Exam 1 Review
Changes in Supply vs. Changes in Quantity Supplied
A change in quantity supplied is a movement along a supply curve, but a change in supply is a shift of the entire curve.
Rational Agent
chooses actions that maximize the expected value of the performance measure given the current percept sequence
Jim Stands is a president of a large state university and has to decide on a project to undertake. Each costs him $1 million dollars to do, and the return to each is given in the table below. Project Return on investment Build a new dorm $1.7 million Upgrade stadium seating $1.6 million Expand bus service $1.4 million Add new dining hall $1.2 million What is Mr. Stands opportunity cost of building the new dorm?
$1.6 million The opportunity cost is the value of the next best alternative.
Marginal Cost MC(Q)
(In english: the marginal cost of producing Q units) What it cost a firm to produce one more (or a little more) unit In the video, we simplified our calculation of marginal costs using the case that we can only change quantities in integers. However, the more formal calculation is the change in the total cost of producing two quantities divided by the change in the two quantities: MC(Q) = (Change in TC(Q))/(Change in Q) (In English: the Marginal Cost of producing Q units is the change in the total cost of producing Q units divided by the change in the number of units). Notice that for two adjacent integers that just becomes: MC(Q2) = (Change in TC(Q))/(Change in Q) =(TC(Q2) -TC(Q1))/1
Total Revenue TR(Q):
(in English: the total revenue of producing Q units) total revenue is a function of quantity produced, the amount of money a firm takes in: TR(Q) = P*Q
interdependence principle
And we are particularly attuned to understanding how different decisions depend on each other.
Dependencies between markets
Changes in one market can affect another market
Just as we had demand shifters, we have supply shifters
Changes in the price of inputs Changes in technology Changes in the prices of other goods (complements and substitutes in production) Changes in expectations Changes int he number of firms
Dependences over time
Choices today affect choices tomorrow
Economics is a science
Economists systematically study the structure and behavior of decision-making. It uses models and assumptions that underlie those models to motivate that study. Because we ultimately care about people's decisions, Economics is a Social Science.
The agent's preferences are non-satiated
I am never satisfied. more. More. MORE!
The agent's preferences are complete and known
I know what I like and am not paralyzed with indecision
The agent's preferences are transitive
If I like A more than B and B more than C, then I like A more than C
You can only consume two goods, gasoline (for your car) and iced lattes (for you). Your current consumption bundle (how much you are buying) each week is 10 gallons of gas and 5 iced lattes. The marginal utility you get from the 10th gallon of gas is 20 and the marginal utility you get from the 5th iced latte is 30. If the price of a gallon of gas is $2 and the price of a latte is $6, are you behaving optimally (and in doing so, maximizing your happiness)? Explain.
No. You should change your puchases to buy more gasoline and fewer lattes because the marginal utility per dollar spent on lattes is less than the marginal utility per dollar spent on gasoline. The current marginal utility per dollar spent on gas is 20/$2 = 10, which means you are getting 10 units of happiness per dollar you spend on the last gallon of gas. The current marginal utility per dollar spent on lattes is 30/$6 = 5 , which means you are getting 5 units of happiness per dollar you spend on the last gallon of gas. You are getting more bang per buck on the gas, so you should buy more gas and less lattes.
Rationality
People do things to make them selves best off as possible (maximizers) (different from satisfiers- people who are good with good enough)
cost-benefit principle
We consider the costs and benefits of a choice
marginal principle
We think at the margin, always asking whether a bit more or a bit less of something would be an improvement
Which of the following would be a question a microeconomist would be interested in? Choose all that apply.
What is the relationship between maternal education and child health? How does industry structure affect CEO pay? Because this has to do with individuals, not aggregates, it is micro.
Law of Demand
consumers buy more of a good when its price decreases and less when its price increases
The law of demand says
as price increases, quantity demanded decreases. The law of demand is why the demand curve is always downward sloping.
economics
as the study of people "in the ordinary business of life."
utility
basically a measure of wellbeing. Notice that it is a measure, which implies it is a numerical value. It is a numerical value! For example, the utility Eric gets from buying 5 bottles of wine might be expressed as something like: U(qw)=U(5)=10
Markets have two agents
buyers and sellers. Demand represents the buyer in a market.
Scarcity requires
choice, every time a choice is made we choose one thing over the other
In a competitive market
demand for and supply of a good or service determine the equilibrium price. Markets are going to motivate pretty much everything we do in principles of micro, so we now start building our market with the concept of demand.
