Week 3-5 Notes
Week 3-5 Notes ECON 2005
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This 7 page Class Notes was uploaded by Glenn Andrew on Sunday February 21, 2016. The Class Notes belongs to ECON 2005 at Virginia Polytechnic Institute and State University taught by Steve Trost in Spring 2016. Since its upload, it has received 33 views. For similar materials see Principles of Economics in Economcs at Virginia Polytechnic Institute and State University.
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Date Created: 02/21/16
Econ Notes Economic Systems Traditional economies – an economy in which tradition alone determines the nature of economic activity - Not many left - Not market oriented - Ex island traders trading necklaces and arm bands Command Economies – an economy in which a central government either directly or indirectly sets output targets, incomes, and prices (aka Centrally Planned economy) - Ex. North Korea, Kuba (80s +90s) - Cuba was the biggest success story o Cause small o Had backing from Soviet Union o Moving towards market oriented ecomomy - Soviet Union – too big to work, much inefficiency Laizssez Faire or Market Economy – The free market; economy in which individual people and firms pursue their own self interests without any central direction or regulation, market determines what is produced or how it is produced and who gets it - Most economies are market oriented - Based heavily on concept of ownership - Consumer sovereignty – comsumers ultimately dictate what will be produced by choosing what to purchase - No pure market economies, Hong Kong and New Zeland are closest 3 Questions In a Market Economy 1. What gets produced? a. Determined by people voting with their dollars 2. How is it produced? a. Determined by the cost of production and the preferences of consumers 3. Who gets it? a. Those who pay for it US Economic System – mix of all three types of economy 1. Tradtitional – tipping 2. Command – welfare, roads, agriculture 3. Market – most stuf Why mixed and not a market? 1. Market system is inefficient 2. Rewards are unevenly distributed 3. Booms and busts Because of these, govt often steps in to fix the problems, to treat the system and shore it up Ch 3 - The players of the game 1. Households buy stuf 2. Firms make and sell stuf, max profits 3. Government establish rules of the game, public services, monitor/tweak the economy 4. Rest of the world, trade with everyone else Market Economy 4 Conditions must be met: 1. Market for resources (especially labor) and those resources must be paid for 2. There must be a market for goods and services 3. People must be able to own private property a. 3 Elements i. Right to consumer property as long as don’t harm others ii. Right to transfer property to whoever iii. Right to exclude any one form using your property or interfering with it 4. The economy must allow economic winners and losers Model of Supply and Demand 1. Buyers/consumers, customers/households 2. Sellers Market Players 1. Houreholds consumer outputs, supply inputs 2. Firms – Product/output markets – Input or factor markets – Input Markets – labor markets, capital market, land markets Output Markets – Demand and the Demand Curve Demand – Buyers cannot chose price, decide how much to buy based on price - Demand - a relationship between price of good and quantity of that good that consumers are willing and able to buy per period, other things constant - Quantity demand – the amount of a product that a consumer would buy in a given period if it could buy all it wanted at the current market price - Law of Demand – price and quantity are inversely related, price goes up, demand goes down etc Substitution and Income Efects 1. Substitution Efect – price good rises, people switch form buying that good to other goods 2. Income efect - as the price of anything you buy goes up, you feel poorer Demand schedule – a table showing how much of a given product a household would be willing to buy at diferent prices Demand curve - a graph showing how much of a given product a household would be willing to buy at diferent prices Poetries of a Demand Curve 1. Demand curves will intersect the price axis 2. Demand curves also intersect the quantity axis Market demand – the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service Changes in price - quantity demanded changes move along demand curve Change in any other factor affects the demand and shifts the entire D curve What shifts the demand curve: 1. Change in consumers income or wealth a. Income – sum of a households wwages, salaries, profits, etc i. Flow measure b. Wealth of net worth – total value of what one owns – what one owes i. Stock measure c. 2. Change in price of other available products a. Substitutes – goods that can serve as replacements for one another: price of one good increases then demand for the other goes up b. Perfect substitutes – identical or interchangeable products c. Complements, complementary goods – goods that go together, a decrease in the price of one results in an increase in demand for the other and vice versa (peanut butter and jelly) 3. Change in consumer tastes a. Can change over time, sometimes products become popular or unpopular literally overnight 4. Change in expectation a. Ie economy is expected to go bad > people buy less b. Shifts demand courve out and back 5. Changes in the Number or Composition of Consumers Normal good – good for which demand goes up when income is higher and for which demand goes down when income is lower (demand curve rises) Inferior goods – Goods for which demand tends to fall when income rises (demand curve shifts back) Shift of curve – brought about by change in original conditions Movement along curge is brought about by change in price of selected good. OUTPUT MARKETS: SUPPLY AND THE SUPLY CURVE Quantity supplied – the amount of a particular product that a firm would be willing and able to ofer at a particular price