WEEK 2

- Micro = businesses, households, governments making decisions (vs. macro = large scale)
o (first 3 chapters are the same-ish) → foundations, trade-offs/comp adv./market, demand & supply
- Remember: GDP = total market value of all final goods and services within a country
- Use study plan on Pearson – also, read chapter (or at least summary) before class
- Example graphs for economics: PPF, linear, pie, step, etc. → graphs and models tell a story!

Chapter 1: Economic Foundations

Definitions
Micro = individual parts of the economy – how households & firms make decisions, interact in specific markets
Macro = economy as a whole – economy-wide phenomena, inflation, unemployment, economic growth
Scarcity (limited resources)
- Exists when human wants (material & non-material) exceed available resources
- Limited resources (land, labour, capital) & time (less time = more valuable)
- Allocation of income and time reveals preferences for a good
Opportunity cost (alternatives)
- What is given up to get something – value of the best forgone alternative that was not chosen
- Different people have different values
Choices (behaviour)
- Vary between individuals, in time and space
- Governments can compensate where markets conflict
- People make choices due to scarcity – at the margin (people are rational)
- About allocation → first come-first served, rationing, social acceptance, random lottery, favouritism, high bidder
Prices
- Generally an indication of value, subjective and negotiable
- Markets put prices on opportunity costs
Value
- Also subjective and personal
- Prices play a role in separating those who put a high value on a good from those who put a low value on it
- Economists comment on what individuals/societies value – very little about what should be valued
- Let the market decide what should be valued and try to explain how that value is derived

What do they mean together → Marginal thinking, value

↪ Scarcity reveals value → the more scarce a good, the higher the value
↪ Marginal thinking focuses on the additional/marginal choices → effects of adding or subtracting from current
↪ All decisions are made on the margin → in econ, the price of something is its marginal value rather than total value
↪ If the value of something depends on whether you have a lot or a little (scarcity), you’re thinking at the margin!
↪ Paradox of value: the more abundant a good is, the less marginal value it has but the more total value it has overall

Key Principles of Economics

- Economics is the study of how society manages its scarce resources
- The management of society’s resources is important because resources are scarce
- Scarcity means that society has limited resources and cannot produce all G&S people wish to have

Two economic questions

1. How to choices end up determining what, how, for whom goods and services get produced
2. When do choices made in the pursuit of self-interest also promote the social interest

Types of economies
- Command (state ownership, central authority, communism)
- Capitalist (private ownership of FOP)
- Mixed
 Chapter 2: Scarcity, PPC, Circular Flow
Think like an economist:
- Think in terms of alternatives
- Evaluate the cost of individual and social choices
- Examine to understand how certain events and issues are related
- Distinguish between causation and correlation
- Think analytically and objectively
- Use the scientific method (recognize the limits the scientific method has in social sciences)
o Use of models in explaining complex issues, discerning cause or correlation
 Purpose/question → research → hypothesis → experiment → analysis → conclusion
o Use independent variable, dependent variable, and a control
 In econ, independent variable is on y-axis (P) , dependent variable is on x-axis (Q)
SUPPLY AND DEMAND MODEL:
OIL
- Assumptions can make questions easier to understand,
make them to control for multiple variables (ceteris
Price

paribus)
- Making assumptions is not precise; wrong assumptions
can lead to wrong conclusions (or right for wrong
reasons)
Quantity - Different assumptions allow us to test different theories
Supply1 Demand
Supply 2 (shifted left)

CIRCULAR FLOW DIAGRAM (free market):

- Describes the reciprocal circulation of income
(money / Y / GDP) between consumers and
producers for payment of goods and services
- A “tidy” illustration of how an economy works
- Firms supply g&s in consumer market, demand
FOP in factor market
- Households demand g&s in consumer market,
supply FOP in factor market
- FOP = land, labour, capital, entrepreneurs
- See macro notes for more detailed version!

