ is less than the original quantity q* (since less of the item is bought at a higher price). Therefore both consumer surplus and producer surplus are reduced. Some of the original consumer surplus and producer surplus has been transformed into tax revenue for the government. However, the government is not able to recoup all of the reduction in total surplus from the original free-market equilibrium. This is because the tax induces less of the item to be exchanged in the market. Some of the benefits to market participants from the original equilibrium have simply vanished as some units are no longer traded at all. This is represented by the gray shaded triangle in the graph and it is known as the excess burden of the tax, or a deadweight loss. The size of the deadweight loss is determined by the elasticities of supply and demand. A deadweight loss is a loss in economic efficiency: before the unit tax, social welfare was higher than after its introduction. Deadweight losses, which are caused by market interventions, are often cited by proponents of a free market economy when arguing for smaller government, less regulation and lower taxes. However, such arguments tend to be somewhat simplistic. In reality, economies are made up of many markets and the actions of participants in one market often have implications for individuals elsewhere in the economy. Government interventions can be very practical responses to market failure. If the market in the example above were that for cigarettes and it were left unregulated and untaxed, cigarette producers and smokers would benefit from their respective surpluses. A unit tax on cigarette packs would reduce those surpluses and there could be a deadweight loss in the market. Yet smoking causes illness and in a society where healthcare is publicly provided, the treatment of smokers’ conditions has to be financed. In addition to the smokers’ potential health problems (the care of which must be funded by taxpayers), they produce another negative externality - secondhand smoke - that may cause health problems for other individuals who are not participating in the cigarette market. Externalities like this one often require taxes to force the market to achieve the socially optimal level of trade. In this case, the unit tax on cigarette packs would reduce the number of cigarettes sold as well as the amount of negative externality produced. Thus, it may be beneficial to society as a whole to have a unit tax on cigarette packs. This shows how a deadweight loss in one market, while still an irrecoverable reduction in efficiency in that particular market, can sometimes be compensated by gains elsewhere in the economy. Further reading Some economists claim that the act of gift-giving is economically inefficient since the giver is typically not perfectly informed about the recipient’s preferences. Logically, a transfer of money that allows the recipient to choose items for themselves would be more efficient than a guess by the giver as to what items the recipient likes. Projected to whole markets at festive times of the year when (non-monetary) gifts are exchanged, this can invoke deadweight losses in the economy. See Joel Waldfogel’s provocative article, “The Deadweight Loss of Christmas” (American Economic Review, 1993). Good to know Some governments restrict the supply of knowledge, e.g. through book-burning, the blocking of internet sites or excessive control of school curricula. This generally results in a significant deadweight loss for society. While such acts may allow governments to achieve certain short-term aims, reducing knowledge in society will stymie progress and growth, making the economy less competitive in the long run. Reinventing the wheel is always inefficient! <o:p></o:p>
A deadweight loss is the cost to society from economic inefficiency that occurs when a free-market equilibrium cannot be reached. This can be due to a market intervention like a price ceiling, the dominance of a monopoly, or some other shock to supply and/or demand.
Public Economics & Economic Policy (JEL H)
For example, the production of fruit and vegetables requires sufficient land of the appropriate type with water and sunlight. It also requires labor and machinery to plant, cultivate and harvest the crop, as well as packaging and people or machines to present the produce for sale. Similarly, the production of a school education requires trained teachers and administrators, books and other learning materials, as well as buildings and/or other space to host the education. Applied to the first example of producing fruit and vegetables, the law of diminishing marginal returns implies that increasing the input of one factor such as land, while holding the input of the other factors (labor and machinery) constant, will increase the amount of the fruit and vegetables produced at a decreasing rate as more land is added. That is, each additional square meter of land, for fixed levels of the other factors, will yield smaller increases in output of fruit and vegetables. Applied to the second example, the first teacher or the first book will add much to the education provided. But, each subsequent teacher employed without increasing the availability of learning materials, administrators, or physical space, will expand education at a decreasing rate. The law of diminishing marginal returns can be represented graphically in two dimensions with the (total) return R as a concave function of the input i of a single factor of production (while the inputs of other factors are held constant). As more of this single factor of production is employed, for the same unit increases in input Δi, the additional (i.e. marginal) return diminishes ΔR” < ΔR’ < ΔR: Figure 1: Law of diminishing marginal returns for a revenue function At first glance, the law of diminishing marginal returns might seem to contradict the concept of economies of scale whereby increasing inputs should generate increasing, not diminishing, returns. Note however that the law of diminishing marginal returns relates specifically to varying the input of a single factor of production while holding all other factors constant. As such, it implies that different factors of production are not perfect substitutes for each other; instead, there is a degree of complementarity between input factors. You might be able to bake a larger cake by adding a bit more flour but if you do not also increase the quantities of eggs, sugar and oil the cake is liable to become dry and tasteless! Its description as a “law” makes the law of diminishing marginal returns sound grand and as indisputable as a law of physics. In fact, it can be considered more of an assumption of the theory of production. As with all assumptions, it is open to challenge. Indeed, some economists argue that marginal returns to input factors are increasing at low levels of production. The law of diminishing marginal returns thus may not apply to all forms of production and therefore should be treated with caution. Further reading The economist Stanley Brue presents a critical history of the law of diminishing marginal returns in economic thought, highlighting the lack of empirical evidence to support it, in “Retrospectives: The Law of Diminishing Returns” (Journal of Economic Perspectives, 1993). Good to know The law of diminishing marginal returns does apply to learning, and in particular to exam preparation: the first hour spent cramming for an exam is generally more productive than subsequent hours. It is important to balance individual learning with dialogue, discussing and questioning the content with others. Experimentation with different input quantities can help you to maximize the returns to your education!
The production of goods and services requires the input of various factors of production. The law of diminishing marginal returns states that as the input of a factor of production increases, ceteris paribus, the additional output from each additional unit of that input decreases.
