CH1 Toolbox - 1 Our toolbox Brief review of 1 Value added 2 Market legal framework 3 Opportunity cost and comparative advantage 4 Economies of scale

CH1 Toolbox - 1 Our toolbox Brief review of 1 Value added 2...

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Our toolbox. Brief review of: 1. Value added 2. Market legal framework 3. Opportunity cost and comparative advantage 4. Economies of scale; Cobb-Douglas 5. Why free trade? 6. Supply and demand; Marshall surplus 7. Competition and monopoly; monopoly social cost 8. Ceiling and floor prices 9. Definitions of “Competition “; neo-classical identification to “social optimum”; roots of governments’ interventionism; Austrian definition of the market as a process 10. Market and government failure This chapter includes all basic tools you are supposed to master. You have been warned … I Value added The measure of wealth is the measure of economic activity in a society. We use “value added” as a common measure because it reflects both men’s creation and men’s destruction. The GDP is the aggregate term for VA in a country and the GWP is the term on the world level. The GDP just provides rough information about people well being since it doesn’t take into account any appropriated goods like environment, quality of life, literacy, life expectancy, etc. But it allows comparisons. How men add value to existing resources? They transform or move resources. Resources are land and tools, and men. These are called factors of production under the names of capital K and labor L. Accumulating and combining (investing) K and L in a production unit (or firm) is a means of improving productivity and production. 1
VA = sales – intermediate consumption C = Production Cost = Remuneration of factors = K × i + L × w π = VA – C = a random rest i and w are predetermined by contract and law π is randomly determined > 0 or < 0 i = rate of return (on capital) w = rate of wage (labor) The two circuits of value added: One is in terms of good and services circulation: left part on the graph. The other is in terms of incomes distribution: right part . Example 1. A farmer sells the wheat he harvested to a miller for $ 1000. The miller sells part of the flour he produces to consumers for $ 200 and the rest of his production to a baker for $ 1600. The baker sells all the bread he is making to consumers for $ 2500. 2 VALUE ADDED PRODUCTI ON UNIT CONSUMER S 2500 – 1600 = 900 (1600 + 200) – 1000 = 800 1000 – 0 = 1000 FARMER BAKER MILLER 200 2500 Σ = 2700 = GDP Σ = 2700 Intermediate consumption FIRM sales supplier Borrowed capital (LT liabilities) Firm Capital (owners equity) O wners labor Hired labor Entrepreneur (innovation, risk taking,
VA goes to factors of production. They spend income by buying final goods. Equations: Σ VA = GDP = Σ INCOMES = Σ CONSUMPTIONS 3
Example 2. In the first column, GDP is measured as the sum of all domestic and foreign effective consumption for national goods. Domestic demand is the sum of household, government, and firm expenditure. Foreigners buy national goods as exports. Domestic consumers buy also imported goods, which reduce the GDP sum. A minuscule additional element is the change in inventories.

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