Economics Study Guide
Chapter 6!
!
1) In an unregulated housing market higher rents create incentives to use current buildings more intensively, increasing the short-run quantity of housing supplied.! 2) At equilibrium price, all those who can afford housing will achieve it.! 3) A rent ceiling above equilibrium price will not result in black markets.! 4) In an unregulated labour market, a decrease in the demand for labour causes the wage rate to rise.! 5) An increase in the minimum wage will reduce the number of workers employed.! 6) Minimum wage laws, when above market equilibrium increase the amount of time people spend ! 7) Perfectly inelastic demand -buyers pay. They will pay whatever the price for that product.! Perfectly elastic demand -sellers pay. Buyers can dip for substitute anytime.! 8) A sales tax creates a deadweight loss as long as it is not inelastic or elastic.! 9) The deadweight loss does not equal the tax revenue for the government.! 10) A production quota creates inefficiency through under production. A quota limits the production.! 11) Subsidy makes the price fall, shifts the equilibrium rightward along the demand, increasing it because the price drop.!
!
Multiple Choice! 1) The short run supply curve for rental housing is positively sloped because the current stock of building will be used more intensively as rents rise.! 2) rent ceilings imposed by governments keep rental prices below the unregulated market price.! 3) Black market prices below the rent ceiling prices not a likely outcome.! 4) The minimum wage set below equilibrium would not create unemployment.! 5) If the minimum wage is set at 6$ and hour, there would be 50 unemployment hours.! 6) “ade” is dead weight loss.! 7) sales tax is vertical distance between tax + demand and regular demand curves.! 8) Buyers pay 60 cents, sellers pay 40 cents.! 9) For each frisbee the buyers share of tax is 40 cents.! 10) Government revenue = $1 frisbee X $4000 (market equilibrium supply) = $4000 revenue.! 11) We can deduce that between 4,000 and 5,000 units , the demand for frisbees is elastic.! 12) The deadweight loss is the area of the demand and supply loss. It is $500.! 13) A tax on buyers has the same effect on price and quantity as a tax on sellers! 14) If the price of a good is not effected by a sales tax, demand is elastic. If the prices rises people will switch to a substitute. ! 15) All of the above are true.! 16) All of the above are true.! 17) If the board sets a quota of 50 million bushels, the market-clearing price of a bushel of wheat bran is $5.! 18) With the quota of 50 million bushels, farmers have an incentive to increaser output because the market-clearing price is above cost of production.! 19) 70 million bushels. When their is a subsidiary (a payment made by the government to a producer the supply curve shits rightward along the demand curve the absolute distance from the equilibrium price and the actual subsidiary cost.! 20) The amount of taxpayers money that the marketing board pays to farmers in question 20 is 5X70 million= $350 million.!
21) Floor prices above market prices create excess supply.! 22) An agricultural subsidy does all of the above.!
! Chapter 8! !
Consumption possibilities: all of the things that you can afford to buy.! Budget line: limit to the consumption possibilities. Much like a PPF -all possibilities within the budget line are possible.! income fluctuations shift budget line.!
!
Preferences: a description of ones likes and dislikes.! Goal: determine what decides marginal benefit! Utility: The benefit or satisfaction that a person gets from the consumption of goods and services. ! Total utility: The benefit that a person gets from consumption of all different goods and services. -more consumption=more total utility.! Marginal utility: the change in total utility that results from a one-unit increase in the quantity of a good consumed.!
!
The principle of diminishing marginal utility: the tendency for marginal utility to decrease as the consumption of a good increases.!
!
In terms of consumer utility they want to maximize.! to determine utility we find..! Just affordable utility: the combinations of movies and pop that exhaust her $40 income.! add the total utilities of pop and movies for each combination to achieve the total costumer utility. !
!
Consumer equilibrium: a situation in which a consumer has allocated all of his or her available income in a way that maximizes his or her total utility, given the prices of goods and services. !
!
Lisa’s equilibrium is at 2 movies 6 pops. Added utilities her to create the total utility is highest with this combination.!
!
Marginal utility per dollar: the marginal utility from a good that results from spending one more dollar on it. -how to interpret the best possible choice. (ex. the increased utility from spending another dollar at the gas pump is the marginal utility per dollar).!
!
One unit from the marginal utility = the marginal unit per dollar. To determine marginal utility per dollar you divide the marginal utility by the cost of the product.!
!
A consumers total utility is maximized by spending all of the available income, and equalizing the marginal utility per dollar for all goods.! -as long as the utility per dollar exceeds the other (between good A and B) there is not a maximized utility (equilibrium) money must be moved from each so that the values are the same. ! If the marginal utility per dollar from movies exceeds the marginal utility per dollar for pop, see less movies and drink more pop.!
!
MUp= utility price of pop! MUm= utility price of pizza! Pp= pop price! Pm= pizza price! maximized if - MUp/Pp = MUm/Pm! Multiply both sides by the price of pop to obtain! MUp=MUm X (Pp/Pm) !
!
-(Pp/Pm) is the ratio of the price of pop to the price of a movie. how much she is foregoing for the other !
