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Midterm

Micro - Midterm Notes

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Department
Economics
Course Code
ECON 1131
Professor
Richard Tresch

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  Tsuruta  1   Economics  Part  1         Chapter  1     The  Economic  Problem   o Objectives/Goals   o Alternatives/Choices:  there  is  more  than  one  way  to  meet  an  objective   o Constraints:  we  are  all  subject  to  Law  of  Scarcity  (limited  resources,  we  will  always   come  up  short)   • Economics:  the  study  of  how  to  best  allocate  scarce  resources  through  the  process  of   exchange     • Capital:  plant  and  equipment     • Three  Key  Players   1. Individuals:  consumers,  factor  of  production     2. Businesses:  firms,  producers   3. Government:  agencies,  redistribute  resources       The  Consumer’s  Economic  Problem   Objective     Maximize  utility   Alternatives   Various  goods  and  services   Constraints     Income,  price  of  goods  and  services,  what’s  the  best   combination         The  Firm’s  Economic  Problem   Objective     Maximize  profit  (TR  –  TC)     Alternatives   What  to  produce,  how  much  to  produce,  how  to   produce,  choice  of  production  technology,   associated  factors  of  production  (inputs)     • Two  types  of  inputs   1. Primary  factors  of  production:  labor  (L),   capital  (K)  (plant  and  equipment,   produced  and  sold  by  firms),  land   (T)(land  and  what  is  contained  in  it)   2. Material  Inputs:  individuals  not  involved,   gets  used  up     Constraints     Demand  for  firms  products  (budget  constraint),  set   of  available  technology,  price  of  factors     • Best  combination  that  maximizes  profit?     • Government  Agencies:  department  of  defense,  political  campaigns     • What  economic  problem  are  they  trying  to  solve?   • Given  that  people  are  rational  (assumption  of  behavior),  economics  predict  outcome     Interdependence     • Interdependence:  unintended  consequences   o Entire  economy  of  a  nation  is  a  closed,  interdependent  circle  which  along  which  all   markets  are  interrelated     o Do  “A”  then  not  B,  C,  D   o Consequences  of  choosing  A  has  at  least  2  consequences       Tsuruta  2     • Circular  Flow  of  Economic  Activity  (p.  64):  the  flow  of  goods  and  services  and  factors  of   production  through  the  product  and  the  factor  markets  of  the  economy  that  results  from  the   interactions  of  individuals  and  business  firms;  the  flow  is  circular  because  firms  sell   products  to  individuals  in  the  product  markets  and  individuals  sell  factors  of  production  to   firms  in  the  factor  markets       • Factor  Markets:  individuals  buy,  business  firms  supply   • Product  markets  (labor,  land,  capital):  individuals  supply,  business  firms  buy     • Inner  circle:  flow  of  real  physical  goods  and  services  and  factors  of  production  through   the  two  sets  of  markets     • Outer  circle:  flow  of  dollars  through  the  two  sets  of  markets     •  All  events  are  interrelated   • Individuals  and  firms  meet  each  other  twice     • National  Product  (GDP):  total  dollar  value  flow  of  activity  –  defines  national  income     • Government  Role:  buyers  and  suppliers,  consumer  (missiles,  protection,  etc.)   redistributes  purchasing  power  (with  taxes  and  transfers  –  doesn’t  change  circularity)  –   doesn’t  break  circular  flow  of  economic  activity     • Only  one  break  in  the  circle  (imports/exports):  economic  relationship  with  foreign   countries     o Total  imports  from  other  countries  must  =  total  exports  to  other  countries..   