Economics Final PDF

1. Opportunity Cost and Scarcity ◦ Opportunity Cost: Opportunity cost refers to the value of the next best alternative that is forgone when a decision is made to choose one option over another. It is the cost of the missed opportunity. ◦ Scar...

1. Opportunity Cost and Scarcity ◦ Opportunity Cost: Opportunity cost refers to the value of the next best alternative that is forgone when a decision is made to choose one option over another. It is the cost of the missed opportunity. ◦ Scarcity: Scarcity is the condition in which there are limited resources to meet unlimited wants. Opportunity cost is closely related to scarcity because every choice we make involves a trade-off between competing alternatives, given that resources are limited. 2. Production Possibility Frontier (PPF) ◦ A Production Possibility Frontier (PPF) shows the maximum combination of two goods that a country can produce using all of its available resources ef ciently. ◦ For a country that can either produce agricultural products or manufactured goods, the PPF would show the trade-off between the two. As more resources are allocated to the production of one good (say, manufactured goods), fewer resources are available to produce the other good (agricultural products). The PPF illustrates opportunity cost by showing how much of one good must be given up to increase the production of the other. ◦ Opportunity Cost and PPF: The slope of the PPF represents the opportunity cost. If the country moves along the PPF, producing more manufactured goods and fewer agricultural products, the opportunity cost of manufacturing increases, since resources that are better suited to agricultural production are being diverted to manufacturing. 3. Opportunity Cost and Manufactured Goods ◦ As more manufactured goods are produced, the opportunity cost increases because the resources being reallocated to manufacturing are likely less ef cient for this purpose (i.e., fewer agricultural goods are produced, which could have been made more ef ciently). This results in a higher cost for additional units of manufactured goods. 4. Price and Quantity Demanded / Price and Quantity Supplied ◦ Price and Quantity Demanded: There is an inverse relationship between price and quantity demanded, which means as the price of a good or service rises, the quantity demanded falls, and as the price decreases, the quantity demanded increases. This is known as the law of demand. ◦ Price and Quantity Supplied: There is a direct relationship between price and quantity supplied. As the price of a good or service rises, the quantity supplied increases, and as the price decreases, the quantity supplied decreases. This is known as the law of supply. 5. Market Equilibrium ◦ Market Equilibrium: Market equilibrium occurs when the quantity demanded equals the quantity supplied at a particular price, resulting in no shortage or surplus. ◦ Restoration of Equilibrium (Price Below Equilibrium): If the price is below the equilibrium price, there will be excess demand (a shortage), as consumers want more of the good than is available at the lower price. To restore equilibrium, suppliers will 1 fi fi fi  raise the price, which reduces demand and increases supply until the market reaches the equilibrium price and quantity. 6. Effects of a Minimum Price (Above Market Equilibrium) ◦ When a minimum price is set above the market equilibrium (e.g., a price oor for agricultural products), it leads to a surplus. At the higher price, the quantity supplied exceeds the quantity demanded, resulting in excess supply (a surplus of cereals). This may lead to wasted resources or government intervention to purchase the surplus. 7. Shift in Consumer Preferences (Electric Cars) ◦ If there is a shift in consumer preferences towards electric cars, the demand for electric cars will increase, shifting the demand curve to the right. As a result, the equilibrium price will increase, and the equilibrium quantity will also increase as suppliers respond to the higher demand. 8. Increase in Hotel Workers' Wages ◦ An increase in hotel workers’ wages increases the cost of production for hotels, which would cause the supply curve to shift to the left. As a result, the equilibrium price of hotel accommodations would rise, and the equilibrium quantity would decrease, as fewer hotel rooms would be supplied at the higher price. 9. Price Elasticity of Demand (PED) ◦ Price Elasticity of Demand refers to the responsiveness of the quantity demanded of a good to a change in its price. ◦ Calculation: It is calculated as the percentage change in quantity demanded divided by the percentage change in price. Mathematically, it is expressed as:—— Firm’s Supply Decision in the Short Run Total Product (TP): The total quantity of output produced by a rm with a given amount of input. Average Product (AP): The average amount of output produced per unit of input, calculated by dividing the total product by the number of inputs used (usually labor). Marginal Product (MP): The additional output produced when one more unit of input is added, keeping all other factors constant. 