1. 7 UTILITY AND DEMAND CHAPTER
Notes and teaching tips: 8, 14, 15, 19, 20, 21, 22, 27, 29, 39, 40
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2. Household Consumption Choices
A household’s consumption choices are determined by:
Consumption possibilities
Preferences
Consumption Possibilities: Budget Constraint
The budget constraint refers to the limits imposed on household choices by income, wealth, and product prices
The choice set or opportunity set refers to the set of options that is defined and limited by a budget constraint.

3. Choice Sets: An Example

4. Budget Constraint and Opportunity Set for Trudee and Mark
Points A, B, and C are each on the budget constraint, meaning that Trudee and Mark have spent their income.
Point D does not spend the entire $200 and point E is unattainable as it would cost more than $200.

5. The Effect of a Decrease in Price on Trudee and Mark’s Budget Constraint
When the price of a good decreases, in this case Thai meals fall from $20 to $10, the budget constraint swivels to the right, increasing the opportunities available and expanding choice.

6. The Basis of Choice: Utility
Utility is the satisfaction, or reward, a product yields relative to its alternative. It is the basis for choice.
Marginal utility is the additional satisfaction gained by the consumption or use of one more unit of something.
Total utility is the total amount of satisfaction obtained from consumption of a good or service.

7. Law of Diminishing Marginal Utility
The more of any one good consumed in a given period, the less satisfaction (utility) is generated by consuming each additional (marginal) unit of the same good.

8. Allocation of Fixed Expenditures per Week Between Two Alternatives
Frank’s utility maximizing decision between basketball games and trips to the club.

9. Frank’s Total and Marginal Utility of Trips to the Club

10. Utility-Maximizing Rule
A utility maximizing consumer allocates his or her expenditures such that the marginal utility per dollar spent on each activity is equal:
MUx = MUy
Px Py

