Academic Decathlon microeconomics

An Inquiry into the Nature and Causes of the Wealth of Nations (Author)

Adam Smith

An Inquiry into the Nature and Causes of the Wealth of Nations (Year and topic)

1776 - Outlined modern economic analysis

economics

study of how individuals make choices about how to allocate resources in order to satisfy virtually unlimited human wants and about how individuals interact with one another

scarcity

inescapable fact of human existence due to limited resources and insatiable human desires

trade-offs

every choice we make requires that we give something to get something else

opportunity cost

the value of the thing you give up when you make a choice (time, money, etc.)

economic models

help us to understand economic phenomena by capturing essential details and eliminating unnecessary details

positive economics (definition)

uses tools of economic analysis to describe and explain economic phenomena and then make predictions about what will happen under particular circumstances

positive economics (simple version)

cause-and-effect relationships

positive economics

objective and fact based

positive economics (gas example)

how much we EXPECT the consumption of gasoline to decrease when the price of gasoline increases

positive economics (minimum wage example)

identifies the way in which an increase in the minimum wage would affect different groups as well as provide estimates of their size

normative economics (definition)

uses tools of economic analysis to evaluate the relative merits of different situations

normative economics (simple version)

what should be opposed to what is

normative economics

subjective and value based (opinionated)

Pareto efficiency

Vilfredo Pareto (Italian) - no way to improve at least one persons well being without reducing the well-being of someone ele

microeconomics (definition)

concentrates on individual behavior and the operation of specific markets

macroeconomics (definition)

concentrates on the overall performance of the national economy

market

comprised of all the buyers and sellers of a particular good or service

highly organized market examples

New York Stock Exchange and the Chicago Mercantile Exchange

Rules for a perfectly competitive market

1. good or service is highly standardized (similar)

2. number of buyers and sellers is large

3. all participants are well informed about the market price

4. firms are price takers (they can't control market price)

nearly competitive market example

gasoline

law of demand

negative relationship

shifts in the demand curve

1. income

2. prices of related goods

3. tastes [benefits of consumption (environmental impact)]

4. expectations (predictions for the future)

5. number of buyers

normal goods

demand is positively related to income (when income rises, the quantity demanded rises)

normal goods (example)

expensive clothes

inferior goods

demand is negatively related to income (when income rises, the quantity demanded falls)

inferior goods (example)

bus rides

substitutes

decline in the price of one good causes a reduction in the quantity demanded of another

substitute (example)

decline in price of airline tickets=decline in demand for driving (gasoline)

complements

lower price for one good causes the demand for another good to increase

complement (example)

lower auto insurance price=more cars bough (they have more money)

law of supply

positive relationship

shifts in the supply curve

1. input prices

2. technology

3. expectations (predictions)

4. number of sellers

competitive markets

tend to gravitate toward the equilibrium quantity and price

consumer surplus

the value between the market price and the amount that consumers are willing to play (has to be more than market price)

producer surplus

if the market price is greater than the opportunity cost, the difference is this monetary measure (market price - sellers price)

marginal seller

seller who would leave the market if the price were any lower

total surplus

combination of consumer and producer surplus that provides a measure of the total benefits that market participants receive from their transactions

Bovine Growth Hormone (BGH)

increases milk production by 10-15%

price elasticity of demand (definition)

1. measures how much the quantity demanded responds to a change in price (price affects quantity)

2. reflects how responsive consumers are to changes in the price of a good

price elasticity of demand (formula)

% change in quantity demanded / % change in price

influences of the price elasticity of demand

1. substitutes (close substitutes=high elasticity because it's easy for consumers to switch products)

2. necessities (low elasticity because people need these)

3. market definition (broad market= few substitutes and low elasticity; soft drinks= low elasticity compared to specific cola brands)

4. time horizon (adjusting to prices might take time)

levels of elasticity of demand

1. perfectly inelastic (vertical line) (no slope)

2. inelastic demand (e

price elasticity of supply (definition)

reflects the ease with which suppliers can alter the quantity of production (price affects supply)

price elasticity of supply (formula)

% change in quantity supplied / % change in price

influences of the price elasticity of supply

1. ease of entry and exit (if it's easy to enter or exit a market as a seller, supply is more elastic)

2. scarce resources (if an input good is scarce, supply is inelastic)

3. time horizon (longer the time is, the greater the elasticity of supply is; firms can't hire additional workers over short periods of time)

levels of elasticity of supply

1. perfectly inelastic (vertical line) (e=0)

