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Pgs 1-36 (Review) and Pgs 36-55

Sheril Christopher

on 26 June 2014

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Transcript of Economics

Study of how individuals make choices about how to allocate scarce resources in order to satisfy virtually
unlimited human wants
, and about how individuals interact with one another
It concentrates on behaviors of individuals and particular markets
It concentrates on the overall performance of the national economy
Micro= small scale
Basic Assumptions of Economics
Its an inescapable part of human existence that results from the fact that available resources are always less than our limitless desires
Scarcity implies that every choice that we make requires that we give up something to get something else
Opportunity cost
Because of trade-offs, you have to give something up when you make a choice. The cost of any choice is what must be given up by making that choice (opportunity cost).
Note: The opportunity cost is not always a monetary price
Individual choices are made by comparing the benefits and costs of different actions and then selecting the action that produces the greatest benefit.
QUESTION: Can you name a situation involving opportunity cost that is not money-related?
People want to maximize utility
REMEMBER: Utility is the total satisfaction received from consuming a good or service
Gains From Trade
The benefits that you and the individual you are trading with get from voluntarily trading with each other.
Individuals specialize in different things
Models and Economic Theory
An economic model shows all the interactions within an economy without the unnecessary details.
Economic analysis relies on careful observations, description and measurement of economic activity. It also relies on theory.
Positive and Normative Economics
Positive Economics
It uses the tools of economic analysis to describe and explain economic phenomena and to make predictions about what will happen under particular circumstances.
Normative Economics
It utilizes the tools of economic analysis and
value judgements
to guide decisions about what
be as opposed to what
the case.
"what is"
"what ought to be"
Which statements are normative economic statements and which are positive economic statements
1. The price of milk should be $6 a gallon to give dairy farmers a higher living standard and to save the family farm.
2. A poor coffee harvest will raise coffee prices and people will drink more tea.
3. The government should increase the national minimum wage to $9 per hour in order to reduce relative poverty.
4. Taxes on tobacco should be raised by 100% to substantially reduce tobacco consumption
5. The price of milk has risen from $3 a gallon to $5 a gallon in the past five years.
6. If government subsidy to basic education is reduced, there will be higher drop-outs among children of poor families.
Focuses on cause-effect relationships and their size
Efficiency as a Goal
An important criterion that economists often apply in evaluating a society's use of scarce resources is the efficiency of the resulting allocation.
Pareto efficiency:

when there is no way to improve at least one person's well-being without reducing the well-being of someone else
Perfectly competitive markets

all the buyers and sellers of a particular good or service.
Perfectly Competitive if:

The number of buyers and sellers is large
All of the participants are well informed about the market price
Few/no barriers for new firms to enter and exit market
Homogeneity of products (the market supplies homogeneous or standardized products that are perfect substitutes for each other)
Each firm is too small relative to the overall market to affect price via a change in its own supply. (price taker)
The quantity demanded of any good is the amount of that good that buyers are willing and able to purchase.
Notice that as the price goes up less gasoline is demanded
Law of Demand:

If the price of the good is higher, buyers will demand less of the good and if the price is lower, then they will demand more. (negative relationship)
As the price of a good increases, the opportunity cost of consuming that good also increases since you have to cut back on consuming other goods in order to afford the higher price.
Shifts in Demand Curve
Prices of related goods
Number of Buyers
Normal Goods
Inferior Goods
When income rises, you demand more of these goods and when income decreases, you demand less.
When income rises, you demand less and when income decreases, you demand more.
Question: If bus rides are an inferior good, and a car is a normal good, what would happen if your income decreases?
Items that can be substituted for each other
Ex: Coke and Pepsi
If the price of Coke increases then buyers will demand less of coke and demand more of Pepsi.
Items that go together
Ex: Printers and ink cartridges
If the price of printers decreases, then there will be an increase in the demand for ink.
Quantity demanded is based on a cost-benefit analysis and if the benefits of consumption change, so will the quantity demanded
Changes that you expect to occur in the future many also affect the quantity demanded
Market demand comes from adding up the demands of individual consumers. If there are more consumers, then the demand will increase
The quantity supplied of any good is the amount that sellers of that good are willing and able to produce.
Note that as the price increases, more goods are supplied
Law of Supply:

If the price of the good is higher, then suppliers will produce more of the good than if the price was lower. (positive relationship)
At higher prices, suppliers are willing to supply more because of cost-benefit analysis.
Shifts in Supply Curve
Input prices
Inputs are anything that suppliers have to purchase to supply a product. Ex: labor costs
If input prices decreases then the quantity supplied increases since it is now easier to supply that good.
Technological advances that increase production efficiency results in the an increase in supply.
For ex: Bovine Growth Hormone
If suppliers expect prices to rise in the future, then they may reduce the quantity they will supply today and store current inventory in expetaion of the higher future prices
Number of sellers
As more suppliers enter a market, the quantity supplied will increase.

a market is in equilibrium when no participant in the market has any reason to alter their behavior.

