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ECON 1000 Package (Ch. 1-8).pdf

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Department
Economics
Course
ECON 1000
Professor
Sadia Mariam Malik
Semester
Fall

Description
ECON 1000 Final Exam-AID Review Package Coordinator E-mail:[email protected] Tutors: Annie Mac & Michael Yeung York SOS: Students Offering Support Preface: This document is directed to ECON 1000 students at York University whom are looking for an additional resource to aid them with studying for the course final exam. It has been created with regard to the Winter 2010 course. This package covers materials from Chapter 1 to Chapter 8. !"#$%&'()(*(+"#%(,-(./0102,/-3( ( !"#$%$&$'%('#()*'%'+$*,( ! Scarcity arises because we have limited resources but unlimited wants ! The choices that we make depend on the incentives that we face. An incentive: a reward that encourages or penalty that discourages an action. Economics: a social science that studies the choices that individual, businesses, governments and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. ! two main parts: Microeconomics and Macroeconomics Microeconomics ! Microeconomics study of choices that individuals & businesses make, the way choices interact in markets, and influence of governments. Macroeconomics ! Macroeconomics study of performance of the national economy and the global economy. -.'(/$0()*'%'+$*(12",&$'%,( o How do choices end up determining what, how and for whom goods and services get produced? o When do choices made in the pursuit of self-interest also promote the social interest? What, How & For Whom ! Goods & Services the objects that people value and produce to satisfy human wants. What : determines the items that we produce How ! factors of production: o Land is the natural resources o Labour is the work time and work effort ! human capital, which is the knowledge and skill that people obtain. o Capital is the tools, instruments, machines, buildings that businesses use to produce goods and services. o Entrepreneurship is the human resource that organizes labour, land, and capital. For Whom: depends on the income that people earn. The more income a person has, the more s/he has to spend on goods and services. We generate income from the factors of production that we own: ! Land earns rents ! Labour earns wages ! Capital earns interest ! Entrepreneurship earns profit. What, How and For Whom Tradeoffs Tradeoff is an exchange – when we give up something to get something else “What” Tradeoffs ! What goods and services get produced depends on choices made by each one of us, by our government, and by the business that produce the things we buy Raising Marks, Raising Money, Raising Roofs www.yorksos.com 2 York SOS: Students Offering Support “How” Tradeoffs ! How goods and services get produced depends on choices made by the businesses that produce the things we buy. “For Whom” Tradeoffs ! Big tradeoff – the tradeoff between quality and efficiency Opportunity Cost ! The highest-valued alternative that we give up when we choose to take one course of actions over another ! Central idea of economics: every choice involves a cost. Choosing at the Margin ! The benefit that arises from an increase in an activity is called marg inal benefit ! The cost of an increase in an activity is called marginal cost. ! Choosing at the margin means to allocate your resources towards the actions that bring you greater benefits than costs Responding to Incentives ! A change in marginal cost or benefit changes the incentives that we face and leads us to change our choice s. ! The central idea of economics is that we can predict how choices will change by looking at changes in incentives ! Less of an activity is undertaken when its marginal cost rises or ma rginal benefit falls and vice versa Human Nature, Incentives and Institutions ! Economists take human nature as given and view people as acting in their self-interest. )*'%'+$*,3(4(5'*$67(5*$"%*"( ! Positive statements o What is statements o They might be right or wrong, and can be tested using facts ! Normative statements o What ought to be statements o These statements cannot be tested Unscrambling Cause and Effect ! Ceteris paribus is a Latin term that means “other things being equal” or “ if all other relevant things remain the same” ! Economic model: a description of some aspect of the economic world that includes only the necessary features for the purpose at hand. 4$$&15,67(8'#$"-(#15(./0102,/-7( • Time-series graph shows the trends and fluctuations in a variable over time • Cross-sectional graph shows how the value of a variable changes across the members of a population • Scatter diagram shows the relationship between two variables (ie. Positively related, negatively related, or unrelated) • Slope of a relationship: o Positive relationship: upward -sloping curve o Negative relationship: downward -sloping curve o Change from positive to negative: has a maximum point o Change from negative to positive: has a minimum point t Maximum Minimum point point • Slope of a relationship o Calculated be taking the change in value of the variable measured on the y-axis divided by the change in value of the variable measured on the x-axis Slope = (change in y) / (change in x) o Straight lines (both horizontal and vertical) have constant slopes Raising Marks, Raising Money, Raising Roofs www.yorksos.com 3 York SOS: Students Offering Support o A curve has varying slope. We calculate the slope of a curve by calculating thpoint or across an arc • To graph the relationship between more than 2 variables o We hold constant the values of all the variables except two o Then plot the value of one of the variables against the value of another !"#$%&'(9(*(:"&(./0102,/(;'0<=&2 ( 89':2*&$'%(8',,$;$7$&$",(6%:(<=='9&2%$&>(?',&( ! (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot. Production Possibilities Frontier ! The PPF illustrates scarcity because we cannot attain the points outside the frontier. ! We can produce at all points inside the PPF and on the PPF. Production Efficiency ! We achieve production efficiency if we cannot produce more of one good without producing less of some other good. ! When we are at a point on the PPF: production is efficient ! When we are at a point inside the PPF: production is inefficient because resources are not being used to their maximum potential ! A point outside the PPF is unattainable with the current resources Tradeoff Along the PPF ! As we move along the PPF, we are giving up on the production of one good to produce more of the other good ! All tradeoffs involve a cost – an opportunity cost Opportunity Cost ! The PPF helps us to make the concept of opportunity cost precise and enables us to calculate it. ! Along the PPF, there are only two goods, so there is only one alternatisome quantity of the other good Opportunity Cost is a ratio ! If an economy only produces good A and B, the opportunity cost of producing one more unit of good A is ***REFER TO THE BEGINNING OF PAGE 34 IN TEXTBOOK*** Increasing Opportunity Cost ! This phenomenon of increasing opportunity cost is reflected in the shape of the PPF. ! The PPF is bowed outward because resources are not all equally productive in all activities. ( @,$%0(6(A",'29*"()##$*$"%&7>( The PPF and Marginal Cost ! The marginal cost of a good is the opportunity cost of producing one more unit of it. ! We calculate marginal cost from the slope of the PPF. As the quantity increases, the PPF gets steeper and marginal cost increases. Preferences and Marginal Benefit ! To describe preferences, economists use the concept of marginal benefit. ! Marginal benefit of a good or service is the benefit received from consuming one more unit of it. ! We measure the marginal benefit of a good or service by the most that people are willing to pionalr an addit unit of it. ! It is a general principle that the more we have of any good or service, the smaller is its marginal benefit and the less we are willing to pay for an additional unit of it. Efficient Use of Resources ! Production efficiency: when we produce goods and services at the lowest possible cost. Raising Marks, Raising Money, Raising Roofs www.yorksos.com 4 York SOS: Students Offering Support ! When we cannot produce more of any good without giving up some other good that we value more highly, we have achieved allocative efficiency and we are producing at the point on the PPF t hat we prefer above all other points )*'%'+$*(B9'.