economics basics
TRANSCRIPT
Some Econ Concepts
Definition of economics the study of how individuals and
societies use limited resources to satisfy unlimited wants.
Fundamental economic problem scarcity. Economics is the study of how
individuals and economies deal with the fundamental problem of scarcity.
As a result of scarcity, individuals and societies must make choices among competing alternatives.
Opportunity Cost
•Economics is all about trade offs
•Because of scarcity our choices require that in order to get something we must give something up
•What you give up to get something else is your opportunity cost.
Rational self-interest When an individual makes a choice
they go through a cost-benefit evaluation
This is the idea that an individual compares the opportunity costs to the benefits and chooses the option which benefits them most (rationality)
Positive and normative analysis
positive economics attempt to describe how the economy
functions relies on testable hypotheses
normative economics relies on value judgements to
evaluate or recommend alternative policies.
Economic methodology scientific method
observe a phenomenon, make simplifying assumptions and
formulate a hypothesis, generate predictions, and test the hypothesis.
Efficiency Economists strive to achieve 100%
efficiency known as Parato Efficiency
In Parato Efficiency society is 100 $ efficient and there is no way to improve on persons well being without reducing another ones.
Microeconomics
Microeconomics vs. macroeconomics
microeconomics - the study of individual economic decisions and choices and how they effect individual markets
Macroeconomics - brings all the individual markets together and observes the behavior of the entire market
Algebra and graphical analysis direct relationship
Direct relationship
Inverse relationship
Linear relationships A linear relationship possesses a
constant slope, defined as:
Demand and Supply
Markets In a market economy, the price of
a good is determined by the interaction of demand and supply
A market for a good is comprised of all the buyers and sellers of that particular good
Demand A relationship between price and
quantity demanded in a given time period
The quantity demanded is the amount of good buyers are willing to purchase at a set price
Demand schedule
Demand curve
Law of demand An inverse relationship exists
between the price of a good and the quantity demanded in a given time period,
Reasons: Related goods Income Tastes Expectations Number of buyers
Income If someone's income is lowered
they will be less willing to spend money on goods and vice versa
Normal goods Inferior goods
Income and demand: normal goods A good is a normal good if an increase in income
results in an increase in the demand for the good.
Income and demand: inferior goods A good is an inferior good if an increase in income
results in a reduction in the demand for the good.
Price of Related Goods Substitutes – a good which
causes a decline in the demand of another good if its price declines
Complement – a good which causes an increase in the demand of another good if its price declines
Change in the price of a substitute good Price of coffee rises:
Change in the price of a complementary good Price of DVDs rises:
Tastes The idea that if an buyers
perception of benefits from buying a good changes so will the buyers willingness to purchase the good
Expectations A higher expected future price will
increase current demand. A lower expected future price will decrease
current demand. A higher expected future income will
increase the demand for all normal goods. A lower expected future income will
reduce the demand for all normal goods.
Number of Buyers The market demand curve consists
of all the individual demand curves put together
So if there are more consumers in the market the market demand will increase
Change in quantity demanded vs. change in demand
Change in quantity demanded Change in demand
Market demand curve Market demand is the horizontal summation of
individual consumer demand curves
Supply the relationship that exists between the price of a good and the quantity
supplied in a given time period Quantity supplied is the amount that a seller is able to produce for a set price
Supply schedule
Demand curve
Law of supply A direct relationship exists
between the price of a good and the quantity supplied in a given time period
Reason for law of supply The law of supply is the
result of the law of increasing cost. As the quantity of a good
produced rises, the marginal opportunity cost rises.
Sellers will only produce and sell an additional unit of a good if the price rises above the marginal opportunity cost of producing the additional unit.
Change in supply vs. change in quantity supplied
Change in supply Change in quantity supplied
Individual firm and market supply curves The market supply curve is the
horizontal summation of the supply curves of individual firms. (This is equivalent to the relationship between individual and market demand curves.)
