econ final exam Flashcards
Search activity defintion
time spent looking for someone with whom to do business/ Price checking to get the best deal/ weighing cost vs benefit
Trend of search activity
housing shortage -> increase in search activity -> 1st come - 1st serve situation
formula of search activity
opportunity cost of a good= price and value of search time
price ceiling/ price cap definition
a government regulation that makes it illegal to charge a price higher than a specified level
effects of price ceiling/ price cap
effects depend on whether the ceiling is above/ below the equilibrium price
- PC> P* has no effect because PC doesn’t constraint the market forces. force of law and market force are not in conflict
- PC <P* has critical effect because PC attempts to prevent the P from regulating QD and QS. force of law and market P are in conflicts
how do you call PC when it’s applied to a housing market
rent ceiling
effects when RC < P*
- housing shortage
- increase search activity
- an illicit market
how does RC < P* cause housing shortage and increase search activity?
RC< P* -> QD> QS -> shortage -> limited QS allocation -> increase search activity
how does RC < P* create an illicit market
- RC encourages illegal trading in an illicit market
- Illicit market occurs in rent controlled housing and many other markets when RC is applied, frustrated renters and landlords constantly seek ways to increase rent which causes:
1. high P of worthless fitting (drape)
2. high P for new locks and keys (key money) - level of IM rent depends on how tightly the RC is enforced:
1. loose enforcement -> IM P is close to the unregulated rent.
2. strict enforcement -> IM P = max P that a renter is willing to pay.
inefficiency of RC
- RC < RP* -> underprod of housing services
- Marginal social benefit > marginal social cost -> DWL
- decrease in consumer and producer surplus
are RC fair?
- Fair rule view -> anything that blocks voluntary exchange is unfair -> RC is unfair
- Fair result view -> a fair outcome is the one that benefit the less well off (fairest outcome is the one that allocates scare housing to the poorest
- blocking rent adjustment doesn’t eliminate scarcity. It decreases QS of housing -> bigger challenge for the market to ration a smaller QS and allocate it according to D.
- when rent is not permitted to allocate scarce housing, other available mechanisms are:
1. lottery
2. 1st come - 1 served
3. discrimination: allocate based on the housing owner’s view and interest (ie: friendship, family, race, ethnicity, sex)
A labour market with min wage:
- trend? (cause and effect between wage and Q of labour)
- who decides what?
- define P floor
- Trend/ effects of PF when it’s in comparison with P*
- how do you call PF when it’s applied to labour market?
- how does min wage rate cause unemployment
- what happens when QS = QD of labour?
- firms decide QD of labour. Trend: dec wage -> increase QD
- household decide QS of labour. Trend: inc wage -> inc QS
- when wage rates are low OR fail to keep up with the increasing P -> labour unions turn to gov and lobby for higher wage rate
- P floor: gov regulation that make it illegal to charge a P < a specified level
+) P floor < P* has no effect -> PF doesn’t constraint the market force. Force of the law and the market force are not in conflict.
+) P floor > P* has powerful effect. PF attempts to prevent P from regulating QD and QS. Force of law and market force are in conflict.
+) PF is applied to labour market -> min wage
+) min wage > P* -> QS > QD -> surplus -> unemployment - At P* QS= QD of labour -> no shortage or surplus
is the min wage fair?
Unfair from both views
- unfair result because
+) only benefit people who have jobs
+) unemployed end up worse off than they would be with no min wage. Refer back to how min wage > P* leads to QS> QD -> unemployment
+) increase cost of job search
+) those who do job search and find one aren’t always the least well off
+) other unfair mechanism: discimmination
- unfair rule because:
+) block voluntary exchange. Firms are willing to hire and workers are willing to work. but they are not permitted due to min wage law
inefficiency of min wage
what is being considered efficient market? and what are the contributing factors?
Define SC in labour market
Define DC in labour market
how does an unregulated market achieve efficiency?
problems with min wage.
what is being considered efficient market? and what are the contributing factors?
- SC: workers marginal social cost of supplying labour = worker’s leisure foregone
- DC: firm’s marginal social benefit of using labour = value of G&S produced
- an unregulated market allocates the economy’s scare labour resource to jobs in which they value the most -> achieve efficiency
why min wage is inefficient?
- min wage frustrates market mechanism and results in unemployment and increase job search. At the Q of labour employed, firms ‘ marginal social benefit of using labour> workers’ marginal social cost of supplying labour. DWL shrinks the firm’s and the workers’ surplus
what kind of tax is applied to each category?
- earnings
- sales
- employers
- specific producers
- earnings: I taxes and social security taxes
- sales: GST and HST
- employers- social security taxes (ie: employment insurance tax for their workers)
- tax on specific producers (ie: tobacco, alcohol, gasoline)
Trend of what P do buyers or sellers respond to?
- buyers respond to the P that include tax
- sellers respond to the P that excludes tax
- Define tax incidence
- Trends of how P paid by buyers share or not share the burden of tax between buyers and sellers?
- How either tax on buyers or sellers lead to the same outcome? How does tax on buyers or sellers affect DC or SC?
