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FULL notes for ECON 101 (Got 92% in the course)

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University of British Columbia
ECON 101

June 2011 Jessica Giang Decisions! ! ! ! ! ! ! ! ! ! June 21 2011 - Who will work to make good and give services? Who will not work? - What good should be produced? How many? More SUVs = Less Toyotas - What resources to use? Labour aka human capital (the main factors of input/production ➞ whatever you use in a production process), physical capital (machines, computers, tools), - Monopoly: even if you have one, you cannot charge the highest price (will not maximize your profit because ppl demand will drop as people look for alternatives/substitutes. I.e. Car, cab, bikes instead of taking the bus). Even if there are no substitutes, charging very high is not a good way to maximize profits - Efficiency: the allocation of resources that maximizes total surplus (benefit) received by all members of a society. Equity: the fairness of distribution of well-being among the members of a society CH 1 - TEN PRINCIPLES OF ECONOMICS How people make decisions 1) People face tradeoffs ➞ to get one thing you usually give up another. I.e. if you want to work 10 hrs instead of 8, then you have 2 hours less for leisure. I.e. Efficiency (bigger pie) vs equity (equal slices) 2) Opportunity cost ➞ what you give up to get what you want. If you want 2 hours leisure time, you give up the money you could have made if you worked those 2 hours. 3) Rational people think at the margin ➞ marginal changes are small, incremental adjustments to an existing plan of action. I.e. Not an all-or-nothing approach, but a “should I have another bite? Study another hour?” kind of approach. Ratna used apple & decreasing satisfaction example. Compare cost (price of apple) and benefits (satisfaction from apple). “Cost of one more, benefit of one more” - Marginal Benefit & Marginal Cost ➞ if MB is higher than MC, then you go for that option. 4) People respond to incentives ➞ 1% bonus mark is incentive to come to class. - Marginal changes in cost or benefits motivate people to respond i.e. Carbon tax How people interact 5) Trade can make everyone better off ➞ don’t have to be self-sufficient, can specialize and enjoy more G&S. You have something the other person wants, they have something you want. 6) Markets are usually a good way to organize economic activity ➞ market economy where households and business firms determine what to buy, to make, who to work for and hire. Households and firm’s decisions are influenced by price and self-interest. Supply & demand determines the price. How much you value something determines if you buy it or not, i.e. Determines allocation of resources (you don’t get the computer, other people get the computer) 7) Government can sometimes improve market outcomes (i.e. Increase GDP) ➞ if market failure results in inefficiency (failure of the invisible hand), then the gov’t can intervene to promote efficiency/equity - Externalities are a market failure (one person’s action harms another) - Market power is the ability of a single person or small group to unduly influence market prices - Asymmetric information is when one party (seller or buyer) has more information about a product than the other party i.e. Insiders know more about how the company is doing than do the shareholders. Gov’t can make it mandatory to release this information. - I.e. If ICBC profits $100 by charging a higher price, but consumers altogether lose more than $100 ➞ this is bad for GDP (decide to bike instead of drive, they become less efficient if it makes them more unproductive ➞ maybe they have less time for work, maybe they’re tired and don’t make as many goods as they could have. Cost of people outweighs benefit of ICBC.) How does the economy as a whole work? 8) A country’s SoL depends on its ability to produce goods and services (being able to provide more goods and services = better SoL and higher GDP) June 2011 Jessica Giang - Productivity ➞ amount of goods and services produced each hour a person works. Higher productivity = higher SoL (higher productivity means you earn more money) 9) Inflation occurs when the gov’t prints too much money ➞ more money in the economy but same amount of G&S means that value of money decreases 10) Society faces a short-run tradeoff between inflation and unemployment - Phillips curve ➞ if you control inflation (by decreasing money supply/increasing taxes), then unemployment increases (tradeoff). In the SHORT RUN, people have less money but prices of goods are sticky, people will buy less, producers will produce