MICROECONOMICS

Economics: The study of how groups allocate scare resources to satisfy unlimited wants and needs

Opportunity Cost: The value of the next-best alternative forgone

Factors of Production: All inputs used to produce goods and servicesC- Capital (equipment)E- Entrepreneurship (management)L- Land (natural resources)L- Labor (workforce)

Normative Statement: A statement that is a matter of opinion

Positive Statement:A statement that can be proven or disproven

PPF (Production Possibilities Frontier):Represents all combinations of the maximum amounts that two goods can be produced in an economy when there is a full employment of resources and efficiency. The PPF model demonstrates concepts such as scarcity and opportunity cost.

Point A = the economy is operating less than full efficiency

Point B = the economy is operating at full efficiency however the opportunity cost to produce more guns is a lot of bread

Point C = the economy is operating at full efficiency however the opportunity cost to product more bread is a lot of guns

Point X = the economy can not operate at this efficiency as they do not have the factors of production to do so

Economic Growth:The measure of a change in countries GDP, or real national income such that an increase in national income is classified as economic growth

Economic Development: The measure of welfare and well-being, instead of being measured in monetary indicators, it is measured in terms of indicators such as education, health and social indicatorsDemand

Demand and the Law of DemandDemand is the quantity of a good that consumers are willing and able to purchase at a given price in a given time period. The law of demand states that as the price of a product falls, the quantity demanded increases. Ceteris paribus.

Shifts in the Demand Curve

IncomeNormal Goods: as a consumers income rises, the demand for the product will also rise, shifting the demand curve to the rightInferior Goods: as a consumers income rises, the demand for the product will fall, shifting the demand curve to the left

SubstitutesIf products are substitutes, then a change in the price of one of the products will lead to a change in the demand for the other product. For example, if there is a fall in the price for Good A (movement along the demand curve), then the demand for Good B will decrease (demand shifts left).

ComplementsIf products are complements to each other, then a change in the price of one good will lead to a change in the demand for the other product. For example, if there is a fall in the price for Good A (movement along the demand curve), then the demand for Good B will increase (demand shifts right).

Calculating the Demand Curve (HL)

A = where the graph meets the x-axis and where demand would be if the price was zero. If A changes, there will be a parallel shift in the demand curve. B = sets the slope for the demand curve (rise/run). If B changes, there will be a change in the steepness of the curve therefore a change in the elasticity.

Supply

Supply and the Law of SupplySupply is the willingness and ability of products to produce a quantity of a good or serve at a given price in a given time period. The law of supply states that as the price of a product rises, the quantity supplied of the product will increase. Ceteris Paribus.

Shifts in the Supply Curve

Cost of Factors of ProductionIf there is an increase in the costs of the factors of production, such as a wage increase, ths will increase the firms costs meaning that they can supply less (shift to the left)

Price of Other ProductsProducers often have a choice of what they would like to produce such that if there is a raise in the price of Good A, they may produce less of Good B (shift to the left) to maximize revenue

TechnologyImproves in the state of teachnology in a firm should lead to an increase in supply thus a shift of the supply curve to the right

Calculating the Supply Curve (HL)

C = the quanitity that would be supplied if the price was zero. If C changes, there will be a parallel shift in the supply curveD = sets the slope of the curve. If D changes, there will be a change in the slope therefore the elasticity.

Market Equilibrium

EquilibriumThe point in which the demand and supply curve intersect and the economy is in a state of rest such that there is no outside disturbance

Changes in EquilibriumIf there is a change in one of the determinants of demand or supply there will be a shift in one of the curves resulting in a new equilibrium.

Surpluses and ShortagesIf the price is raised above the equilibrium, suppliers will have more incentive to produce however demand will decrease resulting in a surplus (excess supply)If the price is lowered, demand will increase while supply will decrease resulting in a shortage (excess demand)

Consumer and Producer SurplusConsumer surplus: the highest price consumers are willing to pay minus the price they actually pay. Consumers who are willing to pay for a product at a higher price, but only have to pay at equilibrium price are experiencing a gain. Producer surplus: the price received by firms for selling their goods minus the lowest price they are willing to accept. Producers who are willing to supply a product at a lower price, but instead can supply at equilibrium are experiencing a gain.

