CH1 Toolbox - 1 Our toolbox. Brief review of: 1. Value...

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Our toolbox.Brief review of:1.Value added2.Market legal framework3.Opportunity cost and comparative advantage4.Economies of scale; Cobb-Douglas5.Why free trade?6.Supply and demand; Marshall surplus7.Competition and monopoly; monopoly social cost8.Ceiling and floor prices9.Definitions of “Competition “; neo-classical identification to “socialoptimum”; roots of governments’ interventionism; Austrian definition of themarket as a process10.Market and government failureThis chapter includes all basic tools you aresupposed to master. You have been warned …I Value addedThe measure of wealthis the measure of economic activity in a society. We use“value added” as a common measure because it reflects both men’s creation andmen’s destruction. The GDP is the aggregate term for VA in a country and the GWPis the term on the world level.The GDP just provides rough information aboutpeople well being since it doesn’t take into account any appropriated goods likeenvironment, 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 productionunder the names of capital K and labor L.Accumulating and combining (investing) K and L in a production unit (or firm) is ameans of improving productivity and production.1
VA = sales – intermediate consumptionC=Production Cost = Remuneration of factors = K ×i + L×wπ= VA – C=a random resti and w are predetermined by contract and lawπis randomly determined> 0 or < 0i = 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 ofhis production to a baker for $ 1600.The baker sells all the bread he is making to consumers for $ 2500.2VALUEADDEDPRODUCTION UNITCONSUMERS2500 – 1600 =900(1600 + 200) – 1000 =8001000 – 0 =1000FARMERBAKERMILLER2002500Σ = 2700 = GDPΣ = 2700Intermediate consumptionFIRMsalessupplierBorrowed capital(LT liabilities)Firm Capital (ownersequity)OwnerslaborHired laborEntrepreneur(innovation, risktaking,
VA goes to factors of production. They spend income by buying finalgoods.Equations:Σ VA = GDP = Σ INCOMES = Σ CONSUMPTIONS3
Example 2.In the first column, GDP is measured as the sum of all domestic and foreign effectiveconsumption 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. Aminuscule additional element is the change in inventories.

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