BUSS1040: Economics for Business Decision Making
BUSS1040
**Sample of pages 1-2
BUSS1040: Economics for Business Decision Making
Week 1: Key concepts and Comparative advantage Chapter 1, 2, 4 What is economics? • Study of choice under scarcity • Key issues that need to be addressed: o What to produce o How to produce o Who should get what is made • Market: place where buyers and sellers of a particular goods or service meet o Economics examines the behaviour of individuals (consumer, firms and government) in markets Scarcity and opportunity cost • Because of scarcity, any choice involves a trade-off or opportunity cost • Opportunity cost includes; o Explicit cost: cost that involve direct payment o Implicit cost: opportunities that are foregone that do not involve explicit cost o Opportunity cost does not include unrecoverable or sunk cost Marginal analysis • Marginal benefit: for a extra unit consumed for an individual • Marginal cost: additional cost of buying one more unit • Marginal analysis: examines the behaviour of individual in market (i.e. comparing marginal cost and marginal benefit) Correlation and causation
BUSS1040 • •
Correlation: when two or more factors are observed to be moving up, down in the opposite directions together Causation: a change in one variable brings about, or causes, a change in another variable
Ceteris paribus (“other things equal) • To isolate the impact of one factor, economist examine the impact of one change at a time, holding everything else constant Production possibility frontier • PPF graph the output that an individual can produce with a particular set of resources (given resources and technology) • Reason for concavity: opportunity cost of each good is increasing in the level of output of that good • Shifts in PPF: when either the amount of resources available or state of technology changes
Gains from trade (or exchange) • Trade/exchange is voluntary • Gains from exchange: helps allocate goods to those who value them most = improvement in income, production or satisfaction owing to the exchange of goods or services • Pareto improving: both agents/traders are better off • Allows people to take advantage of gains from specialization (in producing the good in which they have lower opportunity cost) = reducing overall costs of producing and increasing output Absolute and comparative advantage • Party A has an absolute advantage over Party B in the production of a good if, for a given amount of resources, A can produce a greater number of that good than B. • Party A has a comparative advantage over Party B in the production of a good if A's opportunity cost of producing that good is lower than B's opportunity cost.
BUSS1040
**Sample of pages 7-12 Week 3: Demand and market equilibrium Chapter 6 & 9 Demand (Consumer behaviour) Benefit and willingness to pay • Assumption: consumer acts in their own best interest/maximise the benefit or utility he or she receives from consuming goods and services, subject to their budget constraints • Consumer derives some benefit from consuming a particular good or service o Measured by willingness to pay (WTP) (i.e. what is the highest amount of money the consumer would be willing to pay for that cup of coffee?) o Total benefit (TB): measures the total benefit she gets from consuming the total number of coffee o Marginal benefit: measures how much extra benefit she derives from consumer one extra cup of coffee § Found by deriving the total benefit function § Expect a diminishing marginal benefit
Individual demand • Individual demand: quantity of a good or service that a consumer is willing and able to buy at a certain price (buy up to the point where P=MB) o P<MB, a consumer should buy that unit because his willingness to pay exceeds the price o P>MB, a consumer should not buy that unit because the price of the good exceeds his willingness to pay • Individual demand curve (given by his MB curve): how much a consumer is willing and able to buy at different price o Law of demand: the negative relationship between price and quantity demanded o Change in quantity demand – shifts along the curve
BUSS1040 o Change in demand – shifts in the demand curve
Market demand
•
•
Market demand curve traces out the combination of; o Market price o Quantities that all consumers in a market are together willing and able to buy at that price Can be derived by horizontally summing together the individual demand curves along the q-axis
Market equilibrium (Functioning of markets) Market equilibrium
BUSS1040
•
•
Market is in equilibrium if at the market price, the quantity demanded by consumer equals the quantity supplied by firms in the market (the price is called market clearing price or equilibrium price) o There is no pressure on price or quantity traded in the market to change When not in equilibrium, there will be a pressure on prices to return to equilibrium
Comparative static analysis • Comparative static analysis: involves an examination of how the market equilibrium is affected by the change or event – that is, a comparison of the old and the new market equilibrium 𝑃 𝑆"
𝑆&
𝑃"∗ 𝑃&∗
𝐷& 𝑄"∗
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𝑄
Welfare analysis: surplus for consumer and firms • Welfare analysis: changes in benefit to market participants (consumer and firm) • Consumer surplus (CS): welfare consumer receive from buying units of a good or service in the market
