Economics Chapter One: Central Concepts of Econ PDF

ECONOMICS CHAPTER ONE: An economy should produce the highest combination of quantity Central Concepts of Econ and quality of goods given its WHY...

ECONOMICS CHAPTER ONE: An economy should produce the highest combination of quantity Central Concepts of Econ and quality of goods given its WHY STUDY ECONOMICS? technology and scarce resources. ➔ Help you make wise economic Resources decisions (how to buy a home, pay Land - natural resources for your children’s education, and Labor - primary human resources set aside a nest egg for retirement). - including entrepreneurs ➔ To understand more deeply what Capital - produced good used for lies behind reports on inflation and further production. unemployment. - both an input and an ➔ To understand what kinds of output. policies might slow global warming. ➔ All your life—from cradle to grave Production and beyond—you will run up Goods - tangible products against the brutal truths of Services - intangible offerings economics. Consumption Now - what we currently need DEFINITION OF ECONOMICS Later - what we will need ➔ The study of how societies choose Problem: Should we sacrifice to use scarce resources to produce consuming now for consumption valuable goods and services and later (invest)? Or prioritize distribute them among individuals consumption now (is there efficiently for consumption. poverty, unemployment, etc.)? Scarcity Distribution Goods are limited relative to Dissemination of resources desires. PH is 15/63 in income inequality. Given unlimited wants, it is The top 1% contributes 17% of important that an economy national income while the button makes the best use of its limited 50% only contributes 14%. resources Efficiency OTHER CONCEPTS Denotes the most effective use of Econometrics its limited resources in satisfying ★ The application of statistical needs and wants. tools to sift through mountains of  data to extract simple ➔ “Post hoc, ergo propter hoc” : relationships. “after this, therefore resulting from it” Micro- vs Macro- economics ★ Micro - concerned with the 2. Caeteris Paribus behavior of individual entities ➔ The failure to hold other such as markets (transaction things/variables constant. facilitation), firms (for-profit ➔ Theoretically, if we want to know selling), and households. whether A or B caused C, we - today, it also includes should first look at A with a the study of monopoly (sole constant B or vice versa to really supplier), the role of international know which caused event C. trade, etc. ➔ Realistically, if we want to raise ★ Macro - concerned with the A to raise B, we should also look overall performance of the at the increase or decrease of economy (GDP, GNI, etc.) other variables C and D relatively since nothing is Positive vs Normative Economics constant in the real world. ★ Positive - describes data as it is ➔ “All other things equal” or “all - questions of fact else constant” - references to analysis and empirical data. 3. Fallacy of Composition ★ Normative - prescribes how data ➔ Just because something worked ought to be or should be for a part of a whole, it works for - involves ethical precepts the whole. [fallacy: not all the - questions of fairness time this is the case.] ➔ If a farmer had higher income COMMON FALLACIES because of a bumper crop 1. Post-hoc fallacy doesn’t mean that all farmers’ ➔ Because A occurred before B, A income will increase if they all immediately caused B [fallacy: had bumper crops. [reality: not all the time this is the case] surplus is never good] ➔ Just because person A died after going to the hospital 3 PROBLEMS OF ECONOMIC ORGS. doesn’t mean that every time WHAT to produce? (product) people go to the hospital, we die HOW to produce? (process) [reality: hospitals are for cure] FOR WHO to produce? (consumer) HOW THEY ARE SOLVED ○ For Who: Individuals consume Through Alternative Economic Systems: depending on where they want to spend their income. Command Economy Laissez-faire economy is an The government makes all extreme case where the important decisions on both government keeps its hands off production and distribution. economic decisions (capitalist The government is the one that economy). answers the major economic questions through its ownership ANALYTICAL TOOL: PPF of resources and its power to (Production Possibility Frontier) enforce decisions. ★ Shows the maximum quantity of Ex. The Soviet Union during most goods that can be efficiently of the 20th century produced by an economy, given its Mixed Economy technological knowledge and the Realistically, no contemporary quantity of available inputs. society falls completely under ★ PPF Schedule: Command nor Market economies. All societies now are “mixed economies” having elements of both economic systems. More on this in Chapter 2. Market Economy The individuals and private firms make the major decisions about ★ PPF Graph: production and