Econ 101

Economics

• Study of choices people make in the face of scarcity.

• Social science seeking to explain how people act.

• Uses models, theories, and assumptions to describe how people behave.

• Empirical science.

Simple Rule of Economics

Benefits > Cost = Do

Costs > Benefits = Don't do

Marginal Cost

Additional cost of doing one more unit of an activity.

Marginal Benefit

Additional benefit of doing one more unit of an activity.

2 Main Branches of Economics

• Microeconomics

• Macroeconomics

Microeconomics

Study of the choices and actions of individual economic units.

Macroeconomics

Study of the behaviour of the entire economy.

Judging Economic Allocations

• Efficiency

• Equity

• Moral/Political Consequences

Efficiency

Occurs when resources are organized so present value of net benefits is maximized.

Present Value

Value today is more than value tomorrow.

Net Benefits

Benefits - Cost.

Equity

Distribution of goods and services in a manner that society considers to be fair.

Moral/Political Consequences

Value based on moral and political consequences.

Positive Economics

• Statements about what is.

• Can be tested by checking statements against facts.

Normative Economics

• Statements about what should be.

• Depends on values and beliefs.

• Cannot be tested.

Model

• Incomplete simple description of the way things work that covers a wide range of possibilities.

• Should be useful in predicting behaviour.

Bliss Point

Consumer is content and doesn't want more.

Empirical Science

Theories and models are tested against observed information.

Correlation Fallacy

Incorrect belief that correlation implies causation.

Post Hoc Fallacy

• Special case of the correlation fallacy.

• Error of reasoning that a first event causes a second event because the first occurred before the second.

Fallacy of Composition

• Incorrect belief that what is true for the individual is also true for the group.

• Macroeconomic concern

Production Possibilities Frontier

• Graph showing the combination of goods that can be produced when the factors of production are utilized to full potential.

• Drawn for a given level of the society's inputs and for given state of the society's technology.

Society's Inputs

• Labour

• Natural resources

• Capital

Production Possibilities Frontier Graph

• Points a, b, c, d, e, and f are attainable.

• Point g is unattainable.

• Points a, b, c, d, and e are efficient because the resources are at their full potential.

• Point f is inefficient.

Opportunity Cost

Benefit given up by not using resources in the best alternative manner.

The Economics Problem

Scarcity forces choices which are costly because you must give up other opportunities that you value.

Production Possibilities Frontier Shifts Out

• Increase in labour

• Technological innovation

• More resources found

• Capital accumulation

Production Possibilities Frontier Shifts In

• Natural disaster

• Labour loss

• Loss of resources

• War

Law of Increasing Goods

In order to produce extra amounts of 1 good, society must give up increasing amounts of another good.

Absolute Advantage

Good or service can be produced at a lower absolute cost.

Comparative Advantage

Good or service can be produced at a lower opportunity cost.

Command Economy

Government controls a country's economy.

Market Economy

Individuals or the open market control a country's economy.

Market

Place where buyers and sellers interact.

Rationality Assumption

Individuals do not intentionally make decisions that will leave them worse off.

Players in Market

• Households

• Firms

• Government

Household

• Consumers of goods and services

• Sellers of factors of production

Household Objective

Maximize satisfaction.

Firm

• Producers of goods and services

• Demanders of factors of production

Firm Objective

Maximize profits.

Government

All public officials.

Main Characteristics of Market Economy

• Self-interest

• Incentives

• Market prices and quantities

• Institutions

Self-Interest

Individuals pursue their own self-interest, buying and selling what seems best for their families.

Incentives

People respond to incentives (prices).

Market Prices And Quantities

Prices and quantities determined in open markets.

Institutions

All activities are governed by a set of institutions, largely created by the government.

Types of Institutions

• Individualist institutions of property and decision making

• Social institutions of trust

• Infrastructure for the smooth flow of goods and services

• Money as a medium of exchange

Social Institutions of Trust

• Trust must exist between buyers and sellers

• Trust may be established through cultural norms, through direct one-to-one direct relationships or through the establishment of contracts.

Infrastructure For The Smooth Flow of Goods and Services

Refers to physical infrastructure of transport and storage.

Money as a Medium of Exchange

A generally accepted means of payment is necessary to facilitate the flow of goods and services.

Demand Function

Shows the quantity demanded at different price levels.

Quantity Demanded

Amount consumers are willing to buy.

Law of Demand

• As a product's price increases the quantity demanded decreases.

• As a product's price decreases the quantity demanded increases.

Variables That Change Demand

• Price of substitutes

• Price of complements

• Number of buyers

• Preferences and tastes

• Expectations

• Income

Price of Substitutes

• Two goods that satisfy the same needs.