The following graph shows the demand curve for a typical good or service. As the item’s price (vertical axis) falls from pD1 to pD2 to pD3, the quantity demanded (horizontal axis) rises from qD1 to qD2 to qD3, and vice versa. As price rises, quantity demanded falls. Figure 1: A linear demand curve Note how the demand curve shown might be representing the preferences of a single individual for the item: the individual decides to buy more (less) of the item as its price falls (rises). This movement along the demand curve shows the inverse relationship between price and quantity demanded, which is known as the law of demand. Alternatively, it represents the quantities of the item demanded by all participants in the market at various prices, i.e. the market demand curve. The market demand curve is simply the sum of all individual demand curves for the item in the economy. In general, firms will be interested in estimating market demand rather than individual demand for their products and services. A demand curve need not be linear (hence the name “curve”!) and its slope at each point represents (but is not the same as) the price elasticity of demand. This shows how sensitive the individual is or consumers in the market are to changes in price. Demand curves are drawn at a given level of income for the individual or consumers in the market. Should the income level change, the demand curve will shift inwards (shift to the left) or outwards (shift to the right), depending on whether income has risen or fallen and the item’s income elasticity of demand. For “normal” consumer goods and services, greater quantities will be demanded at every price if income rises and the demand curve shifts outwards to the right. For so-called “inferior” consumer goods and services, lower quantities will be demanded at each price if income rises. The demand curve will shift inwards to the left, as consumption of such goods and services is replaced by consumption of other goods and services that have become affordable due to the rise in income. A special case arises when people buy goods and services in order to display their income or wealth to others, so-called “conspicuous consumption”. In this case the demand curve can be upward-sloping because the item’s value to the individual rises as price increases. This is because the show-off, social-status power of the item rises, the higher its price. Such items are typically branded as “luxury” and are known by economists as “Veblen” goods or services due to the economist and sociologist Thorstein Veblen who first studied them. In practice, demand curves can be estimated by experimentation with price changes, observing consumer behavior for similar products or by surveying consumers about hypothetical changes in prices. Economists will generally choose to observe actual behavior rather than rely on hypothetical claims, i.e. revealed preferences are more meaningful than stated preferences. Market research is a huge industry but it essentially boils down to understanding the relationship between price and quantity and calculating demand curves. Further reading Most introductory economics text books cover the theories of demand and supply extensively. Often, the supply curve is discussed alongside the demand curve, and together these determine equilibrium price and quantity in a market. For a more in-depth understanding of the demand curve, a neat critique of Alfred Marshall’s original theory of demand is presented by the free-market economist and 1976 Nobel prize winner Milton Friedman in “The Marshallian Demand Curve” (Journal of Political Economy, 1949). Good to know Many firms today conduct real-time analysis of customer demand and engage in “dynamic pricing”. Understanding how willingness-to-pay changes at different times of the day, week or year and differentiating prices accordingly allows producers to capture some of the consumer surplus for themselves. The markets for electricity and air travel are examples where dynamic pricing has become standard practice. As a consumer it is, therefore, often worth observing how prices change over time before making important purchases.
A demand curve shows the relationship between the price of a good and the quantity of the good demanded, either by an individual or by all participants in the market. Demand curves are downward-sloping for most items as greater quantities are demanded at lower prices.
A basic economic idea is that the price for a good or service will eventually settle at a point when quantity demanded and quantity supplied are equal (assuming all other factors remain equal). This is referred to as the equilibrium. Our article on market equilibrium describes how this process works in the economy. The consumer side of market equilibrium is demand. Quantity demanded depends, with all other factors being equal, on the price of the commodity. Of course, all other factors are never constant: other goods in the market, the preferences of consumers, and many other things influence the demand for a good. The demand curve generally slopes downward, showing that consumers want more of a product when it is cheaper, and less when it is more expensive. Demand is also dependent on many other factors: whether complements or substitutes are available, the amount of income the consumer has, the elasticity of demand, and more. Meanwhile, the supply curve typically slopes upward. This shows that firms like to sell goods that have higher prices, and will offer to sell a large quantity of a good if the price is high. But when the price is low, firms offer less of the good for sale. Other factors that influence supply include production costs, the difficulty of competition, the presence of taxes or subsidies, and more. For more about supply and demand, and how they interact, see our article about Market Equilibrium.
“Supply and demand” is probably one of the first things people learn about economics. Supply refers to the quantity of a product or service that producers are willing to supply at each price, while demand refers to the quantity consumers are willing to buy at each price at a given point in time.
A simple example of this: the opportunity cost of using a machine to make and sell one product (call it Product A) is the lost potential revenue from selling another product (Product B) that could have been made using the machine instead. That is, Product B cannot be produced, and its unrealized revenue is the opportunity cost of using the machine to make Product A. If Product A is worth €50, and Product B is worth €35, then this opportunity cost for making Product A is €35 - €50 = -€15. For Product B, it is €50 - €35 = €15. This might seem confusing at first, but it makes logical sense. A suboptimal choice (Product B) should have a positive opportunity cost, because it eliminates the chance for a higher return by choosing the better alternative (Product A). Meanwhile, Product A’s opportunity cost is negative because the “cost” of choosing Product A is the “opportunity” to make a worse choice and lose money. To extend this example, if the machine involved in production is specialized to only make Product A, it may seem like there is no opportunity cost involved in the production process. Since the machine couldn’t produce anything else anyway, no “sacrifice” of other products is needed. However, this is not correct. The resources used as inputs for Product A have an opportunity cost of whatever next-best purpose they may have been used for. This opportunity cost is known as an implicit cost, since money is not actually exchanged. On the other hand, explicit costs are simply the money given out. In this case, the explicit cost is the price to buy the specialized machine. Opportunity cost considers both explicit and implicit costs, which is a key difference between opportunity cost and how cost and profit are typically measured in accounting or business contexts. You might be wondering where we stop counting additional opportunity costs. If this company sold Product A for €50, what is the opportunity cost? The lost chance to sell Product B for €35 instead? Or is it the lost chance to make and sell Product C for €15? When we count opportunity cost, usually we only consider the “next-best” option. In this ongoing example, the opportunity cost of selling Product A is the profit from Product B that could have been made instead. We do not consider Product C or other alternatives. This is because those other alternatives are worth less than Product B. If selling Product A was suddenly impossible, the rational, utility maximizing choice would be to sell Product B instead. Opportunity cost is concerned only with the next-best option, not every possibility under the sun. Thus, we do not need to consider Product C or other options less valuable than Product B. A further application of opportunity cost is in international trade. The theory of comparative advantage states that it is most efficient for different countries to specialize their production in the goods that they have the lowest opportunity cost of producing. Then, they trade with other countries to acquire the other goods they need. In this way all countries benefit, and economic efficiency is achieved. Good to Know A good manager should always be considering business decisions in the context of the next best alternative. Even if a business move is profitable (in an accounting sense), without considering opportunity costs, it might not be the best choice available. As an example, opportunity cost can be used in tandem with return on investment (ROI) and risk analysis to analyze business decisions. Risk measures the potential (expected) outcomes of a choice, while ROI measures the expected return of a choice compared to its cost of implementation. These are common methods used to compare options, choosing a low-risk, high-ROI option, ceteris paribus. Opportunity cost adds context to this analysis by including a different perspective. Unlike risk analysis and ROI, it compares the actual outcomes of different choices to one another. Thus, the best choice is one with the lowest opportunity cost after accounting for the potential risk of each option, and the relative cost of implementing them. Of course, it is impossible to know the actual cost or the actual risk of a decision before it is made. Thus, these analyses are never perfect unless they examine decisions or events that already took place. So, it is often quite difficult to know the actual opportunity costs before they occur! Now, what was the opportunity cost to you for reading this article?
