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ECON 1000 MIDTERM NOTES.docx

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Department
Economics
Course
ECON 1000
Professor
All Professors
Semester
Fall

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CHAPTER 1: WHAT IS ECONOMICS? • Economics as a discipline exists because of material and temporal scarcity. (not enough “things” to satisfy all wants, and not enough “time” to do everything). • Because of scarcity, choices must be made (by individuals, by companies, by governments) • Choices depend benefits and costs (and tradeoffs). • Benefits (pleasure, profits, votes) are an incentive/ reward that encourages an action. Costs are a dis-incentive/penalty that discourages an action. • Most decisions involve more or less, rather than all or none, and involve marginal analysis Economics is the social science: 1. It is theory and logic based and relies on evidence based analysis. 2. It’s domain (scope of study) is the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. 3. It pays particular attention to the role of markets and prices as a “form follows function” human inventions (tools) to assist in choice making. Microeconomics is the study of choices (individuals, businesses, gov’t) make, the way those choices interact in markets, and the influence/role of governments.  Example of a microeconomic question: Why are people buying more e-books and fewer hard copy books, and why are the prices what they are? Macroeconomics is the study of the performance of the national and global economies at the aggregate level.  Example of a macroeconomic question: Why is the unemployment rate high in Canada? Two big questions summarize the scope of economics:  How do choices end up determining what, how, and for whom goods and services get produced?  When do choices made in the pursuit of self-interest also promote the social interest?  Issues: Who’s self-interest counts here (the rich?, the homeless?) and who’s definition of social interest are we to use? What, How, and For Whom? Goods and services are the objects that people value and produce to satisfy human wants. 1. What gets produce? At the microeconomic level mainly market forces (& gov’t policy). At the macroeconomic level mainly levels of affluence and productivity, and foreign trade markets 2. How involves asking what inputs and in what combinations: Economists call inputs factors of production. Factors of production are grouped into four categories:  Land (natural resources, “gifts of nature” – land, forest, minerals, etc.)  Labour (humans – work time and work effort that people devote to producing goods and services , skilled labour involves human capital)  Capital (plants and equipment – not financial capital- The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services)  Entrepreneurship (ability to organize and orchestrate activity (entrepreneur is capitalist owner, but this ability can rest in an agency, or community, or other entity- The human resource that organizes land, labour, and capital) 3. For Whom? Who gets the goods and services depends on “effective demand” in turn based on the income and wealth that people have.  Land earns rent. (which differs from “Economic Rent”)  Labour earns wages. (may include Economic Rent)  Capital earns interest.  Entrepreneurship earns profit as a residual Self-Interest: choices you make in your self-interest —are choices that you think are best for you. Social Interest: Choices that are best for society as a whole are said to be in the social interest. Social interest has two dimensions:  Efficiency: the best use of inputs to produce the outputs. Achieved when the available resources are used to produce goods and services: 1. At the lowest possible input cost, (or price if prices measure real costs) Problem of Externalities 2. In quantities that give greatest possible benefit. (How do markets help achieve this, or prevent this from occurring?)  Equity: Some notion of “fairness” or “social justice” as far as who does the work, and who gets what. It is about fairness. 1. Economics has nothing special to say about this. 2. Individual economists have a variety of views about what is fair. Big Question? When can choices made in self-interest promote the social interest? Two Big Economic Question: Four topics that generate discussion and that illustrate tension between self-interest and social interest are 1. Globalization: Where production and income occur. Expansion of international trade (goods and services), in the flow and ownership of factors of production, and growth of global financial markets (borrowing, lending and investment).  Self-interest of consumers who buy low-cost imported goods and services. (What about “fair trade (coffee); locavour/100 mile diet)  Self-interest of the multinational firms that profit maximize producing in low-cost regions and selling in high-price regions. 2. The information-age economy: Impact of ICT (information and communication technology). Expands time and space by adding virtual time/space to literal time/space to support organizations and processes.  Has created has been called the Information Revolution.  Served self-interest: providing affordable cell phone, application, and Internet access  Brought wealth to innovators: Entrepreneurs behind Microsoft, Apple, and Intel have seen their wealth soar. 3. Global warming: Extent, Causes, Effects, Actions  Self-interested choices to use electricity and gasoline contribute to carbon emissions, and leave a carbon footprint.  The carbon footprint can be reduced by walking, riding a bike, taking cold showers, or planting a tree.  