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Econ 2020

by: Brie Burnett

Econ 2020 Econ 2020

Brie Burnett
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Exam 1 is on Chapter notes 1-4
Principles of Economics: Microeconomics
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This 13 page Class Notes was uploaded by Brie Burnett on Tuesday August 16, 2016. The Class Notes belongs to Econ 2020 at Auburn University taught by Banerjee in Fall 2016. Since its upload, it has received 180 views.


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Date Created: 08/16/16
August 18 , 2016 Chapter 1: What is Economics? Social science that studies the choices we make as we cope with scarcity and the incentives that influence and reconcile our choices Scarcity: available resources are insufficient to satisfy wants. Implies that we have to  make choices Incentives:   Rewards (benefits, encourage action) vs. penalties (costs, discourage action)   Benefits > costs = do it  Benefits < costs = don’t do it ­Assume people are rational  ­Social Science: create theories and models that we’d like to test ­Ceteris paribus= other things equal  4 Economic Resources  1. Land/natural resources 2. Labor (human capital) [capital is physical: building, machines, not money] 3. Capital (not financial capital)  Physical capital  Buildings, equipment, and machinery 4. Entrepreneurship  Microeconomics  Macroeconomics  Individual consumers, households,   How countries interact, trade &  firms, & government influence how it benefits  3 basic questions:  Financial well being of country  I. What is produced  How the whole country produces,  II. How it is produced not one single decision III. For whom it is produced Labor=wages Capital=interest Land=rent Entrepreneur=profit The economic way of thinking   Positive analysis= facts (inc. facts, decreases population need income)  Normative analysis= judgment   Economic cost= opportunity cost & value of best alternative   Explicit costs= monetary costs   Implicit costs=forgone alternative   “Free good”= even free goods have an economic cost, not actually free  Cost of free good= value of your time  ­Tuition, forgone wages, books, parking permit= economic cost ­Housing, food= sunk cost (can’t recover/get back the cost) Marginal benefit: benefit of one additional unit of a good or activity ­Assumption: marginal benefit declines  Marginal cost: Cost of one additional unit of a good or activity. Ex) college education ­Assumption: marginal cost rises MC & MB graph: Q* where MC=MB is best you can do  8/23/16 Chapter 2: The Economic Problem Ex) Brain surgeon owns an Escalade. Escalade needs a tune up. Brain surgeon can fix up  in 1 hour.  Ex) Mechanic needs 2 hours to fix up the car. Brain surgeon makes $1000/hour.  Mechanic charges $100/hour  Absolute advantage (faster) Comparative advantage (lower cost)  Production of a good can be   Cost of production is lowest.  achieved in less time  Brain surgeon has absolute   More can be produced in the same  advantage but mechanic has  amount of time comparative advantage (since  produces at least costly rate) Ex) Cleaning Business Two people own a cleaning business # Of bathrooms cleaned per # Of beds made per hour hour Scott 4 12 Caroline 3 10 It is apparent that Scott and produce 4 or 12 and Caroline can produce either 3 or 10.  Absolute advantage: Scott (He can produce more of both goods) Impossible to have comparative advantage in both goods.  Caroline vs Scott 3 1/3 beds > 3 beds Scott has comparative advantage in cleaning bathrooms Caroline has comparative advantage in making beds. Scott Caroline 4 Bath= 12 beds 3 Bath= 10 beds 1 Bath= 12 beds/4 bath 1 Bath= 10 beds/ 3 bath 1 Bath= 3 Beds 1 Bath= 3.33 Beds ­Marginal cost of 1 Bath= 3 beds ­Has Comparative advantage for beds since ­Marginal cost= Opportunity cost Scott has comparative advantage for baths.  ­Has comparative advantage  Lower # = has comparative advantage Production Possibility Frontier (PPF): has negative slope  Graph of maximum output that can be produced by an individual or an economy  Slope= change in y/ change in x= PPF  Ratio/rate is always fixed & constant  Slope= always negative (Resources are scarce: have to give up something to  produce something= tradeoffs)  Magnitude of the slope = MC of the good represented on the ‘x’ axis  Slope of PPF gets steeper as we produce more of the good on the ‘x’ axis (since  MC increases with quantity)  Flatter slope (smaller #, more horizontal) has comparative advantage in good “x” Combine Scott and Caroline’s production to make an economy­wide PPF ­If Scott and Caroline both clean bathrooms: 4+3=7 max (7,0) ­If Scott and Caroline both make beds: 12+10=22 max (0,22) PPF and Marginal Cost  A B C D E Cars 0 10 20 30 40 Donuts 600 560 500 400 0 What is the MC of car production between C & D?  10 card cost 100 donuts  1 car costs 10 donuts  Efficiency  Production efficiency: Producing at lowest cost  Allocative efficiency: Using resources where they have the highest value Shifts in PPF: Move graph outward  Technological change  Capital accumulation   Population growth  Change in productivity of labor  8/25/16 Chapter 3: Demand and Supply ­Demand: Maximum quantity a consumer is willing and able to purchase at various  prices  ­Law of demand: Inverse relationship between price and quantity demanded ­Assume linear relationship between price (P) & quantity demanded (Qd) ex) Demand for thin mints Qd (x) P (y) 6 0 5 2 4 4 3 6 2 8 1 10 0 12 Qd= ­1/2 P + 6 P= ­2 Qd +12 ­2= slope 12= y­intercept  [2Qd= ­P +12]  [P= ­2 Qd +12]  shows inverse relationship between supply &  demand  As consumer consumes more, moves along demand curve, happiness from  consuming particular good  Demand=marginal benefit   Y= mx +c [m= slope, c=y­intercept] Interpret demand as marginal benefit   P= ­2 Qd +12  Qd= 3  P= $6 rd  3= 3  box of Thin mints is worth $6  $6= Marginal Benefit of 3  box  Determinants of Demand  Demand increase= shift right  Demand decrease= shift left   Change in quantity demanded= when price of good inc/dec, quantity demanded  changes following laws of demand (Q1 Q2, along x axis)  Changing demand=shift in demand curve (to left or right)  Increasing demand is NOT same as increasing quantity demanded  Demand curve= always negative sloped Changes in Demand [shifts: inc= shift right, dec= shift left] 1. Income  Normal goods: goods where demand rises when income rises and falls when  income falls   Inferior goods: goods where demand rises when income falls and demand falls  when income rises  2. Price ­Substitutes:   Price increases so demand decreases and consumers demand a substitute  Ex) Price of tea increases = Quantity 1 Tea decreases to Q 2 demanded of tea.  Sugar demand would also decrease since its associated with tea. People would consume coffee since they substitute drink choice due difference in  price. Demand of coffee would increase as demand for tea decreases.  ­Compliments:  Goods that are used together & consumed together  Ex) Coffee and cream, cereal and milk  Inc. price of coffee, increase price of cream 3. Expectations    Price: Expect price to rise: increase current demand Expect price to fall: decrease current demand    Income: Expected income rise = current demand increases Expected income decrease= current demand decreases 4. Tastes and preferences   Ex) Market for eggs  Ex) Fashion: if something is trendy, the demand for the item will increase 5. Number of Buyers  More buyers= Demand increases  Fewer buyers= Demand decreases Supply  Supply: Maximum quantity a seller is willing and able to sell at various prices ­ Supply increase= shift right (outward) ­ Supply decrease= shift left (inward)  Law of supply: Positive relationship between price