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ECON 110: Textbook Notes Through Week 5

by: Connor Workman

ECON 110: Textbook Notes Through Week 5 ECON 110

Marketplace > Brigham Young University > Economcs > ECON 110 > ECON 110 Textbook Notes Through Week 5
Connor Workman
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These notes cover textbook reading through week 5 on Professor Pope's ECON110 class at BYU.
Principles of Economics
Professor Arden Pope
Class Notes
byu, Econ, Economics, econ110, Pope
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This 14 page Class Notes was uploaded by Connor Workman on Sunday February 7, 2016. The Class Notes belongs to ECON 110 at Brigham Young University taught by Professor Arden Pope in Winter 2016. Since its upload, it has received 25 views. For similar materials see Principles of Economics in Economcs at Brigham Young University.


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Date Created: 02/07/16
ECON 110  Introduction o Chapter 1: Ten principles of Economics  Chapter Introduction  Economy: “One who manages a household”  Scarcity: Society has limited resources, and so society has to decide how those resources are distributed. Not everyone can be given everything they want.  Economics: The study of how society manages its scarce resources. Since this is a broad definition, there are many facets of economics.  1-1 How people make decisions o An economy In essence is a group of people dealing with each other in their lives. The first four principles deal with individual decision making.  1-1a Principle 1: People Face Trade-offs o The core of making decisions is trading off one goal against another. (studying student metaphor) o Classical example: Guns and butter. Raise the standard of living at home (butter), or help protect country more (guns)? Clean environment or high level of income? Efficiency or equality? o Efficiency means society is getting maximum benefit from its scarce resources, while equality means those benefits are distributed uniformly among society’s members.  Governmental policies designed to eliminate poverty are a huge example of this trade-off. The more equality increases, the less hard work is valued.  1-1b Principle 2: The cost of something is what you give up to get it o Cost-benefit tradeoff must be considered first. o Consider college. While tuition and physical costs are expensive, the time that you would take in learning could have been spent working. This is usually the largest cost, called the opportunity cost. Rephrased as: What you give up to get the item.  1-1c Principle 3: Rational people think at the margin. o In economics, rational people are considered people who purposefully do their best to achieve their objectives, given available opportunities. o Since rational people try to increase proficiency in small margins, these proficiency increases are called marginal change. These small course adjustments can also be separated into marginal benefits and marginal costs. o While the overall cost of an average plan ticket might be $500, the airline should still allow last- minute cheaper flights. While the overall cost might be $500, the marginal cost is only soda and peanuts. o Train your mind to think in terms of marginal benefits and costs.  1-1d Principle 4: People respond to incentives o Because rational people think in terms of marginal costs and benefits, incentives (the prospect of a punishment or a reward) can be used to induce that person to act. o For example, as the prices of apples rise, people are incentivized to eat less of them. Producers then respond to that incentive by picking more apples, which lowers prices, and incentivizes consumers to eat more apples. o People analyze marginal cost-benefits in wearing seatbelts. Driving slowly and carefully is costly, so people will drive recklessly if they can. Driving with a seatbelt lowers the cost of getting into a crash, and lowers the benefit of driving carefully, and therefore makes people drive more recklessly.  1-2 How people Interact o The next principles describe how people interact with one another.  1-2a Principle 5: trade can make everyone better off o Just like people specialize in services that allow for a more rounded world through trading, countries specialize in trade items as well. We are all competing to find the best services at the lowest prices, but this competition generally benefits everyone involved.  1-2b Principle 6: Markets are usually a Good way to organize economic activity o Centrally planned economies are those where the government decides who produces and consumes what (generally communistic). In Market Economies, the central planning is abandoned in favor of the decisions of millions of firms and households. Even if there is no one looking out for the economy as a whole, it is still a remarkably successful strategy. It’s almost like an invisible hand is guiding these economies. o Prices are what this invisible hand uses to guide consumers and producers to the most beneficial outcome. When governments interfere with this hand, it leads to disaster, which makes centralized economic planning obsolete.  1-2c Principle 7: Governments can sometimes improve market outcomes. o Although governments should not interfere with a free market, they should still regulate laws and rules to maintain the economy. A farmer won’t grow food if their crop is stolen. Property rights must be enforced by some form of institution, or the invisible hand will be unable to function. o The only other reason the government should intervene in the economy is to produce either efficiency or equality. A situation where this is needed because of a failure to produce sufficient resources is a market failure. One possible cause of market failure is an externality, which is the impact of one person’s actions on the well-being of a bystander (pollution is a good example, or even college, as all education benefits all of society). Unpriced costs or benefits from an action. Another cause is market power, which refers to the ability of a single person or small group to unduly influence market prices (monopoly).  