ECON 110 Notes PDF

Micro Economics Notes Highlighted = Terms to Know EXAM 1 will mainly be about Supply and Demand CHAPTER 1 -​ Scarcity: the limited nature of society’s resources -​ Economics: the study of how society manages its scarce resources -​ How people decide what to buy, how much to wor...

Micro Economics Notes Highlighted = Terms to Know EXAM 1 will mainly be about Supply and Demand CHAPTER 1 -​ Scarcity: the limited nature of society’s resources -​ Economics: the study of how society manages its scarce resources -​ How people decide what to buy, how much to work, save, and spend -​ How firms decide how much to produce, how many workers to hire How people make decisions: Principle #1: People Face Tradeoffs -​ All decisions involve tradeoffs -​ Examples: -​ Going to a party the night before your midterm leaves less time for studying -​ Having more money to buy stuff requires working longer hours, which leaves less time for leisure. -​ Society faces an important tradeoff: -​ Efficiency vs. Equality -​ Efficiency: when society gets the most from its scare resources -​ Equality: When prosperity is distributed uniformly among society’s members -​ Tradeoff = To achieve greater equality, could redistribute income from the wealthy to the poor. But this reduces the incentive to work and produce, shrinks the size of the economic “pie” Principle #2: The Cost of Something Is What You Give Up to Get It -​ Making decisions requires comparing the costs and benefits of alternative choices -​ The opportunity cost of any item is whatever must be given up to obtain it. -​ It is the relevant cost for decision-making. -​ Example: The opportunity cost of … Going to college for a year is not just the tuition, books, and fees Principle #3: Rational People Think at the Margin -​ Rational people -​ Systemically and purposefully do the best they can to achieve their objectives -​ Make decisions by evaluating costs and benefits of Marginal Changes - incremental adjustments to an existing plan -​ Example: When a manager considers whether to increase output, she compares the cost of the needed labor and materials to the extra revenue Principle #4: People Respond to Incentives -​ Incentive: Something that induces a person to act, i.e. the prospect of a reward or punishment -​ Rational people respond to incentives Principle #5: Trade Can Make Everyone Better Off -​ Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. -​ Countries also benefit from trade & specialization -​ Get a better price abroad for goods they produce -​ Buy other goods more cheaply from abroad than could be produced at home -​ Specializing = doing what you do best Principle #6: Markets Are Usually A Good Way to Organize Economic Activity -​ Market: a group of buyers and sellers (need not be in a single location) -​ A market economy allocates resources through the decisions of many households and firms as they interact in markets (Supply & Demand) -​ The invisible hand works through the price system: -​ Adam Smith - Author of “The Wealth of Nations” (the bible of economics) “Created the Invisible hand theory” -​ The interaction of buyers and sellers determine the prices - Supply and demand determines the price -​ Each Price reflects the good’s value to buyers and the cost of producing the good. -​ Willingness to Pay (WTP) -​ Prices guide self-interested households and firms to make decisions that, in many cases, maximize society’s economic well-being. Principle #7: Governments Can Sometimes Improve Market Outcomes -​ An important role for govt: enforce property rights (with police, courts) -​ People are less inclined to work, produce, invest, or purchase if large risk of their property being stolen -​ Market Failure: when the market fails to allocate society’s resources efficiently -​ Causes: -​ Externalities: when the production or consumption of a good affects bystanders (e.g. pollution) -​ Market Power: a single buyer or seller has a substantial influence on market price (e.g. monopoly) -​ Govt may alter market outcome to promote equity -​ If the market’s distribution of economic well-being is not desirable, tax or welfare policies can change how the economic “pie” is divided (8,9,10 = Macro-Economics) Principle #8: A country’s standard of living depends on its ability to produce goods & services. -​ The most important determinant of living standards: productivity, the amount of goods and services produced per unit of labor. -​ Productivity depends on the equipment, skills and technology available to workers. Principle #9: Prices rise when the government prints too much money -​ Inflation: increases in the general level of prices Principle #10: Society faces a short-run tradeoff between inflation and unemployment -​ In the short run (1-2 years) many economic policies push infllation CHAPTER 2 Assumptions & Models -​ Model: a highly simplified representation of a more complicated reality. -​ Economists use models to study economic issues. First Model: The Circular-Flow Diagram: -​ A visual model of the economy shows how dollars flow through markets among households and firms. -​ Two markets: -​ The market for goods and services -​ The market for “factors of production” - inputs -​ The resources the economy uses to produce goods & services, including: -​ Labor - people -​ Land - natural resources -​ Capital (buildings & machines used in production) - tech -​ Entrepreneurship - idea -​ Households: -​ Firms: -​ Buy/hire factors of production, use them to produce goods and services -​ Sell goods & services -​ Markets for Factors of Production: -​ The firms are the buyers in the market for factors of production -​ Wages, rent, interest, profit Second Model: The Production Possibilities Frontier: (PPF)  -​ A graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology -​ Recall: The opportunity cost of an item is what must be given up to obtain that item -​ Moving along a PPF involves shifting resources (e.g. labor) from the production of one good to the other -​ Society faces a tradeoff: Getting more of one good requires sacrificing some of the other The Shape of the PPF (on a graph) -​ The PPF could be a straight line, or bow-shaped -​ Depends on what happens to opportunity cost as economy shifts resources from one industry to the other. -​ If opp. Cost remains constant, PPF is a straight line. Essentially the same resources are equally useful for producing in either industry (Coke and Pepsi use the same ingredients/resources) -​ If opp. Cost of a good rises as the economy produces more of the good, PPF is bow-shaped. Essentially, the resources are specialized and not easily adaptable for producing in either industry. (same resources are not used) -​ Whenever technology has advances or additional resources are obtained, it makes production more efficient -​ When the graph is bow shaped: -​ When two goods use different resources for production (ex:beer & mountain bikes) -​ 1. If a point is at top or bottom of the bow shaped line, it is efficient. - If its under the line, its inefficient -​ 2. If the point is above the line, it is currently unattainable -​ PPF is bow-shaped when different workers have different skills, different opportunity costs of producing one good in terms of the other Microeconomics: the study of how households and firms make decisions and how they interact in markets (the smaller picture) Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic grown (the bigger picture) Positive statement: something that can be proven as a fact Normative statements: an opinion that describes the world as it should be. People may think these are true, but they are opinions. CHAPTER 3 Comparative Advantage: -​ Produce a good - lower opportunity cost than another producer -​ Reflects - relative opportunity cost ★Comparative advantage is based on opportunity cost -​ Principle of Comparative Advantage -​ Each good - produced by the individual that has the smaller opportunity cost of producing that good Absolute advantage: -​ Produce a good using fewer inputs than another producer Opportunity cost: -​ Whatever must be given up to obtain some item -​ Measures the trade-off between the two goods that each producer faces -​ How to Solve for Opportunity Cost: -​ You have to write down the opportunity cost for each item and each state FOUR TIMES! -​ Look “C” on the first page of the worksheet linked below -​ Whatever you are trying to find the opportunity cost of - it goes on the bottom of the fraction! (look at multiple choice section on worksheet below) David Recardo = The Father of Comparative Advantage -​ One person: -​ CAN have absolute advantage in both goods -​ CANNOT have comparative advantage in both goods -​ READ “D” on the first page of the worksheet below to understand -​ Opportunity cost of one good -​ Inverse of the opportunity cost of the other -​ Gains from specialization and trade -​ Based on comparative advantage -​ Total production in economy rises -​ Increase in the size of the economic pie -​ Everyone - better off Practice Examples: Comparative & Absolute Advantage Worksheets II Answers.pdf *Remember exam is multiple choice - you will not need to draw graphs! -​ Trade can benefit everyone in society -​ Allows people to specialize in activities -​ Have a comparative advantage -​ The price of trade “terms of trade” -​ Must lie between the two opportunity cost  -​ Principle of comparative advantage explains -​ Interdependence -​ Gains from trade Should the U.S. trade with other countries? YES CHAPTER 4 Demand -​ The quantity demanded (QD) of any good is the amount of the good that buyers are willing and able to purchase at a specific price. QD is a point on the demand curve. -​ The demand curve is a set of various quantities demanded (QD) at corresponding prices. It is the curve itself. -​ Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal -​ Demand schedule is a table that shows the relationship between the price of a good and the quantity demanded Demand Curve Shifters: (graphs on blackboard under Learning Module 1) -​ The demand curve shows how price affects quantity demanded, other things being equal. A change in the price of the good changes QD and results in a movement along the D curve. -​ If the price of the good itself is changing, you move along the curve -​ These "other things" are non-price determinants of demand (ie., things that determine buyers' demand for a good, other than the good's price). -​ Changes in them shift the D curve... -​ Increase in # of buyers increases the quantity demanded at each price, shifts D curve to the right. -​ Ex: Game day - all tailgate products shifts to the right (coolers, paper plates, etc.) -​ Income: -​ 2 sub-categories for income -​ Demand for a Normal Good is positively related to income. -​ An increase in quantity demanded at each price, shifts D curve to the right. -​ Demand for an Inferior Good is negatively related to income. -​ Increased income shifts D curves to the left.  -​ Prices of Related Goods -​ Two goods are substitutes if an increase in the price of one causes an increase in demand for the other. -​ Ex. of substitutes: Colgate vs Crest, Coke vs Pepsi, Chevy vs Ford. -​ An increase in the demand for one will create an increase in the price for the other and vice-versa. -​ Substitutes move in the same direction. -​ Two goods are complements if an increase in the price of one causes a fall in demand for the other. -​ Ex. of complements: College tuition and textbooks, cereal and milk. -​ Ex: Computers and software - if prices of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left. -​ Compliments move in the opposite direction. -​ Tastes -​ Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right. -​ Ex: Because many people quarantined at home during the pandemic, there was an increase in demand for Netflix, Disney+, and other online streaming services and entertainment, etc. -​ Expectations -​ Expectations affect consumers’ buying decisions. -​ Ex: if people expect shortages because of the COVID 19 pandemic, the demand for toilet paper, sanitizer, cleaning supples, will increase now. All of these shift the D curve. Supply -​ The quantity supplied (QS) of any good is the amount that sellers are willing and able to sell a specific price. QS is a point on the supply curve. -​ The Supply Curve (SC) is a set of various quantities supplied (QS) at corresponding prices. -​ Law of Supply: The claim that the quantity supplied of a good rises when the price of the good rises (same direction) -​ ★Price is an incentive for a producer to make more products -​ Supply Schedule: A table that shows the relationship between the price of a good and the quantity supplied -​ Price always goes on the verticle axis and quantity always goes on the horizontal Supply Curve Shifters -​ Input Prices: -​ Ex: wages, prices of raw materials, -​ Lack of oil = lack of gasoline, lack of chickens = lack of eggs -​ If the price of milk falls, at each price, the quantity of lattes supplied will increase. -​ A fall in input prices makes production more profitable at each output price, so firms, supply a larger quantity at each price, and the S curve shifts to the right. -​ Technology: -​ Technology determines how much inputs are required to produce a unit of output. -​ A cost-saving technological improvements has the same effect as a fall in input prices, shifts S curve to the right. -​ Ex: US was not a big oil producer until the technological advancement of fracking - the US then became an exporter. -​ # of Sellers -​ An increase in the number of sellers increases the quantity supplied at each price, shifts S curve to the right -​ Expectations: -​ Only determinate that effects both supply and demand -​ In general, sellers may adjust supply when their expectations of future prices change. -​ S curve shifts to the left -​ Ex: if people expect shortages because of the COVID 19 pandemic, the demand for toilet paper, sanitizer, cleaning supples, will increase now. -​ Equilibrium: -​ Look at slides on blackboard -​ Surplus: (excess supply) -​ On a graph, a supply is above the equalibrium -​ When quantity supplied is greater than quantity demanded -​ Shortage: -​ Shortage is below the equilibrium -​ When quantity demanded is greater than quantity supplied STUDY FOR TEST: Terms for Shift vs Movement along the Curve: -​ Change in supply: a shift in the S curve occurs when a non-price determinant of supply changes (like technology or costs) -​ Change in the quantity supplied: a movement along a fixed S curve occurs when P changes -​ Change in demand: a shift in the D curve occurs when a non-price determinant of demand changes (like income or # of buyers) -​ Change in the quantity demanded: a movement along a fixed D curve occurs when P changes