The article, enlightening some of the essential steps toward reducing emissions of carbon dioxide, is a great example of how the market failure arising from externalities in practice can be solved. Since 1990, several countries have acknowledged the important problem of global warming, resulting from CO2 emissions. In order to fight this negative externality, these countries signed a treaty in Kyoto in 1990. Nevertheless, it would have no significant effect without active involvement from U.S, which accounts for 25 % of the world’s CO2 emissions. Developing countries, such as China and India, also represent a threat toward a deterioration of the global warming issue. Currently, China is the second-largest CO2 emitter, and India right behind them on the fifth place. It is therefore essential that the fight against global warming has the participation of these countries.
The externality, which by definition is the uncompensated impact of one person’s action on the well-being of a bystander, is as mentioned global warming. When industries emit CO2, it becomes trapped by the earth’s atmosphere, creating a greenhouse effect, where the heat can’t escape the surface. The consequence will be a general increase in the world’s temperature, causing the north and south poles’ ice caps to melt, thus raising the sea level. The worst case scenario, would be that several large cities like London and Miami, would be flooded, destroying economically prosperous areas. In any case, the effects of global warming will be devastating and will affect everybody. So in fact, when a consumer purchases a certain good, which production emits CO2, there will be an extra cost on him, in the form of global warming.
In diagram #1, the external cost (externality) is represented by G. When the extra cost is not included in the price, the supply curve is at SPrivate Cost. The equilibrium will be at Em, thus the price is at Pm and the quantity at Qm. If the extra cost is included, which it in fact is, the supply will be represented by SSocial Cost. This will result in a new price at POptimum and quantity at QOptimum. The new equilibrium point is illustrated by Eo. In other words, the price at which the goods are bought does not reflect the true cost to society. The price mechanism has been distorted, thus causing a misallocation of resources, since prices function as signals. The market is no longer efficient.
In order to make the market efficient, the negative externality has to be internalized. In other words, the external cost has to be removed. This is accomplished by shifting the supply curve in diagram #2, from Sm to So. The supply should be decreased by as much as the external cost is to society. This will decrease the quantity and increase the price. Since the price now reflects the true cost of the product, resources can be allocated efficiently.
However, one thing is how a market failure is solved in theory; another is what measures are taken in reality. In this case, the problem is prevalent; it affects society as a whole. Therefore it is up to the governments in cooperation, to come up with a policy of how the negative externality should be internalized. Regulations, taxes and the extension of property rights are all remedies that can be used against negative externalities. However, the most efficient tool is tradable permits (called emission trading in the article). A tradable permit is a regulation imposed on emitters of CO2, according to their production capacity, with the option of trading it among producers, regardless of nationality. Since these can be traded, manufacturers that find it relatively easy to reduce emissions below the permitted level, can sell their remaining permits to other producers that find it difficult and more expensive to reduce their emissions. This solution is efficient because it benefits both parties: It gives producers an incentive to pursue their own self-interest, which promotes efficiency.
As a conclusion, the negative externality created from C02 emissions, has to be internalized, in order to make the market efficient and remove the extra cost on society. Several countries have taken the step toward this by signing the Kyoto Protocol. However, as countries develop, the production increases, resulting in a greater amount of CO2 emission, further steps have to taken, to secure the intentions of that treaty. Therefore it is essential, that U.S. and developing countries sign the treaty. Overall, this article illustrates a great example of a negative externality and how it can be internalized.
The article, illuminating European policymakers’ attempt to stabilize the rapidly growing economy, is a great example of how monetary policies are used to combat short-run fluctuations. The Euro zone economy is expanding at its fastest rate in six years, and is expected to reach even higher levels of growth. As a result, the European Central Bank, ECB, is worried about a sustained increase in the general price level. Currently, the inflation rate is 1.8% (November, 2006), but is expected to rise. To avoid a so-called “bubble burst,” an overheated economy, the ECB has taking contractionary monetary policies into use, in the form of increasing interest rates.
First of all, different viewpoints can be taken on how to deal with the macroeconomic outlook. According to classical economics, one should leave the market alone: laissez faire. This comes from the theory that in the long run, nominal factors, such as the money supply, doesn’t affect the economy. On the other hand, Keynesian politicians believe that the government needs to step in, to speed up the recovery. In this case, the ECB, advocates government intervention.
