Notes
MARKETS
Market
A group of economic agents that trade goods and services and their rules for trading
This chapter explains how markets allocate prices to goods and services
Market price
All sellers and buyers face the same price
Perfectly competitive markets
Sellers sell an identical good or service
An individual agent (buyer/seller) cannot influence market price
Buyers and sellers are price takers
BUYER BEHAVIOR
Demand
Quantity demanded
The amount that buyers or sellers are willing to buy at a certain price
Demand schedule
A table of the quantity demanded at various prices
Demand curve
Graph relationship between prices and quantity demanded
Does not have to be a straight line
Law of demand
Price and quantity are negatively related
The quantity demanded rises when price falls
All this is assuming that all else is held equal or constant, or that other factors are not changing (which we know they are in reality but simplify it for models)
Excess demand
Consumers want more than suppliers can provide
Excess supply
Suppliers provide more than consumer want at a given price
Willingness to pay
The highest price that a buyer is willing to pay is also known as the reserve price
Diminishing marginal benefit states that your willingness to pay decreases for each additional unit as you consume more of a good
Individual to Aggregate
Can be aggregated individually or for an entire market
Price stays fixed while you add quantities demanded
Shifting demand
Demand shifts due to changes in
Tastes and preferences
Movement of curve vs movement along curve
Movement of curve indicates change in quantity demanded
Movement along curve indicates change in price
Income and wealth
Availability and prices of related goods
Number and scale of buyers
Buyer beliefs about the future
SELLER BEHAVIOR
How do sellers behave
Willingness to accept
The lowest price that a seller is willing to get paid to sell an extra unit of a good
Market supply curve
Plots the relationship between total quantity supplied and market price
Sum of individual supply curves of firms
Shifts
Prices of inputs used to produce a good
Technology used to produce a good or service
Number and scale of sellers
Sellers beliefs about the future
Quantity supplied changes at a given price
Changes in price of the good itself causes movement along the curve
EQUILIBRIUM
Where supply and demand curves cross
Quantity demanded is equal to the quantity supplied
Excess supply results in a surplus
Excess demand results in a shortage
Sometimes both curves shift at the same time
There are many possible combinations of shifts
Price caps tend to result in shortages
Practice Questions
What is meant by holding all else equal? How is this concept used when discussing movements along the demand curve? How is this concept used when discussing movements along the supply curve? It means that nothing else changes the market in any way. There are no new products or policies that may affect consumers decisions about what they want to buy or can afford. For suppliers, this means that nothing affects their production process. |
What is meant by diminishing marginal benefits? Are you likely to experience diminishing marginal benefits for goods that you like a lot? Are there exceptions to the general rule of diminishing marginal benefits? (Hint: Think about a flashlight that requires two batteries.) Explain your answer. It means when you get less utils out of buying something after a certain amount of times. There may be very limited exceptions but I would assume one gets tired of everything eventually. Only things that give general utility like the batteries might be an exception. |
How is the market demand schedule derived from individual demand schedules? How does the market demand curve differ from an individual demand curve? |
Explain how the following factors will shift the demand curve for Gillette shaving cream.
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What does it mean to say that we are running out of “cheap oil”? What does this imply for the future supply curve for oil? What does this imply for the price of oil in the future? Oil is becoming more scarce as we use more of it since we use more of it than can be replaced fast enough. This means the future supply curve will shift left, which will increase the price of oil in the future. |
What does the Law of Supply state? What is the key feature of a typical supply curve? It states that quantity supplied and price are positively related |
What is the difference between willingness to accept and willingness to pay? For a trade to take place, does the willingness to accept have to be lower, higher, or equal to the willingness to pay? Willingness to pay is for demand/consumers while willingness to accept is for suppliers/firms. For a trade to take place, the willingness to accept must be equal to or lower than the willingness to pay. |
Explain how the following factors will shift the supply curve for beer, which is made from hops.
