Econ 221 Notes for Entire Course
Econ 221 Notes for Entire Course ECON 221
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9/24/15 questions and activies The textbook presents the following definition of economics: "The study of choices when there is scarcity." Can you think of another definition? • Looking at how individuals make choices and the driving factors behind those choices What are the five "factors of production"? • Natural resources • Labor • Physical capital • Human capital • Entrepreneurship What is the difference between physical capital and human capital? Why do you suppose that financial capital is not included as a factor of production? • Human capital = knowledge and skills humans have • Physical capital = supply of physical equipment and machines used to produce goods and services Provide an example of a positive question. Provide an example of a normative question. • Positive = if the price of jelly increases, how will the demand for peanut change? • Normative = should we increase the price of jelly? • Positive = what is or what will be? • Normative = what ought to be Answer question 1.4 from the "Exercises" at the end of the chapter. Thinking back on world history from ancient times to the present, what types of economic systems have existed in countries around the world? How did these economic systems answer the three key economic questions? • What products do we produce? • How do we produce them? • Who consumes them? Given an example of an economic model? What are the steps in developing an economic model? • Often use graphs and words and equations • Ie highway speeds and number of cars What is the meaning of the Latin phrase "ceteris paribus"? Why do you suppose economists apply the "ceteris paribus" assumption? • Holding all other variables constant • Economists use this because it allows us to examine the relationship between two variables, such as the price and quantity of a good • Simplification Provide an example of "thinking on the margin"? • If I answered one more question in class per day, will my participation points increase to the point that makes it worth it to put in that effort? • What's the extra benefit of doing it versus the extra cost? Thinking on the margin is just calculus • **most important concept this quarter!!! • How many hours should you study for this class each week? Should I study one more hour per week? What's the additional benefit? But what am I giving up? Who is Adam Smith? • Philosopher who said that people will act in their own self interest => lead to assumption that rational people respond to incentives • Founder of economics • Use incentives to look for alternatives • People act rationally What is the difference between macroeconomics and microeconomics? • Macro = studying economy on the whole ◦ Ie inflation ◦ Unemployment rate • Micro = study of choices made on the individual / household level Notes 9/24/15 **Reminder: movement along a curve is caused by a change in the X or Y variable or a change in supply, whereas a shift in a curve is caused by a change in any variable we hold constant (a variable that isn't on the graph) • Chapter 1: what is economics? • Economics is the study of "choices when there is scarcity" ◦ Production, consumption, and distribution of goods and services • Because resources are limited, people must make choices • Normative analysis: deals with values, should we do something as opposed to describing the consequences to some action (positive = descriptive, normative = prescriptive) • Exercise 1.4 ◦ Should or ought = mostly normative (but not always) • Types of economies ◦ Centrally planned economy ◦ Mixed economy ‣ Non market aspect of USA economy = cal poly, cal poly is a state university, not a market part of USA economy, it's planned ◦ Capitalistic ◦ Traditional economy ◦ Authoritarian economy • Suppose you belong to a tennis club that has a monthly membership fee of $100 and a charge of $10 per hour to play tennis. Draw a graph of the relationship between the number of hours that you play tennis in a month and the total cost, putting hours on the horizontal axis and cost on the vertical axis? What is the slope of this relationship? If you allocated $500 for tennis play, how many hours could you play in a month? How would your graph change if the membership fee was reduced to $50? How would it change if the membership fee was raised to $200? • Answer question A.2 from the "Exercises" at the back of the chapter. • Suppose the price of gasoline increases from $3.00 per gallon to $3.20 per gallon. Use the "initial value" approach to compute the percentage change. 9/29/15 questions and activities What is the principle of opportunity cost? • Opportunity cost = what you sacrifice to get it What do you believe is the total cost of attending Cal Poly for one academic year? Just provide a dollar figure, discussion will follow after everyone has had an opportunity to provide their own figure for the total cost. • Opportunity cost of money spent on tuition and books = 10k • Opportunity cost of of college time (assuming you could work for 20k a year) = 30k Answer question 1.7 from the "Exercises" at the end of the chapter. Suppose a nation produces only two goods: t-shirts and grapes. Putting the quantity of grapes produced on the horizontal axis, and the quantity of t- shirts on the vertical axis, show what a production possibilities curve might look like for this nation. In your graph identify two points where the resources of this nation are fully employed and efficiently used. Identify another point where the resources of this nation are not fully employed and efficiently used. How does this graph of a production possibilities curve enable us to determine the opportunity cost of producing more grapes? How does the production possibilities curve change with economic growth? The green line indicates where th resources of this nation are not fully employed. This graph can show the opportunity cost of producing grapes because as more grapes are produced, you are sacrificing the production of shirts. With economic growth, the whole curve shifts outward and more of everything can be produced What is the marginal principle? • Increase the level and an activity as long as it's marginal benefit exceeds the marginal cost. (Additional revenue more than additional cost) Answer questions 2.5 and 2.8 from the "Exercises" at the end of the chapter. What is the principle of voluntary exchange? What is the key underlying assumption about human behavior underlying this principle? (See the segment from chapter 1 entitled "Rational People Respond to Incentives") • A voluntary exchange between two people makes them each better off • Key underlying assumption: Adam smiths assumption that rational people respond to incentives and act in their own self interest Answer questions 3.5 and 3.7 from the "Exercises" at the end of the chapter. What is