Micro Midterm 1

Economics

the choices you make on how to allocate resources to best satisfy needs and wants

TRIES TO MAXIMIZE OUTPUTS OF PRODUCTS WITH LEAST AMOUNT OF RESOURCES

Microeconomics vs. Macroeconomics

Micro: small scale. markets of individual goods, prices, how goods are produced and consumed. Scarcity, competition. Customers, firms, and governments
-In a brick wall, we examine the individual bricks

Macro: large scale. Focuses on entire economy. Overall production, overall price, economic growth, inflation, international trade, government
-in a brick wall, examines the wall, not the bricks

resources

inputs, factors of production

satisfy our needs and wants

1. Labor: employees
2. Capitol: everything created to create goods and services OR HUMAN CAPITOL LIKE EDUCATION
3. Land: natural resources used in production
4. Entrepreneurial Ability: talent or ability to organize labor, land, capital MOST IMPORTANT

Scarcity

resources are scarce, we have limited resources and unlimited wants
NOT ALWAYS ABOUT MONEY

everything comes at a cost. The wood you use in a table now can't be used in a house

Opportunity Cost

value of the next best option. The one you gave up. 2nd best

exists because of scarcity

everyone has different opportunity costs and make different decisions

Rational Decision making done based on:

1. Self interest: people do things that interest them and make them happy, like volunteering. ALL ABOUT THEIR GOALS

2. marginal decision making: people make choices in small increments by evaluating MB against MC

3. Optimization: people choose to do something if MB\>MC. TRYING TO OPTIMIZE YOUR UTILITY OR PROFITS

Rational Decision Making

Doing more of something when MB\>MC. Or less when MC
Marginal Benefits: additional satisfaction or utility from doing something

Marginal Cost: additional cost of expanding economic activity

Diminishing Marginal Benefit

marginal benefit of each additional item is smaller than the marginal benefit of the previous item

you enjoy it less

Marginal cost increases with increased activity

As you produce more, the cost of producing each unit rises
-as production goes on, you use less productive resources which increases MC

Law of Increasing Opportunity Costs

as the production of a particular good increases, the opportunity cost of producing an additional unit rises

Increasing Marginal Costs

as more of a good is produced, the cost of producing rises

Relative Scarcity

comparison of scarcity of one good to another.

ex: drinkable water has a greater relative scarcity compared to water in general

diamonds vs water. We have much more water than we have diamonds

Is financial capital a resource?

No, it gives you the ability to acquire resources

Rational Decision

comparison of MB and MC
accounts for scarcity of resources
doesn't always leave people better off

Total Benefit or Marginal Benefit?

MARGINAL BENEFIT

Productions Possibility Schedule

Table of 2 possibilities of how much of each product you can make in a certain time

about scarcity, we don't have unlimited resources so you can only make so much of a product

production possibilities frontier

the line on a production possibilities graph that shows the maximum possible output

shows the most efficent use of resources on the line, inefficent under the line, and impossible use above the line

YOU CAN ONLY EXCEDE THE LINE THROUGH TRADE

Slope of the PPF is

tells you the opportunity cost of one good in terms of the other

Constant Opportunity Costs

when the cost of one thing in terms of another is the same at every level of output

Is a straight line a curve

yes

PPF usually bow outwards, show increasing opportunity costs
AS WE MAKE MORE PRODUCTS, WE HAVE TO USE LESS EFFICENT RESOURCES

Comparartive advantage

the ability to produce at the lowest opportunity cost

aka low cost producers

if you have the comparative advantage in one, the other person has the comparative advantage in the other

absolute advantage

the ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources

MAY NOT HAVE COMPARATIVE ADVANTAGE THOUGH

Specialization

increases productivity and excedes PPF through comparative advantages

Right Price

price you sell your item for, greater than cost ot make it

Terms of Trade

final price

Circular Flow Model

In the resource market, houses give firms employees, and firms give houses income.

in the product market, firms give houses products (AKA EXPENDITURES), houses give firms revenue

