Unit 2

1. Unit 2 Microeconomics Ch 4 – Demand Ch 5 – Supply Ch 6 – Prices and Decision Making Ch 7 – Market Structures

2. Microeconomics The area of economics that deals w/ behavior + decision making by small units, such as individuals + firms. Micro = Small

3. Demand The desire, ability, + willingness to buy a product. It is NOT just the desire to have a product. Ex. We all may desire a $100,000 sports car, but there isn’t that much of a demand since we cannot all afford it or are not willing to pay the price the dealer is selling at. Understanding demand is important to understand how the economy works + for good business planning. Ex. Knowing where the demand is to start a business, knowing the competitors’ prices (or if no competition, to know what people can + are willing to pay), + knowing who your target market would be (for things like advertising). Ch 4 – Demand

4. Visualizing demand A demand schedule is a listing that shows the various quantities demanded of a particular product at all prices prevalent in the market.

5. A demand curve is a graph showing the quantity demanded at each + every price prevalent in the market. D1

6. The Law of Demand States that the quantity demanded of a good or service varies inversely w/ its price. In other words, the more something costs, the less people demand. Marginal utility is the extra usefulness or satisfaction a person gets from getting 1 more unit of a good or service. Ex. 2 Scoops of ice-cream. Diminishing marginal utility is when the extra satisfaction we get from using additional quantities of a product or service begin decreasing. Ex. 6 Scoops of ice-cream End Section 1

7. Change in the quantity demanded A movement along the demand curve that shows a change in the quantity of the product purchased in response to a change in price. Causes a MOVEMENT along the demand curve. What causes a change in the quantity demanded? - A change in price of the item being graphed. Sellers start charging more or less for the product.

8. Change in demand A demand curve shifts when consumers demand more or less at every price. Causes a SHIFT in the demand curve. What causes a change in demand? - Consumer income You make more, you spend more + vice versa - Consumer tastes Things go out of style or become popular - Substitutes Ex. Butter + margarine – if the price of one , demand for its substitute + vice versa - Complements Ex. Peanut butter + jelly – If the price of one , demand for its complement - Change in expectations Ex. Forecast predicts a blizzard – more people buy milk. Ex. AT&T announces a new phone to be released in 6 months, many people wait to buy new phone - # of consumers More or less people interested in an item End Section 2

9. Cause-and-effect + elasticity Economics involves the study of cause-and-effect relationships. A business owner needs to know the effect a raise in prices would have on sales. A corporation needs to know the benefits of diversifying vs. the benefits of further investing in current production. An investor needs to know the effect various factors would have on his/her stock values. A country’s people need to understand the effects of gov.’t policies on the economy which could effect their income, jobs, retirement, entitlement programs, etc… A gov.’t needs to know the effect a tax increase would have on the economy (or on their chances of getting re-elected ) Elasticity is a measure of responsiveness that shows how a dependent variable responds to a change in an independent variable. It shows how much one thing changes due to a change in something else. Demand elasticity is the extent to which a change in price causes a change in the quantity demanded.

10. Elastic demand Demand is elastic when a change in price causes a relatively larger change in quantity demanded. This is a BIG response to a price change. Ex. People demand 20 widgets @ $15, but they demand 50 widgets @ $10. Close to a horizontal line on a graph.

11. Inelastic demand Demand is inelastic when a change in prices causes a relatively small change in quantity demanded. This is a SMALL response to a price change. Ex. People demand 30 whats-its @ $10, but they only demand 32 whats-its @ $5. Includes things like basic medicines, salt, etc Close to a vertical line on a graph.

12. Unit elastic demand Unit elastic demand is when a product is halfway b/w elastic + inelastic. Change in quantity demanded is PROPORTIONAL to the change in price. People demand 15 whatchacallits @ $20, but they demand 30 whatchacallits @ $10. So if price drops 50%, quantity demanded increases 50%. P D1 Q

13. Determinants of demand elasticity What makes demand elastic or inelastic? 1. Can the purchase be delayed? - The more urgent the need, the more inelastic demand tends to be. 2. Are adequate substitutes available? - The fewer substitutes available, the more inelastic demand tends to be. (- Also, depends on # of sellers for a local area). 3. Does the purchase use a large portion of income? - If the answer to this question is no, demand tends to be inelastic. - You can’t buy something if you don’t have the $. End Section 3

14. Supply The amount of a product that would be offered for sale at all possible prices. The law of supply says that suppliers will normally offer more for sale at high prices + less at lower prices. In other words, more will be offered at a higher price. Ch 5 – Supply

15. Visualizing supply A supply schedule is a listing of the various quantities of a particular product supplied at all possible prices in the market.

16. A supply curve is a graph showing the various quantities supplied at each + every price that might prevail in the market. S1

17. Change in the quantity supplied A movement along the supply curve that shows a change in the quantity of the product offered for sale in response to a change in price. Causes a MOVEMENT along the supply curve. What causes a change in the quantity supplied? - A change in price of the item being graphed. Sellers start charging more or less for the product.

