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Principles of Microeconomics

by: Bridie Batz

Principles of Microeconomics ECON 2010

Marketplace > University of Colorado at Boulder > Economcs > ECON 2010 > Principles of Microeconomics
Bridie Batz

GPA 3.53


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This 14 page Class Notes was uploaded by Bridie Batz on Friday October 30, 2015. The Class Notes belongs to ECON 2010 at University of Colorado at Boulder taught by Staff in Fall. Since its upload, it has received 16 views. For similar materials see /class/232144/econ-2010-university-of-colorado-at-boulder in Economcs at University of Colorado at Boulder.


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Date Created: 10/30/15
Notes 9122011 85800 PM Principles of Microeconomics Chapter 1 ten principles of economics principles 17 for micro Scarcity the limited nature of society s resources gives rise economics the study of how society manages its scares resources o Scarcity is everywhere If you are as rich as me if you own the whole world the unfortunate truth is we can only spend our time energy and more in one thing and meanwhile giving something up So there is always a trade off Principle 1 people face tradeoffs o Example the tradeoff between efficiency and the property of society getting the most it can from its scare resources and equity the property of disturbing economic prosperity uniformly among the members of society o Decisionmaking is at the heart of economics 0 Le how much to save for retirement how much to spend on different goods and services how many hours a week to work etc the firm must decide how much to produce what kind of labor to hire Society as a whole much chose how much to spend on national defense versus how much to spend on consumer goods Principle 2 the cost of something is what you give up to get it o Decisionmaking requires consideration about costs 0 What s your cost of attending college What is your cost ifI give you a free movie ticket o Opportunity cost whatever you give up to obtain some item Every time you do something think about what you give up in terms of the opportunity given up Principle 3 rational people think at the margin o Rational people those who systematically and purposefully do the best they can to achieve their objectives economics assumes people are rational o Marginal changes small incremental adjustments to a plan of objectives Just focus on every single move benefit vs cost 0 At dinner time the decision you face is not between fasting or eating like a pig but whether to take that extra spoonful of mashed potatoes Principle 4 people respond to incentives o Incentive something that induces a person to act 0 At first in a country a yearly consumption of gasoline is 100000 Then if the government taxes 5 for each 100 spent on gasoline will the government raise 5000 The above 4 are directly related to how people make decisions The principles 57 are about how people interact Principle 5 Trade can make everyone better off o Each party does what it is best at specialization at and then everyone exchanges with one another and is better off 0 If a countryperson can trade with others it gives a country s consumers access to a greater variety of goods Principle 6 market is usually a good way to organize economic activity o Market economy an economy that allocates resources through the decentralized decisions of many firms and household as they interact in the market for goods and services invisible hands Decentralized o Each of many households decides who to work for and what goods to buy o Each of many firms decides whom to hire and what goods to produce As if led by an invisible hand a mechanism called price simply speaking As the course unfolds you will know more about how exactly the mechanism works what I mean by social wellbeing and what if when there is some bug in the mechanism Principle 7 government can sometimes improve market outcomes o Market economics need institutions to enforce property rights the ability of an individual to own and exercise control over scarce resources 0 If a farmer works hard on hisher land both heshe and the whole society will be better but people are less inclined to work produce invest or purchase if there is a large risk of their property being stolen o A music company wont produce CDs if too many people avoid paying by making illegal copies c When price is absent or does not reflect the true value of a thing government can use tax income transfer and regulation or even violence and so on to bigger things up o Market failure is a situation in which a market left on its own fails to allocate resources efficiently is given rise 0 Externally the impact of one person s actions on the well being of a bystander but the person who chooses the actions need not to consider the impact on others eg when there is no price for pollution o Market power is a single economic actor or small group of actors to have substantial influence on market prices eg the price does not reflect the true value of the good or service 0 Le Andrew Carnegie and his oil 0 Externality and market power are very important topics in this course and much more will be discussed in later chapters Chapter 2 thinking like an economist Two roles of economists 1 Scientists try to explain the world positive statement claims that attempt to describe the world as it is the policy of minimum wage will cause unemployment 2 Policy advisors try to improve the world normative statement claims that attempt to prescribe how the world should be the government should enact minimum wage o IfI drink too much I will die causality o I should drink too much judgment Microeconomics vs macroeconomics o Microeconomics the study of how households and firms make decisions and how they interact in markets o Macroeconomics the study of how economy works as a whole entity also study economywide phenomena such as inflation unemployment and economic growth o The relationship how an economy works as a whole depend on how every element of it works so micro is the basis of macro macro is more average while micro is more individual Model and assumption and two economic models Economists use models and simplifying assumptions to try to understand the world around them o Model is a simplified representation of reality 1 Circular flow diagram Circular flow diagram a visual model of the economy that shows how dollars flow through markets among households and firms two players and two markets o Pg 25 diagram o This is quite easy Very complicated model to represent some deep truth of our society But the purpose of simplified representation of reality is the same A good model however complicated is always simpler insightful and incisive than a detailed record of real life 2 Production possibilities frontier PPF o PPF a graph that shows the combination of output that the economy can possibly give the available resources and production technology Some points F if you only produce beer 1000 kegs 0 pizza E if you only produce pizza 5000 pizzas kegs Most likely some combo like point A and B PPF depends on Availability of resources and level of technology Points A B E and F On PPF feasible and efficient efficient using resources fully cant produce more of one good without producing less of another Point D feasible but inefficient lazy works food going bad etc Point C Infeasible PPF illustrates Principle 1 Tradeoffs If producing 2700 pizzas and you want to increase pizza production to 3000 how much beer do you have to give up 100 PPF Illustrates Principle 2 opportunity cost what we give over what we gain What you give up for something else is the opportunity cost The law of opportunity cost DEF the opportunity cost of producing additional units of a good rises as a society produces more of that good o Example from B to A the OC of 1 beer are 3 pizzas and from A to F the OC of 1 beer is 27 pizzas BA 300 pizzas 00 beers AF 2700 pizzas100 beers PPF bowed out due to law of increasing OC o Straight line PPF implies constant OC o The more practice questions you ve just done you will have to give up more other things for one extra practice question PPF moveshift o Change in technology and resources increase in technology and resources can push out PPF Decrease in technology and resources can contract PPF 0 Example what if a change in technology allows for faster brewing PPF moves out for production 0 What if there is an increase in labor force 0 What if wars kill half of the labor force The power of assumptions how many workers the structure of the underground politycapitalism or communism the size of the production factory and so on and so on and so on Only when we look at this we can have a clear understanding about something with the help of the model Chapter 3 interdependence and the gains from trade How can trade make everybody better off Principle 5 What are absolute advantages and comparative advantages Why do we want these concepts What s the relationship between these concepts and OP o PPF and Trade Hours Hours Amount Amount needed to needed to produced in produced in produce produce one 8 hours 8 hours one ounce ounce of of Meat Potatoes Meat potatoes Farmer 1 hour 14 hour 8 32 Rancher 13 hour 16 hour 24 48 How to draw a simple PPF linear slope o Assume that the farmer s and rancher s technology for producing meat and potatoes allows them to switch between making one good and the other at a constant rate the two points and a straight line Meat Farmer s PPF 8 4 potatoes gt I 18 32 meat Rancher s PPF 24 12 potatoes 24 48 specialization and trade absolute advantage rancher has absolute advantage in meat and potato production o the ability to produce a good using fewer inputs than another producer does or the ability to produce more goods within given inputs The inputs here are assumed only to be time comparative advantage o opportunity cost 0 farmer 8 meats32 potatoes so 1 meat4 potatoes 0 rancher 24 meats48 potatoes so 1 meat2 potatoes Amount Amount Opportunity Opportunity produced produced cost cost Meat Potatoes Per meat Per potato Farmer 8 32 4 potatoes 14 meat Rancher 24 48 2 potatoes 12 meat opportunity cost of producing one goodinverse of the opportunity cost of producing another good Comparative Advantage the ability to produce a good at a lower opportunity cost than another producer o Thus the rancher has OC in producing meat rancher has OC in producing potatoes The price of the trade o For both parties to gain from trade the price at which they trade must lie between the 0C In the above example the farmer and the rancher must trade at the rate between September 9212011 83700 AM Chapter 4 THE MARKET FORCES OF SUPPLY AND DEMAND Demand and supply paradigm an understanding of economic world 1 Market and Competition a Market a group of buyers and sellers of a particular good or service abstract i Teacher says not exactly market could be abstract just buying and selling or the interaction of demand and supply Buying and selling does not have to happen at the same time and place b Competitive market a market in which there are so many buyers and so many sellers that each has a negligible impact on the market price extreme situation that does not happen very often Assumptions about perfectly competitive markets are i Goods are identical ii Buyers and sellers are so numerous that no single buyerseller has an influence over the market price Thus buyers and sellers are price takers In the real world there are relatively few perfectly competitive markets But for now these assumptions can offer us some essence of the economy operation This is one extreme point the opposite of which is monopoly and the reality is a kind of combination of these two situations i ie there is no competition or there is a lot of competition that works together perfectly so in real life our market is a combination of both A paradox of pedagogy the students will not admire the usefulness and interestingness of something before learning and knowing there needs to be this admiration to inspire student s learning before knowing 2 Demand a Quantity demanded the amount of a good that buyers are willing and able to purchase at some specific price b Demanded schedule a table that shows the relationship between the price of a good and the quality demanded c Demand curve graphical representation of the demand schedule relationship between the price and quality demanded n D Example Steve s demand schedule for coffee Price Quality Demanded 5 5 4 10 3 15 2 20 1 25 d When price decreases by 1 the demand increases by 5 e With slope constant how we know this since two points decide a line plot two points individually and link them together we get the demand curve O c uantity of demand 5 10 15 20 25 f Law of demand other things equal the quantity demanded of a good fails when the price of a good rises i When price decreases demand increases 3 Change in quantity demanded vs change in demand a Change in a quantity demanded other things equal a change in a good s price