Determinants of supply Price received by supplier Input price technology the expectations of producers the number of producers Relative Goods
Price Received by Supplier This is the law of supply The more money the supplier
receives for the good he’s selling the more willing he/she will be to sell it
Price of resources (Input Price) Inputs are the goods the supplier has to
purchase in order to produce the supply As the price of a resource rises, profitability
declines, leading to a reduction in the quantity supplied at any price.
Technological improvements Technological improvements (and any changes that raise the
productivity of labor) lower production costs and increase profitability.
Expectations and supply An increase in the expected future
price of a good or service results in a reduction in current supply.
The supplier will hold off on selling his goods if he can sell them for a greater profit later.
Increase in the Number of Sellers
Prices of other goods More than one firm produces and sells
the same good or a relative good Because of this firms compete with each
other to sell more goods and in order to do so they have to lower their prices below that of their competition
Without this effect all markets would be monopolistic and we would all be screwed
Equilibrium…the fun never stops
Market equilibrium
Price above equilibrium If the price exceeds the equilibrium price,
a surplus occurs:
Price below equilibrium If the price is below the equilibrium
a shortage occurs:
Consumer and Producer Surplus
Consumer surplus – the utility (or level of satisfaction) a buyer receives by being able to purchase a product for a price less then the maximum they were willing to pay
Producer surplus – the amount that producers benefit by selling at a market price which is greater than the minimum they would be willing to sell for
Consumer/Producer Surplus Visualized
Consumer surplus Individuals buy an item only if they
receive a net gain from the purchase (i.e., total benefit exceeds opportunity cost.)
This net gain is called “consumer surplus.”
Example Suppose that an individual buys 10
units of a good when the price is $5
Benefits and cost of first unit
• Benefit = blue + green rectangles (=$9)
• Cost = green rectangle (=$5)
• Consumer surplus = blue rectangle (=$4)
Total benefit to consumer
Total cost to consumer
Consumer surplus
Demand rises
Demand falls
Supply rises
Supply falls
Price ceiling Price ceiling - legally mandated
maximum price Purpose: keep price below the
market equilibrium price
Price ceiling (continued)
Price floor price floor - legally mandated
minimum price designed to maintain a price above
the equilibrium level
Price floor (continued)
Elasticity
Elasticity A measure of the responsiveness
of one variable (quantity demanded or supplied) to a change in another variable (price)
Most commonly used elasticity: price elasticity of demand, defined as:
Price elasticity of demand =
Price elasticity of demand Demand is said to be:
elastic when Ed > 1, unit elastic when Ed = 1, and inelastic when Ed < 1.
Perfectly elastic demand
Perfectly inelastic demand
Elasticity & slope
a price increase from $1 to $2 represents a 100% increase in price,
a price increase from $2 to $3 represents a 50% increase in price,
a price increase from $3 to $4 represents a 33% increase in price, and
a price increase from $10 to $11 represents a 10% increase in price.
Notice that, even though the price increases by $1 in each case, the percentage change in price becomes smaller when the starting value is larger.
Elasticity along a linear demand curve
Elasticity along a linear demand curve
Determinants of price elasticity
Price elasticity is relatively high when:
close substitutes are available the good or service is a large share
of the consumer's budget (necessities)
a longer time period is considered (time horizon)
Price elasticity of supply
Perfectly inelastic supply
Perfectly elastic supply
Determinants of supply elasticity Ease of Entry and Exit Scarce Resources Time Horizon
Elasticity and total revenue Total revenue = price x quantity What happens to total revenue if
the price rises?
Price elasticity of demand =
Elasticity and TR (cont.)
A reduction in price will lead to: an increase in TR when demand is elastic. a decrease in TR when demand is inelastic. an unchanged level of total revenue when
demand is unit elastic.
Price elasticity of demand =
Elasticity and TR (cont.)
In a similar manner, an increase in price will lead to: a decrease in TR when demand is elastic. an increase in TR when demand is inelastic. an unchanged level of total revenue when
demand is unit elastic.
Price elasticity of demand =
…...Let’s Stick to the Non-confusing Example
Everyone's Favorite…Taxes!!!!
