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Questions and Answers

What is the fundamental problem in economics?

Scarcity

Define scarcity.

Scarcity exists when the available resources are insufficient to satisfy all wants and needs.

What is scale of preference?

Scale of preference is a list that ranks all our wants in order of importance.

What is opportunity cost?

<p>Opportunity cost is the value of the best alternative foregone when making a choice.</p> Signup and view all the answers

What are the two main branches of economics?

<p>Microeconomics and macroeconomics</p> Signup and view all the answers

What is microeconomics?

<p>Microeconomics is the study of individual choices and how these choices interact in markets.</p> Signup and view all the answers

What are the two big economic questions that summarize the scope of economics?

<ol> <li>How do choices determine what, how, and for whom goods and services get produced?</li> <li>When do choices made in self-interest also promote the social interest?</li> </ol> Signup and view all the answers

What are goods and services?

<p>Goods and services are the objects and actions that people value and produce to satisfy human wants.</p> Signup and view all the answers

What three questions help us understand the scope of economic activity?

<p>What, how, and for whom?</p> Signup and view all the answers

What is self-interest?

<p>Self-interest is the pursuit of personal gain or satisfaction.</p> Signup and view all the answers

What is the social interest?

<p>The social interest is what is best for society as a whole.</p> Signup and view all the answers

The economic way of thinking emphasizes that choices have no costs.

<p>False</p> Signup and view all the answers

What is a tradeoff?

<p>A tradeoff is an exchange where one thing is given up to obtain another.</p> Signup and view all the answers

Explain how opportunity cost is the best thing you must give up to get something.

<p>Opportunity cost represents the highest-valued alternative foregone. It's the most desirable option that you relinquish by choosing another.</p> Signup and view all the answers

What is a rational choice?

<p>A rational choice is a decision that optimally utilizes available resources to achieve a desired objective.</p> Signup and view all the answers

Explain how marginal analysis helps us make choices.

<p>Marginal analysis involves comparing the additional benefits and costs of making a change, such as producing one more unit or consuming one more item.</p> Signup and view all the answers

What is an incentive?

<p>An incentive is a reward or a penalty that encourages or discourages a specific action.</p> Signup and view all the answers

Describe the role of economics as a social science.

<p>Economics utilizes scientific methods to understand, analyze, and predict human behavior and its implications for resource allocation and social outcomes.</p> Signup and view all the answers

What is an economic model?

<p>An economic model is a simplified representation of a complex economic phenomenon that focuses on key features and relationships.</p> Signup and view all the answers

What is a production possibilities frontier (PPF)?

<p>A production possibilities frontier (PPF) graphically showcases the maximum combinations of goods and services that can be produced with given resources and technology.</p> Signup and view all the answers

What three key features of production possibilities are highlighted by the PPF?

<p>Attainable combinations, efficiency, and opportunity cost.</p> Signup and view all the answers

Explain what an attainable combination is in relation to the PPF.

<p>Any point on or inside the PPF represents an attainable combination of goods, meaning it's possible to produce that combination with available resources.</p> Signup and view all the answers

What is production efficiency?

<p>Production efficiency describes a situation where it's impossible to produce more of one good without sacrificing production of another good.</p> Signup and view all the answers

Explain how the PPF illustrates increasing opportunity cost.

<p>As we move down the PPF, producing more of one good requires increasingly larger sacrifices in the production of another good, reflecting increasing opportunity cost.</p> Signup and view all the answers

Explain the concept of 'free lunch' as it pertains to the PPF.

<p>A 'free lunch' in the context of the PPF represents a situation where an economy can produce more of one good without sacrificing any production of another. This scenario is considered unattainable due to scarcity.</p> Signup and view all the answers

How is the opportunity cost of a good calculated using the PPF?

<p>The opportunity cost of a good is calculated by dividing the decrease in the quantity of another good by the increase in the production of the first good, as we move along the PPF.</p> Signup and view all the answers

Why is the opportunity cost of a good increasing as we move down the PPF?

<p>The opportunity cost of a good increases as we move down the PPF because resources are not perfectly interchangeable. To produce more of one good, we must allocate resources that were previously dedicated to other goods, leading to a higher cost in terms of the forgone alternatives.</p> Signup and view all the answers

What is demand?

<p>Demand represents the quantities of goods and services that consumers are willing and able to purchase at various prices at a given time.</p> Signup and view all the answers

What is the law of demand?

