Glossary of Joab Microeconomics Corey Final
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- 4 pitfalls of economic thinking
- 1. Violation of the ceteris paribus principle
2. The belief that good intentions equal desirable outcomes.
3. The belief that association is causation
4. The fallacy of composition
- The 8 guideposts to economic thinking
- 1. Resources are scarce, so decision makers must make tradeoffs (Know the concept of opportunity cost)
2. Individuals are rational: They try to get the most from their limited resources
3. Incentives matter
4. Individuals make decisions at the margin
5. Information helps us make better choices but is costly
6. Beware of secondary effects
7. The value of a good or service is subjective
8. The test of a theory is its ability to predict
- Economics is the study of...
- how we make choices under scarcity
- Positive vs. Normative economic statements
- Positive are testable, Normative are not.
Positive- Jessie is a cat.
Normative- Everyone in the world loves chocolate.
- The concept that there is less of a good freely available from nature than people would like.
ex. time, money, cars, etc.
- 3 Types of Resources
- 1. Human resources (human capital)
2. Physical resources (physical capital)
3. Natural resources
Capital: Human-made resources used to produce other goods and services.
- Voluntary trade creates....
- Transaction costs
- The time, effort, and other resources needed to search out and complete an exchange.
- Importance of middlemen
- A person who buys and sells goods or services or arranges trades. A middleman reduces transaction costs.
- Importance of Property Rights
- Private property rights involve:
1. The right to exclusive use of the property
2. Legal protection against invasion from other individuals
3. The right to sell, transfer, exchange, or mortgage the property
- 4 Incentives of property rights
- 1. Incentive to use resources in ways that are considered beneficial to others.
ex. Empty lot
2. Private owners have an incentive to care for and manage what they own
ex. How do you drive a rental car compared to your own car?
3. Private owners have an incentive to conserve for the future
ex. Popcorn at the movies
4. Private owners have an incentive to make sure their property does not damage your property
- The PPC...
- outlines all possible combinations of total output that could be produced, assuming a:
1. fixed amount of productive resources
2. given amount of technical knowledge
3. full and efficient use of resources
- 4 factors that shift the PPC
- 1. A change in the economy’s resource base
2. Changes in technology
3. A change in the rules under which the economy functions
4. Changes in work habits
- The law of comparative advantage
- The total output of a group of individuals, an entire economy, or a group of nations will be greatest when the output of each good is produced by whoever has the lowest opportunity cost.
- 3 questions every economy faces
- 1. What will be produced?
2. How will it be produced?
3. For whom will it be produced?
- Fundamentals of Consumer choice
- 1. Limited income necessitates choice
2. Consumers make decisions purposefully
3. One good can be substituted for another
4. Consumers must make decisions without perfect information
5. The law of diminishing marginal utility applies to consumption
- The law of diminishing utility
- as the consumption of a product increases, the marginal utility derived from additional consumption will eventually decline (banana eating contest)
- Consumer equilibrium
- consumers maximize utility by spending their money on what makes them happiest until they are equally happy wherever they spend their next dollar.
- Substitution effect
- the good has become cheaper relative to other goods
- Income effect
- its as if your real income has increased (you can buy more of the good)
- The Market Demand Curve
- The market demand curve is the horizontal sum of the individual demand curves
Ex. Mario and Luigi
- Price Elasticity of Demand
- >1: elastic
=1: unitary elastic
- Determinants of Price Elasticity of Demand
- 1. The most important determinant of the price elasticity of demand is the availability of substitutes
Good Substitutes = Higher Elasticity
2. Products share of the consumers total budget
- Elasticity and Total Revenue.
- 1. Inelastic: The price effect dominates
2. Elastic: The quantity effect dominates
3. Unitary elastic: the effects are the same (no change in total revenue)
- Income Elasticity and types of goods.
- 1. Normal good: positive income elasticity
Necessity: income elasticity is between 0 and 1
Luxury: income elasticity is greater than 1
2. Inferior good: negative income elasticity
- Working at less than the expected rate of productivity, which reduces output.
- Principle-agent problem
- The incentive problem that occurs when the purchaser of services lacks full information about the circumstances faced by the seller, and therefore, cannot know how well the seller performs the service.
- 3 Types of business firms
- 1. Proprietorship: a business firm owned by a single individual.
2. Partnership: A business firm owned by two or more individuals
3. Corporation: A business firm owned by shareholders
- Implicit vs. Explicit costs
- 1. Explicit Costs: The payments a firm makes to purchase the goods and services of productive resources.
