Mr. Dunn, Room 221Economics/Business/Free

Enterprise

Periods 3, HONORS

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EastWestNorth

MICROECONOMICS

MICROECONOMICS

THE STUDY OF THE INTERACTION BETWEEN INDIVIDUAL COMPONENTS OF AN ECONOMY INCLUDING

• INDIVIDUALS (RESOURCE OWNERS)• HOUSEHOLDS (CONSUMERS)• BUSINESSES (FIRMS) (PRODUCERS)• INSTITUTIONS (BANKS, LABOR,

PACS, C of C, ORGS, etc)

SIMPLE CIRCULAR FLOW

COMPONENTS OF SIMPLE CIRCULAR FLOW

SECTORSHOUSEHOLDS-RESOURCE SUPPLIERS-CONSUMERBUSINESSES-RESOURCE DEMANDERS-PRODUCER

MARKETSFACTOR—EXCHANGE RESOURCES FOR PAYMENTSPRODUCT—PAYMENTS FOR GOODS/SERVICES

DEMANDThe quantities of a good or service consumers are willing and able to buy at different possible prices at a particular time

LAW OF DEMAND

CONSUMERS ARE WILLING TO BUY MORE AT LOWER PRICES.

SHIFTING DEMAND• PRICE EFFECT/SUBSTITUTION EFFECT

=MOVEMENT ALONG THE CURVE• CHANGES IN DEMAND

PRICES OF RELATED GOODS

CHANGES IN CONSUMER INCOME

CONSUMER EXPECTATIONS

POPULATION

CONSUMER TASTES AND ADVERTISING

=SHIFT OF ENTIRE DEMAND CURVE

SHIFT RIGHT—INCREASED DEMAND

SHIFT LEFT—DECREASED DEMAND

SUPPLYThe various amounts of something producers are willing and able to sell at different possible prices at a particular time

LAW OF SUPPLY

PRODUCERS ARE WILLING TO PRODUCE MORE AT HIGHER PRICES.

SHIFTING SUPPLY

CAUSES FOR SHIFTS IN SUPPLYINPUT COSTSCHANGES IN TECHNOLOGYREGULATORY POLICYNUMBER OF SUPPLIERSPRODUCER EXPECTATIONS

ECONOMIC REALITIES

PRICE CEILINGS-SETTING A MAXIMUM PRICE-CAUSE SHORTAGES. EXAMPLES INCLUDE RENT CONTROL AND OPEN-SPACE LAWS.

PRICE FLOORS-SETTING A MINIMUM PRICE-CAUSE SURPLUSES.EXAMPLES INCLUDE MINIMUM WAGE AND FAIR TRADE PRICING.

PRICE SYSTEM•COMPETITION•COSTS OF PRODUCTION

FIXED-(RENT, MANAGEMENT, INTEREST, OBLIGATIONS)VARIABLE-(PRODUCTION-BASED, LABOR COSTS, SHIPPING COSTS)

•SUPPLYAND DEMAND• CONSUMER DRIVEN--MARKET FORCES

THE ROLE OF PRICE• INCENTIVE TO CONSUME/PRODUCE

• INFORMATION FOR BUYERS/SELLERS

• SIGNAL TO CONSUME/PRODUCE

• RATIONS GOODS AND SERVICES

• VOLUNTARY EXCHANGE

PRICE ELASTICITY• SENSITIVITY OF QUANTITY TO CHANGES IN PRICE

• ELASTICITY = % CHANGE IN QUANTITY DEMANDED % CHANGE IN PRICE

• % CHANGE= NEW NUMBER(y2) – OLD NUMBER(y1) X 100

OLD NUMBER(y1)

To ensure the same percentage whether quantities and prices increase or decrease, economists use the ARC formula as shown below:

Price elasticity of demand = (Q2-Q1)/[(Q1+Q2)/2] / (P2-P1)/[(P1+P2)/2]

IF THE QUANTITY DEMANDED OR SUPPLIED INCREASES OR DECREASES GREATLY DUE TO MINOR CHANGES IN PRICE, IT IS SAID TO BE RELATIVELY “ELASTIC” WITH THE ELASTICITY VALUE BEING > 1.

IF THE QUANTITY DEMANDED OR SUPPLIED DOES NOT INCREASE OR DECREASE SIGNIFICANTLY DUE TO MINOR CHANGES IN PRICE, IT IS SAID TO BE RELATIVELY “INELASTIC” WITH THE ELASTICITY VALUE BEING < 1.

