Economics Notes

The Economic Problem Unlimited wants and limited resources. Wants are different from needs. Needs are our basic essentials: Food, clothing and shelter Economic attempts to allocate scarce resources efficiently Resources/Factors of Production Land Labour Capital Entrepreneurship Output/Production Goods Services Consumers Consumer goods and Services Tangible (Touch and see) Intangible (Cant touch or see)

Enterprise: Entrepreneur Organize/manage the other factors of production. Owner or part-owner of the business, they put their money into the business Capital: Money is NOT capital Machines, buildings, cars and equipment. (Depends on who buys it) Land: Vital for the making of natural resources. (Plants, mineral, coal, oil, animals for meat and skins.) Includes seas, rivers, forests and minerals. Labour: Physical and mental effort to make goods and resources. Another word for human resources. Very important in determining the size and ability of the goods and services produced. Opportunity Cost: Because resources are scarce, we cannot produce and consume everything we want. Therefore we all have to make choices and give things up. This leads to opportunity cost. This is the next best we give up in order to consume or produces good. E.g. Government spends money on guns, it has to give up spending more on schools- this is an opportunity cost -We go to the cinema, so we give up buying pizza -The business spends money on computers so they cant afford to hire more workers. All economic goods/services are scarce and have an opportunity cost.

Free goods are goods that are not scarce and have zero app. cost. E.g. Air, seawater and sand in the desert. Consumer Sovereignty: The consumers decide what is produced on the market. If things that customers dont like are put on the market, they wont be bought and it will go out of business. This happens in a Market Economy. Price Mechanism: E.g. there is demand for more oranges. This creates a shortage. The price goes up because there is too much demand and not enough supply. When prices are raised, they start to produce more supply to gain more profit. Therefore, because the consumer wants more oranges, they get more oranges. There is less demand for apples. There is a surplus of apples. The price goes lower. The supply of apples goes down. Planned Economy: The government decides everything and there are no private firms. There is no consumer sovereignty. Completely controlled by government. China was until about 30 years ago. Markets: A place where there are buyers and sellers.

The Allocation of Resources Notes Cover work) - There are two main economic systems: Market and Command - Some countries choose the command system and some countries choose the market system. Other countries are somewhere in between these two. - The market system is where decisions such as how to make the resources, where to make them, etc. is made by individual business owners. In the command system, all these decisions are made by the government. -Generally, the countries that use a system that is some sort of mix between the two systems have a higher GDP than the other countries but tend to have higher unemployment rates. Chapter 7 Exercise 1 1. The consumers and the businesses. 2. Issues of health and diet have increased so consumers want more healthy food products.

3. At first, there will be a shortage of supplies and the prices will go up but then more of the products will be produced and the prices will lower. 4. Once there is no shortage, the price will lower, making the product more affordable. Exercise 2 1. 200p: 2 150p: 5 50p: 8 30p: 10 20p: 20 10p: 25 1p: 30

1. The main aim of a business producing goods and services is to maximize profits. 2. Firms decide what to produce by selling what customers demand so that customers well buy their products. 3. They try to find the cheapest way to produce goods to increase profit.

September 15, 2011 Demand: Willingness and ability to purchase a given quantity of a good, at a given price, over a given period of time. A demand curve (called curve but is a straight line) goes downwards on a graph. There is an inverse relationship between price and quantity demanded. When price increases, the quantity that is demanded falls.

Pri ce

Demand

Quantity A movement along a demand curve shows a change in price.

E.g. Demand for cars in China increases because of higher incomes. A shift in the demand curve to the right means an increase in demand due to anything (but not a price change)

P D2 D1

Cars are known as a normal good and when incomes increase, quantity of demand increases. Some goods may experience lower demand when incomes increase. These goods are known as inferior goods e.g. buses. As incomes go up, demand for bus travel gods down as people can afford cars and/or taxis. This is seen as a shift inwards/to the left in the demand curve. Gold Course: The price of the golf rounds go up.