Economic EfficiencyWhen allocative and productive efficiency are achieved and marginal cost = marginal benefit (MC=MB) in every market

Allocative EfficiencyWhen an economy produces the combination of goods most desired by society where the consumer surplus is equal to producer surplus thus community surplus is achieved and where marginal cost is equal to marginal benefit

Calculating Market Equilibrium

1. Set Qs and Qd equal to one another and solve for P to get the equilibrium price2. Substitute P into either of the equations to get the equilibrium quantity

Elasticitys

Elastic vs. InelasticElastic: responds substantially to price (e.g. luxuries, goods with close substitutes), such that if the price goes down the change in Qd/Qs is greaterInelastic: does not respond to price (e.g. necessities, addictiveness), such that if the price goes down the change in Qd/Qs is smaller

Price Elasticity of Demand (PED)

Price Elasticity of DemandThe measure of how much the demand for a good changes when there is a change in the price of the product

*Percentage change is calculated by taking (New Old)/Old

Values of PED

PED1 elasticPED=1 unit elasticPED=0 perfectly inelasticPED=P perfectly elastic

Inelastic DemandIf a product has inelastic demand, then a change in the price of a product leads to a proportionally smaller change in the quantity demanded of it. Therefore raising the price of an inelastic product leads to a larger total revenue. P TR P TR

Elastic DemandIf a product has elastic demand, then a change in the price leads to a greater than proportionate change in the quantity demanded of it. P TR P TR

Determinants of PEDThe number of substitutes: If a product has more substitutes then likely the demand will be elasticThe necessity of the product: If a product is a necessity, then likely it will have inelastic demand

Cross Elasticity of Demand (XED)

Cross Elasticity of DemandThe measure of how much the demand for a product changes when there is a change in the price of another product

Values of XEDXED>0 substitutes XED0 normal goodYEDMC indicating there is an under allocation of resourcesProductive: when P= min AC, in this market P>min AC therefore average cost is higher than what is optimal, if excess capacity is lowered than it can become productively efficient

Oligopolies

OligopolyType of Product: similar Market Power: compete on strategy not priceNumber of Sellers: fewRole of Advertising: highBarriers to Entry: very high

CollusionOligopolistic firms are very competitive and because of that, they try to limit competition on price as much as possible. A cartel is an agreement between firms to limit competition, or what is referred to as collusion.

Cost Curves when firms Collude

The light grey box represents the firms costs, while the dark grey box represents supernormal profits.

Cost Curves when firms do not collude

The Kinked Demand Curve explains price inflexibility of oligopolistic firms that do not collude. Firms also maximize profits where MC=MR, therefore firms will always produce at Q, which is the point that reflects the dashed part of the MR curve.

MACROECONOMICS

Expenditure Components of GDPConsumers (C) = consumer expenditureInvestment (I) = investment by firms in capitalGovernment (G) = government expenditureNet Exports (X-M) = exports minus imports

Aggregate Demand (AD)The total quantity of goods and services that all sectors of the economy (GDP) are willing and able to buy at all possible price levels

Changes in Consumer SpendingChanges in wealthChanges in interest ratesChanges in expectationsChanges in personal income taxes

Changes in Investment SpendingChanges in interest ratesChanges in business taxesChanges in expectationsImprovements in Technology

Changes in Government SpendingChanges in political prioritiesDeliberate efforts to influence AD

Short Run in MacroeconomicsThe period of time during which the nominal prices of resources do not change in response to changes in the price level

Long Run in MacroeconomicsPeriod of time in which the nominal prices of all factors and resources change so as to reflct fully any changes in price level

Aggregate Supply (SAS)The total quantity of goods and services produced in an economy at different price levels

Shifts in SASWages: if wages increase, SAS shifts left. If wages decrease, SAS shifts right.Resource Prices: if prices increase, SAS shifts left. If the price decreases, SAS shifts right. Taxes: If business taxes increase, SAS shifts left. If business taxes decrease, SAS shifts right. Subsidies: if subsidies increase, SAS shifts right. If subsidies decrease, SAS shifts left. Long Run Aggregate Supply (LAS)Represents potential GDP where resources are being used efficiently and where unemployment is at its natural rate. LAS represent potential GDP.

Short Run EquilibriumOccurs where AD intersects SAS, this point determines the price level, the level of output and the level of unemployment

Changes in the Equilibrium

Inflationary GapWhen real GDP is larger than potential GDP and occurs when AD shifts rightOutput increasesUnemployment decreasesPrice increases

Recessionary GapWhen real GDP is less than potential GDP and occurs when AD shifts leftOutput decreasesUnemployment increasesPrice decreases

StagflationOccurs when there is high unemployment and high inflation and occurs when SAS shifts leftOutput decreasesUnemployment increasesPrice increasesGives rise to an economic contraction

Neoclassical Perspective

Neoclassical PerspectiveIn the long run all resource prices change so as to match changes in price levels. The LAS curve is vertical at potential GDP because inflationary and deflationary gaps are only in the short run. This is because if unemployment is increased in short run there is a downward pressure on wages.