the principle of diminishing returns? There is a better name for this principle. What one word could be added to the name of this principle to clarify its meaning? • If we increase one input while holding the others constant, beyond some point, the point of diminishing returns, the output will increase at a decreasing rate • Diminishing MARGINAL returns Answer questions 4.7 and 4.9 from the "Exercises" at the end of the chapter. What is the real nominal principle? • People care about the real value of money or income, ie it's purchasing power, which depends on the price of goods and services that you buy Answer questions 5.3 and 5.4 from the "Exercises" at the end of the chapter. Notes 9/29/15 chapter 2 • Total profit = total revenue - total cost • Marginal profit = additional profit for every additional product (slope, rate of change of total profit) • 2.1 - yes, because the additional marginal revenue is more than the additional cost of adding 1 cab. The $420 per cab is the average cost, NOT slope • 1.7 • 2.5 Good economic models predict well • 2.8 -3.5 A) no, because the opportunity cost of doing her own plumbing is the potential lives lost she would have saved if she we doing surgery B) -3.7) the resident must have given everyone else something that benefitted them in exchange for her cutting away the shade for her view, such as throwing them a party. -4.7) A. Yes, because in the short run the inputs are fixed so you can apply the principle of diminishing marginal returns, ie your sales will go up less and less for each worker you hire. B. No, because in the long run you can increase the number of other inputs as well (everything is variable) so that you don't experience the problem of diminishing marginal returns -4.9) see table in book -5.3) decreases by 3% -5.4) 65,000k 10/1/15 questions and activities What is comparative advantage? How is comparative advantage different from absolute advantage? If a person, company or nation has an absolute advantage in producing a product, does that necessarily mean that it also has a comparative advantage in producing that product? Explain why or why not? • Comparative advantage: the ability of one person or nation to produce a good at a lower opportunity cost than another person or nation • Absolute advantage: the ability of one person or nation to produce a product at a lower resource cost than another person or nation • If a person or company has an absolute advantage in producing a product, this does not necessarily mean they also have a comparative advantage in producing that product because although they may be able to produce a product at a lower resource cost than another, this does not mean that they can produce it at a lower opportunity cost than another nation or person. According to economists what type of advantage, absolute or comparative, creates opportunities for specialization and exchange? • Comparative advantage Answer question 1.1 from the Exercises at the end of the chapter. Quigley has a comparative advantage in tax returns, while slokum has a comparative advantage in financial statements Robin and Terry are stranded in a desert island and consume two products, coconuts and fish. In a day, robin can catch 2 fish or gather 8 coconuts, and Terry can catch 1 fish or gather 1 coconut. Use the numbers to prepare a table like Table 1 at the beginning of the chapter. Which person has a comparative advantage in fishing? Which person has a comparative advantage in gathering coconuts? Comparative advantage in fishing - robin Comparative advantage in gathering coconuts - terry Suppose that each person is initially self-sufficient. In a six-day week, robin produces and consumes 32 coconuts and 4 fish, and Terry produces and consumes 4 coconuts and 2 fish. Show that specialization and exchange (at a rate of 3 coconuts per fish) allows Robin to consume more coconuts and the same number of fish, and allows Terry to consume more coconuts and the same number of fish. What are the differences between a market economy and a centrally planned economy? • Market - decisions are made by the millions of people who already have information of consumers desires, production technology, and resources ◦ Competition for profit, consumers want to get the best value for their money ◦ Result of interaction of supply and demand: prices! • Centrally planned - a planned authority decides what products to produce, how to produce them, and who gets them • USA is a mixed economy Answer question 2.6 from the Exercises at the end of the chapter. One loaf of bread for one chocolate bar. Price of chocolate is 15 cigs per bar, price of bread is 40 cigs per loaf A) there is an opportunity for beneficial exchange if someone wants a chocolate bar and has bread. But if someone wants more cigarettes then trading bread for chocolate is not beneficial. B) 3 loafes of bread, 120 cigarettes, 5 chocolate bars (because he started with 3 chocolate bars to trade) What is market failure? What are some examples of market failure? • Market failure is when the market doesn't generate the most efficient outcome • Examples ◦ Pollution - people making the decisions about production and consumption must bear the full costs of their decisions, but in some cases, oth people might bear the costs ◦ Public goods - a good avaable for everyone to utilize, regardless of who pays and who doesn't ◦ Imperfect information - information that leads people to make decisions that lead to inefficient market operations ◦ Imperfect competition - when markets are dominated by a few firms, such as the diamond market What are some of the roles of government in a market-based economy? • Establishing uses for market exchange and using its police power to enforce the rules • Reducing economic uncertainty and providing for people who have lost a job, have poor health, or experience other unforeseen difficulties and accidents Answer question 3.6 from the Exercises at the end of the chapter. A) as a textbook consumer, we would be better off because the price of an Econ textbook would drop to 0$. B) the implications for the next generation of Econ students are that Econ textbooks may become a public good. Notes 10/1/15 chapter 3 • Question 1) c • 2) a - figure out the opportunity costs! • Law of comparative advantage - people specialize in things where they have the comparative advantage • Comparative advantage - ability to produce something at a lower opportunity cost than others (David Ricardo) • Absolute advantage - ability to produce something with fewer resources than other producers (Adam smith) • Because of comparative advantage and specialization most people consume little of what they produce and produce little of what they consume • USA and Japan example ◦ opportunity cost of an auto in Japan: 8 computers ‣ opportunity cost of a computer in Japan: 1/8th of an auto ◦ opportunity cost of an auto in the USA: 10 computers ‣ opportunity