04 28 2015 Economics 202 Final 1 What is economics 2 Principles The study of choices of how to allocate scarce resources 1 People face trade offs o People make choices and decisions o Opportunity Cost The next best alternative that you have to give up because you chose a particular option Includes not only money but also time 2 Cost of something is what you give up to get it 3 Rational people think at the margin o Marginal Benefit The additional benefit resulting from a one unit increase The additional cost associated with one unit increase in in the level of activity o Marginal Cost the level of activity 4 People respond to incentives 3 Market failure vs Market power Market Failure o A situation in which the market on its own fails to production efficient allocation of resources Market Power o The ability of a single person or small group to have a substantial influence on market price All combinations of input that an economy can possibly produce it 4 Production Possibilities Frontier PPF resources are used efficiently 5 Economists play 2 roles 1 Scientists o make positive statement describe the world as it is Example A tax cut is needed t stimulate the economy 2 Policy Advisors o make normative statement prescribe how the world should be Example An increase in the price of gasoline will increase people s demand for compact cars 6 Slope 7 Market Rise run A group of buyers and sellers of a particular good 8 Competitive Market Many buyers and many sellers No one can influence the market 9 Demand The quantity demanded of a good is the amount that buyers are willing and able to purchase 10 Normal Good vs Inferior Goods Normal Good o When income increases peoples demand increase Examples diamonds cars clothes shoes wine purses Inferior Good o When income increases people demand decrease Examples bus rides roman noodles frozen dinners 11 Substitutes vs Complements Substitutes o The two goods can satisfy the same set of goods or preferences Examples Coke and pepsi Sugar and honey Tea and coffee Examples Cereal and milk Peanut butter and jelly Computer and software Complements o The two goods are used in a combination with each other 12 Surplus vs Shortage Surplus Shortage o Qs Qd o Qs Qd 13 3 Step Analysis Step 1 determine which curve is affected Step 2 determine the direction of the shift of the curve Step 3 compare the old EQ and the new EQ to draw the conclusion 14 Elasticity Is a numerical measure of the responsiveness of Qd or Qs to the change of one of its determinants 15 Price Elasticity of Demand how much Qd of a good respond to the change in its price change in Qd change in Price 16 Midpoint Method End Value Start Value Midpoint Average 17 change in Qd Qa Qb Qa Qb 2 18 change in P Pa Pb Pa Pb 2 19 Price Elasticity if higher when Close substitutes are available Luxury goods are available Long run goods are available A good has more substitutes 20 Types of Demand Curves Perfectly Inelastic D extreme case o Price Elasticity of D 0 o Vertical Line Inelastic D o Price Elasticity of D 1 o Steep Line Elastic D o Price Elasticity of D 1 Perfectly Elastic D o Price Elasticity of D Infinity o Horizontal Line Unit Elastic D o Price Elasticity of D 1 o Intermediate Line Not too steep not too flat 21 Price Ceiling the legal maximum Price ceiling Free Mkt EQ price Price ceiling Free Mkt EQ price o Nonbinding o Binding o Shortage the legal minimum Price floor Free Mkt EQ Price o Nonbinding Price floor Free Mkt EQ Price 22 Price Floor o Binding o Surplus 23 Tax incidence 24 Effective price to buyers 25 Effective price to sellers how the tax burden is shared between buyers and sellers the amount that buyers actually need to pay after paying the tax The amount that sellers receive after paying the tax 26 Profit 27 Explicit Cost Total Revenue Total Cost Require an outlay of money Paid in money Examples o Purchase of fruit and blenders o Blenders o Wages o Rent o Insurance o Utility bills 28 Implicit Cost The cost that do not require a cash outlay Measured in the units of money but are not paid for in money Examples o Forgone wages o Forgone interest 29 Economic Profit Total Revenue Explicit cost implicit cost 30 Accounting profit Total Revenue Explicit Cost 31 Perfectly Competitive Market Many buyers and many sellers o Price Takers Take mkt price as it is No one can influence mkt price Average Fixed Cost Average Variable Cost Goods are largely the same No barriers on the entry or exit 32 Total Cost 33 Fixed Cost Fixed Cost Variable Cost A cost that is constant 34 Average Total Cost 35 Average Total Cost Total Cost Quantity 36 Average Fixed Cost Fixed Cost Quantity 37 Average Variable Cost Variable Cost Quantity 38 Average Total Cost is always U Shaped 39 Efficient Scale 40 If Marginal Cost average Total cost Avg Total cost increases The quantity level that minimize the average total cost 41 If Marginal cost Average Total Cost Avg Total Cost decreases 42 Marginal Revenue change in total revenue change in quantity Explicit and Implicit Cost Example Suppose that Eric opens a local donuts store off University Avenue He receives a loan from the bank for 40 000 He withdraws 20 000 from his personal savings account The interest rate on the loan is 5 and the interest rate on his savings account is 2 Suppose that Eric can sell 1000 donuts at 3 1 What is Eric s explicit cost of capital 40 000 x 5 2000 2 What is Eric s implicit cost of capital 20 000 x 2 400 3 What is Eric s total opportunity cost of capital 2000 400 2400 4 What is Eric s total cost if calculated by an economist 3000 2000 600 600 5 What is Eric s total cost if calculated by an accountant 3000 2000 1000 04 28 2015 04 28 2015