Notes on Lecture Principles of Economics

Book: Principles of Economics (N. Gregory Mankiw) http://admin. wadsworth. com/resource_uploads/static_resources/0324168624/8413/Mankiw_TenPrinciple_Videos. html Introduction economy: Greek: the one who manages the household scarcity: the limited nature of society`s resources economics: the study of how society manages it? s scarce resources economy: a group of people interacting with one another as they go about their lives important: management of society? s resources; resources are scare most societies, resources are allocated not by a single household, but through the combined action of millions of households and firms Economist: study how people make decisions: how much they must work; what they buy; how much they save; how they invest their savings, how people interact with each other; also analyze forces and trends that effect the economy as a whole, including the growth in average income and the rate at which prices are rising; Ten Principles of Economics: How people make decisions: #1 People face tradeoffs “There is no such thing as a free lunch. ” To get one desired thing, usually required giving up another desired thing: making decisions ( trading off one goal against another e. : How I spend my money (save/invest); The subject I want to study; The job I want to work in; The meal I am going to have; The place where I want to live or to study abroad … classical tradeoffs: “guns & butter”; (e. g. reducing pollution vs. low wages and high producing costs) “efficiency & equity” : conflicts when government policies are being designed efficiency: the property of society getting the most it can from it`s scarce sources (size of economic pie) equity: the property of distributing economic prosperity fairly among the members of society (how the pie is divided) 2 The cost of something is what you give up to get it because people face tradeoffs, making decisions requires comparing the costs and benefits of alternative courses of action; (often cost of some item not as obvious: e. g. all the incoming cost when decided to study: money & time) opportunity cost: whatever must be given to obtain some item (How much do I have to give up = measure for the trade-off) e. g. start a Master`s Course or not: alternatives (opportunity costs: working; work & travel; another Bachelor; Internship; (each decision causes new Costs. marginal costs? ); #3 Rational People think of the Margin e. g. examination: not black & white: blow of vs: 24h studying ( decisions are shades of gray (airline) e. g. average cots of seat: $500, marginal cost: bag of peanuts & soda (e. g. $20) marginal changes: small incremental (schrittweise, zunehmend) adjustments to a plan of action (adjustments around the edge of what you are doing) e. g. thinking of the alternatives of not proceeding with a Master`s course (opp. Cost), but start to work directly after the B. A. ( marginal costs: lower wage; less career possibilities; marginal benefits: a wage at all; BUT: only profitable when marginal benefit of the action exceeds the marginal costs #4 People respond to incentives although comparing costs & benefits (c & b) behaviour may change when costs or benefit change ( d. h. people respond to incentives effect of price on the behaviour of buyers & sellers is crucial e. g. price of an apple rises: buyer: decide to buy pears; fewer apples bec. cost of buying apple is higher; sellers: hire more workers & harvest more apples bec. enefit of selling one is higher e. g. policy changes: tax on gasoline: encourage people to drive smaller, more fuel-efficient cars or public transportation etc. ( when analyzing policy we must consider not only the direct effects but also the indirect effects that work through incentives (e. g seat belt law); if the policy changes incentives, it will cause people to alter their behaviour e. g. when receiving an income parents (money) for studying it might change the incentive to work and earn own money How people interact: #5 Trade can make everyone better off rade bw. Two countries can make each country better off; e. g. each family in the economy is competing with all other families (despite comp: family would not be better off isolating itself; but gains much from its ability to trade with others) ( trade allows each person (country) to specialize in the activities he or she does best; by trading with others, people can buy a greater variety of goods and services at lower costs e. g. #6 Markets are usually a good way to organize economic activity . firms decide whom to hire & what to make ouseholds decide which firms to work for & what to buy with their