Microeconomics Outline I
Microeconomics Outline I ECON 0100
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Date Created: 02/09/15
Chapter 1 Economy the social science that studies the production distribution and consumption of goods and services Revolves around the allocation of scarce resources Types of Economies l Market Economy production and consumption are the result of decentralized decisions made my many rms and individuals a Each producer makes what heshe thinks will be the most pro table and each consumer buys what they choose ll Command Economy there is a central authority making decisions about production and consumption Invisible hand the manner in which a market economy manages to harness the power of selfinterest for the good of society Market failure when the individual pursuits of one s own interests make society worse off Recession a down uctuation in the economy Four economic principles underlying the economics of choice I People must make choices because resources are scarce a Resource anything that can be sued to produce something with b Scarcity when there is not enough of the resource available to satisfy all the ways a society wants to use it II The opportunity cost of an item what you must give up in order to get it is its true cost Hi How much decisions require making tradeoffs at the margin comparing the costs and bene ts of doing a little bit more of an activity versus doing a bit less IV People usually respond to incentives exploiting opportunities to make themselves better off a Incentive opportunity to make oneself better off Five economic principles that underlie the economics of interaction There are gain from trade a Trade people divide tasks among themselves and each person provides a goodservice that others want b Specialization different people each engage in a different task specializing in those tasks that they are good at performing ll Because people respond to incentives markets move toward equilibrium a Equilibrium an economic situation where no individual would be better off doing something different lll Resources should be used as ef ciently as possible to reach society s goals a Ef cient an economy is ef cient when it takes all opportunities to make some people better off without making other people worse off b Equity fairness IV Because people usually exploit gains from trade markets usually lead to ef ciency V When market don t achieve ef ciency government intervention can improve society s welfare a Reasons for market inef cacy i Individual actions have side effects that are not properly taken into account by the market ii One party prevents mutually bene cial trades in an attempt to capture a greater share of resources for itself iii Some goods are unsuited for ef cient management by markets Big picture principles One person s spending is another s income ll Overall spending sometimes gets out of line with the economy s productive capacity a In ation a rise in prices throughout the economy that occurs because the amount people want to but outstrips the supply lll Government policies can change spending Chapter 2 Production possibility frontier considering a simpli ed economy that produces only two goods Production Possibility Fi i IE iEr Iii59F I A Pm duct A I I T I I Product El Capyrignl 2323 L lmn inpediam m Points A B and C are ef cient and possible point X is inef cient and possible point Y is impossible Types of Ef ciencies 1 Ef ciency in production the point lies along the production possibility frontier 2 Ef ciency in allocation the point on the curve is the point which maximizes the desires of a given society Opportunity cost Constant opportunity cost the PPF is a straight line with a constant slope Increasing opportunity cost the PPF is a curved line with an increasing absolute valuewise slope Economic growth the growing ability of the economy to produce goods and services Represented by an upward and to the right shift of the PPF 0 Causes of this shift Increase in factors of production the resources used to produce goods and services 0 Land labor physical capital human capital Technology the technical means for the production of goods and services 0 Composite materials for example Comparative Advantage and Gains from Trade fond USA f d China Sn H33ij 43 E 32 C LLL 3D ATSL EQCI13xI 16 1 C I 12 39 I I Lifjjjjh E I 3112ij I I I I 39339 3393 32 43 clothing ID 12 16 clothing 111 produce and consume before trade E produce with trade 3 consume with trade US Opportunity Cost China Opportunity Cost 1 unit food 06 unit of clothing 333 unit of clothing gt 1 unit clothing 166 unit of food 3 unit of food lt China 48 unit food USA 48 unit clothing Comparative advantage a country has this when the opportunity cost of that production is lower for that country than for other countries Absolute advantage in a given amount of time some worker from country A can produce more of either type of product than a worker from country B 0 However comparative not absolute advantage is the basis for mutual gain Circular ow diagram er Fl E i f i j i156 Preduet Merket Petrrnent fer Geede 3 Sereieee Reeenuee Geede end Sereieee Geede end Sereieee Heueehelde Bueineeeee 1 lnpute lnpute lneeme I Wegee Rent 5 Prefit Market fer Feetere ef Preduetien Household individual or group of people that share income Firm organization that produces goods and services for sale Product market market for goods and services households but the goods and services they want from rms Factor market rms buy resources they need to produce goods and services 0 Such as land labor physical capital and human capital Types of Economics 1 Positive economics analysis that tries to answer questions about the way the world works with de nite right and wrong answers 2 Normative economics analysis that involves saying how the world should work Chapter 3 Competitive market a market in