cost of a computer in the USA: 1/10th autos ◦ USA has the comparative advantage in computers, and Japan in autos ◦ Japan has absolute advantage in both • USA and Japan self sufficiency example ◦ USA has 24 in resources, Japan 16 million, each country uses half its resources to produce both ◦ USA can produce 1000 autos and 10,000 computers ◦ Japan can produce 1000 autos and 8000 computers • Specialization based off of comparative advantage - Jaspan and USA ◦ USA has 24 million in resources, Japan 16 ◦ USA specializes in computers, Japan in autos ◦ USA can produce 20,000 computers and 0 autos ◦ Japan can produce 2000 autos and 0 computers ◦ Now there is a reason to trade, what are the terms of trade? ‣ The answer is between the two opportunity costs of each country! ‣ Ie 9 computers/auto and 1/9th autos/computer ‣ ***Each country wants to push the terms of trade towards the opportunity cost of the other country • Question 3) ◦ USA opportunity cost in tomatoes: 5 corn ◦ Mexico opportunity cost in tomatoes: 3 corn ◦ B is false • Market failure: when we aren't at market efficiency (when we aren't producing things most efficiently and we aren't producing the things people want) ◦ Imperfect competition: such as health insurance (oligopoly, where a few firms dominate) diamond industry (monopoly) ‣ Natural monopoly: the bigger the company is, the lower your cost ◦ Externalities or spillovers (ie pollution is negative externalities) ◦ Imperfect information: we have bad information ◦ Public goods 10/6/15 questions and activities What is the law of demand? What is the reasoning that supports the law of demand? Draw a demand curve that is consistent with the law of demand. • Law of demand: the is a negative relationship between price and quantity demanded • Reasoning: consumers are willing to buy more of a product if the prices are lower Complements: inverse (negative) relationship between price of one good and quantity demanded of the other Substitutes: positive relationship between price of one good and the quantity Answer questions 1.3 and 1.7 from the Exercises at the end of the chapter. demanded of the substitute good 1.3) price of the product, quantity of the product produced 1.7) What is the law of supply? What is the reasoning that supports the law of supply? Draw a supply curve that is consistent with the law of supply. • Law of supply: the is a positive relationship between price and quantity supplied • Reasoning: producers are more willing to produce a product when they can sell it for a higher price Answer questions 2.2 and 2.9 from the Exercises at the end of the chapter. 2.2) price of a product, quantity of the product purchased are NOT held fixed 2.9) we expect the quantity of soybeans supplied to increase as the number of soybean farmers increases and the output per farmer increases. A farmer who enters the market is likely to have a lower marginal cost than an original firm Define the following terms: market equilibrium, excess demand and excess supply. Draw a graph that illustrates a market equilibrium, an excess demand, and an excess supply. • Market equilibrium: when the quantity demanded equals the quantity supplied at the prevailing market price • Excess demand: quantity demanded is greater than quantity supplied • Excess supply: quantity supplied is greater than quantity demanded Answer questions 3.6 and 3.7 from the Exercises at the end of the chapter. 3.6) market eq = point c, price of CD players is 150$ and the quantity of CD players is 200 per day. At a price of 100, there would be excess demand, so we would expect the prices to rise. At a price exceeding EQ, there would be excess supply, so we would express the price to fall. 3.7) the EQ price of corn is $100 and equilibrium quantity is 1000. At a price of $110, there is excess supply equal to 300 tons Draw a graph that illustrates an increase in the quantity demanded. What can cause an increase in the quantity demanded? Cause = price drop Draw a graph that illustrates an increase in demand. What can cause an increase in demand? Cause: increase in income (normal good), decrease in income (inferior good), increase in price of a substitute good, decrease in the price of a complementary good, increase in population, consumer preference for good increases, they expect future prices of good to rise Draw a graph that illustrates an decrease in demand. What can cause a decrease in demand? Cause: opposite as for and increase in demand Draw a graph that illustrates an increase in supply. What can cause an increase in supply? Cause: wage decrease, price of materials decreases, technology advances, government subsides increase, expected future prices decrease, number of producers increases Draw a graph that illustrates a decrease in supply. What can cause an increase in supply? Cause: opposite as for an increase in supply Answer questions 4.4, 4.5, 5.10, 6.1, 6.3, 6.4 and 6.10 from the Exercises at the end of the chapter. 4.4) increases, decrease, increase (assuming it's a normal good), increase 4.5) increases both price and quantity 5.10) increase, decrease 6.1) book 6.3) decrease in supply 6.4) increase in demand 6.10) Questions and activies 10/8/15 What is the price elasticity of demand? The price elasticity of demand measures the responsiveness of the quantity demanded to changes in price. It is equal to the absolute value of percentage change in quantity demanded divided by the percentage change in price Suppose the price of gasoline increases from $3 per gallon to $3.30 per gallon, and as a consequence the quantity demanded decreases from 10,000,000 gallons to 9,500,000 gallons. Using the initial values formula, calculate the price elasticity of demand for gasoline. Is the price elasticity elastic or inelastic? Answer question 1.8 from the Exercises at the end of the chapter. Demand is relatively elastic if the product has many substitutes, a long time passes, and the consumer spends a large action of his or her budget on the product. Draw a demand curve that is consistent with perfectly elastic demand. Draw a demand curve that is consistent with perfectly inelastic demand. Referring to the law of demand and the formula for the price elasticity of demand, explain the relationship between the price elasticity of demand and total revenue. Demand is elastic on the first half of the demand curve, which means that a decrease in price will increase quantity sold by a large amount, and total revenue will increase. However, on the second half of the curve, demand is in elastic, meaning that a decrease in price will increase the quantity sold by a lesser percentage amount. Therefore, total revenue will decrease. This is because as we move down the demand curve we are moving towards larger quantities so the same absolute change in quantity becomes a smaller perfect change and at the same time we are moving towards lower prices, so a change in price will yield a larger price change. Since elasticity of demand is the perfect change of quantity demanded divided by percent change in price, the elasticity of demand is smaller and therefore more inelastic as we move down the demand curve, Answer questions 2.13, 2.15, 3.6, and 3.8 from the Exercises at the end of the chapter. 