incomes; ( these firms & households interact in the marketplace, where prices & self-interest guide decisions; in a market economy nobody is looking put for economic well-being society as a whole; free markets contain many buyers & sellers of numerous goods & services; all primarily own well-being; ( yet: despite decentralized decisionmaking and self-interested decisionmakers; market economies have proven successful in organizing economic activity in a way that promotes overall economic ell-being ( invisible hand (Adam Smith: 1776): does not ensure that economic prosperity is distributed fairly ( prices are the instrument with which the invisible hand directs economic activity; ( price have to adjust naturally to supply and demand! ( Prices reflect both: value of a good to society & the cost to society of making the good ( bec. ouseholds & firms look at prices when deciding what to buy & sell: unknowingly consider the social benefits & costs of their own actions; ( prices guide these individual decisionmakers to reach outcomes that often maximize the welfare of society as a whole; market economy: an economy that allocates (zuteilen) resources through the decentralized decisions of many firms and households as they interact in markets for goods and services (vs: centrally planned economies, like in communism); #7 Government can sometimes improve market outcomes or two broad reasons: ( to promote efficiency and equity: most policies aim either enlarge the economic pie, or to change how it`s devided; invisible hand usually leads markets to allocate resources efficiently, but sometimes it does not work for various reasons: ( market failure: a situation in which a market left on its own, fails to allocate resources efficiently (Marktversagen) one possible reason: ( externality: the impact of one person`s actions on the well-being of a bystander (unbeteiligter Dritter e. g. pollution (external cost) or creation of knowledge (external benefit) (Externalitat) another possible reason: arket power: the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices (Marktmacht) (e. g. only one well: monopoly ( regulation of the price by the government can potentially enhance economic efficiency) How they economy as a whole works #8 A country`s standard of living depends on its ability to produce goods and services the growth rate of a countries` productivity determines the growth rate of its average income productivity: the amount of goods and services produces from each hour of a worker`s time undamental relationship bw. productivity & living standards is simple, but: its implications are far-reaching! #9 Prices rise when the government prints to much money e. g. 1921: German newspaper: 0,30 Mark; 1923: 70,000,000 Mark ( inflation inflation: an increase in the overall level of prices in the economy (Anstieg des Preisniveaus der Volkswirtschaft) reason: growth in the quantity of the money: reduces value of the money bec. high inflations imposes various costs on society, keeping inflation at a low level is a goal of economic policymakers around the world 10. Society faces a short-run trade-off between inflation and unemployment Phillips curve: a curve that shows the short-run trade-off between inflation and unemployment reducing an inflation is often thought to cause a temporary rise in unemployment over a period of a year or two, many economic policies push inflation and unemployment both start out at high levels; short-time trade-off bec. some prices are slow to adjust; (prices are sticky in the short-run) ( various types of policy have short-run effects, that differ from their long-run effects: when gov. educes the quantity of money, it reduces the amount that people spend; Lower spending together with prices that are stuck too high reduces the quantity of goods & services that firms sell; Lower sales in turn, cause firms to lay off workers ( unemployment [pic] #1 People face tradeoffs #2 The cost of something is what you give up to get it #3 Rational People think of the Margin #4 People respond to incentives #5 Trade can make everyone better off #6 Markets are usually a good way to organize economic activity #7 Government can sometimes improve market outcomes 8 A country`s standard of living depends on its ability to produce goods and services #9 Prices rise when the government prints to much money #10. Society faces a short-run trade-off between inflation and unemployment Mon. 17/10/11 Lecture 2 THINK LIKE AN ECONOMIST Microeconomics: the study of how households and firms make decisions & how they interact in markets Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment and economic