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This 14 page Class Notes was uploaded by James Cavanaugh on Tuesday October 11, 2016. The Class Notes belongs to Eco 001 at Lehigh University taught by Marija Baltrusaitiene in Fall 2016. Since its upload, it has received 2 views. For similar materials see Introduction to Economics in Economics at Lehigh University.
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Date Created: 10/11/16
Chapter 1 Economics: Foundations and Models 1.1 Three Key Economic Ideas Economics is the study of the choices consumers, business managers, and government officials make in order to achieve their goals, given the scarce resources. People need to make choices due to scarcity, which means that all our wants are unlimited, and their aren't enough resources to fulfill our wants. A market is a group of buyers and sellers of a good or service and the arrangement by which they come together to trade. 3 Key Economic Ideas: ● People Are Rational: Economists usually assume that people are rational. Even though not everyone behaves rationally all the time, the assumption that everyone is rational is useful in explaining the choices people make. ● People Respond to Economic Incentives: Although people act from a variety of motives, studies show that they react to economic incentives. ● Optimal Decisions Are Made at the Margin: The word marginal in economics means "extra." marginal benefit (MB) means the additional benefits you receive, while marginal cost (MC) are the benefits you lose when you choose something over another thing. Economists reason that the optimal decision is to continue any activity up to the point where the marginal benefit equals the marginal cost (MB=MC). The analysis that involves comparing marginal costs and marginal benefits is called marginal analysis. 1.2 The Economic Problems That Every Society Must Solve Since we live in a world with a limited amount of resources and services, every society faces tradeoffs. Tradeoff is the idea that because we live in a world of scarcity, producing on of one good or service means producing less of another good or service. The opportunity cost of any activity is the highestvalued alternative that must be given up to engage in that activity. Tradeoffs force society to make choices when answering the following questions: ● What goods and services will be produced? The answer to this question is determined by the choices that consumers, firms, and the government make. In other words, when consumers buy a good or service, they help firms decide which good or service to produce. ● How will the goods and services be produced? Firms face tradeoff between using more workers or using more machines. ● Who will receive the goods and services? Who receives the goods and services largely depends on the income of different people. Centrally Planned Economies, Market Economies, and Mixed Economies: In order to answer these three questions, you must know how societies organize their economies. There are two main ways in which they do this. A society can have acentrally planned economy in which the government decides how economic resources will be allocated. Or a society can have a market economy in which the decisions of households and firms interacting in markets allocate economic resources. A mixed economy falls somewhere between a market economy and a centrally planned economy because its and economy in which most economic decisions result from the interaction of buyers and sellers in markets but in which the government plays a significant role in the allocation of resources. Efficiency and Equity: There are two types of of efficiency: Productive efficiency and allocative efficiency. Productive efficiency is a situation in which a good or service is produced at the lowest possible cost. Allocative efficiency is a state of the economy in which production is in accordance with consumer preferences; in particular, every food or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it. MR=MC=MP. Voluntary exchange is a situation that occurs when both the buyer and seller of a product are made better off by the transaction. Equity is the fair distribution of economic benefits even if the outcome is less efficient. Government policy makers are often faced with this tradeoff. 1.3 Economic Models Economists use economic models when they need to apply economic ideas or theories to real world problems. Economic models are simplified versions of reality used to analyze realworld problems. The Role of Assumption in Economic Models: Any model is based on making assumptions because we cannot analyze economic issues unless we reduce its complexity. Forming and Testing Hypothesis in Economic Models: An economic variable is something measurable that can have different values. Economists accept and use economic models if it leads to hypotheses that are confirmed statistical analysis. Economics is a social science because it apples the scientific method to study the interaction among individuals. Normative and Positive Analysis: Economics is concerned with positive analysis rather than normative analysis Positive analysis is concerned with what is and measures the costs and benefits of different courses of action. Normative analysis is concerned with what ought to be. 1.4 Microeconomics and Macroeconomics Microeconomics is the study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices. On the other