Opportunity Cost
the cost of the next best alternative. Not all of the alternatives, just the next best one. To calculate opportunity cost: What happens if you make that choice (cost of choice) What happens if you make the next best choice (Cost of alternative)
willingness to pay
the highest price that a buyer is willing to pay for an extra unit of a good
Total revenue
is how much money a business takes in from selling something. It completely ignores costs; its just the amount that a firm sells (quantity) multiplied by the price it charges.
a marginal cost
is the cost of each additional time you spend in class.
economic surplus
The benefit of something is greater than its cost, keep doing it. The difference between the cost of an action and the benefit is called.. (keep doing something until MB=MC because you maximize economic surplus)
Macroeconomics
The study of economics as a whole -issues like unemployment, real GDP, inflation, interest rates
Marginal Revenue MR(Q)
(In english: the marginal revenue of selling Q units)What a firm earns from selling one more (or a little more) unit Similarly, Marginal revenue is the difference in total revenue divided by the change in quantities: MR(Q) = (Change in TR(Q))/(Change in Q) (In English: the marginal revenue from selling Q is the change in the total revenue from selling Q units divided by the change in the number of units). Remember how I said not to get intimidated by the Greek letters? For a perfectly competitive firm, this breaks down into something ridiculously simple. Suppose a firm can sell 10 units at $6 or 11 units at $6. This then becomes: MR(Q2) = (Change in TR(Q))/(Change in Q) MR(11)=(TR(11)-TR(10))/(11-10) =$6
Profit II (Q) = TR(Q)-TC(Q)
(in English: the profit from producing Q units is the difference between the total revenue of producing Q units and the total cost of producing Q units). The difference between what a firm earned from selling and what a firm had to pay to produce. Yes, that is a greek letter used to stand for profit (P is already taken)!
Total Cost TC(Q):
(in English: the total cost of producing Q units)The entire amount that the firm paid for resources to produce that quantity. It includes fixed costs (costs that don't vary with quantity) and variable costs (costs that do vary with quantity).
Marginal Benefits are not always consistent, in fact they are frequently decreasing
-Consider going from 0 hours of studying to 1 -Consider going from 10 hours of studying to 11 -Consider a 6 shot latte vs a 5 shot latte
Ceteris Paribus
-Given that this massive interwoven system of things affecting other things, how can we possibly keep it al straight? Ceteris paribus: all else equal We assume that nothing else is changing. Isolate to just what we are immediately interested in explaining
Marginal costs aren't always constant, in fact, they are frequently increasing
-consider normal hourly pay vs overtime -when we get to production decisions we frequently run into the issue where ore input produce more but at smaller incremental amounts (increasing marginal cost)
Perfectly competitive market
-many buyers -many sellers -completely identical sellers -perfect information (symmetric) -free entry and exit (buyers and sellers cant control the price)
Your marginal utility from the 9th donut you ate this week is 48 utils. Donuts cost $6. Your marginal utility from the 10th cup of coffee you drank this week is 16 utils. If you are behaving optimally, it must mean that the price of coffee is $____. (What value goes in this blank? Enter number only... leave out the dollar sign).
2 (with margin: 0) MUdonut MUcoffee Pdonut = Pcoffee 48 16 $6 = Pcoffee 8 = 16 $2 Make sure you can show your work on problems like this!
Not part of opportunity cost
Not all out-of-pocket costs are oppertunity costs (food and clothing weather you go to grad school) Some nonfinancial costs are not opportunity costs (10 hours of work vs 10 hours of studying)
Fixed costs don't matter in the short run.
Once a firm has incurred these costs, it can't do anything about them in the short run. We revisit this when we get to the long run, but for now, it means that ONLY marginal costs and marginal revenue matter for decision-making.
Don't confuse COST and PRICE.
Price is what a buyer pays for an item and what a producer gets for selling the item. Notice that price is the same value there! If I pay Starbucks $7 for a latte, Price=$7. I paid $7, they received $7. When we use cost, though, this may have "cost" me $7, but it didn't cost Starbucks $7! Cost to them is what it paid to sellers of various resources that produce that latte: the coffee beans (land), barista (labor), equipment (capital).
When Kroger puts a fancy cheese on sale, I buy more of it. Which of the following statements best captures what is going on when the price of cheese goes down?
Quantity demanded of cheese increases A change in price leads to a change in quantity demanded. A change in anything else besides price that affects demand is a change in demand.
Pitfalls
Say it with me: price is not a determinant of demand. A change in the price does not shift the demand curve. If price changes, quantity demanded changes, not demand. A common mistake new learners make is confusing total revenue and profit. Total revenue is how much money you take in if you are selling something (think: the money that goes into the cash register). For example, if I sell 20 cookies for $1 each, my total revenue is 20*$1=$20. Profit is what is leftover from revenue once you account for costs. For example, if I have to buy $0.75 worth of ingredients, electricity, and other inputs in order to make each of those cookies, then my profit is 20*$1 - 20*$0.75 = $5. Know the difference between revenue and profit.
Dependencies between each of your individual choices
Scarcity means you will have a constraint. Limited time, income, attention, cognitive load, etc.
supply curve
This curve represents the quantity that sellers are willing to sell at every possible price. That begs the question: why are they willing to sell that quantity that price? Well, we said buyers are rational agents. Aren't sellers people too? They also behave rationally and are maximizers, but they maximize profit, not utility.