1-3 the Economy as a whole works o The last three principles concern the workings of the economy as a whole.  1-3a Principle 8: A Country’s standard of living depends on its ability to produce goods and services. o Differences in average yearly earnings almost always variate based on productivity, or the amount of goods and services produced by each unit of labor input. The more workers can produce, the higher standard of living we have. o This leads to workers needing more education, better equipment, and a higher drive to work.  1-3b Principle 9: Prices Rise When the Government Prints too Much Money o Consider the inflation in Germany after World War I. People began burning money because it was less valuable than spending it on firewood. o Inflation is almost overwhelmingly caused by the government printing a large quantity of money. Why did we ever get off the gold standard?  1-3c Principle 10: Society Faces a Short-Run trade-off between inflation and unemployment o Inflation in the long run is always too much printing, but in the short term it is much more controversial. o This trade-off plays a key role in analysis of the business cycle, or the irregular and largely unpredictable fluctuations of economic activity. o Government can affect these things by changing taxes, printed money, spending, and by changing demand for goods and services.  Conclusion  He will refer back to these ten things.  Know the following problems o Calculating opportunity cost o Marginal Analysis  Multiple Choice  A, c, b, b, d, a  Personal Observations  Be able to specifically list ten steps and vocab definitions.  Be able to list trade-offs.  Personal Questions  Can the possible return on an investment be calculated into an opportunity cost? If you save $100 and put it into a bank with reasonable interest, wouldn’t you lose money because you lost the opportunity to invest?  How exactly are unemployment rates and inflation related, and why is there such a large trade-off between them? o Chapter Two: Thinking Like an Economist  2-1 The Economist as Scientist  2-1a The scientific Method o Economists have to make due with whatever data the world gives them, and can’t test their theories by manipulating governments. They are historical scientists in a way.  2-1b The role of assumptions o While friction can be eliminated for a marble, as it hardly changes things, it cannot be an eliminated calculation for a beach ball of the same weight. Assumptions can sometimes be invalid. Economists use the same discretion in short-run and long-run economics.  2-1c Economic models o They are understandably imperfect, as they eliminate many details in favor of simplicity.  2-1d Our first model: The circular-flow diagram o Circular-flow diagrams show the relationship between firms and households, firms producing goods with factors of production (labor, land, capital), while households consume those products. o Households provide labor to run firms, while firms provide goods and services in return. o Money circles throughout households and firms, even if this model doesn’t account for government or international trade.  2-1e Our second model: The Production possibilities frontier o The production possibilities frontier shows exactly how much output a nation is capable of between two products. If it focuses everything on one product, it can produce more of that product. It in essence measures opportunity cost in terms of the neglected item’s output that could have been accomplished. o Inefficient outcomes are described by being below the threshold, while efficient outcomes are described as being on the threshold. o This diagram can also tell us the opportunity cost of producing far more of one item than another. Middle ground is best. o A scientific advancement towards one good will raise production of both goods.  2-1f Microeconomics and Macroeconomics o Microeconomics studies how households and firms make decisions and interact with specific markets. Macroeconomics is the study of economy-wide phenomena.  2-2 The economist as policy advisor  2-2a Positive vs normative analysis o Positive statements are descriptive, and make a claim about how the world works. Normative statements are prescriptive, and try to fix the world or say how it should be. We can refute positive statements by evidence, while normative statements require a drawing from philosophy and ethics to be refuted.  2-2b Economists in Washington o They influence policy almost more than the politicians.  2-2c Why economists’ advice is not always followed o Economists offer crucial input into the policy process, but their advice is only one ingredient of a complex recipe.  2-3 Why economists disagree  2-3a Differences in scientific judgements o These judgements effect positive analysis in economics. How is it determined that something is actually valid?  2-3b Differences in values o All policies are normative, and therefore unable to be judged on only scientific grounds.  2-3c perception versus reality o Economists usually agree on a great many subjects.  