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Definition of Economics
Social science concerned with how individuals, institutions, and society make optimal (best) choices under conditions of scarcity
What are the 3 parts of economic perspective?
- 1. Scarcity & choice (unlimited wants, limited resources create opportunity costs - to obtain more of one, you forgo the opportunity of getting the next best thing)
- 2. Purposeful behavior (Utility, happiness/satisfaction)
- 3. Marginal Analysis (Marginal Benefit/Marginal Cost)
The added benefit from adding one more thing: the marginal benift for adding one more class is that I'm that much closer to obtaining my degree.
The added cost of adding one more unit: The marginal cost of adding is one more class is money, combined with the additional time I'd need to be in class, study, etc.
What is the difference between microeconomics and macroeconomics?
- Microeconomics is the study of the individual, a consumer, a worker, a household, a firm
- Macroeconomics is the study of the whole economony: interest rates, value of the dollar, inflation
Just the facts, cause and effect, no value judgement
- Value judgements: cause, effect, recommendations
- Think "should" or "ought"
The economizing problem
- Our economic wants exceed our economic means.
- limited income, unlimited wants
When something's marginal benefits exceed its marginal costs, what should you do?
A well-tested economic theory
Suppose an economist says that "Other things equal, the lower the price of bananas, the greater the amount of bananas purchased." This statement indicates that:
all factors other than the price of bananas (for example, consumer tastes and incomes) are assumed to be constant.
When economists say that people act rationally in their self interest, they mean that individuals:
look for and pursue opportunities to increase their utility.
Microeconomics is concerned with:
a detailed examination of specific economic units that make up the economic system.
An increase in income:
Shifts the consumer's budget line to the right.
If you know the slope of the line and the vertical intercept you can graph without plotting points.
Y (line) = a (vertical intercept) + bx (b is slope)
If there is an upward sloping line, is the relationship direct or indirect?
Direct (also positive)
If the slope of the line is downward, is the relationship positive or negative?
Where is the vertical intercept?
Where the slope crosses the vertical line
How do you know when something is attainable or unattainable on a budget line?
All combinations on the inside of the budget line are attainable. All combinations beyond the budget line are unattainable.
The pleasure happiness or satisfaction obtained from consuming a good or service
A command system
- Also known as socialism or communism
- Government owns most resources and economic decision making occurs through a central economic plan
Examples of command system
- A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem.
- What goods produced? How produced? Who gets products? How accomodate change and promote technological progress?
What countries are market economies?
There are independantly acting buyers and sellers in each market
A fundamental difference between the command system and the market system is that, in command systems:
the division of output is decided by central planning rather than by individuals operating freely through markets
Economic systems differ according to which two main characteristics?
Who owns the factors of production, and the methods used to coordinate economic activity.
The invisible hand promotes society's interests because:
Individuals pursuing their self-interest will try to produce goods and services that people in society want and are willing to purchase.
What is a fundamental characteristic of the market system?
Black markets are associated with
Price ceilings and the resulting product shortages
- consumption varies directly with income
- demand curve increases as income rises
Because of unseasonably cold weather, the supply of oranges has substantially decreased. This statement indicates the:
amount of oranges that will be available at various prices has declined
government is imposing a minimum legal price that is typically above the equilibrium price
is an institution that brings together buyers and sellers
The upward slope of the supply curve indicates
the law of supply (as price rises, the quantity supplied rises, as price falls, the quantity supplied falls)
Law of demand
- As price falls, the quantity demanded rises, as price rises, the quantity demanded falls
- There is a negative or inverse relationship between quantity demanded and price
- Downward slope
The subsitution effect
When the price of a product rises, consumers shift their purchases to other products whose prices are now relatively lower.
College students living off-campus frequently consume large amounts of ramen noodles and boxed macaroni and cheese. When they finish school and start careers, their consumption of both goods frequently declines. This suggests that ramen noodles and boxed macaroni and cheese are
government is imposing a legal price that is typically below the equilibrium price
Is where the demand curve intersects the supply curve
If the demand for product X is inelastic, a 4 percent increase in the price of X will:
decrease the quantity of X demanded by less than 4 percent
Cross elasticity of demand
Measures how sensitive purchases of a specific product are to changes in:the price of some other product
Basic determinants of supply
- 1. resource prices
- 2. Technology
- 3. taxes and subsidies
- 4. prices of other goods
- 5. producer expectations
- 6. number of sellers in the market
A change in any one of the determinants of supply will...
