Chapter 2 - Economics V2 PDF

Chapter 2 Economics  Chapter Topics Microeconomics Macroeconomics Basics of supply and demand Key players and factors of Substitutes and complements production Elasticity Money supply and demand...

Chapter 2 Economics  Chapter Topics Microeconomics Macroeconomics Basics of supply and demand Key players and factors of Substitutes and complements production Elasticity Money supply and demand Marginal cost analysis Inflation, employment and interest Profit maximization rates Game theory Ignore pg. 100 thru pg. 113  Why Should I Care? Implications for many practical Topics appear in advanced business issues graduate business courses Pricing of products and services Accounting for Planning & Control Projections of future costs Strategic Marketing Assessment of competitive Corporate Financial Management conditions Managerial Economics Microeconomics  Microeconomics Describes factors that influence prices of assets and services I.e., the “physics of markets” How are prices set? The interaction between supply and demand We will assume that all parties are rational and act in their own self-interest  Law of Demand For normal goods, there is an inverse relationship between price and the quantity of a good/service demanded. Sketch of demand curve graph: Price on y-axis Quantity on x-axis Curve shifts Factors that shift the demand curve: consumer preferences, number of buyers, consumer incomes, prices and availability of substitutes, prices of complementary goods, consumer expectations. A change in price does not shift the demand curve; it’s a movement along the existing demand curve. Demand Curve  Law of Supply For normal goods, there is a positive relationship between price and the quantity of a good/service supplied. Sketch of graph: Price on y-axis Quantity on x-axis Curve shifts Factors that shift the supply curve: number of competitors, prices for raw materials and resources, subsidies and taxes, prices of production substitutes, producer expectations. Supply Curve Interaction of Supply and Demand  Shifts in Supply and Demand Curves Textbook shows an example of Other variations of curve shifts an increase in the supply curve (rightward shift) Surplus and Shortage  Complements and Substitutes Complements: A good that adds Substitutes: Similar products that value to another are used for the same purpose Butter and toast Butter and margarine Price effects for one influences Price increase for one reduced the quantity demanded for both the quantity demand for the item Positive relationship in quantity but increases the quantity demanded demanded for the substitute Negative relationship in quantity demanded Price of Substitutes Branded vs. Price= $6.29 Price= $4.59 Generic VS. Price=$5.29 Price= $5.99 Branded Products VS. 14  Price Elasticity Indicates how quantity demanded or supplied will change in response to a change in price What does your intuition tell you? Customer Demand Example In general, an increase in price will lower quantity demanded. For management, the issue involves the tradeoff between higher price and lower sales volume. Revenue = Unit Sales Price * Quantity Demanded Does the lower Quantity Demanded offset the higher Unit Sales Price?  Price Elasticity Equation , where E is Price Elasticity %ΔQ is the percentage change in quantity (demanded or supplied) %ΔP is the percentage change in price per unit  Interpreting Price Elasticity If E is Greater than 1 or less than -1, then demand or supply is highly elastic Between 1 and -1, then demand or supply is relatively inelastic  Examples of Elasticity High Elasticity Low Elasticity  Deviations from Perfect Competition Cartels Taxes Antitrust Laws Quotas Monopoly/Monopsony Network Natural Monopoly Externalities  Cost Concepts Opportunity Costs Total Cost Sunk Costs Fixed Cost Variable Cost  Total Cost Total cost is the sum of fixed and variable costs Example TC = $800 + $2Q Q TC 0 units $800 100 units $1,000 200 units $1,200  Marginal Costs Additional cost of making one more unit Example TC = $800 + $2Q Q TC 200 units $1,200 201 units $1,202  Average Cost Average cost to produce a given quantity of units Example TC = $800 + $2Q Q TC AC 100 units $1,000 $10 200 units $1,200 $6 Analysis of Average Costs  Economies and Diseconomies of Scale Economies of scale: Lower average cost at increasing quantities Diseconomies of scale: Higher average cost at increasing quantities  How to Make the Most Profit Example Profit = Revenues – Total Cost What is Profit at a Quantity of 100 , where: units? Revenues = $5Q Revenues = $5*100 = $500 Total Cost = $800 + $2Q Total Cost = $800 + $2*100 = $1,000 Profit = $500 - $1,000 = -$500 Profit Maximization  Other Microeconomic Topics Price Discrimination Consumer Surplus Marginal Utility Macroeconomics  Macroeconomics Branch of economics focusing on Key macroeconomic variables: the structure, performance, Gross domestic product (GDP) behavior, and decision-making of Inflation rates an aggregate economy Interest rates Taxes Government spending Net economic activity of firms, governments, and individuals “Circular flow” For pgs. 70-82, let’s keep it simple  Drivers of Macroeconomic Activity GDP is synonymous with output, symbolized as Y Factors driving GDP/output include: Capital (K) Labor (N) Higher capital and/or labor implies increased output….but with diminishing returns  Money Supply and Demand and r This video covers pg. 82-100 (w/ exception of inflation) Most important concept from this section is r: the real interest rate that prevails in a given macro-economy I will streamline the discussion for you Do not be overly concerned with the names of the various curves Focus on essential concepts and connections to the bigger picture  Money Supply (MS) Big picture: MS matters because MS definitions: a loose MS lowers r, while a M1: cash in circulation + balances tight MS increases r held in checking accounts M2: M1 + savings and money market account balances Federal Reserve controls U.S. MS via Short-term interest rates Reserve requirement Open market operations  Money Multiplier Effect Reserve Requirement has a pronounced effect on the MS  Money Demand (MD) Two primary factors that influence MD: 1. National income: Positive relationship 2. Real interest rate (r): Inverse relationship  Putting MS and MD Together Identify equilibrium r and likely outcomes at levels of r below and above the equilibrium r  Inflation The rise in the general price Terminology level Deflator Inflation is essentially an erosion Nominal values of purchasing power Real values Think of movie tickets sold Implications of inflation? Evaluating trends in economic Nominal Rate = Real Rate + Inflation Rate performance Determining true borrowing costs  Inflation Example GDP in Nominal$ 2017 2018 $900,000 $1,000,000 What is the percentage growth in GDP in nominal terms? Nice growth, right? What about the general increase in prices (i.e., inflation)?  Inflation Example Two approaches to determine real growth in GDP 1. Inflate 2017 GDP to 2018 dollar amounts using the given inflation rate of 3% 2. Deflate 2018 GDP to 2017 dollar amounts using the 3% inflation rate  Putting It All Together Nominal Rate = Real Rate + Inflation Rate Nominal Rate = 7.87% + 3% = 10.87% ~ 11% End of Chapter 2