ECONOMICS FOR MANAGERS
ECONOMICS FOR MANAGERS MBA 7035
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This 34 page Class Notes was uploaded by Bernardo Schaden on Monday September 21, 2015. The Class Notes belongs to MBA 7035 at Georgia State University taught by Jon Mansfield in Fall. Since its upload, it has received 14 views. For similar materials see /class/209831/mba-7035-georgia-state-university in Business Administration at Georgia State University.
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Date Created: 09/21/15
Demand Supply amp Equilibrium Prices MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Micro Lecture 1 Behavior of 1 buyers 39 Individual and Market Demand Functions Relationship shows the quantities of a good or service that buyers are willing and able to buy at various prices holding everything else constant ceteris paribus General Demand Function 0 f P T Py Pz Exc Nc demand shift parameters P The amount demanded quantity demanded depends on o P price of the good or service A B o T tastes and preferences P0 income normal good inferior good Py price of substitute goods Pz price of complementary goods D0 D1 Exc expectations of future prices Nc number of consumers in the market Q5 Qb Qd A change in price causes a movement along a given demand curve A change in any other variable in the general demand function causes a shift of a demand curve For example when income increases for a normal good everything else held constant the demand curve will shift out Another way of stating this is an increase in Qd at every price moving from A to B at P0 and also at every other price Demand Supply amp Equilibrium Prices Behavior of Firms producers sellers suppliers Individual and Market Supply Functions Relationship shows the quantities of a good or service that firms are willing and able to produce at various prices holding everything else constant ceteris paribus General Supply Function Qsf P Tx Pi Pa Pb Exp Np supply shift parameters The amount supplied quantity supplied depends on P price of the good or service p0 Tx technology Pi resource prices Pa Pb prices of goods related in production Exp expectations Np number of producers in the market A change in price causes a movement along a given supply curve A change in any other variable in the general supply function causes a shift of a supply curve For example when resource prices decrease everything else held constant the supply curve will shift out Another way of stating this is an increase in Qs at every price moving from A to B at P0 and also at every other price MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Demand Supply amp Equilibrium Prices Market Equilibrium firms QdQs Changes in Equilibrium a state of balance between opposing economic forces the behavior of consumers is consistent with the behavior of intersection of Demand and Supply curves P C 5 P1 A B P0 D1 0 D 100 150 200 Q P D0 5 51 A B P0 c P1 I 100 150 200 D0 100 Q Increase Income for a normal good At each price the quantity demanded increases the demand curve shifts out to D1 At the original equilibrium price there is now excess demand Qs 100 and Qd 200 Consumers start to bid up the price As the price rises Qs increases moving up along the supply curve from A to C and Qd decreases moving up along the new demand curve from B to C Equilibrium is restored at a higher price and a higher than the original quantity Increase in Technology At each price the quantity supplied increases the supply curve shifts out to S1 At the original equilibrium price there is now excess supply Qd 100 and Qs 200 Firms start to lower the price As the price falls Qd increases moving down along the demand curve from A to C and Qs decreases moving down along the new supply curve from B to C Equilibrium is restored at a lower price and a higher than the original quantity MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld The Basic Model Spending amp Money MBA 7035 Dr Jon Mansfield Macro Lecture 2 1 The Components of Spending C I G X M Consumption spending Household sector Household spending on currently produced goods durable nondurable amp services primary determinant is disposable income Yd Y T marginal propensity to consume as Yd inc C inc but by a smaller amount C f Y T i Cons Conf Wealth Credit Investment spending Firm sector Business spending on structures amp equipment also firm s additions to inventories amp household spending on residential increase ability to produce goods and services in future