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Intro to Microeconomics

by: Melody Posthuma

Intro to Microeconomics ECO 211

Melody Posthuma
GPA 3.94

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This is all the information for the ethics course at Grand Valley that you will need, including reading notes, class notes, and study guides.
Intro to Microeconomics
Microeconomics, GVSU, Economics
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Date Created: 08/24/16
Chapter 5 - 13 Review Chapter 5: 1. Elasticity: measure of quantity demanded or quantity supplied to a change in one of its determinants. The larger the price range, the bigger elasticity. 2. Price Elasticity of Demand: how Qd responds to price change, how willing consumers are to buy a good as the price increases. *Availability of Close Substitutes: Ex: demand for butter elastic (close sub. is margarine) while demand for eggs is inelastic. *Necessities vs. Luxuries: necessities are inelastic, luxuries are elastic *Definition of Market: narrowly defined markets elastic, broadly defined is inelastic because there aren’t good substitutes (ex: food), ice cream is narrower and more elastic because there are substitutes for ice-cream like froyo, but if it was just vanilla ice-cream it would be inelastic. Vanilla ice-cream is even narrower (way more substitutes like chocolate, strawberry ice-cream). *Time Horizon: more elastic over long periods of time. Ex: gas prices increase & demand decreases over time. Computing Price Elasticity of Demand: % Change in Qd/% Change in $, take absolute value, NEVER negative. *Midpoint Method: elasticity from point A to B isn’t the same from B to A (Q2 - Q1)/[(Q2 + Q1)/2]/(P2 - P1)/[(P2 + P1)/2] End Value - Start Value/Midpoint Value X 100% 3. Demand Curve: *Elasticity > 1, quantity moves > price, Ex: perfectly competitive gods (corn) perfect elastic demand), GRAPH *Elasticity < 1, quantity moves < price, GRAPH *Elasticity = 1, quantity moves same amount as price, unit elastic, GRAPH *Elasticity = 0, any change in $ leaves demand unchanged, GRAPH *Elasticity = infinity, at any $ quantity demanded is infinite, very small changes in price lead to huge changes in Qd, GRAPH 4. Total Revenue & the Elasticity of Demand: amount paid by buyers and received by sellers of a good computed as PXQ *If Pd increases & Pd > 1, TR decreases (the price increase is much less than the quantity demanded decrease) *If Pd decreases & Pd > 1, TR increases (price decreases is much less than quantity demanded increase) *If Pd decreases & Pd < 1, TR decreases (prices decrease is much greater than quantity) *If Pd increases & Pd < 1, TR increases (price increase is much greater than quantity decrease) *Inelastic = price and TR move in the same direction *Elastic = price and TR move in opposite directions *Unit Elastic = TR constant with changes in price 5. Linear Demand Curve: slope of linear curve is constant, but elasticity is not. Slope is ratio of changes in 2 variables where elasticity is ratio of percent changes in 2 variables. *A decrease in $, increase in quantity = inelastic *An increase in price and decrease in quantity = elastic 6. Income Elasticity of Demand: measures how Qd changes as consumer of income changes *Income elasticity of Demand = % change in Qd/% change in income *Normal goods = + income elasticity *Inferior gods = - income elasticity *Necessities = smaller income elasticities *Luxuries = large income elasticities 7. Cross-Price Elasticity of Demand: measures how the Qd of one good responds to a change in the $ of another good *Cross-Price elasticity of demand = % change in Qd of good 1/% change in $ of good 2 *Substitute: cross-price elasticity is positive because price of one good & Qd of another go in same direction. *Complements: cross-price elasticity is negative, increase in $ of one good reduces Qd of another good. 8. Price Elasticity of Supply: measures how much quantity supplied responds to changes in price depends on flexibility of sellers to change the amount of the good they produce. Ex: beachfront land is inelastic because it’s impossible to produce more while manufactured goods are elastic, ALWAYS POSITIVE. *More elastic in the long run, can’t change as fast in short run. *Price Elasticity of Supply: % change in Qs/% change in price, Example: if it’s 2, Qs is 2X as much as price. *Perfectly Inelastic Supply = 0, any price leaves Qs unchanged, GRAPH *Inelastic Supply < 1, greater price greater the quantity, closer to vertical, GRAPH *Unit elastic supply = 1, GRAPH *Elastic Supply > 1, line in positive direction & closer to horizontal *Perfectly elastic supply: elasticity = infinity, GRAPH *For low levels of supply, elasticity is high, but for high quantity supplied, firms begin to reach capacity and need to build more plants so price increases & supply becomes less elastic. 9. Supply Curve: *Elastic: decrease in price, decrease in Qs *Inelastic: increase in price, increase in Qs *GRAPH 10. Applications of supply and demand: #1 New technology to grow 20% more WHEAT/acre: supply curve shifts right because farmers are willing to supply more wheat at any given price, Qd increase and price decreases. Wheat is usually inelastic because of few substitutes, so lower the price, lower the TR (price decrease is much greater than quantity increase). Worse off for farmers, farmers grow less and price increases. #2 OPEC fail?! Supply is inelastic because Qs of oil reserves can’t be changed quickly. Demand is inelastic because buying habits don’t respond immediately to changes in price. (short run) In the long run, suppliers respond to increased prices by increasing oil exploration and building new extraction capacity. Consumers conserve more - more elastic! Shift in supply causes a much smaller price increase so price increase in short run is more profitable than in long-run. #3 Drugs: when government stops flow of drugs, increase cost of selling and decrease Qs so price increases and supply curve shifts left. Demand is inelastic because druggies don’t want to stop. So, increase in price = increase in TR. Drug interdiction could increase drug related crime. #4 Drug education: demand curve shifts left: price decreases, quantity decreases, TR decreases because of reduced drug use and related crime. Chapter 6: 1. Price Ceiling (binding only) - Rent Control *government created a legal maximum price *if BINDING, price at ceiling < equilibrium price (Pc < Pe) *Permanent disequilibrium = Qd > Qs @ Pc (actual quantity @ Pc is Qs) *Example: apartment quality decreases because of policy 2. Price Floor (binding only) - minimum wage *government created legal minimum price *if binding, price floor > equilibrium (Pf > Pe) *Permanent disequilibrium Qd < Qs (actual quantity @ Pc is Qs) *Example: minimum wage: surplus = Qs - Qd @ Pf, surplus of workers because firms don’t want to pay as much for minimum wage. 3. Perfectly Inelastic Supply *no producer surplus 4. Classic Price Ceiling 5. Binding vs. Not Binding *Pe1 = not binding case, actual price is Pe *Pe2 = binding case, actual price is Pc (price ceiling) Chapter 7: 1. Welfare Economics: study of how the allocation of resources affects well-being, maximizes total benefits to buyers & sellers - joint action directed by market price does this. 2. Consumer Surplus: *Willingness to pay: max amount a buyer will pay measures how much a buyer values a good *Consumer Surplus: willing to pay more of an item than they did, amount buyer is willing to pay - value to buyers *Total Consumer surplus: add the C.S. of each together. Change in Total Surplus = value to buyer - cost to seller *A decrease in price = increase in C.S., an increase in C.S. of existing buyers is the reduction in the amount they pay. Also, new buyers enter the market who are willing to pay the lower price so Qd shifts to the right. *What does it measure? The benefit buyers receive from a good as buyers themselves perceive it. It’s used when economists respect the preference of the buyers & they assume buyers are rational. (do the best they can to achieve objectives given their opportunities) 3. Demand Curve to Measure C.S.: Price given by the demand curve shows willingness to pay by marginal buyer (the buyer who would leave the market first if the price got any higher) *Area below the demand curve and above the price = C.S. 4. Producer Surplus: *Cost: the workers opportunity cost (out-of-pocket expenses & how much they value their time). They’d sell their services the pay is greater than their cost but not > & would be indifferent if it was = to their cost. *P.S. = amount a seller is paid - cost of production, measures the benefits a seller receives from participating in the market. THE AREA BELOW THE $ AND ABOVE THE SUPPLY CURVE. 