Shift of LASA shift in the LAS curve indicates a decrease or increase in potential output and therefore economics growth. The LAS curve may shift due to improvements in the factors of production, improvements in technology or an increase in efficiency.

Government InterventionGovernment intervention may intensity the business cycle and only result in price changes therefore governments should encourage competition to stimulate economic growth rather than intervene themselves

Keynesian Perspective

Keynesian PerspectiveThe economy can stay stagnant for a long time thus it is imperative for government intervention. As the economy approaches potential GDP, all factors of production are employed

Government InterventionGovernment policies are imperative to deal with short term fluctuations therefore they should intervene with polices that will increase AD until it intersects LAS at potential GDP

Demand Side Policies

Demand Side PoliciesThese aim to change AD to meet macroeconomic objectives. There are two types of demand side policies, fiscal and monetary policies

Weaknesses in Demand Side PoliciesFiscal and monetary policies are unable to fix both inflation and unemployment at the same time because inflation worsens unemployment and unemployment worsens inflation

Fiscal Policy

Fiscal PolicyWhen governments use government expenditure and taxation to influence AD. Fiscal policies can affect consumption with personal taxes, investment with business taxes and government expenditure with government spending.

Expansionary Fiscal Policy This is used when the economy is experiencing a deflationary gap. It may consist of:1. Government spending increased2. Personal taxes decreasing3. Business taxes decreasing

Contractionary Fiscal PolicyThis is used when the economy is experiencing an inflationary gap. It may consist of:1. Governments spending decreased2. Personal taxes increased3. Business taxes increased

Strengths of a Fiscal PolicyCombat Inflation: contractionary policy helps bring problem under control Recession: expansionary policy can pull an economy out of a recession

Weaknesses of a Fiscal PolicyTime Lags: lags such as recognition, decision or implementation lagsPolitical constraints: tax increases could be inappropriately enactedCrowding out effect: when the government borrows to pursue an expansionary policy, in effect it increases the demand for money and interest rates get too high

Monetary Policy

Monetary PolicyThese policies are carried out by central bank, which is a government financial institution to change money supply and interest rates to affect consumption and investment

Expansionary Monetary PolicyThe objective is to expand aggregate demand. It may consist of:1. Increasing the supply of money2. Decreasing interest rates

Contracting Monetary PolicyThe objective is to increase the costs of borrowing therefore reducing aggregate demand. It may consist of:1. Decreasing the supply of money2. Increasing interest rates

Strengths of a Monetary PolicyQuick Implementation: does not have to go through political processesNo political constraints: greater freedom to pursueNo crowding out effect

Weaknesses of a Monetary PolicyTime Lags: lags in recognition or implementationIneffective in recession: expansionary policy aims to increase AD by encouraging spending however this is under the assumption that consumers will increase spending

Supply Side Policies

Supply Side PoliciesAim to shift the LAS curve to the right in order to achieve long-term economic growth. The objects are to increase efficiency, decrease the natural rate of unemployment and increase production possibilities. There are two types, market oriented or interventionist.

Market Oriented Supply Policies

Reducing the size of the Government SectorLarge government sectors may be inefficient. The methods to reduce may include privatization, restricting monopoly power or private funding however privatization may make products less affordable.

Incentives by Lowering TaxesLower personal taxes = incentives for people to work and spend moreLower investment taxes = more motivated to saveLower business taxes = increase profits therefore investment spendingThe weaknesses however is that this may worsen income distribution or have a larger impact on AD than AS

Make Labor Market More ResponsiveAbolish minimum wage legislationWeaken labor unionsReduce unemployment benefits The weaknesses however are that it may increase income inequalities and have a downward pressure on consumer spending

Interventionist Supply Policies

Interventionist Supply Side PoliciesPresuppose that the economy cannot by itself achieve desired results therefore government intervention is required. Examples may include:1. Training and education (more skills in workforce)2. Improved health care (more productive)3. Research and development4. Support for small businesses and infant industries

Money Multiplier

Money MultiplierA change in an injection of expenditure will lead to a proportionally larger change in the level of national income

LeakagesSize of savings ratio (mps)Amount spent on imports (mpm)Level of taxation (mrt)

The greater these leakages are, the smaller the multiplier is

Marginal Propensity to ConsumeMPC is the proportion of each extra dollar that households will spend in the economy, the higher the value the larger the multiplier.

