Download Chapter 1 – Economics: The Core Issues and more Study notes Microeconomics in PDF only on Docsity!
Chapter 1 – Economics: The Core Issues The Economy The economy is the grand sum of all our production and consumption activities We have unlimited needs, but limited resources Scarcity Scarcity is the lack of enough resources to satisfy all desired uses of those resources Scarcity of resources limits the amount of goods and services that can be produced Somebody’s wants will have to go unfulfilled Scarcity requires economic choices to be made Factors of Production Factors of production are resource inputs used to produce goods and services Labor: skills and abilities of all humans at work Land: all natural resources Capital: goods produced for use in further production Entrepreneurship: assembling of resources to produce new products/technologies Limits to Outputs Limited resources require choices and trade-offs to be made Economics is the study of how best to allocate scarce resources among competing uses Efficiency is the economic goal of this “best” or “optimal” allocation The maximum output at least cost Allocate: to distribute (resources or duties) for a particular purpose Opportunity Cost When we choose to use resources to produce one thing, we must give up producing something else with those resources Opportunity Cost: the most desired goods or service forgone to obtain something else These costs are associated with every decision Forgone: to go without (something desirable) Production Possibilities Production possibility model illustrates the economic concepts of: Scarcity Tradeoffs Opportunity costs Efficiency
Production Possibilities: the combination of final goods and services that could be produced in a given time period with all available resources and the best technology Increasing Opportunity Cost Each time we give up one thing, we get less back in the other’s production Resources are specialized to produce one good better than the other This causes the bowed (concave) shape of the PPC Efficiency and the PPC The maximum output of a good from the resources used in production Points on the PPC are efficient and attainable Points outside the PPC are unattainable Points inside the PPC are inefficient but attainable Economic Growth and the PPC An increase in output and an expansion of production possibilities Caused by increasing the available resources or by technology advancing Raises our standard of living, satisfies more wants and needs, and creates jobs Present Choices, Future Possibilities The point we choose on the PPC (what to produce) determines the growth in the future Although both points are present of the PPC, one way produce a more optimal outcome in the future Three Basic Decisions What to Produce The point we choose on the production possibilities curve determines what mix of output gets produced How to Produce Someone must decide which production methods and technologies to use, the goal is efficiency For Whom to Produce There must be a mechanism to determine whose wants and needs will be satisfied and who must go without
Market Failure and Government Failure If the market does not produce the mix of goods that society desires, market failure is said to occur, the government has an opening to step in If government can move us closer to the mix society desires, the intervention is successful Government Failure: when the government can do the opposite, or impose such high costs that a failure occurs What Economics is All About Understanding how economies function is the basic purpose of studying economics Society and its leaders set the nation’s economic goals Economics focuses on the means of achieving those goals Normative vs Positive Analysis Positive analysis focuses on “what is” Based on facts Normative analysis focuses on “what should be” Based on opinions and judgements Micro vs Macro Macroeconomics: The study of aggregate economic behavior, of the economy as a whole Microeconomics: The study of individual behavior in the economy, of the components of the larger economy Theory vs Reality The economy is vast and complex, therefore we model the economy and make simplifying assumptions Ceteris Paribus: the assumption of nothing else changing We want to develop a reasonable perspective on economic behavior and an understanding of basic principles
Chapter 2 – Supply and Demand Market Participants Market participants are trying to obtain the maximum return from the scarce resources they have Consumers: maximize the utility (satisfaction of unmet wants) they can get from available incomes. Businesses: maximize profits by selling goods that satisfy while keeping costs low. Government: maximize the general welfare of society. Specialization and Trade Most of us cannot produce everything we want to consume due to time, talent, and resource constraints. We should specialize and produce what we can at a lower opportunity cost than others Produce more than we need for ourselves and trade the excess for the goods we want to consume (which are produced by other specialists) Example: this logic applies to international trade We specialize in production in which we have a lower opportunity cost, use some and sell the excess to other countries Other countries specialize in production in which they have a lower opportunity cost, use some and sell the excess to us Because of this, both nations are able to consume more than if they had to produce everything for themselves The Circular Flow Two markets (factor market and product market) and four participants: The Factor Market: when businesses are the buyers The Product Market: where goods and services are sold and bought Consumers They are owners of factors of production (e.g., labor) who supply them to business firms in the factor market and earn income They purchase goods and services in the product market Business Firms They produce goods and services for the product market using the factors of production they bought from their owners in the factor market