&C( ( ! Expansion of production is called economic growth. ! Economic growth increases our standard of living . The Cost of Economic Growth ! 2 factors influence economic growth: technological change and capital accumulation ! Technological change: the development of new goods and of better ways of producing goods and services. ! Capital accumulation the growth of capital resources, which includes human capital ! To use resources in research and development and to produce new capi tal, we must decrease our production and consumption goods and services B6$%,(#9'+(-96:"( ! Concentrating on the production is called specialization. ! We can gain by specializing in the production of the good in which we have a comparative advantage ngd tradi with others The Cost of Economic Growth ! Comparative advantage is when one can perform an activity at a lower opportunity cost than anyone else ! A person who is more productive than others has an absolute advantage ! Absolute advantage involves comparing pr oductivities – production per hour – while comparative advantage involves comparing opportunity costs ! Absolute advantage does not mean you have a comparative advantage in every activity Dynamic Comparative Advantage ! At any given point in time, the resourc es and technologies available determine the comparative advantages that individuals and nations have ! Dynamic comparative advantage is a comparative advantage that a person (or country) possesses as a result of having specialized in a particular activity and as a result of learning-by-doing, having become the producer with the lowest opportunity cost. )*'%'+$*(B9'.&C( ( ! People gain by specializing in the production of those goods and services in which they have a comparative advantage and then trading with each other ! Central economic planning ! To make a decentralized coordination work, four complementary social institutions that have evolved over many centuries are required: firms, property rights, markets and money Firms ! A firm is a economic unit that hires factors of production and organizes those factors to produce and sell goods and services Property Rights ! The social arrangements that govern the ownership use and disposal of resource goods, and services are called property rights ! Real property includes land and buildings ! Financial property includes stocks and bonds and money in the bank ! Intellectual property is the intangible product of creative effort Markets ! A market is any arrangement that enables buyers and sellers to get information and to do business with each other Money ! Money is any commodity or token that is generally acceptable as a means of payment Circular Flows through Markets ! Households specialize and choose the quantities of labour, land and capital and entrepreneurship tt toll or ren firms. Firms choose the quantities of factors of production to hire. These flow through the factor markets. ! Households choose the quantities of goods and services to buy, and firms choose the quantities to produce. These flow through the goods markets. ! Households receive incomes and make expenditures on goods and services. Coordinating Decision Raising Marks, Raising Money, Raising Roofs www.yorksos.com 5 York SOS: Students Offering Support ! Markets coordinate individual decisions through price adjustments. !"#$%&'(>7(?&2#15(#15(@A$$=B( ( D69E"&,(6%:(89$*",( ! Competitive market o a market that has many buyers and sellers o no single buyer or seller can influence the price ! Producers offer items for sale only if the price is high enough to cover their opportunity cost. And consumers respond to changing opportunity cost by seeking cheaper alternatives to expensive items ! The opportunity cost of an action is the highest valued alternative forgone ! The ratio of one price to another is called a relative price, and a relative price is an opportunity cost ! The normal way of expressing a relative price is in t erms of a “basket” of all goods and services. To calculate this relative price, we use the price index, which is: ! The theory of demand and supply determine relative prices, and the word “price” means relative price !"+6%:( ! The quantity demanded of a goo d or service is the amount that consumers plan to buy during a given time period at a particular price. ! The quantity demanded is measured as an amount per unit of time The Law of Demand ! Higher prices reduce the quantity demanded for two reasons: substitu tion effect and income effect Substitution Effect ! Each good has substitutes, which are other goods that can be used in its place. As opportunity cost of a good rises, people buy less of that good and more of its substitutes Income Effect ! When a price rises, certeris paribus, the price rises relative to people’s incomes. ! When facing a higher price and an unchanged income, people cannot buy all the things they previously bought. ! They decrease the quantities demanded of at least some goods and services. Normally, the goods whose price has increased will be one of the goods the people buy less of Demand Curve and Demand Schedule ! Demand refers to the entire relationship between the price of the good and quantity demanded of the good. ! Quantity demanded refe rs to a point on a demand curve – the quantity demanded at a particular price ! Demand curve shows the relationship between the quantity demanded of a good and its price when all other influences on consumers’ planned purchases remain the same A Change in Demand ! When any factor that influence buying plans other than price of the good changes, there is a change in demand ! 