PRIN MICROECONOMICS ECON 2000
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Date Created: 10/13/15
Econ 2000 Chp 2 Production Possibility Frontier PPF Assuming limited resources are aligned in such a way that goods maybe produced there must be limits to what can be produced In analyzing such limits and tradeoffs the PPF is a tool for comparing the production of2 goods Conditions of the Model 1 Only 2 goods in question 0 The tradeoff of production give and take of choosing one vs another is the dominant theme 0 Representative goods 0 Ex Coke vs Potato chips 0 Guns vs butter defense vs domestic spending 2 Fixed time duration 0 The PPF addresses production capability as it exists during a specific time frame 0 Why important what may or may not be possible later is not the issue it is about what can be done now 3 Possible Production gives the available technoloqv and using fullv emploved resources 0 Again moving out possible levels of production the point is what can be produced The word frontier implies what lies at the edgemargin thus the model examines the farthest reaches of possible outcome Opportunity cost Every choice entails selecting one option over another where by an opportunity cost will be incurred when the PPF is no different Over range of PPF each point represents different levels of goods X and good Y Whether moving from all X all Y or somewhere in between opportunity cost arises Straight line PPF When frontier of production features a straight line with a constant slope this condition re ects constant opportunity costs Why constant the forgone opportunity is the same when choosing between any level of output Reality is most choices do not entail constant opportunity costs First unit ofany choice typically entails a lower opportunity cost than last 0 First hour of study vs fth Law of increasing opportunity costs addresses this phenomenon by stating opportunity costs will increase as production increases This concept will hold true when analyzing production and not simply within context of PPF So if opportunity costs rise with each unit produced than first units produced ofX will require fewer units forgone on than the last units ofX Because of changing cost slope changes when moving through the frontier PPF is curved not straight Why concave and not convex 0 Increasing not decreasing opportunity costs 0 Very last good on margin of frontier is not least expensive in terms of opportunity Scarcity limits of production Choice different combinations available Opportunity cost incurred with movement Efficiency vs inef ciencies of production Productive ef ciencies occurs when the economy operates on the frontier producing at the maximum Anything less is inef cient On frontier ef cient Should output fall beneath the frontierthan it is likely there are unemployed resources Something is not being utilized if attained output is less than its potential Economic growth Should improve technology increase productivity or other business advances be gained the effect will be an outward rightward shift of the PPF Why because using same inputs more may be produced expanding the frontier Improving technology might benefit one good or both Overtime one would expect various structural changes good and bad Economy might also endure negative circumstances warstore that impairs production As one should expect this would farce the PPF inward m Act of exchanging goods between people or groups enables greater consumption and therefore higher utility to those trading Given constants on production trade can make possible levels of consumption not othenNise available Sometimes trade occurs to gain products not supplied by one s own production Trade may occur to gain currency for purchasing goods for some other third party As well trade may occur because some are simply better off doing something else The PPF demonstrates what is possible for each party given their own abilities and resources Than when comparing individual PPF s it may be determined if some would benefit from trade When comparing production abilities advantage between parties maybe discovered Absolute advantage is most obvious One party can produce more of a good than the other party sometimes one may hold an advantage in both goods Holding absolute advantage does not mean trade would not be beneficial Comparative advantage will arise when party A enjoys a lower opportunity cost for a given good than does the party B In other words A faces a tradeoff for production ofthe good having a lesser consequence than does B A may not produce more but what it does produce comes at less of a cost in terms of one good to another than does B There fair if choosing one good entails a higher opportunity cost for B then B will produce the other good and trade with A for the first thus the decision to trade is determined not by who holds an absolute advantage but who holds the comparative advantage Trading will occur in quantities only such that the final mix enables a consumption level by and the original PPF of both parties There is no point in trading if it is worse for both parties Econ 2000 Chp 1 Scarcity when wants exceed our ability to satisfy A condition faced by living creatures since the dawn