distribution. The market mechanism, the Invisible hand, or the forces of demand and supply determine the price and quantity of goods and services traded. ○ What: Firms sell products with the highest net yields ○ How: Firms use techniques of productions with the least ★ The PPF of a society shows the costs optimal schedule which a society can choose from. Points outside the  frontier ( I) is just unattainable ★ Societies must choose whether to while points inside the curve ( U) prioritize private (bought at a means that the society hasn’t price: food) vs public goods (paid achieved productive efficiency yet. by taxes: education), needs (rice) ○ Ex. for U is when and luxuries (cellphones). unemployment is high during ○ If a country is poor, then they severe business cycles. Only a could only afford private few is hired (e.g. U) than the goods. With economic growth, optimal employment (e.g. D). public goods take a larger The gap between U and D share of the output. determines the unemployment. Choices in PPF ★ Productive efficiency is achieved ★ A nation can produce either when a society is on its PPF (ex. E) current-consumption goods rather than inside (ex. U). (pizzas and concerts) or PPF in Economic Growth investment goods (pizza ovens and concert halls). ★ Investing heavily can have high returns in the future but the choice to sacrifice current consumption must be made depending if the nation can survive i.e. if a country is under severe poverty, then they should prioritize consumption or basic needs first: ★ Before, the nation was poor and must devote almost all its resources to food (A). ★ With economic growth, may be due to technological change and growth of inputs, a nation’s PPF shifts outward to B, expanding its food consumption along with its increased consumption of luxuries. It can increase its consumption of both goods if it desires.  ★ Ex. INcreasing the number of guns produced from D (9,000) to C (12,000) will relatively result to the DEcrease of butter produced from D (3M) to C (2M). Doing the math: the difference between 3M and 2M, opportunity cost is 1M lbs. of butter forgone. (a) Today’s Choices: Starting out even, Country 1 does not invest at all (A1), Country 2 invests a little and abstains a bit from consumption (A2), and Country 3 sacrifices current consumption a lot and invests heavily (A3). (b) Future Consequences: In the following years, countries that invest more heavily forge ahead. Thus thrifty Country 3 has shifted its PPF far out, while Country 1’s PPF has not changed at all. Opportunity Cost ★ Can be seen as the next-best good forgone to be able to choose the best good. ECONOMICS CHAPTER TWO: and buyers are willing to buy at that “equilibrium” price. The Mixed Market Economy ❖ If this is attained, it will be A. MARKET MECHANISM maintained. The “Invisible Hand” (1776) Adam Smith’s The Wealth of Nations ❖ “Every individual endeavors to employ his capital so that its produce may be of greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, Market only his own gain. And he is in this ❖ In simple terms, the market is the led by an invisible hand to promote interaction between demand and an end which was no part of his supply. intention. By pursuing his own ❖ A mechanism where buyers and interest he frequently promotes sellers interact to determine that of society more effectually prices and exchange goods, than when he really intends to promote it.” services, and assets. ❖ Central role: to determine the ❖ In simpler terms: All individuals are “equilibrium price” just out there only for themselves wanting to gain the most profit Price from the least effort. But, without ❖ The value of the good in terms of realizing it, they often end up money. helping society in the process (e.g. Represents terms on which producing rice only for profit, while different items can be fulfilling society’s basic need). This exchanged idea is sometimes called being Serve as signals to producers guided by an "invisible hand". and consumers ❖ Caveat: This only works when it The “balance wheel” of the takes place in a well-functioning market mechanism. market mechanism. Market Equilibrium ❖ A balance among all buyers and sellers i.e. sellers are willing to sell B. MODERN MARKET ECONOMY : A cost of globalization is when TRADE, MONEY, CAPITAL one “specialized” country fails, it affects all other consumer Trade in Specialization and Division countries, e.g. an oil-supplying of Labor country runs out of oil, therefore When people specialize in a trade those who trade off its oil suffer or industry, they are able to gain as well. expertise and exchange/trade it Autarky is the term used to with a larger range and higher describe some countries that try quality of other products, thus to eliminate trade and become improving their living standards. self-sufficient, aiming to produce This also improves division of most of what they consume. labor since in specialization, not