PRODUCTION POSSIBILITIES FRONTIER (also PPC):

X-axis = gas cars | Y-axis = electric cars
- Shows the combinations of output that the economy can possibly
produce given the available FOP and production technology
- Also illustrates efficiency, tradeoff, opportunity cost, economic
growth
- Expanding the PPF = economic growth
o ↪ micro level: increases firm’s production
o ↪ macro level: increases standard of living
A=inefficient. B,C,D=efficient. X=beyond frontier → growth!

Factors that contribute to economic growth:

- Technology (new/better ways of production)
- Capital (human, financial, physical)
 * for every decision there is a trade-off
- choice is to invest now for future growth → costs present consumption
:. Economic growth is not free!
Three fundamental questions that inevitably must be faced/answered in a world of scarcity are:
1. What is to be produced
2. How are these goods produced
3. For whom are the goods produced

Specialization, Division of Labour, Trade

Specialization: concentrating energies on only one or a few activities (marginal benefit)
- Allows making the best use of limited resources, gaining most benefit from limited resources
Comparative Advantage: able to produce a g/s at lower opportunity cost than others
↪ see macro notes for ‘gains of trade’ diagram/table! (apples & cherries, also nachos & video games)
By specializing based on comparative advantage, can trade to make up for tradeoff→increases wealth
Advantages of specialization:
- Higher skill development based on repetition
- More productive time (no set-up/clean-up between tasks or jobs)
- Higher quality of tasks/job
- More employee job satisfaction and suitability

Economists as policy advisors:

- Scientists when trying to explain the world
- Policy advisors when trying to change the world
- When doing both, how well they offer ideas for change depends on how well they can explain what’s happening

↪ Positive statements attempt to describe the world as it is (descriptive analysis)

↪ Normative statements are about how the world should be (prescriptive analysis) → policy advisor!

Why economists disagree:

- Fundamental theories of economics (keynesian v neoconservative)
- Difference of values (liberal v conservative views)
- Validity of assumptions
- Differences of strategy, tactics, time and circumstances

Chapter 3: Supply, Demand, & Equilibrium

note - AXES ARE REVERSED

should be P but isn't

8 8
6 Supply and Demand (see supply & demand model from week 3)
6
4 4 Law of Demand: inverse relationship between price and quantity
2 2 demanded (ceteris paribus)
0 0 Law of Supply: positive relationship between price and quantity
12 13 14 15 16 17 18 supplied (ceteris paribus)
should be Q but isn't - Modern microeconomics is about supply, demand, and
S D
market equilibrium!
- Market = group of buyers and sellers of a particular good or
service, supply/demand refers to interactions
- Buyers determine demand, producers determine supply
- In a competitive market, we are all price takers – each buyer/seller has negligible impact on price
Demand = want + ability to purchase
Demand Schedule & Curve
Shifts in the Demand Curve (change other than price)
1. Consumer income → normal goods vs. inferior goods (opposite effects)
2. Prices of related goods → substitutes & complements (how do the goods interact with/affect each other)
3. Tastes
4. Expectations → beliefs about the future will affect purchases today
5. Number of buyers / demographics
***A change in price is a movement along the demand curve!***

Supply
Supply Schedule & Curve

Shifts in the Supply Curve (change other than price)

1. Input prices
2. Prices of substitutes in production
3. Technology
4. Expectations
5. Number of sellers

Equilibrium
Law of supply & demand
- Price of any good adjusts to bring quantity supplied and quantity demanded for that good into balance
- The balance point = equilibrium (quantity supplied = quantity demanded) → Eprice and Equantity on graph
Surplus
- When price > Eprice then quantity
supplied > quantity demanded
Shortage
- When price < Eprice then quantity
supplied < quantity demanded

4-step process to analyzing changes in equilibrium

1. Demand or supply issue
 2. Price or non-price (movement along or shift of the curve)
3. Increasing or decreasing (movement right or left)
4. How much = critical! Will determine E, P, Q changes if both D&S are shifting

Chapter 3 continued
↪ note: tech change can shift supply curve left (ex. issues implementing)
↪ Remember that how much each curve shifts will determine the change in E, P, Q (when D&S both shift)
↪ ensure you can tell a story for each graph (9 different market possibilities graphs in slides)
↪ marketing can affect consumer taste and shift demand!

