Intermediate Microeconomics EC 301
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Date Created: 09/19/15
Book Notes Chap 1 962011 10300 AM Intro Scarcity is the mother of economics Microeconomics is the study of how individuals and firms make themselves as well off as possible in a world of scarcity and the consequences of those individual decisions for markets and the entire economy o In Micro we examine how individual consumers and firms make decisions and how the interactions of many individual decisions affects the market 11 Microeconomics The allocation of scarce resources 12 Models 13 Uses of Microeconomic Models Microeconomics The Allocation of Scare Resources 962011 10300 AM Individuals and firms allocate their limited resources to make themselves as well off as possible Consumers choose mix of goods and services that makes them as happy as possible given their limited wealth Firms decide which goods to produce where to produce them how much to produce to maximize their profits and how to produce those levels of output at the lowest cost by using more or less of various inputs such as labor capital materials and energy TradeOffs o People make tradeofffs because they cant have everything o 3 key tradeoffs 0 Which goods and services to produce To produce one good you pay the opportunity cost of producing another good How to produce What inputs used to make the output Who gets the goods and services The more goods and services you get the less another person gets Who Makes Decisions o 3 Tradeoff decisions can be made by a government or may reflect the interaction of independent decisions by many individual consumers and firms Prices Determine Allocations o Prices link the decisions about which goods and services to produce how to produce them and who gets them o Market An exchange mechanism that allows buyers to trade with sellers 0 O Models 962011 10300 AM Model A description of the relationship between two or more economic variables o Economist use models to predict how a change in one variable will affect another Income Threshold Model and China o Income threshold model No one who has an income level below a threshold buys a particular consumer durable fridge car etc Also holds that almost everyone whose income is above the threshold does buy the consumer durable Simplifications by assumption c When using economic models economist make assumptions to simplify their models If the assumption is correct we make our analysis simpler without losing important details If assumption is wrong and the ignored issues are important predictions may be inaccurate Testing Theories o Economic theory is the development and use of a model to test hypotheses which are predictions about cause and effect c Economist test theories by checking whether predictions are correct o Key assumption in most microeconomic models is that individuals allocate their scarce resources to make themselves as well off as possible o Consumers pick goods that maximize possible enjoyment for cost o Firms try to maximize their profits given limited resources and technology Positive vs Normative o Positive statement A testable hypotheses about cause and effect c Normative statement A conclusion as to whether something is good or bad Applying the Consumer Theory 9212011 43000 PM 51 Deriving Demand Curves 52 How Chanqes in Income Shift Demand Curves 53 Effects of Price Change 54 Costof Livinq Adiustments 55 Derivinq Labor Supply Curves Deriving Demand Curves 9212011 43000 PM We derive a demand curve using information about tastes from indifference curves o Construct the demand curve by holding budget taste and substitutes price constant Then you find the demand for a good at varying prices Price Consumption Curve line through the optimal bundles of rotated budget constraints holding one price constant How Changes in Income Shift Demand Curves 9212011 43000 PM Rise in income causes budget constraint to shift upwards Incomeconsumption Curve curve through the optimal bundles of budget constraints shifted due to a change in income on an indifference map Engel Curve the relationship between quantity demanded of a single good and income holding prices constant Income Elasticity tells us how much the quantity demanded changes as income changes EAQQAYY Normal Good a commodity of which quantity demanded increases if income increases Inferior Good a commodity of which quantity demanded decreases if income increases Income elasticities of some goods may vary with income o Ex Poor don t eat much meat 0 If income rises a little hamburger consumption increases making hamburger a normal good 0 If income rises again hamburger may be substituted with steak making hamburger an inferior good Effects of a Price Change 9212011 43000 PM Substitution Effect the change in the quantity of a good that a consumer demands when the goods price changes holding other prices and the consumer s utility constant The substitution effect is unambiguous a consumer always sbustitues a less expensive good for a more expensive one holding utility constant Causes a movement along the indifference curve Income Effect The change in the quantity