Sunday, February 14, 2016

How do you describe microeconomics?

ECO211- Exam Study Guide

Chapter 1-5

- Economics: study of how you allocate resources under conditions of scarcity

• Microeconomics: study of how individuals allocate resources under conditions of  scarcity (small scale)  

• Positive economics: “as it is”, description and explanation of economic phenomena  (scientific explanation: focuses on facts and cause-effect relationships and testing  of economic theories)

• Normative economics: “as it should be”, how to make things better (prospective) - 3 Principles (to maximize utility/pleasure)

1. Optimization: process of making the best choice possible with given available  information

2. Equilibrium: when everyone is optimizing, no one would be better off with a  different choice

What is the difference between correlation and causation?

If you want to learn more check out How do you find the perfect order?

3. Empiricism: analysis that uses data that is evidence-based to determine what is  causing things to happen in the world

- Opportunity cost: best alternative use of a resource (going to the watch one  movie instead of the other one)  

- Scientific Method (2 Steps)

• Step One: Developing models that can explain some part of the world

• Step Two: Testing those models using data to see how closely the model matches  what we actually observe  Don't forget about the age old question of Where do bacteria come from?

- model: simplified description of reality (drastic simplification)  

- Causation VS Correlation

• Causation: when one things affect the other  

• Correlation: when two things are related  

What is mean by demand curve?

• Correlation doesn’t prove causation (There are omitted variables.) 1

Sunday, February 14, 2016

- Principle of Optimization at the margin

• if the option is the best choice, you’ll be made better off as you move toward it, and  worse off as you move away from it

• marginal: incremental (small change)

- Demand Schedule

• Demand curve: Price increases, Quantity decreases

• Exogenous: outside the system

• Endogenous: inside the system (on the axis, price and  

quantity) Don't forget about the age old question of What are the notable developments in the late-20th century?

• Quantity demanded: Things along the curve

- Ceteris Paribus: all else equal

- Supply Schedule

• Price increases, Quantity increases  

- Things that shift the demand curve

• Related goods: changes in prices of a  If you want to learn more check out What is succubi?

substitute/complimentary good

• Taste and preferences  

• Consumer income

• Expected price of good

• Normal VS Inferior goods

- Normal: Income increases, consume more (demand increases) Don't forget about the age old question of What is expected return?

- Inferior: Income increases, consume less (demand decreases)

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Sunday, February 14, 2016

- Things that shift the supply curve

• Improvement in technology

• Decrease in the cost of input

• Expectation of falling prices

• Weather

• Exogenous factors cause the curve to shift,  

endogenous factors are along the line If you want to learn more check out What is speech?

- Equilibrium: the point where the demand and supply  

curves intersect  

- Budget Constant

- Consumer Surplus Formula

- (What you’re willing to pay) - (what you actually pay)  

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Sunday, February 14, 2016

- Elasticities of Demand (IMPORTANT FOR EXAM)

- Elasticity can go from zero to infinity on the demand curve

- slope is constant **Elasticity DOES NOT EQUAL slope**

- Can’t eyeball the number, must calculate except when:

Or  

When demand or supply curve is  

vertical, it is perfectly inelastic. When demand or supply curve is  horizontal, it is perfectly elastic.

- Estimate of Elasticity formula

•If the points are closer together, the more accurate the  

estimate will be  

•Take the absolute value of the answer so it will never  

be a negative number  

• Q intercept is perfectly inelastic

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Sunday, February 14, 2016

- Elasticity of demand  

• Price elasticity of demand: � • Price elasticity of supply: η - Characteristics of � and η

= � or η

Values of � and η

Characteristics

� and η= 0

Perfectly Inelastic

� and η= between 0 and 1

Inelastic

� and η= 1

Unit Elastic

� and η= greater than 1

Elastic

� and η= ∞

Perfectly Elastic

- Graph Example 1

Price

Quantity Demanded (�)

Quantity Supplied (η)

