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SUMMARY CHAPTERS 1-15

SUMMARY CHAPTERS 1-15. Defining Economics. Economics The study of how people allocate their limited resources to satisfy their unlimited wants The study of how people make choices Resources Things used to produce other things to satisfy people’s wants Wants

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SUMMARY CHAPTERS 1-15

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  1. SUMMARYCHAPTERS1-15

  2. Defining Economics Economics The study of how people allocate their limited resources to satisfy their unlimited wants The study of how people make choices Resources Things used to produce other things to satisfy people’s wants Wants What people would buy if their incomes were unlimited

  3. Defining Economics With limited income (resources), people must make choices to satisfy their wants. We never have enough of everything, including time, to satisfy our every desire. Individuals, businesses, and nations face alternatives, and choices must be made . Economics studies how these choices are made…

  4. Factors of production : • The inputs into the process of production. Another term for resources. • Land • means all natural resources. • Labor • is all the human time, effort, talent used to make products. • Capital • is a producer’s physical resources; sometimes called physical capital or realcapital. • Entrepreneurship • vision, skill, ingenuity, willingness to take risks.

  5. Factors of production : Three factors of production:land, labor and capital, don’t always mean what we think they do: LandNot just real estate. All resources, such as mined minerals, native plants and animals. LaborNot just physical strength. All human endeavors, such as mental abilities. CapitalNot just money. All human creations that help produce wealth, such as a car used as a taxi.

  6. Factors of production and Corresponding Factor Payments

  7. Three Basic Economic Questions Every society must answer three basic economic questions because of scarcity. What will be produced? How will it be produced? Who will get what is produced? Societies answer these questions differently, leading to a variety of economic systems.

  8. Economic Systems The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions? Economic systems are the basic arrangements made by societies to solve the economic problem. They include: Command economies Laissez-faire economies Mixed systems

  9. Differences Between Command Economies, Free Market Economies, And Mixed Economies There are differences in terms of the ways they address the three basic economic questions:

  10. Microeconomicsversus Macroeconomics • Microeconomics • The study of decision making undertaken by individuals (orhouseholds) and by firms. • The effects of changes in gasoline prices • A family’s choice of having a baby • An individual firm’s decision to advertise • Macroeconomics • The study of the behavior of the economy as a whole. • Deals with economywide phenomena. • The national unemployment rate • The rate of inflation • The yearly output of goods and services in a nation

  11. Opportunity cost is what you give up because you choose to do something else. or Opportunity cost is value of next-best alternative a person gives up -not the value of all possible alternatives- An idea closely related to opportunity cost is called  comparative advantage. Comparative advantage the ability to produce a good at a lower opportunity cost than another producer. if you produce a good at a loweropportunity costthen you should specialize in it.

  12. The production possibility frontier (PPF) is a graph that shows all of the combinations of goods and services that can be produced if all of society’s resources are used efficiently. Capital goods Consumer goods are goods used to produceare goods produced for other goods and services.presentconsumption. The production possibility frontier curve has a negative slope, which indicates a trade-off between producing one good or another.

  13. The production possibility frontier (PPF) The slope of the PPF curve is also called the marginal rate of transformation (MRT). The negative slope of the PPF curve reflects the law of increasing opportunity cost. As we increase the production of one good, we sacrifice progressively more of the other.

  14. Consumer demand and price The relationship between price and quantity demanded is the starting point for building a model of consumer behavior.  The determinants of demand The primary determinant is price.

  15. Price and Quantity Demanded: The Law of Demand Thelaw of demand says that when the other determinants of demand remain constant, there is a negative (or inverse) relationship between the quantity demanded of a good and its price.

  16. Demand Curve Individual demand is how much of a product a consumer will buy at a given price. Demand is based on the actual ability of consumers to purchase the product, not just what they would like but cant afford. Demand curves slope down from left to right - this is because the higher the price the more of a consumers income must be spent on it & the more satisfaction they must get from it to justify the opportunity cost.

  17. Shift of the Demand Curve A shift of the demand curve represents an increase or decrease of demand at a given price level.

  18. Price and Quantity Supplied: • The Law of Supply • An increase in market price will lead to an increase in quantity supplied, • and a decrease in market price will lead to a decrease in quantity supplied.

  19. Supply Curve Supply curve - shows the relationship between different prices and the quantities that sellers will offer for sale, regardless of demand.

  20. How Supply and Demand Interact Market Equilibrium Supply and demand curves meet at the equilibrium price. Buyers and sellers make choices that restore the equilibrium price. Changes affect both supply and demand. At equilibrium, there is no tendency for price to change .