of a good a consumer demands because of a change in income holding prices constant When a price changes the total change in the quantity purchased is the sum of the substitution and income effects How to separate total effect into substitution and income effects Draw an imaginary budget constraint line parallel to the new budget constraint line and tangent to the original indifference curve The substitution effect is the difference between the original quantity and the quantity where the imaginary budget constraint is tangent to the original indifference curve The Income effect is the difference between the new quantity and the quantity where the imaginary budget constraint is tangent to the original indifference curve Incomesubstitution effect for an inferior good With inferior goods the income and substitution effects go in opposite directions For most inferior goods the income effect is smaller than the substitution effect Giffen Good a commodity for which a decrease in its price causes the quantity demanded to fall The demand curve of a giffen good has a positive slope CostofLiving Adjustments 9212011 43000 PM Many long term contracts and government programsinclude costofliving adjustments COLAs which raise prices or incomes in proportion to an index of inflation Calculating inflation indexes Use the basic formula for all of the goods in the bundle o CPI Price Quantity of good A Price Quantity of good B o CPI is the amount of income it takes to purchase the bundle o CPI is a weighted average of the price increases for each good the weights are each good s budget share in the base year 0 CPI adjustment of prices in longterm contracts overcompensate for inflation To calculate the true costof living adjustment o Use the same method to find the substitutionincome effects o Draw an imaginary budget constraint parallel to the new one and tangent to the original indifference curve c Find the income using the value of an axis intercept and the price of that good CPI Y2 Y1 Y Y1 Y2 Y 0 First part is the increase in true cost of living 0 Second term reflects the substitution bias in the CPI 9162011 60200 PM 31 How Shapes of supply and demand curves matter 32 Sensitivity of quantity demanded to price 33 sensitivity of guantity supplied to price 34 effects of a sales tax How shapes of supply and demand curves matter9162011 60200 PM Curve slope examples o If the demand curve has a slope gt 1 as it approaches a vertical line consumers are less sensitive to changes in price o If the demand curve has a slope lt 1 as it approaches a horizontal line consumers are more sensitive to changes in prices Sensitivity of Quant Demanded to Price 9162011 60200 PM Elasticity the percentage change in a variable in response to a given percentage change in another variable Price elasticity of demand the percentage change in the quantity demanded in response to a given percentage change in the price 0 0 Income Elasticity of demand percentage change in quantity demanded percentage change in price dQQ dPP Varies along most demand curves Demand is perfectly inelastic where the demand curve hits the vertical axis Demand is perfectly elastic where the demand curve hits the horizontal axis Demand is unitary elastic at the midpoint of the demand curve Elasticity is a larger negative number at higher prices and approaches 0 as price approaches 0 Demand is inelastic 1 lt E lt 0 Demand is elastic E lt 1 elasticity of demand Income elasticity of demand percentage change in quantity demanded percentage change in income dQQ dYY measure of how sensitive quantity demanded at a given price is to income necessities have an income elasticity near 0 luxury goods have an income elasticity greater then 1 Crossprice elasticity Crossprice elasticity percentage change in quantity demanded percentage change in price of another good dQ Q dPO P0 when cross price elasticity lt 0 the goods are compliments when cross price elasticity gt 0 the goods are substitutes Sensitivity of quantity supplied to price 9162011 60200 PM price elasticity of supply the percentage change in the quantity supplied in response to a given percentage change in the price o price elasticity of supply percentage change in quant supplied percentage change in price 0 dQQdpp inelastic 0 lt elasticity of suppylt 1 o elastic elasticity of supply gt 1 Firms and Production 10262011 64400 PM 61 The Ownership and Manaqement of Firms 62 Production 63 ShortRun Productiongt One Variable and One Fixed Ingut 64 LongRun Production Two Variable Inguts 65 Returns to Scale 66 Productivity and Technical Chanqe The Ownership and Management of FirmS10262011 64400 PM Firm an organization that converts inputs such as labor materials and capital into outputs the goods and services that it sells Private Public and Nonprofit Firms o Private sector forprofit private sector consist of individuals or other nongovernmental entities and whose owners try to earn a profit o Public sector consists of firms and organizations that are owned by governments or government agencies o Nonprofit sector notforprofit consists of organizations that are neither governmentowned nor intended to earn