Principal of Economics Lecture / Textbook Notes

Week 1 - Introduction / Choices and Trade-offs

What is economics?
• The study of choices people and societies make to attain their unlimited wants, given their scarce resources.
Economics is all about resource allocation.

Scarcity: The situation in which unlimited wants exceed the limited resources available to fulfil those wants.
Resources: Inputs used such as land, water and minerals, labour, capital and entrepreneurial ability.
Trade-off: The idea that, because of scarcity, producing more of one good or service means producing less of
another or service.

Key Economic Choices

What
• What goods and services will be produced? ( What will our consumers buy and producers sell?)

How
• How will the goods and service be produced? (Manual labour or machines?)

Who
• Who will receive the goods and services produced? (Do we sell them internationally, domestically, lower
price for lower income people etc)

Market
• A group of buyers and sellers of a good or service and the institution or arrangement by which they come
together to trade.

Market Economy
• An economy in which the decisions of households and firms interacting in markets allocate economic
resources.
• In a market economy, consumers get to choose what goods and services to buy. Not allocated a certain of
resources that are given to you, or you are limited to buy. You make the decision of by yourself.
• Central feature of market economies is consumer sovereignty.
• Consumer sovereignty: The concept that in a market economy it is ultimately consumers who decide what
goods and services will be produced.
• E.g - Consumers decide what goods and services are going to be produced. (Apple exam, nobody wants,
price drops, pears?) This occurs because firms must produce goods and services that meet the wants of
consumers, or the firms will go out business.
• In a market economy, we are making that the consumers are making rational and effective choices, and that
their actions don’t have consequences for others.

Centrally Planned Economy

• An economy in which the government decides how economic resources will be allocated.

Mixed Economy
• An economy in which most economic decisions result from the interactions of buyers and sellers in markets,
but in which the government plays a significant role in the allocation of resources. (Australia is a mixed
economy, more of a market economy however.)
 Efficiency
Productive efficiency: When a good or service produced using the least amount of resources. (There’s no
waste, or extra waste than normal. Using least of resources and least amount of waste.) (Competition amongst
sellers)

Allocative efficiency: When production reflects consumers preferences; in particular, every good or service is
produced up the points where the last unit unit provides a marginal benefit to consumers equal to the marginal
cost of producing it.

Dynamic efficiency: Occurs when new technology and innovation are adapted over time.

Equity
“The fair distribution of economic benefits between individuals and between societies”

Microeconomics and Macroeconomics

Microeconomics : The study of how households and firms make choices, how they interact in market, and how
the government attempts to influence their choices. ( Individuals, or legal entity. BHP - many people working
there but one firm at a time. Local cafe with a family member. Single decision making entity. )

Macroeconomics : The study of the whole economy as a whole, including topics such as inflation,
unemployment, and economic growth.

Models in Economics
• Decide on the assumptions of the model, to create a SIMPLIFIED description of reality. (When we are trying
to understand, what are some of the key phenomenon, key driving forces that are influencing individual firms
and house holds, the government makes individual choices, we want to stripe of complexity. We want to
focus on 1 or 2 issues at a time.
• Create a model under those assumptions.
• Often using maths or diagrams to describe relationships.
• Use that model to make predictions or to generate hypotheses.
• Test the model using data.

Assumptions
• Assumptions are SUPER IMPORTANT.
• They should be driven by data, and by a theoretical understanding of how they affect the model.
• Assumptions that are demonstrably false may be appropriate in some models.
• It is important if they may have driven the result.
• Assumptions should be different depending on the context and questions under investigation.

Rationality
• People are rational.
• People respond to economic incentives.
• Optimal decision are made at the margin. Marginal analysis: Analysis that involves comparing marginal
benefits and marginal costs.
Opportunity Cost
Definition: The highest-valued alternative that must be given up to engage in an activity.

Marginal Benefit = Marginal Cost

Production Possibility Frontier

L

A curve showing the maximum attainable combinations of two products that maybe be produced with available resources and
current technology.

Quantity combination thati s

A

f
of Sedans A unattainable with current
·

produced per resources.

day ↑
D

apageoratthe

of SUVs
Quantity
day.
Acombinationthatie
s
produced per

all resources are not

being used.

Increasing Marginal Opporturnity Cost

• The bowed-out shape of the PPF illustrates the concept of increasing marginal opportunity cost.
• Increasing marginal opportunities costs demonstrates an important economic concept. The more resources already devoted
to an activity, the smaller the pay off to devoting additional resources to that activity.
• Not all resources are equally productive in all activities.
• If there is a change in technology/ anything that would affect both axis on the PPF it would get bigger. As indicated below.