6 factors change demand: price of related goods, expected future prices, income, expected future incomes, population, preferences Price of Related Goods ! A substitute is a good that can be used in place of another good. o An increase in price of the substitutes of good A will increase demand for good A -> demand curve shifts right o A decrease in price of the substitutes of good A will decrease demand for good A -> demand curve shifts left ! A complement is a good that is used in conjunction with another good o An increase in the price of the complement of good A will decrease demand for good A -> demand curve shifts left o A decrease in the price of the complement of good A will increase demand for good A -> demand curve shifts right Expected Future Prices ! If consumers expect the price of a good to rise in the near future, they will buy more of that good now because the opportunity cost of obtaining the good is lower today than it will be when the prices has increased. Raising Marks, Raising Money, Raising Roofs www.yorksos.com 6 York SOS: Students Offering Support ! Your current demand increases and you future demand decreases ! Similarly, if the price of a good is expected to fall in the future, consumers will demand less of that good now, and more in the future, when the opportunity cost of buying the good is lower. Income ! A normal good is one for which demand increases and income increase. ! An inferior good is one for which demand decreases as income increases Expected Future Growth ! When expected future income increases, demand might increase Population ! Demand also depends on the size and age structure of the population. The larger the population, the greater is the demand for all goods and services; the smaller the population, the smaller is the d emand for all goods and services Preferences ! Preferences are an individual’s attitudes towards goods and services ! Can be affected by advertising or public media A Change is the Quantity Demanded Versus a Change in Demand ! Changes in the factors that influe nce buyers’ plans cause either a change in the quantity demanded or a change in demand. They cause either a movement along the curve or a shift of the demand curve ! A point on the demand curve shows the quantity demanded at a give n price. So a movement along the demand curve shows a change in the quantity demanded. Movement along the Demand Curve • Occurs when there is a change in price, and everything else remains the same ! A fall in the price of a good increases the quantity demanded and a rise in the pric e of a good decreases the quantity demanded A shift of the Demand Curve ! When there is no change in price, but changes in one of the 6 factors listed above. ! Results in shift of the entire demand curve, not a movement along the curve 52==7>( ! If a firm supplies a good or service, the firm: has the resources and technology to produce it, can profit from producing it, and plans to produce it and sell it ! The quantity supplied of a good or service is the amount that producers plan to sell during a given timat ariod particular price The Law of Supply ! law of supply: certius paribus, the higher the price of a good, the greater the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied. ! Higher price increase the quantity supplied because marginal cost increase. As the quantity produced of any good increase, the marginal cost of producing the good increases Supply Curve and Supply Schedule ! Supply refers to the entire relationship between the quantity supplied and the price of a good. ! Quantity supplied refers to a point on a supply curve – the quantity supplied at a particular price ! Supply curve shows the relationship between the quantity supplied of a good and its price when all other inf luences on producers planned sales remain the same Minimum of Supply Price ! The supply curve can be interpreted as a minimum -supply-price curve. Shows the lowest price at which someone is willing to sell another unit. A change in Supply ! Results from changes in one, or more of these 4 factors: Cost of production ! If the price of the resource required to produce good A rises, supply of good A decreases Prices of Related Good Produced ! Substitutes in production – goods that can be produced by using the same re sources o If A and B are substitutes of each other, an increase in price of good A will decrease the supply of good B because producers can make more money from selling A ! Compliments in production –goods that must be produced together o If A and B are compliments of each other, an increase in price of good A will increase the supply of good B, because producers can now make money from selling both goods Expected Future Prices Raising Marks, Raising Money, Raising Roofs www.yorksos.com 7 York SOS: Students Offering Support ! If the price of a good is expected to rise, the return from sellin g the good in the future is higher than it is today. Supply of the good decrease today and increases in the future Technology ! The term “technology” is used broadly to mean the way that factors of production are used to produce a good. ! A positive technology change occurs when a new method is discovered that lowers the cost of producing a good ! A positive technology change increases supply and a negative technology change decreases supply A Change in the Quantity Supplied Versus a Change in Supply ! Changes in the 4 factors listed above cause a change in supply, resulting in the shifts of the supply curve ! Changes in price of the good cause a movement along the supply curve . ! A point on the supply curve shows the quanti ty supplied at a given price. ! Movement along supply curve shows a change in the quantity supplied. ! A shift of the supply cure shows a change in supply. D69E"&()F2$7$;9$2+( ! Occurs when demand and supply curves intersect ! The equilibrium price is the price at which the quantity demanded equals the qua ntity supplied. ! The equilibrium quantity is the quantity bought and sold at equilibrium price. Price as a Regulator ! The price of a good regulates the quantities demanded and supplied Price Adjustments ! If the price is below equilibrium there is a shortage ! If the price is above equilibrium there is a surplus ! A shortage forces the price up ! A surplus forces the price down ! The best deal available is when the quantity supplied and the quantity demanded are equal C HANGES IN D EMAND AND S UPPLY Demand: 1. When demand increases, both the price and the quantity increase 2. When demand decreases, both the price and quantity decrease Supply 1. When supply increases, the quantity increases and price falls 2. When supply decreases, the quantity decreases and price rises Demand & Supply change in SAME direction 1. When both demand and supply increase, the quantity increases and the price might increase decrease or remain the same 2. When both demand and supply decrease, the quantity decreases and the price might increase, decreamain the same Demand & Supply change in OPPOSITE directions 1. When demand decreases and supply increases, the price falls and the quantity might increase, decrease or remain the same 2. When demand increases and supply decreases, the price rises and the quanti ty might increase, decrease or remain the same 4$$&15,67(?&2#15C(@A$$=BC(#15(.DA,=,('#(!"