ECON 2306OVERVIEWTen Fundamental Principles of Economics1. Scarcity is inescapable2. Risk is unavoidable3. Therefore all persons must make choices4. Incentives matter5. People generally act in their own self-interest6. There is often more than one way to produce things7. Voluntary exchange is mutually advantageous8. It is wealth, not poverty, which has causes9. Public policies have primary & secondary effects. Some good, some bad10. In the end, economic laws tend to prevailEconomics: A social science which attempts to explain how individuals, firms, & nations allocate scarce resources among competing interest.Father of Economics: Adam smithPositive vs. normative: Positive is a statement of what is (Fact). Normative is a statement that should be (judgement)EQUITY: Normative IssueEFFICIENCY: Positive issue. ALLOCATIVE (distributing) Right mix/PRODUCTIVE: Right MethodsMicro vs macro: Levels of Micro (small picture) =Individual/Entrepreneur/Firm/Industry/politicians voters. Sectors of Macro (big picture) = Sectors (Households, Business) /Aggregates (AS, AD, AE)4 factors of production (& their respective payments): Land (Rent)= A payment to a factor of production. In excess of what is necessary to call forth the desired supplyLabor (Wages)= Capital (Interest)Entrepreneurship (Profit)= The ultimate bearer of riskCircular flow diagram: 4 C’s of Economic Systems (what answers the 3 questions): Capitalism (price), Command & Control (gov’t), Compromise (price & gov’t), Customary (tradition) 3 Questions: What? (Allocation of inputs) How? (Production) For Whom? (Allocation of output)6 Economics Warning: 1. After this therefore because of this “fallacy’’ (time series data)2. Fallacy of composition: belief what holds true for me, holds true for the whole3. Correlation doesn’t necessarily mean causation (Cross-sectional data)4. Violation of “ceteris paribus” (others things being equal) “don’t compareapples to oranges”5. Exclusion of a relevant variable. (don’t leave out anything important)6. Inclusion of an irrelevant variable. (don’t input anything not important)“Shaving with Ockham’s razor” The idea that you prefer simple explanations rather than long explanations.PRODUCTION POSSIBILITIES FRONTIERS (PPF)Slope: Negative (opportunity cost)Shape: Bowed Outward (Law of increasing opportunity cost)Production probability curve represents all possible combinations of output that could be produced assuming fixed productive resources and their efficient use.Inside (A), Outside (x), Along the Curve (B, D, C): Inefficient to be inside the curve, currently unattainable to be outside the curve, Productive Efficient to be along the curve.Goods: More is preferred to lessBad: Less is more preferred Capital goods: goods that produce other goodsConsumer goods: Goods that last a long timeDevoting more toward capital goods than consumer goods will bring the curve shift out (opportunity) faster.Movement of the curve suggest trade, technology, or laborShift on the curve suggest changes in economyDemand: The varies quantities of a good or service which a consumer is BOTH WILLING & ABLE to purchase at varies prices per unit of time, ceteris peribus.Supply: The varies quantities of a good or service which a seller is BOTH WILLING & ABLE to sell at varies prices per unit of time, ceteris peribus.Price: Always dependentQuantity: Always dependentLaw of demand: P Qd, P QdLaw of supply: Functions of Supply & demand: Qd= F (P|). |: Ceteris PeribusNon price parameter demand: Income (Normal, Inferior). Price of other goods (complements (AND goods), subtitles (OR goods), unrelated goods (BUT goods), number of buyers, taste/preference, price expectations of buyers, & advertising.If a non-price parameter changes then there is a shift in demand (SHIFT)If price changes (moving along the curve) change in quality demand (MOVEMENT)Non-price parameter supply: # of sellers, expectations of sellers, price of input, taxes/subsidies, technology, weatherIf a non-price parameter changes then there is a shift in supply.Movement on the graph is quantity supply or demand. Shift on the graph is just supply or demand.Quantity demand > Quantity supply= shortageQuantity Supply > Quantity demand= surplus Quantity supply = Quantity demand= equilibriumCOMPARATIVE STATICS THREE STEPS: 1.) Identify the initial equilibrium. 2.) Identify the shift. 3.) Identify the new equilibriumPRICE FLOOR = A case in which the gov’t says “you must charge at least…” (Minimum. Gov’t has sided with the seller)EFFECTIVE PRICE FLOORS MUST BE SET ABOVE EQUILIBRIUM & MUST RESULT IN A SURPLUS.PRICE CEILING = A case in which the gov’t says “you can charge no more than…” (Maximum. Gov’t has sided with the buyer)EFFECTIVE PRICE CEILING MUST BE SET BELOW THE EQUILIBRIUM PRICE & MUST RESULT IN A SHORTAGE.ELASTICITY: A measure of responsiveness/sensitivity. Elasticity demand greater than 1 means the quantity is elasticElasticity demand less than 1 means the quantity is inelasticElasticity demand equal to 1 means the quantity is unit elasticElasticity demand of infinity means the quantity is perfectly elasticElasticity demand equal 0 means the quantity is perfectly inelasticFormula for elasticity: % change quantity divided by the % change priceTR (total revenue): Price x QuantityWHAT MAKES A GOOD MORE (OR LESS) PRICE ELASTIC?1.) Substitutes (many= Elastic, few= inelastic)2.) Time (short run= inelastic, Long run= elastic)3.) Product definition (narrowly= elastic, broadly= inelastic)4.) % of Budget (Small= inelastic, large= elastic)5.) Luxury= elastic vs. Necessity= inelasticMID-POINT FORMULA: Top of the slope is where it is most elastic and the bottom is where it is inelastic.TEST TWO NOTESUTILITY: A measure of satisfactionTOTAL UTILITY: the total satisfaction derived from the consumption of a given quantity of a good or serviceSHORT RUN PRODUCTION FUNCTION: LONG RUN PRODUCTION FUNCTION:TAOTAL VARIABLE COST CURVE:TOTAL FIXED COST CURVE:MARGINAL COST: (CHANGES) IS THE SLOPE AT ANY GIVEN POINT ON THE CURVEMarginal Revenue Curve: Always twice as steep as the demand curve.MARGINAL UTILITY: the change in total utility due to a one-unit change in the consumption of the good orservice.diminishing marginal utility: tells us that each successive marginal unit of a good consumed adds less extra utility.The law of diminishing marginal returns shows the relationship between inputs and