Fundamental Economic Problem
“How to allocate resources” – to the benefit at society
Micro VS Macro
The study of how individual “agents” make decisions
How much gasoline should I purchase?
How much money should I donate to charity this year?
Studies the performance of an economy as a whole – overall performance
Growth – development
Money – banking – credit
The Production Possibilities Frontier
The maximum amount of any combination of goods that can be produced by a single economy
“Production” – amount produced
“Possibilities” – What is possible
“Frontier” – edge or limit
Two good Economy
Attainability & Production Efficiency
Any level of production w/in or on the PPC is attainable
Any level of production outside the PPC is unattainable
Any level of production on the PPC is production efficient.
The reason the economic problem exists is b/c resources are scarce
The opportunity cost of any action is the value of the next best option forgone.
The slope of the PPC tell us how sever the opp. cost is
As the PPC becomes more steep, larger amount of goods have to be sacrificed in order to increase production of another good.
Marginal cost is the cost of producing one more unit of output.
The marginal cost of moving from 10 lumber and 4 corn to 6 lumber and 6 corn
The change in lumber = -4
The change in corn = +2
= -2 lumber
Consumption & Allocative Efficiency
The preferences of consumer determine the actual amount of production/consumption in an economy.
Suppose consumers want to buy equal amounts of corn & lumber
A market is a mechanism of exchange of goods and services
Perfectly Competitive Market
Many buyers & Sellers
No single buyer or seller can influence price
Full information about the goods & services exchanged
Markets are Two-Sided: Supply and Demand
Economic demand is the willingness & ability to pay for a good or service.
Law of Demand
At higher prices individuals are less willing and able to purchase any given quantity
Demand curves are down sloping
Demand vs. Quantity Demanded
Quantity demanded is the amount of a good or service demanded at each price
Changes in quantity demanded are caused only by changes in price
Changes in Demand
What determines willingness & ability to pay?
Preferences for a good or service
Consider an increase in income
Normal good is a product or service that you demand more of when income rises
Inferior Good is a product or service that you demand less of when income rises
Consider changes in tastes
Suddenly discover French Onion Soup is excellent
Discover that DDT causes health problems
Change in relative preferences
Substitutes are goods such that when the price of one good goes up demand for the other good rises.
Complements are good such that when the price of one good goes up demand for the other falls
Market supply is the willingness and ability of a firm to produce & sell a good or service.
Law of Supply
At higher prices firms are wiling & able to supply (produce & sell) a greater quantity.
Supply curves are upward sloping
“Supply” vs Quantity demanded
Quantity supplied is the amount that firms are willing & able to supply at any given price
Changes in supply
Determinants of supply curve
Cost of inputs
The outside opportunities of the firm
We say there is a market equilibrium when quantity demanded equals quantity supplied
Price and quantity are directly determined by supply and demand
Changes in market price
A binding price ceiling creates shortage in the market place
Furthermore, a binding price ceiling reduces the # of transactions in the market place
In a labor market workers