Opportunity cost refers to the loss of the next-best positive outcomes of a choice when an alternative decision is made. In other words, the next best alternative that is given up is the opportunity cost. This cost does not only refer to money, but any lost benefits that the other choice could have bestowed. Opportunity costs are involved in every decision that is made, even if they are not obvious at first.
\begin{equation*}\epsilon_{AB} = \frac{\Delta\mathit{q}_{A}}{\Delta\mathit{p}_{B}} = \frac{\frac{{dq}_{A}}{\mathit{q}_{A}}}{\frac{{dp}_{B}}{p_B}}\end{equation*} In microeconomics, individuals' utility (or material well-being) is assumed to depend on their access to, or consumption of, bundles of items. It is also contingent on individuals seeking to maximize their utility. The precise relationship between the consumption of particular items and an individual’s utility is determined by the person’s preferences. Individuals are constrained in their consumption by their budgets and by the prices of the items. If the price of an item increases, then the individual’s ability to obtain utility through consumption of that item is reduced. It may be possible to obtain utility more efficiently through consumption of a different item instead. The extent to which this is possible depends on the substitutability of other items with the item whose price has increased. For example, an individual may like to consume hazelnuts and peanuts. Ideally the individual likes to consume both types of nuts (due to diminishing marginal utility). However, if the price of one nut type – say peanuts – increases, then the individual can afford fewer peanuts. This would lead them to reduce peanut consumption and replace some of this product with hazelnuts. Hazelnuts and peanuts are thus substitutes in consumption. Note that the reverse is also true if the price of peanuts falls and becomes more affordable. The individual will then obtain utility more efficiently by reducing hazelnut consumption and increasing peanut consumption. This means that in the case of substitutes, the cross elasticity of demand is positive ϵHazelnutsPeanuts > 0. The interrelationship between items is key in the cross elasticity of demand. Some items are consumed together as complements rather than as replacements or substitutes. For example, fuel is required to power vehicles. If the price of either one of these items changes, demand for both goods will move in the same direction. If the price of vehicles increases then demand for the vehicles will fall. Because of this the demand for the fuel that powers the vehicles will also fall. Likewise, if the price of fuel rises then demand for both fuel and vehicles will fall. So, in the case of complements, the cross elasticity of demand is negative ϵFuelVehicles < 0. Other items have conceivably very little to do with each other. For example, if the price of yogurt changes then this would not be expected to affect the demand for smartphones. The cross elasticity of demand between these items should be close to zero ϵSmartphonesYogurt ≈ 0. However, note that if an item that makes up a large or necessary part of individuals’ budgets becomes less affordable, people might buy fewer goods in general because they are relatively poorer. This will then lead indirectly to change in the demand for other seemingly unrelated items. For example, if smartphones triple in price, people might decide they need smartphones but end up buying much less yogurt because they have less leftover money to spend. But, this still doesn’t mean that smartphones and yogurt are truly substitutes; there’s a different effect at play. See income elasticity of demand for details about this type of effect. As with the standard price elasticity of demand for a single item, a cross elasticity of demand can be elastic (IϵABI ≥ 1), unit elastic (IϵABI = 1), inelastic (IϵABI < 1), perfectly inelastic (IϵABI = 0) or (in theory) perfectly elastic (IϵABI → ∞). This reflects the extent of the change in quantity demanded relative to a change in price. Further reading To better understand the difference between substitutes and complements and its importance for policy makers, read “Marijuana and Alcohol Evidence Using Border Analysis and Retail Sales Data” (2018). This paper from researchers Baggio, Chong and Kwon from the University of Connecticut and Georgia State University reflects on the effect of legalizing cannabis on the consumption of alcohol. More generally, it has recently been reported that current cross-price elasticities are lower than previously estimated (Auer and Papies, Journal of the Academy of Marketing Science, 2019). The median estimate of ϵAB is about 0.1, implying typically only a small degree of substitutability between items. The authors mention firms’ focus on the development of brand loyalty as one reason why consumers may switch less between items than traditional economic theory would predict. Good to know The United States Department of Agriculture Economic Research Service provides a data tool to access estimates of price elasticities. This includes cross elasticities of demand, both for major commodities and countries (particularly the USA and China). The estimates are derived from research published by US academic and government sources.
The cross elasticity of demand (or cross-price elasticity of demand) ϵAB refers to the sensitivity of the demand for item A qA to changes in the price of item B pB:
In microeconomics it is assumed that firms aim to maximize profits. They can do this by reducing unit costs through economies of scale, and/or by growing big enough to push competing firms out of the market, thus reducing competitive price pressure on their revenues. Some firms seek to grow big quickly by taking over, merging, or coordinating activities with other firms. Such collaboration between firms is known as a “trust” and it can lead to a reduction in market competition with higher prices for consumers. The existence of a trust can also act as a barrier to entry, making it more difficult for smaller firms to participate in the market. Governments representing consumers and smaller firms may hence choose to intervene in the market with legislation against the trust, i.e. antitrust policies. Antitrust policies gained prominence through the (US American) Sherman Antitrust Act of 1890. This Act outlaws the formation of monopolies and other practices that restrict trade. One of the most famous antitrust cases is that of the Standard Oil Company founded by John D. Rockefeller. By the early 1900s, Standard Oil had grown both organically (by increasing its own sales) and inorganically (by purchasing competing firms as well as client and supplier firms) to control an estimated 90% of the US market for petroleum. In 1911 the US Supreme Court ruled that Standard Oil constituted an illegal monopoly. The Court concluded that Standard Oil had restrained trade through its dominance of the market, increasing prices, lowering output, and diminishing the quality of the oil traded. The Court ordered that Standard Oil be divided into 34 separate entities. National governments subsequently set up agencies to design and implement antitrust policies. Such agencies include the Federal Trade Commission (USA), the Competition and Markets Authority (UK) and the Federal Cartel Office (Bundeskartellamt, Germany). Antitrust policies are also enshrined in European law, through Articles 85 and 86 of the European Community Treaty of Rome and Articles 101 and 102 of the Treaty on the Functioning of the European Union. In addition to lower output and higher prices, having one firm dominate a market and restrict competition can cause a lack of innovation for the product or service and a reduction in the choice available to consumers. Such reasoning was used in the case against Microsoft in the late 1990s and early 2000s regarding its dominance of Operating Systems for personal computers which were restricting the use of software provided by competitor firms. The European Commission won the case and Microsoft was forced to pay substantial fines and to make its source codes available to other producers of software. The European Commission highlights cartels and the coordination of prices and sales between supposedly competing firms as “the most flagrant example of illegal conduct infringing Article 101”. A well-known case of price-fixing involved the common surcharges for fuel levied by British Airways and Virgin Atlantic for their long-haul