Pri ce

Quantity

Gold clubs: Shift to the left as fewer clubs demanded. Complementary goods as they are jointly consumed/demanded. ]

Pri ce

Quantity Mountain Dew

Pri ce

Quantity

Homework Exercise 4 1. The big tax cuts in Australia mean that taxpayers will have higher incomes. -Costumer confidence is still low - The heat wave caused shortages in crop -The population is rising in India -Growing more genetically modified food. -Interest rates were raised and consumer price inflation also raised. 2. Demand will increase in Australia, as more people will have the ability to buy what they want due to higher income. -It will remain the same as the confidence of the customers is still at the same level as last year. - Demand will decrease, as the price will be raised due to shortage of crops. - Demand will increase, as the more people there are, the more resources are needed. -Demand for organic farming will decrease as more people buy GM foods. -Demand will stay the same as the interest rates and the price inflation cancel each other out. Exercise 5 Goods and Services Electric Oven Woolen Jumpers Gas Supplies iPods Passenger Rail Journeys Goods and Services LCD TV Displays Fountain Pens Guitars Toothbrushes Computers Possible Substitutes Gas Oven Leather Jacket Solar Power MP3 Players Plane Journeys Possible Complements DVD players Ink Guitar picks Toothpaste Computer Games

September 26, 2011 Supply: The willingness and ability of firms to supply a given quantity of a good at given prices over a given time period. Pri ce P2 S

P1

Q1

Q2

Quantity

A change in price will cause a movement along a supply curve. E.g. the price of corn increases so farmers use more land to grow corn (Movement from a to b) Shift in S. Curve Cost of Production- Lower costs of production will enable firms to supply more at lower prices. A shift to the right in the S. Curve shows this. On the other hand, if the cost of production rises, the demand curve shifts to the left.

Pri ce

S1 S2

P1

Q1 Quantity

Price of Other Goods- Corn prices go up which means that farmers take land that was previously used for growing rice and use it now for growing corn. Rice would go down in supply as its land is used for growing corn so the supply curve would shift to the left. S2 S1

Pri ce

Quantity Improvement in Technology/Efficiency (better training for workforce)This can allow more goods to be produced at the same cost. E.g. machines and better production methods. S1 S2

Pri ce

Quantity

Pri ce

S2 S1

Business Optimism and Expectations- If firms are optimistic about the economy; they supply more and cause a shift to the right in the S. Curve. Whereas if the firms are pessimistic, they will supply less, causing a shift to the left in the S. Curve.

Quantity

Global Factors- Factors such as the weather or wars that cannot be controlled by the producers can affect the amount of supplies firms produce. E.g. If the weather is bad, the supply of crops will go down. If the weather is good, the supply of crops will go up. S2 S1

Pri ce

Quantity

The market or equilibrium price is where S=D At higher prices there will be S>D, so there will be a surplus, which will force firms to lower the price. At lower prices D>S and there will be a shortage, which pushes the price up. Equilibrium is at PeQe Pri ce Surplus

Shortage Quantity

Homework: Notes on Pg. 111-112

September 26, 2011

Factors that can cause change in demand and shifts in the market demand curves: Changes in consumers incomes: Actual demand can only happen when the consumer has the ability to pay. If incomes rise, more consumers will have the ability to create actual demand. However, the amount of impact a rise in income has on the customers demand on the product depends on the product. E.g. a consumer wouldnt by more newspapers everyday. If demand for a product rises when people have higher incomes, it is called a normal good. If the demand decreases, it is called an inferior good, meaning that the consumer has the ability to demand a better good to replace it. Changes in taxes or incomes: Disposable income is the income consumers have left to spend after paying taxes. Any change in taxes or incomes would change the disposable income, therefore changing the amount of demand. The prices and availability of other goods: Complementary goods have joint demand, as they are goods that go with each other such as bread and jam. If the demand of bread goes up, so will the demand for jam. Substitutes are goods that can replace other goods when the consumer has more money to spend on goods. Changes in tastes, habits and fashion When consumers change taste or if the newest fashion changes, demand for goods and services can be changed dramatically. Population Change An increase of population usually increases demand as more people more resources are needed for the people to use. Other factors: Weather (E.g. Good weather means that crops grow well the food tastes better, causing more demand from consumers.

 Exercise 8 pg. 118

Change in laws (E.g. Its illegal not to wear a crash helmet when biking so demand for crash helmets increases.)