11. Predictions of Marginal Utility Theory
A Rise in the Price of Pop
Now suppose the price of pop rises.
We know that MUP/PP falls, so before the consumer changes the quantities consumed, MUP/PP < MUM/PM.
To restore consumer equilibrium (maximum total utility) the consumer decreases the quantity of pop consumed to drive up the MUP and increases the quantity of movies consumed to drive down MUM. These changes restore MUM/PM = MUP/PP.
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12. 8 POSSIBILITIES, PREFERENCES, AND CHOICES CHAPTER
Notes and teaching tips: 4, 14, 32, 38, 45
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13. Consumption Possibilities
The Budget Equation
We can describe the budget line by using a budget equation.
The budget equation states that:
Expenditure = IncomePPQP + PMQM = Y
QP = Y/PP – (PM/PP)QM
The term Y/PP is Lisa’s real income in terms of pop.
A household’s real income is the income expressed as a quantity of goods the household can afford to buy.
Lisa’s real income in terms of pop is the point on her budget line where it meets the y-axis.
The term PM/PP is the relative price of a movie in terms of pop.
A relative price is the price of one good divided by the price of another good.
It is the magnitude of the slope of the budget line.
The relative price shows how many pops must be forgone to see an additional movie.
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14. Preferences and Indifference Curves
An indifference curve is a line that shows combinations of goods among which a consumer is indifferent.
All the points above the indifference curve are preferred over the points on the curve.
And all the points on the indifference curve are preferred over the points below the curve.
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15. Preferences and Indifference Curves
An indifference curve above I1 is I2 . All the points on I2 are preferred to those on I1 .
For example, point J is preferred to either point C or point G.
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16. Preferences and Indifference Curves
Marginal Rate of Substitution
The marginal rate of substitution, (MRS) measures the rate at which a person is willing to give up good y (the good measured on the y-axis) to get an additional unit of good x (the good measured on the x-axis) and at the same time remain indifferent (remain on the same indifference curve).
The marginal rate of substitution is the ratio at which a household is willing to substitute good Y for good X.
MRS = MUx / MUy
The magnitude of the slope of the indifference curve measures the marginal rate of substitution.
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17. Preferences and Indifference Curves
A diminishing marginal rate of substitution is the key assumption of consumer theory.
A diminishing marginal rate of substitution is a general tendency for a person to be willing to give up less of good y to get one more unit of good x, and at the same time remain indifferent, as the quantity of good x increases.
If the indifference curve is relatively steep, the MRS is high.
In this case, the person would be willing to give up a large quantity of y to get a bit more x.
If the indifference curve is relatively flat, the MRS is low.
In this case, the person would be willing to give up a small quantity of y to get more x.
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18. Preferences and Indifference Curves
Figure shows the diminishing MRS of movies for pop.
At point C, Lisa is willing to give up 2 six-packs to see one more movie—her MRS is 2.
At point G, Lisa is willing to give up 1/2 a six-pack to see one more movie—her MRS is 1/2.
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19. Preferences and Indifference Curves
Degree of Substitutability
The shape of the indifference curves reveals the degree of substitutability between two goods.
Figure shows the indifference curves for ordinary goods, perfect substitutes, and perfect complements.
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20. Predicting Consumer Behaviour
The consumer’s best affordable point (Consumer Utility-Maximizing equilibrium):
Is on the budget line
Is on the highest attainable indifference curve
Has a marginal rate of substitution between the two goods equal to the relative price of the two goods
Here, the best affordable point is C.
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21. Predicting …
Figure illustrates the price effect and shows how a demand curve is generated.
Initially, the price of a movie is $6 and Lisa consumes at point C in part (a) and at point A in part (b).
The price of a movie then falls to $3. The budget line rotates outward.
Lisa’s best affordable point is now J in part (a).
In part (b), Lisa moves to point B, which is a movement along her demand curve for movies.
Explain that the fall in the price of a movie leads Lisa to substitute away from pop and into movies. The change in the relative price changes the best affordable point. She can reach a higher indifference curve by substituting away from the relatively more expensive good and toward the relatively inexpensive good.
The new consumption bundle satisfies the three properties: it is on the new budget line, it is on the highest attainable indifference curve, and the MRS has changed, matching the slope of new budget line.
Also emphasize that tracking the change in the quantity of the good for which the price falls reveals the demand curve for that good.
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22. Predicting Consumer Behaviour
Substitution Effect and Income Effect
For a normal good, a fall in price always increases the quantity consumed.
We can prove this assertion by dividing the price effect into two parts:
Substitution effect:
is the effect of a change in price on the quantity bought when the consumer remains indifferent between the original situation and the new situation.
Income effect:
When a good is a normal good, the quantity consumed changes in the same direction as the change in income.
Students find this topic hard. Take it slowly. Get the students to tell you how it goes. That’s the best way of judging the pace that will work for them.
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23. Substitution Effect When the relative price (opportunity cost) of a good or service rises, people seek substitutes for it, so the quantity demanded decreases. When the price of a product falls, that product becomes more attractive relative to potential substitutes. Income Effect When the price of a good or service rises relative to income, people cannot afford all the things they previously bought, so the quantity demanded decreases. When the price of a product falls, a consumer has more purchasing power with the same amount of income and is better off.

24. Predicting Consumer Behaviour
The price of a movie falls from $6 to $3 and her budget line rotates outward.
Lisa’s best affordable point is then J.
We’re going to break the move from C to J into two parts.
The first part is the substitution effect, and the second is the income effect.
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25. Predicting Consumer Behaviour
To isolate the substitution effect, we give Lisa a hypothetical pay cut.
Lisa is now back on her original indifference curve but with a lower price of movies, and her best affordable point is K.
The move from C to K is the substitution effect.
The direction of the substitution effect never varies: a fall in price brings an increase in the quantity bought.
The substitution effect is the first reason why the demand curve slopes downward.
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26. Predicting Consumer Behaviour
To isolate the income effect, we reverse the hypothetical pay cut and restore Lisa’s income to its original level (its actual level).
Lisa is on indifference curve I2 and her best affordable point is J.
The move from K to J is the income effect.
For Lisa, movies are a normal good.
When her income increases, she sees more movies—the income effect is positive.
For a normal good, the income effect reinforces the substitution effect and is the second reason why the demand curve slopes downward.
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27. 9 ORGANIZING PRODUCTION CHAPTER
Notes and teaching tips: 7, 17, 25, 36, 48, 54.
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28. Where Total Revenue is the receipts from the sale of a product (P x q)
Profit
The Firm’s Goal
A firm’s goal is to maximize profit.
Profit is the difference between total revenue and total costs.
Profit = Total Revenue (TR) - Total Cost (TC)
Where Total Revenue is the receipts from the sale of a product (P x q)
Economists measure profit based on an opportunity cost measure of cost.

