2 In the beginning … Economics Resources How to allocate scarce resources with unlimited wants or desires.ResourcesLaborLand/Natural ResourcesCapitalEntrepreneurship
3 Opportunity Costs & Marginal Analysis The cost of doing the next best option.MarginalThe cost or benefit of “the next one”EX If one candy bar costs $2 and two bars cost $3, the Marginal Costs of 1st bar is $2 and the MC of the 2nd bar is $1.Basis of economic study.
4 Production Possibility Frontier Measures different combinations of productionGoodAZ is beyond capacity,borrowing or runninga deficitYZX & Y are equallyefficient, on thePPF curveWXW is inefficient,Not all resourcesIn use – a recessionGood B
5 Trade Advantages Example: Country A Country B 60 Pizzas 80 Hot Dogs
6 Absolute Advantage Who can produce the most? Pizzas: Hot Dogs: Country A – 60Country B – 40Hot Dogs:Country A – 80Country B – 20Country A b/c60 > 40.Country A b/c80 > 20.
7 Comparative Advantage Who gives up the least to produce?(items produced/items no longer produced)Pizzas:Country A – (60 Pizzas/80 HD) = 0.75Country B – (40 Pizzas/20 HD) = 1.50Hot Dogs:Country A – (80 HD/60 Pizzas) = 1.33Country B – (20 HD/40 Pizzas) = 0.50Country B b/c2.00 > 0.75.Country A b/c1.33 > 0.50NB There is always comparative advantages for both countries evenwhen one country has an absolute advantage in both products
14 Equilibrium Consumer Surplus Price S P Producer Surplus D Q Quantity Total Welfare is the sum of Consumer & Producer Surpluses
15 ElasticityMeasures change in QUANTITY caused by small changes in PRICE= %ΔQ / %ΔPMidpoint Formula =(Q1-Q2)/((Q1+Q2)/2)(P1-P2)/((P1+P2)/2)
16 Elasticity Perfectly Elastic Elastic Unit Elastic Inelastic ED = ∞Elastic1 < ED < ∞Unit ElasticED = 1Inelastic0 < ED < 1Perfectly InelasticED = 0
17 Determinants of Elasticity SubstitutesIncomeTime
18 Total Revenue (TR) Method ElasticPrice & TR move in opposite directionP TR P TR InelasticPrice & TR move in the same directionP TR P TR TR = P * Q ….do not compare P & Q !!!
19 Types of Elasticity Income elasticity Cross elasticity %ΔQ / %Δ Income Negative number for Inferior GoodsCross elasticity% Δ Q Good A / % Δ P Good BNegative number for Complementary Goods
20 Elasticity & Taxes Government Revenue Consumption Taxes paid By ConsumerTaxes Paid by SupplierPerfectlyElasticLeastMost0 %100 %InelasticZero
21 Changing Elasticities PriceInelastic – A large change in price…… leads to a small change in quantity1310Elastic – A small change in price…… leads to a large change in quantity32451114Quantity
22 Graphing Tax Revenue ST Price Tax shifts supply Curve – Price up & Quantity downSPTTax RevenuePDQTQQuantity
23 Firms, Markets & Costs Accounting π = TR – Explicit Costs Economic π = Acct π – Implicit CostsImplicit Costs are Opportunity costsLong-run has no fixed costsSunk CostsEconomies of ScaleTC = TFC + TVC
24 Total & Average Cost Graphs ATCTCPMCAVCVCFCAFCQQ
25 Profits Π determined by MC = MR P MC ATC Π = (P-ATC)*Q P1 MR Q Q1 NB Shut down price for business If Price < Minimum AVC
26 Perfect Competition (profits) FirmIndustryPricePriceSProfitsMCS2ATCP1D=MR=AR=PP1P2D2DQ1Q2q2q1QuantityQuantityNew firms enter b/c profits, Results in P, Industry Q, Firm q, & π = 0
27 Perfect Competition (losses) IndustryFirmPriceATCPriceS2SLossesMCP2D2P1P1D=P=MR=ARDQ2Q1q1q2QuantityQuantityFirms leave b/c losses, results in P , Industry Q , Firm q , & π = 0
28 Monopoly Monopoly P set by demand Curve point above MC=MR Price Socially optimal allocation orallocative efficiency at MC = DMCATCPFair return Price ATC=P(0 economic profit)Deadweight loss (DWL)Difference betweenMonopoly P & Sociallyoptimal PDQuantityQΠmax set by MC=MRMR
29 Monopolistic Competition MCPATCATC tangent to DPEquilibrium atzero economicprofitsMRQQExcess Capacity
30 Monopolistic Competition MCPATCATC < DPEconomic profit willcause firms to enter,with more firms inthe market, consumershave more choice &demand for thecompany decreaseP2MRD2DQQ
31 Monopolistic Competition MCATCATC > DPP2Economic losses willcause firms to exitwhich will increasedemand for companiesstill in businessPD2MRDQQ
32 Oligopoly Barriers to entry May or may not have differentiation JackConfessDon’t ConfessBarriers to entryMay or may not have differentiation4 Firm ratioPrisoner’s dilemmaDominant StrategyOne choice is always betterNash EquilibriumEach player know options of opponent – no need to change10 year20 yearsConfess10 yearFreeJillDon’t Confess1 yearsFree20 years1 years
33 Oligopoly: Incentive to Collude Game theory appliedOligopolists have a strong incentive to collude and raise their prices.However, each firm also has an incentive to cheat by lowering price because the demand curve facing each firm is more elastic than the market demand curve.This conflict makes collusive agreements difficult to maintain.
35 Factor Economics If MRP > MRC If MRP = MRC If MRP < MRC Increase ProductionIf MRP = MRCMax profitsStop (ideal) ProductionIf MRP < MRCDecrease production
36 Factor Economics Marginal Productivity / Least Cost Derived Demand MPA / PA = MPB / PBFirms produce at a level where all costs are minimizedDerived DemandDemand for products creates or affects the demand for resources such as labor
37 Factors & Distribution Marginal Productivity Theory of Income DistributionIncome allocated by how much production is createdTheory may lead toIncome inequalityMarket Imperfections
38 Types of Goods Rivals in Consumption Yes No Private Goods Natural MonopolyYesExcludableNoCommonResourcesPublic Goods
39 Negative Externalities ExternalityCostSupply FailureSuppliers do not have to pay the full valueWill supply more b/c costs paid by othersCosts affect supplyTaxes raise price to public equilibriumSocial CostPPrivateCostP2P1PrivateValueQ2Q1Q
40 Positive Externalities Demand FailurePublic not willing to pay full valueBenefits or subsidies needed to induce suppliers to supply at lower price levelsBenefits affect demandSubsidies absorb costs creating public equilibriumExternal BenefitPrivate CostPPublicCostP1P2PrivateValueQ1Q2Q
41 Income Inequality Lorenz Curve Gini Index Measures ratio between richest & poorest quintiles.Gini IndexMeasures among of distributionIncreasing numbers (ranges from 0.0 to 1.0) means less equality
42 Miscellaneous Taxes Moral Hazard Adverse Selection ProgressiveIncreasing Marginal RatesProportionalRegressiveDecreasing Marginal RatesMoral HazardTaking higher risks b/c of insurance or government bail-outsAdverse SelectionSignalingOnly those who need product would buy it (insurance)
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