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Competency 3003.1.1: The Economic Way of Thinking
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What are the basic economic questions that every society must answer?
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1. What goods and services will be produced?
2. How will goods and services be produced?
3. Who will consume the goods and services?
2. How will goods and services be produced?
3. Who will consume the goods and services?
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What are the core ideas that combine to make up the economic way of thinking?
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Core Economic Ideas:
• Rational choice
• Cost
• Benefit
• Margin
• Incentives
• Rational choice
• Cost
• Benefit
• Margin
• Incentives
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How can we analyze production to determine if it is efficient or inefficient and to understand the tradeoffs involved?
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Use the production possibilities frontier (PPF) graph
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How do absolute advantage, comparative advantage, and specialization affect trade?
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Absolute advantage: When one person (or nation) is more productive than another—needs fewer inputs or takes less time to produce a good or perform a production task.
Comparative Advantage: The ability of a person to perform an activity or produce a good or service at a lower opportunity cost than anyone else.
Specialization: Production is much more efficient if roles/tasks are broken up and each person specializes in a specific area rather than each person completing some or all of the steps to make a product
Comparative Advantage: The ability of a person to perform an activity or produce a good or service at a lower opportunity cost than anyone else.
Specialization: Production is much more efficient if roles/tasks are broken up and each person specializes in a specific area rather than each person completing some or all of the steps to make a product
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Competency 3002.1.2: Supply and Demand
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What factors cause a change in demand?
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Changes in price of related goods
Tastes and preferences of the consumer
Income of the people
Future expectation
Population
Income distribution
Tastes and preferences of the consumer
Income of the people
Future expectation
Population
Income distribution
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What causes a change in the quantity demanded?
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Caused when consumers buy more in response to a decrease in price or less in response to an increase in price, the quantity demanded is said to move "move along the demand curve"
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What are the effects of a change in demand?
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An increase in demand shifts the demand curve rightward and creates a shortage. The price rises, the quantity supplied increases, and the equilibrium quantity increases.
A decrease in demand shifts the demand curve leftward and creates a surplus. The price falls, the quantity supplied decreases, and the equilibrium quantity decrease
A decrease in demand shifts the demand curve leftward and creates a surplus. The price falls, the quantity supplied decreases, and the equilibrium quantity decrease
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What are the effects of a change in quantity demanded?
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If the price of an item rises when other things remain the same, the quantity demanded will decrease and there is a movement up along the demand curve. If the price falls when other things remain the same, the quantity demanded increases and there is a movement down along the demand curve.
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What factors cause a change in supply?
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A change in supply can be brought on by new technologies, making production more efficient and less expensive, or by a change in the number of competitors in the market
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What causes a change in the quantity supplied?
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A change in the price of goods
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What are the effects of a change in quantity supplied?
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If the price of bottled water falls when other things remain the same, the quantity supplied of bottled water decreases and there is a movement down along the supply curve. If the price rises when other things remain the same, the quantity supplied increases and there is a movement up along the supply curve
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What are the effects of a change in supply?
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If any influence on water bottlers' plans other than the price of bottled water changes, there is a change in the supply of bottled water. When the supply of bottled water decreases, the supply curve shifts leftward. When the supply of bottled water increases, the supply curve shifts rightward.
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How do changes in demand and supply affect market equilibrium?
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Supply and demand have to be in balance to create market equilibrium. When equilibrium is disturbed, market forces restore it. The law of market forces states: When there is a surplus, the price falls; and when there is a shortage, the price rises.
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Competency 3002.1.3: Changes in Supply and Demand
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How do you calculate the price elasticities of supply and demand if given price and supply/demand tables?
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Price Elasticity (PED or Ed) = % Change in Quantity divided by % Change in Price
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What causes a change in consumer and producer surplus?
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Changes in the elasticity of the commodity being demanded.
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What conditions affect the efficient allocation of scarce resources?
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The methods of allocating scarce resources are market price; command; majority rule; contest; first-come, first-served; sharing equally; lottery; personal characteristics; and force.
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Competency 3002.1.4: The Economic Problem
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What is opportunity cost and how is it calculated?
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Opportunity cost is the best thing you must give up to get something.
What you are sacrificing / what you are gaining = the opportunity cost
What you are sacrificing / what you are gaining = the opportunity cost
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What is the production possibilities frontier (PPF)?
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The boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced, given the available factors of production and the state of technology.
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What conditions must be satisfied for an allocation of productive resources to be efficient?
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When production is efficient it is not possible to produce more of one good or service without producing less of something else. There must be full employment—not just of labor but of all the available factors of production—and each resource must be assigned to the task that it performs comparatively better than other resources can.
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What are examples of inefficient production?
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Producing within the production possibilities frontier
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Competency 3002.1.5: Effects of Government Actions
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What is the impact of a price ceiling on efficiency and fairness?
