ECON 2030 Test 1 Notes - Charles Roussel PDF

Preview

Summary

Charles Roussel...

Description



The most basic basics o Definitions  Economics – the study of how societies provision themselves with the material means of existence  The physical stuff (food, coffee, clothing, tables, etc.)  Services (Haircuts, bank tellers, etc.)  People providing services are typically viewed as primarily economic transactions  Going into a voting booth has economic aspects, but not primarily economic (although economics may play a role in this politically decision)  The Economy – people doing stuff (stuff involved with providing for the material means for our existence)  Teachers teaching, construction workers constructing, businessmen doing business, etc.  Has existed throughout human history because humans need things to exist. The organization of these economies is what varies in history  Markets  In this class we will focus on markets  A social process of people interacting in which a good or a service is exchanged for money  X—goodY  Y--$-->X  Y is the buyer (not necessarily the consumer)  X is the seller (not necessarily the manufacturer)  The arrows are the transactions which is the act of buying and selling  If gas prices go up, its good for the seller but not the buyer (multiple viewpoints on each transaction) o What? How? For whom?  Microeconomics – the decisions and behaviors of individual people and individual businesses (from mom and pop stores to Walmart)  What material means of existence (what type of food or clothing)?  How are we to produce these materials means of existence (Farmland or subdivisions for this land)?  Who will receive the material means of existence (who will get the coffee)?  Whoever is willing and able to purchase it will purchase it o Consequences?  What we do in the economy impacts everything in the economy  Macroeconomics – the big picture of economics o The individual grade on one exam is the microeconomics and the average is the macroeconomics. Macro does say anything about individual but does give big picture



Economic reasoning: the basics o Economists assume that people act purposefully and are trying to accomplish something  Businesses do not randomly produce stuff but only for profits  People (ought to) purposefully think about purchases o Benefit is just what you get  When buying gasoline is the benefit  There are also some non-monetary benefits (a teacher seeing students’ faces or intellectual stimulation) o Opportunity cost: What you give up  Benefit from best alternative not chosen  If you were not here, you would be doing the next best thing  We give up a certain opportunity to be engaged in another activity o Rationality  Do something if benefit ≥ opportunity cost  We are not omniscient so we cannot be completely sure  When you see a bad movie, you thought would be great  You had to make an educated guess about it o Total vs. marginal  Total=all. All the relevant benefits added up and compare it to the costs  Either/Or decisions  Marginal refer to the margin of cost  Charles’ Corndog Stand whether or not he is open at 9 instead of closing at 8  Lunchtime profits don’t affect this, but the extra salaries from 8-9 do (the margin)  How much/How many decisions



Examples of Economic Reasoning o A question: Suppose it’s the end of the year. You’ve been running a small family business for the whole year and you wonder how you did. Your accountant friend comes in and says that you made a very large profit of $125,000. Would it ever be a good, rational business decision to stop doing that?  The answer is absolutely yes o Either/or Choices  Whether or not to go to Jazzfest  The expected pleasure is the relevant benefit  The ticket price is the relevant cost  The rational decisions among the multiple stages is which artist you believe you will enjoy the most  Relevant benefits, costs: Total o How much/many Choices  At a buffet it starts with a either or decision  The expected benefit is the pleasure of the food





 The relevant cost is NA. It’s a sunk cost  Relevant benefits, costs: Marginal o The answer – Of course it could help you more to do something else  Just because you are earning a profit doesn’t mean it’s the biggest profit possible  Delta and the Mayor  Delta airlines are cutting the number of non-stop flights from Knoxville to Atlanta  The mayor of Knoxville said that if the extra nonstop flight is still there then they will earn a profit  Relevant costs Positive vs. Normative economics o NOT ALL FACTORS IN A DECISION ARE ECONOMIC but we will be discussing the monetary o Positive economics – describes how the world is (the unemployment rate is…) – Descriptive o Normative economics – describes how the world should or ought to be – Prescriptive o The difference between the two is that normative statements can be manipulative o To figure out which is which, collect data and analyze How Trade Can Benefit All: An example o Assumptions  England produces more cloth and are better at producing cloth while Portugal produces more wine and is better at producing wine  Two Countries: England, Portugal  Two Homogeneous Goods: Wine, Cloth  All workers in a country are equally productive  Resources: 100 worker/hours in each country  The workers in Portugal are most productive in world and have production advantage  Why interact with “deadbeat” England? o It’s not about production IT IS THE COST  England has Portugal beat on opportunity cost for wine, so if these countries trade, everyone gets cheaper products o Relevant Concepts  Productivity = output per worker per hour  Absolute Advantage = highest productivity  Comparative Advantage = lowest opportunity cost o Autarky: production = consumption  BOTH countries are producing efficiently  Efficiency=using all available resources  England decided to divide up their 100 worker/hours equally between wine and cloth  50/50 for wine/cloth  If they want more wine, they need to produce less cloth