1. 30p 2. A) 30p B) 200,000 3. A) 20, 10 and 5p B) 40 and 50p 4. A) It will be raised B) 30p September 29, 2011 There are only 4 things that can change price: -Increase of demand -Decrease of demand -Increase of supply -Decrease of supply Increase in demand: 1. The demand curve shifts to the right 2. Theres a shortage 3. Price rises. Firms put more supply and consumers demand less 4. New equilibrium is reached. Decrease in demand: 1. Surplus 2. Price goes down 3. Demand goes down and supply goes down 4. New equilibrium Increase of supply: 1. Increase in supply 2. Surplus 3. Price goes down 4. New equilibrium Decrease of supply: 1. Decrease in supply 2. Shortage 3. Price rises 4. New equilibrium Exercise 11 Pg. 122

1. Demand increased because more people wanted high quality TV sets to watch the World Cup. 2. There would have been less demand for cathode ray tube televisions and less would be supplied. 3. The supply was increased because there was a improvement in technology. 4. The price will lower and the demand will get higher. October 10, 2011 E.g. we can produce two times of goods: Food and guns. Factors of Products 100% in Food (A) 50% into each (B) 100% into Guns (C) Food 20 10 0 Guns 0 20 40

The opportunity cost of going from point B to point A, which is an extra unit of food, is 2 units of guns. The opportunity cost of 1 extra unit of guns (point B to point C) is a unit of food. October 20, 11 Price Elasticity Pri ce Pri ce

P1

Demand is Price elastic

P2

Demand is Price inelastic

P1

P2 Quantity Q1 Q2 Q1

Q2

Quantity

Price elasticity of demand measures the responsiveness of demand due to a change in the price of a product.

PED Price elasticity of demand: measure the responsiveness of demand due to a change in the price of a product. PED= Inverse relationship between the price and demand Price Demand = Negative Price Demand = Negative TAKE OFF THE MINUS SIGN FOR PED. PED > 1 = elastic % change in quantity demand > % change in price PED < 1 = inelastic % change in quantity demand < % change in price

PED = 0, Demand here is perfectly inelastic. Demand does not change no matter how price changes. If PED is between 0 and 1 (i.e. the percentage change in demand from A to B is smaller than the percentage change in price), then demand is inelastic. Producers know that the change in demand will be proportionately smaller than the percentage change in price. If PED = 1 (i.e. the percentage change in demand is exactly the same as the percentage change in price), then demand is said to unitary elastic. A 15% rise in price would lead to a 15% contraction in demand leaving total spending by the same at each price level. Price falls by $10 to $8 and demand increases from 5 to 7 units ((7-5)/5 x 100)/((8-10)/10 x 100) =40%/-20% = -2 PED

Price increases from 20 to 25. Demand changes from 6 to 4 ((4-6)/ 6 x 100) / ((25-20)/20 x 100) =33.3%/25% =1.32 What Determines Price Elasticity of Demand? Number of substitutes % Of income the good takes up Addictiveness Time period - The number of close substitutes for a good / uniqueness of the product the more close substitutes in the market, the more elastic is the demand for a product because consumers can more easily switch their demand if the price of one product changes relative to others in the market. The huge range of package holiday tours and destinations make this a highly competitive market in terms of pricing many holidaymakers are price sensitive - The % of a consumers income allocated to spending on the good goods and services that take up a high proportion of a households income will tend to have a more elastic demand than products where large price changes makes little or no difference to someones ability to purchase the product. - The time period allowed following a price change demand tends to be more price elastic, the longer that we allow consumers to respond to a price change by varying their purchasing decisions. In the short run, the demand may be inelastic, because it takes time for consumers both to notice and then to respond to price fluctuations. - Whether the good is subject to habitual consumption when this occurs, the consumer becomes much less sensitive to the price of the good in question. Examples such as cigarettes and alcohol and other drugs come into this category. Exercise 12 Product

Oil

Small or Large Change in Quantity Demanded Small

Price elastic or Price Inelastic Inelastic

Why?

DVD Recorders

Large

Elastic

Bread

Small

Inelastic

Because people still need the same quantity for their cars. People dont need DVD recorders and they can just watch them on a computer. 10% rise in price for bread would

Cars

Large

Elastic

Newspapers

Small

Inelastic

be a small change and people wouldnt care too much about it. The price for cars is very expensive so a 10% change would be a lot and people wouldnt be able to afford it. Newspapers dont cost much at all so a 10% rise in price would not affect the consumers demand a lot.