10

0

7.5

9

1

6

8

2

4.5

7

3

3

6

4

1.5

5

5

0

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Sunday, February 14, 2016

• (�) is greater than 1, the demand curve is elastic and is above the unit elastic point  which is 1 (Increase supply and lower price)

• (η) is greater than 1, the supply curve is elastic

• Short-run: Things tend to be more inelastic  

• Long-run: Things tend to be more elastic  

Factors of Production

- Perfect Competition: no one buyer or seller can affect the market price by themselves  (both consumer and firms are price takers) (free entry: anyone can enter the market)

- Inputs of the production function (Factors of production)

• Capital: physical input to the production process to create output (land, natural  resources, machinery, factories)

• Labor: human work effort  

- Cost of production  

- Cost = Fixed Cost + Variable Cost

- Cost of Production Example

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Sunday, February 14, 2016

- Function: C= 4x+2q2  

- p= 10

q: level of  output for  the firm

FC (Fixed  Cost)

VC  

(variable  

cost) (2q2)

C (Total  

Cost)

MC  

(Marginal  Cost)  

(ΔC/ΔQ)

ARC  

(FC/ q)

AVC  

(VC/q)

AC  

(C/q)

R (p x q)

Profit  

(R-C)

0

4

0

4

2

-

-

-

0

-4

1

4

2

6

6

4

2

6

10

4

2

4

8

12

10

2

4

6

20

8

3

4

18

22

14

4/3

6

22/3

30

8

4

4

32

36

18

1

8

9

40

5

5

4

50

54

-

4/5

10

10 4/5

50

-4

Profit is going to be maximum between q (2) and q (3)

- MC will go through  

and intersect AC  

curve at its  

maximum

-AC will always be a  

“U” shape

Competitive  

Model/ Point of Beauty  

** Chapter 7 Online Homework NOT NEEDED, NO textbook reading required** ** Everything that’s going to be on the test will be mentioned during lecture**

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Sunday, February 14, 2016

- Competitive Model (Perfect Competition/ Competition)  

• Assumptions:  

- Many buyers and sellers (both firms and consumers are price takers) - Free entry and exit (no barriers to enter market)  

- 0 profits in the long run (not actually 0, but economists don’t know what the rate  of return is so they use 0)

- homogeneous product (undifferentiated product): everybody makes exactly the  same thing  

• Point of beauty: Profit = 0  

• Firms must operate well to stay within point of beauty to stay in business • AC curve is like the supply curve for the firm

• Supply curve for the industry is the aggregate supply

• if the firm is not regulated (has choices): Output= MC = MR

- Finding Profit  

• Function: Profit = (P-AC) x q

•Shaded rectangle  

is the profit

• There is profit if  

the shaded  

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Sunday, February 14, 2016

rectangle is above the AC curve, loss if the shaded rectangle is below the AC curve.  

Example test questions  

1. What does it mean when the long-run supply curve is horizontal.  - Because there is free entry and exit, when the price of a good is too high, firms will  enter the market (supply increases), causing the price to go down back to the point  of beauty/ back new equilibrium at the long run supply curve.

D2

• Will always go back to the point of  beauty

• LR Supply is in line with the point of beauty • Situation: Demand goes up, E1 shifts to E2  causing the price to go up

• Because prices go up, more firms enter the  market causing the Supply to increase, E2  shifts to E3 and meets back at the LRS  curve

2. What does it mean when the price is determined by technology in a competitive  market?  

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Sunday, February 14, 2016

• If the firm comes up with better  

•LR

technology to increase output more  

efficiently, the AC curve shifts down,

and the point of beauty goes down  

(Price becomes cheaper and the  

consumer benefits)

Production Possibility Frontier/ Comparative and Absolute Advantage  - Production Possibility Frontier (PPF)

•Sloping down because of diminishing returns  

•Shows maximum output possibilities for two goods  

•Y intercept: maximum output for Product A  

•X Intercept: maximum output for Product B  

- Absolute Advantage  

- country’s ability to produce a certain good more efficiently than the other country  (Who can produce more of Product A? Who can produce more of Product B?)