Investment is the addition to the capital stock I change in CS I f Y i Bus Conf Competition Governmentspending Public Sector Federal State and Local spending on consumer and investment g amp 5 independent of income used as a policy instrument G f Y policy 0 Exports Spending on domestically produced goods amp services by other countries X f Y foreign GDP Y Exchange Rate R 0 Imports Spending on foreign produced goods amp services by domestic residents M f Y Exchange Rate R The Basic Model Spending amp Money 2 2 Aggregate spending Planned spending on currently produced g amp s by all sectors in the economy household business government foreign E C I G X M AE autonomous expenditures expenditures that don t depend E1 on the level of income everything else that is held constant E f Y T i ConsConf Wealth Credit BusCon Comp G Y R 45 line equilibrium income from production must equal expenditures Y E point D unplanned inventory decrease planned expenditures gt E El income point I unplanned inventory increase planned expenditures lt income D movement along the curve E1 T i G Y R constant 45 Y 3 Changes in planned aggregate expenditures AE dec i gt inc C 1 gt inc E at every Y E 45 dec T gt inc C gt quot E2 inc CC gt inc C gt quot inc W gt inc C gt quot B T inc Cr gt inc C gt quot inc BC gt incI gt quot E1 inc Comp gt inc 1 gt quot inc G gt inc G gt quot inc Y gt inc X gt quot A dec R gt inc X dec M gt quot AY Y The initial increase in expenditure generates a multiplier effect on income AY gt AAE MBA 7035 Economics for Managers Dr Jon Mans eld The Basic Model Spending amp Money 4 Money Circular flow Financial Markets Channels funds from savers primarily households to borrowers primarily firms but also government Inverse relationship between interest rate and the price of a bond Money anything that is generally accepted as a medium of exchange 0 Functions medium of exchange unit of account store of value 0 Basic measure of money M1 C D currency held by the public plus checkable deposits 0 Goals of monetary policy low inflation low unemployment high real GDP growth Tools of Monetary Policy Open Market Operations 0M0 the buying and selling of Government securities in the open or secondary market This is the main tool in the economy for conducting monetary policy since it can be done in any amount and can be implemented or reversed quickly In the example below when the Fed buys 1000 of government securities and if r 10 Required Reserves 1 by 100 and Excess Reserves 1 by 900 the initial 1000 gets multiplied by the banking system into 10000 of new deposits one component of M1 Federal Reserve Commercial Bank Public Gov39t Sec Reserves Reserves Deposits Deposits Gov39t Sec Reserve Requirements r is the reserve requireme nt on deposits and is set by the Board of Governors Because changes in reserve requirements have immediate and strong effects they are not really used as a policy tool I r no change in Total Reserves only a change in composition xix lending ability Discount Rate the interest rate dr that the FR charges banks on short term borrowings and is set by the Board of Governors Although it is available the discount rate is not really used as a policy tool xix dr gtgt I borrowings gtgt I lending ability Apolicy tool gtgt AReservesampDeposits gtgt lt nominal Ms gtgt A i gtgt A C ampI gtgt A GDP and P level MBA 7035 Economics for Managers Dr Jon Mans eld The Basic Model Spending amp Money 4 Money Creation The Fed provides currency to the public C and Reserves to the Banking System R This represents the Monetary Base MB which supports a larger amount of money in the economy based on the money multiplier The simple money multiplier is based on the reserve requirement The effect is to multiply Reserves into Deposits Example of increasing the nominal Money Supply 0 Fed conducts OMO buys 1000 Government Securities This increases the checking account of the seller which increases Reserves of a bank The bank now has 1000 more Reserves only 100 ofwhich are required 900 are excess The bank extends a loan of 900 by creating a checking account for the borrower The borrower spends this money which get deposited into another bank within the banking system This new bank now has 900 more Reserves only 90 of which are required 810 are excess The process continues until the initial 1000 reserves all becomes required deposit keep 10 RR using excess reserves D L rounds ongmal lioney SUpply 1 00 Deposits increase 21000 1000 20000 39 2 I 1039000 Deposit multiplier 39 m r 