Study Guide Chapters 1,2,3, & 4

What does Marginal Cost mean?

Chapter 1 

∙ Incentives

-Rational self-interest: Benefits/cost change peoples’ choice changes, only pertains to those that affect you, not others

- Seatbelt example: cost of reckless driving became less for self with  new seatbelt legislation that made it illegal to drive without seatbelt  (less likely to die if in an accident), so there were more accidents,  especially involving pedestrians and others’ property  

- Incentives are a much stronger tool than persuasion alone (monetary  incentives)

Electricity prices example: When companies started charging a fee for  using more than a certain amount of electricity (incentive to not),  many more people used less electricity as opposed to the government  trying to persuade people to use less, but with no monetary penalty

∙ Institutions Affect Incentives (society only changes with right  incentives)

What are the types of surplus?

- Institutions are organizations, customs, rules, laws, contract terms,  taboos (explicit like laws, implicit like social norms), all institutions  driven by money but that is not always a bad thing

-Good institutions create socially beneficial outcomes  

Example: Wal-Mart re-routing majority of supplies to specific areas  when there is a natural disaster prediction (Wal-Mart makes money off  the people who buy up the supplies, but the people in need also have  more supplies available to them)

-Bad institutions create socially destructive outcomes (institutional  failure)  We also discuss several other topics like freud's dream protection theory

Example: Venezuela cheap toilet paper law led stores not to stock toilet paper bc they would lose money and it became hard for all ppl to get  toilet paper (no incentive for institution, public suffered)  

∙ Opportunity Cost (is this activity worth the amount of time I’m giving  up that I could spend doing something else?)

What are the 4 things that affect supply?

-Opportunity cost of going to college in a recession vs. in time of  economic prosperity (enrollments rise during recessions bc if you hit  the labor market straight out of hs you will likely be unemployed, and If you want to learn more check out penn state art history

the opportunity cost is less to go to college bc you’re not losing money  in that market, enrollments fall during economic prosperity bc  opportunity cost is higher in salary you would lose from not joining  labor market while in school)

∙ Marginal Cost/Benefit  

-The more plentiful/common something is, the greater the marginal  cost it generates as it accumulates and continued accumulation leads  to marginal cost outweighing marginal benefit If you want to learn more check out iman salehinia

-The more novel/ scarce something is, the more marginal benefit it has, especially when it is first or only *see candy example in PowerPoint* Example: Water vs. diamonds (water is plentiful and is constantly  available & diamonds are rare, many ppl don’t have them or very few), diamonds have more marginal benefit and marginal cost of water  outweighs marginal benefit even though water is much more valuable  for survival (only people at sustenance level deem water to have more  marginal benefit)

-People are willing to pay more for things that have the highest  marginal benefit

 Marginal benefit is essentially what value a customer assigns to an  object*

Example: cost/ compensation that ppl willing to pay is based on  whether skills are scarce (NFL quarterback) or relatively common  (schoolteacher)

Chapter 2 

∙ Division of Knowledge  

- Trade allows people to specialize and gain advanced knowledge on any  given subject because they can trade for all the knowledge not within their  own specialty (able to learn things beyond basic survival because everyone  is not self-sufficient) If you want to learn more check out anth 1001 lsu

-Sharing of knowledge increases total knowledge available in a society  and overall standard of living  

-A country becomes better the more they trade because it encourages  specialization and increases the influx of knowledge (allows people to focus  on what they’re good at and rely on trade and other specialized people to  make up for what they’re not good at)  

*see Alice and Bob 2-person society example in Powepoint*

∙ Comparative Advantage

- Absolute advantage-:the ability to produce something using fewer inputs than the competitor  

- Comparative advantage is about who can produce the most at the  lowest opportunity cost, so it is often profitable for countries that have  an absolute advantage concerning a specific product to trade for it with  other countries that have the comparative advantage  

Example: California vs. Kansas wheat (Cali has the absolute advantage on wheat, but they also have an absolute advantage on items like fruit,  which generate a larger profit. The opportunity cost of producing anything other than fruit would cause Cali to lose money, so Kansas produces most  of the country’s wheat because they have the comparative advantage)

∙ Trade etc.