!
For lisa when Pm=$8 and Pp=$4 we observe that in a month she goes to the movies twice and buys 6 cases of pop. So we know that her MUp from 6 cases equals her Mum from 2 movies multiplied by $4/$8. That is, for Lisa the marginal utility from 6 cases of pop equals on half of the marginal utility from 2 movies. !
!
Paradox of Value: How can valuable water be so cheap, while a relatively useless diamond is so expensive?!
!
The paradox is resolved by distinguishing through total utility and marginal utility. We use so much water that the benefit from it diminishes to a small value.!
!
Water has a low price, low marginal utility, diamonds have a high price, high marginal utility. ! When the high marginal utility from diamonds is divided by high price of a diamond, the result is a number that equals the low marginal utility from water divided by the low price of water.!
! Questions! !
1) All points within a consumers budget line are affordable, not maximized however.! 2) The principle of diminishing marginal utility means that as consumption of a good increases, total utility increases but at a decreasing rate.! 3) A household is maximizing utility if the marginal utility per dollar spent is equal for all goods and all its income is spent. ! 4) If the marginal utility per dollar is not equal consumer cannot be at equilibrium. Marginal utility ratios will not be consistent however if the prices are different. ! 5) If marginal utility per dollar spent on good X exceeds the marginal utility per dollar spent on good Y, total utility will increase by increasing consumption of good X (to decrease marginal dollar value), and decreasing consumption of Y (to increase marginal dollar value). If marginal gain from an action exceeds marginal loss you take the action.!
!
1) A households consumption choices are determined by prices of goods and services, income, and preferences.! 2) Total utility equals the sum of the marginal utilities of each unit consumed.! 3) Total utility is always increasing when marginal utility is positive. Positive Marginal Utility: All things that people enjoy and want more of have a positive marginal utility. ! 4) According to the principle of diminishing marginal utility, as consumption of a good increases, total utility decreases at an increasing rate.! 5) If a consumer is in equilibrium, total utility is maximized given the consumer’s income and the prices of goods.!
6) Miniskirts: MU/P= 16/4= 4, Law Books= MU/P= 8/2= 4. Marginal Price per dollar is equal at 4, therefore the equilibrium amount of miniskirts is 1.! 7) If potato chips were free, individuals would consume them until the quantity of chips at which marginal utility from chips falls to 0.! 8) In consumer equilibrium, the consumer equates the the marginal utility per dollar spent on each good. Or the highest total utility combination. ! 9) Equilibrium = MUp/P=MUa/P ! 10/.5=5/P! 10/.5=20 (market price per dollar)! must be equal! 5/P must = 5/20 = .25! The banana has half the total utility as the apple, this means the banana must be half the price as well. !
!
10) If marginal cost per dollar of squid is 10 at equilibrium, and no octopus were purchased, then the marginal utility of squid must be at least less then 20 so that the dollars cannot match up. If it was 20 exactly then it would be worth purchasing a squid.!
!
11) If Soula is maximizing her utility and two goods have the same marginal utility she will be willing to pay the same price for both.! 12) the marginal utility of the las purchased beer is greater then the last purchased bubblegum! 13) TU= 8+6+16+12= 42.!
! Chapter 9! !
A households budget line describes the limits to its consumption choices.! Divisible goods can be bought in any quantity desired.!
!
Budget lines are described by Budget Equations.! Expenditure = income! Expenditure is equal of the sum of the price of each good multiplied by the quantity bought.! Ex. Expenditure= (price of pop X quantity of pop) + (price of movie X quantity of movies)= $40!
!
A households real income is its income expressed as a quantity of goods that the household can afford to buy.!
!
Relative Price is the price of one good divided by the price of another. ! The relative price essentially equals the slope of the budget line.! ! When the relative price of something changes on the budget line it rotates.! When income increases the line shifts left, decreases shifts right.!
!
Preference Map: people can sort all the possible combinations of goods into three groups: preferred, not preferred, indifferent.! An indifference curve is a line that shows combinations of goods among which a consumer is indifferent. ! -any combination within the indifference curve is not preferred and outside it is preferred. ! A preference map is a series of indifference curves that allow us to understand somebody's preferences.!
Marginal rate of substitution: the rate at which a person will give up good Y (measured on the Y axis), to get and additional unit of good X (measured on the X axis).! steep difference curve=high substitution.! flat=low substitution! Diminishing marginal rate of substitution: a general tendency for a person to be willing to give up less of good Y to get one more unit of good X, while at the same time remaining indifferent as the quantity of X increases. ! -when two goods are perfect substitutes there indifference curves are straight lines that slope downward. For perfect substitutes the slope is 1.! Compliments produce an L shaped indifference curve. You cannot have one without the other. ex. you want 1 left and right running shoe.!
!
The best point that intersects with the budget line and indifference curve is the best affordable point.!
! demand curve is basically a budget line.! !
Income effect: the effect of a change in income on buying plans. ! budget line shifts when income changes, produces different intersections on the indifference curve.!
