What is Econ?
The study of the CHOICES people make and the actions they take in order to make the best use of SCARCE resources in meeting their WANTS and NEEDS ex. 4.0 GPS vs Social Life (Time is Scarce)
Consider some activity X. Then a simple rule of econ is...
- If benefits (X) > Cost (X), then do activity X
- If cost (X) > Benefits (X), then do not do activity X
Ex. X is a policy to reduce speed limits on a highway from Edmonton to Calgary to 10 Km/HR
Costs: traffic, increased time, more cops, more emissions, replace signs, fuel consumption
Benefit: Less deaths
What are the 2 main branches of Econ?
MICROECON: The study of choices and actions of individual economic units such as households, firms, consumers etc.
MACROECON: The study of the behaviour of the entire economy, including issues like unemployment, inflation, and changes in the levels of national income
Judging Econ Allocations
Allocation of resources can be evaluated on the basis of ...
1) EFFICIENCY: allocative efficiency is present when society resources are so organized that the present value of net benefits are maximized. (Net Benefits = Benefits - Cost)
2) EQUITY: Distributing goods and services in a manner considered by society to be FAIR
3) MORAL and POLITICAL CONSENQUENCES
Positive vs Normative Econ
POSITIVE ECON: Involves statements about what is and can be tested by checking the statements against the observed facts. Ex. if the price of coffee raises, ppl will buy less
NORMATIVE ECON: Involves statements about what ought to be. Depends upon values and beliefs and can't be tested Ex. Taxes should be used to re-dist income from high income families to low econ groups
Econ As a Science
Econ is a social science that seeks to explain how people act.
Like any other science it uses models, theories and assumptions to decide how people behave.
A model is a simplified description of the way things work.
A model is not a complete description of ever detail but rather a simple description that covers a wide range of possibilities
Models and theories are meant to provide an understanding and explanation.
They also should be useful in predicting behaviour
Econ is an EMPIRICAL science
Theories and models are tested against observed info
The Correlation Fallacy
Incorrect belief that correlation implies causation. (One causes another, possible 3rd factor)
The Post Hoc Fallacy
Special case of the correlation fallacy From latin "post hoc ergo propter hoc" meaning after this therefore bc of this
Error of reasoning that a first event causes a second event bc/ the first event occurred before the second Ex. Shopping causes christmas
Incorrect belief that what is true for the individual is also true for the group.
Ex. When the econ is struggling, one individual takes out all of his money out of the bank, but if everyone does it, it will make the economy go into recession.
The Production Possibilities Front (PPF)
The graph that shows the combinations of goods that can be produced when the factors of production are utilized to their full potential. Is drawn for a given level of the society's inputs (Labour, natural resources, capita) and for a given state of the society technology
TYPES OF POINTS ATTAINABLE: Points that are on the PPF graph line, and within
EFFECIENT: Strictly only the points that are on the PPF Graph line
INEFFECIENT: Points that are OUTSIDE of the PPF graph line PPF illustrates Scarcity and Choice When we make choices, we incur costs
Is the benefit given up by not using the resource sin a next best alternative way
Ex. Opp Cost of Econ Class Sleeping has the most value to us. So that is our next best option, opportunity cost
Law of Increasing Costs
In order to produce extra amounts of one good, society must give up amounts of another good
This occurs because resources are not equally productive in all activities. Product workers with many years of experience for the bottled water company are very good at bottling water but not very good at making DVD's. Other workers may not be very productive at bottling water so if we move them to DVDs from Bottled Water, production, we get an increase in quantity of DVDs but a small decrease in the quantity of bottled water. As we produce more DVDs, we would have to move ppl who are good at producing bottled water into DVD production Another unit of DVDs would cost an increasing number of bottled water.
This is true to some of capital inputs, we are moving resources away from their best relative use
The Market Economy
In economics, we assume that individuals act as if we are motivated by self interest and act in a rational way
The Rationality Assumption
Individuals do not intentionally make decisions that will leave them worse off Notice that the rationality assumption doesn't imply that people only make choices based upon monetary benefits Nor, does it rule out acts of kindness or charity It only states that people will not intentionally make themselves worse off
The players in the market belong to what 3 groups?
Consumers of goods and services and the sellers of factors of production.
Objective: Maximize their satisfaction
Producers of goods and services and demanders of factors of production.
Objective: Maximize profits
All public officials
Main Characteristics of Market Economies
1. SELF-INTEREST Individuals pursue their own self-interest, buying and selling what seems to be best for them and their families
2. INCENTIVES People respond to incentives
3. MARKET PRICES ABD QUANTITIES Prices and quantities are determined in open markets in which would be sellers compete to sell their products to would be buyers
4. INSTITUTIONS All of these activities are governed by a set of institutions largely created by government. These institutions include...
A) INDIVIDUALIST INSTITUTIONS OF PROPERTY AND DECISION MAKING Before people can begin to think about making an exchange, they must be clear about what belongs to whom. For decentralized exchange to take place, people must have individually held private property which is the ownership assets by non-gov econ agents
B) SOCIAL INSTITUTIONS OF TRUST Trust must exist between buyers and sellers. This trust may be established through cultural norms, through direct 1-on-1 relationships or through the establishment of contracts
C) INFRASTRUCTURE FOR THE SMOOTH FLOW OF GOODS AND SERVICE Refers to the physical infrastructure of transportation and storage
D) MONEY AS A MEDIUM OF EXCHANGE To facilitate the flow of goods and service, we need a generally accepted means of payment The natures of private property and contractual obligations are defined by legislature and enforced by the courts
What does the CIrcular Flow DIagram Consist of?
