Macroeconomics

Econ3 midterm UCR

Economics

The study of how humans make decisions in the face of scarcity.

Scarcity

Human wants are unlimited, but human resources are limited.

Resources (land, labor, tools, raw materials, etc.) are necessary to produce the goods/services that we want, but exist in limited supply.

Adam Smith

The father of economics

Division of labor

The way a good/service and its production is divided into a number os tasks that different workers perform.

Why the division of labor increases production?

Reason 1: Specialization, which allows workers to focus on the parts of the production they have an advantage in. Ex: Talents/skills, education/knowledge

Reason 2: Workers who specialize in certain tasks often learn to produce more quickly and with higher quality. Which leads to suggesting new innovations t produce faster/better.

Reason 3: Specialization allows firms to take advantage of economies of scale.

Economies of scale

As the level of production increases, the average cost of producing each individual unit declines

Trade and market

Specialization only works if there is a market that allows the trade of the goods produced in specialization. The market allows you to specialize and use the pay to buy other goods/services from others.

Macro

Looks at the econ as a whole, focusing on broad issues, ex: growth of production, Number of unemployed people, inflation, etc.

Micro

Focuses on the actions of individual agents within the economy, such as: Households, workers, and business firms.

Traditional economy

Organize their economic affairs according to tradition and custom.

Occupation stays within family, what you produce is what you consume, little econ progress, rigid hierarchies

Command economy

Devotes its economic affairs to the goals of the state.

Government decides what g & s will be produced, sets prices for g & s, and wages for workers. Government allocates capital and decides what production methods to use. Government usually owns the means of production

Market

Institution that brings together buyers and sellers.

Decision making is decentralized and based on private enterprise: Private individuals own and operate the means of production. Firms supply g & s based on demand. Workers supply labor based on demand. Incomes are based on an individual’s ability to convert resources into something that others are willing to pay for.

Circular Flow Diagram

Budget Constrain

All possible consumption combinations of g & s that someone can afford, given the prices of goods, when all income is spent, the boundary of the opportunity set. Every point on or inside of the budget constraint.

B= P1*Q1+P2*Q2

Straight line, the slope is given by the relative prices of the two goods, these prices are fixed from the perspective of an individual consumer, thus slope is constant

Opportunity cost

Measures cost by what we give up in exchange the value of the next best alternative

Marginal decision-making

Examining decision on teh margin that is, examining the benefits and cost of choosing a little more or a little less of good. How cost and benefits change from one option to another.

Utility

Satisfaction, usefulness, or value one obtains from consuming a good or service (subjective).

Diminishing marginal Utility

Economists typically assume that the more of a good one consumes, the more utility one obtains.

The utility one receives from the first unit of good is generally more than that form the fifth unit or the ninth unit.

Law of diminishing marginal utility

As we consume more of a good or service, the utility we get from additional units of the good or service tends to become smaller than what we receive from earlier units.

explains why people rarely make all-or-nothing choices.

Sunk Cost

Costs that were incurred in the past and cannot be recovered

Production Possibility Frontier (PPF)

A diagram that shows the productively efficient combinations of products that an economy can produce given the resources it has available

Bowed outward shape (concave to origin). Every point on or inside the PPF shows the combination of production that someone can produce. Its slope shows opportunity cost.

Law of increasing opportunity cost

As production of a good or service increases, the marginal opportunity cost of producing it increases as well.

This happens because some resources are better suited fro producing certain goods and services instead of others.

Productive Efficiency

Given the inputs and technology, it is impossible to produce more of one good without decreasing the quantity that is produced of another good.

Points on the PPF are productively efficient: you can produce more of one good without giving up any of the other good.

Allocative Efficiency:

The particular combination of the g & s on the PPF curve that society most desires.

(Only one of the productively efficient choices will be the allocatively efficient choice as a whole).

Comparative Advantage

When a country can produce a good at a lower opportunity cost than another country, that is, produce a good at a lower cost in terms of the other goods than another country.

Countries specialize in the production of goods in which they have a comparative advantage and trade part of that production for goods in which they do not have a comparative advantage.

Positive Statement

A statement that describes the world as it is.

Can be proven true or false by empirical/scientific methods.

Normative Statement

A statement that describes the world as it should be.

Contains a value judgment; therefore cannot be proven true or false by empirical/scientific methods.

Should, must, ought to, have to, Important, special, best worst.

Ceteris paribus

All else being equal

The Law of Demand

There is an inverse relationship between the price of a good and the quantity of the good that consumers are willing to buy.

A demand schedule is a table showing the various quantities of a certain good or service that consumers are willing to buy at different possible prices.

A demand Curve is a graphic representation of the relationship between price and quantity demanded of a certain good or service.

Demand vs. Quantity Demanded

A change in quantity demanded: a movement between points along a stationary demand curve.