!
Price effect: The effect of a change in the price of a good on the quantity of the good consumed.! For a normal good a fall in its price always increases the quantity bought.! The substitution effect is the effect of a change in price on the quantity bought when the consumer remains indifferent between the original situation and the new one. !
!
When the relative price of a good falls the consumer substitutes more of that good for the other good.!
!
Inferior good: A good for which demand decreases as income increases. a fall in price decreases the quantity demanded. !
!
Questions ! 1) The graph of a budget line will be straight. An indifference line will be bowed toward the origin.! 2) at any point on a budget line all income.! 3) Real Income is the amount of goods your income can afford. (ex. 10 cases of pop).! an increase in the price of goods means that real income falls because you can afford less.! 4) an increase in income causes a rightward parallel shift in the budget line.! 5) More of any good is always preferred. Demonstrated in the indifference curve.! 6) Higher indifference curves represent higher levels of satisfaction. ! 7) The principle of diminishing marginal rate of substitution is a general tendency for a person to be willing to give up less of good Y to get one more unit of good X, while at the same time remaining indifferent as the quantity of X increases. ! 8) Perfect substitutes have downward sloping indifference curves.! 9) If an indifference curve is steep, the marginal rate of substitution is high.! 10) The closer two goods are to perfect substitution, the closer the marginal rate of substitution is too being constant.!
11) At the best affordable consumption point of movies and pop, the marginal rate of substitution equals the ratio of the price of movies to the price of pop.! 12) When the relative price of a good decreases ! 13) When the relative price of a good decreases the income effect always leads to increased consumption of that good.! 14) when the price of an inferior good falls, the income effect decreases consumption.!
!
1) 2) 3) 4) 5)
The set of all affordable consumption choices.! Real income is measured in units of goods.! 2X6 =$12 Y=$12. 12/8= $1.5! The budget line depends on income and prices.! Bill consumes apples and bananas. Suppose Bill’s income doubles and the prices of apples and bananas also double. Bill’s budget line will shift right but not change slope.! 6) The relative price is 3/2.! 7) If the price of a good on the vertical axis becomes increases the budget line will become flatter.! 8) If income increases the budget line will d shift right ward but stay parallel to the original budget line.! 9) Y=$40, Pm=$20! 10) The shape of an indifference curve depends on the sustainability between goods for the household.! 11) In general, as a consumer moves down an indifference curve increasing consumption of good X (measured on the horizontal axis). less of Y must be given up for each additional unit -law of diminishing marginal rate of substitution.! 12) Indifference curves bow in towards the origin.! 13) In moving down and indifference curve, the marginal rate of substitution for complements will decrease faster than the MRS for substitutes. ! 14) If two goods are perfect substitutes, their indifference curves are negatively sloped straight lines.! 15) When the price of an inferior good rises, the income effect increases consumption of that good and the substitution effect decreases it.! 16) Point T is preferred to point Q, but T is not affordable.! 17) For rising price the substitution effect always decreases consumption for any good.! 18) point A to C! 19) If the price of a good falls the substitution effect is represented by a movement to a flatter part of the same indifference curve.! 20) Choices changed when preferences changed.! 21) When the price of an inferior good falls, the income and substitution effect both move quantity demanded in opposite directions. The substitution effect is usually larger then the income effect.! 22) For a rise in price, the substitution effect decreases consumption for all goods.!
! Chapter 10! !
Each firm is an institution that hires factors of production and organizes those factors to produce and sell goods and services.! Firm seeks to maximize profit -ultimate goal.! Depreciation is the fall in value of a firms capital!
Economic Profit is equal to total revenue minus total costs. Total costs are the opportunity costs.! A firms opportunity cost of production is the sum of the cost of using resources:! -Bought in the market! -Owned by the firm! -Supplied by the firms owner!
!
Implicit rental rate of capital: The opportunity cost of using capital the firm owns (it is implicitly renting capital from itself). This is measured in two components:! Economic depreciation: The fall in the market value of a firms capital over time.! Foregone Interest: The funds used to buy capital could have been used for some other purpose, and in their next best use, they would have earned interest.!
!
the owner or a hired worker is the entrepreneur: the factor of production that organizes a firm and makes decisions. Entrepreneurs earn Normal Profit: the return. This can be seen as an opportunity cost to the firm itself. !
!
To maximize economic profit, a firm must make five decisions: ! 1) What to produce and in what quantities! 2) How to produce ! 3) How to organize and compensate its managers and workers! 4) how to market and price its products! 5) What to produce itself and buy from others.!
!
Three features limit this maximization: ! 1) Technology constraints (technology: any method of producing a good or service).! 2) Information constraints (firms have limited information).! 3) Market constraints !
!
How firms make decisions..! 2 kinds of efficiency! Technological efficiency: occurs when a firm produces a given output by using the least amount of inputs.! Economic efficiency: occurs when the firm produces a given output at the least cost.! a technologically efficient method is never economically efficient!
!
