TOPICS 1: INTRODUCTION
TOPICS 1: INTRODUCTION Economics: study of how society manages its scarce resources Scarcity- the limited nature of society’s resources INTRODUCTORY ISSUES: SEVEN LESSONS FROM MICROECONOMICS 1.
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People face trade-offs: to get one thing, we have to give up another thing Efficiency vs equity trade-off o Efficiency: society gets the most it can from its scarce resources o Equity: benefits of these resources are distributed fairly among members of society – difficult to measure Opportunity costs: the cost of the next best alternative forgone Knowing this allows us to see whether we are using this resource in the most efficient way E.g seeing a movie: cost of the ticket & the time spent seeing the movie (working, at home) Rational people think at the margin Individual/firm can weigh up the costs/benefits associated with any decision and choose the option that maximises the net benefit Marginal changes are small incremental adjustments to an existing plan of action People make decisions by comparing costs & benefits at the margin People respond to incentives: Incentive: something that induces a person to act, prospect of reward/punishments (rational) Important in analysing how markets work & why public policies are working/failing – taxes/externalities, how people will respond to the incentives Trade can make everyone better off: gains from trading Markets are a good way to organise activity: Market economy: an economy that allocates resources through the decentralised decisions of many firms and households as they interact in markets Firms decide who to hire & what to produce, households decide what to buy & who to work for Invisible hand: buyers and sellers freely interacting in a market economy will create an outcome that allocates g/s to those people who value them the most and makes the best use of our scarce resources. Prices guide decision makers to outcomes that tend to maximise the welfare of society as a whole buyers and sellers act in their own interest but end up unknowingly taking into account the social costs of the actions. Governments can sometimes improve market outcomes: can intervene to produce the socially efficient outcome, the invisible hand can only work if the gov enforces rules and maintains the institutions that are key to a market economy. markets work only if property rights are enforced.
Productivity: the quantity of g/s produced from each hour of a workers time leads to higher standards of living Phillips curve: the short term trade-off between inflation and unemployment: are negatively related in the short term, reducing inflation entails costs to society in the form of higher unemployment as prices are slow to adjust (sticky)
TOPIC 2.2: SUPPLY: Supply: the amount of a g/s the producers are willing and able to sell at a particular price at a particular point in time The relationship between price & quantity of a g/s supplied Why does it slope upwards? The curve slopes upward because when the price is high even more expensive production becomes profitable, therefore suppliers supply more output to the market Law of supply: as the price of a g/s rises, the quantity supplied will also rise, ceteris parabis (positive relationship) Factors affecting supply: Price =movement along the curve Non price factors shift Price of inputs Price of related goods Technology Expectations of prices. E.g deliberately decrease supply if expect price to rise in the future Natural disasters (weather)
SUPPLY CURVE
The increase in price acts as a signal to firms to allocate more resources As price rises, producers are willing to supply more Reflects higher (marginal costs) of producing more, > revenues
Law of supply & demand: the claim that the price of any good adjust to the bring the supply and demand for that good into balance Shifts in curves versus movements along curves: A shift in the supply curve is called a ‘change in supply’ A movement along the supply curve is called ‘change in quantity supplied’
TOPIC 2.3 MARKET EQUILBIRUM MARKET EQUILIBRIUM: Occurs when the demand curve and the supply curve intersect (market-clearing price) Market: a mechanism that co-ordinates the independent intentions of buyers & sellers. No pressure for change in price.