- Why after tax, Q* is no longer at the intersection of DC and SC? Where is the new Q*?
- the division of the burden a tax between buyers and sellers
- when the gov imposes a tax on the sale of G&S and factors of prod - land, labour , capital, P paid by buyers might inc by the full amount of tax or less or not at all:
1. P paid by buyers inc by the full amount of tax -> burden of tax falls entirely on buyers -> buyers pay the tax
2. P paid by buyers inc lesser than the full amount of tax-> burden of tax falls partly on both buyers and sellers
3. P paid by buyers doesn’t change -> burden of tax falls entirely on sellers - tax incidence doesn’t depend on tax law. the law might impose a tax on sellers/buyers but the outcome is the same in either case:
1. tax on sellers -> dec in S. to determine the position of new SC, add tax to the min P sellers are willing to accept for sale of each Q
2. tax on buyers -> dec P they’re willing to pay -> dec D + shifts DC leftward. to determine the position of this new DC, subtract the tax from the max P that buyers are willing to pay for each Q.
Conclusion: tax is a wedge driven between P buyers pay and P sellers get. With tax, Q* is no longer at the intersection of DC and SC but at the Q where vertical gap between the curve = size of tax
taxes and efficiency
- why does tax lead to underprod?
- how does tax affects MSB and MSC and causes DWL?
- what factor does the burden of tax between buyers/sellers depend on?
- tax as a wedge -> inefficient undeprod
- P buyers pay = buyers’ willingness to pay = MSB
- P sellers receive = sellers min S-P = MSC
- tax leads to MSB > MSC -> dec producer and consumer surplus -> DWL
- division of the burden of tax between buyers/sellers depend on PE of D and S
tax incidence and E of D
- 2 cases
- who pay when
- what happens to Q* and effect of it?
- overall trend
focus on 2 extreme cases:
- Perfectly inelastic D = buyers pay
+) buyers’ QD stays the same regardless of P -> Q* doesn’t change -> no underprod OR no DWL
- perfectly elastic D = sellers pay
+) Q* dec -> underprod + DWL. DWL arises when D is not perfectly inelastic and is largest when D is perfectly elastic.
=> overall trend: the more inelastic D is -> the more tax for the buyers
tax incidence and E of S
- 2 cases
- who pay when
- what happens to P sellers accept to sell and P buyers accept to purchase? QD and QS? Q*?
- overall trend
focus on 2 extreme cases:
- perfectly inelastic -> sellers pay
+) P sellers accept to sell and buyers accept to purchase remain the same. QD and QS also stay the same -> buyers are willing to pay for all the tax.
+) Q* stays constant -> no underprod and no DWL
- perfectly elastic -> buyers pay
+) inc tax -> P sellers receive remain the same but P buyers pay inc by the full amount of tax.
+) Q* dec -> underprod + DWL (arise from a tax when S is not perfectly inelastic and is largest when S is perfectly elastic.
=> overall trend: the more elastic S is -> the more tax paid by buyers
tax and fairness
Political view:
- NDP wants higher tax on the riches to pay for public services and hand out for the poor
- Conservative wants lower tax for the riches as they already pay for the majority of it.
=> 2 conflicting principles of fairness that apply for tax system:
+) benefit principle
-> proposition that people should pay taxes = benefits they receive from the services provided by the gov
-> fair because people who pay most will benefit most -> make tax payment and consumption of gov - provided services similar to private consumption and expenditure.
-> justify:
1. high fuel taxes to pay for highways
2. high taxes on alcoholic beverages and tobacco products to pay for public health care services
3. high income taxes on high I earners to pay for the benefits from law and order and from living in a secure environ, from which the rich might benefit more than the poor.
+) ability to pay principle
-> the proposition that people should pay taxes according to how easily they can bear the burden of the tax.
-> it’s easier for the riches to bear the burden of the tax than the poors.
-> reinforce benefit principle to justify high income tax on high income earners
=> big trade off:
-> conflict between efficiency
Define subsidy
A payment made by the gov to the producers
How effects of subsidy and tax are in comparison to each other?
They go opposite directions
Effects of subsidy
- An inc in S -> shift SC rightward
- A dec in P and inc in Q produced
- An inc in marginal cost
- Payments by gov to farmers
- Inc Q* -> At new Q*, MSC (SC) > MSB (DC) -> Inefficient overprod
- inc the P that sellers receive
What’s the difference between subsidy and tax in their concepts?
- Subsidy = A negative tax OR A dec in cost -> inc S -> shift the SC rightward
- Tax = An inc in cost
How to determine the new position of SC after a subsidy is applied?
subtract the subsidy from the farmer’s min S-P
SC shifts to red curve labelled S - subsidy
how does a subsidy influence the P paid by buyers and marginal cost, hence impact the SC and marginal cost C?
A subsidy lowers the P paid by customers/buyers and inc the marginal cost of the product/service. marginal cost inc because producers are producing more goods, which means they start using less ideal res for production -> slide up on SC and marginal cost C.
more about inefficient overproduction
- At Q produced with the subsidy, MSB = market P which has dec. MSC inc and > market P => MSC> MSB -> inefficiency
How does subsidy impact the domestic market and international market?