during a given time period Supply: a relationship between the price of a good and the quantity of that good and the quantity of that good that firms are willing to sell per period 5 Things which afect supply 1. Change in technology – breakthrough in technology would cause the supply curve to shift right (increase in qty produced 2. Change in the price of inputs – an increase in the price of cheese would cause the supply curve of pizzas to shift to the left (decrease in qty produced) 3. Change in the price of other (alternative) goods – if you own a dairy and the price of skim mik increases, you and other producers would increase production of skim milk (move up the curve) to do this you would have to make less chocolate milk at any given price, causing the suppy curve for chocolate milk to shift to the left 4. Change in producer expectations – if producers thingk that their product will become very popular in the future, they wil withhod or derease supply today so they wil have moreleft over to sell tomorrow, think product will not be popular – sell fast 5. Change in number of producers – more people start producing, supply shifts out Movement aong supply curve – change in quantity suppied brought about by a change in price Suppy curves are usualy smooths upward sloping lines Vertical suli MARKET EQUILIBRIUM Equilibrium – the condition that exitsts when quantity suppied and quantity demanded are equal. Equilibriums Ecvess demand – what happens whehn the quantity demanded exceeds the quantity supplied Excess supply – the condition that exists when a quantity supplied exceeds quantity demanded at the current Adjustment in the Supply and Demand Model What happens when Supply and Demand curves move? - Equilibrium point changes, price can go up or down Price Theory 1. Case: Quantity demanded is higher than quantity supplied (SHORTAGE) a. Price rationing commences Price floor – legal minimum price on a good Price ceiling – max price on a good Efective price floors or ceilings prevent the market from reaching equilibrium and cause persistent shortages (in the case of ceilings) and surpluses (in the case of floors) Price floor – keeps price artificially high, produces surplus of goods 1. How do I gt rid of a price surplus? a. Increase demand, decrease supply b. Govt can purchase the surplus to (price support) i. Store for later ii. Give away domestically iii. Give it away as foreign aid iv. Destroy it c. Example i. Tobacco has a price floor, so there is a surplus of tobacco in the US 1. Surplus a. Encourage exports of tobacco b. Restruct supply by buying up surplus and destroying it c. Restrict supply by giving out allotments of permits that allow farmers to grow tobacco. If you grow too much without a permit, the government will punish you ii. Low skill labor has a price floor, min wage 1. Therefore there is a surplus of min wage labor 2. Unemployment - quantity of workers supplied is greater than the quantity or workers demanded Auction – a market where the equilibrium price is reached out loud Auctioneer attempts to find the max price that consumers are willing to pay for a given good Elasticity of Demand and Supply Chapter 5 Elasticity - a general concept used to quantify the response in one variable Price elasticity of demand - percentage change in price / percentage change in demand Midpoint formula – for a precise calculation of elasticity, use a value halfway between P1 and P2 for the base in calculating the percentage change in price - % change in quantity demanded = change in quanitity demanded / (q1 + q2)/2 * 100 - % change in price = change in price / (p1 + p2)/2 Elasticity in demand = % change in quantity demanded (above) / % change in price (above) Elastic demand – – demand for which the percentage change in quantity demanded is larger in absolute value that the percentage change in price. Very responsive demand, negative elastic number Perfectly elastic demand – demand for which quantity drops to zero at the slightest increase in price. Infinitely responsive demand HORIZONTAL LINE – LOOKS LIKE AN I Unitary elasticity – demand for which the perentage change in quantity of Inelastic demand – demand for which the percentage change in quantity demanded is less in absolute value than the percentage change in price, Ed is between 0 and negative 1 Perfectly inelastic demand – demand for which quantity demanded does not respond at all to a change in price, Ed = 0, demand does not respond to change in price., VERTICAL LINE – DOESN’T LOOK LIKE AN I Steep demand curve means fairly inelastic – quantity doesn’t change much when the price change Flat curve – more elastic - small price changes cause large change in quantity demanded WARNING: Be careful with the signs. Book reports a -3 number with 3. One of the most important applications of elasticity concers the relationship between the price elasticity of demand and the total revenue Total Revenue = Price x Quantity When price declines, quantity demanded increases. Determinants of Demand Elasticity 1. Availability of Substitutes – more substitutes = higher elasticity; less substitutes = less elastic 2. Low Price + Infrequently Purchased = Low Elasticity – not likely to notice a change in price 3. The Time Dimension Elasticity of Supply – a measure of the response of quantity of a good supplied to a change in price of that good Elasticity of supply = % change in quantity supplied / % change in price Income Elasticity of Demand – measures the responsiveness of demand to changes in income %shift in demand / % change in demand - If positive, normal good - If negative, inferior good Luxury good: income elasticity > 0 Necessities: income elasticity = 0 Cross price elasticity of demand – a measure of the response of the quantity of one good demanded to a change in the price of another good CPED is positive, goods are substitutes CPED is negative, goods are complements
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