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EU Econ Pt2
Terms in this set (48)
Why do we need a little unemployment?
•Need to have a little unemployment to ensure growth as they have flexibility and mimics the transactional
Why Unemployment is Important? (4)
1. If high lowers output and low growth
2. Poverty and insecurity
3. Depletes Human Capital
4. Higher public spending through benefits
Why is long-term unemployment bad for policymakers?
•Long-term unemployment because it has financial and social effects on personal life of the person unemployed but it also affects social cohesion and may hinder economic growth
What are the bad effects of Unemployment? (3)
• Costly--> requires a lot of public funding
• Demotivates the work force
• Halts growth
Working Pool Population (P)
everybody who is eligible to work in the country
What causes E/P Ratio to go up?
•Unemployment Rate decreases
•The activity Rate increases
What is the Differences in EU labour Market? (3)
•Differences in Productivity
•Dual Labour Market
•Differences in Unemployment Benefits
Difference in Productivity
o Labour Cost
Unit labor costs = Total Labor Costs/ Real Output
Productivity = Real Output / Worker (or hours worked)
o Rigid Labour Markets
Employees are highly protected hard to fire them
Dual Labour Markets...
What is the difference between Insider vs Outsiders
Insiders (long-term contracts) vs Outsiders (temporary contracts)
Ratio of unemployment benefits a worker receives relative to the worker's last gross earning
Different Labour Market policies? (2)
Passive labor market policy (unemployment benefits)
Active labor market policy (Start-up incentives, Public jobs, Training, Public services like Placement or labor agencies, Employment incentives)
oWeak demand leads to why firms do not hire enough people
Where c is consumption and L is leisure
oNot sensitive to Wage increases
If you double the wage it doesn't equal double the productivity
o Price = wages
o Labour Demand = demand
o Production Function = F(L)
Marginal productivity of each worker decreases since the less wage you pay the less motivation they have to give high return
o Unemployment is associated to some form of rigidity in the labor market
Rigidity = the wage rate cannot be adjusted to clear the market.
oFocus on the equilibrium determinants on economic output thorough demand and supply analysis
oThere exist some of kind of ridgities that prevent the wage from adjusting to its equilibrium level
Neoclassical Demand for Labour
How many hours are companies hiring according to Neo-classical?
What happens if the wage rate/ productivity goes up?
• Companies hire until the unit cost of an additional hour is less than its product
• Productivity: each hour produces more, so the firm would hire more hours at a given wage rate!
What can prevent the wage rate from reaching the equilibrium level in Neoclassical Approach? (3)
1. Minimum wages
2. Efficient wages (managers have the incentive to pay more than average to increase productivity or efficiency, e.g. Ackerlof ("fair wage") or Shapiro and Stiglitz (firms cannot perfectly monitor workers)
3. Labor unions: when negotiating higher wages it decreases labor supply
What happens to labor demand, wages, employment, output if there is a positive productivity shock in Neoclassical?
Increases labor demand
Wages go up
Increases employment - increases output
•Assumption: No Sales constraint
Keynesian Criticism of Neoclassical Short Term (3)
1. Firms are not always able to sell all the produce
2. If the supply is bounded to a certain amount of hours because of the sales constraint, the profit maximizing firm is still going to hire just enough hours they need to produce for the sales constraint, even if the wage rate is small and they could hire more hours!
3. Decreasing the wage rate might not increase employment because of the sales constraint and might even reduce demand and therefore further aggravate the crisis!
Causes of High EU Unemployment (4)
1. Demand Driven
2. Due to labor market ridgities
oMismatch between demand for labor and supply of skills from workers
oCoal Industry falls then Coal specialized workers are laid off
oEducation: Finland meet the government to fill gaps in the labor market
What is the Danish Flexicurity Model and who profits?
• Attempt to unite the fundamental needs of social cohesion, social protection and be able to adapt fast and to innovate
oComponents: flexible and reliable contractual arrangements, comprehensive life-long learning, ALMP
•It is protecting people not protecting jobs —> maintain income and increase employability
Young people Limits extent of dual labor markets
How did Italy try to close the gap between outsiders and insiders in 2015
•Temporary contracts becomes permanent after 3 years
•No reinstatement of workers who have been unfairly fired —> compensation instead
Immigrations Effect on Labour Markets-Neoclassical Theory
•Neoclassical theory predicts that immigration leads to and increase in supply and therefore lower wages and more employment of native workers
o However: It assumes that workers are perfect substitutes!
What happens if there are skilled and unskilled workers in the market and #of unskilled workers increases? (3)
• Increases the marginal productivity of the skilled workers so the wage of the unskilled workers drops and the demand and therefore also the wage of the skilled workers increases!
• Every wage in unskilled workers there is now more hours available —> drop in wage!
• Leads to higher employment rate in both terms
What are the 3 benefits from trade?
1. Economic growth (economies of scale)
2. Consumer benefits (variety and lower prices)
3. Labour Effects (exporting firms pay higher wages, more jobs)
Why do countries trade? What are the 2 theories?
1)Traditional Trade Theory
•Gains from specialization made possible by countries being different
oDifferent levels of productivity, different endowment (worker,load)
oLeads to a comparative advantage of one country so it can gain from trade (gains from specilization)
2) New Trade Theory
•Why do similar countries trade?
oEconomies of scale (producing only one product can help focus/ decrease costs/ increase productivity)
o Consumer love variety!