Exercise 13 1. ((1500-1000)/1000 x 100)/((30-40)/40 x 100) = 50%/-25% PED = -2 2. PED is greater than 1 so the demand for beans is price elastic. 3. Pri ce P2 P1

October 27, 11 Assumption: Firms wish to maximize profits. Profits = Total revenue Total costs Total revenue = Price x Quantity Pri ce P2

P1

Q1

Q2

Quantity

Total revenue = Area of box When demand is inelastic we should raise price to maximize total revenue. Pri ce P1

P2

Q1

Q2

Quantity

If PED is price elastic, firms will raise total revenue by reducing their price. (Profits will increase IF total costs increase less than total revenue.)

Price

Quantity Total Revenue Total revenue increases or decreases? s 4000 5040 5760 6160 6240 6000 5440 4560
Increased PED= Elastic Increased PED= Elastic Increased PED= Elastic Increased PED= Elastic Decrease PED= Inelastic Decrease PED= Inelastic Decrease PED= Inelastic

per unit Units 20 18 16 14 12 10 8 6 200 280 360 440 520 600 680 760

Change in the market

What happens to total revenue?

Increases Increases Decreases Decreases Increases

Ped is inelastic and a firm raises its price. Ped is elastic and a firm lowers its price. Ped is elastic and a firm raises price. Ped is -1.5 and the firm raises price by 4% Ped is -0.4 and the firm raises price by 30% Ped is -0.2 and the firm lowers price by 20%

Decreases

Ped is -4.0 and the firm lowers price by 15%

November 7, 11

Increases

Price Elasticity of Supply

Price Elasticity of Supply

PES= Price elasticity of supply: measure the responsiveness of supply due to a change in the price of a product. Example: Price increases from $1 to $1.2, quantity supplied increases from 1000 tons to 1300 tons. PES=

S1 (inelastic)

S (elastic)

PES values are always POSITIVE due to a positive relationship. Positive relationship between the price and quantity supplied: Price Supply = Positive Price Supply = Positive PES=0, Perfectly price inelastic, Vertical line. QS of a commodity remains the same whatever its price. PES= , Infinitely price elastic, Horizontal line. Producers are willing to supply as much as they can at one particular price and supply nothing at any other price. PES=1, Unitary elasticity. A percentage change in price will cause an equal percentage change in quantity supplied. Line passes through the point of origin of its graph, % change in QS = % change in Price PES>1, elastic, % change in quantity supplied > % change in price PES<1, inelastic, % change in quantity supplied < % change in price

Factors affecting Elasticity of supply

Spare Capacity

If there is spare capacity, the firm should be able to increase output without a rise in costs and therefore supply will be elastic. Supply of goods and services is often elastic at the end of an economic recession, when there is plenty of spare labour and capital resources available to step up output. Stocks If stocks of raw materials, components and finished products are high then the firm is able to respond to a change in demand quickly by supplying these stocks onto the market - supply will be elastic. Time period Supply is more elastic the longer the time period a firm has to adjust its production. In the short run, the firm may not be able to change its factor inputs. In agricultural markets, the supply is fixed and determined by planting decisions made months before, and climatic conditions, which affect yields. Economists sometimes refer to the momentary time period a time period that is short enough for supply to be fixed i.e. supply cannot respond at all to a change in demand.

Market Failure
Market mechanism Market mechanism aims to allocate resources. It refers to the use of money exchanged by buyers and sellers with an open and understood system of value and time trade offs to produce the best distribution of goods and services. Market failure is a failure of the market mechanism to allocate scarce resource efficiently. Most of the time the market mechanism does allocate resources efficiently. E.g. consumers want more pies, so price pies. = supply so consumers get more

Market Failures Market failure is simply a failure of the market mechanism to do its job properly. Now remember that "the job" of an economic system, be that system a planned economic system or a market economic system, is to allocate resources efficiently. So basically market failure is when the market economic system fails to allocate resources efficiently. What this basically means is one of 3 things: Some goods/services are over produced/consumed Some goods/services are under produced/consumed Some goods/services are not produced at all. When market failure occurs Governments intervene (Government intervention) to try and correct these failures. It is because of market failures that most economic systems are "mixed economies" as without government intervention, market failures would lead to resources being allocated inefficiently. "Externalities" and Market Failures Many market failures occur because of the existence of externalities. Externalities are third party effects arising from production and consumption of goods and services. Third parties are people who are neither Suppliers nor demanders of the good. An example may be smoking-I dont produce or consume tobacco, but if someone is smoking near me I certainly am affected by this. This is therefore a negative externality as it is a bad effect on a 3rd party. External costs and benefits are around us every day the key point is that the free market mechanism may fail to take them into account when pricing goods and services. Externalities can cause market failure if the price mechanism does not take them into account.