29. The Firm and Its Economic Problem
A firm’s opportunity cost of producing a good is the best, forgone alternative use of its factors of production, usually measured in dollars.
Explicit costs are costs paid directly in money.
Implicit costs are costs incurred when a firm uses its own capital or its owners’ time for which it does not make a direct monetary payment.
The implicit rental rate of capital is made up of:
Economic depreciation
is the change in the market value of capital over a given period.
Interest forgone
is the return on the funds used to acquire the capital
The opportunity cost of the owner’s labour spent running the business is the wage income forgone by not working in the next best alternative job.
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30. Calculating Total Revenue, Total Cost and Profit For a Small Belt Firm

31. Technology and Economic Efficiency
Technological efficiency occurs when a firm produces a given level of output by using the least amount of inputs.
Economic efficiency occurs when the firm produces a given level of output at the least cost.
An economically efficient production process is also technologically efficient.
A technologically efficient process may not be economically efficient.
Minimizing the quantity of resources used in production is not the same as minimizing the value of the resources used. Be sure that students appreciate the difference between technological efficiency and economic efficiency. Point out that technological efficiency minimizes the quantity of resources used in producing a given level of output, while economic efficiency minimizes the value of the resources being used. Since all resources are not equally priced (let alone equally productive), there will inevitably be a difference between technological and economical efficiency.
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32. 10 OUTPUT AND COSTS CHAPTER
Notes and teaching tips: 4, 7, 29, 34, 38, 61, 69.
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10-32

33. Decision Time Frames
The short run is a time frame in which the quantity of one or more resources used in production is fixed.
For most firms, the capital, called the firm’s plant, is fixed in the short run.
Other resources used by the firm (such as labour, raw materials, and energy) can be changed in the short run.
The long run is a time frame in which the quantities of all resources—including the plant size—can be varied.

34. Short-Run Technology Constraint
Product Schedules
Total product is the total output produced in a given period.
The production function or total product function is a numerical or mathematical expression of a relationship between inputs and outputs.
It shows units of total product as a function of units of inputs.
The marginal product of labour is the change in total product that results from a one-unit increase in the quantity of labour employed, with all other inputs remaining the same.
Marginal product is the additional output that can be produced by adding one more unit of a specific input, ceteris paribus.
The average product of labour is equal to total product divided by the quantity of labour employed.
The average product is the average amount produced by each unit of a variable factor of production.

35. Law of Diminishing Returns
The law of diminishing returns states that when additional units of an input are added to fixed inputs after a certain point, the marginal product of the variable input declines.

36. Production Function (Sandwich Making)
Labor Total Marginal Average
Units Product Product Product

37. Short-Run Technology Constraint
The total product curve is similar to the PPF.
It separates attainable output levels from unattainable output levels in the short run.

38. Typical Production Function
Marginal and average product curves can be derived from total product curves.
The marginal product of labour is the slope of the total product curve.
Average product follows marginal product; it rises when marginal product is above it and falls when marginal product is below it.

