Micro Econ Notes PDF

[First week] [Required reading:] Principles of Microeconomics, 9th canadian edition Economics: Study of human behavior over scarce resources Economists study how people make decisions: ▪ How Much They Work\ ▪ What they buy\ ▪ How Much They Save ▪ How they invest their savings\ ▪ Economists study...

[First week] [Required reading:] Principles of Microeconomics, 9th canadian edition Economics: Study of human behavior over scarce resources Economists study how people make decisions: ▪ How Much They Work\ ▪ What they buy\ ▪ How Much They Save ▪ How they invest their savings\ ▪ Economists study how people interact ▪ How buyers and sellers together determine the price at which goods are sold and the quantity that is sold Economists Analyze Forces And Trends That Affect:\ ▪ The Economy\ ▪ The Growth In Average Income\ ▪ The fraction of the population that cannot find work ▪ The Rate At Which Prices Are Rising Principle 1-4: "How people make decisions" ========================================== Principle 1: ------------ **People face Tradeoffs** **Eg. Guns v.s Butter, must trade one for the other.** Key terms**:** **Efficiency**: Society getting the most it can from scarce resources **Equity**: Distributing economic prosperity fairly among members of society Efficiency vs Equity, there will be a tradeoff. Eg, If society tries it's best to get the most of its resources and you must distribute it in an equitable manner, there will be people who do less than others and get the same amount or even more than people who do more. More equity, less efficiency, and vice versa. Principle 2: ------------ **The Cost of Something is what you Give up to Get it** Key Terms: **Opportunity Cost:** Whatever must be given up to obtain some item. Cost of attending this lecture: Time, energy, tuition, even potential working hours at your job, potential enjoyment with others. Time taken can be used for many other things. Opportunity costs vary greatly on the person, and can be viewed subjectively. The next best alternative = Opportunity cost In terms of money, the term is **Accounting Cost.** This would be direct money costs like tuition, gas, transit fee, etc. Accounting and Opportunity cost are not always the same. Principle 3: ------------ **Rational People Think at the Margin** Key Terms: **Rational People:** Those who systematically and purposefully do the best they can to achieve their objectives. Differs from self interested. Objectives: Everyone has different objectives but the main objective is to **Maximize** utility (time, feeling, other's wellbeing) subject to **constraints** (time, money, energy). **Marginal Changes:** Small incremental adjustments to a plan of action. Little decisions to slightly benefit; a Rational person should only make a decision if **MB \> MC** Marginal cost vs. marginal benefits; when is the marginal cost no longer worth the marginal benefit. Principle 4: ------------ **People respond to Incentives** **Incentive:** Something that induces a person to act - - - - Economics: studying human behavior, most behavior is a reaction to incentive. Principle 5-7: "How People Interact" ==================================== Principle 5 ----------- **Trade can make everyone better off** Trade allows countries to specialize in what they do best so they can enjoy a variety of goods and services Trade between two countries can make each country better off - - 1. Markets, retail stores, malls, etc. 2. 3. 4. **Although trade is meant to benefit both countries**, why are countries like the US not trying to impose tariffs to prevent trade? - - - - Principle 6: ------------ **Markets are usually a good way to organize economic activity** An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for good and services **Free Market:** Creates competition for better quality, cost, etc. Maximize objectives subject to our constraints (doing the best with what we have) **Local information:** Can only be known by yourself. As long as we make the best choice for ourselves, then the overall economy should be efficient. Creates Incentive. In his 1776 book, Adam Smith observed that households and firms interacting in markets act as if they are guided by an **invisible hand** that leads them to desirable market outcomes. Principle 7: ------------ **Governments can sometimes improve market outcomes** We need governments for many reasons: - - - - - - - - **Market Failure:** a situation in which a market left on its own fails to allocate resources efficiently (Start of a monopoly) - **Market Power** - For each of the following situations, what is the government's role? Does the government's intervention improve the outcome? 1. 2. 3. 