As mention, the ECB utilizes contractionary monetary policies in order to stabilize the economy and attain creeping inflation of about 2%. To accomplish this, an approach of increasing the interest rates was used. In Diagram 1, the impact of higher interest rates is shown. The LRAS, SRAS and Aggregate demand intersect at equilibrium, E, to produce at Q*, which represents full employment. When the interest rate is increased from 3.25% to 3.5%, firms and companies will borrow less money, because it is more expensive. Firms will have less money for investment, which will decrease. Since investment is a component of aggregate demand (C+I+G+NX), it will shift downward from AD¹ to AD². The price level thus moves from P¹ to P². In addition, the output is decreased alongside with the price. In turn, this will increase unemployment, because firms will have to lay off workers at a lower price. This is a great example of the trade off, governments face between inflation and unemployment.
At this point, the ECB can utilize two different approaches as a way to decrease inflation even further. It can either intervene in the market, or it can leave the market by itself: Laissez Faire. In the case of promoting the classical philosophy, monetary neutrality becomes evident. Diagram 2, illustrates how the economy returns to full employment, but with a different price level. The SRAS¹, shifts downward to SRAS², decreasing the price level even further, and returning to full employment at Q*. The reason for this downward shift in the SRAS curve comes after lower price expectations. At lower price levels, wages are lower, thus production cost. Since costs are lower, manufacturers have an incentive to produce more. Compared to the original price in diagram 1, the price is lower now, but the economy is still producing at the same level. This clearly illustrates that in the long run, nominal variables doesn’t affect real variables.
According to the article, the ECB is expected to raise the interest rate even more. In other words, they will continue the use of contractionary monetary policies. If the ECB actually carries it out, the aggregate demand curve would shift further downwards. In diagram 3, the effects are shown. The price level would decrease from P² to P³, and the output would face a negative shift too.
So what should the ECB do? Obviously that is a rather normative question, but two things have to be taken into consideration: How fast the economy is growing and thus has to be slowed down, and what the goals of the society are. Firstly, if the economy is growing at a very fast pace, it is likely that, in Diagram 2, the AD² would shift upward. The SRAS curve wouldn’t shift, however, because the higher interest rates haven’t discouraged investment sufficiently. On the other hand, if the ECB intervenes, unemployment will rise further. In this case, the article stresses the point that the economy is growing at its fastest rate in six years. It is therefore clear, that the economy has to be slowed down, to maintain gradual growth. Since the ECB, doesn’t have the ability to affect the production cost, by for example providing new and better technology, the most secure way, is to use the Keynesian approach.
As a final remark, this article does a good job in portraying the various dilemmas policy makers have to deal with in the economy.
Although, the main focus is on the rise in Denmark’s current account surplus, lead by exports to Sweden and Germany, the article gives an insight to other perspectives and arguments for and against trade. In 1993, Sweden accounted for 10 percent and Germany for a quarter of Denmark’s exports. Today, in 2007, the outlook has flattened out, with the two countries taking an equal share of 14.2 percent each. Sweden, in line with what has been the tendency over the previous years, is expected to increase their imports from Denmark, as they will cut taxes.
In favor of trade, Danish exports to Sweden will benefit both the countries’ total welfare. This is illustrated by diagram #1a and #1b. In the first diagram, the benefit from trade is illustrated from Denmark’s perspective. Without trade, the total surplus/welfare of Denmark is (A+B+C). Since producers have an incentive to sell their products at a higher price they will adjust prices to the world price, and start exporting. They will now start to produce more than what is needed to balance out with the demand, and a surplus is created. This part will be exported. The total welfare is hence increased to (A+B+C+D), showing the gains from trade. Even though, there is an overall benefit from exporting, consumers will be worse off. According to the graph, their surplus will decrease from (A+B) to (A). Nevertheless, the gains to producer are enough to exceed that of consumers.
As mentioned in the article, the Swedish economy is in an expansionary phase, meaning that people have more money between their hands to spend. At the same time, the prices of various Swedish products are increasing. Consumers will therefore look for lower prices, and hence start importing goods from Denmark. On the graph, imports are shown by the difference between Q1 and Q2. Again the total surplus will increase, but this time producers will be worse off. The total surplus will in addition to (A+B+C) get an extra (D). The producer surplus will decrease from (B+C), and the consumer surplus will go from (A) to (A+B+C), as they can enjoy a greater and cheaper variety of products.