But can each one of us be relied upon to make decisions that affect the Earth’s carbon-dioxide concentration in the social interest? What options or mechanisms are available to make the right (or better) decisions here? 4. Economic instability: Causes, Effects, Actions  From 1993 to 2007 Canada and global economies grew.. Canadian incomes increased by 30%, China’s tripled.  Banks conducted self-interested borrowing & lending, people made self- interested home buying decisions.  How did, or did not, this lending and borrowing serve the social interest? What role did industry driven changes in the “rules of the game” contribute to this economic mess Economic Way of thinking: Six key ideas 1. A choice is a tradeoff. The economic way of thinking places scarcity and its implication, choice, at center stage. Every choice is a tradeoff — giving up one thing to get something else. “Tonight, will you study or have fun? You can’t study or have fun at the same time, so you must make a choice.” Whatever you choose, you could have chosen something else. Every choice is a tradeoff. When you think you have no choice it is usually because any other option is too costly. 2. People make rational choices by comparing benefits and costs. Compares costs and benefits and achieves the greatest total benefit, for those costs, as viewed by the person making the choice. Only the wants of the person making a choice are relevant. 3. Benefit is what you gain from something. The benefit of something is the gain or pleasure that it brings and is determined by preferences. Preferences are what a person likes and dislikes and the intensity of those feelings. (Preferences come from where?) 4. Cost is what you must give up to get something. Relevant Cost: What is best thing you Must Give Up. Opportunity cost: the highest-valued alternative given up to get it. “What is your opportunity cost of taking ECON1000?” • Opportunity cost has two components: - What you can’t afford to buy if you pay tuition, purchase text books, pay for transportation, etc. (things foregone). - The things you can’t do with your time if you study and go to class. 5. Most choices are “how-much” choices made at the margin. Choosing at the Margin “You can allocate the next hour between studying and instant messaging your friends.” The choice is not all or nothing, but you must decide how many minutes to allocate to each activity. To make this decision, you compare the benefit of a little bit more study time with its cost—you make choices at the margin, so marginal analysis is central to decision making. To make a choice at the margin, you evaluate the consequences of making incremental changes in the use of your time. The benefit from pursuing an incremental increase in an activity is its marginal benefit. The opportunity cost of pursuing an incremental increase in an activity is its marginal cost. If the marginal benefit from an incremental increase in an activity exceeds its marginal cost, your rational choice is to do more of that activity. 6. Choices involve incentives, constraints, options, and information. A change in marginal cost or a change in marginal benefit changes the nature/value of the incentives that we face and leads us to change our choice. One central idea of economics is that we can predict how choices will change by looking at changes in incentives. Incentives are also the key to reconciling self-interest and the social interest, given the right context and conditions. A social science and policy tool Economist as Social Scientist Economists, Philosophers, Scientists and others distinguish between two types of statement:  Objective “What is” statements called positive statements (term from Logical Positivist School)  Subjective “What ought to be” statements called normative statements A positive statement can be tested by checking it against facts.(e.g. Falling oil prices will drive down the Canadian dollar) A normative statement expresses an opinion and cannot be tested. (e.g. Gasoline prices are too high) Economic science: Discover positive statements (relationships/laws) that are consistent with: what we observe in the world, enable us to understand how the economic world works, and carry out effective policies at the individual, organizational, and governmental levels. To do this economists create and test economic models. Economic model: Description of some aspect the economic world that includes only those features that are needed for the purpose at hand. (Occum’s Razor) A model is tested by comparing its predictions with the facts. But testing economic models is difficult, so economists also use  Natural experiments: Mainly comparative data (US vs Canada contexts, same variables, different outcomes)  Statistical investigations: Work with time-series or cross section data (StatCan data, survey data, market data)  Economic experiments: Experimental Economics (run subjects through market scenarios to explore reactions) Economist as Policy Adviser: Economics is also a toolkit for advising governments and businesses and for making personal decisions. All the policy questions involve a blend of the positive and the normative. Economics can’t help with the normative part—the goal, other than assess marginal tradeoffs between goals. For a given goal, economics provides a method of evaluating alternative solutions (how to’s)—comparing marginal benefits and marginal costs. CHAPTER 2: THE ECONOMIC PROBLEM Production possibilities and Opportunity Cost: The production possibilities frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot.  