Micro Economy Chapter 1-4 Review
Morgan Brunner Morgan Brunner Dr. Ismail Microeconomics February 8, 2024 Micro Economy Chapter 1-4 Review Chapter 1 In Microeconomics, we understand from Chapter 1 that there are some technical concepts we need to explain and understand. Microeconomy studies individuals like households and firms making decisions with scarce resources. Another important thing we need to learn is the difference between macroeconomy and microeconomy. As a whole, macroeconomy and microeconomy work hand in hand with each other in studying the economy. Microeconomy focuses on individuals and firms across a country, while macroeconomy focuses on the actions and decision-making of a government. On to the technical part of this first chapter, within microeconomy. Understanding what a trade-off signifies is important. The easiest way for me to understand how a trade-off works is if you choose to do something, you are going to lose another thing. I like to think about it like trading football trading cards. When making a decision within a household, for example, whether to buy a new car or take the family on vacation to Europe. On a personal side, a trade-off could be sacrificing pleasure for education. A trade-off for a firm could be something along the lines of deciding whether the firm wants to invest in a risky trade for a big reward or a safe trade but a smaller reward. 1 Morgan Brunner After trade-offs, we need to understand what an opportunity cost is. Although it is a complicated concept, I will try my best to explain it. An opportunity cost is the highest-valued alternative that must be sacrificed to get something greater later. In simpler words, it’s the positive gain from choosing the next best alternative instead of the one that was chosen. In my case, a great opportunity cost is taking out a huge student loan to be able to afford college and then making a whole lot more money when I graduate. For a firm, an opportunity cost could be investing in a new tangible asset and generating income rather than investing in stocks. When discussing economic models, you always must consider marginal thinking. The proper definition of marginal thinking is evaluating whether the benefit of one more unit of something is greater than its cost. A good way to put this in perspective of a real-life event is to imagine a cupcake shop thinking about making one more cupcake that costs $2.50 to make (Ingredients and labor) but can sell for $4.50. The marginal benefit of this is 4.50 – 2.50 = $2.00. From this calculation, we can determine that it is worth making that extra cupcake. That is marginal thinking. The following important concept is marginal benefit. That is what will be the benefit of producing one more unit of something. In a household, a marginal benefit can be explained by, for example, my current living situation. We do not have a dishwasher, so if we bought one, we could spend less time washing the dishes and more time studying microeconomies. In a firm, the marginal benefit could be the same example I used for marginal thinking, but in this case, it would be the action of producing that extra cupcake. Remember that producing one more cupcake will cost me $ 1, and I can sell it for $ 3. My marginal benefit will be $2. In the context of decision-making, we also come across the idea of marginal costs in addition to the concept of marginal benefits. These stand for the concessions or extra expenses 2 Morgan Brunner made while choosing to use one more unit of a specific resource or activity. For example, in a home setting, think about the choice to use a dishwasher. Although it provides the convenience of saving time, the marginal cost might result in less money available for other needs, including auto maintenance. In a similar vein, a company’s construction costs for a new plant may be included in the marginal cost. These factors highlight the significance of opportunity cost, which is the process by which people and organizations balance the advantages of a certain course of action against the associated costs. In the end, wise and calculated judgments are needed to make the best use of limited resources like time, money, and space, whether one is managing home resources or streamlining commercial operations. In marginal family, we also have marginal costs. That is what I will lose to gain this benefit. It’s the additional cost incurred from an extra unit. In a household, we can use the dishwasher; for example, my marginal cost to have a dishwasher is that I will have less money to spend to fix my car. It’s a better opportunity but at a cost to save a scarce resource like time. A firm’s marginal cost could be what it will cost to build a new factory. All those factors make a household or a company weigh in the opportunity cost, and the final decision must be an informed decision to maximize resource use like time, money, and space allocation. On something different, comparative advantage is when an individual, business, or country can produce a good at a lower opportunity cost than a competitor. In other words, for a household, a good example of the comparative advantage is Jerry can make three wooden tables or one birdhouse in one day while his brother can make two tables and one birdhouse. Jerry has the comparative advantage of making tables, but his brother has the comparative advantage of making birdhouses. This is not to be confused with the absolute advantage. The absolute advantage is defined as a person or firm that can produce more of something than another person 