ECON Reviewer - Lecture notes 1-14 PDF

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CHAPTER 1: TEN PRINCIPLES OF ECONOMICSEconomic Principles – idea of “principles of economic life”; of how the economy works; economy actors; parallel the principles or laws in natural sciencePrinciples of Economics – basic methods and concepts economists use when doing economicsEconomics – disciplin...

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CHAPTER 1: TEN PRINCIPLES OF ECONOMICS Economic Principles – idea of “principles of economic life”; of how the economy works; economy actors; parallel the principles or laws in natural science Principles of Economics – basic methods and concepts economists use when doing economics Economics – discipline; clarifies the basic concepts that make and shape the analysis and the thinking of economists

10. Game theory – study situations of interdependence where people have incentives to think and behave strategically How People Make Decisions:   

10 Principle of Economics: 1. Scarcity – situations where needs/ wants exceed means; people have to make choices 2. Rationality – guide people’s choices/ decisions; gauge pros and cons 3. Preferences – fixed and given that allow assignment of value to all opinions, and to choose the option that maximizes net utility 4. Restrictions - ppl face constraints that they cannot change themselves and have to take as given (ex. Current amount of money) 5. Opportunity cost – deciding in favor of one option always means deciding against some other options 6. The Economic Principle – application of rationality to situations of scarcity; “minimize cost/ maximize utility” 7. Efficiency – getting the maximum benefits from its scarce resources 8. Marginal analysis – additional benefits from its scarce resource 9. Equilibrium – basic economic models deal with the comparison of two equilibria

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People face tradeoffs – to get one thing, you have to give up something else The cost of something is what you give up to get it – consider both the obvious and implicit cost of their actions Rational people think at the margin – takes action if and only if the marginal benefit of the action exceeds the marginal cost People respond to incentives – behavior changes when costs/ benefits change

How People Interact:   

Trade can make everyone better off – it allows person to specialize in the activities he does best Markets are usually a good way to organize economic activity – invisible hand Governments can sometimes improve market outcomes – public policy

How the Economy Works as a Whole: 

 

A country’s standard living depends on its ability to produce goods and services – workers who produce large quantity of goods = enjoy high standard living Process rise when the government prints too much money – Society faces a short-run trade-off bet inflation and unemployment – reducing inflation = rise of unemployment

CHAPTER 2: THINKING LIKE AN ECONOMIST Economics – social science that deals with the allocation of scarce resources (human, natural, physical) to satisfy unlimited human wants Economic problem – unlimited wants vs limited resources; needs vs wants

Opportunity cost – true cost of choosing one alternative over the other; the one you give up when the choice is made; opportunity lost Trade-offs – giving up one thing in order to obtain another Branches of economics: 

Problem of choice – scarcity of resources = economic problem Basic economic questions: 1. What to produce? 2. How much to produce? 3. How to produce? 4. For whom to produce? Production Possibilities Frontier (PPF) – combi of goods and services that can be produced from a fixed amount/ resources in a given period of time Resources – limited – use so much of them to produce certain goods; factors of production Natural resources – free gifts of nature; land minerals, oil, forests, air and timber Capital resources – manufactured aids to production; tools, machines, equipment, factory Human resources – mankind’s physical and mental talent; skills, labor Entrepreneur – the indv who combines that factors of production in order to produce a good or service; risk taker, policy maker, innovator

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Microeconomics – behavior of individual economic units; households, firms, markets Macroeconomics – whole/ aggregate economy; GNP, GDP, inflation, unemployment

Business Cycle:    

Peak – boom; highest point in the economic cycle Recession – contraction; decline in the economies’ performance that could lead to depression Trough – depression; sustained economic downturn; lowest economic point Recovery – expansion; economic activity begins to pick-up and depression end; economic growth

CHAPTER 3: INTERDEPENDECE AND GAINS FROM TRADE

Market – a group of buyers and sellers of a particular product

Trade – commercial business of buying and selling goods for profit; within or between countries

Competitive market – one with many buyers and sellers, each has a negligible effect on price

International trade demands:  

Physical flow of goods from seller to buyer Payment from buyer to seller

Economic interdependence – trade can make everyone better off – allow each person to specialize in the activities he does best Comparative advantage – ability to produce a good at a lower opportunity cost than another producer Absolute advantage – ability to produce a good using fewer inputs than another producer

Perfectly competitive market – all goods exactly the same; buyers and sellers so numerous that no one can affect the “price taker” Demand – various quantities of goods/ services that consumers are willing to purchase; capacity to pay vs. willingness to pay; comes from the behavior of the buyers Law of Demand – “the quantity demanded of a good falls when the price of the good rises” INVERSE RELATIONSHIP OF QUANTITY AND PRICE (downward slope) Demand schedule – shows relationship between the price of a good and the quantity demanded

