Review Notes – Scarcity, Opportunity Costs, and Basic Economic Questions
ខែវិច្ឆិកា 13, 2008 ដោយ limchheng
- What is Economics?
- Basic Economic Questions.
- what?, how?, who?, when?
- Definition of Terms.
- opportunity cost
- scarcity.
- efficiency.
Review Notes – The Production Possibility Model
- assumption of the model
- scarcity
- understanding the model
- what does the frontier represent/how does it divide up the production space?
- how does the frontier move?
- increase or decrease in technology?
- increase or decrease in resources?
- how is opportunity costs demonstrated in the model?
- What does the model show?
- Scarcity
- Technological efficiency and inefficiency
- Unemployment and full employment of resources
- Opportunity cost
- Law of diminishing returns/law of increasing (opportunity) costs (what is the difference between the two?)
- How choices made today affect future production possibilities
Review Notes – The Market
- Specialization and Exchange
- advantages of specialization of labor
- why do we have exchange? under what conditions?
- systems of exchange
- Definitions
- the market?
- an economy?
- Actors in the Market
- households
- firms
- government
- what do each of the actors in the market do? What assumptions are made about their behavior?
- interrelationships
- circular flow model of an economy
- what are factor markets?
- what are goods and services markets?
- who owns factors of production?
- etc.
Review Notes – Demand and Supply
- Demand Defined
- definition
- the law of demand (as P increases => Qd decreases)
- Why?
- substitution effect
- income effect
- absolute vs. relative price for the law of demand
- market demand
- Other influences on Demand
- tastes and preferences: as they increase => D increases and reverse
- income (Y)
- normal goods: as Y increases => D increases and reverse
- inferior goods: as Y increases => D decreases and reverse
- the price of related goods
- substitutes in consumption: as Ps increases => D increases and reverse
- complements in consumption: as Pc increases => D decreases and reverse
- the number of demanders (buyers) in a market: as # increases => D increases and reverse
- expectations about the future: if expect P increase in the future => D increases in the present and vice versa
- Change in Demand (D) vs. change in Quantity Demanded (Qd)
- Supply Defined
- definition
- the law of supply (as P increases => Qs increases )
- market supply
- Other influences on Supply (besides the good’s own price)
- costs of production: as costs increases => S decreases and reverse
- technology: as tech. increases => costs decrease and reverse
- input prices: as input prices increases => costs increase and reverse
- the price of related goods
- substitutes in production: as Ps increases => S decreases and reverse
- complements in production: as Pc increases => S increases and reverse
- the number of suppliers (firms) in a market: as # increases => S increases and reverse
- expectations about the future: if expect P increases in the future => S decreases in the present and vice versa
- Change in Supply (S) vs. change in Quantity Supplied (Qs)
- Demand and Supply as flow variables (vs. stock variables)
Review Notes – Market Equilibrium and Applications
- Market equilibrium
- Definitions
- equilibrium
- stable equilibrium
- How does the market attain equilibrium?
- excess demand or a shortage
- price competition among consumers
- excess supply or a surplus
- price competition among suppliers
- Predictions about equilibrium P and Q
- increase in D => what happens to equilibrium P and Q?
- decrease in D => what happens to equilibrium P and Q?
- increase in S => what happens to equilibrium P and Q?
- decrease in S => what happens to equilibrium P and Q?
- increase in D and increase in S => what happens to equilibrium P and Q?
- increase in D and decrease in S => what happens to equilibrium P and Q?
- decrease in D and increase in S => what happens to equilibrium P and Q?
- decrease in D and decrease in S => what happens to equilibrium P and Q?
- Applications
- Price Ceilings
- definition
- what is an effective price ceiling?
- equilibrium
- enforceable price ceilings?
- black markets
- cheating by suppliers
- Price Floors
- definition
- what is an effective price floor?
- equilibrium
- supporting an effective price floor
- government subsidies
- what is the effect if price floor is not supported?
Review Notes – Elasticity
- Definition of 4 different types
- Price Elasticity of Demand (n)
- Price Elasticity of Supply (ns)
- Income Elasticity of Demand (ny)
- Cross Elasticity of Demand (nx,y)
- Interpretation of size and sign of the elasticity coefficient for each type of elasticity.
- sign
-n < or = 0 always;
reflects the law of Demand (as P increases => Qd decreases)
-ns > or = 0 always;
reflects the law of Supply (as P increases => Qs increases)
-ny;
if ny > 0 => as income increases, Qd increases => the good is normal.
if ny < 0 => as income increases, Qd decreases => the good is inferior.
-nx,y;
if nx,y > 0 => as Px increases Q increases => x and y are substitutes.
if nx,y < 0 => as Px increases Q decreases => x and y are complements.
if nx,y = 0 => as Px increases Q is constant => x and y are unrelated.