Focus on two goods, and hold the quantities of all other goods and services constant. PPF for two goods: cola and pizzas. Any point on the frontier such as E and any point inside the PPF such as Z are attainable. Points outside the PPF are unattainable. Production Efficiency We achieve production efficiency if we cannot produce more of one good without producing less of some other good. Points on the frontier are efficient. Any point inside the frontier, such as Z, is inefficient. At such a point, it is possible to produce more of one good without producing less of the other good. At Z, some resources are either unemployed or misallocated. Tradeoff Along the PPF Every choice along the PPF involves a tradeoff. On this PPF, we must give up some cola to get more pizzas or give up some pizzas to get more cola. In moving from E to F: The quantity of pizzas increases by 1 million. The quantity of cola decreases by 5 million cans. The opportunity cost of the fifth 1 million pizzas is 5 million cans of cola. One of these pizzas costs 5 cans of cola. In moving from F to E: The quantity of cola increases by 5 million cans. The quantity of pizzas decreases by 1 million. The opportunity cost of the first 5 million cans of cola is 1 million pizzas. One of these cans of cola costs 1/5 of a pizza. Increasing Opportunity Cost Because resources are not equally productive in all activities, the PPF bows outward. The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost. All the points along the PPF are efficient. To determine which of the alternative efficient quantities to produce, we compare costs and benefits. The PPF and Marginal Cost The PPF determines opportunity cost. The marginal cost of a good or service is the opportunity cost of producing one more unit of it. Resources Efficiency Preferences and Marginal Benefit Preferences are a description of a person’s likes and dislikes. To describe preferences, economists use the concepts of marginal benefit and the marginal benefit curve. The marginal benefit of a good or service is the benefit received from consuming one more unit of it. We measure marginal benefit by the amount that a person is willing to pay, or give up, or forego (i.e. opportunity cost) for an additional unit of a good or service. It is a general principle that: The more we have of any good, the smaller is its marginal benefit and … the less we are willing to pay for an additional unit of it. We call this general principle the principle of decreasing marginal benefit. The marginal benefit curve shows the relationship between the marginal benefit of a good and the quantity of that good consumed. Allocative Efficiency When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency. We are producing at a point on the PPF. When we cannot produce more of any one good without giving up some other good that we value more highly, we have achieved allocative efficiency. We are producing at the point on the PPF that we prefer above all other points. The point of allocative efficiency is the point on the PPF at which marginal benefit equals marginal cost. This point is determined by the quantity at which the marginal benefit curve intersects the marginal cost curve. On the PPF at point B, we are producing the efficient quantities of pizzas and cola. If we produce exactly 2.5 million pizzas, marginal cost equals marginal benefit. We cannot get more value from our resources Economic Growth: The expansion of production possibilities—and increase in the standard of living, Two/Three key factors influence economic growth:  Technological change is new goods and better ways of producing new and existing goods and services.  Capital accumulation is the growth of capital resources, which includes human capital.  Finding/Acquiring additional resources (explore/trade) The Cost of Economic Growth  To use resources in research and development and to produce new capital, we must decrease our production of consumption goods and services.  So economic growth is not free.  The opportunity cost of economic growth is less current consumption. (e.g. US housing vs. education) Figure 2.5 illustrates the tradeoff we face. We can produce pizzas or pizza ovens along PPF . 0 By using some resources to produce pizza ovens today, the PPF shifts outward in the future. Gains from Trade: Comparative Advantage and Absolute Advantage A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else. A person has an absolute advantage if that person is more productive than others. Absolute advantage involves comparing productivities while comparative advantage involves comparing opportunity costs. Example: Comparative Advantage Liz’s opportunity cost of a smoothie is 1 salad. Joe’s opportunity cost of a salad is 1/5 smoothie. Joe’s opportunity cost of a smoothie is 5 salads. Liz’s opportunity cost of a salad is 1 smoothie. Liz’s opportunity cost of a smoothie is less than Joe’s opportunity cost of a salad is less than Joe’s. Liz’s. So Liz has a comparative advantage in producing So Joe has a comparative advantage in smoothies. producing salads. Joe gives up 6 salads for 1 smoothie, Liz gives up 1 salad for 1 smoothie Joe gives up 1 smoothie for 6 salads, Liz gives up 1 smoothie for I salad. Joe has a Comparative Advantage in Salads & Liz in Smoothies. They trade salads for smoothies along the red “Trade line.” The price of a salad is 2 smoothies or the price of a smoothie is ½ of a salad. Joe buys smoothies from Liz and moves to point C—a point outside his PPF. Liz buys salads from Joe and moves to point C—a point outside her PPF. Economic Coordination To reap the gains from trade, the choices of individuals must be coordinated. To make coordination work, four complimentary social institutions have evolved over the centuries:  Firms- an economic unit that hires factors of production and organizes those factors to produce and sell goods and services.  