Midterm #1 Flashcards
What is microeconomics?
study of the behaviour of individual economic units (consumers and workers) and the market that formed by these units
Microeconomics deals with limits
example-budgets, time, ability to produce
Trade-offs
workers, firms and consumers must make trade offs
ex) do I work or go on vacation?
Consumers
have limited incomes
ex) how to maximize well being
Workers
individuals decide when and if to enter the work-force
ex) how many hours do individuals choose to work?
Firms
ex) what types of products do firms produce?
Prices and markets
Based on prices faced by consumers and producers
- workers made decisions based on prices for labour
- firms make decisions based on prices for inputs and on prices for the goods they produce
How are prices determined?
1) centrally planned economies- governments controls prices
2) market economies- prices determined by interaction of market participants
Theory of the firm
- assumption
- prediction
1) assumes firms try to maximize their profits
2) reveals whether a firm’s output level will increase or decrease in response to an increase in wage rates or a decrease in the prices of raw materials
Models
- mathematical representation to make predictions
ex) how much a firm’s output level will change as a result of percentage change drop in prices in raw materials
Validating a theory
determined by the quantity of its prediction, given the assumptions
-theories must be tested and refined
Factual statement
ex) what will happen?
Value judgement
ex) what is the best?
Positive analysis
explains facts, circumstances and the cause and effect relationships, and predict the probable outcomes
describes what it is
Normative analysis
involves ethics and value judgments, is used to prescribe alternative policy options
describes what it ought to be
Sellers
consumers sell labor
Buyers
consumer purchases goods
Arbitrage
practice of buying a product at a low price in one location and selling it for more in another location
Perfectly competitive markets
many buyers and sellers, no individual buyer or seller can influence the market price
- acts as price takers
ex) most agricultural markets
Noncompetitive markets
where individual producers can influence the price
Market price
price prevailing in a competitive market
ex) some markets only have one price- gold
Why is the market definition important?
1) in order to set price, make budgeting decisions, companies must know their competitors and product characteristics and geographic boundaries of the market
2) public policy decisions
Nominal price
absolute or current dollar price of a good or service when it is sold, not adjusted for inflation
Real price
price relative to an aggregate measure of prices or constant dollar price, adjusted for inflation
Consumer price index (CPI)
measure of aggregate prices
Supply and demand
why and how prices change
-economic conditions affect market price and production
The supply curve
relationship between the quantity of a good that producers are willing to sell and the price of the good, holding other supply-determining factors
The demand curve
relationship between the quantity of a good that consumers are willing to buy and the price of the good, holding other demand-determining factors constant
Demand Factors
Supply Factors
1) demand- income, weather and complementary goods
2) supply- wages, interest charges, raw materials
Market mechanism
in a free market for price to change until the market clears at the market-clearing equilibrium price
Market surplus
Quantity supplied > quantity demanded
Downward pressure on price
Quantity demanded increase and quantity supplied decreases
Market shortage
Quantity demand > quantity supplied
upward pressure on price
Quantity demand decrease and quantity supplied increases
Price elasticity of demand > 1
Price elasticity of demand < 1
1) the good price elastic
2) the good price inelastic
Completely inelastic demand
Infinitely elastic demand
1) vertical line (graph)
2) horizontal line
Cross price elasticity of demand
Elasticity < 0
Elasticity > 0
1) complementary goods ex) cars and tires- compliment each other
2) substitute goods ex) butter and margarine- they can replace each other
Price elasticity of supply
Elasticity > 1
Elasticity < 1
1) price is elastic
2) price inelastic
Point Vs Arc Elasticities
Point elasticity of demand- particular point on demand curve
Arc elasticity of demand- calculated over a range of prices
Effects of government intervention-price controls
-markets are rarely free of government intervention- imposed taxes and granted subsidies
price controls usually hold the price above or below the equilibrium price
excess demand- shortage
excess supply- surplus
Consumer surplus
- measures the total benefit that consumers receive beyond what they pay for the good in a competitive market
- demand curve shows how much of a good consumers are willing to buy as the price per unit changes
Producer surplus
- measures the total profits that producers receive beyond what it cost to produce a good
- supply curve shows the amount that producers are willing to take for a certain amount of a good
Welfare effects
gains and losses to producers and consumers
Price ceiling
the price of a good cannot go above that price
ex) rent control
Price control and surplus changes
-when the price is too low
- causes quantity demand increases and quantity supply decreases
- some consumers are worse off because they can no longer buy the good= decrease in consumer surplus
- some consumers can buy it at a lower price- increase in consumer surplus
