Econ Mid Session

Costs in long run

- In long run, all costs are variable, no fixed costs - In long run, total cost equals variable cost - Average total cost equals average variable cost - In long run, have law of returns to scale (see below)

Eco models

- Eco models: simplified versions of reality used to analyse real world eco situations

Short run and long run

- In short run: period of time during which at least one input is fixed - Long run: period of time long enough to allow a firm to vary all inputs

Real Gross domestic product

- Real gross domestic product: value of all the final g & s produced in a country during a year. It is corrected for effects of inflation

4 market structures

- Industries have enough similarities for economists to group them into 4 market structures. o Perfect competition on one end of spectrum and monopoly on other. Other two in between o Characterised by: § Number of firms in industry § Similarity of g or s produced § Ease with which new firms can enter industry, ie: barriers to entry

Cross price elasticity of demand

- % change in quantity demanded on one g or s divided by % change in price of another g or s - Will be positive or neg depending on whether two products are substitutes or complements - Increase in price of sub lead to increase in quantity demanded of first good, so cross price elasticity of demand will be positive - Increase in price of complement lead to decrease in quantity demanded of first g, so cross price elasticity of demand will be negative - If two products are unrelated, cross price elasticity of demand will be 0 - Important to managers because allows them to measure whether products sold by other firms are close substitutes for their products and allows them to predict effect on demand for their product if price of complement changes. - Pricing behaviour of firms producing products complementary to each other is crucial for production decisions and sales levels. o Sometimes, firms produce both products, which reduces dependence on pricing decisions of other firms

Perfectly competitive markets

- 3 conditions that make a market perfectly competitive: o 1) There must be many buyers and sellers, all are small relative to market. o 2) Products sold by all firms in market must be identical, ie: homogenous o 3) There must be no barriers to new firms entering the market or leaving - There are no industries that are fully perfectly competitive, although some possess some or most of the characteristics o Since arrival of app-based ride sharing, passenger car transport industry is example of an industry close to being perfectly competitive market o Market for agricultural products comes close, eg; apples - The markets for most g & s don't come very close to meeting conditions for perfect competition

Long run average cost curves

- A curve showing lowest cost at which firm able to produce given quantity of output in long run, when no inputs are fixed - U shaped curve - Downward part of curve is economies of scale, with average costs decreasing - Upward part of curve is diseconomies of sale, with per unit costs increasing - Minimum efficient scale is point where curve doesn't decrease any further. All economies of scale have been exhausted - Constant returns to sale: point of curve where long run average cost curve is constant - Long run average cost curve is an envelope over many short run cost curves. Shown by tangential touching, ie: $22 and $20 below - Below shows long run average cost in retail book industry - If bookshop expects to sell 1000 books per month, the small store represented by ATC curve on left will allow it to sell this quantity of books at lowest average cost. o For small bookshop, average total cost of selling 1000 books per month would be $22 per book. - Larger bookshop will sell 20000 books per month at a much lower average cost. o For large, average total cost of selling 20,000 books would be $18 per book - This decline in average cost represents economies of scale that exist in bookselling. o Larger bookshop has lower average costs because selling 20x as many books per month as the small store but need only 6x as much heating/lighting. This saving in electricity cost reduce its average cost of selling books. - Bookshop selling 20,000 books per month and one selling 40,000 per month could have same average cost - Bookshop selling 20,000 books per month has reached its minimum efficient scale - For sales above 40,000 books per month, firms in industry will experience diseconomies of scale

How markets eliminate surpluses and shortages

- A market not in equilibrium moves towards equilibrium and once in equilibrium, the market remains in equilibrium - When quantity supplied is greater than quantity demanded, there is a surplus in the market. o When have surplus, firms have unsold g piling up, which gives incentive to increase their sales by reducing price. Reducing price will simultaneously increase quantity demanded and decrease quantity supplied. This adjustment reduce surplus o When there surplus, there is downward pressure on price - When quantity demanded greater than quantity supplied, there is a shortage in market. o When shortage occurs, some consumers unable to buy the g at current price o Firms will realise they can raise the price without losing sales o A higher price will simultaneously increase quantity supplied and decrease quantity demanded. This adjustment reduces the shortage o When there shortage, there upward pressure on price - It's interaction of demand and supply that determines equilibrium price, not consumers or firms (they cannot dictate what equilibrium price will be) - When shift in demand or supply curve causes change in equilibrium price, the change in price doesn't cause further shift in demand or supply

Variables that shift market demand

- A shift of demand curve is increase or decrease in demand - Movement along demand curve is increase or decrease in quantity demanded - Shift demand curve to right if consumers decide to buy more of g or s at each price - Shift demand curve to left if consumers decide to buy less at each price - Many variables other than price influence market demand - Income: o Income that consumers have available to spend affects their willingness and ability to buy g & s o Good is normal good when demand increases following increase in income and decreases following decrease in income. Most g are normal g, eg: luxury g o A good is inferior g when demand decreases following increase in income and increases following decrease in income. Eg: sausages and canned tuna as buy less when your income increases o If income goes up, then can buy more of a g, shifting demand curve to right - Price of related goods: o Price of other g can affect consumers' demand for product o G & s that can be used for same/similar purpose are substitutes, eg: tablets and laptops § When two g are substitutes, more you buy of one, less you buy of other § A decrease in price of substitute causes demand curve for first g to shift to left § An increase in price of substitute causes demand curve for first g to shift to right o Products use together are complements, eg: hot dog sausages and hot dog rolls § When two g are complements, the more you buy of one, more you will buy of other § Decrease in price of complement causes demand curve of first g to shift to right § Increase in price of complement causes demand c of first g to shift to left - Tastes o Consumers influenced by advertising campaign for product. If advertise heavily, consumers more likely to buy at every price, and demand curve shifts to right o Taste is broad category that refers to many subjective elements that can enter into a consumers' decision to buy product o Consumers' taste for product can change for many reasons, eg: popularity of it, change in seasons o When consumers' taste for product increases, demand curve shift to right. When taste decrease, demand curve shift to left - Population and demographics: o Can affect demand for product o As pop increases, the number of consumers increases, so increased demand for most products o Demographics: populations' characteristics with respect to age, race, gender o As demographic change, demand for g & s increase or decrease because different categories of people tend to have different preferences for those g, eg: older pop means less demand for smartphones or trendy products - Expected future prices: o Consumers chose when products to buy and when to buy them o If people think product will sell for less in 3 months, demand for it will decrease now as consumers postpone their purchase to wait for expected price decrease

Absolute advantage vs comparative

- Absolute a: ability of an individual/firm/country to produce more of a g & s than other producers using same amount of resources. Producing at least cost - Comparative a: ability of an individual/firm/country to produce a g & s at a lower opp cost than other producers. Producing at lowest opp cost - Possible to have ab a in producing g & s without having a comparative a - Possible to have comparative a in producing g & s without having ab a. - Basis for trade is comparative a, not absolute a. Individuals/firm/countries better off if specialise in producing g & s for which they have comparative a and obtain other g & s they need by trading - If you produce g or s at lowest opp cost than rest of world, then have comparative advantage in that, and should form basis of your trade - If trade in your comparative advantage, ends up benefitting all parties in the trade - Specialisation: do what has the smallest opp cost

Marginal product of labour and the average product of labour

- Additional output produced by a firm due to hiring one more worker is called marginal product of labour - Calculate it by determining how much total output increases as each additional worker is hired - Eg; one worker, produces 625 copies. Two workers produce 1325 copies. 3 workers produce 2200 o Marginal product of labour for first worker is 625 copies, and second worker is 700 copies. Third worker is 875 - Increases in marginal product result from division of labour and specialisation. o By dividing tasks to be performed (division of labour), reduces time workers lose moving from one activity to next. Allows them to be more specialised at tasks.