- A subsidy dec the domestic market P -> subsidized farmers will offer some of their output for sales in the international/world market
- Inc S of the world market -> overall P reduction for the rest of the world -> farmers in other countries produce less and receive less revenue
A free market for a drug
- DC shows that other things remaining the same, dec P of a drug -> inc QD
- SC shows that, other things remaining the same, dec P of a drug -> dec QS
- If drugs are not illegal, the Q bought and sold is QC at a price of PC at point E.
- If selling drugs is illegal, the cost of breaking the law by selling drugs (CBL) is added to the minimum supply-price and supply decreases to . The market moves to point F.
- If buying drugs is illegal, the cost of breaking the law is subtracted from the maximum price that buyers are willing to pay, and demand decreases to D- CBL . The market moves to point G.
- With both buying and selling illegal, the SC and the DC shift and the market moves to point H. The market price remains at PC , but the market price plus the penalty for buying rises—point J—and the market price minus the penalty for selling falls—point K
market for an illegal drug
- good is illegal -> cost of trading inc. how much the cost inc and who bears the cost depend on the penalties and to what degree the law is enforced
- inc penalties -> inc policing -> inc the cost.
- penalties are applied to sellers/buyers/both
penalties on sellers of illegal drug and how does this penalty impact the SC?
- drug dealers in Canada face large penalties if their activities are detected. (ie: trafficking - 2 years of jail
- penalties as an attempt to inc cost of illegal drug -> dec S -> shift SC leftward
- to determine the new SC, add the cost of breaking law to the minimum P drug dealers are willing to accept (S + CBL)
- if penalties are only applied to sellers, market equi shifts from point E to F.
penalties on buyers of illegal drug
- Canada: cocaine, heroine , methamphetamine
- possession of cocaine: 6 months of prison, fine: 1,000 cad
- possession of heroine: 7 years of prison
- penalties fall upon the buyers and CLB is subtracted from the value of good to get the max P buyers are willing to pay => D dec -> DC shifts leftward -> DC shifts to D- CBL. If penalties are only applied to buyers, market equi will shift from point E to G
penalties on both buyers and sellers of illegal drug
- Both S and D dec -> both SC and DC shift leftward by the same amount when CBL are the same for both buyers and sellers -> market equi moves to point H (market P remains at the competitive market P at PC but the Q bought dec to QP.
- buyers pay PB which = PC + CBL
- sellers pay PS which = PC - CBL
- inc penalties + inc law enforcement -> dec in D and S
- if penalties are heavier on the sellers -> SC shifts farther than DC + market P inc above PC
- if penalties are heavier on the buyers -> DC shifts farther than SC + market P dec below PC
- this theory does not work that well in reality due to high cost of law enforcement and insufficient res for police to achieve effective enforcement -> canada has legalized marijuana for recreational use -> sold openly but with high tax
legalizing and taxing drugs
- Q bought can be dec when drugs are legalized and taxed.
- sufficient tax -> dec S + inc P -> same Q as prohibition of drugs
- illegal trading may still exist even when drugs are legalized due to high tax.
illegal trading of drugs to evade tax
- cost of breaking tax law
- Q bought of drugs depend on how severe the penalties are and which way the penalties are applied to buyers and sellers
tax vs prohibition of drugs (pros and cons)
- view (favour tax - against prohibition): tax revenue can make the law enforcement more effective + run educational campaign against illegal drug use
- view (favour prohibition- against tax): prohibition may influence preference -> dec D + some people really hate the idea that the gov is profiting from the trade of harmful substances.
Define consumption choice and household’s budget line and what factors limiting it?
- Consumption choice are limited by income and P
- Household’s budget line:
+) limit of consumption choice
+) shows what one can or cannot afford
Define divisible and indivisible goods
How to read the budget line
- Divisible goods: goods that can be bought at any desired Q (ie: electricity, gasoline)
- best understand household choice if we suppose all goods and services are divisible (ie: 1/2 movie per month- 1 movie per 2 months) ->so we have to consider all the points (even if they’re decimals) on the budget line
- affordable and unaffordable Q: areas inside and on the budget line are affordable . Outside the line is unaffordable
Budget Equation
Expenditure = Income
Expenditure = (P good A x Q bought good A) + (P good B x Q bought good B)
(PC x QC) + (PM x QM) = Y
QC + PMxQM/PC = Y/PC
QC = Y/PC - PMxQM/PC
Sub in Y (income), PC (P good A), PM (P good B) to find
QC = y int +/ - slope x QM (QC - Q bought of good A, QM - Q bought of good B)
How to set up budget line on a graph:
Set QC = 0
Set QM = 0
you get x and y int
Define household’s real income
household’s real income: Q of goods that the household can afford to buy (Y/PC = income/ price of good = max Q can be bought)
Define relative P
- Relative P: P good A/ P good B = opportunity cost (how much of good B must be sacrificed to gain extra Q of good A)
- Relative P = magnitude of slope
How does change in P affect the budget line?