CHAPTER 4: MARKET FORCES OF SUPPLY AND DEMAND

Market demand – sum of individual demands

Flow of goods, services and money 1. Firms – produce and sell goods and services; hire factors of production 2. Household – provide factors of production/ labor for firm; buy goods and services 3. Government – TAX

Change: change in price of good Shift:

1. Income – demand for good Normal good – increase in income causes increase in quantity demanded at each price; buying nike shoes (shift right) Inferior good – demand decreases when consumer income rises; prefers class a shoes (shift left) 2. Prices of related goods Substitutes – alternative for good (coke and pepsi-r) Complements – (computer and software- left)

3 .Taste - shifts right 4. Expectations 5. # of buyers – to right

1. Decide whether event shifts S curve, D curve, or both. 2. Decide in w/c direction curve shifts 3. Use supply-demand diagram to see how the shift changes eq’m P and Q

Supply – various quantities of goods/ services that producers are willing to sell Law of supply – the quantity of the supply rise, the price rises DIRECT RELATIONSHIP Supply schedule – upward slope Shift:

1. Input prices – wage/ raw materials (right) 2. technology - more machine less workers (right) 3. expectations – 4. # of sellers – increase then quantity of S increase too(r)

Equlibrium – price has reached the level where quantity supplied equals quantity demanded Equilibrium price – price that equates quantity supplied with quantity demanded Equilibrium quantity – quantity supplied and demanded at the equilibrium price

CHAPTER 5: ELASTICITY AND ITS APPLICATION Elasticity – measures how much buyers and sellers respond to changes in market conditions Price Elasticity of Demand – measures how much the quantity demanded responds to a change in price; change in Q d over change in P Elastic – substantial changes Inelastic – insignificant change Rules of the thumb (what influence the price elasticity of demand): 1. Availability of close substitutes – price elasticity is higher when close substitutes are available; substitutes (elastic), complements (inelastic) 2. Necessities vs. Luxuries – necessities (inelastic); luxuries (elastic) 3. Definition of the market – narrow (elastic); broad (inelastic) 4. Time horizon – longer time horizon (elastic) Consumer view:

Surplus – excess supply; when quantity supplied is greater than quantity demanded

>1 1

Elastic

cost of production

Market efficiency – economic well-being of everyone in society can be measured by total surplus Total surplus – total value to buyers of the goods, as measured by their willingness to pay, minus the total cost to sellers Total surplus = consumer surplus + produces surplus = value to buyers – cost to sellers Social planner should consider: Efficiency – property of a resource allocation of maximizing the total surplus received by all members of society Equity – fairness of the distribution of well-being among the various buyers and sellers Market equilibrium – where consumer surplus and producer surplus meet Total surplus – total area between the supply and demand curves up to the point of equilibrium Market outcomes: 1. Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. 2. Free markets allocate the demand for goods to the sellers

Price – at least close to production cost Marginal seller - cost = price High price – raise producer surplus; they receive more product than before

who can produce them at the lowest cost. 3. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus.

Equilibrium outcome – efficient allocation of resources

Laissez faire – leave the market outcome as it is Market power – ability to influence prices; can cause inefficient markets

Positive externality – impact on the bystander is beneficial; produce a smaller quantity than is socially desirable; immunization, new technologies Positive – optimal output level is more than equilibrium quantity (intersection of supply curve and social-value curve)

Externalities – side-effects of the market; makes an inefficient equilibrium to the society as a whole

Technology spillover – positive externality that exists when a firm’s innovation/ design not only benefits the firm, but enters society’s pool of technological knowledge and benefits society as a whole

Market failure – inability of some unregulated markets to allocate resources efficiently

Internalizing externalities: subsidies

CHAPTER 10: EXTERNALITIES Externalities – uncompensated impact of one person’s actions on the well-being of a bystander; cause markets to be insufficient thus fail to maximize total surplus; when a transaction bet a buyer and seller affects a third party Invisible hand – self-interested buyers and sellers in a market to maximize the total benefit that society can derive from a market Negative externality – impact on the bystander is adverse; produce larger quantity than is socially desirable; cigarette smoking, loud stereos Socially optimal output – intersection of the demand curve and the social cost Internalizing an externality – altering incentives so that people take account of the external effects of their actions; tax Tax – reduce equilibrium quantity to the socially desirable quantity

Industrial policy – government intervention in the economy that aims to promote technology-enhancing industries Patent laws – form of technology policy that give the firm with patent protection a property right over its invention Solutions: 

Government action is not always needed to solve the problem of externalities.