Thus, they discover that it is the all can be teachers and/or road to stagnation. doctors, thus widening the range of employment opportunities. Money: The Lubricant of Exchange Not only labor can be specialized, The medium of exchange or the but also capital and land. means of payment in the form of currency and checks used to buy Trade things. In the same way individuals gain Easier than having to barter for from trade, countries do too. every good we need/want. Different countries specialize in different products, thus, again, Capital increasing the range and quality A durable output of the economy of consumption, raising each that is used for input e.g. textile country’s living standards to machines that are used to make some point or another. t-shirts. It has to be produced This trade increases the rate of first before used as an input. globalization. One example is This is usually owned by how American Apple’s iPod is individuals who profit from that “made in China”. Apple may have ownership, therefore bearing the ‘designed’ the iPod but its many name Capitalism. parts are produced all around the It involves time-consuming, world and are mainly assembled roundabout methods of in China. Therefore, the iPod is a production which is why great product of specialization producing capital requires us to and globalization through trade. sacrifice current consumption to  be able to produce more in the consumer is large/powerful enough future. to affect the market price. Ex. Stop handmade production of ❖ Homogeneity - commodities cannot textile to make textile machines be distinguished from one another, (a capital equipment) in order to i.e. there is no difference if you buy make more textile faster in the Apple or Cherry Mobile, they are one future. and the same. ❖ Perfect information C. THE VISIBLE HAND (GOV’T) ❖ Perfect mobility The 3 functions of the Government in Market Failures: Inefficiency a Market Economy: ❖ Imperfect competition/Monopoly 1. Increase efficiency by providing There is no competition; gives public goods, promoting producers too much power in competition (avoid monopoly), quantity produced and in hiking and by keeping externalities, like prices pollution, at bay. Only one producer of product A 2. Promote equity through tax and may make the supplier sell it at an expenditure programs to unreasonable price. redistribute income toward ❖ Externalities/Spillovers particular groups. The unintentional benefit, or harm 3. Foster macroeconomic stability in this case, of economic activities and growth — reducing inflation Smoking and pollution and unemployment while ❖ Public goods encouraging economic growth — Commodities which can be through fiscal (taxation and enjoyed by everyone and from spending) and monetary (interest which no one can be excluded. rates and credit conditions) A positive externality which is policy. [Could also be solved paid for by Taxes. through borrowing. Just make Since UP already enforces sure ROI is high] matriculation based on ❖ CORRUPTION is mostly why socioeconomic status, not government advances fail. excluding it from the ‘free tuition’ results in free-riding of those who EFFICIENCY are capable of paying and then Perfect Competition getting slots of those incapable to ❖ The ‘invisible hand’ is applied here. pay. ❖ Atomistic - a single unit; no firm or EQUITY ❖ Fiscal policies: focused more on ❖ Justice, fairness, and recognizing taxation and spending that we do not all start from the ❖ Monetary policies: focused more on same place and must acknowledge economic cash flow or how much and make adjustments to money is in the economy imbalances. Market Failure: Macroecon. Problems ❖ EFFICIENCY vs EQUITY ❖ Business cycles e.g. high inflation Efficient = maximized productivity and unemployment with limited resources (e.g. ❖ Slow economic growth dividing a 10M budget equally, no ❖ In a realistic modern market hassle, no waste). economy, not everything is smooth Equitable = fairness in how flowing, thus still needing resources are distributed (e.g. government intervention. dividing a 10M budget based on standing, more to the poor and THE MIXED ECONOMY TODAY less to the already rich). Drawing the right boundary between Market Failure: Inequality market and government is an enduring ❖ Not equal in income and wealth problem for societies. Economics is distribution indispensable in finding the golden The PH is 15th out of 63 countries mean between an efficient market and when ranking income inequality. publicly decided regulation and The top 1% (rich) contributes to redistribution. An efficient and humane 17% of national income while the society requires both halves of the bottom 50% (poor) only adds 14%. mixed system—market and government. The 4Ps program is not a dole out because it has a caveat and it capitalizes: giving money in exchange for sending more children to school. MACROECONOMIC GROWTH AND STABILITY ❖ Economic growth denotes the