"I
Comparative and Absolute Advantage
Absolute advantage - the ability of a individual, firm or country to produce more of a good or service than other producers,
using the same amount of resources.

Tables Per Hour Chairs per hour

You 3 ↳

Your friend 6 12

Your friend has absolute advantage with both cars and tables.

Absolute advantage - How much can each individual produce?

Comparative advantage - Going to determine who should produce what? Just cause an individual as absolute advantage in
both does not mean he would have comparative advantage.

OC of tables O2 chairs
of

3/2=1.5 tables per

You 2/3 0.67 chairs per
=

table chair

1216=2 chairs 6/12=0.5 tables per chair

Your friend per table

Comparative advantage is who has the lowest opportunity cost.

Definition - The ability of an individual, firm or country produce a good or service at a lower opportunity cost than other
produces.
·

Gains from trade - producing what your good at and relying on the other to produce what they are good at. If each producer
specialises in the task in which they have comparative advantage, then we can have gains from trade.

The Market System

Market: A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to
trade.

Product Market: Markets for goods (such as computer) and services (such as medical treatments).

Factor Market: Markets for the factors of production, such as labour, capital, natural resources and entrepreneurial ability.

Factors of production: Labour, capital, natural resources and entrepreneurial ability used to produce good and services.

Free Market: A market with few government restrictions on how a good and service can be produced or sold. Or on how a
factor of production can be employed.

Topic 2: Demand and Supply

Quantity Demanded: The amount of a good or service that a consumer is willing and able to buy at a given price.

Demanded Schedule: A table showing the relationship between the price of a product and the quantity and quantity of the
product demanded.

Demanded Curve: A curve that shows the relationship between the price of a product and quantity of the product demanded.

Market Demand: The demand by all the consumers of a given good service or service.
 Topic 2: Demand and Supply
The law of demand:
• Holding everything else constant, when the price of a product falls, the quantity demanded will increase, and when the price
of a product rises the quantity demanded will decrease. (Possible exam q)

The substitution effect:

• The change in the quantity demanded of a good or service that results from a change in price making the good or service
more or less expensive relative to other goods and services that are substitutes. (Holding the constant effect of the price
change on consumer purchasing power.

When we change the price of a good, we change how relatively expensive it is to other goods. ( Decreasing price makes it more
desirable than other goods).

The income effect (Changing the price has another effect)

• The change in quantity demanded of a good or service that results from the effect of a change in price on consumer
purchasing power. (Holding all other factors constant)

• Example: Groceries - All the prices of all groceries went down, (more money to spend on other stuff). Lowering prices of all
groceries - the substitution effect says here that we should buy more groceries. However, consumer might not want to
spend all the money on extra groceries, can use that cash to buy other goods.
• Price of groceries going down = cheaper / Income Effect / Buying more of other goods due to a different good becoming
cheaper.

CETERIS PARIBUS - (All else being equal ) - The requirement that when analysing the relationship between two variables - such
as price and quantity demanded - other variables must be held constant.

Holarsnoe
Increase
Change in demand:
The whole curve moves left or right.
"demand,
It does not mean the same thing as
quantity demanded. Decrease
indemand
j
Demand, De

Demand, Di

Demand, Ds

8 Quantity
Stablets per month)

Variables that shift demand curve

• Prices of related goods. The current price of the product does not shift the demand curve, we would move along the
demand curve.
• Income
• Population and demographics
• Taste and preferences
• Expected future prices
All of these will shift the demand curve.
 Topic 2: Demand and Supply
Related goods - substitutes or Complimentary Goods

Substitute Goods: Goods or services that can be used for the same or similar purpose. (If price of Pepsi falls, some people
move away from coke and buy Pepsi)

If the price of a substitute increases than demand for other products will increase.
If the price of a substitute decreases than demand for other products decrease.

Complementary Goods: Goods and services that are used together. (That complement each other eg bread & jam, milk &
cereal, car & petrol, gin & tonic).

If the price of a compliment increases, then demand for the other product will decrease.
If the price of a compliment decreases, then demand for the other product will increase.

Income

Normal Goods:
• If income increases, demand will increase.
• In income decreases, demand will decrease.

Inferior Goods:
• If income increases, demand will decrease.
• If income decreases, demand will increase.

Population and Demographics

• As the population increases, the demand for good and services will increase.