- producers can sell less at a lower price- producer surplus decreases
Deadweight loss
inefficiency of the price controls- the total loss in surplus
Economic efficiency
maximization of aggregate consumer and producer surplus
Two important types of market failures
1) Externalities- action taken by either a producer or a consumer which affects other producers or consumers but is not accounted for by the market price ex) pollution
2) Lack of info- about the quality or nature of a products prevents consumers from making utility-maximizing purchasing decisions
Minimum prices
government policy seeks to raise prices above market-clearing levels
- minimum wage law
- agricultural policies
Effects of minimum wage
1) decreased quantity of workers demanded
2) workers hired receive higher wages
3) unemployment
Price supports
price set by government above free-market level and maintained by governmental purchases of excess supply
Welfare effects of a price support policy
- consumers must pay higher price for the good
- producers gain since they are selling more at a higher price
- government cost
Production quotas
government can restrict supply either by imposing production quotas or by giving producers a financial incentive to reduce output
Import quotas and tariffs
import quota- limit on the quantity of a good that can be imported
tariff- tax on imported good
-domestic producers to enjoy higher profits, but costs to consumers is high
Impact of a tax or subsidy
burden of tax falls partly on the consumer and partly on the producer
-how it is split depends on the relative elastics of demand and supply
Four conditions must be satisfied after the tax is in place
also used for subsidy
1) quantity sold and buyers price must be on the demand curve. buyers are only concerned with what they must pay.
2) quantity sold and sellers price must be on the supply curve. sellers are only concerned with what they receive
3) quantity demanded must equal quantity supplied
4) difference between Pb and Ps is the tax
Tax burdens
- if demand is relatively inelastic- will fall on buyers ex) cigarettes
- if supply relatively inelastic- will fall on seller
Effects of a subsidy
- Payment reducing the buyer’s price below the seller’s price
- treated as negative tax
- sellers price exceeds the buyer’s price
Benefit of subsidy
1) affects mostly buyers if Ed/Es is small
2) affects mostly to sellers if Ed/Es is large
Labour market
allocates workers to jobs and coordinates employment decisions
Supply of labour
Demand of labour
- workers willing to supply their labour services
- employers looking to buy the labour services of workers
Labour Market
Buyers and sellers
Buyer- worker
Seller- employees
Labour force
employed and unemployed but actively seeking work or expecting a layoff
ex) new entrants and reentrants
Not in labour force
unemployed and not looking for work, not waiting to be recalled from layoff
ex) retirements, dropouts
Tight Market
low unemployment, hard to find employees, hard to find qualified workers
# of jobs > # of employees
less than 5%
Loose Market
high unemployment, easy to find workers, hard to find jobs
# of employees > # of jobs
more than 5%
The earnings of labour
1) wage rate
2) nominal wage
3) real wage
1) hourly wage
2) pay per hour in current dollars
3) nominal wage divided by some measure of price
used to compare purchasing power of a worker’s earnings over a period of time
Labour market
Problem with consumer price index
used to measure change in worker’s purchasing power
1) consumers change the consumption bundle over time due to price changes
2) quality of goods and services changes over time
Employee benefits
Deferred benefits
1) in kind ex) vacation and bonus
2) pension plan
Unearned income
income you didn’t work for ex) dividends and interest
How the labour market works
firms purchase inputs- labour (L) and capital (K) used in the production of goods and services from the labour market to the capital market
Demand for labour can be analyzed on 3 levels
1) firm level
2) industry level
3) market level
Long vs short run
LABOUR
Long
- responses to changes in wage or other forces affecting Ld are larger and more complete
Short
-employers find it difficult to substitute K(fixed) and L (variable)
-Quantity demanded may not change much in response to a price change
Supply of Labour
to a particular market is positively related to the wage rate prevailing in that market, holding other wages constant
Horizontal supply curve of a labour
going wage, a firm could get all the workers it needs
Disequilibrium and non market influences
labour market
- changing jobs often requires an employee to invest new skill
- hiring workers can involve an initial investment
Overpaid (Above equilibrium)
- employers are paying more than necessary
- more workers want jobs than they can find
- wage is higher than equilibrium
Underpaid (below equilibrium)
- employers face labour shortage
- difficult to find and keep workers
- below equilibrium
Economic rents
difference between the wage received and the worker’s reservation wage
Reservation wage
wage below which the worker would refuse (or quit) the job in question
-giving up hours at work
Unemployment and responses to tech changes across countries
- strength of non market forces- government programs, laws, customs
- acceleration of tech change led to a decline in demand for less skilled workers and their real wages
- non-market forces causes the real wages of low paid workers to rise increased the unemployment rate for the less educated
What affects demand?