flights between 2004 and 2006. Although both airlines profited from the scheme (through higher prices paid by passengers) the deal ultimately failed because there was an incentive for whistle-blowing: Virgin Atlantic reported the collusion to the UK Office of Fair Trading and only British Airways was fined for the illegal activity. Occasionally, governments contradict themselves due to the national and international dimensions of antitrust policies. While a national government can be keen to stimulate competition in its domestic market through policies that deter monopolies and cartels, it may also be under pressure to represent “national champion” firms that compete in international markets. For example, the French electricity provider EDF received state aid in the form of lower corporation tax at the time the European market for electricity was being liberalised, strengthening the firm’s ability to compete against other large European suppliers. However EDF was also accused of using its dominant position in the French market to reduce output and raise the price of electricity for French consumers. It should be noted that more competition is not always conducive to a better market for consumers. Intense price competition should lower prices but it can also reduce the quality of goods and services provided. So-called “natural” monopolies that are forced to break up in the name of antitrust simply for being big are not always substituted well. For example, a national mail firm charged with delivering mail is able to provide complete coverage of a country by compensating less profitable areas through its revenues from highly profitable areas. However if the firm is split and sold then profitable areas such as large cities with high population density will tend to see a better delivery service while remote areas can suffer due to a lack of profitability. A similar example is that of public-transport networks. Thus, in order to serve the consumer, good antitrust policies should be applied on a case-by-case basis. <11an>limit:2;categories:jobs|courses|conferences;disciplines:Law and Economics (JEL K)|Microeconomics (JEL D) </11an> Further reading Herbert Hovenkamp has written extensively on antitrust policies in the United States from both legal and economic perspectives. For an introduction and brief history of antitrust policies, see his article, “The Antitrust Movement and the Rise of Industrial Organization” (Texas Law Review, 1989). Good to know Antitrust policies are still very much a hot topic, particularly regarding big-tech firms such as Facebook, Alphabet (Google) and Amazon. These firms boast revenues that outstrip the Gross Domestic Product of some smaller nations and they wield political power on a global scale through their control of people’s personal data and the information that people receive. The international coordination of antitrust policies is a key challenge in today’s world.
An antitrust policy is a law or other government regulation that limits the dominance of large firms and promotes competition in the market.
In competitive markets for consumer goods and services there are typically many producers selling the items and many consumers purchasing them. Participation in the free market is more attractive for producers, the higher the price at which they can sell their product. The quantity of the item offered on the market thus increases as the price increases and the supply curve is generally upward-sloping. Conversely, participation in the market is more attractive for consumers, the lower the price at which they can purchase the item. The quantity demanded thus increases as the price falls and the demand curve is generally downward-sloping. The market equilibrium, consisting of the item’s price p* and quantity q* bought and sold, is determined where supply meets demand, i.e. where the supply and demand curves cross. For lower quantities of the item than q*, consumers in the market would be willing to pay a higher price than p*. However in the equilibrium they are able to purchase and consume all q* of the item at price p* per unit. The difference between the higher prices they would have paid for the lower quantities and those lower quantities priced at p* is the consumer surplus. This is a gain for consumers in terms of the value that they attach to the item in excess of the price they pay for it. The consumer surplus is represented in the graph below by the area below the demand curve D stretching to price level p*. Figure 1: Depiction of consumer and producer surplus in a competitive market Similarly, for lower quantities of the item than q* producers in the market would be willing to accept a lower price than p*. This is because typically it’s cheaper to produce fewer units. However, in the equilibrium they are able to sell all q* of the item at price p* per unit. The difference between the lower prices they would have accepted for the lower quantities and those lower quantities priced at p* is the producer surplus. This is a gain for producers in terms of the money that they receive for the item in excess of the price at which they value it. The producer surplus is represented in the graph by the area above the supply curve S stretching to price level p*. The sizes of consumer surplus and producer surplus are determined by the relationship between the elasticities of supply and demand. Ceteris paribus, the more elastic demand is for an item, the flatter the demand curve and the smaller consumer surplus will be. Price-sensitive consumers do not tend to value items much more than the price they pay for them! Analogously, the more elastic supply of an item is, the flatter the supply curve and the smaller producer surplus will be. In a perfectly competitive market the supply curve is horizontal in the long run (supply is perfectly elastic) and producers make no profits; producer surplus then reduces to zero. Both consumer surplus and producer surplus are somewhat hidden in reality. A reservation price is the private information of the individual who keeps it in reserve. How much a consumer is willing to pay or how little a producer is willing to accept for an item will only be revealed if they actually exchange the item at those prices. Nevertheless, economic surpluses on both sides of the market can be estimated by observing consumers and producers joining and leaving the market over time, or by observing what happens in the market in response to various events such as major changes in markets for related items or government interventions. Indeed, estimates of consumer surplus and producer surplus are important for guiding policy: a government considering a change in the tax on an item will be interested in who will bear its main burden in terms of forgone surplus (consumers or producers), and in estimating how much of it they will cede to the exchequer (i.e. how high the tax can be set). Similarly, producers with market power will be interested in understanding consumer surplus in their markets and whether they can extract value from it through market segmentation and price discrimination. Occasionally, groups of consumers may also exert their power in numbers and negotiate lower prices with producers, effectively taking a cut from producer surplus. Further reading When new technologies or business models disrupt long standing markets, opportunities to find out how to calculate consumer and producer surplus are created! Economists Cohen, Hahn, Levitt, and Metcalfe collaborated with Jonathan Hall of Uber to estimate consumer surplus of US $2.9 billion in the market for taxi journeys while the UberX service was operating in 4 major US cities in 2015. Projected to the whole of the United States, consumer surplus in the taxi market may have been as high as $6.8 billion that year, or $1.60 consumer surplus for every $1 spent on taxi journeys. See “Using Big Data to Estimate Consumer Surplus: The Case of Uber” (National Bureau for Economic Research, Working Paper No. 22627, 2016). Good to know A form of consumer surplus may also develop after the purchase of some goods. It has been shown in economics experiments that individuals tend to attach personal value to objects after they have obtained them such that they are unwilling to exchange them for the same price at which they purchased them. This is known in the literature as the “endowment effect”. Think about it: how hard would it be for you to part with your favorite pair of shoes or that special jacket?
