February 15 2012 I Economics a The study of how we allocate scarce resources across competing interests b Parts 1 Microeconomics 2 Macroeconomics 3 Econometrics c Factors of production 1 Natural resources 2 Labor 3 Physical capital 4 Human capital d What should be produced 1 Trade offs a Illustrated by the production possibilities curve 1 Production is efficient if a All factors of production are being used b All factors of production are being used in their most productive employment e Key principles of economics 1 Opportunity cost a The cost of foregoing the next best opportunity 1 Opportunity cost Cost Gain a At which point is the opportunity cost the highest 1 When more iPads are foregone 1 Cost of accounting cost and opportunity cost a Point B b Economic cost a Accounting cost 1 Total cost 2 Marginal principle a Fixed costs FC 1 Costs that do not change with quantity b Variable costs VC 1 Costs that change with quantity c Total cost TC 1 Total cost of an activity 2 Total cost Fixed cost Variable cost a TC FC VC d Marginal cost MC 1 The change in total cost when producing one additional unit 2 The slope along the total cost curve e Total revenue TR 1 The amount of money a firm makes for selling goods f Profit 1 Profit Total revenue Total cost a TR TC g Marginal revenue MR h Marginal principle MP 1 The change in total revenue when one the firm sells one additional unit 2 The slope along the total revenue curve 1 The optimal level of an activity max profit occurs when marginal revenue is equal to marginal cost a MP occurs when MR MC b Set MR MC to find Q 1 At Q profit is maximized 3 Diminishing returns a In any productive activity increasing an input beyond some level will eventually result in diminishing increases in output b Short run c Long run 4 Externalities 1 The period of time in which at least 1 production factor is fixed 1 The period of time in which all production factors are adjusted a Also known as spillovers b Economic costs or benefits not experienced by the economic decision maker 1 Negative externalities a Costs imposed 2 Positive externalities a Benefits imposed be socially optimal 5 Gains from trade c When externalities exist private decisions about the level of economic activity may not a Absolute advantage b Comparative advantage The ability to produce a good using fewer inputs than another producer another producer 1 With trade the countries specialize in the good in which they have comparative The ability to produce a good at a lower opportunity cost than advantage a By specializing in the good in which a country has comparative advantage countries are better off or at least as well off with trade than without trade f Math digression 1 Graphing lines a Formulas 1 Slope intercept form a y mx b 2 Slope a m the change in y 1 m y2 y1 x2 x1 the change in x 3 Percentage change 1 Percentage change a P 2 P 1 100 P1 2 Notes a Price p is on the y axis b Quantity q is on the x axis c Coordinate point is p q g Consumer behavior price 1 Consumer behavior The demand curve maps the quantity consumers demand at a given 2 Law of demand a Demand curve slopes downward Decreasing price results in increasing quantity demanded 1 Example a Moving from point A to point B 1 Demand has not changed 2 Price decreases 3 Quantity demanded increases b Moving from demand curve 1 to demand curve 2 changes demand c Moving from demand curve 1 to demand curve 3 changes demand 1 Demand increases 1 Demand decreases b Factors that shift demand 1 Income a For a normal good increasing income causes an increase in demand b For an inferior good increasing income causes a decrease in demand 2 Changes in the price of a related good a When goods are substitutes the increase in the price of good A will lead to an increase in demand for good B 1 Substitutes are consumed in an either or fashion b When goods are compliments the increase in the price of good A will lead to an decrease in demand for good B 1 Compliments are consumed together 3 Population a Increasing population increases demand 4 Taste a Increasing taste increases demand 5 Consumer expectations about future prices a b If consumers receive news that future prices will increase demand increases in the present If consumers receive news that future prices will decrease demand decreases in the present h Producer behavior 1 Producer behavior The supply curve maps the quantity producers supply at a given price 2 Law of supply a Supply curve slopes upward Increasing price results in increasing quantity supplied 1 Example a Moving from point A to point B 1 Supply has not changed a Does not change firm behavior 2 Price increases 3 Quantity supplied increases b Moving from supply curve 1 to supply curve 2 changes supply c Moving from supply curve 1 to supply curve 3 changes supply 1 Changes behavior of firms 2 Supply increases 1 Changes behavior of firms 2 Supply decreases b Factors that shift supply 1 Change in variable input prices a An increase in the price of a variable input decreases supply 2 Technological change a Technological advances increases supply 3 Number of firms a An increase in the number of firms increases supply 4 Producer expectations about future prices a b If producers receive news that future prices will increase supply decreases in the present If producers receive news that future prices will decrease supply increases in the present i Market equilibrium 1 A price at which quantity supplied is equal to quantity demanded 2 Surplus a When quantity supplied is greater than quantity demanded 3 Shortage a When quantity demanded is greater than quantity supplied 4 Invisible hand of the market a Works to eliminate shortage and surplus by driving the market to equilibrium b Demand 1 Price 100 Quantity a P 100 Q c Supply 1 Price 10 2 Quantity a P 10 2Q d Equilibrium 1 PDD PSP a 100 Q 10 2Q 5 Equilibrium changes a Demand shifts Income 1 2 Changes in the price of a related good 3 Population a Anytime supply and demand are both changing either supply or demand is 4 Tastes 5 Consumer expectations about future prices ambiguous b Supply shifts 1 Change in variable input prices 2 Technological change 3 Number of firms 4 Producer expectations about future prices j Elasticity 1 Elasticity tells how many percent quantity changes by when price increases by 1 2 3 4 If E is 1 demand is elastic If E is 1 demand is unit elastic If E is 1 demand is inelastic 5 Price elasticity of demand a How sensitive quantity demanded is to a change in price 1