5/7/2012

INTRODUCTION TO CONTEMPORARY
ECONOMICS
THE NATIONAL INSTITUTE OF PUBLIC ADMINISTRATION
(INA)
DR. HUMAM AL-JAZAERI
2012

AN INTRODUCTION!

Session One
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WHAT IS THE IMPACT OF RISING FOOD PRICES?

In the United States, when world wheat prices rise by 75 percent, as
they have over the last year, it means the difference between a $2
loaf of bread and a loaf costing maybe $2.10.
IF, however, you live in New Delhi, those skyrocketing costs really
matter.
PRICES ARE CLIMBING, BUT THE IMPACT IS NOT AT ALL BEING FELT EQUALLY!

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NEW TRENDS IN FOOD PRICES!

Historically, price spikes tended to be almost exclusively driven by
unusual weather -- a monsoon failure in India, a drought in the
former Soviet Union, a heat wave in the U.S. Midwest. Such events
were always disruptive, but thankfully infrequent.
Today's price hikes are driven by trends that are both elevating
demand and making it more difficult to increase production:
A rapidly expanding population,
Crop-withering temperature increases, and
Irrigation wells running dry.
Each night, there are 219,000 additional people to feed at the global
dinner table.
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CRITICAL CHANGE
The world is losing its ability to soften the effect of shortages.
In response to previous price surges, the United States, the world's
largest grain producer, was effectively able to steer the world away
from potential catastrophe.
From the mid-20th century until 1995, the United States had either
grain surpluses or idle cropland that could be planted to rescue
countries in trouble.

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Grain for fuel!

The United States, which once was able to act as a global buffer of
sorts against poor harvests elsewhere, is now converting massive
quantities of grain into fuel for cars (converting grain into ethanol),
even as world grain consumption, which is already up to roughly 2.2
billion metric tons per year, is growing at an accelerating rate.
In 2010, the United States harvested nearly 400 million tons of grain,
of which 126 million tons went to ethanol fuel distilleries (up from 16
million tons in 2000).

WHAT DOES IT MEAN TO CONVERT GRAIN TO FUEL?

This massive capacity to convert grain into fuel means that the price
of grain is now tied to the price of oil.
So if oil goes to $150 per barrel or more, the price of grain will follow
it upward as it becomes ever more profitable to convert grain into oil
substitutes.

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ITS A GLOBAL PHENOMENON!

It's not just a U.S. phenomenon: Brazil, which distills ethanol from
sugar cane, ranks second in production after the United States, while
the European Union's goal of getting 10 percent of its transport
energy from renewables, mostly biofuels, by 2020 is also diverting
land from food crops.

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THE BOTTOM LINE!

This is not merely a story about the booming demand for food.
Everything from falling water tables to eroding soils and the
consequences of global warming means that the world's food supply
is unlikely to keep up with our collectively growing appetites.
Take climate change: The rule of thumb among crop ecologists is that
for every 1 degree Celsius rise in temperature above the growing
season optimum, farmers can expect a 10 percent decline in grain
yields.
This relationship was borne out all too dramatically during the
2010 heat wave in Russia, which reduced the country's grain
harvest by nearly 40 percent.
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ITS ALSO ABOUT MANAGEMENT!

Even as we are running our wells dry, we are also mismanaging our
soils, creating new deserts.

Soil erosion as a result of over-plowing and land

mismanagement is undermining the productivity of one-third of
the world's cropland.

Technology!
Decade after decade, advancing technology underpinned steady
gains in raising land productivity.

World grain yield per acre has tripled since 1950. But now that
era is coming to an end in some of the more agriculturally
advanced countries, where farmers are already using all
available technologies to raise yields.
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WHAT COMES NEXT?

Many exporting countries tried to control the rise of domestic food
prices by restricting exports. Among them were Russia and Argentina,
two leading wheat exporters. Vietnam, the No. 2 rice exporter,
banned exports entirely for several months in early 2008. So did
several other smaller exporters of grain.
Should countries/ firms negotiate long-term grain-supply agreements
with exporting countries?
Buying or leasing land in other countries on which to grow grain for
themselves?
What about water rights?
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INFRASTRUCTURE MATTERS!
The public infrastructure for modern market-oriented agriculture does not
yet exist in most of Africa.
In some countries it will take years just to build the roads and ports needed
to bring in agricultural inputs such as fertilizer and to export farm products.
What for?
Most of the land bought up so far will be used to produce biofuels and other
industrial crops.
How it is made?
Even if some of these projects do eventually boost land productivity, who
will benefit? If virtually all the inputs -- the farm equipment, the fertilizer,
the pesticides, the seeds -- are brought in from abroad and if all the output
is shipped out of the country, it will contribute little to the host country's
economy.
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RATIONALITY, EQUILIBRIUM &MARKET SYSTEM

SCARCITY & CHOICE

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The Economic Problem: Scarcity & Choice

The concepts of constrained choice and scarcity are central to

the discipline of economics.

