Intro to Microeconomics
Exam 1: Chapters 15
Monday, October 1, 2018
- Define economics and distinguish between micro and macro economics - Explain the notion of opportunity cost
- Identify the opportunity cost of a given action/choice
- Use marginal analysis to predict decisions
- Describe the benefit of allocating resources using economic markets and the limits of such markets
- Recognize the importance of assumptions and model in economics
- Distinguish between positive and normative statements
- Describe the movement of inputs, outputs, and dollars in an economy using the circular flow diagram
- Relate the productions possibilities frontier to the concepts of scarcity, efficiency, opportunity cost, and diminishing marginal returns
- Recognize how trade influence everyday life
Don't forget about the age old question of gatech math
- Distinguish between absolute and comparative advantage
- Explain why trade occurs according to the Principle of Comparative Advantage - Identify areas of specialization, mutually beneficial terms of trade, and consumption possibilities given a scenario
- Recall the laws of demand and supply
- Distinguish between changes in quantity demanded (supplied) and changes in demand (supply)
- Explain the role of markets in determined prices and quantities sold
- Illustrate how changes in economic factors affect markets using the supplyanddemand model
Define, calculate, and interpret price/income/crossprice elasticity of demand and price elasticity of supply
Identify factors influencing demand and supply elasticities
Relate price elasticity of demand to total revenue
Chp 1: Principles of Economics
- The choices we make when we can’t get everything we want
- How society allocates scarce resources among competing uses
- Ten Principles of Economics 17
How people make decisions
1. People face tradeoffs
2. The cost of something is what you give up to get it
3. Rational people think at the margin
4. People respond to incentives
How people interact
5. Trade can make everyone better off
6. Markets are usually a good way to organize economic activity
7. Governments can sometimes improve market outcomes We also discuss several other topics like dq2 guide
- Production: output in individual industries and businesses
- Prices: prices of individual good and services
- Income: distributions of income and wealth
- Employment: employment by individual businesses or industries
- Ten Principles of Economics 810
How the Economy as a Whole Works
8. A country’s standard of living depends on its ability to produce goods and services.
9. Prices rise when the government prints too much money.
10. Society faces a shortrun tradeoff between inflation and unemployment - Production: national output We also discuss several other topics like ger 2010 class notes
- Prices: aggregate price level
- Income: national income
- Employment: (un)employment in the economy
Some Fields of Economics
- Development economics
- Labor economics
- Health economics
- Environmental economics
- Comparative economics
- Sports economics
- Industrial organization
- Regional economics
- Economics history
- Most decisions we make are economic; we act with considering weighed tradeoffs. - Three key tradeoffs in society:
1. Resources: What gets produced?
Allocation of resources
2. Producers: How is it produced?
Distribution of output/Mix of output
3. Households: Who gets what is produced?
- opportunity cost: the value of the best alternative use of a resource; the value of the next best thing; includes explicit & implicit costs
Ex: there is no such things as a free lunch because you would spend your time, the best alternative, waiting for it
- explicit cost: direct payment made to others in the course of running a business Ex: wage, rent, materials Don't forget about the age old question of pinacocytes function
- implicit cost: any cost that results from using an asset instead of renting/selling it - opportunity gain: the value of the contribution of a resource
- sunk cost: the value of a cost that has already been made and cannot be recovered
Thinking at the Margin
- marginal change: a small incremental adjustment to an existing plan of action - A rational decision maker aims to get greatest benefit/satisfaction & compares marginal benefits to marginal costs
- Take action IF marginal benefit greater/equal to marginal cost; then reevaluate for next step
- incentive: anything that induces you to act
- Can be positive (trying to get us to come to class for participation points) or negative (trying to get us not to cheat with bad grades and disciplinary action) We also discuss several other topics like the process by which social structures are increasingly characterized by the most direct and efficient means to their ends is called rationalization.