A change in demand is an increase (rightward shift) or decrease (leftward shift) in the quantity demanded at each possible price, requires a change in nonprice determinant.

Nonprice Determinants of Demand

Number of buyers: Increase in the # of Buyers (rightward shift) in demand curve (increase in demand). Decrease in the # of buyers (leftward shift) in demand curve (decrease).

Taste & preferences: Favorable change in consumers’ taste/preference (rightward shift) in demand curve. Unfavorable change in consumers’ taste/preference (leftward shift) in demand curve.

Income:

A normal good is any good for which there is a direct relationship between changes in income and its demand curve. Buyers receive a higher income (rightward shift) in demand curve. Buyers receive lower incomes (leftward shift) in demand curve.

An Inferior good for which there is an inverse relationship between changes in income and its demand curve. Buyers receive higher income leftward shift in demand curve. Buyers receive lower incomes rightward shift demand curve.

Expectations: Expectations that price of the good will be higher in the future (rightward shift) in demand curve. Expectations that the price of the good will be lower in the future (leftward shift) in demand curve.

Prices of related goods:

A substitute good: is a good that competes with another good for consumer purchases. thus a direct relationship between price change for one good and demand for another. Price for substitute good increases (rightward shift) an increase in demand for the other good. price. For substitute decrease (leftward shift) a decrease in demand for other good.

A complement: is a good that is jointly consumed with another good. Thus there is an inverse relationship between a price change for one good and demand for the other good. If price of complementary good increases (leftward shift) a decrease in demand for the other good. If price of complementary good decreases (rightward shift) an increase in demand for the other good.

The law of supply

Direct relationship between the price of a good and the quantity of the good that producers are wiling to sell.

A supply schedule: a schedule is a table showing the various quantities of a certain good or service that producers are willing to sell at different possible prices.

A supply curve is a graphic representation of the relationship between price and quantity supplied of a certain good or service.

Supply VS Quantity Supplied

A change in quantity supplied is a movement between points along a stationary supply curve.

A change in supply is an increase (rightward shift) or decrease (leftward shift) in the quantity supplied at each possible price requires a change in non price determinant.

Nonprice Determinants of Supply

Number of sellers in the market: Increase in the number of sellers (rightward shift) increase in supply. Decrease in the number of sellers (leftward shift) decrease in supply.

Technology: New and more efficient technology decrease production cost (rightward shift) an increase in supply. Destruction of technology increase production cost (leftward shift) decrease in supply.

Climate and weather: Favorable change in climate and weather (rightward shift) an increase in supply. Unfavorable change in climate and weather (leftward shift) decrease in supply.

Input prices: Decrease in the price of inputs used to make product (rightward shift) an increase in supply. Increase in the price of inputs used to make product (leftward Shift) a decrease in supply.

Taxes: Decrease in taxes on production or sale of product (rightward shift) an increase in supply. Increase in taxes on production or sale of product (leftward shift) a decrease in supply.

Subsidies: Decrease in subsidies for production or sale of production (leftward shift) a decrease in supply. An increase in production or sale of product (rightward shit) an increase in supply.

Expectations of producers: Expectations that price of the good will be lower in the future (rightward shift) an increase in supply. Expectations that price of the good will be higher in the future (leftward shift) a decrease in supply.

Market supply and demand analysis

Market: is any arrangement in which buyers and sellers interact to determine the price and quantity of goods and services exchanged.

A shortage in market condition existing at any price where the quantity supplied is less then the quantity demanded (excess supply)

A surplus is a market condition existing at any price where the quantity supplied is greater then the quantity demanded (excess supply).

Equilibrium

Is a market condition that occurs at any price and quantity at which the quantity demanded and the quantity supplied are equal.

Price: The price at which quantity demanded is equal to quantity.

Quantity: The quantity at which demanded is equal to a quantity supplied for a certain price.

Price controls

Laws that governments enact to regulate prices

Price ceiling

A legal maximum price. Transactions at a price above the price ceiling are illegal.

Price floor

A legal minimum price. Transactions at a price below the price floor are illegal.

Consumer Surplus

The extra benefit consumers receive from buying a good or service, measure by what the individuals would have been willing to pay minus the amount that they actually paid.

Producers surplus

The extra benefit producers receive from selling a good or service, measured by the price the producer actually received minus the price the producer would have been willing to accept.

Social Surplus

Also called econ surplus or total surplus =. The sum of consumer surplus and producer surplus.

Efficiency

Social surplus is larger at equilibrium price and quantity than at any other price or quantity; it demostrates the economic efficiency of the market equilibrium.

Inefficiency

Deadweight loss: the loss in social surplus when a market produces an inefficient quantity.

Removing price ceilings and floors will increase social surplus.