SURPLUS CURVE (S> D)
SHORTAGE CURVE (D>S)
-Consumers are willing to buy 10 units of this good & sellers are willing to sell 40 units surplus of 30 units. -Downwards pressure on price, as price falls the quantity demanded increases until we reach equilibrium. expansion along demand, contraction along supply
-Consumers are willing to buy 26 units, suppliers willing to sell 8 results in a shortage -Upwards pressure on prices, which induces more firms to supply more. -As prices increase, the quantity demanded will decrease until we reach equilibrium. expansion along supply, contraction along demand
PRODUCTION THEORY
The organisation of resources is directed (largely) by firms
FIRMS: Economic units formed by profit-seeking people. They employ resources to produce g+s for sale. Help reduce transaction costs we let firms do things that would take us a long time + money Assume that the over-riding goal of firms is to maximise profit. P = TR – TC COSTS: All resources have an opportunity cost Explicit costs: opportunity costs of resources that take the form of a cash payment. E.g computers Implicit costs: the OC of a firm using its own resources (or those provided by its owners) without a corresponding cash payment. E.g owner’s time (could be working for another firm earning a wage) ECONOMIC PROFIT= TR – explicit costs – implicit costs Economists also subtract those opportunity costs that don’t have an explicit monetary value (next best alternative e) + economic profit: signal that the firms are doing very well – better than anywhere else, employing resources in the optimal manner PRODUCTION THEORY: looks at the relation between output & inputs necessary for production of that output Inputs (factors of production): land, labour, capital, entrepreneurship (profit) Short run: a period of time during which at least one of the factors of production are fixed (typically capital) e.g a manufacturing firm in the short run can vary its labour quickly, but takes a long time to increase capital Long run: the period of time needed for all factors of production to become variable LAW OF DIMINISHING MARGINAL RETURNS: short run concept in that we hold at least one factor constant. As long as one of the factors of production is fixed, output must eventually increase by smaller and smaller amounts when added to fixed factor. In the SR, with one input fixed (K) and one variable (L) we can plot how total product (TP) changes as we add more of the variable input (L). Assumption that labour is homogenous (same skills) MARGINAL PRODUCT (MP): the increase in output that arises from an additional unit of input
Explains what happens to output when we add units of input to production Increasing returns: Holding K constant, output will at first increase by increasing amounts as labour is added Diminishing returns: after some point, labour will increase output, but by smaller amounts
PRODUCTION FUNCTION: relationship between quantity of inputs used to make a good and the quantity of output of that good TOTAL COST CURVE: shows the relationship between the quantity of output produced and total cost of production
PRODUCTION IN THE LONG RUN:
MONOPOLY CHARACTERISTICS: 1. One firm- many buyers 2. Barriers to entry 3. Resource mobility and market info may be influenced by the monopolist 4. No close substitutes for the product 5. Monopolist aims to maximise profit WHERE THEY COME FROM? Barriers to entry: 1. Government regulation: Gov gives a single firm the exclusive right to produce some g/s Patents & copyright incentives – public franchise ( exclusive provider) 2. Monopoly resources: One firm has control of a key resource material necessary to produce a good Firm controls some non-reproducible resource critical to production, e.g BHP 3. There are many important networking externalities in supplying the g+s Getting a ‘critical scale’ of users make entry difficult for other firms, e.g windows, facebook 4. The production process: Economies of scale are so large that one firm has a natural monopoly, e.g gas, NBN Natural monopoly: a monopoly that arises because a single firm can supply a g/s to an entire market at a smaller cost than two or more firms could.
MONOPOLY VS COMPETITION: Key difference is the monopoly’s ability to influence the price of its output, by adjusting the quantity it supplies to the market. Competitive firm faces a horizontal demand curve: as it can sell as much or as little it wants as this price, the demand cruve that any one firm faces is perfectly elastic As the monopoly is the sole producer in its market, its demand curve is the market demand curve (downwards sloping) REVENUE AND THE MONOPOLIST Because the monopolist supplies the entire market, the market demand curve is also the demand curve faced by the monopolist Implications: if the monopolist wishes to ↑ production, it must lower its price not just for the additional units, but for all units Effects: o Output effect: Gain in revenue from selling more output o Price effect: Loss in revenue from selling each unit at a lower price MR is the extra revenue from selling one more unit of output (net effect) Marginal revenue is always less than the price of the good as it faces a downwards sloping demand curve MR is negative when the price effect > output effect ECONOMIC PROFIT: SHORT RUN:
Profit max: MR = MC Consumers pay P1, max level of output at Q1 Profit = (P- ATC) x Q
LONG RUN: 1. Because of barriers to entry, the distinction between the long and short run for a monopolist is not as revelantmonopolists can enjoy positive economic profits indefinitely 2. Cannot ‘charge what they like’ – constrained by the demand for their product, as well as their cost
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5. 6.