39 m 11 10 39 39 39 Original Monetary Base C Reserves increase 3000 1000 2000 1000 21 00 1000 MBA 7035 Economics for Managers Dr Jon Mans eld The Basic Model Spending amp Money 5 Money Supply i The nominal money supply is ultimately controlled by the Federal FMSO rMSl Reserve and the Banking System nMs f FR policy where nMs is positively related to Federal Reserve policy What is important for economic analysis however is the real money supply or the purchasing power of the available nominal amount To derive the real Ms divide the nominal Ms by the price level P real Ms nominal Ms P Note that for a fixed nominal Ms the real Ms or the purchasing power of the fixed nominal Ms varies inversely with P By extension the real money supply relationship is real MS realMsf i FRpolicyornMs P 0 Money Demand People demand money not for itself but for its functions as a medium of exchange to purchase real goods and services and as a store of value The general money demand function can be written as follows Md P f i Y or nominal Md P real Md Note that the price Md1Y1 level is positively related to nominal Md but unrelated to real Md This assumes people do not have money illusion they know when the prive MdO YO level of goods and services changes and will demand nominal money real Md balances accordingly in order to maintain their real purchasing power Assuming no inflation the nominal interest rate is equal to the real interest rate realMd f i Y rMs Equilibrium B Equilibrium in the real money market is determined by supply and I demand In the graph to the right equilibrium occurs at either point A or 1 B depending on the level of income Note that at a higher level of i0 Md income Md 0 shifts out to Md 1 A Mdo real MBA 7035 Economics for Managers Dr Jon Mans eld The Basic Model International MBA 7035 Economics for Managers Dr Jon Mansfield 1 US International Transactions in 2007 The Balance of Payments is a record of all transactions between residents of the reporting country and residents of the rest of the world over a period of time accounts below are in billions of rounded An inoome item is a positive and a payment item is a negative Current Account transactions Exports of Goods amp Services 1630 Imports of Goods amp Services 2340 Trade Balance 710 Receipts on US assets abroad 780 Payments on foreign assets in US 700 Net Investment Income 80 Unilateral Transfers 100 Current Account Balance 730 Capital Account transactions bank deposits securities direct t ent inves m Change in foreign holdings of US assets ki 1870 Change in US holdings of foreign assets ko 1200 Net Capital Flows to US 670 Statistical Discrepancy 60 The Basic Model International Capital account transactions capital flows result from changes in interest rates or differences in interest rates as residents adjust their stocks of assets Capital inflows ki arise when US residents sell real and financial assets to residents of the rest of the world capital outflows ko occur when US residents buy real and financial assets from residents of the rest of the world All international transactions can be classified in one of two ways whether they generate receipts or income to US residents or whether they generate payments or expenses by US residents They can be listed in a Revenue Account which following the accounting concept of the income statement records international transactions as either expense generating items listed on the left hand or debit side or income generating items listed on the right hand or credit side dl 39 Revenue Account cr 4 US residents39 payments expenses to US residents39 receipts income from residents of the rest of the world residents of the rest of the world Since we are recording all transactions between US and rest of the world residents the left hand side must equal the right hand side total expenditures must equal total income recall the transaction identity between 2 economic units Payments Receipts Importtype transactions debit Exporttype transactions credit Imports of Goods amp Services 2340 Exports of Goods amp Services 1630 Payments on foreign assets in US 700 Receipts on US assets abroad 780 Unilateral Transfers 100 Change in US holdings of foreign 1200 Change in Foreign holdings of US 1870 assets assets Statistical Discrepancy 60 Total 4340 Total 4340 The statistical discrepancy arises from the fact that data collection is not perfectly efficient we can39t actually account for every single transaction between US residents and residents of the rest of