+6%:( ! The price elasticity of demand is a units -free measure of the responsiveness of the quantity dem anded of a good to a change in its price when all other influences on buyers plans remain the same Calculating Price Elasticity of Demand ! By using the average price and average quantity we calculate the elasticity at a point on the demand curve midway between the original point and the new point Average Price and Quantity ! We use average point and average quantity because it gives the most precise measurementlasticity – at the midpoint of the original price and the new price Percentages and Proportions ! Elasticity is the ratio of two percentage changes ! The proportionate change in price is !Pavgand the proportionate change in quantity demanded is !Q/avg. So if we divide !Q/Q avgby !P/P avg we get the same answer we get by using percentage change A Units-Free Measure ! Elasticity is a units-free measure because the percentage change in each variable is independent of the units in which the variable is measured Minus Sign Elasticity ! Will always be positive because absolute values are always taken into account. Inelastic and Elastic Demand ! If the quantity demanded remains constant when the price changes, then the price elasticity is zero and the good is said to have a perfect inelastic demand. ! If the percentage change in the quantity demanded equals the percentage change in price, then the price elastic equals 1 and the good is said to have a unit elastic demand. ! If the price elasticity is between 0 and 1 then the good is said to have an inelastic demand ! If the quantity demanded changes by an infinitely large percentage in response to a tiny price change, then the price elasticity to demand is infinity and the good is said to have a perfect elastic demand ! If the price elasticity is said to be greater than 1 then it is said to have an elastic demand Elasticity along a Straight-Line Demand Curve ! On a straight line demand curve, elasticity decreases as the price falls and the quantity demanded increases. ! Demand is unit elastic at the midpoint of the demand curve. ! Above the midpoint, demand is elastic; below the midpoint, demand is inelastic Total Revenue and Elasticity ! The total revenue from sale of a good equals the price of the good multiplied by the quantity sold ! When a price changes, total revenue also changes ! The change in total revenue depends on the elasticity of demand ! When demand is elastic, a price cut will increase total revenue ! When demand is inelastic, a price cut will decrease total reven ue ! When demand is unit elastic, a price cut will leave total revenue unchanged ! TR follows Q Dhen demand is elastic, TR follows P when demand is inelastic o At unit elastic, total revenue is at its maximum Your Expenditure and Your Elasticity ! When a price changes, the change in your expenditure on the good depends on your elasticity of demand. ! So if you spend more on a item when its price falls, your demand for that item is elastic; if you spend the same amount your demand is unit elastic; if you spend les s, your demand is inelastic The Factors That Influence the Elasticity of Demand ! closeness of substitutes ! proportion of income spent on the good Raising Marks, Raising Money, Raising Roofs www.yorksos.com 9 York SOS: Students Offering Support ! time elapsed since a price change Closeness of Substitutes ! The closer the substitute for a good or service, the more elastic is the demand for it. ! The degree of substitutability between two goods also depends on how narrowly (or broadly) we define them. ! A necessity is a good that has poor substitutes and that is crucial for our well -being. So generally, a necessity has an inelastic demand ! A luxury is a good has many substitutes, so a luxury generally has an elastic demand Proportion of Income Spent on the Good ! Certius paribus, the greater the proportion of income spend on a good, the more elastic is the de mand for it Time Elapsed Since Price Change ! The longer the time that has elapsed since a price change, the more elastic is demand D'9"()76,&$*$&$",('#(!"+6%:( Cross Elasticity of Demand ! We measure the influence of a change in the price of a substitute or c omplement by using the concept of the cross elasticity of demand ! The cross elasticity of demand is a measure of the responsiveness of the demand for a good to a change in the price of substitute or complement, other things remaining the same. ! We calculate the cross elasticity of demand by using the formula: ! • The cross elasticity of demand can be positive or negative. It is positive for a substitute and negative for a complement Substitutes ! EXAMPLE: a burger is a substitute for a pizza. When the price of a burger rises, the demand for pizza increases and the demand curve for pizza shifts rightward from 0 to D1. Cross elasticity of the demand is positive. Complements ! EXAMPLE: soft drinks are a complement of pizza. When the price of soft drin ks rises, the demand for pizza decreases and the demand for pizza decreases and the demand curve for pizza shifts leftward from0Dto D2. The cross elasticity of the demand is negative. ! The magnitude of the cross elasticity of demand determines how far th e demand curve shifts. The larger the cross elasticity (absolute value) the greater is the change in demand and the larger is the shift in the demand curve. ! If two items are very close substitutes the cross elasticity is positively large. If two items are close complements the cross elasticity is large. Income Elasticity of Demand ! The income elasticity of demand is a measure of the responsiveness of the demand for a good or service to a change e in income, other things being equal ! The income elasticity of demand is calculated by using the formula: ! Income elasticities of demand can be positive or negative and fall into 3 categories: o greater than 1 (normal good, income elastic) o positive and less than 1 (normal good, income is inelastic) o negative (inferior good) Income Elastic Demand ! As income increases the quantity demanded of an item increases faster than income. Income Inelastic Demand ! If the percentage increase in quantity demanded in less than the percentage increase in i ncome, the income elasticity of demand is positive and less than 1. Inferior Goods ! If the quantity demanded for a good decreases when income increases, the income elasticity of a good is negative. )76,&$*$&>('#(52==7>( ! We measure the degree of responsiven ess by using the concept of the elasticity of supply. Calculating the Elasticity of Supply Raising Marks, Raising Money, Raising Roofs www.yorksos.com 10 York SOS: Students Offering Support ! The elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain t he same. ! No matter how steep the supply curve is, if it is linear and passes through the origin, supply is unit elastic. The Factors That Influence the Elasticity of Supply ! Resource substitution possibilities ! Timeframe for the supply decision Resource Substitution Possibilities ! Some goods and services can be produced only by using unique productive resources. These items have a low, perhaps a zero, elasticity of supply. ! Other goods & services can be produced by using commonly available resourc es that could be allocated to a wide variety of alternative takes. - high elastic of supply ! The quantity produced can be increased but only by incurring a higher cost. If a higher price is offered, the quantity supplied increases. Such goods and services have an elasticity of supply between zero and infinity. Time Frame for Supply Decisions ! 1. Momentary supply; 2. Long-run supply; 3. Short-run supply ! Momentary supply curve shows the response of the quantity supplied immediately following a price change ! Long-run supply curve shows the response of the quantity supplied to a change in price after all the technologically possible ways of adjusting supply have been exploited. ! Short-run supply curve shows how the quantity supplied responds to a price change wh en only some of the technologically possible adjustments to production have been made. !"