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The production Possibilities curve
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- shows the different combinations of various goods, any one the producer can turn out, given the available resources and existing technology
- max that can be produced is along the curve; beyond is unattainable
- always slopes downward and to the right
- max that can be produced is along the curve; beyond is unattainable
- always slopes downward and to the right
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Economics
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the study of the allocation of scarce resources among competing wants and needs
- the science of how people and societies make choices in the face of scarce resources and competing needs
- the science of how people and societies make choices in the face of scarce resources and competing needs
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Scarce Items
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- Money
- Time
- Land
- Skills
- Time
- Land
- Skills
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Wants\Needs
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- Food
- Clothing
- Shelter
- Clothing
- Shelter
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gross domestic product (GDP)
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the output of goods and services measured by the quantities produced and evaluated at price level
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Microeconomics
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studies the choices and scarcity problems at the individual level and market level
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Efficiency
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- there is no way one can produce larger amounts of any output without using larger input amounts or giving up some quantity of another output
- when firms or consumers operate along the production possibilities curve, they are fully using their resources, not below it
- an absence of waste; produces maximum amount of output that its technology permits
- when firms or consumers operate along the production possibilities curve, they are fully using their resources, not below it
- an absence of waste; produces maximum amount of output that its technology permits
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Comparative advantage
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specialized in a particular task over other firms
- when a good is produced less inefficiently than it produces other goods
- two people \countries\firms can gain by specializing in an activity and then trading with one another
- when a good is produced less inefficiently than it produces other goods
- two people \countries\firms can gain by specializing in an activity and then trading with one another
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Scarcity and Choice
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- choosing the best alternatives among options that are possible based on the available resources
- key problem are preferences
- given your resources, you make choices on what to buy\firms make choices on what to produce.
- limited resources force hard choices on society as a whole
- key problem are preferences
- given your resources, you make choices on what to buy\firms make choices on what to produce.
- limited resources force hard choices on society as a whole
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optimal decision
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the one selected by the consumer or firm after all comparison of the consequences and most promotes the individuals wealth or profits
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opportunity cost
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how much you give up of one good to get another good.
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the demand curve
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graphic depiction of a demand schedule that shows how the quantity demanded of some product will change as the price of that product changes during a specified period of time, holding all other determinants constant
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The Law of Demand
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states that if the price of a good rises, the quantity demanded will fall and vice versa
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The determinants of demand
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Income
- changes in income can cause shifts of the demand curve as consumers are constrained in their purchases by their income and wealth
Population
- more consumers = more demand for goods and services at every price
Consumer Preferences
- affect demand - e.g beef in India
Prices of related goods (complimentary or substitutes)
- if the price of one product goes up (e.g : Peanut butter) than the demand for the complimentary item (e.g : Jelly) will decrease
- if the price of one substitute item falls (e.g.: Pepsi), then consumers may substitute one item for the other (e.g.: Coke)
- changes in these determinants shift the demand curve
left = decrease
right = increase
- changes in income can cause shifts of the demand curve as consumers are constrained in their purchases by their income and wealth
Population
- more consumers = more demand for goods and services at every price
Consumer Preferences
- affect demand - e.g beef in India
Prices of related goods (complimentary or substitutes)
- if the price of one product goes up (e.g : Peanut butter) than the demand for the complimentary item (e.g : Jelly) will decrease
- if the price of one substitute item falls (e.g.: Pepsi), then consumers may substitute one item for the other (e.g.: Coke)
- changes in these determinants shift the demand curve
left = decrease
right = increase
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The Law of Supply
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states that if the price of a good rises, the quantity supplied also rises and vice versa
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The determinants of supply
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Price
Prices of Inputs
- in order to produce and sell a good or service, a company needs labor, capital, and raw materials
- the higher the price of these inputs the greater the cost of supplying. if the price falls than more can be produced and sold at any price
Technological Progress
- reduces the cost of many inputs over time shift the supply curve to the right
Prices of related outputs
- if the price of one product falls while the price of another stays the same, a firm may shift resources from one item to another
Number of Firms in the market
- when more firms enter the market for a good or service, the market supply will increase at every price
Prices of Inputs
- in order to produce and sell a good or service, a company needs labor, capital, and raw materials
- the higher the price of these inputs the greater the cost of supplying. if the price falls than more can be produced and sold at any price
Technological Progress
- reduces the cost of many inputs over time shift the supply curve to the right
Prices of related outputs
- if the price of one product falls while the price of another stays the same, a firm may shift resources from one item to another
Number of Firms in the market
- when more firms enter the market for a good or service, the market supply will increase at every price
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Equilibrium
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where the quantity demanded and the quantity supplied intersect and are equal.