the world Since it is usually attributed to short term capital flows we can include SD 60 in the Change in Foreign holdings of US assets account Generalizing the above transactions gives the following table In the examples that follow the assumption is perfectly efficient data collection so SD 0 MBA 7035 Economics for Managers Dr Jon Mansfield The Basic Model International 3 Payments Receipts Imports 3140 Exports 2410 Capital Outflows 1200 Capital Inflows 1930 Total Expenditures 4340 Total Income 4340 Total expenditures is the sum of imports and capital outflows M ko and total income is the sum of exports and capital inflows X ki In the above Revenue Account Income Expenditures so Income Expenditures 0 Substituting the components gives X ki M ko 0 and rearranging X M ki ko This is just the equation for Net Exports F X M plus the equation for Net Capital Flows K ki ko so that the Balance of Payments is the sum of the balance on the Current Account plus the balance on the Capital Account or BP F K 0 The Balance of Payments equation separates the above transactions into flows affecting current income or current GDP trade flows and flows involving existing assets capital flows Recall the identity from the Macro Introduction Y Z X M where Y is income from domestic production and Z is domestic spending CIG If both sides of the identity are 730 it means that the domestic economy is spending 730 more than it is earning in income from domestic production this is reflected in payments for imports being 730 greater than income from exports What enables the domestic economy to do this US residents must have generated additional income by selling assets or borrowing from residents of the rest of the world We account for this by including other income on the left hand side and the capital account on the right hand side The left hand side now shows Total Income less Expenditures for the domestic economy and the right hand side shows Total Income less Expenditures for US International Transactions other income Y Z X M k kg 2410 3140 1930 1200 730 730 730 730 0 0 MBA 7035 Economics for Managers Dr Jon Mansfield The Basic Model International 2 Deriving the Foreign Exchange Market This section uses the US and Japan a simple 2 country model to derive the foreign exchange market We can use the Revenue Account described in the previous section which shows the quantity supplied and quantity demanded for and To pay for US goods whether newly produced exports or existing assets as capital inflows Japanese residents will demand by supplying their own currency to the foreign exchange market They sell and buy Alternatively US residents receive when they sell their goods but is not the US currency so US residents take to the foreign exchange market and exchange them for they buy with The income side of the Revenue Account shows the amount demanded of dollars US sells to Japan if Japan paysin if Japan paysin in foreign exchange Japan sells to buy US sells to buy Qd market A similar analysis holds for the expense side To pay for Japanese goods whether newly produced US imports or existing assets US k0 US residents will demand They will supply to the foreign exchange market in exchange for Alternatively Japanese residents receive when they sell these goods and will take these to the market to acquire their own currency Either way these transactions give rise to an amount supplied of dollars Note that this discussion only includes the supply and demand for and in the foreign exchange market not the domestic money market US buys from Japan if US pays in I if US pays in in foreign exchange Japan sells to buy US sells to buy Qs market Based on the main accounts in the USInternationalTransactions the general functional relationships are XfYJapan R Mf YUS R kif iUSgtiJapan kof iUSltiJapan H Since these accounts generate a supply of and demand for and Q5 Qd we have M X Qd fX ki Qs f M ko k0 ki MBA 7035 Economics for Managers Dr Jon Mansfield The Basic Model International Qd f R YJapan iUSgtiJapan Qs f R YUS iUSltiJapan R With the assumption that i US i Japan we can use these S0 relationships to derive the foreign exchange or dollar market where R is the price of in terms of and Q is the quantity of dollars In the graph to the right a movement down along the D0 curve drawn for a given level of Japanese income shows the Q d increasing this is because of the decrease in the translated price of US exports to Japanese residents please see the example on page 2 In the same way a