Академический Документы
Профессиональный Документы
Культура Документы
Economics Notes
What is economics? Rationing systems Demand and Supply The Interaction of, and applications of, Demand and Supply Elasticities Indirect taxes, subsidies and elasticity Costs, revenues, and profits Perfect competition
Micro Economics
What is economics?
Adam Smith (1723-1790)
father of economics Wrote one of the first and most important books on economics An Inquiry into the nature and causes of the wealth of nations The book was written during the beginning of the industrial revolution. Smith believed in the free market
Simple Agricultural systems Most people involved in producing basic products Few people providing other necessities such as leather and farming equipment Coming of the steam engine Increased use of machinery able to produce more good with more efficiency Banks for investment Birth of stock exchange
Scarcity
All goods and services that have a price are relatively scarce. Scarce in relation to peoples demand for them. The earth is finite peoples wants/demands are infinite. Price is usually used to ration out goods; the more expensive something is the smaller the market for it.
Needs:
Things we must have to survive; food, shelter, clothing
Wants:
Things we want but are not necessary for our immediate survival
Micro Economics
Goods:
Physical objects that are capable of being touched/ they are tangible
Services:
Still give satisfaction but are intangible.
Opportunity Cost
The next best alternative given up from choosing between alternatives. If a good or service has opportunity cost it is therefore relatively scare and must be an economic good. Goods such as air, salt and water which are not in limited supply thus do not have an opportunity cost. They are known as free goods.
Micro Economics
. .
Important economic questions are answered by individuals not the government. NO government intervention.
PLANNED ECONOMY (greater depth later) . Government makes all economics decisions . Most resources and property is owned by the government. . No knowledge of supply and demand as government chooses everything.
Factors of Production:
Four resources that allow an economy to produce its output
LAND:
Everything that grows on the land or is found underneath it; this includes the sea and everything that is found in and under the sea. . Basic raw materials: gold, coal, oil and natural gas. . Cultivated products: wheat, rice, pineapples . Natural resources: renewable resources and all cultivated products . Non-renewable: including all fossil fuels LABOUR: Human factor; the physical and mental contribution of the existing work force to production CAPITAL: . Physical Capital: stock of manufactured resources . Human Capital: value of work force . Social Overhead Capital: large-scale public systems/services and facilities MANAGEMENT/ ENTREPRENEURSHIP: . Organising and risk taking factor of production . Entrepreneurs use their own money plus the money of investors to buy factors of production so they can produce goods and services . A profit is never guaranteed, investments can be lost
Micro Economics
Used by economists to show concepts of scarcity, choice, and among other things, Opportunity Cost. PPF/PPC shows the maximum combinations of goods and services that can be produced by an economy in a given time. A PPF is a curve because not all the factors of production are equally usable/productive for both goods.
At point B, both product A and B are being produced at equal amounts and all factors of production are being used efficiently.
An outward shift in a PPF means there has been growth in the economy. The only way for this to occur is if there is an improvement in the quantity or quality of the factors of production.
Utility:
Measure of usefulness and pleasure The total satisfaction gained from consuming a certain quantity. Eg. If a person ate five ice creams the total pleasure gained from eating all five ice creams. The extra utility gained from consuming one more unit. In most cases marginal utility gained from extra units falls as consumption increases. Total Utility
Marginal Utility
Micro Economics
Rationing Systems
Micro Economics (continued later):
Deals with smaller economic agents and their reactions to changing events. . Individual consumers: how they make their decisions about demand and expenditure. . Individual firms: how they make their decisions, what to produce? How much to produce? . Individual industries: how are they affected by things such as government intervention?
Positive Economics:
Positive statement: can be proven right or wrong by looking at facts. Positive Economics deals with areas of the subject that are capable of being proven to be correct or not. "The unemployment rate for china for 2004 was 9.8%".
Normative Economics:
Micro Economics
Normative statement: matter of opinion, cannot be conclusively proven to be right or wrong; uses words like 'ought', 'should', 'too much' or 'too little'. Normative economics deals with areas of the subject that are open to personal opinion and belief. Unlikely to have a conclusive outcome in normative economics. For example theories as to why economies tend to move from periods of economic activity to periods of depressed activity.
