ECN 104 Lecture Notes - Consumer Sovereignty, Market System, Productive Efficiency
-Microeconomics is a methodology; it's a way of looking at the world.
-Economics is the science of scarcity and choice.
-There is an economic problem when people have desires and there is something limited.
-Individuals want to maximize happiness.
-Other-Things-Equal Assumption means everything is held constant.
-Microeconomics examines individual units (household, firm or industry) and their
decision making process.
-Macroeconomics examines the whole economy: national output of G and S (GDP) and
the subdivisions or aggregates: unemployment, inflation.
-Positive statements are based upon facts & cause-and-effect relationships. There are no
-Normative statements are based upon subjective beliefs.
-What is needed to produce G and S: Property Resources: Land-natural resources,
Capital- manufacturing aids to produce G and S: factory, storages, machines.
Human Resources: Labor- physical and mental talents of individuals used in producing G
and S. Entrepreneurial Ability- takes initiative, makes policy decisions, innovates, and
-The Production Possibilities Model Assumptions: full employment and productive
efficiency, fixed resources (factors of production), fixed technology, two goods.
-Opportunity Cost is the sum of all that is lost by taking one course of action over
-The law of increasing opportunity cost: shape of the curve is concave to the origin.
Economic explanation: resources-factors of production-are not completely adaptable to
alternative uses, thus you need to give up the production of one input in order to increase
the other input.
-Decide on optimal allocation of resources by comparing Marginal (extra) Cost (MC) to
Marginal Benefit (MB). Marginal Benefit is the extra benefit associated with consuming
one more unit. Marginal Cost is the extra cost of the extra unit. Want to have MC=MB.
-We want a growing economy. To do so we must increase in factor supplies (more land
,labor, capital and entrepreneurial activity), advance in technology.
-Countries that produce more goods tend to grow faster. A company that invests in future
goods will grow faster.
-Individual nations are limited by the PPC. But not when there is international
specialization and trade!
-Products provided for “free” to an individual are not free for society because of the
required use of scarce resources to produce them. Companies provide “free” goods as a
marketing strategy to promote brand awareness. Products that are promoted as “free” to
the individual may actually be bundled with another good for which the consumer must
pay. Because a purchase is required to obtain them, these products are not really free to
-The increase of women in the workforce has lead to the shifting of the PPC outward.
More women because of increase in women wage rate, greater access to jobs.
-Post hoc fallacy: when two events occur in time sequence the first event is not
necessarily the cause of the second.
-Correlation vs causation: events may be related without a casual relationship.
-Economic system: A particular set of institutional arrangements and a coordinating
-The command system: also known as socialism or communism. Government owns
most of the property resources and economic decisions occur through a central
-Market system key characteristics:
Private property: can enjoy it and dispose of it as one sees fit.
Freedom of enterprise and choice: enterprise (businesses can buy and sell as they
choose) & choice (owners can use or sell property as they choose, workers can work
where they like and consumers can buy what they want).
Self interest: is what interests one. Businesses seek profits. Consumers seek value.
Competition: independently acting sellers and buyers- no single buyer or producer
controls the market. Easy entry and exit.
Markets and Prices: prices signal scarcity and guide resource allocation.
Other characteristics: Technology and capital goods (advances technology and
capital goods promote efficiency and output). Specialization (division of labour,
ability differences, learning by doing, save time switching tasks, geographic
specialization). Use of money: it is a medium of exchange (money substitutes for
barter, which requires a double coincidence of wants). Active, but limited
government: although the market system promotes efficiency, it has certain
shortcomings such as the over production of goods with social costs such as
-Five Fundamental Questions:
1.What will be produced? Those goods and services that can be produced at a profit-
businesses must respond to consumers’ (individuals, other businesses, and the
government) wants and it desires to make profits. It is what consumers vote for
with their dollars (consumer sovereignty). Market restraints on freedom-
Businesses are not free to produce what they want must match their production
choices with consumer choices or they will face losses and eventual bankruptcy.
2.How will the goods and services be produced? The goods and services will be
produced in the most efficient and least costly method.
3.Who will get the goods and services? Those with the greatest willingness and
ability to pay.
4.How will the system accommodate change? By responding to price and profit
signals. Markets are dynamic- what is efficient today may not be efficient tomorrow
as tastes, technology, and resource supplies change(price help signal those
5.How will the system promote progress? Technological advance. Creative
destruction occurs when new products and production methods destroy the market
positions of firms that are not willing or able to adjust. Capital accumulation- which
helps to finance technological change.
-The “Invisible” Hand:
Prices communicate information about scarcity and value.
Markets bring private and public interest closer together.
Three special merits of the market system: 1. Market systems promote efficiency. 2.
Market systems provide incentives for people to be productive through work effort
and acquiring skills. 3. Market systems provide personal freedom in making
-The Demise of the Command System:
The coordination problem- difficult for central planners to co-ordinate million of
individual decisions by consumers, resource suppliers, and businesses. The outputs
of some industries serve as inputs for others. Outputs of some industries serve as
input for others.
-The Circular Flow Diagram ** See powerpoint slide 17 and 18.
*Read Last word and Korea
-Demand: is a schedule or a curve that shows the various amounts consumers are
willing and able to purchase at each of a series of possible prices, during some
specified period of time.
-Law of Demand: Inverse relationship between price and the quantity demanded.
(Price goes up, demand goes down) Supported by: Diminishing marginal utility
which states as consumption of a good or service rises the marginal utility falls-
consumers buy more only if price falls. Income effect-as prices fall a consumer’s real
income rises and buys more. Substitution effect- consumer substitutes more
expensive goods with less expensive goods.
-Demand Shifters are changes in: tastes (preferences), number of buyers, income
(when increases demand for normal goods increase, demand for inferior goods
(example starch products) decrease) prices of related goods, expectations.
-Supply: a schedule or a curve showing the amounts that producers are willing and
able to make available for sale at each of a series of possible prices, during some
specified time period.
-Law of Supply: all else being constant, as prices rise, the quantity supplied rises
(direct relationship). Why? To generate more revenue.
-Supply shifters are changes in factor prices, technology, taxes and subsidies
(subsidies is opposite of taxes), prices of other goods, producer expectations, and
number of sellers.
-Equilibrium price will be established where the supply decisions of producers and
the demand decisions of buyers are mutually consistent.
-Rationing Function of Prices: combination of freely made individual decisions
results in market-clearing price.
-Efficient Allocation: Productive Efficiency and Allocative Efficiency.
-Changes in demand or supply will affect the equilibrium price and quantity.
*Look at graphs for increase and decrease in demand and supply.
-Government interventions: Price Ceiling- A legally established maximum price for a
good or service. Price Floors- A legally established price above an equilibrium price.