39. Short-Run Cost
To produce more output in the short run, the firm must employ more labour, which means that it must increase its costs.
We describe the way a firm’s costs change as total product changes by using three cost concepts and three types of cost curve:
Total cost
Marginal cost
Average cost
Explain the intuition behind each cost measure. For example, explain why the relationship between marginal product and marginal cost is worth understanding.
Point out that although separating fixed and variable components of cost help us understand why unit cost of production is U-shaped in the short-run, fixed costs don’t matter in a firm’s output decision.

40. Short-Run Cost Total Cost
A firm’s total cost (TC) is the cost of all resources used.
Total fixed cost (TFC) is the cost of the firm’s fixed inputs. Fixed costs do not change with output.
A fixed cost is any cost that a firm bears in the short run that does not depend on its level of output. These costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run.
Total variable cost (TVC) is the cost of the firm’s variable inputs. Variable costs do change with output.
A variable cost is any cost that a firm bears that depends on the level of production chosen

41. Total Costs Labor Output Total Total Total TFC TVC TC 0 0 25 0 25
(workers/D) fixed cost variable cost cost
TFC TVC TC

42. Short-Run Cost Figure shows a firm’s total cost curves.
Total fixed cost is the same at each output level.
Total variable cost increases as output increases.
Total cost, which is the sum of TFC and TVC, also increases as output increases.

43. Short-Run Cost Marginal Cost
Marginal cost (MC) is the increase in total cost that results from a one-unit increase in total product (producing one more unit of output).
Marginal costs reflect changes in variable costs.
In the short run, every firm is constrained by some fixed input that leads to diminishing returns to variable inputs and that limits its capacity to produce. As the firm approaches capacity, it becomes increasingly costly to produce more output. Marginal costs ultimately increase with output in the short run.
Over the output range with increasing marginal returns, marginal cost falls as output increases.
Over the output range with diminishing marginal returns, marginal cost rises as output increases.

44. Declining Marginal Product Implies That Marginal Cost Will Eventually Rise With Output

45. Short-Run Cost Average Cost ATC = AFC + AVC
Average cost measures can be derived from each of the total cost measures:
Average fixed cost (AFC) is total fixed cost per unit of output.
Average variable cost (AVC) is total variable cost per unit of output.
Average total cost (ATC) is total cost per unit of output.
ATC = AFC + AVC

46. Total Costs; Marginal Cost; Average Costs
L Outp. Total Total Total Marginal Average Average Average
fixed C variable C C Cost fixed C variable C total C
TFC TVC TC MC AFC AVC ATC

47. Short-Run Cost The ATC curve is also U-shaped.
The MC curve is very special.
Where AVC is falling, MC is below AVC.
Where AVC is rising, MC is above AVC.
At the minimum AVC, MC equals AVC.

48. Short-Run Cost Shifts in Cost Curves
The position of a firm’s cost curves depend on two factors:
Technology
Prices of productive resources

49. Long-Run Cost Long-Run Average Cost Curve
The long-run average cost curve is the relationship between the lowest attainable average total cost and output when both the plant size and labour are varied.
The long-run average cost curve is a planning curve that tells the firm the plant size that minimizes the cost of producing a given output range.
Once the firm has chosen that plant size, it incurs the costs that correspond to the ATC curve for that plant.

50. Long-Run Cost
Figure 10.8 illustrates the long-run average cost (LRAC) curve.

51. Long-Run Cost Economies and Diseconomies of Scale
Economies of scale are features of a firm’s technology that lead to falling long-run average cost as output increases.
Diseconomies of scale are features of a firm’s technology that lead to rising long-run average cost as output increases.
Constant returns to scale are features of a firm’s technology that lead to constant long-run average cost as output increases.

52. Long-Run Cost
Figure 10.8 illustrates economies and diseconomies of scale.

53. Long-Run Cost
A firm experiences economies of scale up to some output level.
Beyond that output level, it moves into constant returns to scale or diseconomies of scale.
Minimum efficient scale is the smallest quantity of output at which the long-run average cost reaches its lowest level.
If the long-run average cost curve is U-shaped, the minimum point identifies the minimum efficient scale output level.