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MACROECONOMIC QUESTIONS
Macroeconomic analysis uses past patterns to try to predict future changes in aggregate economic activity
Income per capita
Average income per person
Government policies can augment patterns of economic growth
Unemployment
Unemployed
He or she does not have a job, is actively available for work, and has looked for work in the past 4 weeks
The unemployment rate fluctuates from month to month and quarter to quarter
National income accounts
Measure the level of aggregate economic activity in a country
National income and product accounts
The system of national income accounts used by the US government
NATIONAL INCOME ACCOUNTS
Production = expenditure = income
This is an identity
The variables are related so that they are mathematically identical
Gross domestic product
The market value of final goods and services produced in a country within a given time
Components to make a final product are not counted separately
Goods in inventory are part of this measurement
Expenditure
Tot total amount of money spent on goods and services produced within an economy during a specific time period
Represents payments for goods and services
Circular Flows
Factors of production
Inputs to the production process; primarily capital (phiscal goods) and labor
Firms demand labor and capital. Households supply this labor and capital
Firms supply services and products that households demand.
Does not account for factors such as international trade patterns
Income
Represents the payments made from firms to households for their labor and capital
Production based accounts measure the firms value added
Value added
Firms sales revenue minus the firms purchases of intermediate goods from other firms
The ability for firms to mark up prices comes from the value it addes through indirect services like reputation and convenience
Adding up the value of all firms by a country will sum its GDP
Exports
Market value of all domestically produced goods that are sold to households and firms both domestically and internationally
Imports
Total market value of all foreign goods and services that are sold to domestic markets
GDP formula
Y = c + i + g + x - m
Total expenditure of domestic economic agents, plus the expenditure of foreign agents on exports from the domestic economy, minus the value of expenditure imported
WHAT DOESN'T GDP MEASURE?
Home Production
Includes domestic work such as cleaning and childcare
Home production in the US is estimated within the $3.5-$4 trillion range
The Underground Economy
Can include illegal activities and professions
Can also include legal activities that are paid under the table
Illegal drug sales are estimated at 1 percent of total US GDP
Externalities
Both positive and negative ones are usually omitted from GDP calculations
Negative externalities can lead to positive contributions to economic output
GDP vs GNP
Gross national product includes the production of workers who normally resides in the US even though they may be working abroad
Measures all production owned by a specific country
Gross national product=(Gross domestic product) =
+(Production of U.S.-owned capital and labor in foreign countries)
−(Production of foreign-owned capital and labor in the United States)
For some countries GNP and GDP vary widely
Increase in Income Inequality
GDP does not measure how economic output is divided up among individual households
Two countries can have similar GDP but differing levels of wealth inequality
High levels of inequality can create political unrest
Leisure
Does Not include whether all this is being done to optimize happiness/quality of life
REAL VS NOMINAL
Real
Uses prices from a base year that may be different from the year the quantities were produced
More talked about in the news/daily life
Includes things households didnt purchase
Nominal
Market value of production using current prices to determine value per unit produced
The Consumer Price Index
100 times the ratio of the consumer basket fog goods
Studies a particular basket of consumer goods
Includes things that households purchase but are not counted in GDP
Has more relevance for the personal consumer
Inflation
Inflation rate is the rate of increases in prices
Calculated as year over year percentage change in pricing index
Adjusting Nominal Variables
Helps when making meaningful comparisons across time
For example, how much money is worth changes over time so buying power needs to be taken into account
Objective:
Convert income per person in different countries to a single currency to allow for comparison
Answer the question if the average person in the US is wealthier than China
INEQUALITY AROUND THE WORLD
Income per capita = gdp per capita = (gdp / total population)
This number results in average income per person
Exchange rate based measure
GDP’s can be converted into a single currency to be compared across countries
Prices of goods can vary across countries
Purchasing power parity measure
The purchasing power parity (PPP) constructs the cost of a representative basket of commodities in each country and uses these relative costs for comparing income across countries.
