Microeconomics-2ALM Midterms PDF

Microeconomics Lourdes Ordoña | Midterms | 2ALM Chapter 1: Resource Utilization Example: You spend time and money going to a movie, you cannot spend that time at home read...

Microeconomics Lourdes Ordoña | Midterms | 2ALM Chapter 1: Resource Utilization Example: You spend time and money going to a movie, you cannot spend that time at home reading a book, WHAT IS ECONOMICS? and you can't spend the money on something else. Definition 3 Es in Economics the study of how society manages its scarce resources 1. Efficiency – productivity and proper allocation of A science that deals with the management of scarce economic resources; Society getting the most it can from resources. It is also described as a scientific study on how its scarce resources. Size of the economic pie (Doing individuals and the society generally make choices. things right) The two Greek roots of the word economics are oikos – 2. Equity – fairness; Distributing economic prosperity meaning household – and nomus – meaning system or uniformly among the members of society. How the pie is management. Oikonomia or oikonomus therefore divided into individual slices. means the “management of household.” 3. Effectiveness - means attainment of goals and e.g. how people decide what to buy, how much to work, objectives; Doing the right things save, and spend. how firms decide how much to produce, how many workers to hire, how society decides how to POSITIVE AND NORMATIVE ECONOMICS divide its resources between national defense, consumer Positive economics goods, protecting the environment, and other needs is an economic analysis that considers economic conditions “as they are” or considers economics “as it Scarcity is”. It uses objective or scientific explanation in analyzing The basic and central economic problem confronting the different transactions in the economy. It simply every society. answers that question ‘what is.’ It is also “limited resources in Demand.” Positive economics is based on fact and cannot be The heart of the study of economics, and the reason approved or disapproved, while normative economics is behind its reality. based on value judgments. Gold, oil, silver, titanium, coal and diamonds and other non-physical goods such as labor can all be considered Normative economics a scarce resource. Limited resources are basically those is economic analysis which judges economic conditions resources that take a relatively long time to replenish. Oil, “as it should be”. It is that aspect of economics that is agricultural soil, and electricity are just some examples concerned with human welfare. It deals with ethics, of the scarce resources in the Philippines. personal value judgments and obligations analyzing economic phenomena. It answers the question ‘what Factors of Production should be’. 1. Land – i.e Rent Normative economics focuses on the value of 2. Labor – i.e Salary/ Wages economic fairness, or what the economy "should be" or 3. Capital – i.e Interest "ought to be.“ 4. Entrepreneurship – i.e Profit Ceteris Paribus Assumption The Circular Flow Model The assumption of “Ceteris Paribus” is important in The circular flow model demonstrates how money studying economics. Ceteris paribus means “all other moves through society. Money flows from producers to things held constant or all else equal.” workers as wages and flows back to producers as payment for products. In short, an economy is an endless circular TWO MAJOR BRANCHES flow of money Microeconomics Deals with the individual decisions of units of the economy—firms and households, and how their choices determine relative prices of goods and factors of production. Consumer equilibrium, individual income and savings are examples of microeconomics. Macroeconomics Studies the relationship among broad economic aggregates like national income, national output, money supply, bank deposits, total volume of savings, investment, consumption expenditure, general price level of commodities, government spending, inflation, recession, and employment. Unemployment, interest rates, inflation, GDP, all fall into Macroeconomics. TYPES OF ECONOMIC SYSTEMS [Fig. 1.1] The Circular Flow Model Traditional Economy It is basically a subsistence economy. A family produces The Concept of Opportunity Cost goods only for its own consumption. Opportunity cost refers to the foregone value of the Traditional economies may be based on custom and next best alternative. It is the value of what is given-up tradition, with economic decisions based on customs or when one makes a choice. The thing thus given-up is beliefs of the community, family, clan, or tribe. Bhutan called the opportunity cost of one’s choice. and Haiti When one makes choices, there is always an alternative that has to be given up. A producer, who Command Economy decides to produce shoes, gives up other goods that he It is a type of economy, wherein the manner of could have produced using the same resources. A production is dictated by the government. The student, who buys a book with his limited allowance, government decides on what, how, how much, and for gives up the chance of eating out or watching movie. whom to produce. 