CH1
Define economics - Economics is social science concerned with individuals, institutions and
society make optimal choices under conditions of scarcity
Microeconomics - study of individual choices and how they affect prices and quantities in
particular markets
Macroeconomics - the whole economy including the role of government
Positive vs normative economics
Positive focus on cause-effect relationships, can be empirically verified
Normative focus on desirable goals, based on individual values
Core issue in microeconomics - resources are scarce relative to desires
Resources can be categorized as - productive resources(provided by nature), Labour(physical
and mental, human capital), Capital(Goods not financial), Entrepreneurship(person who puts all
together to run a business), Money(financial capital), Time
Sept 13
Individual choices are influenced by rational decision making based on cost vs benefit. (Rational
empirically stands for clear objective such as well being, achieve objectives in the best known
manner)(cost vs benefit means take action if the extra benefit is greater than extra cost, called
marginal benefit/cost)
The ‘true’ costs under this approach are called: Opportunity cost- value of the next best
alternative forgone
Theories, principles and models
The scientific method - Observe>formulate a hypothesis>test hypothesis. This leads to accept,
reject and modify hypothesis or test the hypothesis if necessary
Models are purposeful simplifications of reality (reality is too complex but a generalization of
economic principles is reached). ‘Other-Things-Equal’ assumption (some value is kept
constant). Frequently expressed in graphs.
Production possibilities
Production possibilities curve (ppc), production possibilities boundary (ppb), production
possibilities frontier (ppf)
Model captures the concept of scarcity, alternatives, opportunity costs and technology.
Alternative combination of final goods and services that can be produced in a given period of
time with all available resources and a fixed technology
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Constant opportunity cost
- Assume that we have a fixed amount of productive resources that are always
employed, a fixed technology and two goods
- Slope of a ppc is opportunity cost of goods on the x-axis
Sept 15
Ch 2
Production possibilities
Increasing opportunity cost - Resources are specialized
Anything which leans towards capital or labour intensity is due to efficiency
Fundamentals of demand and supply
Market Prices (Market economy)
How are market prices determined ?
Supply/Demand both determine the price as they are intertwined
Demand - A goods own price is the most significant determinant of its demand. A specific time
period is also crucial in determining the demand.
*Qd=f(P-)* - This is an inverse relationship which says holding everything constant, increase in
price leads to decrease in quantity demanded.
A linear relationship : *Qd=a-bP*, where a and b are fixed numbers
When we graph this relationship, it is the the form of : *P=f(Q-d)*
Sept 20
Fundamental characteristic of demand is: Other things equal, price falls quantity demanded
rises and price rises quantity demanded decreases. This inverse relationship is called the law of
demand. Eg- If prices of Nike, relative to Adidas (which is constant) rises, demand for Nike will
be lower.
Reasons for inverse relationship- Consistent with common sense. People are willing and able to buy products at lower
prices rather than at higher. Sales that we see is a prime example of this concept.
- Diminishing marginal utility, As consumption of a good , the marginal utility obtained from
each additional unit of the good decreases. People will consider buying such item if the
price is progressively reduced.
- Income and substitution. Lower price means more buying power, equals to more
purchasing. Lower price means people can substitute said product for an expensive one.
Demand curve, quantity demanded on x and price on y. Also called marginal benefit curve.
Basic determinants of demand are consumers tastes, number of consumers in market,
consumers incomes, the prices of related goods, consumers expectations.
Supply is products producers are willing and able to make to sell. Most important factor
influencing the amount supplied is its own price. Quantity supplied (Qs) is determined by its own
price (P).
Formula is Qs=f(P+)
This is a positive/direct relationship which says holding everything constant, increase in price
leads to increase in quantity supplied, also called law of supply.
Determinants of supply are Factor prices, technology, taxes and subsidies, prices of other
goods, price expectations, no. of sellers on the market.
Sept 22
Market Equilibrium - market equilibrium price (P*) and its equilibrium quantity exchanged (q*)
is determined by the intersection of the two curves, such that: i) Qd=Qs=Q* ii) Pd=Ps=P*
Mathematically, two expression must be equal, that is: Ps=Pd=P*
Supply price = demand price
2+1/2Q* = 10-1/2Q* --> Q*=8
Therefore the equilibrium price is 10-½(8) = 6
Prices act as a ‘rationing’ method of allocation of resources. Comp markets use prices to get
equilibrium where the demanders' wish to purchase is equal to the among suppliers are willing
to sell. (rationing function of prices)
Comp markets lead to an efficient allocation of resources. They achieve productive efficiency by
producing goods in the least costly way, using best technology and occurs where
price=marginal cost (p=mc)
Comp markets also achieve allocative efficiency by producing the right mix of goods, combining
goods highly valued by society and occurs where marginal benefit=marginal cost (mb=mc)
Equilibrium price is the price at which the intentions of buyers and sellers match. Equilibrium
quantity is quantity where the inventions of buyers and sellers match so quantity demanded and
quantity supplied are equal.