Consumer surplus is the gain made by consumers when they purchase an item at the competitive market price rather than the (highest) price that they would have been willing to pay for it. Analogously, producer surplus is the gain made by producers when they sell an item at the market price rather than the (lowest) price that they would also have accepted for it.
Similarly, governments often require funding beyond their tax revenues in order to commission large infrastructure projects or new services that are critical to the economy. Capital markets offer the opportunity for entrepreneurs and governments to be matched with individual and corporate investors in order to access the necessary capital. Capital markets are generally categorised into two groups: primary and secondary markets In a primary capital market, investors provide capital directly to investees, who issue a “security” (typically equity in the business, or a promise of repayment with interest) in exchange. Investors in primary capital markets tend to spend time getting to know the investee and exploring the proposed projects and ventures in detail to assess whether they can make a positive return. Examples of primary capital markets include fora where private-equity investors and providers of venture capital (also known as angel investors or venture capitalists) meet potential investees, initial public offerings (IPOs) where new stock in a company is issued to the public for the first time, as well as bond markets where firms and governments issue new debt securities to fund their spending. In a secondary capital market, a security that has already been issued in a primary market can be traded between investors. There is no need for direct contact between investors and the original investee/ issuer of the security. Public stock markets such as the New York Stock Exchange and the London Stock Exchange are examples of secondary capital markets. By their public nature, secondary capital markets offer access to very high numbers of traders and they tend to be more liquid than primary capital markets. The prices of securities traded in secondary capital markets are transparent, guaranteeing fair deals to buyers and sellers. In theory, prices of securities in a capital market reflect all available information about the corresponding projects and ventures. It follows that there is no room for arbitrage because no one would buy a security for more than its fair value, nor would they sell it for less than its fair value. This idea is known as the “efficient-market hypothesis” and the assumption of its validity underpins much economic thinking. However, there are some obvious flaws to it in practice: there is a real cost to obtaining and processing information and this cost can differ among market participants. Indeed, the way that information is interpreted differs from individual to individual so the notion that the price of a security must be the same for everyone is also doubtful. A sub-field of behavioral economics, behavioral finance has gained traction since the global financial crisis of 2007-2009 when traditional economics failed to predict the market crash. In behavioral finance, insights from psychology are combined with economic modeling to study what happens in capital markets when their participants are not perfectly rational and instead react to information according to their emotions. An important example here is the phenomenon of “herd instinct”, where investors have been shown simply to follow what they think others are doing rather than processing information independently for themselves. Further reading Eugene Fama is one of three economists to have won the Nobel Prize in 2013 for empirical analysis of asset prices. In his fundamental analysis, see this particular formulation of the efficient-market hypothesis in “Efficient Capital Markets: A Review of Theory and Empirical Work” (Journal of Finance, 1970). Good to know Most transactions in capital markets today are performed by computers and there is a very high degree of automation. Exchange-traded funds (or ETFs), which are financial instruments that automatically track stock-market indices, have emerged as a cheap and increasingly popular alternative to traditional stock-broking for trading transactions. Yet, despite their computing power, machines are only ever as good as their makers: a small human error in the programming can quickly lead to so-called “flash crashes” and a lot of lost money!
In capital markets, capital is exchanged between investors (who supply it from their assets) and investees (who need it to fund projects and ventures). The investment horizon is usually at least one year. At its core, economics is about the efficient allocation of scarce resources. If the initial division of resources in an economy is not efficient then the individuals within that economy can be made better off through a reallocation. Capital markets exist to smooth the process of reallocation. Indeed, without capital markets, many investments that help an economy to grow would not take place. Entrepreneurs with their bright ideas need access to finance in order to turn them into reality.
Browse our academic job listings The problem of disciplines Inter-disciplinary dating remains a largely theoretical proposition in academia, and that is to say nothing of the taboo against undergraduates dating postgraduates - or vice versa. Whereas the first of these can be termed horizontal dating, and carries casual social penalties, the second, vertical dating, is often viewed with much more serious contempt. Indeed, for all of academia’s professed liberalism, there remains a severely entrenched elitist platform upon which status and seniority carry significant weight. As in every social and professional situation, groups quickly form, select cliques are established and patterns followed, until soon enough you find yourself surrounded solely by people on the same course and level of study as yourself. As noted above, it is a curious thing given that the university environment should provide a warm bed - no pun intended - for open-minded dating. Clearly, though, this is rarely the case. What becomes apparent when it comes to dating in academia is that it would be helpful if short manuals on dating etiquette and rules were handed out during freshers/orientation week, as these would provide a basic layout of the hostile battlefield. And yes, the library is as hostile a terrain as you will ever come across. Just try asking somebody out in a whispering voice, or try following somebody around the bookshelf corridors without appearing like a stalker, and you will know what we mean. Libraries aside, the whole set-up seems unfriendly. Even career academics seem not to have mastered the art, often electing to stay within the safe confines of their chosen academic field. Perhaps - dare it be said? - the longer you remain in academia the greater the chances are that your dating behaviour fossilises within your disciplinary speciality. In fact, the ever-increasing wave of students and teachers turning to online dating could be a result of the unfriendly character of dating in academia. In part this can be understood and explained by the nature of academic speciality. After all, how many conversation convergences can there be between a physics PhD and economics Bachelor? That is not to say, though, that it is impossible for them to converse or to find common ground, or that people of common study areas should always stick together. It is just that it sure does help in an opening conversation if there is an easy point of convergence. Hope? Even though horizontal dating is strategically difficult and vertical dating is frowned upon, that is not to say either is entirely impossible - but it's no coincidence that many of those long-term couples who say that their love first blossomed during their university years shared the same disciplinary field. So here, in summary, are the two fundamental principals to dating in academia: 1. If you want to make your dating life both easier and more successful, don’t stray far from your chosen academic field. 2. Never try to begin a romantic adventure in the library.
Dating in academia is riddled with potholes, the most immediate of which is do not stray far from your academic discipline. Curious indeed considering that the academic world is meant to be populated by an abundance of young and energetic minds from a variety of different cultures, races and ethnicities, all of whom are hungry for new information and experiences. One would think that such an environment would provide the perfect dating terrain, right? Wrong!