There is one combination of price and quantity at which the marker is at equilibrium. It is where the two curves intersect.
Markets have an automatic tendency to gravitate towards the equilibrium.
Note: This surplus is different than consumer/producer surplus

Competitive Market Equilibrium
This two-way communication is how markets insure that scarce goods and services are produced at the lowest cost and allocated to the buyers who value them the most highly .
competitive markets are extremely effective method of allocating resources .
When the market for a good is in equilibrium, the price conveys important information for potential suppliers about the value that consumers place on that good .
At the same time, the price informs potential demanders about the opportunity cost of supplying the good .
The competitive market equilibrium insures that the
available supply goes to those buyers who value the
good most highly, and that it is provided by those sup-
pliers who have the lowest costs of supplying the good .
It it maximizes the benefits
that buyers and sellers receive from exchange .
the height of the market demand
curve at each point reveals the willingness to pay of
the marginal buyer, that is the buyer who at that price
is just indifferent between buying the good in question
or not buying it .
the surplus value that consumers receive
If the market price exceeds opportunity cost, the difference is a monetary measure called producer surplus
Changes in Market Equilibrium
Technological progress .
New are continually being developed that allow suppliers to
produce more at lower costs
This innovation helps dairy farmers to increase the quantity of milk they supply at any price, so the supply curve for milk shifts to the right . As a result, the point at which supply and demand intersect moves down along the demand curve from point A to point B . In the new equilibrium, the price is lower, and the quantity is higher . It is clear that the total surplus has increased as well, since the shaded area between the supply and demand curves is now larger . Since the market price is now lower, everyone who previously purchased milk receives a larger surplus . In addition, at the lower price consumers purchase additional quantities of milk . The effect on producers is more ambiguous . The increase in sales causes an increase in producer surplus, but the lower price reduces the producer surplus on the quantity that was previously being sold . Whether producers benefit depends on the balance of these two effects .
The height of the demand curve shows the buyers’ willingness to pay
The height of the supply curve shows the suppliers’ willingness to supply at that quantity
By combining consumer surplus and producer surplus, we are able to measure the total benefits that market participants receive from their transactions.
The goal of a market should be to maximize total surplus
Consumers benefit more from this innovation
% change in quantity demanded
% change in price
Elasticity measures how consumers or producers respond to a change in price.
Price elasticity of demand:

Since the law of demand has a negative relationship, the elasticity is calculated by using its absolute value.
The greater the price elasticity of demand, the greater proportionate change in quantity consumers demand due to any given change in price.
If two curves pass through the same point, the flatter curve is said to have a higher elasticity.
 Extreme cases 
Perfectly Elastic: Elasticity equals ∞
Perfectly Inelastic: Price changes but there is no change in quantity
Inelastic: 1% change in price results in a less than 1% change in quantity.
Unit Elastic: 1% change in price results in 1% change in quantity.
(a unit of something=1)
Elastic : 1% change in price
results in more than 1% change
in quantity.
Goods with close substitutes have a high price elasticity of demand. Remember that the more elastic you are, the more you react to a change in price. So for example, if the price of Coke increases, the demand for Coke will decrease significantly since it can be substituted by another brand of soda like Pepsi.
Items that are considered necessities will generally have a low price elasticity of demand.
Market Definition:
The price elasticity of demand depends on how we define the market. The broader the market definition, the fewer close substitutes there will be and lower the elasticity of demand. Ex: Demand for Coke vs Demand for soft drinks.
Time Horizon:
Fully adjusting to price changes may take time. For example, if the price of gasoline rises, there is not much that can be done to reduce consumption immediately. But over time, the demand for gasoline will decrease as more people use more fuel-efficient cars or another form of transportation.
Factors that influence the price elasticity of demand
Price elasticity of supply
% change in price
% change in quantity supplied
Price elasticity of supply:

It reflects the ease with which suppliers can alter the quantity of production.
Similar to the price elasticity of demand, there is elastic supply, inelastic supply, unit elastic supply, perfectly inelastic supply and perfectly elastic supply. Both are the same, except that one relates to the demand curve while this one relates to the supply curve.
Ease of entry and exit:
If it is easy for new firms to begin supplying a product or for those in the market to leave, then supply will tend to be more elastic
Scarce resources:
If an inputs such as labor, capital or raw materials are scarce, then the supply will be inelastic. If the price increases, suppliers want to produce more of the product. But if the inputs are scarce, suppliers can’t change the amount they supply.
Time Horizon:
The longer the time horizon is, the greater the elasticity of supply will be. Over a long time horizon, firms will be able to hire and train additional workers, or add necessary equipment to increase production.
Factors that influence price elasticity of supply
Total revenue= Equilibrium Price x Equilibrium Quantity
If demand is elastic, cutting the price of an item will increase total revenue by more than 20 percent. If demand is unit-elastic, a 20 percent price cut will bring in exactly 20 percent more revenue. If demand is inelastic, dropping the price by 20 percent will bring in less than 20 percent additional revenue.
Total Revenue
Price controls
Price floor
Policy Interventions
Price Ceiling
Review pgs(1 - 35)
New information pgs (36 - 55)
Government- or group-imposed limit on price charged for a product

Total surplus is reduced because transactions that could have occured didn't.
Goods aren't allocated efficiently since the good no longer goes to the individual who values them the most highly.
Price floor
International trade

exchange makes people better off . It does so by
aging specialization .
When individuals specialize in the activity they do the best, the overall economic pie increases .
These gains from trade is the reason that our modern economy is characterized by such a high degree of interdependence .
Isolated economy
Government- or group-imposed limit on how low a price can be charged for a product
This also reduces consumer and producer surplus
Governments impose taxes to raise revenue that is used to pay for public expenditures
Effects of Tax
A tax creates a price wedge between the amount consumers pay and the amount suppliers receive
Deadweight loss:
loss to society resulting from beneficial transactions not occurring
The less elastic the demand is, the greater the share of the tax paid by buyers
Elastic goods are not good to tax because it creates more deadweight loss
Applications of the Competitive Market Model
Question: What is PPF?
Production Possibility Frontier: is the graphical depiction of the most efficient combination of output that can be produced by an economy.
Crusoe is able to collect more fish or coconuts in an 8-hour period so she has an
absolute advantage
Both Crusoe and Robinson will collect the combination of fish and coconuts that maximize their satisfaction
Question: Should Crusoe trade with Robinson even though Crusoe has the absolute advantage?
The absolute productivity doesn't matter when it comes to trade but what matters in their respective

comparative advantage
So what is comparative advantage?

Even though Robinson produces fewer coconuts per hour than Crusoe, he has a comparative advantage in producing coconuts.
The ability to produce a food or service at a lower opportunity cost than other producers
Why do people oppose free trade?
Because when countries become increasingly specialized, the costs and benefits of trade fall on different groups of people. As a result, even though the gains from free trade exceeds the losses, the people who experience losses will most likely oppose free trade.
Consumers benefit, Producers suffer losses
Producers benefit, Consumers suffer losses
The Profit Motive and the Behavior of Firms
Question 1
Question: What is a firm?
1)What does PPF stand for
a)Production Possibility Frontier
b)Personal People Fair
c)Production Possible Frontier
d)People Pay Frogs
Question 2
2) Write P next to choices that are perfectly competitive and write I for imperfectly competitive.
a) Automobiles
b) Water
c) Electricity
d) computers
A firm's goal is to maximize profits.
Economic Profit is the difference between the firm's
total revenue
and its
total costs
Question 3
The benefit that someone gets from another of something is the additional revenue that it will produce. What is another word for additional revenue?
a) Marginal cost
b) Marginal revenue
c) Opportunity cost
d) Opportunity revenue
4) Why do monopolies arise?
Why do monopolies arise?
a)Barriers to entry
b)The ownership of a key resource
c)Its Natural
Question 4
Total revenue:

the total quantity of output the firm produces for sale multiplied by the price it receives.