Review Class
Economies of scale - savings in costs gained by an increased level of production (larger companies gain advantage)
How people make decisions
1. People face tradeoffs
a. Efficiency = society gets
the most from scarce
resources (bigger pie)
b. Equity = benefits of
resources are distributed
fairly among members of
society (divide pie)
2. Cost of something is what you
give up to get it (opportunity
costs)
3. People are rational
4. People respond to incentives
Economic growth
- See graph →
- Econ. Growth = increasing production
possibilities
Gains of trade, specialization

Chapter 3 (extra notes b/c group summary!)

Markets and competition
- Modern economics is about supply, demand, market equilibrium
- Market = group of buyers and sellers of a particular good/service
- Supply & demand refer to the behaviour of people as they interact with one another in markets
- Buyers determine demand, producers determine supply
- We are all price takers in a competitive market
Demand
- Quantity demanded is the amount of a good that buyers are willing/able to purchase at a given price
- Law of demand = ceteris paribus, negative relationship between q and p of good
- Demand = want + ability to purchase
- Change in quantity demanded = movement along demand curve, caused by change in price
- Visualize through demand schedule, curve
Shifts in demand curve
1. Consumer income (normal goods = positive, inferior products = negative relationship)
2. Prices of related goods (substitutes vs. complements)
3. Tastes
4. Expectations
5. Number of buyers / demographics
Supply
- Quantity supplied is the amount of a good that sellers are willing and able to sell at a given price
- Law of supply = ceteris paribus, positive relationship between q and p of good
- Change in q supplied = movement along supply curve, caused by change in price
- Visualize through supply schedule, curve
NOTE: Demand and Q Demanded are not the same! Supply and Q Supplied are not the same!
Shifts in supply curve
1. Input prices
2. Prices of substitutes in production
3. Technology
4. Expectations
5. Num ber of sellers
Equilibrium
- Law of supply & demand = price adjusts to bring q supplied and q demanded into balance (for any good)
- Equilibrium = price has reached level where q supplied = q demanded
- Equilibrium Price and Equilibrium Quantity are where curves intersect
Surplus
- When price is greater than equilibrium price, Q supplied > Q demanded
- Excess supply (more than demand)
- Suppliers will lower the price to increase sales and move toward equilibrium
Shortage
- When price is less than equilibrium, Q demanded > Q supplied
- Suppliers will raise price due to too many buyers chasing too few goods
4-step process to analyzing changes in equilibrium
1. Demand or supply issue?
2. Price or non price? (shift or movement along curve?)
3. Increase or decrease (left or right?)
4. How much?!?! (especially if both are moving)
 Chapter 4: Economic Efficiency, Government Price Setting, and Taxes
What’s covered in chapter 4:
- Link between buyers’ willingness to pay & demand curve
- Define and measure consumer surplus
- Link between sellers’ cost of producing a good and supply curve
- Define and measure producer surplus
- See that equilibrium of supply and demand maximizes total surplus
Reminder from ch3: Market Surplus and Market Shortage
- When Qs>Qd, surplus
- When Qd>Qs, shortage
Questions re: market equilibrium…
- Does Eprice and Equantity maximize total welfare of buyers & sellers?
- Equilibrium reflects how markets allocate scarce resources – is it efficient?
- Whether market allocation is desirable an be addressed by welfare
economics: addressing equity
Attributes which affect your buying decisions
- Constraints: price, income
- Preferences: quality, colour, need, desire, fad, etc.
Consumer Surplus
- The difference between what the consumer pays and what they would have been willing to pay (savings)
- Measures economic welfare from buyer’s side

Producer Surplus
- The difference between what a product sells for and what a supplier would have been willing to sell for (gain)
- Measures economic welfare from the seller’s side
- Marginal cost = supply curve
o What is the additional cost per unit produced
o BxH / 2
Welfare Economics: Study of how the allocation of resources affects economic
wellbeing. Equilibrium in the market results in maximum benefit, maximum total
welfare for both consumers and producers
- Consumer surplus + producer surplus = economic surplus
Willingness to pay
- Maximum amount a buyer will pay for a good
- Measures how much the buyer values the good/service
Consumer Surplus = buyer’s willingness to pay for a good less what they actually pay
for it
Producer Surplus = amount seller is paid for a good less the consumer’s cost (closely related to profit)
Market Efficiency
NOTE: as price rises, consumer
surplus is reduced, and producer
surplus is increased

Efficiency
- The property of a resource
allocation of maximizing the
total surplus received by all
members of society

Equity
- The fairness of the
distribution of well-being
among the various buyers
and sellers

Is the competitive market efficient?