Top Recruiting Trends You Need to Know in 2020
But, before you go about implementing your recruitment strategy, there are certain trends, approaches and developments you should consider to ensure maximum success. The way recruitment works has changed significantly in recent years. In fact, research suggests that in today's world, the recruitment process is 90% candidate-driven. That said, to reach out and connect with the right talent, evolving your approach to recruitment is essential. Apart from providing niche career hubs to recruit the best researchers, professionals and students, at 11 Academia Networks (particularly INOMICS as our flagship brand), we think about helping universities, research centers, private companies and think tanks design their recruitment strategies. To help you get 2020 off to the best possible start, here are the recruitment trends you should know. Recruitment marketing By focusing on your recruitment marketing and inbound recruiting, you’ll be able to promote your brand values, services, offerings and USPs to a targeting segment of prospective employees, attracting them to your institution. Investing in this area will not only help bring the right talent to you but it will ensure a steady flow of engaged candidates on an ongoing basis. Employer branding 86% of HR professionals feel that recruitment is becoming more like marketing. Expanding on our previous point, to entice the right candidates to your organization and showcase your value, focusing on your employer branding efforts will be essential to success in 2020. Additionally, to prioritise candidate experience will help you create a good image as company as well as attract the best talent. According to Talent Board, during the last 9 year over 1,000 organisations have worked harder to define clear processes to improve the candidate experience. According to Deloitte, 87% of candidates say that a great recruitment experience can change their mind about a company they have once doubted. If you want to learn more about candidate experience and journey, check here the complete report of Deloitte. Moreover, if you are ready to start boosting your employer branding activities, here we share with you digital tools that you could use to optimize the process. We offer multiple online products to help you boost your employer branding strategy and build reputation among the best academics and professionals online. If you are interested in more information, please contact us at info@11academianetworks.com. If you are a INOMICS Customer, please contact us at info@inomics.com. Talent pools As the digital world continues to evolve, active talent pools will become all the more valuable. Essentially, a talent pool is a platform or database where recruiters and HR Managers store all of the details of their top-performing candidates. By adopting this approach in an intuitive, organized an accessible way, when you need a specific type of talent to complete a project or fill a vacancy, you can filter through your talent pool and pick the best person for the job with ease, enjoying the results you deserve in the process. Social recruiting Studies suggest that, in the near future, 94% of recruiters plan to use social media for recruitment. Moreover, of the current businesses using social media for recruitment, 49% confirm that they've seen an increase in candidate compatibility. While job seekers use internet and social media as a marketing medium, it allows companies and recruiters to view candidates, their portfolios, microsites and encourage the best to apply to open positions. By using social media to proactively search for candidates that match your needs and sparking up meaningful dialogues with them, you will boost your chances of finding the right candidate for the job significantly. If you are looking to connect to top economists worldwide, INOMICS has more than 90,000 fans in social media ready to explore job opportunities at your institution. If you want to access our pool of economists, please contact us at info@inomics.com and ask for our social media campaign options. Diversity Recruitment According to our previous article about diversity recruitment and multicultural talent, diversity is one of the best ways to ensure the success of an institution. "With today’s globalized markets, it is necessary to understand a different set of cultures, and their associated behaviors, needs, and demands, in order to develop appropriate products and services. The most valuable market insight can come from employees who have a cultural background comparable to those of your target groups." Additionally, the report created by McKinsey & Company in 2015 revealed that institutions with a greater diversity were 35% more likely to have a better return on investment than their peers in the same industry with lower diversity quotas. Collaborative hiring/ Employee referrals According to Careerbuilder Ebook on Referral Madness, 82% of employers have rated employee referrals as the best recruitment channels based on return on investment metrics. Your own employees are the best proof and advocates of your employer brand. Collaborative hiring is a recruitment method in which both HR teams and those from other departments work in unison to source, screen and hire talent. Collaborative hiring is significant as it improves the quality of new hires by addressing the broader needs of the business and those working within it. As a result of this more panoramic approach to hiring, turnover rates tend to drop down which, in turn, positively affects the overall recruitment and hiring strategy. And if you’re looking to source new a host of new candidates in 2020, this is certainly a method you should explore. and last but not least Soft Skills: Looking beyond the traditional set of skills Nowadays it is a big challenge to find candidates who fit culturally and skill-wise to the institutions. Hence more and more organisations are looking beyond the traditional standards of their industry and hiring candidates who are more than eager to learn. According to Cubiks, a 2016 survey revealed that 9 in 10 recruiters have rejected candidates due to their lack of cultural fit. Cubiks explains in their report that the "cultural fit is formed from the values, vision, norms, working language, symbols, belief systems and habits of staff along with their tacit agreement to a set of acceptable behaviours". The New Year is just around the corner, but by taking these essential recruitment trends on board, success will be yours for the taking in 2020, and beyond - best of luck. Do you have any recruitment tips or trends that you’d like to share? Please feel free to do so by leaving a comment. If you are interested in knowing more about our products and services, drop us an email to info@11academianetworks.com . We will be happy to consult you on the best ways to approach your target audience and get the best candidates for your institution. Join our community of recruiters! Subscribe to our newsletter to get news in the education and recruitment industry, as well as offers from our company Subscribe now
With a fresh year fast approaching, you might be thinking about recruiting new members of staff - forward-thinking talent that will drive your institution forward and take its offerings to the next level.