2 fi fl  Law of Diminishing Marginal Returns The Law of Diminishing Marginal Returns states that as a rm increases the number of workers (or units of a variable input), holding all other inputs constant (like capital or machinery), the marginal product of labor initially rises but eventually decreases. For example, if a rm adds more workers to a xed amount of machinery, each additional worker might initially increase output signi cantly. However, after a certain point, adding more workers leads to a smaller increase in output as workers start to crowd each other or lack the necessary tools, which decreases ef ciency. Firm’s Marginal Cost (MC) Marginal Cost: Marginal cost is the change in total cost that results from producing one more unit of output. Connection between Marginal Product and Marginal Cost: The marginal product of labor and marginal cost are inversely related. When the marginal product of labor is increasing (workers are more productive), the marginal cost decreases because each additional worker is producing more output at a lower cost. When the marginal product of labor starts to decrease (due to diminishing returns), the marginal cost increases because more inputs are required to produce each additional unit of output. 5. Short Run vs Long Run for a Firm’s Supply Decision Short Run: In the short run, at least one factor of production (such as capital) is xed, and rms can only adjust the variable factors (e.g., labor). The rm faces constraints in adjusting its production capacity. Long Run: In the long run, all factors of production are variable. Firms can adjust both labor and capital and enter or exit the industry, allowing for more exibility in production decisions. Economies and Diseconomies of Scale Economies of Scale: Economies of scale occur when a rm’s average total cost (ATC) decreases as it increases the scale of its production. This can happen due to factors like specialization, mass production, and more ef cient use of resources. ◦ Example: A car manufacturer may reduce per-unit costs by producing cars in bulk, leading to lower average costs as production scales up. Diseconomies of Scale: Diseconomies of scale occur when a rm’s average total cost increases as it increases production. This can result from factors such as inef ciency, poor management, or logistical problems in larger rms. 3 fi fi fi fi fi fi fi fi fi fi fi fl fi fi  ◦ Example: A large company might face communication problems, slower decision- making, or reduced employee morale, which leads to higher costs. Effect on Long-Run Average Total Cost: As a rm grows, economies of scale cause the long-run average total cost to fall initially. However, after reaching a certain scale, diseconomies of scale cause the long-run average total cost to rise. Firm's Minimum Ef ciency Scale (MES) Minimum Ef ciency Scale (MES) refers to the smallest level of output at which a rm can achieve the lowest average total cost. It marks the point at which economies of scale are fully realized and where the rm operates most ef ciently. 6. Perfect Competition vs Monopoly Perfect Competition: ◦ Number of Firms: Many rms, all producing identical products. ◦ Product Characteristics: Homogeneous (identical products with no differentiation). ◦ Barriers to Entry: Low or none; rms can freely enter or exit the market. Monopoly: ◦ Number of Firms: A single rm controls the entire market. ◦ Product Characteristics: Unique product with no close substitutes. ◦ Barriers to Entry: High; signi cant barriers like patents, government regulation, or control over resources prevent new rms from entering. Normal vs Supernormal Pro ts Normal Pro ts: The level of pro t that allows a rm to cover its costs, including opportunity costs. It is the minimum pro t needed for a rm to remain in business in the long run. Supernormal Pro ts: Pro ts that exceed normal pro ts, occurring when a rm earns more than it would in a perfectly competitive market. These pro ts are above the normal pro t level and occur due to market power, like in a monopoly. Perfect Competition and Monopoly in the Short and Long Run Perfect Competition: ◦ In the short run, rms can make supernormal pro ts due to high demand or low competition. However, in the long run, new rms enter the market, increasing supply, which drives prices down, and the rms end up earning only normal pro ts. Monopoly: ◦ A monopoly can make supernormal pro ts in both the short and long run due to barriers to entry that prevent other rms from entering the market and driving down prices. ——————————————— 4 fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi 1. Production Possibility Frontier (PPF) PPF for Clothing and Electronics: The production possibility frontier (PPF) shows the maximum combinations of two goods (in this case, clothing and electronics) that a country can produce given its resources and technology. The curve is typically downward sloping and concave because resources are scarce and not perfectly adaptable to the production of both goods. The country must allocate its limited resources (like labor, capital, and raw materials) between the two goods, and as more resources are allocated to one good, fewer resources are available for the other. Scarcity and Opportunity Cost: The PPF re ects the problem of scarcity, where the country must make choices about how to allocate its limited resources. The opportunity cost of producing more of one good is the amount of the other good that must be sacri ced. The PPF illustrates this trade-off, as the movement along the curve shows how increasing the production