2.13) 2.15) see book 3.6) 3.8) What is the income elasticity of demand? Income elasticity of demand measures the rooms overseas of demand to changes in income. It is equal to the pecentage change in quantity demanded divided by percentage change in income. What is the cross-price elasticity of demand? The cross price elasticity of demand measures the responsiveness of demand to changes in the prices of other goods. It is equal to the percentage change in quantity demanded of one good divided by the percentage change in price of the other good. Answer question 4.6 from the Exercises at the end of the chapter. What is the price elasticity of supply? The price elasticity of supple measures the responsiveness of quantity supplied to changes in price. It is equal to the percentage change in quantity supplied divided by the percentage change in price Answer question 5.2 from the Exercises at the end of the chapter. Write down the formula that is used to predict the change in the equilibrium resulting from a change in demand. Percent change in equilibrium price = percentage change in demand / (elasticity of supply + elasticity of demand) Answer question 6.6 from the Exercises at the end of the chapter. Notes elasticity 10/8/15 • Businesses more likely to raise their price when there is inelastic demand because this will increase total revenue. If there is an elastic demand, an increase in price will cause consumers to purchase significantly less and therefore total revenue could be less • Needs are an inelastic demand! (Ie I will pay any price for this new iPhone, which is why at the beginning the price is much more expensive! The consumers have an inelastic demand for the iPhone) • Brands of products have a more elastic demand than the product as a whole (ie chevron gas has a more elastic demand than gas in general because there are multiple brands of gasoline) • Question 4 • Question 5: if your current price is at a point where price elasticity is 1.5 (elastic) and you decrease the price, demand becomes less elastic and total revenue increases If you decrease the price when demand is elastic, the increase in the quantity overrides the decrease and price and therefore revenue goes up when you decrease the price (Upper half of curve). But if you increase the price when the demand is elastic, quantity demanded goes way down so your revenue decreases. Elasticity is still falling, but since we are in the inelastic section of the demand curve, the percentage change in price is larger than the percentage change in quantity so total revenue will go down when you decrease the price. But if you are inelastic and you increase prices, quantity demanded won't change much so your revenue will increase • Profit = TOTAL REVENUE - TOTAL COST. Therefore, the unit elastic point on the graph is not where all firms want to be because that is just the point where TORAL REVNUE is maximized, not necessarily TOTAL COST. firms are trying to maximize profit, not revenue. • Because the firm wants to sell more so they need to decrease the price Chapter 6 questions and activities What is consumer surplus? Consumer surplus is your willingness to pay (the maximum amount you are willing to pay for a product) - the price you actually pay. (Profit for consumers) What is producer surplus? Producer surplus is the price the producer receives - the marginal cost of production (supply curve). (Profit for producers) What is deadweight loss? Deadweight loss is the decrease in the total surplus of the market that results from a policy such as rent control (price ceiling) Answer questions 1.7, 2.1 and 2.8 from the Exercises at the end of the chapter. 1.7) greater consumer surplus 2.1) if you agree to split the difference, the price is $1700, your consumer surplus is $300 and the producer surplus is $300. 2.8) A. ABC B. EDF C. ABCDEF D. ABD E. F F. ABDF G. ABD H. F I. ABDF If the residents of the City of San Luis Obispo were presented with the opportunity to vote for rent control on all apartments in the city would you vote in for against this proposition? Explain why or why not. I would vote against this proposition because the poor do not benefit from it since both wealthy and poor people pay for rent. The decrease in price causes a shift downward along the supply curved and the quantity supplied decreases as well, while there is an excess demand due to the decrease in price. The total surplus of the market is decreased and it outlaws transactions that would make both parties better off thus reducing efficiency. Answer questions 3.7 and 3.12 from the Exercises at the end of the chapter. 3.7) At the minimum price, the quantity supplied is 125 and the quantity demanded is 92, meaning there is an excess supple of 33 units of powdered milk. 3.12) Deadweight loss is greater with a more elastic supply Suppose a local community requires commercial drone operators to obtain a license in order to use community airspace. How would quantity controls on the number of licenses issued affect the market for commercial drone services? Quantity controls on the number of licenses issued would decrease the total surplus of the drone market. By limiting the number of licenses, the consumer surplus is decreased, resulting in higher price and lower quantity supplied. This causes inefficiency in the market. How would restrictions on the quantity of avocados that could be imported into this country affect the market for avocados? If we restricted avocado imports, foreign suppliers would decrease from the market, so the total supply of avacados would only consist of the U.S. Market. Th decrease in supply resulting from the restriction would increase the price of avacados and decrease the quantity demanded of avacados in our country. The total surplus in the avacado market also decreases. Thus, the restriction would cause domestic producers to to gain at the expense of domestic consumers. Consumers will loose more than domestic producers will gain, thus there is a net loss for people in the USA. Answer question 4.12 from the Exercises at the end of the chapter. If the demand is inelastic a tax will increase the market price by a __________ (large/small) amount, so consumers will bear a (large/small) share of the tax. If the demand is elastic a tax will increase the market price by a __________ (large/small) amount, so consumers will bear a (large/small) share of the tax. Answer question 5.7 from the Exercises at the end of the chapter. Chapter 6 notes • Consumer and producer surplus is not like a shortage or surplus, which shows quantity demanded versus quantity