growth (p. 7) ( since they address different questions, they sometimes take different approaches and are often taught in separate courses; Two Functions of Economists: – 1. (try to explain the world) scientists: devise theories; collect, evaluate & analyze data ( to verify or refute theory; have own terminology; – 2: policy adviser: if Economists try to explain the world, they are scientists; if economists try to change the world they are advisers. ” (book) make positive statement (claim): describing real world, model, outcome…without valuing: claims that attempt to describe the world as it is: are testable with data • make normative statement (claim): about how the world should be (personal opinion): claims that attempt to prescribe how the world should be: are not testable with only data (involves our views of religion, ethics, political philosphy) • (may be related: our positive views about how the world works affect our normative views about how the world should be; essence of science: scientific method: the dispassionate development and testing of theories about how the world works – scientific method: observation, theory & more observation – Ec. use theory & observation but face obstacles when it comes to experiments; – Substitute for laboratory: attention on natural experiments offered by history (e. g. the effect on the natural resource of oil during a war on the prices all over the world and on policy makers, gives Ec. good opportunity to study the effects of a key natural resource on the world`s economies;
The role of Assumptions: – can make the world easier to understand – e. g. to study effect of international trade, we may assume the world consists of only two countries with each producing only two goods ( to focus our thinking ( helps understand the real more complex world – the art is, which assumption to make: different assumptions for different problems ( e. g. for studying the short-run and long-run effects of a change in the quantity of money requires different assumptions (p. 22) 3 types of models: abstract, formel, simplification of reality to understand basic correlation: if it does: good model) 1. purly theoretical (statistical) 2. purly empirical (with data, data drift) 3. combination of the two – In the model: own terminology is incorporated; built with assumptions (not judging on the assumptions; realistic: think of paper airplane; judge by the output not by the input), irrelevant questions are assumed away 1. First type of model: most simple model of market economy: THE CIRCULAR-FLOW DIAGRAM pic] ( a visual model of economy that shows how money flows through markets among households and firms – 2 types of decisionmakers: households & firms – firms produce goods & services using inputs (labor, land, capital) ( factors of production (natural resources, land, knowledge, labor, human capital, machinery.. ) – households own the factors of production & consume all the goods & services the firms produce – households & firms interact in 2 types of market inner loop: represents the flow of goods & services between households & firms: households sell the use of their labor, land & capital to the firms in the market for the factors of production; firms use these factors to produce goods and services, which in turn are sold to households in the market for g & s; ( the factors of production flow from households to firms; goods & services flow from firms to households; – outer loop: represents the corresponding flow of money to buy g & s from the firms; firms use some of the revenue from these sales to pay for the factors of production (e. . wages of workers); what is left is the profit of the firm owners, who themselves are members of the households; – value of factors of production is same as value of g & s – if that is true: value of goods & services = value of factors of production – (green is so called: real economic activity) – causality runs in both ways (no real beginning or end ( circle) – economic models are often composed of diagrams and equations ——————————- Why do economists disagree: . Disagreement about validity of alternative theories about how the world works; disagreement about positive statements (differences in scientific judgments); but also often about the data; when no data exists that supports ones theory or when different data are used 2. Scientists have different values; different normative statements about what policy should try to accomplish ( but choosing the positive statement and theory and specific type of date etc. s already bec. of normative reasons (sort of mixture exists); Lecture 3, Mon 24/10/11 2. Second Type of Model: THE