hand, Macroeconomics is the study of the economy as a whole, including topics such as inflation, unemployment and economic growth. Models 1. Make the assumptions and simplifications (dumb that shit down) 2. Formulate a testable hypotheses 3. Use the data available to test the hypotheses 4. Revise the model if needed 5. Retain the model Positive statement: What is (most economics questions are this) Normative: What ought to be Profit: RevenueExpenses Technology: A process used to produce a good or a service Capital: Resources that are used to manufacture a good or a service (humans can b dis) Chapter 2 Tradeoffs, Comparative Advantage, and the Market System 2.1 Production Possibilities Frontiers and Opportunity Costs A production possibility frontier (PPF) is a curve showing the maximum attainable combination of two products that may be produced with available resources and current technology. The PPF is used to illustrate the tradeoffs that arise from scarcity. Any point inside the PPF are inefficient while any point outside the frontier are unattainable. Points that are on the PPF are the most efficient. The opportunity cost mentioned in chapter one is the highestvalued alternative that must be given up to engage in that activity. Because of increasing marginal opportunity costs, production possibilities frontiers are usually bowed out instead of straight lines. (What we give up to do something else, reflected in slope) This shows the important economic concept that the more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity. Shifts in the PPF represent economic growth because they allow the economy to increase the production of goods and services, which ultimately raises the standard of living. Economic growth is the ability of the economy to increase the production of goods and services. 2.2 Comparative Advantage and Trade Markets are fundamentally about trade, the act of buying and selling. On the basis of comparative advantage, people trade. If a firm can produce a good or service at the lowest opportunity cost it is said to have the comparative advantage in producing that good or service. People are better of specializing in the activity in which they have the comparative advantage and trade those resources for other resources they want or need. Absolute advantage is something completely different. If a firm can produce more of a good or service from the same amount of resources, they have the absolute advantage in producing that good or service. It is possible to have the absolute advantage in producing a good or service without having the comparative advantage just as you can have the comparative advantage of producing a good or service without having the absolute advantage. 2.3 The Market System There are two types of markets. Product markets are markets for goods and services such as shoes and medical treatment. Factor markets are markets for the factors of production like labor, natural resources, and entrepreneurial ability. The factors of production are the inputs that are used in order to make goods and services. A circularflow diagram is a simple economic model that illustrates how participants (households, factor markets, firms, product markets) in markets are linked. A free market is a market with few government restrictions on how a good or service can be produced or sold or on how a factor of production can be employed. In a free market, firms have to respond produce the goods and services most desired by consumers. When consumers demand more of a good or service, prices will rise which then cause firms to increase their production. When the demand for a product or service decreases, its prices will fall causing firms to produce less of the good or service. Entrepreneurs are people that operate businesses. They are responsible for organizing the production of goods and services in the free market. The market system will work best when there is protection for property rights, which are the rights firms have to use their property. Supply and Demand Chapter 3 notes Demand Law of demand As price goes up, quantity demanded goes down. DemandThe entire line Quantity demandedThe points on the demand line (the demand at a certain price) Substitution effect As the good becomes cheaper relative to the substitute good, you will buy more of the good.(apple v android, butter v margarine) Income effectWhen you buy more of a good because your purchasing power went up. Purchasing power goes up because the prices goes down, vice versa. What causes a shift in the demand curve? 1. Consumer income increasing demand curve shifts right 2. Price of a related good goes up a. A substitute goes upDemand for original increases b. A complement goes upDemand for original drops 3. Tastes go updemand is increased 4. Population and demographics goes updemand increases 5. Expectation of future prices (substitute for today’s good) goes updemand goes up Types of goods Inferior goodsWant less as income goes up Normal goodsPretty fuckin self explanatory Supply Law of supplyAs price goes up, quantity supplied goes up. Movements of the supply curve to the right mean supply increase, movement left means decrease What causes a shift in the supply curve? (thinking in the firm's’ shoes) 1. Price of inputs goes up, supply goes down. Profits=Price x Quantity Cost x Quantity, makes producing it less viable.