supplied Pink is consumer surplus, green Producer surplus and profit is the same in the long run since there are is producer surplus no variable costs. In the short run you have to subtract the variable costs. • Higher consumer surplus at top of demand curve, demand curve shows what people are willing to pay, which varies at you move up and down the curve • Price ceiling below equilibrium leads to excess demand, but a price ceiling above equilibrium would have no effect because the market has a natural tendency to be at equilibrium and the excess supply would cause the prices to go back down to equilibrium and quantity supplied to be less • Price floor above equilibrium price leads to surplus, but a price floor below equilibrium has no effect • Controlling quantities: Limiting quantity supplies creates excess demand, thus driving prices upwards as the market moves upward along the demand curve. Thus, there is an increase in price and decrease in the quantity of goods produced. The total surplus is not maximized. • When demand is relatively inelastic and a tax is imposed, the consumer will bear the greater share of the tax because the producer can shift this burden on to the consumer by increasing prices ◦ The producer pay the tax in a legal sense, they burden can be passed onto the consumer ◦ **tax shifting • when demand is elastic, the producer bears a greater share of the tax Questions and activities 10/20/15 Suppose a consumer has $400 each month to spend on DVDs and books. Also, suppose the price of a DVD is $20 and the price of a book is $10. Based on this information draw the consumer's budget line, putting the quantity of DVDs on the horizontal axis and the quantity of books on the vertical axis. How many books must the consumer sacrifice in order to obtain one more DVD? To obtain one more DVD, the consumer must sacrifice 2 books Explain what is the difference between total utility and marginal utility? Total utility increases or satisfaction from a good increases with the number of the good but at a decreasing rate. The marginal utility from a good decreases as the number of the good decreases. (Negative slope). Both of these reflect the law of diminishing marginal utility. Describe the law of diminishing marginal utility? The first unit of a product generates more additional satisfaction or utility than the second unit, which generates more additional utility than the third. As the number of a good increases, the total utility curve becomes flatter, meaning that it's slope decreases. The marginal utility curve shows the slope of the total utility curve, so by the law of diminishing marginal utility, it is negatively sloped. Answer question 1.4 from the Exercises at the end of the chapter. As the consumption of a product increases, utility increases at a decreasing rate, so the marginal utility curve is negatively sloped. This illustrates the law of diminishing marginal utility. Chapter 3 of our textbook introduces the marginal principle as one of the key principles in economics. Explain what is the marginal principle in the context of consumer choice? To maximize utility, a consumer picks the quantity of a product at which the marginal benefit of the product equals its marginal cost. The law of diminishing returns tells us that the marginal benefit decreases as the number of the product increases. Thus, the consumer will only buy more of the product if the marginal benefit exceeds the marginal cost. Given a fixed budget, what are the two conditions required for a consumer to maximize his or her utility? 1) the marginal benefit per dollar for the first activity equals the marginal benefit per dollar for the second activity. 2) the money spent on the two goods adds up to the fixed budget for the two goods: ie the chosen bundle is affordable, meaning that it is on the budget line. Suppose the price of a DVD is $20 and the price of a book is $10. Also, suppose at the consumer's current levels of consumption the marginal utility of a DVD is 80 utils, and the marginal utility of a book is 30 utils. In this situation is the consumer maximizing his or her utility? If not, how can the consumer increase his or her utility? Marginal utility per $ for DVD: 80 utils / $20 = 4 Marginal utility per $ for book: 30 utils / $10 = 3 This consumer is not maximizing his or her utility. The consumer can increase his or her utility by shifting her focus away from books and towards DVDs because the DVDs have a larger marginal bang per buck in comparison to books. 1.6) opportunity cost video game: 12 songs. Marginal cost of a video game: 24 utils. Marginal benefit benefit video game: 48 utils. **marginal cost video game = number of songs you give up x marginal utility, the opportunity cost of the video game * marginal utility song The marginal benefit of something is its marginal utility (what you 1.9) decrease songs, increase movies gain by consuming one more of that item) 1.12) see book 2.2) book 2.3) ***the income effect of a price change is that a decrease in price increases your real income and increases the consumption of a normal good 2.4) Notes consumer choice: utility theory and insights from neuroscience • Consumers are trying to maximize their total utility subject to their budget constraints. ◦ Marginal utility per dollar for all goods that you buy is equal = equimarginal rule ◦ Has to be in their budget (affordable) • This model explains the theory behind the demand curve and why it is downward sloping • Also explains the theory of dinisnishing marginal utility • **good models predict a situation well => therefore this model is good because it predicts consumer behavior well • Affordability = what's in the budget set • Opportunity cost of one item = price of the one item / price of the other item ◦ Price ratio • For budget line: the opportunity cost of whatever is on the horizontal axis is the slope! (Ie if chairs is on the horizontal axis and the opportunity cost is 4 towels then the slope is 4) ◦ Budget line: any point on the line or below the line and on the end points is affordable, but only one point maximizes utility • Marginal utility per dollar = marginal utility / price • Budget line that depicts a decrease in the price of good X: this is correct because the price of Y is not changing, therefore it's intercept is the same. However, since the price of X has decreased, you can buy more of it • Diminishing marginal utility: shows the change in marginal utility and how it increases at a decreasing rate ◦ Marginal utility is the slope of total utility • Budget line problem • Utility = satisfaction that people enjoy from consuming goods • If the marginal utility per dollar of one good is less than the marginal utility per dollar of the other good, buy more of the good with the higher marginal utility per dollar. (More bang for your buck). Even if the marginal utility of one good is greater, this does not necessarily mean that it also has a greater marginal utility per dollar. ***** Questions and activities 10/20/15 & notes Explain why accounting profits are always higher than economic profits. Answer questions 1.3 and 1.9 from the Exercises at the end of the chapter. 