Firms organize using 2 systems:! command system: a method of organizing production that uses a managerial hierarchy. Commands pass downward through information passes upward. Ex.military system! Incentive system: A method of organizing production that uses a market-like mechanism inside the firm. Incentives to induce workers to perform in ways that maximize the firm’s profit. Ex. commission.!
! Firms use a mixture of commands and incentive. The mixture that maximizes profit.! ! Economists identify 4 market types:! 1) Perfect competition - many firms selling an identical product. Many buyers.!
2) Monopolistic competition - Large number of firms compete by making similar but slightly different products. (called product differentiation). The products don’t have to be different, just perceived as different.! 3) Oligopoly: a market structure in which a small number of firms compete. ! 4) Monopoly: a market structure in which there is only one firm and it. !
! !
Chapter 11! Firms make their decisions based on the market type.! To study the relationship between a firms output decisions and its costs, we distinguish between two time frames:! The Short-run: A time frame in which the quantity of at least one factor of production is fixed. (ex. firms capital, land, etc) -fixed factors of production are defined as the firm’s plant. To increase output here a firm must increase the quantity of a variable factor of production.! Total product: The maximum output that a given quantity of labour can produce. Increase in employment increases total product.! Marginal Product: the increase in total product that results from a 1 unit increase in the quantity of labour employed. Marginal product increases initially then decreases.! Average Product: Tells how productive workers are on average. It is equal to the total product divided by the quantity of labor employed. Also increases initially then decreases.!
!
The Long-run: A period in which the firm can change its plant. The quantities of all factors of production are varied. -decisions not as easily reversed. Once a plant decision is made, firm usually must live with it -non-reversible. This is defined as a sunk cost.!
!
The product curve illustrates the relationship between these 3 concepts as a graph -similar to the PPF. Only points on total product curve are technologically efficient.!
!
Marginal product is also calculated as the slope of the curve.! Every product curve may look different but they share 2 things in common:! 1) Increasing marginal returns initially (marginal product is greater then last)! 2) Diminishing marginal returns eventually (marginal product is less then last)! Diminishing marginal return occurs when the marginal product of an additional worker is less than the marginal product of the previous worker arises from the fact that more workers are using the same capital and working in the same space -counterproductive. !
!
The law of diminishing returns states as a firm uses more of a variable factor of production with a given quantity of the fixed factor of production, the marginal product of the variable factor eventually diminishes. !
!
Firms must employ more labor to produce greater outputs, therefore it must increase costs. ! relationship described by:! Total Cost: the cost of all factors of production it uses.! Total fixed cost: cost of the firms fixed factors. (ex. machines, normal profit).! Total variable cost: cost of the firms variable factors. (ex. labor). changes as output changes.! Total fixed cost + total variable cost = total cost! TC = TFC + TVC!
!
a firms marginal cost is the increase in total cost that results from a one unit increase in output.!
calculated by the total cost divided by the increase in output.! at small outputs, marginal cost decreases as output increases. as marginal cost increases further, marginal cost eventually increases because of law of diminishing returns.!
!
Costs of production! 3 costs of production are:! 1) Average fixed costs: total fixed cost per unit of output! 2) average variable costs: total variable cost per unit of output! 3) average total costs: calculated as TC= TFV + TVC, if you divide each one by the quantity produced you get ATC = AFC + AVC! Average fixed cost declines with increasing input! -When marginal cost is less then average cost, average cost is decreasing. When marginal cost exceeds average cost, average cost is increasing.!
!
Firms spread fixed cost over a larger output and so its average fixed cost decreases! Diminishing returns means that as output increases, ever larger amounts of labor are needed to produce an additional unit of output so as output increases, average variable cost decreases initially but eventually increases.!
!
The position of a firms short-run cost curve depends on 2 factors! Technology -increases marginal product! Prices of factors of production -an increase in fixed costs shifts TFC upward. Increase in variable costs shifts TVC upward. Both cases shift the TC upward.!
!
All short run ATC’s are U-shaped.! For each short-run ATC curve, the larger the plant, the greater is the output at which average total cost is minimum. -they are all u shaped because as the quantity of labour increases, its marginal product initially increases then diminishes. !
!
The economically efficient plant for producing a given output is the one that has the lowest average total cost.!
!
The long-run average cost curve: The relationship between the lowest attainable average total cost and output when the firm can change both the plant it uses and the quantity of labour it employs. -it is a planning curve. ! The piece of each ATC that have the lowest average total costs all form to create the long run average cost curve.!
!
Economies of scale: features of a firms technology that make average total cost fall as output increases. Present when LRAC curve slopes downward.!
!
Diseconomies of scale: features of a firms technology that make average total cost rise as output increases. When present, LRAC slopes upward.!
!
Constant Returns to scale: features of a firms technology that keep average total cost constant as output increases. LRAC is horizontal when present.!
!
A firms minimum efficient scale is the smallest output at which long-run cost reaches its lowest level. !
When minimum efficient scale is small relative to market demand, the market has room for many firms and is competitive.! When large relative to market demand only a small number of firms (possibly only 1) can make a profit and the market is either in oligopoly or a monopoly.!
! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! !
!
!
1) In an unregulated housing market higher rents create incentives to use current buildings more intensively, increasing the short-run quantity of housing supplied.! 2) At equilibrium price, all those who can afford housing will achieve it.! 3) A rent ceiling above equilibrium price will not result in black markets.! 4) In an unregulated labour market, a decrease in the demand for labour causes the wage rate to rise.! 5) An increase in the minimum wage will reduce the number of workers employed.! 6) Minimum wage laws, when above market equilibrium increase the amount of time people spend ! 7) Perfectly inelastic demand -buyers pay. They will pay whatever the price for that product.! Perfectly elastic demand -sellers pay. Buyers can dip for substitute anytime.! 8) A sales tax creates a deadweight loss as long as it is not inelastic or elastic.! 9) The deadweight loss does not equal the tax revenue for the government.! 10) A production quota creates inefficiency through under production. A quota limits the production.! 11) Subsidy makes the price fall, shifts the equilibrium rightward along the demand, increasing it because the price drop.!
!
Multiple Choice! 1) The short run supply curve for rental housing is positively sloped because the current stock of building will be used more intensively as rents rise.! 2) rent ceilings imposed by governments keep rental prices below the unregulated market price.! 3) Black market prices below the rent ceiling prices not a likely outcome.! 4) The minimum wage set below equilibrium would not create unemployment.! 5) If the minimum wage is set at 6$ and hour, there would be 50 unemployment hours.! 6) “ade” is dead weight loss.! 7) sales tax is vertical distance between tax + demand and regular demand curves.! 8) Buyers pay 60 cents, sellers pay 40 cents.! 9) For each frisbee the buyers share of tax is 40 cents.! 10) Government revenue = $1 frisbee X $4000 (market equilibrium supply) = $4000 revenue.! 11) We can deduce that between 4,000 and 5,000 units , the demand for frisbees is elastic.! 12) The deadweight loss is the area of the demand and supply loss. It is $500.! 13) A tax on buyers has the same effect on price and quantity as a tax on sellers! 14) If the price of a good is not effected by a sales tax, demand is elastic. If the prices rises people will switch to a substitute. ! 15) All of the above are true.! 16) All of the above are true.! 17) If the board sets a quota of 50 million bushels, the market-clearing price of a bushel of wheat bran is $5.! 18) With the quota of 50 million bushels, farmers have an incentive to increaser output because the market-clearing price is above cost of production.! 19) 70 million bushels. When their is a subsidiary (a payment made by the government to a producer the supply curve shits rightward along the demand curve the absolute distance from the equilibrium price and the actual subsidiary cost.! 20) The amount of taxpayers money that the marketing board pays to farmers in question 20 is 5X70 million= $350 million.!
21) Floor prices above market prices create excess supply.! 22) An agricultural subsidy does all of the above.!
! Chapter 8! !
Consumption possibilities: all of the things that you can afford to buy.! Budget line: limit to the consumption possibilities. Much like a PPF -all possibilities within the budget line are possible.! income fluctuations shift budget line.!
!
Preferences: a description of ones likes and dislikes.! Goal: determine what decides marginal benefit! Utility: The benefit or satisfaction that a person gets from the consumption of goods and services. ! Total utility: The benefit that a person gets from consumption of all different goods and services. -more consumption=more total utility.! Marginal utility: the change in total utility that results from a one-unit increase in the quantity of a good consumed.!
!
The principle of diminishing marginal utility: the tendency for marginal utility to decrease as the consumption of a good increases.!
!
In terms of consumer utility they want to maximize.! to determine utility we find..! Just affordable utility: the combinations of movies and pop that exhaust her $40 income.! add the total utilities of pop and movies for each combination to achieve the total costumer utility. !
!
Consumer equilibrium: a situation in which a consumer has allocated all of his or her available income in a way that maximizes his or her total utility, given the prices of goods and services. !
!
Lisa’s equilibrium is at 2 movies 6 pops. Added utilities her to create the total utility is highest with this combination.!
!
Marginal utility per dollar: the marginal utility from a good that results from spending one more dollar on it. -how to interpret the best possible choice. (ex. the increased utility from spending another dollar at the gas pump is the marginal utility per dollar).!
!
One unit from the marginal utility = the marginal unit per dollar. To determine marginal utility per dollar you divide the marginal utility by the cost of the product.!
!
A consumers total utility is maximized by spending all of the available income, and equalizing the marginal utility per dollar for all goods.! -as long as the utility per dollar exceeds the other (between good A and B) there is not a maximized utility (equilibrium) money must be moved from each so that the values are the same. ! If the marginal utility per dollar from movies exceeds the marginal utility per dollar for pop, see less movies and drink more pop.!
!
MUp= utility price of pop! MUm= utility price of pizza! Pp= pop price! Pm= pizza price! maximized if - MUp/Pp = MUm/Pm! Multiply both sides by the price of pop to obtain! MUp=MUm X (Pp/Pm) !
!
-(Pp/Pm) is the ratio of the price of pop to the price of a movie. how much she is foregoing for the other !
