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Chapter 2: Basic Economics Tools

Chapter 2: Basic Economics Tools. Scarcity Supply and Demand Consumer Theory Production Theory. Scarcity. A society must decide how to use its limited resources to meet unlimited wants. Production Possibilities Frontier Shows unattainable, inefficient, and efficient points of production.

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Chapter 2: Basic Economics Tools

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  1. Chapter 2: Basic Economics Tools Scarcity Supply and Demand Consumer Theory Production Theory Health Economics

  2. Scarcity • A society must decide how to use its limited resources to meet unlimited wants. • Production Possibilities Frontier • Shows unattainable, inefficient, and efficient points of production. • Shape reflects opportunity costs. Health Economics

  3. Demand Curve (or “willingness to pay”) • Only Price “slides” you along the curve • “Shift” factors • Income • Prices of related goods • Insurance • Tastes and Expectations Health Economics

  4. Supply Curve (or “willingness to sell”) • Only Price “slides” you along the curve • “Shift” factors • Technological Change • Input Prices • Prices of Production-Related Goods • Industry Size • Weather Health Economics

  5. A Review of Functions • Linear Functions: Intercept and (constant) slope • y = a + bx • y = mx + b • y = β1 + β2x Health Economics

  6. A Review of Functions • Nonlinear Functions: “Curves” y = a + bx2 y = a + b(1/x) Slope = first derivative = Health Economics

  7. Examples of Demand Functions • qd = 500 – 10P +5PS + 20Y + 40Z • qd = 7P-.05PS.002Y.8Z.01 • Theory only tells us • Downward sloping • Direction of Shift Factors Health Economics

  8. Consumer Theory • “Rational Choice” • Preferences under Constraints • Utility Theory: Cardinal vs. Ordinal • Total Utility Functions • Indifference Curves • Slope = Marginal Rate of Substitution = MUX/MUy • Budget Constraints: I=Pxx + PyY • Rearrange to Find Intercept and Slope! Health Economics

  9. Utility Maximization • Achieve highest Utility, given the BC • Max. Condition: Slope of IC = Slope of BC • MRSXY = PX/PY Health Economics

  10. Elasticities A Measure of “Responsiveness” Health Economics

  11. Calculating Elasticity For the following demand function, find the price elasticity of demand at prices of $80 and $40. qd = 1000 - .6P Health Economics

  12. Production Theory • Production Functions • Marginal Product and Law of Diminishing Returns • Isoquant Curves • Isocost Curves • Costs and Economies of Scale Health Economics

  13. Cobb-Douglas Production Function Q = L.8K.2 • Q = X-ray services • L = technicians, radiologists, nurses, etc • K = X-ray machines, film, computers Health Economics

  14. Cobb-Douglas Production Function Health Economics

  15. Labor Total Product Health Economics

  16. Average and Marginal Product Health Economics

  17. Cobb-Douglas Production Function Health Economics

  18. Isoquant with Q = 10 Health Economics

  19. Costs of Production • TC = Total Cost = wL + rK • Rearrange to find Intercept and Slope! • AC = Average Cost = TC/Q • MC = Marginal Costs = ∂TC/∂Q Health Economics

  20. Cost Minimization ↔ Output MaximizationTangency of Isocost Curve and Highest Isoquant Curve Health Economics

  21. Economies of Scale • If AC is falling → IRTS (Economies of Scale) • If AC is rising → DRTS (Diseconomies) • If AC is constant → CRTS Health Economics

  22. Example 1 • TC = q3 - 6q2 + 9q • What is the firm's average cost? • What is the firm's marginal cost? • Is this firm experiencing increasing, constant, or decreasing returns to scale? (i.e., find "s”) Health Economics

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