Markets- any arrangement that enables buyers and sellers to get information and do business with each other.  Property rights- the social arrangements that govern ownership, use, and disposal of resources, goods or services.  Money- any commodity or token that is generally acceptable as a means of payment. How households and firms interact in the market economy. Factors of production, goods and services flow in one direction. Money flows in the opposite direction. Coordinating Decisions Markets coordinate individual decisions through price adjustments. CHAPTER 3: DEMAND & SUPPLY A market is any arrangement (with rules) that enables buyers and sellers to do business with each other. Information and/or the lack of is an important factor in market behavior A competitive market has many buyers and sellers. No single buyer or seller has market power to influence the price. The money price of a good is the amount of money (common unit of account) needed to buy it. The relative price of a good—the ratio of its money price to the money price of the next best alternative good—is its opportunity cost. DEMAND & QUANTITY DEMAND Demand is a relationship between quantities and prices. QD coffeeF( P coffee| Psubstitutecomplementsincome TtastesW wealth Quantity Demanded is the outcome of a market equilibrium. QD coffeeQS coffee Markets are defined as a particular good, (e.g. coffee, shoes, truck) available during a particular time period (day, week, month) across a particular space (York U, Toronto, Canada, World) of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price. The law of demand: Inverse relationship between Price and Quantity demanded. QD coffeeF( P coffee| Psubstitutecomplementsincome Ttastes ^Other^things^remaining^the^same^ The higher the price, the smaller the quantity demanded The lower the price, the larger the quantity demanded. The law of demand results from  Substitution effect (as price falls we substitute away from other goods) - the quantity demanded of the good or service decreases.  Income effect (as price falls we feel richer and usually can by more. people cannot afford all the things they previously bought) - the quantity demanded of the good or service decreases (usually). Demand Curve and Demand Schedule Demand refers to the entire relationship between the price of the good and quantity demanded of the good. 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.  QD coffeeF( P coffee| substitutecomplementsincome Ttastes Demand Schedule: Just a table of QD coffeeF( P coffee A rise in the price, other things constant, brings a decrease in the quantity demanded - movement up along the demand curve. A fall in the price brings an increase in the quantity demanded - movement down along the demand curve. A demand curve is also a willingness-and-ability-to-pay marginal benefit curve. Willingness and Ability to Pay A demand curve is also a willingness-and-ability-to-pay curve. The smaller the quantity available, the higher is the price that someone is willing to pay for another unit. Willingness to pay measures marginal benefit. A Change in Demand (i.e., things that shift the demand curve) When some influence on buying plans other than the price of the good changes, there is a change in demand for that good. ( e.g. loss of wealth in family home) The quantity of the good that people plan to buy changes at each and every price, so there is a new demand curve. When demand increases, the demand curve shifts rightward. (driver is other than own price) When demand decreases, the demand curve shifts leftward. (driver is other than own price) Six main factors that change demand: 1. Prices of Related Goods: A substitute is a good that can be used in place of another good. (e.g. transit (TTC vs vehicle). A complement is a good that is used in conjunction with another good. (e.g. vehicle & fuel ) 2. Expected Future Prices: If the expected future price rises, current demand for the good increases and the demand curve shifts rightward. (why does this exaggerate housing price swings? - prices rising: get in now; prices falling: what a bit longer) 3. Income (or wealth) When income increases, consumers buy more of most goods and the demand curve shifts rightward. Normal good: demand increases as income increases. Inferior good: demand decreases as income increases 4. Expected Future Income and Credit: When expected future income increases or when credit is easy to obtain, the demand might increase now and vice versa. 5. Population: The larger the population, the greater is the demand for all goods. 6. Preferences: People with the same income have different demands if they have different preferences A Change in the Quantity Demanded Versus a Change in Demand Movement Along the Demand Curve When the price of the good changes and everything else remains the same, the quantity demanded changes and there is a movement along the demand curve. A Shift of the Demand Curve If the price remains the same but one of the other influences on buyers’ plans changes, demand changes and the demand curve shifts. SUPPLY: If a firm supplies a good or service, then the firm 1. Has the resources and the technology to produce it, 2. Can profit from producing it, and 3. Has made a definite plan to produce and sell it. Resources and technology determine what it is possible to produce. The supply curve (supply) reflects the quantities the producer would supply across a range of prices. The quantity supplied is the amount that producers plan to sell during