THe demand function shows the quantity demanded of a good for differet levels of the goods price given the values other relevent variables
Define Quantity Demanded
Amount consumders are willing to buy during a given time period.
As product prices increases, quantity demanded decreases and vice versa. This is the ceteris peribus
Define Law of Demand
Changes in the commoditys price correspond to movements along the demand curve whic are reffered to as a change in quanity demanded
One and only variable causes a change in quantity demanded; that variable is the PRICE OF THE GOOD
Variables that influence demand: Soup quality, weather, price of chili, cost of making soup
1. PRICES OF SUBSITUTES
(Satisfy the same basic need)
Ex. Butter and margirin, coffee and tea
If the price of the subsitute for good A increases, the demand for good A increases
2. COMPLIMENTS PRICE
If the price of a complement of good A increases, the demand for good A DECREASES
(Decrease in demand)
Consumers views towards future prices and availibility
(Impact demand today, if we suspect that the price of vodka is increasing, we will bulk buy before then)
Variables that Influence Demand
1. Price of Subsitutes
2. Price of Compliments
4. Numbers of Buyers
As the number of buyers increases, so does demand
5. Preferences in taste (fashion trends)
As preferences change, demand changes
a) Normal good
as income increases (decreases), demand increases (decreases)
b) Inferior good
As income increases (decreases), demand decreases (increases)
Ex. Kraft dinner
Law of Supply
As the price of a commodity increases (decrease), the quantity supplied increases (decreases), ceteris paribus
Changes in the commodity price correspond to movements along the supply curve which are reffered to as changed in quantity supplied.
What are the 7 Variables that Influence Supply?
As technology improves, supply increases.
(NOTE: A tech improvement is an improvement in production)
Ex. Not DVD to blue ray, BUT tech to make blue ray
2. TAXES AND SUBSITIES
Taxes increase costs and there by decrease supply subsidies are negative taxes.
3. COSTS of INPUTS
(Wages, interest rates, energy prices, oppourtunity cost)
As cost increase, supply decreases
4. NUMBER OF FIRMS
As the number of firms increases, supply increases
As expectations change, supply changes.
Ex. Farmers anticipating a higher price for one crop might farm more of those specific crops
6. PRICES OF COMPLEMENTS IN PRODUCTION
If the price of a complement in productiton for good A increases, the supply of good A increases.
7. PRICES OF SUBSITUTES
(If you can replace a good with this)
If price of a substitute in production for good A increases, supply for good A decreases.
Equilibrium in the Market
Equilibrium is achieved int the market when the supply curve intersects with the demand curve
Eq: Quantity demanded = Quantity supplied
Note that at the equilibrium the market clears. That is, there is no suprlus and no shortage.
What is Comparative Stats?
Change in equilibrium when a variable is changed
Ex. Commodity: Pizza
Price of compliment increases (Beer)
Suppy and Demand With Government Intervention
Economic forces ration commodities and services through changing prices. The market works like an INVISIBLE HAND guiding economic forces to coordiniate individual actions and allocate SCARCE resources.
All individuals acting only in their own self interest are guided by the invisible hand of the market to produce allocations that are the best for society
First, whis is it that when we look at the real world, we don't see these economic forces working as smoothly as the above discussion would suggest
Second, and a related question, if these economic forces work so well, why do we need governments?
1) INFO PROBLEMS
Consumers and producers do not possess perfect info. People make mistakes
2) OTHER FORCES ACT IN SOCIETY
These forces stop some markets from operating and precent some markets from CLEARING (Equilibrium)
- SOCIAL AND HISTORICAL FORCES (The Invisible Handshake): Social and Historical forces (Such as tradition) can prevent a market from marketing
- POLITICAL AND LEGAL FORCES (The Invisible Foot): Governments and legal forces also guide and limit market activities
- SOMETIMES MARKETS FAIL (The Invisible Elbow)
We need governments to...
- Insure that activities and markets conform to social, cultural, legal and political norms. Recall that allocations of resources must be morally and political acceptable
- To correct markets that fail
What are some regulations on price?
- Price Floors
- Price Ceilings
Government sets the MINIMUM price for a good or service
- With Price floor Quantity Supplied > Quantity Demanded = SURPLUS
Ex. Min wage is a price floor (Creates unemployment)
Government sets the MAX PRICE for a good or service
- With Quantity Supplied SHORTAGE
ex. Rent Controls
Government sets the max quantity for a good or service
What influences the size of elasticity of demand?
1. The Number of Substitutes
The more substitutes a good has, the more consumers can respond to a change in the price of good A. Thus, the more ELASTIC is the demand for good A
The more time consumers have, the more they can respond to a change in the price and again the more elastic demand is
3. Whether the good is a necessity or a luxury
The demand for a luxury is more elastic than the edemand for a necessity.
Revenue = P X Q