(s1s3) 2. Technological changes go up, supply goes up(s1s2) 3. Price of a substitute good goes upsupply goes down (s1s3) a. This is because if the price of a substitute goes up, there is less motivation to supply the original as people switch to the new good. 4. Number of firms goes up, supply goes up. (s1 s2) 5. Future prices of good goes up, supply goes down (s1s3) Supply AND Demand Market EquilibriumPoint of intersection between supply and demand. If you have no graph, look for where Qd=Qs SurplusWhere there is an excess of supply (above equilibrium) ShortageToo high of a demand and not enough supply, exists below equilibrium. When supply and demand are both moving, quantity increases but price should remain the same. Equilibrium point has a rightward shift, price is constant in this situation. Price shifts are not guaranteed. Chapter 5: Externalities 143173 ExternalityA side effect enjoyed by parties that did not pay for the side effect. ● Negative ExternalitiesPollution, smoking ○ Taxes reduce negative externalities ● Positive externalitiesRoses by the fence, Education ○ Subsidies encourage positive externalities Coase Theorem ● Property rights ● Low transaction cost Positive Externalities ● Positive externalities go with quantity and demand changes ● Deadweight LossAllocative inefficiency, always present with externalities ● Max Social BenefitQuantity goes up with subsidy to reach max social benefit Market equilibrium is lower than the social efficiency equilibrium, but there is always a deadweight loss. The individual benefit is lower than the societal benefit. To maximize societal benefit you have to increase the quantity. Negative Externality ● Negative externality shifts supply and price ● Quantity of market is too high, result in tax to lower quantity ● Results in deadweight loss The tax (amount of regulation) is the difference between P and P1 RivalryWhoever gets to the good first can consume it ExcludabilityYou pay for the good Eco 1 Fall 2016 Chapter 7,8 + Elasticity ElasticitiesThe responsiveness of supply or demand on changes in price ● Types of elasticity ○ InelasticTakes a large amount of change in price to change the demand ○ ElasticChanges easily and is vulnerable to price ● Elasticity can be expressed by percent change in quantity/percent change in price ○ Unit ElasticElasticity is 1, perfect responsiveness of quantity to price ○ Elasticity = ((Q1 Q2) / (Q1 + Q2)/2 )) / ((P1 P2)/( (P1 + P2)/2)) ○ Elasticity is greater than 1Elastic, has a large change in small price change Healthcare ● Private good ○ Rival ○ Excludable ● Externalities a. Negative: Poor health choices b. Positive: Healthier population, results in more productive ● Health Insurance Company: a third party payer in the transaction (you do not pay a full cost) Principal Agent Problem Eco 1 Fall 2016 ● Where one person (agent) can make decisions on the behalf of the other (principal) ○ In healthcare, the doctor is the agent, the patient is the principal ○ Doctor can make choices (ordering tests) that someone else pays for ● Asymmetric InformationOne party has better info than the other ○ Adverse selection: Take advantage of having more info ○ Comes before signing up for insurance ● Moral hazardActing differently because protected ○ (patient) order more services because you don’t pay for it fully (patient) ○ Comes after insurance Eco 1 Fall 2016 Chapter 8Firms Firms: A business that produces or sells goods for a profit. ● Can be classified three ways ○ New and better goods. Produce less 1. Sole proprietorshipowner 2. Partnership ○ Old but big goods. Produce more 3. Corporations ● Most (3/4ths) of firms are sole and partnership ● Most new jobs are sole or partnership ● Corporations still have a much larger output regardless How to Distinguish Firms ● How funds are raised is a good indicator ○ Sole ownership: Funds come from owners ○ Partnership: Funds come from owners, friends, banks. ■ Borrowing is indirect financing ○ Corporations: Stocks and bonds. ■ This is known as direct financing (exchange market, NYSE) ■ Stock actually sells part of the company ● Shared benefit, shared risk. ■ Bonds do not. Low risk, guarantee a payout ● Legal liability ○ Sole and Partnership: There is no limit to personal liability ○ Corporation: Limited personal liability ● Taxes ○ Corporations ■ Dual taxation: Paid twice because corporations are viewed as separate entities from the shareholders. ■ Profits: First tax ■ Retained Earnings: Retained and reinvested into the business ■ Dividends: Paid off to investors Profit ● RevenueCost: PQCQ ● Different costs ○ Economic cost: Explicit cost+implicit cost Eco 1 Fall 2016 ○ Accounting cost: Only measured in dollars ○ When profit is measured in dollars, known as explicit cost (given by PQCQ) ○ Implicit Cost ■ Not measured in dollars ■ Is equal to the opportunity cost ■ Example: Lost wages from going to college instead of working ● Accounting Profit ○ Accounting profit: RevenuesExplicit Cost ○ Accounting profit is greater than economic profit ● Economic Profit (more important) ○ Will be lower than accounting profit ○ Economic Profit = RevenueExplicit CostImplicit Cost(accounting profit does not have this) Financial Statements ● Income statements ○ RevenuesAmount that comes in ○ CostsExpenses ○ Will give you accounting profit ● Balance sheet ○ AssetsThings a company owns ○ Liabilities + Shareholder Equity ○ LiabilitiesAny debt(claim, must be paid back) ○ Shareholder Equity
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