leads to a change in quantity demanded a move along a given demand curve eg price decreases the quantity demanded increases i Only factor that is involved with quantity demand is price vs change in demand which involves other factors r b Change in demand factors other than goods own price can change the demand for a good that is a change in one of these factors shifts the entire demand curve eg for any given price the quantity demanded increasesdecreases The demand curve is a relationship between price and quantity demanded Move while keeping the relationship stays the same vs the change of relationship itself i ie at this price I demand this quantity or at this price the market demands this quantity 4 Factors determents of this relationship a D39 0 DO The price of related goods i Substitutes two goods for which the increase in the price of one leads to an increase in the demand for another pepsi and cocacola pairs of goods that are use in place of or partially for each other Compliments two goods for which an increase in the price of one leads to a decrease in demand for the other Gas and cars pairs of goods that are used together Income i Normal good a good for which other things equal an increase in income leads to an increase in demand 1 Luxuries expensive clothes etc ii Inferior good a good for which other things equal an increase in income leads to a decrease in demand 1 Secondhand clothing fast food Number of buyers market demand is derived from individual demands As N increases D decreases i Bigger cohort sizeimmigration bigger demand Tastes preferences like it or not how much you like it Expectations your expectations for the future may affect your demand for a good or service now 5 Supply a Quantity supplied supply schedule and supply curve i Quantity supplied amount b Change in quantity supplied vs change in supply Change in quantity supplied a change in a good s own price leads to a change in quantity supplied a movement along a given curve ii Change in supply factors other than a good s own price can change the supply of a good The demandsupply curve gives us a relationship between price and quantity demandedquantity supplied Move under the constraint of this relationship keeping the relationshipthe curve stays the same iv Price of input suppliers are strongly influenced by the costs of inputs used in the production process v Expectation expecting prices of what to go up will make the farmer s decrease their supply now and increase their supply later v39 Number of suppliers Technology technology improvement leads to cost reduction and an increase in supply viii Othersregulations weather price of substitutes in production 1 Regulations a Cigarettes 2 Weather a Floridaorange juice 3 Prices of substitutes in production a Wheat and corn 6 Supply and demand together a Equilibrium a situation in which the market price has reached the level at which the quantity suppliedquantity demanded i Graphically it is the intersection of the supply curve b Why do we call it equilibrium i Surplus a situation in which the quantity supplied is greater than the quantity demanded and therefore sellers will be frustrated 1 Happens when the price becomes greater than the equilibrium price S 2 If there is a surplus suppliers will reduce the supplythe goods available in the market is less than before and the price decreases a The supplier continues to reduce supply until the quantity supplythe quantity demanded which is the equilibrium point ii Shortage a situation in which quantity demanded is greater than the quantity supplied and buyers will be frustrated 1 Happens when price is smaller than the equilibrium price 7 Law of supply and demand the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance Recall the price mechanism a Exercise change in the equilibrium price and quantity b A change in demand i Coffee market 1 Income increasesa9price of tea decreasesb c A change in supply i Coffee market 1 Technology improvement makes farmers produce more coffee beansc9Less farmers grow coffee beansd d Change in both supply and demand i If u have a and b then the whole demand line will move to the right ii If you have a and d then the whole demand line will move to the left If you have b and c then the supply increases and the equilibrium quantity is greater than before but the equilibrium price is lower iv If you have b and d then the price will go up but the quantity will go down Chapter 5 Elasticity and Its Application 1 Elasticity a measure of responsiveness of quantity demanded or quantity supplied to one of its determinants such as price income price of the other goods etc kind of sensitivity N a Elastic if it changes a lot b c Elasticity measures how sensitive people are to changes Price elasticity of demand a measure of how much quantity Inelastic if it doesn t change a lot demanded of a good responds to a change in the price of that good computed as the percentage change in quantity demanded divided by the percentage change in price a U39 oAQd sd 0 Determinants of price elasticity of demand i Availability of close substitutes easy to move from one good to the other 1 more substitutes higher elasticity ii Necessity or luxury 1 prescription drugs necessary inelastic 2 diamonds luxury elastic a More luxury a good is the more elastic it is Definition of the market 1 All beverages broad inelastic versus soda versus coke narrow elastic iv Time horizon 1 In the long run when more substitutes become available it becomes more elastic Computing the price elasticity of demand i Price elasticity of demandpercent change in quantity demandedpercent change in price AP Elasticity unit elasticity inelasticity intuition with graph Perfectly Elastic if Einfinity horizontal demand curve ii Elastic if Egt1 Unitary Elastic if E1 Inelastic if Elt1 Perfectly Inelastic if E0 vertical demand curve The flatter a demand curve the more elastic it is d A general view of sensitivity i The midpoint method of calculating the elasticity of demand NOTE percent change is end value start valuestart value100 In this case going from point A to B will have different elasticity than going from B to A But we just need a measure of how big the sensitivity is a So ifI ask the elasticity between AampB people will get different values depending on what they determine as the start value i change of going from 100 to 120 is 20 120 to 100 is 167 ii We can get around this problem with the midpoint method H Ed changeQ changeP


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