2. Implicit Costs: The opportunity costs associated with the firm’s use of resources that it owns
ex. Foregone interest, foregone rent
- Economic vs. Accounting profit
- Economic Profit: The difference between the firms total revenue and its total costs (including both explicit and implicit costs)
Accounting Profit: The sales revenue minus the expenses of the firm (does not usually include implicit costs)
- Short run vs. Long run
- Short Run: A time period so short that a firm is unable to vary some of its factors of production.
Long Run: A time period long enough to allow the firm to vary all of its factors of production.
- Calculate price elasticity of demand
- Price elasticity of demand indicates how responsive consumers are to a change in the products price.
Price elasticity of demand = %∆QD / %∆P
- Income Elasticity of Demand
- Income elasticity measures the responsive-ness of the demand for a good to a change in income.
Income elasticity = %∆QD / %∆I
- Price Elasticity of Supply
- Price elasticity of supply measures how responsive suppliers are to a change in price
Price elasticity of supply = %∆QS / %∆P
- TC; TFC; AFC; TVC; AVC; ATC; TC; MC; AP
- Total Costs: The costs (both explicit and implicit) of all of the resources used by the firm
Total Fixed Costs: Total Fixed Costs (TFC): The sum of the costs that do not vary with output
Average Fixed Costs (AFC): Total Fixed Costs divided by the number of units produced
AFC = TFC / Q
Total Variable Costs (TVC): The sum of those costs that change with output
Average Variable Costs (AVC): Total variable costs divided by the number of units produced
AVC = TVC / Q
TC = TFC + TVC
Average Total Costs (ATC): Total Cost divided by the number of units produced
ATC = TC / Q
ATC = AFC + AVC
Marginal Costs (MC): The change in total costs required to produce an additional unit of output.
Average Product (AP): The total product divided by the number of variable units (labor) used to get that total product
AP = TP / Q
- Why are cost curves shaped the way they are?
- Remember that ATC is U-shaped Remember that AFC falls with output AVC is a small part of ATC when output is small and a LARGE part of ATC when output is LARGE MC curve may decrease at first, but then rises MC < AVC (ATC) → AVC (ATC) decreases MC > AVC (ATC) → AVC (ATC) increases AVC>
- Law of diminishing returns
- As more and more units of a variable resource are applied to a fixed amount of other resources, output will eventually increase by smaller and smaller amounts
- Sunk costs
- Sunk Costs: Costs that have already been incurred as a result of past decisions
- Characteristics of Price Taker markets
- 1. There are a large number of firms in the market
2. Each firm produces identical products
3. Their output is small relative to the total market
4. They are able to sell all of their output at the market price
5. There are no barriers to entry or exit of firms in the market
- Price Searchers vs. Price Taker Markets
- Price Takers: The sellers who must take the market price in order to sell their product
Price Searchers: firms that choose the price they charge for their product, but the quantity they are able to sell is inversely related to price
- Why price takers demand curves are perfectly elastic
- The market forces of supply and demand determine price.
Price takers have no control over this price, so the demand for the product of the firm is perfectly elastic
- The profit maximizing rule
- Calculate Marginal Revenue
- Marginal Revenue (MR): The change in total revenue derived from the sale of one additional unit of a product
For a price taker:
Marginal Revenue (MR) = Price (P)
- Remaining open in the Short-Run...or not.
- A firm making losses will remain open in the short run if:
1. It can cover its variable costs now
2. Expects price to be high enough in the future to cover all of its costs
Otherwise, it will shut down.
- Entry and Exit in the Long Run
- 1. If firms are making an economic profit: New firms will enter and drive price down
2. If firms are making an economic loss: Firms will leave the market and drive price up
- TOTAL REVENUE AND TOTAL COSTS AND PROFIT
- TR= PxQ
- Contestable Markets
- Contestable markets are markets in which firms can enter and exit with minimal risk
Ex. an airline route
- Bundling: the sale of two or more goods and services together.
Ex. extra value meal
- Price Discriminations and 2 steps to effectively practice it.
- A practice whereby a seller charges different consumers different prices for the same product or service.
1. Identify and separate at least two groups with different elasticities of demand
2. Prevent those who buy at the low price from reselling to those who buy at the high price.
- the act of making the purchase of one good conditional on the purchase of a second good
Ex. hospital room
- Causes of High Barriers to entry
- 1. Economies of scale
2. Government licensing and other barriers to entry
4. Control over an essential resource
- Characteristics of a Monopoly
- 1. High barriers to entry
2. A single seller of a well-defined product that has no good substitutes
- Oligopoly and the characteristics of them
- a market that consists of a small number of sellers
Ex. automobiles, crude oil, tennis balls, etc.
