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In the beginning … Economics Resources
How to allocate scarce resources with unlimited wants or desires. Resources Labor Land/Natural Resources Capital Entrepreneurship
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Opportunity Costs & Marginal Analysis
The cost of doing the next best option. Marginal The 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.
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Production Possibility Frontier
Measures different combinations of production Good A Z is beyond capacity, borrowing or running a deficit Y Z X & Y are equally efficient, on the PPF curve W X W is inefficient, Not all resources In use – a recession Good B
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Trade Advantages Example: Country A Country B 60 Pizzas 80 Hot Dogs
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Absolute Advantage Who can produce the most? Pizzas: Hot Dogs:
Country A – 60 Country B – 40 Hot Dogs: Country A – 80 Country B – 20 Country A b/c 60 > 40. Country A b/c 80 > 20.
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Comparative Advantage
Who gives up the least to produce? (items produced/items no longer produced) Pizzas: Country A – (60 Pizzas/80 HD) = 0.75 Country B – (40 Pizzas/20 HD) = 1.50 Hot Dogs: Country A – (80 HD/60 Pizzas) = 1.33 Country B – (20 HD/40 Pizzas) = 0.50 Country B b/c 2.00 > 0.75. Country A b/c 1.33 > 0.50 NB There is always comparative advantages for both countries even when one country has an absolute advantage in both products
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Supply and Demand Price S P D Q Quantity
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Demand Movement along the curve Curve Shift Change in Price
Change in Determinants Income Substitutes Complements Number Consumers Consumer Tastes Consumer Expectations
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Supply Movement along the curve Curve shift Change in price
Change in Determinants Costs of inputs Number sellers Change in technology Taxes Producer expectations
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Supply & Demand Substitutes Complements Normal goods Inferior goods
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Equilibrium Price S surplus P+1 P P-1 shortage D Q Quantity
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Price Floors & Ceilings
Pf Deadweight Loss (DWL) Pc Price Ceiling D QD QS Quantity 13
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Equilibrium Consumer Surplus Price S P Producer Surplus D Q Quantity
Total Welfare is the sum of Consumer & Producer Surpluses
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Elasticity Measures change in QUANTITY caused by small changes in PRICE = %ΔQ / %ΔP Midpoint Formula = (Q1-Q2)/((Q1+Q2)/2) (P1-P2)/((P1+P2)/2)
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Elasticity Perfectly Elastic Elastic Unit Elastic Inelastic
ED = ∞ Elastic 1 < ED < ∞ Unit Elastic ED = 1 Inelastic 0 < ED < 1 Perfectly Inelastic ED = 0
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Determinants of Elasticity
Substitutes Income Time
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Total Revenue (TR) Method
Elastic Price & TR move in opposite direction P TR P TR Inelastic Price & TR move in the same direction P TR P TR TR = P * Q ….do not compare P & Q !!!