1 Microeconomics Lourdes Ordoña | Midterms | 2ALM China, Iraq, Belarus, Russia, Libya, North Korea, and the former Soviet Union are examples of countries that John Maynard Keynes have command economies. Since decision-making is An English economist who offered an explanation of mass centralized the government controls all of the supply and unemployment and suggestions for government policy to sets all of the demand. cure unemployment in his influential book: The General Theory of Employment, Interest and Money (1936). Market Economy or capitalism’s basic characteristic is that the Non-Walrasian Economics (1939) resources are privately owned, and that the people themselves make the decisions. It is an economic John Hicks system wherein most economic decisions and means of was recognized for his analysis of the IS–LM model, which production are made by the private owners. is an important macroeconomic model. IS refers to the The United States, England, and Japan are all examples goods market for a given interest rate, while LM means of market economies. money market for a given value of aggregate output or income. Socialism It is an economic system wherein key enterprises are Post-Keynesian Economics (1940 and 1950s) owned by the state. In this system, private ownership is recognized. This period welcomed various economists like Paul A. Socialism is an economic and political system where the Samuelson, Kenneth J. Arrow, James Tobin and Lawrence community or state owns the general means of Klein, to mention some recognized leaders; and others are production (i. e. farms, factories, tools, and raw Joan Robinson; and Michael Kolechi. Another stream of materials.) Ex. Vietnam, Sri Lanka, Bangladesh, Nepal thought was introduced by liberal market post-Keynesians, mainly the monetarists, led by Milton Friedman. Mixed Economy This economy is a mixture of market system and the New Classical Economics command system. The Philippine economy is described as a mixed economy since it applies a mixture This development in economics is applicable to concerns of of three forms of decision-making. developing countries and was largely an outcome of concern A mixed economy consists of both private and for the growth of developed countries. The great economists government/state-owned entities that share control of like Smith, Ricardo and Malthus addressed this problem. owning, making, selling, and exchanging good in the country. Two examples of mixed economies are the U.S. Chapter 2: Basic Analysis of Supply and Iceland, Sweden, UK, and France. Russia, China Demand BRIEF HISTORY: CLASSICAL, KEYNESIAN, AND MODERN THE MARKET ECONOMICS Where buyers and sellers meet. The place where buyers and sellers trade or exchange Birth of Economic Theory: Classical Economics goods or services - it is where their transaction takes place 1723-1790: Adam Smith Markets can be physical like a retail outlet, or virtual like He is considered the most important personality in the an e-retailer. Other examples include the black market, history of economics—being regarded as the “Father of auction markets, and financial markets. Economics”. He was responsible for the recognition of economics as a DEMAND separate body of knowledge. His book, “Wealth of the What is Demand? Nations”, published in 1776, became known as “the bible Pertains to the quantity of a good or service that in economics” for a hundred years. people are ready and willing to buy at given prices One of his major contributions was his analysis of the within a given time, when other factors besides price relationship between consumers and producers through are held constant. demand and supply, which ultimately explained how the refers to consumer’s desire to purchase goods and market works through the invisible hand. services and willingness to pay a price for the specific good or service. David Ricardo Let’s give Real Life examples for better understanding: He developed the basic analysis of the political 2020 has been rocked by the arrival of coronavirus, economy or the importance of a state’s role in its starting in Wuhan China. People in China and in national economy. neighboring countries have become desperate to protect themselves from the transmission of the virus Karl Marx and that has led to an increased demand for face mask. A German, who is influenced by the conditions brought Another example; Public is increasingly interested in about by the industrial revolution upon the working turning toward natural sweeteners like honey over the classes. His major work, Das Kapital, is the centerpiece cane sugar. from which major socialist thought was to emerge. Demand therefore implies three things: Neoclassical Economics (1870s) 1. desire to possess a thing; 2. the ability to pay for it or means of purchasing it; and Leon Walras, who introduced the general economic system, 3. willingness in utilizing it. and Alfred Marshall, who became the most influential economist during that time because of his book Principles in The Law of Demand Economics. If price goes UP, the quantity demanded will go DOWN. Conversely, if price goes DOWN, the quantity demanded will go UP ceteris paribus. PRICE QUANTITY DEMANDED Demand Schedule Keynes’ General Theory of Employment, Interest and Money 2 Microeconomics Lourdes Ordoña | Midterms | 2ALM A demand schedule is a table that shows the relationship between prices and the specific quantities demanded at each of these prices [Fig. 2.3] Change in Quantity Demanded [Fig. 2.1] Demand Schedule Table Forces that cause the demand curve to change: Taste or preferences Demand Schedule Formula Changing incomes 𝑄 −𝑄 Occasional or seasonal products 𝑄𝐷 = 𝑃 2 − 𝑃1 Population change 2 1 Substitute goods Expectations of future prices The demand curve is a graphical representation showing the relationship between price and quantities demanded per time SUPPLY period. What is Supply? The quantity of goods or services that firms are ready and willing to sell at a given price within a period of time, other factors being held constant. It is the quantity of goods or services which a firm is willing to sell at a given price, at given point in time. Thus, supply is a product made available for sale by firms. It should be remembered that sellers normally sell more at a higher price than at a lower price. Willingness and ability of producers to create goods and services to take them to market. Amount of goods that are available. Law of Supply – Direct Relationship If the price of a good or service goes UP, the quantity supplied for such good or service will also go UP; if the price goes DOWN the