a given time period at a particular price The Law of Supply states: Other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and The lower the price of a good, the smaller is the quantity supplied. The law of supply results from the general tendency for the marginal cost of producing a good or service to increase as the quantity produced increases (Chapter 2, page 33). Producers are willing to supply a good only if they can at least cover their marginal cost of production. Supply Curve and Supply Schedule The term supply refers to the entire relationship between the quantity supplied and the price of a good and can be depicted as a supply curve or a supply schedule (table). (Other influences on producers’ plans remain unchanged) Supply Curve A rise in the price of an energy bar, other things remaining the same, brings an increase in the quantity supplied. Minimum Supply Price A supply curve is also a minimum- supply-price curve. As the quantity produced increases, marginal cost increases. The lowest price at which someone is willing to sell an additional unit rises. This lowest price is marginal cost…only in a purely competitive market A Change in Supply When some influence on selling plans other than the price of the good changes, there is a change in supply of (shift in supply curve for) that good. The quantity of the good that producers plan to sell changes at each and every price, so there is a new supply curve or supply schedule When supply increases, the supply curve shifts rightward. When supply decreases, the supply curve shifts leftward. Factors that change supply of a good are  The prices of related goods produced  Expected future prices (intertemporal sales strategy)  The number of suppliers (pricing strategy, market power and market structures: pure competition, monopoly, etc.)  Technology (changing efficiency and production costs)  State of nature (e.g. weather as it affects cost: flooding and car parts production in Thailand) A Change in the Quantity Supplied Versus a Change in Supply The distinction between a change in supply and a change in the quantity supplied. Movement Along the Supply Curve When the price of the good changes and other influences on sellers’ plans remain the same, the quantity supplied changes and there is a movement along the supply curve. A Shift of the Supply Curve If the price remains the same but some other influence on sellers’ plans changes, supply changes and the supply curve shifts. Market Equilibrium is a situation in a market when the price balances the plans of buyers and sellers. The equilibrium price is the price at which the quantity demanded equals the quantity supplied. The equilibrium quantity is the quantity bought and sold at the equilibrium price.  Price regulates buying and selling plans.  Price adjusts, and quantities offered and demanded adjust, when plans don’t match.  Price works as a signal (constraint/incentive) and reflects opportunity cost in a common denominator (money) Price as a Regulator: the equilibrium price and equilibrium quantity. If the price is $2.00 a bar, the quantity supplied exceeds the quantity demanded. There is a surplus of 6 million energy bars. Price Adjustments At any price above the equilibrium price, a surplus forces the price down. At any price below the equilibrium price, a shortage forces the price up. At the equilibrium price, buyers’ plans and sellers’ plans agree and the price doesn’t change until some event changes either demand or supply. An Increase in Demand Demand increases the demand curve shifts rightward. At the original price, there is now a shortage. The price rises, and the quantity supplied increases along the supply curve. An Increase in Supply Figure 3.9 shows that when supply increases the supply curve shifts rightward. At the original price, there is now a surplus. The price falls, and the quantity demanded increases along the demand curve. All Possible Changes in Demand and Supply A change demand or supply or both demand and supply changes the equilibrium price and the equilibrium quantity. Increase in Both Demand and Supply (Q up & P ?) An increase in demand and an increase in supply increase the equilibrium quantity. The change in equilibrium price is uncertain because the increase in demand raises the equilibrium price and the increase in supply lowers it. Decrease in Both Demand and Supply (Q down & P ?) A decrease in both demand and supply decreases the equilibrium quantity. The change in equilibrium price is uncertain because the decrease in demand lowers the equilibrium price and the decrease in supply raises it. Decrease in Demand and Increase in Supply A decrease in demand and an increase in supply lowers the equilibrium price. (P down & Q ?) The change in equilibrium quantity is uncertain because the decrease in demand decreases the equilibrium quantity and the increase in supply increases it. Increase in Demand and Decrease in Supply An increase in demand and a decrease in supply raises the equilibrium price. ( P up & Q ?) The change in equilibrium quantity is uncertain because the increase in demand increases the equilibrium quantity and the decrease in supply decreases it. CHAPTER 4: ELASTICITY Elasticity: An economist's tool that measures the responsiveness of demand (or supply) to price - The Percentage Change in Quantity divided by the Percentage Change in Price Price Elasticity of Demand An increase in supply brings  A large fall in price  A small increase in the quantity demanded  i.e. inelastic demand An increase in supply brings  A small fall in price  A large increase in the quantity
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