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Types of Elasticity Income elasticity Cross elasticity %ΔQ / %Δ Income
Negative number for Inferior Goods Cross elasticity % Δ Q Good A / % Δ P Good B Negative number for Complementary Goods
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Elasticity & Taxes Government Revenue Consumption Taxes paid
By Consumer Taxes Paid by Supplier Perfectly Elastic Least Most 0 % 100 % Inelastic Zero
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Changing Elasticities
Price Inelastic – A large change in price… … leads to a small change in quantity 13 10 Elastic – A small change in price… … leads to a large change in quantity 3 2 4 5 11 14 Quantity
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Graphing Tax Revenue ST Price Tax shifts supply Curve – Price up
& Quantity down S PT Tax Revenue P D QT Q Quantity
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Firms, Markets & Costs Accounting π = TR – Explicit Costs
Economic π = Acct π – Implicit Costs Implicit Costs are Opportunity costs Long-run has no fixed costs Sunk Costs Economies of Scale TC = TFC + TVC
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Total & Average Cost Graphs
ATC TC P MC AVC VC FC AFC Q Q
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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
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Perfect Competition (profits)
Firm Industry Price Price S Profits MC S2 ATC P1 D=MR=AR=P P1 P2 D2 D Q1 Q2 q2 q1 Quantity Quantity New firms enter b/c profits, Results in P, Industry Q, Firm q, & π = 0
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Perfect Competition (losses)
Industry Firm Price ATC Price S2 S Losses MC P2 D2 P1 P1 D=P=MR=AR D Q2 Q1 q1 q2 Quantity Quantity Firms leave b/c losses, results in P , Industry Q , Firm q , & π = 0
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Monopoly Monopoly P set by demand Curve point above MC=MR Price
Socially optimal allocation or allocative efficiency at MC = D MC ATC P Fair return Price ATC=P (0 economic profit) Deadweight loss (DWL) Difference between Monopoly P & Socially optimal P D Quantity Q Πmax set by MC=MR MR
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Monopolistic Competition
MC P ATC ATC tangent to D P Equilibrium at zero economic profits MR Q Q Excess Capacity
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Monopolistic Competition
MC P ATC ATC < D P Economic profit will cause firms to enter, with more firms in the market, consumers have more choice & demand for the company decrease P2 MR D2 D Q Q
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Monopolistic Competition
MC ATC ATC > D P P2 Economic losses will cause firms to exit which will increase demand for companies still in business P D2 MR D Q Q
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Oligopoly Barriers to entry May or may not have differentiation
Jack Confess Don’t Confess Barriers to entry May or may not have differentiation 4 Firm ratio Prisoner’s dilemma Dominant Strategy One choice is always better Nash Equilibrium Each player know options of opponent – no need to change 10 year 20 years Confess 10 year Free Jill Don’t Confess 1 years Free 20 years 1 years
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Oligopoly: Incentive to Collude
Game theory applied Oligopolists 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.
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Factor Economics Demand for inputs MRP = Marginal Revenue Product
Labor Resources MRP = Marginal Revenue Product MR for factor markets = ΔTR / ΔQ MRC = Marginal Revenue Cost MC for factor markets = ΔTC / ΔQ
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Factor Economics If MRP > MRC If MRP = MRC If MRP < MRC
Increase Production If MRP = MRC Max profits Stop (ideal) Production If MRP < MRC Decrease production
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Factor Economics Marginal Productivity / Least Cost Derived Demand
MPA / PA = MPB / PB Firms produce at a level where all costs are minimized Derived Demand Demand for products creates or affects the demand for resources such as labor
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Factors & Distribution
Marginal Productivity Theory of Income Distribution Income allocated by how much production is created Theory may lead to Income inequality Market Imperfections
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Types of Goods Rivals in Consumption Yes No Private Goods Natural
Monopoly Yes Excludable No Common Resources Public Goods
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Negative Externalities
Externality Cost Supply Failure Suppliers do not have to pay the full value Will supply more b/c costs paid by others Costs affect supply Taxes raise price to public equilibrium Social Cost P Private Cost P2 P1 Private Value Q2 Q1 Q
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Positive Externalities
Demand Failure Public not willing to pay full value Benefits or subsidies needed to induce suppliers to supply at lower price levels Benefits affect demand Subsidies absorb costs creating public equilibrium External Benefit Private Cost P Public Cost P1 P2 Private Value Q1 Q2 Q
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Income Inequality Lorenz Curve Gini Index
Measures ratio between richest & poorest quintiles. Gini Index Measures among of distribution Increasing numbers (ranges from 0.0 to 1.0) means less equality
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Miscellaneous Taxes Moral Hazard Adverse Selection
Progressive Increasing Marginal Rates Proportional Regressive Decreasing Marginal Rates Moral Hazard Taking higher risks b/c of insurance or government bail-outs Adverse Selection Signaling Only those who need product would buy it (insurance)
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