doesn’t  always  happen  …  right  now  US  importing  more  than  exporting     • Economic  events  are  interdependent   o OPEC  lose  control  over  oil  market  à  plummeting  prices  of  crude  oil  à  people   who  worked  in  industries  lost  jobs  +  consumers  gained  because  of  price  cuts  …   ALSO  à  Texas  relied  heavily  on  income  from  oil  à  citizens  of  Texas  have  less   income  à  spend  less  à  businesses  suffer  +  real  estate  market  collapsed     • People  try  to  solve  economic  problems  by  engaging  in  exchanges         Tsuruta  3   Cost  as  Opportunity  Cost     • Relative  concept   • Cost  of  A  is  the  value  in  terms  of  the  objects  of  the  next  best  alternative     • Do  A  if  it  is  profitable   o If  value  of  A  >  cost  of  A   o If  value  of  A  >  value  of  B     o Value  of  B  =  Cost  of  A     Chapter  2  (Solving  the  Economic  Problem)     Efficiency     • Assumption:  people  are  self  interested     • Efficiency:  people  have  made  choices  that  best  meet  their  objectives   o Unambiguous  if  single  objective   o Does  objective  have  a  natural  limit?  Just  maximize  utility  if  no  limit  (?)   o Ambiguous  with  two  objectives:  allocation  is  efficient  if  moving  closer  to  any  one   object  is  not  possible  without  moving  farther  away  from  at  least  one  other   objective     • Law  of  Substitution:  moving  closer  to  one  objective  can  be  achieved  only  by  moving   father  away  from  another  objective  (any  outcome  can  be  efficient)   • Achieving  an  absence  of  slack  –  for  any  inefficient  outcome  there  is  always  an  efficient  one   • Assign  value  to  objectives   o Two  objectives  into  1  (by  index  weighing  scheme)  i.e.  value  GPA   Equity  (fairness)   • Equity  in  terms  of…     o Economic  outcomes/end  results  (is  the  outcome  fair)   o Process  that  generated  end  results  (are  the  rules  fair)   • End-­‐Results  Equity:  fair  outcomes?   o How  should  society  value  the  losses  of  the  rich  against  the  gains  of  the  poor?   o Consumer  sovereignty:  individuals  are  best  able  to  judge  their  own  self  interests   o A  policy  or  event  is  desirable  if  it  makes  at  least  one  person  better  off  without   making  anyone  else  worse  off     • Horizontal  Equity:  requires  that  equals  be  treated  equally   o If  there  is  equal  opportunity,  there  is  horizontal  equity     • Process  Equity:  are  the  rules  of  the  game  fair?  :  A  criterion  for  judging  economic  activity   that  asks  whether  the  rules  under  which  the  economy  operates  are  fair     • Equality  of  opportunity:  individuals  should  have  equal  access  to  whatever  economic   opportunities  they  are  willing  and  able  to  pursue     • Equality  of  opportunity  >  equality  of  results     • Tends  to  produce  equity     • Any  outcome  of  a  fair  game  is  fair     Economists  as  Module  Builders     • Social  mobility:  ability  to  move  through  economic  distribution     o Some  move  up  while  others  move  down       Tsuruta  4   Chapter  3  (Society’s  Economic  Problem)       Society’s  Economic  Problem   Objective     Efficiency  and  Equity   Alternatives   What?  –  Goods  and  services,  depends  on  output     How?  –  How  to  produce  goods/services  (input)  at   lowest  possible  cost     For  Whom?  –  Distribution   Now  vs  Future?  –  Long  run  economic  growth     Constraints     1) Quantity  and  quality  of  a  nation’s  resources,   primary  factors  of  production  (L,  K,  T)       2) Available  production  technologies:  what  are   the  different  ways       Production  Possibilities  Frontier  (PPF)       • Certain  resources  are  suited  better  for  certain  things     • X  is  inefficient:  for  any  point  that  is  inefficient,  there  are  an  infinite  number  of  points  that   dominate     • All  societies  live  under/below  their  frontiers     • All  points  along  frontier  are  efficient     • Why  might  a  society  be  producing  less?   o Not  allocating  scarce  resources  well     • Y  is  impossible:  countries  try  by  printing  more  money:  risk  price  inflation,  hard  to  stop   • The  PPF  is  the  limit:  companies  and  firms  can  get  there  with  time:  long  run  economic   growth     • Efficiency  is  directly  tied  to  notion  of  opportunity  costs   Long  Run  Economic  Growth   • Lasting  increases  year  after  year  in  potential  of  economy  to  produce  goods  and  services   • Textbook  definition:  persistent  increase  in  economy’s  potential  for  producing  goods  and   service       Tsuruta  5   • Reasonable  maximum  of  circular  flow?   • Counties  pushing  out  production  potentials  –  but  how?   • Constraints  determine  start  off  points   o Quality  and  quantity  of  nation’s  resources  (L,  K,  T)   o Available  production  technologies     • Labor  –most  important  factor  of  production  (around  80%)   Capital  (around  20%)   o Output/population:  average  standard  of  living   • Land  (around  .5%)   Capital:  key  to  grow:  amassing  enormous  amounts  of  capital  =  key  to  growth  of  outcome  per  person   • Change  in  human  capital  =  education   • How  do  you  get  growth  started?  ..  Extremely  complex…   • Plant  and  equipment   • Stock  variable  (can  be  measured  in  an  instant)   Investment  (I)     • Flow  variable:  has  a  time  variable   o I  =  change  in  K  (capital  stock)   o What  you  put  in  is  declining  in  value     o Depreciation  of  K     • Why  does  capital  increase  output?   o Not  just  more  but  different  capital   o Changes  not  only  quantity  but  quality     o Adding  to  production  technology     • Physical  K  vs  Human  K  :  society  has  to  invest  in  both,  which  is  more  important?   1) Scientific,  engineering  skills   2) Managerial  talent/abilities   3) High  general  levels  of  education   • Growth:  creative  destruction   • Stock  of  human  K:  3  times  more  important  than  physical  (plant)  …  so  why  don’t  all   countries  do  it?   o To  grow  there  is  opportunity  cost:  need  to  give  up  consumption  of  goods   o Production  hierarchy     o Where  do  final  products  go?     1) Consumers   2) Businesses  increase  capital  stock   o Patience:  how  fast  can  a  frontier  grow?     o #  of  years  that  it  takes  something  growing  to  double  in  value  (Rule  of  72?)     Tsuruta  6   Chapter  4     Market  Exchange   • Prices  are  always  too  high  or  too  low   • How  do  prices…   a. Provide  information  to  buyers  and  sellers   b. Coordinate  the  exchange       i. Exchanges  are  interdependent   ii. No  one  is  directing  exchanges   iii. Self-­‐serving   • Interdependence  applies  to  economic  problem  AND  fundamental  principle  of  market   exchange     o Economic  problem  –  economic  decisions  are  interrelated,  consequences  of  decision   always  spread  beyond  the  immediate  objectives  of  decision,  any  one  decision  always   has  at  least  two  consequences:  the  benefit  and  the  loss   o Market  Exchange  –  entire  economy  is  a  closed  interdependent  circle  along  which  all   markets  are  interrelated,  individuals  purchase  goods  and  service  from  firms  AND   supply  them  with  labor  land  and  funds;  Business  firms  purchase  factors  of  factors  of   production  to  produce  goods  and  services  that  they  sell  to  the  individuals     • See  Chapter  3  on  Interdependence       Tsuruta  7   Chapter  5   Laws  of  Supply  and  Demand     • What  goes  wrong  in  a  market   economy?  