Underproduction
- If too little of an item is produced (inefficient → shortage)
- Not operating at limit of PPF, economy can be diverting more resources if demand warrants
Overproduction
- If too much labour or capital is being used to produce goods that aren’t being sold (inefficient → surplus)

Tue Oct 1 | Chapter 4 Continued

Marginal Cost = Supply Curve, Marginal Benefit = Demand Curve
- When marginal supply = marginal benefit, supply = demand, p = q → EQUILIBRIUM! & economic efficiency
Deadweight Loss: reduction in economic surplus resulting
from a market not being in competitive Equilibrium
At Equilibrium:
- consumer surplus = A + B + C
- producer surplus = D + E
- deadweight loss = none

At higher price / quantity surplus:

- consumer surplus = A
- producer surplus = B + D
- deadweight loss = C + E

Price Floors
Minimum wage → if above market wage, will create deadweight
loss
- shifts consumer surplus to producer
Price Ceilings
Rent control → can create shortage, which is also deadweight
loss
- shifts producer surplus to consumer
Black Market
Market in which buying and selling take place at prices that violate
government price regulations **SOVED PROBLEM 4.3**
Government imposed price floors or price ceilings: some people win, some people lose, loss of economic efficiency
Effect of Taxes on Economic Efficiency → mostly the consumer is burdened by tax (see example fig4.10)

TEST 1 REVIEW

TAXES:
- when tax is implemented, there is a reduction in supply
- price increases → mostly the consumer is burdened by tax

Things to study:
- Chapter 4 (econ efficiency, govt price setting, taxes)
o Solved Problem 4.3 (taxes)
o Taxes
o Price floors & ceilings
o Black market
o Consumer surplus, producer surplus (add them together = economic surplus)
o Marginal benefit = demand curve, marginal cost = supply curve → equilibrium = when mb = mc
o Economic efficiency vs equity
- Chapter 3 (supply, demand, equilibrium)
o What shifts supply & demand curves
- Chapter 2 (trade offs, comparative advantage, market system)
o Difference between absolute & comparative advantage
- Chapter 1 (economic foundations and models)
 Chapter 5: Externalities, Public Goods
~~Reminder: “ceteris paribus” = all else equal
~~from chapter 4: competitive market achieves economic efficiency by
maximizing the sum of consumer and producer surplus – that only
holds if there are no externalities in production or consumption
What’s covered in chapter 5:
- How individual decisions affect and impact others, compare
effects from positive and negative standpoints
- Examine solutions which impose costs to societies by
individual decisions
- What do governments do to incent individual behaviours to
behave in the best interests of society
- How and why society views some goods and services uniquely
beneficial to the public, why privatization doesn’t necessarily
ensure efficiency
Fallacies of individualism:
- What I do doesn’t affect you, why should you care? (ex: smoking)
- If everyone concentrated on doing their best, all society would benefit & we wouldn’t need gov’t intervention
- There is no need for governments to be involved in regulating aspects of our lives – the less the better
Externalities:
- Uncompensated benefits or costs to those who are bystanders (not directly involved)
- Interfere with economic efficiency of market equilibrium, causes some amount of total economic surplus
(inefficiency, sum of consumer surplus and producer surplus)
(negative)
- Added together, they are total economic welfare (economic surplus)
- When the effect on the bystander is adverse = negative externality (think
Fleming riots, secondhand smoke…)
- When the effect is beneficial = positive externality (think vaccinations,
subsidies, neighbour’s garden…)
Private and social costs (negative):
- Externality causes difference between the private cost and the social cost
of production
- When there is a negative externality in producing a good or service, too
much of the good or service will be produced at market equilibrium (so it
moves to efficient equilibrium, resulting in deadweight loss)
Private and social benefits (positive): (positive)
- Externality causes difference between the private benefit and the social
benefit from consumption
- When there is a positive externality in consuming a good or service, too
little of the good or service will be produced at market equilibrium
Market failure:
- Market failure and externalities result from incomplete property rights (or
difficulty enforcing property rights in certain situations)
- Property rights = exclusive right of their property, to buy/sell, use/not use
- Market failure is a situation where the market fails to produce the
efficient level of output
Coase Theorem (private bargaining):
- Explains how private bargaining can lead to econ efficiency in market w/externality
- Under some circumstances, private solutions to the problem of externalities will occur
- Completely eliminating an externality usually is not economically efficient or reasonable (econ. perspective)
o Ex: eliminating the last amount of pollution takes substantial resources away from other productive
uses, which causes other costs to society… so the question is “how much” is best
o Remember: economic efficiency occurs when marginal benefit = marginal cost (graph from class)
- What would happen if utility companies were held legally liable for pollution illnesses? ERIN BROCKOVICH!
Government policies to deal with externalities:
- Negative externality → tax on producer
- Positive externality → subsidies for consumer
4 categories of goods:
- Rival = when one person consumes a unit of a good, no one else can consume
- Excludable = can only consume a good if you pay for it
- Rival, excludable: private
- Rival, nonexcludable: common (can have tragedy)
- Nonrival, excludable: quasi-public
- Nonrival, nonexcludable: public (freeriding)