- US has an Absolute Advantage  

in making Laptops (3 is greater  

than 2 (China’s production of  

laptops))

-China has an Absolute  

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Sunday, February 14, 2016

Advantage is making Cars (6 is greater than 2 (US’s production of cars))  - Efficiency: “How big?” Maximizes welfare

- Equity: Who gets what?

- Trading can have winners and losers  

- Autarky: absence of trade  

- Comparative Advantage  

- Countries should tend to specialize in industries that take advantage of their  relative factor endowments (Inputs: natural resources, labor, human capital) and  specialize to be made better off

- Steeper slope: has comparative advantage in product on Y axis

- Flatter slope: has comparative advantage in product on X axis  

-Comparative Advantage Example Problem

• Which has the absolute advantage in making guns?

• No one. Both countries will produce 3 in autarky  

• Comparative Advantage  

• Swaziland: Guns

• Swaziland has a steeper slope and has a comparative advantage in the Y axis  product, guns

• Madagascar: Butter

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Sunday, February 14, 2016

• Madagascar has a flatter slope and has a comparative advantage in the X axis  product, butter  

• What is the opportunity cost of producing 2 guns in Swaziland?

* Multiply (2 guns) by (1 butter/ 3 guns) to cancel out the guns algebraically, so  that we are left with just the butter

• What is the opportunity cost of producing 1 gun in Madagascar?

* Multiply (1 gun) by (2 butter/ 3 guns) to cancel out the guns algebraically, so  that we are left with just the butter

Welfare Analysis  

- Autarky: absence of trade  

- Dead weight gain: the market is working efficiently

- tariffs: tax on imports

- Infant Industry Argument (Import Substitution Industrialization)

• putting tariffs of imports (ie: $1,000 on a Japanese car) so that infant industries  (new industries) will develop and local manufacturers start producing

• as local production rise, government can take off tariffs later and allow the local  manufacturers to compete in the global market

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Sunday, February 14, 2016

• the argument is used in Latin American countries and is failing

EXAMPLE 1 

Autarky (1)

Free Trade (2)

Δ (2-1)

Consumer Surplus

A+B

A

A-(B+A)= -B

Producer Surplus

E

B+C+D+E

(B+C+D+E)-(E)=

B+C+D

Government Revenue

0

0

0

Welfare (Add column)

A+B+E

A+B+C+D+E

(A+B+C+D+E)-(A+B+E)=

C+D

Welfare analysis: Welfare is positive (C+D): efficient, increase welfare, total  surplus, dead weight gain (look at bottom right corner of table)

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Sunday, February 14, 2016

**Consumer Surplus: area below Demand curve, above the PA/PFT line** **Producer Surplus: area above Supply curve, below PA/PFT line** **Government Revenue: 0 in this case because there is no government intervention**

EXAMPLE 2 

Free Trade (1)

With Tariff (2)

Δ(2-1)

Consumer Surplus

A+B+C+D+E+F

A+B

(A+B)-(A+B+C+D+E+F)=

-C-D-E-F

Producer Surplus

G

C+G

(C+G)-(G)= C

Government  

Revenue

0

Area of rectangle  E

(E)-(0)= E

Welfare

A+B+C+D+E+F+G

A+B+C+E+G

(A+B+C+E+G)-(A+B+C+D+E+F +G)= -D-F

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Sunday, February 14, 2016

Welfare analysis: Welfare is negative(-D-F): inefficient, decrease welfare, dead  weight loss (look at bottom right corner of table)

**Consumer Surplus: area below Demand curve, above the PFT/PWT line** **Producer Surplus: area above Supply curve, below PFT/PWT line**

**Government Revenue: Area of rectangle E because the space presents the amount of  taxes the government is collecting from the goods**

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