Essay About Price Increases And Opportunity Costs

Microeconomics
Microeconomics:Chapter 1:Economics revolves around the scarcity principle; wants are unlimited but resources are not.Economic decisions are concerned with maximising consumer surplus. They involve opportunity costs (trade-offs)In determining the trade-offs, one must take into account the cost-benefit principle; only undertake an action if the marginal benefit equals or exceeds the marginal costEconomic surplus: difference between benefit arising from an action and the cost of its undertakingOpportunity cost: what was given up/what was receivedCeteris paribus: all other things being equal (important in economic decisions)Incentive principle: an individual is more likely to undertake an action if its benefit rises and its cost fallsPositive economics: analysis that explains what will happen and why, but not what should happen (i.e. what will happen because of human behaviour)Normative economics: analysis that states what should happen (economically optimal)Pitfalls:Failing to account for all opportunity costsFailing to account for all benefitsFailing to consider time as a resourceFailing to ignore sunk costsFailing to know when to use marginal benefits/costs vs average benefits/costsFailing to measure costs/benefits in absolute terms rather than proportionsChapter 2:Absolute advantage: where one person is able to produce more than another given the same amount of resourcesComparative advantage: where someone has a lower opportunity cost than another Specialisation occurs where an individual focuses on one area of production. An individual should specialise in his area of lowest comparative advantage to maximise total output of the economyThe increase in total production is greater as the difference in opportunity cost increasesProduction possibility curve: graphical representation of the potential output of one good in relation to anotherAttainable points: points along or within the PPCUnattainable points: points outside the PPCEfficient: points along the PPCInefficient: points within the PPCMany-person economy: PPC is represented as a curve rather than as a straight line. Reflects the principle of increasing opportunity costShift in the PPC reflects an increase in productive capacity (economic growth). Factors than drive economic growth:Increase in amount of resourcesIncrease in quality of resources/technology/knowledgeChapter 3:Market: a market is the collective of all buyers and sellers for a good or serviceDemand curve: slopes down due to law of demand – as price increases, demand for a product falls (i.e. consumer surplus falls). Relationship between price and quantity demandedSupply curve: slopes up due to law of supply – as price increases, suppliers are willing to provide more (i.e. producer surplus increases). Relationship between price and quantity suppliedSubstitution effect: change in demand for a good/service due to the change in price of another good/service, causing said good to become cheaper/more expensive relativelyIncome effect: change in demand for a product due to a change in price, causing the PPP of the consumer to changeVertical interpretations: demand – consumer’s reservation price (highest price willing to pay)supply – supplier’s reservation price (lowest price willing to sell)Market equilibrium: occurs at a price where quantity demanded and supplied is the sameExcess supply (surplus): price is too high, usually occurs due to price floorExcess demand (shortage): price is too low, usually occurs due to price ceilingDifference between demand/supply and quantity demanded/suppliedBLAH SOME STUFF GOES HERECash on the table: unexploited gains from exchange, occurs when market is in disequilibriumSocially optimum quantity: quantity whereby the difference in total benefit and total cost of producing+consuming a good is maximised. (the point at which marginal cost and benefit are the same).Efficiency: where all goods are produced at their socially optimal quantityEquilibrium principle (no cash on the table): market is at equilibrium; there are no unexploited opportunities Chapter 4:Elasticity: responsiveness of one variable in relation to a change in another variableDemand elasticity: percentage change in quantity demanded over a one percent change in price. The value of demand elasticity tells us whether the good is elastic/inelastic<1: inelastic=1: unit elastic>1: elasticDeterminants of elasticity:Substitution: goods with substitutes will be more elastic than those that don’t Budget share: goods comprising a lower proportion of budget share (salt) are likely to be less elastic than those of higher proportion (plane tickets)Time: in the short term, products are less elastic than in the long term as it takes time to seek out alternatives Luxury or necessity: necessities are less elastic than luxury itemsCalculating demand elasticity:Percentage change quantity/percentage change pricePoint elasticity: P/Q x 1/slopeMidpoint elasticity: [pic 1]Special cases:Perfectly elastic: demand is infinite at one price, but is zero at any price above itPerfectly inelastic: demand is infinite regardless of priceElasticity and total expenditure: total expenditure/revenue varies with elasticity of a product. Total revenue = price x quantity. Price and quantity always move in opposite directions (law of demand). Increase in price does not always result in increased