a profit Ownership of ForProfit Firms o Sole Proprietorships firms owned by a single individual who is personally liable for the firm s dept o General Partnerships businesses jointly owned and controlled by two or more people who are liable for the firm s depts o If any partner leaves the agreement a new partnership agreement is created if the firm is to continue operations o Corporations owned by shareholders in proportion of the number of shares or amount of stock they hold 0 Shareholders elect a board of directors to represent them The board of directors usually hires managers to oversee the firm s operations Limited liability condition whereby the personal assets of the owners of the corporation cannot be taken to pay a corporation s debt if it goes into bankruptcy The Management of Firms 0 O o In small firms the owner usually manages the firm s operations o In larger firms typically corporations and larger partnerships a manger or a management team usually runs the company What Owners Want 0 Profit 7 TC R C 0 Revenue Cost o Revenue R R pq 0 Price Quantity Efficient Production situation in which the current level of output cannot be produced with fewer inputs given existing knowledge about technology and the organization of production 0 Given the quantity of inputs used no more output could be produced using existing knowledge Efficient production is necessary condition for profit maximization Efficient production is not a sufficient condition to ensure that a firm s profit is maximized Production 10262011 64400 PM Factors of production Capital K long lived inputs such as land buildings and equipment Labor L Human services such as those provided by managers skilled workers and lessskilled workers Materials M raw goods and processed products Output can be a service or a physical product Production Function the relationship between the quantities of input used and the maximum quantity of output that can be produced given current knowledge about technology and organization q 1 LIK Time and variability of inputs Short run a period of time so brief that at least one factor of production cannot be varied practically Fixed input a factor of production that cannot be varied practically in the short run Variable input a factor of production whose quantity can be changed readily by the firm during the relevant time period Long run a lengthy enough period of time that all inputs can be varied ShortRun Production One Variable and One Fixed Input 10262011 64400 PM In the short run assume that capital is fixed input and labor is a variable input 0 q fLLlt 0 production function 0 llt is fixed capital 0 L is variable labor Marginal Product of Labor MPL The change in total output resulting from using an extra unit of labor holding other factors constant MPL Aq AL Average Product of Labor APL The ratio of output to number of workers used to produce that output 0 APL q L Long Run Production Two Variable Inputs 10262011 64400 PM Isoquant a curve that shows the efficient combinations of labor and capital that can produce a single level of output o Similar to indifference curves but isoquants hold quantity constant indifference curves hold utility constant c Properties of isoquants o The farther an isoquant is from the origin the greater the level of ouput o Isoquants do not cross 0 Isoquants slope downward Marginal rate of technical substitution MRTS the number of extra unites of one input needed to replace one unit of another input that enables a firm to keep the amount of output it produces constant MRTS AKAL MPLMPK Returns To Scale 10262011 64400 PM Constant Returns To Scale CRS property of a production function whereby when all inputs are increased by a certain percentage output increases by that same percentage Increasing returns to scale IRS property of a production function hwereby output rises more than in proportion to an equal increase in all inputs Decreasing returns to scale DRS property of a production function whereby output increases less than in proportion to an equal percentage increase in al inputs Chap 4 Notes 9192011 92600 PM Consumer behavior is based on following premises o Individual taste or preferences determine the amount of pleasure people derive from the goods and services they consume o Consumers face constraints or limits on their choices o Consumers maximize their wellbeing or pleasure from consumption subject to the constraints they face Consumers spend their money on the bundle of products that give them the most pleasure 41 Preferences 42 Utility 43 Budget Constraints 44 Contrainted Consumer Choice 45 Behavioral Economics Preferences 9192011 92600 PM Properties of Consumer Preference Completeness when facing a choice between any two bundles a consumer can rank them according to which bundle they prefer or decide that they like the bundles equally TransitivityA consumer s preferences over bundles is consistent if AgtB and BgtC then AgtC o More is better Nonsatiation or Monotonicity more of a commodity is better than less of it Good a commodity for which more is preferred to less Bad a commodity which less is preferred to more ex pollution PreferenceIndifference