Another aspect that the article indirectly illuminates, regards Germany. Since 1993, Danish exports to Germany has decreased 10.8 percent (25 – 14.2). There are two reasons for this. First of all, Germany has undergone high levels of unemployment over the last decade (according to Federal Statistical Office, as great as 10 percent). A simple reason could be explained by a lower demand and thus a smaller amount of imports from Denmark and other countries. However, these higher levels of unemployment might be due to imports. As said, producers are worse off in an importing country. As consumers stop buying their product, they will decrease their production and eventually lay off workers. In other words, import – trading – is responsible for unemployment, since the jobs will flee to the exporting country. In this case, the government might want to protect these suppliers (and the unemployed), by imposing a barrier to trade, such as a tariff. In diagram #2, the effect of a tariff is shown. This tax on imported goods will increase the price, and thus minimize the total welfare from (A+B+C+D+E+F+G+H) to (A+B+C+D+E). As the government intended, the producers will be better of with an extra (C) to their initial (D), but with the consumers accounting for a greater part of the market, the overall effect is negative. Finally, (G) represents the government revenue, which it can spend on for example promoting infant industries, and (F+H) is deadweight loss.
In conclusion, this article reflects the nature of the Danish exports, but also gives a further insight into the reasons for trading. As a final remark, to determine whether a country should trade or not, depends entirely on what the goals of society is. Since the countries mentioned in the article all claim to be free market economies, where resources are allocated through the spending decisions of consumers and producers, they all promote efficiency. Efficiency in the meaning of maximizing total welfare. As shown by the examples in the article, trade does in fact increase total welfare. In other words, these countries should trade.
The structure of the Japanese mobile phone industry is outlined in the article, and hence provides a good insight into the challenges facing firms of such a market. The article summarizes an ongoing price war between the firms with the largest market share, and how the individual firm’s profit maximizing strategy is based on the other firms’ strategy. Indeed the article points to a central trait of such a market, which is interdependence. Such a trait characterizes an oligopoly, and it is within the scope of this commentary to show how the article underlines that description and how it narrates the decisions the individual firm makes.
For an industry to labeled with the term, oligopoly, it needs to fulfill certain requirements. As compared with a perfectly competitive- and a monopolistically competitive market, an oligopolistic industry is controlled by relatively few firms. One way to measure this is using the concentration ratio of the top four firms in the market (the CH4). In this case, DoCoMo has a market share of 50%, and as the article says, still lacks control of the market due to competitors and “big rivals,” such as KDDI and Softbank.
Secondly, each firm faces a kinked downward sloping demand curve, which in the article is suggested by the decrease in profits proportionally to price. Conversely, no firms are in a position in which they can afford to keep or at least raise prices, which, during a price war, would result in massive losses. In the diagram below, the kinked demand curve has been illustrated. As it can be seen, below the point of bending, the demand curve is relatively steep, implying that demand changes proportionally less than price, which is due to the comparative lack of substitutes, as compared to other more competitive industries. Above, the demand curve is flatter/more elastic, because substitutes, despite their limit, do exist in the market. This lead to the idea about the Nash equilibrium.
The Nash equilibrium is the point where the kinked demand curve bends. It was a term coined by a man of the same name, and its meaning also covers the result of the strategy of one firm based upon other firms. In other words, the Nash equilibrium is reached when firms pursue their self-interest (profit-maximization) in a legal way. This process of incentive-respondance is unique to the oligopolistic market. The article’s focus is directed mainly at such a case. “It is a fight to keep users from switching carriers,” at which the root of interdependence lies. If, for example, KDDI lowers the price for their services, they steal demand from DoCoMo and Softbank, and hence profit. Those two firms will therefore lower their price in order to recoup the lost consumers. Hence all three firms sell their service at a lower price with the same demand, but with lower profit due to the inelastic demand below the Nash equilibrium.
All three firms are in a dilemma in which they will experience a drop in profits, which is held accountable for by other firms, regardless of what they do. As it is mentioned in the article, competition also takes place in a non-price respect. DoCoMo, for example, now offers free calls between family members, which Softbank responded to with free calls between all its users. Logically the formation of cartels is not mentioned in the article, since it is illegal, but the firms could actually raise their profits if they decided to collude and act as a monopoly. The result of the non-collusive market described in the article is lower profits, which is due to lower prices. If the firms acted as a monopoly they could keep the price at a higher level. This is shown in the diagram below. Eventually the market would settle at the Nash equilibrium. If it were to act as a monopoly, profits would increase to Qab. This illustrates that short run incentives sometimes can mislead the individual from where the actual profit is.
The article provides an excellent insight into the nature of an oligopolistic market. Such a market is characterized by interdependence among other things as explained. All those traits are reflected in the Japanese cell phone industry, and thus underline the structure of its own market. Eventually the market will settle after the price war, but as it has been shown, the profit for the entire market will decrease, and it would actually have been better for them to form a cartel.
http://www.destatis.de/indicators/e/arb210ae.htm
