Economics Final Notes Economics the study of allocating scarce resources CHOICES Microeconomics individual decision making units o 1 Households o 2 Firms Interactio n Macroeconomics overall totals aggregates Positive statement what is fact can be proven correct or incorrect Normative statement what ought to be depends on values can t be proven correct Opportunity cost value of next best alternative Production possibilities frontier PPF combinations that can be produced if resources are used efficiently Constant opp Cost Increasing opp cost Push out frontier o 1 Tech improvements 2 Capital investments 3 increased quality quantity of the labor force Law of demand all else equal price increases Qd decreases price decreases Qd increases Law of supply all else equal Price increases Qs increases price decreases Qs decreases Equilibrium Qs Qd If p p Qd Qs Shortage pressure for price to increase If p p Qd Qs Surplus pressure for price to decrease If P changes we move along existing demand or supply curve If anything else changes shift to new demand or supply curve Demand Shifters o 1 Tastes o 2 Income Normal good Income increase Demand increases shift right Inferior good Income increase Demand decreases shift left o 3 Prices of related goods Substitutes coffee tea If Px increases Dy increases right Complements if Px decreases Dy decreases left Demand increases right P increases Q increases equil increases Demand decreases left P decreases Q decreases equil decreases Supply Shifters o 1 Technology improvement S increases right deterioration S decreases left o Prices of inputs oil is input in gasoline Pinput increases S decreases left Pinput decreases S increases right Supply increases right P decreases Q increases 2 Supply decreases left P increases Q decreases Price floor minimum legal price o Floor equil equil is legal no effect o Floor equil surplus Price ceiling maximum legal price o Ceiling equil equil is legal no effect o Ceiling equil shortage Qs Qd Qd Qs Tariff revenue Comparative advantage lower opp cost efficient to specialize in comp advantage and trade Interferences with international trade o Tariff tax on import Price mechanism o Import quotas operated by importing countries o VERs operated by exporting countries Quantity restrictions controls Quota profit for holder of import license VER profit for exporter Own price elasticity of demand o E change d change p Tariffs Quota VER 3 o E change Qd Qd change p p Rules absolute value for reference level use average of begin tend o If p decreases Qd increases o Total revenue pXq o P decreases by itself TR decreases o But p decreases Qd increases by itself TR increases If change Qd change p o E 1 elastic o P increases Qd decreases TR decreases If change Qd change p o E 1 unit elastic o TR unchanged If change Qd change p o E 1 inelastic o P increases Qd decreases only a little TR increases Income elasticity of demand o change Q change income o 0 for normal o 0 for inferior Cross price elasticity of demand o change Qa change Pb o 0 for complements o 0 for substitutes Elasticity of supply o S change Qs change P Law of supply Es 0 If irreproducible Es 0 perfectly inelastic supply Consumer o Marginal utility measured in dollars o MU diminishing o Consumer takes P as given 4 o Rational do the best they can o optimal purchase rule Q at which MU P Consumers D curve is the MU curve Mkt D curve is horizontal sum of individual D curves Consumer surplus o Max willing to pay Amt actually paid o Total utility Total expenditures o Area under D above p consumer surplus Change in consumer surplus is our measure of gain from p decrease or loss from p increase Total Cost TFC TVC Marginal Cost change TC change Q o slope TC o slope TVC o change TVC change Q TC Q TFC Q TVC Q o If marginal average average increases 5 o If marginal average average decreases o If marginal average average constant Profit TR TC o TR PxQ Perfect competition o Firms small o Homogenous output o Firm takes market price as given Assume firm wants max profit o Maximize vertical distance between TR and TC o TR TC parallel slope TR slope TC o Q at which MR MC Mkt S curve is horizontal sum of individual firms S curve o Profit Q TR Q TC Q o Profit per unit P ATC profit Economic profit net of opp cost of being in business o Zero econ profit is fine o if econ profit 0 o if econ profit 0 new firms enter mkt S increases right P decreases until zero econ profit eventually some firms exit mkt decreases left P increases until zero econ profit S curve of perfect comp firm is MC curve if P AVC If P AVC Qs 0 and firm shuts down o Free entry and exit tendency for perfect comp to move toward zero econ profit 6 Monopoly o One dominant firm o Barriers to entry o Can t be close substitutes o Firms D curve is Mkt D curve o Firm is price maker has complete market power Perfect Competition Monopoly Straight line D curve MR is straight o Slope MR 2 slope of D Barriers to entry may have econ profit 0 for years Deadweight loss Profit Max elastic region monopoly profit lost consumer surplus deadweight loss 1 2 BH Price discrimination same product sold to different customers at different prices o To increase profits 1 Not a perfectly competitive firm because they can t manipulate price 7 2 Some way to distinguish customers 3 Difficult to resell Monopolistic Competition o Many small firms o Free entry and exit zero econ profit o Product differentiation some market power variety is good Oligopoly o Few sellers o Market power by size o Cartel collusive oligopoly cartels often break down prisoners dilemma o If potentially competitive regulation can increase prices railroads airlines Regulation Anti trust laws o Prohibit Monopolization Price fixing Tie in sales Interlocking directorates Predatory pricing o Broken up standard oil American tobacco ALCOA AT T o Not broken up U S steel IBM Microsoft Factor markets Input markets o Demand for factor of production o Marginal revenue product MP MR o If firm takes input price as given D curve is MRP curve Labor supply o Tradeoff between income and leisure Leisure is normal non labor income will reduce work if wage increases Income effect work decreases Substitution effect work more because opp cost is bigger o Net effect of wage on Ls is income effect and substitution effect 8 Education increase Experience increase Higher wages o Unpleasant jobs S farther to the left compensating wage rate differential results in higher wage all else equal o Minimum wage price floor o