3 Morgan Brunner or firm with the same number of resources. If Jerry can make three tables per day or one birdhouse, it costs him 1/3 of a birdhouse per day, while it costs his brother ½ to make two tables. With that being said, we understand that the brother has the absolute advantage of making birdhouses. Chapter 2 In this chapter, we will cover more basic terminology and concepts. I will start by explaining positive and normative statements and their applications. A positive statement is a statement within the economy that can be tested and describes “what is, was, or will be”; for example, Income in the US has been increasing. A positive statement is based on data and evidence, describing and proving the economy as it truly is and can be tested and verified. On the other hand, a normative statement is more of an opinion that can not be tested or verified. It is “what ought to be, or what is desirable.” These statements can not be proven or disproven based on solely empirical evidence. An example of a normative statement is: The United States should send foreign aid to other countries in need. With this statement, we can not evaluate or test the repercussions that this aid would have on the United States economy. It is a judgment statement that the government should provide free healthcare for all American citizens, but this can not be tested without consequences. When talking about the economy, we can often refer to the Latin phrase “Ceteris paribus,” which translates to other things being equal or holding other things constant. When making economic decisions, Ceteris paribus is used to isolate a single variable to see the effect of an outcome when all other factors remain unchanged. A good example would be if an economist wants to study the effect of reducing the price of a good while keeping the same quality, the economist can use the Ceteris paribus principal method to simplify his analysis. By 4 Morgan Brunner keeping the same quality and reducing the price, he can observe the demand curve shifting. Ceteris paribus is a useful analytic tool. An economist can analyze trends without having to do real-life testing but rather make accurate assumptions using the different laws of economics. I will now explain different factors that must be considered, including the “Endogenous factor” and the “Exogenous factor.” Before I go into details the Endogenous factors are variables that can be controlled for inside a model. It is a factor that is pre-determined and put into the system that is being studied. An example of an endogenous factor in a model is economic growth, where the factors are investments, technological innovations, and human capital development, which are considered endogenous variables because they are variables that a firm investment decision has set. In comparison, the opposite is the exogenous factors, variables that can not be accounted for in a model. They are external factors that impact the model from the outside of the firm. An easy way to understand what an exogenous factor is anything that someone can not control. For example, government policies, natural disasters, or shifts in global economic conditions. The Production possibility frontier also referred to as the PPF is a graph illustration model that is a combination of outputs a society can produce if all of its resources are being used efficiently. When looking at the production possibility frontier, you can immediately see when production is efficient when the point is on the production possibility frontier line. If your point is above the ppf, you have an impossible scenario where you can not supply that demand with the currently allocated resources, and anything below the ppf is inefficient. In this case, an example for a firm would be that some workers are not producing. Some of the different possible ways the production can be shifted is if the company hires more workers or adds technology to help the workers. One factor that can not be changed is time, the fact that there are only 24 hours 5 Morgan Brunner in one day. Overall, the production possible frontier is a useful tool in economics to visualize concepts like trade-offs, opportunity costs, scarcity, and economic growth in an economy with limited resources and technology. Assumptions like ceteris paribus are essential in economic modeling to isolate the impacts of particular inputs. One of the most important elements is technology, where the study of resource allocation changes and efficiency is made possible by assuming a fixed quantity of resources, while assumptions about constant levels help focus on the influence of other variables. Analyzing trade-offs and opportunity costs is made easier by reducing manufacturing to two goods. Furthermore, the evaluation of the varied effects of economic growth on different economic outcomes is made possible by assumptions regarding growth, whether it be continuous or specified. Economic models are based on these underlying assumptions, which offer insights into intricate economic processes inside streamlined frameworks. There are three very important sorts of goods. You have consumer goods, which are things meant to be consumed right away. Anything that will satisfy your wants and needs of the moment, like clothing, food, and entertainment, are all good examples of consumer goods. We talk about capital goods, which help you achieve the production of future goods and services. Capital goods within a firm are like computers, vehicles, and factories. The last good is called an investment, which is