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Scarcity, Choice, And Opportunity Cost

All points below and to the left of

the curve (the shaded area)
represent combinations of capital
and consumer goods that are
possible for the society given the
resources available and existing
technology.
Points above and to the right of
the curve, such as point G,
represent
combinations
that
cannot be reached.
If an economy were to end up at
point A on the graph, it would be
producing no consumer goods at
all; all resources would be used
for the production of capital. If an
economy were to end up at point
B, it would produce only
consumer goods.

The Production Possibility Frontier

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The Production Possibility Frontier

The ppf illustrates a number of economic
concepts. One of the most important is
opportunity cost. The opportunity cost of
producing more capital goods is fewer
consumer goods.
Moving from E to F, the number of
capital goods increases from 550 to 800,
but the number of consumer goods
decreases from 1,300 to 1,100.
D may illustrate lack of efficiency
(mismanagement) OR a downturn: During

economic downturns or recessions,

industrial plants run at less than their
total
capacity.
When
there
is
unemployment of labor and capital, we
are not producing all that we can.
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The Law of Increasing Opportunity Cost

Production Possibility Schedule for Total

Corn and Wheat Production

Point
on ppf

Total
Corn Production
(Millions of
Bushels Per Year)

Total
Wheat Production
(Millions of Bushels
Per Year)

700

100

650

200

510

380

400

500

300

550

Moving from point B to A, we get only 50 million bushels of corn at

a cost of 100 million bushels of wheat. The cost per bushel of
corn measured in lost wheat has increased.
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The Production Possibility Frontier

Economic Growth
Productivity
increases
have enhanced the ability of
the
United
States
to
produce both corn and
wheat.
Productivity
increases
were more dramatic for corn
than for wheat. Thus, the
shifts in the ppf were not
parallel.

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THE LAW OF DEMAND & SUPPLY

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Price and Quantity Demanded: The Law of Demand

Annas Demand Schedule for Telephone Calls

Price
(Per Call)
$
0
.50
3.50
7.00
10.00
15.00

Quantity Demanded
(Calls Per Month)
30
25
7
3
1
0

Law of Demand
The negative relationship
between price and quantity
demanded:

As price rises, quantity

demanded decreases; as
price
falls,
quantity
demanded increases.
Does this
products?

apply

to

all

The relationship between price (P) and quantity

demanded (q) presented graphically is called a
demand curve. Demand curves have a negative
slope, indicating that lower prices cause quantity
demanded to increase.
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Shift of Demand VS. Movement Along a Demand Curve

Shift of Demand Schedule Due to increase in Income

Schedule D0

Schedule D1

Quantity Demanded
(Calls Per Month at an
Income of $300 Per
Month)

Quantity Demanded
(Calls Per Month at an
Income of $600 Per
Month)

$ 0.00

30

35

0.50

25

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3.50

18

7.00

12

10.00

15.00

20.00

Price
(Per Call)

When the price of a good changes, we move

along the demand curve for that good.
When any other factor (determinant) that influences
demand changes (wealth/ income, tastes, price of other
products and so on), the relationship between price and
quantity is different; there is a shift of the demand curve,
in this case from D0 to D1.
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Inferior VS. Normal Goods

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Price and Quantity Supplied: The Law of Supply

Clarence Browns Supply Schedule for Soybeans
Price (Per Bushel)

Quantity Supplied
(Bushels Per Year)

$1.50

1.75

10,000

2.25

20,000

3.00

30,000

4.00

45,000

5.00

45,000

Law of Supply
A producer will supply more when the
price of output is higher. The slope of a
supply curve is positive.

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Shift of Supply versus Movement Along a Supply Curve

Shift of Supply Schedule for Soybeans Following

Development of a New Disease-Resistant Seed Strain

Price
(per Bushel)

SCHEDULE D0

SCHEDULE D1

Quantity Supplied
(Bushels per Year
Using Old Seed)

Quantity Supplied
(Bushels per Year
Using New Seed)

$1.50

5,000

1.75

10,000

23,000

2.25

20,000

33,000

3.00

30,000

40,000

4.00

45,000

54,000

5.00

45,000

54,000

When the price of a product changes, we move

along the supply curve for that product; the quantity
supplied rises or falls.
When any other factor (determinant) affecting
supply changes, the supply curve shifts. Think of

factors of production
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THE ANALYTICAL ARCHITECTURE OF THE ECONOMIC MODEL

THE FREE MARKET MODEL

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Core Assumptions:

Rationality, Perfectly Working Markets &

Equilibrium
Rationality is strictly defined in terms of individuals maximizing
their own utility (Max Profit/ Min Costs)
Perfect Information Firms/ Individuals ALL information of the qualities
and prices of everything available in the market and that firms have all
available information concerning wage rates, capital costs, and output
prices.
Perfect Competition An industry structure in which there are many
firms, each small relative to the industry and producing virtually identical
products, and in which no firm is large enough to have any control over
prices.
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The Free Competitive model is a reasonably

accurate description of reality?