 Portugal decided to divide up 60/40 for wine/cloth o Specialization and trade according to Comparative Advantage  Portugal makes ALL the wine and England makes ALL the cloth  Each country gets more product for less o With Trade: consumption > production  If consumption goes up and production goes down, both benefit from trade (mutually beneficial trade)  THIS WILL NOT always occur o Conclusions  Gains from trade  Winners and losers  The difficult thing to ask is who are the winners or losers  WINNER: Some is obvious such as the English textile industry and workers is a winner because there are more jobs and selling more at a higher price (also Portuguese cloth consumers because lower price). Portugal wine industry and workers and English wine consumers  LOSER: Portuguese textile mills and English wineries cannot compete with their counterparts. Even though the jobs are the same, and former textile worker in North Carolina can’t commute to a wine job in Oregon. In addition, the Portuguese wine consumers and English textile consumers must pay a higher price because they are forced to match price with what the other country pays  Consumers of imported goods and the workers of goods exported  Consumers of exported goods and the workers of goods imported 

Buyers’ side of market: Demand (D) o Buyers’ decisions are INDEPENDENT of the decisions of sellers o When Chuck puts something on the grocery list, he does not know what will be on the shelves and Walmart does not know what’s on the list o Buyers and sellers instead of demand and supply  It’s about patterns of people making decisions  Discussions buyers describe people’s behavior o The behavior of buyers and sellers are independent of one another

 Suppose something is going on, how is the buyer going to change their behavior? Pattern of all economic questions o Definition of Demand – the ability and willingness to purchase a good or service regardless of price  The actual price of a good or service does not matter with demand  Price is important but not relevant to demand  Things that influence our willingness and ability to purchase are relevant  With income X, can I afford this? (ability)

Do I like this item? Will it go bad before I can use it? Will it be on sale next week? (willingness)  Change in anything other than price will cause buyers to change their behavior  Change in actual price causes a change is the quantity demanded o Not to be confused with Quantity Demanded (QD)  Definition – the specific amount of a good or service you are willing and able to purchase at a specific price  When a buy one get two free sale occurs, people buy these goods in greater quantities  Demand and QD ALWAYS move in opposite directions and are inverses  Cause (i.e., determinant) of change in Quantity Demanded  Price (P) of good (-)  Link with Reservation Price; benefit from buying o Definition – maximum price that you’re willing and able to pay for a good or service o “It’s watcha think it’s worth” o When someone says “I’d pay $20 for that but not one cent more” they are establishing their reservation price o Causes (i.e., determinants) of changes in Demand  You could have all the money on the planet, but it will not be purchased if you don’t want it  Not about the specific goods but about the behaviors of the people buying these goods  When you get a massive raise you will:  You will buy something you couldn’t afford before  Known as normal goods  Change in income  Normal good (+) o Now I can afford more stuff that I like  Inferior good (-) o Now I don’t have to buy this but I can afford this better thing o Requires a desire for a good to go down and another to go up o As soon as we can afford something better we switch o Spam is gross and an inferior good, but great in Hawaii, so culture influences our idea of these terms  Change in price of related goods  There are relationships between demand for different goods  How does the price of one good affect the price of another?  Substitutes: Increase price (+) o Good that are consumed in rivalry 