income, season, weather, price of complements/substitutes and interest rates
What affects supply?
cost of production, interest rate, tech and expectation
Perfectly inelastic
when the demand for a product doesn’t change as much as the price.
What causes the demand curve to shift?
- decrease in price of a substitute
- decrease in income if a good is normal
Complementary goods
1) when price increases, demand increases
(vice versa) ex) cars and gas
Normal good
1) when income increases, demand increases ex) travel and clothing
Inferior good
demand decreases when consumers income rises ex) public transit
What would causes the supply curve to shift?
-input prices. price of raw material used in production of a product goes down then supply will increase
Excess supply
Excess demand
1) producers accept lower prices
2) consumers accept higher prices
Factors that affect elasticity
1) many substitutes
2) luxury
3) narrowly defined (specific)
Factors that affect elasticity
inelastic
1) few substitutes
2) necessity
3) broadly defined industry
4) short run
Perfectly inelastic demand
price doesn’t affect demand
vertical line on graph
ex) business can charge any price they want
Perfectly elastic demand
quantity doesn’t change
- horizontal line on graph
ex) gas station
If the gov wants to limit imports of a certain good. is import quota or tariff better?
producer and consumer surplus changes are the same.
tariffs are better since the gov can redistribute the tax revenue to offset the deadweight loss
burden of tax- when will producers pay more tax?
if demand is relatively more elastic than supply
What determines the share of a subsidy that benefits consumers?
demand is relatively less elastic than supply, consumers will benefit more from the subsidy than producers
Why does tax create a deadweight loss? what determines the size of the loss?
1) tax raises price consumers pay and lowers the price producers receive
2) depends on elasticity of demand and supply, if the demand is relatively elastic,, loss will be larger
profit-maximizing output will always occur where
marginal revenue equals marginal costs
Marginal product of labour (MPL) represents
additional output generated by increasing labour by one unit
Marginal income
- from an additional unit of input
- profit maximizing decisions- questions whether, and how, to increase or decrease output
The search for profit improving possibilities means that small (marginal) changes must be made daily
-major decisions ex) open new plant- rare decision
-trial and error process with small changes
-decide on optimal level of output :
Q is profit maximizing or loss minimizing when MR=MC
Marginal expense
- labour market competitive
- capital market competitive
1) each worker is paid the same wage= horizontal supply curve
2) each additional unit of capital will have the same rental cost MEk= C
when both product and labour markets are competitive we assume
1) all producers and sellers are price takers in the product market
2) all employers of labour are wage takers in the labour market
Short run demand for labour when both product and labour markets are competitive
firm cannot vary its capital stock
only employment of labour can be adjusted
Labour force in Canada is defined as
1) age 16and over
2) actively seeking work
3) expecting recall from a layoff
how does the firm decide if they want to increase labour or capital?
1) income generated by employing one more unit exceeds the additional cost associated with that input-the firm should add one more input (one more worker)
(vise versa- do not add)
2) income generated by one more unit=additional cost of one more unit- optimal point
Assumptions about the MPL and MPK
1) production function increases output when either capital or labour input increases
2) MPL and MPK have diminishing marginal returns
Revenue maximization in the short run
- assume k is fixed
- profit maximizing is when Marginal product times labour =wage
income elasticity > 0
income elastic < 0
- normal good
- inferior good
Tax ALWAYS creates
deadweight loss
Employing large amounts of labour, barely use any capital
L > K
MPK likely be very high
MPL and MPK have diminishing returns