1.3) economic profit = total revenue - total cost 1.9) A) marginal cost cutting lawns: Average cost cutting lawns: B) new MC: new AC: Define the following terms: total product, marginal product, the principle of diminishing [marginal] returns. ~Total product curve = relationship between the quantity of labor and the quantity of output produced, total output that is produced with your workers ~****marginal product = increase in output that results from the addition one more unit of labor (one more worker) ~principle of dinminishing marginal returns = output will increase at a decreasing rate. The rate of change of total product curve is the marginal product. Diminishing marginal returns implies that marginal costs are increasing On a graph draw a total-product curve. Explain why this curve has a particular shape. Diminishing marginal returns occurs when the slope begins to decline Below is a list of short-run cost variables. For each variable provide a definition, draw a graph with the corresponding curve, and explain why the curve has a particular shape. When you can, also provide a formula for the variable. fixed cost Now this specifics the amount of labor required for a given level of output. Fixed cost is something that doesn't change variable cost regardless output, it's the cost of the physical capital, whereas the variable cost is the cost of the workers. total cost average fixed cost AVC = the variable cost / the Q of output, or the slope of the line that joins the origin to the point you are looking for. As you increase the quantity of output, the average variable cost decreases, but when you pass the point of diminishing returns, the average variable cost increases average variable cost average total cost Marginal cost is the additional cost of producing one more unit of output. It is the slope of the total cost curve. The curve is negatively sloped marginal cost until you hit diminishing returns. Whenever there at diminishing returns, marginal cost increases. From total cost to average total cost (use the slopes!!!) Explain the relationship between marginal cost and average cost. Whenever the marginal cost is less than the average cost (before you hit diminishing returns), the average cost (be it marginal or total) is falling. However, when the marginal cost exceeds the average cost (after diminishing returns), the average cost is rising. When the marginal cost equals the average cost, the average cost is neither rising nor falling. Therefore, the marginal cost curve intersects the short run average total cost at its minimum point. BE ABLE TO DRAW THIS GRAPH Answer questions 2.4 and 2.9 from the Exercises at the end of the chapter. 2.4) increase 2.9) see book table Consider the difference between the short run and the long run. How do we define these two periods and what is the key difference? • Short run: period of time too short to vary all factors, in the short run additional output can be produced only by increasing the quantity of variable factors. (Physical capital is fixed and the only way to increase output is to add more labor/workers) • Long run: a period of time in which all the factors of production are variable • Long run average cost: all inputs are variable • Long run average cost = total cost / quantity output • LRAC is U shaped or L shaped Define the following terms: constant returns to scale, economies of scale, diseconomies of scale. • Constant returns to scale: no benefit or cost really of producing more • Economies of scale: cost associated with scaling up (aka adding more Capital, labor, and materials • Diseconomies of scale: coordination problems, increasing input costs On a graph draw a long-run average cost curve, that at first exhibits economies of scale, then constant returns to scale, and then finally diseconomies of scale. LRAC curves are segments of short run average cost curves There are no fixed costs in the long run, so if a graph shows you a cost at an output of 0, then this is a short run total cost curve because that implies a fixed cost! Answer questions 3.3, 3.7 and 3.8 from the Exercises at the end of the chapter. 3.3) diminishing returns are not applicable in the long run 3.7) diseconomies of scale: costs increase as output increases due to lack of coordination or increasing input costs due to how big the company is getting. This happens in the long run. Diminishing returns happen in the short run Perfect competition notes and questions What is the difference between the four different types of market structures? • Perfectly competitive market - a market with many sellers and buyers of a homogenous product and no barriers to entry. Both buyers and sellers are price takers, which means they take the market price as given (agriculture is a good example, or the stock market) • Monopoly - single firms serves the entire market, barriers to market entry are very large • Monopolistic competition - there are no barriers to entry to many firms sell a slightly different product and compete for customers • Oligopoly - the market has only a few firms because economies of scale or government limit the number of firms Draw a market demand curve. Draw a demand curve for a perfectly competitive firm. Draw a demand curve for a monopoly. The demand curve for a monopolist is the market demand curve, whereas a perfectly competitive firms demand curve is horizontal because they take the market price as given and demand is perfectly elastic . What is marginal revenue? In a perfectly competitive market, where firms are price takers, what is the relationship between marginal revenue and the price of the good or service? • Marginal revenue = the change in total revenue form selling one more unit of output. In a perfectly competitive market the firms takes the market price as given, so marginal revenue is simple the price. Which one of the following policies is consistent with the condition for profit maximization? a) a policy that maximizes the total revenue of the firm; b) a policy that minimizes the total cost of the firm; c) a policy that maximizes the difference between marginal revenue and marginal cost; d) a policy that maximizes the average profit per unit of output of the firm; e) none of the above policies are consistent with profit maximization. To maximize profit (TR - TC), a firm should produce the quantity where price = marginal cost. Economic profit = the difference between the price and the average total cost * the quantity produced Answer questions 1.4, 2.3, and 2.5 from the Exercises at the end of the chapter. 