Rationing Systems:
Economic decisions guided by the change in prices that occur as individual buyers and sellers interact with the market place. . Most of resources are owned by private citizens. . Economic decisions are based on free enterprise (competition between companies) . Important economic questions are answered by individuals not the government. . NO government intervention. THREE ECONOMIC QUESTIONS: Who decides what to Who decides how to Who are the goods and services produce? produce? produced for? Business base decisions on demand and supply and free enterprise (PRICE) Businesses decide how to produce goods and services. Consumers.
Micro Economics
PLANNED ECONOMY
. . .
Government makes all economics decisions Most resources and property is owned by the government. No knowledge of supply and demand as government chooses everything. . This system has not been very successful and more and more countries are abandoning it. THREE ECONOMIC QUESTIONS: Who decides what to Who decides how to Who are the goods and services produce? produce? produced for? Government makes all economic decisions. Government decides how to produce goods and services. Whoever the Government decides to give them to.
MIXED ECONOMY
There is no true market economy . Market + Demand = Mixed . There is no pure market or command economies. All modern economies, to some extent, exhibit characteristics of both systems; however closer to one system than the other. . Business owns most resources and determine what and how to produce however the government still regulates certain industries. . Most democratic countries fall under mixed economy.
DISADVANTAGES OF MARKET 1. Demerit goods (drugs/brothels etc) will be over provided, driven by high prices and thus high profit motive.
DISADVANTAGES OF COMMAND 1. Total production, investment, trade and consumption, even in a small economy, are too complicated to plan efficiently and thus there will be miscalculations of resources. Shortages and surpluses.
Micro Economics
2. Merit goods (medicine/health care) will be underprovided, since they will only be produced for those who can afford it.
2. Because there is no price system in operation, resources will not be used efficiently. Arbitrary decisions will not be able to make the best use of resources. 3. Resources may be used up too 3. Incentives tend to be distorted. quickly and the environment may Workers with guaranteed be damaged by pollution, as firms employment and managers who seek to make high profits and gain no share of profits are difficult minimize costs. to motivate. Output/quality will suffer. 4. Some members of society will not 4. The dominance of the be able to look after themselves government may lead to a loss of such as orphans, the sick and long personal liberty and freedom of term unemployed- will not survive. choice. 5. Large firms may grow and 5. Government may not share the dominate industries, leading to high same aims as the majority of the prices, a loss of efficiency and population and yet, by power, may excessive power. implement plans that are not popular, or corrupt.
Transition Economies:
. Countries such as Hungary, Poland and Russia, previously planned economies have been moving towards market-oriented balance in their systems. Them movement started mostly in the late 1980's.
Economic Growth:
. National income is the value of all the goods and services produced in an economy in a given time period, normally one year. National income can be measured by looking at the total value of the output of the good and services/ the expenditure on the good and services. Measure real national income per capita. This measure of the increase in economic activity is known as economic growth. Any increase caused by rising prices/inflation is ignored; once this has been done the national income is know as real national
.
.
Micro Economics
income. Real means having allowed for the effects of inflation. Economic growth is a money measurement and an average. Doesnt have anything to do with welfare of the people in a country.
Economic Development:
. Is a measure of welfare, a measure of well-being: using not only monetary terms but health, education and social indicators.
LAW OF DEMAND: As the price of a product falls, the quantity demanded of the product will using increase, 'ceteris paribus'. . It is important to remember that a shift along the curve will only happen if the determining factor is the price.
Micro Economics
A change in the price of the product itself will lead to a change in the quantity demanded and a movement along the curve.
A shift of the demand curve to the right indicates an increase in demand for the good.
INFERIOR GOODS:
Micro Economics
. .
Income rises, the demand for the product will fall and the demand curve itself will shift to the left. For example cheap wine or "home brand" supermarket detergent. When income gets to a certain level demand for inferior goods will become zero.