When terms of trades are closer to your opportunity cost, the gains from the trade

decrease for you

law of increasing opportunity cost

To produce more of one item, you have to give up more of another

when firms have increasing Opportunity costs of production, an increase in price allows them to increase production

bowed PPF

consumption expenditure

Households buying goods from firms

Consider two products, clean air and health care. Assuming everything is held constant (ceteris paribus), because of scarcity an increase in clean air means that there will less healthcare available.
True or False

Always True.
You're using resources to clean the air, which takes resources from. healthcare

Price

Based on what customers are willing and able to pay, as well as what producers are willing and able to sell it for

Market

a group of buyers and sellers of a particular good or service
NOT A SPECIFIC PLACE

People buy stuff based on

their willingness and ablility to pay (which depends on income and wealth)

Law of Demand

consumers buy more of a good when its price decreases and less when its price increases
QUANTITY DEMAND DECREASES BUT DEMAND STAYS THE SAME

SLOPES DOWN

Demand Curve

a graph of the relationship between the price of a good and the quantity demanded

Quantity Demand goes down because

1. Income Effect:
Purchasing Power
if price goes up, you buy less
2. Substitution Effect: when something is too expensive, you buy something you want less, but it's cheaper
3. Law of Diminishing Marginal Utility: the more you consume of a product, the less you enjoy it. marginal cost rises.

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WHY THE DEMAND CURVE IS DOWNWARD

BECAUSE MARGINAL BENEFITS ARE DECREASING

Market Demand

Sum of all demand for an item all over world

Sum of individual demand curves

Only variable that can change in demand curve is:

price, everything else held constant

Demand vs. Quantity Demanded

A change in demand is when the whole curve shifts.
Shift to the left is a decrease in demand.
Can be from things like income, or substitutions, or future expectations

change in quantity demanded is movement along the demand curve due to a change in price.

Normal Income vs. Inferior Income

Normal: when you income increases, you buy more of the item (like lobster)

Inferior Income: when your income increases, you buy less of the item (like dollar store items)

Substitutes vs. Complements

- Substitutes: two goods for which an increase in the price of one leads to an increase in the demand for the other. Ex: hot dogs and hamburgers.


- Complements: two goods for which an increase in the price of one leads to a decrease in the demand for the other. Ex: peanut butter and jelly.

Demand Schedule

displays the demand for an item and it's price in a table

Increase of Quantity demand looks like

downward movement on graph. You're willinging to buy more of an item because the price lowered.

Increase of demand means you're willing to buy more of an item at the same price

Informal Markets

refer to markets in which economic activity is not officially measured/ recorded.

like garage sales

Relative Price vs. Absolute Price

Absolute price: expressed in dollars
ex: 1 hotdog is 3 dollars

RElative Price: expressed as what you gave up.
ex: 1 hotdog is 2 waters

Supply Curve

a graph of the relationship between the price of a good and the quantity the producer is willing and able to supply

Law of Supply

as the price of a product goes up, the amount producers are willing and able to sell will rise

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\-WHY THE SUPPLY CURVE HAS A POSITIVE SLOPE

\-HOLDS UP 90% OF THE TIME, WHILE THE DEMAND CURVE HOLDS UP 99% OF THE TIME

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so if you supply 5 boquets for $20, and 25 boquets for $30, and the price rises from $20 a boquet to $30, the quantity of boquets supplied will increase by 20 boquets

Diminishing Marginal Productivity

\-general rule that as a firm employs more labor, eventually the amount of additional output produced declines because employees have to share resources and spaces

\-the more resources you apply to production, the less productive it is, so cost of production rises and prices rise

\-SO MARGINAL COST RISES AND PRICES RISE

\-WHY THE SUPPLY CURVE IS UPWARD RISING

Market Supply

the sum of all that is supplied each period by all producers of a single product

supply curve shifters (non price determinants)

INCREASE OF SUPPLY=RIGHT SHIFT


1. Subsidies: gov pays businesses, so COST OF PRODUCTION decreases, so there is an increased supply. Lowered if governments want less of the item produced, or raised if the government wants more of the item produced.
2. Taxes: businesses have to pay gov, so COST OF PRODUCTION increases, so decrease supply