<p>The law of demand states that, all other things being equal, as the price of a good increases, the quantity demanded by consumers decreases, and vice versa.</p> Signup and view all the answers

What is a demand schedule?

<p>A demand schedule is a tabular representation of the relationship between the price of a good and the quantity demanded at different price points, assuming all other factors remain constant.</p> Signup and view all the answers

What is a demand curve?

<p>A demand curve is a graphical representation of the demand schedule, illustrating the inverse relationship between price and quantity demanded as a downward-sloping curve.</p> Signup and view all the answers

What is a demand function?

<p>A demand function is a mathematical expression that represents the relationship between the price of a good and the quantity demanded, holding all other factors constant.</p> Signup and view all the answers

What is market demand?

<p>Market demand is the sum of all individual demands for a product at various price points.</p> Signup and view all the answers

What factors influence demand other than price?

<p>Other factors that influence demand include income, prices of related goods, expected future prices, expected future income and credit, number of buyers, and preferences.</p> Signup and view all the answers

Explain the difference between a change in quantity demanded and a change in demand.

<p>A change in quantity demanded occurs along the same demand curve when price changes, while a change in demand shifts the entire demand curve due to changes in non-price factors.</p> Signup and view all the answers

Explain the difference between normal goods and inferior goods in relation to income changes.

<p>Normal goods experience an increase in demand when income rises and a decrease in demand when income falls. Inferior goods exhibit the opposite pattern, seeing a decrease in demand as income increases and an increase in demand as income decreases.</p> Signup and view all the answers

What is a substitute?

<p>A substitute is a good that can be used in place of another good to serve a similar purpose.</p> Signup and view all the answers

What is a complement?

<p>A complement is a good that is typically used in conjunction with another good.</p> Signup and view all the answers

What is supply?

<p>Supply is the quantity of goods and services that producers are willing and able to produce and offer for sale at various prices over a given period.</p> Signup and view all the answers

What is the law of supply?

<p>The law of supply states that, all other things being equal, as the price of a good increases, the quantity supplied by producers increases, and vice versa.</p> Signup and view all the answers

What is a supply schedule?

<p>A supply schedule is a tabular representation that shows the relationship between the price of a good and the quantity supplied at different price points, assuming all other factors remain constant.</p> Signup and view all the answers

What is a supply curve?

<p>A supply curve is a graphical representation of the supply schedule, illustrating the law of supply as an upward-sloping curve.</p> Signup and view all the answers

What is a supply function?

<p>A supply function is a mathematical expression that represents the relationship between the price of a good and the quantity supplied. It is a precise formula that encapsulates the law of supply.</p> Signup and view all the answers

What is market supply?

<p>Market supply is the total quantity of goods and services that all producers are willing and able to offer for sale at various price points.</p> Signup and view all the answers

What factors influence supply other than price?

<p>Other factors that influence supply include the cost of production, prices of related products, technology, weather conditions, and government regulations.</p> Signup and view all the answers

What is meant by a 'change in quantity supplied'?

<p>A 'change in quantity supplied' refers to a movement along the same supply curve, caused solely by a change in the price of the good.</p> Signup and view all the answers

What causes a 'change in supply'?

<p>A 'change in supply' is represented by a shift in the entire supply curve, driven by factors other than the price of the good.</p> Signup and view all the answers

What is market equilibrium?

<p>Market equilibrium is the state where the quantity demanded by consumers equals the quantity supplied by producers at a specific price.</p> Signup and view all the answers

What is the equilibrium price?

<p>The equilibrium price is the price at which the quantity demanded by consumers equals the quantity supplied by producers, achieving stability in the market.</p> Signup and view all the answers

What is the equilibrium quantity?

<p>The equilibrium quantity is the amount of goods that are bought and sold at the equilibrium price, where demand and supply meet.</p> Signup and view all the answers

What is a shortage?

<p>A shortage occurs when the quantity demanded by consumers exceeds the quantity supplied by producers.</p> Signup and view all the answers

What are the three things that can cause the price of a good to change?

<p>Changes in supply (other than changes in price), changes in demand (other than changes in price), or simultaneous changes in both supply and demand (other than changes in price) can cause the price to change.</p> Signup and view all the answers

Explain the concept of excess capacity in a monopolistic competition.