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Excess demand (shortage)
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less is consumed than what is demanded
- will cause prices to increase
- will cause prices to increase
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excess supply (surplus)
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more is consumed than what is demanded
- will cause prices to decrease
- will cause prices to decrease
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Price ceilings
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an artificial limit on the upper price for a good
- create inefficiency such as misallocation of resources and coruption
- create inefficiency such as misallocation of resources and coruption
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price floors
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an artificial limit on the lower price of a good
- create inefficiency such as misallocation of resources and coruption
- create inefficiency such as misallocation of resources and coruption
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Marginal utility
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- maximum amount a consumer is willing to pay for one more unit of a good
consumers will buy goods and services that maximize their satisfaction
- as more units are consumed the total level of satisfaction will increase
- when a consumer is satisfied then consuming more will yield no additional satisfaction
MU = Price
consumers will buy goods and services that maximize their satisfaction
- as more units are consumed the total level of satisfaction will increase
- when a consumer is satisfied then consuming more will yield no additional satisfaction
MU = Price
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Law of Diminishing Marginal Utility
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as we consume more, the additional level of satisfaction declines
the more of a commodity that you posses the less utility you have from acquiring more
the more of a commodity that you posses the less utility you have from acquiring more
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Consumer Surplus
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the difference between what consumers pay and are willing to pay
= total utility - total expenditures
= total utility - total expenditures
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Market Demand
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the aggregation of individual quantities demanded at each price
- shows how the total quantity of some product demanded by all consumers in the market changes as the price of that product changes, holding all other determinants constant
- shows how the total quantity of some product demanded by all consumers in the market changes as the price of that product changes, holding all other determinants constant
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Price Elasticity of Demand
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the shape of the demand curve reflects the sensitivity of quantity demanded to changes in price
- greater sensitivity to prices changes = higher price elasticity
- calculated as the percent change in quantity demanded divided by the percent change in price
- always calculated in absolute value
- greater sensitivity to prices changes = higher price elasticity
- calculated as the percent change in quantity demanded divided by the percent change in price
- always calculated in absolute value
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price elasticity impacts on revenues
answer
if E < 1 then an increase in price will result in an increase in revenue
if E > 1 then and increase in price will result in a decrease in revenue
if E = 1 (unit elastic) then an increase in price will have no effect on revenues
if E > 1 then and increase in price will result in a decrease in revenue
if E = 1 (unit elastic) then an increase in price will have no effect on revenues
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The different types of demand curves (horizontal, vertical, etc.)
answer
Horizontal = infinite \ perfectly elastic
price change leads to a larger percentage change in quantity demanded
Vertical = 0 \ perfectly inelastic . the quantity does not change therefore any decline in price will result in no change in quantity demanded
straight line = less than lower prices than higher prices \straight line elastic. the lower the initial price the lower the price elasticity of demand and vice versa
unit elastic = 1 at all price levels
price change leads to the same percentage of change in quantity demanded
price change leads to a larger percentage change in quantity demanded
Vertical = 0 \ perfectly inelastic . the quantity does not change therefore any decline in price will result in no change in quantity demanded
straight line = less than lower prices than higher prices \straight line elastic. the lower the initial price the lower the price elasticity of demand and vice versa
unit elastic = 1 at all price levels
price change leads to the same percentage of change in quantity demanded
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What determines demand elasticity?
answer
1. the nature of the good : if the good is a necessity then demand will be less sensitive to price change ; eg Healthcare
2. Availability of close substitutes
3. Share of consumer's budget
4. Passage of time
2. Availability of close substitutes
3. Share of consumer's budget
4. Passage of time
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product
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output of a firm
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Total Physical Product (TPP)
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as the number of input increases, the number of output increases
- amount of output it obtains in total from a given quantity of input
- amount of output it obtains in total from a given quantity of input
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Average Physical Product (APP)
answer
measures the output per unit of input
= TPP / number\quantity of input
eg: 4 carpenters can turn out 32 garages annually
= 32[TPP] / 4 = 8 garages per carpenter
= TPP / number\quantity of input
eg: 4 carpenters can turn out 32 garages annually
= 32[TPP] / 4 = 8 garages per carpenter
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Marginal Physical Product (MPP)
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the increase in total physical product\output from a one increase in the input
=increase of TPP/ increase of Input
eg: = 4th carpenter = 32 - 24= 8 garages
=increase of TPP/ increase of Input
eg: = 4th carpenter = 32 - 24= 8 garages
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The Law of Diminishing Productivity
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adding input will increase total product by decreasing amounts, holding all other inputs constant
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Marginal Revenue Product
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measures the additional revenue from increasing our output by 1 unit
= MPP x price of product\output
= MPP x price of product\output
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profit
answer
= total revenue - costs
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total revenue (TR)
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price (P) x total physical product (TPP)
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Total Cost
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the cost of producing all product
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Variable Cost
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firms can change both their capital and labor commitments
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Fixed Cost
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cost of an input whose quantity does not rise when output goes up
- cannot be varied
- cannot be varied
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Average Variable Cost
answer
...
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average revenue (AR)
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total revenue / quantity = P x Q/Q=P
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Marginal Cost
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the change in total cost due to the change in total physical product
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Marginal revenue
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additional in total revenue resulting from the addition of one unit to total output
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Economic Cost
answer
...
