BSB113 - Economics Notes

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Department
Management and Human Resources
Course Code
BSB113
Professor
All

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Lecture 1 How people make choices What economists assume  People are rational  People respond to economic incentives  Optimal decisions are made at the margin  Individuals make choices that maximize their own welfare/utility/happiness  We are selfish  Firms make decision that maximize profit  Governments make decisions that maximize the welfare of society The Economic Problem – How to use our limited resources to satisfy our unlimited wants and needs to the greatest extent.  What goods and services will be produced  How will the goods and services be produced  Who will receive the goods and services produced Opportunity Cost  The cost in terms of the most valuable alternative that is sacrificed  Spending limited resources on a selection of wants and needs Types of Economies  Centrally planned economy – government decides how economic resources will be allocated  Market economy – an economy in which the decisions of households and firms interacting in markets determine the allocation of economic resources  Mixed economy - mixture of both Market economies and efficiency  Productive efficiency – situation in which a good or services is produced using the least amount of resources  Allocate efficiency – state of the economy in which production reflects consumer preferences  Dynamic efficiency – occurs when new technology and innovation are adopted over time Equity  A fair distribution of economic benefits between individuals and between societies  Policies to achieve equity can be pursued through the tax structure  Progressive tax – high income earners pay the highest marginal tax rate (rich give to poor)  Equity may compromise efficiency Economic models/analysis  Positive analysis – concerned with what is what is, involves value-free statements that can be tested by using the facts  Normative analysis – concerned with what ought to be, involves making judgments which cannot be tested Economics is grouped into two areas  Microeconomics – study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices  Macroeconomics – study of the economy as a whole, including inflation, unemployment and economic growth Lecture 2 Demand Curve Price (Dollars) Quantity Market demand is the demand by all the consumers of a give good or service. The market demand curve is derived by horizontally summing all the individual demand curves for a good or service. The ceteris paribus condition  “All else being equal”  Requirement that when analyzing the relationship between two variables, such as price and quantity demanded, other variables must be held constant. Substitution effect, change in the quantity demanded of a good/service that results from a change in price, making the good or service more or less expensive relative to other goods and services that are substitutes Income effect, change in the quantity demanded of a good or service that results from the effect of a change in price on consumer purchasing power. Prices of related goods  Substitutes, goods or service that can be used in place of other goods or services (iPhone and Android) Price of iPhones increases, the demand for Androids will go up.  Complements, goods and services that are consumed together (iPhone and apps) price of iPhone increases, the demand for apps will go down. Income  Normal good, good for which the demand increases as income rises and decreases as income falls  Inferior good, good for which the demand increases as income falls and decreases as income rises (homebrand). Tastes  Subjective elements that influence a consumer’s plans to buy a good or service. Population and demographics  Population - as population increases the demand for most goods and services will increase  Demographics – changes in the characteristics of the population (age, race and gender) will influence demand for various goods and services Expected future prices  Consumers choose when to buy goods and services based on their expectations regarding future prices relative to present prices  If consumers expect prices to increase in the future, they have an incentive to increase purchases now and vice versa Supply Curve Price Quantity Market supply is the supply by all the firms of a give good or service. The market supply curve is derived by horizontally summing all the individual supply curves for a good or service. Prices of inputs  Increase in the cost of an input increase the cost of production (firms supplies less)  Decrease in the cost of an input decreases the cost of production at every price (firms supplies more at ever price) Technological change  Change in the ability of a firm to produce a give level of outputs with a given quantity of inputs  Positive technological change allows the firm to produce more outputs with the same amount of inputs  Negative technological change is rare Prices of substitutes in production  Alternative products a firm can produce with the same resources (pizza or calzone)  Increase in the price of a substitute in production o Price of pizza goes up o Productive capacity moves to making pizza o Fewer calzones are made at every single price o Calzone supply curve shifts inwards  Decrease in the price of a substitute in production o Price of pizza goes down o Productive capacity moves to calzone o More calzones are made at every single prices o Calzone supply curve shifts outwards Market equilibrium  Increase in demand – increases price and quantity  Decrease in supply – increase in price decrease in quantity  Shortage – shortage of goods due to price below equilibrium  Surplus – surplus of goods due to price above equilibrium Lecture 3 Elasticity  Price elasticity of demand o Is the responsiveness of the quantity demanded of a good to a change in its price  PED is relatively inelastic o When change in quantity demand is not very responsive to a change in price (petrol, energy, water)  PED is relatively elastic o When change in quantity demand is very responsive to a change in price (cinema tickets)  How is PED measured o Recall that PED is the responsiveness of the quantity demanded of a good to a change in its price %change in quantity demand PED  o %change inprice o eg 10% increase in the price of cigarettes is associated with a 5% decrease in the quantity of cigarettes demanded PED  5%  0.05 10% 0.10 o o PED  -0.5  What does PED figure mean (Ignore the minus sign)  Elastic demand o Demand is elastic when the percentage change in quantity demanded is greater than the percentage change in price (eg PED=5)  Inelastic demand o Demand is inelastic when the percentage change in quantity demanded is less than the percentage change in price (eg PED=0.4)  Unit elastic demand o Demand is unit elastic when the percentage change in quantity demanded is equal to the percentage change in price (eg PED=1) Calculating PED without percentages  Use mid point formula (Q Q ) (P P ) PED  2 1 2 1 ((Q 2Q )12) ((2 P1)/2)   Where P=Price and Q=Quantity Elasticity is not constant along linear demand curve  This is because o A decrease in price is a smaller % change when price is high o An increase in QD is a larger % change when the QD is small o A decrease in price is a larger % change when the QD is large o An increase in QD is a smaller % change when the QD is large When demand is price inelastic  A decrease in price leads to a