which there are many buyers and sellers of the same good or service Supply and demand model used to describe the behavior of competitive markets has 5 key elements i The demand curve ii The supply curve iii The set of factors that cause shifts in the demand and supply curves iv The market equilibrium including the equilibrium price and quantity v The way the equilibrium changes when the supplydemand curve shifts Demand Curve 0 Demand depends on price the higher the price the lower the demand 0 Demand schedule a table showing how much of a good consumers will buy at different prices 0 Demand curve graphical representation of a demand schedule M3 Price Elliaritit iiir p m Demanded mid LI 512 3 w a 53 2 5 la 339 if E an l an SD 3 quotq I Law of demand a higher price for a good other things equal leads people to demand a smaller quantity of that good Changes in Demand i Shift of the demand curve a shift of the demand curve itself arising from an increase in quantity demanded a Changes in prices of related goods or services i Substitute a good that consumers are more willing to buy as a result of the price increase of another good ii Compliments a good that consumers are less willing to buy as a result of the price increase of another good b Changes in income i Normal goods demand increases as consumer income rises ii lnferior goods demand decreases when income rises Changes in tastes Changes in expectations e Changes in number of consumers an i Individual demand curve shows the relationship between quantity demanded and price for an individual consumer ii Market demand curve the horizontal sum of the individual demand curves of all the consumers in a market ii Movement along the demand curve shift up or down an existing demand curve arising from changes in a good s price Supply Curve 0 Supply depends on the price offered to producers 0 Supply schedule table showing the price and quantity supplied at each price 0 Supply curve graphical representation of the supply schedule Quantity Supplied Price 15 3 per Price Month 12 15 5mm 9 12 4pm 9 span 5 E gum 3 man 3 1123455 Quantityr Changes in Supply i Shift of the supply curve a change in the supply schedule a Changes in input prices i Input any good or service that is used to produce another good or service b Changes in the prices of related goods and services i Substitutes in production products that ful ll the same need ii Compliments in production products that are produced together c Changes in technology d Changes in expectations e Changes in the number of producers i Individual supply curve the relationship between the quantity supplied and the price for an individual producer ii Market supply curve shows the horizontal sum of the individual supply curves of all producers ii Movement along the supply curve changes in the quantity supplied arising from a change in price Equilibrium Friaa SEWquot Damahd 25a Quantity Demanded Equilibrium price the price that matches the quantity supplied and the quantity demanded Also known as the market clearing price Equilibrium quantity the quantity bough and sold at the equilibrium price Surplus an excess supply of a product caused by the market price being above the equilibrium price FEEHH 354i ii trite Mimii Ilijligiliiili iiiiiiiii ilTiesjits i H Surname Phil i E n E E E Lia El Quantity Shortage an excess demand of a product caused by the market price being below the equilibrium price Fi iiri 3L1 i Prim iiienam Equilibrium Herijil i39 in 511 Silht t gte ii39iite T E sharing I n l l 1 Lil iii Quaii39iiiy Changes in Supply and Demand Demand curve shift PriiZE39 p 393 EH Quantity Zupyitg 39rt weltaweoitomts n litecmuk Supply curve shift F39rice P1 P2 D1 D2 Dua n tgr Chapter 4 Consumer Surplus The amount the price is below the price a consumer would be willing to pay for the good Ceneumer eurplue iethe difference between the price that a consumer is prepared te pay and the aetual price paid in the market Friee Suppl r Equilibrium Feint IIllzineumer Surplus e1 Dmand m Quantity Total Consumer Surplus the sum of the individual consumer surpluses of all the buyers in the market Producer Surplus the difference between the minimum price a producer would have been willing to sell at and the market price Cost the lowest price a potential seller is willing to sell at F39lf dulEEf Euiiriplliu i Ihlemelteireann 39 25 a e33 30G 4 quot J 7 LL u U P ete39a Eur ilue i l a U Fl Pm 39kpt r E E39 r a a J hn39s U eeee Surplus E Market I H U Predueer V g 0 ll U Surplue v equot 39 ll U v i 1M 39 U u U I U U U J U U l U E U H ll i a 1 a a uent Quantity Total Surplus the sum of the consumer and producer surpluses in a market Ef ciency if a market is ef cient there is no way to make some people better off without making other people worse off Ways that would fail to increase the total surplus of a market i Reallocate consumption among consumers ii Reallocate sales among sellers iii Change the quantity traded 4 important functions performed by an ef cient market 1 Allocates consumption of the good to the potential buyers who value it the most indicated by highest willingness to pay 2 Allocates sales to potential sellers who most value the right to sell the good indicated by them having lowest cost 3 Ensures every consumer who makes a purchase values the good more than the sellers who make the sale all transactions are mutually bene cial 4 Ensures every potential buyer who doesn39t make a purchase values the good less than every potential seller who doesn39t make a sale no mutually bene cial transactions are missed Why Markets Work Well 0 Property Rights valuable items have speci c owners 0 Economic Signals any piece of info that helps people make better economic decisions Why Markets Fail Monopolies Externalities Nature of goods are unsuited for ef cient management by markets Chapter 5 Price ceiling an upper limit on the