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Economic Profit
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net earnings - the opportunity cost of capital and other inputs
= accounting profit - opportunity cost of capital and inputs
= accounting profit - opportunity cost of capital and inputs
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Corporations
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a firm that has the legal status of a fictional individual
- owned by a number of people, called shareholders
- run by a set of elected officials and board of directors
- owned by a number of people, called shareholders
- run by a set of elected officials and board of directors
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noteworthy features of corporations
answer
1. Special Limits are placed on losses to the firm, or limited liability; shareholders only lose the money they invested in the company
2. They are subject to taxation as well as the shareholders, or double taxation
3. It is considered a separate entity from its shareholders; considered and individual in the eyes of the law
2. They are subject to taxation as well as the shareholders, or double taxation
3. It is considered a separate entity from its shareholders; considered and individual in the eyes of the law
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How corporations finance operations
answer
1. Common Stock: Units of Ownership in the firm; may pay dividends to shareholders but their value can drop to zero
2. Bonds: Certificates of obligations to repay money borrowed; commit to pay interest and principal over the life of the bond
3. Retained earnings: instead of paying dividends to shareholders, corporations will keep or retain those profits to finance the business.
2. Bonds: Certificates of obligations to repay money borrowed; commit to pay interest and principal over the life of the bond
3. Retained earnings: instead of paying dividends to shareholders, corporations will keep or retain those profits to finance the business.
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Securities and Exchange Commission (SEC)
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The primary regulator of the stock market
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National Association of Securities Dealer (NASD)
answer
the financial services industry also self regulates
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Derivatives
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used by the financial markets to hedge the risk of an adverse market event
- value is based on the value of the underlying stock or bond
-traded on the commodities exchange
- value is based on the value of the underlying stock or bond
-traded on the commodities exchange
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Futures
answer
contracts to buy or sell shares of stocks at a future date
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Options
answer
contracts to buy or sell a stock at a certain price until a certain date
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Swaps
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exchange of two securities, interest rates, or currencies for the mutual benefit of the exchangers
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Credit Default Swap
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the buy of the swap pays the seller regular payments for a period of time as long as the underlying security does not go into default; if there is a default then the seller pays the buyer the value of the underlying security
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Perfect Competition (PC):
answer
highly impossible
has to charge the market price
no control over the price
reflects maximum economic efficiency
has to charge the market price
no control over the price
reflects maximum economic efficiency
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The 4 characteristics of PC
answer
1. numerous small firms and customers. no one firm can dominate the market in terms of market share or price
2. standardized product
3. freedom of entry and exit; no cost to enter or exit the market
4. perfect information; each customer and firm is fully informed about the product
2. standardized product
3. freedom of entry and exit; no cost to enter or exit the market
4. perfect information; each customer and firm is fully informed about the product
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The demand curve of a PC firm
answer
horizontal
infinitely elastic
infinitely elastic
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Profit maximization condition
answer
...
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What determines the perfectly competitive firm's supply curve
answer
...
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Zero economic profits
answer
means that a firm makes enough to meet their opportunity costs of staying in business
-only true for a perfect competition
-only true for a perfect competition
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Monopoly
answer
only one firm in the market
- no close substitutes
- very high cost of entry making competition responsible
leads in inefficient resource allocation
controls price and can restrict output
- no close substitutes
- very high cost of entry making competition responsible
leads in inefficient resource allocation
controls price and can restrict output
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Sources of monopoly
answer
1. Legal restrictions
2. Patents: exclusive rights to certain goods
3. Control of scarce resources
4. Deliberately erect entry barriers
5. large sunk costs : large investment for entry
6. Technical Superiority
7. Economies of Scale
2. Patents: exclusive rights to certain goods
3. Control of scarce resources
4. Deliberately erect entry barriers
5. large sunk costs : large investment for entry
6. Technical Superiority
7. Economies of Scale
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Natural monopoly
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increasing returns to scale gives an advantage to a form
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Price Makers
answer
monopolies can choose a price since they are the only firm in the market
interact with the demand side of the market to determine the best price where profits are maximized
interact with the demand side of the market to determine the best price where profits are maximized
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Price Discrimination
answer
the sale of a different product at different prices for different customers
- cost more to supply a good to one customer vs another
- cost more to supply a good to one customer vs another
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Monopolistic Competition
answer
imperfect competition
downward sloping demand curve
downward sloping demand curve
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Four requirements for monopolistic competition
answer
1. Numerous participants
2. Freedom of Exit and Entry
3. Perfect information
4. Heterogeneous products : perceptible differences in products for buyers
2. Freedom of Exit and Entry
3. Perfect information
4. Heterogeneous products : perceptible differences in products for buyers
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Excess Capacity Theorem
answer
firms have unused or wasted resources
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Oligopoly
answer
market dominated by a few sellers in which at least several are large enough relative to the total market to be able to influence the market price
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Characteristics of Oligopolies
answer
1. Interdependence: a firm will take the actions of competitors into account
2. Strategic Interaction: the firm will play strategic games to analyze the potential impact of competition on pricing and marketing actions
3. Cartels
4, Price Leadership and Tacit Contusion
2. Strategic Interaction: the firm will play strategic games to analyze the potential impact of competition on pricing and marketing actions
3. Cartels
4, Price Leadership and Tacit Contusion
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