growth in a nation’s total output. ❖ Productivity is the output per unit input or the efficiency with which resources are used. ECONOMICS CHAP. THREE: The law of downward-sloping demand: shows the inverse Basic Elements of Supply relationship of price and demand. and Demand ○ The lower the price, the higher the demand. vv: the higher the A. DEMAND price, the lower the demand. THE DEMAND SCHEDULE How to: simply plot the points from Shows the relationship between the the demand schedule and then market price of a good and the draw a line/curve to connect them. quantity demanded of that good, Why the inverse relationship? other things held constant, through 1. Substitution Effect a table or a “schedule”. ○ When the price of a good rises, The market demand is found by the I’ll simply substitute it with other sum or simply adding together the similar goods. quantities demanded by all ○ Ex. If the price of Kellogs cereal individuals at each price. increases, I’ll simply buy Koko Krunch for a much cheaper cost. 2. Income Effect ○ When the price of a good rises, it takes more from my income, so I’ll just buy it less. ○ Ex. When gas prices go up, I’ll stop driving as often or as far, so as to save consumption and. THE DEMAND CURVE OTHER FACTORS THAT AFFECT THE DEMAND CURVE 1) Average income - income effect. 2) Population - the more the people, the more consumers there are. 3) Prices of related goods - low coffee prices increase demand for sugar 4) Tastes - status symbol, preferences 5) Special influence - I will buy a car because public transport is inefficient; or I will buy black coffee because milk tea is unhealthy Shifts in Demand THE SUPPLY CURVE ❖ When non-price factors affect the demand curve, it results in a shift in the curve. An upward sloping shows a ❖ More or less quantity is now positive relationship: the higher the demanded for the same price. price, the more suppliers are willing to produce. B. SUPPLY ○ Since producing more will entail more costs, a higher THE SUPPLY SCHEDULE selling price encourages more Shows the relationship between its suppliers to produce more. market price and the amount of How to: simply plot the points from that commodity that producers are the demand schedule and then willing to produce and sell, other draw a line/curve to connect them. things held constant, through a table or a “schedule” OTHER FACTORS THAT AFFECT THE SUPPLY CURVE 1) Technology - more efficiency results to lower production costs which increase supply 2) Input Prices - lower production costs (wages, etc.) increase supply 3) Prices of related goods - when truck prices fall, it may be less profitable for producers, so they opt to supply  more cars since they use the same Bra ₱₱ Qd Qs Market State Pressu re machinery in production. nd 4) Government policy - removing tariffs A 5 9 18 Surplus ⇩⇩⇩ on imported automobiles may prompt more supply. B 4 10 16 Surplus ⇩⇩⇩ 5) Special influences - online shopping C 3 12 12 Equilib — rium makes price comparing easier which could drive high-priced products D 2 15 7 Short ⇧⇧⇧ slowly lessen supply and eventually E 1 20 0 Shotr ⇧⇧⇧ close down business. This denotes that all supply and Shift in Supply demand orders are filled, the books When non-price factors affect the are “cleared” of orders, and supply curve, it results in a shift in demanders and suppliers are the curve. satisfied. More or less quantity is supplied at Gaps below and above equilibrium the same market price of the good. price represents the amount of shortage and surplus respectively. C. S AND D EQUILIBRIUM A market equilibrium a.k.a. A Effect of a Shift in S / D market-clearing price comes at the DEMAND: Positive relationship price at which quantity demanded equals quantity supplied.  Rise in demand → Curve shift to the right → Both eq. price and quantity increases ECONOMICS CHAP. FOUR: Fall in demand → Curve shift to the Elasticity and Applications left → Both eq. price and quantity decreases PRICE ELASTICITY ★ Responsiveness of quantity demand SUPPLY: Inverse to price, positive to / supply to a change in price. quantity ★ How much the quantity demanded / supplied of a good changes when its price changes. ★ Usually, price elasticities are higher for luxuries, goods with many substitutes, and when there is more time for decision while lower elasticities for necessities, goods with few substitutes, and shorter deciding time. Calculating Elasticities Rise in supply → Curve shift to the 𝑄2−𝑄1 right → Lower eq. prices, higher ∆𝑄 ( (𝑄1+𝑄2) ) 𝐴𝑣𝑒. 𝑄 ( ) quantity ∆𝑃 𝑜𝑟 2 𝑃2−𝑃1 Fall in supply → Curve shift to the 𝐴𝑣𝑒. 𝑃 ( (𝑄1+𝑄2) ) ( ) left → Higher eq. prices, lower 2 quantity * Total revenue = PxQ Price Elasticity in Diagrams Shortcut for Calculating Elasticity ELASTICITY AND REVENUE 1. When demand is price-elastic (greatly affects), a price decrease will increase total revenue. 2. When demand is price-inelastic (doesn’t affect much), a price decrease will reduce total revenue. 