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A price ceiling set above the equilibrium price has no effects.
• A price ceiling set below the equilibrium price creates a shortage and increased search activity or a black market.
• A price ceiling is inefficient and unfair.
• A rent ceiling is an example of a price ceiling.
• A price ceiling set below the equilibrium price creates a shortage and increased search activity or a black market.
• A price ceiling is inefficient and unfair.
• A rent ceiling is an example of a price ceiling.
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What is the impact of a price floor on efficiency and fairness?
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A price floor set below the equilibrium price has no effects.
• A price floor set above the equilibrium price creates a surplus and increased search activity or illegal trading.
• A price floor is inefficient and unfair.
• A minimum wage is an example of a price floor.
• A price floor set above the equilibrium price creates a surplus and increased search activity or illegal trading.
• A price floor is inefficient and unfair.
• A minimum wage is an example of a price floor.
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What are the effects of subsidies on efficiency and fairness?
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A price support increases the quantity produced, decreases the quantity consumed, and creates a surplus.
• To maintain the support price, the government buys the surplus and subsidizes the producer.
• A price support benefits the producer but costs the consumer/taxpayer more than the producer gains—it creates a deadweight loss.
• A price support is inefficient and is usually unfair.
• To maintain the support price, the government buys the surplus and subsidizes the producer.
• A price support benefits the producer but costs the consumer/taxpayer more than the producer gains—it creates a deadweight loss.
• A price support is inefficient and is usually unfair.
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Competency 3002.1.9: Examining Externalities
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What are negative externalities, marginal social costs, marginal social benefits, marginal private costs, and marginal private benefits?
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Negative Externality: A production or consumption activity that creates an external cost
Marginal Social Cost: The marginal cost incurred by the entire society—by the producer and by everyone else on whom the cost falls. It is the sum of marginal private cost and marginal external cost
Marginal Social Benefit: The marginal benefit enjoyed by society—by the consumer of a good or service and by everyone else who benefits from it. It is the sum of marginal private benefit and marginal external benefit.
Marginal Private Costs: The cost of producing an additional unit of a good or service that is borne by the producer of that good or service.
Marginal Private Benefits: The benefit from an additional unit of a good or service that the consumer of that good or service receives.
Marginal Social Cost: The marginal cost incurred by the entire society—by the producer and by everyone else on whom the cost falls. It is the sum of marginal private cost and marginal external cost
Marginal Social Benefit: The marginal benefit enjoyed by society—by the consumer of a good or service and by everyone else who benefits from it. It is the sum of marginal private benefit and marginal external benefit.
Marginal Private Costs: The cost of producing an additional unit of a good or service that is borne by the producer of that good or service.
Marginal Private Benefits: The benefit from an additional unit of a good or service that the consumer of that good or service receives.
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How can government actions lead to more efficient outcomes when negative externalities are present?
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Cap-and-trade programs encourage businesses to be more efficient
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Competency 3002.1.8: Examining Public Goods
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What are examples of private goods, public goods, common resources, and natural monopolies?
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Private Goods: Excludable, Rival in consumption (Food, Congested Toll Road)
Public Goods: Non-excludable, and Non-rival (National Defense, Uncongested Non Toll Road)
Common Resources: Rival, Non-excludable (Ocean Fish, Congested Non Toll Road)
Natural Monopolies: Non Rival, Excludable (Cable TV, Uncongested Toll Road)
Public Goods: Non-excludable, and Non-rival (National Defense, Uncongested Non Toll Road)
Common Resources: Rival, Non-excludable (Ocean Fish, Congested Non Toll Road)
Natural Monopolies: Non Rival, Excludable (Cable TV, Uncongested Toll Road)
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How can efficient quantities of public goods be identified?
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Marginal benefit = marginal cost
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How does the delivery of public goods and services lead to external benefits?
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Public goods are available for all to enjoy, i.e. a streetlight or a fountain
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Competency 3002.1.10: Consumer Choice
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How do consumers determine the quantities goods they can consume given their budget (income) and prices?
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Budget line... A line that describes the limits to consumption possibilities and that depends on a consumer's budget and the prices of goods and services.
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What is the diamond-water paradox and what does marginal utility theory tell us about it?
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Water is more valuable than a diamond because water is essential to life itself. Yet water is much cheaper than a diamond. When consumers maximize total utility, they use resources efficiently. Marginal utility theory resolves the paradox of value. When we talk loosely about value, we are thinking of total utility or consumer surplus, but price is related to marginal utility. Water, which we consume in large amounts, has a high total utility and a large consumer surplus but a low price and low marginal utility. Diamonds, which we consume in small amounts, have a low total utility and a small consumer surplus but a high price and a high marginal utility.