5. Supply Curve to Measure P.S.: Price given by supply curve show cost to the marginal seller (seller who would leave the market if the price got any lower). The total area is the sum of the P.S of all the sellers. 6. Market Efficiency: one way a social planner can measure economic welfare is the sum of the C.S. & P.S. (total surplus) AKA value to buyers - cost to sellers. *If an allocation of resources maximizes T.S. it’s efficient. If inefficient, potential gains from trade among buyers and sellers isn’t realized (goods aren’t produced by sellers with lowest cost so moving production from a high cost producer to a low cost producer will decrease TC & increase P.S. OR goods aren’t consumed by buyers who value it most highly (moving consumption of good from buyer who values it least to the buyer who values it the most will increase TS0. *Equality: social planners may also care about this to see if buyers and sellers have similar level of economic well-being. 7. Market Equilibrium: total area between S & D curves up to the point of equilibrium = Total Surplus *Buyers who value good < equilibrium price don’t buy *sellers whose cost < equilibrium price sell good *Free markets allocate the supply of goods to buyers who value them most highly and allocate demand for goods to sellers who produce them at the lowest cost & produce goods that maximize TS. A social planner can NOT increase economic well-being by changing allocation of consumption among buyers or allocation of production among sellers. It also won’t increase from a change in quantity of a good. *Any quantity above equilibrium, the value to the marginal buyer < cost to the marginal seller so a decrease in quantity & increase in TS until Q falls to equilibrium level. *Any quantity below equilibrium the value to the marginal buyer > cost to the marginal seller so increase in quantity & increase in TS until Q reaches equilibrium level. *A social planner choses where the lines intersect. *If market outcome makes TS as large as possible = “laissez faire” - allow them to do, social planner would let it be. 8. Market Power can cause markets to be inefficient b/c it keeps the P & Q away from equilibrium (market failure), Example: government price ceilings. 9. Externalities (side effects) cause welfare in a market to depend on more than just the value to the buyers and the cost to the sellers (market failure) 10.Exception to the Consumer Surplus Benefit: Illegal drugs b/c addicts are willing to pay an increased price for heroin, society’s standpoint (drug addicts don’t get a large benefit from buying drugs at decreased price). 11.Consumer Surplus Graph 12. Producer Surplus Graph 13. The efficiency to the equilibrium quantity *Demand schedule: derived from the willingness to pay of possible buyers. *Supply schedule: derived from the costs of suppliers 14. Adam Smith’s invisible hand: takes into account all information of buyers and sellers, guides market to best outcome - free markets are the best! 15. Assumptions about market equilibrium & efficiency #1 Markets are perfectly competitive #2 No externalities exist #3 No market power exists (Market failure = inability of unregulated markets to allocate resources efficiently (public policy can sometimes remedy the problem) 16. Efficiency: maximizing TS by all members of society with the problem 17. Equality: distributing economic prosperity fairly among members of society Example: market for organs? Public policy = illegal to sell, government price ceiling of zero (shortage). Some people - extra kidney they don’t need, others - dying to get one. Alternative: balance S & D, sellers have extra cash, buyers live, no shortage & efficient. Worry: benefit only rich. 18. Market outcome = sum of CS + PS (as large as it can be) 19. Calculating Change in Total Surplus: P1Q1 - P2Q2 CS1 + PS1 = TS1 CS2 + PS2 = TS2 Change CS = CS2 - CS1 Change PS = PS2 - PS1 Chang TS = TS2 - TS1 Chapter 13: 1.Industrial Organization: study of how firm’s decisions about prices & quantities depend on the market conditions they face. 2.Total Revenue = the quantity of output the firm produces X price it sells output 3.Total Cost: amount the firm pays to buy inputs, opportunity cost: what you give up to get something else; because they cause the firm to pay money they are called explicit costs (loan from bank) & when the don’t require cash outlay they are called implicit costs (ex: financial capital invested in business like investing savings) 4.Economists vs Accountants: Economists look @ both implicit & explicit costs, accountants only look at explicit costs. 5.Profit = total revenue - total cost 6.Production Function: relationship between the quantity of inputs (workers) and quantity of outputs (the good) 7. Marginal Product: increase in quantity of output obtained from 1 unit of input. Diminishing marginal product: # of workers increases, marginal product decreases, so each worker contributes less additional product to total production. 8. Total Cost Curve: between quantity produced (x) & total costs (y), steeper as Q increases while production function gets flatter as Q increases. *Example: when kitchen is crowded producing an additional cooking requires a lot of additional labor & is more costly. 9. Fixed Cost: don’t vary with the quantity of output produced, happen even if firm produces nothing at all, ex: rent, paying salaries to workers *Average fixed cost = fixed cost/quantity of output 10.Variable Cost: change as the firm alters the quantity of output produced, ex: cost of coffee, sugar, cups, salaries of workers *Average variable cost = variable cost/quantity of output *Total Cost = fixed + variable cost, Average total cost = firm’s costs/quantity of output 11. Marginal Cost: change in total cost/change in quantity (tells how much it costs to increase production of coffee by one cup for example. *Marginal costs increase with increase in Q reflecting the property of diminishing marginal product. Ex: few workers and equipment isn’t used to M.P. of extra worker is large and marginal cost of a cup of coffee is small. If many worker, most equipment is used, but will have to wait for equipment os marginal product of an extra worker is small and marginal cost of a cup is large. *Graphs! x-axis = quantity firm produces, y-axis = marginal & average costs. 12. U-shaped Average Total Cost: *Average fixed cost decreases as output increases while variable cost increases as output increases because diminishing marginal product causing a u-shaped average total cost. *Bottom of u-shaped @ Q that minimizes total average cost (the efficient scale of the firm) *At high levels of output, average total cost is higher than minimum because marginal product of inputs has diminished significantly. *At low levels of output, average total costs is higher than minimum because fixed cost is spread over few units. 