ECON1010 Sem 1 (Marco)
ECON1010 SUMMARY
INTRODUCTION
-Model = a simplified representation of reality
-PPC = Production Possibility Curve captures all maximum output possibilities for two (or more) goods, given a ‘set of inputs’ (or resources i.e. time) if inputs are used efficiently
-An Efficient Production Point represents a combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of the other. This is on the PPC.
-An Inefficient Production Point represents a combination of goods for which currently available resources allow an increase in the production of one good without a reduction in the production of another. This is under/to the left of PPC.
-An Attainable Production Point represents any combination of goods that can be produced with the currently available resources. This is on/under PPC.
-An Unattainable Production Point represents any combination of goods that can not be produced with the currently available resources. This is above the PPC.
-An agent has an Absolute Advantage in a productive activity when he does this activity with less resources than another agent
-The Opportunity Cost of a given action is the value of the next best alternative to that particular action. It is the slope of the PPC.
-An agent has a Comparative Advantage in a productive activity when he/she has a lower opportunity cost of carrying this activity than another agent
-Everyone is better off if each agent specialises in the activities for which they have a comparative advantage.
-Trade to sell if Price cost of production
-Trade to buy if Price cost of production themselves
-Principle of Increasing Opportunity Cost (Low Hanging Fruit Principle) – in the process of increasing the production of any good, first employ those resources with the lowest opportunity cost and only once these are exhausted turn to resources with a higher cost.
-Factors driving economic growth:
- Increase in infrastructure,
- Population and
- Advancements in knowledge and technology
-CPC – Consumption Possibility Curve) – this represents all combinations of two goods that the economy can feasibly consume when it is open to international trade
-Closed economy = no trade, PPC and CPC are identical, self-sufficient
-Open economy = trade on international market, CPC is above and to the right of PPC
-In a many-agent economy the PPC is a smooth curve and you calculate the slope tangentially (at a point). The Slope is increasing – i.e. the OC is increasing
-This model is critiqued:
- No psychological cost of performing same activity
- No transaction costs associated with trading i.e. regulation, transport costs etc.
- No import quotas or tariffs – limit gains by specialisation (because at a certain point it is pointless)
- No changes in preferences for goods/services
-Combining PPCs: translate up by no. of units which other person can contribute. First send the lower opportunity cost – flatter slope (Low-Hanging Fruit principle)
-Maximise CPC: start producing at outermost point on PPC usually
-Utility represents the satisfaction that an individual derives from consuming a given good or taking a certain action. It is measured in utils per unit of time. Maximise utility.
-Decreasing Marginal Utility captures the fact that the utility from consuming an extra unit of a given good decreases with the number of units that have been previously consumed.
-The Quantity Demanded by a consumer represents the quantity of a given good or service that maximizes the utility experienced by the individual consuming it.
-The Demand Curve represents the relationship between the price of a good or service and the quantity demanded of that good or service.
- Demand curve can be interpreted
Horizontally: Start from a certain Price and then use the demand curve to derive the Quantity of goods that the consumer is willing to buy at that price.
Vertically: Start from a given Quantity, find the associated Price on the demand curve the maximum amount of money the consumer is willing to pay for the marginal unit of the good, also called Consumer Reservation Price (or Willingness to Pay)
-Demand Curve = MB curve (for consumer).
-ΔP ?? ΔQ move along the demand curve
-Δ preferences (marketing, price of other goods) shift of the demand curve
-What shifts the demand curve to the right:
- Successful marketing campaign
- Decrease in the price of complements
- An increase in the price of substitutes
- An increase in income for a normal good
- A decrease in income for an inferior good
- A positive shift in consumers’ preferences for a good
- Expectations (about in future prices that push the buyers to try to purchase the goods early
- Population growth
-Law of Demand:
The tendency for a consumer to demandmore of a certain good or service when the price of that good or service decreases.
Law of Demand:
Demand curves have the tendency of being downward sloping.
-The Substitution Effect captures the change in the quantity demanded of a given good following a change in its relative price. Other goods become relatively cheaper
- Price Substitution Effect quantity consumed
- Price Substitution Effect quantity consumed
-The Income Effect captures the changes in the quantity demanded of a given good following the reduction in the consumer’s purchasing power. An increase in the price is increase in proportion to income
- For a normal good,
In income in the quantity consumed.
In income in the quantity consumed.
- For an inferior good,
In income in the quantity consumed.
In income in the quantity consumed.
-Usually the Substitution Effect dominates so
Price overall quantity consumed
Priceoverall quantity consumed
- For a Giffen good (very rare),
In price overall quantity consumed!!
-Market: a collection of buyers and sellers to exchange goods and services
-In a perfectly competitive market:
- Sellers compete to get more buyers
- Buyers and sellers are price-takers – cannot command increase in price and would not make sense to sell below market value.
