ECON 11 NOTES (1) PDF

CHAPTER 1 sellers). The outer set of arrows shows the flow of dollars, and the inner set of arrows shows the corresponding flow of inputs Economics...

CHAPTER 1 sellers). The outer set of arrows shows the flow of dollars, and the inner set of arrows shows the corresponding flow of inputs Economics and outputs. Social science that analyzes ○ Production Inner circle and Outer circle ○ Distribution ○ Consumption Personalize your examples sa presentation Chapter 1: The Fundamentals of Economics - Economics is common sense made confusing - Our entire lives revolve around economics - Social science that deals with the allocation of scarce resources to satisfy unlimited human wants Twin Themes of Economics Government is in the middle Scarcity vs Efficiency How the government influences the market: Tax (Simple Scarcity example of Government intervention) - Economy’s inability to satisfy human needs and wants Efficiency Forms of Economic Organization - An economy is producing efficiently when it can make Command Economy - Market Economy one better off without making someone else worse off < Mixed Economy > Main Branches of Economics Players of the Economy Macro and Micro - Firms Macro - Households - National, GBP, unemployment, inflation - Government - Into the economy as a whole Ten Principles of Economics Scarcity Micro ○ Where needs or wants exceed means - Consumer, supply, demand, price, budget therefore people have to make choices - Ito tayo lang eyy Rationality ○ Guide people’s choices or decisions Circular Flow of Economics systematically gauge pros (benefit or utility) LLC - Land, Labor, Capital and cons (cost) Preferences ○ Fixed and given that allow assignment of value to all options and to choose the option that maximizes (net) utility ○ Wala tayo magagawa pag preference talaga like preference sa lalaki ni nina Restrictions ○ People face constraints that they cannot change themselves Opportunity cost ○ Deciding in favor of one option always means deciding against some other options The Economic Principle ○ Application of rationality to situations of scarcity; minimize cost or maximize utility Efficiency ○ Maximum benefits from scarce resources Marginal analysis The Circular Flow This diagram is a schematic representation ○ Additional benefits vs additional costs of the organization of the economy. Decisions are made by ○ Iphone specs discussion households and firms. Households and firms interact in the Equilibrium markets for goods and services (where households are buyers and firms are sellers) and in the markets for the factors of production (where firms are buyers and households are  ○ Basic economic models deal with the Mankiw's "Ten Principles of Economics" comparison of two equilibria (comparative statics) How People Make Decisions: Game Theory ○ Study situations of interdependence where 1. People Face Trade-offs: people have incentives to think and behave ○ To get something, one must give up strategically something else. 2. The Cost of Something is What You Give Up to Get It: PRINCIPLES OF ECONOMICS ○ Decision-makers must consider both explicit and implicit costs (opportunity cost). These principles explain how the economy works (or should 3. Rational People Think at the Margin: work) and refer to economic actors. They are similar to ○ Rational decision-makers take action if principles or laws in natural science. marginal benefit exceeds marginal cost. 4. People Respond to Incentives: Economic Principles: ○ Behavior changes when costs or benefits change. Refers to the "principles of economic life." The term "economics" refers to the discipline, not How People Interact: to the economy. It clarifies the basic concepts that shape the analysis and thinking of economists. 1. Trade Can Make Everyone Better Off: ○ Specialization and trade improve outcomes Ten Principles of Economics (as a Discipline) for everyone. 2. Markets Are Usually a Good Way to Organize 1. Scarcity: Economic Activity: ○ Economists study situations where needs or ○ The "invisible hand" efficiently allocates wants exceed means, leading people to resources without central planning. make choices. 3. Governments Can Sometimes Improve Market 2. Rationality: Outcomes: ○ Guides people's choices by weighing pros ○ Public policies can address market failures (benefits/utility) against cons (cost). and inefficiencies. 3. Preferences: ○ Fixed preferences help assign value to How the Economy Works as a Whole: options, leading to choices that maximize utility. 1. A Country's Standard of Living Depends on Its 4. Restrictions: Ability to Produce Goods and Services: ○ People face constraints they cannot change ○ Higher productivity leads to a better standard and must take them as given. of living. 5. Opportunity Cost: 2. Prices Rise When the Government Prints Too ○ Choosing one option always means Much Money: forgoing others. ○ Excess money supply leads to inflation. 6. The Economic Principle: 3. Society Faces a Short-Run Trade-off Between ○ The application of rationality to scarcity: Inflation and Unemployment: minimizing cost or maximizing utility. ○ Reducing inflation may temporarily increase 7. Efficiency: unemployment. ○ Getting maximum benefits from scarce resources. Invisible Hand- The invisible hand allows the market to reach 8. Marginal Analysis: equilibrium without government or other interventions forcing it ○ Weighing additional benefits against into unnatural patterns. additional costs. 9. Equilibrium: ○ Basic economic models compare different equilibria (comparative statics). 10. Game Theory: ○ Studies interdependent situations where strategic behavior affects outcomes. CHAPTER 2 A, C: Efficient points B: Inefficient point. First Model. The circular-flow Diagram D: Beyond the possibility frontier and devoted to the scarcity of the resources, it is an impossible point to reach for this ○ It is a visual model of the economy that shows how economy given the factors that they cannot go there and dollars flow through markets among households and produce firms. ○ The economy has two types of decision makers: Households and firms ○ Firms: Produce goods and services, using inputs, such as labor, land and capital (buildings and machines. ○ Inputs are called factor of production. (land, labor, capital). Outputs are service and goods ○ Households own the factors of production and consume all the goods and services that firms Production Possibilities Frontier produce. ○ Households and firms interact in two types of - They can producer inside the economy markets. In the markets for goods and services. ○ Imagine that there is an advance in technological in ○ Households are sellers and firms are sellers. the computer industry, raising the numbers of ○ Households provide firms the inputs that the firms use computer produced per worker. to produce goods and services. ○ The PPF shifts outward. ○ Inner loop represents the flow of goods and services between households and firms. The household sell the use of their labor, land and capital to the firms. ○ The firms use these