EMA1310 Foundations and Applications of Economics is a foundational course offered at the University of Malta that provides students with an introduction to the principles and applications of economics. The course aims to equip students with a basic understanding of economic theory, its methods of analysis, and its applications in real-world settings.
The course is divided into two parts: microeconomics and macroeconomics. The microeconomics section covers topics such as supply and demand, consumer behavior, production and costs, and market structures. The macroeconomics section covers topics such as national income accounting, inflation, unemployment, economic growth, and monetary and fiscal policy.
The course is designed for students who have little or no background in economics and is suitable for students from a range of academic disciplines. Upon completion of the course, students will have a solid foundation in economic theory and will be able to apply this knowledge to real-world issues.
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Learning Outcome 1: Comprehend and describe how markets work across various typologies of market structures as well as.
Markets are places where buyers and sellers meet to exchange goods and services. Market structures refer to the characteristics of a market that affect the behavior of buyers and sellers, such as the number of firms, the level of competition, and the extent of barriers to entry. There are several types of market structures, including perfect competition, monopolistic competition, oligopoly, and monopoly.
In a perfectly competitive market, there are many small firms that produce identical products, and no single firm can influence the market price. In this type of market, buyers and sellers have perfect information about prices and products, and there are no barriers to entry or exit. As a result, firms in a perfectly competitive market earn zero economic profit in the long run.
In a monopolistic competition market, there are many firms that produce similar but not identical products. Each firm has some control over the price of its product, but there are still low barriers to entry and exit. Firms in this market structure can earn positive economic profit in the short run but not in the long run.
In an oligopoly market, there are only a few large firms that dominate the market. These firms have significant control over the price of their product, and there are high barriers to entry for new firms. Firms in an oligopoly market can earn positive economic profit in the long run.
In a monopoly market, there is only one firm that dominates the market and has complete control over the price of its product. There are high barriers to entry, making it difficult for new firms to enter the market. As a result, the monopolist can earn significant economic profit in the long run.
Understanding these different market structures is important because they affect the behavior of firms and the outcomes of markets. For example, in a perfectly competitive market, prices are determined by supply and demand, while in a monopoly market, the monopolist sets the price. Governments may intervene in markets to promote competition and prevent firms from gaining excessive market power, which can lead to higher prices and lower output.
Learning Outcome 2: Evaluate how profit maximization is attained under different market structures.
Profit maximization is the primary objective of firms in any market structure. However, the approach to profit maximization differs depending on the market structure in which the firm operates.
In a perfectly competitive market, a firm maximizes profit by producing at the point where its marginal cost equals its marginal revenue, which is equal to the market price. Since there are many firms producing identical products, the market price is determined by supply and demand, and the firm cannot influence the price. As a result, the firm earns zero economic profit in the long run, as any positive profit attracts new entrants to the market, increasing supply and lowering the market price.
In a monopolistic competition market, a firm maximizes profit by producing at the point where its marginal revenue equals its marginal cost. Since the firm has some control over the price of its product, it can charge a price above its marginal cost, earning positive economic profit in the short run. However, because there are low barriers to entry and exit, the firm’s profits attract new entrants to the market, increasing competition and reducing the firm’s market power. As a result, the firm earns zero economic profit in the long run.
In an oligopoly market, firms may use various strategies to maximize profit, such as price collusion, price leadership, or non-price competition. Price collusion occurs when firms agree to fix prices and restrict output, earning monopoly-like profits. Price leadership occurs when one dominant firm sets the price, and other firms follow suit, resulting in stable prices and lower price competition. Non-price competition occurs when firms differentiate their products through branding, advertising, or product quality, allowing them to charge a higher price and earn positive economic profit.
In a monopoly market, the monopolist maximizes profit by producing at the point where its marginal revenue equals its marginal cost, which is a lower quantity than in a competitive market, resulting in a higher price. Since there are high barriers to entry, the monopolist can maintain its market power and earn positive economic profit in the long run. However, this comes at the expense of consumer surplus and may lead to a misallocation of resources.
Learning Outcome 3: Develop the tools to describe the process of utility maximization and be able to apply the concepts learned to basic microeconomic scenarios.
Utility maximization is the process by which individuals or consumers make choices to maximize their satisfaction or utility subject to a budget constraint. To understand this process, it is essential to understand the concepts of utility, budget constraint, and marginal utility.
Utility is the satisfaction or happiness that an individual derives from consuming a good or service. It is a subjective measure and varies from person to person. The utility derived from consuming additional units of a good or service is known as marginal utility. Marginal utility usually decreases as the quantity consumed increases, reflecting the law of diminishing marginal utility.
The budget constraint represents the limit on the quantity of goods and services that an individual can afford given their income and the prices of goods and services. The budget constraint can be expressed as an equation, such as income = price of good A x quantity of good A + price of good B x quantity of good B.
To maximize utility subject to a budget constraint, individuals need to allocate their income among different goods and services in such a way that the marginal utility per dollar spent is equal for all goods. This is known as the rule of equal marginal utility per dollar spent. The intuition behind this rule is that if one good provides more marginal utility per dollar spent than another good, the individual should allocate more of their budget towards that good until the marginal utility per dollar spent is equalized.
To apply these concepts to basic microeconomic scenarios, consider the following example: Sarah has $100 to spend on two goods, pizza (P) and soda (S). The price of pizza is $10 per unit, and the price of soda is $5 per unit. Sarah’s utility function is U(P,S) = P x S.
To maximize her utility subject to her budget constraint, Sarah needs to allocate her budget such that the marginal utility per dollar spent on pizza is equal to the marginal utility per dollar spent on soda.