4. Principle 8-10: How the economy as a whole works ------------------------------------------------ Principle 8: ------------ **A country's standard of living depends on its ability to produce goods and services** **Productivity:** the quantity of goods and services produced from each hour of a worker's time Many factors can affect a country's productivity, social care services, natural services, culture, education, healthcare Principle 9: ------------ **Prices rise when the Government prints too much Money** Inflation: an increase in the overall level of prices in the economy What causes inflation? Principle 10: ------------- **Society faces a short-run Tradeoff between inflation and unemployment** This short-run tradeoff plays a key role in the analysis of the business cycle **Business Cycle:** the irregular and largely unpredictable fluctuations in economic activity, as measured by the production of goods and services or the number of people employed Chapter 2 ========= **Thinking like an economist** A scientific method 1. 2. 3. Economists do a similar job as a physicist, just different observations/data. - Model; a Fable/theory - - **Assumptions** - - Best model is the simplest one The best way to judge a model is based on how useful it is All models are wrong, but some are useful **The Circular Flow Diagram** 2 decision makers: Firms and households 2 markets: Factors of production and Good & Services **The production possibilities frontier** 1. 2. 3. Slope of PPF - - Macro vs Micro Economics ------------------------ **Micro:** the study of how households and firms make decisions and how they interact in markets **Macro:** the study of economy-wide phenomena, including inflation, unemployment, and economic growth When economists try to explain the world, they are **scientists** When they are trying to help improve it, they are **policy advisers** **Policy Advisor** Positive vs Normative analysis **Positive statements:** Claims that attempt to describe the world as it is (Economist) **Normative statements:** Claims that attempt to prescribe how the world should be (Policy advisor) Different value judgements **Economic Disagreements:** 2 basic reasons - - Economists recommendations are not always heeded by the government, as figuring out the right policy is only part of the job for the government. Chapter 3 ========= Midterm 1: Multi Choice and Short answer problems Chapter 1-3 **Interdependence and the gains from trade** 1 of the 10 principles in chapter 1, **Trade can make everyone better off** Sometimes we shouldn't assume that one country being specialized in one thing makes them better than their trading country at producing that one product **Absolute Advantage:** the comparison among producers of a good according to their productivity **Comparative Advantage:** the comparison among producers of a good according to their opportunity cost **Production Possibilities Frontier** shows the various mixes of output that an economy can produce. **Import:** goods and services produced abroad and sold domestically **Export:** goods and services produced domestically and sold abroad. The principle of comparative advantage states that each good should be produced by the country with the lowest opportunity cost Chapter 4: ---------- **Markets** How **price** is determined **Supply** and **Demand** - - - Basic model Supply: Firms Demand: Consumers What is a **Market?** A group of sellers and buyers of a particular group of goods/service - - Markets can take many forms Highly organized: Like many agricultural commodities Less organized: Like a small ice cream shop **Competitive Market:** A market that has so many buyers and sellers so that they do not have an impact on the market price. The price is determined by all buyers and sellers in the market **In this chapter**, it is assumed that all markets are perfectly competitive - - Buyers and sellers are **Price Takers**, people only able to take the current market price and are unable to change it **Monopoly:** One seller in the market and this seller sets the price Other markets fall between perfect competition and monopoly. **Demand** The **Demand Curve:** relationship between price and quantity demanded **Quantity demanded**: amount of good that buyers are willing and able to purchase **Law of demand:** the claim that, other things equal, the quantity demanded of a good falls when the price of a good rises Can be **represented** by: Table Graph Algebra **Market Demand:** the sum of the demand from all the individuals in the market *What can affect the market demand?* - - - - Income Price of related goods More factors: Tastes Expectations Number of buyers **Movement along demand curve vs Movement OF demand curve** Price of good represents a movement along demand curve, but all the other factors shift the demand curve itself **Supply:** The supply curve: relationship between price and quantity supplied **Quantity supplied:** The amount of good sellers are willing and able to sell **Law of supply:** the claim that, the quantity of supplies rises with price rises **Supply schedule:** a table that shows the relationship between the price of a good and the quantity supplied **Supply curve:** a graph of the relationship between the price of a good and the quantity supplied. It is represented by a positive upwards slope / **Market Supply:** the