factors to produce goods and services. Factors of production flow from households to firms, and goods and services flow from firms to households. ○ The outer loop represents the flow of dollars. The households spend money to buy goods and services from the firms. ○ The firms use some of the revenue from these sales to pay for the factor of production. ○ We see a summary of scarcity, efficiency, tradeoffs, ○ The profit of the firms owner, who themselves are opportunity cost, and economic growth members of households. Microeconomics - It is the study of households and firms make decisions and how they interact in specific markets. Macroeconomics - It is the study of economy wide phenomena, including inflation, unemployment, and economic growth. The Role of Economists - As Scientists: Develop and test theories, collect and analyze data to understand economic behavior. - As Policy Advisors: Apply economic knowledge to advise on improving economic outcomes, such as reducing Second Model: The production possibilities frontier. unemployment or controlling inflation. ○ It is an economy that just produces only two goods, Positive vs. Normative Analysis: cars and computers. - Positive Analysis: Objective, fact-based (e.g., "The ○ Together they use all the factor of production unemployment rate is 6%"). available. -Normative Analysis Subjective, value-based (e.g., "The The production possibilities frontier is a graph that government should reduce unemployment"). shows the various combinations of output (cars and computers). - Economists may agree on facts but differ on policies due to ○ They can produce given the available factors. varying normative views. EXERCISES: C. Imagine a society that produces military goods (guns) and consumer goods (butter). A. One common assumption in economics is that the products of different firms in the same industry are indistinguishable. For 1. Draw a production possibilities frontier (PPF) for guns each of the following industries, discuss whether this is a and butter, and explain why it most likely has a reasonable assumption. bowed-out shape. A.steel - We can consider as indistinguishable, because it is almost as commodity. Then the product offered by different companies could be assumed as equal. B. Novels - There are several authors, and all the writers have different styles to write. Then in this case is almost impossible to think in equal good. C. Wheat. - It is a commodity. We can talk about similar goods - The bowed-out shape is given by the nature of usually when the good do not have too much process. resources. D. Fast food. - This means that the opportunity cost of guns in terms - It is reasonable to think as indistinguishable good, of butter depends on how much of each good the because there is almost the same good for different economy is producing. producers. - The PPF is bowed out because of the opportunity cost associated with reallocating resources between B. 1. Sam pays a storekeeper $1 for a quart of milk: Sam, the production of guns and butter. As more resources representing a household, buys milk, representing the flow of are devoted to producing one good, the opportunity dollars in the outer loop. The storekeeper, part of the goods cost of producing the other good increases. For and services market, provides the milk in exchange for $1. example, producing more guns requires sacrificing a significant amount of butter, especially as you move 2. Sally earns $4.50 per hour working at a fast-food restaurant: closer to the maximum production of guns. Sally offers labor to a firm in the market for factors of production, earning $4.50 per hour. The firm receives labor in 2. Show a point that is impossible for the economy to return. achieve. Show a point that is feasible but inefficient. 3. Serena spends $7 to see a movie: Serena, a household D: Impossible to achieve. member, spends $7 on a service (movie). The firm provides B: Feasible but inefficient the service in exchange. 4. Stuart earns $10,000 from his 10% ownership of Acme Industrial: Stuart’s capital investment results in a $10,000 return from Acme Industrial, representing the flow of dollars in the outer loop. The firm compensates him for his capital contribution. 3. Imagine that the society has two political parties, called the Hawks (who want a strong military) and the Doves (who want a smaller military). Show a point on your production possibilities frontier that the Hawks and a point the Doves might choose  4. Imagine that a neighboring country reduces the size The impact or higher national saving on economic of its military. As a result, both political parties, the growth. (Macro) Hawks (who favor a strong military) and the Doves A firm's decision about how many workers to hire. (who favor a smaller military), reduce their desired (Micro) production of guns by the same amount. Which party The relationship between the inflation rate and would get the bigger "peace dividend" (measured by changes in the quantity of money.(Macro) the increase in butter production)? F. Classify each of the following statements as positive or normative. Explain. Society faces a short-run tradeoff between inflation and unemployment. (Positive). It is a fact due to the Philips curve. A reduction in the rate of growth of money will reduce the rate of inflation. (Positive) One of the principles of economics. The Federal Reserve should reduce the rate of growth of money. (Normative) prescriptive value. Society ought to require welfare recipients to look for - The party that would get a bigger peace dividend is jobs. (Normative) the Hawk party. Lower tax rates encourage more work and more - This is given by the slope at this point. saving. (Positive). - The Doves, who initially produced fewer guns, will experience a smaller increase in butter production because the opportunity cost of guns was higher for them. In contrast, the Hawks, who initially produced more guns, will experience a larger increase in butter production because the opportunity cost of producing guns was lower. Therefore, the Hawks will receive a bigger peace dividend. D. The first principle of economics discussed in Chapter One is that people face trade-offs. Use a PPF to illustrate a society's trade-off between a clean environment and high incomes. What do you suppose determines the shape and position of the frontier? Show what happens to the frontier if engineers develop an automobile engine with almost no emissions. - If engineers develop an automobile engine with almost no emissions, the PPF would shift outward, indicating that society can achieve higher incomes without sacrificing as much environmental quality. This technological advancement would effectively reduce the opportunity cost of maintaining a clean environment while pursuing economic growth. E. Classify the following topics a relating to microeconomics or macroeconomics. A family's decision about how much income to save. (Micro) The effect of government regulations on auto CHAPTER 3 emissions. (Macro) Interdependence and the gains from trade  - the