Total Costs:
opportunity costs of all the resources required for production
5)Because of the (fill in) effects that monopolies create, government policymakers have adopted a variety of responses intended to (fill in) the impact of monopoly?
a)Positive, reduce
b)Positive, increase
c)Negative, reduce
d)Negative, increase
Question 5
What is an oligopoly
a) A market with 3 seller
b) A market with a few sellers
c) A market with many sellers
d) a market with the same number of buyers and seller
Question 6
Question 7
Write t next to statements that are true about cartels and write f next to statements that are false
a) Illegal drug group
b) Illegal
c) An agreement
d) A positive thing
Fixed Costs:
Doesn't depend on the quantity of goods produced and cannot be changed in the short run
Variable Cost:
a cost of production that depends on the quantity produced (ex: labor and materials)
What is the Coase Theorem
a) A geometry theorem for logic proofs
b) As long as the parties involved can negotiate with each other, the private market should be able to resolve the
inefficiencies created by externalities
c) As long as the parties involved can negotiate with each other, the private market shouldn't be able to resolve the
inefficiencies created by externalities
d) Course spelled wrong
Marginal Costs:
Question 8
The increase in costs that occurs when producing an addition unit of output
Question 9
Question 10
Question 11
Question 12
Question 13
Question 14
Question 15
increase in total costs
increase in quantity produced
What is a rival good
a) A good that fights with you
b) Something that one you eat, for example means there is one less for you friend
c) An object you compare with someone else
What is excludability?
a) When you are a loser and someone excludes you
b)the ability to control who consumes the good
c) The ability to remove the good
What is Logrolling?
a) When you roll a log
b) vote trading activity
c) When you run for office
d) When you propose a bill
What is rent seeking?
a) Looking for a place to live
b) When you look for a good and compare it to the price of the same good in another shop
c) socially unproductive activities that seek
simply to direct economic benefits to one set of actors rather than another
Diminishing returns to scale:
the property whereby each additional increase in inputs results in a smaller increase in quantity produced
Is this statement true or false?
Government is an important factor in enhancing well-being through its support of private property and market transactions, but pork barrel politics
and logrolling are inefficient outcomes that arise because of how governments operate
Marginal revenue:
the increase in revenue when you produce one more of a good
Is this statement true or false?
Elasticity provides a measure of the responsive- ness of supply and demand to price changes that is independent of the units used to measure supply and demand
Is this statement true or false
In a competitive market, the entry and exit of firms insures that the firms in the market earn zero economic profits .
1) a
2) p, i, i, p
7)f, t, t, f
12) C
15) F
Rent seeking
socially unproductive activities that seek
simply to direct economic benefits to one set of actors rather than another
refers to the proclivity of elected
officials to introduce projects that steer money to their communities
often popular withvoters who matter for the particular legislator, but the combined effect of these projects is to increase the cost of government .
Pork barrel politics
When legislature votes, on trading activities
One of the central insights of economics is how markets help to convert the actions of self-interested individuals into socially desirable outcomes
Collective decision-making begins with institutions. Institutions are both formal and informal rules that structure human interaction
. Like institutions, organizations help to organize human interaction, but do so through formal rules and structures
The first of these is the ability to tax its citizens .Private businesses can earn revenue only by selling their products
government possesses two distinctive powers
The second distinctive power of government is the legal monopoly on the legitimate use of force . This power is used to restrain criminals, compel military
service, and to protect national security
Public/Private Goods
Private goods
Collective goods
Public goods
Rival goods: Ex: Pizza
excludability: This describes the ability to control who consumes the good
Conventional private goods are characterized by a high degree of rivalry in consumption and a high degree of excludability
Goods that have a low degree of rivalry but a high degree of excludability are termed
collective goods . Such goods can easily be privatized, but they are often natural monopolies because nonrivalry in consumption means that the marginal cost
of producing them is zero or close to zero
combines non-rivalry in consumption with nonexcludability . Because it is difficult to exclude consumers, it is difficult for private actors to charge for these goods . And, because they are non-rival in consumption, the marginal cost of their provision is close to zero .
Property rights
However, the institution of property rights is a natural occurrence; it is a social innovation . The importance of this innovation becomes clear when we consider what happens when valuable economic resources have no owner
Private ownership
When a resource is owned jointly, no
one takes account of the negative externalities caused by overuse .
the tragedy of the commons
Coase Theorem
the parties involved can negotiate with each other, the private market should be able to resolve the inefficiencies created by externalities

this arises when the actions of
person affect the well-being of someone else, but neither party pays nor is paid for these effects
When effect of these actions is beneficial, it is called a positive externality.
when the effect of these actions causes harm, it is called a negative externality .
The second type of market failure occurs when the institution of private property breaks down
Private Property
Monopolistic Competition
Price discrimination
By charging different prices, marginal revenue curve would be identical to the market demand curve,and it would choose to supply a quantity equivalent to the competitive market outcome . Such a strategy is called perfect price discrimination
a market with only a few sellers is an
The simplest case to consider the extreme situation of a single supplier, a situation
called a monopoly . Monopolies arise because there are barriers to entry that prevent competitors from entering the market .
The ownership of a key resource
Government-created monopolies
Natural monopolies
Imperfect Competition
The market residential electricity supply is a monopoly in most communities because a single company owns the retail electricity distribution system . It would not be possible for a competitor to establish another distribution system .
Government-created monopolies . Many
lies are created when the government gives the
rights to supply a product to a single company
Disadvantages of Monopolies
Disadvantages of Monopoly (PIE)
Prices high
Inefficient use of resources Exploitation of consumer
Think of a monopolist owning the ‘whole pie’ and not sharing it all out
An industry is a monopoly when a single firm can supply the market at a lower cost than could two or more firms This happens when there are large fixed costs that
cause the firm’s average costs to be falling at a scale of production that can serve the entire market
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