What are the limits to full specialization? (3)
• Transport costs (non-tradeable goods)
• Technology: decreasing marginal productivity
• Governments may restrict trade (quotas, tariffs, import licensing)
Does free trade exploits cheap labor abroad?
• If we buy goods from low wage countries , we do not contribute to them having lower wages, to the contrary, high demand will push wages upwards, employment increases
Preferential Trading Arrangements
• Free Trade Areas
• Custom Unions Common External Tariff
• Common Market Uniform Tax, Free movement, no special treatment
Common Agricultural Policy
oProtects for the agricultural sector
oAlmost 50% of the EU Budget
oEU is the world largest exporter of agricultural products
•Environmental risks related to overproduction
Gradually reduce export subsidies
Replace aid related to output
Industrial Organization Issues Why do firms exist?
• To produce goods and services demanded by consumer.
• What are the basic constraints of a firm?
o Tastes (demand funtion) —> Volumes, Price elasticity
oTechnology —> cost function
oCompetitors —> strategic interaction
What kind of demand elasticity does a firm aim for?
• As a firm you want an inelastic demand because when I increase my price my revenue increases as well!
• A product is inelastic if a large change in price is accompanied by a small amount of change in quantity demanded!
What are economies of scale and technology?
•Returns of Scale
oConstant returns to scale: f(2x1,2x2) = 2*f(x1,x2)
o Increasing returns to scale: f(2x1,2x2) > 2*f(x1,x2)
o Decreasing returns to scale: f(2x1,2x2) < 2*f(x1,x2)
•Marginal costs = additional costs of producing one more unit
•Total Costs: TC = C(q) MC = C'(q) = dTC/dq
•Average costs = TC/q
When do we have constantly decreasing average costs and constant marginal costs?
• example is the Pharmaindustry where you invest in R&D first but then every pill has the same cost to produce!
o C(q) = F + c*q (fixed costs variable costs) MC = c
How to Max Profit
•π = TR - TC
π = p * q - C(q)
max π = dπ / dq
What kind of market structures do exist?
1. Homogenous product: Competition (many firms), Monopoly (one firm), Oligopoly (few firms)
2. Differentiated Product: Monopolistic competition (many firms), Monopoly (one firm), Oligopoly (few firms)
What are the characteristics of a market in perfect competition?
o Many small firms producing a homogenous product (all the same, no differentiation)
o Perfect information (everybody knows everything about the market)
o No barriers of entry (free entry in the long-run) - firms are price-takers
What is the optimal choice, what quantity should be produced? Perfect Competition
•MC = p —> where the marginal costs are equal to the price! Find out the according Y
oReminder: MC = C'(q)
oProfit = (MC - AC)
BUT: If there is profit more firms are going to enter the market!
What is the short-run supply curve of the competitive firm?
• The supply curve of the competitve firm in the short-run is the MC above the price!
o Because if the price is increasing the formula MC = p is at a higher Y*!
MC = AC in the minimum of the average costs!
What is the market supply in the short-run? How is it shifting if more people are entering?
• If more firms are entering the market the market supply curve is going to shift to the right and have a lower slope (adding the supply of every firm together for every single price)
• If we get the demand curve as well we can see that the more companies are entering the market, price gets lower and lower because of the lower slope of the supply
• Every single firm is going to produce less, but the market supply is increasing because of more market entries!
When do firms stop entering the market?
• When there is no profit anymore —> MC = p = min AC
o This means that in the long-run firms enter until there is no profit anymore!
How much is the consumer surplus in a competitive market?
• Consumer surplus is at its highest
Lowest feasible price (Ideal case)
Which barriers do monopoly have or create? (3)
• Legal barriers of entry (Patents or sensible activities) —> Patents imply temporary market power through innovation
• Technological barriers of entry (decreasing average costs)
• Strategic barriers of entry
What is the marginal revenue of a Monopolist?
MR = ∆TR/∆q
For a monopolist the marginal revenue is always lower than demand/price!
How can you find out the optimal quantity and the price a monopolist is selling at?
•Equilibrium condition of a monopolist: MR = MC —> p(q) * (1 - e^-1) = C'(q)
Gives you the according quantity Y
Is there a welfare loss for the economy when a monopolist is dominating the market?
• YES, this is why the EU is paying attention to discriminating monopolies!
What is the so called Price Discrimination of Third Degree?
• If the monopolist can segment the market, meaning he observes a consumer characteristic related to demand elasticity and there is no resale allowed —> Monopolist can ask for different prices according to the demand elasticity of the segment (price will be higher the more inelastic the segment is!)
o Example: SNCF (elder vs. younger travelers)
What is Article 82 of the EC treaty for? Prohibits the abuse of a dominant position
1. Exclusive dealing
a. requiring a customer to purchase exclusively or to a large extent from the dominant undertaking
a. customers buying one product are required to purchase another product
a. product is set at very low price to drive competitors out of the market or create entry barriers
4. Refusal to supply or margin squeeze
• Fines for fixing prices and other abuses: up to 10 % of global worldwide sales
o After 2006, up to 30%
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