PRODUCTION POSSIBILITY FRONTIER (PPF) Fig. 1 [pic] ( shows the combination of output that economy can possibly produce given the available factors of production and the available production technology. The economy can produce any combination on or inside the frontier. Points outside the frontier are not feasibly given the economy`s resources; – e. g. n economy that produces only cars and computers; – if all resources were used in the car industry ( economy would produce 1000 cars & 0 PCs – if all resources were used in the PC industry ( economy would produce 3000 PCs & 0 cars – if economy were to divide its resources between the two industries ( 700 cars & 2000 PCs – outcomes at point D are not possible because of scarce resources: economy does not have enough factors of production to support that level of output; – efficient outcome: when economy is getting all it can get from its scarce resources that are available; points ON the frontier represent efficient levels of production (rather than inside); – when economy is producing at such a point (on the frontier) e. g. point A, there is no way it could produce more of one good, without producing less of the other – inefficient outcome: all combination of outcomes inside the frontier, e. g. point B; for some reasons e. g. idespread unemployment, the economy produces less than it could from the resources it has available: (300 cars & 1000 PCs); if source of inefficiency were eliminated, economy could move from point B to A, increasing production of both cars & PCs; ( People face tradeoffs: PPF shows one tradeoff society faces: once we have reached the frontier, the only way of getting more of one good is producing less of the other (e. g. producing more PCs at the expense of producing less cars) ( The cost of something is what you have to give up (opp. cost): PPF shows the opportunity cost of one good as measured as measured in term of the other good (e. g. the opportunity cost of producing 200 more PCs is a 100 cars); Fig. 2 [pic] ( A SHIFT IN THE PPF: an economic advance in the computer industry shifts the PPF outward increasing the number of cars and computers the economy can produce – Fig. : PPF is bowed outward (can also be bowed inward): means: the opportunity cost of cars in terms of computers depends on how much of each good the economy is producing; – When economy uses most of resources to produce cars ( PPF is quite steep – Because even workers & machines best suited to making PCs are being used to make cars, the economy gets a substantial increase in the number of computers for each car it gives up; – By contrast: when economy is using most of its resources to make computers the PPF is quite flat; resource best suited to make PCs are already in the computer industry and each car the economy gives up yields only a small increase in the number of PCs; (?? – Slope of the PPF represents how much of one item you have to give up to produce the other item Videos for PPF: – http://www. youtube. com/watch? v=KPHyvOn8i6s&feature=related – http://www. youtube. com/watch? v=a5rxIY46J7s TRADE No. 5: Trade can make everyone better off: WHY ( – We have specialization, which has a downside: we are interdependent! e. g. I`m depending on someone who is making bread; – why should people be willing to depend on the behavior of others: because. people choose freely to become dependent ( so there must be some sort of benefit from it e. g. 2 producers (agents) – one producer: potato farmer ( potatoes (2 goods) – cattle rancher ( meat |Good |Minutes/hours |8 hours/day |Marginal opportunity cost of | | | | | |meat/potato | |Farmer |Meat |60 min. = 1 oz = 1h for 1 oz |Meat = 8 oz |- 4 oz of pot. = 32/8 | | |Potatoes |15 min. = 1 oz = 1h for 4 oz |Potatoes = 32 oz |- 1/4 oz of meat = 8/32 | |Rancher |Meat |20 min. = 1 oz = 1h for 3 oz |Meat = 24 oz |- 2 oz of pot. = 48/24 | | |Potatoes |10 min. 1 oz = 1h for 6 oz |Potatoes = 48 oz |- 1/2 oz of meat = 24/48 | | | | | |Unit: | | | |oz of potato | |oz of potato | | | |oz of meat | |8h (48/24) | | | | | | | ( How do people decide on what to produce? – more time for farmer to produce meat ( rancher is better/more productive – what are the marginal opportunity costs: how much meat does a farmer have to give up i. o. to get 1 unit of potatoes; – by reducing production of potatoes he would have more time to produce meat; but 1 oz meat requires. 