movement upward along the SO curve drawn for a given level of US income shows the Q s increasing because the demand for imports is increasing imports are becoming less expensive 100 Q Equilibrium in the foreign exchange market is at point A at the exchange rate R 1 and Q d Q s 100 Dollar market initial equilibrium BP X M K 100100 0 0 U S International Transactions Qs Qd M 100 x 100 ko 0 ki 0 100 100 3 Exchange Rate Systems Flexible There is no central bank intervention the exchange rate is determined stricty by the interaction of supply and demand so that payments imbalances a surplus or a de cit can t arise Note a BP surplus is when autonomous receipts exceed autonomous payments at a given R Q d gt Q s a BP deficit is when autonomous payments exceed autonomous receipts at a given R Q s gt Q d Assume the US uses expansionary policies to raise income while maintaining prices and interest rates at their current levels and that no policy action is taken in Japan everything else held constant With increased income US residents will not only increase their demand for domestically produced goods and services but also for foreign goods This increases the demand for imports at every exchange rate At each R US residents MBA 7035 Economics for Managers Dr Jon Mansfield The Basic Model International will supply a larger amount of dollars to exchange for demand more yen In the graph below this is shown as a shift outward from SO to 1 Assuming that at the original exchange rate R 1 the demand for imports increases to 150 there would now exist a BP deficit in the US Q s 150 gt 100 Q d or planned expenditures payments exceed planned receipts income BP x M 100 150 50 In the Dollar market the US BP deficit is represented by the distance AB an excess supply of dollars R 5 A Do 100 125 150 increase in US income Q Under a flexible exchange rate system competitive pressures will force the exchange rate down the dollar depreciates or becomes worth less As R falls the effect on US exports is shown as a movement along the D0 curve from A to C as the translated price of US goods decreases Japanese residents will increase the amount of dollars demanded Also as R falls the effect on US imports is shown as a movement along the new 1 from point B to C as R falls the translated price of Japanese goods increases thereby cutting off some of the demand increase induced by the increase in US income The final equilibrium is at point C in the Dollar market at a lower exchange rate R 05 Flexible exchange rates automatically eliminate balance of payments disequilibrium BP X M K 125125 0 0 US International Transactions pointA points A B point C M 100 X 100 M 150 X 100 M 125 X 125 ko 0 ki 0 ko 0 ki 0 ko 0 ki 0 100 100 150 100 125 125 Fixed This analysis applies either to a gold standard Where central banks agree to buy or sell gold to keep the exchange rate at a certain level or to a managed oat Where central banks intervene in the foreign exchange market to maintain or stabilize the exchange rate payments imbalances can arise MBA 7035 Economics for Managers Dr Jon Mansfield The Basic Model International 7 Assume the US uses expansionary policies under the same conditions as in the previous example Also the Federal Reserve and the Bank of Japan want to maintain the exchange rate at R 1 To do this they must use their Reserve Assets gold certificates SDR s the reserve position in the IMF and holdings of foreign currencies are included as assets of Central Banks Changes in this account are labeled as Changes in Of cial Reserve Assets in the International Transactions and Balance of Payments The function of this account is to accommodate any payments imbalances which arise from autonomous transactions of the household business and government excluding central bank sectors more simply it is used to equate the quantity supplied and quantity demanded for and so as to maintain or influence the exchange rate Recall the US BP is in deficit of 50 an excess supply of R P The objective of intervention is to counter the competitive so forces which are exerting downward pressure on the exchange rate The Federal Reserve needs to generate receipts income of 50 to do this it will sell Reserve Assets gold or yen foreign currency At every exchange rate the Federal Reserve will increase the demand for by supplying decrease its Reserve Assets to the foreign exchange D1 market This is shown in the graph at the right as the original D0 shifts out to intersect point B at R 1 and Q 150 The shift from