Econ103 ES - ©Prep101 Economics 103 Study Sheet Basic...

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Unformatted text preview: ©Prep101 Economics 103 Study Sheet Basic Concept and Models Opportunity cost refers to the value of the next‐best alternative that you give up when you make a choice. Opportunity cost arises because resources are scarce and choosing more of one thing means choosing less of another thing. A production possibilities curve (or production possibilities frontier) shows all possible combinations of two goods that can be produced in an economy. Computers The production possibilities curve shows all possible combinations of two goods that can be produced 1 Points on the curve, like points 1 and 2, are efficient combinations of computers and lumber which can be produced 3 4 Points inside the curve, like point 4, are attainable but inefficient 2 Points outside the curve, like point 3, are unattainable Lumber An economic system is an institutional arrangement that decides what and how much is produced, how it is produced, and who gets it. There are following 4 types of economic systems: command economy, capitalist (or free market economy), traditional economy and mixed economy. Positive economics is concerned with what WILL happen to the economy as a whole when the government decides to raise taxes, cut funding for road repairs, or both. Normative economics is concerned with what the government SHOULD do, given what will happen when the government chooses the above options. One country is more efficient in the production of goods and services than the other; we can say that this country has an absolute advantage in producing these goods and services. A country has a lower opportunity cost in one good has the comparative advantage in the production of that good. The efficient allocation of resources is when the marginal benefit equals to the marginal cost of those resources. Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 Demand, Supply and Elasticity Note that when economists talk about demand they are referring to the demand curve. Conversely, when economists talk about quantity demanded they are referring to a single point on the demand curve. Note that when economists talk about supply they are referring to the supply curve. Conversely, when economists talk about quantity supplied they are referring to a single point on the supply curve. An inferior good is a good for which an increase in income causes a decrease in demand, or a leftward shift in the demand curve. A normal good is a good for which an increase in income results in an increase in demand, or a rightward shift in the demand curve. Factors that shift Demand Curve Effect on Demand Curve for X Price of X ↑(↓) Movement down (up) along Demand Curve Substitute ↑(↓) Shifts Right (Left) Price of Related Good Y Complement ↑(↓) Shifts Left (Right) Normal Goods Shifts Right (Left) Income ↑(↓) Inferior Goods Shifts Left (Right) Product more fashionable Shifts Right Tastes Product less fashionable Shifts Left Population ↑(↓) Shifts Right (Left) Expect price to ↑ Shifts Right Expectations about Future Expect price to ↓ Shifts Left Factors that Shift Supply Curve Effect on Supply Curve for X Price of X ↑(↓) Movement up (down) along supply curve Prices of Inputs ↑(↓) Shifts Left (Right) Technology* ↑ Shifts Right Number of suppliers ↑(↓) Shifts Right (Left) [* Note: Technology can’t ↓as firms won’t switch to less efficient technology] Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 Dynamics of Demand and Supply Supply ↓ (S shifts left) Demand ↓(D shifts left) Demand unchanged Supply ↑ (S shifts right) p* ↑ or ↓ q* ↓ Supply unchanged Effect on P* and Q* p* ↓ q* ↓ P* unchanged q* unchanged p* ↓ q* ↑ p* ↑ q* ↓ p* ↓ q* ↑ or ↓ p* ↑ q* ↑ Demand ↑(D shifts right) p* ↑ q* ↑ or ↓ p* ↑ or ↓ q* ↑ Note: When changes occur in both supply and demand, the effects are sometimes known and sometimes depend on the exact shape of the supply and demand curves and the amount they shift. Elasticities η = Price Elasticity = ‐ % change in the quantity of demanded = ‐∆Q/Q ¯ of Demand % change in the price ∆P/P ˉ ηS = Price Elasticity = % change in the quantity supplied = ∆Q/Q ¯ of Supply % change in the price ∆P/P ˉ ηY = Income Elasticity = % change in the quantity of demanded = ∆Q/Q ¯ ¯ of Demand % change in income ∆Y/Y ηXY =Cross-Price Elasticity= % change in the quantity of good X demanded = ∆QX/ QX ¯ of Demand % change in the price of good Y ∆PY/ PY ¯ Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 Markets and Efficiency Consumer surplus is the difference between a buyer’s willingness to pay and how much the buyer actually pays. Producer surplus is the difference between the price at which sellers sell their goods and the cost of production. The total surplus is equal to consumer surplus plus producer surplus. The deadweight loss is the difference between the total surplus corresponding to the efficient allocation, and the total surplus resulting from any other allocation. Price ($) S Consumer Deadweight pm surplus loss Producer p* surplus D m q q* Quantity Price floor (minimum wage) A price floor is a government regulation that makes it illegal to pay an amount lower than a specified level. A price floor is only binding (or effective) if it is set above equilibrium price and the price floor becomes the new equilibrium price. A price floor set below equilibrium price has no effect. Price ceiling (rent control) A price ceiling is a government regulation that makes it illegal to pay an amount higher than a specified level. A price ceiling is only binding (or effective) if it is set below equilibrium price and the price ceiling becomes the new equilibrium price. A price ceiling set above equilibrium price has no effect. Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 The Theory of Demand (Consumers) Total utility is a measure of the total level of satisfaction a consumer receives from consuming goods. Marginal utility (MU) is the additional utility received by a consumer from consuming one more unit of a good. Marginal utility = Change in total utility Change in number of units consumed Utility Maximization Criterion (MUX/PX = MUY/PY) An indifference curve shows all combinations of good X and good Y that give the consumer the same utility level. The budget line is the boundary of the budget set. QCD Optimal bundle I Budget line QPS The marginal rate of substitution (MRS) is the number of units of one good a consumer is willing to give up to get one more unit of the other good. The substitution effect of a price change is the change in quantity demanded that results from a move along the indifference curve to a point where the MRS equals the slope of the new budget line. The income effect of a price change is the change in consumption that results from a change in the real income of the consumer, while keeping relative prices fixed. Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 Production and Cost Explicit costs are expenses paid directly by firms. Because accounting profits do not include implicit costs (or opportunity costs), there is a difference between accounting profits and economic profits. Accounting profit = Total Revenue – Explicit Costs Economic profits = Total Revenues – (Explicit + Implicit Costs) The short run is a time period in which the quantities of some factors of production are fixed. For this reason, these factors are called fixed factors. The long run is a time period in which all inputs may be varied. Like the short run, the long run does not correspond to a specific length of time. The very long‐run is the time period during which all inputs and technologies may be varied. Average physical product (AP) is the total product (TP) divided by the number of units of the variable factor (L) used to produce it: TP AP L Marginal physical product (MPP) is the increase in total product resulting from the use of one extra unit of L. TP MP L Total cost (TC) is the costs of all the inputs used in production. Total cost is divided into two categories: total fixed cost and total variable cost. Total fixed cost (TFC) is the cost of the fixed input, and thus it does not vary with the level of output. Total variable cost (TVC) is the cost of the variable input, and thus it varies with the level of output. Average total cost (ATC), also called average cost (AC), is the total cost per unit of output. That is, TC ATC Q Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 Average fixed cost (AFC) is the total fixed cost per unit of output. That is, TFC AFC Q Since TFC is constant, AFC always decreases with Q. Average variable cost (AVC) is the total variable cost per unit of output. That is, TVC AVC Q Marginal cost (MC) is the increase in total cost resulting from a unit increase in output. TC That is, MC Q Shut Down Price P = lowest level of Short Run AVC When price is lower than ATC but higher than AVC, firms should keep running. Breakeven Price P = ATC When price just covers all AFC and AVC, a firm is at breakeven point, and it has no profit or loss. Comparing Market Structures Market Structure Number of firms Ease of entry into industry Ability to set price Product differentiation Perfect Competition Many Easy Price taker Identical Monopoly One Impossible Price setter Unique Monopolistic Competition Many Easy Price setter Differentiated Oligopoly Few Difficult Price setter Identical or differentiated Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 Perfect Competition The market form of perfect competition is characterized by: large number of firms and each is small compared to industry as a whole; firms are price takers that accept market price and each firm is so small that its actions have no effect on market price; firms sell identical goods and consumers are indifferent which firm they buy goods from as long as prices are the same; firms and consumers have perfect information; there are no barriers to firms entering or exiting the market (which leads to zero economic profits in the long run) and existing firms have no advantage over new firms. Total revenue (TR) TR= P* q Average revenue (AR) AR = TR/q = P MR= TR/q = slope of TR curve Marginal revenue (MR) In perfect competition, MR= P The profit maximization for each individual firm occurs at the optimal level of output Q*, at which marginal revenue equals marginal cost, MR = MC. MR & MC ($) MC Loss from Profit-max. 5th unit point p Profit from 3rd unit 1 2 3 4 5 Output q Monopoly q* (units) The market form of monopoly is characterized by: o one firm (monopolist); o the monopolist is a price setter (price maker); o unique product with no close substitutes; o legal or natural barriers to entry (possibility of long run economic profits). Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 Just like in perfect competition, a monopolist will maximize profits when it produces a quantity where MR = MC. The only difference is that now MR is downward sloping. MC P ATC P* Economic profit ATC* D M Q* Price discrimination means to charge different prices for different units of the same product for reasons not justified by differences in cost. Marginal cost pricing (below left) sets a price ceiling where price equals marginal cost (P = MC). Average cost pricing (below right) sets a price ceiling where price equals average total cost curve (P = ATC). Monopolistic Competition and Oligopoly The market form of monopolistic competition is characterized by: Large number of firms (but less than perfect competition) Firms are price setters Firms sell differentiated products that are close substitutes No barriers to entry and exit (which leads to zero profits in long run) The market form of oligopoly is characterized by: small number of large firms (and possibly many small firms) firms are price setters products may be identical or differentiated barriers to entry (possibility that profits can persist in long run) interdependence among firms (each firm’s decisions on output and price based on how other firms will respond) leads to cooperative or non‐cooperative strategic behaviour. Lots more Free Study Aids at www.prep101.com/freestuff ©Prep101 Factor Markets The extra revenue received as a result of using an additional factor of production is called that factor’s marginal revenue product (MRP). The optimal levels of capital and labour a profit maximizing firm should use are given by w = MRPL for labour and r = MRPK for capital, i.e. hire factors until the marginal benefit of hiring them is equal to the marginal cost of hiring. Market Failure Market failure means that the market has allocated too many or too few resources to a particular economic activity and the result is inefficient. Externalities refer to the effects on parties not directly involved in the production or use of a commodity. Pollution and Abatement Pollution imposes social and economic costs; however, the abatement of pollution is also costly. The optimal amount of pollution is at where marginal cost of pollution is equal to its marginal benefit. The marginal benefit of pollution is the abatement cost saved. Therefore, we can use the following diagram to help us understand the optimal level of pollution. Lots more Free Study Aids at www.prep101.com/freestuff ...
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