Mid point method

% Change in quantity= (q2 - q1) / ((q2 + q1)/2) *100

% Change in price = (p2-p1) / ((p2+p1)/2) * 100

Price elasticity

The ratio of percentage change in quantity tot eh corresponding percent change in price:

Price Elasticity= %change in quantity / %change in price

Price Elasticity of Demand

The ratio of the percentage change in the quantity demanded of a good to the percentage change in price of that good.

PED=Ep= %change in quantity demanded/ %change in price always less then 0

Because price and quantity demanded move in opposite directions (law of demand) price elasticity of demand is generally a negative number.

Greater then 1 is elastic

equal to one is unitary

Less then 1 is inelastic

Price Elasticity of Supply

The ratio of the percentage change in the quantity supplied of a good to the percentage change in price of that good.

PES=Es= %change in quantity supplied/ %change in price always greater than zero.

Perfect elasticity (infinite elasticity)

Extreme case of elasticity where quantity changes by an infinite amount in response to any change in price Horizontal

Ed=-infinite

Es= infinite

Its unrealistic but good with readily available inputs and whose production can easily expand highly elastic. Ex: Pizza, bread, books, etc.

goods with many substitutes highly elastic demand curve.

items that take a large share of individuals’ income

Luxury goods

Perfectly inelasticity (zero elasticity)

Extreme case of elasticity where quantity does not change at all in response to any change in price vertical line

Ed=0

Es=0

Goods with limited supply of inputs highly inelastic

goods with few substitutes and which are necessities

Items that take a small share of individuals’ income

Addictive activities or substances

The effect of price increase on revenue

Elastic >1 total revenue decrease

Unitary=1 total revenue is unchaged

Inelastic <1 Total Revenue increases

Effect of price changes on revenue

Elastic >1 Total Revenue increases

Unitary = 1 Total Revenue is unchanged

Inelastic <1 total revenue decreases

Excise tax

A per unit tax on a particular product or limited set of products, costing a specific amount per volume or unit of the product that is purchased. Different from sales tax

Tax incidence

The manner in which a tax burden is divided between consumers and producers.

the tax burden falls mostly on the less elastic side of the market:

if demand is less elastic than supply, consumers bear most of the tax burden.

If supply is less than demanded, producers bear most of the tax burden.

By imposing an excise tax, the government creates a wedge between Pc (price paid by consumers) and Pp (price paid by producers)

Long-run VS Short-run impact

elasticities or both demanded and supply are often lower in the shorth run than in the long run

on demand: Consumption may be difficult to change in the short run, but easier in the long run.

On supply: production may be difficult to change in the short run, but easier to in the long run.

Price elasticity of supply =

% change in quantity supplied / % change in price

Income elasticity of demand =

% change in quantity demanded / % change in income

Is positive for normal goods: A rise in income will cause an increase in quantity demanded of the good. +/+ -/-

Is negative for inferior goods: A rise in income will cause a decrease in quantity demanded of the good. +/- -/+

Cross-price elasticity of demand =

% change in quantity demanded of a good A / % change in price of good B

is positive for substitute goods: A rise in the price of a good will cause an increase in quantity demanded of its substitute goods

Is negative for complement goods: A rise in the price of a good will cause a decrease in quantity demanded of its complement goods.

Wage elasticity of Labor Supply (Elasticity of Labor Supply) =

%change in quantity of labor supplied / % change wage

A measure of quantity of labor supplied is hours worked

Fairly elastic in teens because of changes in hour worked.

Fairly inelastic for adult workers

Elasticity of Savings

% change in quantity of financial savings supplied / % change in interest ratio

Theory of the firm

explains how firms behave

A firm (or producer or business): Combines inputs of labor, capital, land, and raw and finished component materials to produce outputs Production is the process (or processes) a frim uses to transform inputs into outputs (the goods and services the firm wishes to sell)

Market Structure

Is a multidimensional concept that involves how competitive an industry is:

Perfect competition: many firms, identical product

Monopolistic competition: many firms, similar but not identical products

Oligopoly: few firm, identical or similar products

Monopoly: One firm, no similar products.

Profit

Total revenue (P*Q) - Total Cost

Total Cost:

Buys inputs

Produce its products (convert inputs to outputs)

sell its products

Cost

Explicit: Out of pocket costs

implicit costs: Opportunity cost of using resources that the firm already owns. For small businesses, often the resources that owner directly contributes. Also includes the depreciation of goods, materials, and equipment.

Profit

Accounting Profit: Total revenue minus explicit cost

A cash concept: the difference between dollars in and dollars out.

Business pay taxes according to accounting profit.

Economic Profit: Total Revenue minus Total Cost

Total Cost include both explicit costs and implicit costs. Determines whether or not a firm is economically successful

Economic Profit = Accounting Profit - implicit Costs