Slide 1Slide 2Slide 3Slide 4Slide 5Slide 6Supply and Demand for New Motor VehiclesSlide 8Slide 9Demand For CementSlide 11Supply Shift: Market for GasolinePrice Elasticity of DemandSlide 14Slide 15Slide 16Price Elasticity of GasolineAn Inelastic Demand Curve for GasolineSlide 19Slide 20Revenue and Marginal RevenueProfit MaximizingProfit Maximizing RuleScale = volumes of produced homogeneous (the same type) outputSlide 25Slide 26Slide 27Slide 28Slide 29Slide 30Perfect competition:Slide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Slide 39Slide 401SENIOR OUTCOMES SEMINAR(BU385)ECONOMICS2 BASIC CONCEPTS IN ECONOMICS I •Opportunity costs•Equilibrium of supply (QS) and demand (QD)•Price elasticity of demand•Marginal costs, revenues, and profits•Economies of scale and scope3 BASIC CONCEPTS IN ECONOMICS I •Sunk costs and barriers to entry•Profit maximization by a competitive firm•Profit max by a monopoly and oligopoly•Pricing policies•Externalities4A rational (reasonable) decision suits interests of the decision maker.The opportunity cost of the rational decision is the value of the next best alternative that is sacrificed because of this decision5Essence of the opportunity cost:• Under scarcity, no gains without pains, i.e. each gain involves some loss• The value of the gain is determined by a ratio between its market price and the market price of the sacrificed next best alternative option.6Equilibrium of QS and QD is a price P* such that QS(P*)=QD(P*)At equilibrium, Quantity supplied = Quantity demandedPrices are information signals that pushQS and QDtowards equalitySupply and Demand for New Motor VehiclesGraph illustrates market equilibrium in new motor vehicle market.At a price of $28,500 buyers are willing to purchase 16.5 million vehicles.At same price, vehicle manufacturers are willing to produce 16.5 million vehicles.Market is in equilibrium since quantity demanded equals quantity supplied.8Equilibrium of QS and QD is a price P* such that QS(P*)=QD(P*) PQD, QSP1P2Surplus at P1Deficit at P29Shifts of DD curves PQD, QSRightward:Population upIncomes upLeftward:Population downIncomes downDemand For CementA construction boom in China increased the world demand for cement.As a result, there was a shift to the right in the demand curve for cement, with the market equilibrium going from point A to point B.11Shifts of SS curves PQD, QSRightward:Size of industry upTech progress upRelative prices of inputs downLeftward:Size of industry down Relative prices of Tech progress down inputs upSupply Shift: Market for GasolineThe graph to the left shows the impact of Hurricane Katrina on the gasoline market.Before the hurricane, equilibrium was at point A.The hurricane caused the supply curve to shift to the left, resulting in higher prices.Price Elasticity of DemandA utility-maximizing consumer will change his or her purchases when prices changes. The price elasticity of demand will determine how much the purchases will change.The price elasticity of demand is the percentage change in quantity demanded that results from a one percent change in price.A price elasticity of 1 means that a 10% increase in price leads to a 10% decrease in quantity demanded.14Elasticity of demand with respect to changes in prices:η = ΔQD/QD : ΔP/PΔQD/QD percentage change in demandΔP/P percentage changes in priceη is the key measure of sensitivity of demand to changes in pricesPrice Elasticity of DemandAn elasticity of 2 means that a 10% increase in price leads to a 20% decrease in quantity demanded. An elasticity of 0.5 means that a 10% increase in prices leads to a 5% decrease in quantity demanded. Demand for a good or service is inelastic if its price elasticity is less than 1, and it is elastic if its price elasticity is greater than 1.16Elastic demand curve: η>1Inelastic demand curve: η<1Unit-elastic demand curve: η=1 PQD 450η>1 (luxury)η=1η<1 (necessities)Price Elasticity of GasolinePrice Annual quantity of gasoline demanded (gallons)Before: $3.00 800After: $3.30 780Percentage change: (3.30-3.00)/3.00 =10%Percentage change:(780-800)/800= -2.5%Elasticity: (-2.5%/10%) = 0.25An Inelastic Demand Curve for GasolineDemand curve 780$3.00Price per gallon800Annual quantity of gasoline bought (gallons)$3.3019Marginal costs (MC) are costs of producing an additional unit of outputSuppose 50 units are already producedTC:= Total costMC (of the 51th unit)= TC (of 51 units)- TC (of 50 units)20Fixed costs (FC) are incurred no matter how much units are producedVariable costs (VC) increase as a volume of production increases Fixed vs. Variable CostsRevenue and Marginal RevenueRevenue is the amount of money companies get from selling their products or services. If company sells only one product at a fixed price, then revenue is calculated by:Multiplying the number of units sold by the price per unit.The marginal revenue is the additional money that the business gets from producing and selling one more unit of output.Profit MaximizingProfits depend on the difference between revenue and cost.Both revenue and cost are affected by the level of production.The business should produce at an output level that maximizes profits.This level can be found by using the profit-maximizing rule.Profit Maximizing RuleThe business will maximize profits at the output level where:marginal revenue = marginal costsThis means that a profit-maximizing business will increase production as long as marginal revenue exceeds marginal costs.(MR>MC)It makes sense to increase production in this case, since it will earn a profit for the firm. (Not so if MR<MC)24Scale = volumes of produced homogeneous (the same type) outputScale + Scope = volumes of produced homogeneous and heterogeneous outputsScope = volumes of produced heterogeneous (different types) outputs25Economies of scale (ES) are changes in efficiency due to changes in volumes of output Decreasing ECScaleACConstant ES Increasing ES26Increasing ES: costs of additional units of output go down due to rationalization of operations fixed costs per unit decreaseDecreasing ES: costs of additional units of output go up due to increasing difficulties of managing added operations27Sunk costs are costs that cannot be recouped Barriers to entry into an industry or market are costs that outsiders should incur to become insiders Higher barriers