quantity supplied also goes DOWN, ceteris paribus. PRICE QUANTITY SUPPLIED [Fig. 2.2] Demand Schedule Curve Supply Schedule A demand schedule can be graphed as a continuous demand A supply schedule is a schedule listing the various prices curve on a chart where the Y axis represents price, and the x of a product and the specific quantities supplied at each axis represents quantity. of these prices; Supply schedule is a table that shows the QS at each price. Y = Price X = Quantity Shift in the demand curve Caused by changes in factors other than the price of the good (e.g., income, consumer preferences, prices of related goods). The entire demand curve shifts to the right (increase in demand) or to the left (decrease in demand). Reflects a change in the quantity demanded at all price levels. Results in a new demand curve. Movement along the demand curve Caused by a change in the price of the good, while other factors remain constant. [Fig. 2.4] Supply Schedule Movement down the curve if the price decreases (increase in quantity demanded). Supply Schedule Formula Movement up the curve if the price increases (decrease in quantity demanded). 𝑄 −𝑄 𝑄𝑆 = 𝑃 2 − 𝑃1 The demand curve itself remains unchanged. 2 1 3 Microeconomics Lourdes Ordoña | Midterms | 2ALM The supply curve is a graphical representation showing the relationship between the price of the product or Surplus = 𝑄𝑠 > 𝑄𝐷 factor of production (e.g. labor) and the quantity supplied Shortage = 𝑄𝑠 < 𝑄𝐷 per time period. Market Equilibrium = 𝑄𝑠 = 𝑄𝐷 Supply schedule is a chart that shows how much product a supplier will have to produce to meet consumer demand at a specified price based on the supply curve. [Fig. 2.5] Supply Curve [Fig. 2.7] Market Equlibrium The meeting of supply and demand results to what is referred to as ‘market equilibrium’ Partial Equilibrium Analysis Demand Equation 𝑄𝐷 = 𝑎 − 𝑏𝑃 Supply Equation 𝑄𝑆 = −𝑐 + 𝑑𝑃 Equilibrium Condition 𝑄𝑠 = 𝑄𝐷 Equilibrium Price (𝑃𝐸 ) 𝑃𝐸 = 𝑄𝐷 = 𝑄𝑆 Chapter 3: The Concept of Elasticity [Fig. 2.6] Change in Quantity Supplied DEFINITION Forces that cause the Supply Curve to change In economics, elasticity means responsiveness. In Optimization in the use of factors of production general, it is the ratio of the percent change in one variable to the percent change in another variable Technological change A tool used by economists for measuring the reaction of Future expectations a function to changes in parameters in a relative way Number of sellers Examples of elastic goods include luxury items and Weather conditions certain food and beverages. Inelastic goods, Government policy meanwhile, consist of items such as tobacco and prescription drugs. MARKET EQUILIBRIUM Equilibrium ELASTICITY OF DEMAND Equilibrium generally pertains to a balance that exists when quantity demanded equals quantity supplied. Demand elasticity Equilibrium is the state in which market supply and in particular, is a measure of the degree of demand balance each other and as a result prices responsiveness of quantity demanded of a product to a become stable. given change in one of the independent variables which affect demand for that product. Equilibrium Market Price o Price elasticity of demand is the responsiveness Equilibrium market price is the price agreed by the seller of consumers’ demand to change in price of the to offer its good or service for sale and for the buyer to good sold pay for it. Specifically, it is the price at which quantity o Income elasticity of demand is the demanded of a good is exactly equal to the quantity responsiveness of consumers’ demand to a change supplied. in their income o Cross elasticity of demand is the responsiveness What happens when there is market disequilibrium? of demand for a certain good, in relation to Surplus – It’s a condition in the market where the changes in price of other related goods quantity supplied is more the quantity demanded. Elastic demand products: Consumer durables like Shortage – IIt’s a condition in the market in which washing machines, cars, Apple iPhones, and iPads. demand is higher than supply. These items are bought infrequently, and their purchase Floor price – It is the legal minimum price imposed by can be delayed if prices rise. the government; Floor price sets a minimum purchase o Apple products: The brand's strong appeal leads cost for a product/service. Farmers seek floor price as consumers to pay a premium. palay sells for just P7 per kilo to compete with imported Income elasticity of demand: If a person's income rises rice. by 20% and they increase consumption of a good by Price ceiling – It is the legal maximum price imposed by 20%, the income elasticity equals 1, categorizing it as a the government. normal good. 4 Microeconomics Lourdes Ordoña | Midterms | 2ALM o Substitute products: If the price of coffee rises, the demand for tea (a substitute) increases as consumers switch to a cheaper alternative. Determinants of Price Elasticity of Demand Availability of close substitutes o Goods with close substitutes – more elastic demand Necessities vs. luxuries o Necessities – inelastic demand o Luxuries – elastic demand [Fig. 3.4] Extreme Types of Demand Elasticity Determinants of Demand elasticity: a) Ease of substitution b) Proportion of total expenditures c) length of time period d) Durability of product which may include i. possibility of postponing purchase ii. possibility of repair iii. used product market [Fig. 3.1] Direct Substitute Goods Variety of demand curves Demand Elastic Demand is elastic o Price elasticity of demand > 1 Demand is inelastic o Price elasticity of demand < 1 Demand has unit elasticity o Price elasticity of demand = 1 ELASTICITY OF SUPPLY Reaction or response of the sellers or producers to price changes of goods sold. It is a measure of the degree of responsiveness of supply to a given change in price An example would be a product that's easy to make and