- size
-n;
if n > 1 => D is price elastic (% change in Qd > % change in P).
if n < 1 => D is price inelastic (% change in Qd < % change in P).
if n = 1 => D is unitarily elastic (% change in Qd = % change in P).
relationship between price elasticity of demand and total revenue?
- when demand is elastic?
- when demand is inelastic?
- when demand is unitary?
- what causes a Demand curve to be more or less elastic?
-ns;
if ns > 1 => S is price elastic (% change in Qs > % change in P).
if ns < 1 => S is price inelastic (% change in Qs < % change in P).
if ns = 1 => S is unitarily elastic (% change in Qs = % change in P).
-ny;
if |ny| > 1 => D is income elastic (|% change in Qd| > |% change in Y|).
if |ny| < 1 => D is income inelastic (|% change in Qd| < |% change in Y|).
if ny > 1 => the good is a luxury.
if 0 < ny < 1 => the good is a necessity.
-nx,y;
if nx,y > 0 => as nx,y increases x and y become closer substitutes.
if nx,y < 0 => as nx,y decreases (increases in absolute value) x and y become closer complements.
- Elasticity and taxes.
- when do consumers bear more of the burden of the tax?
- when do suppliers bear more of the burden of the tax?
Review Notes – The Firm and Production
- Organization of the firm.
- Single Proprietorship – Advantages and Disadvantages.
- Partnership – Advantages and Disadvantages.
- Corporation – Advantages and Disadvantages.
- Definitions.
- Production function, Q = f(K, L, N, E). What does it mean?
- When does production occur? When goods are transformed to make them more valuable in form, place, possession, or time.
- short-run = a period of time during which a least one input is fixed.
- long-run = a period of time during which all inputs are variable.
- very long-run = a period of time during which all inputs are variable as is technology.
- Economic costs of production.
- explicit costs = require direct payments for inputs.
- implicit costs = the opportunity cost of inputs which do not require direct payments like lost wages, interest, rent, etc.
- total costs = explicit costs + implicit costs.
- Profits.
- Accounting profit = total revenue – explicit costs.
- Economic profit = total revenue – total costs (explicit + implicit costs).
- “Normal” profit = implicit costs (what a business would normally need to make in accounting profits to just stay in business. Thus, when accounting profits are normal economic profit = 0).
Review Notes – Short-Run Production and Costs
- Short-Run Production.
- Definitions.
- Total Product of Labor (TPL), what does it look like in a graph?
- MPL = change in TPL(change in Q) ÷ change in L. What is MPPL? What is the relationship between TPL and MPPL?
- APL = TPL(Q) ÷ L. What is APPL. What is the relationship between MPL and APL?
- The law of diminishing marginal productivity – As the use of labor increases in the short-run, ceterus paribus, the output produced by the last worker hired must eventually fall – why is this true?
- Graphs and the relationship between the graphs.
- Short-Run Costs.
- Definitions.
- Total Fixed Cost (TFC) = the cost of all inputs which are fixed in the short run => TFC does not vary as Q changes.
- Total Variable Cost (TVC) = wage (w) * Labor (L) = wL.
- Total Cost (TC) = TVC + TFC.
- Marginal Cost = change in TC ÷ change in Q = change in TVC/change in Q. What does MC really stand for? The cost of producing the last unit.
- Average Variable Cost (AVC) = TVC ÷ Q.
- Average Fixed Cost (AFC) = TFC ÷ Q.
- Average Total Cost (ATC or AC) = TC ÷ Q.
- ATC AVC + AFC.
- Graphs – You need to know what the graphs are and what the relationship between the various concepts are on the graphs.
- What does TC, TVC, and TFC look like on a graph?
- What does ATC, AVC, AFC, and MC look like on a graph?
- What is the relationship between MC and AVC? MC and ATC? ATC and AVC?
- Relationship between production and costs.
- if MPL increases (or decreases) => what happens to MC, AVC, ATC, AFC? Why?
- if APL increases (or decreases) => what happens to MC, AVC, ATC, AFC? Why?
Review Notes – Long-Run Production and Costs.
- Least Cost Production. How do Firms produce at least cost? Impact of changes in various factors on the use of resources when the firm is in the long run producing at minimum cost? Suppose the price of Capital, the price of Labor, etc; the MPK, MPL, etc.; increases or decreases, how should the firm respond in each situation to minimize costs?
- Long Run Average Cost Curve. How do we get the LRAC?
- Definition of Economies of Scale, Diseconomies of Scale, Constant Returns to Scale. Why do we observe each?
Review Notes – Market Structure: Perfect Competition
- Characteristics of P.C. market
- many buyers and sellers
- all small relative to the market
- homogeneous product
- no entry/exit barriers
- What is firm D in a P.C. market? Market Demand?
- profit maximization by P.C. firms (the same principles apply to all firms).
- definition of MR = change in TR ÷ change in q. What does this mean?
- if MR > MC => continue to produce (increase q).