BUSS1040 o Measure by evaluating the net value (net benefit) of a good or service to the consumer, as he or she perceives it (CS = Consumer willingness to pay – price actually paid for each unit bought) 𝑃 𝑆
CS 𝑃∗
𝐷 𝑄∗
𝑄
o An individual/market CS is by calculating the area between the individual/market demand curve and the price line. o Change in CS with a decrease in price
•
Producer surplus (PS): welfare producers that firm receive from selling units of goods or services in the market o Measured by considering the net benefit of selling a good or service (PS = price producer receives – cost of production) o A firm/market PS is calculated y finding the area between the price line and the firm/market’s supply curve
BUSS1040 𝑃 𝑆
𝑃∗ PS
𝐷 𝑄
∗
o Producer surplus with an increase in price
•
𝑄
Total surplus (when considering two participants – consumer and producers): sum of consumer surplus and producer surplus and the market equilibrium o TS = CS + PS 𝑃 𝑆
TS
𝐷
𝑄
BUSS1040 Pareto efficiency (to further analyse welfare in a competitive market) • An outcome is Pareto efficient if it is not possible to make someone better off without making someone worse off o Conversely, an outcome is NOT Pareto efficient if is possible to reallocate resources and make someone better off without making someone worse off o Pareto efficient outcome maximise total surplus
The outcome in a COMPETITIVE MARKET is Pareto efficient: o For all the trades up to the competitive market equilibrium (Q*), MB ≥ MC. o Hence, the consumer is willing to pay more than the extra cost required to make the item. o Trading all units up until Q* increases total surplus (as it increases CS, PS or both). • If fewer than Q* units are traded, this outcome is not Pareto efficient, because it is possible to increase the number of units traded in order to make the consumer and/or the producer better off, without making any one worse off. • If more than Q* units are traded we know that MC > MB. All units traded beyond Q* make someone worse off: either the buyer paid more than his MB, the seller received a price less than her MC, or both. Therefore, this outcome is not Pareto efficient, because total surplus would rise if output were reduced (back to Q*). Competitive market outcome and efficiency • In the competitive-market equilibrium, all the potential gains from trade are exhausted. o There are no consumers left in the market with a willingness to pay higher than any seller’s MC to provide an additional unit. o The price mechanism ensures that the people with the highest value for the product (those that are willing to pay more than the price) end up with the goods, and that those firms with the lowest cost are the ones who make the goods (the firms who have a MC less than the market price). •
**Sample of pages 1-2
BUSS1040: Economics for Business Decision Making
Week 1: Key concepts and Comparative advantage Chapter 1, 2, 4 What is economics? • Study of choice under scarcity • Key issues that need to be addressed: o What to produce o How to produce o Who should get what is made • Market: place where buyers and sellers of a particular goods or service meet o Economics examines the behaviour of individuals (consumer, firms and government) in markets Scarcity and opportunity cost • Because of scarcity, any choice involves a trade-off or opportunity cost • Opportunity cost includes; o Explicit cost: cost that involve direct payment o Implicit cost: opportunities that are foregone that do not involve explicit cost o Opportunity cost does not include unrecoverable or sunk cost Marginal analysis • Marginal benefit: for a extra unit consumed for an individual • Marginal cost: additional cost of buying one more unit • Marginal analysis: examines the behaviour of individual in market (i.e. comparing marginal cost and marginal benefit) Correlation and causation
BUSS1040 • •
Correlation: when two or more factors are observed to be moving up, down in the opposite directions together Causation: a change in one variable brings about, or causes, a change in another variable
Ceteris paribus (“other things equal) • To isolate the impact of one factor, economist examine the impact of one change at a time, holding everything else constant Production possibility frontier • PPF graph the output that an individual can produce with a particular set of resources (given resources and technology) • Reason for concavity: opportunity cost of each good is increasing in the level of output of that good • Shifts in PPF: when either the amount of resources available or state of technology changes
Gains from trade (or exchange) • Trade/exchange is voluntary • Gains from exchange: helps allocate goods to those who value them most = improvement in income, production or satisfaction owing to the exchange of goods or services • Pareto improving: both agents/traders are better off • Allows people to take advantage of gains from specialization (in producing the good in which they have lower opportunity cost) = reducing overall costs of producing and increasing output Absolute and comparative advantage • Party A has an absolute advantage over Party B in the production of a good if, for a given amount of resources, A can produce a greater number of that good than B. • Party A has a comparative advantage over Party B in the production of a good if A's opportunity cost of producing that good is lower than B's opportunity cost.
