TOPIC 1: INTRODUCTION AND CORE CONCEPTS.

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Baldric Cannon
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1 TOPIC 1: INTRODUCTION AND CORE CONCEPTS. Chapter 1 10 Lessons from Economics: Management of society s resources are scarce Scarcity means that society has limited resourced = cannot produce all goods and services people want Economics Is a social science focusing on how societies react to scarcity and solve economic questions. It is the study of markets (demand and supply), incentives, choices and the allocation of scarce resources and the distribution of incomes and wealth among competing groups and nations. Economists study how people make decisions, how much they work, what they buy, how much they save and how they invest, how people interact with each other, and analyze forces and trends that affect the economy How people make decisions: Lesson 1 - People face tradeoffs: Making decisions requires trading off one goal for another Classic trade off = guns & butter = the more resources spent towards defense the less spent on standard of living Modern society trade off = clean environment and high level of income = laws that require firms to reduce pollution usually raise the cost of producing goods and services Another trade off in society = efficiency (the property of society getting the most it can from its scarce resources) vs equity (the property of distributing economic prosperity fairly among the members of society). Often when government policy is being designed, these two goals conflict Acknowledging life s tradeoffs is important b/c people are likely to make better decisions when they understand the available options Lesson 2 The cost of something is what you give up to it: Due to facing tradeoffs, making decisions requires comparing the costs and benefits of alternative courses of action. Opportunity cost = the best alternative that must be given up to obtain some item Decision makers should be aware of the opportunity costs that accompany each possible action Lesson 3 Rational people think at the margin: Economists normally assume that people are rational Rational people systematically and purposefully do the best they can to achieve their objectives, given the opportunities they have

price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell The equilibrium price is sometimes called the market-

2 Supply and demand together: Equilibrium: Equilibrium = a situation in which supply and demand have been brought into balance. It is the point at which the supply and demand curve intersect The price at the intersection is called the equilibrium price and the quantity is called the equilibrium quantity At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell The equilibrium price is sometimes called the market- clearing price b/c at this price, everyone in the market has been satisfied Surplus = a situation in which quantity supplied is greater than quantity demanded. A.k.a. excess supply They respond to surplus by cutting their prices Falling prices in turn, increase the quantity demanded and decrease the quantity supplied. These changes represent movement along the supply and demand curves. Prices continue to fall until the market reaches equilibrium Shortage = a situation in which quantity demanded is greater than quantity supplied. A.k.a. excess demand Sellers can respond to excess demand by raises their prices without losing sales

Deadweight loss and the gains from trade: Taxes cause deadweight losses b/c they prevent buyers and sellers from realizing some of the gains from trade Deadweight loss is the reduction in total

3 Deadweight loss and the gains from trade: Taxes cause deadweight losses b/c they prevent buyers and sellers from realizing some of the gains from trade Deadweight loss is the reduction in total surplus that results from a market distortion such as a tax or a monopoly price. The deadweight loss is the surplus that is list b/c the tax discourages these mutually advantageous trades The determinants of the deadweight loss: A tax raises the price paid by buyers, so that they consume less The tax also lowers the price received by sellers, so they produce less Because of these changes in behaviour, the equilibrium quantity in the market shrinks below the optimal quantity. The greater the elasticities of supply and demand, the greater the deadweight loss of a tax. When supply is relatively inelastic, the deadweight loss of the tax is small. When supply is relatively elastic, the deadweight tax is large. Same application for demand elasticities. Deadweight loss and tax revenue as taxes vary: The larger the tax, the larger the deadweight loss. Application: International trade: The determinants of trade: The world price and comparative advantage: World price = the price of a good that prevails in the world market for that good. Comparing the world price and the domestic price before trade indicates whether that country has a comparative advantage in producing a certain product If the domestic price is low = the country has a comparative advantage of producing that product If the domestic price is high = foreign countries have a comparative advantage n producing that product. Trade is beneficial as it allows each country to have a specialization.

4 TOPIC 3: COSTS AND PROFITS Chapter 13 The cost of production: What are costs? Total revenue, cost and profit: Total revenue = the amount a firm receives for the sale of its output Total cost = the amount a firm pays to buy the inputs into production Profit = total revenue less total costs Costs as opportunity costs: Explicit costs are things directly linked with the operation of that good Implicit = imaginary, opportunity cost of doing something else entirely Accountant doesn t include implicit costs only explicit b/c they only are outflows of money Economist however will include implicit costs b/c it affects the decision of the owner The cost of capital as an opportunity cost: An important implicit cost for every business is the opportunity cost of the financial capital that is being invested into the business Economic profit vs accounting profit: Economists and accountants measure cost and profit differently Economist measures the firms economic profit as the firms total revenue minus all the opportunity costs of producing the good and services sold Accountant measures the firms accounting profit as the firms total revenue minus only the firms explicit costs

5 Monopolistic competitors, like a monopoly, maximize profit by producing the quantity at which marginal revenue equals marginal cost. In panel (a), price exceeds average total cost, so the firm makes a profit. In panel (b), price is below average total cost. In this case, the firm is unable to make a positive profit, so the best firm can do is to minimize its losses. Long run equilibrium When firms are making profits, as in panel (a), new firms have an incentive to enter the market. In other words, profit encourages entry, and entry shifts the demand curve faced by the incumbent firms to the left. Conversely, when firms are making losses, as in panel (b), firms in the market have an incentive to exit. In other words, losses encourage exit, and exit shifts the demand curve of the remaining to the right. The process of entry and exit continues until the firms in the market are exactly zero economic profit. To sum up, two characteristics describe the long- run equilibrium in a monopolistically competitive market: o As in a monopoly market, price exceeds marginal cost. This conclusion arises because profit maximization requires marginal revenue to equal marginal cost and because the downward sloping demand curve makes marginal revenue less than the price. o As in a competitive market, price equals average total cost. This conclusion arises because free entry and exit drive economic profit to zero. This second characteristics shows how monopolistic competition differs from monopoly. Because a monopoly is the sole seller of a product without close substitutes, it can earn positive economic profit, even in the long run. In contrast, because there is a free entry into a monopolistically competitive market, the economic profit of a firm in this type of market is drive to zero.

Learning Objectives. Chapter 6. Market Structures. Market Structures (cont.) The Two Extremes: Perfect Competition and Pure Monopoly

Learning Objectives. Chapter 6. Market Structures. Market Structures (cont.) The Two Extremes: Perfect Competition and Pure Monopoly Chapter 6 The Two Extremes: Perfect Competition and Pure Monopoly Learning Objectives List the four characteristics of a perfectly competitive market. Describe how a perfect competitor makes the decision