sum of supplies of all sellers **Factors that shift supply curve:** - - - - **Equilibrium:** a situation in which the price has reached the level where quantity supplied equals quantity demanded P\*: Qs = Qd = Q\* **EQUILIBRIUM PRICE**: the price that balances quantity supplied and quantity demanded **EQUILIBRIUM QUANTITY**: the quantity supplied and the quantity demanded at the equilibrium price When quantity supplied is greater than quantity demanded, there is a **surplus** When quantity demanded is greater than quantity supplied, there is a **shortage** In an economic system, scarce resources have to be allocated among competing uses - Supply and demand together determine the prices of the economies many different goods and services - Chapter 5 Elasticity Demand --------------------------- **Elasticity:** a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants - - - - **Midpoint method** Price elasticity of demand = [(Q2 - Q1)/\[(Q2 + Q1)/2\]] (P2-P1)/\[(P2+P1)/2\] **Variety of demand curves** **Demand curves** are classified according to their **Elasticity** - - - If elasticity equals 0 = perfectly inelastic, no matter what the price is, demand is still the same If elasticity is infinite = perfectly elastic, at a certain price, demand is infinite **Total revenue:** is the amount paid by buyers and received by sellers of a good TR = P x Q When demand is inelastic, price and TR move in the same direction When demand is elastic, price and TR move in opposite directions When demand is unit elastic, TR remains constant when price changes 🔺TR = (P+🔺P)(Q+🔺Q) - P x Q **Other demand elasticities** In addition to the price elasticity of demand ***Income elasticity of demand** = [Percentage change in Qd]* ***Cross price elasticity of demand** = [% Change in Qd of good 1]* *% Change in Price of good 2\ * When income elasticity of demand is \< 0, inferior, because as peoples income rises, their demand for this good decreases. **E.g. margarine** When income elasticity of demand is \> 0, normal good, because as peoples income rises, their demand increases. **E.g. sports cars** When cross price elasticity of demand \> 0, the goods are substitutes, because increase of price of good 2 increases demand of good 1 **e.g. coffee and tea** When cross price elasticity of demand \< 0, goods are compliments, because increase of price of good 2 will lower quantity demand of good 1. **E.g. peanut butter and jelly** Q1: John income went from 20k to 22k, his Qd of burgers went from 20 to 10 1. -67%/21% = -7 elasticity **USE MIDPOINT METHOD. CHANGE/AVERAGE** 2. Q2: P shrimp went from \$4 to \$6, whole Q steak went from 80 to 95 1. 2. Week 6 - YAPPING **Chapter 6** **Government policies** - - **Controls on pricing** - Binding - Leads to a **shortage** **Price Floor** - - **Principle 5:** Markets are usually a good way to organize economic activity - - - - **Taxes** **Tax incidence** is the manner in which the burden of a tax is shared among participants in a market **2 scenarios** 1. 2. Pd = Ps + 15 Ps = Pd - 15 Pd - Ps = 15, That\'s why buyer tax burden will be higher most of the time. **How burden of tax is divided** Elastic supply, Inelastic demand: **Buyers pay more** Inelastic supply, elastic demand: **Sellers pay more** A **subsidy** is the opposite of a **tax** Chapter 7: Consumers, Producers, and the efficiency of markets -------------------------------------------------------------- **Welfare Economics**: the study of how the allocation of resources affects economic wellbeing Begins by looking at the benefits buyer receive **Willingness to pay:** maximum amount that a buyer will pay for a good Consumer surplus is a good measure of **economic well being** Initial Cs: ½(B-C)(A-B) Change in Cs: ½ (D-F)(A-D) - ½ (A-B)(B-C) Change in **Area** **Cost** is the value of everything a seller must give up to produce a good  The **area** **above** the supply curve and below the price measures the **producer surplus** As long as the sellers cost is lower than the price, it will be beneficial.  Change in Ps = Q1 + Q2 / 2 (P2 -P1) MKT Efficiency Measured by Total Surplus = CS + PS CS = Value to buyers - amount paid by buyers PS = Amount received by sellers - cost to sellers TS = Value to buyers - cost to sellers **Efficiency vs Equity** tradeoff **Evaluating the Market Equilibrium** MB to any buyer = **P** = MC to any seller Chapter 8: The costs of taxation -------------------------------- TS = CS + PS The tax cost is **not equal** to the loss in CS & PS When Tax is levied on buyers, demand curve shifts downward by the size of this tax When levied on sellers, supply curve shifts upward by that amount 1. 2. 3. TS = CS + PS + Tax Revenue 1. 2. 