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What is Economics?
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The science of making decisions in the presence of scarce resources
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Trade-offs
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Scarcity is ever-present and therefore everything has alternative uses
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What is a Free Good?
What is a Economic Good?
What is a Economic Good?
answer
- Free Good: "No such as a free lunch"
- Economic Good: Scarce --> must be allocated/economical
- Economic Good: Scarce --> must be allocated/economical
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Broken Window Fallacy
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When there is a disaster (for example braking a window), it creates more jobs and wealth and spreads the money around (not the case).
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Incentives
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- People act "humanly" rationally
- 2 common mistakes
1. doesn't have enough info
2. lack of proper incentives
- 2 common mistakes
1. doesn't have enough info
2. lack of proper incentives
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Find the Problem (3 questions)
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1. Who made the wrong decision?
2. Was this due to lack of info?
3. Was it in the decision-maker's best interest to make that decision?
2. Was this due to lack of info?
3. Was it in the decision-maker's best interest to make that decision?
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Fixing the Problem (3 anwsers)
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1. Letting someone else (someone w/ incentives) make the decision
2. Giving more info to decision maker
3. Changing the incentives of the decision maker
2. Giving more info to decision maker
3. Changing the incentives of the decision maker
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Opportunity Cost
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> Obtaining something is the value on whatever be sacrificed to obtain it.
> What you value - The actual value = Net Benefit/Cost
> What you value - The actual value = Net Benefit/Cost
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Difference between Technical Efficiency and Economic Efficiency
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-Technical: focuses on objective data & not on the values that consumers (buyers and sellers) place on the inputs and outputs
-Economic: compares the additional benefits against the additional costs from the chooser's perspective
(when you ask, "is it worth it?" You ask about economic efficiency)
-Economic: compares the additional benefits against the additional costs from the chooser's perspective
(when you ask, "is it worth it?" You ask about economic efficiency)
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Accounting Cost
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- Typically income statements include explicit costs only
- These include
>cost paid to suppliers
>general operating expenses such as salaries, marketing expenses, etc.
>depreciation and amortization
>interest payment on borrowed funds
- These include
>cost paid to suppliers
>general operating expenses such as salaries, marketing expenses, etc.
>depreciation and amortization
>interest payment on borrowed funds
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Economics (Opportunity) Costs
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- All accounting cost + implicit cost not listed on balance sheet
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Profit Measurement: Business (accounting) π
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= [Sales Revenue - Explicit Cost]
- Explicit Cost include labor costs, RM, equip., electricity, semi-finished goods, interest payments, etc.
- Explicit Cost include labor costs, RM, equip., electricity, semi-finished goods, interest payments, etc.
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Profit Measurement: Economic π
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= [Sales Rev. - Opportunity Cost]
- business profits minus implicit costs of equality capital and other owner-provided inputs
- business profits minus implicit costs of equality capital and other owner-provided inputs
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The Fixed (Sunk) Cost Fallacy
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You consider costs that do not vary as a consequence of your decision
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The Hidden Cost Fallacy
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You ignore relevant costs that do not vary with the consequences of your decision
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Rules for the "Economic Game"
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- In a free market economy, these property rights can be exchanged or traded for similar rights to other goods and services
- Knowing w/ certainty who legally owns/controls what
- Knowing the 3P's and 3I's
- Knowing w/ certainty who legally owns/controls what
- Knowing the 3P's and 3I's
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3P's and 3I's
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3P's
1. Price System
2. Profit and Loss Mechanism
3. Private Property Rights
3I's
1. Information
2. Incentives
3. Innovation
1. Price System
2. Profit and Loss Mechanism
3. Private Property Rights
3I's
1. Information
2. Incentives
3. Innovation
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Average Cost
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= Total Cost (fixed + variable) / total units produced
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Marginal Cost
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= ∆TC / ∆Q
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Break Even Analysis
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QBE = TFC / (P-AVC)
- Managers also use it to evaluate their investment alternatives
- Managers also use it to evaluate their investment alternatives
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Degree of Operating Leverage (DOL)
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- DOL is the elasticity of profit with respect to output sold
-DOL measures the sensitivity of profits to changes in salves volume
= [Q (P - AVC)] / [Q (P -AVC) - TFC]
-DOL measures the sensitivity of profits to changes in salves volume
= [Q (P - AVC)] / [Q (P -AVC) - TFC]
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Law of Demand
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as the price of products falls, the quantity of the product demanded increases
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Marginal Analysis and Pricing
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- Reduce price to sell more if MR > MC
- Increase price to sell less if MR < MC
- Increase price to sell less if MR < MC
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Cross-Price Elasticity
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Responsiveness of demand to changes in the price of a related product.
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Substitutes and Complements (Cross-Price Elasticity)
answer
-If the cross-price elasticity is <0: COMPLEMENTS
-If the the cross-price elasticity is >0: SUBSTITUTES
-If the the cross-price elasticity is >0: SUBSTITUTES
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Income Elasticity
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Measures the change in demand arising from changes in income.
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Normal vs. Inferior Goods (Income Elasticity)
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-If income elasticity >0: NORMAL GOOD
>Non-cyclical: 0 < Ɛ < 1 (necessities)
>Cyclical: Ɛ > 1 (luxury)
-If income elasticity <0: INFERIOR GOOD
>Non-cyclical: 0 < Ɛ < 1 (necessities)
>Cyclical: Ɛ > 1 (luxury)
-If income elasticity <0: INFERIOR GOOD
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What is Contribution Margin?
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The contribution of each unit sold towards covering the fixed costs
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