of time Several investment banks are allotted a designated portion of an lPO for selling to retail customers creating a back log oforders Economics study of society s response to scarcity Science of dealing with wants greater than resources available Key Ideas 1 People are rational 2 People respond to incentives 3 Optimal decisions are made at margin Economists assume people will have rational wants and needs and generally make rational decisions using the information available at the given time Consumers and businesses will evaluate costs and benefits 0 More is betterthan less 0 Better to worse 0 Greater incomesavings to less income to less incomepayments People respond to incentives 0 They change behavior o If rational they modify decision of actions if given a positive reason to do so 0 EX Happy hour Not everyone responds hopefully enough will to benefit Increased bene t pushes them beyond theirthreshold of resistance Benefits outweighed the costs and they acted Cost and Bene t lf rational they consider only those choices providing utility bene t If we know all choices entail an opportunity taken or lost then there must always be a cost Thus every choice offers a cost and bene t As such economic theory suggests all decisions should be evaluated on the basis of cost bene t analysis 0 Eliminate pollution 0 Study or work Decisions are best judged in terms of costs and benefits Decisions are made at the margin Choices are evaluatedon the basis of costs and benefits then it stands to reason the following question will frequently arrive c To what extent or quantity is a good choice The decision is made based upon whether the additional bene t continues to outweigh the additional cost Marginal benefit MB occurs with each additional unit consumed Marginal cost MC is what we must incurto consume that additional unit If costs and benefits are increasing marginally then there will exist some point where costs exceed benefits Before that though there is a level where MB MC Intersection point is the ideal level of consumption aka ef ciency Why do we want to continue exercising our choices until ef ciency 0 Maximize utility benefit If we stop before MB MC there remains utility to be gained greater than cost Consumer faces scarcity and has wants greater than needs It would be irrational to stop attaining net positive utility when it is available Trade offs Every decision entails a cost and benefit and we cannot have everything it s a give and take o If you buy more ofX then you need to buy less on o If we produce more of one good we may get less ofanother Society faces tradeoffs because of scarcity We simply do not have all the workers and resources to produce everything for everyone 3 fundamental issues 1 What goods and services are produced 2 How are they produced 3 Who receives the products Opportunity cost highest value alternative forfeited Not the cost of your choice Reward lost when choosing against that which would offer it No Free Lunch All choices entail something picking one over the other Resources will be spent in every action meaning they could have been invested in an alternative action Result opportunity forgone Economic Structure If everyone cannot have everything and choices must be made as to what is or what is not produced some overriding method will arise to make these decisions within society Economic structure within society can veer towards either end of the spectrum 1 Central planned economy command economy 0 Government rulers decide produced goods how resources are utilized and how people interact within society 2 Market economy 0 Resources allocation and production are determined by rms and households interacting in markets within society Mixed economy any economy that neither perfectly controlled or free of government involvement Some societies are freer others are more controlled The US is a mixed economy closer to a free market than other European nations Efficiency 2 types 1 Production ef ciency goods andor services are produced at lowest possible cost 2 Allocative ef ciency every good or service is produced right up to point where MC MB Resources would not be better utilized else where Allocation of the Market Resources used as inputs in goods production are scarce as well therefore goods cannot be produced in unlimited quantities Rationing devices are introduced 0 Such devices may take the form of price expressed in currency or exchange or a deterrence such as a line 0 These are naturally occurring Only those who derive utility will wait or pay the rationing Positive vs Normative economics Positive economics focuses on that which is fact What is economics is study based upon observable and tested phenomenon Cause and effect emphasis on reality with no opinion 0 Sales will rise 10 if prices lower 5 Normative is concerned with what should be opinion What should be refers to the study concerned with advancing ideals and values More philosophical than empirical Micro vs Macro Micro is concerned with primary elements ofan economy the individual firm industry speci c market Macro studies the economy as a whole rms and individuals reacting to scarcity in a collective sense Micro Individual consumer level economic activity