!
For lisa when Pm=$8 and Pp=$4 we observe that in a month she goes to the movies twice and buys 6 cases of pop. So we know that her MUp from 6 cases equals her Mum from 2 movies multiplied by $4/$8. That is, for Lisa the marginal utility from 6 cases of pop equals on half of the marginal utility from 2 movies. !
!
Paradox of Value: How can valuable water be so cheap, while a relatively useless diamond is so expensive?!
!
The paradox is resolved by distinguishing through total utility and marginal utility. We use so much water that the benefit from it diminishes to a small value.!
!
Water has a low price, low marginal utility, diamonds have a high price, high marginal utility. ! When the high marginal utility from diamonds is divided by high price of a diamond, the result is a number that equals the low marginal utility from water divided by the low price of water.!
! Questions! !
1) All points within a consumers budget line are affordable, not maximized however.! 2) The principle of diminishing marginal utility means that as consumption of a good increases, total utility increases but at a decreasing rate.! 3) A household is maximizing utility if the marginal utility per dollar spent is equal for all goods and all its income is spent. ! 4) If the marginal utility per dollar is not equal consumer cannot be at equilibrium. Marginal utility ratios will not be consistent however if the prices are different. ! 5) If marginal utility per dollar spent on good X exceeds the marginal utility per dollar spent on good Y, total utility will increase by increasing consumption of good X (to decrease marginal dollar value), and decreasing consumption of Y (to increase marginal dollar value). If marginal gain from an action exceeds marginal loss you take the action.!
!
1) A households consumption choices are determined by prices of goods and services, income, and preferences.! 2) Total utility equals the sum of the marginal utilities of each unit consumed.! 3) Total utility is always increasing when marginal utility is positive. Positive Marginal Utility: All things that people enjoy and want more of have a positive marginal utility. ! 4) According to the principle of diminishing marginal utility, as consumption of a good increases, total utility decreases at an increasing rate.! 5) If a consumer is in equilibrium, total utility is maximized given the consumer’s income and the prices of goods.!
6) Miniskirts: MU/P= 16/4= 4, Law Books= MU/P= 8/2= 4. Marginal Price per dollar is equal at 4, therefore the equilibrium amount of miniskirts is 1.! 7) If potato chips were free, individuals would consume them until the quantity of chips at which marginal utility from chips falls to 0.! 8) In consumer equilibrium, the consumer equates the the marginal utility per dollar spent on each good. Or the highest total utility combination. ! 9) Equilibrium = MUp/P=MUa/P ! 10/.5=5/P! 10/.5=20 (market price per dollar)! must be equal! 5/P must = 5/20 = .25! The banana has half the total utility as the apple, this means the banana must be half the price as well. !
!
10) If marginal cost per dollar of squid is 10 at equilibrium, and no octopus were purchased, then the marginal utility of squid must be at least less then 20 so that the dollars cannot match up. If it was 20 exactly then it would be worth purchasing a squid.!
!
11) If Soula is maximizing her utility and two goods have the same marginal utility she will be willing to pay the same price for both.! 12) the marginal utility of the las purchased beer is greater then the last purchased bubblegum! 13) TU= 8+6+16+12= 42.!
! Chapter 9! !
A households budget line describes the limits to its consumption choices.! Divisible goods can be bought in any quantity desired.!
!
Budget lines are described by Budget Equations.! Expenditure = income! Expenditure is equal of the sum of the price of each good multiplied by the quantity bought.! Ex. Expenditure= (price of pop X quantity of pop) + (price of movie X quantity of movies)= $40!
!
A households real income is its income expressed as a quantity of goods that the household can afford to buy.!
!
Relative Price is the price of one good divided by the price of another. ! The relative price essentially equals the slope of the budget line.! ! When the relative price of something changes on the budget line it rotates.! When income increases the line shifts left, decreases shifts right.!
!
Preference Map: people can sort all the possible combinations of goods into three groups: preferred, not preferred, indifferent.! An indifference curve is a line that shows combinations of goods among which a consumer is indifferent. ! -any combination within the indifference curve is not preferred and outside it is preferred. ! A preference map is a series of indifference curves that allow us to understand somebody's preferences.!
Marginal rate of substitution: the rate at which a person will give up good Y (measured on the Y axis), to get and additional unit of good X (measured on the X axis).! steep difference curve=high substitution.! flat=low substitution! Diminishing marginal rate of substitution: a general tendency for a person to be willing to give up less of good Y to get one more unit of good X, while at the same time remaining indifferent as the quantity of X increases. ! -when two goods are perfect substitutes there indifference curves are straight lines that slope downward. For perfect substitutes the slope is 1.! Compliments produce an L shaped indifference curve. You cannot have one without the other. ex. you want 1 left and right running shoe.!
!
The best point that intersects with the budget line and indifference curve is the best affordable point.!
! demand curve is basically a budget line.! !
Income effect: the effect of a change in income on buying plans. ! budget line shifts when income changes, produces different intersections on the indifference curve.!
!