Why is elasticity important?

- All bus have strong interest in knowing how much less they will sell as prices rise. - Govs interested in knowing how consumers will react if price increases following tax increase on product, eg: petrol, cigarettes, alcohol - Knowing price elasticity of demand allows you to calculate effect of price change on quantity demanded - Important concept for bus and policy makers. Eg: if gov wants to discourage smoking, increase price of cigarettes by increasing tax on them. If know price elasticity of demand for cigarettes, can estimate how many fewer packets will be demanded, and whether gov's policy is likely to be successful.

Elasticity and revenue with a linear demand curve

- Along most demand curves, elasticity is not constant at every point - Eg below: shows that when price falls by $1, consumers always respond by downloading two or more movies per month. When price high and quantity demanded is low = demand is elastic. o This is true because $1 fall in price is a smaller % change when price is high, and increase of 2 movie rentals is larger % change when quantity of movie rentals is small - So, demand inelastic when price is low and quantity demanded is high - As move down demand curve for movie rental downloads, price elasticity of demand declines. Aka, at higher prices demand is elastic and at lower prices, demand is inelastic - Elasticity of demand decreases as move down demand curve

Mixed eco

- An eco where most eco decisions result from interaction of buyers and sellers in markets, but where gov also plays a sig role in allocation of resources o Both gov and market decide answers to 3 questions above o Gov intervention in eco dramatically increased in beginning to middle 20th century due to high rates unemployment and bus bankruptcies during Great Depression, and to increase income of elderly, sick, people with limited skills. o Govs provide g & s the market doesn't or fails to provide in sufficient quantities or affordable prices, eg; roads, street lighting, national defence, education, health services o Extent of gov intervention in Aus, US, Canada, Japan, etc means mixed eco. Most modern eco are mixed. o Most desirable, as market eco prone to failures, but here, gov fixes/addresses failures o China: Moved from centrally planned eco to more mixed eco, as eco suffered eco stagnation following intro of centrally planned eco in 1949

Eco growth

- At any given time, the total resources available to an eco are fixed. So, if Aus produces more wheat, must produce less of something else - PPF can illustrate eco growth - Over time, resources available to an eco may increase, eg: labour force and capital stock increase - This increase shifts PPF outwards and makes it possible to produce more wheat and wool - Tech advancements make it possible to produce more g with same number of workers and amount of machinery, which shifts PPF outwards o Tech advancements need not affect all sectors equally (see below: had tech advance in wheat industry but not wool) - Outward shifts in PPF = eco growth because allow eco to increase production of g & s, which ultimately raises standard of living - Eco growth def: ability of an eco to produce increasing quantities of g & s, expansion of society's production potential - Possible for PPF to shift inwards. Occurs if eco experienced a reduction in productive resources, causing max amount of output that could be produced to fall. Disasters like earthquakes, floods, fires can lead to inward shift - First PPF below shows balanced eco growth, whereas second PPF shows biased eco growth towards wheat

Determinants of price elasticity of demand

- Availability of close substitutes o Most important determinant because how consumers react to change in price of product depends on what alternatives they have o Eg: when price of petrol rises, consumers have few alternatives, so quantity demanded falls only a little. o Eg: in market for pizzas, if Domino's Pizza raises price, consumers have many alternative pizza markers, so quantity demanded is likely to fall by quite a lot. o Key constraint on firm's pricing policies is how many close substitutes exist for its product. o Generally, if product has more substitutes, will have more elastic demand. o If product has fewer substitutes, will have less elastic demand - Passage of time: o Usually takes consumers some time to adjust buying habits when prices change o Eg: if price of chicken falls, will take while before consumers decide to change from eating chicken once a week to eating it twice a week. o While today may not be readily available substitutes for product, over time more substitutes may be developed o More time that passes, more elastic demand for product becomes - Whether product is luxury or necessity o G or s that are luxuries usually have more elastic d curves than necessities. o Necessities have more inelastic demand curves o Eg: demand for milk is inelastic because is necessity for most (has few or no substitutes) and quantity that people buy not very dependent on its price. o Eg; tickets to concert are luxury, so demand much more elastic - Definition of the market o In narrowly defined market, consumers have more substitutes available o More narrowly we define a market, more elastic demand will be o Eg: if price of Kellog's Sultana Bran rises, many consumers start buying another brand of sultana bran. If prices of all brands of sultana bran increase, responsiveness of consumers will be lower. If prices of all breakfast cereals rise, responsiveness of consumers will be even lower. - Share of expenditure on the good in the consumer's budget o G or s that take only small fraction of consumer's budget tend to have less elastic demand than g or s that take large fraction o Eg: most buy salt infrequently and in relatively small quantities. Share of average consumer's budget that spent on salt is very low. So, even 50% increase in price of salt likely to result in only small decline in quantity demanded.

Revenue for a firm in a perfectly competitive market

- Average revenue (AR) is total rev divided by number sold - For any level of output, a firm's average revenue is always equal to market price. - Marginal revenue: - For firm in perfectly competitive market, market price is equal to both average revenue and marginal revenue

Equations for cost

- Average total cost: total cost / quantity of output produced (ATC = TC/Q) - Average fixed cost: fixed cost / quantity of output produced (AFC = FC/Q) - Average variable cost: variable cost / quantity of output produced (AVC = VC/Q) - Average total cost: sum of average fixed cost and average variable cost (ATC = AFC + AVC)

Average total cost curve

- Average total cost: total cost divided by quantity of output produced - ATC curve roughly U shaped - As production increases from low levels, ATC curve falls. After reaching min point, begins rising at higher levels of production

Profit, loss or breaking even

- Can express profit in terms of average total cost (ATC) which allows you to show profit on cost curve graph - Equation for relationship between total profits and average total cost is: o Profit = (P - ATC) x Q - The area representing total profit has height equal to (P - ATC) and a base equal to Q, ie: green rectangle below - Firm maximises profit at level of output at which marginal revenue equals marginal cost. Whether firm actually makes a profit at this level of output depends on relationship of price to average total cost. - P > ATC = Profit - P = ATC = firm breaks even (total costs = total rev) - P < ATC = loss

The role of entrepreneur

- Central to working of market system - Someone who operates a bus, bringing together factors of production to produce g & s - They must determine what g & s they believe consumers want, and decide how they might be produced more profitability, using the available factors of production - Successful entrepreneurs able to find opps to provide new g & s, often opps created by new tech - They think of products consumers may not realise they need, eg: smart phone - Put their own funds at risk when start bus. Can lose funds if wrong about what consumers want or best way to produce g & s - Great importance to eco because often responsible for making new products widely available to consumers, eg: Henry Ford with cars, Steve Jobs with iPhone - Make a vital contribution to eco growth through their roles in responding to consumer demand and intro new products. - Gov policies that encourage entrepreneurship likely to increase eco growth and raise standard of living

Change in demand vs change in quantity demanded

- Change in demand: shift of demand curve. There is a change in one of the variables other than price of product that affects willingness of consumers to buy product - Change in quantity demanded: movement along demand curve due to change in product's price - In diagram below, A to B is movement along, and A to C is shift

Change in supply vs change in quantity supplied

- Change in supply: shift of supply curve. Shift when there is change in one of variables other than price of product that affects willingness of suppliers to sell product - Change in quantity supplied: movement along supply curve due to change in product's price - Rightwards = increase - Leftwards = decrease

Free markets

- Def: a market with few gov restrictions on how a g & s can be produced or sold, or on how a factor of production can be employed - Govs in all modern eco intervene more than consistent with fully free market - There relatively few gov restrictions on eco activities in Aus, US, Hong Kong, Singapore - In countries, eg: Cuba, North Korea, free market system been rejected in favour of centrally planned eco with extensive gov control over product and factor markets - Countries closest to free market system more successful than countries with centrally planned eco in providing rising living standards - When consumers want more or less of product, the market system responds - The effect price changes have on behaviour of firms and consumers referred to as price mechanism (the system in free market where price changes lead to producers changing production in accordance with level of consumer demand)

Eco models

- Def: simplified versions of reality used to analyse real-world eco situations - Economists rely on them to analyse real world issues and answer qs - One purpose: make eco ideas sufficiently explicit and concrete to be used for decision making by individuals, firms, gov - Economic variable: something measurable that relates to resources that can have different values, eg: wages, prices. Aka data, can use it to make eco decision and explain - To develop one, economists generally follow these steps: o 1) Decide on the assumptions to be used in developing it § Based on making assumptions because models have to be simplified to be useful § Eg: assume consumers buy those g & s that max their wellbeing/satisfaction, assume firms act to max profits § We discover if assumption in model is too simple/limiting when we form hypothesis based on these assumptions and test them o 2) Formulate a testable hypothesis o 3) Use eco data to test the hypothesis § A hypothesis: a statement that may be correct or incorrect about an eco variable, something measurable that can have different values, eg: wages paid to IT workers § Eg: 'Outsourcing to offshore locations reduces wages of IT workers in Aus' § Must test it, do this by analyse statistics on relevant eco variables § Has to be proved or disproved by statistical analysis § In testing, must distinguish between correlation and causality. · Correlation: association between 2 variants · Correlation doesn't necessarily mean causality § Null hypothesis and alternative hypothesis o 4) Revise model if it fails to explain well the eco data § If statistical analysis clearly rejects hypothesis, then model needs to be reconsidered, assumption may be too simple or limiting o 5) Retain the revised model to help answer similar eco questions in the future

Demand schedules and demand curves

- Demand schedule: a table showing relationship between price of product and quantity demanded - Quantity demanded: amount of g & s consumer is willing and able to purchase at given price - Demand curve: a curve that shows relationship between price of product and quantity demanded - In real markets, demand c not straight line, but often drawn as such in eco models for convenience - Demand curve slopes downwards because consumers buy more of product as price falls, as product becomes less expensive relative to other products and because they can afford to buy more at lower price

Eco and politics

- Eco theories/models have huge influence on gov policy - Even when eco evidence very strong, doesn't mean its adopted by politicians - Politicians acutely aware of conclusions voters believe to be correct but which may not be supported by positive analysis, eg: believe immigrants take jobs away from native, but this not true, most economists agree immigration contributes to eco growth

Economics def

- Economics: study of the choices people and societies make to attain their unlimited wants given their scarce resources

What is elasticity?

- Economists use concept of elasticity to measure how one eco variable, eg quantity demanded, responds to changes in another eco variable, eg; price. - Responsiveness of quantity demanded of g or s to changes in its price is called price elasticity of demand - Responsiveness of quantity supplied of g or s to changes in its price is called price elasticity of supply.

Adam Smith

- Father of economics - Book: An Inquiry into the Nature and Causes of the Wealth of Nations (1776) - Guild system: o 18th century in Europe o Meant extensive gov restrictions on markets o Govs would give guilds (ie: producers, orgs) the authority to control the production of a g, eg; shoemakers guild controlled who allowed to produce shoes, how many, what price charged o Smith argued this reduced income/wealth of country and people by restricting the quantity of g produced o Defenders of guild system worried that if, eg: shoemakers' guild didn't control shoe production, either too many or few shoes would be produced o Smith argued that prices would do better job of coordinating activities of buyers and sellers than guilds could o Key to understanding Smith's argument is assumption that individuals usually act in rational, self-interested way. Individuals take actions most likely to make themselves better off financially. - Said firms would be led by 'invisible hand' of market to provide consumers with what they wanted. Firms would respond to changes in prices by making decisions that ended up satisfying the wants of consumers - It is consumers in free market eco that decide what to produce, how and for whom - Price mechanism: system in free market where price changes lead to producers changing production in accordance with level of consumer demand - Forces of demand and supply govern fate of market and produce most efficient outcomes

Relationship between price and total rev

- Firm interested in price elasticity because allows firm to calculate how changes in price will affect its total revenue (total funds received by seller of good or service) - Total revenue calculated by multiplying price per unit by number of units sold, ie: P x Q - When demand inelastic, price and total revenue move in same direction o Increase in price raises total revenue, decrease in price reduces total revenue - When demand elastic, price and total revenue move inversely o Increase in price reduces total revenue, decrease in price raises total revenue - When demand unit elastic, change in price is exactly offset by proportional change in quantity demanded, leaving rev unaffected. Neither decrease nor increase in price affects rev. - For Panel A below: o Demand curve is inelastic between point A and B o Total rev received at point A equal to price of $30 multiplied by 16 copies sold, so $480 (area of rectangles C and D) o Because demand curve inelastic between A and B, reducing price to $20 (point B) reduces total rev o New total rev shown by areas of rectangles D and E, ie: $20 x 20 copies = $400 o Total rev fell because increase in quantity demanded not large enough to make up for decrease in price. So, $80 increase in rev gained (rectangle E) due to price reduction is less than $160 in revenue loss (rectangle C) - For Panel B above: o Demand curve elastic between A and B o Reducing price increases total rev o At point A, areas of rectangles C and D are equal to $480, but at point B, areas of rectangles D and E equal to $560 ($20 x 28 copies) o Total rev increases because increase in quantity demanded is large enough to offset lower price o The $240 increase in rev gained due to price reduction (rectangle E) is greater than $160 in revenue lost (rectangle C)

Deciding whether to produce or shut down in short run

- Firm suffering loss has 2 choices in short run: continue produce or stop production by shutting down temporarily - During temporary shutdown, firm must still pay its fixed costs. o If firm does not produce, will suffer a loss equal to its fixed costs. This loss is max the firm will accept. - Firm will shut down if producing would cause it to lose amount greater than fixed costs. - Firm can reduce its loss below amount of its total fixed cost by continuing to produce, provided that total rev it receives is greater than its variable cost. o Revenue over and above variable cost can be used to cover part of firm's fixed cost. So, firm will have smaller loss by continuing to produce than if it shut down - In analysing firm's decision to shut down, are assuming that its fixed costs are sunk costs. o A sunk cost is a cost that has already been paid and cannot be recovered. Assume that the firm cannot recover its fixed costs by shutting down. o Eg: farmer taken out loan to buy more land, farmer legally required to make monthly loan repayment regardless of whether or not any crops are grown. The farmer has to spend those funds and cannot get them back, so farmer should treat sunk costs as irrelevant to short-term decision making. o Eg: if sunk costs huge, then makes sense for them to continue because already paid so much - Whether total rev is greater or less than its variable costs is key to deciding whether or not to shut down or continue producing in short run. - As long as total revenue is greater than variable cost, it should continue to produce no matter how large or small its fixed costs are. - Option not available to firm with losses is to raise its price because then would lose all customers and sales drop to

Technology

- Firm's tech is the processes it uses to turn inputs into outputs of g or s - Inputs: factors of production (land, labour, capital, enterprise) - Depends on factors like skill of managers, training of workers, speed and efficiency of machinery - When experience tech change, able to produce more output using same inputs, or same output with fewer inputs. Shifts supply curve to right - Tech change can come from many sources, eg: training program, better machinery

Perfectly competitive market: cannot affect market price

- Firms in perfectly competitive industries unable to control prices of products they sell and unable to earn economic profit in long run. o Because firms in these industries sell identical products and easy for new firms to enter industries - Prices determined by interaction of demand and supply - The actions of any single consumer or firm have no effect on market price. - Consumers and firms have to accept market price if want to buy and sell - A firm is very small relative to the market and because selling exactly same product as every other firm, can sell as much as wants without having to lower its price - If firm tries to raise its price, won't sell anything because consumers will switch to buying product from firm's competitors - Every firm will be a price taker (buyer or seller who unable to affect market price) and will have to charge same price as every other firm in that market.

Law of supply

- Holding everything else constant (ceteris paribus), increase in price causes increase in quantity supplied, and decrease in price causes decrease in quantity supplied - Positive relationship so upward sloping curve - Firms plan output to enable them to make as much profit as possible - When decrease in supply, saying there is less supply at each and every price point. When increase, then more supply at each and every price point - At higher price, holding everything else constant, profits greater than before and firms want to sell more - Devoting more and more resources to production of a g results in increasing marginal costs. Eg: if Apple increase production of iPhones during given period, likely to find that cost of producing additional tablets increases as they run existing factories for longer hours. o With higher marginal costs, firms supply a larger quantity only if price is higher

Law of demand

- Holding everything else constant, when price of a product falls, quantity demanded of product will increase. When price of product rises, quantity demanded will decrease o So other factors affecting demand, eg: changes in income, advertising, are held constant and unchanged o This holding all variables other than price constant when constructing demand curve called the ceteris paribus condition - Inverse relationship and downward slope

The market system

- Households/firms/gov face trade-offs and incur opp cost due to scarcity of resources - Market: group of buyers and sellers of g & s and the institution or arrangement by which they come together to trade. Platform for buyers and sellers to interact and in doing so, they are both better off, ie: voluntary exchange principle o Market may need supporting institutions for it to function, ie: rules, guidelines, otherwise may fail o Institutions important, are supporting mechanisms for efficient functioning of markets - Markets facilitate production, exchange and consumption of g & s - Markets take many forms, eg: local fruit market, stock exchange, eBay - In market, buyers are demanders of g & s and sellers are suppliers - Households and firms interact in 2 types of markets: product and factor markets - Product markets: markets for g & s - Factor markets: markets for the factors of production, ie: the inputs used to make g & s. There are 4: o Labour: includes all types of work, eg: part time o Capital: physical capital, eg: machines, tools, computers, that are used to produce other goods o Natural resources: include land, water, oil, other raw materials used in producing g o Entrepreneurial ability: Entrepreneur is someone who operates a bus. E ability is ability to bring together other factors of production to produce and sell g & s successfully - In factor markets, households are suppliers and firms' demanders - At centre of market system is consumer - To be successful, firms must respond to desire of consumers and these desires are communicated to firms through prices.

Elastic demand

- If quantity demanded is responsive to changes in price, % change in quantity demanded will be greater than % change in price. o Price elasticity of demand will be greater than 1 in absolute value o Here, demand is elastic o Eg; if 10% decrease in price results in 20% increase in quantity demanded, then price elasticity of demand is 20%/-10% = -2 o Flatter the demand curve, more elastic it is o Even small change in price bring about big change in quantity demanded

Legal basis of successful market system

- In free market, gov doesn't restrict how firms produce and sell g & s or how they employ factors of production. But, absence of gov intervention not enough for market to work well - Gov has to provide secure rights to private property and enforce contracts through independent court system for market system to work at all. These provide a legal basis that allows market system to succeed - Shows how markets need institutions to sustain them, as ensures market remains intact and functioning

Graphs

- Info on eco variables often displayed in time-series graphs. The date (often the year) in which the variable is measured is along horizontal/x axis and value of the variable is on vertical/y axis - Eg: demand curve - The slope of line tells us how much the variable we are measuring on y axis changes at the variable we are measuring on x axis changes - Slope = change in value on y axis / change in value on x axis - Use graphs to show relationship between any 2 variables. o Sometimes, relationship is negative, so as one variable increases in value, other decreases o Relationship can be positive, so values of both variables increase together - Reverse causality: occurs when we conclude that changes in variable X cause changes in variable Y when it actually changes in variable Y that cause changes in variable X. - In many eco debates, cause and effect can be more difficult to determine - Few eco relationships actually linear. o In practice, it useful to approx a non-linear relationship with a linear relationship, eg: demand curve sometimes not actually a straight line when plotted correctly. o If relationship reasonably close to being linear, analysis not sig affected. - To measure slope of non-linear curve at particular point, measure the slope of the tangent line to the curve at that point. We measure slope of tangent line just as we would the slope of any straight line

Demand and supply

- Interaction of demand and supply in markets determines quantity of g & s that is produced and price at which it sells - Demand and supply curves in most markets are constantly shifting, and prices and quantities that represent equilibrium are constantly changing

Demand curve for output of a perfectly competitive firm

- It is a horizontal (perfectly elastic) - Must accept market price, eg below $4 o Whether sell 3000 bushels per year or 7500, has no effect on market price. - A firm is selling exactly same product as many others. Therefore, can sell as much as wants at current market price, but cannot sell anything if it raises price by even one cent. So, demand curve for a perfectly competitive firm's output is a horizontal line. - Demand curve for a firm is also the price, average revenue and marginal revenue - In a perfectly competitive market, price determined by intersection of market demand and market supply. - In panel (a), demand and supply curves for oats intersect at a price of $4 per bushel. An individual oats farmer has no ability to affect market price for oats. Therefore, as panel (b) shows, demand curve for Farmer Jones' oats is horizontal line

Variables that shift supply

- Many factors, other than price, that affect willingness of firms to supply g & s. These shift the supply curve, ie: increase or decrease supply - If, at every price level, firms increase quantity of product they wish to sell, supply curve shifts to right - If at every price level, firm decrease quantity they wish to sell, supply curve shifts to left - Price of inputs: o Factor most likely to cause supply curve for a product to shift o Input: anything used in production of g & s o Eg: if price of tablet rises, cost of producing it will increase and tablets will be less profitable at every price. Supply of tablets will decline and market supply curve shift to left o If price of input falls, supply will increase, and supply curve shift to right o Increase in cost of input increases cost of production, so firm supply less - Tech change: o Tech change: change in ability of a firm to produce output with given quantity of inputs o Allows firm to produce more output using same amount of inputs, so shift curve o Shift happen when productivity of workers/machines increases o Productivity: output produced per unit of input. More productivity = more supply o If firm produce more output with same amount of inputs, costs lower and g & s more profitable to produce at any given price. o When tech change occurs, firm will increase quantity supplied at every price and supply curve shift to left o Labour productivity = total output / total number of labourers - Number of firms in market: o A change in number of firms in market will change supply o When new firms enter, supply curve shifts to right and when existing firm leave a market, supply curve shifts to left - Expected future prices o If firm expects price of products will be higher in future than today, it has incentive to decrease supply now and increase in future - Prices of substitutes in production o Substitutes in production are alternative products firm can produce with same resources o Increase in price of substitute in production decreases supply of initial g. Decrease in price of substitute increases supply of initial good. o Switch to more profitable one

Offshoring

- Many firms have been moving production of g & s to other countries where wages are lower - Manufacturing jobs, jobs that require high skill levels, eg: research and development, IT system analysis are being outsourced - Argued that developments in robotics will replace both onshore and offshore jobs, particularly within service sector - Offshoring and use of robotics means lower wages and greater flexibility for firms, lower production costs so bus more profitable, can then invest in other areas of eco and create new jobs - Most economists argue that some jobs will be lost, but offshoring and automating routine tasks will lead to higher wages and increased prosperity for Aus

Marginal cost and average total cost

- Marginal and average products of labour affect firm's costs - Marginal cost: o Optimal decisions are made at the margin o Marginal cost: change in firm's total cost from producing one more unit of g or s o Calculate marginal cost for a particular increase in output by dividing change in cost by change in output. o - Relationship between marginal cost and average total cost: o When marginal product of labour rising, marginal cost of output will be falling o When marginal product of labour falling, marginal cost of production rising o Eg: only additional cost from producing more copies is additional wages paid to hire more workers. Pays new worker $50 per day. Marginal cost of additional copies each worker makes depends upon worker's additional output or marginal product. As long as additional output from each new worker is rising, marginal cost of that output will be falling. o The marginal cost of product falls and then rises, producing a U shape o As long as marginal cost is below average total cost, average total cost will fall. o When marginal cost is above average total cost, average total cost will rise. o Marginal cost will equal average total cost when average total cost is at its lowest point. o Marginal cost curve intersects average cost curve at its lowest point o When marginal cost curve starts increasing, it pull up average total cost curve

Cost curves

- Marginal cost (MC), average total cost (ATC) and average variable cost (AVC) curves are all U-shaped - MC curve intersects the AVC and ATC curves at their minimum points. - When marginal cost is less than average variable cost or average total cost, causes them to decrease. - When marginal cost is above average variable cost or average total cost, causes them to increase. - When marginal cost equals average variable cost or average total cost, must be at their minimum points. - As output increases, average fixed cost gets smaller and smaller. o Happens because in calculating average fixed cost, dividing something that gets larger and larger (output) into something that remains constant (fixed cost). o Firms often refer to this process of lowering average fixed cost by selling more output as 'spreading the overhead' (where overhead refers to fixed costs) - As output increases, difference between average total cost and average variable cost decreases. o Happens because difference between average total cost and average variable cost is average fixed cost, which gets smaller as output increases. - If you produce more, average fixed cost is low but if produce little, then AFC is high o ATC = AFC + AVC, or AFC = ATC - AVC, so, AFC decreases as output increases. o Let's say FC = 100. At output 10, AFC = TFC / output = 100/10 = 10. At output 50, AFC = TFC / output = 100/50 = 2

Marginal product and average product

- Marginal product of labour: how much total output changes as quantity of workers hired changes. - Average product of labour: total output produced divided by quantity of workers - Relationship between them: the average product of labour is the average of the marginal products of labour. - Eg: marginal product of first worker is 625, marginal product of second is 700, and marginal product of the third is 875. Average product of labour for 3 workers is 733.3 - Panel A shows relationship between quantity of workers and total output o Due to specialisation and division of labour, output will at first increase at increasing rate o After third worker hired, fall in marginal product o Once point of diminishing returns has been reached, production increases at decreasing rate. Each worker after third causes production to increase by smaller amount than did hiring previous worker - Panel B shows marginal product of labour and average product of labour o Marginal product of labour curve rises initially due to specialisation and division of labour, then falls due to diminishing returns o Whenever marginal product of labour greater than average product of labour, average product of labour must be increasing. Whenever less than, average product of labour decreasing o Marginal product of labour equals average product of labour for quantity of workers where average product of labour is at its max. - When marginal product of labour starts decreasing, it starts bringing down average product of labour curve (can see this on diagram below)

Efficiency

- Market eco more efficient than centrally planned - There 3 types of efficiency every market should strive to achieve. A perfectly competitive marker delivers all three: productive e, allocative e, dynamic e - Markets tend to be efficient because promote competition and facilitate voluntary exchange (situation where buyer and seller are made better off by transaction) - Facilitating voluntary exchange ensures efficient functioning of market as encourage buyers and sellers to engage and interest - Competition forces firms to continue producing and selling g & s as long as the additional benefit to consumers is greater than additional costs of production. So, g & s produced will reflect consumer preferences, achieving consumer sovereignty - Markets promote efficiency, but don't guarantee it

Market supply curve in perfectly competitive industry

- Market supply curve is determined by adding up quantity supplied by each firm in industry at each price. - Market supply curve can be derived from marginal cost curves of firms in industry - Upward sloping - Panel a shows marginal cost curve for one oat farmer. o At $4, supplies 8000 bushels of oats. o If every oats farmer supplies same amount of oats at this price, and if there are 10,000 oat farmers, total amount of oats supplied at price $4 will be 800 x 10,000 = 80 million bushels of oats - Panel b shows price of $4 and quantity of 80 million bushels at a point on market supply curve for oats.

Market def

- Market: group of buyers and sellers of a g or s and the institution or arrangement by which they come together to trade. A platform that facilitates eco transactions by bringing together buyers and sellers in one place.

Measuring price elasticity of demand

- Measure it using slope of demand curve as curve tells us how much quantity demanded changes as price changes - Using slope of demand curve to measure has drawback: measurement of slope sensitive to units chosen for quantity and price. Value changes dramatically depending on units used for price and quantity o So, economists use percentage changes when measuring price elasticity of demand - Measured by dividing percentage change in quantity demanded by percentage change in price - - NOTE: not the same as the slope of demand curve (slope calculated using changes in quantity and price) - If calculate price elasticity of demand for price reduction, % change in price will be negative and % change in quantity demanded will be positive - If calculate for price increase, % change in price will be positive and % change in quantity will be negative o So, price elasticity of demand and one number in equation is always negative due to law of demand - When comparing elasticities, usually interested in their relative size. So, drop minus sign and compare their absolute values, eg: although -3 is actually smaller than -2, price elasticity of -3 is larger than price elasticity of -2

Income elasticity of demand

- Measures responsiveness of quantity demanded to change in income - When measuring income, usually use disposable income (consumer income after income taxation has been paid) - Income elasticity of demand is calculated as: - If quantity demanded of g or s increases as income increases, then product is a normal good. o Normal g often further divided into luxury g and necessity g. § G or s is luxury if quantity demanded is very responsive to changes in income, so that 10% increase in income results in more than 10% increase in quantity demanded. § Calculated income elasticity of demand is greater than 1 for luxury products. § G or s is necessity if quantity demanded not very responsive to changes in income, so that 10% increase in income results in less than 10% increase in quantity demanded. § Calculated income elasticity of demand between 0 and 1 for necessity g. - G or s is inferior if quantity demanded falls when income increases. o Calculated income elasticity of demand for inferior good is negative. - Most g are normal goods. So, during periods of eco expansion when consumer income is rising, most firms can expect (holding all other factors constant) that quantity demanded of products will increase. o Sellers of luxuries can expect particularly large increases - During eco contractions/recessions, falling consumer income can cause firms to experience increases in demand for inferior goods. - Allow you to determine if it is a normal good or inferior good o If positive, then it is a normal good o If negative, then it is inferior good o If positive and greater than 1, then luxury good o If positive and less than 1 than necessity good

Micro and macro economics

- Microeconomics: study of how households and firms make choices, how they interact in markets and how gov attempts to influence their choices - Macroeco: study of the eco as a whole, eg: inflation, unemployment, eco growth, monetary and fiscal policy - Division between the two not always clear. Many eco situations have a micro and macro aspect, eg: level of total investment by firms in new machinery/equipment helps determine how rapidly eco grows (macro), but to understand how much new machinery/equipment needed, have to analyse incentives individuals' firms face (micro) - Examples of micro eco issues: o How consumers react to changes in product prices o How firms decide what prices to charge for products they sell o Which gov policy would most efficiently reduce teenage smoking o What is most efficient way to reduce air pollution o Demand and supply behaviour o Market structures and interactions - Examples of macroeconomic issues: o Why eco experience periods of contraction and increasing unemployment o What determines inflation rate o What determine value of the AUD o Whether gov intervention can reduce severity of an economic contraction

Production possibility frontiers and real world trade offs

- PPF is a curve showing max attainable combinations of 2 products that may be produced with available resources and current tech - PPF can be used to show opp cost (the highest valued alternative that must be given up to engage in an activity) - All combinations on frontier or inside it are attainable with current resources/tech available - Combinations on frontier are efficient as all available resources being fully utilised, and fewest possible resources being used to produce a given amount of output - Combinations inside are inefficient because max output not being obtained from available resources - Points beyond PPF = unattainable given firm's current resources/tech - If producing on PPF, only way to produce more of one is to produce less of other, ie: opp cost. Eg: moving from point B to C below has opp cost of producing 10 more SUVS per day but at cost of 20 fewer sedans - Can use PPF to explore issues concerning eco as whole, eg: assume eco produces only 2 types of goods, wool and wheat o As eco moves down PPF, experiences increasing marginal opportunity costs because increasing wheat production by given quantity requires larger and larger decreases in wool production. o Increasing marginal opp costs occurs as some workers/machines/other resources better suited to one use than another. As eco moves down PPF, more and more resources that better suited to wool production are switched to wheat production. So, increases in wheat production become increasingly smaller while decreases in wool production become increasingly larger o Increasing marginal opp costs illustrates an important eco concept: the more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity. Eg: the more hours you have already spent studying eco, the smaller the increase in your test grade from each additional hour you spend, and greater the opp cost of using hour in that way. o PPF is bowed outward due to increasing marginal opp cost

Basic eco rule

- People must make choices to attain their goals as we live in a world of scarcity (unlimited wants exceed the limited resources available to fulfil those wants). These choices = trade offs

Positive and normative analysis

- Positive analysis: concerned with what is and involves value free statements that can be checked by using facts, eg: 'a reduction in taxation rates will lead to increase in spending by individuals' - Normative analysis: concerned with what ought to be, involves making value judgements/opinions which cannot be tested, eg: 'individuals should receive reductions in taxation as they are able to decide how to spend money to max their satisfaction better than gov can' - Eco about positive analysis, which measures costs and benefits of different actions

Law of diminishing returns

- Principle that, at some point, adding more of a variable input, eg labour, to same amount of a fixed input, eg capital, will cause marginal product of variable input to decline. - Happens because at some point, have used up all gains from division of labour and specialisation. Ie: more workers for same number of machines, get in each other way - Eg: hiring fourth worker raises quantity of copies from 2200 to 2600. Increase in quantity of 400 is less than increase when hired third worker, ie: 875 - When marginal product is negative, level of total output declines. - Beyond certain number of workers, each extra worker employed produces less output than worker previously employed, given that all other inputs are held constant. - Extra service of output a worker can provide is limited by the fixed amount of capital

How firm max profits in perfectly competitive market

- Profit is difference between total revenue (TR) and total cost (TC). Ie: Profit = TR - TC - To maximise profit, should produce quantity of goods where difference between total revenue received and total costs is as large as possible - Profit maximising level of output is also where marginal revenue equals marginal cost: MR = MC o See below graphs for Farmer Joe to see

Determining profit-max level of output

- Profit maximising level of output is where difference between total rev and total cost is greatest, and also where marginal rev equals marginal cost - Have to consider costs and revenue - A firm's marginal cost is increase in total cost resulting from producing another unit of output - Profit = total revenue - total cost - Panel a below shows Farmer Jones' total rev, total cost and profit. o Total rev is straight line on graph because increases at a constant rate of $4 for each additional bushel sold o His profits are maximised when vertical distance between line representing total rev and total cost curve is as large as possible. Occurs at an output of 6 bushels. - Panel b: shows Farmer Jones' marginal rev and cost o Marginal rev is always equal to $4, so is horizontal line (same as demand curve) o His marginal cost of producing oats falls then rises o He maximises profits by producing oats up to point where marginal rev of last bushel produced is equal to its marginal cost (MC), or MR = MC o Difference between marginal rev and marginal cost is additional profit or loss from producing one more bushel o As long as marginal rev larger than marginal cost, profits are increasing and will want to expand production § Eg: he will not stop producing at 5 bushels because producing and selling the sixth bushel adds $4 to rev but $3 to cost, so profit increases by $1. o He wants to continue producing until MR he receives from selling another bushel is equal to marginal cost of producing it. At that level of output, will make no additional profit by selling another bushel, so has maximised profits. o In B, at no level of output does MR = MC, but closest is at 6

Production function

- Relationship between inputs employed by firm and max output it can produce with those inputs is called firm's production function Represents the firm's tech

Resources def

- Resources: inputs used to produce g & s, including natural resources, labour, capital, and entrepreneurial ability

Price elasticity of supply

- Responsiveness of quantity supplied to a change in price - Measure of how much quantity supplied increases when price increases - Calculate it using % changes - Because supply curve upward sloping, price elasticity of supply will be positive number - When calculate price elasticity of supply, we hold values of other factors constant - If price elasticity of supply less than 1, supply is inelastic. o Eg: supply of many agricultural products in Aus is price inelastic - If price elasticity of supply greater than 1, supply is elastic. o Eg; if price of petrol increases before weekend, quantity supplied by petrol service stations likely to be price elastic, as likely to have fuel in storage tanks or can order further deliveries from refineries in relatively short period of time - If price elasticity of supply equal to 1, supply is unit elastic

Scarcity, trade offs and key eco questions

- Scarcity: situation where unlimited wants exceed limited resources available to fulfil those wants - Price of g reflects its scarcity, eg: diamonds - Resources will always be scarce, regardless of whether in developed or developing world. Humans always want more than they have o However, nature of problems can vary, eg: USA decide between resources for hospitals or to build rockets, whereas developing country choose between building a road or providing education - Every society faced with problem of allocating scarce resources to max satisfaction of wants - Live in a world of scarcity, so have eco problem that we only have limited eco resources, eg: workers, natural resources, machines, and therefore can produce only limited amounts of g & s. So, society faces trade-offs, ie: producing more of one g & s means producing less of another - Trade-offs force society to make choices - Have to ask what g & s to produce, how and for whom

Economies of scale

- Short run average cost curves represent costs firm faces when some input is fixed. - Long run average cost curve shows lowest cost at which firm is able to produce given level of output in long run, when no inputs are fixed. - Firm may experience economies of scale (aka increasing returns to scale). o Means firm's long run average costs fall as it increases its scale of production and quantity of output it produces. - Managers can use long-run average cost curves for planning because show effect on cost of expanding output by, for example, building a larger factory or store. - Firms may encounter economies of scale for several reasons. o Firm's tech makes it possible to increase production with a smaller proportional increase in at least one input o Workers and managers become more specialised, so more productive, as output expands o Large firms, eg: Bunnings, may be able to purchase new inputs at lower costs than smaller competitors. Its bargaining power with respect to its suppliers increases and average costs fall. o As firm expands, may be able to borrow money more cheaply, lowering its costs. - Economies of scale don't continue forever. Long-run average cost curve in most industries has a flat segment that often stretches over a substantial range of output. Over this range of output, firms in industry experience constant returns to scale - Level of output at which all economies of scale have been exhausted is called minimum efficient scale. - Diseconomies of scale, aka decreasing returns to scale, exist when firm's long-run average costs rise as it expands scale of production and increases quantity of output. o Ie: when firm become larger, increase management layers, may expand operations to new locations. Org structure becomes more complex, monitoring and maintaining costs harder, industrial disputes occur. All cause rising costs. - Constant returns to scale: exist when a firm's long run average costs remain unchanged as it increases its scale of production and quantity of output it produces