Anything that causes the cost of production to go up, will cause supply to go down. Raised if governments want less of the item produced, or lowered if the government wants more of the item produced.
3. Resource costs: if price of resource increases, COST OF PRODUCTION increases, so decreased supply
4. Technology: if a more productive resource is introduced, INCREASE OF PRODUCTION, increase of supply
5. Number of Sellers: more companies making a product, the more of those products there are, INCREASE OF SUPPLY
6. Expectations of Future Prices: DEPENDS!!!!! If a corn company thinks prices will decrease in future, they may increase supply now and stop production for later. If video game companies think prices will decrease, they will decrease production
* If the seller thinks they can sell more of their product than they can today, than they will decrease their supply now to save it for later
* If demanders think prices will increase, they will demand more today

Quantity supplied

movement up or down the curve in response to price. Like if the price of mushrooms are going up, mushroom suppliers will supply more and move down the up the curve

Higher resource costs

increase cost of production and decrease supply

Production vs. supply

production = quantity of output firms produce (their inventory)

supply = quantity and output firms are willing and able to provide to the market at different prices. They don’t have to sell their whole inventory.

How Market determines price

by bringing together buyers and sellers to exchange goods and services

Equilibrium Price

\-When demand and supply intersect

\-develops through interaction of buyers and sellers

\-BALANCES MB AND MC

Market cleared

equilibrium

Shortage

\-when quantity demand is greater than quantity supply

\-price of good lies under equilibrium price

\-CAN ONLY BE ELIMANTED BY RAISING PRICES

\-doesn’t mean expensive. Just because gas raised in price doesn’t mean you can’t get enough gas. When there’s a shortage that means there isn’t enough to go around

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ex: 10,000 pounds of ice cream is the quantity demand in the winter for $5 a pound.  it’s summer so demand for ice cream is greater, and 12,000 pounds of ice cream is the quantity demanded.

* At the same price, $5, the quantity demanded is greater than quantity supplied, so there is a shortage
* So they raise the price, to $6 allowing producers to produce more strawberries
* Higher prices will discourage some customers from buying more strawberries. 
* BRINGS PRICE TO EQUILIBRIUM

size of shortage or surplus

quantity supplied minus quantity demanded

ex: supplied 30, demanded 70. Size of shortage: -40

Surplus

\-quantity supplied is greater than quantity demanded

\-price is above equilibrium

\-ELIMINATED BY LOWERING PRICES

\-signal that prices are too high

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ex: Now that it’s winter, no one wants ice cream. So demand decreases from 12,000 pounds to 10,000 pounds.

* At the same price, $6, quantity supplied is greater than quantity demanded, so there’s a surplus.
* So they lower the price to $5, lowering production
* Consumers will buy more at a lower price

What happens to quantity and price when demand and supply move in the same direction

If supply and demand increase, quantity increases

if supply and demand decrease, quantity decreases

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if demand is greater than supply, price increases

if demand is less than supply, price decreases

if demand is the same as supply, price is the same

What happens to quantity and price when demand and supply move in opposite directions

If DEMAND INCREASES, and supply decreases, price INCREASES

if DEMAND DECREASES, and supply increases, price DECREASES

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if demand increases more than supply decreases, quantity increases

if demand increases less than supply decreases, quantity decreases

if demand is the same as supply, quantity is the same

If supply increases:

supply curve moves to the right

there’s a surplus

they lower prices, producers produce less, and then quantity demanded increases

DRAW PICTURE, QUANTITY SUPPLIED MAY INCREASE

Lower prices, higher quantity

If supply decreases:

supply curve moves to the left

there is shortage

raises prices, so quantity demand lowers

Price Ceiling

\-maximum legal price that something can be sold at

\-Binding price ceiling is below equilibrium

\-non binding is above equilibrium, it will have no affect

\-imposed to make prices more fair

\-Ironic though because it makes things cheaper, raising demand, but supply will decreases because less money is made off of it, CAUSES SHORTAGE

MAKES LESS AVALIBILE FOR PEOPLE, NOT MORE

Binding vs. Nonbinding

Nonbinding is uneffective.

ex: if equilibirum is at $800, then a nonbinding price ceiling would be $800 or more

ex: if gas is $4, and a nonbinding price ceiling is imposed that gas can’t be more than $25, it doesn’t really matter, it’s uneffective, because the equilibrium is far below that.