<p>Excess capacity describes a situation in a monopolistically competitive market where firms produce less than the quantity that would minimize their average total cost. This means that they are producing at a level below their optimal efficiency.</p> Signup and view all the answers

Explain the concept of markup in a monopolistic competition.

<p>Markup refers to the difference between the price a firm charges in a monopolistically competitive market and its marginal cost. This markup allows firms to generate some economic profit due to the imperfect competition they face.</p> Signup and view all the answers

What is a price taker?

<p>A price taker is a firm that has no control over the price of its product, meaning it must accept the market price that’s determined by the overall forces of supply and demand.</p> Signup and view all the answers

What are the four main market structures?

<p>The four main market structures are perfect competition, monopolistic competition, oligopoly, and monopoly.</p> Signup and view all the answers

What is the main characteristic that distinguishes perfect competition from other market structures?

<p>The main characteristic that distinguishes perfect competition is the presence of many small firms, each producing identical products, with easy entry and exit from the market. This creates a highly competitive environment.</p> Signup and view all the answers

In a perfectly competitive market, firms have complete control over the price of their goods.

<p>False</p> Signup and view all the answers

A firm in a perfectly competitive market is able to maximize its profit in the long run.

<p>False</p> Signup and view all the answers

What is monopolistic competition?

<p>Monopolistic competition is a market structure that features many firms, each selling differentiated products with similar but not identical features, with moderate barriers to entry.</p> Signup and view all the answers

Monopolistically competitive firms are price takers.

<p>False</p> Signup and view all the answers

A monopoly is the only market structure that allows for the possibility of economic profits in the long run.

<p>False</p> Signup and view all the answers

What is an oligopoly?

<p>An oligopoly is a market structure where a few large firms dominate the industry and have some market power, often engaging in strategic interactions and interdependence.</p> Signup and view all the answers

A monopoly can always be considered to be in the social interest.

<p>False</p> Signup and view all the answers

How do governments respond to the problem of monopoly?

<p>Governments can respond to the problem of monopoly by promoting competition through antitrust laws, regulating prices, converting private monopolies into public enterprises, or allowing the market to regulate itself even if it brings some inefficiency, depending on the specific circumstances and their potential effectiveness.</p> Signup and view all the answers

What is the welfare cost of monopoly?

<p>The welfare cost of monopoly refers to the inefficiencies and deadweight losses that it generates, as a result of its price-setting abilities and restricted output.</p> Signup and view all the answers

What is the main reason for the welfare cost of monopoly?

<p>A monopoly sets its price higher than its marginal cost, leading to a wedge between the consumer's willingness to pay and the producer's actual costs. This results in a reduction in the quantity produced compared to a perfectly competitive market.</p> Signup and view all the answers

Antitrust laws aim to promote competition in the market.

<p>True</p> Signup and view all the answers

What is the main goal of government regulation of monopolies?

<p>Government regulation of monopolies aims to prevent monopolies from engaging in anti-competitive or exploitative market behavior, such as setting excessively high prices or limiting output, with the goal to protect consumers and promote a more balanced market.</p> Signup and view all the answers

A monopolist always makes supernormal profits.

<p>False</p> Signup and view all the answers

Product differentiation refers to the process where a product is made completely unique from all others.

<p>False</p> Signup and view all the answers

A firm in monopolistic competition typically earns supernormal profits in the long run.

<p>False</p> Signup and view all the answers

Study Notes

Introduction to Economics

  • Economics is the study of how societies allocate scarce resources to satisfy unlimited wants.
  • Scarcity is the fundamental economic problem. Resources are limited, but human wants are unlimited.

Session Overview

  • Wants are unlimited but resources are scarce.
  • Scarcity leads to choices among available options.
  • Economics is a social science examining tools for analyzing economic problems.

Learning Objectives

  • Understand the reasons behind studying economics
  • Define the concepts of microeconomics and macroeconomics

Reading List

  • Bade and Parkin (2013)
  • Begg, Dornbusch, and Fischer (5th Edition)

Definition and Questions

  • Scarcity is the fundamental problem economies face.
  • A scale of preference is a list of wants ordered by importance.
  • Opportunity cost is the value of the next best alternative forgone.

Definition and Questions continued

  • Opportunity costs include explicit and implicit costs.
  • Microeconomics studies individual/business choices and their interactions with governments;
  • Macroeconomics studies aggregate (total) effects of choices on the national/global economy.