- Other things remaining the same, dec of P on the x axis -> dec the slope of budget line -> budget line becomes flatter
- Other things remaining the same, inc of P on the x axis -> inc the slope of budget line -> budget line becomes steeper
DO NOT mistaken P as the independent variable - IT”S NOT. CORRECT ANSWER: Q of good B is on the x axis, Q of good A is on y axis
SCENARIO: real income (income/ P of good A) of good A remains the same. the original P of good B is 8 then Q of good B is 5.
-> if P good B inc to $16 -> y int still remains the same but x int shifts backward to 2.5 -> budget line is shifting down and becomes steeper
-> if P good B dec to $4 -> y int still remains the same but x int shifts forward to 10 -> budget line is shifting up and becomes flatter
How does change in income affect the budget line
- income (monthly income - Y NOT real income - Y/PC)
- income dec while P of good remain the same -> Q of both goods dec -> y int and x int both go down on the axises -> budget line shifts inward
- IMPORTANT NOTE: relative P do not change, which means the opportunity cost remains the same - you still have to exchange the same Q of one good for another good -> slope remains the same
- Trend:
1. Inc monthly income (Y) -> inc real income (Y/PC) -> shifts the budget line outward/rightward + slope remain the same
2. dec monthly income (Y) -> dec real income (Y/PC) -> shifts the budget line inward/leftward + slope remain the same
Structure and the interpretation of preference map and indifference curve
- preference map: not preferred, indifference curve, preferred where the area underneath the curve is not preferred, the slope of the curve always starts from the top slide down, areas on top/ inside of the curve is preferred. X axis is Q of good B, Y axis Q of good A
- points on the higher indifference curve are more preferred than points on the lower indifference curve
Define indifference curve
- A curve that shows combinations of goods among which a consumer is indifferent -> same level of happiness regardless the different combinations of goods she get as long as all of these points are on the same curve.
- looking at the shape of the indifference curve, we can tell a person’s preference
Define preference map
- A series of indifference curves that resemble the contour lines on the map. Looking at the contour lines , we can draw conclusion about the terrain
Define marginal rate of substitution
- Marginal rate of substitution: the rate at which a person will give up good on the y axis (I mention it as good A) to get an additional Q of good on the x axis ( good B) while remaining indifferent/ on the same indifference curve
- Marginal rate of substitution = magnitude of the slope of an indifference curve
- Trend:
1. indifference curve is steep -> MRS is high
2. indifference curve is flat -> MRS is low - calculation
MRS = points where the line of MRS intersects with the indifference curve
IMPORTANT = MRS = y int line of MRS/ x int line of MRS
Define diminishing marginal rate of substitution/ its trend?/ in what way and how this concept is represented on the preference map
- A general tendency for a person to be willing to give up less good of y (good A) to get more unit of good x (good B), while remaining indifferent as Q of good on x axis inc
- Trend:
inc Q of good B -> Dec in the willingness/ Q of good A that a person is willing to give up for an additional Q of good B - Shape of indifference curve represents this concept because it’s bowed toward the origin. Tightness of the curve shows the person’s willingness to give up while remaining indifferent
Degree of substitutability
- to consume less of one good and still remains indifferent, one must consume more of another good
- different degrees:
+) Close sub
1. (ie: 2 pens with different brand name, but one is cheaper - easy for customers to forego and opt for cheaper alternative)
2. when 2 goods are perfect sub -> slope of indifference curve is a vertical line
3. marginal rate of sub is constant
+) complements (ie: left and right running shoes)
1. indifference curves of perfect complements are L shaped
2. you do not receive any more benefit if you have 2 left shoes 1 right shoes in comparison to 1 left and 1 right - trends:
1. the closer the 2 goods are to perfect sub -> the closer the marginal rate of sub to be constant ( a straight not a curve one like, constant instead of diminishing)
Best affordable choice
- spend all the income + on the highest attainable indifference curve
- point on this curve: best affordable point - is on the budget line. At this point, MRS (magnitude of the slope of the indifference curve = relative P (slope of budget line) => one’s willingness to pay for a good = opportunity cost of that same good
- every point on the budget line lies on an indifference
Define P effect
- P effect: effects of P change on the Q of good being consumed while other things remaining the same
- Effects on the best affordable point
+) P inc -> QD dec -> budget line rotates inward and becomes steeper
+) P dec -> QD inc -> budget line rotates outward and becomes flatter
+) consume less of good A as P of good B is cheaper and consume more quantity of good B and vice versa if the opposite situation happens instead (while income (Y) and price of good A remain constant)
how do law of demand and slope of DC relate to best affordable points?
law of demand and the downward slope of DC are the consequences of consumer’s choosing their best affordable combinations of good
Define income effect
- Define: effect of income change on the buying plan while other things remaining the same.
- Trend: income (Y) dec -> dec QD of both goods (normal goods)
- Effects:
+) shift the budget line inward/leftward
+) change the best affordable point (dec in x and y coord)
+) Dec D
How do we prove that for a normal good, a dec in P will always result in an inc in Q bought?