amount that can be charged for a good or service wigE mining pmiilin 39 Quantity 31 Problems with Price Ceilings i Shortages 39 MPH Frieze rim mailmm 39 raga hl ng Dema E1 ma WHIij ii Deadweight loss Reall Hallow per will per month x x iCumum ar yij ff z 39ufllu H Deoi wia iglll 2 lms Rem cei ihg yr Ma39s 7 7 73 5 iv surplus l 7 I I 1 FE 39339 EEC Quantity themesde all wilt per munlhl Illegal ActivityBlack Markets Price Floors a lower limit on the amount that can be charged for a good or service priae floor 2 ll39lliliaritilizli i39il Problems with Price Floors Surplus Price per bushel Wage F l39 Edilllmrs par h uri Surplus W1 Bushels per year Deadweight Loss F L L Fll39mcal l 1 gileIJE f FiE iil l l is 39Fr m ital 531mlle Minimum wage Wnrkmal lsu lus z fg 3 I I Un li i lmllli ns Ell Elm5 3935quot Fair Illegal Activity Controlling Quantities Quota a regulation of the quantity of a good that can be bought and sold Deadweight 11155 Gnvenunent Quota amigm 055 mnIIIild IlllluantitfF Price received by S A Price paid by B C CA the price of the quota rent 0 Also known as the wedge Chapter 6 Price Elasticity of Demand change in quantity demanded change in price a Inelastic demand PE of D lt 1 b Elastic demand PE of D gt 1 c Unitelastic demand PE of D 1 Total Revenue Price x Quantity sold Tamil Romn39enmf is that area ml1 Iihii39 Itlthmzaml Emn ii Prime Elli lirrnrinerl mil Quiltilli ljr Price effect after a price increase each unit sells at a higher price which tends to increase revenue Quantity effect after a prices increase fewer units are sold which tends to lower revenue rii lf 39l H La U 39ll EmEJ f f thanquot antianti The sum of these two effects on revenue can be determined by the price elasticity of demand Unitelastic demand an increase in price does not change total revenue quantity and price effect exactly offset one another Inelastic demand an increase in price increases total revenue the price effect is stronger than the quantity effect 0 Elastic demand an increase in price decreases total revenue the quantity effect is stronger than the price effect Price Elasticity along a Demand Curve price T 5 5 gm grjllritE H EET m ml l mriitiiri 4 4 1 efr rft 39iEEJ FE LFEHHi39T EEETWEFIUquot til i r a a i u r j i I w a3iellri5ritterri ed it 3 E i t H 1 u I gt 2 irrigatrc rn39 ti E 1 U 2 1111mm Factors Determining the Price Elasticity of Demand i Availability of Close Substitutes price elasticity is high if there are other readily available goods similar to the one in question ii Necessity or Luxury For necessities the price elasticity is low for luxuries it is high iii Share of income spent if spending on a good accounts for a small share of income price elasticity tends to below iv Time elapsed since price change price elasticity tends to increase as consumers have more time to adjust to a price change Other Demand Elasticities CrossPrice Elasticity of Demand determines the strength of the relationship between two goods 0 Formula change in quantity A demanded change in price of B Substitutes positive CPE the higher the value the closer the substitutes Compliments negative CPE the lower the value the closer the compliments 0 Income Elasticity of Demand measures how much the demand of a good is affected by changes in consumer s income 0 Formula change in quantity demanded change in income Normal good positive IED quantity demanded increases as income increases Inferior good negative IED quantity demanded decreases as income increases Price Elasticity of Supply change in quantity supplied change in price a Perfectly inelastic price has no effect on quantity supplied b Perfectly elastic any fall in price cases quantity supplied to be 0 c In between ordinary upwardsloping supply curve Chapter 7 Taxes Drives a pricewedge between the supply and demand curves equal to the amount of the tax Pdce PC Po Pp quotMK Eris quot Deadweight 39P E lossofvalue Qt Iii Quantity Incidence who bears the burden of a tax Incidence and Price elasticity a Demand inelastic amp Supply elastic a Incidence falls mainly on consumer b Demand elastic amp Supply inelastic a Incidence falls mainly on producer Tax Revenue Quantity x tax rate Tax rate amount of tax levied per unit of whatever is being taxed Relationship between tax rate and revenue Ihismaill cncarn If v Costs of Taxation rapht 3mm 5mm Price of a car S 556131 3209 36 Lil Quantity if cars Area in grey is formerly total surplus it is transferred to the government in terms of tax revenue Area in red is deadweight loss due to the tax these are transactions that would have occurred without the tax but with the tax are now illegal Area in green is consumer surplus Area in yellow is producer surplus Effect of Elasticity on Deadweight loss of a tax Deadweight loss is smaller when demand supply or both are inelastic Deadweight loss is larger when demand supply or both are elastic Equity vs Ef ciency 0 Abilitytopay principle those with greater ability to pay a tax should pay more 0 Bene ts principle those who bene t from public spending should bear the burden of the tax that pays for that bene t Types of Taxes i Income tax tax that depends on the income of an individual ii Payroll tax a tax that depends on the earnings an employer pays to an employee iii Sales tax a tax that depends on the value of goods sold iv Pro ts tax a tax that depends on a rm s pro ts v Property tax a tax that depends on the value of property such as the value of a home vi Wealth tax a tax that depends on an individual s wealth Tax Structures Proportional Tax Flat tax same percentage of the base regardless of the taxpayer s income or wealth Progressive Tax a tax that rises more in proportion to income Regressive tax a tax that rises less than in proportion to income Marginal Tax Rate the percentage of an increase in income that is taxed away
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