#$%&'(F7(.GG,/,&1/B(#15(.DA,%B ( A",'29*"(477'*6&$'%(D"&C':,( ! Resources might be allocated by: " Market price " Command " Majority rule " Contest " First come first serve " Lottery " Personal characteristics " Force Market Price ! When a market price allocates a scare resource, the people who are willing and able to pay that price get that resource Command ! A command system allocates resources by the order (command) of someone in authority Majority Rule ! Majority rule allocates resources in the way that a majority of voters choose. Contest ! A contest allocates resources to a winner. First-Come, First-Served ! A first-come, first-served method allocates resources to those who are firs t in line ! By serving the user who arrives first, this method minimizes the time spend waiting for the resources to become free Lottery ! Lotteries allocate resources to those who pick the winning number, draw the lucky cards, or come up lucky on some other gaming system ! Lotteries work best when there is no effective way to distinguish among potential users of a scarce resource Personal Characteristics ! When resources are allocated on the basis of personal characteristics, people with the “right”cs get theisti resources Raising Marks, Raising Money, Raising Roofs www.yorksos.com 11 York SOS: Students Offering Support Force ! It provides the state with an effective method of transferring wealth from the rich to the poor, and it provides the legal framework in which voluntary exchange in markets take place. !"+6%:(6%:(D690$%67(/"%"#$&( ! To determine whether a competitive market is efficient, we need to see whether, at the market equilibrium quantity, marginal benefit equals marginal cost Demand, Willingness to Pay, and Value ! The value of one more unit of a good or service is its marginal benefit. And we measure marginal benefit by the maximum price that is willingly paid for another unit of the good or service. ! Demand curve is a marginal benefit curve Individual Demand and Market Demand ! The market demand curve is the horizontal sum of the individual demand curves and is formed by adding the quantities demanded by all the individuals at each price ! The market demand cure is the economy’s marginal social benefit curve (MSB curv e). Consumer Surplus ! When people buy something for less than it is worth to them, they receive a consumer surplus. ! A consumer surplus is the value (or marginal benefit) of a good minus the price paid for it, summed over the quantity bought. ! All goods and service, have decreasing marginal benefit. So people receive more benefit form their consumption than the amount they pay. ! ***REFER TO PG. 111 IN TEXTBOOK*** 52==7>(6%:(D690$%67(?',&( Supply, Cost, and Minimum Supply-Price ! Producers distinguish between cost and price. Cost is what a producer gives up, and the price is what a producer receives ! The cost of one more unit of a good or service is its marginal cost. And marginal cost is the minimum price that producers must receive to induce them to offer to sell another unit of the good or service. But the minimum supply price determines supply. ! A supply curve is a marginal social cost curve Individual Supply and Market Supply ! The market supply is the horizontal sum of the individual supply curves and is formed by adding the quantities supplied by all the producers at each price Producer Surplus ! When price exceeds marginal cost, the firm receives a producer surplus. ! A producer surplus is the price received for a good minus its minimum-supply price (or marginal cost), summed over the quantity sold ! Consumer surplus and producer surplus can be used to measure the efficiency of a market G,(&C"(?'+="&$&$H"(D69E"&()##$*$"%&I(( Efficiency of a Competitive Equilibrium ! The marginal social benefit curve (MSB = Demand) and marginal social cost curve (MSC = supply) intersect where supply and demand intersect ! So at the equilibrium price and quantity, marginal social benefit equals marginal social cost. ! But when marginal social benefit equals marginal social cost, resources are allocated efficiently and to their highest- value used ! When efficient quantity is produced, total surplus (the sum of consumer surplus and producer surplus) is maximized. ***Efficiency*** Competitive equilibrium occu rs when the quantity demanded equals the quantity supplied. Consumer surplus is the area under the demand curve and above the price. Producer surplus is the area above the supply curve and below the price. Resources are use efficiently when marginal social benefit, MSB, equal s marginal social cost, MSC. The efficient quantity market is the same as the equilibrium quantity. The competitive market produces the efficient quantity. The Invisible Hand ! Smith was the first to suggest that competitive markets send resources to the us es in which they have the highest value Raising Marks, Raising Money, Raising Roofs www.yorksos.com 12 York SOS: Students Offering Support The Invisible Hand at Work Today ! The market economy performs to achieve an efficient allocation of resources. ! Market forces persistently bring marginal social cost and marginal social benefit to equality and me total surplus Underproduction and Overproduction ! Inefficiency can occur because either too little of an item is produced – underproduction ! Too much is produced – overproduction Obstacles to Efficiency ! Price and quantity regulations ! Taxes and subsidies ! Externalities ! Public goods and common resources ! Monopoly ! High transaction costs Price and Quantity Regulations ! Price regulations sometimes block the price adjustments that balance the quantity demanded and the quantity supplied sometimes lead to underproduction. Taxes and Subsidies ! Taxes increase the price paid by buyers and lower the prices received by sellers. S o taxes decrease the quantity produced and lead to underproduction. ! Subsidies decrease the prices paid by buyers and increase the prices received by sellers. So subsidies increase the quantity produced and lead to overproduction. Externalities ! An externality is a cost or a benefit that affects someone other than the seller or the buyer of a good Public Goods and Common Resources ! A public good is a good/ service that is consumed simultaneously by everyone even if they don’t pay for it. (national defence). ! Competitive markets would under produce a public good because of a free -rider problem – it is in each person’s interest to free ride on everyone else and avoid paying. ! People ignore the costs of their own use of common that fall on others, which leads to overproduction. Monopoly ! A monopoly is a firm that is the sole provider of a good or service. ! The self-interest of a monopoly is to maximize its profit. To achieve its goal, a monopoly produces too little and charges too high a price. It leads to underproduction. High Transaction Costs ! Economists call the opportunity costs of making trades in a market transaction costs ! To use market price as the allocator of scarce resources, it must be worth bearing the opportunity cost of establishing a market. ! When transaction costs are high, the market may under produce Alternatives to the Market ! There is no one efficient mechanism for allocating resources efficiently. But when supplemented by majority rule, command systems and by occasionally suing first -come first-served markets do an amazingly good job 49"(D69E"&,(J6$9I(( ! All ideas about fairness can be divided into two broad groups. They are: it’s not fair if the result isn’t fair. It’s not fair if the rules aren’t fair. It’s Not Fair if the Result isn’t Fair ! Everything is not equal and everyone does not get a fair share of the pie Utilitarianism ! Idea that only equality bring efficiency ! Principle that states that we should strive to achieve “the greatest happiness for the greatest