Economics Revision Notes.docx

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Monash University
George Rivers

Economics Revision Notes Lecture 1- Introduction  Economics: study of the choices people and societies make to attain their unlimited wants, given their scarce resources.  Market: A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.  Scarcity: where unlimited wants exceed the limited resources available to fulfill those wants.  Trade-off: where producing more of one good or service means producing less of another good or service, because of scarcity.  The opportunity cost of any production or consumption activity is the value of ‘next best’ alternative that must be given up to engage in that activity.  The true cost of ‘something’ in economic terms is its ‘opportunity cost’ (i.e. what you give up to get it!)  Centrally planned economy: government decides how economic resources will be allocated.  Market economy: decisions of households and firms interacting in markets determine the allocation of economic resources.  Mixed economy: where most economic decisions result from the interaction of buyers and sellers in markets, but in which the government plays a significant role in the allocation of resources.  Consumer sovereignty is a central feature of market economies and occurs because firms must produce goods and services that meet the wants of the consumers, in order to be successful.  Productive efficiency: where a good or service is produced using the least amount of resources.  Allocative efficiency: production reflects consumer preferences, resources are allocated to their best uses, and every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.  Dynamic efficiency: Occurs when new technology and innovation are adopted over time.  Production possibility frontier: A curve showing the maximum attainable combinations of two products that may be produced with available resources. Lecture 2- Demand and Supply  Quantity demanded: The amount of a good or service that a consumer is willing and able to buy at a given price.  As the price falls, the quantity of a good or service demanded increases  Holding everything else constant, when the price of a product falls, the quantity demanded will increase, and when the price of a product rises, the quantity demanded will decrease.  Change in quantity demanded that results from a change in price, making the good or service more or less expensive relative to other goods and services (holding constant the effect of the price change on consumer purchasing power).  The five most important variables are: 1. Prices of related goods (substitutes and compliments) 2. Income (normal good Vs. inferior good) 3. Tastes 4. Population and demographics 5. Expected future prices  Quantity supplied: the amount of a good or service that a firm is willing and able to supply at a given price.  As the price falls, the quantity of the good or service supplied decreases  Holding everything else constant increases in the price of a product cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.  The five most important variables are: 1. Prices of inputs 2. Technological change 3. Prices of substitutes in production 4. Expected future prices 5. Number of firms in the market  Market equilibrium is when quantity demanded equals quantity supplied.  Shortage: A situation in which the quantity demanded is greater than the quantity supplied.  Surplus: A situation in which the quantity supplied is greater than the quantity demanded. Lecture 3- Elasticity  Responsiveness in one dependent variable Y to changes in another independent variable X, ceteris paribus.  (% change in Y) / (% change in X) = (ΔY/Y) / (ΔX/X)  Demand is elastic if the elasticity is larger than one in absolute value  Demand is inelastic if the elasticity is less than one in absolute value  Unitary elastic if the elasticity is one in absolute value  Perfectly elastic if the elasticity is infinity in absolute value  Perfectly inelastic if the elasticity is zero  The flatter demand curve means that demand elasticity will be higher generally.  What determines price elasticity of demand?  Availability of close substitutes (electricity vs Big Mac)  The length of time involved  Necessities vs. luxuries (i.e. discretionary goods) (milk vs restaurants)  Definition of the market  Share of expenditure on the good in the consumer’s budget  Total revenue is the amount paid by buyers and received by sellers of a good.  The elasticity of supply will always be positive as price and quantity supplied always move in the same direction  Availability of resources  Flexibility and mobility of inputs  Time Lecture 4- Economic Efficiency  Consumer surplus: The difference between the highest price a consumer is willing to pay and the price the consumer actually pays.  Producer surplus: The difference between the lowest price a firm would have been willing to accept and the price it actually receives.  Marginal benefit: The additional benefit to a consumer from consuming one more unit of a good or service.  Marginal cost: The additional cost to a firm from producing one more unit of a good or service.  Equilibrium in a competitive market results in the economically efficient level of output where MB = MC.  Economic surplus: The sum of consumer surplus and producer surplus.  Deadweight loss: The reduction in economic surplus resulting from a market not being in competitive equilibrium.  Price floor: A legally determined minimum price that sellers may receive.  Price ceiling: A legally determined maximum price that sellers may receive.  Taxes finance government activities.  Taxes on goods and services affect market equilibrium and result in a decline in economic efficiency.  Taxes reduce consumer surplus and reduce producer surplus and result in a deadweight loss.  Taxes reduce the production of goods and services.  Tax creates a deadweight loss by reducing the quantity exchanged and the gains from trade.  The size of the deadweight loss depends on elasticities.  If sellers or buyers can more flexibly adjust to the adverse changes in price, then the deadweight loss is larger (as more gains from trade will be lost).  The deadweight loss is larger if demand and/or supply are more price-elastic. Lecture 5- Labour Markets and International Trade  The demand for labour is a derived demand: derived from the demand for the good or service the factor produces.  The labour demand curve is downward sloping and shows the relationship between the wage rate and quantity of labour demanded.  The marginal product of labour is the additional output a firm produces as a result of hiring one more worker.  MP = ΔQ/ΔL  Because of the law of diminishing returns, MP declines as a firm hires more workers.  The marginal revenue is the additional revenue firm receives as a result of producing an additional unit of output.  MR = ΔTR/ΔQ  The labour supply curve shows the relationship between the wage rate and quantity of labour supplied.  The labour supply curve for most people is upward sloping.  At very high wage levels the labour supply curve for an individual may become backward bending.  Tariff: a tax on imported goods- Government collects tariff revenue.  Quota: a limit on the amount of import Lecture 6- Market Failure and Government Intervention  Output produced at a minimum average cost (productive efficiency)  Economic problem of how to produce is addressed.  Output produced where marginal benefit to society equals the marginal c
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