Price Floor

\-minimum legal price for a good

\-binding price floor must be above equilibrium

\-designed to ensure sellers receive a minimum price that is greater than that is available at market equilibrium

\-designed for minimum wage to get them a higher wage than equilibrium

\-ironic though because now that employeers have to pay their employees more, quantity supplied of labor will increase, but quantity demanded of labor will decrease because they can’t pay everyone, so there’s A SURPLUS OF LABOR, leading to unemployement

In labor markets how are firms and employees referred to?

employees=Suppliers of labor

firms: Demanders of jobs

PRICE FLOORS ARE MADE TO BENEFIT THE SUPPLIERS

Excise Taxes

\-tax put on good that depends on units sold

\-increases price paid by consumer, decreases price earned by producer, decreases quantity demands

\-VERTICLE SHIFTS THE SUPPLY LINE UP BY THE AMOUNT OF TAX IMPOSED

\-OR SHIFT DEMAND CURVE DOWN BY THE AMOUNT OF TAX, AND THEN LATER ADDING TAX BACK ON WHEN ASKED HOW MUCH CONSUMER PAYS

\-tax is paid by both consumer and producer

\-ex: if a $4 tax is imposed on wine that used to be sold for $10 a bottle for 50,000 bottles. Consumers now have to pay $12 for it, producers only earn $8, those $4 go to the government, and now only 40,000 bottles are sold.

TR=40,000x4

Tax Revenue

tax times quantity traded

so the tax times quantity of the new equilibrium?

raises price paid by customers, reducing quantity traded

raises revenue for government

reduces prices earned by producers

Surpluses and Shortages are measured by

horizontal distances, measured in quantity demand, not dollars

When supply decreases, the equilibrium price

increases and the equilibrium quantity decreases

When supply increases, the equilibrium price

decreases and the equilibrium quantity increases

Be careful moving the demand curve due to income, think if the income is:

normal or inferior

No relationship between price and demand, it’s between

quantity demanded and price

5 things that cause demand to shift

* Number of consumers
* Income 
* Future Expectations
* Compliments 
* substitutes

What makes a seller willing to sell a product

* Interested in profit, which isn’t revenue
* Revenue is the amount of money you receive for the product
* Profit is revenue minus cost

Higher Production causes higher

marginal costs

You have to raise the price of your product to compensate for higher production cost to maintain profits

The more a company produces something, what happens to their opportunity cost?

it rises

Does a raise in price affect the quantity supplied or shift the supply curve

shifts the supply curve

QUANTITY SUPPLIED AND QUANTITY DEMANDED ARE ONLY CHANGED WHEN THE PRICE OF THE PRODUCT CHANGES

Changes in demand and supply curves may have different results for price and demand in the

Equilibrium curve

DRAW IT OUT!!!!

The market is always trying to move towards

equilibrium

Consumer Surplus

* difference between the maximum amount someone is willing to pay for a good, minus the price they actually paid
* If you are prepared to buy something for $30, but it’s on sale for $20, consumer surplus is $10
* Benefits the consumer gets when they pay less for a good. 
* MEASURED IN DOLLARS. DIFFERENT FROM SURPLUS ITSELF, WHICH IS MEASURED IN OUTPUTS
* Also thought as the wealth created by the trade
* The item is worth more to you than the price you paid
* INCREASES THE WEALTH OF CONSUMERS

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* under the demand curve and above equilibrium
* as more trades are made, consumer surplus decreases

Producer Surplus

* difference between price received for good, and the minimum price you were willing to sell it for
* Points on graph represent willingness to sell (MC of each unit)
* Increase the wealth created by the market for sellers
* Line represents price of each unit sold (MB of the sale)