distribute, such as a fidget spinner. [Fig. 3.2] Demand Elastic Supply Elastic An example of products with an elastic demand is consumer durables. These are items that are purchased infrequently and can be postponed if price rises. luxury goods, such as cruises and sports cars, tend to be relatively elastic. Demand Inelastic [Fig. 3.5] Supply Elastic Elastic means the product is considered sensitive to price changes. Supply Inelastic [Fig. 3.3] Demand Inelastic Necessities and medical treatments tend to be relatively inelastic because they are needed for survival. Extreme Types of Demand Elasticity [Fig. 3.6] Supply Inelastic Extreme Types of Supply Elasticity 5 Microeconomics Lourdes Ordoña | Midterms | 2ALM Superior customer value leads to highly satisfied loyal customers who buy more The final step of the marketing process is to capture value from customers, which is the form of sales, market share and profits. By creating superior customer values, the cos. Create satisfied customers, thus, customer stays loyal and buys more in the future. GOODS AND SERVICES Goods refer to anything that provide satisfaction to the needs, wants, and desires of the consumer (like cars, books, clothes, etc.) that contribute directly (final goods) or [Fig. 3.7] Supply Inelastic indirectly (intermediate goods) to the satisfaction of human needs and wants Determinants of Supply elasticity: a) TIME Services b) Time horizon involved with which production can be are any intangible economic activities (such as increased hairdressing, catering, insurance, banking, telecommunications, etc.), that likewise contribute directly or indirectly to the satisfaction of human wants Essential or necessity goods are goods that satisfy the basic needs of man that are necessary in the daily existence of humans are free gifts of nature which are available free of cost. Ex. sunshine Luxury goods are those which men may do without, but which are used to contribute to his comfort and well being (e.g. private jet, yacht, luxury cars, perfumes, jewelry, etc.) Rolex, Omega, Patek Philippe; Rolls-Royce, Bentley, [Fig. 3.8] Formula Range Rover, Maserati, Ferrari Variety of supply curves Economic and free good Supply is unit elastic An economic good is that which is both useful and o Price elasticity of supply = 1 scarce. Water from a faucet is an economic good, Supply is elastic because we are not utilizing it for free, we have to pay to o Price elasticity of supply > 1 its distributor Supply is inelastic The air that we breathe and the sunlight coming from o Price elasticity of supply < 1 the sun are examples of free good are scarce in supply and have to be purchased by paying Chapter 4: Consumer Choice and Utility a price. Ex. Soap, dresses table Maximization Tastes and Preferences CONSUMER Consumers have various tastes and preferences. Generally, tastes and preferences are determined by age, Who is a Consumer? income, education, gender, occupation, customs and One who demands goods and services traditions as well as culture. Without consumption (households), there is no need for Preferences are the choices made by us consumers as to production (firm). The consumer is the king in a capitalist which products or services to consume. or free-market economy. Producers, for their own Taste & preferences determines the demand for a interests, have to satisfy the needs and wants of good consumers in order to earn profits. A consumer is any person or group who is the final user UTILITY THEORY of a product or service. Ex: A person who pays a hairdresser to cut and style their hair. A company that Maslow’s hierarchy of needs identifies the basic priorities of buys a printer for company use. every consumer. Maslow saw human needs in the form of a hierarchy, ascending from the lowest to the highest: [Fig. 4.1] Influences on Consumer Behavior [Fig. 4.2] Maslow’s Hierarchy of Needs Capturing Value From Customers Utility Theory 6 Microeconomics Lourdes Ordoña | Midterms | 2ALM Utility, in economics, refers to the satisfaction or pleasure that an individual or consumer gets from the consumption of a good or service that (s)he purchases For purposes of economic analysis, utility is also measured by how much a consumer is willing to pay for a good/service. An example would be a consumer purchasing a hamburger to alleviate hunger and to enjoy a tasty meal, providing her with some utility. Marginal utility is the additional satisfaction that an individual derives from consuming an extra unit of a good or service added satisfaction a consumer gets from having one more unit of a good or service. For example, you might [Fig. 4.5] Marginal Utility Curve feel fairly full after two slices of cake and wouldn't really feel any better after having a third slice. Marginal means ‘additional’ or ‘extra’. In economics, we What is Consumer Surplus? use marginal analysis in the examination of the effects of Consumer surplus is a measure of the welfare we gain adding one extra unit to, or taking away one unit from, from the consumption of goods and services, or a some economic variable. measure of the benefits that we derive from the exchange of goods Take, for example, drinking water. Drinking water has a high consumer surplus. If we need water to survive, we will pay whatever it takes to stay alive. An airline ticket for a flight to Disney World during school/Christmas vacation for $100, but you were expecting to pay $300 for one ticket, the $200 represents your consumer surplus. [Fig. 4.3] Hypothetical Demand Schedule Total utility is the total satisfaction that a consumer derives from the consumption of a given quantity of a good or service in a particular time period. Our total utility usually increases as we consume more [Fig. 4.6] Graphical Illustration of Consumer Surplus and more of a good or service, but generally the increase is at a slower or declining rate. The Indifference Curve For