Your Guide to Student Recruitment Tools & Trends in 2020
But, of course, if your prospects aren’t privy to what you have to offer, you’d may as well not exist. It’s harsh, but in many ways, it’s true. And, in the age of digital transformation, reaching out to the right students though the touchpoints that they’re most likely to engage with is essential to success. No longer is demonstrating your values, telling your story and showcasing your offerings online optional - these days, if you want to get budding higher academics excited about your institution, you have to get digital. To help you enhance your student recruitment efforts in 2020, we’ve put together a guide that outlines current student recruitment trends, in addition to a rundown of the tools that will help you connect with your audience in the most valuable way possible. Student recruitment trends A UCAS report revealed that in the UK alone, student applications for higher education dropped by 5% in 2017, with a 7% drop in the EU. But, while this may be the case, understanding your audience while remaining abreast of the latest recruitment trends will help you boost your enrollment rates this year, and beyond. To help you steer your student recruitment efforts in the right direction this year, here are the three latest recruitment trends that you should know: Emerging technology continues to evolve: In recent times, recruitment and technology have become almost synonymous, with artificial intelligence (AI) and machine learning (ML) tools and platforms becoming increasingly sophisticated, and tailored, to specific goals, needs and preferences. With such platforms, potential candidates are presented to the user based on their skills, background, personal goals and personality type. By using tech-driven recruitment platforms, you’ll be able to understand your target demographic on a deeper level, while sourcing potential candidates that you can potentially reach out to and engage. Data-driven recruitment equals success: You might use digital data for a number of reasons within your organization: measure student engagement, internal efficiencies, financial fluency, and more. But have you ever considered using demographic data to understand your target audience on a deeper level? Harness the power of analytics platforms such as Google Analytics to gain tangible insights that will help you tailor your communications, campaigns and recruitment processes to the needs, wants desires and interests of your prospects, and you will start to see positive results. Data-driven recruitment is set to be a big deal this year, and beyond, so ride the crest of this valuable wave now, before it’s too late. Recruitment marketing is now essential: Expanding on our previous point, creating cohesive recruitment student marketing strategies is now essential, with today’s student spending large proportions of their time on various digital touchpoints, most of which are mobile. That said, to help inspire your intuition’s recruitment marketing efforts, explore our 10 top tips to build your university brand online Modern day students: the hard facts As mentioned, understanding the students of today holds the key to recruitment success. To give you a headstart, here are the essential facts you need to know about today’s ambitious academics: Campus visits are critical to the decision-making process: 46.7% of students consider a campus visit a significant factor in selecting a college or university. Social media usage is at an all-time high: Social media usage has peaked among all demographics - and various studies suggest that more students now use social media platforms on a daily basis than ever before. Get social and engage your prospects where they feel the most comfortable. More students are consuming online content all year around: Recruitment is not a seasonal activity anymore. The modern students are looking to engage to Universities even during festive seasons. Even more the social networks have made more accesible and easy to consume content of Universities during holidays. Take advantage of these dates and create campaigns that are driven to generate brand awareness for your Institution. As an inspiration we share here ideas on how to increase student engagement to your University over Christmas. Offline or online is not enough: with the boom is new online technologies, apps, influencers, social media channels, etc. multi-channel campaigns are the only way to keep your brand relevant to digital-geeky generations who handle communicationand take decisions in channels such as websites, online and offline catalogues, email, direct mail, mobile, messaging apps, social media, etc. Multi-channel marketing has been heavily used mostly in the retail industry by enabling customers to buy a product or service by using the communication channel of their preference. However this approach can also be very effective in the recruitment industry. Designing and implementing a multi-channel campaign can be a project that demands time and effort from you and your recruitment team. It may also seem to be expensive and it often requires resources that are not easily available at your institution. At 11 Academia Networks this month we have designed a special promotion package to help your institution implement a successful multi-channel campaign. Thanks to our experience with the summer schools, we decided to implement our knowledge in content marketing, social media promotion and online listing to promote masters and PhDs. From past campaigns, our customers attributed around 10% of the campaign results to our multichannel offer. If you are interested in booking a multichannel campaign for your program, you can contact us at info@11academianetworks.com. If you are already an INOMICS customer, please contact your account manager or send us an email to info@inomics.com to get more information about this offer. Student recruitment tools Now that you’re up to data with the student recruitment trends, let’s explore the tools you can use for ultimate success: Applicant tracking systems (ATS): An ATS will empower you to make your application experience more cohesive, allowing you to monitor applications across a multitude of digital channels, in turn, offering a more personalized level of support to those interested in your organization. In doing so, you’re likely to earn a higher recruitment conversion rate and more quality enrollments as a result. Internet sourcing tools: Fundamentally, internet sourcing is using the right tools to source the right prospective candidates for your institution and reaching out to them on a personal level. By leveraging services such as LinkedIn for Students, XING, social media forums, and connecting with the right people, you’ll be able to demonstrate your unique value and encourage more enrollments. YouTube: With 1.8 billion users every month, YouTube boasts a great deal of opportunity for Institutions looking to entice prospective students. By offering virtual tours as well as mix of engaging, inspirational content that answers your prospects’ most burning questions and delivering said content at an optimal time via the right online channel, you stand to drive more students to your application pages and onto your campus. We hope these student recruitment trends and tips help you with your initiatives in 2020 and while it may be challenging out there on the digital battlefield, we know you have what it takes to boost your enrollment in 2020, and for many years to come. Stay tuned this coming month for our PhD and academia recruitment and employer branding mini series where we will share invaluable tips and actionable advice on sourcing the best students and talent for your institution. Do you have any of your own student recruitment tips? Share them with us by leaving a comment. Join our community of recruiters! Subscribe to our newsletter to get news in the education and recruitment industry, as well as offers from our company Subscribe now
With a fresh year in full swing, it’s time to start thinking about fresh blood, or in other words: attracting new, prosperous students to your institution. You know that you’re worthy; you know that you have something unique to offer, and you know that you have the faculty, as well as the facilities, to provide an exciting, inspirational academic experience.
Esther Duflo, Abhijit Banerjee, Michael Kremer win the 2019 Nobel Prize
Michael Kremer showed the efficacy of experiments in economics with his research (alongside other colleagues) in Kenya in the 1990s. These experiments were aimed at increasing the effectiveness of schooling. Kremer received his PhD from Harvard University in 1992 and is the Gates Professor of Developing Societies at Harvard University, Cambridge, USA. Abhijit Banerjee is the Ford Foundation International Professor of Economics at MIT; he formerly taught at Princeton and Harvard. He earned his PhD from Harvard University in 1988. He has authored a number of books in economics, and is a fellow of the National Academy of Sciences, the American Academy of Arts and Sciences and the Econometric Society2. Alongside Esther Duflo, he has conducted research using more experiments – making novel use of randomized controlled trials in economics – in areas such as health, education, and microcredit. Esther Duflo is something of a rarity in her field, being the youngest ever recipient of the Nobel Prize in Economics (she received her PhD from MIT in 1999), and the second female winner. Eschewing the grand theory model favored by her contemporaries, Duflo has carved out her own academic path, pursuing a rigorous analysis of - in her own words - "the pieces that comprise the whole". Her motivation: a long-held commitment to the alleviation of poverty. She is the Abdul Latif Jameel Professor of Poverty Alleviation and Development Economics at Massachusetts Institute of Technology at MIT. "Instead of relying on our intuition, or that of others, we set up large-scale, rigorous randomized controlled trials to understand what works, what does not work, and why. We are not alone: this movement has taken hold in economics" She's not wrong. Randomised Controlled Trials (RCTs), whose popularization the Nobel winners have helped to spearhead, have changed the face of development economics in two very different ways. The first is practical: they’ve simply become the new norm. As put by the Royal Swedish Academy of Sciences, RCTs now ‘dominate development economics’, and are riding the wave of methodological supremacy. Originally borrowed from medicine, their premise is easily understood. Researchers assess the effect of a ‘development intervention’ by dividing participants into groups, with only some being subjected to said intervention. The outcomes of each group are then measured against each other, and the efficacy of any intervention is thus determined. Through the Abdul Latif Jameel Poverty Action Lab, which Duflo and Banerjee co-founded (along with Sendhil Mullainathan) in 2003, over a thousand of these experiments have been conducted across the developing world. These have occurred in studies ranging from levels of immunization in India to primary school standards in Kenya. In RCTs, these researchers saw an apt way of identifying - if present - causal relationships between intervention and outcome, while simultaneously guarding against the chronic problem that blights much development policy - selection bias. Especially in development, but also across economics more broadly, the method has been readily accepted. The commitment to RCTs is rooted in humility - a sentiment that elsewhere in economics often appears conspicuously absent. Duflo has likened her work to plumbing: "we solve problems with a combination of intuition grounded in science, some guesswork aided by experience and a bunch of pure trial and error". Their approach also helps address something economics has long failed to do: it humanises the poor. Again, it’s Duflo's words that capture this best: "we have to abandon the habit of reducing the poor to cartoon characters and take the time to really understand their lives, in all their complexity and richness." Awareness of this kind not only imbues their research with nuance and thus precision, it gives it morality too - an appreciation and respect of the human subjects at the center of their work. Sources 1: https://www.nobelprize.org/uploads/2019/10/press-economicsciences2019-2.pdf 2: https://economics.mit.edu/people/faculty/abhijit-banerjee/short-bio
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2019 has been awarded to three economists “for their experimental approach to alleviating global poverty”1: Esther Duflo, Abhijit Banerjee and Michael Kremer.