4 oz of potatoes; – but it`s just a linear relation ship – how much has the farmer to give up in order to get 1 more unit of meat! (what is opportunity cost)? rancher has a comparative advantage: is less productive in producing potatoes; but farmer is even less productive in producing meat: derived from comparing the marginal opportunity cost ( Comparative advantage: the comparison among producers of a good according to their opportunity cost (who has the lower one? ) ( or absolute advantage for one product, when both produce more in time: ( Absolute advantage: the comparison among producers of a good according to their productivity 1. Marginal opportunity cost of meat for each person is the inverse of the marginal opportunity cost of potatoes! ( try to measure one good in terms of the VALUE of the other good 2. Production & consumption are no more equal like in autarky |Good |Minutes |8 hours/day |Marginal opportunity cost of | | | | | |meat/potatoes | |Farmer |Meat |60 min. = 1 oz = 1h for 1 oz |Meat = 8 oz |- 6 oz pot. = 48/8 | | |Potatoes |10 min. = 1 oz = 1h for 6 oz |Potatoes = 48 oz |- 0. 16 oz of meat = 8/48 | |Rancher |Meat |20 min. = 1 oz = 1h for 3 oz |Meat = 24 oz |- 1 oz of pot. = 24/24 | | |Potatoes |20 min. 1 oz = 1h for 3 oz |Potatoes = 24 oz |-1 oz of meat = 24/24 | | | | | | | | | |oz of potato | |Unit: oz of pot | | | |oz of meat | |8h (48/24) | | | | | | | ( The rancher has an absolute advantage because he is more productive than the farmer Production Possibility Frontier (PPF) oz of meat 8 4 16 32 oz of pot ( p = c ( production = consumption) without trade (autarky) ( c bigger p (with trade consume more than can produce) – if I already produce y meat, I can only produce y below the line is a waste of time; and the line shows efficiency in terms of productivity and time, – slope is opportunity cost; usually slope changes depending on where I am already ( Overall conclusion: farmer should produce potatoes while the farmer should produce meat; Assuming each of persons would split the time of production Farmer Rancher (without trade) p = c autarky meat prod. 4 oz 12 oz consumption 4 oz 12 oz potatoes prod. 16 oz 24 oz consumption 16 oz 24 oz meat pot. 0 oz = 30 oz (or changing the price: 34 oz; but relative price must be higher than opportunity cost to trade at all; if he gets more from the trade than in the production, he would not produce and just trade) farmer rancher with trade meat prod. 0 oz 24 oz (18 oz) consumption 5 oz 19 oz (13 oz) potatoes prod. 32 oz 0 oz (12 oz) consumption 17 oz 15 oz (gives up 15 oz) (27 oz) although the farmer has to give up something, he is a little bit better off with trade – the rancher is not better of because he consumes less potatoes than in autarky ( (now: the rancher gets more in term of meat AND in terms of potatoes) – can be applied to countries as well; rough explanation for international trade patterns (e. g when countries exporting cars and importing oil ( country has comparative advantage in producing cars) Questions to be answered: – so define what comparative & absolute advantage – show in production possibility frontier – who is producing what NOTES FOR EXERCISES FROM OTHER E. G. CHAPTER 2: Demand – How to define these words properly (definition can only be appropriate or not; not right or wrong); it`s not a question of personal disposition What is a Market: A group of people: suppliers (sellers) and buyers (demand) of particular good or service (does not mean that it`s particularly defined or unique; – no general identification strategy; – competitive market: each buyer and seller (individual) has a negligible effect on the market outcome (infinite no. of sellers and buyers) – implications of perfect competitive markets: buyers and sellers operate economically perfect (take price as given)? ( e. g. we have no influence over the price: take the price as given in a supermarket (no bargaining; no negotiation) ( buyers and sellers are both price takers – in monopolies: price taker vs. price setter Perfect Market and Competitive Market Monopoly, Oligopoly, Monopson, Monopolistic Competition DEMAND
Quantity Demanded: is the amount of a good, that buyers are willing and able to purchase (now) Law of Demand: States that, other things equal, the quantity demanded of a good falls when price of the good rises (slopes downward) Demand Schedule: The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. Demand Curve: Q(p) = p ( function of p (y (x) = 2x): if price changes, the Qd changes MARKET DEMAND vs. INDIVIDUAL DEMAND ( everybody has a single demand: the sum of it = market demand (for a special good demanded) ( demands are added horizontally [pic] Changes in Quantity Demanded: ( result in an movement ON the curve, caused by a change in the price of the product [pic] Examples for incentives that induce a changed Qd: 1. PRICE (given as a variable on the demand curve) 2.