of one good comes at the expense of reducing the production of the other. Opportunity Cost as More Clothing is Produced Opportunity Cost and Clothing Production: As more clothing is produced, the opportunity cost increases. This is due to the law of diminishing returns, where initially, resources (like labor or land) are more ef cient in producing clothing, but as more resources are allocated to clothing production, those resources are likely less ef cient (since they are less suited to clothing production). As a result, the country has to give up more and more electronics to produce each additional unit of clothing. PPF in Economic Recession and Capital Investment Economic Recession with High Unemployment: In the case of an economic recession with high unemployment, the economy operates inside the PPF curve. This means that the country is not fully utilizing its resources (labor and capital), and there is idle capacity. The production point would be below the PPF, indicating inef ciency. Increase in Capital Investment: An increase in capital investment leads to higher productivity, which shifts the PPF outward. With more or better capital (machinery, technology), the country can produce more of both clothing and electronics, increasing its production capacity and ef ciency. 2. Market Equilibrium Market Equilibrium: Market equilibrium occurs when the quantity demanded equals the quantity supplied at a speci c price. At this point, there is neither a surplus nor a shortage of the good in the market, and the market is in a stable state. Restoration of Equilibrium if Price is Above Equilibrium: If the price is above equilibrium, there will be excess supply (a surplus), because suppliers are willing to produce more at the higher price, but consumers will demand less. To restore equilibrium, the price will fall. As the price drops, the quantity demanded increases, and the quantity supplied decreases, until the market reaches the equilibrium price and quantity. 5 fi fi fi fl fi fi fi  Price Elasticity of Demand De nition of Price Elasticity of Demand (PED): Price elasticity of demand measures the responsiveness of the quantity demanded of a good to a change in its price. ◦ Formula: ◦ If PED > 1, demand is elastic (consumers are very responsive to price changes). ◦ If PED < 1, demand is inelastic (consumers are less responsive to price changes). Cigarette Demand and Tax Impact Price Elasticity of Demand for Cigarettes: Cigarettes generally have price inelastic demand because they are a habit-forming product and there are few substitutes. This means that even if the price increases, the quantity demanded does not decrease signi cantly. Effect of EU-Wide Tax on Cigarettes: A new tax on cigarettes would increase the price, and because demand is inelastic, the quantity demanded will not decrease much. As a result, the government will collect higher revenue from the tax due to the smaller reduction in quantity demanded. The total revenue from cigarettes will increase because the higher price compensates for the slight reduction in quantity sold. 3. Demand-Supply Framework in the Rental Market Increase in Population and Market Equilibrium: An increase in Malta's population due to higher in ows of migrant workers will lead to an increase in demand for rental properties. This shift in the demand curve to the right results in a higher equilibrium price (higher rent) and a higher equilibrium quantity (more rentals rented). Other Factors Increasing Demand for Rented Properties: Besides population growth, factors like an increase in average income or government policies promoting rental housing can also increase the demand for rented properties. This would shift the demand curve to the right, increasing both the equilibrium price and quantity. Effect of Rent Ceiling (Maximum Rent Below Equilibrium): A rent ceiling set below the equilibrium price creates a shortage in the rental market. At the lower price, more people want to rent, but fewer landlords are willing to supply rental properties. This leads to a situation where demand exceeds supply, and there is not enough housing to meet the demand, causing inef ciency in the market. 4. Short Run vs Long Run for a Firm's Supply Decisions Short Run: In the short run, at least one factor of production (like capital or machinery) is xed, so the rm can only adjust variable inputs (like labor) to change its output. The rm has limited exibility in production decisions. 6 fi fi fl fl fi fi fi fi  Long Run: In the long run, all factors of production are variable. Firms can adjust both labor and capital, and new rms can enter or exit the market. Firms have more exibility in adjusting to changes in market conditions. Firm's Marginal Product and the Law of Diminishing Marginal Returns Marginal Product: Marginal product is the additional output produced by one more unit of input (typically labor), holding other inputs constant. Law of Diminishing Marginal Returns: As a rm increases its labor input (hiring more workers), holding capital constant, the marginal product initially increases but eventually begins to decrease. This happens because, with more workers and a xed amount of capital, workers have less equipment or space to work with, reducing their productivity. Firm's Marginal Cost and Relationship with Marginal Product Marginal Cost (MC): Marginal