decrease in total revenue  And increase in price leads to an increase in total revenue When demand is price elastic  A decrease in price leads to an increase in total revenue  An increase in price leads to a decrease in total revenue Cross price elasticity of demand  % percentage change in the quantity demanded of one good divided by the percentage change in the price of another good  positive when two goods are substitutes in consumption  negative when the two goods are complements in consumption Income elasticity of demand  Measures the responsiveness of quantity demanded to change in income %change in quantity demand of one good YED   %change inincome  Positive but less than 1 – quantity demanded is not very responsive to a change in income – the good is normal and a necessity  Positive and greater than 1 – quantity demanded is very responsive to a change in income – normal and a luxury  Quantity demanded falls as income increases – an inferior good The price elasticity of supply  The responsiveness of the quantity supplied to a change in price  Elasticity of supply will always be positive as price and quantity supplied always move in the same direction % change in quantity supplied PES = % change in price Lecture 4 Economic Efficiency and Market Failure Consumer Surplus  Difference between the highest price a consumer is willing to pay and the price the consumer is actually prepared to pay  Measures the net benefit (total benefit minus total price paid) to consumers from participating in a market Marginal Cost  Additional cost to a firm from producing one more unit of a good or service Producer Surplus  Difference between the lowest price a firm would be willing to accept and the price it actually receives  Measures the net benefit (total benefit minus total cost of production) to producers from participating in a market Efficiency of competitive markets  Equilibrium in a competitive market results in economically efficient level of output  Economic efficiency o A market outcome in which the marginal benefit to consumers of the last unit consumed is equal to it marginal cost of production (marginal benefit = marginal cost) Government intervention  When the government imposes price controls o Some people win o Some people lose o There is a loss of economic efficiency  Price floor o A legally determined minimum price that sellers may receive (to be binding it must be set above the equilibrium price) o A high price floor may lead to be a surplus in goods o An example of this is the national minimum wage  Price ceiling o A legally determined maximum price that sellers may receive (to be binding it must be set below the equilibrium price) o A low price celling may lead to a shortage in goods The economic impact of taxes  Taxes finance government activities  Taxes on goods and services may affect market equilibrium and result in a decline in economic efficiency  Taxes may reduce consumer surplus and reduce producer surplus and result in a deadweight loss  Taxes reduce the production of goods and services If the Consumers pay the tax  Demand curve shifts back If the producers pay the tax (excise tax)  Supply curve shifts back What happen to efficiency when there is market failure  Externalities o A benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service  Negative eternality causes a difference between the private cost of production and the social cost of production o Producers do not bare the full cost of producing the good o Part of the cost is borne by society  Positive eternality causes a difference between the private benefit from consumption and the social benefit of consumption o The individual does not receive the full benefit of their consumption of a good or service o Part of the benefit of consumption is borne by society Negative externalities  Negative externality o Producers do not bear the full cost of producing the good o Part of the cost is borne by society  There will be overproduction of the good or service Positive externalities  Positive externality o The individual does not receive the full benefit of their consumption of a good or service o Part of the benefit of consumption is borne by society  There will be under consumption of the good or service Policy solutions to externalities  Command and control approach o Quantitative limits on the amount of pollution firms are allowed to generate o Required installation by firms of specific pollution control devices  Market based approaches o Pigovian taxes and subsidies  Tax of production equal to the cost of the externality to internalize a negative externality  Subsidy to consumers equal to the value of the positive externality, that is, equal to the external benefit Lecture 5 Technology, production and costs Economists’ view of the activities of a firm  Firms use inputs to produce outputs  Technology o Is the processes a firm uses to turn inputs into outputs of goods and services  Technological change o Results in a change in the ability of a firm to produce a given level of output with a given quantity of inputs The Short and Long Runs  Short run o The period of time during which at least one of the firm’s inputs is fixed  Long run o A period of time long enough to allow a firm to vary all of its inputs, to adopt new technology, and to increase or decrease the size of its physical plant Costs in the short and the long run  Total cost (TC) o The cost of all the inputs a firm uses in production  Variable costs (VC) o Costs that change as the quantity of output changes  Fixed costs (FC) o Costs that remain constant as quantity of output changes  Total costs = fixed cost + variable cost o TC=FC+VC Implicit and explicit cost  Opportunity cost o The highest-valued alternative that must be given up to engage in an activity  Explicitly cost (Wages, electricity, lease) o A cost that involves spending money o Rules of accounting generally require that only explicitly costs are recognized for the purposes of companies’ financial records  Implicit cost (Salary and interest) o A non-monetary opportunity cost o These cost do not represent payments that were actually made o But they are real costs that are incurred Economists – firm’s production  Production function o The relationship between the inputs employed by the firm and the maximum output it can produce with those inputs  Factors of production o Natural resources (land) o Labor o Capital o Entrepreneurial ability (entrepreneurship)  Total product o Total output generated from the factors of production employed by a business  Average product o Total output divided by the number of units of the variable factor of production employed  Marginal product o Change in total product when an additional unit of the variable factor of production is employed Law of diminishing returns  As more units of a variable input (ie labor or raw materials) are added to fixed amounts of capital, the change in total output will at first rise and then fall  Total output will still be increasing (but at a decreasing rate) Lecture 6 The market for labor Factors of production  The inputs used by firms to produce goods and services o Labor o Natural resources o Capital  Demand for factor of productions is a derived demand o It is derived from the demand for the good or service the factor produces The relationship between the marginal revenue product of labour and the wage When  MRP>W – should hire more workers to increase profits  MRP
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