Perfectly elastic supply

- Supply curve is horizontal line - Quantity supplied is infinitely responsive to price changes - Price elasticity of supply equals infinity. - Small increase in price causes large increase in quantity supplied. - Flatter the supply curve, more elastic it is

Perfectly inelastic supply

- Supply curve is vertical line - Quantity supplied completely unresponsive to price change - Price elasticity of supply equals zero. - Regardless of how much price increase or decrease, quantity remains same. - Over brief period of time, supply of some g&s may be perfectly inelastic. Eg: car park may have only fixed number of parking spaces. If demand increases, price to park in car park may rise but no more spaces will become available. - Eg: particular original painting by Monet or da Vinci, supply of it is perfectly inelastic - More vertical supply curve, more inelastic it is

Supply schedules and supply curves

- Supply schedule: table that shows relationship between price of product and quantity of product supplied - Supply curve: curve that shows relationship between price of product and quantity supplied - Market supply curve is upward sloping

Trade

- The act of buying and selling - One key activity in markets is trade - Through trade, people can raise their standard of living - Makes it possible for people to become better off by increasing both their production and consumption - Trade allows people to specialise according to their comparative advantage - Trade today involves decisions of billions of people around world - In Aus and most countries, trade carried out in markets

Market equilibrium

- The demand curve crosses supply curve at only one point - Market equilibrium: situation where quantity demanded equals quantity supplied. - Markets that have many buyers and sellers are competitive markets and equilibrium in these markets is a competitive market equilibrium. o At competitive market equilibrium, all consumers willing to pay market price will be able to buy as much of product as want, and all firms willing to accept the market price will be able to sell as much of product as want. So, no reason for price to change unless either demand or supply curve shifts

Supply curve of firm in short run

- The marginal cost curve for firm tells us same thing as a supply curve, ie: how many units of a product firm is willing to sell at any given price o Ie: supply curve in short run given by marginal cost curve - Because price = marginal revenue for a firm, firm will produce where P = MC. - For any given price, can determine from marginal cost curve the quantity of output firm will supply. - If price drops below average variable cost, firm will have a smaller loss if it shuts down and produces no output. o So, firm's marginal cost curve is its supply curve only for prices at or above average variable cost. - Marginal cost curve intersects average variable cost where average variable cost curve is at its minimum point. o So, firms supply curve is its marginal cost curve above the min point of the average variable cost curve. o For prices below min average variable cost, firm will shut down and its output will fall to 0. Min point on average cost curve is called shutdown point. P < AVC o Should continue to operate if P > ATC as price is covering operating costs

Estimating price elasticity of demand

- To estimate price elasticity of demand, economists need to know demand curve for product - Generally, use statistical methods to estimate demand curve and price elasticity - When calculating price elasticity for new products, firms often rely on market experiments o With market experiments, firms try different prices and observe change in quantity demanded that results

Fixed costs and variable costs

- Total cost: cost of all inputs a firm uses in production - Fixed costs: cost of fixed inputs. Costs that remain constant as quantity of output changes - Variable costs: costs of variable inputs. Costs that change as quantity of output changes - All firm's costs are either fixed or variable - Typical fixed costs are lease payment, insurance payments, advertising payment - Typical variable costs include labour, raw material, utilities cost - Total cost = fixed cost + variable cost o TC = FC + VC

Midpoint formula

- Used to calculate price elasticity of demand between 2 points in a demand curve - Use to ensure we only have one value of price elasticity of demand between same two points on same demand curve - Uses average of initial and final quantity and average of initial and final price

Unit elastic demand

- When % change in quantity demanded equal to % change in price, price elasticity of demand equals -1 (or 1 in absolute value) o Here, demand is unit elastic

Effects of shift in demand and supply over time

- When both curves shift, when demand shifts to right by more than supply, equilibrium price rises - When supply shifts to right by more than demand, equilibrium price falls

Effects of shifts in demand on equilibrium

- When demand curve shifts to right, from D1 to D2, this causes a shortage at og equilibrium price, P1. - To eliminate shortage, equilibrium price rises to P2 and equilibrium quantity rises from Q1 to Q2. - If demand curve shifts to left, equilibrium price and quantity will both decrease

Using price elasticity of supply to predict changes in price

- When demand increases, amount price increases depends on price elasticity of supply - Knowing price elasticity of supply makes it possible to predict more accurately how much price will change following an increase or decrease in demand - For below: Shows demand and supply for parking spaces o In Panel A: on typical summer weekday, equilibrium occurs Point A, where demand weekday intersects supply curve that is inelastic. o Increase in demand for parking spaces on weekends shifts demand curve to right, moving equilibrium to Point B. o Because supply curve inelastic, increase in demand results in large increase in price, from $2.00 per hour to $4.00, but only small increase in quantity of spaces supplied, from 1200 to 1400. o In Panel B, supply is elastic. So, shift in equilibrium from Point A to Point B results in smaller increase in price and larger increase in quantity supplied. o Increase in price from $2.00 per hour to $2.50 is sufficient to increase quantity of parking supplied from 1200 to 2100.

Necessities

- When price rises, quantity demanded tends not to fall by very much, at least not be same proportion as price rise. - Takes very large price increase to have sig effects - Eg: petrol. Estimates by Department of Infrastructure and Transport, in short term, for every 10% increase in petrol price, quantity demanded falls by around 1.5%.

Inelastic demand

- When quantity demanded not very responsive to price, % change in quantity demanded will be less than % change in price o Price elasticity of demand will be less than 1 in absolute value o Means demand is inelastic o Eg: if 10% in price results in 5% increase in quantity demanded, then price elasticity of demand is 5%/-10% = -0.5 o Steeper demand curve, less elastic it is o Even big change in price brings about small change in quantity demanded

Implicit and explicit costs

- When spend money, incur explicit cost - When firm experiences non-monetary opportunity cost, incurs implicit cost, eg: depreciation of equipment, forgone salary - Eco depreciation is difference between what paid for it at beginning of the year and what can sell for at end of year - Rules of accounting generally require only explicit costs be recognised for financial records and taxes - Economic costs include both explicit and implicit

The effects of shifts in supply on equilibrium

- When supply curve shifts to right (increase in supply), there will be a surplus at og equilibrium price, P1. - Surplus is eliminated as equilibrium price falls to P2 and equilibrium quantity rises from Q1 to Q2 - If some existing firms decide to exit market, supply curve will shift to left, causing equilibrium price to rise and equilibrium quantity to fall

