Week 2 - Decision making in markets Flashcards
What is an useful modal?
It is clear - better understand something important
It predicts accurately - makes predictions consistent with evidence
It improves communication - Understand what we agree (and disagree) about
It is helpful - find ways to improve things
Absolute advantage:
Agent can produce a good using fewer resources than another agent, or produce more goods for the same resources
Opportunity cost:
The value of the next best alternative
E.G If Paul spends an hour making pastries, he sacrificing his time to make coffee in that hour
Why do we trade?
Agents can have an absolute advanatage but can’t have an comparative advantage due to specisilisation.
Results in people engaging in mutaually benfitifal trade
Trade expands consumption bundles beyond what is possible through self sufficiency
Comparative advantage:
An agent has a comparative advantage when they can perform a task at a lower opportunity cost relative to another agent.
What are the two types of decision makers in competitive markets:
Buyers and sellers
In a competitive market, each buyer and seller is a price-taker
- In a competitive market no buyer and seller has enough sway and influence in the market to change the price.
The importance of opportunity cost in a competitive market
Opportunity cost is essential in the decision-making of buyers and sellers
Individual demand:
All consumers have a maximum price (reservation price) they would pay
- This reservation price is informed by opportunity costs
For each unit, consumers compare their reservation price (the marginal benefit) for that unit with the price charged (the marginal cost)
If MB ≥ MC, buy the unit
Competitive market model:
When happens to the market when quantity decrease?
= The price increases and quantity decreases
What happens when demand increases?
= Both Price and Quantity increases
What happens to the market equilibrium price and quantity when there’s a 10% off sale?
= Price goes down but Quantity is ambiguous
Market Equilibrium:
Market demand is the horizontal sum of individual consumer demands
Market supply is the horizontal sum of individual seller supplies
The equilibrium price is the price at which quantity demanded = quantity supplied
Individual Supply:
All sellers have a minimum price they would accept
- The reservation price is informed by opportunity costs
For each unit, sellers compare their reservation price (the marginal cost) for that unit with the price charged (the marginal benefit)
If MB ≥ MC, sell the unit
Price Elasticity of Demand (PED):
When price increases, quantity demanded will probably fall
- PED depends on the accessibility to alternative substitutes to the goods that went up in price
Other factors:
- Time horizon - Do you need a good tomorrow?
- Availability of substitutes - Are the substitutes just as good as the item
- Definition of good - Did it affect something specific or a broad category
- Income share - How impactful is this price increase
Price Elasticity of Supply (PES):
Price of good increases = quantity supplied will probably rise.
PES depends on how easy it is to make/sell more of the good when the price goes up
Other factors:
- Time Horizon: is the price rise sudden or anticipated
- Availability of raw materials: Are raw material available
- Inventories: Are there available finished good or must you make more first
- Excess capacity: are your inputs already at its maximum