  21. Supply and Demand and Market Efficiency consumer surplus The difference between the maximum amount a person is willing to pay for a good and its current market price.

  22. Supply and Demand and Market Efficiency producer surplus The differencebetween the current market price and the full cost of production for the firm.

  23. Supply and Demand and Market Efficiency Competitive Markets Maximize the Sum of Producer and Consumer Surplus Total Producer and Consumer Surplus Total producer and consumer surplus is greatest where supply and demand curves intersect at equilibrium.

  24. Supply and Demand and Market Efficiency deadweight loss The net loss of producer and consumer surplus from underproduction or overproduction. Deadweight loss from underproduction Deadweight loss from overproduction

  25. Concept of Elasticity Elasticity is used to describe the behavior of buyers and sellers in the market. We know when P Qd and Qs but how much? Elasticity is a measure of the quantity demanded or supplied to one of its determinants.

  26. Concept of Elasticity Initial Value method Midpoint method • Types of Elasticity • if the result is > 1, demand is said to be elastic • if the result is < 1, demand is said to be inelastic • if the result is = 1, demand is said to be unitary elastic • if the result is = 0, demand is said to be perfectly inelastic

  27. Concept of UTILITY utility a numerical indicator ofa person’s preferences in which higher levels of utility indicate a greater preference. marginal utility (MU) The additional satisfaction gained by the consumption or use of one more unit of something. total utility The total amount of satisfaction obtained from consumption of a good or service. Marginal utility comes only from the last unit consumed; total utility comes from all units consumed. When marginal utility is zero, total utility stops rising.

  28. Income and Substitution EffectsOf A Price Change (For Normal Goods) • Income effect: • When the price of a product falls, a consumer has more purchasing power with the same amount of income. • When the price of a product rises, a consumer has less purchasing power with the same amount of income. • Substitution effect: • When the price of a product falls, that product becomes more attractive relative to potential substitutes. • When the price of a product rises, that product becomes less attractive relative to potential substitutes.

  29. The Production Process: The Behavior of Profit-Maximizing Firms firm is an organization that comes into being when a person or a group of people decides to produce a good or service to meet a perceived demand. The primary objective of a firm is to - maximize profits Profit (economic profit) is the difference between total revenue and total economic cost.

  30. The Production Process: The Behavior of Profit-Maximizing Firms Total revenue is the amount received from the sale of the product: Total Revenue (TR)= Price per unit of output x Quantity of output sold Marginal revenue (MR) is the additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition, P = MR.

  31. Total cost (total economic cost) • is the total of • Accounting costs (Explicit or out-of-pocketcosts): • involve a direct money outlay for factors of production(purchased inputs). • Economic costs (Implicitcosts): • do not involve a direct money outlay. Theyinclude the full opportunity cost of every input(non-purchased inputs). • Total Cost (TC)= Total Variable Cost + Total Fixed Cost • Total Variable Cost(TVC) = The cost of all Variable Inputs.   • Total Fixed Cost(TFC) = The cost of all Fixed Inputs.   • Variable Inputs • are those inputs whose use does vary with the quantity of output produced.  • Fixed Inputs • are those inputs whose use does not vary with the quantity of output produced.

  32. Two Decision Situations:  The Long-Run and The Short-Run In economics, the Long-Run and the Short-Run are not defined in terms of time, but rather in terms of how many things in a situation are considered parameters vs. variables. Short-Run is a period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied. Long-Run is a period of time in which the quantities of all inputs can be varied.

  33. Production function is the technical relationship between inputs and outputs over a given period of time Mathematıcal Expressıon Of Productıon Functıon Long-RunQ = F ( L , K , I , R ,E ) Short-RunQ= F ( L , K) Production technology refers to the quantitative relationship between inputs and outputs. A labor-intensive technology relies heavily on human labor instead of capital. A capital-intensive technology relies heavily on capital instead of human labor.

  34. Marginal and Average Costs

  35. ISOQUANTS • AnIsoquant is the set of all combinations of variable inputs that could be used to produce a given quantity of output in the short run.    • Iso– «Equal»; Quant – «quantity» • Isoquant – a line of equal quantity • With a fixing level of output Q at some quantity we have an implicit relationship between units labor( L ) and capital (K) • Qc = F ( L , K ) • It is possible to produce the same amount of output by using different combination of input.

  36. ISOCOST • ISOCOST line is the budget line of a producer in terms of two inputs. • ISOCOST line is points of all the different combinations of labor and capital that firm can employ given the total cost and prices of inputs. • ISOCOST lines expressed as • C = w L + r K • Where • price of labor is wage - w • price of the capital is interest - r • total cost is - C • Usually the ISOCOST line is linear with slope equal to ratio of the factor prices.