3. **Deadweight Loss**: the fall in total surplus that results from a market distortion such as tax Lowers quantity in market, overall **TS decreases** When demand is inelastic, deadweight loss of a tax is smaller When demand is elastic, deadweight loss of a tax is larger  **Deadweight loss** continuously increases as tax size increases **Tax revenue** increases, then decreases as tax size increases **Marginal cost of public funds** is the total cost to society of raising one more dollar in tax revenue. **Marginal benefit of public funds** is the value that society places on more dollar of expenditure on a government program. The government should continue increasing until MCF = MBF Chapter 9 SELF READ ------------------- Chapter 10 Externalities ------------------------ **Externality:** the uncompensated impact of one person's actions on the wellbeing of a bystander Suppose a factory emits pollution This smoke creates a health risk of those who breathe it - **External Cost of pollution** Social Cost = Private cost + External Cost Shows the **real** cost of producing the good Shifts the supply curve up **Deadweight loss of a negative externality** Total surplus = CS + PS - External Cost = (A+B+C+D)+(F+G)-(C+D+E+F+G) = A+B-E at Qmarket **Internalizing the externality** is when incentives are altered in a way in which the external effects of their actions are accounted for. Ie: carbon tax **Public Policies toward externalities** 1. 2. Price Instruments Quantity Instruments Use Permits to control the total quantity Cap & Trade **Private Solutions** - - - **Coase theorem** is the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own **READ POSITIVE EXTERNALITY CHP 11 -12** CHAPTER 10-12 **GOVERNMENT** CHAPTER 13-19 **FIRMS** CHAPTER 21 **CONSUMERS** Chapter 13: Costs of Production ------------------------------- Firm behaviour **Industrial organization** is the study of how firm's make decisions regarding prices and quantities depending on the market conditions. Perfectly competitive --- Monopolistic Competition --- Oligopoly ---- Monopoly Moving down the line ----\> less and less firms, more power on price and quantity Firms Objective: Max Profit = TR - TC Cost = C - O **Explicit costs** Require an outlay of money by the firm **Implicit costs** - **Production function** is the relationship between the quantity of inputs used to make a good and the quantity of output of that good Total cost is the sum of fixed and variable costs **Fixed costs** do not vary with output produced **Variable costs** vary with output produced Average and Marginal Costs **Average total cost (ATC)** total cost divided by Q TC/Q **Average fixed cost (AFC)** fixed cost divided by Q TFC/Q **Average variable cost (AVC)** variable cost divided by Q TVC/Q **Marginal Cost (MC)** Increase in TC from an exra unit of production ∆TC / ∆Q ATC = AFC + AVC **Efficient Scale** is the quantity of output that minimizes avg total cost MC affects the variable costs, not the fixed costs. If MC is lower than ATC or AVC, then ATC or AVC is decreasing. When MC is equal to or greater than ATC or AVC, ATC/AVC is increasing. **Short Run vs Long Run** Fixed costs and variable costs depend on time horizon. In the **long run,** all costs are **variable**.  As factories begin to grow, ATC varies between **small factories** and **large factories** **Economies of scale** is the property where longrun ATC falls as output quantity increases **Diseconomies of scale** is where long run ATC rises as the output quantity increases **Constant returns to scale** is where ATC stays the same as the quantity of output changes. Chapter 14: Firms in the competitive market ------------------------------------------- **Competitive market** is a market where there are so many buyers and sellers that they cannot affect the market price or quantity. Firm\'s **goal** is to make profit Max Profit = TR - TC Max profit = (P-ATC) \* Q TR = Price x Quantity P = Price Q = Quantity R = Revenue AR = (P x Q) / Q MR = ∆TR/∆Q If MR/P \> MC, firm should continue producing At MR/P = MC, perfect price MC curve shows us the competitives firms supply curve Under some circumstances, a firm will decide to shut down and not produce at all - - Produce when **TR \> TVC** **P \> AVC** Shut down when **TR \< TVC** **P \< AVC** **Sunk cost** is a cost that has already been committed and cannot be recovered. Should be ignored because nothing can be done If a firm exits, it will lose all revenue but it saves now on both fixed and variable costs. Firm should exit if revenue is less than total costs **TR \< VC TR \< TC** **P \< TC = EXIT** Can produce in short run, but should not produce in the long run. Over time 0 profit should make sense. If firms in a market are making profit, new firms will have an incentive to enter - - Some reasons why a long run supply curve might slope upwards - - Chapter 17: Oligopoly --------------------- Oligopoly is a market structure in which few sellers offer similar or identically products. Inbetween monopoly and regular market, closer to a monopoly **Game Theory** is the study of how people behave in strategic situations Cooperation is **difficult**, the others person\'s response is difficult to predict. Ways to break this dilemma (prisoners dilemma) - - - FINALS COMING UP STUDY MATERIAL CH 1-8, 10,13,14,17 ===================================================