2-4 Let’s get going  Chapter review  Personal questions  How can such a simplistic cycle somehow equalize money for everyone when it is a closed system? o Chapter Three  3-1 A Parable for the Modern economy  3-1a Production possibilities o Goes over the production possibilities of two separate individuals if they were to devote their time to a certain percentage of their production potential.  3-1b Specialization and trade o When two different countries specialize and trade, they both end up better off. I don’t know why, but the numbers just add up.  3-2 Comparative Advantage: The Driving Force of Specialization  3-2a Absolute Advantage o Absolute advantage is a comparison between one person, firm, or nation to another. The entity that can produce the same amount of product with a lower input cost is the one with absolute advantage.  3-2b Opportunity Cost and Comparative Advantage o The secret to this disparity between numbers is opportunity cost. While Rose’s opportunity cost is high for growing potatoes, Frank’s is lower, and therefore it is more beneficial for him to grow potatoes. This concept is Comparative advantage, and is the reason that specialization is better. It is impossible for one person to have the comparative advantage for two goods. Your advantage being the largest is where you should specialize.  3-2c Comparative Advantage and Trade o Trade benefits everyone!  3-2d The Price of the Trade o For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs  3-3 Applications of Comparative Advantage  3-3a Should Tom Brady mow his own lawn?  Should The United States Trade With Other Countries? o Imports and exports  3-4 Conclusion  Personal Questions  Chapter 21: The Theory of Consumer Choice o Chapter Introduction o 21-1 The Budget constraint: what the consumer can afford  Just like the production possibilities frontier, the budget constraint measures two goods on the x and y axis of a graph. Unlike a production possibilities frontier, a budget constraint tracks the amount of each of two goods that can be consumed when each good has a fixed price, and the money allocated to those goods is also fixed. It shows the trade-off between these two goods.  The slope of the line is defined as the opportunity cost of buying one good over another, or relative cost (ex. 5 liters of pepsi per pizza). o 21-2 Preferences: What the consumer wants  21-2a Representing preferences with indifference curves  The consumer chooses between different ratios of pizza to pepsi. If two ratios suit the consumer equally well, it is called indifference. An Indifference curve shows the various ratios of two goods that make the consumer equally happy.  The slope of the indifference curve is not static, because it shows the rate at which the consumer is willing to substitute one good for another (obviously you wouldn’t want all pepsi or all pizza). This rate is called the marginal rate of substitution. The consumer is equally happy at all points on the indifference curve. Although, the higher the indifference curve, the more it is preferred.  21-2b Four Properties of indifference curves  Property one: Higher indifference curves are preferred to lower ones (more food, nom nom)  Property two: Indifference curves are downward sloping (math, duh)  Property Three: Indifference curves do not cross (mathematically it wouldn’t work. We always want more food, and we couldn’t be equally happy with less)  Property Four: indifference curves are bowed inwards (unless, of course, you begin to like one good way more than the other the more you have of it, lolzzzz)  21-2c Two extreme examples of indifference curves o The more bowed, the harder the goods are to substitute. The less bowed, the easier the goods are to substitute.  Perfect substitutes o These manifest themselves as straight lines, like a tradeoff between 5 $20 bills and 1 $100 bill. They are perfect substitutions for each other, since the value is identical.  Perfect Compliments o These manifest themselves like the corner of a square, like a tradeoff between left and right shoes. You need both for the other to bet worth something. o 21-3 Optimization: What the consumer chooses  21-3a The consumer’s optimal choices  Balance between indifference curves and budget constraints.  A consumers optimum is where the indifference curve and budget constraint meet. This is where the slope of both graphs are equal as well.  Utility is the happiness you get out of a bundle of goods. Closely related to indifference graphs, which are kind of like an equal-utility curve. Diminishing marginal utility is the more a consumer gets of a good, the less utility they get out of the good.  21-3b How changes in income affect the consumer’s choices  Income increases raise the budget constraint, while income decreases lower it. If a consumer wants more of a good when their income rises, it is called a normal good. If the consumer buys less of a good when their income rises, economists call it an inferior good. Pizza could be the normal good, while pepsi could be the inferior good. Bus rides are an example of an inferior good.  21-3c How changes in prices affect the consumer’s choices  When the price of pepsi falls, the consumers budget constraint shifts outward in that direction as they can afford more pepsi, as well as changes slope to be more pepsi-favored. It does however lower the price of pepsi in terms of pizza.  21-3d Income and substitution effects  The income effect is when a price of a good falls, and people respond by taking advantage of buying more of two goods that previously split their income. The Substitution effect is when one reacts to a fall in the price of pepsi by considering pizza as more expensive and buying less pizza and more pepsi. These effects could work together or work against each other depending on the situation (leads to overall increase in pepsi sales, but conflicting direction on pizza sales).  “The income effect is the change in consumption that results from the movement to a higher indifference curve. The substitution effect is the change in consumption that results from being at a point on an indifference curve with a different marginal rate of substitution.”.  Income effect is better.  21-3e Deriving the demand curve  Cost on y axis, quantity on x axis, shows the demand increase as prices go down. o 21-4 Three applications  Do all demand curves slope downward?  Mostly yes, because of the law of demand (the more people have of something the less they want even more of it.  Sometimes there are goods called giffen goods that violate the laws of demand (ex. As price increases, demand increases). Giffen goods are inferior goods for which the income effect dominates the substitution effect, and have demand curves that slope upward.  How do wages affect labor supply?  Tradeoff between leisure and consumption (hard working and relaxing). The opportunity cost of relaxation is very high if you make $50 an hour.  As wages increase, the opportunity cost for an hour of leisure increases. That means that as wages increase, hours of work can either increase or decrease, depending on the state of mind of the person. Indifference curves will determine which way the person will go.  Substitution effect would cause a person to work more the higher wages go. Income effect would cause a lowering of worked hours and a raise of leisure hours.  How do interest rates affect household saving?  Consumption vs saving tradeoff can be analyzed using indifference curves and budget restraints. o 21-5 Conclusion: Do people really think this way?  Chapter 13: The Costs of Production o 13-1 What Are Costs?  13-1a Total Revenue, Total Cost, and Profit  Profit= Total Revenue – Total Cost  In this equation, total revenue is the amount that the firm receives for the sale of its output. The amount that the firm pays to buy inputs (raw materials) is called total cost. Profit is almost like a net income.  13-1b Costs as Opportunity Costs  Some costs are easily forseen, like paying workers. These costs are called explicit costs. Opportunity costs however, are generally easier to miss. Opportunity costs are generally referred to as implicit costs. Economists focus on both of these costs, while accountants only focus on explicit costs.  13-1c The Cost of Capital as an Opportunity Cost  The cost of capital is the opportunity cost of interest when choosing to invest money into your business instead of other businesses. You could invest in a bank and earn interest that way. You could invest in a large corporation through the stock market and see returns that way. These are all opportunity costs of investing your own money.  13-1d Economic Profit versus Accounting Profit  Economic profit is defined as the firms total revenue minus all implicit and explicit costs. Accounting Profit is the firms total revenue minus only explicit costs. o 13-2 Production and Costs  13-2a The Production Function  A production function is a graph that compares output of product to workers (as the amount of workers increases, so does the product).  The marginal product of any input in the production process is the increase in the quantity of output obtained from one additional until of that input. So if you’ll only be able to bake two more cookies if you hire another full-time worker, you might not want to hire that full time worker. Diminishing marginal product is when every person you hire leads to a smaller marginal product production. This can happen when conditions in a factory become too crowded to work.  13-2b From the Production Function to the Total-Cost Curve  These two curves both show the same thing: That when labor increases, marginal production is more costly (it takes more labor to pump out a cookie, so to speak, making that cookie more valuable). o 13-3 The Various Measures of Cost  13-3a Fixed and Variable Costs  Fixed costs do not vary with the quantity of output produced, and are present even if the firm produces nothing at all (monthly rent, salary, ect). Variable Costs change as the firm alters the quantity of output produced (cost of coffee beans for a coffee shop). A firms total cost is the sum of these two costs.  13-3b Average and Marginal Cost  Asking the question, “How much does it cost to make an average cup of coffee?” is an example of average total cost, and can be found by total cost/total cups of coffee. This can be separated into two different classes. When you use the fixed cost divided by cups of coffee, it is called average fixed cost. When you use the variable cost it is called average variable cost. Total cost/quantity  Marginal cost is the difference between two costs when production is increased. Change in total cost/change in quantity.  13-3c Cost Curves and Their Shapes  Be able to look at four different graphed representations of these concepts together. Know what they mean.  Marginal cost generally rises as a line, reflecting the properties of diminishing marginal return at the end.  The average variable and average fixed costs tug at the graph of average costs. The minimum of the U shape is called the efficient scale, which represents the lowest average cost per cup of coffee. At low levels of output, average total cost is very high (not using all the equipment, low amount of workers, ect. Caused by average fixed cost). As output increases, average fixed cost is overwhelmed and declines. When overproducing however, average variable costs increase and become too large, so the graph starts to curve up.  