If income falls the demand curve for inferior goods will shift to the right as the consumer no longer has the ability to purchase higher priced goods.
A shift in the demand curve to the left indicates that demand for the good has fallen and as income rises this is exactly what happens.
COMPLEMENT
Micro Economics
. .
A change in the price of one will lead to a change in the demand for the other. For example if the price of DVD players when down not only would demand for that particular good go up the demand for DVDs would also increase.
UNRELATED . A change in the price of one will have no effect on the demand for another good.
Tastes:
.
A change in tastes in favour of a product will lead to more being demanded at every price. Marketing may/can alter tastes. Changes in income distribution
Relatively poor become better off and rich become slightly worse off there may be an increase in the demand for basic necessity goods.
Other factors
Changes in age structure
Age structure alters, the quantity of demand for certain products will be affected.
Seasonal changes
Changes in the season can lead to changes in the pattern of demand.
Micro Economics
. . .
.
Unique type of inferior good. Key aspect is POVERTY Price goes up , demand increases This is because as the price of the good goes up the poor can no longer afford higher priced/ quality products. If price goes down, real income increases and they can afford higher priced goods.
VEBLEN
. .
. .
Price Goes down, demand goes GOODS: down Seen as a luxury Failure to consume in due quantity and quality becomes a mark of inferiority and demerit. As price rises, demand increases. At low prices goods have normal demand curve, once the good reaches a certain price it achieves a snob value status.
Micro Economics
Role of Expectations:
(The bandwagon effect)
Quantity demanded rises as price rises . People expect prices to continue to rise in the future . More people jump on the bandwagon
Supply:
The willingness and ability of producers to produce a quantity of a good or service at a given price in a given time period. . MUST BE WILLING AND ABLE LAW OF SUPPLY: As the price of a product rises the quantity supplied of the product will usually increase, ceteris paribus.
Micro Economics
Determinants of Supply:
The cost of factors of Production:
.
The cost of a factor of production increases, this increases the firms cost, resulting in the firms ability to supply decrease (they supply less). [ Inverse relationship] This leads to a shift of the curve to the left.
Price of other products, which producer could produce instead of the existing product:
.
Producers have a choice of what they will produce; can they produce two different goods with a minimal change in production facilities? If the price of good A rises (more demand), more of A will be produced and there will be movement along the supply curve for A. The supply for B will decrease and there will be a shift of the curve its self.
State of Technology:
. . Improvements of technology lead to an increase of supply, thus the curve shifts to the right. Natural disasters can have a negative effect on the state of technology
Government intervention:
INDIRECT TAXES (EXPENDITURE TAXES): (Taxes that are added onto the cost of the product) . Because prices are forced up, this forces the supply curve upwards.
Micro Economics
SUBSIDIES: (Payments made to firms by the gov. to reduce firms costs) . Because costs are reduced more of the product will be supplied at every price. Forcing the demand curve downwards.
Micro Economics
Micro Economics
Once this is achieved the market is in equilibrium as it will stay in this state until there is an outside disturbance to cause change. At Pe everything produced in the market will be sold. This is known as the Market Clearing Price.
If the market does not reach equilibrium there will either be excess demand or excess supply. To find out how much excess there is you subtract Q2 from Q1 ( Qs Qd )
Micro Economics
Price Controls:
Governments usually intervene in the market to achieve a different outcome that a free market would achieve.
Micro Economics
Commodity Agreements:
Pioneered in the 1960s Commodiity Agreements are when different countries work together to operate a buffer stock system.
Elasticities
Elasticity is a measure of responsiveness; measuring how much something changes when there is a change in one of the factors that determine it. If something is elastic the percentage change in demand is greater than the percentage change in price. Usually wants/luxuries. If something is inelastic the percentage change in demand is less than the percentage change in price. Usually needs.
Micro Economics If something is unit elastic the percentage change in demand is equal to percentage change in price.