Definition and Questions continued

  • Two big economic questions:
  • How do choices determine what, how, and for whom goods and services are produced?
  • When do choices made in self-interest also promote social interest?

What, How, and For Whom?

  • Goods and services are necessary to fulfill human wants.
  • Economics identifies how societies use resources to produce these goods and services. Defining what, how, and for whom these goods and services are produced.

Can the Pursuit of Self-Interest Be in the Social Interest?

  • Self-interest guides individual choices;
  • Social interest guides choices best for society
  • Self-interest can sometimes benefit society

Globalization

  • Globalization is the expansion of international trade and production of goods and services by firms in other countries.

The Economic Way of Thinking

  • Six ideas define the economic way of thinking:
  • Choice is a tradeoff
  • Cost is what you must give up to get something
  • Benefit is what you gain from something
  • People make rational choices by comparing costs and benefits.
  • Most choices are "how much" choices made at the margin.
  • Choices respond to incentives

A Choice Is a Tradeoff

  • Scarcity forces choices.
  • A choice is a tradeoff.

Cost: What You Must Give Up

  • Opportunity cost is the highest-valued alternative forgone.
  • Benefit is the gain or pleasure something brings.

Rational Choice

  • Rational choice uses available resources to best achieve the objective
  • Rational choices are made by comparing costs and benefits

How Much? Choosing at the Margin

  • Marginal choices involve comparing incremental costs and benefits

Marginal Cost

  • Marginal cost is the opportunity cost of a one-unit increase in an activity.

Marginal Benefit

  • Marginal benefit is the gain from getting one more unit of something.

Choices Respond to Incentives

  • Incentives, rewards, or penalties encourage or discourage action.

Economics as Social Science

  • Economists use scientific methods (observation, hypothesis, testing) to understand and predict economic forces.

Economic Models

  • Economic models describe features of the economy to aid in analyzing complex economic problems.

Check Models Against Facts

  • Natural experiments involve observing changes in real-life economies
  • Statistical Investigations use data to identify causes and effects
  • Economic Experiments create artificial conditions to test cause and effect relationships.

Disagreement: Normative versus Positive

  • Normative statements refer to what ought to be (opinion-based).
  • Positive statements refer to what is (factual).

Economics as Policy Tool

  • Economics helps governments, businesses, and individuals make well-informed decisions.

The Economic Problem

  • Use the production possibilities frontier to illustrate scarcity and opportunity cost.
  • Calculate opportunity cost based on PPF.
  • Explain production possibilities expansion.

Production Possibilities Frontier (PPF)

  • A PPF shows maximum combinations of goods and services that can be produced, given factors and available technology.
  • The PPF illustrates opportunity cost via its slope changes illustrating increasing opportunity costs.

Attainable and Unattainable Combinations

  • Points on the PPF are attainable.
  • Points inside the PPF are attainable but inefficient
  • Points outside the PPF are unattainable.

Efficient and Inefficient Production

  • Production is efficient when it is on the PPF.
  • Production is inefficient if it is inside the PPF.

Tradeoffs and Free Lunches

  • A tradeoff demonstrates the choice made when something is lost in exchange for gaining something else.
  • A free lunch is an opportunity cost-free gain or exchange

Opportunity Cost

  • The decrease in DVDs divided by the increase in cell phones, along with the PPF, shows opportunity cost.

Increasing Opportunity Cost

  • Opportunity cost rises as more of one good is produced in relation to the other.

Opportunity Cost: Cost of a Cell Phone

  • The trade off value or reduction of another variable or factor of production.

Opportunity Cost Continued

  • Opportunity cost increases as output increments along the PPF.

Opportunity Cost and the Slope of the PPF

  • The slope of the PPF represents opportunity cost.
  • The slope's steepness increase as the price of one item in relationship to another increases as well.

Opportunity Cost is a Ratio

  • Opportunity cost is calculated as the comparative value of one item versus another measured in quantity to quantity.

Increasing Opportunity Costs Are Everywhere

  • Opportunity costs increase when there's an increase in production of output regarding a product.

Learning Objectives continued

  • Understand demand and the factors that influence it
  • Understand supply and the factors that influence it
  • Understand market equilibrium and how price and quantity change

Demand

  • Demand is the quantity of a good or service consumers are willing and able to buy at different prices at a certain point in time.
  • Price is a main determinant in demand, that higher prices lead to reduced demand, and lower prices increase demand.