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People face trade-offs: to get one thing, we have to give up another thing Efficiency vs equity trade-off o Efficiency: society gets the most it can from its scarce resources o Equity: benefits of these resources are distributed fairly among members of society – difficult to measure Opportunity costs: the cost of the next best alternative forgone Knowing this allows us to see whether we are using this resource in the most efficient way E.g seeing a movie: cost of the ticket & the time spent seeing the movie (working, at home) Rational people think at the margin Individual/firm can weigh up the costs/benefits associated with any decision and choose the option that maximises the net benefit Marginal changes are small incremental adjustments to an existing plan of action People make decisions by comparing costs & benefits at the margin People respond to incentives: Incentive: something that induces a person to act, prospect of reward/punishments (rational) Important in analysing how markets work & why public policies are working/failing – taxes/externalities, how people will respond to the incentives Trade can make everyone better off: gains from trading Markets are a good way to organise activity: Market economy: an economy that allocates resources through the decentralised decisions of many firms and households as they interact in markets Firms decide who to hire & what to produce, households decide what to buy & who to work for Invisible hand: buyers and sellers freely interacting in a market economy will create an outcome that allocates g/s to those people who value them the most and makes the best use of our scarce resources. Prices guide decision makers to outcomes that tend to maximise the welfare of society as a whole buyers and sellers act in their own interest but end up unknowingly taking into account the social costs of the actions. Governments can sometimes improve market outcomes: can intervene to produce the socially efficient outcome, the invisible hand can only work if the gov enforces rules and maintains the institutions that are key to a market economy. markets work only if property rights are enforced.
Productivity: the quantity of g/s produced from each hour of a workers time leads to higher standards of living Phillips curve: the short term trade-off between inflation and unemployment: are negatively related in the short term, reducing inflation entails costs to society in the form of higher unemployment as prices are slow to adjust (sticky)
TOPIC 2.2: SUPPLY: Supply: the amount of a g/s the producers are willing and able to sell at a particular price at a particular point in time The relationship between price & quantity of a g/s supplied Why does it slope upwards? The curve slopes upward because when the price is high even more expensive production becomes profitable, therefore suppliers supply more output to the market Law of supply: as the price of a g/s rises, the quantity supplied will also rise, ceteris parabis (positive relationship) Factors affecting supply: Price =movement along the curve Non price factors shift Price of inputs Price of related goods Technology Expectations of prices. E.g deliberately decrease supply if expect price to rise in the future Natural disasters (weather)
SUPPLY CURVE
The increase in price acts as a signal to firms to allocate more resources As price rises, producers are willing to supply more Reflects higher (marginal costs) of producing more, > revenues
Law of supply & demand: the claim that the price of any good adjust to the bring the supply and demand for that good into balance Shifts in curves versus movements along curves: A shift in the supply curve is called a ‘change in supply’ A movement along the supply curve is called ‘change in quantity supplied’
TOPIC 2.3 MARKET EQUILBIRUM MARKET EQUILIBRIUM: Occurs when the demand curve and the supply curve intersect (market-clearing price) Market: a mechanism that co-ordinates the independent intentions of buyers & sellers. No pressure for change in price.