13. Typical Cost Curves: At low levels of output, the firm experiences increased marginal product before diminishing marginal product sets in, so.... at low levels of output = increased marginal product and the marginal cost curve falls. Eventually, firm experiences diminishing M.P. and marginal cost curve rises (U-shaped) #1 Marginal cost eventually rises w/ quantity of output #2 Av. Total Cost Curve is U-shaped #3 Marginal cost curve crosses average total cost curve at minimum of average total cost #4 Total cost and variable cost NEVER meet each other on a graph. 14. Short-Run & Long-Run Average Total Costs: fixed over a short period of tim (can’t change circumstances quickly), variable cost over long amount of time. As firm moves along long-run curve, it adjusts size of factory to quantity of production. It’s much flatter than a short term curve & all short-run curves lie on or above long- run curve. Average total cost may be greater in short-run than in long-run. 15. Economies and Diseconomies of Scale *Economies of Scale: when long run average total cost declines as output increases, specialization among workers can be the cause. *Diseconomies of Scale: when long run average total cost rises as output increases, coordination problems can cause this. *Constant Returns to Scale: when long=run average total cost doesn’t vary with level of output. *Long-run average total costs falls at decreased levels of production because of specialization and rising at high levels of production because of coordination problems. 16. Marginal Product of Labor = change in quantity/change in labor Microeconomics Chapter 1 - Scarcity: society has limited resources and therefore cannot produce all the gods and services people wish to have. Economics: study of how society manages its scarce resources. Economists study how people make decisions (how much they work, amount they buy, how much they save, and how they invest) and analyze forces and trends that affect the economy as a whole (growth in income, price changes, amount of unemployed people). Ten Principles of Economics 1-4 = how individuals make decisions #1 People Face Trade-Offs - To get one thing that we like, we usually have to give up another thing we like. -Trade-off examples: “Guns and Butter”, clean environment vs. high level of income (laws that require firms to reduce pollution raise the cost of producing goods and services) -Efficiency vs. Equality: Efficiency means that society is getting the maximum benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society’s members. Efficiency refers to the size of the economic pie and equality refers to how the pie is divided into individual slices. Equality (welfare and income tax) = reduced efficiency. When government tries to cut economic pie into more equal slices = smaller pie -Scarcity - trade-off - government policy or program -Lower efficiency but higher equity: unemployment insurance & progressive income tax (the progressive income tax is a federal tax, MI tax is a flat tax about 4.3%, sometimes cities have taxes as well) **Review what a progressive income tax is (don’t have to know the numbers). Lower income people benefit more from a progressive tax program. -Disposable income - your actual amount of money you have after taxes taken out -Greater efficiency, lower equity: a flat tax would help out higher income people -Scarcity - trade-off - opportunity cost -Opportunity cost of 2 hours of studying: give up working, give up wage = foregone wage -Opportunity cost of 2 hour movie: a ticket (10 dollars) (explicit opportunity cost = outlay of money) + 2 hours of studying (implicit opportunity cost - no outlay of money) #2 The Cost of Something Is What You Give Up to Get It The opportunity cost of an item is what you give up to get that item. #3 Rational People Think at the Margin - Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities. -Marginal change: a small incremental adjustment to an existing plan of action. Adjustments around the edges of what you are doing. -Plane example: as long as a standby passenger pays more than the marginal cost (peanuts and a drink), selling the ticket is profitable and there won’t be empty seats on the plane. -There is a greater marginal benefit to buying diamonds than water because diamonds are rare and water is plentiful. A rational decision maker takes an action if the marginal benefit of the action exceeds the marginal cost. #4 People Respond to Incentives -Incentive: something that includes a person to act, rational people respond to incentives -Example: A higher price in a market provides an incentive for buyers to consume less and an incentive for sellers to produce more. -Example: when road conditions are icy, people drive more attentively and at lower speeds than they do when road conditions are clear since the benefit of increased safety is high. -Example: Seat belts make accidents less costly, so seat belts reduce the benefits of slow and carful driving. The result of a seatbelt is a larger number of accidents. -If the policy changes incentives, it will cause people to alter their behavior. CASE STUDY - The Incentive Effects of Gasoline Prices The economic downturn that began in 2008 and continued into 2009 reduced the world demand for oil and the rice of gasoline declined substantially. 5-7 = how people interact with one another #5 Trade Can Make Everyone Better Off -Trade between two countries can make each country better off -Trade allows each person to specialize in the activities he or she does best. -Trade allows people to buy a greater variety of goods and services at a lower cost. #6 Markets Are Usually a Good Way to Organize Economic Activity -Market Economy: the decisions of a central planner are replaced by the decisions of millions of firms and households. Firms decide who they hire and households decide who they work for. Both interact in the market place, where prices and self-interest guide their decisions. It is more focused on each person’s well-being rather than overall economic well-being, but this type can be successful in organizing economic activity to promote overall well-being. -An Inquiry into the Nature and Causes of the Wealth of Nations by Adam Smith: Households and firms interacting in markets act as if they are guided by an “invisible hand” that leads them to desirable market outcomes. Prices adjust to guide these individual buyers and sellers to reach outcomes that maximize the well-being of society as a whole. -Market prices reflect both the value of a good to society and the cost to society of making the good. -Taxes distort prices and thus the decisions of households and firms. -Communism failed because planners lacked the information about consumers’ tastes and producers’ costs, which in a market economy is reflected in prices. #7 Governments can Sometimes Improve Market Outcomes -Market economies need institutions to enforce property rights so individuals can own and control scarce resources. -Property right: the ability of an individual to own and exercise control over scarce resources. -There are two reasons for a government to intervene and change the allocation of resources that people would choose on their own: to promote efficiency or to promote equality. -Market failure: a situation in which a market left on its own fails to allocate resources efficiently. -Externality: the impact of one person’s actions on the well-being of a bystander. A possible cause of market failure. Example: pollution -Market power: the ability of a single economic actor (or small group) to have a substantial influence on market prices, another potential cause of market failure. -Market economies often increase efficiency rather than equality. The government can help provide equality, but doesn’t always do so. 8-10 = workings of the economy as a whole #8 A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services -Productivity: the quantity of goods and services produced from each unit of labor input. Greater the productivity, greater the average income. -Policymakers need to raise productivity to boost living standards. #9 Prices Rise When the Government Prints Too Much Money - Inflation: an increase in the overall level of prices in the economy -Causes of inflation: quantity of money #10 Society Faces a Short-Run Trade-off Between Inflation and Unemployment 1. Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services. 2. Higher demand may over time cause firms to raise their prices, but in the meantime, it also encourages them to hire more workers and produce a larger quantity of goods and services. 3. More hiring means lower unemployment. This line of reasoning leads to one final economy-wide trade-off: a short-run trade-off between inflation and unemployment. AKA many economic policies push inflation and unemployment in opposite directions. -Business cycle: fluctuations in economic activity, such as employment and production. -Policymakers change the amount that the government spends, amount it taxes, and the amount of money it prints. SUMMARY: 1. People face trade-offs among alternative goals, the cost of any action is measured in terms of forgone opportunities, that rational people make decisions by comparing marginal costs and marginal benefits, and people change their behavior in response to the incentives they face. 2. Trade and interdependence can be mutually beneficial, markets are a good way of coordinating economic activity among people, and the government can potentially improve market outcomes by remedying a market failure or by promoting greater economic equality. 3. Productivity is the ultimate source of living standards, growth in the quantity of money is the ultimate source of inflation, and society faces a short-run trade-off between inflation and unemployment. Chapter 2 of Microeconomics - Thinking Like an Economist The Scientific Method: Observation, Theory, and More Observation -Economists use theory and observation like scientists. Instead of doing experiments, economists have to usually make do with data. They use history to see how a key natural resource for example, effects the world’s economies. Situations in the past help illustrate and evaluate economic theories of the present. The Role of Assumptions -Assumptions simplify the complex world and make it easier to understand. * Example: studying effects of international trade - assume the world is 2 countries and each produces 2 goods to focus our thinking -Economists use different assumptions when studying short-run (fixed prices) vs. long- run (flexible prices) effects of a change in the quantity of money. Economic Models -Economists use models composed of diagrams and equations. They omit many details to allow us to see what’s truly important. -All models are built with assumptions. Our First Model: The Circular-Flow Diagram -A visual model of the economy that shows how dollars flow through markets among households and firms. Firms produce good and services using inputs (land, labor, capital) called the factors of production. Households own the factors of production and consume all the goods and services that the firms products. -The inner flow is represents inputs and outputs while the outer flow represents the flow of money. -Leaves out roles of government and international trade, but they aren’t crucial for basic understanding of how the economy is organized. Our Second Model: The Production Possibilities Frontier -Production Possibilities Frontier is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available production technology that firms use to turn these factors into output. -Diagram: Economy produces 1,000 cars & no computers or 3,000 computers and no cars. The two endpoints of the production possibilities frontier represent these extreme possibilities. Due to scarcity, point C will never be possible. The economy can produce at any point on or inside the production possibilities frontier. The opportunity cost of each car is 2 computers and the opp. cost of a car = the slope of the PPF. The opp. cost of a computer is highest at point E and the opp. cost of cars is highest at point F. -An outcome is efficient if the economy is going all it can from the scarce resources available. Points on the line are efficient while points inside are inefficient. -The Product Possibilities Frontier show the trade-off that society faces. Once reaching efficiency, the only way to produce more of something is to produce less of another. It shows the opportunity cost of one good as measured in terms of the other good. -The PPF is often bowed shaped because when the economy is using most of its resources to make one product, the resources best suited for another product are being used to make the first product. The opportunity cost of the 2nd product in terms of the first is small and the frontier is relatively flat. In contrast, when the economy is using most of its resources to make the 2nd product: producing an additional product means moving some of the best producers of the other product. So producing an additional product would mean substantial loss of the 1st products output. The opp. cost is high and the frontier is steep. (GO OVER THIS MORE) Microeconomics and Macroeconomics -Micro: the study of how households and firms make decisions and how they interact in specific markets. -Macro: the study of economy-wide phenomena. The Economist as Policy Adviser - economists are asked to recommend policies to improve economic outcomes. When economists are trying to explain the world, they are scientists. Positive vs. Normative Analysis -Positive statements are descriptive, claiming about how the world is. (analyzing data oR changes over time) -Normative statements are prescriptive, making a claim about how the world ought to be. (evaluating the statements by values and facts, not just data) -The biggest difference between the statements are how we judge their validity. -Positive statements are the main statements by economists (economist as a scientist) and normative statements are less spoken of (economist as a policy maker) Economists in Washington -Since 1946, the president has a Council of Economic Advisers (3 members and a staff of a few dozen economists). They advise the president and write the annual Economic Report of the President, discussing recent developments in the economy and present the council’s analysis of current policy issues. -Economists at the Office of Managements & Budget help formulate spending plans and regulatory policy. Economists at the Dep. of Treasury help design tax policy. Economists at Dep. of Labor analyze data on workers and unemployed to formulate labor-market policies. Economists at the Dep. of Justice help enforce antitrust laws. -Congress relies on the advice of the Congressional Budget Office, staffed by economists. -Federal Reserve, employes economists to analyze economic developments in the US & worldwide. Why Economists’Advice Is Not Always Followed -After a president hears from his economic advisors, he turns to other advisers for related input (how to propose it to the public, anticipate misunderstandings, how the news will report, opinions by the newspapers, how Congress will view it, what groups to organize, how it will effect his election, how it’ll effect any other policies) Why do economists seem to conflict: -Economists may disagree about the validity of alternative positive theories about how the world works. -Economists ma have different values and therefore different normative views about what policy should try to accomplish. Differences in Scientific Judgments (along with differences in values) -Economists disagree because they have different hunches about the validity of alternative theories or about the size of important parameters that measure how economic variables are related. -They disagree about whether the government should tax a household's income or its spending. They hold different normative views about the tax system because they have different positive views about the responsiveness of saving to tax incentives. Perception vs. Reality - Economists agree more than you think. They agree that there shouldn’t be rent control since it adversely affects the availability and quality of housing. City governments ignore the advice and place ceilings on the rents that landlords may charge. Most also oppose barriers to free trade while Congress has restricted the import of certain goods. What most economists agree upon: 1. A ceiling on rents reduces the quantity and quality of housing available 2. Tariffs and import quotas usually reduce general economic welfare 3. Flexible and floating exchange rates offer an effective international monetary arrangement 4. Fiscal policy has a significant stimulative impact on a less than fully employed economy 5. The US shouldn’t restrict employers from outsourcing to foreign countries 6. Economic growth in developed countries leads to greater levels of well-being 7. The US should eliminate agricultural subsidies 8. An appropriately designed fiscal policy can increase the long-run rate of capital formation 9. Local and state governments should eliminate subsidies to professional sports franchises 10.If the federal budget is to be balanced, it should be done over the business cycle rather than yearly. 