The Law of Demand

  • All other things equal;
  • The higher the price, the lower the quantity demanded.
  • The lower the price, the higher the quantity demanded.

Demand Schedule, Demand Curve and Demand Function

  • These three tools show demand's relationship to price without any other factors affecting the value.

Demand Schedule

  • A list showing different prices and their respective demanded quantities of products.

Demand Curve

  • A graph showing the relationship between different product prices and the respective quantities demanded without other factors' impact.

Demand Function

  • A mathematical relationship showing the relative price/quantity demand for products.

Demand Continued

  • Factors influencing demand other than price: -Income -Prices of related goods (substitutes/complements) -Expected future prices -Expected future income and credit -The number of buyers -Preferences

Income

  • Normal goods - demand increases with income,
  • Inferior goods - demand decreases with income,
  • Substitutes - price increase of a substitute will increase the demand of another product
  • Complements-price increase of a complement will decrease the demand of another product.

Expected Future Prices

  • Expected future price increases will cause current demand to increase.

Number of Buyers

  • An increase in the number of buyers increases demand

Preferences

  • Changes in preferences will shift demand curves

Changes in Quantity Demanded

  • A change in quantity demanded results from changes in the good's price only.
  • This causes a movement along that specific demand curve.

Changes in Demand

  • A change in demand results from any factor affecting demand other than the price.
  • This causes a shift in the entire demand curve to the left or right.

Supply

  • Supply is the quantity of a good or service producers are willing and able to sell at various prices during a given period of time.
  • Price is a main determinant of supply, as higher prices increase quantity supplied and lower prices reduce quantity supplied.

Law of Supply

  • All other things equal;
  • The higher the price, the greater the quantity supplied.
  • The lower the price, the lower the quantity supplied.

Supply Schedule and Supply Curve

  • Shows the relation between prices and quantities supplied.

Supply Schedule

  • Shows a list of different prices and the corresponding quantity supplied.

Supply Curve

  • Graph showing relation between different prices and respective quantities supplied.

Supply Function

  • Mathematical expression describing relationship between prices and quantities supplied

Supply Continued (Factors influencing Supply other than price)

  • Cost of production (input prices, technology)
  • Prices of related goods (substitutes/complements in production)
  • Technology (technological advancements, improvements)
  • Expectations
  • Number of Sellers
  • Weather Conditions (e.g., climate change impacts on agricultural products)

Market Equilibrium

  • Market equilibrium is where quantity demanded equals quantity supplied at a certain price.
  • This point is called the equilibrium point.

Measuring Profit

  • Profit = TR − TC
  • Dividing both sides by Q, Profit = (TR/Q) − (TC/Q) x Q
  • Profit = (P − ATC) × Q where, P = Price, and ATC = Average Total Cost

Market Equilibrium Continued

  • If a market's price is above equilibrium, a surplus occurs (quantity supplied exceeds the demand).
  • If a market's price is below equilibrium, a shortage occurs (quantity demanded exceeds the supply).
  • The market will self-adjust toward equilibrium through price changes to eliminate surpluses and shortages.

Effects of Changes in Demand

  • An increase or decrease in demand (due to factors other than price) will shift the entire demand curve to the left or right.

Effects of Changes in Supply

  • An increase or a decrease in supply (due to factors other than price) will cause a shift of the entire supply curve to the left or the right, respectively.

Change in Quantity Supplied Versus Change in Supply

  • A change in quantity supplied only occurs with changes in price, whereas a change in supply occurs from other factors other than price that causes a shift in the supply curve.

Effects of Changes in Both Demand and Supply

  • Both demand and supply can shift at the same time resulting in varying changes in equilibrium price and quantity.

Price Control

  • Price ceilings and price floors are government-imposed price controls
  • Price ceilings set maximum prices below market equilibrium, creating shortages;
  • Price floors set minimum prices above market equilibrium, creating surpluses.

Minimum Price

  • Minimum Price is set by the government to protect suppliers from low market prices.
  • Government imposed minimum prices cause excess supply or surplus
  • Suppliers will continue in the market even if profits are diminished
  • Additional measures must be taken to counter excess supply

Maximum Price

  • Maximum Price is set by the government to protect the consumer and set maximum price, and will lead to excess demand

Elasticity of Demand and Supply

  • Elasticity measures responsiveness of quantity demanded/supplied to changes in price.

