Monday, June 11, 2018

Economy Lecture 2 – Class Notes

Economy Lecture 2 – Class Notes

Markets are classified into –

1) Perfect Competition 2) Monopoly 3) Monopolistic Competition 4) Oligopoly

Perfect competition describes markets such that  no participants are large enough to have the market power  to set the price of a homogeneous product. There are few if any perfectly competitive markets.

Still, buyers and sellers in some auction-type markets, say for commodities (like wheat) or some  financial  assets,  may  be  closer  to  this  market.  Demand  and  supply  curves  become  fully operational only in the case of perfect competition.

Specific characteristics of a perfect market are


     Infinite (very large number of) buyers and sellers
     Zero entry and exit barriers
     Perfect factor mobility
     Perfect information
     Zero transaction costs
     Property rights

A monopoly is a market structure in which a single supplier produces and sells a given product. If there is a single seller in a certain industry and there are no close substitutes for the product, then the market structure is that of a "pure monopoly".

 Railway is a pure monopoly, but since it is for public good, it is desirable.

Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the goods  being produced,  but  nevertheless  companies  retain  some  market  power.

 This  is  termed monopolistic competition. Most of the items we find in the grocery shops are part of monopolistic competition.

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers. Because there are few sellers, each oligopolist is likely to be aware of the actions of the others.

The decisions of one firm influence, and are influenced by, the decisions of other firms. For example, telecom and civil aviation – if one firm reduces the price, others will also have to be.

Cartels convert oligopolistic markets into monopoly. Most famous cartel is OPEC, for petroleum pricing.

Resource Allocation – “What to produce…and in what quantity?”

Two ways of allocation

     Government (Planning Commission) through taxation, subsidies, licensing, quota etc

o Advantage – Can take care of even those who are willing, but ‘unable’ to
buy; can take care of the macroeconomic problems (unemployment)

o Disadvantage – Less efficient
     Market Mechanism based on demand and supply considerations

o Advantage – Based on collective wishes of people; more competition leading to higher efficiency of firms; more initiatives (by private players)

o Disadvantage – Cannot ensure social justice; cannot fill the gap between
‘need and supply’; insensitive to the macroeconomic problems (inflation,
environment degradation)

Government  Intervention:   In  general,  govt  intervention  in  the  market  mechanism  creates distortions like suppliers reducing production, shortages, unequal distribution and black marketing.

     But the govt can provide subsidies to (poor) consumers and incentives to (unwilling)
producers
     Administrative measures can take care of black marketing (Acts like Prevention of Black
Marketing and Maintenance of Essential Supplies)

Post  reforms  (1991),  govt  has  started  inviting  private  players  to  participate  in  otherwise  non-
profitable sectors (like infrastructure) by providing them Viability Gap Funding (VGF)

VGF - Ministry of Finance Department, Department of Economic affairs has introduced a scheme for support to public private partnership (PPP) in infrastructure.


G.O.I. has made provision to financially support the viability gap to the tune of 20% of the cost of the project in the form of capital grant from its viability gap fund.

The scheme is confined to Public Private Partnership projects taken by the Government or its agencies, where the private sector is selected through open competitive public bidding.

Under the scheme of Government of India, a provision has been made that Government of India’s support will be limited to tune of 20% of the cost of the Project. It is also mentioned that State Government or its agencies that owns the project may also provide additional grants out of its budget not exceeding further 20% of the total cost of the Project.

LPG – Liberalization (reducing govt control and allowing economic units to take their own  decisions,  Privatization  (increasing  the  role  of  private  sector),  Globalization(integrating Indian economy with the world economy)
Competition Commission of India created in 2002 is not anti-competition – it ensures that the companies play by the rules and no company takes undue advantages




National Income Accounting

Gross Domestic Product (GDP) – Monetary value of all final goods and services produced in the domestic territory of a country during an accounting year.