1.4) price taker, price maker 2.3) price, marginal cost = price 2.5) decrease, increase What is the break-even price? The price at which economic profit is zero, where price equals average total cost, but we are interested in the minimum point on the ATC curve What is the shut-down price? Why would it ever make sense for a firm to continue to produce if it is losing money? If the price is greater than the minimum average variable cost, stay open. If total revenue is less than total variable cost, shut down. If a firms shuts down in the short run, its profits equal the -FC (because TC = VC + FC and they aren't going to be paying any variable costs). Profit = TR (total revenue) - TC. On one graph draw the typical curves for the marginal cost (MC), the average total cost (ATC), and the average variable cost (AVC) for a perfectly competitive firm. On this graph point out the break-even price and the shutdown price. If you can pay your variable costs stay open. (If revenue is greater than variable cost) Answer questions 2.7, 2.12, 3.2, 3.4, 3.7, 4.8 and 4.10 from the Exercises at the end of the chapter. 2.7) zero, price = average total cost 2.12) 3.2) 3.4) 3.7) 4.8) 4.10) What is an increasing-cost industry? Draw two graphs for an increasing-cost industry, one showing the market equilibrium, and the other showing MC and ATC curves for an individual firm in this industry. Show what happens when there is an increase in demand in this industry. In increasing cost industry is where the average cost of production increases as total output increases because of increasing input prices and less production inputs. Answer questions 5.5, 5.6, 5.10, 5.11, 6.3 and .7.4 from the Exercises at the end of the chapter. Short run supply curve • A firms short run supply curve is the firms short run marginal cost curve above the shut down price Long run supply curve • In the long run, equilibrium for economic profits will be zero • All inputs are flexible • In industries where the rate of return is above normal, more firms will enter that industry, driving down the price back to zero economic profits • In the long run, if the demand for the product increases, the price will initially rise and eventually fall because when the price goes up the supply curve as a result of the in case in demand, more firms will enter the industry since the rate of return is greater, but as more firms enter, the supply will increase, thus driving the price back down. • Conditions for long run equilibrium ◦ Zero economic profit ◦ Maximizing their profits (price = marginal cost) ◦ aka... ◦ PRICE = LRAC ◦ PRICE = MC = MR Monopoly and price discrimination questions and notes Marginal revenue = change in total revenue / change in quantity Define the following terms: • monopoly - a market in which a single firm sells a product that does not have any close substitutes • market power - the ability of a firm to affect the price of its product • barrier to entry - something that prevents firms from entering a profitable market • economies of scale - a situation in which the long run average cost of production decreases as output increases • natural monopoly - a market in which the economies of scale in production are so large that only a single large firm can earn a profit Answer questions 1.6 and 1.10 from the Exercises at the end of the chapter. In answering question 1.10 first compute the total revenue resulting from the price-quantity combinations in the table. Then use the marginal revenue formula presented above, to answer this question. 1.6) decrease price to maximize quantity 1.10) This is a question for students familiar with calculus and taking derivatives. We start with a general formula for a linear demand curve of a monopolist: P = a - bQ. Based on this formula write down the corresponding general formula for the total revenue of the monopolist. Next derive the corresponding formula for marginal revenue by taking the derivative of total revenue with respect to quantity. Answer the following questions. MR = a - 2bQ **the slope is twice as steep as the demand curve! This means that if you know the demand curve you can draw any marginal revenue line -What is the general relationship between the demand curve and the marginal revenue curve of a monopolist? If a firm is a monopolist, the market demand curve shows how much the firm will sell at each price. The marginal revenue curve is always shifted to the left and down of the market demand curve because the firm must cut its price, not only to the new customers but the old custurmers as well, so they loose revenue from some of those old customer, to sell more output. They must cut price to follow the market demand curve. -Suppose a monopolist has a demand curve with the following formula: P = 800 - 2Q. Given this information, on a graph draw the demand curve and marginal revenue curve for this monopolist. If we know the equitation for the market demand curve, we also know the marginal revenue curve because the slope of the marginal revenue curve is twice that of the market demand curve and they have the same y intercept (price for first unit) Draw a graph illustrating the profit-maximizing results for a monopolist. Do this by drawing an upward-sloping marginal cost curve and a linear demand curve on your graph. Next draw the corresponding marginal revenue curve. Based on your graph answer the following questions. The maximize profit, the monopolist picks a quantity corresponding to point a, where marginal cost equals marginal revenue. The price is given by the demand curve, which corresponds to point b on the demand curve Profit = TR - TC Profit = (P - ATC)*Q point out the price and quantity of the profit-maximizing monopolist point out the marginal revenue and total revenue of the profit-maximizing monopolist point out the deadweight loss resulting from the monopoly Based on the information in your graph are you able to point out the profits of the monopoly? The switch from a perfectly competitive market to a monopoly decreases consumer surplus by B and D, while profit increases by rectangle B. The net loss to society is D, the deadweight loss Answer questions 2.8 and 2.9 from the Exercises at the end of the chapter? What is a patent? What are the advantages and disadvantages of a patent? A patent is an exclusive right to sell a new good for some period of time. Parents encourage innovation en encourage the development of products that would have otherwise not been developed, but the firm can also charge a higher price and produce less quantity than would have been produced in a perfectly competitive market. Thus, it is only sensible for a govnement to grant patents for products that would otherwise have not been developed, but not sensible for other products. Answer question 3.6 from the Exercises at the end of the chapter. What is price discrimination? What are the conditions required in order for a monopoly to engage in price discrimination? Price discrimination is the practice of selling a good at different prices to different consumers. Three conditions must be met for a monopoly to engage in price discrimination. 