o They consumed in an either/or decision  Chevron or Shell, Tide or Arm and Hammer  Complements: Increase price (-) o Goods consumed and purchased together o Peanut butter AND jelly  Price of good A goes up, demand for B goes up o This is an example of substitute o Same with the inverse, but substitutes move in the same direction for price of one and demand for the other  Price of good A goes up, demand for B goes down o Opposite effect o If the price of peanut butter goes up, no one will only buy the jelly o Goods are used together  Change in tastes/preferences (+)  If my tastes change, this will affect how much I buy of it  Change in expectations  “What you think is gonna happen in the future”  If I think something will be on sale next week, I will wait until next week to buy it then my demand goes down  Future price (+)  Future income: normal good (+); inferior good (-)  Change in number of buyers (+)  Number of buyers goes up, demand goes up  Fewer buyers, less demand o This is all irrelevant without a seller Sellers’ side of market: Supply (S) o Recall market price is both a cost and benefit depending on perspective o Definition of Supply – see demand but instead of purchase its sell  The ability and willingness to SELL a good or service regardless of price o Not to be confused with Quantity Supplied (Qs)  Price is relevant for quantity supplied  Same as Qd but purchased to sold  The specific amount of a good or service you are willing and able to SELL at a specific price o Benefit of selling  Getting paid  In order to get paid for selling, you need something to sell o The Cost of selling  You have to give up the good or service (something of value)  Reservation Price  You have the good or service of value

The reservation is the minimum price at which the seller is willing and able to sell (what it’s worth to the seller)  Like a reserve at an auction (the minimum price for a sale) o Cause=Action, Effect=Reaction  Change in actual price is action. Change in quantity supplied (+) is reaction  If the price goes up, that is goods news for the seller. DOES NOT MATTER ABOUT BUYER  Put yourself in the position of the seller Causes (i.e., determinants) of changes in Supply o Cost of material goes up, bad news for seller (higher cost) o Cost of labor (i.e., wages, benefits) (-)  2/3 of cost are in cost of labor  Cost of labor goes up, bad news for the seller o Other input costs (-)  Rent, materials, transportation, utilities  Everything I need to make the good, other than the labor  Does not matter if you have to pay more for input costs or labor, still bad news for the seller o Productivity (+)  Worker productivity goes up, less you need to pay for labor  Unit cost per labor example  Worker can produce 20 units per hour and $20 per hour means $1 per unit  Worker can produce 40 at $20 per hour means $.50 per unit o Expectations  Future price (-)  If the future price is higher, the seller would want to sell it then and hang on to it now because the benefit is the price of the good or service  If future price will be lower, the seller would want to sell it now for a HIGHER price o Number of sellers (+)  More sellers=more supply Market Equilibrium and Disequilibrium o At any moment in time, the price could be at any level o Equilibrium: Quantity Supplied = Quantity Demanded  Means balance  Means no incentive to change behavior FOR BOTH THE BUYER AND SELLER  The market will be at equilibrium when Quantity Supplied=Quantity Demanded o Disequilibrium  When not at equilibrium, there will be changed behavior  Excess supply: Surplus: too much 





When there is a surplus the seller has the incentive to change (the price of the good)  A sale occurs and the price keeps going down until they either sell out their surplus or are forced to sell their overstock  Excess demand: Shortage: not enough/too little/too few  At an auction, you have 1 item up and 5 people who want to buy  The buyers would then change their behavior and be willing to pay more  As the price goes up, more buyers leave the bidding and eventually gets to one bidder to reach equilibrium o Return to equilibrium The Method o In the real world, can you predict change in price?  Foresaw the price of gas would go up, buy it sooner o Who is DIRECTLY affected?  Means who is going to notice the change and alter their behavior as a result of it  If income goes up, the buyers are directly affected when they see their paycheck, but the seller is NOT directly affected  If a hurricane wiped out half of the oranges in Florida, the seller is directly affected but the buyer does NOT notice  i.e., Who would notice the change and alter their behavior? o How does behavior change? o What is the result?  How does the market equilibrium change? o More means more quantity transactions o Less means fewer quantity transactions Elasticity – ability to be changeable and responsive; how sensitive we are o If someone likes something, they will up play the benefits and vice versa o Rationality – assumes someone is doing something meaningfully (Benefit>Cost is good) o Cost is imbedded in productivity (mutually beneficial trade is possible) o Anticipating price changes are vitally important because a dollar spent is a dollar earned o Businesses try to manipulate us to separate us from our money o Interest rates greatly affect the buying of a house, so more important than may seem to us  If people run out to buy whenever interest rates go down o Running a successful business  Location location location – you want a good location but everyone else wants it  The price will be high so do the benefits outway the cost? 





