Econ test 2 - Lecture notes Material for Test 2 PDF

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Chap. 4 • • ▪ ▪ ▪ ▪ •

Markets Conditions to be met: At least one buyer At least one seller A product or a service A price for the product or service Markets play an important role in the allocation of resources

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Demand The quantities of a product or a service that consumers are willing and able to buy at different prices during a specific period. Not actual purchases A flow concept A hypothetical relationship, not actual quantity demanded and price The relationship between quantity demanded and price can be expressed in different ways Mathematically: the demand equation In a table: demand schedule Graphically: the demand curve The distinction between demand and quantity demanded Demand: the inverse relationship between various prices and quantities Quantity demanded: the amount a product that consumers wish and are able to buy at a specific price

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Law of Demand States that as the price of a product decreases the quantity demanded of the product increases, other things being equal Why the inverse relationship between quantity demanded and price? The market-size effect: as price decreases the number of customer for the product increases The income effect: as price decreases the purchasing power of income increases The substitution effect: as price decreases, the product becomes relatively inexpensive Demand Curve A graphical representation of the inverse relationship between quantity demanded and price Can be linear or non-linear Quantity demanded: a point on the demand curve Demand: the entire curve Variables affecting Demand 1) Income Income affects the demand for a product For most products, as the income of consumers increases, the demand for a product increases Normal good: a product whose demand increases as income increases Inferior product: a product whose demand decreases as income increases Example: non-brand products 2) Prices of related goods Substitutes: products that fulfill the same needs

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Pepsi or Coke or Pizza or hamburger As the price for one product increases the demand for its substitute increase Complements: jointly used products Shoes and socks or Car and gasoline As the price of a product increases, the demand for its complement decreases 3) Tastes and preferences Consumers’ preferences for a product A number of variables influence people’s preferences Culture Age Gender Advertisement Fashions and fads 4) Expectations What consumers expect future economic conditions to be Expectations could relate to the price of a product If consumers expect the price to decrease, they will postpone their purchase and vice versa Expectations may also relate to the economy at large If consumers expect that their income will increase, they may undertake major expenditures 5) Population The potential buyers of a product depend on the size of a country’s population But because of international trade, the number of potential buyers extends beyond a country’s population Within a country, not all individuals buy the same product Only certain individuals buy most products The demand for a product depends on certain demographic characteristics

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A Change in Demand VS a change in Quantity Demanded A change in quantity demanded is the result of a change in price Graphically, it leads to a movement along the demand curve A change in demand is caused by changes in the variables other than price A change demand: at each price level, quantity demanded of the product changes Graphically, it leads to a shift in the demand curve An increase in Demand: a shift to the right A decrease in demand: a shift to the left

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A Shift in Demand The demand curve shifts if the following variables change

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Income

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The price of a subtitle

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The price of a complement

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Tastes and preferences

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Expectations

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Population

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Supply

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The quantities of a product that sellers are willing and able to sell at various prices during a specific period

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NB:

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Not actual sales

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A flow concept

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A hypothetical relationship, not actual quantity supplied and price

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The relationship between quantities supplied and price can be expressed in a number of ways

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Mathematically: the supply equation

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Graphically: the supply curve

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In a table: the supply schedule

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Shows the direct relationship between price and quantity supplied Law of Supply

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States that as the price of a product increases, other things remaining the same, the quantity supplied of the product increases

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Why the direct relationship between price and quantity supplied?

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Suppliers sell products to earn profits

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As the price a product increases, assuming costs remain unchanged, profits will increase

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So, price acts as an incentive to increase production

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Supply Curve

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A graph showing a direct relationship between price and quantity supplied Can be linear or non-linear

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Quantity supplied: a point on the supply curve

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Supply: the entire curve

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Determinants of Supply 1) Number of producers (sellers)

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As the number of producers increases, the supply of the product increases 2) Price of related goods

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Substitutes in production

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Alternatives in production

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GM can produce more sedans or vans

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Complements in production

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Jointly produced goods

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Producing one product results in producing the other

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Chicken wings and chicken breasts 3) Technology

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Improvement in technology increases supply 4) Expectations

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Producers’ expectation of future prices 5) Costs of inputs

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Changes in the cost of inputs

Supply and Quantity Supply

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A change in the price of the product leads to a change in quantity supplied

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Graphically, it results in a movement along the curve

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A change in supply results from changes in the variables other than price

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Graphically, it leads to a shift in the supply curve

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An increase in Supply: the curve shifts to the right

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Changes in Supply

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Changes in the following variables will result in a change in supply

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Graphically, the supply curve will shift

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The number of producers

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The price of the substitute

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The price of the complement

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Improvement in technology

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Producers’ expectations

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The costs of production

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Equilibrium Price and Quantity

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Equilibrium is a state of equality

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A competitive market: a market in which D and S determine price

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Market condition: a comparison between quantity demanded and quantity supplied of a product in a market

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When Q > Q : shortage or excess quantity demanded D S

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Price increases When Q < Q : surplus or excess quantity supplied D S Price decreases When Q = Q : equilibrium D S Equilibrium price and quantity (P and Q ) E E

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P E : Graphically

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P : where the demand curve intersects the supply curve E

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Any other point results in a situation of disequilibrium between Q

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Any price higher than P , creates a situation of surplus =Q < Q E D S

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Any price lower than P , creates a situation of shortage = Q > Q E D S

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D

and Q

S

Changes in P and Q E E

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A relatively larger increase in D than in S = an increase in P and Q E E

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A relatively larger increase in S than in D = a decrease in P and an increase in QE E

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An increase in D and a decrease in S of the same amount = higher P but same Q E E

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An increase in S and a decrease in D of the same amount = lower P but same QE E

• Effe c t sofCha ng e si nSuppl y •

I nc r e a s ei ns uppl y

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Ca us e ss u r pl us

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Lo we r se q ui l i b r i u m pr i c e

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De c r e a s ei ns uppl y

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Ca us e ss h or t a g e

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Ra i s e se q ui l i br i u m

Chap.6 •

National Income Accounting

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GDP is one of the most important measures of economic activity.