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* FOR EACH UNIT SOLD THE PRODUCER ENJOYS ADDITIONAL PRODUCER SURPLUS, SINCE MC ARE RISING, AND PRICES ARE CONSTANT, PRODUCER SURPLUS FALLS WITH EACH ADDITIONAL UNIT UNTIL MB=MC.
* Above supply curve and below equilibrium
* Producers like higher prices because of:
* More surplus on the units they would’ve sold anyways
* Higher prices cover the cost of production
* Total producer surplus is larger
* DIFFERENT THAN PROFIT. PRODUCER SURPLUS IS WHEN YOU SELL COOKIES FOR $10 WHEN IT COST YOU $5 TO MAKE IT. $5 ISN’T QUIET YOUR PROFIT BECAUSE YOU MAY STILL NEED TO PAY RENT AND BUY A NEW MIXER, ETC. 

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* Also refers to suppliers of labor (employees). If you expect to be paid $10, and you get paid $15, that’s producer surplus

Consumer Surplus and Producer Surplus measure

the wealth producers or consumers get from raising or falling prices

Economic Surplus

* sum of producer and supplier surplus
* Aka social welfare
* The sum of their 2 areas
* If there was more suppliers wanting to trade than consumers, trade would be limited by the number of consumers, not maximized, only the units demanded will be traded
* MB=MC
* EQUILIBRIUM PRICE: MAXIMIZES THE NUMBER OF TRADES PRODUCERS AND SELLERS CAN MAKE

Deadweight Loss

* loss in social welfare from missing trades (aka DWL)
* Not allocatively efficent
* Dollar value representing missing wealth
* There is no surplus or shortages in an equilibrium market
* Economic surplus and total social welfare are maximized in a equilibrium market too
* Creates as much wealth as possible
* But if prices are above or below equilibrium, we miss out on economic surplus
* Because one side of the market doesn’t want to trade as much as when they’re in equilibrium
* Result of missing trades
* CAUSED BY PRICE CEILINGS AND FLOORS

Competitive markets reduce scarcity through

* productive and allocative efficiency
* Productive efficiency
* TOTAL SURPLUS IS MAXIMIZED .
* PRODUCING PRODUCT AT THE LOWEST COST (DOESN’T MEAN YOU’RE ALLOCATIVELY EFFICENT)
* Achieved by using the least-cost methods of production
* Maximizes outputs with the least amount of inputs
* ex: MC of producing these 4 million units was less than or equal to $50 a unit
* Units beyond 4 million didn’t get produced because it would’ve cost more than $50 to produce, wasting resources and increase scarcity
* Allocative Efficiency
* Occurs when the goods that consumers want most are being produced
* DOESN’T MEAN YOUR PRODUCTIVELY EFFICENT
* when MB=MC
* Total welfare is maximized
* When quantity demanded equals quantity supplied. Allocative and productive efficiency, economic surplus is maximized
* Productive efficiency: producing output at the lowest possible average total cost of production
* Allocative efficiency: producing goods that are most wanted by consumers in a way that MB=MC
* NO DEADWEIGHT LOSS
* Markets are always trying to move towards this
* Only time it doesn’t happen is when governments are setting price floors and ceilings
* NOT THE SAME AS PRODUCTION POSSIBILITIES FRONTIER. THAT SHOWS HOW TO EFFICIENTLY PRODUCE TWO OUTPUTS. ALLOCATIVE EFFICIENCY SHOWS YOU HOW TO PRODUCE THE GOODS CONSUMERS WANT MOST

Who benefits from Price Ceilings

some consumers, but not all

producers lose

overall society is worse off

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ex: Some benefit because apartments are cheaper, but some don’t get apartments at all

* All producers loose, they provide less and at a lower price

Who benefits from Price Floors

all consumers loose

some producers benefit, but not all

society is worse off

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ex: Consumers are worse off (the people hiring), they have to pay more and hire less

* Some workers are worse off because they can’t find a job, but those who can get more money

Taxes affect how much economic surplus is created for consumers and producers

\-lowers consumer and producer surpluses

\-raises money for tax revenue

\-society is worse off

their is deadweight loss too

Consumer loss, producer loss, net loss

\-Consumer surplus before tax minus consumer surplus after tax

\-net loss: consumer loss + producer loss minus tax revenue

\-find surpluses and tax revenue using 1/2 base times height

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helps us figure out the welfare effects of a tax, gives you tools needed to make comparisons of costs and benefits of public policy

