Economics PDF

Section 1 The average supermarket has about 31,530 different items. Adam Smith wrote An Inquiry into the Wealth of Nations Scarcity implies that every choice we make requires us to give up something to get something else. Trade-Offs ○ Watching a movie instead of working ov...

Section 1 The average supermarket has about 31,530 different items. Adam Smith wrote An Inquiry into the Wealth of Nations Scarcity implies that every choice we make requires us to give up something to get something else. Trade-Offs ○ Watching a movie instead of working overtime for 10 more dollars ○ Spending 10 dollars on the movies that you now can't spend on video games or college savings. Opportunity Cost ○ Definition: The cost of what you choose is what you have to give up to get it. ○ Example: Your friend offers you a FREE baseball game ticket, but you planned to mow lawns at the time of the game. Even though the ticket is free you are losing 60 dollars you could have made mowing lawns. Rationality: ○ Considering something purely based off the benefits (opportunity cost vs. opportunity cost) ○ No emotions are considered. Example: Make this new factory will produce 200 million per year but then the whole world be severely polluted ○ This doesn't matter to someone using only rationality. ○ Rationality is often determined off of broad estimations. (cost-benefit analysis) The same way that a basketball player does not stop to calculate the physics behind a perfect three-point shot. Gains From Trade:  ○ People have different skills, interests, and resources, so we tend to be better at and enjoy some activities more than others. Everyone benefits by specializing in what we do best and trading with others with different strengths. Voluntary exchanges occur when both parties find the trade more beneficial than costly. Positive Economics: ○ It focuses on identifying cause-and-effect relationships and measuring their size. ○ Uses previous information to make predictions. ○ In this sense, positive economics is essentially value-free. ○ Example: Positive economics tells us how much we might expect the consumption of gasoline to decrease when the price of gasoline increases. Normative Economics ○ Normative Economics is about opinions and what people think should happen. ○ Example: “I think everyone should share their toys because that’s fair.” Question: So Positive is saying what will happen if something happens but, Normative is saying what should happen and why regardless of its effect? ○ Exactly! You've got it: Positive economics focuses on describing and predicting what will happen in the economy if certain actions are taken. It's based on facts and data, like saying, "If the price of ice cream goes up, people will buy less ice cream." It doesn't make any judgment about whether this outcome is good or bad; it just states what is likely to happen. Normative economics deals with opinions and suggestions about what should happen in the economy, based on personal beliefs or values. It's about what people think is the right thing to do, regardless of the actual outcomes. For example, "The government should provide free healthcare to everyone because it's the fair thing to do," is a normative statement. It expresses an opinion about what ought to be done, not what will happen. So, positive economics is about facts and predictions, while normative economics is about opinions and what people think is best.  Efficiency ○ Pareto Efficiency (Vilfredo Pareto (1848-1923)) If there is no way to improve at least one person's well-being without reducing the well-being of another person, Pareto Efficiency has been achieved. Notice that Pareto efficiency can characterize a wide range of different economic outcomes. Consider, for example, an economy with ten people that produces $100 worth of goods and services. If each citizen receives $9 of benefits and $10 of production is wasted, then this outcome is not Pareto efficient. Redistributing the $10 would make at least some of the citizens better off without making any of them worse off. On the other hand, a situation in which each citizen receives $10 is Pareto efficient; there is no way to increase the well-being of any citizen without reducing the benefits of another. However, it is also Pareto Efficiency if one person gets $91 and the other gets $1 because you would have to decrease the well-being of the person with $91 to increase the pay of the people with $1. Section 2 The Interaction of supply and demand in markets is the central topic of microeconomics. A Market is comprised of buyers and sellers of a good or service. ○ Some markets, such as the New Stock Exchange or the Chicago Mercantile Exchange are highly organized (Buyers and sellers all meet in one location and an auctioneer helps to set a price at which the exchange will take place in. We say that a market is perfectly competitive if the good or service being bought and sold is highly standardized, the number of buyers and sellers is large, and all of the participants are well informed about the market price. ○ In such a market, buyers and sellers know they can buy or sell as much as they wish without influencing the market price.  If the price of the good is higher, buyers will demand less of the good; if the price is lower, then they will demand more. ○ This negative relationship between a good’s price and the quantity demanded is called the law of demand. The law of demand is a result of the cost-benefit analysis that rational decision-makers use when deciding how to allocate their resources. As the price of a good increases, the opportunity cost of consuming that good also increases since consumers must cut back on their consumption of other goods to afford the higher price. If, for example, the price of gasoline rises, people will likely find ways to reduce the amount they drive. They might do this by planning their trips more carefully or choosing to take the bus or ride a bicycle rather than drive. Figure 1  ○ ○ The table in Figure 1 illustrates how Steve’s purchases of gasoline each month depend on the price per gallon. At $1 per gallon, Steve buys 50 gallons; when the price rises to $2 a gallon, he cuts back to 45 gallons. If the price rises further, to $3 a gallon, he cuts back to 40 gallons. This table is called a demand schedule. ○ The graph in Figure 1 shows another way of representing Steve’s demand schedule. The downward-sloping line in this graph is called Steve’s demand curve. ○ NOTE: Look at the axes To find the market demand schedule, we must add up the quantity that every consumer will purchase at each possible price. Figure 2  ○ ○ Figure 2 illustrates how this process works with two individuals. In addition to Steve, the market now includes Nora. The table in Figure 2 shows that the market quantity demanded is the sum of the quantities that Steve and Nora wish to consume at that price. Normal Goods: A good that has a demand increase when there is an income increase and a demand decrease when there is a decrease in income. Goods for which the quantity demanded falls as income rises are called inferior goods. ○ Bus rides might be an example of an inferior good. As their income increases, consumers will be more likely to buy a car and drive instead of taking the bus. When the price of a good decreases and causes the demand for another good to decrease, we say that these goods are substitutes.  