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National income accounting: the process of collecting, measuring, and recording data on the economy’s output.

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Statistics Canada: the agency responsible for collecting and publishing national economic and social data.

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Output of a country:

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A country’s total output of goods and services is the most widely used indicator of its economic performance

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Gross domestic product (GDP): the market value of all final goods and services produced in an economy over a period

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GDP is a flow concept

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Measured in monetary terms

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GDP (Gross Domestic Product)

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GDP: the market value of all final goods and services produced in a country, regardless of who owns the resources

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Must avoid double counting

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Double counting: counting an item more than once when measuring GDP Includes:

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Intermediate products

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Final products

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Second-hand products

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Used products

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Double counting can be avoided by taking sums of values added or the value of the final product

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Value added: the difference between the value of a firm’s output and the costs of its inputs

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Intermediate product: the output of one firm used as input by another firm

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Final product: a product or a service intended for final use

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Since GDP measures GDP in the current period, the purchase and sale of used products are excluded

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Ontario has the largest GDP

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Non-Productive Transactions

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GDP measures current production

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Transactions that do not involve current production are excluded from GDP

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Examples include:

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Government transfer payments

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Payments made by the government without receiving goods or services in return

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Private transfer payments

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the transfer of purchasing power from one individual or a group to another without receiving goods or services in return

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Sale and purchase of financial assets

Measuring GDP Two approaches in measuring the total output of an economy

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Income  Incomes derived from the factors of production

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Expenditure approaches  Expenditures on the economy’s output

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Both approaches measure the value of output

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GDPY ≡ GDPE The two approaches can be demonstrated using the Circular Flow Model. 1) Income Approach

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Estimates GDP by calculating the total income generated in producing goods and service

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Wages and salaries account for the largest share of GDP

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Focuses on the various incomes earned by resources used in production

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Total income = wages and salaries + rent + interest + profit

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Wages and salaries include supplementary income

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Supplementary income: contribution to employment insurance premium, pension, health insurance, and others

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Interest and investment income: interest received by individuals from private businesses

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Includes royalties and dividends

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Excludes interest paid by the government

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Profits:

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Corporate profits: include profit taxes, dividends, and retained earnings

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Profits of government-owned enterprises

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Accrued net income of farmers includes:

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Revenue from the sale of farm products

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Value of farm products consumed

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Value of changes in inventories

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Net income of non-farm unincorporated business includes:

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Net income of unincorporated businesses

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Rent

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Inventory valuation adjustment: reflects the changes in the prices of inventories. Adjustments are made to arrive at the GDP figures

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Calculating with the Income Approach

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NDP = W + ∏ + i + R + O + t f

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Where: W = wages, salaries, and supplemental income

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∏ = profits

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i = interest

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R = net income non-farm unincorporated businesses including rent

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O = accrued net income of farm products

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tf = taxes less subsidies

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Capital consumption allowance (D): an allowance made for the depreciation of the economy’s capital stock. GDP =W + ∏ + i + R + O + t +D Y f

2) Expenditure Approach •

Estimates GDP by calculating the total amount spent on final goods and services

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Consumer expenditures account for the largest share of GDP

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When a product is sold:

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Total expenditure on goods and services ≡ total income earned on producing the goods and services The expenditure approach focuses on aggregate expenditures on final goods and services When what is produced is sold, the value of output = the value of expenditure Who buys what is produced in the economy? Consumers: C Excludes spending on houses Government: G

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Current goods and services and capital

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Inventories

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Businesses: I Inventories

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Foreigners: exports (X)

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Canadians also buys goods and services produced in other countries, imports (M)

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Net exports: the difference between a country’s value of exports and the value of imports.

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Net exports = (X – M)

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Statistical discrepancy: an entry to balance the income and expenditure approaches

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GDP =C+I +G+(X–M) E g

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Related concepts

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Gross national product (GNP): the market value of all final goods and services produced by the resources of a country, regardless of where the resources are located.

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GNP = GDP + net investment income from non-residents

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For Canada GDP > GNP Personal income: the total income of individuals from all sources before taxes Personal income minus taxes = Disposable income Disposable income = consumption + saving Disposable income can be spent or saved

Extended Circular Flow

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The basic circular flow income introduced earlier can be extended

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It can be used to show the relationship between aggregate income and aggregate expenditure

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Nominal and Real GDP Nominal GDP is expressed in current dollars Nominal GDP changes when prices change

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Price indexes are used to show changes in prices over time

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Price indexes are also used to estimate change in output

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Base year: a reference year used for constructing price indexes

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Real GDP is expressed in constant dollars using a price index.

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Real GDP = (Nominal GDP/Price Index) *100

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Real GDP is used a measure of economic well-being.

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Inflating and Deflating GDP

Shortcomings of GDP Figures

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Population size: GDP does not indicate the population that shares GDP

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Per capita income = Real GDP/Population

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Used to indicate standard of living

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Distribution of income: GDP does not show who receives how much.

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Non-marketed goods: GDP excludes un-marketed goods and services.

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Underground economy: unreported economic activities

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Estimated to be about 5% of GDP

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GDP does take into account leisure

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GDP does not indicate quality of life

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Alternative Way of Calculating Well-Being

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Better measure of economic well-being (BMEW) takes into account the shortcomings of GDP

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BMEW = GDP + non-marketed goods + under-the- table transactions – environmental damage

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Human development index (HDI): an index used by the UN to indicate well-being...