11.The gap between Social Security funds and expenditures will become unsustainable large within the next 50 years if current policies remain unchanged 12.Cash payments increase the welfare of recipients to a greater degree than do transfers-in-kind of equal cash value. 13.A large federal budget deficit has an adverse effect on the economy. 14.The redistribution of income in the US is a legitimate role for the government. 15.Inflation is caused primarily by too much growth in the money supply. 16.The US shouldn’t ban genetically modified crops. 17.A minimum wage increases unemployment among young and unskilled workers. 18.The government should restructure the welfare system along the lines of a “negative income tax.” 19.Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings. 20.Government subsidies on ethanol in the US should be reduced or eliminated. APPENDIX -Graphs visually express ideas that might be less clear if described with equations or words and when analyzing economic data, they provide a powerful way of finding and interpreting patterns. -Graphs of a single variable: pie chart, bar graph, time-series graph. -Graphs of two variable: coordinate system -Demand curve: traces out the effect of a good’s price on the quality of the good consumers want to buy. If there are three variables, hold one constant. Variables can either be negatively related or positively related. -Movements along a curve vs. shifts of a curve: when a variable that’s not named on either axis changes, the curve shifts. -Slope: if the curve is flatter, the x-variable is more sensitive to the y-variable. To answer questions about how one variable responds to changes in another variable, use slope. Horizontal line’s slope = 0, vertical line’s slope = infinite. A small slope = flatter curve, a large slope = steeper curve. -Cause and Effect: there may sometimes be a third omitted variable not in a graph. Reverse causality - we think A causes B when B causes A when there is a 3rd omitted variable. Example: lighters don’t cause cancer (lighters are dangerous to your health), cigarettes cause cancer. Always question graphs that are about cause and effect. Search for a possible omitted variable. -Reverse Causality: Economists can also make mistakes about causality by misreading its direction. Example: Police increase the amount of urban violence (greater violence, greater amount of police), crime increases and police are forced to expand (greater police because of the violence). A city expects more crime, they may hire more police now. Expectations of future conditions can cause a current circumstance. Example 2: people buy minivans while anticipating the birth of a child, you wouldn’t want to conclude that the sale of minivans causes the population to grow. Chapter 4: Markets & Competition -A market is a group of buyers and sellers of a particular good or service. The buyers determine the demand of the product and the sellers determine the supply. Most markets are not organized (ex: group of ice-cream buyers and ice-cream sellers form a market) -Competitive market: a market in which there are so many buyers and sellers that each has a negligible impact on the market price. Each ice-cream seller has little control over price because other sellers are offering similar products. Each buyer has little influence because they only buy a small amount. -Assume perfect competition: (1) the goods offered for sale are all exactly the same (2) the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price. Since buyers and sellers must accept the price the market determines in perfectly competitive markets, they are called price takers. At the market price, buyers can buy all they want and sellers can sell all they want. Ex: wheat. A monopoly is the opposite of perfect competition. Demand -Relationship b/w price and quantity: The quantity demanded of any god is the amount of the good that buyers are willing and able to purchase. * Law of Demand: other things equal, when the price of a good rises, the quantity demanded of the good falls and vice versa. * Demand Schedule: a table that shows the relationship b/w the price of a good and the quantity demanded, holding constant everything else that influences how much of the good consumers want to buy. * Demand curve: the downward-sloping line relating price and quantity demanded. The y-axis is price and the x-axis is quantity. ** They took Catherine’s demand schedule and Dan’s Demand Schedule and added the quantity together under a certain price = market demand. ** If something happens to alter the quantity demanded at a given price, the demand curve shifts. Increase in demand = curve shifts to the right, decrease in demand = curve shifts to the left. ***What causes the shift in a demand curve? (1) Income: Demand for a good falls when income falls, the good is called a normal good. If demand for a good rises when income falls, it’s called an inferior good. (ex: bus rides over car rides) (2) Price of Related Goods: when a fall in the price of one good reduces the demand for another good, the 2 goods are called substitutes. They often are pairs that are used in place of each other. Ex: sweaters & sweatshirts, movie tickets & movie rentals. When a fall in the price of one good raises the demand for the other, the 2 are called complements. They are goods that are used together. Ex: gas & cars, PB&J, cigarettes and marijuana. (3) Tastes: if you like a good, you will buy more of it. (4) Expectations: your expectations of the future may affect your demand for a good or service today. Ex: higher income next month, you may save less now, expect price of a good to fall tomorrow, you may not buy the good at today’s price (5) Number of Buyers: greater number of buyers = greater demand (6) Change in price of a good = MOVEMENT ALONG THE CURVE NOT SHIFT OF THE ACTUAL CURVE Supply -Quantity Supplied: amount that sells are willing and able to sell. Higher price = sellers willing to sell more goods -Law of supply: other things equal, when the price of a good rises, the quantity supplied of the good also rises, and when the price falls, the quantity supplied falls as well. -Supply schedule: a table that shows the relationship b/w the price of a good and the quantity supplied, holding constant everything else that influences how much producers of the good want to sell. -Supply curve: the curve relating price and quantity supplied, slopes upwards because a higher price means greater quantity supplied -Market Supply vs. Individual Supply: add individual quantities found on the horizontal axis of the individual supply curves. -Shifts in supply curve: (1) Input: price of one of the inputs to make a good rises = less supply of that good (2) Technology: higher technology = reduced amount of labor necessary = fewer costs = higher supply of a good (3) Expectations: what may happen in the future affects choices now. Ex: if a firm expects the price of ice-cream to rise, it will supply less now and put some in storage for the future (4) Number of Sellers: greater number of sellers = greater supply of a good Supply and Demand Together - Equilibrium -Equilibrium: the point where the supply and demand curves meet. The price at this intersection is called the equilibrium price and the quantity at the intersection is called the equilibrium quantity. At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell. The equilibrium price is AKA market-clearing price. The actions of buyers and sellers naturally move markets toward equilibrium. -Surplus: suppliers are unable to sell all they want at the going price. It’s a situation in which quantity supplied > quantity demanded. AKA excess supply. The response of the surplus is to cut prices which increases quantity demanded. These changes are movements ALONG the S&D curves, not shifts. Prices continue to fall until the market reaches equilibrium. * Surplus line is above the intersection of S&D curves. -Shortage: Demanders are unable to buy all they want at the going price. AKA excess demand. It is a situation in which the quantity demanded > quantity supplied. Sellers respond to shortage by raising their prices without losing sales. They increase to cause the quantity demanded to fall. These price increases are changes along the S&D curves and they move the market toward equilibrium. *Shortage line is below the intersection of S&D curves. -In most free markets, surpluses and shortages are only temporary b/c prices eventually move toward their equilibrium levels. -Law of supply and demand: the price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance. -Three steps to analyzing changes in equilibrium: when some event shifts one of the supply or demand curves, the equilibrium in the market changes, resulting in a new price & quantity exchanged b/w buyers and sellers. 1st, decide if the even shifts the S curve, the D curve, or both. 2nd, decide if the curve shifts to the right or the left. 3rd, compare the initial to the new equilibrium, which shows how the shift affects the equilibrium price and quantity. A change in a curve is represented by D1 & D2, S1 & S2, or both. -Shifts in curves vs. movements along curves: If there was an increase in demand, there is an increase in the “quantity supplied” but no change in “supply.” Supply refers to the position of the supply curve whereas the quantity supplied refers to the amount suppliers which to sell. Movement along curve = change in quantity supplied or demanded, shift of curve = change in supply or demand *When the supply or demand curve shifts to the right, it is an increase in the supply or demand. *When the supply or demand curve shifts to the left, it is an decrease in the supply or demand. No Change in An Increase in A Decrease in Supply Supply Supply No Change in P same, Q same P down, Q up P up, Q down Demand An increase in P up, Q up P ambiguous, Q up P up, Q ambiguous Demand A Decrease in P down, Q down P down, Q P ambiguous, Q Demand ambiguous down Definitions: Allocate: distribute Ambiguous: open resources or duties to more than one for a particular interpretation purpose Chapter 5: Elasticity is a measure of quantity demanded or quantity supplied to a change in one of its determinants. The Price Elasticity of Demand and Its Determinants -Price elasticity of demand: measures how much the quantity demanded responds to a change in price. Demand for a good is elastic of the quantity demanded responds substantially to changes in the price. This measures how wiling consumers are to buy less of the good as its price rises. -Influences on the price elasticity of demand: * Availability of close substitutes: demand for butter elastic (because there’s margarine), demand for eggs inelastic * Necessities vs. Luxuries: necessities are inelastic, luxuries elastic. What determines if something is a necessity is the preferences of the buyer. * Definition of the Market: narrowly defined markets = elastic, broadly defined markets = inelastic b/c it’s easier to find close substitutes for narrowly defined goods. Ex: food (broad category) is fairly inelastic because there aren’t good substitutes for it. Ice cream is narrower and is more elastic b/c there are easy subs for ice cream. Though, If it was just vanilla ice cream, it would be elastic. * Time horizon: more elastic demand over longer time periods. Ex: quantity of gas demanded at a higher price falls slightly in the first few months, but over time, the quantity demanded falls more substantially. Computing the Price Elasticity of Demand: Price elasticity of demand = percentage change in quantity demanded/percentage change in price. That answer reflects that the change in quantity demanded is proportionally ___ as large as the change in price. In this book, report all price elasticities of demand as positive numbers (absolute value). The greater the price elasticity = greater responsiveness of quantity demanded to changes in price. The Midpoint Method: A better Way to Calculate Percentage Changes & Elasticities Often the elasticity from point A to point B seems different than from B to A. * Ex: Point A: price = $4, quantity = 120, Point B: Price = $6, Quantity = 80, going from A to B the price rises by 50% but from B to A it falls by 33%. * FORMULA: (Q2 - Q1)/((Q2 + Q1)/2)/(P2 - P1)/((P2 + P1)/2), the numerator is the percentage change in quantity computed using the midpoint method and the denominator is the percentage change in price computed using the midpoint method. The Variety of Demand Curve -Demand is elastic if elasticity > 1 (quantity moves proportionately more than the price) -Demand is inelastic if elasticity is > 1 (quantity moves proportionally less than the price. -Elasticity = 1, the quantity moves the same amount proportionally as the price (unit elasticity) -Perfectly Inelastic demand: Elasticity = 0, vertical line (any change in price leaves the demand unchanged) -Inelastic Demand: Elasticity < 1, negative sloping curve that is closer to vertical -Unit Elasticity demand: Elasticity = 1, negative sloping curve -Elastic demand: elasticity > 1, negative sloping curve that is closer to horizontal -Perfectly elastic demand: Elastic = infinity, horizontal line (at a price value, quantity demanded is infinite, very small changes in price lead to huge changes in the quantity demanded) Total Revenue and the Price of Elasticity of Demand -Total Revenue: the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold, P X Q = total revenue -If demand is inelastic, increase in price = increase in total revenue, fall in Q is proportionately smaller than rise in P -If demand is elastic, the increase in price leads to a decrease in quantity that’s proportionately larger, so total revenue decreases. -General rules: * When demand is inelastic, price and total revenue move in the same direction * When demand is elastic, price and total revenue move in opposite directions. * If demand is unit elastic, total revenue remains constant with price changes Elasticity and Total Revenue along a Linear Demand Curve -The slope of a linear demand curve is constant, but the elasticity is not. The slope is the ratio of changes in the two variables, whereas the elasticity is the ratio of percentage changes in the two variables. You can calculate the elasticity with the midpoint method and see how different points in the line may be elastic or inelastic. A constant elasticity is possible, but it’s not always the case. Other Demand Elasticities -The Income Elasticity of demand: measures how the quantity demanded changes as the consumer income changes. FORMULA: percentage change in quantity demanded/ percentage change in income. Normal goods have positive income elasticities. Inferior goods have negative income elasticities. Luxuries have large income elasticities because