Initially, Sarah purchases 5 units of pizza and 10 units of soda, spending her entire budget. The marginal utility of the 6th unit of pizza is 40, while the marginal utility of the 11th unit of soda is 20. Therefore, the marginal utility per dollar spent on pizza is higher than the marginal utility per dollar spent on soda.
To equalize the marginal utility per dollar spent, Sarah needs to allocate more of her budget towards soda and less towards pizza. She decides to purchase 5 units of pizza and 15 units of soda, spending her entire budget. The marginal utility of the 6th unit of pizza is still 40, while the marginal utility of the 16th unit of soda is 20. The marginal utility per dollar spent is now equalized, and Sarah has maximized her utility subject to her budget constraint
Learning Outcome 4: In relation to the knowledge and understanding gained with respect to macroeconomics issues the students will be able to describe how the Gross Domestic Product (GDP) statistic is constructed as well as evaluate its limitations, distinguish between real and nominal GDP and explain how inflation is measured in the economy.
Gross Domestic Product (GDP) is a key measure of the size and health of an economy. It is defined as the total value of all goods and services produced within a country’s borders during a specific period, typically a year or a quarter. The GDP statistic is constructed by adding up the value of all final goods and services produced in the economy. Final goods and services are those that are consumed by households or used in investment, while intermediate goods and services are those that are used in the production of other goods and services.
There are two ways to measure GDP: Nominal and Real.
Nominal GDP is the value of goods and services produced using current market prices, while real GDP adjusts for changes in prices over time by using a constant base year. Real GDP is a more accurate measure of economic growth because it eliminates the effects of inflation on the value of goods and services produced.
Despite its importance as a measure of economic activity, GDP has several limitations. First, it does not take into account the distribution of income or wealth within a country. Two countries may have the same GDP, but one may have a much more unequal distribution of income than the other. Second, GDP does not include non-market activities, such as household production and volunteer work, which can be significant in some economies. Third, GDP does not account for the environmental costs of economic growth, such as pollution and resource depletion.
Inflation is the rate at which the general level of prices for goods and services is rising. It is measured using an index called the Consumer Price Index (CPI). The CPI tracks the prices of a basket of goods and services that are representative of what the average consumer buys. The CPI is calculated by comparing the prices of the basket of goods and services in the current period to the prices of the same basket of goods and services in a base period. The percentage change in the CPI from the base period to the current period is the inflation rate.
Inflation can have significant effects on the economy, such as reducing the purchasing power of consumers and distorting investment decisions. Central banks often use monetary policy tools, such as adjusting interest rates and controlling the money supply, to manage inflation and maintain price stability.
Learning Outcome 5: Analyze, through the use of macroeconomic models, how specific fiscal and monetary policies impact various areas of the macro economy.
Fiscal and monetary policies are the two main tools that governments and central banks use to influence the macro economy. Fiscal policy refers to changes in government spending and taxation, while monetary policy refers to changes in the money supply and interest rates.
Macroeconomic models can be used to analyze how specific fiscal and monetary policies impact various areas of the macro economy. For example, the Keynesian model predicts that government spending can stimulate economic growth by increasing aggregate demand, while the classical model predicts that government spending can lead to inflation and crowding out of private investment.
Similarly, the IS-LM model can be used to analyze the effects of monetary policy on the macro economy. This model shows the relationship between interest rates and output in the short run. A decrease in interest rates, brought about by an increase in the money supply, can stimulate investment and consumption, leading to an increase in output.
In addition, the Phillips curve model can be used to analyze the relationship between inflation and unemployment. This model suggests that there is a trade-off between inflation and unemployment in the short run. Expansionary monetary policy can lead to lower unemployment but higher inflation, while contractionary monetary policy can reduce inflation but lead to higher unemployment.
Learning Outcome 6: Apply basic economic tools and theoretical approaches necessary to evaluate the effects of various demand and supply side policy measures.
Demand-side and supply-side policies are two types of macroeconomic policies used to influence the level of economic activity in an economy.
Demand-side policies aim to stimulate aggregate demand and include measures such as fiscal stimulus and monetary policy. Fiscal stimulus involves increasing government spending and reducing taxes to boost consumer spending and investment. Monetary policy involves increasing the money supply and lowering interest rates to encourage borrowing and spending.
Supply-side policies aim to increase the productive capacity of the economy and include measures such as deregulation, tax cuts, and investment in education and infrastructure. Deregulation aims to reduce the cost of doing business and increase competition, while tax cuts encourage investment and entrepreneurship. Investment in education and infrastructure can improve the skills of workers and increase productivity.
To evaluate the effects of demand and supply-side policy measures, economists use various tools and theoretical approaches. One approach is the use of macroeconomic models, such as the Keynesian and neoclassical models, which can be used to predict the effects of policy measures on variables such as output, inflation, and unemployment.
Another approach is the use of cost-benefit analysis, which compares the costs and benefits of policy measures to determine their overall effectiveness. For example, policymakers may use cost-benefit analysis to evaluate the effectiveness of a fiscal stimulus package by comparing the costs of increased government spending and reduced tax revenue to the benefits of increased consumer spending and investment.
Finally, economists may use econometric analysis to estimate the effects of policy measures on specific variables of interest, such as the impact of tax cuts on investment or the effect of monetary policy on inflation. Econometric analysis involves the use of statistical techniques to estimate the relationships between economic variables and identify causal effects.
By using these economic tools and theoretical approaches, policymakers can evaluate the effects of various demand and supply-side policy measures and make informed decisions about how to promote economic growth and stability.
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