Economics 101: Understanding Scarcity, Choice, and Markets, Study notes of Microeconomics

Download Economics 101: Understanding Scarcity, Choice, and Markets and more Study notes Microeconomics in PDF only on Docsity! ECON 2005 Chapter 1: The Scope of Economics Two important fields: 1. Microeconomics is the branch of economics that examines the behavior of individual decision-making units – that is, business firms and households. 2. Macroeconomics is the branch of economics that examines the behavior of economic aggregates – income, output, employment, and so on – on a national scale. Production Prices Income Micro Production/Output in Individual Industries and Businesses Prices of individual goods/services Distribution of income Wages in the auto industry Minimum wages Poverty Macro National Production/Output Gross Domestic Product Growth of Output Consumer/ producer prices Rate of inflation National income Total wages and salaries Total corporate profits Employment Money Government Micro Employment by individual businesses Number of employees in a firm --- Why there is a Gov? Do we need a Gov? What is an efficient tax? Regulation Public good Macro Employment and unemployment in the economy Unemployment rate Money supply Interest Rate Exchange Rate Fiscal policy Monetary policy  Other fields of Economics o Econometrics  Uses data and statistics to validate Economic theories o Development  Is about poverty, growth, education, population o International Econmics  Is about trade between countries and exchange rates o Heath Economics  Is about Economics of health o ….. The World Factbook Rank Orders: 1. GDP 2. GDP - per capita 3. GDP - real growth rate 4. Unemployment Rate 5. Oil Production 6. Proved oil reserves The Method of Economics Page 1 of 10 ECON 2005  Positive economics studies economic behavior without making judgments. It describes what exists and how it works.  Example: “The US GNP is about $12000 billion”  Normative economics analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action.  Example: “Inflation is harmful” or “Outsourcing jobs is bad”  Positive economics includes:  Descriptive economics, which involves the compilation of data that describes phenomena and facts i. Example “The US GNP is about $12000 billion”  Economic theory, which involves building models of behavior Theories and Models  Ockham’s razor is the principle that irrelevant detail should be cut away. Models are simplifications, not complications, of reality.  Using the ceteris paribus, or all else equal, assumption, economists study the relationship between two variables while the values of other variables remain constant.  The post hoc fallacy refers to a common error made in thinking about causation: If event A happened before event B, it is not necessarily true that A caused B.  The fallacy of composition is the erroneous belief that what is true for a part is also true for the whole.  Example: Data shows that women who earn higher income tend to have lower fertility. o Theory 1: Women who have opportunities to earn higher income make a bigger sacrifice when they take time off to have children. o Theory 2: Women who have more children need more flexible hours, so they accept low wage jobs to gain that flexibility. o Theory 3: Rising level of education among women cause their wages to rise and separately cause their fertility to fall. The Two Fundamental Assumptions 1. Individuals are selfish a. Households maximize their utility b. Firms maximize their profit 2. Individuals are rational decision makers a. Households and firms make the right decision to maximize their utility or profit Opportunity Cost  Opportunity cost is the best alternative that we forgo, or give up, when we make a choice or a decision.  Nearly all decisions involve trade-offs  Opportunity cost includes both explicit and implicit costs. o Example:  You are going to start a new business (Student Burger), you need a place:  You sign a lease for $1,000/month  You need $100,000 for equipment  You get a loan from a bank, the interest rate is 6% so the cost of capital is equal to 6% * 100,000 = $6,000/year or $500/month  Pricing inputs that are already owned: Page 2 of 10 ECON 2005  Creates the opportunity for large scale production  Creates the most benefits when the marginal cost is decreasing or there is a huge sunk cost  Without trade, there is no specialization  Specialization and trade improve countries’ relationships because of the huge benefits that it creates  “Learning by doing” means specialization will improve each worker’s job skills leading to further productivity increase  Allow the most efficient producer to produce each good  Why are some against trade? o They have invested in becoming a specialist in the wrong field! Something that they don’t have comparative advantage in it.  Creating advantages takes time and needs investment The Production Possibility Frontier  The production possibility frontier (ppf) is a graph that shows all of the combinations of goods and services that can be produced if all of society’s resources are used efficiently.  The slope of the ppf curve is also called the marginal rate of transformation (MRT).  Points inside of the curve are inefficient. Points on the PPF curve are efficient points and this is called technical efficiency.  Points outside of the curve are not attainable.  