Ch 6: Elasticities
What’s covered in ch 6:
- Meaning of the elasticity of demand, what determines the elasticity of demand
- Meaning of elasticity of supply, what determines elasticity of supply
- Apply concept of elasticity in two very different markets
To write down…
- “%age change in” (price vs quantity demanded)
- Unitary elastic = 1:1 relationship between price & Q, straight line, axes have same units, slope=-1
- Elasticity quotient
Why lower prices?
- You want to sell more and generate a profit
o So long as the seller believes lower prices will result in greater number of sales that will offset the loss of
lowering the price
- Elastic = responsiveness, sensitivity
Elasticity
- Allows us to analyze supply and demand with greater precision
- Is a measure of how much buyers and sellers respond to changes in market conditions
Elasticity of demand
- Measure of how much the quantity demanded of a good responds to a change in the price of that good
- Percentage change in quantity demanded given a percent change in the price
Determinants:
o Availability of close substitutes
 More substitutes = more elastic
o Time horizon (time passed since price change)
 Elasticity of demand tends to be greater the longer the time period involved
o Necessities vs luxuries
 Larger % of indiv. Income spent on a commodity = more elastic/responsive demand
o Definition of the market
 More narrowly defined market = more elastic demand
o Percent of consumers budget
 (similar to luxuries vs necessities)
- In summary, demand tends to be more elastic:
o The larger the number of close substitutes
o The longer the time period
o If the good is a luxury
o Share of the consumer’s income
o The more narrowly defined the market
percentage change∈quantity demanded
- price elasticity of demand= (elasticity quotient/coefficient)
percentage change ∈price
o Quotient > 1 = elastic, <1 = inelastic
 (Q 2−Q 1)/¿
price elasticity of demand =
- P 2+ P 1 (midpoint method)
(P 2−P 1)/[ ]
2
o Aka delta Qd / avg Qd x 100 ÷delta P / avgP x 100
Interpretation of price elasticity of demand
o Elasticity coefficient
 Measures the responsiveness of Qd to a change in price
o Price and quantity move in opposite directions so will always be a negative number
- Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10
to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:
( 10+8 }
(10−8) /[ ]
2 2/9 0.2222
o = = = 2.33 = large quantity changes relative to price change =
2.20+2 .2/2.10 0.0952
(2.20−2)/[ ]
2
elastic!
- Variety of demand curves (closely related to the slope of the demand curve)
o Inelastic (I) = Qd does not respond strongly, <1
o Elastic (E) = Qd responds strongly to changes in price, >1
Examples:
Price Q sold
Set 1 $1.50 200
$2.00 100
ANSWER (200-100)÷[(200+100)÷2]/(1.5-2) ÷[(2+1.5) ÷2]
= 100 ÷150 / -.5 ÷ 1.75
= 0.6667 / - 0.2857
= - 2.3336
Set 2 $120 1600
$100 1800
ANSWER .65
Set 3 $18.50 48
$22.50 40
ANSWER .93