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Competency 3002.1.11: Short-Run and Long-Run Costs
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How do we calculate economic profit given revenue and cost data?
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A firm's economic profit equals total revenue minus total cost.
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How do costs affect a firm's output in the short run?
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Costs must be increased to increase output in the short run
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What is the long-run average cost curve?
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A curve that shows the lowest average total cost at which it is possible to produce each output when the firm has had sufficient time to change both its plant size and labor employed.
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Competency 3002.1.12: Looking at Perfect Competition
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How does a firm in a perfectly competitive market maximize profit?
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Increase output, because price cannot be changed in a perfectly competitive market
In order to maximize profits in a perfectly competitive market, firms set marginal revenue equal to marginal cost (MR=MC)
In order to maximize profits in a perfectly competitive market, firms set marginal revenue equal to marginal cost (MR=MC)
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How are equilibrium output, price, and economic profit determined in a perfectly competitive market in the short-run?
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In the short-term, it is possible for economic profits to be positive, zero, or negative . When price is greater than average total cost, the firm is making a profit. When price is less than average total cost, the firm is making a loss in the market.
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How are equilibrium output, price, and economic profit determined in a perfectly competitive market in the long-run?
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Over the long-run, if firms in a perfectly competitive market are earning positive economic profits, more firms will enter the market, which will shift the supply curve to the right. As the supply curve shifts to the right, the equilibrium price will go down. As the price goes down, economic profits will decrease until they become zero.
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Competency 3002.1.13: Understanding Monopoly Markets
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What are the characteristics of monopoly?
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No close substitutes
A barrier to enter market
A barrier to enter market
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What are the different price setting strategies that can be employed by a monopolist?
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Single price
Price discrimination
Price discrimination
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How does a single-price monopoly set price?
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The demand for a monopoly's output is the market demand, and a single-price monopoly's marginal revenue is less than price. A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost and by charging the maximum price that consumers are willing to pay for that quantity.
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How do equilibrium price and output differ in monopoly versus a perfectly competitive market?
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Compared to perfect competition, a single-price monopoly produces a smaller output and charges a higher price.
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What are the different methods of monopoly regulation?
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Regulation: Rules administered by a government agency to influence prices, quantities, entry, and other aspects of economic activity in a firm or industry.
Deregulation: is the process of removing regulation of prices, quantities, entry, and other aspects of economic activity in a firm or industry. During the past 30 years, deregulation has occurred in domestic air transportation, telephone service, interstate trucking, and banking and financial services. Cable TV was deregulated in 1984, re-regulated in 1992, and deregulated again in 1996.
Social interest theory: The theory that regulation achieves an efficient allocation of resources.
Capture theory: The theory that the regulation serves the self-interest of the producer and results in maximum profit, under-production, and deadweight loss.
Deregulation: is the process of removing regulation of prices, quantities, entry, and other aspects of economic activity in a firm or industry. During the past 30 years, deregulation has occurred in domestic air transportation, telephone service, interstate trucking, and banking and financial services. Cable TV was deregulated in 1984, re-regulated in 1992, and deregulated again in 1996.
Social interest theory: The theory that regulation achieves an efficient allocation of resources.
Capture theory: The theory that the regulation serves the self-interest of the producer and results in maximum profit, under-production, and deadweight loss.
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Competency 3002.1.14: Monopolistic Competition and Oligopoly
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What are the characteristics of monopolistic competition?
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Monopolistic competition is a market structure in which a large number of firms compete; each firm produces a product that is slightly different from the products of its competitors; firms compete on price, quality, and marketing; and new firms are free to enter the industry. Monopolistic competition is identified by a low degree of concentration measured by either the four-firm concentration ratio or the HHI.
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How do firms in monopolistic competition maximize profit?
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A firm in monopolistic competition makes its output and price decision just as a monopoly firm does: producing the quantity at which marginal revenue equals marginal cost and by charging the highest price that buyers are willing to pay for this quantity.
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What is the effect of advertising in monopolistically competitive markets?
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Because of product differentiation, a firm in monopolistic competition must market its product. Marketing takes two main forms: advertising and packaging. A firm that produces a high-quality product wants to sell it for a suitably high price. To be able to do so, it must advertise and package its product in a way that convinces buyers that they are getting the higher quality for which they are paying
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What are the characteristics of oligopoly?
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• A small number of firms compete.
• Natural or legal barriers prevent the entry of new firms.
• Natural or legal barriers prevent the entry of new firms.
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What does game theory (The Prisoner's Dilemma) tell us about the decisions oligopolists must make?
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The prisoner's dilemma is a type of game that illustrates why cooperation is difficult to maintain for oligopolists even when it is mutually beneficial. In this game, the dominant strategy of each actor is to defect. However, acting in self-interest leads to a sub-optimal collective outcome.
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