less and employ less people ➞ unemployment. - Gov’t and open market operations to increase or decrease money supply. CH 2 - THINKING LIKE AN ECONOMIST Circular flow model ➞ a simply way of describing all the economic transactions that occur in a market economy. Consists of households, businesses, product markets (final goods and services), resource markets (labour, land, capital), Production possibilities frontier (PPF) ➞ a graph showing the various combinations of output the the economy can produce given the available factors of production and technology (the best combination of output derived from given factors of production) - Shows efficiency, tradeoffs, opportunity cost, and economic growth (PPF will be drawn larger) - Curved PPF means that the cost of producing X at the expense of Y increases as you move along the curve (top of curve = sacrifice little Y for X, middle of curve = sacrifice more Y for X). Positive (descriptive) analysis: statements or assertions dealing with matters of FACT or QUESTIONS about how things are Normative (prescriptive) analysis: statements about how the world should be CHAPTER 3 - INTERDEPENDENCE AND THE GAINS FROM TRADE - We’ve moved from agriculture & mining/construction to producing more G&S. To satisfy our needs, we can either be economically self-sufficient to participate in economic interdependence (specializing and trading with others). Interdependence prevails because people are better off when they specialize in the goods which they can produce at lower opportunity costs, and then trading with others to get goods that we don’t have a comparative advantage in. As long as there are differences in opportunity costs, everyone can benefit from trade. Proposed Trade Ratio (Slope): 10 Meat for 5 Potato = 2 (5 potatoes is traded for 10 meat) - Farmer’s OC of 1 potato is 1 meat. With the above TR, farmer trades 1 potato for 2 meat. Any TR greater than 1 (such as the proposed TR above) makes the farmer better off. Rancher’s OC of 1 potato is 4 meat. With the above TR, rancher trades 2 meat for 1 potato. Any TR smaller than 4 will make rancher better off. Any TR between 1 and 4 will make BOTH better off. The Principle of Comparative Advantage - Decides who should specialize in what and trade for what, depending on opportunity costs. Comparative advantage: producer that has a lower opportunity cost in producing a good Absolute advantage: producer that requires a smaller quantity of inputs to produce a good Interdependence and trade allow everyone to enjoy a greater quantity and variety of goods and services June 2011 Jessica Giang CHAPTER 4 - MARKET FORCES OF SUPPLY AND DEMAND - Producers determine supply, consumers determine demand Market: an institution, mechanism, or arrangement that facilitates the exchange of G&S. Also, a group of buyers and sellers of a particular good or service (e.g. A market for cars, computers, legal services). Competitive market - The goods offered for sale are all exactly the same - So many buyers and sellers that no single person can influence the price of the G&S. - Price is determined by total demand and supply (buyers and sellers are price takers). - Firms can enter or exit freely. Monopoly: one seller controls the price. E.g. BC Hydro, Shaw Cable, ICBC Oligopoly: few sellers, very little competition. Prices are determined by looking at a rival’s price. Monopolistic Competition: many sellers, each seller produces slightly different products (differentiated products) i.e., Honda Civic is different from Toyota Corolla, but they are both cars. Demand Quantity demanded refers to the amount (quantity) of a good that buyers are willing to purchase at various prices for a given period. Law of Demand: other things being equal, there is a negative rlnship between price and quantity: if prices are higher, demand is lower; if prices are lower, demand is higher. Qd = Qd (P) ➞ quantity demanded is a function of the price. Total market demand: sum of all individual demands at each possible price (e.g. 2+ people buying identical products at the same price. However much they buy combined is the market demand). What determines demand? 1) Price: when price is high, demand is low. When price is low, demand is high 2) Consumer income: if you have more wealth, you want to buy more (demand higher) - Normal goods: as income increases, your demand for this type of good increases (car, house). - Inferior goods: as income increases, demand for these goods decrease. E.g. Used goods. 