Price effect: The effect of a change in the price of a good on the quantity of the good consumed.! For a normal good a fall in its price always increases the quantity bought.! The substitution effect is the effect of a change in price on the quantity bought when the consumer remains indifferent between the original situation and the new one. !
!
When the relative price of a good falls the consumer substitutes more of that good for the other good.!
!
Inferior good: A good for which demand decreases as income increases. a fall in price decreases the quantity demanded. !
!
Questions ! 1) The graph of a budget line will be straight. An indifference line will be bowed toward the origin.! 2) at any point on a budget line all income.! 3) Real Income is the amount of goods your income can afford. (ex. 10 cases of pop).! an increase in the price of goods means that real income falls because you can afford less.! 4) an increase in income causes a rightward parallel shift in the budget line.! 5) More of any good is always preferred. Demonstrated in the indifference curve.! 6) Higher indifference curves represent higher levels of satisfaction. ! 7) The principle of diminishing marginal rate of substitution is a general tendency for a person to be willing to give up less of good Y to get one more unit of good X, while at the same time remaining indifferent as the quantity of X increases. ! 8) Perfect substitutes have downward sloping indifference curves.! 9) If an indifference curve is steep, the marginal rate of substitution is high.! 10) The closer two goods are to perfect substitution, the closer the marginal rate of substitution is too being constant.!
11) At the best affordable consumption point of movies and pop, the marginal rate of substitution equals the ratio of the price of movies to the price of pop.! 12) When the relative price of a good decreases ! 13) When the relative price of a good decreases the income effect always leads to increased consumption of that good.! 14) when the price of an inferior good falls, the income effect decreases consumption.!
!
1) 2) 3) 4) 5)
The set of all affordable consumption choices.! Real income is measured in units of goods.! 2X6 =$12 Y=$12. 12/8= $1.5! The budget line depends on income and prices.! Bill consumes apples and bananas. Suppose Bill’s income doubles and the prices of apples and bananas also double. Bill’s budget line will shift right but not change slope.! 6) The relative price is 3/2.! 7) If the price of a good on the vertical axis becomes increases the budget line will become flatter.! 8) If income increases the budget line will d shift right ward but stay parallel to the original budget line.! 9) Y=$40, Pm=$20! 10) The shape of an indifference curve depends on the sustainability between goods for the household.! 11) In general, as a consumer moves down an indifference curve increasing consumption of good X (measured on the horizontal axis). less of Y must be given up for each additional unit -law of diminishing marginal rate of substitution.! 12) Indifference curves bow in towards the origin.! 13) In moving down and indifference curve, the marginal rate of substitution for complements will decrease faster than the MRS for substitutes. ! 14) If two goods are perfect substitutes, their indifference curves are negatively sloped straight lines.! 15) When the price of an inferior good rises, the income effect increases consumption of that good and the substitution effect decreases it.! 16) Point T is preferred to point Q, but T is not affordable.! 17) For rising price the substitution effect always decreases consumption for any good.! 18) point A to C! 19) If the price of a good falls the substitution effect is represented by a movement to a flatter part of the same indifference curve.! 20) Choices changed when preferences changed.! 21) When the price of an inferior good falls, the income and substitution effect both move quantity demanded in opposite directions. The substitution effect is usually larger then the income effect.! 22) For a rise in price, the substitution effect decreases consumption for all goods.!
! Chapter 10! !
Each firm is an institution that hires factors of production and organizes those factors to produce and sell goods and services.! Firm seeks to maximize profit -ultimate goal.! Depreciation is the fall in value of a firms capital!
Economic Profit is equal to total revenue minus total costs. Total costs are the opportunity costs.! A firms opportunity cost of production is the sum of the cost of using resources:! -Bought in the market! -Owned by the firm! -Supplied by the firms owner!
!
Implicit rental rate of capital: The opportunity cost of using capital the firm owns (it is implicitly renting capital from itself). This is measured in two components:! Economic depreciation: The fall in the market value of a firms capital over time.! Foregone Interest: The funds used to buy capital could have been used for some other purpose, and in their next best use, they would have earned interest.!
!
the owner or a hired worker is the entrepreneur: the factor of production that organizes a firm and makes decisions. Entrepreneurs earn Normal Profit: the return. This can be seen as an opportunity cost to the firm itself. !
!
To maximize economic profit, a firm must make five decisions: ! 1) What to produce and in what quantities! 2) How to produce ! 3) How to organize and compensate its managers and workers! 4) how to market and price its products! 5) What to produce itself and buy from others.!
!
Three features limit this maximization: ! 1) Technology constraints (technology: any method of producing a good or service).! 2) Information constraints (firms have limited information).! 3) Market constraints !
!
How firms make decisions..! 2 kinds of efficiency! Technological efficiency: occurs when a firm produces a given output by using the least amount of inputs.! Economic efficiency: occurs when the firm produces a given output at the least cost.! a technologically efficient method is never economically efficient!
!