ability to produce a good using fewer inputs than Interdependence between countries. another producer There are two goods in the world: meat and potatoes. The rancher needs 8 hours to produce a pound of There are two people in the world a cattle rancher and potatoes. a potato farmer. The farmer needs 10 hours. Each of whom would like to eat both meat and There is absolute advantage for the rancher potatoes. Absolute advantage is the comparison among The gains are most obvious if the rancher can producers of a good according to their productivity. produce only meat and the farmer just potatoes. Absolute advantage in both goods Trade would allow them to enjoy greater variety. Comparative advantage - the ability to produce a good at a lower opportunity cost than another producer We can compare through opportunity costs The rancher producing 1 pound of potatoes, she spends 8 hours of work, then she lost these hours for producing meat. The 8 hours lost can be used producing 8 pounds. Hence the cost of 1 pound of potatoes is 8 pounds of meat. The farmer producing 1 pound of potatoes takes him 10 hours. Because he needs 20 hours to produce 1 pound of meat. 10 hours would yield ½ of meat. Hence, the opportunity cost of 1 pound of potatoes is ½. - Improve situations with trade The producer who has the smaller opportunity cost of producing a good. Then it has the comparative advantage producing this good. The producer with the small opportunity cost of producing meat is the Rancher. The producer with small opportunity cost of producing potatoes is the farmer. The farmer gets 3 pound of meat in exchange of 1 pound of potatoes: price 1/3 pound of potatoes instead of 1 pound of meat for 2 pounds of potatoes The rancher gets one pound of potatoes for 3 pounds of meat. Her cost is one pound of potatoes for 8 pounds of meat. Imports - goods produced abroad and sold domestically Exports - goods produced domestically and sold abroad Chapter in a Nutshell Each person consumes goods and services produced by many other people both in the United States and around the world. Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services. There are two ways to compare the abilities of two people to produce a good. The person who can produce the good with the smaller quantity of inputs is said to have an absolute advantage in producing the good. The person who has the lower opportunity cost of producing the good is said to have a comparative advantage. The gains from trade are based on Absolute Advantage comparative advantage, not absolute advantage.  Trade makes everyone better off because it allows people to specialize in those activities in which they have a comparative advantage. The principle of comparative advantage applies to countries as well as to people. Economists use the principle of comparative advantage to advocate free trade among countries. 1. C 2. B 3. A CHAPTER 4 The Market Forces of Supply and Demand The Demand Curve: The Relationship between Price and Quantity Demanded The terms supply and demand refer to the behavior of people as they interact with one another in competitive The quantity demanded of any good is the amount of the markets. Before discussing how buyers and sellers behave, good that buyers are willing and able to purchase. let’s first consider more fully what we mean by the terms market and competition. law of demand the claim that, other things being equal, the quantity demanded of a good falls when the price of the good - A market is a group of buyers and sellers of a rises particular good or service. - The buyers as a group determine the demand for the INVERSE RELATIONSHIP- taas baba product, and the - sellers as a group determine the supply of the What determines the quantity an individual demands? product. Quantity demanded: It is the amount of the good that buyers Competitive market to describe a market in which there are are willing and able to purchase. We think in this parte about so many buyers and so many sellers that each has a negligible ice cream. impact on the market price. Price: If the price rises, you would consume less. If the price fell you would buy more. The quantity demanded is negatively Perfectly competitive related to the price. This is the law of demand. - To reach this highest form of competition, a market Income: Lower income means you consume less. This is a must have two characteristics: normal good. There is other case, where the income goes up (1) The goods offered for sale are all exactly the you consume less. This is an inferior good. same, and Prices of Related goods: Price of frozen yogurt falls. These (2) the buyers and sellers are so numerous that no are called substitutes goods. Price of hot fudge increases. single buyer or seller has any influence over the These are called complements. market price. Tastes: If you like more the ice cream you buy more. Because buyers and sellers in perfectly competitive markets Expectations: If you expect you are contract is to finish, you must accept the price the market determines, they are said to will buy less. The price will go down tomorrow. be price takers. At the market price, buyers can buy all they want, and sellers can sell all they want. Monopoly: Just one seller (water) Oligopoly: Fewer sellers (cellphone) Monopolistically competitive: Many sellers, each offering a slightly different Not all goods and services, however, are sold in perfectly competitive markets. Some markets have only one seller, and this seller sets the price. Such a market is called a monopoly. Local cable television, for instance, is a monopoly if residents of the town have only one company from which to buy cable service. Many other markets fall between the extremes of Demand schedule a table that shows the relationship perfect competition and monopoly between the price of a good and the quantity demanded Demand curve a graph of the relationship between the price of a good and the quantity demanded (negative-downward)  Shifts in the Demand Curve- shift to the right or left - Because the market demand curve holds other things constant, it need not be stable over time. If something happens to alter the quantity demanded at any given price, the demand curve shifts. For example, suppose the American Medical Association discovers that people who regularly eat ice cream live longer, healthier lives. The discovery would raise the demand for ice cream. At any given price, buyers would now want to purchase a larger quantity of ice cream, and the demand curve for ice cream would shift. Movement- along the graph line Ceteris Paribus It assumes that income, tastes, expectations, and the prices of related products are not changing. All relevant variables, except those being studied at that moment, are held constant. It helps to isolate the impact of one independent variable on a dependent variable. For example, if the price of milk falls, ceteris paribus, the quantity of milk demanded will rise, assuming no other factors change. Figure 3 illustrates shifts in demand. Any change that increases the