Maps graphical interpretation of consumer preferences o Indifference Curves a set of all bundles of goods that a consumer views as being equally desirable o indifference maps are a complete et of indifference curves that summarize a consumer s tastes or preferences o 4 properties of indifference maps 0 bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin 0 there is an indifference curve through every possible bundle o indifference curves cannot cross 0 indifference curves slope downward Marginal rate of substitution the maximum amount of one good a consumer will sacrifice to obtain one more unit of another good o Measure of willingness to trade one good for another 0 MRS AGoodA AGood B o Slope of the indifference curve 0 Indifference curves are always negatively sloped and normally the double derivative is positive o The principle of diminishing returns normally applies to MRS o Perfect Substitutes goods that a consumer is completely indifferent as to which to consume o Perfect Complements goods that a consumer is interested in consuming only in fixed portions 0 O Utility 9192011 92600 PM Utility a set of numerical values that reflect the relative rankings of various bundles of goods Utility Function the relationship between utility values and every possible bundle of goods Ordinal measure tells us the relative rankings between two things but does not say how large the difference in the rankings are c Utility is an ordinal measure Cardinal measure a measure that an absolute comparison can be made Marginal Utility the extra utility that a consumer gets from consuming the last unit of a good MU AUtiity AQuant of Good o MRS is the negative ratio of marginal utility of a good to the marginal utility of another good o MRS AQuant of Good A AQuant of Good B o MU of Good B MU of Good A Budget Constraint 9192011 92600 PM Budget constraint line bundles of goods that can be bought if the entire budget is spent on those goods at given prices Opportunity Set all the bundles a consumer can buy including bundles inside the budget constraint and on the budget constraint Marginal rate of transformation the tradeoff the market imposes on the consumer in terms of the amount of one good the consumer must give up to obtain more of the other good o MRT Aquant of good A Aquant of good B o price of good B price of good A Constrained Consumer Choice 9192011 92600 PM Optimal bundle is tangent to the budget constraint Interior solution an optimal bundle that has positive quantities of both goods and is tangent to the budget constraint c To find the bundle where the indifference curve is tangent to the budget constraint set MRS MRT o MUA PA MUB PB Corner Solution an optimal bundle that the indifference curve intersects the budget constraint at one of the axis it has a positive value for one good and 0 of the other good Book Notes Chap 2 962011 83000 PM Intro Supply and demand model describes how consumers and suppliers interact to determine the quantity of a good or service sold in a market and the price at which it is sold c To use the model you need to determine three things buyers behaviors sellers behaviors and how they interact 21 Demand 22 Supply 23 Market Eguilibrium 24 Shocking the Eguilibrium 25 Equilibrium Effects of Government Interventions 26 When to Use the Supply and Demand Model Demand 962011 83000 PM Consumers determine how much of a good or service to buy on the basis of its price and other factors Factors that influence demand 0 Their own tastes People don t buy food they don t like 0 Information Public opinion and facts about a good or service 0 Prices of compliments or substitutes 0 Income 0 Gov actions The Demand Curve Quantity Demanded The amount of a good that consumers are willing to buy at a given price holding other factors of demand constant Demand Curve The quantity demanded at each possible price holding other factors of demand constant Law of Demand consumers demand more of a good the lower its price holding other factors of demand constant Movement along the demand curve occurs when a new point is selected that is already on the curve this can be caused by changing price Shifting a demand curve occurs when quantity demanded is changed by a factor other then price examples above The Demand Function To sum demand curves 0 Q1 D1P Quantity demanded of the first buyer equals first buyer s demand as a function of price 0 Q2 D2P o QT Q1 Q2 Supply 962011 83000 PM Firms determine how much of a good to supply on the basis of price of that good and other factors o Factors that influence supply 0 Cost of production 0 Gov rules and regulations The Supply Curve o Quantity supplied the amount of a good that firms want to sell at a given price holding other factors that influence supply constant c Supply curve The quantity supplied at each possible price holding other factors that influence supply constant c Changing the price leads to movement along the supply curve the new quantity supplied is Q the new price o Quota the limit that a government sets on the quantity of a foreign produced good that may be imported
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