Divide the P effect into 2 parts:
- Substitution effect
- income effect
How substitution effect is used to prove that for a normal good, a dec in P will always result in an inc in Q bought?
- Define: the effect of P change on Q bought by the consumer when they remain indifferent between the original and new situation.
- to work out the effect:
+) when P of good dec, we must lower the consumer’s income enough to keep them on the same indifference curve
+) the move from the original best affordable point to the new one on the same indifference curve is the substitution effect
+) dec in P of one good -> inc in QD as consumers demand more this good to sub for another good that’s more expensive.
How income effect is used to prove that for a normal good, a dec in P will always result in an inc in Q bought?
- calculation:
+) inc the consumer’s back to the original level
Trend:
inc income -> shift the budget line outward + slope of budget line remains the same as relative P and P for each good stays the same -> A jump of best affordable point from lower to higher indifference curve - for normal good, income effect reinforces the substitution effect - same direction -> downward slope of DC
- Recall definition of inferior good
- P, Income, Substitution effect on inferior goods
- Define: A good for which D dec when income inc.
- Trend:
+) negative income effect: Dec in P doesn’t inevitably lead to an inc in D
+) sub effect of a dec in P -> inc in QD
+) the negative income effect and sub effect work in opposite directions -> negative income effect offsets sub effect to a certain degree. Different degrees:
1. negative income effect = positive sub effect -> dec in P has no effect on QD -> vertical DC + perfectly inelastic D
2. negative income effect < positive sub effect -> dec in P inc QD -> downward slope DC (similar to normal good) + D maybe less elastic than normal good
3. negative income effect > positive sub effect -> dec in P dec QD -> upward slope DC (Does not happen in reality)
Recall definition of firm
An institution that hires factors of prod and organizes those to produce and sell goods and services
What is the goal of entrepreneurship/firm?
- Goal: max profit
- Different kinds of profit
+) Accounting profit - calculation
-> step 1: calculate cash surplus:
revenue - expense (ie: raw material, utilities, wages, machinery, interest on bank loan) = cash surplus
-> step 2: calculate profit:
cash surplus - depreciation of asset (ie: buildings, machinery) = profit
+) Economic accounting:
-> purpose of measure a firm’s profit for accountants: ensure that the firm pays the correct amount of income tax and to show the investors how their funds are being used
-> purpose of measure a firm’s profit for economists: enable them to predict the firm’s decision (which aim to max profit)
Economic profit equation
total rev - total cost (opportunity cost of prod) = economic profit
- define opportunity cost of any action
- define opportunity cost of prod for firm
- what are the costs included in the firm’s opportunity cost of prod?
- define opportunity cost of any action: the highest valued alternative forgone.
- define opportunity cost of prod: the value of the best alternative use of the res that a firm uses in prod, which is the sum of the cost of using res:
+) res bought in the market : why it is considered an opportunity cost?
Ans: because the firm can buy different res to produce and sell other goods and services
+) res owned by the firm
-> derived from its own capital
-> why it is considered an opportunity cost?
Ans: it can sell its capital and borrow capital from other firms/companies
-> also known as: implicit rental rate of capital (firm’s opportunity cost of using its own capital) which has 2 components:
1. economic depreciation
+ IMPORTANT NOTE: this is different from normal depreciation, dec in firm’s capital, which uses formulas that are unrelated to the change in market value of capital
+ define economic depreciation: dec in market value of a firm’s capital over a given period.
+ economic depreciation = market P of the capital at the beginning of the period - market P of the capital at the end of the period
2. forgone interest: funds used to buy capital could have been used for other purposes, which could generate other profit for the firm
+) res supplied by the firm’s owner: a firm’s owner might supply both entrepreneurship and labour:
-> entrepreneurship:
1. factors of prod that organizes a firm and makes its decisions might be supplied by the firm’s owner or a hired entrepreneur
2. Return of entrepreneurship: profit
3. profit that an entrepreneur earns on average: normal profit which = cost of entrepreneurship - owner’s labour service:
+) in addition to supplying entrepreneurship, the firm’s owner may also supply labour but not take wage
+) opportunity cost of owner’s labour service is the wage income forgone by not taking the best alternative job
what decision does firm have to make to achieve the objective of max economic profit?
- What to produce and in what Q?
- How to produce?
- How to organize and compensate its managers and workers?
- How to market and price its products?
- What to produce itself and buy from others?
what constraint a firm’s decisions?
