AGEC 3333 1st EditionExam # 1 Study Guide Intro:Economic Questions- What will be produced?- How will it be produced?- Who will get it?- These questions must be answered regardless of what social/political/economic system is used.- Scarcity: Resource AllocationScarcity is the Basis for all economics- Scarcity means that choices must be made and that tradeoffs are inevitable.- Tradeoffs lead to opportunity costs: what must be given up to have something else.- Choices are based on preferences.- Economic example: Stranded alone on a tropical islandSpecialization and Gains from Trade- Labor efficiency- Different talents- Skill improvement- Accumulated knowledge- Does not depend on an “economic” systemBasic Economic Concepts- Scarcity- Choiceso Preferenceso Resource Allocation- Opportunity Cost- Gains from Tradeo SpecializationMarket System- Individual producers and consumers make decisions- Economic activity (production and consumption) is coordinated through market exchangeso Market institutions and structureo Values expressed as prices- Consumption: Preferenceso What and how much will be produced- Production: Resource Allocationo How to produceWhy Use a Market System?- Choices must be made so…- Markets are a decentralized system- Alternative is some sort of centralized command systemo Monarchyo Dictatorshipo Theocracy o Communist/Socialist- How to Evaluate Alternative Systems?o Is it Equitable?o Is it Efficient?- Market system emphasizes efficiency but not equityo Ours is a limited or bounded market systemEconomic Perspectives- Positive Economics: “What is”o How do economic systems work?o What happens when things change?o What are the tradeoffs?o What are the incentives?- Normative Economics: “What should be”o This is good (or bad)o This policy is preferredWhat is Needed for a Market System?- Property Rights – Defined and Enforceableo Market activity (trading) is simply the exchange of property rights between economic agents.- Free Enterprise or Capitalism- “Laissez Faire”o Markets functioning with little government interferenceWhat Else is Needed for a Market System?- Legal Systemo Define and enforce property rightso Contracts and liability- Monetary Systemo Functions of Money Store of wealth; unit of account; medium of exchange Facilitates transactions, gives them a basis for transactionso Banking System- Regulatory Systemo Grades and Standardso Prevent fraud Weights and measures Truth in advertising Disclosure (contents; ingredients, etc)- Government functions to facilitate trade and reduce transaction costsMarket Process- 1) Buyer and Seller communicationo Agree to exchange property (rights) Establish value (i.e. price)- 2) Physical Transfer of Property- Steps 1) and 2) happen at the same time and place in many markets- In agricultural markets, 1) and 2) often occur at different times and placesAgricultural Markets are Unique- Weather- Biological processo Uncertain productiono Time lag in production- Perishable- Commodities versus productso Undifferentiated- Complex production and market system- Price adjusted rather than quantity adjustedo Manufactured products then adjust the number producedo Agriculture relies on price to keep things in balance- Role of inventoriesAgricultural Markets- Demando What gets producedo How much gets producedo Who gets it- Marketing System: Everything between production and consumptiono Moves products from “Gate to Plate”o Time, Place and Form functions Storage (When) Transportation/Assembly (Where) Processing (commodity into product)- Productiono How (and where) things get produced What resources are used Market Economics Principles: The 3 I’s of Markets- Incentiveso People have incentives to make choices Consumers choose according to preferences Producers choose how to allocate resources- Interactionso Consumer and producer choices impact many related markets- Indifferenceo Values (prices) adjust in all markets until no one has any incentive to make a different choiceWhy Price Analysis?- Prices don’t just happen!- Prices are information about economic conditions.- Agricultural markets rely on price signals to efficiently allocate resources to meet consumer demand.o Price levels and changes in prices provide guidance to agricultural marketsPrice Determination- Demand and supply forces that determine the level of priceso These exist but may not always be obvious Indicated by data- Prices (or at least values) are determined in all markets but may not be revealed- Price analysis involves understanding how supply and demand determine prices and how to use data to explain and anticipate price changesPrice Discovery- The actions and mechanisms used in a market system to reveal market prices- Depend on market structure and institutions o For example: Why are feeder cattle often sold at auction but fed cattle are rarely sold this way?Worksheet 1:Market equilibrium is usually depicted as the following graph:In reality, what we usually observe is just the price and quantity: In general, the price-quantity space (area) of the graph represents all possible price and quantity combinations that might occur. Our objective in undertanding markets and price analysis is to be able to explain what would cause us to be at any given point or to move from one point ot another.DemandSupplyQuantityPrice Q*P*QuantityPriceQ*P*We assume that some demand and supply curves meet at prices and quantities that we observe. (We assume market equilibirum). We do not oberve the entire demand or supply curve but we hypothsize that a demand and supply curve pass through the price/quantity point.Equilibrium is an important assumption. We can talk about equilibrium in two ways: mathematically and behaviorally. What is equilibrium in the mathematical sense?QD= QSWhat are the behavioral (economic) implications of market equilibrium?The quantity supplied is the same as the quantity demanded -narrowed down all possible quantities supplied and demanded to one pointThink of situations where markets are not at equilibrium. - How is equilibrium reestablished and how fast?Surplus-manufacturers produce less, decrease cost; retailers lower price; consumers buy more at lowerprice; process continues until it reaches equilibriumShortage- manufacturers produce more increase cost, consumers buy less until it reaches equilibriumAdjusts fairly quicklyDemandSupplyQuantityPriceQ*P*Why do markets tend towards equilibrium?We can use