Nicole Neri SHORT REPORT OF ECONOMICS 6/12/11

Topics of the short report:  Property rights and politica stability  Origin of inflation and Value of money  Collusive and non – collusive oligopoly

Protecting property rights and promoting political stability is a way in which policymakers can foster economic growth. Property rights refer to the ability of people to exercise authority over the resources they own. An economy – wide respect for property rights is an important prerequisite for the price system to work, so, it is necessary for investors to feel that their investments are safe. Property rights and political stability

Example: A mining company will not make the effort to mine iron ore if it expects the ore to be stolen. The company mines the ore only if it is confident that it will benefit from the ore’s subsequent sale. For this reason, courts serve an important role in market economy: They enforce property rights: through the criminal justice system, the courts discourage direct theft; Through the civil justice system, the courts ensure that buyers and sellers live up to their contracts

What happens when the system of justice does not work well? Contracts are hard to enforce, and fraud often goes unpunished. In more extreme cases, the government not only fails to enforce property rights but actually infringes upon them. To do business in some countries, firms are expected to birbe powerful governemnt officials. Such corruption impedes the coordinating of power of markets. It also discourages domestic saving and investment from abroad.

Another threat to property rights is political instability: When revolutions and coups are common, there is doubt about whether property rights will be respected in the future. If a revolutionary government might confiscate the capital of some businesses, domestic resident have less incentive to save, invest, and start a new business. Thus, economic prosperity depends on political prosperity: A country with an efficient court system, honest government officials, and a stable constitution will enjoy a higher economic standard of living than a country with a poor court system, corrupt officials, and frequent revolutions and coups.

Origin of inflation and Value of money Inflation is an increase in the overall level of prices. Inflation in the Eurozone: it is controlled by the ECB (Europe Central Bank) that is indipendent from governments and has the task of containing inflation at low levels ( target level 2%) Inflation is an economy-wide phenomenon that concerns, first and foremost, the value of the economy’s medium of exchange.

The value of money is determined by the supply and demand for money: The supply of money is determined by the Federal Reserve together with the banking system The demand for money is affected by many variables, one in particular stands out in importance: The average level of prices in the economy According to the quantity theory of money, the quantity of money available in the economy determines the value of money, And growth in the quantity of money is the primary cause of inflation. As economist Milton Friedman once said: “Inflation is always and everywhere a monetary phenomenon”

The immediate effect of a monetary injection is to create an excess supply of money The injection of money increases the demand for goods and services. The economy’s ability to supply goods and serivces, however, has not changed. Thus, the greater demand for goods and services causes the prices of goods and services to increase. As a consequence, money looses its value, because each dollar/euro in your wallet now buys a smaller quantity of goods and services.

In the long run the overall level of prices adjusts to the level at which the demand for money equals the supply: Equilibrium The orizontal axis shows the quantity of money. The left vertical axis shows the value of money. The right vertical axis shows the price level. The supply curve for money is vertical because the quantity of money is fixed by the Fed. The demand curve for money is downward sloping beacuse people want to hold a larger quantity of money when dollars buy less. At the equilibrium, the quantity of money supplied and the quantity of money demanded are into balance.

When the Fed increases the supply of money, the money supply curve shifts to a new money supply. The value of money and the price level adjust to bring supply and demand back into balance. Thus, the price level increases, while the value of money decreases.

Collusive and non – collusive oligopoly An oligopoly can be characterized by collusion or by comeptition between companies. Collusion is an implicit or explicit agreement among firms about quantities to produce or price to charge, and the group of firms acting in unison is called cartel. When the oligopoly is competitive, the participants in the economy decide separately the quantities to produce, reaching a nash equilibrium: A situation in which economic actors interacting one another each choose their best strategy given the strategies the other actors have chosen.

Cartels are formed by companies that aim to prevent or restrict competition. Once a cartel is formed, the market is in effect served by a monopoly, in which every firm must agree not only on the total level of production but also on the amount produced by each member. Although oligopolists would like to form cartels and earn monopoly profits, often that is not possible. This, not only because collusion is prohibited by Antitrust laws, but also because it is more difficult to put in practice when: There are many companies in the sector The product is not homogeneous The demand and cost conditions change rapidly There are not barriers to entry ( such as predatory pricing, advertising and R & D, product proliferation) Companies have excess of capacity

Tension between cooperation and self-interest: Each oligopolist is tempted to raise production and capture a larger share of the market. But as each of them tries to do this, total production rises, and the price falls. A clear example is the case of OPEC ( Organization of Petroleum Exporting Countries): Like any cartel, OPEC tries to raise the price of its product through a coordinated reduction in quantity produced. OPEC tries to set production levels for each of the member countries. But when member countries began arguing about production levels, maintaining cooperation became more difficult. During the 1990s the members made production decisions largely independently of one another, and the world market for oil was fairly competitive. In 1999, however, cooperation among oil-exporting nations started to pick up.

In a non – collusive oligopoly: For every action the single firm has to anticipate the reaction of competitors. There is the risk of a price war ( the less they change price the less is the risk) Firms pay great caution in changes Prices tend to be sticky, and are modified only in face of major and permanent costs.