Individual firm s behavior Firm generic term for single business unit Industry of similar firms Single markets comprised of individuals or rms with a similar business sector m Economy at large Nations economy Economic market not subdivided into industrial groups lssues may involve exchange rates capital investment mass labor market or trade Chapter 1 Economics The Core Issues Class Econ 2000 Instructor Masa Onda Date August 29 2014 1 Opportunity cost a Definition The most desired goods or services that are forgone to obtain something else b ex What would you be doing if you were not in the class now c Sleeping working attending other classes driving to Houston for tigers game etc d How would you order them e What is your opportunity cost Think your quotnext best thing 2 Scarcity a Definition The fact that available resources are insufficient to satisfy all needs b ex Your time c Key concept Tradeoff 3 Economics a Definition The study of how best to allocate scarce resources among competing uses b The 3 core issues i WHAT do we produce with our limited resources ii HOW do we produce the goods and services we select iii WHO should get them c Approach social science Theory 9 empirical research 9 keeprevise theory d Theory abstraction from real world 4 MARKET answers WHAT HOW and WHO questions a Definition Market Mechanism The use of market prices and sales to signal desired outputs ex stock market PampG many demanders many stocks dealers unique price ex automobile market WHAT Market determines WHAT to produce HOW Suppliersfirms maximizes their profit by minimizing the production costs WHO The highest bidder get a goodservice in market Key concept i Price is signal individual demandersupplier CANNOT control it ii Market players are us amoeba Chapter 5 Taxes Efficiency Recall the discussion concerning Supply Demand and the tendency toward equilibrium When Equilibrium is reached 0 Every consumer willing to pay market price may consume 0 Every supplier willing to sell at market price may supply 0 Marginal benefits of consumption equal marginal costs of production When the Qs orthe Qd is not equal a shortage or surplus will result When equal more units are actually consumed and are sold at Price of equilibrium Both consumers and producers enjoy bene t by trading at this price Price controls Arbitrary mechanisms by which the government sets a price despite whatever level market force might achieve Price Ceiling the maximum pricing level permitted No trade may occur above this price Price Floor the minimum pricing level permitted No trade may occur below this price Price ceilings can create shortages if the maximum allowed price is below the market equilibrium Producers will react to the ceiling by producing less units than they would have ifthe higher price were allowed Consumers pay less but are now forced to contend with fewer available goods Non price rationing devices result adding inefficiency to the process of attaining goods These may include lines and acts ofappeasement Price floors create a surplus of the given good Producers will react to the floor by producing more units than they would have if the lower price were allowed Consumers must pay more and in turn demand less The producers seek to sell at the floor price but no wants to buy the quantity The result is few overall exchanges Government Government may institute price floors or price ceilings Some people will gain while others lose M When taxes are introduced into a market there will be an impact upon ef ciency The original equilibrium Q and P will no longer hold Taxes can be imposed upon the buyer or seller When taxes are placed upon the buyer the demand curve will shift inward When taxes are placed upon the seller the supply curve will shift inward These leftward shifts reflect higher prices for every pricequantity combination as taxes are now included Government may place a tax on either a producer or consumer but the laws of supply and demand determines who actually pays Who pays the tax is actually determined by how responsive both the consumer and supplier are to change in price If buyers and sellers are equally responsive They may split the tax regardless upon who it is actually placed Tax incidence refers to the burden divided bw buyers and sellers when taxes are introduced Even though the tax may be placed entirely on buyers or sellers there will likely be some sharing of the tax Market Structures Perfect Competition A market in which economic forces operate unimpeded Perfect Competition Conditions 1 Both Buyers and Sellers are price takers 2 The number of rms is large 3 There are no Barriers to Entry 4 Firms Products are Identical 5 There is Complete Information 6 Selling rms are Pro tMaximizing Entrepreneurial rms MRMC Pro t Price Total Cost X Eq Quantity Zero Pro t in LongRun Number Barriers Pricing Output Interdependence Pro t P and of Firms to Entry Decisions Decisions MC Almost None MCMRP No Output Each Firm acts No long PMC In nite Restriction Independently run economlc pro t possible Monopoly Market Structure in which one rm makes up the entire market MRgtMC Monopolistic Gains Pro t by Increasing Output MRltMC Monopolistic Gains Pro ts by Decreasing Output MRMC Pro