Price Elasticity of Demand

  • Elastic demand has Ep>1, inelastic demand has Ep<1, and unit elastic demand has Ep=1
  • The absolute value of Ep tells us how much quantity demanded changes when price changes.

Extreme Elasticities

  • Perfect elasticity—quantity demanded changes drastically with even subtle price changes,
  • Perfect inelasticity-quantity demanded remains the same no matter how price changes.

Cross Price Elasticity of Demand

  • This measures how the demand for one good changes in response to a change in price of a related good.

Income Elasticity of Demand

  • This measures the responsiveness of a good's quantity demanded to changes in income, other factors being equal.
  • Normal goods: demand increases when income increases.
  • Inferior goods: demand decreases when income increases.

Determinants of Elasticity of Demand

  • The availability of substitutes for a product
  • The percentage of a customer's total income devoted to a product
  • The length of time to adjust when prices change.

The Price Elasticity of Supply

  • Elastic supply -the percentage change in supply is higher than the percentage change in price.
  • Inelastic supply- the percentage change in supply is lower than the percentage change in price,
  • Perfectly elastic supply- a small change in price leads to a large percentage change in supply
  • Perfectly inelastic supply- there is no change in supply no matter how much the price changes

Theory of Consumer Behavior

  • Consumers choose from thousands of goods each day, but constrained by income.
  • The theory of consumer choice analyses the sacrifices and tradeoffs consumers face in their choices.

Utility Theory

  • Consumers purchase goods because of the satisfaction they receive from having and using them.
  • Utility is the satisfaction a consumer gets from consuming a specific good or service.
  • Schools of thought include Cardinalist and Ordinalist

The Cardinal Approach

  • Utility can be measured in units called utils (numerical).
  • Consumers can measure total utility (TU), average utility (AU), and marginal utility (MU).

Relationship between Total Utility and Marginal Utility

  • Total utility increases to a maximum, then decreases, while marginal utility is positive but decreases until it becomes negative.

The Cardinal Approach

  • Total utility—total satisfaction from consuming units of a commodity.
  • Average utility—satisfaction per unit of a commodity consumed.
  • Marginal utility—extra satisfaction from consuming an additional unit of a commodity.

The Cardinal Approach Continued

  • Marginal utility (MU)—satisfaction received from consumption of a commodity.
  • Law of diminishing marginal utility—marginal utility decreases as more units of a commodity are consumed.

Consumer Equilibrium-Single Good

  • Equilibrium occurs when the price of a good equals marginal utility (MU)
  • Disequilibrium occurs when the marginal utility of a good exceeds its market price (MU>P). Consumers react by buying more.

Consumer Equilibrium -Multiple Goods

  • Equilibrium occurs where the marginal utility (MU) per dollar spent is equal for all goods.

Derivation of the Demand Curve

  • The equilibrium point where MR=MC establishes the firm's quantities produced. The price is then determined by the corresponding point on the firm's demand curve.

Ordinal Approach

  • Utility cannot be measured numerically;
  • Consumers can compare and rank goods based on preferences, implying preferences for one item over another.

The Budget Constraint

  • The budget constraint shows all possible combinations of two items and services.
  • It shows the purchasing limits and options given a fixed income.

Slope of the Budget Line

  • The slope of the budget line represents the relative price of the two goods.
  • It measures the rate at which a consumer can trade one good for another.

Changes in the Budget Line

  • Changes in prices will rotate the budget line, while changes in income will shift the line parallel.

Indifference Curve

Indifference curves show combinations of goods and services that yield the same level of satisfaction for consumers. • Negatively sloped—for more of one good, consumers must sacrifice some of the other good. • Higher curves—represent greater satisfaction. • Bundles aren’t intersected.

Properties of the Indifference Curve

  • Indifference curves are convex to the origin—this shows the diminishing marginal rate of substitution (MRS).
  • All points along an indifference curve provide the consumer the same level of satisfaction.

The Slope of the Indifference Curve (MRS)

  • The slope—measures the rate at which a consumer is willing to trade one good or service for another good or service,
  • Shows the consumer's rate of substitution for the commodity.

Consumer Equilibrium

  • Consumer equilibrium occurs when the indifference curve is tangent to the budget line.
  • It indicates the point the consumer can maximize utility given the budget constraint.