number” ! “the greatest happiness for the greatest number,” income must be transferred from the rich to the poor up to the point of complete equality ! The greater a persons’ income, the smaller is the marginal benefit of a dollar. Raising Marks, Raising Money, Raising Roofs www.yorksos.com 13 York SOS: Students Offering Support The Big Tradeoff ! Recognizing the cost of making in come transfers leads to what is called the big tradeoff, which is a tradeoff between efficiency and fairness ! Income can be transferred from people with high incomes to people with low incomes only by taxing the high incomes. ! Taxing people’s income from em ployment makes them work less # results in the quantity of labour being less than the efficient quantity ! Taxing people’s capital makes them save less # results in the quantity to capital being less than the efficient quantity ! With smaller quantities of bot h labour and capital, the quantity of goods and services produced is less that the efficient quantity Making the Poorest as Well Off as Possible ! A fair distribution of the income makes the poorest person as well off as possible. It’s Not Fair If the Rules Aren’t Fair ! Based on a symmetry principle , which is requirement that people in similar situations be treated similarly. o Equality of opportunity ! In a competitive market, resources will be allocated efficiently if there are no o Price and quantity regulation s o Taxes and subsidies o Externalities o Public goods and common resources o Monopolies o High transaction costs !"#$%&'(H7(I#'J&%-(,1(4/%,01 ( K'2,$%0(D69E"&,(6%:(A"%&(?"$7$%0( Short-Run Supply ! The short-run supply curve shows the change in the quantity of housing supplied as the rent changes while the number of houses and apartment building remain constant Long-Run Supply ! The long-run supply curve shows how the quantity of housing supplied responds to a change in price after enough time has elapsed for new apartment buildings and houses to be erected or for existing ones to e destroyed ! The longrun supply curve is perfectly elastic Equilibrium ! The equilibrium rent and quantity are determined by demand and short -run supply Long-Run Adjustments ! The long-run supply curve tells us that in the long run, housing is supplied at a rent of $16 a month ! ***REFER TO PAGE 125*** A Regulated Housing Market ! A price ceiling is a regulation that makes it illegal to charge a price higher than a specified level ! The effect of a price ceiling depends on whether it is imposed at a level that is above or below the equilibrium price. ! A price ceiling set above the equilibrium price has no effect. ! But a price ceiling below the equilibrium price has powerful effect on a market. The reason is th at the price ceiling attempts to prevent the price from regulating the quantity demanded and supplied. ! Effective price ceilings create shortages because quantity demanded is greater than quantity supplied ! When a rent ceiling creates a housing shortage, two developments occur. Thesearch activity and black markets Search Activity ! The time spent looking for someone with whom to do business is called search activity ! When a price is regulated and there is a shortage, search activity increases . This is because there is not enough supply to meet the demand of the consumers. Consumers must keep looking for the goods/services. ! The opportunity cost of a good is equal not only to its price but also to the value of search time spent finding the good. ! So the opportunity cost of housing is equal to the rent plus the time and other resources spend searching for the restricted quantity available Raising Marks, Raising Money, Raising Roofs www.yorksos.com 14 York SOS: Students Offering Support ! A rent ceiling control the rent portion of the cost of housing, but it d oes not control the opportunity cost which might even be higher than the rent would be if the market were unregulated Black Markets ! A black market is an illegal market in which the price exceeds the legally imposed price ceilings. ! To calculate the maximum price that the black market can charge for a good that is under a price ceiling, first draw the demand and supply curve with the price ceiling. Where the price ceiling and demand intersects, draw a vertical line. The point where this vertical line and the supply curve intersect is the price level that consumers are willing to pay for the goods/services. Inefficiency of Rent Control ! In an regulated market, the MSB (demand) exceeds MSC (supply). A dead weight loss has occurred and the consumer surplus/producer surplus shrinks. ! To see how deadweight loss is calculated refer to figure 6.2 on page 131 Are Rent Ceilings Fair? ! According to the fair rules view, anything that blocks voluntary exchange is unfair, so rent ceilings are unfair. But according to the fair results view, a fair outcome is one that benefits the less well off ! Blocking rent adjustments doesn’t eliminate scarcity. Rather, because it decrease the quantity of ho using available, it creates and even bigger challenge for the housing market. ! Possibilities of allocating markets: a lottery, a queue, and discrimination ! When rent adjustments are blocked, other methods of allocating scarce housing resource operate that do not produce a fair outcome Rent Ceilings in Practice ! Rent ceilings definitely cr eate a housing shortage. ! They lower rent for some but raise them for others ! The bottom line is that in principle and in practice rent ceilings are inefficient and unfair. -C"(L6;'29(D69E"&(6%:(D$%$+2+(M60"( ! Wage rate is on y-axis, Quantity of hours worked is on x-axis ! Labour demand = how many hours of work demanded by the suppliers ! Labour supplied = how many hours of work supplied by the consumers ! Lower wage rate = higher quantity demanded for labour ! Greater the wage rate = higher quantity supplied of labo ur ! The wage rate adjusts to make the quantity of labour demanded equal to the quantity supplied ! In the short-run there are a given number of people who have a given skill, training, and experience. Short -run supply of labour describes how the number of ho urs of labour supplied by this given number of people changes as the wage rate changes. ! In the long run, people can acquire new skills and find new types of jobs. The number of people in the low -skilled labour market depends on the wage rate in this market compared with other opportunities. ! The long-run supply of labour is the relationship between the quantity of labour supplied and the wage rate after enough time has passes for people to enter or leave the low -skilled labour market. ! If people can freely enter and leave the low skilled labour market, the long -run supply of labour is perfectly elastic ! Long-run supply is assumed to be perfectly elastic A Minimum Wage ! A price floor is a regulation that makes it illegal to trade at a price lower than a speci fied level. When a price floor is applied to labour markets, it is called a minimum wage. ! If a minimum wage is set below the equilibrium wage, the minimum wage ahs no effect. But a minimum wage set above the equilibrium wage is in conflict with market for ces, and it does have some effects on the labour market Inefficiency of a Minimum Wage ! When an effective minimum wage is set, the wage rate is higher than the equilibrium wage rate. This means the labour supplied by workers is greater than the labour demanded by suppliers. This surplus results in an increase in