consumers feel they don’t need these with lower incomes. -The Cross-Price Elasticity of Demand: measures how the quantity demanded of one good responds to a change in the price of another good. FORMULA: percentage change in quantity demanded of good 1/percentage change in the price of good 2 * Substitutes: cross-price elasticity is positive (ex: b/c the price of hot dogs and the quantity of hamburgers demanded move in the same direction, the cross-price elasticity is positive) * Complements: cross-price elasticity is negative (ex: increase in price of computers reduces quantity of software demanded) The Price Elasticity of Supply and Its Determinants -Price of elasticity of supply: measures how much the quantity supplie responds to changes in the price. Supply of a good is elastic if the quantity supplied changes in price. Supply is inelastic if the quantity supplied responds only slightly to changes in the price. The price elasticity of supply depends on the flexibility of sellers tochange the amount of the good they produce. Ex: beachfront land is inelastic because it’s almost impossible to produce more of it. Books, cars, & TVs are elastic b/c the yare manufactured goods. Firms can run factories longer in response to a higher price. -Supply is more elastic in LONG RUN. Firms can’t easily change the size of their factories to make more or less of a good. In the short fun, the quantity supplied isn’t very responsive to the price. Computing the Price Elasticity of Supply -Price elasticity of supply = percentage change in quantity supplied/percentage change in price * Ex: % change in $ = ($3.15- $2.85)/(3.00 X 100) = 10%, % change in quantity = (11,000-9,000)/(10,000X100) = 20%, Price elasticity of supply = 20%/10% = 2, the quantity supplied changes proportionately 2X as much as the price A Variety of Supply Curves -Perfectly inelastic supply: elasticity = 0, vertical line (any price leaves the quantity supplied unchanged) -Inelastic supply: elasticity is less than one, line going in the positive direction closer to vertical (increase in price = increase in quantity) -Unit Elastic supply: elasticity = 1, line going in the positive direction -Elastic supply: Elasticity > 1, line going in positive direction closer to horizontal -Perfectly elastic supply: elasticity = infinity (very small changes in price lead to very large changes in the quantity supplied) -For low levels of quantity supplied, elasticity is high (firms respond substantially to changes in price, small changes in price make it profitable for firms to begin using this idle capacity). Higher the quantity supplied, firms begin to reach capacity and will eventually need to build new plants. To induce firms to incur this extra expense, prices rise substantially and supply becomes less elastic. (look at figure 6) Three Applications of Supply, Demand, and Elasticity Can Good News for Farmers Be Bad News for Farmers? -A new hybrid is created that grows 20% more wheat per acre -The supply curve shifts to the right b/c farmers are willing to supply more wheat at any given price. The quantity increases fro 100 to 100 and the price decreases from $3 to 2$. -Wheat is usually inelastic because of few substitutes. A decrease in price causes total revenue to fall. The price of wheat falls substantially and the quantity of wheat sold rises only slightly. Total revenue falls by $80. -Supply of wheat rises, price falls, farmers are worse off, now there are less farmers. If all farmers decide to grow less, the overall price increases. Why Did OPEC Fail to Keep the Price of Oil High? -In the short run, supply and demand for oil are relatively inelastic. Supply is inelastic because the quantity of known oil reserves and the capacity for oil extraction can’t be changed quickly. Demand is inelastic because buying habits don’t respond immediately to changes in price. A lower supply of oil = higher prices. -In the long run, producers of oil outside OPEC respond to high prices by increasing oil exploration and by building new extraction capacity. Consumers respond with greater conservation. The supply and demand curves are more elastic (less vertical, more horizontal) so the shift in supply (less) causes a much smaller increase in price. -Raising oil prices are more profitable in the short run than the long run. Does Drug Interdiction Increase or Decrease Drug-Related Crimes? -To discourage the use of drugs, the government pays billions per year to reduce drug flow into the US. -When the government stops some drugs from entering, it raises the cost of selling drugs and reduces the quantity of drugs supplied. The supply curve moves to the left and the equilibrium price rises as the equilibrium quantity falls. -Druggies don’t want to stop, so the demand is inelastic. An increase in price raises total revenue b/c drug interdiction raises the price proportionality more than it reduces drug use. Drug interdiction could increase drug-related crime. -Policymakers might try to reduce the demand by pursuing a policy of drug education. The demand curve shifts to the left and the equilibrium quantity falls along with the equilibrium price. Total revenue falls. -Drug education can reduce both drug use and drug-related crimes. Advocates for drug interdiction might say that it’s inelastic in the short run (not reduce drug-related crime), but elastic in the long run (it would reduce drug-related crime). Some Summary Points: 1. If quantity demanded moves less than the price, elasticity is < 1. If quantity demanded moves more than the price, elasticity is > 1. 2. For inelastic demand curves, total revenue moves in the same direction as the price. For elastic demand curves, total revenue moves in opposite direction as the price. 3. If quantity supplied moves less than price, elasticity is < 1. If quantity supplied moves more than the price, elasticity > 1. -Price elasticity of Demand = % Change in Qd/% Change in price (Delate = “change in...”) -Calculate the Pd using mid-point method: (end value-start value/midpoint of above two values) * 100% -Midpoint = average of E.V. and S.V. #1 midpoint method = % change Qd = (EV - SU/M.P.) X 100% (the answer is a negative percent). The values we are looking at are on the x-axis. #2 Midpoint method = % change in price = (EV - SU/M.P.) X 100%. The values we are looking at are on the x-axis. (the answer is always the absolute value of the original answer. The negative sign shows up because of the law of demand, but we will always have our answer be positive.) -Elasticity #1 Pd > 1: price elastic (ex: Pd = 4.1 - 41% decrease in Quantity demanded and 10% increase in price, 2.3) = the greater the number, the more sensitive to price change #2 Pd < 1: price inelastic (ex: Pd = .3 - 3% decrease in Qd and 10% increase in price, .25) = the smaller the number, the less sensitive to price change, % change of Qd > % change in Price *10% price increase in price is just an example, it could be a 1%, 5%, or 50% change. *The change in quantity demanded will always be greater than the change in price, % change in quantity demanded < % change in price. -Definition of market: (1) Narrowly-defined market: greater number of substitutes. Ex: ice-cream (2) Widely-defined market: smaller number of substitutes. Ex: food -Pd = increasing from 10%/decreasing form 10% = 1 (at same rate) (unit elasticity) --2%/+2% = 1 (unit elasticity) -Pd = % change in Qd/% change in Price = 0 (perfectly inelastic - when divided if the change is 0) -perfectly inelastic (vertical) -perfectly elastic (horizontal) Pd = infinity -Any curve closer to the vertical line is more inelastic and any curve closer to the horizontal curve is more elastic. -Id (Income elasticity of demand) = % change in Qd/% change in income. * Income increases = Demand increases (normal good) * Income decreases = Demand decreases (inferior good) * Midpoint: % change in Qd= (EV - SV/midpoint) X 100% * Midpoint: % change in Income = (EV - SV/midpoint) X 