quantity demanded at every price, such as our Market Demand versus Individual Demand imaginary discovery by the American Medical Association, - Market demand is the sum of all individual demands shifts the demand curve to the right and is called an for a particular good or service increase in demand. Any change that reduces the quantity demanded at every price shifts the demand curve to the left and is called a decrease in demand. Movement along the demand curve: Price of the good itself (up or down) Shifts in the Demand Curve: Income, prices of related goods, tastes, expectations and number of buyers. (left or right) normal good a good for which, other things being equal, an increase in income leads to an increase in demand inferior good a good for which, other things being equal, an increase in income leads to a decrease in demand (An example of an inferior good might be bus rides. As your income falls, you are less likely to buy a car or take a cab and more likely to ride a bus.) (pag tumagal/continuous consumption magiging normal) substitutes two goods for which an increase in the price of one leads to an increase in the demand for the other Perfect substitute- same product diff brand (starbs/dunkin)11 complements two goods for which an increase in the price of one leads to a decrease in the demand for the other 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 4. B 5. A 6. d The Supply Curve: The Relationship between Price and Quantity Supplied The quantity supplied of any good or service is the amount that sellers are willing and able to sell. law of supply the claim that, other things being equal, the quantity supplied of a good rises when the price of the good rises Price tumaas - Quantity supply tataas - maximizing profit Supply - Quantity supplied, is the amount that sellers are willing and able to sell (upward sloping) What determines the quantity an individual supplies? ○ Price. When the price of an ice-cream is high then is more profitable to sell. The price and quantity is positively related to the price of the good. This relationship is called the law of supply. ○ Input Prices: In ice cream: machines, labor of workers, cream, sugar, flavoring, etc. When the price of one or more of these inputs rises, producing is less profitable, and the supply decreases. Negatively related. ○ Technology: Technology of turning this inputs in ice cream. For instance, the production automatized. ○ Expectations: If you expect that the price of the ice-cream will increase, then you supply less today. Market Supply versus Individual Supply At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity Just as market demand is the sum of the demands of all that sellers are willing and able to sell. buyers, market supply is the sum of the supplies of all sellers. equilibrium price is sometimes called the market-clearing price because, at this price, everyone in the market has been satisfied: Buyers have bought all they want to buy, and sellers have sold all they want to sell. surplus a situation in which quantity supplied is greater than Shifts in the Supply Curve quantity demanded - There is a surplus of the good: Producers are unable to sell all they want at the going price. - A surplus is sometimes called a situation of excess supply. shortage a situation in which quantity demanded is greater than quantity supplied - There is a shortage of the good: Consumers are unable to buy all they want at the going price. - A shortage is sometimes called a situation of excess demand - Input prices - Technology - Expectations - baba ang product don’t produce - Number or sellers- monopoly and competitive EQUILIBRIUM law of supply and demand the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded of that good into balance equilibrium Supply refers to the position of the supply curve, whereas the a situation in which the market price has reached the level at quantity supplied refers to the amount producers wish to sell. which quantity supplied equals quantity demanded The economy goes where it needs to go equilibrium price the price that balances quantity supplied and quantity demanded equilibrium quantity the quantity supplied and the quantity demanded at the equilibrium price The price will adjust para macatch up ng bagong equilibrium To summarize - A shift in the supply curve is called a “change in supply,” and - A shift in the demand curve is called a “change in demand.” - A movement along a fixed supply curve is called a “change in the quantity supplied,” and - a movement along a fixed demand curve is called a 10. B “change in the quantity demanded.” 11. A 12. C 13. D Economists use the model of supply and demand to analyze competitive markets. In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price. The demand curve shows how the quantity of a good demanded depends on the price. According to the law of demand, as the price of a good falls, the quantity demanded rises. Therefore, the demand curve slopes downward. In addition to price, other determinants of how much consumers want to buy include income, the prices of substitutes and complements, tastes, expectations, and the number of buyers. When one of these factors changes, the quantity demanded at each price changes, and the demand curve shifts. The supply curve shows how the quantity of a good supplied depends on the price. According to the law of supply, as the price of a good rises, the quantity supplied rises. Therefore, the supply curve slopes upward. In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers. When one of these factors changes, the quantity Summary supplied at each price changes, and the supply curve We have just seen three examples of how to use supply and shifts. demand curves to analyze a change in equilibrium. Whenever The intersection of the supply and demand curves an event shifts the supply curve, the demand curve, or perhaps represents the market equilibrium. At the equilibrium both curves, you can use these tools to predict how the event price, the quantity demanded equals the quantity will alter the price and quantity sold in equilibrium. Table 4 supplied. shows the predicted outcome for any combination of shifts in The behavior of buyers and sellers naturally drives the two curves. To make sure you understand how to use the markets toward their equilibrium. When the market tools of supply and demand, pick a few entries in this table and price is above the equilibrium price, there is a surplus make sure you can explain to yourself why the table contains of the good, which causes the market price to fall. the prediction that it does. When the market price is below the equilibrium  price, there is a shortage, which causes the market Narrowly defined markets tend to have more elastic demand price to rise. than broadly defined markets because it is easier to find close To analyze how any event influences the equilibrium substitutes for narrowly defined goods. price and quantity in a market, we use the supply-and-demand diagram and follow three steps. - if we go narrow, it is going