Factors that Set Demand Behavior Tastes Income Expectations Other goods: Substitutes Complements Number of buyers If any of these factors change, demand behavior changes. A demand behavior change is shown by shifting the demand curve Increase in demand: shift the curve right Decrease in demand: shift the curve left Changing the Demand Demand increases (shifts right) when Taste for the good increases Income increases Price of a substitute rises Price of a complement falls Future prices are expected to rise Number of buyers increases Vice versa, and demand decreases (shifts left) Movements vs Shifts Change in Quantity Demanded: movement along a demand curve in response to a change in price Change in Demand: a shift of the demand curve due to a change in one or more of the determinants of demand, but NOT in response to a change in price Supply The ability and willingness to sell specific quantities of a good at alternative prices in a given time period, ceteris paribus. Law of Supply The quantity of a good supplied in a given time period increases as its price increases, ceteris paribus, and vice versa Direct relationship between price (P) and quantity supplied (Qs) It is an upward-sloping curve on a market diagram
Individual Supply and Market Supply Each producer is willing and able to produce a good or service if he or she can make a profit The amount produced depends on its price If the price goes up, more will be produced If the price goes down, less will be produced Market supply is the collective summation of all producers’ individual supplies Market Qs = Sum of individual Qs Factors that Set Supply Behavior Technology Factor Costs Taxes and subsidies Expectations Other goods Number of sellers If any of these factors change, supply behavior changes This type of change is shown by shifting the supply curve. Increase in supply: shift the curve right Decrease in supply: shift the curve left Changing Supply Supply increases (shifts right) when New technology lowers operating costs Factor costs decrease Taxes decrease or subsidies increase Future prices are expected to rise Price of alternative goods fall Number of sellers increases Vice versa, and supply decreases (shifts left) Movements vs Shifts Change in quantity supplied: movement along the supply curve due to a change in price Change in supply: a shift in the supply curve due to one or more changes in the determinants of supply, but NOT in response to a change in price.
What Causes the Price to Change? Price changes when equilibrium is upset Due to a shift in demand (a change in buyers’ behavior) Due to a shift in supply (a change in sellers’ behavior) Due to a shift in both demand and supply After the shift, a surplus or a shortage is created, and the market mechanism begins to find the new equilibrium Demand Increases Buyers’ behavior changes Demand shifts righ Old equilibrium is upset. Creates a shortage Price rises A new equilibrium is established. Price rises from P 1 to P 2. Quantity rises from Q 1 to Q 2 Demand Decreases Buyers’ behavior changes Demand shifts left Old equilibrium is upset Creates a surplus Price falls A new equilibrium is established Price falls from P 1 to P 2 Quantity falls from Q 1 to Q 2
Supply Increases Sellers’ behavior changes Supply shifts right Old equilibrium is upset Creates a surplus Price falls A new equilibrium is established Price falls from P 1 to P 2 Quantity rises from Q 1 to Q 2 Supply Decreases Sellers’ behavior changes Supply shifts left Old equilibrium is upset Creates a shortage Price rises. A new equilibrium is established Price rises from P 1 to P 2 Quantity falls from Q 1 to Q 2 Summary: Why do Prices Change? Only when a market is in disequilibrium Shortage? Price rises Surplus? Price falls A shift in either demand or supply causes the price to change, but…. A price change does NOT cause The demand curve to shift The supply curve to shift Price Controls Governments may impose an arbitrary maximum price (price ceiling) or a minimum price (price floor) on a market The result is that the market cannot reach equilibrium
Chapter 19 – Consumer’s Choice Utility Theory The more pleasure we get from a product, the higher the price we’re willing to pay for it Utility: the pleasure or satisfaction obtained from using a good or service Total utility: the amount of satisfaction obtained from the consumption of a series of products Marginal utility: the change in total utility obtained by consuming one additional (marginal) unit of a product Diminishing Marginal Utility As long as marginal utility > 0, total utility increases. When marginal utility reaches zero, total utility maxes out, and when marginal utility becomes negative, total utility decreases. The Law of Diminishing Marginal Utility The marginal utility of a good decreases as more of it is consumed over a given time period Additional quantities of a good yield smaller and smaller increments of satisfaction From the Law of Diminishing Utility to the Law of Demand The more marginal utility a product delivers, the more we are willing to pay for it, and vice versa As marginal utility diminishes, we will buy additional quantities only if the price decreases The demand curve slopes downward because of diminishing marginal utility To justify buying more, the price must be lower Chapter 20 – Elasticity If a seller needs to lower the price of a product, how much should it be lowered? Reduce too little, and projected increase in sales will not meet desired goals Reduce too much, and the projected profit target might not be achieved We need to know the price elasticity of demand: how much quantity demanded changes in response to a change in price Price elasticity of Demand: the percentage change in quantity demanded divided by the percentage change in price Price elasticity of demand is always negative But we use the absolute value of E
