Principles of Economics

The Basic Ideas and Principles that will guide our year

Economics

Greek word in origin, meaning “one who manages a household.”

Our definition: the study of the production, distribution and consumption of goods and services

Two major divisions in economics Microeconomics: studies how people make decisions and how

these decisions interact Macroeconomics: branch of economics concerned with the

overall ups and downs in the economy

Who’s in charge of this whole thing?

No one directly; instead, it is the MARKET ECONOMY Decisions about production and

consumption are made by individuals Used in all capitalist countries. Differs sharply from a Command

Economy (used in the former Soviet Union) where a central body controls economic decisions.

In this market economy, the “individual hand” refers to the way that individual pursuit of self-interest can lead to good results for society.

For the most part, but occasionally we can have MARKET failure where the pursuit of self-interest leads to bad results for society.

Examples of Market Failure

So, let’s being our look at Microeconomics!!!

• Every economic issue involves individual choice—what to do and what not to do.

• Four economic principles underlie the economics of individual choice…

Resources are scarce• Since the world sadly lacks an infinite amount of

resources, economics is simply the study of how society (individuals, governments, corporations, etc.) manages its scarce resources.

The real cost of something is what you must give up to get it.

• In order to receive one thing, we have to give up something else (money, time, sleep, etc.).

• In economics, whatever must be given up to obtain some item is called an

opportunity cost.

• Examples of opp. Costs?

“How Much?” is a Decision at the Margin

• People face trade-offs in all decisions of life.– Should I study for the semester exam

or hit up the club?– Your decision ultimately depends on

your analysis of the costs and benefits.

• The typical answer is you will do both, but for how much time?

• In your decision, you weigh the costs (an hour of studying or an hour missed of throwing it down) versus the benefits (an increase in your grade).

• As long as the benefit of studying outweighs the cost, you should study.

• This is a marginal decision. They involve making a trade-off between doing a little bit more of something versus a little bit less. To study it is a marginal analysis.

People Usually Exploit Opportunities to Make Themselves Better Off

• We respond to incentives, or anything that offers reward to people who change their behavior

• Changing behavior rarely happens without some incentive for doing so.

When calculating the cost of college, which of the following should you probably not include?

-Cost of Tuition-Cost of books required for classes-The income you would have earned had you not

gone to college-The price of the college’s meal plan

• We STOPPED HERE at end of Ch. 1, don’t look at slides below until getting to Ch. 3

The Marketplace

• Group of buyers and sellers of a particular good or service

• For this point in class, we will assume all markets are perfectly competitive, meaning that no one single person or company can control it.

The Demand Curve The relationship between the price of a good and the

quantity demandedA.k.a. demand schedule, demand table

Price of Smoothie Quantity Demanded

$0.00 40

$1.00 32

$2.00 24

$3.00 16

$4.00 8

$5.00 2

Law of Downward Sloping DemandGiven all things equal, the quantity demanded of a good falls

when the price of a good rises

A Sample Demand CurvePrice of Smoothie Quantity Demanded $0.00 40$1.00 32$2.00 24$3.00 16$4.00 8$5.00 2

The demand curve plots quantity demanded on the horizontal axis and the price on the vertical axis.

The price that the consumer is willing to pay for any given quantity is graphed in the coordinate plane.

For the quantities and prices given below, a smooth curve is drawn that then imputes the price for any quantity.

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The demand curves of different individuals for the same product may look quite different. Consider the following demand curves for burritos. What might explain the differences among these demand curves? For example, Person A is willing to pay more at any quantity than person D. Both Person A and Person D are willing to buy more for a relatively small change in price. Person B is different. Even when price changes, they are not a big fan of the product. Person C is like a hybrid of Persons A and B. What factors might explain these behaviors?

Individual Demand Curves

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Market Demand

The market demand for a product is simply the sum of the demands of all individuals in the market. At any given price, the market will consume a certain quantity. That quantity will represent the convergence of all consumers tastes and preferences in that

market.

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Shifts in the Demand Curve

If there is a “change in quantity demanded,” then the price has moved ON the demand curve. But at other times, there are “changes in demand” when the curve shifts to the RIGHT for an increase and the LEFT for a decrease. Changes in demand are caused by:• Change in income• Change in prices of related goods• Change in tastes• Change in expectations• Change in population (# of buyers)

• Change in Income– Normal Good: As income increases, demand for

good increases.– Inferior Good: As income increases, demand for

good decreases. (ex: public transportation)• Price of Related Goods

– Substitutes: an increase in the price of one leads to an increase in the demand of the other

• Ex: Hot Dogs/Hamburgers, Chips/Pretzels

– Complements: an increase in the price of one leads to a decrease in the demand of the other

• Ex: Hot Fudge/Ice Cream, Peanut Butter/Jelly

• Tastes: a person’s preference affects whether they want to purchase an item or not

• Expectations: a person will buy a good if they expect good results as a benefit of the purchase (ex: buying fancy clothes will help you look in style with friends and co-workers)

• # of buyers, or population: The demand can always shift depending on who is purchasing the product.