to be more elastic. First, we decide whether the event shifts the supply - For example, food, a broad category, has a fairly curve or the demand curve (or both). Second, we inelastic demand because there are no good decide in which direction the curve shifts. Third, we substitutes for food. Ice cream, a narrower category, compare the new equilibrium with the initial has a more elastic demand because it is easy to equilibrium. substitute other desserts for ice cream. In market economies, prices are the signals that guide decisions and allocate scarce resources. For every Time horizon: good in the economy, the price ensures that supply and demand are in balance. The equilibrium price - Tends to be more elastic with the time. then determines how much of the good buyers - Goods tend to have more elastic demand over longer choose to consume and how much sellers choose to time horizons. produce - Example: When the price of gasoline rises, the quantity of gasoline demanded falls only slightly in the first few months. Over time, however, people buy CHAPTER 5 more fuel-efficient cars, switch to public transportation, and move closer to where they work. ELASTICITY AND ITS APPLICATION Computing the price elasticity of demand Elasticity Percentage change in quantity demanded divided by - is a measure of how much buyers and sellers respond the percentage change in the price: to changes in market conditions, allows us to analyze supply and demand with greater precision. Price elasticity of demand = Percentage change in quantity demanded/Percentage change in price Elasticity of demand: - It measures how much demand responds to changes That there is and increase 10% in ice cream price, in its determinants. and there is a decrease of 20% in consumption. The price elasticity of demand and its determinants. Price elasticity of demand =20%/10% = 2 - a measure of how much the quantity demanded of a good responds to a change in the price of that good, The change in the quantity demanded is computed as the percentage change in quantity proportionately twice as large as the change in the demanded divided by the percentage change in price price. We just take into account positive values. It measures how much the quantity demanded (Mathematicians call this the absolute value.) With responds to a change in price. this convention, a larger price elasticity implies a Elastic: Quantity demanded responds substantially greater responsiveness of quantity demanded to to changes in the price. changes in price. Inelastic: Quantity demanded responds only slightly to changes in the price. The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities Necessities vs luxuries. - Inelastic and elastic. Availability of Close Substitutes: - Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others. - elastic. Examples: pepsi and coca cola. Eggs- less elastic Definition of the market: (6-4) / 5 x 100= 40% The Variety of Demand Curves - Demand is considered elastic when the elasticity is greater than 1, which means the quantity moves proportionately more than the price. - Demand is considered inelastic when the elasticity is less than 1, which means the quantity moves proportionately less than the price. - If the elasticity is exactly 1, the percentage change in quantity equals the percentage change in price, and demand is said to have unit elasticity. Total Revenue and the Price Elasticity of Demand Total revenue - the amount paid by buyers and received by sellers of a good. In any market - total revenue is P x Q, the price of the good times the quantity of the good sold. - When demand is inelastic (a price elasticity less than 1), price and total revenue move in the same direction: If the price increases, total revenue also increases.  Other Demand Elasticities. The income Elasticities. To measure how the quantity demanded changes as consumer income changes. Income elasticity of demand = Percentage change in quantity demanded/Percentage change in income Normal goods: Higher income raises quantity - When demand is elastic (a price elasticity greater demanded. Positive. than 1), price and total revenue move in opposite Inferior goods: Higher income lowers the quantity directions: If the price increases, total revenue demanded. Negative. decreases. - If demand is unit elastic (a price elasticity exactly Cross-price elasticity of demand equal to 1), total revenue remains constant when the - measures how the quantity demanded of one good price changes. responds to a change in the price of another good. cross-price elasticity of demand = percentage change in quantity demanded of good 1/percentage change in the price of good 2 substitutes are goods that are typically used in place of one another, such as hamburgers and hot dogs. An increase in hot dog prices induces people to grill hamburgers instead. Because the price of hot dogs and the quantity of hamburgers demanded move in the same direction, the cross-price elasticity is positive. Conversely, complements are goods that are typically used together, such as computers and software. In this case, the cross-price elasticity is negative, indicating that an increase in the price of computers reduces the quantity of software demanded. Inelastic: Increase in price increase revenue. Decrease in Price decrease revenue. The Elasticity of Supply Elastic: Increase in Price decrease revenue. Decrease in Price increase revenue. ○ It measures how much the quantity supplied responds to changes in the price. ○ Elastic: Quantity supplied responds substantially to changes in the price. ○ Inelastic if the quantity supplied responds only slightly to changes in the price. ○ Supply is usually more elastic in the long run than in the short run. Computing the Price Elasticity of Supply Elasticity and Total Revenue along a Linear Demand Curve The Variety of Supply Curves CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT How Price Ceilings Affect Market Outcomes price ceiling - a legal maximum on the price at which a good can be sold How Price Floor Affect Market Outcomes price floor - a legal minimum on the price at which a good can be sold Purpose of Floor Price - To protect the producer from abusive consumer (barat customers) Purpose of Ceiling Price - To protect consumer from abusive producers (over priced na sellers) - Monopoly (gas) Maximize the utility of the goods that they are buying Price is the correcting mechanism Minimum Wage - When wages are higher more people want to work  - Floor Price Effective Price= Market Price-Tax - Can lead to unemployment (not afford by the firm) Elasticity and Tax Incidence tax incidence - the manner in which the burden of a tax is shared among participants in a market Government- steps in to control price TAXES- payments that individuals and businesses are required to make to the government How Taxes on Buyers Affect Market Outcomes A tax burden falls more heavily on the side of the market that is less elastic. - elasticity measures the willingness of buyers or sellers to leave the market when conditions become unfavorable. - A small elasticity of demand means that buyers do not have good alternatives to consuming this particular good. - A small elasticity of supply means that sellers do not have good alternatives to producing this particular good. p1. Initial Price and price received by sellers - When the good is taxed, the side of the market with P3: Price paid by buyers fewer good alternatives is less willing to leave the р3 - p1 = Tax market and, therefore, bears more of the burden of How Taxes on Sellers Affect Market Outcomes the tax. ○ Taxes discourage market activity. When a good is taxed, the quantity of the good sold is smaller in the new equilibrium. ○ Buyers and sellers share the burden of taxes. In the new equilibrium, buyers pay more for the good, and sellers receive less.  