o Perfectly Inelastic = Qd does not respond to price change

o Perfectly Elastic = Qd changes infinitely with any change
in price
o Unitary elastic = Qd changes by same percentage as
price
Total revenue and the price elasticity of demand
o Total revenue = amount paid by buyers, received by
sellers of a good
 TR = P x Q
o If demand is elastic, price and total revenue move in
opposite directions
o If demand is inelastic, price increases = revenue increases
(and viceversa)
- Elasticity and slope are different yet related! Any demand curve
has elastic (upper) and inelastic (lower) portions
Other (demand) elasticities
Cross price elasticity
o As price increases on one product, how does demand for another (related) product?
 % change∈Qd of one good
o cross price elasticity of demand= (positive=subst., negative = compl.)
% change∈ price of other
Income elasticity
o What is the percentage change in demand when income changes by a certain percentage?
% change ∈Qd of your good
o income elasticity of demand= (0<e<1 = normal, <0=inferior,
% change ∈income
>1=normal)
Elasticity of supply
- Price elasticity of supply is the responsiveness of the quantity supplied to a change in price
- Supply of inputs of production are relatively fixed in the short term, the supply curve for most products is
inelastic → if we measure over longer periods, it will be more elastic
% change ∈Qs of a good
- elasticity of supply=
% change ∈ price
Variety of supply curves
- Perfectly inelastic = Qs does not respond to price changes
- Perfectly elastic = Qs changes infinitely with any change in price
- Unitary elastic = Qs changes by same percentage as the price
Summary
- Price elasticity of demand and supply measures how much the quantity responds to changes in price
- Calculated as the percentage change in quantity divided by the percentage change in price (midpoint)
- If a curve is elastic, TR falls when price rises
- If it is inelastic, TR rises as the price rises

Elasticity practice – supply and demand (Clifford on youtube)

4 types of elasticity: demand, supply, income, cross-price
Assume the price of apples increases from $20 to $25 and the quantity demanded falls from 10 tons to 5 tons.
1. Use the total revenue test to determine if the demand is relatively elastic or relatively inelastic
 $20 x 10 tons = $200 revenue
 $25 x 5 tons = $125 revenue
 Qd decreases by 50%, price increases by 25%
 Therefore, relatively elastic
 IF Qd only decreased to 9, 9x$25
2. Calculate the elasticity of demand coefficient
 Price: (25-20)/20=0.25
 Qd: (5-10)/10=-0.50
 -.50/.25=|-2|
 2>1, therefore demand is elastic
3. Calculate the elasticity of supply if the change in price caused quantity supplied to increase from 10 to 25 tons
 Qs: (25-10)/10=1.5
 Price: (25-20)/20=0.25
 1.5/0.25=|6|
 6>1, therefore supply is elastic
4. Explain why the total revenue test cannot be used to determine elasticity of supply:
 Quantity supplied =/= quantity sold, so that’s not total revenue
5. Assume the increase in the price of apples decreased the quantity demanded of vanilla ice cream – are these
complements or substitutes?
 Complements → negative correlation (less apples = less ice cream)
6. Assume the increase in the price of apples increased the quantity demanded of peaches from 20tons to 30 tons.
Calculate the cross-price elasticity of demand
 Qd: (30-20)/20=0.5
 Price: 0.25
 0.5/0.25=2
  2>1, therefore it is elastic (and products are substitutes because it is positive)
7. Assume instead that a 10% increase in income caused the quantity demanded of apples to decrease from 10 to
8 tons. Calculate income elasticity of demand
 Qd: (8-10)/10=-.2
 -.2/.1 = -2
 -2<0, therefore elastic and inferior good