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Although perfect competition never existed, nor ever could exist,

as all the textbooks agree, yet in neoclassical economics the real
world is said to be approximately like, not far from, or even very
close to the idealised world of perfect competition.
Blaug (1997, p. 70-1; 2003)

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Ronald Coase (1994, p. 5):

[w]hat is studied is a system which lives in the minds of
economists but not on earth. He then calls it blackboard
economics, only to argue that there is limited application of
blackboard economics other than for its own idealised world of
zero transaction costs.

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Core Question:
IS IT POSSIBLE FOR THE OPTIMAL ALLOCATION OF RESOURCES BE ATTAINED
BY MEANS OF A PERFECTLY COMPETITIVE EQUILIBRIUM?
WHY IT ISNT?

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Because the formal model leaves out all disequilibrium forces (i.e.
forces that disrupt or do not lead to equilibrium).
All the non-price forms of competition assigned to a low degree of
significance or remaining outside the scope of the analysis:
What about favourable locations?
Product innovation?
Marketing battles?
Logistics?
Quicker deliveries?

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Market Equilibrium
Excess Demand

At a price of $1.75 per

bushel, quantity demanded
exceeds quantity supplied.
When excess demand
exists, there is a tendency
for price to rise.
When quantity demanded
equals quantity supplied,
excess demand is
eliminated and the market is
in equilibrium. Here the
equilibrium price is $2.50
and the equilibrium quantity
is 35,000 bushels.

When quantity demanded exceeds quantity supplied, price tends

to rise. When the price in a market rises, quantity demanded falls
and quantity supplied rises until an equilibrium is reached at
which quantity demanded and quantity supplied are equal.
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Market Equilibrium
What about Quick Fashion Industry?
Turkey sells European
retailer (Zara) at a price
of $2. 50 per unit, and
China sells it at $1.75.
What determines the
choice of the European
retailer?
Think of proximity factor!

Also, why do we buy

Apple ipod at a much
higher price its quality
equivalent
from
a
Taiwanese firm?

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Market Equilibrium
What about the Fashion Industry?
Turkey sells European
retailer (Zara) at a price
of $2. 50 per unit, and
China sells it at $1.75.
What determines the
choice of the European
retailer?
Think of proximity factor!

The Quick
Industry

Fashion

Also, why do we buy

Apple ipod at a much
higher price its quality
equivalent
from
a
Taiwanese firm?
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Supply and Demand Analysis: An Oil Import Fee

At a world price of $18, domestic

production is 7.7 million barrels per day
and the total quantity of oil demanded in
the United States is 13.6 million barrels
per day. The difference is total imports
(5.9 million barrels per day).

If the government levies a 33 1/3 percent tax on

imports, the price of a barrel of oil rises to $24. The
quantity demanded falls to 12.2 million barrels per
day. At the same time, the quantity supplied by
domestic producers increases to 9.0 million barrels
per day and the quantity imported falls to 3.2 million
barrels per day.
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Why then the U.S. Government is NOT

applying such tax?
Why not alternative energies take
over? Are they?

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REVIEW TERMS AND CONCEPTS

capital market
complements, complementary goods
demand curve
demand schedule
entrepreneur
equilibrium
excess demand or shortage
excess supply or surplus
factors of production
firm
households
income
inferior goods
input or factor markets
labor market
land market
price rationing

law of demand
law of supply
market demand
market supply
movement along a demand curve
movement along a supply curve
normal goods
perfect substitutes
product or output markets
profit
quantity demanded
quantity supplied
shift of a demand curve
shift of a supply curve
substitutes
supply curve
supply schedule
wealth or net worth
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IMPORTANT LINKS
UNCTAD: www.unctad.org
World Bank: www.worldbank.org

IMF: www.imf.org

OECD: www.oecd.org
Additional Business Links
Wall Street Journal: www.wsjonline.com
Bloomberg: www.Bloomberg.com
Business Week: www.businessweek.com
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End of Session One

Take Care..!

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