18. Change in supply A supply curve shift when suppliers offer more or less at every price. Causes a SHIFT in the supply curve. What causes a change in supply? - Cost of inputs If the cost of inputs , the amount supplied will + vice versa NOTE: labor is an input - Productivity An in productivity causes an in the amount supplied + vice versa - Technology New technology causes an in the amount supplied UNLESS there is an unexpected problem - Taxes + Subsidies (gov.’t payment to an individual, business, or other group to encourage or protect economic activity) An in taxes causes a in the amount supplied + vice versa An in subsidies causes a in the amount supplied + vice versa - Change in expectations If sellers expect the price of their goods to in the future, the amount supplied + vice versa - Gov.’t regulations An in regulation causes a in the amount supplied + vice versa - # of sellers An in the # of sellers causes an in the amount supplied + vice versa

19. Supply elasticity Is a measure of the way in which quantity supplied responds to a change in price. The questions that determine demand elasticity (Substitutes? Delay? Large % of income?) DO NOT APPLY!!!! What makes supply elastic or inelastic? Can a firm react quickly to higher or lower prices? If a firm CAN react fast then it is ELASTIC. If a firm CAN NOT react fast then it is INELASTIC.

20. Types of supply elasticities Elastic supply – when a change in price causes a relatively LARGER change in the quantity supplied. Ex. The price doubles + the quantity supplied triples. Inelastic supply – when a change in price causes a relatively SMALLER change in the quantity supplied. Ex. The price doubles + the quantity supplied only increases by 10%. Unit elastic supply – when a change in price causes a PROPORTIONAL change in the quantity supplied. Ex. The price doubles + the quantity supplied doubles. Supply P S1 Q End Section 1

21. The Theory of Production Deals w/ the relationship b/w the factors of production + the output of goods + services. Usually based on the short run, when the only thing producers can change in input is labor. During the long run producers can adjust the quantities of all of their inputs. Ex. In the short run, BMW fires 50 employees, but in the long run it closes down one of its factories. The Law of Variable Proportions says that in the short run, output will change as 1 input is varied while the others stay the same. In other words, if you change only 1 input, the output will change. Ex. Adding more salt to your meal changes the taste. Economists prefer to change only 1 input at a time to better judge the impact each input has on the output.

22. The production function A concept that describes the relationship b/w changes in output to different amounts of a single input while other inputs are held constant. Illustrates the Law of Variable Proportions. It can be illustrated w/ a schedule or w/ a graph. Measures marginal product (the extra output or change in total product by an addition of 1 more unit of variable). Current total product – Previous total product = Marginal product

23. The 3 stages of production Increasing returns – The marginal return grows at an increasing rate. -Too many resources per worker so add a worker(s) + production 2. Diminishing returns – The marginal return grows at a decreasing rate. -Production at a slower rate. 3. Negative returns – The marginal return decreases. -Workers are getting in the way + production End Section 2

24. Measures of cost To run businesses efficiently, owners must analyze the different types of costs. Fixed cost – the cost of production that doesn’t change when output changes. These are costs the business must pay even if they aren’t producing anything. All fixed costs combined make up a business’s overhead. Ex. Executive salaries, rent, etc Variable cost – the cost of production that changes when output changes. These are the costs the business can change to suit their needs. Ex. Labor, raw materials, electricity etc Fixed cost + variable cost = total cost. Marginal cost is the extra cost incurred when a business produces 1 more unit of a product. It is a type of variable cost.

25. Measures of revenue Revenue - $ earned. Total # of units sold x the average unit price per unit = total revenue All the $ a company earns. Ex: 7 units are sold at $15 each Total Revenue = 105 Marginal revenue is the extra revenue earned w/ the production + sale of 1 more unit of output. Ex: 5 workers produce 90 units and generate 1,350 total revenue. 6 workers produce 110 units (extra 20) and generate 1,650. Total revenue is increased by $300 by the additional 20. SO the marginal revenue is 15 dollars. (300 divided by 20). End Section 3

26. Price The monetary value of a product determined by supply + demand. It communicates info: High prices are signals for producers to produce more + for buyers to buy less. Low prices are signals for producers to produce less + for buyers to buy more. Advantages of prices in a competitive market: Neutral – favor neither sellers nor buyers. Flexible – can adjust to unpredictable factors. No cost of administration. Familiar + easy to understand. Ch 6 – Prices and Decision Making

27. How can resources be distributed w/o prices? 1. Rationing – a system in which an agency (usually a gov.’t) decides everyone’s “fair” share. Often used in times of war. Problems: almost everyone thinks their share is too small, high administrative cost, negative impact on people’s incentive to work + produce. 2. Position in society – influential, powerful, member of the political party in power (ex. Communist), etc… 3. Tradition End Section 1

28. Economic models B/c transactions in a market economy are voluntary, buyers + sellers must compromise. An economic model is a set of assumptions that can be listed in a table or illustrated w/ a graph to help analyze behavior + predict outcomes. We get an economic model by combining demand + supply info. - Remember the Payless examples?

