Category Archives: Micro

A2 Economics – Marginal Revenue Product Theory

Marginal Revenue Product of Labour

Marginal revenue productivity (MRPL) is a theory of wages where workers are paid the value of their marginal revenue product to the firm.

The MRP theory outlined below is based on the assumption of a perfectly competitive labour market and the theory rests on a number of key assumptions that realistically are unlikely to exist in the real world. Most labour markets are imperfect, one of the reasons for earnings differentials between occupations which we explore a little later on.

  • Workers are homogeneous in terms of their ability and productivity
  • Firms have no buying power when demanding workers (i.e. they have no monopsony power)
  • There are no trade unions (the possible impact on unions on wage determination is considered later)
  • The productivity of each worker can be clearly and objectively measured and the value of output can be calculated
  • The industry supply of labour is assumed to be perfectly elastic. Workers are occupationally and geographically mobile and can be hired at a constant wage rate

Marginal Revenue Product (MRPL) measures the change in total output revenue for a firm as a result of selling the extra output produced by additional workers employed. A straightforward way of calculating the marginal revenue product of labour is as follows:

MRPL = Marginal Physical Product x Price of Output per unit

Therefore the MRP curve represents the firm’s demand for labour curve and the profit maximising condition is where:

MRPL = MCL (Marginal Cost of Labour) where the revenue generating by employing an additional worker (MRPL) = the cost of employing an additional worker (MCL).

Mind Map below adapted from Susan Grant’s book CIE A Level Revision Guide

A2 Revision: The Perfectly Competitive Firm and the Market

Supernormal, normal, and subnormal profit only identified what happens to the firm. However it is important to be aware of what is happening in the market as a whole. Take for instance a firm making supernormal profits. The price that the firm charges is determined by what is happening in the market (supply and demand). If a firm makes supernormal profits this attracts other firms into the industry to take advantage of these profits. Therefore the supply of firms in the market increases which in turn reduces the price that firms can charge and they now make normal profits and are in the long-run see fig below.

AS Revision – Income Elasticity of Demand graph

Currently taking CIE revision classes this holiday and was working through Unit 2 and income elasticity of demand. Quite a few of the class had never come across this graph which is popular in multiple-choice questions. It is important that you read the axis.

Usefulness of Income Elasticity of Demand

Knowledge of income elasticity of demand for different products helps firms predict the effect of a business cycle on sales. All countries experience a business cycle where actual GDP moves up and down in a regular pattern causing booms and slowdowns or perhaps a recession. The business cycle means incomes rise and fall.

Luxury products with high income elasticity see greater sales volatility over the business cycle than necessities where demand from consumers is less sensitive to changes in the economic cycle

The NZ economy has enjoyed a period of economic growth over the last few years. So average real incomes have increased, but because of differences in income elasticity of demand, consumer demand for products will have varied greatly over this period.

Over time we expect to see our real incomes rise. And as we become better off, we can afford to increase our spending on different goods and services. Clearly what is happening to the relative prices of these products will play a key role in shaping our consumption decisions. But the income elasticity of demand will also affect the pattern of demand over time. For normal luxury goods, whose income elasticity of demand exceeds +1, as incomes rise, the proportion of a consumer’s income spent on that product will go up. For normal necessities (income elasticity of demand is positive but less than 1) and for inferior goods (where the income elasticity of demand is negative) – then as income rises, the share or proportion of their budget on these products will fall. See table below for a summary of values.

A2 Revision – Economies of Scale Mind Map

With the A2 exam not far away here is something on Economies of Scale – also a mind map which I have edited from Susan Grant’s book.

When the average cost curve slopes downwards it means that average costs are decreasing as output increases. Whenever this happens the firm is experiencing economies of scale . If on the other hand the average costs are increasing as output increases the firm is experiencing diseconomies of scale . Why do firms experience economies of scale?

Technical Economies: large firms can take advantage of increased capacity machinery. For example, a double-decker bus can carry twice as many passengers as a single decker bus. But without the purchase costs and the running costs are not doubled.

Managerial Economies: In a small firm the manager may perform the role of cost accountant, foreman, salesman, personnel officer, stock controller etc. However, as a firm increases in size it can take advantage of specialisation of labour.

Commercial Economies: The large firm can buy it raw materials in bulk at favourable rates.

Financial Economies: the larger firm can negotiate loans from banks and related institutions     easily and at favourable rates.

Risk-Bearing Economies: All firms are subject to risk at sometime or other. However, the larger firm has distinct advantages in this area as small changes in supply and demand can often ruin a small company and larger firms can cover itself by producing a variety of products for a variety of markets.

New Zealand vegetables prices spike in March with bad weather

Tomato, lettuce, cauliflower, cabbage, and broccoli prices rose sharply in March 2018, boosting vegetable prices 9.5 percent in the month after adjusting for typically seasonal changes.

“Vegetable crops have been affected by a run of storms in recent weeks – lower supply (supply curve to the left) due to bad weather usually means higher prices,” consumer prices manager Matthew Haigh said.

“In February, we saw rising prices for lettuce, broccoli, and cauliflower, due to a combination of humid weather and cyclone Gita. As expected, that wet weather has affected vegetable prices in March too.”

Tomatoes rose more than 60 percent in March to $4.65 a kilo. In March last year, tomatoes were 83 cents cheaper at $3.82 a kilo.