NOTE: the elasticity is NOT a measure of the slope of the demand curve, PED changes as you move along the curve. (PED decreases as you move down the slope)
Determinants of PED:
Micro Economics
XED Value
Negative Positive Close Close Complements Substitutes Zero Remote Complements Unrelated products Remote Substitutes
Relationship
Micro Economics or if the percentage increase of quantity demanded is less than the percentage rise in income.
if the answer is one then the product is unit elastic. A change in price leads to a proportionate change in supply. NOTE: if a supply curve starts in the origin it is unit elastic. If the answer is greater than one and less than infinity it has elastic supply. A change in price leads to a greater than proportionate change in quantity supplied.
Micro Economics
Determinants of PED:
Micro Economics
b) A percentage tax (Valorem Tax): the tax is a percentage of the selling price.
When 1. 2. 3. 4.
imposing an indirect tax, four questions must be asked: What will happen to the price that consumers pay? What will happen to the amount received by the producer? How much tax will the government receive? What will happen to the size of the market, and so employment?
PED=PES
The burden of any tax imposed will be shared equally between producer and consumer.
Micro Economics
The effect of a subsidy on the demand for, and supply of, a product:
A subsidy is an amount of money paid by the government to a firm, per unit of output.
When granting a subsidy certain things must be considered: 1. The opportunity cost of government spending on the subsidy in terms of other alternative government spending projects. 2. Whether the subsidy will allow firms to be inefficient, if they do not have to compete with foreign producers, in a free market. 3. Tax payers are funding subsidies, who is paying taxes? 4. What damage will it do to the sales of foreign producers who are not receiving susidies from their governments? NOTE: although percentage subsidies are sometimes given, they are extremely PED = PES rare! The price of the product will fall by half of the subsidy. Specific subsidies are much more common.
The price of the product will fall by less than half of the subsidy.
The price of the product will fall by more than half of the subsidy.
Micro Economics
AP = TP/V
TP = total product V = number of units of the variable factor employed. Marginal Product is the extra output that is produced by using an extra unit of the variable factor.
MP = TP/V
TP = change in TP V = change in the number of units of the variable factor employed.
Micro Economics
Short-run costs:
Firms have many different costs when producing whatever goods or services. In order to explain different ways of measuring costs we separate the subject of costs into three groups: 1. Total costs: the complete costs of producing output can be measured three ways: a) TOTAL FIXED COSTS (TFC): the total cost of the fixed assets that a firm uses in a given time period. It is a constant amount. b) TOTAL VARIABLE COSTS (TVC): the total cost of the variable assets that a firm uses in a given time period. c) TOTAL COST (TC): is the cost of all the fixed and variable factors used to produce a certain output. TC = TFC + TVC
2. Average costs: the costs per unit of output: a) AVERAGE FIXED COST (AFC): the fixed cost per unit of output.
AFC = TFC/q
Q is the level of output b) AVERAGE VARIABLE COST (AVC): the variable cost per unit of output. NOTE: as with AVC, ATC AVC = TVC/q tends to fall as output increases, and then starts to c) AVERAGE TOTAL COST (ATC): rise again is the output ATC = TC/q continues to increase.
Micro Economics
3. Marginal Costs: the increase in total cost of producing an extra unit of output.
MC = TC/q
The long run:
the long run is that period of time in which all factors of production are variable, but the state of technology is fixed. All planning takes place in the long run. When planning in the long run, an entrepreneur is free to adjust the quantity of all the factors of production that are used and is only restrained by the current level of technology.
We look at what happens to costs when all the factors of production are increased in order to increase output. However the theory of the long run is quite different to reality.
There are two reasons long-run costs may increase or decrease: 1. Economies of scale: any decreases I long-run average costs when a firm alters all of its factors of production in order to increase its scale of output. Economies of scale lead to increasing returns to scale. Specialisation, division of labour, bulk buying, financial economies, transport economies, large machines, and promotional economies are all economies of scale. 2. Diseconomies of scale: any increases in long-run average costs that come about when a firm alters all of its factors of production in order to
Micro Economics increase its scale of output. Diseconomies of scale lead to decreasing returns to scale. Control and communication problems, alienations and loss of identity are two internal diseconomies of scale.