IF THE QUANTITY DEMANDED OR SUPPLIED DOES NOT CHANGE DUE TO CHANGES IN PRICE, IT IS SAID TO BE “UNITARY ELASTIC” AND THE ELASTICITY VALUE = 1

DETERMINANTS OF ELASTICITY

AVAILABILITY OF SUBSTITUTES

NECESSITY OR LUXURY

PRICE AS PERCENTAGE OF INCOME

TIME TO COMPARE OR REACT TO PRICE CHANGES

Lowering the price on elastic goods increases total revenue.Raising prices on inelastic goods increases total revenue.

NOTE: All products are elastic in demand in the long run.

P

Q

5

7

54

5-4/[(5+4)/2)] = .22 / 7-5/[(5+7)/2] = .33 .22 / .33 = .67

.67 < 1 INELASTIC

EXAMPLE OF INELASTIC DEMAND

5

5

12

3

EXAMPLE OF RELATIVELY ELASTIC DEMAND

P

Q

12-5/[(5+12)/2] = .82 / 5-3/[(3+5)/2] = .50.82 / .50 = 1.6 1.6 > 1 ELASTIC

EXAMPLES OF ELASTICITYINELASTIC DEMAND (SALT, MEDICINE, etc) < 1

D

ELASTIC DEMAND (CARS, SODA, etc) > 1

D

UNITARY ELASTIC (PERFECTLY ELASTIC) = 1 PERFECTLY INELASTIC (SUPPLY OF TICKETS)

S

D

THE REVENUE BOX

EFFECT OF ELASTICITY OF DEMAND

7 PRICE = 7 TR = 14

3 PRICE = 3 TR =18

2 6

PROFIT: BUSINESS INCENTIVEBUSINESS INCOME IS REVENUE

BUSINESS SPENDING IS COSTS

INCOME

TR = P x Q (PRICE X QUANTITY=TOTAL REVENUE)

COSTS (EXPENDITURES)

TC = FC + VC (FIXED COSTS + VARIABLE COSTS = TOTAL COSTS)

Profit = TR – TC(PROFIT = TOTAL REVENUE – TOTAL COSTS)

BOTTOM LINE IN BLACK OR IN RED

PROFIT (+) OR LOSS (-)

BREAK-EVEN POINT MR = MC NO PROFIT/LOSS

TYPES OF BUSINESS ORGANIZATIONS

• SOLE PROPRIETORSHIP (75%/20% $)--OWNER KEEPS PROFIT/MAKES ALL DECISIONS--PERSONAL TAX RETURN/NO LEGAL PAPERWORK --UNLIMITED LIABILITY—LIMITED LIFE

• PARTNERSHIP (7%/10% $)--GENERAL—UNLIMITED LIABILITY FOR PARTNERS--LIMITED—(SILENT PARTNER(S) CONTRIBUTE(S) $)--LIMITED LIABILITY (LLP) ALL PARTNERS--SPECIALIZATION/DIVISION OF LABOR

--PROVIDES LARGER POOL OF CAPITAL • CORPORATION (18%/70% $)

-LIMITED LIABILITY/UNLIMITED LIFE AND $--DOUBLE TAXATION/CORPORATE TAX RETURN--BOARD OF DIRECTORS/LEGAL PAPERWORK

BUSINESS FINANCING

•SHORT-TERM LOANSLESS THAN ONE YEAR

•MEDIUM-TERM LOANS1-10 YEARS

•LONG-TERM LOANSMORE THAN TEN YEARS

MARKET STRUCTURE

• PERFECT COMPETITION

• MONOPOLISTIC

• OLIGOPOLY

• MONOPOLY

MARKET STRUCTURE• PERFECT COMPETITION

--”PRICE TAKERS”-(NO CONTROL OVER PRICE)--IDENTICAL PRODUCTS/MANY SELLERS--NO BARRIERS TO ENTRY

• IMPERFECT COMPETITION– MONOPOLISTIC COMPETITION --SIMILAR PRODUCTS/MANY SELLERS

--FEW IF ANY BARRIERS TO ENTRY --DIFFERENTIATED PRODUCTS– OLIGOPOLY

-- “PRICE SEARCHERS” --DIFFERENTIATED PRODUCTS/FEW SELLERS

--PRICE LEADERSHIP (A FEW FIRMS DOMINATE INDUSTRY)

– MONOPOLY --PRICE MAKER-(TOTAL CONTROL OVER PRICE) --ONLY SELLER --SIGNIFICANT BARRIERS TO ENTRY

How businesses compete in a market economy

$$ MONEY $$•MEDIUM OF EXCHANGE

•STORE OF VALUE

•UNIT OF ACCOUNT

$$ MONEY $$•PORTABLE•DURABLE•DIVISIBLE•RECOGNIZABLE•ACCEPTED AS PAYMENT•STABLE