Why is economics necessary?
∙ Study of how individuals, firms, and society make decisions to allocate limited resources to many competing wants.
∙ Remember “I” for the INDVIDUAL
∙ Individual firms
∙ Individual consumers
∙ Individual markets
∙ Economics as a whole
How do you judge a model?
∙ Predictions We also discuss several other topics like What type of graph is best for showing a pattern in a set of data?
Don't forget about the age old question of What is the meaning of gestalt psychologists in psychology?
Why does every decision we make have an opportunity cost?
∙ We give something up
What is meant by the word marginal? We also discuss several other topics like Where did the axial age happen?
How should individuals make decisions using marginal analysis?
∙ To help them maximize there potential profits.
∙ Individuals Unconsciously use marginal analysis as well to make a host of everyday decisions. We also discuss several other topics like How do you write a memorandum of understanding between two parties?
4 IMPORTANT QUESTIONS TO REMEMBER:
∙ What is on the axis?
∙ Why are curves upward or downward sloping?
∙ What shifts the curves?
∙ What is the story behind the graph?
What are the types of resources?
∙ Labor (human capital)
∙ Capital (careful!)
What does the PPF diagram illustrate?
∙ Output of Goods = f(Resources, Technology)
∙ These resources can only produce a certain amount =>Choice =>Opportunity Cost Can you show the opportunity cost on a PPF diagram (draw the PPF and show opportunity cost)?
Quant. Of Corn
Opp. Cost of Corn
1 1 gun
2 2 guns 3 3 guns 4 0 4 guns If you want to learn more check out What is meant by amphipathic?
If the PPF for a country is a straight line, what does that say about opportunity cost?
∙ A straight line PPC means that for every unit of good y relinquished, an additional unit of good x can be produced.
In general, why does opportunity cost tend to increase as more of one good is produced? What does this say about the shape of the PPF?
∙ The factors (resources) used in production of y is perfectly substituted for the production of x.
∙ This is known as production under constant costs.
∙ Tradeoffs for society
Which points in a PPF diagram are attainable?
∙ Points on or inside the PPF are attainable
∙ Points outside the PPF are unattainable
Which points in a PPF diagram are productively efficient?
∙ Lie on existing PPF
Can you tell, using just a PPF diagram, which point on the PPF is allocatively efficient?
∙ Where the supply and demand curve intersect
∙ Allocative efficiency will occur when marginal benefit = marginal cost.
∙ An increase in the PPF illustrates growth in the economy.
What kinds of changes will cause the PPF to shift?
∙ Economic growth, more resources, better technology Don't forget about the age old question of What are the methods for organizing and summarizing information?
Who is represented by demand?
∙ Describes the behavior of buyers in a market
Who is represented by supply?
∙ Describes the behavior of sellers in the market
What does the law of demand say?
∙ Ceteris paribus, price and quantity demanded are inversely related
Why is the law of demand true? (Income and substitution effects)
∙ Substitution Effect
∙ Income Effect (purchasing power goes down as price goes up, so you buy less)
Explain why each of the following categories will cause the demand curve to shift?
∙ Prices of related goods (subs / comp) The prices of related commodities also affect consumer decisions.
o Movies and popcorn, on the other hand, are examples of complementary goods.
o Movies, concerts, plays, and sporting events are good examples of
substitute goods, because consumers can substitute one for another
depending on their respective prices
∙ Income (normal / inferior) EXAMPLE: as income rises, demand for most goods will likewise increase. Get a raise, and you are more likely to buy more clothes and acquire the latest technology gadgets. Your demand curve for these goods will shift to the right
∙ Expected future income and prices If consumers expect shortages of certain products or increases in their prices in the near future, they tend to rush out and
buy these products immediately, thereby increasing the present demand for the products.
∙ Number of buyers Clearly, the more consumers there are who would be likely to buy a particular product, the higher its market demand will be (the demand curve will shift rightward)
∙ Tastes and Preferences EXAMPLES: Automobiles, fashions, phones, and music are just a few of the products that are subject to the whims of the consumer.
Why doesn’t a change in the good’s price shift the demand curve?
∙ No relevant economic factors, other than the product’s price, are changing. ∙ Economists call this assumption ceteris paribus, a Latin phrase meaning “other things being equal”.
∙ Ceteris paribus
What does the law of supply say?
∙ Ceteris paribus, quantity supplied and price are directly related
Why do firms need to receive a higher price in order to increase their quantity supplied? ∙ The opportunity cost of producing a good increases as we produce more Explain why each of the following categories will cause will cause the supply curve to shift?
∙ Cost of resources (factors of production) If resources such as raw materials or labor become more expensive, production costs will rise and supply will be reduced
∙ Prices of related goods produced (subs in production / comp in prod) EXAMPLE: If the price of celery should rise, for instance, most farmers will start growing more celery
∙ Expectations When sellers expect prices of a good to rise in the future, they are likely to restrict their supply in the current period in anticipation of receiving higher prices in some future period
∙ EXAMPLE: Plane Tickets
What happens if the price of a good is above / below the equilibrium price?
∙ If the market price is above the equilibrium price, quantity supplied is greater than quantity demanded, creating a surplus.
What is meant by equilibrium in a market?
∙ Supply in the market is equal to the demand in the market.
Illustrate with a diagram and explain what happens to the equilibrium price equilibrium quantity of a good if:
∙ Demand increases Excess demand will cause the price to rise, and as price rises producers are willing to sell more, thereby increasing output.
∙ Demand decreases A decrease in demand will cause a reduction in the equilibrium price and quantity of a good.
∙ Supply increases Excess supply causes the price to fall and quantity demanded to increase.
∙ Supply decreases Excess demand causes the price to rise and quantity demanded to decrease.
Chapter 4 Market Efficiency, Market Failure, and Government
Know that allocative efficiency says we need to weigh the marginal costs vs. the marginal benefits of doing something.
Demand is the marginal benefit or value to consumers.
Supply is the marginal cost to firms
What is consumer surplus? How do you find the area that represents CS on a supply and demand graph?
∙ TOP PORTION above equilibrium
∙ ½ base x height
What is producer surplus? How do you find the area that represents PS on a supply and demand graph?
∙ Below equilibrium
∙ ½ base x height
Welfare = Total Surplus = CS + PS
Understand that market equilibrium, the allocatively efficient quantity, is where welfare is maximized.
Understand that market failure occurs when the market does not produce the allocatively efficient quantity of a good or service for society.
∙ Price ceiling – maximum legal price
∙ Rent controls
What is meant by deadweight loss?
∙ is a loss of economic efficiency that can occur when equilibrium for a good Price floor
∙ Price floor– minimum legal price
∙ Agricultural price guarantees
Use the diagram below to answer question 1. Quantity of Corn
1 2 A B
1 2 3 4
Q u a n t i t y o f P e a n u t s
1. Which of the following is true?
a. The opportunity cost of the second unit of peanuts is 1 corn.
b. The opportunity cost of peanuts is constant as more peanuts are produced. c. The opportunity cost of the third unit of peanuts is 4 corn.
d. The opportunity cost of the first six units of corn produced is 3 peanuts.
2. The invention of a fully automated pizzaproducing machine in the pizza market would ___________ the equilibrium price of pizza and ___________ the equilibrium quantity of pizza.
a. decrease, increase
b. decrease, decrease
c. increase, increase
d. increase, decrease