- Free entry and exit from the market
- Products sold are homogenous – identical
- Full information is available – price and characteristics of products involved is well known to everyone involved
- No externality – production activities have no negative impact on other producers or society as a whole
- Excludability – can prevent consumers from consuming product
- Rivalry – once consumed, product becomes unavailable to other customers
-Marginal benefit – the benefit of producing an extra product/unit
-Marginal cost – the cost of producing that extra unit of product
-Cost-benefit principle: if marginal benefit marginal cost, take action.
-Marginal cost is opportunity cost, not absolute cost. If something becomes less readily available its OC increases and therefore its MC increases too.
-Draw a Supply Function– the relationship between the price (P) of a good/service and amount an individual decides to produce (Q)
-The Quantity Supplied represents the quantity of a given good or service that maximises the profit of a supplier.
-Market equilibrium occurs when price is such that the quantity that consumers want is the same as the quantity suppliers want to sell.
-The Economic Surplus of a certain action is the difference between the marginal benefit and the marginal cost of taking that action.
-The Law of Supply is the tendency for a producer to offer more of a certain good or service when the price of that good or service increases.
-The Supply curve can be interpreted:
- Horizontally: start from a certain price and then use the supply curve to derive the quantity of goods that will be supplied at that price
- Vertically: start from a given quantity, find the associated price on the supply curve – the minimum amount of money the producer is willing to accept to supply the marginal unit of the good – Producer Reservation Price
-A Sunk Cost is a cost that once paid cannot be recovered. E.g. commercial/marketing costs
-If a Factor of Production is Fixed, its cost does not vary with the quantity produced. A Fixed Cost is a cost associated with a fixed factor of production.
-If a Factor of Production is Variable, its cost tends to vary with the quantity produced. A Variable Cost is a cost associated with a variable factor of production.
-The Short run has at least one fixed cost of production
-The Long run is where all costs are variable
-The Total cost is the fixed cost + variable cost
-The Marginal cost is the =
-The Average total cost = =
-The Average variable cost =
-The Average fixed cost = FC/Q
-The min ATC and the min AVC intersect the MC
-The Profit= total revenues (TR) - total costs (TC).
-Shut Down Condition (Short Run):
In the short run, the entrepreneur should shut down production if πproductionFC.
-Shut Down Condition (Long Run):
In the short run, the entrepreneur should exit the industry if πproduction0.
-What shifts the supply curve to the right:
•Drop in the price of (variable) inputs
•Advancements in technology (via its impact on productivity)
•Expectations (on future prices/demand )
•Drop in the price/demand of other products
•In number of suppliers
-Elasticity = % change in Q supplied resulting from a 1% change in P. Can work out ideal relationship between P and Q to maximise profit because TR = PQ. Measures the responsiveness of the supply (if working out the elasticity of supply). Can measure the responsiveness of demand (if working out the elasticity of demand).
- >1 = elastic (horizontal graph)
- = 1 is unit elastic
- <1 = inelastic (vertical graph)
-What changes the elasticity of supply:
- Availability of raw materials
- Factors mobility
- Inventories / Excess capacity
- Time horizon
-The Price Elasticity of demand represents the percentage change in the quantity demanded resulting from a very small percentage change in price. It also measures the responsiveness of the demand to changes in price.
-ElasticityA = (1/slope) x (PA/QA)
-ElasticityA = (ΔQ/QA) / (ΔP/PA)
-What changes the elasticity of demand:
- Availability of substitutes
- Definition of goods
- Income share
- Time horizon
-
-The Shutdown condition is anything under the min AVC
-Profit = TR – TC = PQ – FC – VC
-Profit is maximised where P = MC
-Produce when profit > -FC NOT when P > 0
- PQ – VC > 0, produce
- PQ > VC
- P > VC/Q = AVC i.e. produce when price is > AVC
-The Aggregate Demand (or Supply) represents the horizontal sum of the individual Demand (or Supply) curves.
-1. In one graph, plot both Aggregate Demand & Aggregate Supply
-2. Find the point (Q*, P*) where Quantity Demand = Quantity Supplied
-Excess Supply depicts a situation where the quantity supplied is larger than the quantity demanded.
-Excess Demand depicts a situation where the quantity demanded is larger than the quantity supplied. (See graph below)
-The Reservation Price of a Buyer is the highest price a buyer is willing to pay for a given good.
-The Reservation Price of a Seller is the lowest price a seller is willing to accept for a given good.
-The Rationing Rule states that buyers who value the good more will be the first to buy it.
-The Consumer Surplus represents the difference between what a consumer pays for a good or service and what she is willing to pay for that good or service (her reservation price). The Total Consumer Surplus represents the sum of the economic surplus of all consumers.
-The Producer Surplus represents the difference between the price a seller receives for a good or service and what he is willing to receive for that good or service (her reservation price). The Total Producer Surplus represents the sum of the economic surplus of all producers.
-The Total Surplus is the sum of the total consumer surplus and total producer surplus.In a perfectly competitive market, Total Surplus is maximized exactly at the equilibrium price P*!!