3. When demand is unit-elastic, a price decrease will have no effect on TR. In other words: 1. Elastic D = Price and TR have inverse relationship: price increase = low TR; price decrease = high TR 2. Inelastic D = Price and TR have a positive relationship : price increase = high TR; price decrease = low TR (Agriculture/Food are inelastic) ★ At point B, it is 3/1 (lower/upper) so the elasticity is 3; it is elastic because 3 > 1. ★ At point R, it is 1/3 (lower/upper) so the elasticity is 0.33; it is inelastic because 0.3 < 1. SUMMARY IMPACT OF A TAX ON PRICE AND QUANTITY 1.80 is the burden of consumers (from old eq.pr to new eq.pr) 0.20 is burden of the producer (from old eq.pr to the equivalent of new eq.pr to the old s-curve) ➔ If people need something no matter what (inel. demand), they Elastic → Ed > 1 → ΔQ > ΔP → ⇩P TR⇧ end up paying more of the tax. Inelastic → Ed < 1 → ΔQ < ΔP → ⇩P TR⇩ ➔ If sellers can’t make more of Unit → Ed = 1 → ΔQ = ΔP → ⇩P TR= something easily (inel. supply), SUPPLY ELASTICITY they end up paying more of the ❖ Elastic supply means producers can tax. easily increase the amount they ❖ Inelastic demand = consumer is supply when prices go up. mostly burdened of the tax ❖ Inelastic supply means producers ❖ Elastic demand = producer is mostly find it hard to increase supply, even burdened of the tax if prices rise. MINIMUM FLOOR AND MAXIMUM MARGINAL ANALYSIS: CEILINGS Rational Decision Making MARGINAL REASONING AND THE LOGIC OF DECISION MAKING “IS IT WORTHWHILE?” “WHERE WILL I GAIN THE MOST IF I SPEND THIS EFFORT?” “ALWAYS TAKE INTO ACCOUNT THE MARGINAL NET YIELD” 2 THEOREMS 1. Optimal Activity Level. How far should I push for this activity? Minimum floor - above E; you If the marginal benefit is equal to cannot sell at E, it should be higher. the marginal cost (zero marginal (can be seen in min. wages) net yield) that is the time to stop. MAXIMIZE until it reaches zero 2. Relative Activity Levels. What should I decide between choices? “Activities should be carried to levels where they all yield the same marginal benefit.” Reallocating resources from an activity with small marginal yield to a larger marginal return. Choose the BETTER OPTION in terms of marginal yield. Maximum ceiling - below E; you TOTALS, AVERAGES, AND cannot sell at E, it should be below. MARGINALS : THEIR ARITHMETIC (can be seen in price ceilings) RELATIONSHIPS 3. First Units. They are all equal As long as all 3 are 0 at the 0th u-  -nit, the total, average, and 6. Average X and Total curves. To marginal are identical at the first know the average profit at a point, unit simply draw a line that connects it to 4. Total and Marginal Relationship. the origin and find its slope: 𝑟𝑖𝑠𝑒 = 𝑦 𝑟𝑢𝑛 = 𝑥 Total is always the sum of all the Looking at Figure 1, simply draw preceding marginals. a line from 0 (origin) to A and Ex. 270 is the total at unit 3 with compute its slope : RA/0R preceding marginals unit 1 = 80, 7. ? Marginal X and Total curves. To unit 2 = 100, and unit 3 = 90. know the marginal profit at a point, 5. Relationship between Average and get the slope of a tangent line to Marginal. For the Average to rise, 𝑟𝑖𝑠𝑒 = 𝑦 that point. (still: ) the Marginal should be above the 𝑟𝑢𝑛 = 𝑥 Average figure and vv. Looking at Figure 1, the slope will Vv: for average to fall, the be CE/AC marginal should be below the average figure; for it to stay the MARGINAL AND AVERAGE X same, they should be equal. CURVES Ex. Marginal Average 1 = 1 2 ⇧ 1.5 3 ⇧ 2 1 ⇩ 1.75 GEOMETRY OF MARGINAL ANALYSIS: TOTAL X CURVES 8. Total x and Average curves: The total cost of any output OQ is the area of the rectangle inscribed under the cost curve which has OQ as its base. Looking at Figure 2, it is the area of rectangle OQ, QR, RS, SO Area: length x width (or OQ x RQ)  9. Total x and Marginal curve. The 11. General marginal and average total cost of producing OQ units of curves. Simply draw a tangent line any commodity is that portion of the to a given point and apply Rule # 10. area under the marginal cost curve Refer to Figure 4. which lies above line OQ. From the straight line’s end point, Looking at Figure 2, it is the area extend the line to the vertical of OQ that is no longer a axis. rectangle (OQ, QT, TC, CO) Draw any horizontal line from Simply get the sum of all the straight-line curve to vertical axis preceding marginals (Rule 4). and get the midpoint. Draw a vertical line from the extended point to the horizontal axis. Be sure to cross both the midpoint and the line perpendicular to the initial point. 10. Straight-line Marginal and Average curves. Deriving marginal from average, always remember Rule # 5 : “for average to ⇧, marginal must be ⇧ and vv.” From the straight line’s end point, extend the line to the vertical axis. Draw any horizontal line from straight-line curve to vertical axis and get the midpoint. Draw a vertical line from the extended point to the horizontal axis, crossing the midpoint.