- Mutually beneficial
- Enables specialization
- Promotes variety
The Role of Prices in Markets
- market: an exchange mechanism that allows buyer to trade with sellersDon't forget about the age old question of reinforcing contributory cause
- price: influences decisions of buyers and sellers and is likewise influenced by their decisions
- A pure market economy relies only on the forces of supply and demand to set the prices of goods and services (i.e. the invisible hand); no intervention by government - Economic spectrum
o Communism: planned system, high degree of government control, high level of social services
o Capitalism: free market systems, low degree of government control, low level of social services
o U.S. on economic spectrum: U.S. is a mixed economy (somewhere btw socialism and communism). Markets do most of the work, but the government plays a role in the allocation of many resources (education, roads, medicine, etc)
o Where should U.S. be on economic spectrum? Consensus of poll more towards socialism
Efficiency vs. Equality
- efficiency: achieving the max benefit given available resources (size of economic pie) - equality: equal distribution of benefits
- Which to focus on is debatable
Ex: government safety net programs improve equality but reduce efficiency; balance unemployment can’t be too low or too high, people must be applying for jobs
The Role of Government
- Governments help to enforce the property rights necessary for markets to function - Property rights are important because if no one is enforcing them then people will steal - Property rights give you ownership of property and right to transfer ownership; trade involuntary exchange; no property rights = no trade
- Government can also improve efficiency when markets fail due to
o externalities: failure of individuals/firms to internalize costs (ex pollution); no efficient outcome = market failure; government can come in and help (ex: taxes polluting firm, firm considers extra cost and proceeds)
Benefits positively impacts bystander
Costs negatively impacts bystander
o market power: ability of firms to exercise undue influence in a market
- Scarce resources force tradeoffs
- Our actions have explicit and implicit costs
- The best decisions are made at the margin; one step at a time, incremental - Allowing trade to be facilitated by markets is generally best, but government can sometimes help to improve outcomes
Chp 2: Economists Wear Many Hats
Positive vs Normative Statements
- As scientists, economists use positive statements to describe the world as it is - Positive statements can be confirmed or refuted; fact; can’t argue other side - As policy advisers, economists use normative statements to describe how the world should be.
- Normative statements can’t be confirmed or refuted; opinion; can argue other side
- Economists may disagree regarding policy prescriptions due to differences in scientific judgments and values
- Sometimes policy makers don’t follow the advice of economists; it’s complicated
Economists as Scientists
- Engage in an objective search for answers
- Some use experiments to gather data; but, many don’t, because experiments may be impractical, costly, of unethical
- ask question conduct background research construct hypothesis gather data analyze data draw conclusions
Assumptions and Models
- Assumptions help to simplify complex situations and direct attention to a specific aspect of a problem
- models: simplified representations of reality often in the form of diagrams and equations Ex: maps, diagrams
- circular flow diagram: a simplified, visual representation of the economy that aims to answer the questions: “How is the economy organized?” & “How do participants in the economy interact?”
The Production Possibilities Frontier
Figure 1: The Circular Flow Diagram (source: screenshots from lecture power point)
- The Production Possibilities Frontier (PPF): a model that shows combinations of two goods the economy can produce (output) given available resources and technology
Figure 2: PPF Example
- Points on PPF: feasible, efficient (produces max possible using all resources)
- Points below PPF: feasible, inefficient (resources are underutilized)
- Points above PPF: Infeasible (too few resources available)
- The opportunity cost of an item is what must be given up to obtain that item
- Moving along a PPF involves shifting resources (Ex: labor) from the production of one good to the other
- The slope (steepness; rise over run; change in y over change in x) of the PPF tells you the opportunity cost of one good in terms of the other; lower slope= lower opportunity cost
- Shape could be straight line (opportunity cost remains constant) or bowshaped curve (opportunity cost rises with population;
opportunity cost of production differs among goods or diminishing
marginal returns); depends on the nature of the
opportunity cost as the economy shifts resources from
one industry to the other
Diminishing Marginal Returns
- Increasing one input, while holding all others constant, will eventually result in smaller and smaller additions to output; increasing opportunity costs
- Marginal benefit/cost determined by difference in two points
Changes in the PPF
- PPF graphical representation of the productive capacity of a twogood economy - The PPF may shift or rotate depending on changes in the quantity and/or productivity of the factors of production
o Shifting reflects changes that have the same impact on both goods
o Rotating reflects changes that impact one good (or, one good more than the other) - Economic growth shifts PPF outward can increase possibilities for production of both products
- Economic growth specific for one product rotation of PPF; wouldn’t impact other product
- The PPF shows all combinations of two goods that an economy can possibly produce, given its resources and tech
- PPF illustrates the concepts of tradeoffs, efficiency, and economic growth - A bowshaped PPF illustrates the concept of increasing opportunity cost
Cpt 3: Why do People Trade?