Consumer income:normal good: I increase ( Qd decrease; I decrease ( Qd decrease inferior good: I increase ( Qd decrease; I decrease ( Qd increase Normal Good: a good for which, other things equal, an increase in income leads to an increase in demand Inferior Good: a good for which, other things equal, an increase in income leads to a decrease in demand 3. Price of related goods: Substitutes: two goods for which an increase in the price of one leads to an increase in the demand for the other (e. g. orange juice & apple juice): P increase ( Qd increase; P decrease ( Qd decrease Complements: two good for which an increase in the price of one leads to a decrease in the demand of the other (e. g.
DVDs & DVD-Players): P increase ( Qd decrease; P decrease ( Qd increase 4. Tastes (fashion, food): economists only examine what happens when tastes change 5. Expectations: may affect demand of a good or service today 6. Number of Buyers: determines the Qd in a market: NoB increase ( Qd increase; NoB decrease ( Qd decrease [pic] ( result in a shifts in the demand curve: when Qd changes because of certain circumstances. But price doesn`t change!!! ( not only price can change demand: a shift in the demand either to left (decrease) or the right (increase) ( caused by any change that alters the demand: everything except the price!! [pic] SUPPLY
Quantity supplied (Qs): is the amount of a good that sellers are willing or able to sell (now) Law of supply: states that, other things equal, the quantity supplied of a good rises when the price of the other good rises (slopes upward: positively related) Supply schedule: is a table that shows the relationship between the price of the good and the quantity supplied [pic] – usually the small “q” refers to the individual supply (a firm) and the “Q” refers to the market supply (all firms in the market – market supply: refers to the sum of all individual supplies for all sellers of a particular good or service: ( individual supply curves are summed horizontally to obtain the market supply curve – ( S(p) = S1(p) + S2 (p) +… Sm(p) [pic] the sum of 2 individual supplies ($2 ( 3 cones; $ 2 ( 4 cones = $ 2 ( 7 cones in the market supply – if the suppliers (sellers) drop out of the market, the supply would increase with the price – (the supply curve represents the set of profit maximizing quantities for firms) – e. g supply function: q(s) = -4 + 8p; 0 = -4 + 8; 8p = 4; p = ? ( is the minimum price required to get any firm to produce at all (within this given supply curve) ( if the price would be below ? the quantity supplied would be 0, so there would be no firm to produce at all; – slope: change in price divided by change in quantity: e. g. 0 – ? : 4 – 0 = 1/8 (slope), which doesn`t change when the function is linear!! Change in the quantity supplied: – A rise in the price of ice cream results in a movement along the curve (law of supply), so when price changes nothing shifts!! – Shifts of the upply curve: Determinants of change in supply: – Any change that raises the quantity that sellers wish to produce at a given price shifts the supply curve to the right. Any change that lowers the quantity that sellers wish to produce at a given price shifts the supply curve to the left [pic] 1. Input prices: (labor, material, land, rent: anything that goes into the manufacturing process of the item in question): Input Pr. increase ( S decrease; Input Pr. decrease ( S increase 2. Technology: Technology increase ( S increase; Technology decrease ( S decrease: Techn. In economic terms is the process by which inputs are converted to outputs; 3.