Price Consumption Curve (PCC)

  • The price consumption curve shows how optimal consumption bundles change as the price of one good changes, holding income and relative prices of other goods constant.
  • A change in the price of one good can cause a rotation of the budget constraint,
  • leading to a movement to a new indifference curve along the PCC.

Income Consumption Curve (ICC)

  • The Income Consumption Curve shows how optimal consumption bundles change as household income changes, holding the price of goods constant.
  • A change in income causes a parallel shift in the budget constraint,
  • leading to a movement along the ICC to a new indifference curve.

Engel Curve

  • The Engel curve shows the relationship between consumer income and consumption for a specific good.
  • A normal good shows an upward-sloping curve that indicates consumption rises as income rises.
  • An inferior good displays a downward-sloping curve showing consumption falls as income rises.

Income and Substitution Effect for Price Change

  • Substitution effect—consumers substitute towards a good with a lower relative price.
  • Income effect—consumers perceive a change in purchasing power; a reduction in purchasing power will cause a reduced consumption of goods or services.

Maximum Prices

  • Maximum price ceilings fixed by the government under a command-control economy that set prices below market equilibrium.
  • The maximum price leads to excess demand as quantity demanded will be greater than supply.
  • The markets will collapse or black markets will arise.

Production and Costs

  • Firms incur costs to produce goods and services.
  • Economists consider opportunity cost-the value of the next best alternative forgone.
  • Accounting costs represent explicit costs, while opportunity cost includes both accounting and implicit costs.

Cost Function

A mathematical expression illustrating the relationship between output quantity and the cost of production, keeping other factors constant.

Short-Run Costs

  • Fixed costs (FC)—costs independent of output quantity (e.g., rent, machinery).
  • Variable costs (VC)—costs that vary with output quantity (e.g., labor).
  • Total cost (TC)—sum of fixed and variable costs.
  • Average fixed cost (AFC)—fixed cost per unit of output (AFC = FC/Q).
  • Average variable cost (AVC)—variable cost per unit of output (AVC = VC/Q).
  • Average total cost (ATC)—total cost per unit of output (ATC = TC/Q = AFC + AVC).
  • Marginal cost (MC)—change in total cost resulting from a one-unit change in output (MC = ∆TC/∆Q).

Example

Illustrative table featuring examples of short term production cost based on hypothetical scenarios like the output and price of capital and labor

Total Cost Curves

  • Total fixed cost (TFC) is a constant curve.
  • Total variable cost (TVC) increases as output increases.
  • Total cost (TC) curve increases from the summation of TFC and TVC.

Average and Marginal Cost Curves

  • AFC decreases continuously as output increases—diminishing marginal returns on the input.
  • AVC also falls at first, reaches a minimum, then increases mirroring those marginal returns.
  • ATC initially follows downward sloping graph, before rising to an equilibrium.
  • MC is U-shaped—MC curve cuts both ATC and AVC curves at their minimum points.

Relationship Between Short Run Production and Cost

  • Formula illustrations to detail production and cost relationships, like average and marginal costs,
  • The production function expresses the relationship between inputs and outputs.
  • The profit-maximizing level of output for each input is determined by that input's marginal product and marginal cost.

Short-Run Cost Continued

  • Why is the average total cost curve U-shaped?
  • Spreading fixed costs over increasing output decreases the AFC.
  • Diminishing marginal returns—causes the AVC to increase.

Relationship between Cost Curves and Product Curves

  • Relationship between marginal product, average product of a given variable input, and their impact on short-run cost curves, which implies cost curves follow the trend with output.

Short-Run Cost Continued

  • At small outputs in production, MC and AVC curves fall as a result of increasing marginal product.
  • At intermediate outputs, MC rises above AVC while AP reaches a maximum before falling, and MC and AVC start to rise.
  • At large outputs in production, MC and AVC curves rise as a result of diminishing marginal product.

Short-Run Cost Continued

  • Causes that shift cost curves
    • Technology shifts curve upwards to the left when advances are made in technology -Input prices shifts output (AVC, TVC, and MC) curves upwards. Fixed costs remain the same (AFC, TFC) shifts -Input prices to produce good shifts cost curve downwards, and vice versa

Market Structure (Market types)

  • The four market types are: Perfect Competition, Monopolistic Competition, Oligopoly, and Monopoly.
  • The differences in pricing and production decisions shape the market structures.
  • A market is considered competitive if the market size dictates that any buyer or seller has little impact on price.