Trade in Everyday Life
- Goods and ideas (design) traded from different countries
PPF and Trade
- PPF shows various combinations of output that an economy can produce - Because the PPF reveals the tradeoffs faced in production, it can be used to explain interdependence among people and nations
- Trade among companies, not just countries, so microeconomic
- To determine why two people trade, we must determine who has the lower cost of production
- We can use the PPF to examine differences in the cost of production using two methods: o absolute advantage: compares the productivity of producers – the number of inputs required to produce one unit of a given good
o comparative advantage: compares the opportunity cost of production – what is given up to produce an additional unit of a good
The Principle of Comparative Advantage
- Each good should be produced by the person that has the lower opportunity cost of producing the cost of producing that good
- The games from specialization and trade are based on comparative advantage, not absolute advantage
Terms of Trade
- terms of trade: amount of one good that must be given up to obtain another - Trade is mutually beneficial if each party can buy a good at a price lower than his/her opportunity cost
- Acceptable terms of trade are those in which the “price” falls between the opportunity costs of both parties.
- Specializing and trading according to comparative advantage (not absolute advantage) is mutually beneficial
- Though trade benefits society overall, some individual producers may “lose” in the process.
- Absolute advantage can make more of a product when producing only that product vs competitor
- Opportunity cost of producing product: not producing/producing
- Specialize dependent on differences in opportunity cost; lower opportunity cost should specialize
- Mutually beneficial fall btw two opportunity costs; each country specializes in product with lower opportunity cost; country selling want prices greater than cost of production - After trade leftover product is consumption possibilities
Cpt 4: Talk is Cheap Because Supply Exceeds Demand
Perfectly Competitive Market
- Goods are homogeneous (exactly the same)
- So many buyers and sellers that non have an influence on price
- Buyers and sellers are price takers
The SupplyandDemand Model
- The most powerful model in economics
- Used to describe how interactions between producers
and consumers in competitive markets determine the
quantities of a good/service sold and the price at which it
is sold & to analyze the response of markets to change in
- Consumer side
- Many factors influence what consumers buy, but economists tend to focus on price. - quantity demanded: amount of a good buyers are willing and able to purchase; the sum of individual demands
- The Law of Demand: all else equal, there is an inverse relationship between price and quantity demanded
- demand schedule: a table showing the quantity demanded of a good at a given price
- demand curve: the graph that corresponds to the demand schedule; inverse relationship between price and quantity
- the ceteris paribus assumption (cp): both demand schedules and demand curves hold ALL other factors influencing demand constant
- change price movement along the demand curve
- change in income, prices of related goods, tastes, expectations, number of buyers shifts in the demand curve (changes quantity demand at every price)
- If you want to increase the DEMAND, then change the price of a related good (shifts line).