No car dealerships in midtown manhattan but on the outskirts of a city  Know your customer  How is your customer going to react to changes?  Should I raise or lower my prices? It depends on how your customers will react to the price change  People can give a free sample or something to get them hooked and then they will do ANYTHING for it o Motivation o Price elasticity of demand (ED)  Definition – the responsiveness and sensitivity of the buyers to change in price  Cause vs. Effect  Action is %change in price and reaction is %change in Quantity Demanded  Definition of price elasticity of demand  Mathetically – ED = abs(%change Qd/%change P) = abs(Effect/Cause)  Measure  If change in price of 10% results in 30% change in Qd, this would be price elastic  Elastic – the reaction is disproportionally greater to the action (ED > 1)  Inelastic – the reaction is disproportionally less than the action (ED < 1)  Unit Elastic – the reaction is exactly proportional (ED = 1)  Determinants – the factors that determine how sensitive the customers are to change in price  Number and availability of substitutes (+) BY FAR MOST IMPORTANT o The greater the availability of substitutes, the more sensitive the customers will be to change in price o The more options, the more things to buy INSTEAD o Gasoline may seem inelastic on the surface but is elastic because of number of gas stations o Advertising  Businesses want to say others are not actually substitutes  Cox communications advertises itself to not get you to switch to Direct TV  Need (i.e. necessity or luxury) (-) o If you really need something, you view it as a necessity  The more you view something as a necessity, the more inelastic to price change 







o Goods perceived as luxury goods will lead to elastic buyers o Advertisements try to ruin self-esteem with self-care products to make you view it as a necessity Proportion of budget spent on good (+) o If a chocolate bar price goes up by 10% that’s nothing o If rent goes up by 10% that’s significant, that’s less food, that’s a new apartment o Medicines at pharmacies are on sale for the elderly because they tend to spend a larger amount of the budget Time (+) o More time we have to decide to buy, the more elastic because more time to find a better deal o Lots of time to buy a car, so many different dealerships (very elastic) o “Three day sales” that last for months o “If you call in the next 30 minutes”

Elasticity o Better means to improve your bottom line in a business o Price elasticity of demand (εD)  Key: Relationship with total revenue  Total revenue is total dollars from selling stuff  If I raise my price, quantity demanded goes down (change in total revenues ambiguous) o Answer to ambiguity is the elasticity of the consumers o Total Revenue = Price x Quantity Demanded o Inelastic is a proportionally smaller reaction to change in price, so increase in price with inelastic is higher total revenue and decrease in price with elastic is lower total revenue o Raise price to elastic customers will lower total revenue o Decrease price to inelastic will also lower total revenue o Remains unchanged if exactly 1 (unit elastic)  Examples o Price elasticity of supply (εS)  Same as demand/supply, Qd/Qs so like price elasticity of demand is with buyers, price elasticity of supply is sellers  The sensitivity of sellers with respect to changes in price  Action is %change in price and reaction is %change in quantity supplied  Measure - %change Qs/ %change P (Effect/Cause)  Elastic: εS > 1







 Inelastic: 0 ≤ εS < 1  Unit elastic: εS = 1 Note: Not in absolute value terms  The price of the good is the benefit for the seller  If price goes up and its good, you do more  No absolute value because %change in price and Qd will always be same direction Determinant  Time (+)  Take time to produce, take to market, and sell  After Katrina, housing prices soared in BR but Qs was low because houses cannot be built instantaneously

So what? o Incidence of taxation  Motivation  Tool: Elasticity o Examples: Who bears the burden of a tax?  Obvious answer is that it is always the consumer because we are paying the money  Businesses cannot pass burden of taxes to consumers  The customers can always say NO  Businesses can either ...