-Pareto Efficiency is a situation in which it is impossible to make any individual better off without making at least one other individual worse off.A perfectly competitive market’s Equilibrium is Pareto Efficient!
-Pareto Improving Transaction = no possible transaction that would make someone better off without harming someone else.
-The Invisible Hand Principle states that individuals’ independent efforts to maximize their gains (profits for sellers; utility for buyers) will generally be beneficial for society and result in the socially optimal allocation of resources.
Government intervention
-The Price Ceiling represents a maximum allowable price imposed by the government. Do it when govt. believes that P is unfairly high (to protect low-income consumers)
-The Deadweight Loss is the loss in economic surplus due to the market being prevented from reaching the equilibrium price and quantity where marginal benefit (MB) equals marginal cost (MC).
-The ‘winners’ of this policy are the consumers with high reservation price (i.e., high willingness to pay) the rich!!
-Solution: If the government wanted to help the low-income households, a direct lump sum transferto the poor is more efficient.
-The Price Floor represents a minimum allowable price imposed by the government.Do it when Gov. believes that P is unfairly low (to protect producers in a certain sector)
-
-The ‘losers’ of this policy are all those harmed by the price floor consumers & producers!!
-Solution: The ‘losers’ would be willing to pay the ‘winners’ the exact amount they gained from the intervention in exchange for cancelling the price floor Pareto Improving Transaction!
-Unlike the price ceiling and the price floor, a tax generates tax revenues. Tax revenues can be used to redistribute wealth within a society. This improves the distribution of Income & Opportunities across different population groups
-The ‘losers’ of this policy are
- Theconsumers & producers (P, Q ) or
- Theconsumers (if D = inelastic OR S = perfectly elastic)
- Theproducers (if S = inelastic OR D = perfectly elastic)
-The ‘winner’ is the Government gets tax revenue. They use tax revenue to subsidize or reduce taxes on other markets or provide public goods, etc.
-Solution: The ‘losers’ would be willing to pay the ‘winner’ the exact amount it gained from the intervention in exchange for cancelling the tax Pareto Improving Transaction!
-Tax those with the lowest elasticity! The more elastic supply & demand are at the initial P*, the bigger the deadweight loss!
-Subsidy: Government Cost to assist certain groups of consumers (or producers). Makes certain goods more affordable for certain groups of consumers
-The ‘winners’ of this policy are the consumers and producers, but it costs more to the Government then it benefits the people.
-Solution: If the government wanted to make certain goods more affordable, a direct lump sum transferto the poor is more efficient.
-OverallPerfectly competitive markets converge to an equilibrium where total surplus is maximized, so any Gov. intervention that prevents a market from reaching its P* is bad for total surplus. Therefore, AVOID Gov. intervention at all cost! Sometimes this is not true: Public Goods!
International trade
-The Domestic Price represents the equilibrium price that would occur in a country if no international trade were allowed.
-The World Price represents the equilibrium price on the international market.
-A Small Open Economy is an economy that participates in international markets, but its production (or consumption) is small enough compared to the rest of the world that its supply (or demand) does not affect the world price.
-A Closed Economy is an economy that does not engage in international trade. Also known as autarky.
-D represents GAINS from trade!The Gains from Trade capture the extra surplus available in an open economy compared to a closed economy.For exporting, The Gains from Trade come from international consumers (at the expense of domestic consumers surplus)!
-C+D are GAINS from trade!For importing, The Gains from Trade come from larger surplus for domestic consumers (who now buy at lower prices)!
-Benefits of trade:
- Consumers have access to a wider variety of goods
- Producers may be able to take advantage of economies of scale by selling to a larger market
- Domestic monopolies or oligopolies might face international competition, reducing their market power
- Flow of ideas and technology is faster and easier.
-An Import Tariff represents a tax on imported goods or services.
- Domestic consumers lose BUT domestic producers/government gain
- There is a DWL, so tariff is bad.
-An Import Quota represents a quantity limit on the amount of goods or services permitted to be imported.
-J represents the importers’ bonus
-Domestic consumers lose BUT domestic producers/government gain. Deadweight Loss Quota is bad!
Imperfectly competitive markets
-Imperfect: one or more of the following assumptions apply:
- Consumers/suppliers are NOT price-takers, or
- Goods are NOT homogeneous, or
- There ARE externalities, or
- Goods are NOT excludable and rival, or
- Imperfect (not full) information, or
- NO free entry and exit.
-A firm is said to be a Price-Maker (or Price-Setter) if it has the ability to set its own prices.
-A firm has Market Power if it has the ability to set its own price.
-Types of market power:
- Monopoly:Only one firm in the market ( the firm’s individual D curve = market D curve!)
- Monopolistic Competition: There are a large number of firms, each producing slightly differentiated goods (almost perfect substitutes).
- Oligopolistic Competition: There is a small number of firms selling goods that are close substitutes.
-Antidote to market power = free entry/exit!