Expectations: supply today depends on future expectations: e. g. when higher price of ice-cream expected in future ( store some ice cream ( supply less today! 4. Number of sellers (only relevant in market supply) [pic] Supply and Demand together: Equilibrium: a situation in which supply and demand have been brought into balance (quantity supplied equals quantity demanded Equilibrium Price: the price that balances quantity supplied and quantity demanded. On a graph it it’s the price, where demand and supply curves intersect Equilibrium Quantity: the quantity supplied and the quantity demanded when the price has adjusted to balance supply and demand [pic]
Ceterius Paribus: other things being equal (latin): all variables other than the one being studied are assumed to be constant Markets Not in Equilibrium A)B) [pic] [pic] Surplus: A situation in which the quantity supplied is greater than the quantity demanded Shortage: A situation in which the quantity demanded is greater than the quantity supplied Law of supply and demand: the claim that the price of any good adjusts to bring the supply and demand for that good into balance – A): when price for ice cream is over the equilibrium price ( quantity demanded is still 4, but the quantity supplied rises to 10 ( there are too many cones produced which can`t be all sold (surplus) bec. f the low demand; ( sellers have to reduce the price again; (prices continues to fall until market reaches equlibrium) – B): when price for ice cream is below the equilibrium price ( quantity supplied 4 exceeds quantity demanded, which is now at 10 (shortage of the good); ( sellers can raise the prices without losing sales; as prices are rising the market moves again toward the equilibrium – market activity of many buyers & sellers automatically pushes prices toward equil. (law of s & d) – Once equil. is reached all buyers & sellers are satisfied & no upward or downward pressure on price Three Steps to Analyzing Changes in The Equilibrium analyzing the change in the market equilibrium through comparative statistics – comparing two statistics: new and old equilibrium – Three steps to decide: – 1. Does event shift the supply curve, the demand curve, or both? – 2. Does the curve shifts to the left or the right side? – 3. Using the supply-and-demand diagram to examine how the shift affects equilibrium price and quantity A) HOW AN INCREASE IN DEMAND AFFECTS THE EQUILIBRIUM. An event that raises quantity demanded at any given price shifts the demand curve to the right. The equilibrium price and the equilibrium quantity both rise. Here, an abnormally hot summer causes buyers to demand more ice cream.
The demand curve shifts from D1 to D2, which causes the equilibrium price to rise from $2. 00 to $2. 50 and the equilibrium quantity to rise from 7 to 10 cones. A)B) [pic][pic] B) HOW A DECREASE IN SUPPLY AFFECTS THE EQUILIBRIUM. An event that reduces quantity supplied at any given price shifts the supply curve to the left. The equilibrium price rises, and the equilibrium quantity falls. Here, an earthquake causes sellers to supply less ice cream. The supply curve shifts from S1 to S2, which causes the equilibrium price to rise from $2. 00 to $2. 50 and the equilibrium quantity to fall from 7 to 4 cones. Shifts in the Curve vs. Movements along the Curve:
Notice that when hot weather drives up the price of ice cream, the quantity of ice cream that firms supply rises, even though the supply curve remains the same. In this case, economists say there has been an increase in “quantity supplied” but no change in “supply. ” “Supply” refers to the position of the supply curve, whereas the “quantity sup- plied” refers to the amount suppliers wish to sell. To summarize, a shift in the supply curve is called a “change in supply,” and a shift in the demand curve is called a “change in demand. ” A movement along a fixed supply curve is called a “change in the quantity supplied,” and a movement along a fixed demand curve is called a “change in the quantity demanded. ” [pic][pic] A SHIFT IN BOTH SUPPLY AND DEMAND.
Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes are possible. In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from Q1 to Q2. (bec. large increase in demand and small decrease in supply) In panel (b), the equilibrium price again rises from P1 to P2, but the equilibrium quantity falls from Q1 to Q2. (because small increase in demand and large decrease in supply) [pic] [pic] NOTES: Elasticity – measures the responsivness for to the quantity demanded and the quantity supplied to a change in the market price by 1 % – measures percentage change in the quantity to a percentage change in price (or other determinants)
Price Elasticity of Demand: a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. Determinants of Price Elasticity of Demand: (How do we react to price changes? ) 1. Necessities vs. Luxury goods (depends on personal perception but in general terms: inelastic vs. elastic); e. g. Food, shelter, clothes vs. diamonds, sailboats etc… 2. Availability of close substitute (few vs. less = inelastic vs. elastic) 3. Market Definition (broad vs. narrowed; e. g. Cars vs. Ford Focus; Food vs. Bread…) 4. Time Horizon (short vs. long; e. g. the adjustment over a short period of time to gasoline price changes vs. long period of time)

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