cost is the additional cost incurred by producing one more unit of output. It is calculated as the change in total cost divided by the change in output. Change in Marginal Cost in the Short Run: As a rm increases output in the short run, its marginal cost initially decreases (as marginal product increases), but after a certain point, marginal cost rises (due to diminishing marginal returns). When marginal product falls, the rm needs to use more labor or resources to produce each additional unit, driving up marginal costs. Relationship Between Marginal Product and Marginal Cost: There is an inverse relationship between marginal product and marginal cost. When marginal product is high, marginal cost is low, and vice versa. This re ects the increased ef ciency of production when labor is more productive and the increased cost when labor becomes less productive. Long Run Average Total Costs, Economies and Diseconomies of Scale Long Run Average Total Cost (LRATC): The long-run average total cost is the per-unit cost of production when all inputs are variable and the rm has had suf cient time to adjust all factors of production. It is represented by the cost curve that shows the lowest possible cost for producing any level of output when a rm has had time to adjust its production capacity. Economies of Scale: Economies of scale refer to the cost advantages that a rm experiences as it increases its scale of production. As the rm grows larger and produces more, it can spread its xed costs over more units of output, leading to a decrease in average total costs. Economies of scale result in more ef cient production, greater specialization, and the ability to negotiate lower prices for inputs. ◦ Example of Economies of Scale: A large car manufacturer might reduce the average cost per car by purchasing raw materials in bulk or using specialized machinery that increases ef ciency. These cost savings are spread across a larger number of cars produced, lowering the overall cost per unit. 7 fi fi fi fi fl fi fi fi fi fi fi fi fi fi fi fl  Diseconomies of Scale: Diseconomies of scale occur when a rm becomes too large, leading to inef ciencies that increase the cost per unit of production. As rms expand beyond a certain point, factors like management dif culties, communication breakdowns, and less ef cient use of resources may lead to higher costs. ◦ Example of Diseconomies of Scale: A multinational company with operations in many countries might face inef ciencies in management and coordination. As the company grows, it may struggle with bureaucracy and poor communication, leading to higher operational costs. Impact on LRATC: ◦ Economies of scale cause the LRATC curve to slope downward, re ecting decreasing costs as output increases. ◦ Diseconomies of scale cause the LRATC curve to slope upward at higher levels of output, re ecting the rising per-unit cost as the rm becomes too large to manage ef ciently. Minimum Ef cient Scale (MES) Minimum Ef cient Scale (MES): The minimum ef cient scale refers to the smallest output level at which a rm can achieve the lowest possible long-run average total cost. It represents the point where the rm has fully exploited economies of scale, and beyond this point, increasing production does not result in lower costs. Impact on Market Structure: The MES can affect the market structure by in uencing the number of rms in the market. In industries where the MES is large (i.e., rms must be large to achieve low costs), there may be fewer rms because only larger rms can compete effectively. This can lead to a more concentrated market, potentially dominated by a few large rms or even a monopoly. ◦ Example: In industries like automobile manufacturing, the MES is large, requiring signi cant capital investment and economies of scale to compete. As a result, the market may be dominated by a few large rms, such as Ford or Toyota, with high barriers to entry for new competitors. 6. Perfect Competition vs Monopoly Perfect Competition: ◦ Number of Firms: Many rms, each producing a small share of the market output. ◦ Nature of the Product: Homogeneous products, meaning there is no differentiation between the products offered by different rms. ◦ Barriers to Entry: Low or nonexistent; rms can freely enter or exit the market. ◦ Example of Perfect Competition: The market for agricultural products like wheat or corn is often considered an example of perfect competition. Each rm produces identical products, and there are many small rms with no signi cant barriers to entry. Monopoly: 8 fi fi fi fl fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi fl fi fi fl  ◦ Number of Firms: Only one rm controls the entire market and is the sole provider of the good or service. ◦ Nature of the Product: Unique product with no close substitutes, which gives the monopoly rm signi cant market power. ◦ Barriers to Entry: High barriers, such as government regulation, control over essential resources, or high capital requirements, prevent new rms from entering the market. ◦ Example of Monopoly: Microsoft was historically considered a monopoly in the operating system market for personal computers due to its control over the Windows operating system. Few competitors were able to enter the market due to the high barriers related to network effects and software development costs. 9 fi fi fi fi