When a decrease in price for one good causes an increase in demand for another good these are called complements. Many factors influence the quantity supplied, but the most important is the price that suppliers receive. The higher the price is, the greater the quantity that suppliers will want to produce. This positive relation between price and quantity supplied is called the law of supply. Figure 4 ○ ○ Figure 4 illustrates the relationship between price and quantity supplied for Shelly. ○ Shelly’s supply curve is upward-sloping, reflecting the positive relationship between price and quantity supplied. Figure 5  ○ ○ The market supply curve is obtained by adding the quantities supplied at each price by all of the suppliers in the market. ○ This is illustrated in Figure 5 for the case where there are two suppliers. Again, we obtain the market supply curve by adding the individual supply curves horizontally. The market supply curve shows the quantity of something at each price. Input Prices ○ Inputs are anything that suppliers have to purchase to sell a product. Ex: the price that gas stations must pay their suppliers for is a major cost of doing business. If the price falls then the suppliers will sell more gas and the supply curve will shift right. Input Prices include:  Electricity Land taxes Etc. The more the input rises the less quantity supplied. The market tends to settle at equilibrium ○ Equilibrium is when no participant has any reason to change their behavior. ○ Equilibrium = Market Supply + Demand Curve intersection. Figure 6 ○ ○ In this hypothetical example, the equilibrium price is $2.50, and the equilibrium quantity is 10,000 gallons of gasoline per month. Figure 7 ○ At a price of $4, a gallon, for example, suppliers would like to sell 10,600 gallons, but buyers only wish to purchase 8,500 gallons a month. In other words, there is an excess supply. No one can force people to buy more gasoline than they want. Suppliers will find that they have too much gasoline on hand, their storage tanks are filling up, and they cannot unload their inventory. Under these circumstances, suppliers have an incentive to lower their price a little bit. If one station posts a price of $3.90 a gallon, it will attract buyers from other stations, and its surplus will be reduced. But once the other stations see that they are losing customers, they will be forced to lower their prices as well. The pressure to cut prices and attract business will not go away until the price has reached the equilibrium level of $2.50 a gallon.  ○ At a price of $1.50, there is an excess demand for gasoline. Buyers wish to purchase 11,000 gallons of gasoline, but suppliers are willing to sell only 9,600 gallons. Now there are shortages: some drivers cannot find any gasoline, and others have to wait in long lines to purchase gasoline. Buyers might be tempted to offer to pay a little bit extra to be sure to get what they need, and sellers will see they can raise prices without sacrificing sales. The pressure to raise prices will continue until the price has reached the equilibrium level. Only at this point will buyers and sellers have no desire to change their behavior. Competitive Markets tend to gravitate toward equilibrium Figure 8 ○ ○ If the concert promoter sets the price of tickets at $60, then Steve will not purchase a ticket, since the most he is willing to pay is $50. The other three consumers will all purchase tickets, but the benefit they receive from being able to purchase the ticket for $60 varies. Barb would have paid $100, so attending the concert produces a benefit valued at $40 for her. Since Bob was willing to pay $80, his benefit is $20, and Sharon’s benefit is just $10. Adding these amounts together, we see that the three purchasers receive a combined benefit of $70. We  call this amount the consumer surplus since it is the surplus value that consumers receive. Figure 9 ○ ○ If the market price exceeds this opportunity cost, the difference is a monetary measure of what is called the producer surplus. And we can measure the combined surplus of all suppliers using the area above the supply curve and below the market price as is illustrated in Figure 9. Consumer Surplus + Producer Surplus = Total Surplus Figure 11 ○ ○ BGH = Bovine Growth Hormone Increases milk production by 10-20 percent.  As is often the case, the introduction of new technology has other, more subtle effects, called externalities, that are not immediately obvious from an analysis of the market that is immediately affected. Figure 12 ○  ○ To illustrate the effect of public efforts to reduce smoking, Figure 12 shows the demand curve for cigarettes shifting to the left. ○ As a result, the intersection of the supply and demand curves shifts down and to the left along the market supply curve for cigarettes. After this shift, the equilibrium price and quantity both decrease. Elasticity ○ The competitive market model we have developed allows us to predict the direction in which equilibrium price and quantity will change in response to changes in market supply or demand. But to fully understand the impact of these changes, it is important to be able to measure the size of the changes in prices and quantities as well as their direction. ○ The price of elasticity demand measures how much the quantity demanded responds to a change in price Formula: Percentage change in quantity demanded _________________________________ Percentage change in price The price of elasticity demand shows how responsive consumers are to a price change. The greater the elasticity the greater the change in consumers. ○ Demand is said to be elastic when a one percent change in price results in a greater than one percent change in quantity demanded Price change = 1% Demand change = >1% ○ Demand is said to be inelastic when a one percent change in price results in a less than one percent change in quantity demand. Price change = 1% Demand change =