the process of using resources to create or buy new capital. For example, my current valuable investment is my going to college. I am using the limited resource time of four years to complete a bachelor’s degree, which will lead me to a high-paying job called gaining human capital. The following concept is a strange one. It is called the invisible hand. This concept was introduced by economist Adam Smith in 1759. The concept of the invisible hand is a metaphor for how the free market economy is the way selfish people function in a 6 Morgan Brunner mutually dependent system in a free market economy. Although no party has any intention to promote market efficiency, self-interest will eventually push the market to reach the best outcome. Chapter 3 There is multiple markets that I will be discussing in this part of the paper, like the competitive market, imperfect market, market power, and monopoly. The competitive market, also called the perfectly competitive market, it is a market with many different buyers and sellers, which means that the influence of the price is set. An example would be a tomato; if a farmer starts to sell his tomatoes for two dollars over what other farmers are selling their tomatoes, people will stop buying tomatoes from the first farmer and go over to the other farmers, and this is mostly due to the product being homogeneous and that there is no different between the two tomatoes. It is a market where the market equilibrium sets prices and can not be changed. Market power refers to a firm or group of firms that influence the price, quantity, or quality of service in a particular market. This is possible when the firms have significant control of the markets and can act as they want against competitive forces. What prevents them from entering this market is control over key resources, brand loyalty, and economies of scale are factors that contribute to this market. Market power permits firms to set their own prices, usually higher than those of competitive competitors, limit outputs or create other anti-competition behavior. This usually makes it more expensive for the buyer and reduces success in the market. There are some people who regulate this if it gets too out of hand. The monopoly market is a market extremely hard, if not impossible, to break into. Like Boeing and Airbus, they have a monopoly on making commercial airline planes. With these two 7 Morgan Brunner giants, no one could enter the market. They would buy out the company before they could even get started. In a monopoly market, the company decides its prices with minimal restrictions. Some barriers to getting into a monopoly market are patents, control of essential resources, or high startup costs. Authorities do have the right to intervene to protect consumers. Within the market environment, “monopoly” denotes a situation when a solitary firm or organization has absolute dominance over a specific service or good, consequently being the only provider amongst all other market competitors. Due to their dominant position, monopolists have the ability to manipulate prices, control supply, and dictate the terms of sale, leading to a dearth of competition in the market. A company with a monopoly in a market is defined by several key characteristics and implications: The phrase “single supplier” denotes a scenario when there exists a sole dominant provider of a particular service or good with no other similar alternatives available. Through this unique position, the monopolist has the ability to wield control over the entire marketplace for that specific commodity or service. Determining Pricing Monopolies possess the capacity to establish prices that surpass those found in competitive markets due to the absence of other choices for consumers to purchase the good or service being sold. This has the capacity to lead to augmented profits for the monopolist. Monopolies are often ascribed to the presence of huge obstacles to entry, which impede other enterprises from entering the market. Examples of difficulties that may be faced include legal barriers such as patents and licenses, technological obstacles such as proprietary technology, and economic barriers such as expensive beginning expenses and efficiencies of size. Lastly, we have the imperfect market, which is when a market does not follow the perfect market condition. For example, a monopoly is an imperfect market due to it having only a handful of sellers for millions of buyers. Imperfect markets often have 8 Morgan Brunner unset prices or very high prices the seller sets. The authorities sometimes step in to give some type of ruling to promote fairness. What determines the demand? Well, when looking at a demand curve, we need to take multiple factors into consideration, like price, income, price of related goods, taste and preference, expectation, and number of buyers. Let me explain in more detail: when a price decreases, the quantity demanded increases. This is represented by the law of demand. When a household’s income increases, they will. Be more tempted to buy more things for normal goods. On the other hand, inferior goods tend to decrease when income increases. The price of related goods will increase when the substitute option increases. In addition, if the price of one increases, the demand for the other may decrease. The taste and preference of a consumer constantly change, making the demand for one good may shift to another product. This affects directly the demand for a good, and if a good get trendy, this will decrease the demand for