Determinants of price elasticity of supply

- Whether supply is elastic or inelastic depends on ability and willingness of firms to alter quantity they produce as prices increase - Major determinant of price elasticity of supply is amount by which production costs rise as output levels rise. o If costs increase significantly as greater quantity is produced, firms will want greater increases in prices in order to induce them to increase quantity supplied. This an inelastic supply response. o If extra output can be produced for relatively small increases in production costs, firms only require small increases in price to induce them to supply greater quantity. Therefore, elastic supply response. - Many of determinants are interrelated - Passage of time o Firms often have difficulty increasing quantity of product they supply during short period of time o Eg: pizza place can't produce more pizzas on given night than possible using ingredients on hand o But in longer term, place can hire more people, get more equipment and resources o Supply curve for most products tend to be relatively inelastic if measure it over a short period of time - Type of industry: o Characteristics of some industries enable them to change quantity supplied quite quickly, while for other industries, not possible o Eg: quantity of agricultural products that can be supplied cannot be changed quickly as crops take time to grow, whereas manufacturing industries able to increase quantity supplied relatively quickly by operating machinery longer - Availability of inputs o Some g and s require resources that are themselves in fixed supply, eg; French winery may rely on particular grape. If all land already taken, supply of that wine will be price inelastic in short term and over a long period. o Some producers able to divert resources from production of one product into production of another, enabling more elastic supply response. o If new workers hired or existing workers learn new skills, supply may be relatively price elastic. o In some industries, takes many years to train workers, eg: doctors, and skilled migration can take years. Supply in these industries therefore price inelastic, particularly over short to medium term. o If skilled labour shortages exist or important raw materials become increasingly scarce, firms faced with steeply rising input and production costs as they attempt to increase output levels. This will reduce willingness and/or ability to increase quantity supplied even if output prices rise. o More inputs available, more elastic supply is - Existing capacity: o If firm has excess production capacity (machines could be operated for longer period) then quantity supplied able to be changed quickly, and supply therefore price elastic o Eg: car manufacturers commonly increase or decrease number of hours their production line machinery operates for, according to increases or decreases in consumer demand o Eg; mining company operating at full capacity not able to increase supply for many years, as this involve exploration, acquiring legal permits, raising finance o More capacity available, more elastic supply is - Inventories held o Holding inventories costly, as involves storage premises and keeping stock that currently not generating revenue. o Some firms/industries able to hold inventories in reserve but others cannot o Eg: Supermarkets hold stocks in warehouses enabling them refill shelves quickly if sales suddenly increase. But if demand for perishable items, eg: fresh lettuces, unexpectedly rose, these not products that can be kept in storage for very long, and quick supply response not likely.

Market eco

- an economy where decisions of households and firms interacting in markets allocate eco resources o Forces and demand and supply answer 3 above questions o All high-income democracies, eg: Aus, US, Japan, are mostly market eco o Rely primarily on privately owned firms to produce g & s and to decide how to produce them o Markets, not gov, determine who receives g & s produced o Firms must produce g & s consumers want, or will go out of business, so ultimately consumers who decide what g & s will be produced, ie: consumer sovereignty o Those who receive the g & s are those most willing and able to buy them o Firms compete to offer highest quality and lowest price, so all under pressure to use the lowest cost methods of production o Income of individual determined by payments received for what they have to sell o Market rewards hard work, ie: generally, the more extensive the training a person has received and the longer hours a person works, the higher their income

Centrally planned eco

- an economy where gov decides how eco resources will be allocated, ie: gov answers 3 above questions o Eg: Soviet Union, North Korea o These eco haven't been successful in producing low cost, high quality g & s, so standard of living tends to be quite low o All of them have been political dictatorships o In them, focus more on capital g and national defence. Consumers not biggest priority

Equity

- fair distribution of eco benefits between individuals and societies - Many prefer eco outcomes they consider fair/equitable, even if they less efficient, eg: equity may be increased by reducing incomes of high income people and increasing incomes of poor, but efficiency may be reduced, as people have less incentive to open new bus, supply labour, save, if gov takes sig amount of income they earn. Means fewer g & s produced and less saving occurs - Efficient outcome may or may not be considered by society as equitable - Gov may step in to restore some equity in market - Often a trade-off between efficiency and equity. The total amount of g & s produced falls, but distribution of income to buy them is made more equal

What g and s will be produced?

o Answer determined by choices consumers, firms and govs make, ie: when purchase a good over a different one o When analysing decision to choose between alternative options, economists use opportunity cost (the highest valued alternative that must be given up engaging in an activity)

Perfectly elastic demand

o Demand curve is horizontal line o Quantity demanded would be infinitely responsive to price changes and price elasticity of demand equals infinity. o Increase in price causes quantity demanded to fall to zero o Markets with perfectly elastic demand curves are rare

Perfectly inelastic demand

o Demand curve is vertical line o Quantity demanded is completely unresponsive to price changes. However much price increase or decrease, quantity remains same o Price elasticity of demand equals 0 o Only very few products have this. Eg: drug insulin, as if price decrease, not affect required dose people need to take, so won't affect quantity demanded. Price increase not affect required dose

Who will receive the g or s

o Depends largely on how income is distributed, as those with highest have ability to buy more o In Aus, gov intervenes to make distribution of income more equal, ie: people with higher incomes pay higher taxes, and gov makes payments to people with low incomes

Eco idea: people are rational

o Economists assume people are rational, act logically o Assume consumers/firms use as much of available info as they can to achieve their goals o Rational individuals weigh the benefits and costs of each action and choose an action only if benefits outweigh the costs

Eco idea: Optimal decisions are made at the margin

o Economists reason that optimal decision is to continue any activity up to the point where marginal benefit equals marginal costs, ie: where MB = MC o Marginal analysis: individual/firm/gov/etc analyse/compare marginal benefits and marginal costs

Eco idea: people respond to eco incentives

o Eg: if medicines were free, then little incentive to use them wisely o All other things remaining constant, consumers buy less of g if price increases while suppliers supply more o Eco incentives are 'signals' that guide the market

How will the g and s be produced?

o Firms choose o In many cases, firms face a trade-off between using more workers or machines

Protection of private property

o For market system to work well, individuals must be willing to take risks, eg: invest in a bus o In high income, market-based countries, someone starting a bus or investing usually doesn't have to worry that gov/military/criminal gangs might seize the bus or demand payments in return for not destroying bus § In many poor countries, owners of bus not well protected from having bus seized by gov or profits/assets taken by criminals. So, operating bus extremely risky o Property rights: rights individuals/firms have to exclusive use of their property, including right to buy or sell it o Property can be tangible, physical property or intangible o Guarantees exists in every high-income country, but in many developing countries, guarantees don't exist or are poorly enforced o Production will fail if property rights not well enforced, move inside PPF o Property rights forms basis of all market exchange o In modern eco, intellectual property rights very important § To protect intellectual prop, gov grant a patent that gives inventor the exclusive right to produce and sell a new product for a period of years from date product invented § Govs grant patents to encourage firms to spend on research and development necessary to create new products. § If other companies could freely copy, no incentive o If prop rights not well enforced, production of g & s will be reduced, which reduces eco efficiency, leaving eco inside its PPF

Inefficiency can arise because of

o May take time to achieve efficient outcome, eg: when Blu-Ray players were intro, productive efficiency not achieved instantly, took several years for firms to discover lowest cost method of producing it o Gov sometimes reduce efficiency by interfering with voluntary exchange in markets, eg: gov may limit the import of some g & s from foreign countries which reduces efficiency by keeping g & s from being produced at the lowest cost

Enforcement of contracts and prop rights

o Much bus activity involves someone agreeing to carry out action in future. Usually these arrangements take form of legal contracts o For market system to work, bus and individuals have to rely on contracts being carried out o If one party doesn't fulfil obligations, other can go to court to have agreement enforced o Court system has to be independent and judge make impartial decision on basis of law o In Aus and other high income eco, court system have enough independence from other parts of gov and enough protection from intimidation o In many developing countries, court system lack independence and may not provide a remedy if gov violates property rights or if contract violated

Productive efficiency

o Occurs when a g & s is produced using least amount of resources or at lowest possible cost o Achieved when competition between firms in market forces them to produce g & s using least amount of resources and thus at lowest cost

Dynamic efficiency

o Occurs when new tech and innovation are adopted over time o Firms seek to adapt their product and use new tech to secure their share of sales in the market

Allocative efficiency

o Occurs when production reflects consumer preferences and resources are allocated throughout the eco to produce what consumers demand o Achieved when competition between firms and voluntary exchange between firms and consumers results in firms producing the mix of g & s that consumers prefer most. o Every g or s produced up to point where last unit provides a marginal benefit to consumers equal to marginal cost of producing it, ie: MB = MC