- decision timeframes
+) meaning: reflects the relationship of a firm’s output decision and its costs
+) 2 types:
-> short run:
1. A timeframe in which Q of at least one factor of prod is fixed
2. Trend: for most firms: fixed factors: capital, land, entrepreneurship. variable factor: labour
3. Fixed factors of prod is also known as the firm’s plant -> trend: in a short run, a firm’s plant is fixed
4. to inc output in a short run: a firm must inc Q of a variable factor of prod -> often is labour (hire more workers in longer hours)
5. are easily reversed
-> long run:
1. A timeframe in which Q of all factors of prod can be varied -> a period in which a firm can change its plant
2. to inc output in the long run: a firm can change its plant as well as Q of labour it hires
3. ie: install more or new machinery, reorganize management, hire more labour
4. not easily reversed. once a plant decision is made, the firm must live with it for some time -> past expenditure on a plant that has no resale value = sunk cost, which is irrelevant to the firm’s current decision. The only cost that influence the firm’s current decision are the short run cost of changing its labour input and the long run cost of changing its plant
short run tech constraint
- to inc output in the short run: a firm must inc QD of labour. We describe the relationship between output and QD of labour with 3 concepts
+) total product
+) marginal product
+) average product
=> these are illustrated by product schedule or product curves:
+) product schedule includes:
-> labour (workers per day)
-> total products (Q produced per day):
1. Define: max output that can be produced at a given Q of labour
2. Trend: inc in QD of labour -> inc in total product
-> marginal product (Q produced per additional worker) - inc in total produce with an inc of one unit of labour while other things remaining the same
-> average product (Q produced per worker) (total product/ QD of labour)
+) product curves:
-> define: graphs of the relationship between employment (Q of labour) and the 3 above concepts (total product, marginal product, average product)
-> 3 kinds:
1. Total product curve
+ on the total product schedule where x axis is labour (workers/day) and y axis is output (QS/day)
+ points above the curve is unattainable
+ points below the curve is attainable but are inefficient
+ similar to prod possibility frontier
+ points above the curve are unattainable.
+ points below the curve are attainable but they are inefficient - use too much labour to produce a certain output
+ only points on the curve are attainable and efficient at the same time
2. Marginal product curve
+ x axis: labour (workers/day); y axis: marginal product (QS/ additional workers)
+ illustrated by graph bars
+ measured by height of the graph bar or slope of the total product C
+ shapes of total product and marginal products are similar across different firms and types of good because almost every prod process has 2 features:
=> inc marginal return initially
~ inc marginal return occurs when the marginal production of an additional worker > marginal product of the previous worker
~ arises from inc specialization and division of labour in the prod process
~ ie: at the beginning, all work must be done by one worker. After the 2nd worker is hired, 2 workers can worker together, each specialize different parts of the job -> inc output -> marginal return product of 2nd worker > 1st worker -> inc marginal return overall
=> diminishing marginal return eventually
~ most prod processes experience inc marginal return initially, all prod process will eventually reach a point of diminishing marginal return. - occurs when marginal product of an additional worker < previous worker
- arises from the fact that more and more workers are using the same capital and working at the same space. As more and more workers are being added -> there is less and less for additional workers to do that is productive.
~ ie: third worker still inc the product marginal return but < 2nd worker -> after hiring 2nd and 3rd workers, all the gains from specialization and division of labour have been exhausted (ie: hire 3rd worker helps to produce more Q but the equipment is operated closer to its limit until there is not any work for workers to do
~ law: as a firm uses more of a variable factor of prod with a given Q of the fixed factor of prod, the marginal product of the variable factor eventually diminishes
3. Average product curve
~the illustration reflects the relationship between the marginal and average product curve
~Average product increases from 1 to 2 workers (its maximum value at point C) but then decreases as yet more workers are employed.
~ With 1 worker, marginal product exceeds average product, so average product is increasing. With 2 workers, marginal product equals average product, so average product is at its maximum. With more than 2 workers, marginal product is less than average product, so average product is decreasing.
~ average product is largest when average product = marginal product are equal -> marginal product C cuts the average product C at the point of max average product.
~ For the number of workers at which marginal product > average product, average product is inc
~ For the number of workers at which marginal product is < average product, average product is dec
Short run cost
- to produce more output in the short run, a firm must inc QD of labour -> inc cost. relationship between output and cost are described through 3 concepts:
+) a firm’s total cost (TC):
-> define: cost of total factors of prod the firm uses
-> divided into 2:
1. total fixed cost (TFC)
+ define: cost of the firm’s fixed factor
+ ie: cost of renting machinery, normal profit - opportunity cost of entrepreneurship
+Q fixed factors don’t change as output changes -> total of fixed costs stay constant for all outputs
2. total variable cost (TVC)
+ define: cost of the firm’s variable factor
+ ie: labour - wage
+ total variable cost changes as output changes
=> total cost = total fixed cost + total variable cost (TC = TFC +TVC)
+) marginal cost
-> define: inc in total cost that results from a 1 unit inc in output
-> calculation: marginal cost = inc in total cost/ inc in output
-> Marginal cost C s U-shaped because when the firm hires a 2nd worker, marginal cost dec but when it hires a 3rd, a 4th, and a 5th worker, marginal cost successively inc
-> At small outputs, marginal cost dec as output inc because of greater specialization and the division of labour. But as output inc further, marginal cost eventually inc because of the law of diminishing returns (output produced by each additional worker is successively smaller)
-> To produce an additional unit of output, ever more workers are required, and the cost of producing the additional unit of output—marginal cost—must eventually inc.
-> Marginal cost tells us how total cost changes as output inc
-> The final cost concept tells us what it costs, on average, to produce a unit of output.
