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ECO 101: Introduction to Microeconomics Midterm 1 Revision slides Parisa Shakur (PSk)

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What is Economics?

• It teaches us to eff iciently allocate scarce resources among competing demands • It is also known as the science of scarcity or the science of ex change

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• The broad ambition of economics is to understand people better.

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Goods, Bads and Resources

• A bad is anyt hing t hat gives disut ilit y or dissat isfact ion. Eg. Headache • Resources are t he factors of product ion or input s. There are 4 t ypes of resources 1 . Land: Any nat ural resource used for product ion. Eg. Oil, coal, field, wat er

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• A good is anyt hing t hat gives ut ilit y or sat isf act ion. Eg. Good f ood

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2 . Labour : The physical and m ent al att ribut es of people that is used for product ion. Eg. Work of a day labour, doctor

3. Capital: Man- made resource that helps to convert raw m aterials int o finished product . Eg. Machineries, m oney 4. Entrepreneur : The risk- taker and organiser of land, labour and capital for product ion. Eg. A fact ory owner.

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Cont’d

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Scarcity and its effects Scarcity is a situation that takes place due to unlimited wants and limited resources to fulfill them. Everyone faces scarcity in this world. • Ef fects 1. It f orces us to make choices 2. It uses rationing devices to allocate scarce resources 3. It leads to competition among people

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•

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Opportunity Cost

• Opportunity cost may increase or decrease and this will change a person ’ s behavior. The higher the opportunity cost of doing something, the less likely it is to be done and the lower the opportunity cost, the more likely it is to be done.

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• It is the nex t best alternative f orgone for the choice made. For ex ample, if you have an option of either watching TV or playing games, if you choose games, then watching TV is your opportunity cost.

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Marginal Benefits

• Marginal Benefit (MB)≠ Total Benefits (except for first unit) • MB curve is always downward sloping

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• Additional/ ex tra benef its gained from an additional/ ex tra consumption of a good or service

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Marginal Costs

• Marginal Cost (MC)≠ Total Costs (except for first unit) • MC curve may be a straight line parallel to the x ax is or upward sloping

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• Additional/ ex tra costs incurred f rom an additional/ ex tra consumption of a good or service

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Efficiency

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Unintended effects and Trade

• Ex change or trade is the giving up of one thing f or another. It only takes place when one ex pects to be better off after the trade than before the trade

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• Not every change brings desirable and/ or predictable results. Some may bring unintended effects. Eg. Ban of Marij uana, smoking ban in the UK

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Economic Categories

• Normative economics is that part of economics that ex presses value judgm ents about econom ic fairness or what the economy ought to be like or what goals of public policy ought to be The price of m ilk should be $6 a gallon This is a normative statem ent, because it reflects value judgments and cannot be proven true or false by comparison against real world data

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• Positive economics is the branch of econom ics that focuses on facts and cause- and- effect behavioral relationships and includes t he developm ent and testing of econom ic t heories. The price of m ilk has risen from $3 a gallon t o $5 a gallon in t he past five years. This is a positive statem ent because it can be proven true or false by com parison against real- world data.

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Cont’d

• Macroeconomics is a branch of economics dealing with the perf ormance, structure, behavior and decisionmaking of the entire economy.

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• Microeconomics is a branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources. Typically, it applies to markets where goods or services are being bought and sold.

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• What it is: It is a graph that shows all the possible combinations of two goods that can be produced in a certain period of time under the conditions of a given state of technology and fully employed resources. • What it does: It demonstrates that 1. There is a limit to what you can achieve, given the existing institutions, resources, and technology. 2. Every choice you make has an opportunity cost. You can get more of something only by giving up something else

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Production Possibility Frontier (PPF)

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% of resources devoted to productio n of guns

No. of guns

% of resources devoted to producti on of guns

Pounds of butter

0

0

100

15

20

4

80

14

40

7

60

12

60

9

40

9

80

11

20

5

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Example

13 100

12

0

0

Finding Opportunity costs

 To move from C to D We get 2 guns by giving up 3 pound of butter Therefore, we get 1 gun by giving up 3⁄2=1.5 pound of buer  To move from D to E We get 2 guns by giving up 4 pound of butter Therefore, we get 1 gun by giving up 4⁄2=2 pound of buer Thus we see that as we want to get more guns, the opportunity cost of getting it increases from 0.25 to 1.5 to 2

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 To move from A to B We get 4 guns by giving up 1 pound of butter Therefore, we get 1 gun by giving up 1⁄4=0.25 pound of buer

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Calculating opportunity costs

Increasing opportunity costs= bowed outward PPF Law of Increasing Opportunity Costs : As more of a good is produced, the opportunity costs of producing the good increase. For most goods opportunity costs increase as more of the good is produced.