Why are the following externalities? Passive smoking Motorists in Shanghai benefiting from less traffic jams due to the Skytrain. Dog owners allow their animals to foul pavements (dog poo!) Air pollution from road use causes a rise in premature deaths Difference between private cost and social cost The existence of production and consumption externalities creates a difference between private and social costs of production and also the private and social benefits of consumption. Social Cost = Private Cost + External Cost Social Benefit = Private Benefit+ External Benefit

Student Task: In the Table below list all of the various costs and benefits of driving a motor car Private Costs Cost of motor car Cost of fuel Parking fee Road tax Licence plate External Cost Traffic congestion damages competitiveness of many businesses, may deter inward investment and damage the tourist sector in the long run. Pollution air, noise Accident risk Health service Private Benefits Efficiency Convenience Speed Easy Show off External Benefit Government gets tax Jobs opportunity car selling, petrol, car services Repair and maintenance Vehicle insurance

P394-395 Exercise 1 1) Private cost and private benefit 2) Yes, external cost and external benefit 3) a) Private benefits are greater than private costs b) Social benefits equal social cost 4) a) $6 million $5 million = $1 million b) Social Cost = $4 million + $2 million = $6 million. Social Benefit = $ 3 million. Social Cost > Social Benefits Therefore, paint production at the factory is not worthwhile for society. 5) This shows resources arent allocated efficiently when social cost is greater than social benefits. Allocative Efficiency Social Cost = Social Benefit If private cost = social cost, and if private benefit = social benefit, and social cost = social benefit, so market equilibrium is achieved. No externalities. Where external costs occur, the market mechanism leads to over consumption/production and market failure occurs. Goods those are over-consumed are known as demerit goods e.g. alcohol, tobacco. Goods those are under-consumed/provided in the market mechanism. This is because external benefits occur with merit goods e.g. educational + healthcare.

S (Private cost = Social cost)

D1 (Social benefit) D (Private benefit) Q Education is a merit good. Merit Good - Subsidies or governments provide them for free. This (high costs = income tax) - Education + advertising to consumption. - Laws. Demerit Good - Place taxes on the goods. Price = Demand - Education + advertising to reduce consumption. - Ban them/Law/Legislation. consumption. Q1

Public Good
A public good is a good that is non rival and non-excludable. e.g. Street Lighting

Market System
Advantages of the Market System 1. The market produces a wide variety of goods and services to meet consumers wants 2. The free market responds quickly to peoples wants. 3. The market system encourages the use of new and better methods and machines to produce foods and services. Disadvantages of the Market System 1. Factors of production will be employed only if it is profitable to do so. 2. The free market can fail to provide certain goods and services. 3. The free market may encourage the consumption of harmful goods. 4. The social effects of production may be ignored, 5. The market system allocates more goods and services to those consumers who have more money than others.

Mixed Economic System The Mixed Economic System The mixed economic system combines government planning with the use of the free market. In the mixed economy, just as in the market economy, people and firms in the private sector own scarce resources with the aim of making as much profit as possible. However, in mixed economies the government or public sector also owns some scarce resources to produce goods and services that they think their country, and its people, need and want. Why have a mixed economic system? 1. Market economies experience high unemployment sometimes because it may not be profitable to employ people. In a mixed economy if there is unemployment the government may be able to create jobs for those people out of work by employing them in their own offices and factories or by helping private firms to provide jobs. 2. Public goods wont be provided in a market economy. In a mixed economy, the government can provide these public goods. 3. In a market economy, harmful goods might be profitable to people but in a mixed economy, the government can decrease consumption on harmful goods. 4. A mixed economy would stop firms from only focusing on their own costs and benefits but also external costs such as pollution. 5. One of the main problems of a market economy is that poorer people with little money are unable to buy many of the goods and services that are available. A mixed economy would allow the government to give goods and services to those who need it.