Economics II

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Supply and Demand model

model how a competitive market behaves

Price elasticity of Demand

the more responsive quantity demanded is to a change in price, the more elastic the demand curve is.

Application of Elasticity demand

price of elasticity of demand = % change in # demanded divided % change in the price

Positive Economics

Description! economics analysis that describes the way the economy actually works

Normative economics

Prescriptions! about the way the economy should work

Disagreements with Economists

Ties to politics, Diverse people and Diverse values, Economic modeling requires simplifying assumptions

Production Possibilities Frontier

a diagram that shows the combinations of two goods that are possible for a society to produce at full employment.

Opportunity cost

what must be given up in order to get a good

Theory of Comparative Advantage

producing things that countries are better at producing and trading with other countries.

Comparative advantage

a country can produce a good/service at a lower cost than another country.

Absolute advantage.

Perfect competition

all buyers and sellers are price takers

Competitive market

has many buyers and seller of the same good or service, none of which can influence the price.

demand curve

shows the quantity demanded at various prices

Normal good

Demand increases when income increases

inferior good

Demand decreases when income increases

Supply curve

quantity supplied at various prices

Equilibrium Price

Where the supply line meets the demand line.

inelastic

price increase that reduces the quantity demanded just a little.

The elasticity rule!

Elasticity does not equal the slope.

the midpoint method

%change in X = (change in X divided by the average value of X) x100

Price Elasticity is = < 1

inelastic

Price Elasticity > 1

elastic

Price Elasticity is = 1

unit elastic

A total price increase effect!!

a Higher price for each unit sold, and fewer units will be sold.

If there are many substitutes, and switching brands is easy?

Demand is elastic

Cross-price elasticity of demand

(Measures how sensitive the quantity demanded of good A is to the Price of good B)

%change in quantity of A demanded / divided by % change in price of B

Substitutes

positive cross-price elasticity.

complements

negative cross-price elasticity.

Income elasticity of Demand

measures how sensitive the quantity demanded of a good is to changes in income.

Price elasticity of supply

% change in quantity supplied / divided by % change in price.

Price controls

legal restrictions on how high or low a market price may go.

Price ceiling

maximum price sellers are allowed to charge for a good or service.

Price Floor

a minimum price buyers are required to pay for a good or service.

Why governments control prices

Not done to please buyers or sellers: Price ceilings or floors can benefit dome people, and buyers may not have a realistic idea of what would happen without price controls.

Inefficiency of Price Floors

Deadweight loss, inefficient allocation of sales, wasted resources, temptation to break the law.

Inefficiency of price ceilings

inefficiently low quantity, inefficient allocation to customers, wasted resources, Black markets

Consumer surplus

the difference between market price and what consumers would be willing to pay.

Total consumer surplus

the sum of individual consumer surpluses (the area above the price)

Producer surplus

the difference between market price and the price at which firms are willing to supply the product

Individual producer surplus

total producer surplus

the sum of the individual producer surpluses of all the sellers of a good in a marke

Producer surplus rises if…

the price increases

Total surplus

the sum of the producer and consumer surpluses

The efficiency of markets

needs a total surplus is maximized with markets

Changing the quantity…

lowers the total surplus

Inefficiency in Markets

opportunities are missed. some people are made better off without making others worse off.

the incidence of a tax

is a measure of who really pays a tax.

Excise tax is paid mainly by consumers…

when the price elasticity of demand is low, and the price elasticity of supply is high,

Excise tax is paid mainly by producers

the price elasticity of demand is high and the price elasticity of supply is low

The effects of a Tax

generates revenue and creates a deadweight loss.

Welfare economics

Demand curve- value to consumers

Supply curve- cost to suppliers

Equilibrium quantity and price- efficient, and maximizes the sum of producer and consumer surplus

Negative externalities

Markets produce a larger quantity than socially desirable

Governments: tax

Positive externalities

Markets produce a smaller quantity than socially desirable

Government: subsidy

Coase Theorem

if private parties can bargain without cost over the allocation of resources → they can solve the problem of externalities on their own.

Private goods

excludable and rival in consumption

Public goods and common resources

not excludable and not rival in consumption

common resources

rival in consumption and not excludable

club goods

excludable and not rival in consumption

Free rider

person who receives the benefit of a good but avoids paying for it.

the tragedy of the commons

why common resources are used more than desired, social and private incentives differ, and arises because of a negative externality.

total revenue

quantity of output produced x the price it sells

total cost

the market value of the input a firm uses in production

Firms costs of production

include all the opportunity costs of making its output of goods and services

Perfectly Competitive Market

Market with many buyers and sellers,

trading identical products

each buyer and seller is a price taker

firms can freely enter or exit the market

Profit Maximization

produce quantity where total revenue minus total cost is greatest

compare marginal revenue with marginal cost

If Marginal revenue is > than Marginal costs

Increase production

If Marginal revenue < Marginal cost

decrease production

Marginal cost Shutdown:

short-run decision to not produce anything, firm still has to pay fixed costs.

Marginal cost for Exit

long-run decision to leave the market,

Firm doesn’t have to pay any costs

Sunk costs

cost that has already been committed and cannot be recovered, in the short run all fixed costs are sunk costs.

Short-run market supply

the number of firms in the market is fixed, and as a result the market supply curve reflects the sum of individual firms marginal cost.

long run market supply

firms will enter or exit the market until profit is driven to zero, as a result the price equals the minimum of average total cost. the market supply curve is horizontal!

monopoly

firm that is the sole seller of a product without close substitutes

price maker

causes barriers to entry

Barriers to entry into a market

monopoly resources

government regulation

the production process- natural monopoly

monopoly’s marginal revenue

revenue per each additional unit of output.

Monopoly profit maximization

choosing the quantity at which marginal revenue equals marginal cost, and the demand curve to find the price that will induce consumers to buy that quantity.

Inefficiency of Monopoly

because it charges above the marginal cost, not all consumers who value the good at more than its marginal cost. there is a significant deadweight lost.

Price discrimination

selling the same good at different prices to different customers

rational strategy to increase profit

requires the ability to separate customers according to their willingness to pay.

can raise total economic welfare.

Perfect Price Discrimination

charge each customer a different price

monopoly firm gets the entire surplus, no deadweight loss