-Trade makes both sides better off when the price is between the 2  opportunity costs, which is how price is calculated  

- Trade is like technology (raises the overall living standards although  some specific sectors of economy are worse off) because it converts easy  to produce goods into hard to produce goods for a low cost  

Chapter 3 

∙ Supply & Demand

- Demand: relationship between the price of something and quality  demanded, two things are negatively related all else equal (All else  equal: the only thing that changes is the price) We also discuss several other topics like astronomy 101 final exam

-Normal Goods: most goods are normal, the richer you are the more  you buy

Ex: clothes  

Positive relationship between demand and income  

-Inferior Goods: based on personal preference, goods that people stop  buying altogether when they become richer  

Ex: ramen for someone who only ate ramen in college, and is sick of it  Negative relationship between demand and income  

-5 things that affect demand:

1. Prices of similar goods (substitutes are often interchangeable for  consumers depending on which is the better price)

2. Prices of compliments (Ex: people willing to pay more for peanut  butter when buying concurrently w/ jelly bc they want them  together)

3. Expectations of future prices (if people expect something to be  more expensive in the future, their demand will increase today  solely for that reason, stocking up)

4. Number of buyers (how many people are willing to pay money  for this good)

5. Tastes (people have own tastes that make them more/less likely  to pay for something

- Supply: relationship between price and quantity supplied, two things  positively related all else equal Don't forget about the age old question of cal poly meats

-4 things that affect supply:

1. Input prices (how much does it cost to produce the product) 2. Expectations of future prices (if the product that you sell is going  to have a higher price in the future, manufacturers will take it off  the shelves and sell it later for that higher price)

3. Number of sellers  

4. Opportunity Costs (Ex: if you have a factory and they find oil on  the land of your factory, opportunity cost becomes extremely  high to keep it a factory and supply changes)

∙ Surplus & Shortage  

-Surplus (unsold product)  prices fall due to competition among sellers to unload the product

-Shortage (not enough product being produced) prices go up due to  competition among buyers for the product

- Sellers want to sell at a higher price to make $, but customers not  willing to buy as much when price is high  

-If sellers try to cater to public and make the price very low so that  they’ll buy a lot, there will not be enough people willing to work for  such a low profit  

-Market is in equilibrium when there is no pressure for price change,  equilibrium constantly changes depending on conditions  

- Shortages and surpluses are pricing problems

Chapter 4 

∙ Types of Surplus

- Consumer surplus: buyers’ gains from trade, difference between  marginal benefit and actual price

-Producer surplus: sellers’ gains from trade, difference between price  and marginal cost  

-Social surplus: society’s gains from trade, difference between marginal benefit and marginal cost (low cost of production and high marginal  benefit is ideal)

-Unexploited Gains: social surplus that could have been gained by  producing a larger amount of high value materials at a low production  cost  

- Wasted Resources: producing a product in such large quantities that a social surplus is created, but value is destroyed  

-The middle ground for UG & WR is “X”, which is most efficient bc  maximizes social surplus

- Markets produce the efficient quantity of “X” on their own bc sellers  have natural self-interest and individual buyers deem any given  product to have a certain value

∙ Energy Independence  

- If we make all cars more fuel efficient and everyone drives at the  same rate as they currently do, it will not make the U.S energy  independent  

 The producers who have the highest production costs (domestic  producers) will stop producing first

 The price of oil will go down since the demand will be lower (people  using less oil) and it will not make any sense for them to produce at  that lower price.

- Increasing energy efficiency would actually make the U.S more  dependent on foreign oil  

 The middle east has the lowest production cost and would be the only  country who would continue to make money even when oil prices  decrease  

 Buying American is not as important to people as it is to buy cheap,  foreign is cheapest

∙ Price Gouging

-When product is in extremely high demand (natural disaster  prediction), price has to change or not everyone will get supplies - If price goes unchanged, shortage happens because:

1. No incentive for buyers to buy only what they need

2. No incentive for sellers to produce more goods because they  won’t make more money for the extra work to increase  

production, send their distributers into a dangerous area, etc. - If price is higher:

1. Buyers will ration more and then more resources will be more  available to everyone

2. Producers make more money and it makes sense for them to  increase production to meet the higher demand

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