2. inelastic supply (e

total revenue equation

price x quantity

first example of a price ceiling

In 1979, Middle Eastern oil prices skyrocketed; the government set a max price

taxes

used to raise revenue to pay for public expenditures

deadweight loss

reduction in social welfare due to taxes (difference between the $ paid by consumers and the $ suppliers receive [tax wedge])

burden of the tax

depends on the price elasticity of supply and demand (the lower the elasticity of demand [necessities], the greater the share of the tax paid by buyers)

production possibility frontier (PPF)

trade-offs faced in production (Robinson Crusoe: coconuts and fish example)

economic "firms"

economic actors who are responsible for supplying goods and services in the economy (firms combine labor, capital equipment, raw materials, and other inputs to produce the products that we consume)

profit vs. economic profit

money made after subtracting expenses from revenue vs. money made after subtracting expenses (including opportunity cost of time) from revenue

fixed costs

opportunity cost of time, rent, equipment

variable costs

labor and materials (ingredients and staff in a restaurant)

marginal cost

increase in costs that occurs when producing an additional unit of output

marginal cost formula

increase in $ / increase in quantity produced

diminishing returns to scale

bakery example ; ovens fill up, so he can only increase his production and revenue by so much (now he has extra labor waiting for ovens, causing him to lose money)

marginal revenue

benefit that someone gets from supplying more products (Bob producing one more loaf of bread)

examples of imperfectly competitive markets

computer operating systems, commercial airplanes, automobiles, air travel, mobile phones (small number of very large firms) ; electricity, water, cable television (single supplier in community)

goal of markets

to maximize profits

imperfectly competitive markets differ from perfectly competitive markets (how)

decisions about how much to supply often do affect the price at which products are sold

market power

firms that have a downward sloping demand curve (increase supply=lower price) ; instead of taking prices as given (like gas), they choose market prices

types of imperfectly competitive markets

1. monopoly (single supplier)

2. oligopoly (few suppliers)

3. monopolistic competition (firms produce similar, but different products)

barriers to entry that cause monopolies

1. ownership of a key resource (DeBeers diamond company owns 80% of all diamond mines)

2. government created monopolies (patents for 20 years)

3. natural monopolies (single firm can supply the market at a lower cost than could two or more firms [large costs] ; railroads, pipelines, and cable television)

Sherman Anti-Trust Act (year)

1890

Sherman Anti-Trust Act

used to break up monopolies

federal government attempts to stop the negative effects of monopolies

1. increase market competition (regulations on mergers to make sure they don't reduce competition) ; AT&T split up in 1984 (government made them break up)

2. regulation (electric power companies and cable television providers can't choose prices freely [because they are natural monopolies] - they have rates approved by government

3. public ownership (local water, sewer, and sanitation services)

price descrimination

separate customers into groups depending on how highly they value the product (allows monopolies to increase profits by capturing a greater fraction of the benefits produced by each transaction)

oligopoly examples

tennis balls, breakfast cereals, aircrafts, electric light bulbs, washing machines, and cigarettes

cartel

an illegal agreement (in the U.S.) where oligopolies would work together to behave like a monopoly to try to maximize profits

Organization of Petroleum Exporting Countries (OPEC)

international, so its cartel isn't illegal ; oil raised from $11 a barrel in 1972 to $35 a barrel in 1981 (members got greedy and raised supply, so prices fell back down to $13 a barrel in 1986)

monopolistic competition

firms produce similar but differentiated products

monopolistic competition (example)

book publishing, restaurants, clothing, breakfast cereals, and service industries

entrepreneurs

individuals who take on the risk of attempting to create new products or services, establish new markets, or develop new methods of production

creative destruction

a term that describes the impact of entrepreneurs as this (Joseph Schumpeter)

market failures

circumstances in which competitive markets fail to produce socially desireable outcomes

market failures (groupings)

1. externalities

2. public goods

externality

actions of one person affect the well-being of someone else, but neither party pays nor is paid for the effects

positive externalitites

beneficial effects

positive externalities (examples)

beekeepers and apple orchard

negative externalitites

harmful effects

negative externalitites (examples)

neighbor failing to maintain his house

solutions to negative externalities

1. split the cost to fix the paper plant pollution

2. internalize the problems by combining the activities that produce the externality within a single company

Coase Theorem (Ronald Coase)

parties involved can negotiate with each other to resolve the inefficiencies caused by externalitites (private markets)

government regulation of externalitites

London tax for driving in town in 2003 (reduce congestion)

United States Environmental Protection Agency (EPA)

regulating externalities by dealing with sulfur dioxide emissions

tragedy of the commons

when a resource is owned jointly, no one takes account of the negative externalitites caused by overuse (over fishing in public pond)

rival good example

pizza (you take some, there is less for other people)

determining public and private goods

extent of excludability and extent of rivalry in consumption

private goods

high exludability and high rivalry (pizza, haircuts, gasoline)

common resources

low exludability and high rivalry (fish in ocean, environment, city streets) ; over utilized

collective goods

high excludability and low rivalry (satellite radio, websites, pay-per-view movies)

public goods

low excludability and low rivalry (radio broadcast, tornado siren, national defense)

institutions

formal and informal rules that structure human interaction

pork barrel politics

elected officials introduce projects that steer money to their communitites

logrolling

legislators will often vote in favor of other people's bills to get a vote on one of their own (accounts for wasteful government spending)