Capital goods (e.g. machinery) are included in GDP, but intermediate goods (e.g. raw materials) are not
     Same good can be final (you consuming milk ) or intermediate (milk in the restaurant)
depending on the usage
     Intermediate goods and services are not included to avoid double counting
   
 In India, Services Sector contributes 60% to the GDP
     Domestic  Territory  =  Country’s boundary  +  Embassies/Consulates +  Military Establishments   of   the   country   abroad   +   Ships/Aircrafts/Fishing   Vessels/Oil   Rigs belonging to the residents of the country

Accounting Year = Fiscal Year; for India it is 1st of April to 31st of March (next year)

     Will include the income generated by MNCs in India

Gross National Product – GNP is the total value of final goods and services by normal residents of India within an accounting year. GDP includes the contribution made by non-resident producers - who work in the domestic territory of other countries - by way of wages, rent, interest and profits. For example, the income of all people working in Indian banks abroad is the factor income earned abroad. Net factor income from abroad is the difference between the income received from abroad for rendering factor services and the income paid for the factor services rendered by non-residents in the domestic territory of a country. GNP is, thus, the sum of GDP and net factor incomes from abroad.

In brief, GNP = GDP + NFIA (net factor income from abroad).

Normal Resident – GoI defines it as someone who has long term economic interest in India. Inputs – 1) Factor: Land, Labour, Capital & Entrepreneurship 2) Non-factor: All others (raw materials)
NFIA may be positive or negative. In case of India, it is negative; so our GDP > GNP

Net value = Gross – Depreciation

Net Domestic Product (NDP) = GDP – Depreciation
Net National Product (NNP) = GNP – Depreciation
NNP = NDP + NFIA (similar to the relation between GNP & GDP)
Theoretically ‘net’ is a better measure of the health of an economy than ‘gross’ but it is
difficult to estimate net values – so GDP & GNP are commonly used measures


Factor Cost (FC) vs Market Price (MP)

FC includes rent, wages, interest and profit
MP = FC + Net Indirect Taxes
o Net Indirect Taxes = Indirect Taxes – Subsidies
o Therefore, GDP at MP = GDP at FC + Net Indirect Taxes
Direct Taxes imposed on income and wealth of people and corporates (Income tax, wealth tax etc); indirect taxes on goods and services (sales tax, excise duty)
FC is used for estimating growth (e.g. our annual GDP numbers)
o GDP at MP can increase merely by increasing the taxes, even without increase in production

Current Prices vs Constant Prices

     Current – Values estimated at prevailing (current) prices
•    GDP at current prices is called Nominal GDP
•    Govt always gets its data in terms of Nominal GDP and then converts it to Real GDP     Constant – Values estimated at the prices of a base year
•    For India, the base year is 2004-05
•    Growth is always estimated at constant price

o So, when we say that the GDP growth rate of India in 2011-12 was 6.5 %, it is
estimated at factor cost and constant prices.
o GDP at current price can increase because of inflation – not a true indicator of increase in production. So it is not used.
o GDP at Constant Prices is called Real GDP – it cannot increase without a real increase in production.
     Converting Nominal to Real GDP – Two ways
•    Estimate inflation, deduct its impact on the nominal GDP – deflating the nominal
GDP
o Real GDP = (Nominal GDP/GDP Deflator) x 100
o GDP Deflator is an index number used to represent inflation
•    Estimate the actual numbers of production – very tough to do. Criteria for selection of base year
•    Normal year – neither too high nor too low
•    Latest possible year
•    Relevant data for that year should be readily available
Two data collection agencies in India
•    Central Statistical Organisation (CSO) – Estimates National Income
National  Sample  Survey  Organisation  (NSSO)  –  Collects  data  on  employment, poverty, consumption, expenditure, etc
o Sample Surveys conducted annually, but Large Sample Surveys conducted every 5 years
o Latest was the 66th  Round of NSSO (2009-10) – but not selected as a base
year, because it wasn’t a normal year (economy affected by financial crisis)
   So, the last Large Sample Survey (61st Round, 2004-05) was used for selecting the base year

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