- move the supply curve either right or left
- a shift to the right is an increase in supply
- a shift to the left is a decrease in supply
The main determinant of elasticity of supply is the
- amount of time the producer has to adjust inputs in response to a price change
- If quantity supplied by produces is relatively responsive to price changes, supply is elastic
- If it is relatively insensitive to price changes, supply is inelastic
Equation for measuring the degree of price elasticity or inelasticity of supply
- divided by
Price elasticity of demand coefficient measures
how sensitive consumers are to changes in price
If demand for a product is elastic, the value of the price elasticity coefficient is
greater than 1
The price elasticity of demand is generally
negative, but the minus sign is ignored
The basic formula for the price elasticity of demand coefficient is:
percentage change in quantity demanded/percentage change in price
Which type of goods is most adversely affected by recessions?
Goods for which the income elasticity coefficient is relatively high and positive
Marginal utility can be
positive, negative or zero
When does an externality occur?
When some of the costs or benefits of a good or service are passed onto or "spill over to" someone other than the immediate buyer or seller
Examples of negative externalities
- The cost of breathing poluted air
- Noise from jet engines on people who live by airports
- Foul smelling gases from biodiesel plants
Examples of positive externalities
- Lighting displays
Positive externalities (bees, vaccines, light displays) cause what kind of market failure?
Negative externalities (pollution, noise) cause what kind of market failures?
Free rider problem
The inability of potential providers of an economically desirable good or service to obtain payment from those who benefit because of nonexcludability
Because of the free rider problem
The market demand for the good is understated or nonexistent
People enjoy outdoor holiday lighting displays, and would be willing to pay to see these displays, but can't be made to pay. Because those who put up lights are unable to charge others to view them, they don't put up as many lights as people would like. This is an example of a:
Demand-side market failure
the extra satisfaction a consumer realizes from an additional unity of that product
Why do demand curves slope downward?
Diminishing marginal utility
Two main characteristics of public goods?
A positive externality or spillover benefit occurs when:
the benefits associated with a product exceed those accruing to people who consume it.
To maximize utility a consumer should allocate money income so that the:
marginal utility obtained from the last dollar spent on each product is the same
- Implicit (opportunity) costs + explicit (actual) costs
- How much should you pay to keep a parcel of land in its current use?
- What must you make per hour to stay in your current job?
- Monetary payments for resources that a firm does not own
- -salaries, rents inputs
- The opportunity costs of using resources the firm does own
- opportunity cost of land, natural resources
- foregone rent,, foregone interest, wages, normal profit
- Total revenue minus explicit costs
- Tends to overstate actual profit
What the business owner could have made doing something else
total revenue minus explicit and implicit costs
Basic characteristics of short run production
- Plant capacity is fixed
- Can adjust the degree to which plant is used
The extra output associated with adding one more unit of a variable resource (workers, pound of fertilizer, etc.)
Total product divided by units of resources
What happens if there is no production in the short run?
The firm loses its fixed costs
Applies to everyone
Law of diminishing returns
- As additional units of variable resources are added to a fixed resource, beyond some point the extra or marginal product attributed to the added resource will decline
- Assumptions: technology is fixed
Total fixed costs + total variable costs
Average total cost
Total cost divided by Quantity
- Added cost of producing one more unit of output
- Change in total cost divided by change in quantity
Economies of scale
- As a firm produces more, there are lower average costs of production
- Labor specialization, managerial specialty, efficient capital, etc.
Diseconomies of scale
- As a firm increases production, average cost increases
- In the long run, your average total cost curve rises
Minimum efficient scale
- The lowest level of output at which a firm can minimize long run average costs.
- The point on the graph where it flattens out (the smallest level of output at which ATC is minimized)
Characteristics of a purely competitive firm
- 1. Very large number of sellers
- 2. Standardized product (corn, soybeans, beef)
- 3. Price takers
- 4. Free entry and exit from market
For purely competitive firm, demand is
- perfectly elastic.
- Firms only determine how much they produce
- Demand curve is a straight line
How should a purely competitive seller set price?
Price= AR, MR, TR/output
MR = MC can be P = MC for a purely competitive market because
each added output adds exactly its price to total revenue
everything above the average total cost curve
Break even point
- The point at which all costs are covered
- ATC = MC
Loss minimizing point
Minimum average variable cost
When average variable cost is greater than the price, shutdown
The demand for agricultural products:
- Has a elasticity coefficient between .20 and .25.
- Suggests prices of farm products would have to fall by 40 to 50 percent for cosnumers to increase their purchases by 10 percent
Farm share of the GDP
is declining, going from 7% in 1950 to about 1% today
Over time, technological advances in ag have
increased the minimum efficient scale of production in agriculture and reduced the prices of farm products.
One consequence of the long-run problem faced by farms has been a:
massive exit of workers from agriculture to other sectors of the economy
An extraordinarily small crop of farm products due to drought causes:
a large increase in the price of farm products because the demand for farm products is price inelastic.
What percent of their spending do US consumers allocate to their food purchases?
- That means more likely to be inelastic
Price supports in agriculture have been criticized because:
They tend to help large producers more than small