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ECONOMICS

Economics is the study of how scarce resources are or should be used

Microeconomics is concerned with the individual component parts of the economy. It is the study of the behavior of firms and consumers and the determination of market prices and quantities. It is the study of how scarce resources are allocated between alternative uses.

EXAMPLE –

Microeconomics would analyze how a small business could better allocate their resources and other factors of production to maximize profits.

Macroeconomics is the study of aggregates (totals) of economic activity. It looks at how economies work and have as a whole, and is concerned with such factors as the overall price level and the rate of inflation, the level of employment and unemployment, the rate of growth of the total output of the economy, aggregate demand and supply and the balance of payments.

EXAMPLE –

Macroeconomics would analyze larger scale, world issues such as the recent world economic crisis is affecting countries all around the world.

NORMATIVE AND POSITIVE

Normative Economics are statements based on value judgments.

EXAMPLE –

The government should lower taxes on land.

Positive Economics are factual statements about the economy.

EXAMPLE –

In 2009, there was a 6.2% drop in GDP in the US, the worst since 1982.

SCARCITY

The inability to provide sufficient goods and services to satisfy the world’s unlimited wants because of a lack of resources.

Needs and wants are unlimited, however, resources are limited and when needs and wants cannot be provided for with the existing resources, it is considered scarce.

EXAMPLE –

Due to environmental issues relating to the pollution of water and population growth, clean water is considered scarce in many underdeveloped countries.

CHOICES AND UTILITY

In making choices we aim to maximize our utility, our perceived satisfaction from consuming a good or service.

MARGINAL UTILITYOur perceived satisfaction from consuming one additional good or service.

EXAMPLE –

To maximize our utility, someone may choose to sky dive over reading a newspaper as it is something new and exciting which maximizes utility.

If skydiving is chosen once again, its marginal utility may be lower as its original quality of being “new and exciting” is inapplicable the second time.

OPPORTUNITY COST

Opportunity cost is the value of the next best alternative forgone as the result of making a decision.

EXAMPLE –

When I have the choice to study for a chemistry test or a physics test, by choosing to study for the chemistry test, the opportunity cost for this situation is studying for the physics test. By choosing the chemistry test, it cost me the opportunity to study for the physics test.

FACTORS OF PRODUCTION

The four factors of production are land, labor, capital, and enterprise.

Land refers to all natural resources (minerals and other raw materials).

Labor refers to all human resources.

Capital refers to all man made machinery and equipment.

Enterprise is the skill of taking a risk to provide goods and services and make profits.

FREE AND ECONOMIC GOODS

Free Goods are gifts of nature supplied without labor and without limit.

EXAMPLE –

Sunlight is a free good that nature supplies.

Economic Goods are scarce and their production involves opportunity costs.

EXAMPLE –

Fossil fuels are scarce and their production involves opportunity costs. Companies could instead mine for other natural resources in the earth.

MARKET

A market is any situation or place that enables the buying and selling of goods and services and factors of production. A market may be a physical location (a street market), it may also be a virtual one (internet buying and selling) or a national one (the market for teachers or doctors).

Markets exist when buyers and sellers interact. This interaction determines market prices and thereby allocates scarce goods and services.

EXAMPLE –

Many brand name stores, such as American Eagle, Abercrombie and Fitch, and Hollister, have online websites where buyers go to make purchases online. This is an example of a virtual market. These brands also have physical stores where buyers can travel to make purchases.

DEMAND

Demand is the willingness and ability to buy at a certain product at a certain price at a certain time period.

The Law of Demand states that as price rises (for a good or service) the quantity demanded falls, and as price falls (for a good or service) the quantity demanded rises.

EXAMPLE –

During Christmas season, many stores like Macy’s, Walmart, JC Penny, have huge sales, significantly lowering prices on good, which in turn increases the quantity demand. Because the prices are lowered, more people are able to make a purchase.

VEBLEN GOODS

A Veblen good is a good that has an upward-sloping demand curve. People buy more of the good because it is more expensive and therefore demand is higher when the price is higher.

EXAMPLE –

Starbucks is a well known coffee shop and in China, there are people who choose to spend the little money they have on coffee from Starbucks as this purchase of a high priced, luxury drink gives people the feeling of superiority. Simply the fact that a good is a luxury good is a reason for people to purchase the good.

GIFFEN GOODS

A Giffen good is a good for which an increase in price results in an increase in demand for the good.

EXAMPLE –

In many Western nations, bread, which comes from the production of flour, is considered a staple food. If the price for this product rises, people will sacrifice their other spendings so they can continue to buy bread even at higher prices.

SUPPLY

Supply is the willingness and ability of a producer to produce a quantity of a good or service at a certain price over a given time period.

The Law of Supply states that as the price of a good rises, the quantity supplied increases, and as the price of a good falls, the quantity supplied decreases.

EXAMPLE –

If Adidas shoes grow in popularity, Adidas may choose to raise the price for their products to increase supply and decrease demand in order to reach an equilibrium where there is no surplus or shortage of Adidas products.

EQUILIBRIUM PRICE

Equilibrium Price is the market clearing price that occurs when demand and supply are equal.

EXAMPLE –

If there is a demand for 10 Nike shoes, and Nike supplies 10 shoes, Nike is at the equilibrium where the demand (10 Nike shoes) is equal to the supply (10 Nike shoes).

SPECIFIC TAX & AD-VARLOREM

A specific tax is a fixed amount of tax charged on each unit. A specific tax will shift the supply curve vertically upwards by the amount of the tax.

EXAMPLE –

For all cigarettes, the government charged 500 yen tax for each package. No matter what brand or price, the tax was consistently at 500 yen.

Ad-varlorem tax is a tax that is levied as a percentage of the selling price.

EXAMPLE –

At the 100-yen store, Daiso, the sales tax on all the products is 5%. No matter what the product, the tax was always 5%.

SUBSIDY

Subsidy is a payment made to firms or consumers designed to encourage an increase in output.

EXAMPLE –

The Japanese government gave subsides to families who gave birth to three or more children to help encourage the Japanese population to give birth to children.

MAXIMUM PRICE

The maximum price is a price set by the government, above which the market price is not allowed to rise. It may be set to protect consumers from high prices, and it may be used in markets for essential goods.

EXAMPLE –

Though the production of oil may be low this year, because the maximum price for oil is set at $5 per gallon, the price did not exceed $5 per gallon.

MINIMUM PRICE

The minimum price is a price set by the government, below which the market price is not allowed to fall. It may be used to protect producers producing essential products from facing prices that are felt to be too low.

EXAMPLE –

The minimum price of oil was set at $4 per gallon and although people did not want to pay, because the minimum price was set, they had no choice but to pay. This benefits the oil companies.

SHORTAGE

Shortage is a disparity between the amount demanded for a product or service and the amount supplied in a market causing not enough to be produced to satisfy demand.

EXAMPLE –

If the consumers tastes changes in favor of beef over chicken, the demand curve for beef with shift to the right, which increases the demand for beef at that price. With this surge in demand, there is not enough supply to satisfy the demand, which causes a shortage of beef.

SURPLUS

Surplus is a disparity between the amount supplied for a product or service and the amount demanded in a market creating excess or extra.

EXAMPLE –

Silly Bandz is a product that was very popular among teens. The company expected this trend to continue and decided to continue production, which lead to having a surplus of Silly Bandz as the consumers tastes changed.

ELASTIC AND INELASTIC DEMAND

Elastic Demand refers to a demand where a change in the price of a good or service will cause a proportionately larger change in quantity demanded.

EXAMPLE –

If the price of pepsi rises, consumers will stop purchasing pepsi as there are many substitutes that can be bought instead at lower prices.

Inelastic Demand refers to a demand where a change in the price of a good or service will cause a proportionately smaller change in quantity demanded.

EXAMPLE –

Salt has an inelastic demand curve as it is a product that is typically bought maybe once or twice a year. Even if the price of salt rises, because it is only bought once or twice a year, people will still buy salt.

PRICE ELASTICITY OF DEMAND (PED)

Price Elasticity of Demand (PED) is the measure of the responsiveness of the quantity demanded of a good or service to a change in its price.

EXAMPLE –

Because the demand for Apple products is inelastic, even if the price changes, the quantity demanded will not change significantly.