Market type 1: Perfect Competition

  • Undifferentiated products among many buyers/sellers,
  • No entry/exit barriers from participation,
  • Existing firms have no advantages over new firms
  • Information is perfect

Revenue of a Competitive Firm

  • The goal of competitive firms is to maximize profits by reducing total costs and increasing total revenues.
  • The price doesn't change regardless of output quantity.

Revenue Function

  • Total revenue (TR) - price multiplied by quantity; TR=P×Q.
  • Average revenue (AR)- total revenue divided by quantity ; AR=TR/Q.
  • Marginal revenue (MR)- change in total revenue resulting from a one-unit change in output; MR=∆TR ÷ ∆Q.
  • In a competitive market, MR=P.

Profit Maximization and the Competitive Firm-Marginal Analysis

  • Profit is maximized when Marginal Revenue (MR) equals Marginal Cost (MC).
  • Recall that Economic profit equals Total Revenue minus Total Cost, where Profit = (TR/Q) − (TC/Q) × Q.

Profit Maximization and the Competitive Firm-Shutdown Point

  • A firm should temporarily shut down if and only if the price is below its minimum average variable cost.
  • In the long-run, the firm can exit the market if and only if the price is below its minimum average total cost.

A Firm's Short-Run Supply Curve

  • A firm's short-run supply curve matches its marginal cost (MC) curve above the minimum average variable cost (AVC)

Output, Price, and Profit in the Short Run

  • Market equilibrium—market supply and demand intersect, setting the market price (P).
  • Profit is maximized when MR = MC.

Short-Run Equilibrium in Normal Times

  • Market demand and supply determine equilibrium price and quantity.
  • If a firm makes a normal profit, Price equals Average Total Cost (ATC)

Short-Run Equilibrium in Good Times

  • An increase in demand will increase the quantity produced, price, and firms will be enjoying positive economic profit at a point where Price (P) > ATC.
  • Higher than normal profits attract firms into the market causing market supply to increase at a new equilibrium and resulting in Price=ATC.

Short-Run Equilibrium in Bad Times

  • A decrease in demand results in a lower price, economic loss, and some firms exit the market decreasing market supply causing a new higher price at a new equilibrium, and firms incur a loss where Price (P) < ATC.

Output, Price, and Profit in the Long Run

  • In long-run equilibrium, firms earn a normal economic profit, price equals ATC.
  • Economic profit attracts new firms into the market.
  • Economic losses cause firms to exit.
  • Entry and exit shift the market supply curve and change price and quantity in the long run to reach equilibrium.

Monopoly, Monopolistic Competition and Competitive Markets

Features and characteristics are identified for the different types of market structures.

Comparing Monopoly and Competition

  • Monopoly's price is set higher than marginal cost, whereas competitive firms' prices are equal to marginal cost.

Monopoly's Profit

  • Calculated as total revenue (TR) minus total cost (TC)
  • Profit = (P - ATC) × Q where, P = Price, and ATC = Average Total Cost

Profit-Maximization for a Monopoly

  • A monopoly maximizes profit by setting price to equal its marginal revenue (MR) and marginal cost (MC)

The Monopolist's Profit

  • The monopolist will make economic profits as long as Price is greater than Average Total Cost (ATC)

The Welfare Cost of Monopoly

  • A monopoly keeps prices above marginal cost, thus leading to inefficiency;
  • It's undesirable for consumers but profitable for the owners of the monopoly.

The Deadweight Loss

  • Deadweight loss is the loss of potential gains from trade;
  • Monopolies result in deadweight loss arising from price being above marginal cost.
  • The effect is similar to loss resulting from tax on consumers and producers.

Inefficiency of Monopoly

  • A monopoly produces a lower quantity and charges a higher price than a competitive market would achieve, resulting in social inefficiency.

Public Policy Toward Monopolies

  • Government may regulate prices by setting the price to equal marginal cost to promote more efficient resource allocation;
  • Government can make or turn monopolized industries into public enterprises or take no action at all.
  • Government can use antitrust laws to promote competition by preventing company mergers and the formation of monopolies.

Other ways of expressing the Production Relationship

  • Isoquant—shows combinations of inputs that yield the same level of output (constant level of production).

Marginal Rate of Technical Substitution (MRTS)

  • The rate at which a firm can substitute one input for another while keeping output constant.

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