and quantity supplied  (inc. P  inc Qs)  Upward sloped  *Supply= entire relationship between the price of the good and the quantity of it *Quantity supplied= point on the supply curve  P Qs 0 0 2 0 3 2 4 4 5 6 6 8 Qs= 2P ­4 P= ½ Qs +2 S= marginal cost Changes in Supply 1. Input prices  Inc. wages paid to labor  Dec. supply (shift left)  Dec. wages paid to labor  Inc. supply (shift right) 2. Price of Related Goods in Production  Substitutes in production= using same resources to produce goods   Ex) Corn & soybeans= same resource (land) Price of corn increases= opportunity cost of producing soybeans increases=  supply of soybeans decreases  Compliments in production: goods must be produced together  Ex) Wool & lamb chops.  Price of lamb increases= quantity of lamb seller is willing to give increases=  supply of wool increases 3. Expectations about prices   Expected price increases= supply decreases  Expected price decreases= supply increases 4. Number of sellers/suppliers  # Of sellers increases= supply increases  # Of sellers decreases= supply decreases 5. Technology   Better technology= lower marginal costs of production= increase in supply  Ex) Assembly lines= Faster/greater supply  Change in marginal cost of production  Decrease costs  Increase supply (more people will buy) 8/30/16 Demand and Supply Together  D: Qd= ­1/2P + 6       or         P= ­2 Qd+12  S: Qs= 2P­4              or          P= ½ Qs+2  Set D=S ­1/2 P + 6= 2P­4 2*(­P + 12)= (4P­8)*2 5P=20 P=4 To find Q*: Substitute price you found into one of the equations  P= ­2 Qd +12 P= ½ Qs + 2 4= ­2 Qd + 12 4= 1/2 Qs + 2 ­8= ­2 Qd 8= Qs +4 4= Qd 4= Qs Equilibrium (P*, Q*)= (4,4) ­Market Equilibrium= S & D cross on graph           = MB=MC          = Sellers & buyers aren’t willing to move ­Supply= MC (marginal cost) ­Demand= MB (marginal benefit) Surplus and shortage  P> P*  Surplus (Qs> Qd)  P starts to fall until P= P*  P< P*  Shortage (Qs< Qd)  P starts to rise until P= P* Changes in Equilibrium 1. Inc. Demand= Increases both price & quantity 2. Dec. Demand= Decrease both price & quantity 3. Inc. Supply= Decrease price, increase quantity 4. Dec. Supply= Increase price, decrease quantity [True if demand is held constant] * 5. D inc, S dec = P inc & Q inc OR P inc & Q dec 9/6/16 Chapter 4: Elasticity *The price elasticity of demand is a units­free measure of the responsiveness of the  quantity demanded of a good to a change in its price when all other influences on buying  plans remain the same. Elasticity is the measure that we use to see by how much the  equilibrium price falls and by how much the equilibrium quantity increases. ­Elasticity= “Responsiveness”, inverse to slope ­Flatter/lower slope=more responsiveness= higher elasticity ­Steeper slope=less responsiveness= lower elasticity  Price Elasticity of Demand (Ed)= % change in Qd / % change in P             Ed= (Change in Qd/Change in P) * ((P1+P2)/(Q1+Q2)) Ed= (1/slope)*(Sum P/ Sum Qd)  Measured by calculating responsiveness of consumers to a change in price  Slope: Change in P/ Change in Qd  Units of measurement vary so we need “unit free” measure use percentage  changes: % change in Qd / change in %P  Starting point use percentage changes 3 Ranges of Ed 1) Ed>1  % change in Qd / % change in P > 1  % change in Qd > % change in P ­“Elastic” demand  ­P inc, Q dec  ­P dec, Q inc  ­Revenue: P*Q inc. 2) Ed<1  % change in Qd / % change in P < 1  % change in Qd < % change in P ­“Inelastic” demand ­P inc, Q dec  Revenue increases  ­P dec, Q inc  Revenue decreases [Price and revenue follow the same direction] 3) Ed=1  % change in Qd / % change in P = 1  % change in Qd = % change in P ­“Unit elastic” demand 9/8/16 Ex) Qd= 0.5 P + 6 Qd: 54 (P= ­2 Qd + 12) P: $2$4 Ed=(Change in Qd/Change in P) * ((P1+P2)/(Q1+Q2))     = ½ * 6/9     = 1/3 < 1     = Inelastic  Ex)  P: $8$10 Q: 21 Qd= ­1/2(8)+8      = 2 Qd=­1/2(10)+8      = 1 Ed= ½ * 18/3     = 3>1     = Elastic People care more about price changes if they spend more on that good to begin with Know how to calculate elasticity given a Qd= equation and given either Qd or P. Find each by plugging into equation and solving for elasticity and determining which of the 3 ranges of Ed it is Determinants of Ed 1. Proportion of budget spent on the good 2. Availability of substitutes   Lots of substitutes: Demand more elastic  Fewer substitutes: Demand less elastic   Ex) Definition of the market: the more broadly the market is defined, the less  elastic demand is  3. Time   More time demand more elastic  Less time demand less elastic  Two Extremes  1. Perfectly inelastic demand: graph of demand line is vertical 2. Perfectly elastic demand: graph of demand line is horizontal  Ed & Revenue [Most important part of this chapter]  Revenue= P*Qd  Higher PRevenue?  Ed<1(Percent change in Qd/Percent change in P)<1 Percent change in Qd<Percent change in P Small Qd change relative to change in P Cross­Price Elasticity  Price Elasticity of Demand  For elasticity of demand, Ed= Percent change in Qd/Percent change in P  Cross­Price Elasticity= Percent change in Qd­x/Percent change in P­y  Unlike Elasticity of demand, it does not have absolute values outside of it  Substitutes in consumption  Complements in consumption Ex) X= Coke, Y= Pepsi Inc. P of Pepsi  Inc. Qd of Coke (Percent change in Qd­x/Percent change in P­y)>0 Positive  Substitute [Ed= +/+ >0 = Substitute] Negative  Compliment [Ed= ­/+ or +/­ <0= Compliment] Ex)  ­P tent: $40  $42 (demand increases) ­Q sleeping bag: 10  9 (demand decreases) ­E tent, sleeping bag= ((9­10)/(42­40))*((42+40)/(9+10))= (­1/2)*(82/19)= ­41/19 < 0 *Since it is less than 0, the two goods are compliment & is inelastic Ex)  ­P tent: $40  $42 (demand increases) ­Q tent: 20  24 ­E= (4/2)*(82/44)= 41/11 > 0 *Since it is greater than 0, the two goods are substitutes & is elastic Income Elasticity  Income Elasticity= (Percent change in Qd/% change in income)  How consumers change their consumption with change in income  Positive  Normal good  Negative  Inferior good  Price Elasticity of Supply  Supply Elasticity: how suppliers adjust supply in regards to market price  Es= (Change in Qs/Change in P)>0  Es>1 Elastic  Es<1 Inelastic  Es=1 unit elastic Determinants of Es 1. Availability of substitute inputs Fewer substitute inputs less elastic supply More substitute inputs  more elastic supply 2. Time More time more elastic supply Less time less elastic supply Ex) Computers change so much, consumers buy new products and therefore, old products are sold for less and have less elastic supply. *Know one formula & know all definitions for test* -Price has to do with Compliments and Substitutes -Income has to do with Normal goods and Inferior goods Difference between quantity supplied of and supply of -The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. -The quantity supplied is one quantity at one price. -When the price of a good changes, a change in the quantity supplied occurs -Expectations about future prices influence supply * The more it costs to produce a good, the smaller is the quantity supplied of that good at each price (other things remaining the same).  Ex) In 2013, the price of corn fell and in 2014 some corn farmers will switch from growing corn to growing soybeans. This illustrates the law of supply because the fall in the price of corn results in a decrease in the quantity of corn supplied.  A corn farmer would grow soybean because soybean is a substitute in production for corn, and when the relative price of corn falls, farmers plant more soybeans. -Demand for a luxury is more elastic than demand for a necessity, because a luxurt has more substitutes. Ex) Food is a necessity and has few substitutes


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