CROSS ELASTICITY OF DEMAND (XED)

Cross Elasticity of Demand (XED) is the measure of the responsiveness of the demand for a good or service to a change in the price of a related good.

EXAMPLE –

If the price of Pepsi rises, the demand for Coke will rise as Coke is a very close substitute for Pepsi.

COMPLEMENTS & SUBSTITUTES

Complements are goods which are typically used together rather than individually. They have a negative XED.

EXAMPLE –

If the price of crackers increased, the demand for cheese may decrease as cheese and crackers are commonly eaten together. They are therefore complements.

Substitutes are goods that can be used in place of another. They have positive XED.

EXAMPLE –

If the price for salmon increased, consumers may purchase herring instead as they are both similar products that provide similar health benefits.

INCOME ELASTICITY OF DEMAND (YED)

Income Elasticity of Demand (YED) is the measure of responsiveness of demand for a good to a change in income.

EXAMPLE –

If a worker receives a raise, he may go out and buy himself a new laptop as he is able to afford one now. This change in income has caused this worker to make a more expensive purchase.

NORMAL GOOD & INFERIOR GOOD

Normal Goods are goods that include both essential and luxury goods. With an increase in income, demand for normal goods increases. Normal goods have a positive YED.

EXAMPLE –

An example of a normal good would be a Louis Vuitton purse or milk from a grocery store.

Inferior Goods are goods that are of lesser quality and price that are available at higher prices and improved quality. Inferior Goods have a negative YED as and increase in income will decrease demand.

EXAMPLE –

A student who works at McDonalds, may purchase more inferior goods such as knockoff items and second hand items as they are cheaper.

PRICE ELASTICITY OF SUPPLY (PES)

Price Elasticity of Supply (PES) is the measure of the responsiveness of the quantity supplied of a good or service to a change in its price.

EXAMPLE –

If the price of rice rises, suppliers will continue to produce rice as it is a staple food. In response to the rise in price, more suppliers will want to produce rice. If the supply curve is more inelastic, the supply will be less responsive, and if the supply curve is more elastic, the supply will be more responsive to a change in price.

INDIRECT TAX & INCIDENCE OF TAX

Indirect Tax is an expenditure tax on a good or service.

EXAMPLE –

The price of rice was increased so that suppliers could pay the tax they owed the government for the rice sold.

Incidence of Tax is the amount of tax paid by the producer or the consumer. Depending on whether a product has an elastic or inelastic demand, the incidence of tax will differ.

EXAMPLE –

Luxury goods such as Cartier products have an elastic demand so that the incidence of tax would be greater for the suppliers as buyers are sensitive to price change.

FIXED COSTS

Fixed Costs are costs of production that do not change with the level of output.

EXAMPLE –

Tax paid on land when renting an area of land owned by the government.

Variable Costs are costs of production that vary with the level of output.

EXAMPLE –

With more workers working for a company, the more it costs to pay workers.

Total Cost is the total cost of producing a certain level of output. This includes both variable and fixed costs.

EXAMPLE –

Tax for land, labor costs, transportation costs, supply cost all go into the total cost.

AVERAGE COST

Average Cost is the average cost of production per unit that can be calculated by dividing the total cost by the quantity demanded.

EXAMPLE –

A company determined the average cost of their product by dividing their quantity demanded of 30 products by their total cost of $12.

Marginal Cost is the additional cost of producing an additional unit of output.

EXAMPLE –

By determining the marginal cost, companies can evaluate whether or not additional units of output is beneficial in maximizing profits or other purposes of production.

SHORT RUN & LONG RUN

The Short Run is the period of time in which at least one factor of production is fixed.

EXAMPLE –

A company decides to increase production to 10,000 pizzas per month, which is the fixed factor of this short run.

The Long Run is the period of time in which all factors of production are variable.

EXAMPLE –

Demand for a certain product increases, so the company changes their factors of production to increase supply.

THE LAW OF DIMINISHING RETURNS

The Law of Diminishing Returns states that as extra units of a variable factor are applied to a fixed factor, the output per unit of the variable factor will eventually diminish.

EXAMPLES –

With only one bucket, one farmer can fill it with 50 apples in 1 hour. But when more farmers are added, the bucket will fill up more, but when too many farmers are hired it will eventually become more difficult to fill with apples as work space is limited and only bucket is available. Returns begin to diminish.

