Price Discrimination in Economics from HelpWithAssignment.com

In Economics, Price Discrimination is an important concept. Price Discrimination occurs when the same product is sold at more than one price.

For example, an airline may sell tickets on a particular flight at a higher price to business travelers than to college students. Even if the products are not precisely the same, price discrimination is said to occur if very similar products are sold at prices that are in different ratios to marginal costs.

Thus, if a firm sells boxes of candy with a label saying, “Premium Quality” in rich neighborhoods for $12 and sells the same boxes of candy without the label in poor neighborhoods for $5, this is discrimination. The mere fact that differences in prices exist among similar products is not evidence of discrimination; only if these differences do not reflect cost differences is there evidence of this kind.

For a firm to be able and willing to engage in price discrimination, the buyers of the firm’s product must fall into classes with considerable differences among classes in the price elasticity of demand for the product and it must be possible to identify and segregate the product easily from one class to another, since otherwise persons could make money by buying the product from the low-price classes and selling it to the high-price classes, thus making it difficult to maintain the price differentials among classes.

The differences among classes in income level, tastes or the availability of substitutes. Thus, the price elasticity of demand for the boxes of candy may be lower for the rich than for the poor.

If a firm practices discrimination of this sort, it must decide two questions: how much output should it allocate to each class of buyer, and what price should it charge each class of buyer?

Suppose that there are only two classes of buyers. Also, for the moment, assume that the firm has already decided on its total output and consequently that the only real question is how it should be allocated between the two classes. The firm will maximize its profits by allocating between two classes in such a way that marginal revenue in one class is equal to marginal revenue in the other class.

For example, if marginal revenue in the first class is $25 and marginal revenue in the second class is $10, the allocation is not optimal, since profits can be increased by allocating 1 less unit of output to the second class and 1 more unit of output to the first class. Only if the two marginal revenues are equal is the allocation optimal.

(1+ 1/n₂) ÷(1+ 1/n₁)

If the marginal revenues in the two classes are equal, the ratio of the price in the first class to the price in the second class will equal n₁ is the price elasticity of demand in the first class and n₂ is the price elasticity of demand in the second class. Thus, it will not pay to discriminate if the two price elasticities are equal. Moreover, if discrimination does pay, the price will be higher in the class in which demand is less elastic.

Turning to the most realistic case in which the firm must also decide on its total output, it is obvious that the firm must look at its costs as well as demand in two classes. Specifically, the firm will choose the output where the marginal cost of its entire output is equal to the common value of the marginal revenue in the two classes.

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This article is in continuation with our previous articles on Economics which include Capital Markets, Market Structure, Factor Markets, Economic Surplus

Industrial Policy for Overall Economic Development in Economics from HelpWithAssignment.com

Industrial Policy:

Beyond support for basic science and technology, an aggressive approach has been proposed for encouraging technological development is industrial policy. Generally, industrial policy is a growth strategy in which the government – using taxes, subsidies, or regulation – attempts to influence the nation’s pattern of industrial development. More specifically, some advocates of industrial policy argue that the government should subsidize and promote “high-tech” industries, so as to try to achieve or maintain national leadership in technologically dynamic areas.

The idea that the government should try to determine the nation’s mix of industries is controversial. Economic theory and practice suggest that under normal circumstances the free market can allocate resources well without government assistance. Thus advocates of industrial policy must explain why the free market fails in the case of high technology. Two possible sources of market failure have been suggested and borrowing constraints and spillovers.

Borrowing Constraints: Borrowing constraints are limits imposed by lenders on the amounts that individuals or small firms can borrow. Because of borrowing constraints, private companies, especially start up firms, may have difficulty obtaining enough financing for some projects. Development of a new supercomputer, for example, is likely to require heavy investment in research and development and involves a long period during which expenses are high and no revenues are coming in.

Spillovers: Spillovers occur when one company’s innovation stimulates a flood of innovations and technical improvements by other companies and industries. The innovative company thus may enjoy only some of the total benefits of its breakthrough while bearing the full development cost. Without a government subsidy (argue advocates of industrial policy), such companies may not have a sufficiently strong incentive to innovate.

A third argument for industrial policy has less to do with market failure and more to do with nationalism. In some industries (such as aerospace) the efficient scale of operation is so large that the world market has room for only a few firms. For the world, the most desirable outcome is that those few firms be the most efficient, lowest – cost producers. However, in terms of a single country, like the United States, at least some of the firms in the market should be US firms so that profits from the industry will accrue to the United States. Moreover, having US firms in the market may enhance US prestige and yield military advantages. These perceived benefits might lead the US to subsidize its firms in that industry, helping them to compete with the firms of other nations in the race to capture the world market.