BUSS1040
**Sample of pages 7-12 Week 3: Demand and market equilibrium Chapter 6 & 9 Demand (Consumer behaviour) Benefit and willingness to pay • Assumption: consumer acts in their own best interest/maximise the benefit or utility he or she receives from consuming goods and services, subject to their budget constraints • Consumer derives some benefit from consuming a particular good or service o Measured by willingness to pay (WTP) (i.e. what is the highest amount of money the consumer would be willing to pay for that cup of coffee?) o Total benefit (TB): measures the total benefit she gets from consuming the total number of coffee o Marginal benefit: measures how much extra benefit she derives from consumer one extra cup of coffee § Found by deriving the total benefit function § Expect a diminishing marginal benefit
Individual demand • Individual demand: quantity of a good or service that a consumer is willing and able to buy at a certain price (buy up to the point where P=MB) o P<MB, a consumer should buy that unit because his willingness to pay exceeds the price o P>MB, a consumer should not buy that unit because the price of the good exceeds his willingness to pay • Individual demand curve (given by his MB curve): how much a consumer is willing and able to buy at different price o Law of demand: the negative relationship between price and quantity demanded o Change in quantity demand – shifts along the curve
BUSS1040 o Change in demand – shifts in the demand curve
Market demand
•
•
Market demand curve traces out the combination of; o Market price o Quantities that all consumers in a market are together willing and able to buy at that price Can be derived by horizontally summing together the individual demand curves along the q-axis
Market equilibrium (Functioning of markets) Market equilibrium
BUSS1040
•
•
Market is in equilibrium if at the market price, the quantity demanded by consumer equals the quantity supplied by firms in the market (the price is called market clearing price or equilibrium price) o There is no pressure on price or quantity traded in the market to change When not in equilibrium, there will be a pressure on prices to return to equilibrium
Comparative static analysis • Comparative static analysis: involves an examination of how the market equilibrium is affected by the change or event – that is, a comparison of the old and the new market equilibrium 𝑃 𝑆"
𝑆&
𝑃"∗ 𝑃&∗
𝐷& 𝑄"∗
𝑄&∗
𝑄
Welfare analysis: surplus for consumer and firms • Welfare analysis: changes in benefit to market participants (consumer and firm) • Consumer surplus (CS): welfare consumer receive from buying units of a good or service in the market
BUSS1040 o Measure by evaluating the net value (net benefit) of a good or service to the consumer, as he or she perceives it (CS = Consumer willingness to pay – price actually paid for each unit bought) 𝑃 𝑆
CS 𝑃∗
𝐷 𝑄∗
𝑄
o An individual/market CS is by calculating the area between the individual/market demand curve and the price line. o Change in CS with a decrease in price
•
Producer surplus (PS): welfare producers that firm receive from selling units of goods or services in the market o Measured by considering the net benefit of selling a good or service (PS = price producer receives – cost of production) o A firm/market PS is calculated y finding the area between the price line and the firm/market’s supply curve
BUSS1040 𝑃 𝑆
𝑃∗ PS
𝐷 𝑄
∗
o Producer surplus with an increase in price
•
𝑄
Total surplus (when considering two participants – consumer and producers): sum of consumer surplus and producer surplus and the market equilibrium o TS = CS + PS 𝑃 𝑆
TS
𝐷
𝑄
BUSS1040 Pareto efficiency (to further analyse welfare in a competitive market) • An outcome is Pareto efficient if it is not possible to make someone better off without making someone worse off o Conversely, an outcome is NOT Pareto efficient if is possible to reallocate resources and make someone better off without making someone worse off o Pareto efficient outcome maximise total surplus
The outcome in a COMPETITIVE MARKET is Pareto efficient: o For all the trades up to the competitive market equilibrium (Q*), MB ≥ MC. o Hence, the consumer is willing to pay more than the extra cost required to make the item. o Trading all units up until Q* increases total surplus (as it increases CS, PS or both). • If fewer than Q* units are traded, this outcome is not Pareto efficient, because it is possible to increase the number of units traded in order to make the consumer and/or the producer better off, without making any one worse off. • If more than Q* units are traded we know that MC > MB. All units traded beyond Q* make someone worse off: either the buyer paid more than his MB, the seller received a price less than her MC, or both. Therefore, this outcome is not Pareto efficient, because total surplus would rise if output were reduced (back to Q*). Competitive market outcome and efficiency • In the competitive-market equilibrium, all the potential gains from trade are exhausted. o There are no consumers left in the market with a willingness to pay higher than any seller’s MC to provide an additional unit. o The price mechanism ensures that the people with the highest value for the product (those that are willing to pay more than the price) end up with the goods, and that those firms with the lowest cost are the ones who make the goods (the firms who have a MC less than the market price). •