External Costs

benefit or cost enjoyed by 3rd party

cost not included in market price

* ex: car companies may benefit from car production, but the MC is actually greater than MB because it pollutes the world
* To be efficient we must consider ALL costs, including externally
* (MBprivate + MB external)> (MCprivate + MCexternal)    =MBsocial>MCsocial
* MB IS FOR CONSUMERS, MC IS FOR PRODUCERS
* Ex: if victor creates a rose garden in his yard, he’s not the only one benefiting, so do his neighbors 
* When ignored, producers may produce to much at too low a price because they aren’t paying all of the price, and consumers may do too little, because they don’t have to pay the whole price

Positive Externality

*  a benefit a 3rd party enjoys from a consumption of a good
* Benefiting from a choice you didn’t have to pay for
* Ex: enjoying someone else’s garden
* May make the market inefficient
* DP STANDS FOR PRIVATE DEMAND
* Graph of the first person and their demand and cost
* Gets the quantity at equilibrium at PP, aka private price
* This only considers his benefits and costs
* Other people will get value from his yard though, so overall demand for the garden he wants looks like an increased demand curve
* DS=social demand
* Creates a new equilibrium, they want more of a garden than what he wants
* New graph is more productively and allocatively efficient

When positive externalities exist, market equilibrium is inefficient because too little is produced and market prices don’t reflect the true value of what is produced

Negative Externality

* when some of an activities costs are paid by a 3rd party
* Ex: a car company pays private costs of production (paying for land, labor, capital, etc)
* WHEN MARGINAL COSTS RISE, THE GRAPH ACTUALLY MOVES TO THE LEFT
* This lowers production and raises prices


* When negative externalities exist, the equilibrium is inefficient, too much is produced and prices are too low
* Governments use these to justify intervention in markets with policies

In an externalities graph, WHEN MARGINAL COSTS RISE, THE GRAPH ACTUALLY MOVES TO THE LEFT

THE GRAPH ACTUALLY MOVES TO THE LEFT

Private goods:

* is rival OR excludable
* Rivalry in consumption: if I consume it, you there won’t be any left for you
* Excludability in consumption: people can be prevented from consuming a good, usually through higher prices
* Results in efficient outcomes 
* Ex: hamburgers, public school (if you don’t live in the neighborhood, or if you don’t sign up in time, you may not get a spot)

Public goods

*  is nonrival AND nonexcludable
* no guarantee that markets will produce them
* Nonrivalry: if one person consumes a good, it doesn’t diminish the consumption of another 
* Ex: when you watch fireworks, everyone else sees the same amount as you
* Nonexcludability: People can’t be prevented from consuming a good
* Hard to recover the costs of creating the good
* Ex: music on radio, national defense,
* Not all public goods come from the government. And the government provides private goods too, like health care

Free Rider

* people who would hitch a ride on a train without paying for a ticket. 
* People who get the benefit without the cost. If there are too many freeriders, it makes it harder for the firm to provide the service Make it harder to for markets to be efficient and provide the goods. Results in market failure
* Why many firms produce private goods, not public goods
* Since you can’t exclude someone from using a public good, they have little incentive to pay for it’s use
* Ex: fireworks are public goods, it costs 10,000 dollars to set off fireworks. If it costs 10 dollars to see the fireworks, even people who don’t pay will be able to see them and the cost of production won’t be covered. Leaving both consumers and producers worse off. Market fails

Solution: government using tax revenue to purchase public goods

How much pollution should there be? Optimal Level

* Cleaning the environment has benefits and costs
* You should clean if MB>=MC when cleaning
* You shouldn’t clean if MC

* Optimal level of pollution to clean up
* Want it to be clean “enough”
* MB diminishes and MC raises the more pollution you clean
* Optimal level of pollution to clean up is at equilibrium
* Different people have different ideas of how clean something should be
* True benefits and costs of cleaning pollution are hard to know

Market Failures

*  When markets don’t produce the efficient and optimal outcome
* Result of poorly defined property rights