29. S1 D1

30. What can we determine w/ the economic model? The equilibrium price – the price at which quantity demanded = quantity supplied. What is the equilibrium price of the shoes? $______ S1 D1 60

31. Market equilibrium A situation in which the quantity supplied is equal to the quantity demanded. Supply = Demand

32. Surplus A situation in which the quantity supplied is greater than the quantity demanded at a given price. Supply > Demand

33. Shortage A situation in which the quantity demanded is greater than the quantity supplied at a given price. Supply < Demand

34. So why does this matter? Economists + businesses use economic models to determine what would happen if there is a change in supply or demand.

38. End Section 2

39. Distorting market outcomes Sometimes we don’t want the market to adjust to the market equilibrium – so we establish price ceilings + floors. Price ceilings – the HIGHEST legal price that can be charged for a product or service. Established by the gov.’t if they feel prices are too high. Problems – can lead to shortages, little incentive for suppliers to be competitive, suppliers may quit supplying the product in favor of something more profitable, etc… Ex: Rent control.

41. Price floors – the LOWEST legal price that can be paid for a good or service. Established by the gov.’t if they feel prices are too low. Problems – can lead to surpluses, not as many people can afford to purchase the goods/services, etc… Ex: Minimum wage (another potential problem w/ minimum wage is that fewer workers may be hired). End Section 3

42. Classifying market structures The nature + degree of competition among firms operating in the same industry. What determines a market structure? How many buyers + suppliers are there? How large are they? Does either have any influence over price? How much competition exists b/w firms? What kind of product is involved (are they exactly the same or just similar)? Is it easy or difficult for new firms to enter the market? Economists group industries into 4 different market structures: Perfect competition Monopolistic competition Oligopoly Monopoly Ch 7 – Competition, Market Structures, and the Role of Gov.’t

43. Perfect competition Characterized by a large # of well-informed independent buyers + sellers who exchange identical products. Necessary conditions: Large # of buyers + sellers. Buyers + sellers deal in identical products. Each buyer + seller acts independently. Buyers + sellers are well-informed about products + prices (keeps prices competitive). Buyers + sellers are free to enter, conduct, or get out of business. Few if any perfectly competitive markets exist (Ex: farmers selling produce out of their trucks). Imperfect competition is a market that is lacking one of the necessary conditions of a perfect competition. Most businesses in the US are imperfect competition markets.

44. Monopolistic competition The market structure that has all the conditions of perfect competition except for the identical products. The products’ differences may be real or imagined or just in appearance. Ex: Athletic shoes Advertising is VERY important to inform potential buyers about why their product is superior to the competition.

45. Oligopoly A market structure in which a few very large sellers dominate the industry. The product may be exactly the same or different. Ex: Coke + Pepsi, automotive industry, etc… Sometimes the businesses may take part in collusion – the formal agreement to set prices or to otherwise behave in a cooperative manner. In these cases, supply + demand doesn’t determine the prices. Illegal.

46. Monopoly A market structure w/ only 1 seller of a particular product. Extremely rare. It is a price maker. Ex: Utilities – determined by the gov.’t (Microsoft, DeBeers, etc…). Mostly illegal. End Section 1

47. Failures in a market economy A competitive economy needs 4 conditions: 1. Adequate competition. 2. Buyers + sellers must be reasonably well-informed about conditions + opportunities in the market. 3. Resources must be free to move from 1 industry to another. 4. Prices must reasonably reflect the costs of production (includes the rewards for the entrepreneur). A market failure can occur when any of these 4 conditions are significantly altered.

48. Inadequate competition Over time, mergers + acquisitions have led to larger + fewer businesses dominating various industries. This has led to a in competition which has several important consequences: 1. Inefficient resource allocation – including $ (instead of investing in the company, executives may get big bonuses + benefits). 2. Higher prices + reduced output – “artificial shortages” 3. Economic + political power

49. Inadequate information W/o knowing the real value of goods or services, market prices can be unnaturally high or low. Also, workers may be over or under paid. $ may be invested unwisely. Stocks could be priced unnaturally high + the market could crash causing a depression or the housing market may be overvalued causing it to go bust which starts a recession (sound familiar?).

50. Resource immobility If resources don’t move to where they’re most needed, markets don’t function efficiently. Ex: A factory closes in Greenville + many people are out of jobs. Those same employees refuse to move to work in a factory in South Dakota that desperately needs workers. Ex: A gas shortage in the southeast causes gas stations to run out of gas while in other parts of the country, they’ve got plenty of gas. End Section 2