As demand increases with constant supply, equilibrium price and quantity increases. As demand
decreases, equilibrium price and quantity decreases. As supply increases with constant
demand, equilibrium price increases and quantity decreases. As supply decreases, equilibrium
price increases and quantity decreases.
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Supply increase and demand decrease will drop price greater than alone. Quantity of
equilibrium depends on the intensity of supply increase and demand decrease. If supply
increase bigger, quantity rises. If demand decreases bigger, quantity goes down.
Supply decrease demand increase, increase price greater than alone. Quantity change
is relative. If supply decrease bigger, quantity decrease. If demand increase bigger,
quantity increase.
Supply and demand increase. If supply increase bigger, price fall. If demand increase
bigger, price rise. Increase in supply and demand raises the quantity.
Supply and demand decrease. If supply decrease bigger, price rise. If demand decrease
bigger, price falls. Decrease in supply and demand decreases quantity.
Government-set Prices
A price ceiling is a maximum price a seller may charge for a good or service.Price ceilings
enable consumers to get essential goods they could not afford at equilibrium prices. Price
ceiling can result in a shortage because sellers have lesser incentive at lower prices.
Resultantly, shortage of amount Qd-Qs occurs.
Price floor is minimum price fixed by government. This results in surplus of goods as producers
will be willing to produce more than companies are willing to buy. This also results in inefficient
allocation of resources as producers would produce more and will allocate a lot of resources
into products with a price floor.
Sept 28
Ch 4
Market failures in competitive markets
Demand side market failure - Demand curves do not reflect consumer’s full will to pay for a
good or service. It is sometimes impossible to charge people for a service. Public fireworks do
not require money to be seen therefore it cannot be projected on a demand curve and suppliers
will be unwilling to produce fireworks.
Supply side market failure - In supply side market failures, firm does not have to pay full cost
of producing its output. In a coal power plant, firm will pay for the land, labour, capital and
entrepreneurship to produce, but it will not pay for the cost of generating pollution in the
atmosphere.
Market failures arise because it is not possible to weigh all the costs and in a situation in which
some of the costs are completely unaccounted for.
Two conditions must be met if a comp market is to produce efficient outcomes.
- The demand curve in the market must reflect consumers full willingness to pay
- The supply curve in the market must reflect all the costs of production
Consumer surplus
The benefit surplus received by a consumer or consumers in a market is called consumer
surplus. It is the maximum price a consumer is willing and able to pay minus the price they do
pay.
Maximum price a consumer is willing and able to pay is determined by the opportunity cost of
the alternatives.
Producer surplus
Producer surplus is the actual price procedures receive and the minimum price that a consumer
would have to pay the producer to make the product.
A producer’s minimum price is equal to the producer's marginal cost of producing. In this
section, we assume that the marginal cost of producing a unit will include all of the costs of
production (including the ones that may get ignored and cause supply side failure). Producer’s
minimum price is also the opportunity cost of transferring resources away from other products to
this product.
Productive efficiency is achieved because competition forces orange growers to use the best
technologies and combinations of resources available, minimizes the per-unit cost of the output
produced
Allocative efficiency is achieve because the correct quantity of oranges is produced relative to
other goods and services.
Allocative efficiency is achieved when total surplus (combination of consumer and producer
surplus triangle is the biggest). Allocative efficiency also occurred when three more conditions
exist together:
MB=MC
Maximum willingness to pay=minimum acceptable price
Total is at maximum
Efficiency loss is reduction of combined consumer and producer surplus which results from
under and over production. For underproduction, maximum willingness to pay exceeds the
minimum acceptable price of sellers and society suffers loss of net benefit.
Private good characteristics
Rivalry (in consumption) - When one person buys and consumes a product, it is not available for
another person to consume.
Excludability - People who do not pay for a product do not obtain its benefits.
Public good characteristics
Non-rivalry(in consumption) Everyone can simultaneously benefit from a public good such as a
street light.
Nonexcludability - There is no effective way to exclude people from benefiting from a good once
it is produced.