SO to 51 results from the increase in US D0 income an autonomous increase The shift from D0 to D1 100 150 Q results from the sale of Reserve Assets by the Federal FederalReserve intervention Reserve an accommodating increase Balance of Payments equilibrium is restored BP X M K RA 100 150 0 50 0 pointA points A B point B M 100 X 100 M 150 X 100 M 150 X 100 ko 0 ki 0 ko 0 ki 0 ko 0 ki 0 RA 50 100 100 150 100 150 150 MBA 7035 Economics for Managers Dr Jon Mansfield Market Structure MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Micro Lecture 4 1 General Types of Market Structure Market Structure Perfect Competition Monopolistic Oligopoly Monopoly Competition of firms availability of substitutes product type barriers to entry firm Demand 2 Perfect Competition 0 Large number of buyers and sellers no one individual can influence the price firms are price takers o Homogeneous Products Within Industries 0 Freedom of Entry and Exit No Barriers to Entry 0 Perfect Information Supply and Demand for the Market and representative firm Market Firm 50 1000 Q q Market Structure Perfectly competitive short run and long run responses to changes in market demand Market Firm P P so A 10 10 D0 1000 Q MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Market Structure 3 Monopoly A single seller of a good or service with no close substitutes no supply curve price searchers Note the relationships between 0 Marginal Revenue amp Marginal Cost 0 Price amp Average Total Cost Sources of Monopoly or Market Power Barriers to Entry 1 Economies of Scale 2 Barriers Created by Government a Licenses b Franchises c Patents d Copyrights 3 Input Barriers a Control Over Raw Materials b Financial Capital Markets 4 Brand Loyalties Short run MR Q Long run MR Q MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Market Structure in the f and quot 39 Models Perfect Competition Monopoly 5 Measures of Market Power H 0quot Lerner Index L P MC P GiventhatMRMCandMRP11ep L P MRP P P11epPorL 1 11ep 1ep Range For Perfect Competition ep gt 00 so L gt 0 and for Monopoly ep gt71 so L gt 1 Higher L equals higher market power Cross elasticity of Demand ecp sensitivity of quantity purchased of one good to a change in the price of another good A large positive ecp indicates close substitutes so market power would be weak Concentration Ratios Share of Market held by X largest firms CR4 CR6 CR8 etc usually in percent Herfindahl Hirschman Index HHI Sum of the squares of the market share of each firm ranges from 0 tol0000 or 1002 Examples a 2 firms equal shares HHI 502 502 2500 2500 5000 b 3 firms unequal shares HHI 6662 3332 3332 4444 1111 1111 6666 Effective Competitors EC Inverse of HHI When market shares are expressed as fractions rather than percentages the EC approaches zero in the competitive case with a large number of small firms and equals one in the monopoly case For a and b above a 2 firms equal shares HHI V2 2 V2 2 V4 V4 V2 and EC 2 b 3firms unequal shares HHI 1 462 162 162 1636 136 136 1836 V2 2 effective competitors MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Market Structure 6 Monopolistic Competition Product differentiation 0 Large number of firms in the product group 0 No interdependence Relatively easy entry Short Run and Long Run Equilibrium in Monopolistic Competition Short run Long run MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Market Structure 7 Oligopoly Characteristics Common Differing Models describing Behavior 0 Mutual o Homogeneous vs Kinked Demand Curve interdependence Differing products Game Theory 0 Market power 0 Cooperative vs Non Barriers to em cooperative behavior Strategic Entry Deterrence W Collusion Cartels 8 Cartel one market 2 firms Collusive behavior when firms have different cost structures similar to multi plant problem single firm with one management structure Q MR MCT MC1 MCz MCT 100 D MR 150 100 50 Cartel Firm 1 Firm 2 Firm Plant 1 Plant 2 joint profit maximization treating one cartel as a collection rather than individuals 0 each member has an incentive to cut deals 0 also tacit collusion price leadership MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Market Structure 9 Multiple Markets Price discrimination one firm 2 markets Charge a lower price in the market with the more sensitive more elastic demand if en gt epz then P1 lt P2 Q MRT MR1 MR2 MC Firm Market 1 Market 2 0 need market power to influence price 0 ability to separate markets with different elasticities prevent resale MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Aggregate Demand amp Aggregate Supply MBA 7035 Dr Jon Mansfield Macro Lecture 3 1 Aggregate Demand The economy operates when both the commodity market and money market are in equilibrium at the same time We can now include changes in the price level in the model to get a broader view of the economy We want to describe the combinations of the price level P and real GDP Y which result in simultaneous equilibrium in both the commodity and money market Commodity Market Y f i T CC W Cr BC Comp G Y R Money Market Point A represents equilibrium in both markets At a lower price level P2 the same nominal Money supply is now worth more in real terms the purchasing power has increased This shifts the LM curve out resulting in a higher level of income Y2 for equilibrium in both markets Plot the new combination PZYZ in the graph below as point B AD Y f P T CC W Cr BC Comp G Y R nMs This gives us the Aggregate Demand curve more appropriately called a Market Equilibrium curve This curve describes the combinations of P and Y which are now possible for simultaneous equilibrium in both the commodity and money markets it does not tell us where the economy will actually operate For that we need to look at the productive capabilities of firms that are producing real goods and services Aggregate Supply This Aggregate Demand curve just gives the total amount of real goods and services real GDP that will be demanded by all the sectors in the economy households businesses government and foreign at different price levels it is independent of Aggregate Supply Aggregate Demand amp Aggregate Supply 2 2 Aggregate Supply The Aggregate Demand curve shows the possible combinations of the price level and real GDP P Y where the economy may operate We now need to include the Aggregate Supply curve to determine where the economy will operate The AS curve shows the price level or cost level for the macroeconomy at which firms are willing and able to produce a certain amount of real goods and services holding certain factors constant this is independent of Aggregate Demand At any point in time short run firms in the economy have a maximum level of production Yf depending on 1 quantity and quality of resources used in production capital labor etc 2 ef ciency with which resources are used 3 production technology Production Possibilities Frontier Choose a price level and assume it remains constant until point A full employment is reached In this region all resources are not being used so that firms could increase real GDP without paying p1 A more for resources there is no reason for the price level to increase but at point A the economy39s supply constraint is reached no more real GDP can be produced fully employed resources Y must be bid away from existing uses to other uses this causes the excess capaCIty general price level or cost level to rise 4 General Aggregate Supply curve 1 classical range inflationary at or near full employment most changes are in prices very little changes in output p AS resources must be bid away from competing uses Classical 2 intermediate approaching full employment of economy changes in both price and output different industries intermediate approach industrial Yf at different times 3 Keynesian recessionary most changes are in output 5 very little in price level price rigidity Keynesian Any variable that influences firms willingness and ability to Yf Y MBA 7035 Economics for Managers Dr Jon Mansfield Aggregate Demand amp Aggregate Supply 3 produce output determines level of AS 0 costs of resources other than labor 0 capital stock plant and equipment 0 technology and productivity Short run shift amounts of capital labor and technology fixed increase in costs of resources for example oil prices shifts AS up for given output level firms need a higher price level shift up or down Shortrun P f Yf Resource costs shift updown 0 Long run shift increase in amount of plant and equipment or other resources increase in efficiency improvement in technology at same price level firms can now produce more output shift right Longrun Yf f P Resources Efficiency Technology shift leftright 0 MBA 7035 Economics for Managers Dr Jon Mansfield Elasticity MBA 7030 amp MBA 7035 Microeconomics for Managers Dr Jon Mans eld Micro Lecture 2 1 Elasticity sensitivity responsiveness Can Be Calculated for Any Variable in the Demand Function 0 Examples Price Income Advertising etc 0 Compare Percentage Changes to Avoid a Units Problem in Measurement Definition