example, a cookie provides a level of utility as Another important concept used in explaining consumer determined by its singular consumption, while a bag of behavior is the indifference curve. An indifference curve cookies may provide total utility over the course of time is a line that shows combinations of goods among it takes to completely consume all the cookies in the bag. which a consumer is indifferent. Indifference Curve shows all combinations of goods that provide an equal level of utility/satisfaction. Kim’s preferences for relaxation for the tradeoffs that she faces in her two main relaxation activities: dining out with friends and going to the mall with friends. [Fig. 4.4] Hypothetical Utility Schedule Law of Diminishing Marginal Utility The Law states that as a consumer continues to get satisfaction from a product, their satisfaction decreases over time. This means that while consuming more of the same good raises total utility, it does so at a slower rate because the additional satisfaction from each unit becomes smaller. In other words, the more we consume, the less satisfaction we get from each additional unit. an individual might buy a certain type of chocolate for a while. Soon, they may buy less and choose another [Fig. 4.7] Indifference Curve type of chocolate or buy cookies instead because the Marginal rate of substitution (MRS) satisfaction they were initially getting from the chocolate The marginal rate of substitution (MRS) helps in is diminishing. understanding a preference map. 7 Microeconomics Lourdes Ordoña | Midterms | 2ALM It represents the rate at which a person gives up good y (on the y-axis, e.g., pizzas) to get more of good x (on the x-axis, e.g., hamburgers) while staying indifferent. Indifference means staying on the same indifference curve. MRS is measured by the slope of the indifference curve. Marginal rate of substitution is the willingness of a consumer to replace one good for another good, as long as the new good is equally satisfying. For example, a consumer must choose between hamburgers and hot dogs. In order to determine the marginal rate of substitution, the consumer is asked what combinations of hamburgers and hot dogs provide the same level of satisfaction. Budget Line A budget or consumption-possibility line shows the various combinations of two products that can be purchased by the consumer with his income, given the [Fig. 4.8] Engel’s Curve prices of the products. In other words, a consumer, given his fixed budget, must spend wisely and efficiently in order to maximize his satisfaction. Chapter 5: Production and Cost budget line shows the combinations of two products PRODUCTION that a consumer can afford to buy with a given income – using all of their available budget. The two What is Production? basic elements of a budget line are as follows: the Production refers to any economic activity, which consumer’s purchasing power (his/her income) and The combines the four factors of production (i.e., land, labor, market value of both the products capital and entrepreneurship) to form an output which o The consumer’s purchasing power (his/her income) will give direct satisfaction to the consumer o The market value of both the products It is the process of converting inputs into outputs o Inputs are any resources used to create goods and Income and Substitution Effect services. Examples of inputs include labor Indifference curves and budget constraints can be (workers' time), knowledge, fuel, materials, helpful in order for us to understand the income and buildings, and equipment. Process manufacturing substitution effects more clearly. Indifference analysis is common in the food, beverage, chemical, can be used to analyze how a consumer would change pharmaceutical, nutraceutical, consumer the combination of two goods for a given a change in packaged goods, and biotechnology industries. their income or the price of the good. Some examples of output include finished goods The income effect is the change in the consumption of and services. Input and output is important because goods by consumers based on their income. The sometimes the demands of a product aren't being substitution effect happens when consumers replace met. he main processes in a water refilling station is cheaper items with more expensive ones when their dictated by raw water quality. The typical steps financial conditions change. are filtration (several stages), softening, and disinfection The Engel Curve or Engel’s Law Engel curves illustrate the relationship between Technology consumer demand and household income. This curve is the production process employed by firms in creating is named after Ernest Engel, a German statistician in the goods and services. It can be classified as labor intensive 19th century who studied the spending patterns of groups or capital intensive. of people of different incomes. He noted that as o A labor intensive technology utilizes more labor individual’s income changes, the pattern of the resources than capital resources; Examples of labor consumption expenditure on goods also changes. intensive industries include agriculture, mining, According to Engel, as the income of a family hospitality and food service. increases, the proportion of its income spent on o A capital intensive technology utilizes more necessities, such as food, declines, while the income capital resources than labor resources in the spent on luxury goods increases. For families that have production process; Examples of capital-intensive low income, a bigger proportion of their income is spent industries include automobile manufacturing, oil on necessities, while those who are rich, relatively spend production, and refining, steel production, a large part of their income on luxury goods. telecommunications, and transportation The percentage of income allocated for food purchase sectors (e.g., railways and