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Moral codes and social sanctions

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Charitable organizations

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Integrating different types of businesses

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Contracting between parties

Coase theorem - proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own Transaction costs - costs that parties incur in the process of agreeing to and following through on a bargain

Public policy – government may attempt to solve the problem

Non-excludability – once provided it is for everybody, you can’t stop using it.

Command-and-control policies – take the form of regulations, forbid/ require certain behaviors

Non-rivalry – when you consume good it doesn’t reduce amount available to others

Market-based policies – taxes to align private incentives with social efficiency Pigovian tax – taxes enacted to correct the effects of a negative externality

RESOURCES CHAPTER 11: PUBLIC GOODS AND COMMON RE SOURCES Kinds of Goods:

Excludable – if you can prevent somebody from using it; one can at low cost prevent those who have not paid for the good from consuming it 2. Rival in consumption – if one person consuming it ‘uses it up’, meaning someone else cannot use it; can be consumed by only one person at the same time Non-rivalrous – consumed by many at the same time at no additional cost

1.

4 categories of goods: a. Private goods – rivalrous and excludable; housing b. Public goods – non-rivalrous and non-excludable; clean air, street lights Club goods – non-rivalrous but it is feasible c. Common resource – rivalrous and non-excludable; fish d. D Free- rider problem – when people can enjoy a good service w/o paying anything; occurs when there is overconsumption of shared resources

Solutions: 1. 2. 3. 4.

Tax Appealing to people’s altruism Make a public good private Legislation

Tragedy of the commons – destruction of common resource Command-and-control – limit/avoid the tragedy Cultural norms – Property rights -

CHAPTER 12: COST OF PRODUCTION (Law of supply) Profit = Total Revenue – Total Cost Total revenue – the amount a firm receives for the sale of its output Total cost – the market value of the inputs a firm uses in production Opportunity cost – all things that must be forgone to acquire that item Explicit costs – input costs that require an outlay of money by the firm Implicit cost – input costs that do not require an outlay of money by the firm Economist profit – total revenue minus total cost; explicit + implicit

Accounting profit – total revenue minus total explicit cost; explicit; larger than economic profit Profitable – if total revenue covers all opportunity costs Production and cost – relationship is positive; more input, more output Production function – relationship between the quantity of input used to make a good and the quantity of output of that good Marginal product – increase in the quantity of output obtained from one additional unit of that output Diminishing marginal product – marginal product of an input declines as the quantity of the input decreases Total-cost curve – gets steeper as the amount produces rises Production function – gets flatter as production rises Fixed cost – do not vary on the quantity/ amount of output produced, even when there is none produced Variable cost – costs that depend on the number of output produced Total cost – sum of fixed and variable cost Average total cost – sum of AFC and AVC; U-shaped Average fixed cost – equal to the quotient of fixed cost over the quantity of output Average variable cost – variable cost over the quantity of the output Marginal cost – how much the increase is in your total cost should you produce an extra unit of production; change in total cost divided by changed in quantity produced Efficient scale – bottom of U-shape Correlation: ATC declines when MC < ATC ATC rises when MC > ATC Minimum ATC – intersection of ATC and MC Long run ATC – variable cost, flexible; flatter curve

Short run ATC – fixed cost Economies of scale – when the long-run ATC diminishes as the output increases; workers specialize, faster work Diseconomies of scale – when long-run ATC increases while the output increases; too many workers, coordination problems Constant returns to scale – when the long-run ATC is not affected by level of output CHAPTER 13: FIRMS IN THE COMPETITIVE MARKET Competitive Market - each buyer and seller is small compared to the size of the market, therefore has little ability to influence market prices Market power - a firm has when it can influence the market price of the good it sells. A competitive market, sometimes called a perfectly competitive market, has two characteristics:  There are many buyers and many sellers in the market.  The goods offered by the various sellers are largely the same  Firms can freely enter or exit the market. Price takers – buyers and sellers in competitive market must accept the price the market determines Firm – maximize profit; takes price as given by market conditions Total revenue = market price (P) x quantity produced and sold (Q) Total revenue – proportional to the amount of output Average revenue – how much revenue a firm receives for the typical unit sold Average revenue = TR/Q = PxQ/Q = P Marginal revenue – change in total revenue from the scale of each additional unit of output Marginal revue = ∆TR/∆Q

Profit maximization: 1. Because the firm’s goal is to maximize profit, it chooses to produce the quantity of milk that makes profit as large as possible. 2. The farm can find the profit-maximizing quantity by comparing the marginal revenue and marginal cost from each unit produced. 3. As long as marginal revenue exceeds marginal cost, increasing the quantity produced raises profit. If there’s increase on Q by one unit, revenue rises by MR, cost rises by MC MR > MC, increase Q to raise profit MR < MC, reduce Q to raise profit Shutdown – short-run decision not to produce anything because of market conditions; TR...