Ten Thoughts on Improving Your Economics Papers

Economics Revision

Geoff Riley, Tutor2u

May 2013

(1) Questioning marginal decisions

• In theory, many decisions are made at the margin– Marginal revenue = marginal cost (profit max output)– Marginal social benefit = marginal social cost (social equilibrium)– Marginal utility of consumption compared to the price

• Few businesses / people have the capacity to reach precise equilibrium points – or even seek to find them

• But……– Marginal changes in behaviour can have a big effect if enough

people make them (e.g. Energy consumption decisions)– Changing behaviour ‘at the margin’ can have important social

effects – social norms can change + policies can have an impact– The fundamental value of something depends on the value of

the marginal unit – important in lots of markets (e.g. oil, food)

2: The Law of Unintended Consequences

• This is a root cause of ‘government failure’

• All interventions in a market have at least one and often many unintended consequences

• Unintended consequences can be positive and negative

• Reasons:– Economics is a social science about behaviour and choices

– Rational agents will look for ways to offset policies that cost them

– Information failure in government when setting policies especially when they have not done randomised controlled trials

– Dynamic nature of markets – markets and the agents that inhabit them move more quickly than government

3: Stakeholders matter!

• A stakeholder is ‘Any person or organization that has a legitimate interest in a specific project or policy decision.’

• Check to see the sources of information in data response questions

• Identify and comment when value judgements are being made / apparent bias – this scores high for evaluation

• Risk of government failure:– Regulatory capture by powerful lobbying organisations

• Micro lobbying: Alcohol manufacturers• Macro lobbying: Negotiations over international trade / climate change policy

– Policy decisions made to please a vested interest– Inequitable impact between one group and another

Stakeholders

• Employees of a business • Communities where a business is located or affected by

a decision• Suppliers• Shareholders• Creditors • Government (and through them – taxpayers)• Trade unions (and the workers they represent)

Stakeholders

• Employees of a business • Communities where a business is located or affected by

a decision• Suppliers• Shareholders• Creditors • Government (and through them – taxpayers)• Trade unions (and the workers they represent)

• NGOs and other advocacy groups (i.e. World Bank, IMF, Pressure Groups)

• Prospective employees • Prospective customers • Local communities • National communities • International community• Competitors within a market• Professional associations

4: Time Periods in Economics

• Be familiar with– Immediate (momentary) especially in primary sectors

– Short run (at least 1 fixed factor, diminishing returns)

– Long run (all factor inputs are variable, economies and diseconomies of scale)

• Applications of time periods in your analysis– Elasticity of supply (micro and macro supply curves)

– Elasticity of demand (Ped, CPed, Income elasticity)

– ‘Discounting’ the future value of costs and benefits (CBA)

– Long run macroeconomic policies e.g. supply-side / trade policy

– Long run micro policies – e.g. liberalising a market, nationalisation, renewable energy policies

5: (a) Demand and supply curves are often non-linear!

P P

Q

D

S

Changing elasticity of supply as output increases

Q

Elasticity might vary across different price ranges

5(b): Upward sloping demand and downward-sloping supply!

P P

Q

D

S1

S2

S2

Long run supply with economies of scale

Q

Perverse upward sloping demand at high prices e.g. When price associated with product quality

6: Change the elasticity to build / develop your analysis!

P

D

S

S + tax

Q1Q2

P1

P2

6: Change the elasticity to build / develop your analysis!

P

Q

D

S

S + tax

Q1Q2

P1

P2

P

Q

D1

S

S + tax

Q1Q2

P1

P2

D2

More close substitutes – higher CPED

Double diagrams can show examiners that you have a clear grasp of ideas and include good analysis in your answers

7: Most markets are inter-related

• Changes in relative prices / rewards in one market affect resource allocation in others

• Key related-market concepts to revise:– Substitutes– Complements– Derived demand– Composite demand– Joint supply– Competitive supply

• Also important in macroeconomics– Factor markets and the economic cycle (labour demand)– Bond markets / currency markets / equity markets– Macroeconomic effects of external demand/supply shocks

8: Relative prices, preferences and incentives

• Markets are powerful – don’t underestimate them – especially the power of setting the right incentives

• Policy interventions seek to change behaviour of agents• People do respond to incentives

– Govt failure if the incentives turn out to be perverse– Govt failure if the incentives are not strong enough (ineffective)

• Behaviour changes when relative costs & benefits alter– Leads to substitution effects (changes in demand for X and Y)– Agents react to changes in costs and benefits of their actions

• This requires– A sufficient change in relative prices to make a difference– Availability and affordability of alternative courses of action– Sufficient time for agents to respond and react

Examples of changes in relative prices

• London congestion charge / underground fares

• National minimum wage

• Changes in relative prices of low and high carbon energy

• Relative prices of different crops in farming

• Relative price of ethical-products

• Relative prices and demand for exports / imports e.g. Following an exchange rate change

• Relative prices of legal versus illegal transactions (e.g. crime / organ sales)

9: Expectations matter!

• Expectations of the future drive current behaviour!– Housing market / property development / decisions on land use– Capital investment decisions by businesses (expected profits)– Food supply decisions – expected returns from different crops– Currency demand and supply – speculative activity in FOREX– Monetary policy / inflation – inflation expectations and wages– Fiscal policy / tax cuts / govt borrowing – expectations of changes in

taxes

• Formation of expectations:– Rational expectations– Adaptive expectations

• In macro – changes in animal spirits among businesses, consumers and other agents has a huge effect

10: The cost-benefit principle

• The mother of all economic ideas is the cost-benefit principle

• It says that should take an action if, and only if, the extra benefit from taking it is greater than the extra cost

• The hard part is– Identifying the relevant costs and benefits– Measuring and valuing them– Applying an appropriate discount rate to future costs and

benefits

• Individual rationality does not always lead to a socially optimum / desirable outcome

• Behavioural economics questions the core rationality embedded into conventional textbook economics

And finally….

• Most policy problems require a combination of strategies• Understand the meaning of efficiency and equity in markets

(allocative, productive, dynamic efficiency)• Have the courage to challenge the conventional wisdom• Let your diagrams do the work for you – develop the

analysis with high quality diagrams• Pick out bias in extracts – value judgements • Use the data that is provided but be aware of limitations• What is rational for individual agents can often leading to

outcomes that are damaging for society• Be cautious about government intervention – markets often

find solutions to intractable problems in the long run – if the incentives are strong enough

Recommended Paragraph Structure

One Main Point/Argument

Analyse / Connectives

Supporting Examples &

Evidence

Evaluate the actual point

made

Evaluate

Assess

Discuss

To what extent

Examine

Questions Requiring Evaluation

Most common errors

Not using the data in the extracts

Not evaluating in every paragraph

Not referring to/explaining diagrams

Not defining terms accurately

Short chains of analysis – missing links

Top Tips

Use signposting from the question

Spread your work out well

Large analysis diagrams

Work timing out beforehand

Short plan helps to frame work

Good Evaluation Phrases

It depends on….

In the short run…however in the long run

The magnitude of the effect….

The most important point…

This will also impact

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