- If you want to increase the QUANTITY DEMANDED, then increase the price of the good itself (movement along line)
- normal goods: goods for which demand is directly related to income
o income and demand move in the same direction (cp)
- inferior goods: goods for which demand is inversely related to income o income and demand move in opposite directions (cp)
- substitutes: a good that can be used in the place of another good
o An increase in the price of one good leads to an increase in demand for the other (cp)
Ex: increase price of butter, demand for margarine increases
- complements: goods used in conjunction with one another
o An increase in the price of one good leads to a decrease in demand for the other (cp)
Ex: increase price of cereal, demand for milk decrease
o Each point on the demand curve represents the quantity demanded at a given price.
o The downward slope of the demand curve illustrates the law of demand. o Changes in ownprice result in movements along the demand curve.
o Changes in nonprice variables result in shifts of the demand curve.
- Producer side
- quantity supplied: amount of a good sellers are willing and able to sell; the sum of individual supplies
- Law of Supply: there is a direct relationship between quantity supplied and price (cp) - Similar to demand, the relationship between price and quantity supplied can be depicted in a table (supply schedule) or in a graph (supply curve) (direct relationship between price and quantity)
- change price movement along the supply curve
- change in input prices, technology, expectations, number of sellers shifts in the supply curve (changes quantity demand at every price)
- If you want to increase the SUPPLY, then increase an ingredient (shifts line). - If you want to increase the QUANTITY SUPPLIED, then increase the price of the good (movement along line)
o Each point on the supply curve represents the quantity supplied at a given price. o The upward slope of the supply curve illustrates the law of supply.
o Changes in ownprice result in movements along the supply curve.
o Changes in nonprice variables result in shifts of the supply curve.
- It’s not OR demand, it’s supply AND
demand. Must have both to have an
exchange and for both consumers and
providers to be happy.
- Quantity supplied = quantity demanded
(equilibrium) = stable market
- Buyers and sellers have different self
interest. Consumers want low prices
(downward push on price), and providers
want to maximize profit (upward push on
price); need to come to agreement
- Their actions drive the market toward equilibrium with the price of a good regulating the quantities demanded and supplied.
o Surplus: QS > QD must lower price to increase demand and come to equilibrium o Shortage: QS < QD must increase price to reduce demand and come to equilibrium
- Analyzing Market Changes
1. Ask yourself: Does the supply and/or demand curves shift?
2. If so, in which direction does the curve shift? Show the change in using a supply anddemand diagram.
3. What is the effect of the change on equilibrium price and quantity? Identify the new equilibrium point on the diagram. Use arrows to show the change in
equilibrium price and quantity.
o If the demand suddenly goes up for a product, and both the equilibrium price and quantity would increase.
o If the price of a product decreases, supply shifts right, the equilibrium quantity increases.
o If the price of a substitute decreases, demand shifts down, the equilibrium quantity and price decrease.
- Changes in Equilibrium
Changes in Equilibrium: events that shift the supply and/or demand curves
No Change in
An Increase in
A Decrease in
- The laws of demand and supply explain how consumers and producers respond to changes in price.
- The actions of selfinterested buyers and sellers naturally drive markets to equilibrium. - Events affecting nonprice variables cause market equilibriums to change. - Due to its simplicity and flexibility, the supplyanddemand model can be used to analyze many market outcomes.
Cpt 5: Elasticity and Its Application
How much consumers and producers respond to market changes; used to quantify changes in quantity demanded and supplied
Elasticity of Demand
Price Elasticity of Demand
Price elasticity of demand: how much quantity demanded responds to a change in price (cp); will always be negative, so use absolute value
o %∆QD Demand in Price Elastic
o %∆QD Demand in Price Inelastic
Computing Price Elasticity of Demand
o Method 1: The Standard Method: PED= ∆Q D
Where ∆ y=∆ y
Easier way to remember it: ∆=newvalue−initial value
Ex: PED= 1.5 1.5
So a 1% increase in price will result in 1.5% decline in quantity demanded (OR 10% increase = 15% decline)
o Method 2: The Midpoint Formula:
Easier way to remember it: ∆=newvalue−initial value
The price elasticity of demand for a given good depends of whether it has close substitutions, is classified as a necessity or a luxury, or is narrowly (or broadly) defined. The time elapsed since a price change (or time horizon) also affects the price elasticity of demand.