3) Prices of related goods (substitute goods): a fall in the price of one good reduces the demand for another good (shift demand curve left). Substitute goods: two goods for which an increase in the price of one leads to an increase in the - demand for the other. I.e. Coke and pepsi - Complement goods: two goods for which an increase in the price of one leads to a - decrease in demand for the other i.e. Hot fudge and ice cream (since they’re often eaten together). 4) Tastes: you buy more of whatever you like. As your tastes change, what you buy changes. 5) Expectations about the future affect your demand today. I.e. If you think you’ll earn more you buy more 6) Number of consumers: more consumers, more demand. Ceterus paribus: all the relevant variables (e.g. Determinants of demand listed above) are held constant, EXCEPT for the one being studied at the time. Change in quantity demanded (due to price change) reflects a movement ALONG the d-curve. Change in demand (not due to price) is a SHIFT in the demand curve left or right. June 2011 Jessica Giang Supply Quantity supplied refers to the amount of a good that producers are willing to make and sell at various prices for a given period. Law of supply: all things being equal, there is a positive relationship between price and supply. As prices go up, supply goes up. As prices go down, supply goes down. Cost of production. The minimum price a seller is willing to sell a product for. Market supply: the sum of all individual supplies at each possible price What determines supply? 1) Price: as prices increase for a product, producers will supply more of that product (positive rlnship) 2) Input prices (cost of production): As P-cost goes up, supply decreases (shift left) 3) Technology: as technology advances, use of labour goes down, which means P-costs go down. 4) Expectation: if you believe the price of a product will fall, you will supply less of that product. 5) Number of producers: the more producers there are, the higher supply will be. Change in quantity supplied (caused by change in price): movement along supply curve Change in supply (due to non-price factors): shift in supply curve left or right Supply and Demand Together Equilibrium price: the price at which the supply and demand curves intersect Equilibrium quantity: the quantity at which the supply and demand curves intersect (quantity supplied = quantity demanded). There is no tendency to move when you’re at equilibrium. If you are not at equilibrium, there is a tendency to move towards equilibrium because: - if there is excess supply: the price is above equilibrium price, producers are unable to sell all they want at the going price, so they will stop producing that product and lower their prices. Lower prices increase the demand for that product and thus decrease supply of that product. - If there is excess demand: the price is below equilibrium price, consumers are unable to buy all they want at the going price. Producers will begin to produce more, and eventually will have to raise prices. Law of supply and demand: the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. Comparative statics: analyzing changes in equilibrium To analyze how some event affects the market, use these 3 steps: 1. Decide whether the event shifts the supply or demand curve, or both. 2. Decide if the curve shifts left or right 3. Decide how the shift affects equilibrium price and quantity (more/less expensive? More/less supply?) When supply and demand shift at the same time, the impact on the equilibrium price & quantity is determined by: 1. The relative size and direction of the change 2. The shape or slope of the supply and demand curves (i.e. Steep or flat curves?) Concluding Thoughts - Supply and Demand together determine the prices of the economy’s different goods and services. - Prices in turn are the signals that guide the allocation of resources CH 5 - ELASTICITY The % change in one variable caused by a 1% change in another variable (assuming all other variables remain constant). If change is great, then it is elastic. If change is not great, then it is inelastic. June 2011 Jessica Giang Price elasticity of demand: when price changes by 1%, how much does demand change? Ed= % change in the Qd divided by a 1% change in its price. Perfectly inelastic: change in prices doesn’t change demand at all, then E =d0. Consumers are “completely unresponsive” to price changes. Results in steep vertical demand curve. Perfectly elastic: change in prices causes large change in demand. I.e. Consumers are “infinitely responsive.” Small increase in price causes demand to almost die off. Results in flat horizontal curve. Unit elastic: consumer’s response is “equal to” the change in price %. I.e. If price increases by 1%, Qd increases by 1%. E = -1. d Demand tends to be more elastic: - Luxury goods (not necessary goods); as prices goes up, demand goes down. - The greater the number of close substitutes - Time period: demand for any goods tend to be more elastic in the long run. I.e. Price of gasoline: if price increases, its hard to cut down on demand within a short period of time. Within a few years, maybe you’ll buy a hybrid or move closer to work, etc. - The more narrowly defined the market is, the more elastic it is. E.g. Demand for car (a broad market) vs toyota corolla (narrow market). If price of toyota goes up, you can switch to different car. Demand tends to be more inelastic: - If the good is a necessity ➞ not easily replaced, i.e. Food. - The shorter the adjustment time ➞ people cannot easily adjust consumption in the short run - If there are few good substitutes ➞ can’t switch as easily from one good to another - The more broadly defined the market. Short-run vs long-run elasticity In general, demand is more price elastic in the long-run, because: 1) Consumers take times to adjust their consumption habits, e.g. If gas prices increase, it takes time for you to find ways to drive less (i.e. Moving closer to where you work, switching to hybrids) 2) More substitutes are available in the long-run. Computing Elasticity Percentage Change in Price Elasticity, Ed= Percentage change in Quantity demanded ! ! ! ! ! ! Percentage Change in Price Midpoint method for E : (Change in Quantity)/Average Quantity of Q2 and Q1 = (Q2-Q1)/[(Q2+Q1)/2] d ! ! ! ! ! (Change in Price) = (P2-P1)/P1 If a positive price increase decreases demand, then price is (+) whereas quantity demanded is (-). |E| = absolute value of elasticity, elasticity is always positive. Elasticity and total revenue If it is elastic, the relationship between price and total revenue (TR) is inverse (indirect). - |Ed| > 1, decrease in price = people buy lots (increase in quantity demanded) = increase in TR. June 2011 Jessica Giang If it is inelastic, the relationship between price and TR is positive (direct). - |Ed| < 1, increase in price = people buy less (Qd decrease), but TR increases b/c revenue from increase in price offsets revenue lost by decreased sales. Price Elasticity and a Linear Demand Curve - Elasticity (at a certain point) depends on the slope and on the values of P and Q at that point. - Top portion of demand curve is elastic. Where Q=0, you are not consuming anything so a small change in P causes you to buy a lot ➞ perfectly elastic. - Bottom portion in elastic. Where Q=8, you are consuming a lot so a small change in P will not affect your demand at all ➞ perfectly inelastic. - Midpoint is ALWAYS -1. Even when the slope if constant the elasticity is not, because the slop is the ratio of changes in the 2 variables (P&Q), whereas elasticity is the ratio of percentage changes in the 2 variables. Income elasticity ➞ how your demand changes when your income changes % change in demand when income changes by 1% (similar idea to price elasticity, except income replaces P) Income elasticity of Demand, Y = %dchange in Demand ! ! ! ! % change in income If Yd = 0, then the goods are income-neutral (your demand for that good is not affected by income) If Yd > 0, then as income increases your demand for that good increases, aka normal goods If Yd < 0, then as income increases your demand for that good decreases, aka inferior goods Luxury goods tend to be income elastic, e.g. Sports cars, furs, expensive food Necessities tend to be income inelastic, e.g. Food, fuel, clothing, utilities, medical services. Cross-Price Elasticity of Demand (E cross - What happens to the demand of one good when the price of another good changes - The % change in demand of good A that is due to a 1% change in the price of good B. Cross-price elasticity of demand =% change in quantity demanded of good A ! ! ! ! ! % change in Price of good B - If cross=positive, price of pepsi goes up, demand of coke goes up (substitutes) - If cross=negative, price of computer goes up, demand of software goes down (complements). Price elasticity of supply - The % change in quantity supplied when there is a 1% change in price. - As price goes up, you want to supply more goods (ALWAYS). As firms begin to increase supply, they use up more of their production capabilities (elastic). When the near capacity, they must receive higher prices to offset higher production costs and increase supply (inelastic). Perfectly Elastic, E = infinite (horizontal curve) Relatively Elastic, E > 1 (flatter curve) Unit Elastic, E = 1 Relatively Inelastic, E < 1 (steeper curve) Perfectly Inelastic, E = 0 (vertical curve) June 2011 Jessica Giang Determinants of elasticity of supply - Flexibility or ability of sellers to produce more supply to meet demand i.e. Hard to supply beachfront land (inelastic), easy to supply manufactured goods (elastic). - Time factor ➞ takes longer to increase supply to meet increased demand, so supply tends to be more elastic in the long run When demand is more elastic, your revenue is more likely to go down. When demand is inelastic, total revenue rises as price rises. CH 6 - SUPPLY, DEMAND, AND GOV’T POLICIES In a free market, prices and quantities would be determined by supply and demand. These equilibrium conditions are efficient, but not every buyer and seller is satisfied. Thus, the gov’t may control the market to help either the buyer or seller, often at the expense of the other. Market price controls Price ceilings - maximum price is not allowed to rise above this level. I.e. Rent ceilings Binding price ceilings creates a shortage (equilibrium price is above price ceiling). Greater - demand than there is supply. Price ceiling = market price. Price floor - minimum price is not allowed to be below this level. I.e. Minimum wages Binding price floor creates a surplus (equilibrium price is below price floor). Greater supply than - there is demand. Price floor = market price. A Binding Price Ceiling A Binding Price Floor Binding pCreates Shortages.nd > supply)!! ! Binding price floor (demand < supply) Price Supply Wage Supply W min E W* P P C Surplus Or Shortage Demand Demand Unemployment D E Q S QE Q D Quantity Q Q Q S Quantity of Labor !! ! Taxes Excise tax - tax based on the quantity of the product that Taxes: Impact From a 50 Cent Tax you buy, not the price of it. I.e. Per liter Price D1 S1 The tax increases When deciding tax incidence (how the burden of a tax is shared between consumers and producers), consider the $3.30 the market price to $3.00 the buyer!in this effects of the tax on both (elasticity). case the price rises $2.80 by $0.30 to $3.30. - A tax on any good means prices will go up and the quantity sold of a product goes down. - If demand is more inelastic, people still buy that good even 600 800 Quantity if prices go up (consumers lose). June 2011 Jessica Giang Taxes: Impact From a 50 Cent Tax S - If supply is more inelastic, producers bear more burden. Price D1 1 - Whatever's more elastic, that side bears less burden. Does not matter which side of the market its imposed upon. The tax decreases $3.30 - A smaller elasticity means that buyers have few good $3.00 the return to the alternatives to buying that good (and thus must keep buying seller as the seller $2.80 gets $0.20 less. it), or else means that sellers have few good alternatives to producing that good. Whichever has fewer good alternatives cannot easily leave the market and therefore must bear more of the burden of the tax. 600 800 Quantity CH 7 - CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS Welfare economics Market equilibrium allows for the most efficient allocation of resources, but how does it affect the economic well-being of both consumers and producers? Marginal benefit/utility The amount of satisfaction (benefit) that one more unit of consumption adds to total benefit (or, the amount that one less unit subtracts from total benefit). Rational consumers try to obtain the largest possible total benefit (utility) from the goods and services they buHow the Price Affects Consumer Surplus? Consumer surplus - Consumer surplus: the amount a buyer is willing to pay Price for a good, minus what they actually pay I.e. I’m willing A Consumer Surplus at to pay $100 but end up paying $80, my CS =$20. Price P 2s. at Price P 1 - It measures how much better off people are, the total net benefit that they gain (total consumer benefit - Initial consumer consumer expense). In a graph, it is the area above the surplus C Consumer surplus price, and under the demand curve. P1 B to new consumers Consumer surplus and market price F P2 - A lower market price usually increases consumer D E Additional consumer Demand surplus, and vice versa. surplus to initial - Consumer surplus is smaller when the demand curve is consumers 0 Q Q Quantity more elastic, large if demand curve is inelastic. 1 2 How the Price Affects Producer Copyright©2003 Southwestern/Thomson Learning Producer surplus Surplus? - Market supply — the various quantities of goods that Producer Surplus at Price P vs. at P suppliers would be willing to sell at different price Price 2 1 - Supply curve is also a measure of the marginal Additional producer Supply (opportunity) cost to the seller of supplying various surplus to initial producers quantities of the
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