airlines). s decreases as income rises. A family that spends 25% of their income on food at an income level of P50,000 will Fixed Input & Variable Input pay 12, 500 on food. If their income increases to P100,000, A fixed input is any resource the quantity of which it is not likely that they will spend P25,000 on food but cannot readily be changed when market conditions will spend a lesser percentage while increasing spending indicate that a change in output is desirable; in other areas. Depreciation, interest paid on capital, rent, salary, property taxes, insurance premium A variable input, on the other hand, is any economic resource the quantity of which can be readily changed in response to changes in output; - Commission on sales, credit card fees, wages of part-time staff Short Run versus Long Run The short run is a period of time so short that there is at least one fixed input therefore changes in the output 8 Microeconomics Lourdes Ordoña | Midterms | 2ALM must be accomplished exclusively by changes in the use company finds that it can double its output by of variable inputs. replicating its current plant and labour force, that is, The long run is a period of time so long that all inputs are by building an identical palnt beside the old one. considered variable. The long run is therefore known as Increasing returns to scale (also called economies of the planning horizon. This is because in the long run, the scale) happens when an increase in all inputs leads to a firm can build new factories or purchase new machinery. more-than-proportional increase in the level of output o For example, if the amount of inputs are doubled and the output increases by more than double, it is Production function said to be an increasing returns returns to scale. functional relationship between quantities of inputs Decreasing returns to scale occurs when a balanced used in production and outputs to be produced increase in all inputs leads to a less-than-proportional increase in total output Ex. Production function of making a dress: o For example, if a car firm increases its variable ODRESS = f (Fabrics, Sewing Machine, Sewer, inputs (capital, raw materials and labour) by 50%, Thread, Buttons, etc.) but the output of cars, increases by only 35%, then we say there are decreasing returns to scale PRODUCTION POSSIBILITY CURVE Production Possibility Frontier (PPF): A curve showing COSTS the combinations of two or more goods/services that can Explicit and Implicit Costs be produced using all available resources efficiently. Economists define the total opportunity cost of a Production Possibilities Curve (PPC): Graph showing business as the sum of explicit costs and implicit costs. the maximum units a company can produce with two products, assuming efficient resource use. Explicit costs Economic Model: The PPC demonstrates production are payments to non-owners of a firm for their resources, efficiency and resource allocation possibilities for an thus, these are the expenses made for the use of economy. resources not owned by the firm itself Trade-off: The curve highlights the trade-off between An explicit cost is one that is a clear and obvious producing two types of goods or services. monetary amount made by the firm. It has a clear monetary amount which can be seen in the firm’s financial balance sheet. Such examples include: Advertising and marketing costs, Employee wages, bonuses, commissions, and any other compensation to employees, Equipment that businesses purchase to make production and output more efficient, Rent or other mortgage payments required for the land the firm is using, Utilities that are required to keep the firm running such as electricity, water, and internet service. For example, spending 5 hours playing video games means those 5 hours cannot be used for studying. Implicit costs are the opportunity costs of using resources owned by the firm The implicit cost is the hours that could have been used for studying instead. Training a new employee presents [Fig. 5.1] Production Possibility Curve an implicit cost in the fact that those seven hours could have been used doing other work, Maintenance means THE LAW OF DIMINISHING RETURNS the firm has to stop production for a time which can lead The Law of Diminishing Returns holds that we get less and to a lower level of output or dissatisfied customers. less extra output when we add additional amount of an input while holding other inputs fixed. In other words, the Fixed Costs and Variable Costs marginal product of each unit of input declines as the amount of that input increases, holding all other inputs Fixed cost constant. or overhead or supplementary cost are those expenses which are spent for the use of fixed factors of production Take the example of a small business. Let us assume, there is FC Costs that do not change in relation to production a small cafe that hires 2 chefs to prepare special breakfast volume. Rent, Advertising, Insurance, Depreciation. dishes. As time passes, 2 more chefs are hired. Variable costs The work, materials, equipment, etc., thus get evenly or prime or operating costs, on the other hand, are those distributed. expenses which change as a consequence of a change in The hiring process continues, and the work per chef quantity of output produced consequently gets reduced. Costs that vary/change depending on the company’s Also, there will be an ever-increasing conflict for raw production volume. Ex. DM& DL. materials like the ingredients, cookware, etc. The work might get slowed down, and even though the Opportunity cost number of dishes might increase, the overall production To produce its output, a firm utilizes factors of rate could be very slow. production: land, labor, capital, and entrepreneurship. Another firm could have used these same resources to RETURNS TO SCALE produce alternative goods or services. In Chapter 1, it is Constant returns to