Takes into account the relative changes in price of goods and services between countries
Think of the big mac index, comparing the prices of big macs across the world
Gdp per capita varies across countries
GDP per worker
Gdp / number of people in employment
Tends to be higher than GDP per capita because not everyone is in the workforce
Productivity
Value of goods and services generated per hour of work
Labor may be more productive in some countries than others
All this data doesnt take into account other factors of living standards like education, healthcare, public safety, etc
One dollar a day per person poverty line
Poverty often brings poor health
HDI, or human development index, tries to provide a more holistic measure of the standard of living
PRODUCTIVITY AND THE AGGREGATE PRODUCTION FUNCTION
Human capital
Each persons stock of skills to produce output/economic value
Physical capital
machines/buildings used for production
typically expressed in a dollar value
Physical capital stock is the aggregate measure in the economy
The larger the capital stock the more productive each worker can be
Technology
devices/practices that determine efficiency of production
Aggregate production function
Used to understand how GDP is determined
Explains why productivity varies across countries
Factors of production include land, capital, and technology
H = L * h
Labor = H
Capital/land = K
Technology = A
Y = (A)(F(K, H))
Gdp is equal to the index of technology times the function of physical capital and labor
Law of diminishing marginal product
Marginal contribution of a factor of production to GDP diminishes when we increase the quantity used of that factor of production
The contribution of the factor of production to GDP gets smaller as you use more of it in the overall gdp
THE ROLE THAT DETERMINANTS OF TECHNOLOGY
When technology improves, it shifts the production curve outwards as there is more production possibilities
Components of technology
Knowledge
Efficiency
Research and development
Research directed at finding new ways of using or applying technology and commercializing it into existing knowledge and products
Efficiency of production
A society can produce a maximal amount of output at a given cost to current knowledge and factors of production levels
Greater values for A correspond with better technology, which increases gdp
Entrepreneurship can be considered another factor of production
Failure decreases economic efficiency
THE POWER OF ECONOMIC GROWTH
As a result of the continued economic growth depicted in Exhibit 7.1, US real GDP per capita and standards of living are much higher today than they were in 1820
Growth rate
Change in quantity (real GDP per capita) between two dates, relative to the baseline (beginning of the period) quantity
Formula
Economic growth = (gdp2-gdp1) / gdp1
Economic fluctuations may also be visible in a GDP over time graph
Exponential growth
The process by which a quantity grows at an approximately constant growth rate
Exponential nature of growth explains GDP differences across countries
A one percent difference in growth rates result in a more than seven fold difference due to rules of exponential growth
Occurs because new growth builds on past growth and its affects compound
Growth patterns
GDP per capita has increased significantly in countries like the US, UK, and France since 1960 keeping growth rates relatively steady around 2 percent
Things like wars and political instability can cause slowdowns or negative growth
The growth of gdp across the glob remains normally distributed with most growth occurring between the 2-3% rate
Patterns can be tracked using historical data and analysis
Catch up growth
Nations are catching up with the technology and income of world leaders like the United States
Technology can be a main factor in this catch up growth
Sustained growth
Steady growth over long periods of time
HOW DOES AN ECONOMY GROW
Aggregate factors of production can affect economic growth
An increase in capital
Improvement in technology
increasing the human capital of workers
Gdp is divided between consumption and investment
All resources that households save will be allocated to firms that use them for investment
High savings can increase gdp
Optimization occurs here when individuals and households choose what to do with their resources
Different households do different things based on their needs
Saving rate
Designates the fraction of income that is saved
Saving rate = total saving / gdp (given as a decimal/percentage)
Sustained growth is obtained by combining increases in physical capital and human capital with technology
Technological change
Process of new technologies and new goods and services being invented and used in the economy
Enables higher level of gdp for given factors of production
Also follows an exponential pattern
Built from past technological innovations
HISTORY OF GROWTH & TECHNOLOGY
Period before 1800 lacks sustained growth
Lack of technology
However some economics like those of larger societies (greece, rome, venice when it became a trading port)
However, this is also hard to prove due to limited data from these times
The industrial revolution created the technological progress necessary for sustained growth
People moved from farm work and agriculture to work in the cities
Manufacturing led to a drop in fertility rates
Recently, there have been dramatic changes in computers, transportation, communications, and electricity that has also helped to create sustained growth
Malthusian limits to growth
Fertility adjusts so that income always remains close to a subsistence level
Increased aggregate income would raise real GDP per capita down toward or below the subsistence level, fueling population growth
That growth puts strain on resources and reduces GDP back to its initial level
Modern growth
is enabled by transition to cities, as reliance on child labor went down
Also helped by increased research and development activity to improve our collective knowledge base
GROWTH, INEQUALITY, AND POVERTY
The relationship between GDP per capita and poverty is negative
Increases in GDP per capita result in lower rates of poverty
The fact an economy is growing does not necessarily imply that all citizens are benefiting from that growth
Ways of reducing poverty
International trade
Improving overall technology and knowledge
While many policies have worked, they have had downsides or some have not worked at all
Advancements in technology has made it easier for poorer people to access more and more services they may not have before