Revenue Theory:
Revenue can be measured in three ways: . TOTAL REVENUE (TR): the total amount of money that a firm receives from selling a certain amount of a good or service, in a given time period.
TR = pxq
P = price a good or service sells for q = quantity of good/service sold . AVERAGE REVENUE (VR):revenue a firm receives from selling a certain amount of a good or service in a given time period.
AR =
.
TR/q = pxq/q =
MARGINAL REVENUE (MR): the extra revenue that a firm gains when it sells one or more unit of a product in a given time period. NOTE: MR is below AR as in order to sell more products the firm has to lower the price of all products sold; losing revenue on products the firm couldve sold at a higher price.
MR = TR/q
Micro Economics
2. Revenue when price falls as output increases ( PED falls as output increases) The firm wants to sell more of its output and it can control the price, at which it sells, and then it will have to lower the price if it wants to increase demand. Faces a normal demand curve.
Micro Economics
Perfect Competition
The assumptions of perfect competition:
. . . . . The industry is made up of a very large number of firms Each firm is so relatively small; it is not capable of altering its own output to have a noticeable effect upon the output of the industry as a whole. The firms all produce exactly identical products. Their goods are homogeneous. Firms are completely free to enter or leave the industry: no barriers to entry or barriers to exit. All producers and consumers have a perfect knowledge of the market.
The demand curves for the industry and the firm in perfect competition:
Micro Economics
The firm takes the price P from the industry, and because in perfect competition demand is perfectly elastic, P = D = AR = MR.
Micro Economics
MC=AC
Productive efficiency is important because if a firm is producing at this point they are combining their resources efficiently as possible, nothing is wasted.
Allocative efficiency:
Where suppliers are producing the optimal mix of goods and services required by consumers, also called socially optimum level of output. Price reflects the value consumers place on a good and is shown by AR. Marginal Costs reflect the cost to society of all the resources (including normal profit) required to produce an extra unit.
Micro Economics
If price is greater than MC the consumers value the good more than it costs to make it. allocative efficiency occurs when:
MC=AR
Monopoly
The Assumptions of a Monopolistic Model: . There is only one firm producing the product so the firm is the industry . Barriers to entry exist, which stop new firms from entering the industry and maintains the monopoly. . As a consequence of barriers to entry the monopolist may be able to make abnormal profits in the long run. Whether a firm is a monopoly depends on how narrowly we define the industry. So the important question is how much monopoly power the firm has. . To what extent is the firm able to set its own prices without worrying about other firms? . To what extent can it keep people out of the industry?
2. Natural Monopoly:
There is only enough economies of scale available in the market to support one firm. Example industries that supply utilities such as water, electricity or gas.
Micro Economics 3. Legal Barriers: The legal right to be the only producer in an industry, this is the case with patents, trade marks and copy right. These three are utilised to encourage invention and give profit incentive for firms to put resources into development. 4. Brand Loyalty: Such a brand loyalty is created that the consumers think of the product as the brand. 5. Anti-competitive Behavior: This will stop competition and can be legal or illegal. For example an established monopoly can start a price war. Lowering the price to be running at a loss but they can sustain the loss-running period longer than the new entrant. The mere knowledge of the capability of this is enough to dissuade new firms.
The demand curve and the profit maximising level of output in monopoly:
The monopolists demand curve is the industry demand curve. Monopolists can only control either level of output or price. Meaning because the demand curve is downwards sloping, monopolists cant charge whatever price they like and still sell products.
Micro Economics
Efficiency in monopoly:
Monopolist produces at profit-maximising level of output. It restricts quantity of out put to force up the price and so is neither producing at allocative nor productive efficiency.
Oligopoly
The assumptions of oligopoly:
. A few firms dominate an industry expressed as a concentration ratio CRX, X being the number of the largest firms. Can be very different in nature with some producing identical products some producing highly differentiated products. There is interdependence; firms can influence the market. Price rigidity.
. . .
Non-collusive oligopolies: . Very aware of the reactions of other firms when making decisions
Micro Economics . Price rigidity; if the firm raises their price, other firms wont and the firm will lose demand if the firm lowers price, other firms will undercut them, creating a price war.