Free-rider problem is the inability of providers of a desirable good to obtain payment from the
consumers because exclusion is not applicable. Non exclusion, which leads to little demand,
makes it impossible for private firms to profitably provide public goods.
Optimal quantity of public good
Government has to estimate demand by surveys or votes. It can then compare the MB of a unit
against the MC.
This practical analysis is also called the cost-benefit analysis which decides which public good
and how much of it should be provided.
Marginal cost = marginal benefit rule is that for a government, marginal benefit should equal
marginal cost to produce maximum benefit to society.
Quasi-public goods are provided by the government but can be produced in a way that
exclusion would be possible.
Externality is benefit or cost from production or consumption accruing without compensation to
nonbuyers and non-sellers of the product.
Negative externalities cause supply side market failures. In negative externalities, there is
overproduction and overallocation of resources to a product. The failure which spills cost on to
others results in the supply curve to shift right of (or below) where they would be if they
accounted for the costs.
positive externalities cause demand side market failures. In positive externalities, there is a
underpoduction and under allocation of resources to a product. The failure which does not
account the parties who receive benefits results in the demand curve to shift left (or below)
where they would be if they included the willingness to pay of the third parties.
Government intervention can be used to achieve economic efficiency and reduce externalities.
Government intervention comes in various methods.
Direct Control implies passing legislation to limit the activity that may cause negative
externalities. Direct control raises the marginal cost of production which causes the supply curve
to shift leftward(or upward).
Pigovian taxes or targeted taxes on a specific product are also used in order to remove negative
externalities.
Subsidies and government provisions are used to remove positive externalities. Some types are
- Subsidies to buyers
- Subsidies to producers
- Government provision
Optimal reduction of an externality means the point at which societies marginal cost and
marginal benefit of reducing externality are equal.
Oct 3
Ch 6
Price elasticity of demand measures the extent to which the Qd of a product responds to a
change in its price.
Ed = percentage change in quantity demanded of product x / percentage change in price of
product x
The above is calculated by [(q1 - q0)/q’]/[(p1 - p0)/p’]
Q’ = (q1+q0)/2
p’= (pq+p0)/2 Midpoint basically
If calculation is less than 1, means inelastic
If calculation is more than 1, means elastic
If calculation yields to be 1, means unit elastic
(Absolute value is taken when calculating elasticity because calculations equal negative)
The flatter the demand function/curve, the more elastic the consumer is.
Demand is perfectly inelastic when price change doesn't result in a change in quantity
demanded. Ed = 0, curve is straight vertically.
Demand is perfectly elastic when a small change in price causes infinite consumption. Ed=
infinity, curve is straight horizontally.
Elasticity changes as it moves along the demand curve. Higher on curve means more elastic
and lower on curve means more inelastic.
Price elasticity of supply measures the extent to which the quantity supplied of a good responds
to a change in price.
Formula is similar to the previous one but with Qs instead of Qd.
Income elasticity of demand measures the extent to which the quantity demanded of a product
responds to a change in income.
The equation is the same but the denominator is change in income which is plotted on y axis.
For this calculation, absolute value is not taken.
If income elasticity of demand is less than zero than inferior good
If income elasticity of demand is greater than zero than normal good
In necessity normal good, income elasticity of demand is between zero and equal to 1
In Luxury normal good, income elasticity of demand is greater than 1
Cross elasticity of demand is measure of extent to which the Qd of product y responds to a
change in the price of product x
The equation is basically the same as price elasticity of demand but with two exceptions. First
exception is that we take qd of product y and price of product x. Second exception is that we do
not take absolute value.
If the cross elasticity below zero, goods are complements
If the cross elasticity above zero, goods are substitutes
Excise tax is a tax on the sale of a particular good such as GST
With a specific supply, the more inelastic the demand for the product, the larger the portion of
the tax shifted to consumers
with a specific demand, the more inelastic the supply, the larger the portion of the tax paid by
producers
Total revenue is the amount received by selling a product over a period of time. TR = P x Q
Total revenue and the price elasticity of demand are related. If total revenue changes in the
opposite direction from price, demand is elastic. If total revenue changes in the same direction
as price, demand is inelastic. If total revenue does not change when price changes, demand is
unit elastic.
Determinants of price elasticity of demand are substitutability, proportion of income and luxury
vs necessities
Immediate market period is the length of time over which producers are unable to respond to a
change in price with a change in quantity supplied.
The short run in microeconomics is a period of time too short to change plant capacity but long
enough to use the fixed plant capacity more or less intensively.
The long run is a period long enough for firms to adjust their plant sizes and for new firms to
enter (or existing firms to leave) the industry.