 

The avocado market – prices up by 143%

The current avocado market has seen the wholesale price of a box of 48 avocados increase by 143%.

US$34.45 in September 2016
US$83.75 in September 2017

The reasons can be explained by simple Supply and Demand.

Supply

There have been droughts, storms, wildfires and strikes in various growing areas including California, Chile and Mexico

California – production down 44%
Mexico – production down by 20%

This has a huge impact on supply with the supply curve shifting to the left – S1 – S2 therefore increasing scarcity and putting up the price.

Demand

Annual consumption in the US has increase from about 0.5 kg in 1989 to 3.5 kg in 2016.

In 2016 total consumption was 1.15 billion kg. Demand curve shifts to the right – D1 – D2 therefore increasing the price.

A lot of demand has been driven by trends like avocado toast and the growth of fast-casual Mexican chains like Chipotle. There has also been higher avocado consumption in China and Europe as health-conscious consumers in the world’s most populous nations show an interest in the “heart-healthy” avocados.

Gourmet chocolate the economic lifeline to Venezuela

At the end of the 18th century Venezuela was the world’s leading cocoa producer. But the rise of the oil industry in the 20th century and the emergence of Hugo Chavez saw the decline of the cocoa industry. Chavez boosted state involvement in the economy and promised to create a society of equals. However since the crash in oil prices – up to 90% of government revenue came from oil – society has been divided. Doctors and engineers rarely make as much as US$50 a month whilst other with access to small amounts of hard currency can afford gourmet products.

Recently in Caracas there have been some 20 new businesses launched producing bars of Gourmet chocolate which retails for around US0.80 each in high end grocery stores — well out of the reach of most Venezuelans who earn less than that in a week but catering for the well-off in a two-tier system. Bars can fetch US$10 in a place like New York and Paris but bureaucracy makes this very difficult.

Although aware of these barriers one producer, Nancy Silva, is now focused on getting her chocolate to France, where she once sold a single kilo of her chocolate for the equivalent of 80 euros (US$96), which is today the equivalent of five years of minimum wage salary in Venezuela.

Venezuela cocoa beans

Venezuela produces 16,000 tonnes per year which is less than 1% of the global output and less than 10% of regional output when you take into consideration big producers like Brazil and Ecuador. However the use of Venezuela cocoa is seen as a marketing tool for shops as bars are produced with 100% local cocoa which is deemed high quality.

Many gourmet bars made in the United States now prominently advertise the use of Venezuelan cocoa but generally mix in other less-desirable cocoas. Bars made in Venezuela by contrast are made with 100 percent local cocoa.

This gives the new Venezuelan chocolatiers a leg up as they tap into the global ‘bean-to-bar’ movement, in which chocolate makers oversee the entire process of turning cocoa fruit into sellable treats.

On the second floor of an old mansion in Caracas, economist and chef Giovanni Conversi has been making specialty chocolate for two years under the name Mantuano. Sprinkled with sea salt or aromatic fruits from the Amazon, the chocolate bars are a hit in London, Miami and Panama City in specialty chocolate stores or shops that specialize in Latin American food.

Source: Reuters – Gourmet chocolate becomes economic lifeline in Venezuela crisis – 12th January

Airline price discrimination

Price discrimination involves charging different prices to different sets of consumers for the same good or service. So when you are on your next flight there are going to be different fares for the same class of seat whether it be in economy, business class or first class. What variables at work to bring about price discrimination in airline routes?

  • What day of the week you fly – Monday and Friday are usually peak times for business so you should find that fares are expensive. Also because it is usually for business purposes it is assumed that firms will be paying for the flights and therefore are prepared to pay more.
  • Times of the day – morning and evening tend to be more expensive as this is peak time.
  • How competitive the route is – if there is a lot of competition fares will be cheaper to the extent that there maybe predatory pricing. There is a good piece in the video showing the fares for flights from Montreal to St Johns Newfoundland. Once low cost carriers entered the market Air Canada dropped their price below cost.
  • Reputation of each airline – better reputation = higher fare

The video below is a very good especially the fare structure on the New York to Los Angeles route.

What are the highest paid sports leagues?

NBA basketball has the highest average salary of any sports league followed by IPL cricket with baseball coming in third. Over half of the highest paid leagues were football with the EPL and the Bundesliga being above US$2 million. It is interesting that La Liga is third within the Football category even though a Spanish team has won the Champions League 5 times in the last 7 years.

In cricket the Twenty20 format has proved to be very popular with television viewers and gets very good attendances most notably in the IPL (India), Big Bash (Australia) and T20 Blast (England). In September this year IPL signed a five year contract worth US$2.55bn (US$510m per year) for broadcast and digital rights with Star India – a TV network owned by 21st Century Fox. The IPL competition involves just 60 matches which equates to US$8.5m per game which is 400% higher than the NBA per game and 66% greater per game than that of the EPL.

Cricket in the USA
Although cricket is globally very popular it has very limited uptake in the USA – both players and spectators. Sport in the USA has a high income elasticity of demand which means a change in income results in a greater percentage increase in demand. An Indian Media firm – Times of India Group – are hoping to tap into the American market and put on high profile cricket matches with the leading players in the game. The games generally take place in baseball stadiums but the firm is considering building cricket stadiums.

Highest paid sports leagues 2014-2015 season.

Top paid sports leagues.png

Source: CIE AS & A Level Revision Guide by Susan Grant