The slope of PPF is negative and usually increasing. o This is called the law of increasing MRT or the law of increasing opportunity cost.  As we increase the production of one good, we sacrifice progressively more of the other Economic Growth  Economic growth is an increase in the total output of the economy. It occurs when a society acquires new resources, or when it learns to produce more using existing resources.  Major reasons for economic growth: o Population growth o Lower unemployment rate o Capital accumulation o Human Capital accumulation o Better weather condition o Discovering new natural resources o Technological advances Trade and ppf  By specializing and engaging in trade, societies can move beyond their own production possibilities. Production outside ppf is still impossible Economic Systems  Economic systems include: o Command economies  A central government either directly or indirectly sets output targets, incomes, and prices. Central government answers the three basic questions o Laissez-faire (let do, let pass) economies  Individuals and firms pursue their own self-interests without any central direction or regulation Page 5 of 10 ECON 2005 o Mixed systems  Consumers dictate what will be produced by choosing what to purchase. This is called Consumer sovereignty.  Free enterprise: individual producers figure out how to plan, organize, and coordinate the production of products and services.  The distribution of output is also determined in a decentralized way. The amount that any one household gets depends on its income and wealth.  The basic coordinating mechanism in a free market system is price.  Invisible hand = price system Government  Markets are not perfect  Government intervention is needed o Minimize market inefficiencies o Provide public goods (roads, law enforcement, information, etc.) o Redistribute income o Stabilize the macro economy:  Promote low levels of unemployment  Promote low levels of inflation Chapter 3: Demand, Supply, and Market Equilibrium  The circular flow of economic activity shows how firms and households interact in input and output markets  Market is where sellers and buyers interact. o It does not need to have a physical location  Input markets o Labor, capital, and land markets 1. Households supply work for wages to firms that demand labor in labor markets. 2. Households supply their savings, for interest or profits to firms in capital markets. 3. Households supply land in exchange for rent in land markets.  Output markets Competitive Market Structure  A market is a Competitive Market if: 1. Everyone is buying or selling the same product. 2. There is no transaction cost. 3. Each buyer or seller is too small to change the price.  There are many small buyers and sellers  All buyers and sellers are price takers. 4. All buyers and sellers have full information about price and product. Law of Demand  Law of demand states that there is a negative, or inverse relationshop between price and the quantity of a good demanded and its price  This means that demand curve’s slope downward. o Price increases – Quantity Demand decreases and price decreases – Quantity Demand increases Income and Wealth  Income is the sum of all HH’s wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure. Page 6 of 10 ECON 2005  Wealth is the total value of what a HH owns minus what it owes. It is a stock measure. Normal Goods, Inferior Goods  Normal good is a good for which: o Demand goes up when income is higher or o Demand goes down when income is lower o Example: BMW, travel to Las Vegas, health  Inferior Good is a good for which: o Demand falls when income rises or o Demand rises when income falls o Example: Tuna fish, instant noodles  Something that is normal for me might be an inferior for you  Example: Crude oil is a normal good in China, and the Chinese income is increasing. What happens? o Demand curve shifts to the right (or demand for oil increases)  Example: Rice is an inferior good in Korea, and the Korean income is increasing. What happens? o Demand curve shirts to the left (or demand for rice decreases) Substitutes and Complements  Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up.  Perfect substitutes are identical products.  Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa  Example: Crude oil and Natural Gas are substitutes in the US, oil price has increased. What happens? o Natural gas demand curve shifts to the right (or demand for Natural Gas increases)  Example: Crude oil and SUVS are complements in the US, oil price has increased. What happens? o SUV demand curve shifts to the left (or demand for SUVs decreases) Taste and Preferences  Example: CNN: Mad Cow Disease is increasing in US. What happens? o Beef demand curve shifts to the left (or demand for beef decreases)  Change in price of a good or service leads to: o Change in quantity demanded (Movement along the curve)  Change in income, preferences, or prices of other goods or services leads to: o Change in demand (Shift of curve) Market Demand  Market demand is the sum of all the quantities of a product demanded per period by all buyers. Supply  Quantity supplied represents the number of units of a product that a firm would be willing and be able to offer fro sale at a particular price  A supply schedule is a table showing how much of a product firms will supply at different prices  A supply curve is a graph illustrating how much of a product a firm will supply at different prices. Page 7 of 10