BEC Economics Flashcards
Study of the allocation of scarce economic resources among alternative uses.
Economics
Microeconomics, Macroeconomics, International Economics
3 general areas of economics
Price (Y-axis)
Independent variable in economics
Quantity (X-axis)
Dependent variable in economics
Y=MX+B
Y= Value of Y
M= slope
X=Value of X
B= Y-intercept
Government largely determines production, distribution and consumption of goods/services. Communism and socialism
Command economic system
Indiv and businesses determine production, distribution and consumption of goods/services.
Market (free-enterprise) economic system
Labor, capital, natural resources
Economic resources businesses acquire from individuals.
Cost of production=Income of individuals
Top half of free market flow model
Cost of purchasing=Income of firm
Bottom half of free market flow model
Desire, willingness and ability to acquire a commodity.
Demand
Quantify of commodity that will be demanded at various prices during specified time ceteris paribus.
Demand schedule creates demand curve (negative slope)
Holding all other variables equal.
Ceteris paribus
2 factors that influence individual demand:
- Income effect
2. Substitution effect
Factors that influence market demand:
- Size of market
- Income or wealth of market participants
- Preferences of market participants
- Changes in prices of other goods/services
- Expectations of price changes
- Organized boycott
Change in quantity demanded=
movement along demand curve
Change in demand=
shift of entire demand curve
Demand for good or service that results from the demand for another related good or service.
Derived demand. Ex. demand for most raw and intermediate materials
Quantity of a commodity provided of good or service at alternative prices during specified time.
Supply
Quantity of goods/services that producer is willing to provide at alternative prices during specified time, ceteris paribus.
Supply schedule creates supply curve (positive slope)
Market supply curve moves in (up)=
Decrease supply
Market supply curve moves out (down)=
Increase supply
Market variables that change aggregate supply:
- Number of providers (increases market supply)
- Cost of inputs
- Technological advances (reduces cost per unit= increased supply)
- Prices of other productive goods (if prices increase, suppliers may shift to creating those items)
- Expectation of prices changes (if prices will be increasing, supply will increase)
Cost of inputs:
- Related commodities- change in price of other commodities with same inputs=change in demand for inputs=change in cost of inputs=change supply of commodity
- Gov influences- increased taxes (cost) or decreased cost (subsidy) will effect aggregate supply
Change in quantity supplied=
Movement along supply curve
Change in supply=
Shift of entire supply curve
Intersection of market supply and market demand curves.
Market equilibrium
The price at which the quantity of commodity supplied in market is equal to the quantity of the commodity demanded.
Equilibrium price (EP)
Actual price (AP) is less than equilibrium price (EP)
Market shortage (demand>supply)=DQ-AQ
Actual price (AP) is more than equilibrium price (EP)
Market surplus (demand
Shifts in demand or supply curve=
Change in market equilibrium
Increase in market demand only=
Increase in EP and EQ
Increase in market supply only=
Decrease in EP and increase in EQ
Increase in BOTH supply and demand=
Higher EQ
Government influences on equilibrium:
- Taxation and subsidy
- Regulation- tend to increase cost of productions and shift market supply curve up
- Rationing- shifts demand curve down= lower EQ and EP
- Price fiat
Price fiat
- Ceiling- APEP=supply is more than demand
Measures the % change in market factor (demand) as a result of a given change in another market factor.
Elasticity
Measures % change in quantity of commodity demanded as a result of a given % change in price.
Elasticity of demand (ED)= % change in quantity demanded/% change in price
ED=
(Change in quantity demanded/quantity demanded)/(Change in price/price)
Can use prechanged, average or new values for denominators.
Value greater than 1=
Elastic
Value=0
Unitary
Value less than 1=
Inelastic
ED and TR relationship
Elastic= Price increase= TR decrease
Inelastic=Price increase=TR increase
Unitary= no change
What influences elasticity?
- Availability of substitutes (more= more elastic)
- Extent of necessity (more necessary= more inelastic)
- Share of disposable income (larger share=more elastic)
- Postchange time horizon (longer time after last price change=more elastic)
Important of price elasticity to a firm?
Indicates extent to which firm is likely to be able to pass on increases in its costs of inputs to its customers.
Percentage change in quantity of a commodity supplied as a result of a given percentage change in price.
Elasticity of supply (ES)=% change in quantity supplied/% change in price
Cross elasticity of demand (XED)
% change in quantity of a commodity demanded as a result of a given % change in price of another commodity
%change in quantity of Y demanded/%change in price of X
XED coefficient results
Greater than 0 (positive)= Good substitutes
0= Independent of each other
Less than 0 (negative)=Complementary
% change in quantity of a commodity demanded as a result of a given % change in income
% change in quantity demanded/%change in consumer income
Income elasticity of demand (IED)
IED calculated coefficient results as income increases
Less than 0 (negative)= Inferior goods (decrease in demand)
0= No change “sticky” normal goods
Greater 0, less 1= “Necessary” normal goods, less than proportional increase in demand
1= Proportional increase (“normal” goods)
Greater than 1= “luxury” normal goods, greater than proportional increase
Marginal utility is maximized when MU of last dollar spend on each and every commodity acquired is the same.