tMaximization Barriers Natural Ability Economies of Scale Government Restriction Number Barriers Pricing Output Interdependence Profit P and of Firms to Entry Decisions Decisions MC One Signi cant MCMR Most Only rm in Possibility PgtMC output market not of long restriction concern about run competition economic pro t Monopolistic Competition Market structure in which there are many rms selling differentiated products and few barriers to entry Monopolistic Competition Conditions 1 Many sellers 2 Differentiated products 3 Multiple dimensions of competition Compare Marginal Costs and Marginal Bene ts Change that Dimension of Competition until Marginal Costs equal Marginal Bene ts 4 Easy entry of new rms in the long run Downsloping Demand Curve Zero Economic Pro t in LongRun Equilibrium Number Barriers Pricing Output Interdependence Pro t P and of Firms to Entry Decisions Decisions MC Many Few MCMR Output Each rms acts No long PgtMC restricted independently run somewhat by economic product pro t differentiation possible Oligopoly Market structure in which there are only a few rms and rms explicitly take other rms likely response into account Small number of small interdependent rms Take account of each other s actions Number Barriers Pricing Output Interdependence Pro t P and of Firms to Entry Decisions Decisions MC Few Signi cant Strategic Output Interdependent Some PgtMC Pricing somewhat strategic pricing longrun between restricted and output economic monopoly decision pro t and perfect possible competition Strategic Decision Makingtaking explicit account of a rival s expected response to a decision you are making Cartel A combination of rms that acts as if it were a single rm a shared monopoly Cartel Model of Oligopoly that assumes that oligopolies acct as if they were monopolists that have assigned output quotas to individual member rms of the oligopoly so that total output is consistent with joint pro t maximization A formal explicit agreement among competing firms It is a formal organization of producers and manufacturers that agree to x prices marketing and production Cartels usually occur in an oligopolistic industry where there is a small number of sellers and usually involve homogeneous products Cartel members may agree on such matters as price xing total industry output market shares allocation of customers allocation of territories bid rigging establishment of common sales agencies and the division of pro ts or combination of these The aim of such collusion also called the cartel agreement is to increase individual members39 pro ts by reducing competition Distinguish Private Cartels from Public Cartels Public Cartel a government is involved to enforce the cartel agreement and the government39s sovereignty shields such cartels from legal actions Private Cartels are subject to legal liability under the antitrust laws now found in nearly every nation of the world Chp 4 Supply and Demand Basic Concepts Those who got it and those who want it In a world constrained by scarcity driven by utility seekers there comes into being the interaction between those who want and those who have to offer The ensuing behavior creates the phenomenon known as a market Those who want and are allocate their own scarce resources to attain demand This observed behavior has precise meaning in economics and refers to the following 3 points 1 Willingness and ability ofthe buyers to wantdemand different quantities of goods 2 Different prices 3 Within a specific time Demand Those who want but are unwilling or unable to part with resources are not considered demanders If given good is known to provide utility and is known to be object of demanders who seek utility offered than it stands to reason 0 Quantity demanded will be higher when price is lower Law of Demand Price ofa goodquantity demand are inversely related all things equal this may be expressed in 4 ways 1 Words definition 2 Symbols 3 Demand Schedule 4 Demand Curve Price Absolute vs Relative Absolute price are re ected in monetary terms 0 Pants 30 Shirt 10 Relative prices are given 0 ShirtsPants 1030 13 Consider each and their implications on behavior 2 factors at work within law of demand and inverse relationship between price and demand 1 Lower priced goods are substituted for goods whose prices rise 2 Consumers may excise choice and are free to select other goods offering greater perceived value Law of Diminishing Marginal utility With each unit ofa good consumed the marginal or additional utility gained declines within a given time Explained in a different way every unit consumed the bene t derived from each subsequent unit is less than the unit consumed before it Therefore if the first unit consumed is the most valuable the last is least than same good in small quantity will fetch a higher price than available in large quantity Consumers implicitly understand that something offering higher utility is worth more than something of less There is no need to pay high prices for goods available in large quantities Aside from packaging costs shelf space bulk is cheaper because marginal utility ofthe ninth unit is less Consumers will only demand if the price is less Fluctuating demand may be caused by 1 