i e supply and demand production possibility frontiers comparative advantage competitive markets Economics the study of how people and firms make choices to use scarce resources 3 Big Economic Questions 1 What will be produced 2 How will it be produced 3 Who gets it once it is produced Models simplification of real world using assumptions 4 Assumptions of Microeconomics 1 Choices create opportunity costs 2 People are rational 3 People respond to incentives 4 The best decisions are made at the margin Macroeconomics concentrates on the overall performance of the economy i e GDP consumption employment Microeconomics concentrates on individual economic units like consumers and firms and focuses on price as an allocative mechanism Mixed economy most economic decisions result from market interactions between buyers and sellers but the gov t plays a significant role in the allocation of resources i e capital labor natural resources and entrepreneurial ability Scarcity unlimited wants exceed limited resources forces us to choose Economic Model 1 Production Possibility Frontier PPF Use PPF to model efficient production possibilities opportunity cost economic growth changes in technology comparative advantage and gains from trade A straight PPF is most basic and it shows constant opportunity costs Opportunity cost the highest valued alternative given up in order to engage in an activity Slope opportunity cost A concave PPF is more realistic and shows increasing opportunity cost Marginal Analysis more or less question Ask does the extra benefit of adding one more outweigh the extra cost Sunk costs are unavoidable should not be considered Economic growth Expansion of the PPF resulting from a More resources b Higher quality resources c Technological change Technology method by which inputs are combined to produce outputs increases productivity Creates a more lopsided PPF represented by the green line above Comparative advantage ability of an individual firm or county to produce a good or service at a lower opportunity cost than competitors Absolute advantage ability to produce more with same number of resources Utility the satisfaction value happiness the comes from a good or service Total utility the enjoyment or satisfaction people receive from consuming goods or services Marginal utility the added enjoyment form consuming one more unit of the good or service Law of diminishing marginal utility consumers experience less and less additional satisfaction as they consume more of a good or service during a given period of time Price price you are willing to pay is derived from the utility the product or service provides Demand willingness and ability to buy certain quantities of a good or service at different prices Law of Demand ceteris paribus C P all things being equal For all normal goods if price P increases the quantity demand Qd decreases Substitution effect a good becomes more less expensive relative to substitutes Income effect consumers purchasing power changes Modeling Demand 1 Demand curve 2 Demand schedule 3 Demand equation Demand Schedule Demand Qd 4 P Equation Price 7 6 5 4 3 2 1 Price 8 6 4 2 0 Quantity Quantity 1 2 3 4 5 6 7 0 1 2 3 4 Income 5 Determinants of Demand 1 2 Tastes Preferences 3 Expectations of Future Prices 4 Price of Related Goods 5 Number of Buyers Income For inferior goods if consumers get more money or feel wealthier demand decreases For normal goods as income increases demand increases Tastes Preferences If tastes change to make a product more popular demand increases Expectations of Future Prices If consumers think prices are going up in the near future demand increases Price of Substitutes If the price of a substitute goes up demand increases If the price of complementary goods goes up demand decreases Price of Complement Number of Buyers If the number of buyers increase demand increases Supply Willingness and ability of firms to produce certain quantities of goods and services at different prices As price P increases quantity supplied Qs increases Supply curve is upward sloping demand curve is downward sloping Modeling Supply 1 Supply curve 2 Supply schedule 3 Supply equation 5 Determinants of Supply 1 Price of Inputs 2 Technology 3 Expectations of Future Prices 4 Number of Sellers 5 Price of Substitute Goods in Production Price of Inputs If the price of inputs rises suppliers are less willing to provide the good or service at the given price therefore supply decreases Technology An advance in technology raises productivity of workers and makes suppliers more willing and able to produce a good or service at a given price therefore supply increases Expectations of Future Prices If suppliers expect the price to go up they hold off selling therefore supply decreases Number of Sellers As number of sellers increases supply increases Price of Substitutes When the price of a substitute good goes up supply decreases Modeling Markets Quantitative equilibrium if we have the demand and supply equations we can solve for the exact equilibrium price and quantity Qd and Qs are tied to price As price changes quantities change Prices will change if market is out of equilibrium Price Controls Because the market wants to be at equilibrium price adjusts If market price is too high Qs Qd and we have a surplus If market price is too low Qd Qs and we have a shortage Consumer Surplus CS The difference between the highest price a consumer is willing to pay and the price the consumer actually pays individual CS Producer Surplus PS The difference between the lowest price a firm is willing to accept and the price it actually receives Total PS addition of all the individual PS s Price ceiling set below the equilibrium price to prevent the price from going to high creates shortage Price floor set above the equilibrium price to prevent the price from going to low creates surplus Economists measure the welfare of all market participants using economic surplus Economic surplus consumer surplus producer surplus At equilibrium economic surplus is greatest Dead weight loss when we lose transactions due to invention we lose CS and PS that went along with those transactions