Economic Development, Innovation and Growth (JEL O)
Download the INOMICS Handbook! Communication At the top of every list of essential soft skills seems to be communication. Effective communication doesn’t just mean being able to talk to another person as though they are a human being (although this is obviously useful on a day-to-day basis) – it also means being able to adapt your communication style to different people based on their seniority, age and relationship to you. It means having the ability to adapt your presentation skills, according to whether you’re talking to five people in a thesis workshop or five hundred at a conference. It means being able to write a pithy research proposal for your PhD thesis, slog out a decent essay introduction that remains concise and yet easy to understand, or compress your ideas into a couple of sentences to efficiently get across exactly what it is you do, want, or need. It also means shutting up and listening to someone else speak in order to learn and grow. This last part includes emotional intelligence, something very important for effective communication. If you can’t empathise with people, it’s impossible to communicate effectively with them. Communication skills will help you in every aspect of your life, from forming new relationships with people (this doesn’t necessarily mean friendship, but rather contacts; an essential part of networking is communication) to listening to what others have to say even when you disagree with their opinions. So how to improve these communication skills? A good way is to surround yourself with people you know are good at communicating – whether that means getting someone who can hold an audience to help you with your next presentation or sitting down with a colleague who seems to know absolutely everyone to help you improve your networking skills. You could also take a course in communication (yes, they exist), or throw yourself in at the deep end by forcing yourself to present and talk to people as often as is humanly possible. Teamwork So what’s next, once you’ve learned how to effectively communicate? The next step is using this skill effectively as part of a team. Humans are social animals, and two heads (or three, or four) are almost always better than one. Solving problems with other people means you’ll hear ideas you would have never thought of by yourself, while additionally becoming familiar with disparate perspectives and means of deciphering complications. But it’s not just about coming up with solutions. It’s also about simply working together with people in the same office or classroom, and being flexible with their plans so you can work together when it’s convenient for both of you. It’s about listening to other people, respecting their viewpoints, and being able to articulate yourself so you can disagree or agree when necessary – being polite while maintaining your integrity. Essentially, it’s about being able to trust others to help you, whether that’s planning and organizing a task together, making important decisions as a group, or using all of your brains to solve a problem. All of this can come in handy when, for example, you need to work with other students or researchers on group projects. Collaborating on a university project can be a great way to improve your teamworking skills. Time management and self motivation The flip side of this, of course, is that it’s also imperative to be able to work by yourself and manage your time effectively. Working by yourself involves having some self direction – that is, motivation to work when there’s nobody pushing you to get stuff done – as well as the initiative to know what to do next. Prioritising can be a difficult task in and of itself. It involves making sure you know what’s most important to get done – not only for yourself, but also for the other people in the team and the company in general. Delegation can be helpful when prioritising, leaving you to get on with more critical tasks. Another technique is to keep a to-do list in order of priority – but make sure organising your to-do list doesn’t become a stressful task. Perhaps most importantly, learning to say no will do wonders for your time management. If someone asks you for help and you think it will distract from more important tasks, or if it’s something that shouldn’t be delegated to you, or if you simply can’t find the time, it’s okay to apologise and say no. The alternative is to take on too much and stress yourself out, leading to lower-quality work, or worse, simply not getting everything done. Being a leader What was the soft skill LinkedIn said was going to be the most likely to get you hired in 2018? That would be leadership. Leadership is the quality of being able to inspire people, talk clearly to them about your ideas, and actually see things through. Leadership is really a combination of many different skills, including most importantly communication, but also being hardworking, delegating, being responsible, going above and beyond your expected work, and creatively finding solutions to problems. On a more basic level, though, a leader is someone people are willing – even happy – to follow. It also includes skills less related to working and more towards people – being open, empathetic and communicative with your employees and a person to whom they can come with questions and concerns is vital. You need to retain the ability to be professional while not coming across as too ‘corporate’, meaning being social while acknowledging the inevitable hierarchies of the workplace. It means listening to your employees’ ideas and judging their utility fairly. Leadership is perhaps the hardest skill to improve as it encompasses so many other qualities, and it seems that some people are simply born leaders. But despair not. There are a few things you can do to improve your leadership skills. Classes exist on refining body language, problem solving, and management and leadership skills. Improving your communication skills can also help you become a more effective leader, opening you up to other people and making you more empathetic (or at least seem so). Other more abstract ways of improving this skill are maintaining a sense of integrity and being passionate about what you do. People are often drawn to leaders who are obviously passionate and genuinely care about what they are trying to achieve. There are many different types of leaders – coaches, dictators, authoritarians, democrats and partners, to name a few. Each of these styles has upsides and downsides. Find the leadership style that fits with your aims, personality and strengths, and hone your other soft skills as best you can. Get to work In the end, soft skills are just as important as the hard skills with which we’re all familiar. Unfortunately, they’re usually more difficult to hone. But it can be done, and employers and bosses love to see them in action. However you choose to improve yourself – through classes, by surrounding yourself with accomplished soft-skillers, by throwing yourself in at the deep end, or a mixture of all three – try to spend at least a little bit of time improving your communication, teamworking, time management and leadership skills. If you do this, you’ll be nicely set up for the myriad job interviews you’ll undoubtedly be attending in later life.
Everyone knows about the hard skills you need to be able to succeed in economics or in academia in general: excellent writing and proofreading skills, the ability to extract information from what are often dense scientific texts, and being able to evaluate and analyse data effectively, among other things. But they aren’t the only skills you need to have. There are, of course, the dreaded soft skills – a slippery term that can mean anything from being able to clearly communicate your ideas to another human being to more abstract concepts like emotional intelligence. But what are the most important soft skills to have, and how can you develop the ones that need some more work?