CHAPTER 21 THE THEORY OF CONSUMER CHOICE Introduction ○  hen you enter in a supermarket you face decision, W what to buy taking into account prices and preferences. ○ We have summarized consumer's decision throughout consumer demand. ○ Demand's curve reflect willingness to pay. ○ P up Q down ○ We will have a look more in the decision behind. ○ People face trades-off The Budget Constraint: What the Consumer Can Afford Most people would like to increase the quantity or quality of the goods they consume—to take longer vacations, drive fancier cars, or eat at better restaurants. People consume less than they desire because their spending is constrained, or limited, by their income. Preferences: What the Consumer Wants Representing Preferences with Indifference Curves - The consumer’s preferences allow her to choose among different bundles of pizza and Pepsi. - If you offer the consumer two different bundles, she chooses the bundle that best suits her tastes. If the two bundles suit her tastes equally well, we say that the consumer is indifferent between the two bundles. B. All in Pepsi An indifference curve C. Middle Point - shows the various bundles of consumption that make A. All in Pizza the consumer equally happy. In this case, the indifference curves show the combinations of pizza Budget constraint and Pepsi with which the consumer is equally satisfied. - shows the consumption bundles that the consumer can afford. In this case, it shows the trade-off between Marginal rate of substitution (MRS) pizza and Pepsi that the consumer faces. - The slope at any point on an indifference curve The slope of the budget constraint equals the rate at which the consumer is willing to substitute one good for the other. This rate is called - measures the rate at which the consumer can trade the marginal rate of substitution (MRS). one good for the other. Recall that the slope between two points is calculated as the change in the vertical distance divided by the change in the horizontal distance (“rise over run”).  MRS = 1 you value both the same may more thirsty than hungry. The bowed shape of the indifference curve reflects the consumer’s greater willingness to give up a good that she already has a lot of. Two Extreme Examples of Indifference Curves - The shape of an indifference curve reveals the consumer’s willingness to trade one good for the 1. I2 is preferred than I1 other. 2. c is indiferent to b - When the goods are easy to substitute for each other, 3. b is indiferent to a the indifference curves are less bowed; when the 4. c is indiferent to a goods are hard to substitute, the indifference curves 5. d is preferred to a, b & c are very bowed. 6. Marginal Rate of Substitution. Four Properties of Indifference Curves Property 1: Higher indifference curves are preferred to lower ones People usually prefer to consume more goods rather than less. Higher indifferent curves represent larger quantities Perfect substitutes Property 2: Indifference curves are downward sloping. - two goods with straight line indifference curves It reflects the rate at which one consumer wants to Perfect complements substitute one for the other. - two goods with right angle indifference curves if the quantity of one good is reduced, the quantity of the other good must increase for the consumer to be equally happy. For this reason, most indifference curves slope downward. Property 3: Indifference curves do not cross. Optimization: What the Consumer Chooses - This contradicts our assumption that the consumer always prefers more of both goods to less. Thus, two pieces necessary for this analysis: indifference curves cannot cross. - the consumer’s budget constraint (how much she Property 4: Indifference curves are bowed inward. can afford to spend) and the consumer’s preferences (what she wants to spend it on). Now we put these two pieces together and consider the consumer’s decision about what to buy. The Consumer’s Optimal Choices - The slope of an indifference curve is the Marginal Rate of Substitution. - The MRS depends on the place where the consumer is. MRS = 6 You are more hungry than thirsty - The consumer would like to end up with the best possible combination.  - It could be the case that end up on or below the budget constraint b. Point below the budget constraint a. Point on the budget constraint Optimal: Slope of MRS is equal slope of budget constraint - Indifference curve is tangent to budget constraint - The slope of Indifference curve is MRS - The slope of budget constraint is the relative price among Pepsi and Pizza Thus, the consumer chooses consumption of the two goods so that the marginal rate of substitution equals the How Changes in Prices Affect the Consumer’s Choices relative price. FYI-Utility An Alternative Way to Describe Preferences and Optimization We can represent preferences with the concept of utility. Utility is an abstract measure of the satisfaction or happiness that a consumer receives for a bundle of goods. A consumer prefer one bundle to another if it provides higher utility. An indifference curve returns the same level of utility. Income and Substitution Effects "equal-utility" curve. Marginal utility is the additional utility you get for an income effect additional unit of that good. - the change in consumption that results when a price Most goods are assumed to exhibit diminishing change moves the consumer to a higher or lower marginal utility. indifference curve (higher income more bibilhin) "Utils" are hypothetical units used to measure substitution effect utility in economics. - the change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution How Changes in Income Affect the Consumer’s Choices Deriving the Demand Curve - consumer’s demand curve as a summary of the optimal decisions that arise from her budget constraint and indifference curves. - Reflects the change of consumption due to changes in price Three Applications Do All Demand Curves Slope Downward? When a good price rises, people buy less of it. This is reflected in the downward slope. Sometimes the demand curve can slope upward. Consumers can violate the law of demand, buy more when a price rises. ○ Due to higher wage she earns more consumption for every hour of leisure that she gives up. ○ Consumption increases but in