Classifying Demand Curves
o Perfectly inelastic: vertical line; no change; (∆Q D
o Relatively inelastic: steeper slope; small change; (∆Q D
o Relatively elastic: less steep slope; large change; (∆Q D
o Perfectly: elastic: horizontal line; extreme change – zero demand to any price above P0; (∆Q D
o Slope: ∆ P
o Price Elasticity: | ∆Q D
o (total expenditure): P x Q; the amount paid by buyers and received by sellers o A price increase has two effects on revenue: higher P mean more revenue on each unit you sell, but you sell fewer units (lower QD) due to the law of demand o If demand is price elastic, a price increase causes revenue to fall (inverse relationship).
o If demand is price inelastic, a price increase causes revenue to rise (direct relationship).
o Increase supply, lower equilibrium price, not large change in quantity demanded, price inelastic good, revenue goes down.
Income Elasticity of Demand
Income elasticity of demand = percent change in QD/percent change in income o For normal goods, income elasticity > 0
o For inferior goods, income elasticity < 0
o For income elasticity of demand, the sign of the coefficient is important Types of Goods
o Inferior: EI < 0
Necessity: 0 < EI < 1
Luxury: EI > 1
CrossPrice Elasticity for Demand
Crossprice elast of demand ¿change∈QDfor good 1
change∈price of good 2
For substitutes, crossprice elasticity > 0
For complement, crossprice elasticity < 0
Types of Goods
o Substitutes: EC > 0
o No relationship: EC = 0
o Complements: EC > 0
Elasticity of Supply
Price Elasticity of Supply
Price elasticity of supply = change∈QS
o Perfectly inelastic: ES = 0
o Relatively inelastic: 0 < ES < 1
o Relatively elastic: ES > 1
o Perfectly inelastic: PES = 0
o Inelastic: PES < 1
o Elastic: PES > 1
o Perfectly elastic: PES = ∞
The flatter the supply curve, the greater the PES; the steeper the supply curve, the lower the PES.
The price elasticity of supply depends on how easy it is for producers to change the quantity supplied: time, spare production capacity, storage capacity/available reserves Supply often becomes less elastic as Q rises due to production capacity limits.
Microeconomics HW Notes Chp 01-05
Homework (Chp 01 & 02) Basic Concepts
∙ Microeconomics is the study of how prices and quantities are determined through interactions between buyers and sellers (individuals and firms) in individual markets. Therefore, microeconomists are more likely to create models to analyze the decisions of firms (such as pricing) and those of consumers (such as shopping choices), as well as how government policies affect those decisions.
∙ Macroeconomics is the study of factors that affect the entire economy. Therefore, macroeconomists tend to create models to analyze how aggregate phenomena such as growth, inflation, and unemployment respond to policy decisions of governments and central banks, changes in aggregate spending or savings, and supply or demand shocks.
∙ Marginal benefit: an additional satisfaction or utility that a person receives from consuming an additional unit of a good or service
∙ Opportunity cost: the value of the best alternative use of a resource; the value of the next best thing; opp cost of a choice includes both the monetary amount paid and the value of your time given up by making that choice over another
∙ Law of increasing opportunity costs states that as you increase production of one good, the opp cost to produce an additional good will increase
∙ A positive statement is one that seeks to describe the world as it is; can always be supported or refuted by data
∙ A normative statement is one that offers an opinion as to the way the world should be; require a larger philosophical framework to evaluate
∙ Describing a statement as positive or normative does not mean true or false. ∙ Households earn their income when firms purchase or rent factors of production in factor markets to use them to produce goods and services
∙ Firms earn revenue when households buy goods and services in product markets ∙ Points inside the PPF represent inefficient output combinations where it is possible to increase the population of both goods because some resources are employed.
∙ Points on the PPF represent efficient output combinations where it is impossible to increase the production of one good without producing less of the other.
∙ Points outside the PPF represent output combinations that are unattainable given current resources and technology.
Homework (Chp 03)
∙ If the resources used in the production of two goods are not specialized and more of product one is produced than product two, then the opp cost of producing each additional product two remains constant as more of product two is produced.
∙ The PPF of two non-specialized products would be a linear PPF instead of a bowed-out PPF. ∙ An individual has an absolute advantage in the production of a good if they can produce a unit of output using fewer resources than someone else; who can produce more of that good if both people devote all of their resources to making it
∙ An individual has a comparative advantage in the production of a good if they can produce a good at a lower opp cost than someone else. A country will specialize in the production of this good and trade it for other goods.
∙ Reciprocal opp cost for producing one good is the opp cost for producing the other. o Ex: Opp cost for producing Good 1 is 5 Good 2. Opp cost for producing Good 2 is 1/5 Good 1.
∙ Possible for one person to have an absolute advantage in the production of both goods, but impossible for one person to have a comparative advantage in the production of both goods ∙ When a country imports goods, the consumption of that good must be larger than what the country produces itself.
∙ When a country exports goods, the consumption of that good must be smaller than what the country produces itself.
∙ Without engaging in international trade, any quantity outside a country’s original PPF is infeasible.
Homework (Chp 04)
∙ Perfectly competitive markets: the goods and services bought and sold are all exactly the same & there are large numbers of buyers and sellers, such that no single buyer or seller can affect the market price
∙ In reality, most markets do not perfectly adhere to the assumptions of the perfectly competitive markets
∙ The quantity demanded of any good is the amount of the god that buyers are willing and able to purchase at a given price.
∙ The demand curve is a graph that shows the entire relationship between the price of a good and the quantity of the good demanded; slopes downward
∙ A demand schedule is a table showing the relationship between the price of a good and the amount that buyers are willing and able to purchase at various prices.
∙ The law of demand states that, other things being equal, the quantity demanded of a good falls when the price of a good rises.
∙ change price movement along the demand curve
∙ change in income, prices of related goods, tastes, expectations, number of buyers shifts in the demand curve (changes quantity demand at every price)
∙ The quantity supplied of a good is the amount of the good that sellers are willing and able to supply at a given price.
∙ The supply curve shows the entire relationship between the price of a good and the quanity of the good supplied; slopes upward
∙ A supply schedule is a table showing the relationship between the price of a good and the amount of it that sellers are willing and able to supply at various prices.
∙ The law of supply states that, other things being equal, the quantity supplied of a good increases when the price of that good rises.
∙ change price movement along the supply curve
∙ change in input prices, technology, expectations, number of sellers shifts in the supply curve (changes quantity demand at every price)
∙ normal goods: goods for which demand is directly related to income
o income and demand move in the same direction (cp)
∙ inferior goods: goods for which demand is inversely related to income
o income and demand move in opposite directions (cp)
∙ substitutes: a good that can be used in the place of another good
o An increase in the price of one good leads to an increase in demand for the other (cp) Ex: increase price of butter, demand for margarine increases
∙ complements: goods used in conjunction with one another
o An increase in the price of one good leads to a decrease in demand for the other (cp) Ex: increase price of cereal, demand for milk decrease
∙ When both the demand and supply curves shift, you can’t always determine the effect on price and quantity without knowing the magnitude of the shirts:
Changes in Equilibrium: events that shift the supply and/or demand curves
No Change in Demand
An Increase in Demand
A Decrease in Demand
∙ Surplus: QS > QD must lower price to increase demand and come to equilibrium
o If a surplus exists in a market, then the current price must be higher than the equilibrium price. For the market to reach equilibrium, you would expect buyers to offer lower prices.
o Downward pressure
∙ Shortage: QS < QD must increase price to reduce demand and come to equilibrium o If a shortage exists in a market, then the current price must be lower than the equilibrium price. For the market to reach equilibrium, you would expect buyers to offer higher prices.
o Upward pressure
Homework (Chp 05)
Don’t forget to do your hw kids.
See finished Chp 5 Notes for Week 5.