Consumer Price Index

Consumer Price IndexThe CPI is the overall cost of the goods and services bought by a typical urban consumer. It is used to monitor the cost of living over time by monitoring a basket of goods and services. As the CIP rises, the typical family has to spend more to maintain the same standard of living

Category WeightingDifferent categories of consumption have different impacts on consumers therefore weighting is used to calculate indices based on the relative expenditure on each category

Problems with Measuring CPISubstitution bias: does not consider consumer substitutionNew goods: does not reflect change in value of dollar as new products are introducedUnmeasured quality changes: if quality changes and the value of the dollar changes, the price of the good remains the same

Inflation

Inflation Rate

Real vs. Nominal Interest RatesNominal interest rates: interest rate not corrected for inflationReal interest rates: Corrected for inflation

Anticipated vs. Unanticipated InflationAnticipated Inflation: firms will constantly change prices and people will be less likely to hold cash, as it will lose valueUnanticipated Inflation: it is difficult to predict if investments will be profitable, wage distortions such that some professions can adjust wages easier than others and assets are worth more while loan is the same

Demand Pull InflationAggregate demand increaseCauses include:1. Decrease in interest rates2. Decrease in taxation3. Increase in government spending

Cost-Pull InflationCosts increase independently of AD (SAS decreases)Types include:1. Wages increase due to power of unions2. Monopolies drive up prices3. Taxes4. Expectations

Unemployment

PPF Model of Full EmploymentFull employment occurs when there is a maximum use of all resources in the economy to product the maximum combination of two goods (i.e. along the PPF curve)

AD/AD Model of Full EmploymentOccurs where the economy is producing at potential output (i.e. at the LAS curve)

Unemployment and UnderemploymentUnemployment: people of working age whoa re without work, available for work and actively seeking employmentUnderemployment: refers to those how only manage part time work or those who are over qualified for their jobs

Difficulties Measuring UnemploymentThe unemployment rate does not include discourages workers, does not capture underemployment and may be overestimated as it does not include works in the informal economy

Costs of UnemploymentFor the unemployed, it is a loss of incomeFor society, there is an increase in crime rates, divorce, health costs and there is an unequal distribution of incomeFor the economy, there is a decrease in production/consumption

Structural Unemployment

Structural UnemploymentWhen industries are no longer capable of competing due to changing demand or new technology there is structural unemployment. There are mismatches between the labor skills demanded and supplied and between the physical location of works and employers

Market Oriented approach Let wages fall so new firms may ariseLower unemployment benefits so works must accept lower payLower income taxes, increased incentive for works to accept worse jobsDISADVANTAGESThere may be an increase in income inequalities

Interventionist approach Setting up training programs and assist youth to pursue education and trainingProvide grants and subsidies to help with relocationEstablish government projectsDISADVANTAGESRequires government funding with high opportunity costs

Frictional and Seasonal Unemployment

Frictional UnemploymentA time lag between someone losing/changing job and starting another. It may be the result of geographical immobility or lack of knowledge regarding available job opportunities

Market Oriented approach Lower unemployment benefits to increase incentives to accept workLower income taxes increase incentives

Interventionist approachEstablish job centers to improve informationEstablish employment agenciesImprove information between employers and job seekers

Seasonal UnemploymentOccurs when the demand for labor in certain industries changes as to reflect in reasons

Correcting Seasonal UnemploymentProving information on jobs available during off-peak seasons in other industries

Cyclical Unemployment

Cyclical UnemploymentCyclical or demand deficient unemployment is when the cyclical nature of the macroeconomic economy goes into a recessionary gap (AD shifts left)

Monetary SolutionsInterest rates decreaseSupply of money increase

Fiscal SolutionsTaxation decreasedGovernment Spending increased

Disequilibrium/Equilibrium Unemployment

Disequilibrium/Equilibrium Unemployment If the wage rate rises above the equilibrium then some unemployment will arise. This is also known as real wage unemployment

SolutionsEliminate minimum wage legislationReduce the power of labor unions This will result in the costs of production decreasing, wages decreasing and SAS shifting to the right

Calculating Employment

Calculating Unemployment Rate