Fixed  expectation   • Demand:  the  amount  that  people  are   willing  and  able  to  buy  in  a  given   time  period   o A  function  of  P own ; other ,  taste   preferences,  income,  wealth,   expectations  of  future  values,   population     o OTE:  other  things  equal     o If  price  rises,  quantity  demand   goes  down     o If  price  decreases,  quantity   demand  goes  up     o (1)  desires  of  what  you  want   to  buy     o (2)  OTE     o Why  the  law  of  demand?     a. Substitution  effect  (part  way):  relative  price  effect,  as  prices  change  –  substitute   in  favor  of  goods  whose  prices  have  become  relative  cheap  and  against  all  other   goods,  works  against  another  product,     b. Income/purchasing  power  effect  (rest  of  way_:  absolute  price  effect,  as  prices   drop  you  have  more  purchasing  power  and  tend  to  buy  more  of  all  products   (normal  goods)  including  the  goods  in  the  question,  in  favor  of  other  products   o Market  Demand  Curve  (aggregate)         Change  in  quantity  demanded  vs.  change  in  demand     • Quantity  demanded:  movement  in  price,  different  points  on  graph,  slope  changes?,     • Change  in  demand:  shift  in  entire  demand  curve  caused  by  increase  in  income,  means  that   the  demand  increased  even  when  the  price  increased,  there’s  an  increase  in  quantity   demand  at  every  point,  OR  when  income  decreases  -­‐  at  same  price  consumers  don’t  want  to     Tsuruta  8   pay  as  much     Substitutes  and  Complements  (lies  behind  law  of  demand)   • Substitutes:  different  products  that  provide  the  same  service  (game  and  concert)   • Complements:  products  that  go  together  (shirt  and  tie)   • Consider  A  &  B   o If  P A  ase  leads  to  D B  increase  then  they  are  complements     o If  P A  decrease  leads  to B  crease  then  they  are  substitutes     o Unrelated  if  difference  in  one  price  doesn’t  affect  another       ASK  ABOUT  GRAPH  NOTES  09/25/13     Elasticity   • Measure  of  responsiveness  of  Q  to  Pown   • Measures  the  responsiveness  of  demand  to  changes  in  price  for  a  particular  good   When  lowering  price  from  P to1   2   • 1)  Law  of  Demand  (P  ê  Q  é)     • 2)  Q    é  then  Total  Cost  é     • 3)  Profit:  Total  Revenue  –  Total  Cost     o Total  Revenue  =  PQ,  P  ($/unit)  – sell  more  units  by  lowering   price,  which  one  wins?  Depends   on  elasticity  of  demand     • If  T2  > 1,  ND?  2 Q 2  > 1 P1Q  then   demand  is  elastic  between  P 1  and  P2     o Quantity  wins,  dominates  price   effect   • If  T2  = 1 TR  a2d 2 P Q 1  1  P Q  then   demand  is  unit  elastic       Tsuruta  9   • TR 2  <  1R  an2 2 P Q 1  1  P Q  then  demand  is  inelastic  (unresponsive)     • Want  TR  to  increase…  want  demand  to  be  elastic   • No  firm  with  100%  confidence  can  draw  out  their  demand  curve  but  most  have  a  good  sense     Elasticity  of  Demand  (E )   D • ED   (% Δ q  % p)     • If D    1  …  elastic  (flat  curve)     • If  E  =  1  …  unit  elastic   D • If D E  <  1  …inelastic  (steep  curve)     • % Δ   inherently  arbitrary  number   • % Δ  q  Δ q  /  q  (midpoint)   • %  p   p  /  p  (midpoint)     • Limits  of  elasticity?     o Perfectly  inelastic  is  a  vertical  line  –  the  quantity  demanded  stays  the  same  despite   the  price     o Perfectly  elastic  is  a  horizontal  line  –  the  price  stays  the  same  despite  the  quantity   demanded     Textbook  Review   • Demand:  what  consumers  are  willing  and  able  to  buy  over  a  certain  period  of  time   • Demand  ≠  what  people  actually  buy   • The  individual  demand  curve   o How  do  changes  in  P  affect  Q  demanded?   o Inverse  relationship  P  ê  Q  é  vice  versa   • The  Law  of  Demand:  OTE,  individual  demand  curves  slope  down  to  the  right   • Substitution  income  effects  (
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