Law of Supply

• When the price of a good rises, the quantity supplied will also rise.

• Supply is always being graphed on an upward slope.

• Change in Quantity Supplied= Price Change

• “Change in Supply” caused by:– Input costs

• Labor, Resources, and Capital

– Technology– Demand of related goods– Special Circumstances– # of suppliers– Expectations

The Market for Nike Tennis ShoesPrice QS QD

$20 8,000 90,000

$50 20,000 77,000

$80 37,000 62,000

$110 54,000 44,000

$140 76,000 25,000

$170 98,000 7,000

Sketch the Supply and Demand market for Tennis Shoes, where is our equilibrium point?

• An article comes out in Sports Illustrated saying that Usain Bolt, the world’s fastest man, credits all of his success to Nike. What impact will this cause?

At the same time of Bolt’s statement, an earthquake hits Malaysia. It has caused sizable damage to Nike’s facilities. What impact will this cause?

• Bolt’s statement had a small impact on consumers, but the earthquake has affected Nike greatly. How will this shift our market?

EquilibriumThe intersection of the supply and demand

curves is the equilibrium.It is where the price and quantity from the

supply and demand sides have found balance.

Three Steps in Analyzing an Equilibrium Problem

1. Decide whether the event affects the supply or demand curve.

2. Decide in which direction the curve shifts.3. Use the supply and demand diagram to see

how the shift affects price and quantity

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In Figure 1, at a price of P', what is happening?

S

Figure 1

S

D

Q

P

D

P'

P''

Moving From Excess Demand (a shortage) to Equilibrium

The quantity demanded in the market exceeds what producers are willing to supply. Shoppers are now competing for a shortage of goods, and so they will bid up the price.

What will cause producers to supply more goods?

Producers will be willing to supply more goods as the price increases.

When the price is bid up to P'', the quantity supplied and quantity demanded will be in equilibrium. This equilibrium point occurs at the intersection of the supply and demand curves.

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In Figure 2, at a price of P', the quantity supplied exceeds the quantity demanded. Shoppers do not want all the goods that are brought to market. Producers will lower the price until quantity demanded equals quantity supplied at the equilibrium price, P''.

Moving From Excess Supply (Surplus) to Equilibrium

S

Figure 2

S

D

Q

P

D

P'

P''

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Assume that supply and demand for orange juice are in equilibrium at the point E. What happens to the equilibrium price and quantity if there is a bad orange season caused by a weather disaster?

Moving to Equilibrium When Supply Shifts

S

Figure 3

S

D

Q

P

D

S'

S'

E'

E

Quantity Decreases

Price Increases

The shortage of oranges will cause the supply curve to shift to the left, from SS to S'S'. The new equilibrium is shown at E'. The equilibrium quantity is lower and the equilibrium price is higher.

On the consumer side, shoppers are willing to pay a higher price, since orange juice is more scarce. Producers are supplying less of the product at any price, because of the shortage of oranges.

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Moving to Equilibrium When Supply Shifts

S

Figure 4

S

D

Q

P

D

S'

S'

E'

E

How would you describe the movement to equilibrium when supply shifts to the right as shown in Figure 4?

What would be a cause of the shift in supply? How do consumers respond? What is the change in price? What is the change in the equilibrium point of quantity demanded and supplied?

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Moving to Equilibrium When Demand Shifts

S

Figure 5

S

D

Q

P

D

D'

D'

E'E

Quantity Increases

Price Increases

Assume that supply and demand for automobiles are in equilbrium at the point E. What happens to the equilbrium price and quantity if the income of all consumers increaeses? The increased income will cause the demand curve to shift to the right, from DD to D'D'. The new equilibrium is shown at E'. The equilibrium quantity is higher and the equilibrium price is higher.

On the supply side, producers are willing to supply more cars, since the good is in greater demand..

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Moving to Equilibrium When Demand Shifts

S

Figure 6

S

D

Q

P

D

D'

D'

E'E

How would you describe the movement to equilibrium when demand shifts to the left?

What would be a cause of the shift in demand? How do producers respond? What is the change in price? In the equilibrium point of quantity demanded and supplied?