100% * Normal good, Id (income elasticity of demand) > 0, Inferior good, Id (income elasticity of demand) < 0 (don’t drop the negative sign). -PAB (price of goods A & B) = % change in Qd of good A/% change in price of good B * PBA = % change in Qd of good B/% change in $ of good (this is DIFFERENT than the first... DO NOT USE THIS). * Good A: coke, Good B: pepsi, A & B are substitutes * Inc. in $ of pepsi = decrease in Qd of pepsi * When Pab > 0, goods are substitutes (Positive cross-price elasticity) * When Pab < 0, goods are complements (Negative cross-price elasticity) -Elasticity of Supply: * Ps = % change in Quantity supplied/% change in price * Midpoint: 1) Percent change in Quantity supplied = (EV - SV)/midpoint * 100% = (Qs2 - Qs1/ M.P.) X 100% 2) Percent change in Price = (EV - SV)/midpoint * 100% = (Ps2 - Ps1/ M.P.) X 100% *Price goes down, supply will decrease (law of supply) *Elasticity of supply is always positive. *Elastic: quantity supplied responds substantially to changes in the price change (>1), % change in Qs > % change in price *Inelastic: Qs < % change in price *Manufacturing tends to be elastic goods. Chapter 7 Class Notes * Welfare economics: whether creating new markets is beneficial or not. * Stepwise demand curve: in order to find out the max value a buyer is willing to pay. * Amount seller will receive doesn’t equal price and it doesn’t equal Pe. * Amount buyers will pay (= prices) but not Pe. * Producer surplus = profit Chapter 7 Book Notes -Welfare economics: the study of how the allocation of resources affects economic well-being. -The equilibrium of S &D in a market maximizes the total benefits received by buyers and sellers. No consumer or producer tries to move prices to the welfare-maximizing outcome, but their joint action directed by market prices moves them there naturally. -Willingness to pay: each buyer’s maximum amount that they will pay for a good, measures how much that buyer values the good. Either they will be eager to pay (lower than this amount), will not pay (above this amount) or indifferent/equally happy buying it or keeping it (equal to this amount). -If someone is willing to pay more for an item than they did, that buyer receives consumer surplus. Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. *If there are two of the goods and are sold at the same price: John and Paul bid $70 and the others aren’t willing to pay this. The albums are sold. John’s consumer surplus is $30 (willing to pay $100) and Paul’s consumer surplus is $10 (willing to pay $80). The total consumer surplus in the market is $40. -Using the Demand Curve to Measure Consumer Surplus: At any quantity, the price given by the demand curve shows the willingness to pay of the marginal buyer, the buyer who would leave the market first if the price were any higher. *Example: Q = 4 albums, demand curve is @ $50, the price that Ringo (marginal buyer) is willing to pay. At Q = 3 albums, the demand curve is @ $70, the price that George (who is now the marginal buyer) is willing to pay. *The area below the demand curve and above the price measures the consumer surplus in a market. *Consumer surplus: the difference between the willingness to pay and the market price -How a Lower Price Raises Consumer Surplus: the increase in consumer surplus of existing buyers is the reduction in the amount they pay. Also, some new buyers enter the market because they are willing to buy the good at the lower price so the quantity demanded in the market shifts from Q1 to Q2. -What does Consumer Surplus measure? Consumer surplus measures the benefit that buyers receive from a good as the buyers themselves perceive it. Thus, C.S. is a good measure of economic wellbeing if policy makers want to respect the preferences of buyers. Economists assume that buyers are being rational (do the best they can to achieve their objectives given their opportunities) and that people’s preferences should be respected. -Producer Surplus - Cost and the willingness to sell: *Example: each painter is willing to take the job if the price she would receive exceeds her cost of doing the work. Here the term cost should be interpreted as the painter’s opportunity cost: out-of-pocket expenses and the value that the painters place on their own time. They would each sell their services at a price greater than her cost, but not less than, and would be indifferent if it was = to her cost. Grandma gets the job because she bid and was the only one left who wanted the job for $600 dollars. Her cost was $500 but she received $600, so her producer surplus is $100. *Producer surplus is the amount a seller is paid minus the cost of the production. It measures the benefits sellers receive from participating in a market. *Example: two painters who get job for same price. You auction the jobs off and the price falls until there are 2 painters left. Georgia and Grama will do it for $800, so Grandma’s producer surplus is $300 (would have done is for $500) and Georgia’s surplus is $200 (would have done it for $600). The total producer surplus is $500. -Using the Supply Curve to Measure Producer Surplus: at any quantity, the price given by the supply curve show the cost of the marginal seller, the seller who would leave the market first if the price were any lower. *Example: At Q - 4 houses, the supply curve has a height of $900, the cost that Mary (the marginal seller) incurs to provide her painting services. At Q = 3 houses, the supply curve has a height of $800, the cost that Frida (who is now the marginal seller) incurs. *The area below the price and above the supply curve measures the producer surplus *in a market. The height of the supply curve measures sellers’ costs, and the difference between the price and the cost of production is the seller’s producer surplus. Thus, the total area is the sum of the producer surplus of all sellers. -How a Higher Price Raises Producer Surplus: Consumer surplus = area below the price and above the supply curve. -Market Efficiency: The benevolent social planer wants to maximize the economic well- being of everyone in society. The planner must first decide how to measure the economic well-being of a society. One possible measure is the sum of consumer and producer surplus (total surplus). Consumer surplus is the benefit that buyers receive form participating in a market and the producer surplus is the benefit that sellers receive. *Consumer surplus = value to buyers - amount paid by buyers *Producer surplus = amount received by sellers - cost to sellers *Total Surplus = (value to buyers - amount paid by buyers) + (amount received by sellers - cost to sellers) AKA value to buyers - cost to sellers *If an allocation of resources maximizes total surplus, we say that the allocation exhibits efficiency. If an allocation isn’t efficient, then some of the potential gains from trade among buyers and sellers aren’t being realized. An allocation is inefficient if a good isn’t being produced by the sellers with lowest cost, so moving production from a high-cost producer to a low-cost producer will lower the total cost to sellers and raise total surplus. It’s also inefficient if a good isn’t being consumed by the buyers who value it most highly (moving consumption of the good from a buyer with low valuation to a buyers with a high valuation will raise total surplus). *Equality: whether the various buyers and sellers in the market have a similar level of economic well-being, the social planner might also care about this. -Evaluating the Market Equilibrium: The total area between the supply and demand curves up to the point of equilibrium represents the total surplus in the market. Buyers who value a good less than the price equilibrium don’t buy the good and buyers who value the good more than the equilibrium price buy the good. Sellers whose costs are less than the price choose to sell the good, but sel


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