scale indicate a case where a said that opportunity cost is the best alternative change in all inputs leads to a proportional change in foregone. output At the ice cream parlor, you have to choose between o common example constant returns to scale occurs rocky road and strawberry. When you choose rocky road, when a firm can easily replicate its production the opportunity cost is the enjoyment of the strawberry. process. For, instance a manufacturer of electrical 9 Microeconomics Lourdes Ordoña | Midterms | 2ALM A player attends baseball training to be a better player instead of taking a vacation. The opportunity cost was the vacation. Jill decides to take the bus to work instead of driving. It takes her 60 minutes to get there on the bus and driving would have been 40, so her opportunity cost is 20 minutes. If you decide not to go to work, the opportunity cost is the lost wages. Tony buys a pizza and with that same amount of money he could have bought a drink and a corn dog. The opportunity cost is the drink and corn dog. Economic Profit A firm’s economic profit equals total revenue minus total cost. Total revenue is the amount received from the sale [Fig. 5.2] Short Run Cost Schedule of the product. It is the price of the output multiplied by the quantity sold. Total cost is the sum of the explicit costs and implicit costs and is the opportunity cost of 𝑇 −𝑇 production. The formula for economic profit is: MC = 𝑄2 −𝑄1 2 1 Economic Profit = Net Operating Profit After Tax - (Capital Invested x Weighted Average Cost of Capital) Profit Maximization Profit is simply defined as the difference that arises when a firm’s total revenue is greater than its total cost. This Economic profit is important because it is used as an indicator definition of ‘economic profit’ differs from that used of how profitable company projects are and it therefore serves conventionally by businessmen (accounting profit) in that as a reflection of management performance. Economic profit accounting profit only takes into account explicit cost attempts to prove that businesses are only truly profitable (refer to our definition in Chapter V). when they create wealth for their shareholders, and the Profit maximization rule (also called optimal output rule) measure of this goes beyond calculating net income. specifies that a firm can maximize its economic profit by Economic profit asserts that businesses should create returns producing at an output level at which its marginal at a rate above their cost of capital revenue is equal to its marginal cost. TOTAL FIXED COST, TOTAL VARIABLE COST AND TOTAL Efficiency COST Efficiency is such an important economic concept that it As production expands in the short run, costs are is part of the definition of economics. Economics is the divided into two basic categories – total fixed cost and efficient allocation of the scarce means of production total variable cost toward the satisfaction of human wants. Total fixed cost (TFC) consists of costs that do not vary as output varies and that must be paid even if output is zero Chapter 6: Labor Wage Market: Wages in Perfect Competition Total variable cost (TVC) consists of costs that are zero when output is zero and vary as output increases (decreases) DEFINITION Total cost is the sum of total fixed cost and total variable cost Markets for the Factors of Production at each level of output: While economics largely focuses on the markets for goods and services, or what we commonly refer to as outputs of production, there are also markets for the TC = TFC + TVC factors of production or inputs to production. Product Market and Factor Market Average fixed cost is total fixed cost divided by the quantity A Product market is the market for a final good or service of output produced which is usually considered to be a consumer product. A Factor market, on the other hand, is the market for the AFC = FC / Q factors used in the production of a consumer product, and not the good produced itself. A Labor market is a market where people offer their skills Average variable cost rises with output. Average variable to employers in exchange for salaries and other forms of cost is total variable cost divided by the quantity of output compensation. produced In economics, the product market is the marketplace where final goods or services are sold to businesses and the public sector. Focusing on the sale of finished AVC = VC / Q goods, it does not include trading in raw or other intermediate materials. for example, the market for airline travel; smart-phones, new cars; pharmaceutical products and the markets for financial services such as Average total cost is total cost divided by the quantity of banking, mortgages and pensions. Factor market is the output produced market for services needed to complete the production process. Some examples are inputs like capital, labor, ATC = TC / Q or ATC = AFC + AVC raw material, entrepreneurship, and land. The factors can be purchased and sold, and they're needed in order AVC = VC / Q for the goods and services market to complete a finished product. A labour market is the place where workers and employees interact with each other. 