These theoretical arguments for government intervention all assume that the government is skilled at picking winning technologies and that its decisions about which industries to subsidize would be free from purely political considerations. However, both assumptions are questionable. A danger of industrial policy is that the favored industries would be those with the most economic promise.

The available evidence on the arguments for industrial policy has been surveyed by Gene Grossmann. Grossmann concluded that, in general, industrial policy is not desirable because, in choosing industries to target governments have frequently “backed the wrong horse”, the costly attempt of European governments to develop Supersonic Transport (SST) and other new types of commercial airplanes is a case in point. Grossman also points out that alternative policies – such as tax break for all research and development spending – promote technology without requiring the government to target specific industries.

However, Grossman also concedes that government intervention may be desirable in some cases, notably in the early development stages of technologically innovative products, such as computers and CAT scanners. Empirically, the potential for beneficial spillovers in these cases appears so large that the government may choose to support ultimately will not prove worthwhile.

This article is in continuation with our previous article on Government Policies to Raise Living Standards

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Government Policies to Raise Long run Living Standards in Economics from HelpWtihAssignment.com

Increased growth and a higher standard of living in the long run often are cited by political leaders as primary policy goals. We will take a closer look at government policies that may be useful in raising a country’s long run standard of living whether changing the form of government – democratic or nondemocratic – affects the long run growth rate of an economy.

Policies affecting the Saving Rate

The Solow Model suggests that the rate of national savings is a principal determinant of long run living standards. However, this conclusion doesn’t necessarily mean that the policymakers should try to force the saving rate upward, because more saving means less consumption in the short run. Indeed, if the “invisible hand” of free markets is working well, the saving rate freely chosen by individuals should be the one that optimally balances the benefit of saving more, against the cost of saving more.

Despite the argument that saving decisions are best left to private individuals and the free market, some people claim that Americans save too little and that US policy should at raising the saving rate. One possible justification for this claim is that existing tax laws discriminate against saving by taxing away part of the returns to saving; a “pro-saving” policy thus is necessary to offset this bias. Another view is that Americans are just too shortsighted in their saving decisions and must be encouraged to save more.

Now, here comes the question of ‘what policies can be used to increase savings?’ If saving were highly responsive to the real interest rate, tax breaks that increase the real return that savers receive would be effective. For example, some economists advocate taxing households on how much they consume rather than on how much they earn, thereby exempting from taxation the income that is saved. Although saving appears to increase when the expected real return available to savers rises, most studies find this responsive too small.

An alternative and perhaps more direct way to increase, the national saving rate is by increasing the amount that the government saves; in other words, the government should try to reduce its deficit or increase its surplus. Many economists also argue that raising taxes to reduce the deficit or increase the surplus will also increase national saving by leading people to consume less. However, believers in Ricardian equivalence contend that the tax increases without changes in current or planned government purchases won’t affect consumption or national saving.

Policies to Raise the Rate of Productivity Growth

Of the factors affecting long-run living standards, the rate of productivity growth may well be the most important in that – according to the Solow Model – only ongoing productivity growth can lead to continuing improvement in output and consumption every year. Government policy can attempt to increase productivity in several ways.

Improving infrastructure: Some research findings suggest a significant link between productivity and the quality of a nation’s infrastructure – its highways, bridges, utilities, dams, airports and other publicly owned capital. The construction of the interstate highway system in the United States, for example, significantly reduced the cost of transporting goods and stimulated tourism and other industries. In the past 25 years the rate of US government investment in infrastructure has fallen, leading to a decline in the quality and quantity of public capital. Reversing this trend, some economists argue that might help achieve higher productivity.

Building Human Capital: Recent research findings point to a strong connection between productivity growth and human capital. The government affects human capital development through educational policies, worker training or relocation programs, health programs, and in other ways. Specific programs should be examined carefully to see whether benefits exceed costs, but a case may be made for greater commitment to human capital formation as a way to boost productivity growth.

One crucial form of human capital, which we haven’t yet mentioned, is entrepreneurial skill. People with the ability to build a successful new business or to bring a new product to market play a key role in the economic growth.

Encouraging Research and Development: The government also may be able to stimulate productivity growth by affecting rates of scientific and technical progress. The US government directly supports much basic scientific research. Most economists agree with this type of policy because the benefits of scientific progress, like those of human capital development, spread throughout the economy, Basic scientific research may thus be a good investment from society’s point of view, even if no individual firm finds such research profitable.

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This article is in continuation with our previous articles on Economics which include Balance of Payments, Economic Development and Growth, Inflation, Business Cycles