SURPLUS CURVE (S> D)
SHORTAGE CURVE (D>S)
-Consumers are willing to buy 10 units of this good & sellers are willing to sell 40 units surplus of 30 units. -Downwards pressure on price, as price falls the quantity demanded increases until we reach equilibrium. expansion along demand, contraction along supply
-Consumers are willing to buy 26 units, suppliers willing to sell 8 results in a shortage -Upwards pressure on prices, which induces more firms to supply more. -As prices increase, the quantity demanded will decrease until we reach equilibrium. expansion along supply, contraction along demand
PRODUCTION THEORY
The organisation of resources is directed (largely) by firms
FIRMS: Economic units formed by profit-seeking people. They employ resources to produce g+s for sale. Help reduce transaction costs we let firms do things that would take us a long time + money Assume that the over-riding goal of firms is to maximise profit. P = TR – TC COSTS: All resources have an opportunity cost Explicit costs: opportunity costs of resources that take the form of a cash payment. E.g computers Implicit costs: the OC of a firm using its own resources (or those provided by its owners) without a corresponding cash payment. E.g owner’s time (could be working for another firm earning a wage) ECONOMIC PROFIT= TR – explicit costs – implicit costs Economists also subtract those opportunity costs that don’t have an explicit monetary value (next best alternative e) + economic profit: signal that the firms are doing very well – better than anywhere else, employing resources in the optimal manner PRODUCTION THEORY: looks at the relation between output & inputs necessary for production of that output Inputs (factors of production): land, labour, capital, entrepreneurship (profit) Short run: a period of time during which at least one of the factors of production are fixed (typically capital) e.g a manufacturing firm in the short run can vary its labour quickly, but takes a long time to increase capital Long run: the period of time needed for all factors of production to become variable LAW OF DIMINISHING MARGINAL RETURNS: short run concept in that we hold at least one factor constant. As long as one of the factors of production is fixed, output must eventually increase by smaller and smaller amounts when added to fixed factor. In the SR, with one input fixed (K) and one variable (L) we can plot how total product (TP) changes as we add more of the variable input (L). Assumption that labour is homogenous (same skills) MARGINAL PRODUCT (MP): the increase in output that arises from an additional unit of input
Explains what happens to output when we add units of input to production Increasing returns: Holding K constant, output will at first increase by increasing amounts as labour is added Diminishing returns: after some point, labour will increase output, but by smaller amounts
PRODUCTION FUNCTION: relationship between quantity of inputs used to make a good and the quantity of output of that good TOTAL COST CURVE: shows the relationship between the quantity of output produced and total cost of production
PRODUCTION IN THE LONG RUN:
MONOPOLY CHARACTERISTICS: 1. One firm- many buyers 2. Barriers to entry 3. Resource mobility and market info may be influenced by the monopolist 4. No close substitutes for the product 5. Monopolist aims to maximise profit WHERE THEY COME FROM? Barriers to entry: 1. Government regulation: Gov gives a single firm the exclusive right to produce some g/s Patents & copyright incentives – public franchise ( exclusive provider) 2. Monopoly resources: One firm has control of a key resource material necessary to produce a good Firm controls some non-reproducible resource critical to production, e.g BHP 3. There are many important networking externalities in supplying the g+s Getting a ‘critical scale’ of users make entry difficult for other firms, e.g windows, facebook 4. The production process: Economies of scale are so large that one firm has a natural monopoly, e.g gas, NBN Natural monopoly: a monopoly that arises because a single firm can supply a g/s to an entire market at a smaller cost than two or more firms could.
MONOPOLY VS COMPETITION: Key difference is the monopoly’s ability to influence the price of its output, by adjusting the quantity it supplies to the market. Competitive firm faces a horizontal demand curve: as it can sell as much or as little it wants as this price, the demand cruve that any one firm faces is perfectly elastic As the monopoly is the sole producer in its market, its demand curve is the market demand curve (downwards sloping) REVENUE AND THE MONOPOLIST Because the monopolist supplies the entire market, the market demand curve is also the demand curve faced by the monopolist Implications: if the monopolist wishes to ↑ production, it must lower its price not just for the additional units, but for all units Effects: o Output effect: Gain in revenue from selling more output o Price effect: Loss in revenue from selling each unit at a lower price MR is the extra revenue from selling one more unit of output (net effect) Marginal revenue is always less than the price of the good as it faces a downwards sloping demand curve MR is negative when the price effect > output effect ECONOMIC PROFIT: SHORT RUN:
Profit max: MR = MC Consumers pay P1, max level of output at Q1 Profit = (P- ATC) x Q
LONG RUN: 1. Because of barriers to entry, the distinction between the long and short run for a monopolist is not as revelantmonopolists can enjoy positive economic profits indefinitely 2. Cannot ‘charge what they like’ – constrained by the demand for their product, as well as their cost