ECONOMIES AND DISECONOMIES OF SCALEEconomies of Scale is any fall in long run average costs that come

about as a result of a firm increasing its scale of production or output.

EXAMPLE –

A computer company was able to buy new machinery used in the production of computers, which allowed them to decrease the number of workers and produce computers more efficiently.

Diseconomies of Scale is any increase in long run average costs that come about as a result of a firm increasing its scale of production or output.

EXAMPLE –

A company hired too many workers for the limited work space available, which decreased production efficiency.

TOTAL REVENUE (TR) & AVERAGE REVENUE (AR)

Total Revenue is the aggregate revenue gained by a firm from the sale of a particular quantity of output (equal to price times quantity sold).

EXAMPLE –

A company sold 20 hats, each costing 500 yen, in one day. 20 x 500 = 10,000 yen. 10,000 yen is the total revenue.

Average Revenue is the total revenue received divided by the number of units sold.

EXAMPLE –

This same company’s average revenue is 500 yen per hat as 10,000 yen divided by 20 hats is 500 yen.

MARGINAL REVENUE

Marginal Revenue is the revenue gained from selling an additional unit of a good or service.

EXAMPLE –

Since the price of the hats are set at 500 yen, the marginal revenue will also be 500 yen.

NORMAL AND ABNORMAL PROFIT

Normal Profit is the amount of revenue needed to cover the total costs of production, including the opportunity costs.

EXAMPLE –

If a company’s total cost is 10,000 yen and their total revenue is 10,000 yen for that day, this company has made a normal profit.

Abnormal Profit refers to any level of profit that is greater than that required to ensure that a firm will continue to supply its existing good or service. It is an amount of revenue greater than the total costs of production, including opportunity costs.

EXAMPLE –

If a company’s total cost is 10,000 yen, their total revenue is 15,000 yen, and if there are no other better opportunities that would be more beneficial with the time and money, then the company is making a abnormal profit of 5,000 yen.

PROFIT MAXIMIZING LEVEL OF OUTPUT

Profit Maximizing Level of Output is the level of output where marginal revenue is equal to marginal cost. In other words, the intersection of the marginal cost curve and the marginal revenue curve is the point of profit maximization.

EXAMPLE –

Some companies focus on maximizing profit, and in order to do so they look at a chart that graphs marginal cost and marginal revenue and uses the intersection to determine a price that maximizes profits.

SHUT DOWN PRICE & BREAK EVEN PRICE

The Shut Down Price is the price where average revenue is equal to average variable cost.

EXAMPLE –

If the company cannot cover the variable costs (where the average revenue is equal to the average variable cost), the company is at its shut down price.

Break Even Price is the price where average revenue is equal to the average total cost.

EXAMPLE –

If a company’s average revenue is at 100,000 yen and its average total cost is 100,000 yen then the company is at its break even price.

ALLOCATIVE & PRODUCTIVE EFFICIENCY

Allocative Efficiency refers to the level of output where marginal cost is equal to average revenue, or price.

Productive Efficiency refers to when production is achieved at the lowest cost per unit of output, which can be achieved at the point where average total cost is at its lowest value.

EXAMPLE –

A company would choose to refer to a chart to determine at what price to sell products to ensure productive efficiency.

PERFECT COMPETITION

Perfect Competition is a market structure where there is a very large number of samll firms, producing identical products. No individual firm is capable of affecting the market supply curve and thus cannot affect the market price. Because of this, firms are price takes. There are no barriers to enter or exit, and all the firms have perfect knowledge of the market.

EXAMPLE –

This market system is theoretical, however, there are markets in China where there are many small shops that offer identical products and buyers can easily bargain as they know that there are other shops with the same product. In order to make sales, prices may be dropped.

MONOPOLISTIC COMPETITION

A monopolistic competition is a market structure where there are many buyers and sellers producing differentiated products, with no barriers to entry or exit.

EXAMPLE –

This is a market structure where there are many large companies that have a very inelastic demand curve as the companies are monopolistic in character. Larger, more “unique” companies are more monopolistic in character lending itself to having greater control over price.