It is tempting to think "supply shifts up" means an increase. Resist that temptation.
This is one of the most common mistakes new learners make. Supply decreases: shift LEFT. Supply increases: shift RIGHT.
Understand the determinants of demand (i.e., what shifts demand curves)
When price changes, quantity demanded changes. In other words, a change in price leads to a movement along the demand curve. An increase in demand shifts the demand curve out (to the right) A decrease in demand shifts the demand curve in (to the left) When demand increases (shifts right), the price people are willing to pay for every quantity has increasedAnother way to think of it: at every possible price, the quantity people want to buy is higher When demand decreases (shifts left), the price people are willing to pay for every quantity has decreasedAnother way to think of it: at every possible price, the quantity people want to buy is higher Changes in income (consider if it is a normal good or an inferior good) Changes in preferences Changes in the price of related goods (consider if they are complements or substitutes) Expectations Congestion and network effects Type and number of buyers
Firms are willing to operate at a loss in the short-run (sometimes).
When we get to the theory of the firm, we will discuss another rule regarding whether a firm is better off shutting down (choosing a Q=0) or producing at a loss in the short run. Intuitively, though, we only need to look at the restaurants that are open around us right now operating at less than full capacity and losing money (i.e., making a loss). They are open, choosing a Q>0. They are doing that because, right now, they are keeping their losses as small as possible, even if they aren't turning a profit.
production possibilities frontier/curve (PPS/PPC)
a curve that illustrates the variations in the amounts that can be produced of two products if both depend upon the same finite resource for their manufacture
demand schedule
a table of prices and quantities demanded at each price -graph (putting math in a picture) first quadrant where x and y are positive -math -story (words)
Marginal analysis
comparing the marginal cost of something (the additional cost of one more or a little more) to the marginal benefit from that additional amount
Dependencies between agents
competition between different buyers and sellers in different "markets"
The distinction between changes in demand and changes in quantity demanded
demand is how much people buy at any possible price we might see -graphically: the whole demand -mathematically: the entire equation Quantity demanded is how much people buy at a specific price -graphically: a point on he demand curve -mathematically: solving the equation Q for a given price A change in price is a change in quantity demanded When there is a change in quantity demanded at every price, then demand has changed
market demand
describes the demand for not just one buyer, but ALL of the buyers. (add up all the buyers in a market, the horizontal sum)
the concept of demand
describes the various quantity demanded at different prices -incorporates willingness to pay -Price: what is paid for an item (in $) -Quantity demanded: how much a buyer wants to purchase at a particular price -Demand: a list of all of the different quantities a buyer wants to purchase at all possible prices
utility function
formula that assigns a level of utility to individual market baskets
Optimization Problems
given his income, tastes and preferences, the prices of other goods, and the price of wine, that quantity is the best quantity for the buyer
microeconomics
in which you'll study individual decisions and their implications for specific markets
macroeconomics
in which you'll trace through their broader implications across the whole economy
a fixed cost (also called a sunk cost)
is a cost like your tuition: no matter how much time you spend in class, your tuition doesn't change
Quantity supplied
is a point on a supply schedule. When price increases, the quantity supplied increases; and when price decreases the quantity supplied decreases.
implicit costs
opportunity costs that need not involve out-of-pocket costs (The money you would at a job if you didn't go to grad school)
a demand curve (mathematically and graphically)
plotting each possible quantity that a buyer is willing to buy y=a+bx instead of y we have price instead of a we have maximum price that he is willing to pay our slope (b) is how much he changes his purchases in response to a change in price Instead of x we have quantities demanded -vertical axis is always going to be labeled P and horizontal will always be labeled Q
P=MR
right now because firms are in perfectly competitive markets. Don't memorize P=MR and just drop MR from the profit-maximizing rule. Remember that perfectly competitive markets are a bit of a fantasy, so when we start introducing reality into these models, we don't have to relearn things!
explicit costs
some of out-of-pocket costs are opportunity costs (tuition)
marginal utility
that is, how much additional happiness did increasing by one more bring me?
Markets
the interactions of buyers and sellers who interact in the exchange of goods and services. We start with the side of the market we are probably most familiar with personally: Demand (the buyers' side of the market).
willingness to sell
the minimum price that a seller is willing to accept in exchange for a good or service
Microeconomics
the study of individual decision making -usually focuses on individuals, households, firm, markets
The independence principle
your best choice depends on your choice, the choices others make, developments in other markets, and expectations about the future. When any of these factors change, your best choice might change. -Dependencies between each of your individual choices -Dependencies between people or business in the same market -Dependencies between markets -Dependencies between time
Your Marginal Costs Include Variable Costs But Exclude Fixed Costs
• Variable costs: Costs (like labor and raw materials) that vary with the quantity of output you produce. • Fixed cost: Costs (like an equipment lease or building rent) that don't vary when you change the quantity of output you produce. • As you calculate marginal cost, make sure that it reflects only the variable costs, excluding all fixed costs.