- if MR < MC => do not produce this unit (decreases q).
- if MR = MC => profit is maxmized. why?
- profit maxmization graphically (see the following figure). You must answer the following questions (again, the same principles apply to all firms).
- What is the profit maximizing quantity level?
- what is the highest price the firm can charge for this quantity?
- Be prepared to find on the graph: profit maximizing q and p, profit, TR, TC, TVC, TFC, AFC, AVC, ATC.
- Should this firm produce in the short-run? Where is the short-run shutdown point?
- Should this firm produce in the long-run? Where is the long-run shutdown point?
- What is the Firm’s short-run supply curve? What is the industry’s short-run supply curve?
- the long-run in P.C. markets.
- the crucial characteristic = free entry and exit.
- profit serves as a signal for entry/exit. If profit > 0 => entry in the long-run. If profit < 0 => exit in the long-run. If profit = 0 => no entry and no exit => long-run equilibrium.
- When in long-run equilibrium => (1) P=MR=MC=AC, (2) q is such that AC is at its minimum point, etc. Make sure you know all of the results when in long-run equilibrium.
- What is the long-run industry supply?
- Increasing Cost Industry?
- Decreasing Cost Industry?
- Constant Cost Industry?
- Are Perfectly Competitive Markets Efficient?
- Technological Efficiency?
- Firm Technological Efficiency? Does the firm produce a given quantity at minimum cost? (Are they on their cost curves?).
- Industry Technological Efficiency? Does the industry produce a given quantity at minimum cost? (Is each firm producing at the minimum point of their AC curve?)
- Allocative Efficiency. Is P = MC (MSB = MSC)? (HINT: make sure you keep profit max. and allocative efficiency straight, they aren’t the same thing.)
Review Notes – Market Structure: Monopoly
- Characteristics of monopoly market
- may be many buyers but only one seller
- single firm is the market
- homogeneous product
- entry barriers
- What is firm D in a monopoly market? Market Demand?
- What is MR in a monopoly market assuming that the firm cannot price discriminate?
- profit maximization graphically (see figure to the right). Be prepared to find profit maximizing q and p, profit, TR, TC, TVC, TFC, AFC, AVC, ATC.
- the long-run in monopoly markets.
- the crucial characteristic = entry barriers => profit can be > 0 in the long-run. Examples of entry barriers?
- Natural Monopoly
- Legal and Illegal barriers
- Are monopoly markets efficient?
- Technological efficiency (both firm and industry)?
- Allocative efficiency?
Review Notes – Market Structure: Monopoly and Perfect Competition Compared
- What is an appropriate policy for monopolies?
Antitrust law – both the per se approach to Antitrust and the rule of reason approach.
- Why might monopolies not be inefficient? (How does each of these show the efficiency of monopoly or do they?)
- economies of scale (natural monopoly) and economies of scope (why do we sometimes regulate monopoly power?).
- contestable markets.
- price discrimination (what 3 characteristics are needed to be able to price discriminate? what is MR for a price discriminating firm?).
- externalities.
- innovation. (how are the conclusions different with patents and without patents?)
Review Notes – Market Structure: Oligopoly
Monopolistic Competition
- Characteristics of M.C. market
- many buyers and sellers
- all small relative to the market
- differentiated product
- no entry/exit barriers.
- What is firm D in a M.C. market? Market Demand? Why is firm D downward sloping? What is the impact of increased product differentiation on Firm D (increases or decreases firm D?; increases or decreases elasticity?).
- profit maximization graphically. Be prepared to find profit maximizing q and p, profit, TR, TC, TVC, TFC, AFC, AVC, ATC. (Remember all profit maxmizing firms will produce, if they produce at all where MR=MC.)
- the long-run in monopollistically competitive markets.
- the crucial characteristic = no entry barriers => profit must be = 0 in the long-run.
- if profit > 0 => entry occurs, what is the impact on Firm D (does D increase or decreases? does elasticity increase or decreases?)? What if profit < 0?
- What is the long-run equilibrium? What does it look like graphically?
- Are monopolisticaly competitive markets efficient?
- Technological efficiency (both firm and industry)?
- Allocative efficiency?
Oligopoly
- Characteristics of oligopoly market
- many buyers but few sellers (more than one)
- firms are large relative to the market
- differentiated or homogeneous product
- entry barriers.
- Mutual Interdependence – oligopoly firms must take into account the actions of their competitors. Models discussed include:
- Know the definitions, etc. of Game Theory
- strategies, players, cooperative solution, cooperative surplus, nash equilibrium, etc.
- We discussed 2 game theory models:
- cartels/collusion (joint profit maximization). What problems are faced by colluding firms? Why do cartels tend to fail? Application of game theory.
- Non-collusive game theory model
- Are oligopoly markets efficient?
- Technological efficiency (both firm and industry)?
- Allocative efficiency?
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