unemployment levels. Provincial Minimum Wage Laws and Their Effects ! Most economists believe that the minimum wage was a big contributor to high unemployment among low -skilled young workers ! One effect of the minimum wage in an increase in the quantity of labour supplied A Living Wage ! A living wage has been defined as an hourly wage rate that enables a person who works a 40 hour work week to rent adequate housing for not more than 30 percent of the am ount earned Raising Marks, Raising Money, Raising Roofs www.yorksos.com 15 York SOS: Students Offering Support Tax Incidence ! Tax incidence is the division of the burden of tax between the buyer and seller. When taxes on a particular good increases by $1, does the supplier pay the $1 or the consumer? ! When the government imposes a tax of the sale of good, the price paid by the buyer might rise by the full amount of the tax, by a lesser amount, or not at all ! If the price paid by the buyer rises by the full amount of the tax, then the burden of the tax falls entirely on the buyer. If the price paid by the buyer rises by a lesser amount than the tax, then the burden of the tax falls partly on the buyer and partly on the seller. And if the price paid by the buyer doesn’t change the price at al, then the burden of the tax falls entirely on the seller Equivalence of Tax on buyers and Sellers Can we Share the burden equally? ! The key point is that when a transaction is taxed, there are two prices: the price paid by buyers, which includes the tax; and the price received by sellers, which excludes the tax (selling price – tax payable = actual amount earned) ! Buyers respond only to the price that includes the tax, because that is the price they pay. Seller respond only to the price that excludes the tax, because that is the price they receive ! A tax is like a wedge between the buying price and the selling price. It is th e size of the wedge, not the size of the market on which the tax is imposed that determines the effect of the tax Tax division and Elasticity of Demand ! The division of the tax between the buyers and seller depends in part on the elasticity of demand for the goods ! When demand is perfectly inelastic (buyers are indifferent to changes in the price), buyers pay entire tax, when demand is perfectly elastic (buyers are extremely sensitive to price changes), sellers pay the entire tax. ! In the usual case demand in neither perfectly inelastic nor elastic and the tax is split between buyers and sellers. ! But the division depends on the elasticity of demand. The more inelastic the demand, the larger is the amoun t of the tax paid by buyers. Tax Division and Elasticity of Supply ! The division of the tax between buyers and sellers also depends, in part, on the elasticity of supply ! When supply is perfectly inelastic, sellers pay the entire tax and when supply is per fectly elastic, buyers pay the entire tax. ! In the usual case supply is neither perfectly inelastic nor elastic and the tax is split between buyers and sellers ! But how the tax is split depends on the elasticity of supply. The more elastic the supply, the l arger is the amount of the tax paid by buyers ******************************************************************************************** ! Perfectly inelastic demand – buyers pay ! Perfectly elastic demand – sellers pay ! Perfectly inelastic supply – sellers pay ! Perfectly elastic supply – buyers pay ******************************************************************************************** Taxes in Practice ! The most heavily taxed items are those that have either a low elasticity of demand or a low elastof supply. For these items, when a tax is imposed the equilibrium quantity doesn’t decrease much. So the government collects a large tax revenue and the dead-weight loss from the tax is small ! It is unusual to tax an item heavily if neither its demand nor i ts supply is inelastic. With an elastic supply and demand, a tax brings large decrease in the equilibrium quantity and a small tax revenue Taxes and Efficiency ! The price that buyers pay is also the buyers’ willingness to pay, which measures marginal benef it. ! The price that sellers receive is also the sellers’ minimum supply price, which is equal to marginal cost ! A wedge between marginal benefit and marginal cost creates inefficiency. With a higher buyer’s price and a lower sellers’ price, the tax decreases the quantities produced and consumed and a deadweight loss arises ! In the extreme cases of perfectly inelastic demand and perfectly inelastic supply, a tax does not change the quantity bought and sold and there is no deadweight loss. The more inelastic is either demand or supply, the smaller is the decrease in quantity and the smaller is the deadweight loss. ! When demand is perfectly inelastic, the quantity remains constant and no deadweight loss arises 52;,$:$",(6%:(12'&6,( Subsidies ! A subsidy is a payment made by the government to a produce r Raising Marks, Raising Money, Raising Roofs www.yorksos.com 16 York SOS: Students Offering Support ! Because the supply curve is the marginal cost curve, and the demand curve is the marginal benefit curve, a subsidy raises marginal cost above marginal benefit and creates a deadweight loss from overproduction Production Quotas ! A production quota is a upper limit to the quantity of a good that may be produced in a specified point ! The effect of a production quota depends on whether it is set below or above the equilibrium quantity ! The quota not only raises the price but also lowers the marginal cost ! A production quota is inefficient because it results in underproduction. At the quota quantity, marginal benefit is equal to the market price and marginal cost is less than the market price, so marginal benefit exceeds margin al cost. D69E"&(#'9(G77"067(B'':,( ! The markets for many goods and services are regulated, and buying and selling some goods in illegal A Free Market for Drugs ! If drugs were not illegal, the quantity bought and sold would be Qc and Pc. A Market for Illegal Drugs ! When a market is illegal, the cost of trading in the good increases ! The larger the penalties and the more effective the policing, the higher are the costs. Penalties might be imposed on sellers, buyers or both Penalties on Sellers ! If penalties were imposed only on sellers, supply would decrease Penalties on Buyers ! If penalties were imposed only on buyers, demand would decrease Penalties on Sellers and Buyers ! If penalties are imposed on both sellers and buyers, both supply and demand will decrease !K4;:.L(M7(N:OP:PQ(4R?