the previous substitutional good. Expectations of market future prices, incomes, or availability of a good heavily affect people’s current demand. For example, if a firm making cars projects the price of iron to rise, the company will be inclined to buy more iron immediately. The last major factor affecting the demand is the number of buyers currently in the market. The more buyers there are, the higher the demand. The number of potential buyers will directly affect the demand. In this last part of chapter three, I will discuss equilibrium price and equilibrium quantity. Defining each of this two concept and giving a few examples. Let’s define what equilibrium in an economy is. Equilibrium is a perfect moment when the quantity demanded equals the quantity supplied. This precise moment happens on a graph when the demand curve and the supply curve intercept each other. If the market is in disequilibrium, that means that the market is not 9 Morgan Brunner receiving the quantity demanded from the consumers. In this case, market forces will drive the prices and quantities to equilibrium. An example would be if the price is above the equilibrium point, then there will be a surplus of goods. Forcing factories to reduce their prices to get rid of their inventories. On the other hand, if the prices are below the equilibrium point, then there will be a shortage of goods, forcing the prices to rise and consumers to compete for scarce supplies. A good example of this was the toilet paper shortage during the first wave of COVID–19. Equilibrium is a crucial concept in economics since it illustrates the market’s response to potential results. The inputs to demand, supply, and government policies all influence market prices and quantities Chapter 4 The degree of change of quantity demanded of a commodity with respect to a change in price is known as the price elasticity of demand. There are three types of elasticity of demand: income elasticity, price elasticity, and cross elasticity of demand. Inelastic demand is when the degree of responsiveness of quantity demanded of a commodity is not changed by a change in price. For instance, this might be true of a commodity that is a lifesaving medicine; if the price of lifesaving medicine goes up and this is the only option available, an increase in its price will not affect the quantity demanded. For instance, another item that might be inelastic would be gasoline and coffee; people need gas to travel from one place to another, and unless an alternative to vehicles has arrived, the demand for gas will tend to be inelastic, as well as coffee. 10 Morgan Brunner It is affected by various factors or determinants such as substitutes available, short-term versus long-term, commodity price, income, complementary goods, time, etc. For instance, if a lot of substitutes for a particular commodity are available, it will tend to be more elastic as a change in price will change the demand, as consumers could switch to other products that fulfill utility and meet their needs. For instance, the demand for complementary goods and the cross-price elasticity of demand come into play when we discuss this. For instance, bread and butter the price of bread increases, it is likely that the consumption or demand of butter will also decrease or stop since these goods are complementary to one another. Additionally, another important concept to understand is the income elasticity of demand, it is the degree of change of quantity demanded of a commodity with respect to a change in income. For instance, for normal goods, the demand increases when the income increases. For inferior goods, the demand decreases when the income decreases. Also, cross price elasticity of demand is a concept where two goods are considered and the price change of one is reflected into the change in demand of another. Price elasticity of supply is the degree of change of quantity supplied with a price change. The determinants of price elasticity of supply are the availability of substitutes, the cost of production, the time, and the mobility of the factors of production. For instance, about time, the price elasticity of supply tends to be more elastic in the long run than in the short run. Since, equipment, machinery, decisions, costing, budgeting, and a range of other decisions can be taken over the long run. Also, if the production costs are low, the price elasticity of supply tends to be more elastic since it is easy to change, and not a lot of cost will be borne by the firm for the switch. On the flip side, if the production costs are high, this will deter firms from changing the supply. 11 Morgan Brunner Also, in a situation when the Price elasticity of supply is zero, a change in the price of the product will have no effect on the quantity supplied. This typically occurs in cases when there are collectible items; for instance, there is a limited quantity of those items, and the supply cannot be increased even if the price increases. There is a type of name for this kind of supply, which is known as perfectly inelastic supply. Moreover, unitary elasticity of supply is when it is equal to 1; it is a condition when the quantity supplied changes with respect to a change in price. For instance, typically, this happens when the equipment we use in the house, our apparel, and items we need, the quantity supplied will change with respect to a change in price. References: Mateer, D., & Coppock, L. (2023). Principles of microeconomics. W. W. Norton. 12
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