Firms organize using 2 systems:! command system: a method of organizing production that uses a managerial hierarchy. Commands pass downward through information passes upward. Ex.military system! Incentive system: A method of organizing production that uses a market-like mechanism inside the firm. Incentives to induce workers to perform in ways that maximize the firm’s profit. Ex. commission.!
! Firms use a mixture of commands and incentive. The mixture that maximizes profit.! ! Economists identify 4 market types:! 1) Perfect competition - many firms selling an identical product. Many buyers.!
2) Monopolistic competition - Large number of firms compete by making similar but slightly different products. (called product differentiation). The products don’t have to be different, just perceived as different.! 3) Oligopoly: a market structure in which a small number of firms compete. ! 4) Monopoly: a market structure in which there is only one firm and it. !
! !
Chapter 11! Firms make their decisions based on the market type.! To study the relationship between a firms output decisions and its costs, we distinguish between two time frames:! The Short-run: A time frame in which the quantity of at least one factor of production is fixed. (ex. firms capital, land, etc) -fixed factors of production are defined as the firm’s plant. To increase output here a firm must increase the quantity of a variable factor of production.! Total product: The maximum output that a given quantity of labour can produce. Increase in employment increases total product.! Marginal Product: the increase in total product that results from a 1 unit increase in the quantity of labour employed. Marginal product increases initially then decreases.! Average Product: Tells how productive workers are on average. It is equal to the total product divided by the quantity of labor employed. Also increases initially then decreases.!
!
The Long-run: A period in which the firm can change its plant. The quantities of all factors of production are varied. -decisions not as easily reversed. Once a plant decision is made, firm usually must live with it -non-reversible. This is defined as a sunk cost.!
!
The product curve illustrates the relationship between these 3 concepts as a graph -similar to the PPF. Only points on total product curve are technologically efficient.!
!
Marginal product is also calculated as the slope of the curve.! Every product curve may look different but they share 2 things in common:! 1) Increasing marginal returns initially (marginal product is greater then last)! 2) Diminishing marginal returns eventually (marginal product is less then last)! Diminishing marginal return occurs when the marginal product of an additional worker is less than the marginal product of the previous worker arises from the fact that more workers are using the same capital and working in the same space -counterproductive. !
!
The law of diminishing returns states as a firm uses more of a variable factor of production with a given quantity of the fixed factor of production, the marginal product of the variable factor eventually diminishes. !
!
Firms must employ more labor to produce greater outputs, therefore it must increase costs. ! relationship described by:! Total Cost: the cost of all factors of production it uses.! Total fixed cost: cost of the firms fixed factors. (ex. machines, normal profit).! Total variable cost: cost of the firms variable factors. (ex. labor). changes as output changes.! Total fixed cost + total variable cost = total cost! TC = TFC + TVC!
!
a firms marginal cost is the increase in total cost that results from a one unit increase in output.!
calculated by the total cost divided by the increase in output.! at small outputs, marginal cost decreases as output increases. as marginal cost increases further, marginal cost eventually increases because of law of diminishing returns.!
!
Costs of production! 3 costs of production are:! 1) Average fixed costs: total fixed cost per unit of output! 2) average variable costs: total variable cost per unit of output! 3) average total costs: calculated as TC= TFV + TVC, if you divide each one by the quantity produced you get ATC = AFC + AVC! Average fixed cost declines with increasing input! -When marginal cost is less then average cost, average cost is decreasing. When marginal cost exceeds average cost, average cost is increasing.!
!
Firms spread fixed cost over a larger output and so its average fixed cost decreases! Diminishing returns means that as output increases, ever larger amounts of labor are needed to produce an additional unit of output so as output increases, average variable cost decreases initially but eventually increases.!
!
The position of a firms short-run cost curve depends on 2 factors! Technology -increases marginal product! Prices of factors of production -an increase in fixed costs shifts TFC upward. Increase in variable costs shifts TVC upward. Both cases shift the TC upward.!
!
All short run ATC’s are U-shaped.! For each short-run ATC curve, the larger the plant, the greater is the output at which average total cost is minimum. -they are all u shaped because as the quantity of labour increases, its marginal product initially increases then diminishes. !
!
The economically efficient plant for producing a given output is the one that has the lowest average total cost.!
!
The long-run average cost curve: The relationship between the lowest attainable average total cost and output when the firm can change both the plant it uses and the quantity of labour it employs. -it is a planning curve. ! The piece of each ATC that have the lowest average total costs all form to create the long run average cost curve.!
!
Economies of scale: features of a firms technology that make average total cost fall as output increases. Present when LRAC curve slopes downward.!
!
Diseconomies of scale: features of a firms technology that make average total cost rise as output increases. When present, LRAC slopes upward.!
!
Constant Returns to scale: features of a firms technology that keep average total cost constant as output increases. LRAC is horizontal when present.!
!
A firms minimum efficient scale is the smallest output at which long-run cost reaches its lowest level. !
When minimum efficient scale is small relative to market demand, the market has room for many firms and is competitive.! When large relative to market demand only a small number of firms (possibly only 1) can make a profit and the market is either in oligopoly or a monopoly.!
! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! !
!