Tax incidence distribution of the burden of a tax
depends on the elasticities of demand and supply.
When supply is more elastic than demand, consumers bear a larger share of the tax burden.
Producers bear a larger share of the burden of a tax when demand is more elastic than supply.
Costs and production
Production possibilities curve Assumptions:
A fixed quantity and quality of available resources
A fixed level of technology
Specialization and trade Adam Smith – economic growth is
caused by increased specialization and division of labor.
Specialization and trade As noted by Adam Smith,
specialization and trade are inextricably linked.
Adam Smith used this argument to support free trade among nations.
Absolute and comparative advantage Absolute advantage – an individual
(or country) is more productive than other individuals (or countries).
Comparative advantage – an individual (or country) may produce a good at a lower opportunity cost than can other individuals (or countries).
Example: U.S. and Japan Suppose the U.S. and Japan produce only
two goods: CD players and wheat.
Absolute advantage? Who has an absolute advantage in
producing each good?
Comparative advantage? Who has a comparative advantage
in producing each good?
Gains from trade Opportunity cost of CD player in U.S. = 2
units of wheat Opportunity cost of CD player in Japan =
4/3 unit of wheat If Japan produces and trades each CD
player to the U.S. for more than 4/3 of a unit of wheat but less than 2 units of wheat, both the U.S. and Japan gain from trade and can consume more goods than they could produce by themselves.
Gains from trade (continued) Note that the U.S. has a comparative
advantage in producing wheat. Countries always expand their
consumption possibilities by engaging in trade (since they acquire goods at a lower opportunity cost than if they produced them themselves).
Free trade? If each country specializes in the
production of those goods in which it possesses a comparative advantage and trades with other countries, global output and consumption is increased.
Robinson and Crusoe? Really USAD……Really?
Profit Motive and Behavior of Firms Profit = total revenue – total cost (costs will likely only include only
monetary expenses) Total cost is comprised of expenses
plus all monetary opportunity costs
Different Costs The costs that do not depend on
production and can’t change in the short run are called fixed costs
However costs that can be varied in the short run are called variable costs
Marginal Cost Notice in figure 23 that when you
go down 1 row there are 50 more loaves of bread produced; however, there is an additional cost for producing more goods
This increase in cost when producing an additional unit of output is called the marginal cost
How to find marginal cost (increase in total cost) MC = ------------------------------------- (increase in quantity
produced)
Law of Diminishing Returns Next notice that the maximum
profit is made when marginal cost is equal to marginal revenue
Think of the marginal cost as the opportunity cost for making an extra unit of good and the marginal revenue as the profit for making that extra unit
Law of Diminishing Returns as the level of a variable input
rises in a production process in which other inputs are fixed, output ultimately increases by progressively smaller increments
So this means that at some point it’s no longer productive to make that extra unit of good
Imperfect Markets
Monopolies A monopoly is an extreme case in
which there is a market with only one producer
Ownership Monopolies Government-Created Monopolies Natural Monopolies
Why Monopolies Are Bad? Because the supplier can charge
whatever amount he/she wants for the product and there is no competition to force the supplier to lower the prices on goods
Price discrimination different customers are charged
different prices for the same product, due to differences in price elasticity of demand
higher prices for those customers who have the most inelastic demand
lower prices for those customers who have a more elastic demand.
Price discrimination (cont.) customers who are willing to pay
the highest prices are charged a high price, and
customers who are more sensitive to price differentials are charged a low price.
Next up…Oligopolies An oligopoly is a market with very
few suppliers Not quite as bad as a monopoly
but still Example: OPEC (Organization of
Petroleum Exporting Countries)
Creative Destruction A term coined by the Australian
economist Joseph Schumpeter “creative destruction” states
that as new industries surged, older industries grow more slowly, stagnate, and shrink
Market failures Not all markets are perfect and
sometimes a market failure will occur when externalities or breakdowns in the system of private property cause markets to deviate from the socially efficient outcome
Oh the Government Pork Barrel Politics – elected
officials introduce projects that steer money into their of pockets
Logrolling – vote trading within legislation