Non-price competition:
Firms tend to not to compete in terms of price. Types of non-price competition include: . Use of brand names . Packaging . Special features . Advertising . Sales promotion . Personal selling . Publicity . Sponsorship deals . Special distribution features An oligopoly is characterised by behaviour to guard and extend market share; very large expenditure on advertising and marketing (firms try to make goods less elastic). This increases the barriers to entry. POSITIVES: Competition among larger companies results in greater choice for consumers. NEGATIVES: Represents a misuse of scares resources.
Micro Economics
Price discrimination:
In order for producers to be able to discriminate: The producer must have some price setting ability The consumers must have different price elasticities of demand The producer must be able to separate the consumers. Producers can spate markets in different ways: . Time: consumers are prepared to pay different amounts at different times . Age: firms charge different prices based on age, e.g. children are charged less than adults.
Micro Economics . . Gender Income: for example lawyers will often charge higher prices to wealthy clients and lower charges/ sometimes pro-bono to those who do not have high income. Geographical distance Types of consumer: industrial or domestic?
. .
First-degree price discrimination The consumer pays exactly the price they are prepared to pay; leeway for bargaining (e.g. Car sales) Second-degree price discrimination The firm charges different prices to consumers depending upon how much they purchase (e.g. Costco, electricity and gas) Third-degree price discrimination Consumers are identified in different market segments, a separate price is charged in each market, (e.g. train and movie tickets)
Advantages to Price Discrimination (firm): . Allows producer to gain higher level of revenue from given amount of sales, as consumer surplus is eroded. . Enables producer to produce more and thus gain from economies of scale. . Enables firm to drive competitors out of the more elastic market (as profits from inelastic market can be used to lower prices for the more elastic markets). Advantages to price discrimination (consumer): . Allows some consumers to purchase products they otherwise wouldve been unable to purchase. . Increases total output and so product is available to more consumers. . Leads to economies of scale and thus could lower the price for all market segments. Disadvantages to price discrimination (consumer): . Any consumer surplus before will be lost . Some consumers will pay more than the price that wouldve been charged in a non-discriminated market. Contestable markets: . Focuses on the probability of new firms entering the industry in the future. A market is contestable when barriers to entry are low.
Micro Economics . Likelihood of entry by other firms is determined by entry costs and exit costs.
Market Failure
Community surplus:
When a market is in equilibrium, with no external influences or effects it is in a state of Pareto optimality. If a market is Pareto optimal it is socially efficient. NOTE: Pareto optimality exists when it is impossible to make someone better off without making someone else worse off. Social efficiency exists when community surplus is maximised
Market Failure:
In the real world markets arent perfect thus allocating resources in an optimal manner is impossible and community surplus is not maximised, this is a market failure.
Imperfect Competition: Monopolists and other imperfect markets restrict output in order to push up prices. They are not producing at the socially efficient level of output. This will lead to a failure to equate MSC and MSB. Government try to reduce this by intervening: . Use legal measures to make markets more competitive
Micro Economics . Set up regulatory bodies to investigate markets where it is felt that a monopoly power is being used against public interest.
Lack of Public goods: Public goods are goods that would not be provided at all in a free market because they are non-excludable and non-rivalrous; for example national defence or flood barriers. Government try to reduce this by intervening: . Provide the public good themselves . Subsidise private firms, covering all costs, to provide the good. Under-supply of merit goods: Merit goods are goods that will be underprovided in the market and thus will be under-consumed, for example education, health, sports facilities and the opera. Government try to reduce this by intervening: . Increase the supply and thus the consumption, depending on how important the gov. thinks the good is they may provide the good themselves or subsidise them. Over Supply of Demerit goods: Demerit goods will be over provided in the market and thus over-consumed, for example cigarettes, alcohol and hard drugs. Government try to reduce this by intervening: . Reduce the supply and/or demand for the good, depending how harmful they feel the good is they may make it illegal (hard drugs) or tax it (alcohol/cigarettes). Existence of externalities: