ECON1201 - Exam Note Review PDF

Preview

Summary

Includes powerpoints and lecture notes in organized format....

Description

TEST #1 – CHOICES, MARKETS, EQUILIBRIUM & ELASTICITY Terms/Definitions: ! Economics o Concerned with the behaviour of individuals, institutions and society engaged in making choices under conditions of limited resources (Economic Problem) ! Microeconomics (1201) o Examines specific economic units (a household, firm or industry) -- Efficiency ! Macroeconomics (1202) o Examines the economy as a whole or basic aggregates (households, businesses and governments) -- Economic Stability ! Opportunity Cost o Value of forgone options when deciding i.e. $20/3hr (Movie), $30/3hr (Work) OC = $50 ! Direct Relationship (graph) o Positive Slope, X inc. / Y inc. ! Inverse Relationship (graph) o Negative Slope, X inc. / Y dec. ! Slope o Not a sound basis for judging Elasticity; However the flatter the line, the more elastic ! Consumer Sovereignty o Notion that the decisions of producers and resource suppliers with respect to the kinds and amounts of goods produced must be appropriate to consumer demand ! Scientific Method (Methodology) o Process of developing hypotheses, testing them against facts, and using the results to construct of goods and services ! Positive Statements o What is, was, will be (Testable, based on facts) i.e. Financial crisis was main cause of recent recession and global slowdown ! Normative Statements o What ought to be done (based on value judgment) i.e. Banks should be regulated ! Invisible Hand o Laissez-Faire; “Leave it Alone” ; Gov’t should not interfere; decisions motivated by selfinterest promote social interest ! Market o A mechanism that brings together buyers and sellers together (Mall), coordinated by prices ! Demand (D) o An inverse schedule, shows relationship between Px and Qdx, ! Supply (S) o A direct schedule, shows relationship between Px and Qx ! Law of Demand o Inverse relationship, Px INC = Qdx DEC, Px DEC = Qdx INC, when other things unchanged ! Law of Supply o Direct relationship, Px INC = Qdx INC, Px DEC = Qdx DEC when others things unchanged ! Equilibrium o A situation when there is no tendency to change Page | 2

! ! ! ! ! ! ! ! ! !

! !

Quantity Demanded (Qdx) o Amount a buyer is willing and able to purchase at Px Quantity Supplied (Qsx) o Amount a producer is willing and able to produce Market Demand o Obtained by adding the quantity demanded by all consumers at each various price Market Supply o Obtained by adding the supply (production) curves of the individual producers Diminishing Marginal Utility o Successive units of a product yield less and less extra satisfaction Derived Demand o The demand for a factor that depends on the products it can be used to produce Substitution Effect o At a lower price, the buyer substitutes the cheaper goods for similar relatively expensive Income Effect o At a lower price, the buyer can afford more of the good Complementary Goods o Products that are used together Inferior Goods o Products whose consumption falls when income increases and rises when income decreases, price remaining constant Allocative Efficiency o Producing most wanted good and services (Quantity) Productive Efficiency o Producing goods and services at lowest cost per unit (Price)

Economic Perspective ! Making rational choices under cost-benefit analysis o 1) Problem of Choice: ! Scarce Resources; What? How? Can’t have it all o 2) Rational (Purposeful Behaviour): ! Self-interest (not selfishness) behavior based on information and constraints o 3) Cost-Benefit Analysis: ! Comparisons / intersection of Marginal Benefits (MB) and Marginal Costs (MC), • MB: Willingness to pay for 1 additional unit • MC: Cost of producing 1 additional unit Budget Line (Constraint) ! Schedule that shows various combinations of goods that a consumer can purchase with a specific income; (un) attainable) vs. opportunity costs o Slope = -Px / Py o Price Relation = Px / Py o Right Shift -- Income INC, Prices DEC o Left Shift -- Income DEC, Prices INC

Page | 3

Economic Systems ! 1) Command System (Communism) o Gov’t ownership of most property resource and is the decision making mechanism ! 2) Market System (Capitalism) o Private ownership of resources and market system is the coordinating mechanism, while gov’t has limited/passive role (protection, law). This increases freedom, Self-interest, competition and specialization ! 3) Mixed System o A mix of command and market system; usually 75% Market and 25% Command Circular Flow Model ! Decision Makers (2) o Households ! Providers of Resources and Spending ! Users of Goods/Services and Income o Businesses ! Providers of Wages and Goods / Services ! Users of Factors of Production and Revenue ! Markets (2) o Factor Market ! Providers of Factors of Production(Inputs) and ! Users of Resources and Wages(Costs) o Product Market ! Providers of Goods / Services and Revenue ! Users of Goods / Services and Spending(Consumption) Curve Shifts: !

Demand Basic Determinants (5) o a. Taste / Preferences ! Favourable Change = (D) INC. and Curve shifts to RIGHT ! Unfavourable Change = (D) DEC. and Curve shifts to LEFT o b. Number of Buyers ! Population/ Tourism Inc. = (D) INC. and Curve shifts to RIGHT o c. Income ! Inc. Income for Superior / Normal goods = (D) INC. / Shift to RIGHT ! Inc. Income for Inferior goods (i.e. used car) = (D) DEC / Shift to LEFT o d. Price of Related Goods ! Substitutes (Direct) • Px INC. , Dy INC. ! Complementary (Inverse) • Px. INC. , Dy DEC. o e. Expectations ! Future price INC. = Dx INC. ! Product availability DEC. = Dx INC. ! Future Income INC. = Dx INC.

Page | 4

!

Supply Basic Determinants (6) o a. Technological Improvements ! Cost DEC. = (S) INC. / Shift RIGHT o b. Number of Producers ! # INC. = (S) INC. / Shift RIGHT o c. Taxes on Businesses ! Subsidies INC. (Taxes DEC.) = (S) INC. / Shift RIGHT o d. Expectations ! (?) Dependent on nature of market and product o e. Resource Prices (Wages) ! INC. = (S) DEC. / Shift LEFT o f. Price of Related Goods ! Substitutes (I ! Joint (Direct) • Px IN • Px. INC. = Dy INC.

Equilibrium and Gov’t Intervention ! 1) Px = ? and 2) Qx = ? o Equilibrium Price (Pe): Quantity Demanded (Qdx) = Quantity Supplied (Qsx) ! Qs = Qd = Intersection Point ! Qs > Qd = Surplus ! Qs < Qd = Shortage ! Price Ceilings (Pc) o Price is unfair to buyers, maximum lawful price o Persistent shortage, under allocated resources ! Pc < Pe i.e. Rent control ! Price Floors (Pe) o Price is unfair to sellers, minimum fixed price o Persistent surplus, over allocated resources ! Pf > Pe i.e. min. wage, farm support prices Elasticity Measures: !

Price of Elasticity of Demand (Ed) o Measures the degree of responsiveness of consumers to a price change o Always negative; *drop the negative sign* o Demand is more elastic at high-price range than at low price range o *Conclusion: If Px INC. by 1% Qdx DEC. by _____% when price goes from A to B ! !

Point: Edx =

%"!! ! %"!!

*Mid-Point: Edx =

=

!! ! !! !

%"!! ! %"!!

(note: Q or P must be initial value)

=

!! !"#$. !! !"#$.

(note: Qavg. or Pavg. are found by [(A+B)/2])

Cause on Total Revenue (TR) ! Inelastic Demand = Ed < 1 , Px INC. Qx DEC. TR. INC. • Consumers are less responsive to price change ! Elastic Demand = Ed > 1 , Px INC. Qx DEC. TR. DEC. • Consumers are more responsive to price change ! Unit Elastic Demand = Ed = 1 , Px INC. Qx DEC. TR. No Change Page | 5

Determinants of Elasticity ! 1) Goods and Services -- Luxuries (Elastic) vs. Necessities (Inelastic) ! 2) Substitutability -- Items with good substitutes (Elastic) vs. none (Inelastic) ! 3) Time -- Time passes, more adjustment, higher elasticity ! 4) Portion of Income / % of Budget -- Major items i.e. car (Elastic), minor items i.e. salt (Inelastic) !

Price of Elasticity of Supply (Es) o Measures the degree of responsiveness of producers to a price change o Always positive o *Conclusion: If Px INC. by 1% Qsx INC. by _____% when price goes from A to B ! !

s

Point: E x =

%"!! !

=

%"!! s

*Mid-Point: E x =

!! ! !! !

%"!! ! %"!!

(note: Q or P must be initial value)

=

!! !"#$. !! !"#$.

(note: Qavg. or Pavg. are found by [(A+B)/2]

Cause on Total Revenue (TR) – Direct (No Need) ! Inelastic Supply = Es < 1 , INC. less than 1% ! Elastic Supply = Es > 1 , INC more than 1% ! Unit Elastic Supply = Es = 1 , INC is 1% Determinants of Elasticity ! 1) Immediate Market Period -- No time to get more (L)labour, (K)capital (Es = 0) ! 2) Short Run -- Enough time to hire more labour, inelastic (Es < 1) ! 3) Long Run -- Enough time to make all changes (L + K), expansion (Es > 1) !

Income Elasticity of Demand (EM) o Measures the degree of responsiveness of consumers to a change in income o Useful in order to protect “growth industries (EM > 1) i.e. Stock Market ! !

Point: EMx =

%"!! ! %"!! M

*Mid-Point: E x =

=

!! ! !! !

%"!! ! %"!!

(note: Q or P must be initial value)

=

!! !"#$. !! !"#$.

(note: Avg. are found by [(A+B)/2])

Income’s cause on Quantity Demanded (Qdx) ! Income Inelastic Demand = EM < 1 , INC. less than 1% ! Income Elastic Demand = EM > 1 , INC more than 1% ! Unit Income Elastic Demand = EM= 1 , INC is 1% (i.e. Gasoline) !

Cross Elasticity of Demand o Measures the degree of responsiveness of consumers of one good to a change in the price of another related good (Size = Strength) ! Substitutes !

• Px INC. = Dy INC. (Positive Value) " Edxy = Complements •

%"!! ! %"!"

Px INC. = Dy DEC. (Negative Value) " Edxy =

%"!! ! %"!"

Page | 6

TEST #2 – EXTERNALITIES, UTILITY, COSTS & SHORT-RUN PERFECT COMPEITTION Terms/Definitions: - Economic (Full) Efficiency o Reaching both allocative and productive Efficiency - Allocative Efficiency o Producing the right quantity of a good/service (Q) MB = MC i.e. Gov’t produce public good and applies rule MB = MB - Productive Efficiency o Producing a good or service at the least cost per unit (P) - Consumer Surplus (CS) o Difference between what a consumer is willing to pay for a good and what consumer actually pays - Producer Surplus (PS) o Difference between the actual price a producer receives and the min. price they would accept Q 1 2 3

MB 20 15 10 45

P 10 10 10 30

CS = +15 -

-

-

Q 1 2 3

MC P 4 10 7 10 10 10 21 PS30 = +9

Efficiency Losses (Deadweight) o Reductions of combined consumer and producer surplus results from … !

Underproduction • MB > MC, Losing potential

!

Overproduction • MC > MB, Losing resources

Behavioural Economies o Used to better understand how actual choice behaviour deviates from predictions made by earlier economic theories Public Goods o Goods that are non-rival and non-excludible Those that are benefits go to the public (no matter who pays for them) i.e. Library, fireworks display, national defense Private Goods o Produced and sold in markets; rivalry in consumption and excludible; when one person buys a good, not available for others Free-Rider Problem o A consumer can enjoy the benefit of the good without having to pay for it Quasi-Public Goods o Those that have large positive externalities, so gov’t will sponsor (subsidize) their provision. Otherwise, they would be under produced (Medical care, Education) Excludability o Sellers can restrict the benefits to those who pay for the good Page | 7

-

-

-

-

-

-

Coase Theorem o Private Bargaining; Gov’t not always needed to remedy external costs / benefits as externalities can be solved with this market approach Demand-Side Market Failures o Impossible to charge people what they are willing to pay i.e. Fireworks display Supply-Side Market Failures o A firm doesn’t pay the full cost of its production i.e. pollution Externalities o Spill over or side effects of production or consumption, occurring when costs or benefits accrue to an individual who is external to the market transaction i.e. Polio shots and chest x-rays provide widespread benefits to community and to individuals who get them Positive Externality o Desirable benefits of a good are received by others in the community although they did not pay for them (Under-production MB > MC); gov’t provides subsidies that will cause supply curve to shift down Negative Externality o Un-desirable; producers are able to shift some of their costs onto the community (Overproduction MC > MB); gov’t provides direct control that will cause curve to shift up Law of Demand o Down sloping curve since marginal utility diminishes as more of a product is consumed Income Effect o Impact of a price change on real income Substitution Effect o Impact of a change in the price of one product on relative price of that product Utility o Satisfaction or benefit from consuming a good i.e. Utility vs. Usefulness | Diamond vs. Water The Law of Diminishing Marginal Utility o Beyond some point additional units of a product yield less and less extra satisfaction to a consumer Indifference Curve o Shows combinations of two products yielding the same total utility to a consumer, existing where the budget line touches the highest possible indifference curve as successive amounts of one factor of production (labour) are added to fixed amounts of other factors of production (property), beyond some point the resulting extra output will decline Consumer Equilibrium o The affordable bundle that yields the highest level of satisfaction ! *Point E = Consumer Equilibrium • “Indifference Curve is tangent to the Budget Line” Value of Time o We should consider the value of consumption time; Full Price = Market Price + Value of Time i.e. Ride a car or fly from Halifax to Toronto Gov’t Transfers o Cash Transfers i.e. welfare payments, are more efficient than non-cash i.e. subsidies, because consumers have unique preferences and want to maximize own satisfaction Sunk Cost o Cost that has been incurred and cannot be partly or fully recouped by some other choice. A rational consumer or firm should ignore it—“don’t cry over spilt milk” Page | 8

-

-

Prospect Theory o How consumers deal with life’s ups and downs and why they fail to see the big picture Hedonic Treadmill o People get used to a certain level of consumption and when consumption increases they are happier for awhile, but then they get used to it and they aren’t any happier than they were at lower consumption levels Nudging o Form of manipulation # to get an individual to do what someone wants him/her to do.

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

(TU) Total Utility o Total satisfaction received from consumption of a product ∆!" (MU) Marginal Utility = ∆! o The extra utility (or change in TU) because of consuming one additional unit of the good !"# (MRS) Marginal Rate of Substitution = !"#

o Absolute value / rate at which the consumer is willing to substitute one good for the other and still maintain same level of satisfaction - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

-

-

-

Total Revenue/Sales o TR = P*Q Economic Costs o TC = Explicit and Implicit Costs Implicit o (Opportunity) costs of resources a firm owns and monetary income sacrificed using resources a firm owns. This includes normal profit. ! Ex. “Harvey quit his job where he earned $45 000 a year. To start the business, he cashed in $100 000 in bonds that earned 10% in interest annually to buy a software company. Note: Add normal profit ($5000)” = $60 000 Explicit Costs o Monetary payments (Cash, Credit Card, etc.) ! Ex. “$55 per unit goes to the costs of production, packaging, marketing, employee wages, benefits and rent (Sold 11000).” = $605 000 Normal Profit o Implicit cost of entrepreneurship, fair return doing that business (earnings) ! Ex. “He figures his entrepreneurial talent or foregone entrepreneurial income to be $5000 a year.” = $5000 Economic Profit o Investment Decision = TR – TC ! Ex. “The price was $75 for each of the 11 000 units sold” = $160 000 Accounting Profit o Taxation = TR – Explicit Costs ! Ex. “The price was $75 for each of the 11 000 units sold” = $220 000

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Page | 9

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

(L) Labour o Number of workers (K) Capital o Plant size and amount of equipment (TP) Total Product = Q o = Total Output " “At max-point make a long run decision”

-

!

-

(AP) Average Product = ! o Output per worker ∆! (MP) Marginal Product = ∆! o Change in output (Q) associated with each additional unit of labour (L)

-

Stages of (TP / AP / MP)

“Crosses Avg. product at its max point” o

-

Increase " Maximize " Diminish

Short Run o Producers have enough time to change (L) but not enough to change fixed (K) Long Run o Producer have enough time to change all resources including (K); expand / down-size

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

(TFC) Fixed Costs o Costs that not vary with changes in output (As [Q] INC, FC remains same) ! i.e. Rent, Insurance, Loans (TVC) Variable Costs o Costs that vary with changes in output (As [Q] INC, VC INC, vice versa) ! i.e. 75% Labour (TC) Total Costs o VC + FC (ATC) *Average Total Cost o Cost per unit of output [Note: Term where businesses ‘cut costs’] !" ! = !

-

(AFC) Average Fixed Costs !" ! =

-

(AVC) Average Variable Costs !" ! =

-

(MC) Marginal Cost o Increase in TC associated with each additional unit of output produced ∆!" ! = ∆!

!

!

*note: u-shape reflects law of diminishing returns & if resource prices / technology changes, there are shifts in the cost curves*

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Page | 10

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

Short-Run Supply Curve o Summing horizontally the segments of MC curves lying above AVC curve for all firms Break-Even Point o P = ATC or TR = MC, Econ. Profit = 0, still Normal Profit Shut-Down Point o P = AVC or TR = VC, Econ. Profit = Loss of FC (TR) Total Revenue o TR = P*Q (AR) Average Revenue !" !" o The demand facing the firm, perfectly elastic = ! = ! ! = !! (MR) Marginal Revenue o Extra revenue for selling one more unit =

∆!" ∆!

=!

!∆! ∆!

= !! = !"

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Perfect Competition Characteristics (5) 1. Large - Very large number of producers 2. Standard - Standardized product 3. Price Taker - No single buyer or seller can influence price (Firms = Price takers) 4. No Barriers - Easy entry and exit (No legal obstacles) 5. Rare - Rare in practice but analysis is useful to learn about markets and evaluating efficient o Example Industry: Wheat / Corn Consumer Choice (Behaviour) Theory - Allocate income so that MU obtained from last dollar spent on each product purchased be the same; to maximize satisfaction within budget constraint, consider the Utility-Maximization Rule: !"# !"# !"# ! !" = ! !" = ! !" = ⋯ note: if they are not equal then: • •

1) Buy less of X, DEC quantity, and INC marginal utility for X 2) Buy more of Y, INC quantity, and DEC marginal utility for Y

Study Question -- The following data shows ...