10 Microeconomics Lourdes Ordoña | Midterms | 2ALM Labor Market Equilibrium The Superstar Phenomenon The demand for labor is simply like a demand for a good Superstar Phenomenon: Explains why athletes, actors, so it generally follows the law of demand. and singers earn large sums, while a plumber does not. Same principle with the law of supply which says that if Only highly sought-after individuals admired by many the price of labor increases, then the supply of labor will earn such high compensation. also increase and vice versa. Market Characteristics Supporting Superstars: When the labor demand and supply meet at a certain 1. People prefer goods/services from the best wage and quantity of workers, equilibrium takes place. producers. This point of equilibrium is called the market clearing 2. Technology allows the best producers to supply at wherein firms may hire an employee at the existing wage a low cost to a large audience. rate and people who would like to have that wage rate would be able to do so. The Efficiency-Wage Theory Efficiency-Wage Theory: Proposed by Carl Shapiro and The labor market is in equilibrium when supply equals Joseph Stiglitz (1984), it suggests that paying workers demand. above the equilibrium wage increases productivity and profits for firms. What determines Market Wage Rates? Efficiency Wages: Wages higher than the market- A basic principle of economics is the notion that the price clearing rate to incentivize better worker performance. or value of goods, services and even resources such as Shapiro-Stiglitz Theory: Explains the relationship labor, is determined by the behavior of demand and between wages and unemployment in labor market supply. equilibrium. o Higher wages improve worker morale and effort o Higher wages reduce worker resignation and labor Chapter 7: Interest, Rent, and Profit turnover costs o Higher wages attract more applicants INTEREST Equilibrium Wages Interest When the job tend to become difficult and dangerous, The word interest is often encountered in our daily lives workers would naturally require a higher wage in order when there are discussions about loans and earnings. In to perform such kind of job. This compensating economics, interest is used in two ways- it can be the differential is the difference in wages that arises to offset price of the credit, which is often referred to as loanable the nonmonetary characteristics of different jobs. funds, and, the return that capital earns as an input in the production process. The equilibrium wage is the wage rate that produces A financial interest is basically the monetary reward for a neither an excess supply of workers nor an excess demand service rendered, a monetary gain for commercial for workers and labor market. dealings, or the ownership of shares with the potential for monetary profit. Some examples are:... An example of interest is the amount that was earned this year on your savings/time deposit account. Determinants of Interest Rate Interest Rate: Determined by the demand and supply of loanable funds. Demand for Loanable Funds: Comes from consumers, investors, and government seeking loans. Supply of Loanable Funds: Comes from savings by individuals who spend less than their income. Example: If someone earns $20,000, spends $18,000, and saves $2,000, that $2,000 adds to the supply of loanable funds. [Fig. 6.1] Labor Market Equlibrium Loanable Funds Market: Represents the interaction between savers and borrowers, with the real interest rate The Philippines’s labor market provides an attractive used to measure market activity. prospect for investors given the large working-age population and growing pool of skilled labor. FACTORS THAT EXPLAIN PRODUCTIVITY AND WAGES: WHY DO WORKERS EARN DIFFERENT EQUILIBRIUM WAGES? Human Capital Investments: Efforts that increase an individual's earnings, such as education and skill development. Natural Abilities: Intelligence and attractiveness can lead to higher wages due to better productivity in certain jobs (e.g., modeling, acting). Effort: Harder work often leads to better wages as a result of increased effort. Chance: Technological advancements can favor individuals with relevant skills (e.g., IT). [Fig. 6.2] Market for Loanable Funds Education: Higher educational attainment signals greater learning ability and productivity, leading to Nominal and Real Interest Rates higher wages. This aligns with the Signaling Theory, Nominal interest rate is the rate determined by the where education reflects capability. supply and demand in the market for loanable funds. Considered as the simplest type of interest rate, this is the stated rate of a given loan. 11 Microeconomics Lourdes Ordoña | Midterms | 2ALM Real interest rate is the nominal interest rate adjusted for inflation. Real Interest Rate = Nominal Interest Rate – Expected inflation Rate RENT Actually, economic rent is the price paid for the use of land and other natural resources or factors of production that is in fixed supply. Rent has been traditionally associated with land, a fixed factor of production. The concept of economic rent applies to economic factors not just land. Economic rent is a payment in excess of opportunity costs. rent is represented as the difference between the total return to a factor of production (land, labour, or capital) and its supply price—that is, the minimum amount necessary to attain its services. [Fig. 7.1] Determination of Rent (Land) PROFIT Profit This is the income made by an entrepreneur for using his entrepreneurial abilities to run a business. Profits are divided into normal profits and economic profits. Profit is a form of nonwage income. Economic profit is the entrepreneur’s return above and beyond normal profits. For Example: If a company had $250,000 in revenues and $150,000 in explicit costs, its accounting profit would be $100,000. Market Niches As entrepreneurs become eager to receive economic profits, they would like to know market niches since these can provide economic profits. Market niche is defined as a segment of the market that demands a commodity that is slightly differentiated from other commodities. A niche market is the subset of the market on which a specific product is focused. The market niche defines the product features aimed at satisfying specific market needs, as well as the price range, production quality and the demographics that it is intended to target. Starbucks found a niche market where it identified what makes its customers happy and has delivered it to them. Continuing to accomplish this will allow Starbucks to maintain its competitive advantage for years to come. 12