different way. ○ Less leisure and more leisure. ○ Why if you receive more money you work less. ○ Leisure becomes more costly relative to consumption. ○ This encourage to change consumption to leisure (substitution effect) Giffen good ○ She tends to have more of both, those are normal goods (Income effect). - a good for which an increase in the price raises the ○ SE > IE: She will work more quantity demanded (inferior good) ex:apple or iphone ○ SE < IE: She will work less How Do Wages Affect Labor Supply? How Do Interest Rates Affect Household Saving? ○  e can use to find how people allocate time. W ○ How much consume today and how much save to the ○ Trade off between leisure and consumption. future. ○ Suppose a person that is awake 100 hours per week ○ Saul, planning for retirement. ○ For every hour she earns 50 dollars. The wage 50 ○ First period, Saul is young and working. He earns dollars reflects the trade off between leisure and 100,000 USD consumption. ○ Second period, old and retired ○ He divides this income between current consumption and saving. ○ When he is old he will consume what he has saved, included the interest that his saving have earned. ○ Suppose that the interest rate is 10%. For each dollar he saves he will get 1.1 USD when he is old. ○ The interest rate determines the relative price of these two goods.  equals the slope of the budget constraint (the relative price of the goods), and the consumer’s valuation of the two goods (measured by the marginal rate of substitution) equals the market’s valuation (measured by the relative price). CHAPTER 22 FRONTIERS OF MICROECONOMICS Introduction Economics try to understand the interactions and decision of individuals. All these decision we have seen are not perfect. Three situations. Asymmetric information: Some people better informed that others. Imbalance of information affect decision on individuals. Political Economy: Government policy can affect the market and influence the results. (power of subsidies, taxes, quotas to the imports, etc.) Behavioral Economics: Psychology into the study of economic issues. More realistic. Higher i and save less? Basic understanding of the ground Substitution effect: Consumption become less costly relative when young. It induces to consume Asymmetric Information more now. Income effect: He goes to higher indiference curve “I know something you don’t know.” Better well being, having more consumption in both Different access to information or knowledge. This is periods. relevant to make decisions is called information IE > SE: Save less asymmetric. IE < SE: Save more A worker knows more how much effort he puts in the job. Hidden action. CONCLUSION: A seller of a used car knows more than the buyer about the car's condition. Hidden characteristic. -The theory of consumer shows how people make Uninformed party (the employer, the car buyer). decisions. They would like to know relevant information. - You can find different scenarios: two goods, work and Informed party (worker, seller)may have an incentive leisure, consumption and saving. to conceal it. - This is a model and this is not 100% realistic. SUMMARY: Hidden Actions: Principals, Agents, and Moral Hazard - A consumer’s budget constraint shows the possible combinations of different goods she can buy given her Moral hazard is a problem that arises when one income and the prices of the goods. The slope of the person, called the agent, is performing some task on budget constraint equals the relative price of the behalf of other person, called the principal. goods. - The consumer’s indifference curves represent her Agent preferences. An indifference curve shows the various - a person who is performing an act for another person, bundles of goods that make the consumer equally called the principal happy. Points on higher indifference curves are Principal preferred to points on lower indifference curves. The - a person for whom another person, called the agent, slope of an indifference curve at any point is the is performing some act consumer’s marginal rate of substitution—the rate at which the consumer is willing to trade one good for the other. If the principal cannot perfectly monitor the agent's - The consumer optimizes by choosing the point on her behavior, the agent tends to undertake less effort budget constraint that lies on the highest indifference than the principal considers desirable. curve. At this point, the slope of the indifference curve The phrase moral hazard refers to the risk, or (the marginal rate of substitution between the goods) “hazard,” of inappropriate or otherwise “immoral”  behavior by the agent. In such a situation, the knowing they will be able to find employment principal tries various ways to encourage the agent to elsewhere. act more responsibly. - Conversely, a firm may choose to pay an above-equilibrium wage to attract a better Employment relationship: Employer (principal), worker mix of workers. (agent).The moral-hazard problem is the temptation of c. Health insurance. imperfectly monitored workers to shirk their responsibilities. - buyers of health insurance know more about Employers can respond to this problem in various ways: their own health problems than do insurance companies. Because people with greater Better monitoring. Employers may plant hidden hidden health problems are more likely to video cameras to record workers’ behavior. The aim is buy health insurance than are other people, to catch irresponsible actions that might occur when the price of health insurance reflects the supervisors are absent. costs of a sicker-than-average person. High wages. According to efficiency-wage theories - As a result, people with average health may (discussed in Chapter 19), some employers may observe the high price of insurance and choose to pay their workers a wage above the level decide not to buy it. that balances supply and demand in the labor market. A worker who earns an above-equilibrium wage is In the used car market, owners of good cars may less likely to shirk because if he is caught and fired, choose to keep them rather than sell them at the low he might not be able to find another high-paying job. price that skeptical buyers are willing to pay. Delayed payment. Firms can delay part of a worker’s In the labor market, wages may be stuck above the compensation, so if the worker is caught shirking and level that balances supply and demand, resulting in is fired, he suffers a larger penalty. unemployment. Example: One example of delayed compensation is In insurance markets, buyers with low risk may the year-end bonus. Similarly, a firm may choose to choose to remain uninsured because the policies they pay its workers more later in their lives. Thus, the are offered fail to reflect their true characteristics. wage increases that workers get as they age may Advocates of government-provided health insurance reflect not just the benefits of experience but also a sometimes point to the problem of adverse selection response to moral hazard. as one reason not to trust the private