(?.I4R? ( • Household consumption choices are constrained by: 1. Income 2. Prices of goods/services • Household’s budget line – describes the limits to its consumption choices (see Figure 7.1) • Relative price – price of one good divided by the price of another good (is also the slope of the budget line • Change in price = change in the slope of the budget line (see Figure 7.2) • Real income – expressed as quantity of goods household can afford • Change in income causes the budget line to shift (see Figure 7.3) • Utility – benefit or satisfaction that a person gets from the consumption of a good or service (see figure 7.3) • Total utility – total benefit a person gets from the consumption of goods and services • More consumption = more utility • Marginal utility – change in total utility that results from a one -unit increase in the quantity of a good consumed • Diminishing marginal utility – decrease in marginal utility as the quantity of the good consumed increases • Fundamental economic problem – scarcity • Consumer equilibrium – is a situation in which a consumer has allocated all his or her available income in the way, that given prices of goods and services, maximizes his or her total utility • Consumer’s total utility is ma ximized when – spend all the available income and equalize the marginal utility per dollar for all goods • Marginal utility per dollar – the marginal utility from a good divided by its price (see page 158 - 159 for example of how this works) • Fall in the price of a substitute of a good decreases demand for that good and a rise in income increases the demand for a normal good • Fall in price – change in quantity demanded (movement along the demand curve) • Rise in price – change in quantity (shift of demand curve) – (refer to pages 160-161) • When the price changes, the consumer can substitute the good/service with something more affordable • Marginal utility theory predicts : 1. When the price of a good rises, the quantity demanded of that good decreases Raising Marks, Raising Money, Raising Roofs www.yorksos.com 17 York SOS: Students Offering Support 2. When prices of one good rises, the demand for another good the can serve as a substitute increases • Review Table 7.7 (page 163) • Larger income – the consumer always buys more of the normal good and less of the inferior good • Marginal benefit – maximum price a consumer is willi ng to pay for an extra unit of a good or service when utility is maximized !K4;:.L(S7(;[email protected]@PUPOP:[email protected](;[email protected](4R?([email protected] ( • Divisible goods – can be bought in any quantity desired • Budget equation : $ Expenditure = income $ Expenditure = sum of the prices of ea ch good x quantity bought • Real income – household’s income expressed as the quantity of goods the household can afford to buy • Relative price – price of one good divided by the price of another good (=opportunity cost – best alternative forgone) • Change in price – change in budget line (lower the price the flatter the budget line) • Change in income – changes real income but not relative price – result is a shift in the budget line but no change in its slope • The smaller the households income the farther to the left is the budget line • Indifference curve – a line that shows the combinations of goods among which a consumer is indifferent (see Figure 8.3) • Marginal rate of substitution – rate at which a person will give up good y to get an additional unit of good x and at the same time remain indifferent • If theindifference curve is steep, the marginal rate of substitution is high • If theindifference curve is flat, that marginal rate of substitution is low • Diminishing marginal rate of substitution – general tendency for a person to be willing to give up less of good y to get one more unity of good x, and at the same time remain indifferent, as the quantity of x increases (see Figure 8.4) • Degree of substitutability 1. Close substitutes – very easily substitutable 2. Complements – go together • see Figure 8.5 • Best affordable point – he/she is on their budget line and have the highest attainable indifference curve • Price effect – the effect of a change in price on the quantity of a good consumed • Demand curve – downward sloping (law of demand – the lower the price the higher the quantity demanded) • Income effect – effect of a change in income on consumption (see Figure 8.8) • Normal good – a fall in price always increases the quantity bought • Substitution effect – effect of a change in price on the quantity bought when the consumer remains indifferently between the original situation and the new one • When the relative price of a good falls, the consumer substitutes more of that good for the other good • For a normal good, the income effect reinforces the substitution effect • Inferior goods – good whose consumption decreases and income increase (income effect is negative) • Labour vs. leisure • More we spend on leisure – the lower our income • Income-time budget line – represents the relationship between leisure and income • Labour supply curve (see Figure 8.10) • Higher wage rate has both substitution effect and an income effect • Higher wage rate increases opportunity cost of leisure so leads to a substitution effectleisure – higher wage rate increases income and so leads to an income effect towards more leisure Raising Marks, Raising Money, Raising Roofs www.yorksos.com 18 YORKUNIVERSITY FACULTYOF ARTS Departmentof Economics Economics 1000.03B,C Introduction toMicroeconomics Professor A. Cohen December 12,2005 FINALEXAMINATION PRINTyourname: _____________________________ _____________________ (LastName) (First Name) Student Number: _____________________________________________________ WebCT User ID: _____________________________________________________ Signature: _____________________________________________________ Question Maximum Grade Question Maximum Grade Marks Marks Multiple Choice 180 52 20 1-45 53 12 46 4 47 20 48 12 Short 49 24 Answer 120 Problems 50 16 51 12 Total 300 ECON1000.03 B,C Cohen 2 2005Final Examination INSTRUCTIONS 1. Checkyourpaper to seethat it contains 28 pages, numbered consecutively. 2. The exam is set for 2 1/2 hours, 300 marks. You must do all questions. Numbers in parentheses in the left margin indicate the marks for each question. 2 marks = 1 minute. However, youwill have approximately 2 hours and45 minutes to write. 3. On thetop of thepinkcomputerized answer sheet, usean HB pencil to: a) Print yournameon thehorizontallineprovided. b) Print your student number in the vertical space provided and fill in the corresponding rectanglesforeachdigit. c) Answers to allMultiple Choice Questions 1 - 45 must be entered on the enclosed pink computerized answer sheet. Useonly an HB pencil. d) Insert (doNOT bendor fold) thepink computerized answer sheet in the middle of the exampaper whenyouarefinished. 4. Forallshort answer problems: a) Answer as concisely as possible. The space allocated under each question is all that is necessary for a full credit answer. If you need more space, use the back of the paper opposite the question. Indicate clearly your answer is continued opposite, and show thequestion number. b) Diagrams must be labeled completely to receive fullcredit. c) If numerical calculationis required, youmustshowyourwork to receive credit. 5. NO CALCULATORS, DIGITAL DICTIONARIES, CELL PHONES, PDAs OR ELECTRONICDEVICESALLOWED. 6. You MUST sign the separate signature sheet the TAs will bring around in order for thisexamto count. ECON1000.03 B,C Cohen 3 2005Final Examination MULTIPLECHOICE (180marks, 90 minutes) Answer all multiple choice questions on the pink computerized answer sheet using an HB pencil. Foreachquestion picktheonebestanswer. Eachright answer is worth 4 marks, each wrong answer zero(45questions,2 minutes perquestion). 1. Whichof the followingstatements is true? A) The market hassolved thefundamental economic problemsof all societies since ancient times. B) The principle of self-interest hasalways been approvedby all societies. C) The two fundamental economic tasksare efficiency and equity. D) The three basicsolutionsto the economic problem are tradition,command and the market. E) All of the above are true. 2. Scarcity differs from poverty because A
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