Marginal cost and average total cost intersect every time, and this intersection point is very important. They always interest at the average total cost minimum.  13-3d Typical Cost Curves  Most marginal cost curves actually decrease for a few workers before increasing. o 13-4 Costs in the Short Run and in the Long Run  13-4a The Relationship between Short-Run and Long-Run Average Total Cost  Many decisions are fixed in the short run but variable in the long run, such as factories being bought and sold for production. Over a period of time, companies can choose which short-run cost curve is better for business.  13-4b Economies and Diseconomies of Scale  When long-run average total cost declines when output increases, there are said to be economies of scale. When long-run average total cost rises as output increases, there are said to be diseconomies of scale. When long-run average total cost does not vary with output, there are said to be constant returns to scale.  Economies of scale arise from specialization, while diseconomies of scale may arise from coordination problems. o 13-5 Conclusion o Chapter Review  Summary  Key Concepts  Questions for Review  Quick Check Multiple Choice  Problems and Applications  Chapter 14: Firms in Competitive Markets  Introduction  Firms that can influence the market price of the goods it sells are considered to have market power. o 14-1 What is a competitive market?  14-1a The meaning of competition  Also referred to as Perfectly competitive, competitive markets have many buyers and many sellers in the market, and the goods offered by various sellers are largely the same. When they are perfect, firms can freely enter or exit the market.  Price takers are said to be the buyers and sellers that must accept a market price for an item.  14-1b The revenue of a Competitive Firm  We are trying to maximize profit (total revenue- total cost).  Average revenue tells us how much revenue a firm receives per output (total revenue/amount of output). Marginal Revenue is the change in revenue between outputs, o 14-2 Profit Maximization and the Competitive Firm’s Supply Curve  14-2a A simple Example of profit Maximization  Marginal cost must always be exceeded by marginal revenue. The max will always be at this point.  14-2b The Marginal-cost curve and the Firm’s Supply Decision  Where the marginal cost curve intersects (or equals) the marginal revenue line/curve.  14-2c The firms short-run decision to shut down  In different situations, a firm might decide to shut down or even exit the market. Shutting down is a short-run decision not to produce anything for a certain period of time. Exiting the market is a long-run decision to leave the market. A firm that shuts down temporarily still has to pay its fixed costs, while an exiting firm does not.  When a firm decides to shut down, fixed costs are considered sunk costs.  Mathematically, a firm shuts down if Variable Costs exceed total revenue (TR<VC). We can take the average of both of these to determine that a firm will shut down if the price of a good is less than the Average Variable Cost of production.  14-2d Split milk and other sunk costs  A cost that has been committed and cannot be recovered is considered a sunk cost. Ignore sunk costs.  14-2e The Firm’s Long-run decision to exit or enter a Market  If total revenue is less than total cost, the firm must decide to exit the market. This can also be expressed by the price of the good being less than the average total cost or P<ATC.  14-2f Measuring Profit in our graph for the competitive firm  Profit = (Price of good- Average total cost) * Number of goods  You can measure loss or income by taking the area of a rectangle with one point at the ATC and another at the intersection between price and marginal cost. o 14-3 The supply Curve in a Competitive Market  14-3a The short run: Market supply with a fixed number of firms  With a fixed number of firms, and all firms producing the same thing, the graphs for a single firm and the whole market are relatively the same (Quantity on the x-axis, price on the y-axis).  14-3b The long run: Market Supply With Entry and Exit  Now what if firms can enter or exit the market?  This is cool. Listen up: If the total profit of the existing firms are above zero, this will constantly drive new firms into the market. Firms will keep entering until the average profit is reduced to zero. Using this information, we could predict whether or not we should enter a market.  So, when the price to create a good equals the average total cost, firms no longer enter or leave the market. The market is at equilibrium. Unless you change prices.  14-3c Why do Competitive Firms stay in business is they make zero profit?  The answer to this question lies in accounting profit. Accounting profit is just as real as economic profit. If a firm is making zero economic profit, it is making enough accounting profit to cover all of its opportunity costs.  14-3d A shift in demand in the short run and long run  In the short run, a shift for demand (demand rises) will increase profit for all companies involved. In the long run, a rising shift in demand will increase production and firms until profit is again zero, or at equilibrium.  14-3e Why the long-run supply curve might slope upward  They always do, because it costs more to enter a market than it does to continue a business in one. Assets need to be accumulated and built. For this reason, long-run supply curves are more elastic than short run ones. o 14-4 Conclusion: Behind the supply Curve  Chapter review  Summary  Key Concepts  Questions for review  Quick Check Multiple choice  Problems and applications


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