Change in quantity demanded 2 Change in demand lf quantity demanded number of units individuals are willing and able to buy at a particular time then Change in quantity demanded the change in units demanded given a change in price It represents the movement from one part to another on the same demand curve caused by change in price Demand Change in demand movement ofentire demand curve It s not that price shifted and quantity demanded has changed Rather the market simply wants more regardless of price Factors causing the shift in demand 1 Income increasedecrease 2 Tastepreference changes 3 Price of related goods increases or decreases 4 Number of buyers within the market increases or decreases 5 Expectation of future price change To better understand how a change in demand can occur it helps to understand the manner in which economist classify goods 1 Normal good 2 lnferior good 3 Neutral good 4 Substitute good 5 Complement good Normal a good consumers demand more ofwhen income rises o This is a type of good most individuals imagine when discussing goods Generally speaking consumers will allocate more resources to this good if not purchasing in greater unit quantities lnferior demand less when income rises 0 Exist certain goods people consume when income is low 0 Ex Raman Neutral goods demand does not react with income 0 Barring extremes a little shift in consumption of certain goods despite differences of income 0 Ex toothpaste 0 Consumer demand relatively similar quantities regardless of income Substitute goods providing the same or nearly the same utility in similar manners or fashion 0 Reason for distinguishing between substitute goods is often a matter oftastes and preferences 0 Maybe normal inferior neutral Generally speaking if the price of one differs greatly than the other demand will shift towards the good featuring a lower price As an aside substitute goods are frequently marketed in ways to prevent them from being considered either as a substitute or commodity Complement goods generally consumed jointly a change in demand for one will likely precipitate a similar change in demand for the other May be normal inferior or neutral Generally speaking are good if not both are not used without the other sometimes flow goes both ways other times not Given different types of goods Income Individualsconsumers within the market lncrease will generally push the demand curve out for normal goods but reduce demand for inferior goods neutral goods will remain the same Taste and preferences The choice determine allowing for the unique difference each consumer exhibits it s this effect also captures the phenomenon of how conumers differentiate between goods that ostensibly serve the same or close to the same purpose Whether consumers are motivated by seemingly trite fashion or more something like health concerns a change in t and p will shift demand All goods maybe effected Prices of related goods effect upon demand will likely be in the same direction Substitute shift will be in opposing direction when price changes we are referring to those changes making a pronounced effect on market dynamics That effect demand across all price ranges not quantity demanded Price of related good effect upon demand is most relevant to complement and substitute goods For complements the shift in demand will likely be in the same direction For substitutes the shift will be in the opposing directions When we speak of price changes we are referring to those changes making a pronounced effect on market dynamics effect all across Number of buyers size ofany market is related to the number of buyers when more are around demand will be greater across all price levels the reverse is also true This can affect all goods Expectations of future price consumers react to a beliefthe future price will change after their behavior in the present Overall demand will shift as people await the new price structure Supply Supply in economic terms is a specific term relating to those who utilize resources in such mannerthey produce goods like demand 3 key points 1 Willingness and ability of sellers to produce and offer goods in different quantities 2 Different prices 3 During specific time period Does this mean a seller who makes only one good must offer it at a different price No rather they react to different price set by the market Law of supply quantity of a good produced is directly related to the price all things equal thus if the market demand for houses shifts outward builders will construct more new houses in response Just as demand was subject to the way ofdiminishing marginal utility supply is subject to increasing opportunity costs Recall the outward shaped PPF where by production was more costly in terms of opportunity at higher levels ofoutput The supply curve is upward sloping in reaction to price but acknowledging that higher levels of production entail more cost A producer will make more only if price merits the extra work and ultimately cost required Ex if work 12 hours there ought to be a payout Supply curve slope Most goods feature upward slope Re ecting opportunity costs Goods available only in xed quantity have vertical slope 0 Additional units cannot be produced