1. A small number of rival firms
2. Interdependence among the sellers
3. High barriers to entry in the market
(Substantial economies of scale)
- Dominant Strategy and Game theory
- DS: A strategy that is best for a player in a game regardless of the strategies chosen by other players
GT: the analysis of strategic choices made by competitors in a conflict situation.
- Collusion and obstacles
- the agreement among firms to avoid competitive practices.
Firms will agree to limit output and keep prices high.
1. Collusion is more difficult the more firms there are in the market.
2. It is difficult to detect and eliminate price cuts
3. Low barriers to entry
4. Unstable Demand Conditions
5. Antitrust laws
A. Sherman Antitrust Act (1890)
B. Clayton Act (1914)
- Problems with High barriers to entry
- 1. The discipline of market forces is weakened
2. Reduced competition results in inefficiency
3. Resources will be wasted by firms attempting to maintain grants of protection
- Potential Solutions to High Barriers to Entry
- 1. Antitrust legislation
2. Reduce artificial barriers that limit competition
3. Regulate the price and output of firms in the market
Does not work because:
Lack of Information
Regulators may become biased
4. Government produces the goods and services instead of the private sector
- Marginal Revenue Product
- The change in total revenue of a firm that results from the employment of one additional unit of a resource.
MRP = Marginal Revenue x Marginal Product
- Value Marginal Product
- The marginal product of a resource multiplied by the selling price of the product it helps produce
VMP = Price x Marginal Product
- VMP AND MRP for Price Takers and Price Searchers
- For Price Takers: VMP = MRP
For Price Searchers: VMP > MRP
- Cost Minimization
- Factors of production will be employed such that the marginal product per last dollar spent on each factor is the same for all factors
- The school you attend, the degree you get, the classes you take, your GPA, your internship experience, are all signals about yourself that you send to other people (including potential employers)
- Sources of Earning Differences
- 1. Worker productivity and specialized skills
2. Worker preferences
3. Employment discrimination
4. Immobility of labor
5. cost of living differences
- Isolate employment discrimination
- 1. Adjust for differences between groups in education, experience, and other productivity related factors
2. Make comparisons between similarly qualified groups of employees who differ only in regard to race (or gender or whatever you are testing).
- Consumer surplus
- The difference between the maximum amount consumers would be willing to pay and the amount that they actually pay.
Consumer surplus is the area below the demand curve but above the price.
- change in quantity demanded vs. change in demand
- QD: a movement along the curve
D: shift of the curve itself
- Shifters of Demand
- 1. Change in consumer income
a: normal goods
b: inferior goods
2. Change in the number of consumers
3. Change in the price of a related good
4. Change in expectations
a: expected price
b: expected income
5. Change in consumer tastes and preferances
- Producer surplus
- The difference between the minimum price suppliers are willing to accept and the price they actually receive.
Producer surplus is the area above the supply curve but below price.
- Shifters of Supply
- 1. A change in resource price
2. Change in technology
3. change in nature of politics
4. change in taxes
- Everything there is to know about market equilibrium
- 1. All trades generating more benefits than costs are undertaken
2. No trades generating more costs than benefits are undertaken
3. The combined area of producer and consumer surplus in maximized
4. There is no excess supply or excess demand
- Labor Market
- Price for labor is called the wage (W)
Quantity of labor is called employment (E)
- Price floor
- Price floor: A legally established minimum price buyers must pay for a good or resource
A price floor above equilibrium price creates a surplus
A price floor below equilibrium price does nothing
- Price ceiling
- A legally established maximum price sellers can charge for a good or resource
A price ceiling below market equilibrium price creates a shortage
A price ceiling above market equilibrium price does nothing
- Impact of a tax
- Raises the price that buyers pay
Reduces the amount sellers receive
Reduces the quantity sold
Increases government revenue
Creates deadweight loss
- Deadweight loss
- The loss to society that results from the loss of gains to trades that do not occur because a tax was imposed.
- Average Tax Rate
- the percentage of income paid in taxes
ATR = tax liability / taxable income
- 3 Tax systems
- 1. Progressive tax: average tax rate rises with income
2. Regressive tax: average tax rate falls with income
3. Proportional tax: average tax rate is the same at all income levels
- Marginal Tax Rate
- The additional tax liability a person faces divided by his or her additional taxable income.
MTR = change in tax liability / change in taxable income
- A payment the government makes to either the buyer or seller when a good or service is purchased or sold.
ex. Subsidizing home gyms
*Note: Subsidies are costly
- Role of government
- 1. Protect individuals and their property rights
2. Provide goods that cannot be easily provided by the market (overcome market failure)
- 4 types of market failure
- Lack of Competition
Lack of information
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