revenueFor a product with a straight line demand curve, the total revenue curve is a parabola (there is a maximum revenue point)For a product with elasticity > 1, price and total revenue changes move in different directionsFor a product with elasticity < 1, price and total revenue changes move in the same directionIncome elasticity of demand: percentage change of quantity demanded in relation to a 1 percent change in incomeNegative elasticity: good is inferior Positive elasticity: good is normalCross-elasticity: percentage change of quantity demanded in relation to a 1 percent change in the price of another goodNegative elasticity: goods are complementsPositive elasticity: goods are substitutesPrice elasticity of supply: percentage change in quantity supplied in relation to a 1% change in price.Calculated same way as elasticity of demandDeterminants of price elasticity of supply:Flexibility of inputs: more flexible = more elasticMobility of inputs: more mobile = more elastic Ability to produce substitute inputs: more easily = more elasticTime: less elastic in short term than in long termChapter 5:Utility: satisfaction. Economics is about maximising utility/consumer surplusMarginal utility: extra utility that results from taking an extra action. To maximise utility, consume until marginal utility is as close to 0 as possible. Law of diminishing marginal utility: tendency for marginal utility to decrease as consumption of a good or service increasesMU1/P1 = MU2/P2. Want MU to be equal; buy more of the one that yields higher MU until optimal combination of goods (yielding highest total utility) is reachedRational spending rule: spending should be allocated so that MU1/P1 = MU2/P2Individual and market demand curves: market demand curve is the sum of all individual demand curvesConsumer surplus: difference between reservation price and price actually paid.Calculated as the area under the demand curve, upwards from the price paid.Chapter 6:Market supply curve curves upwards due to increasing opportunity costs; suppliers exhaust means of lowest opportunity cost first. Also because different individuals have different opportunity costs. Market supply curve is the sum of all individual supply curves Firms will typically aim to maximise profit (difference between total revenue and costs)Perfect competition:Homogenous productNo barriers to entry/exitBuyers and sellers are well informedBuyers and sellers comprise an insignificant proportion of the marketSuppliers are price takers; they have no influence on the market price. I.e. the demand for the firm’s product is perfectly elastic. Price is set by market demand and supply interactionShort-term production: period where at least one factor of production is fixedLong-term production: all factors are variableLaw of diminishing returns: in the short-term, marginal product decreases as variable inputs increase. Usually due to congestion (1 computer, more workers will result in less increase)More inputs required to achieve outputs, resulting in increased variable costsFixed cost: sum of payments made to fixed factors of productionVariable cost: sum of payments made to variable factors of productionTotal cost: variable + fixed costMarginal cost: change in cost/change in outputMaximum profit where marginal revenue = marginal cost (cost-benefit)Short-term shutdown: firm should shutdown if PQ < VC at all values of Q. Alternately, firm should shut down if P < AVCFirm assumes FC, but would not lose as much as it would if it stayed open (VC)Firm’s profit = total revenue – total cost (PQ – ATCxQ). Profitable if P > ATCMaximum profit where P = MC. Profit = (P-ATC)xQChapter 7:Pareto efficiency: situation in which trade is not possible such that one person is made better off without making another worse off.Pareto-improving transaction: transaction that betters one without harming anotherWhenever market is not in equilibrium, there is forgone economic surplusSubsidies: reduce economic surplus since subsidy is not free (represents an opportunity cost)Compensation policy is more efficient than the first come first served policyEvent organisers underprice to maintain image of event or to garner goodwill from patronsLeaves cash on the table → ticket scalpingTax: for a product with perfectly elastic supply, tax is completely borne by consumer. For a product with perfectly inelastic supply, tax is borne by producer.Deadweight loss: reduction in total economic surplus that results market operates at a point where marginal cost does not equal marginal revenue/benefit. (surplus lost to the market)Deadweight loss is smaller if elasticity of demand/supply is lowChapter 8:Consumption possibility frontier (CPC): graphical representation of an economy’s potential consumption of a good relative to another good. In a closed economy, CPC = PPC. In an open economy, CPC > PPC. (tangent to PPC)Economy opens up to international trade, world price becomes the domestic priceIf original domestic price > world price, product will be importedIf original domestic price < world price, product will be exported (comparative adv.) Specialisation, will become net exporter While opening up to free trade does result in some loss of economic surplus, the gain is much greater.Protection: policies that give domestic industries an artificial advantage over foreign producersTariffs and quotas are forms of protection; they cause market inefficiency