+) average cost - 3 kinds:
-> average fixed cost (AFC): total fixed cost per unit of output
-> average variable cost (AVC): total variable cost per unit of output
-> average total cost (ATC): total cost per unit of output
=> the average cost concepts are calculated from the total cost concepts:
1. Step 1: TC = TFC + TVC
2. Step 2: TC/Q = TFC/Q + TVC/Q
OR ATC = AFC + AVC
=> AFC curve slopes downward. As output inc -> the same constant total fixed cost is spread over a larger output. => ATC and AVC curves are U-shaped. The vertical distance between ATC and AVC curves is = AFC. That distance dec as output inc because AFC dec with inc output.
+) marginal cost and average cost:
-> marginal cost curve intersects the AVC curve and the ATC curve at their min points.
-> marginal cost < average cost, average cost is dec
-> marginal cost > average cost, average cost is inc
=> This relationship holds for both the ATC curve and the AVC curve.
Why the ATC curve is U- shaped?(short run cost)
- ATC = AFC + AVC -> shape of ATC curve combines the shape of AFC and AVC curves
- cause of ATC curve’s U shaped arise from the influencing of 2 opposing forces:
+) spreading TFC over a larger output:
firm inc its output, its TFC is spread over a larger output -> average FC dec -> AFC curve slopes downward
+) Eventually diminishing returns:
-> output inc -> ever-larger amounts of labour are needed to produce an additional unit of output -> AVC dec initially but eventually inc -> AVC curve slopes upward and is U-shaped.
-> shape of the ATC curve combines both spreading TFC over a larger input and eventually diminishing return effects.
1. Initially, as output inc, both AFC and AVC dec -> ATC dec -> ATC curve slopes downward.
2. But as output inc further and diminishing returns set in, AVC starts to inc.
3. With AFC dec more quickly than AVC is inc -> ATC curve continues to slope downward.
4. Eventually, AVC starts to inc more quickly than AFC dec -> ATC starts to inc-> ATC curve slopes upward.
total product and total variable cost (short run cost)
- there are links between the firm’s total product curve, TP, and its total variable cost curve, TVC.
- The graph:
+) illustrates 2 variables on the x-axis—labour and variable cost.
+) graph of TVC curve but with variable cost on the x-axis and output on the y-axis.
+) can show labour and cost on the x-axis because variable cost is proportional to labour. One worker costs $25 a day. Graphing output against labour gives the TP curve, and graphing variable cost against output gives the TVC curve.
where do a firm’s cost curves come from?
what factor do cost curve and product curve include?
(short run cost)
- A firm’s cost curves come directly from its product curves
- included:
+) total product cost
+) total variable cost
shifts in cost curve (short run cost)
Shifts in short run’s cost curve depend on:
- tech
+) trend: better tech -> inc productivity –> marginal product and average product of labour
+) better tech + same factors of prod -> inc output -> dec in cost of prod + shifts the product curve upward + shifts the cost curve downward. but the relationship between product and cost C remains unchanged
+) attempt to advance tech may result in the firm’s inc use of capital (fixed factor) and dec use of labour (variable factor) -> dec total cost but inc fixed cost and dec variable cost. the change in mix of FC and VC means at small output, ATC might inc, whereas at large output, ATC might dec
- P of factors of prod: inc P of factors of prod -> inc firm’s cost + shifts its cost curve. How the cost curve shifts depend on which factor P changes:
+) inc in rent or other FC shifts the TFC, AFC, TC curves upward + leaves the AVC, TVC, MC curve unchanged. Ie: inc interest expense of a trucking company-> inc FC of transportation services
+) inc wage, gasoline or other VC shifts TVC, AVC, MC curves upward + leaves AFC and TFC curves unchanged. Ie: inc truck driver’s wage or P of gasoline -> inc variable and marginal cost of transportation service
Define long run cost and production function
- Define long run cost: In the long run, a firm can vary both Q of labour and capital -> in the long run, all the firm’s costs are variable.
- production function is included in long run cost:
+) prod function table lists total product schedules for labour (workers/day) with different Q of capital (output - Q/day).
+) Q of capital identifies the plant size. The numbers for plant 1 are for a factory with 1 knitting machine. The other three plants have 2, 3, and 4 machines. If the firm uses plant 2 with 2 knitting machines, the various amounts of labour can produce the outputs shown in the second column of the table. The other two columns show the outputs of yet larger quantities of capital. Each column of the table could be graphed as a total product curve for each plant. - Diminishing return:
+) occur with each of the 4 plant sizes as the Q of labour inc.
+) calculation:
-> calculate the marginal product of labour in each of the plants with 2, 3, and 4 machines. With each plant size, as the firm inc the QD of labour, the marginal product of labour (eventually) diminishes.
+) also occur with each Q of labour as the Q of capital inc. calculation: calculate the marginal product of capital at a given Q of labour.