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Opportunity cost is increasing as we move from A through to F

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Choice

Eggs

Rye

A

10

0

B

8

1

C

6

2

D

4

3

E

2

4

F

0

5

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Straight line PPF

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Economic concepts explained with PPF

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1. Scarcity: The fact that PPF intersects the axes shows that there are limits to what we can achieve given our resources

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Economic concepts explained with PPF 3. Opportunity Costs: The downward slope of the PPF represents the opportunity cost concept. Each production choice is associated with an opportunity cost. 4. Productive Efficiency: An economy is said to be productively efficient if it is producing the maximum output with given resources and technology. All the points A to F are productively efficient points.

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2. Choice: The different combinations of goods and services to choose from.

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5. Productive inefficiency: This takes place when resources and technology are not fully and efficiently used and more of one good an be produced without giving up another good. The point U is productively inefficient. 6. Unemployed resources: When all the resources are not fully used for production. Point U is the example.

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Economic concepts explained with PPF

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7. Economic Growth: The increase in the productive capacities of an economy. This can occur due to a)  Increase in amount of resources b)  Advancement in technology This will shift the PPF outward

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Economic concepts explained with PPF

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Giving up of something for something else. Takes place only when we expect to be better off after trade than before trade.

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Exchange or Trade

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The rate of exchange of one good or service for another. How much of something is traded for how much of something else. Whereas trade is the giving up of something for something else

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Terms of Trade vs. Trade

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Costs involved in Trading

They determine whether a potential trade will become an actual trade or not Lowering transaction costs can turn a potential trade to an actual trade One of the role of the entrepreneur is to try to lower transaction costs

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Transaction costs: Costs incurred while making a trade. Costs associated with the time and effort needed to search out, negotiate and make a trade.

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Gains from Trading

A person has a comparative advantage at producing something if he/she can produce it at lower cost than anyone else (opportunity cost is lower).

Comparave advantage ≠being best at something

Individuals gain from specialising. This reduces cost and increases profit

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Individuals can be better off by producing and trading goods and services that they have a comparative advantage on than otherwise.

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Fridges

Microwaves

Italy

1000

200

Germany

800

500

Using all its resources efficiently, Italy can produce more fridges than Germany. The opportunity cost of letting Italy make fridges is 800 fridges by Germany. This is lower than the opportunity cost of letting Germany make the fridges (that is 1000 fridges). Therefore as opportunity cost is lower when Italy makes fridges, Italy will make them. Using all its resources efficiently, Germany can produce more microwaves than Italy. The opportunity cost of letting Germany make microwaves is 200 microwaves by Italy. This is lower than the opportunity cost of letting Italy make the microwaves (that is 500 microwaves). Therefore as opportunity cost is lower when Germany makes microwaves, Germany will make them

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Comparative Advantage

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How an Economist says I Love You

How an Economist says I Love You

Demand • What is Demand?

• Individual and market demand curve • Change in quantity demanded vs. change in demand

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• Law of Demand and why it holds

• Shift factors and movement factors 28

Demand

A Market is any place where buying and selling takes place Ceteris Paribus is a Latin term that means nothing else changes or all other things held constant

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Demand is the willingness and ability of buyers to purchase different quantities of a good or service at different prices and during a specific time period

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Law of Demand

 }Law of Demand can be expressed in four ways 1.  In words 2.  In symbols 3.  In a demand schedule 4.  As a demand curve

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Law of Demand states that as the price of a good rises, the quantity demanded of that good falls, and as price of the good falls, its quantity demanded rises, ceteris paribus

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Demand

• Change in quantity demanded vs. change in demand

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• Individual demand curve vs. Market demand curve

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Demand

• Shift factors 1.Income Norm al, Inferior, Neutral 2.Preferences 3.Price of related goods Substitutes, Complements 4.Num ber of buyers 5.Ex pectations of future price

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• Movem ent factors 1.Own price

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Diagrams 1. The demand curve

3. Movement of the demand curve (up & down) 4. Shif t of the demand curve (right and left)

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2. Individual and Market demand curves

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Supply • What is Supply

• Why m ost supply curves are upward sloping 1.Increasing Opportunity cost • Supply curve vs. Mark et supply curve • Change in quantities supplied vs. change in supply

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• Law of Supply and ex ceptions

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Supply

• Shift factors 1.Prices of relevant resources 2.Technology 3.Number of sellers 4.Ex pectations of f uture prices 5.Tax es and subsidies 6.Government restrictions

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• Movement factors 1.Own price

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Diagrams 1. The supply curve

3. Movement of the supply curve (up & down) 4. Shif t of the supply curve (right and left)

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2. Individual and Market supply curves

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Absolute and Relative prices Absolute price is the price of the good in money terms

}   For example,   If the price of a sock is Tk.2 and the price of a shoe is Tk.200, The relative price of a shoe (in terms of socks)=Absolute price of a shoe ⁄ Absolute price of a sock=200 ⁄2=100 The relative price of a sock (in terms of shoe)=Absolute price of a sock ⁄ Absolute price of a shoe=2 ⁄ 200=1⁄ 100

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Relative price is the price of the good in terms of another good.

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GOOD LUCK! 38

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