• If the price of a substitute (good B) increases, the demand for good A increases.

Price of Complements

• Two goods that are consumed together.

• If the price of a complement to good A increases, the demand for good A decreases.

Number of Buyers

When number of buyers increases, demand increases.

Preferences and Tastes

As preferences change, demand changes

Expectations (Demand)

Consumer's expectations of the future will influence today's demand curve.

Income

• Normal goods

• Inferior goods

Normal Goods

As income increases, demand increases

Inferior Goods

As income increases, demand decreases

Supply Function

Shows the quantity supplied at different price levels.

Law of Supply

• As the price of a good or service increases the quantity supplied increases.

• As the price of a good or service decreases, the quantity supplied decreases.

Variables the Influence Supply

• Technological advancements

• Costs of inputs

• Number of firms

• Taxes

• Expectations

• Changes in nature

Technological Advancements

As technology improves/advances, supply increases.

Costs of Inputs

As costs increase, supply decreases.

Inputs

• Wages

• Interest rates

• Fuel prices

• Opportunity costs

Number of Firms

As the number of firms increases, supply increases.

Taxes

As taxes increase, supply decreases.

Expectations (Supply)

Consumer's expectations of the future will influence today's supply curve.

Equilibrium Price

Occurs when demand equals supply.

Reasons for Government

• Information problems.

• Non Invisible Hand forces.

• Market Failure.

Non Invisible Handshake Forces

• Social and historical forces.

• Legal and political forces.

Social and Historical Forces

• The Invisible Handshake.

• Born out of tradition and culture.

Legal and Political Forces

The Invisible Foot

Government Activities

• Ensuring activities and markets conform to social, cultural, legal, and political norms.

• Correcting market failure.

Regulations on Price

• Price floors.

• Price ceilings.

Price Floor

• Government sets minimum price.

• Surplus.

Price Ceiling

• Government sets max price.

• Shortage.

Quota

Government sets max quantity

Price Elasticity of Demand (N_D)

Measures responsiveness of quantity demanded to changes in price.

N_D ≤ 0

N_D = %ΔQ_D/%ΔP

Price Elasticity of Demand = Percent Change in Quantity Demanded/Percent Change in Price

N_D = ((Q₁ - Q₂)/(P₁ - P₂)) x (((P₁ - P₂)/2)/((Q₁ - Q₂)/2))

Price Elasticity of Demand = ((Quantity 1 - Quantity 2)/(Price 1 - Price 2)) x (((Price 1 + Price 2)/2)/((Quantity 1 + Quantity 2)/2))

N_D = (ΔQ_D/ΔP) x (P̅/Q̅_D)

Price Elasticity of Demand = (Change in Quantity Demanded/Change in Price) x (Average Price/Average Quantity Demanded)

Change in Quantity Demanded (ΔQ_D)

ΔQ_D = Q₁ - Q₂

Change in Quantity Demanded = Quantity 1 - Quantity 2

Average Quantity Demanded (Q̅_D)

Q̅_D = (Q₁ + Q₂)/2

Average Quantity Demanded ₌ (Quantity 1 + Quantity 2)/2

Change in Price (ΔP)

ΔP = P₁ - P₂

Change in Price = Price 1 - Price 2

Average Price (P̅)

P̅ = (P₁ + P₂)/2

Average Price = (Price 1 + Price 2)/2

N_D < -1

Demand is elastic/responsive.

N_D > -1

Demand is inelastic/not responsive.

N_D = -1

Demand is unit elastic.

N_D = 0

Demand is perfectly inelastic.

N_D = -Infinity

Demand is perfectly elastic.

Variables that Influence Elasticity of Demand

• Number of substitutes.

• Time

• Luxury status.

Number of Substitutes (Elasticity of Demand)

More substitutes means good is more elastic.

Time

Demand becomes more elastic over time.

Luxury Status

Luxuries are more elastic.

Total Revenue (R)

R = P x Q

Revenue = Price x Quantity

Total Revenue Rule

• Demand is elastic, total revenue moves opposite to price.

• Demand is inelastic, total revenue moves with price.

• Demand is unit elastic, total revenue does not change.

Income Elasticity of Demand (N_I)

Measures responsiveness of quantity demanded to changes in income.

N_I = %ΔQ/%ΔI

Income Elasticity of Demand = Percent Change in Quantity/Percent Change in Income

N_I = (ΔQ/ΔI) x (I̅/Q̅)

Price Elasticity of Demand = ((Change in Quantity)/(Change in Income)) x ((Average Income)/(Average Quantity))

N_I > 0

Normal good.

N_I < 0

Inferior good.