+) marginal product of capital = change in total product/ change in capital when the Q of labour is constant—equivalently, the change in output resulting from a one-unit inc in Q of capital. Ie: if the firm has 3 workers and inc its capital from 1 machine to 2 machines, output inc from 13 to 18 sweaters a day. The marginal product of the 2nd machine is 5 sweaters a day. If the firm continues to employ 3 workers and inc the number of machines from 2 to 3, output inc from 18 to 22 sweaters a day. The marginal product of the 3rd machine is 4 sweaters a day, down from 5 sweaters a day for the 2nd machine.
What does prod function imply to long run cost?
- Plant size has a big effect on the firm’s ATC
- Each short-run ATC curve is U-shaped.
- For each short-run ATC curve, the larger the plant, the greater is the output at which ATC is at a min.
- Each short-run ATC curve is U-shaped because, as the Q of labour inc -> its marginal product initially inc and then diminishes. This pattern in the marginal product of labour occurs at all plant sizes.
- The min ATC for a larger plant occurs at a greater output than it does for a smaller plant because the larger plant has a higher TFC and therefore, for any given output, a higher average FC.
- Which short-run ATC curve a firm operates on depends on the plant it has.
+) In the long run, the firm can choose its plant and the plant it chooses is the one that enables it to produce its planned output at the lowest average total cost.
+) To see why, suppose that the firm plans to produce 13 sweaters a day. With 1 machine, the ATC curve is ATC1 and the average total cost of 13 sweaters a day is $7.69 a sweater. With 2 machines, on , ATC is $6.80 a sweater. With 3 machines, on , ATC is $7.69 a sweater, the same as with 1 machine. Finally, with 4 machines, on , ATC is $9.50 a sweater.The economically efficient plant for producing a given output is the one that has the lowest ATC. For this firm in this example, the economically efficient plant to use to produce 13 sweaters a day is the one with 2 machines.In the long run, Cindy chooses the plant that minimizes ATC. When a firm is producing a given output at the least possible cost, it is operating on its long-run average cost curve which is the relationship between the lowest attainable average total cost and output when the firm can change both the plant it uses and the quantity of labour it employs and it also known as a planning curve that tells the firm the plant and Q of labour to use at each output to minimize average cost. Once the firm chooses a plant, the firm operates on the short-run cost curves that apply to that plant.
An outcome is considered efficient if
it is not possible to make someone better off without making someone else worse off
What happens in the market for laptop if the expected future P of a laptop rises?
SC shifts leftward
the opportunity cost of shifting the production possibility frontier outward is
reduced current consumption
A technological improvement lowers the cost of producing coffees. At the same time, preferences for coffee
inc/dec/ remains the same depending in the relative shifts of DC and SC
When P good A inc, SC good B shifts rightward
A and B are complements in production
the flows in the market economy that go from firm, to households are (1). The flows in the market economy that go from households to firms are (2)
- the real flows of goods and services and the income flows of wages, rent, interest, and profit
- the real flows of labour, land, capital, and entrepreneurship and the flow of expenditure on goods and services
Hector is buying an icecream sundae in a shop near Lake Erie. He has the option of spending an extra dollar to get either chocolate sauce or sprinkles. the opportunity cost of getting sprinkle is
there is not enough info to answer this question
marginal cost curve is
a horizontal line is derived from a PPF that has a constant slope
wages paid to worker is not a factor of production. Why?
Factor of production:
- land used by a farmer to grow wheat
- water used for a nuclear power plant
- effort of farmers raising cattle
- management skill of a small business owner
factors of production
- Land/natural res
- Labour:
+) mental and physical effort of workers
+) quality of labour depends on human capital (workers’ knowledge and skills obtained through education, training, past experience) - Capital
+) normally: tools, instruments, machinery, buildings, constructions
+) financial capital: money, stocks, bonds -> not used to produce goods and services, hence, NOT a factor of prod - Entrepreneurship
people earns income through selling the services of factors of prod they own
- land earns rent
- labour earns wages
- capital earns interest
- entrepreneurship earns profit
which factor of prod earns most income?
Labour!, which is 70% of total income. the rest of 30% are land, capital, entrepreneurship
Economic way of thinking
- Define choice: A tradeoff ( an exchange—giving up one thing to get something else.
- People make rational choices by comparing benefits and costs (one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice)
- Define benefit: what you gain from something and is determined by your preference OR the most that a person is willing to give up to get something
- Define cost/ opportunity cost: what you must give up to get something OR the highest-valued alternative that must be given up to get it.
- Most choices are “how much” choices made at the margin.
+) marginal benefit: benefit you receive when you increase an activity
+) marginal cost: opportunity cost you incur when you increase an activity
=> decision making: compare marginal benefit and cost - Choices respond to incentives.
+) everyone makes choices based on upon self-interest
+) econ key idea: predict people’s self interest
+) purpose of incentive: attempt to reconcile self-interest and social interest.
+) goal: figure out the incentives that result in self-interested choices being in the social interest.
positive statement
- Characteristics:
+) it’s about what is.
+) what is currently believed about the way the world operates.
+) might be right or wrong, but testable against the facts.
+) ie: “Our planet is warming because of the amount of coal that we’re burning” is a positive statement.
+) goal: test positive statements about how the economic world works and to weed out those that are wrong.