market to provide the right amount of health insurance on its Hidden Characteristics: Adverse Selection and the own. Lemons Problem Signaling to Convey Private Information Adverse selection is a problem that arises in markets in which the seller Signaling knows more about the attributes of the good being - which refers to actions taken by an informed party for sold than the buyer does. the sole purpose of credibly revealing his private buyer runs the risk of being sold a good of low quality. information. Example: - Offers a way of solving the situation of asymmetric a. Used cars. information - Sellers of used cars know their vehicles’ Example: defects while buyers often do not. Because 1. Chapter 16, firms may spend money on advertising to owners of the worst cars are more likely to signal to potential customers that they have sell them than are the owners of the best high-quality products. cars, buyers are worried about getting a 2. Chapter 19, students may earn college degrees “lemon.” As a result, many people avoid merely to signal to potential employers that they are buying vehicles in the used car market. high-ability individuals, rather than to increase their - This lemons problem can explain why a used productivity. car only a few weeks old sells for thousands of dollars less than a new car of the same (the informed party (the firm, the student) uses the signal type. A buyer of the used car might surmise to convince the uninformed party (the customer, the that the seller is getting rid of the car quickly employer) that the informed party is offering something of because the seller knows something about it high quality. that the buyer does not. b. Labor market ○ Firms that advertise, customer that try a product once - different information between workers and they will likely become common Users. firms. Workers know more about their ○ To enter into specific schools is hard. More talented abilities than firms do. students choose to get education as signal. Firms will - When a firm cuts the wage it pays, the more pay attention to this information. talented workers are more likely to quit, Screening to Uncover Private Information than the private entities involved in the transaction. For example: Screening In a healthcare market, the government may not fully understand individual health risks or medical histories - informed party takes actions to reveal private better than insurance companies and patients. information In labor markets, the government may lack information about the specific skills or productivity Example: levels of workers compared to employers. 1. A person buying a used car may ask that it be As a result, government interventions designed to correct the checked by an auto mechanic before the sale. A inefficiencies caused by asymmetric information may not seller who refuses this request reveals his private always lead to better outcomes. information that the car is a lemon. The buyer may decide to offer a lower price or to look for another car. - Government itself is an imperfect 2. Consider a firm that sells car insurance. The firm institution. The government itself is subject would like to charge a low premium to safe drivers to its own set of imperfections and and a high premium to risky drivers. But how can it tell limitations, which makes addressing market them apart? Drivers know whether they are safe or failures more difficult. These imperfections risky, but the risky ones won’t admit it. A driver’s include: history is one piece of information (which insurance Bureaucracy: Governments are often slow to companies in fact use), but because of the intrinsic respond and adapt to changing market conditions, randomness of car accidents, history is an imperfect which can make their interventions outdated or indicator of future risk. ineffective. Political Influence: Decision-making may be The insurance company might be able to sort out the influenced by political agendas rather than economic two kinds of drivers by offering different insurance efficiency, leading to suboptimal policies. policies that would induce the drivers to separate Inefficiency and Corruption: Government agencies themselves. might lack incentives to operate efficiently, and in some cases, corruption can skew the allocation of Asymmetric Information and Public Policy resources. - Chapter 7 that the equilibrium of supply and demand These imperfections mean that government intervention may is efficient in the sense that it maximizes the total not always lead to a more efficient or fair outcome. In some surplus that society can obtain in a market. cases, the government might introduce new problems while - Chapter 10 (Study of externalities). Chapter 11 (Public trying to solve existing ones, making the solution as flawed as goods) the initial market failure. - Chapter 15-17 (Imperfect competition). Chapter 20 (Poverty) Political Economy - Government can sometimes improve market outcomes. The Condorcet Voting Paradox ○ People with high quality car, have trouble when others think that they sell a lemon. Political economy (sometimes called the field of public ○ Healthy people with health insurance. choice) uses the methods of economics to study how government works. ○ Government can intervene in these markets. However, there are few problems. Example: - Private markets can deal with advantages of screening and signaling. These private ○ Example of a public park. Where should be located. mechanisms can sometimes alleviate the Many possibilities. negative effects of asymmetric information ○ Imagine three outcomes, A, B & C. without needing government intervention. - Government hardly ever has more information than private parties. Maybe it can be the best that can be achieved. Even if the government steps in to address the issue of asymmetric information, it faces a significant limitation: the government rarely has better information  ○ If people can choose between B &C. Type 1 (B), Type aggregating individual preferences into a valid set of 2 (B). Total of 80% for B. social preferences ○ If people can choose between A & B. Type 1 (A), The Median Voter Is King Type 3 (A). Total of 55% for A. ○ A Beats B. B beats C. Then "A is the best option" Despite the Arrow's theorem. ○ If people can choose between A & C. Type 2 (C), Democracy is the leader in terms of choosing leaders. Type 3 (C). Total of 65% for C. Imagine the situation of election between army and national parks. Condorcet paradox The voters prefer the election closer to the budget they prefer to spend. - is that democratic outcomes do not always obey this property of transitivity. The median voter theorem A>B>C A>CX - majority rule will produce the outcome most preferred by the median voter. - The narrow lesson is that when there are more than two options, setting the agenda (that is, deciding the order in which items are voted on) can have a powerful influence over the outcome of a democratic election. - The broad lesson is that majority voting by itself does not tell us what outcome a society really wants. Ar