The Three Cases of Elasticity If E > 1 => demand is elastic Consumer response is large relative to the price change If E < 1 => demand is inelastic Consumer response is small relative to the price change If E = 1 , => demand is unitary elastic Computing Price Elasticity To get the percentage change in quantity: Take the quantity before and the quantity after the price change and average them Divide the average quantity into the change in quantity to get the percentage change in quantity To get the percentage change in price: Take the price before and the price after and average them Divide the average price into the change in price to get the percentage change in price Elasticity Extremes Completely Elastic (E=∞): horizontal line Completely Inelastic (E=0): vertical line Determinants of Elasticity Necessities vs. Luxuries Demand for necessities is relatively inelastic Demand for luxuries is relatively elastic Availability of Substitutes The greater the availability of substitutes, the more elastic is the product’s demand No or few substitutes? Inelastic demand Relative price to income Demand for low-priced goods is relatively inelastic Demand for high-priced goods is relatively elastic Time The more time you have to adjust to a price change, the more elastic is your response No time to adjust? Highly inelastic demand
Chapter 21 – The Costs of Production Producers are profit-seeking, so they aim to produce a salable product at the lowest cost of resources used Costs are not the only important factor Productivity is also important The Production Function Shows the maximum quantity of a good attainable from different combinations of factor inputs How much “can” we produce with the land, labor, and capital available? Consider the land to be a fixed amount Capital can be varied in the long run Only labor can be varied in the short run production period In order for labor to produce, it needs land and capital. With neither, production is zero With fixed land and capital in the short run, adding more labor will increase production First, at a rapid rate as the added workers put the capital to full use Later, more workers will not add as much new production as workers overwhelm the available capital The productivity of any variable factor of production (example: labor) depends on the amount of fixed resources (land and capital) available to it Capital is fixed. As labor increases, output or total product (TP) increases but ultimately at a slower rate. Output maxes out at point H and begins to decline. The measure of additional output as labor increases is marginal physical product (MPP) Marginal Physical Product Marginal physical product (MPP) goes up at low levels of output but peaks and then diminishes throughout other levels of production MPP is the slope of TP The Law of Diminishing Returns The marginal physical product of a variable input (labor) declines after a certain point, as more of it is employed with a given quantity of other (fixed) inputs (land, capital). Added output begins to decrease and ultimately goes negative as more and more workers are added with no increase in capital
Link between Production and Costs The sales manager wants to maximize sales revenue The production manager wants to minimize production costs The business owner wants, instead, to maximize profit (revenue- costs) There is no reason to expect these three goals to occur at the same output From MPP to Marginal Cost As MPP diminishes, it takes more variable input to make a product, so marginal costs (MC) rise As MPP decreases with added workers, we continue to pay the added workers, but we get less added product with each added worker Therefore, the cost per added product increases as MPP declines. Marginal Cost (MC): the increase in total cost associated with a one-unit increase in production Marginal Cost When MPP decreases, MC must increase, and vice versa. For any production with fixed capital, the MC curve will fall at low levels of production but will rise sharply at higher levels when diminishing marginal returns set in Short Run Dollar Costs Total cost (TC): the market value of all resources used to produce a good or service Total Cost = fixed cost + variable cost Fixed cost (FC): costs of production that don’t change when the rate of output is altered Variable cost (VC): costs of production that change when the rate of output is altered Fixed Costs Payments for the fixed inputs Includes the cost of basic plants and equipment Must be paid even if output is zero Do not increase as output increases Variable Costs Payments for the variable inputs Include the costs of labor and raw materials At zero output, these costs are zero As output increases, variable costs increase rapidly at first, then more slowly, and finally very fast as the firm approaches maximum capacity
Economic vs Accounting Costs Accountants count only dollar costs of production – that is, the explicit costs Explicit Costs: a payment made for the use of a resource Economists add the value of all other resources used in production, including resources not paid for in dollars Implicit Costs: the value of resources used in production, even when no direct payment is made Economic Cost = Explicit Costs + Implicit Costs Explicit costs can be identified by the accountant with a paper trail denominated in dollars. Implicit costs are the cost of resources for which no payment is made – that is, the opportunity cost of using those resources. They can be identified only by the entrepreneur. Long Run Costs The short run is characterized by fixed costs The objective is to make the best use of those fixed inputs while making the production decision. In the long run, we can change the plants and equipment Long run: a period of time long enough for all inputs to be varied There are no fixed costs in the long run. All costs are variable Long Run Average Costs In the long run, a firm can build a plant of any desired size As plant size gets larger, each plant’s ATC curve has a lower minimum point In this case, building a larger plant would lower production costs There are unlimited options One option delivers the lowest ATC It is at this point where the long-run marginal cost curve intersects the long-run average total cost curve
Economies of Scale Economies of scale: also called “increasing returns to scale”, involve reductions in minimum average costs that come through increases in the size (scale) of plants and equipment. Larger plants reduce minimum average costs. Greater efficiency may come from Specialization vs. Multifunction Workers Mass Production vs. Small Batch Mode Production Diseconomies of Scale If the plant size gets too big, however, long-run average costs begin to rise, creating diseconomies of scale or “decreasing returns to scale”. Operating efficiency may be reduced Worker alienation may increase Rigid corporate structures emerge Off-site management may be unresponsive