  37. Short-Run Supply Curve of a Perfectly Competitive Firm The shut-down point is the lowest point on the average variable cost curve. When price falls below the minimum point on AVC, total revenue is insufficient to cover variable costs and the firm will shut down and bear losses equal to fixed costs.

  38. Minimizing Losses • Operating profit (or loss) or net operating revenue • equals total revenue minus total variable cost • (TR – TVC). • If revenues exceed variable costs, operating profit is positive and can be used to offset fixed costs and reduce losses, and it will pay the firm to keep operating. • If revenues are smaller than variable costs, the firm suffers operating losses that push total losses above fixed costs. In this case, the firm can minimize its losses by shutting down.

  39. Input Markets: Basıc Concepts Demand for inputs depends on demand for the outputs that they produce; input demand is thus a derived demand. Inputs can be complementaryor substitutable. Productivity is a measure of the amount of output produced per unit of input.

  40. Marginal product of input • Marginal product of input (labor , land, capital) • (MPL , MPA ,MPK) • is the additional output produced by one additional unit of input. • The marginal revenue product • (MRP) • of a variable input is the additional revenue a firm earns by employing one additional unit of input, ceteris paribus. MRPL= PX MPL

  41. The Firm’s Profit-Maximization Condition in Input Markets Profit-maximizing condition for the perfectly competitive firm is: where L is labor, K is capital, A is land (acres), X is output, and PXis the price of that output. PL = MRPL = (MPL X PX) PK = MRPK = (MPK X PX) PA = MRPA = (MPA X PX)

  42. Capital Capital goods are those goods produced by the economic system that are used as inputs to produce other goods and services in the future. Capital goods thus yield valuable productiveservices over time.

  43. TypesofCapital physical, or tangible, capital Material things used as inputs in the production of future goods and services. The major categories of physical capital are : nonresidential structures, durable equipment, residential structures, and inventories. intangible capital Nonmaterial things that contribute to the output of future goods and services. human capital A form of intangible capital that includes the skills and other knowledge that workers have or acquire through education and training and that yields valuable services to a firm over time. social capital, or infrastructure Capital that provides services to the public. Most social capital takes the form of public works (roads and bridges) and public services (police and fire protection).

  44. Measuring Capital capital stock For a single firm, the current market value of the firm’s plant, equipment, inventories, and intangible assets. Capital stocks are affected over time by two flows: investment and depreciation. investment New capital additions to a firm’s capital stock. Although capital is measured at a given point in time (a stock), investment is measured over a period of time (a flow). The flow of investment increases the capital stock. depreciation The decline in an asset’s economic value over time.

  45. The Capital Market • capital market • The market in which households supply their savings to firms that demand funds to buy capital goods. • financial capital market • The part of the capital market in which savers and investors interact through intermediaries. • bond • A contract between a borrower and a lender, • in which the borrower agrees to pay the loan • at some time in the future, • along with interest payments along the way. • stock • A share of stock is an ownership claim • on a firm, • entitling its owner to a profit share.

  46. Present Value Present value describes how much a future sum of money is worth today.  The formula for present value is:Where:R - cash flow in future periodr - the periodic rate of return or interestt - time, number of periods

  47. General Equilibrıum And The Efficiency Of Perfect Competition partial equilibrium analysis The process of examining the equilibrium conditions in individual markets and for households and firms separately. general equilibrium The condition that exists when all markets in an economy are in simultaneous equilibrium. efficiency The condition in which the economy is producing what people want at least possible cost.

  48. Allocative Efficiency And Competitive Equilibrium The economy will produce an efficient allocation of resources if : output markets are perfectly competitive input markets are perfectly competitive 3. households have perfect information on product quality and on all prices available 4. firms have perfect knowledge of technologies and input prices 5. decision makers consider all the costs and benefits of their decisions

  49. Allocative Efficiency And Competitive Equilibrium Pareto efficiency or Pareto optimality Acondition in which no change is possible that will make some members of society better off without making some other members of society worse off. This very precise concept of efficiency is known as allocative efficiency. To demonstrate that the perfectly competitive system leads to an efficient, or Pareto optimal, allocation of resources, we need to show that no changes are possible that will make some people better off without making others worse off.

  50. The Sources Of Market Failure • Market failure • occurs when resources are misallocated, or allocated inefficiently. • The result is waste or lost value. • Evidence of market failure is revealed by the existence of: • Imperfect markets • Public goods • Externalities • Imperfect information

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