1) market power - the firm must have some control over its price, thus the only type of firm that cannot engage in price discrimination is a perfectly competitive market. 2) different consumer groups - consumers must differ in their willingness to pay for the product or in their responsiveness to changes in price (elasticity of demand). 3) resale is not possible - it must be impractical for one consumer to resell the product to another consumer. Charge lower price to consumers with higher elasticity of demand Answer questions 4.1, 4.4 and 4.7 from the Exercises at the end of the chapter. Notes • Monopoly prices are higher but quantities are lower than a perfectly competitive market (total surplus is maximized) ◦ Loss of surplus in a monopoly => deadweight loss ◦ They create an artificial scarcity to drive up the price and move up the demand curve ◦ Only concerned with profits, not about maximizing the gains of the market • Marginal revenue and marginal cost start at the same price for the first unit • Barriers to entry = patents, control to a key resource, network externalities, large economics of scale*** Economies of scale are the biggest barrier to entry because if you are an economy of scale, output increases as cost decreases, meaning that larger firms will always have an advantage over the smaller firm • To maximize profit in a monopoly, even if you can't find a point on the table where marginal revenue = marginal cost, pick the last quantity where marginal revenue is still greater than marginal cost. At the quantity after that, the marginal cost will be greater than marginal revenue. Chapter 15 notes and questions - public goods and public choice Define the following terms. -external benefit: a benefit from a good experienced by someone other than the person who buys or sold the good -public good: a good that is available for everyone to consume, regardless of who pays and who doesn't; a good that is nonrival in consumption (people can benefit from it simultaneously) and nonexcludable • something provided by the govnement isn't necessarily a public good! It can be a private good. Some public goods provided by private companies. -private good: a good that is consumed by a single person or household; a good that is rival in consumption and excludable -free-rider problem: a person who gets the benefit from a good but does not pay for it, each person will try to benefit from the public good without paying for it Provide examples of goods that are public goods. Provide examples of goods that are private goods. Provide examples of private goods with external benefits. -public goods: national defense, law enforcement, fireworks shows -Private goods: slices of cheese, ice cream, an apartment -Private goods with external benefits: buying a fire extinguisher for your house, education** Answer the following questions 1.1, 1.5, 1.6, 1.8 and 1.10 from the Exercises at the end of the chapter. 1.1) cost is less than 40,000$, tax of 3$ 1.5) A. The wifi System is efficient. B. I wouldn't expect voluntary contributions to cover the $20000 cost. C. Yes 1.6) A. No. B. Yes. C. If a private good provides external benefits, and buyers and sellers ignore the external benefit, then the market will produce __________ (the efficient/ less than the efficient/more than the efficient) quantity of the good. Answer question 2.4 from the Exercises at the end of the chapter. To support your answer to this question on a graph draw lines that are representative of the marginal cost, marginal private benefit and marginal social benefit of education. What is the median-voter rule?Answer questions 3.3, 3.4 and 3.7 from the Exercises at the end of the chapter. -median voter rule: the choices made by the government will match the preferences of the median voter 3.3) special interest theory of govnement suggests that a government will approve an inefficient project if the costs of the project are paid by a large number of citizens and the benefits go to a small number of citizens 3.4) median location, efficient choice 3.7) see book Notes • Difficult to pay for public goods from voluntary contributions because of the free rider problem ◦ Therefore difficult for private company to profit from a public good • If the marginal social benefit (including the private benefit to the buyer and external benefit to society) is greater than the marginal social cost, produce more! • Marginal private cost = marginal social cost People act in their own self interest and don't consider external benefits to society. So sometimes we end up with a market producing too little. To give people incentive to go to college for more years and bring education up to the socially optimal point, you must give a subsidy, ie lower the cost to p2 as shown by point d. The subsidy = the marginal external benefit. • External benefits of education: workplace externalities, civic externalities, crime externalities ◦ Education benefits third parties, so it's only fair that third parties help pay for our education (through taxes) ◦ Everyone who comes to cal poly receives a subsidy • U.S. federal government expenditures ◦ Social security, medicare, Medicaid, defense the biggest parts of budget ◦ Education is only 2% because most expenditures spent on education come from local government • Market failure sources: monopolies, imperfect information, externalities and public goods ◦ Ie free rider problem leads to less efficient output of a public good, or people ignoring the external benefits of something and therefore the market produces less than the efficient amount of that good • Public good won't be built unless total benefit outweighs the cost • Overcoming the free rider problem ◦ Private organizations could... ‣ Give contributors private goods ‣ Arranging matching contributions - if you donate 30$ the city will donate 30$ ‣ Appealing to a person's sense of moral responsibility ◦ Government taxes • externalities - costs or benefits associated with a good that are not confined to the individual or organization ◦ Third party is affected ◦ Benefits and costs ‣ Benefit: being vaccinated for diseases ◦ Marginal social benefit = marginal private benefit + marginal external benefit ◦ Markets ignore marginal external costs and benefits. As a result markets tend to be inefficient when there are externalities ◦ Local governments provide 100% subsidy for primary and secondary education • Reasons for govnement inefficiency => inadequate information, inflexible tax systems, special interest groups ◦ If the median voter rule is valid, then how is it possible for special interest groups to succeed? Tax a lot of people for benefit of a few Notes and questions 11/10/15 - external costs and environmental policy Should we eliminate al
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