ep AQ AP AQQ AP P AQAP PQ Arc Elasticity Point Elasticity Discrete Range ep Q2 Q1QP2 P1P Point on the Demand Curve epAQAPPQ ep Q2 Q1 Q1 Q2 2 P2 P1 P1 P2 2 Linear demand curve price form P a bQ bAPAQand1bAQAP epAQAPPQ 9p Q2 Q1 Q1 Q2J P2 P1 P1 P2 9p1bPPabJPPBJ Values ep gt 1 Elastic A Q gt A P ep lt 1 Inelastic A Q lt A P ep 1 Unit Elastic AQAP You should be able to work through the derivation of both elasticity formulas Elasticity 2 Downwardsloping Linear Demand Curve Demand Function P 12 Q or Q 12 P Total Revenue Function TR TR PQ 12 QQ 12Q Q2 Average Revenue Function AR AR TR Q PQ Q P Marginal Revenue Function MR MR ATR AQ TRQ TR1 Q2 Q1 MR using calculus MRc MRc ATR AQ 12 2Q Calculate the elasticities using the formulas Q P TR MR MRc Arc elasticity Point elasticity 9p Q2Q1Q1 Q2JP2P1P1 9p PPBJ P2 0 12 0 12 1 11 11 11 10 23 11 2 10 20 9 8 7 5 3 9 27 7 6 380 3 4 8 32 5 4 243 2 5 7 35 3 2 167 14 6 6 36 1 0 118 1 7 5 35 1 2 085 07 8 4 32 3 4 060 05 9 3 27 5 6 041 03 10 2 20 7 8 026 02 11 1 11 9 10 014 009 12 0 0 11 12 004 0 As the price decreases from 12 what happens with both types of elasticities MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Elasticity Based on the information and table above graph the Demand and Marginal Revenue functions on one diagram and the Total Revenue function directly beneath P P12 Q 12 MR12 2Q 6 D Q 6 12 TR 40 TR12QQ2 Q 6 12 MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Elasticity 3 Price Elastia39ty and Total Revenue The Price Effect and Quantity Effect of a Price Change A X B Dem a n d area B C D Q1 Q2 Q 4 What is the signi cance of vertical and horizontal demand curves D D an 0 ep 00 MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Elasticity 5 Howsensitive is the amount demanded to a change in price This is primarily determined by 0 number of substitute goods 0 importance in consumer s budget product durability 0 time period under consideration 6 other Elasticities Income Elasticity of Demand 91 AQxAI A QxA 1 1Qlt e gt 0 Normal Good e lt 0 Inferior Good Elastic Cross Elasticity of Demand 9c A Qx APy A Qx A Pv Pv Qx ec gt 0 Substitute Goods ec lt 0 Complementary Goods MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Production amp Cost MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Nhnsfield Micro Lecture 3 1 Shortrun Production Function For a representative firm the production function relates resources to output It describes the technically efficient way to produce Assume there are two resources used in production labor and capital Q f L K In the short run or production period the production function describes the maximum amount that can be produced using the existing technology assuming one input is fixed usually capital and one input is variable usually labor In the long run or the planning horizon all resources are variable Total Product Average Product Marginal Product TPorQfL K APTPL MPATPAL Q L Q Production amp Cost 2 ShortRun Cost Function Based on the short run production function and resource prices PL PK Cost Average Cost Marginal Cost Fixed TFC PK K AFC TFC Q 0 Variable TVC PL L AVC TVC Q MC ATC AQ ATVC AQ Total TC TFC TVC ATCAFCAVC TCQ Using the production function graph the following in the top graph 0 Total Cost 0 Total Variable Cost 0 Total Fixed Cost MC ATCAQATVCAQ Graph the associated average cost curves total variable and fixed and the marginal cost curve MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Production amp Cost 3 Relationship between Shortrun Production and Cost MC ATVCAQ PL AL AQ AVC TVC Q PL L Q MCPLAQALPLMPL AvcPLQLPLAPL MP AP L when MPL is increasing gt MC is when MPL is decreasing gt MC is when APL is increasing gt AVC is when APL is decreasing gt AVC is MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld Production amp Cost 4 Production With Two or More Variable Inputs Input Substitution is it technically feasible what are the incentives 5 LongRun Average Cost LRAC the minimum average cost of producing any level of output when all inputs are variable increase scale of operations 0 Economies of Scale Specialization and Division of Labor Technological Factors Financial Factors 0 Diseconomies of Scale limitations to efficient management Economic Profit TR explicit implicit or opportunity costs 0 includes normal rate of return on investment 0 measures payments to all factors of production including borrowed capital MBA 7030 amp MBA 7035 Economics for Managers Dr Jon Mans eld
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