in current time frame 0 Additional units simply can never be made Supply curves act similar to demand curves Movement can result from a change in quantity supplied or an overall change in supply As with demand those do not mean the same thing Change in quantity supplied Only factor influencing a change in quantity is the price ofa good own price Changes in supply Supply may increase or decrease in reaction to changes effecting the market 6 factors are said to cause such shifts in supply Prices of relevant resources Technology Number ofsellers Expectations of future price Taxes and subsidies Government restrictions DUIhook Prices of relevant resources the supply of goods inversely related to the cost of resources utilized in its production lf raw material cost increases the supply curve will shift inward and vice versa Technology Advances in technology may bring about lower production costs If such changes allow more efficient production more production same input than producers will increase supply Production is more profitable across the supply curve Number of sellers on a market More producers yields more supply less suppliers yields less supply Expectation of future price Producers will alter what they deliver to the market if there is an expectation of change in future price If producers think a higher price will be attained in the future why send now Likewise ifthe price is expected to drop a producer may try and capture more ofthe higher price now Again markets react today to those events thought to occur in the future there is no waiting Taxes and subsidies Taxes have an adverse effect on supply The more government taxes supply less will come to market Subsidies encourage production for better for worse the subsidies incentivizes producers to allocate resources beyond what market conditions might demand simply put less produced of that which is taxed more of that which is subsidized Government restriction Regulation has a negative effect upon supply The supply curve will shift inward with increasing governmental restrictions The more arduous the regulation the more producers began to curtail production or drop out entirely ofthe market Supply and Demand Surplus vs shortage Equilibrium vs disequilibrium Equilibrium price vs disequilibrium price Equilibrium quantity AQNA Surplus a condition existing when quantity supplied as greater than quantity demanded Shortage quantity supplied is less than quantity demanded Eguilibrium A market is said to have reached equilibrium when demonstrating a pricequantity combination from which there is no tendency for either buyers or sellers to move away no shortage or surplus exists those that want to buy can do so those who sell can do alike as well Disequilibrium a market experiencing either a shortage or surplus condition Eguilibrium price the price at which the quantity demanded will equal the quantity supplied Disequilibrium price any price which results in quantity demanded differing from quantity supplied Eguilibrium quantity the quantity corresponding with equilibrium price At this level there exist an equal number of units demanded by willing and able buyers as there are units supplied by willing and able producers The amount produced is the amount sold no leftover units and left out buyers Search for eguilibrium Markets do not necessarily have readily apparent supply and demand graphs for all concerned to readily see the equilibrium point Rather the natural equilibrium is found through transaction experience This process maybe on going as a single market is not insulated from other markets or worldly events Search for equilibrium in action Recall demand and supply curves stem from schedule Therefore we know quantities both demanded and supplied at play given varying prices levels The graph turn is a physical representation of market forces Movement on the graph has its basis in the numerical schedule At a level where demand and supply are not equal and a surplus or shortage results the price will face pressures to increase or decrease until balance arises A market where supply exceeds demand numerically suppliers are producing more goods than for which there is demand At current price goods remain unsold Consumers simply do not generate necessary utility to justify allocating resources for the good at such a level 0 With excess inventory suppliers will begin lowering price 0 Buyers are enticed to consume more increasing demand The price will continue falling until there is no more surplus Graphically this is shown 0 Left movement along the supply curve 0 Right movement along demand Along both demand and supply movement lowers the relative locations re ecting decreasing price Movement continues until curves intersect Demand exceeds supply Numerically demanders seek more goods than for sale at current price supply is exhausted before all buyers have consumed Suppliers will not produce more units because price does not justify allocating more resources for production 0 With excess demand consumers are willing to pay more 0 Suppliers are enticed to produce more increasing supply The price will continue rising until there is no more shortage
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