MU of X/price of X=MU of Y/price of Y
100utils/$2=Y/$10, Y=500 utils
Total utility
Total satisfaction derived from acquisition or use of commodity (increases as quantity increases)
Marginal utility
Law of diminishing marginal utility- decreasing utility derived from each additional marginal unit.
In the long run, a firm may experience increasing returns due to:
Economies of scale (downward slope of U shaped LAC curve where quantity of output increases in greater proportion that the increase in all inputs.
The marginal product (output) falls as more units of a variable input are added to fixed inputs
Law of diminishing returns (short-run issue)
Time period in which quantity of at least one input cannot be varied, quantity of at least one input is fixed.
Short-run analysis
Time period during which quantity of all inputs to production process can be varied, no inputs are fixed.
Long-run analysis
Average cost
Cost per unit of commodity produced, computed by dividing the cost by the quantity of units produced.
Marginal cost (MC)
Dollar cost of producing one additional unit of physical output. Difference between successive total variable costs. MC curve crosses ATC and AVC at their respective lowest point.
Marginal product (MP)
Change in physical output that will result from one additional unit of physical input, change in total output that results from using one additional unit of particular input.
Average revenue (AR)
Total revenue divided by total units sold.
Marginal revenue (MR)
Dollar increase in revenue that results from the sale of one additional physical unit of output. Change in total revenue from selling one additional unit.
Long-run average cost (LAC) curve
Shows min avg cost of production with various inputs (ex. different plant sizes), economies of scale applies with LAC
Economies of (increasing return to) scale
Quantity of output increases in greater proportion that the increase in all inputs, primarily due to specialization. Downward close of LAC curve.
Constant return to scale
Bottom of LAC curve, output increases in proportion to inputs.
Diseconomies of (decreasing return to) scale
LAC curve going up, quantity of output increases in lesser proportion than increase in all inputs. Shows problems with managing large-scale operations.
Normal profit
Just the amt of profit necessary to cover operating costs and compensate owners for their capital investment. No excess.
Economic profit
Any amount greater than the normal profit, not constrained or of a limited amount. “Accounting profit”
Characteristics of perfect competition:
- Large # of indep buyers and sellers
- Firms sell homogeneous products/services
- Firms enter/leave market easily
- Resources are completely mobile
- Buyers/sellers have perfect information
- Gov does not set prices
- Firms are “price takers”, demand curve is a straight line and firm can sell product at market price only.
How can market demand shift in perfect competition?
Only if ALL suppliers raise/lower prices
How to maximize profit in perfect competition?
MR(D)=MC
Describe cost and revenue relationships in perfect competition.
MR=ATC- firm breaks even
MR less than ATC but greater than AVC- Cover VC but not total cost.
MR less than AVC- firm would shut down
Long equilibrium in perfect competition
MR=MC=LAC
Increase in market demand= more firms enter market and drive price back to equilibrium
Decrease in market demand= firms leave market and drive price back up to equilibrium
Firm strategy in perfect competition
Focus on innovation in production, distribution and sales, financial success depends on being the lowest-cost producer.
What would cause a natural monopoly?
Increasing return to scale (ex. public utilities)
Monopoly could exist because of:
- Control of input or process (ex. patent)
- Government action (ex. exclusive franchise)
- Natural monopoly
Characteristics of a perfect monopoly:
- Single seller
- Commodity for which there are no close substitutes
- Restricted entry into the market
How to max revenue in perfect monopoly?
MR=MC
Demand and MR curves are downward sloping and separate as quantity increases. Price determined by demand curve at quantity were MR=MC. At this point, monopoly has inefficient use of resources and higher price than in perfect competition.
How does perfect monopoly make a profit?
When price is above average cost.
How does perfect monopoly increase revenue?
Price discrimination- selling at different prices to different customers (must have fairly distinct segments of customers)
Ways to improve total profits in long-run for perfect monopoly?
- Reduce its costs
- Increase demand through promotions, advertising
Since market cannot set price, generally gov regulations are in place, so monopolies spend more $ on lobbying.
Characteristics of monopolistic competition:
- Large # of sellers
- Slightly differentiated product/service
- Firms can easily enter/leave market
Demand, MR and MC curve are like monopoly, but since firms can easily enter and leave, cannot be profitable in the long-run.
Monopolistic competition firm strategy:
- Differentiate their product (innovation)
- Extensive market research
- Extensive advertising and development of customer relations.
- Online shopping should be convenient, descriptive with good return policy.
ex. common in general retail industry
Firms conspire to set output, price or profit.
Cartel (overt collusion)- illegal in US
Firms tend to follow price changes initiated by a price leader.
Tacit collusion (not illegal)
Characteristics of oligopoly
- Few sellers
- Homogeneous or differentiated product
- Restricted entry into market
Ex. steel industry, auto industry, oil&gas
In short run, oligopoly will produce where MR=MC, as long as cost is below price, will continue to make profit since new firms have restricted entry into market.
Strategy of oligopoly
Oligopoly firm strategy
- Focus on actions and anticipated actions of competitors because firms are interdependent
- In order to avoid price wars, compete on factors other than price
- Strategic action taken to discourage new entrants
When price one good goes up, demand for other increases, these goods are:
Substitute goods