Demographics: Changes in the characteristics of a population with respect to age, race and gender.
• Demographics influence the demand for particular goods and service.

Taste and Preferences

A broad category that refers to the many subjective elements that can influence a consumers plan to buy a good or service.
• Seasons (EG ice cream in summer)
• Trends / Fashion (Cargo pants)
• Changes in information
• Expected future prices - Consumers choose when to buy goods and services and serves based on their expectations
future prices relative to present prices. If consumers expect prices to increase in the future, they have an incentive to
increase purchases now, and vice versa.

Supply

Quantity supplied: The amount of a good or service that a firm is willing and able to supply at a given price.

Supply Schedule: A table showing the relationship between the price of a product and the quantity of the product supplied.

Supply Curve: A curve that shows the relationship between the price of a product and the quantity of the product supplied.

Market Supply: The supply by all firms of a given good or service.

The Law of Supply

Holding everything else constant, an increase in the price of the product causes an increase in the quantity supplied, and a
decrease in the price of a product causes a decrease in the quantity supplied.
 an
Supply, Sa

i
Supply, S,

says

Quantity

Variables that shift supply curves

• Price of inputs (our labour, wheat seeds or water)

• Technological change
• Price of substitute in production
• Number of firms in the market
• Expected future prices

Increase in productivity will shift right.

Prices of inputs
• An input is anything used in the production of a good or service.
• An increase in the cost of an input increases the cost of production. The firm supplies less.
• A decrease in the cost of an input decreases the cost of production at every price. The firm supplies more at every price.

Technical Change
• A change in the ability of a firm to produce output with a given quantity of input.
• Technological change allows the firm to produce more outputs with the same amount of inputs. So will tend to increase the
supply.
• Productivity: the input produced per unit of input.

Prices of Substitutes in Production

• Substitutes in production are alternative products a firm can produce with the same reasons.
• An increase in the price of a substitution in production decrease the supply of initial good, while a decrease in the price of a
substitute in production increases the supply of the initial good.

Number of firms in the market

• When new firms enter the market, supply increases.
• When firms exit the market, supply decreases.

Expected future prices

• An increase in the expected future price will cause supply to decrease now.
• The reason being is that firms will want to hold on to goods/inventory/stock to sell at a higher price.
• Conversely a decrease in the expected future prices will cause supply now to increase.
Demand and Supply Market Equilibrium
Pric

$500 iquilibrium

Tal nkan
-

Equilibrium price supplied.

which quantity demanded
equal quantity
at
Equilibrium price:The price

5
Equilibrium Quantity
quantity

Market Equilibrium: A situation in which quantity demanded equals quantity supplied.

Surplus: A situation in which the quantity supplied is greater than the quantity demanded.

Shortage: A situation in which quality demanded is greater than the quantity supplied.

Changes in the market

Four basic cases:
• Increase in demand - Increase in price and increase in quantity

• Decrease in demand - Decrease in price and increase in quantity

• Increase in supply - Decrease in price and increase in quantity

• Decrease in supply - Increase in price and decrease in in quantity

Topic 3: Elasticity / Economic Efficiency

Formula of “Price elasticity of demand” = Percentage change in quantity demanded / percentage change in price

Elastic demand and Inelastic Demand

Product 1: A 10% price increase leads to 20% decrease in the quantity demanded.
Product 2: A 10% price increase leads to 5% decrease in the quantity demanded.

Product 1: Use formula: -20/10 = -2.

Demand is said to be ‘elastic’ when the percentage change in quantity demanded is larger that percentage change in price, or in
other words when the absolute value is greater than “1”.

Product 2: Use formula: -5/10 = -0.5%

Price elasticity of demand is always negative. “Can refer as absolute value”.

 Topic 3: Elasticity / Economic Efficiency
demanded
Calculating price elasticity of demand
Price elasticity ofdemand
-
antity
change
Price

*
Demand
Price Elasticity of

agal:
Pave
"-:di
B

Demand

Q -
Q2 Quantity

Demand Curves

Price Price

Demand

demand
perfectly elastic
Price elasticityof demand:infinity

demand
Perfectly inelastic

Price ofelasticity of demand 8

=

Demand
P,

Qu Quantity
Quantity
No matter how much price increases

demand will remain the same.

Determinants of price elasticity of demand

• Availability of close and substitutes (Elastic)
• Passage of time (Time horizon is short (Inelastic))
• Luxuries versus necessities (Necessities - inelastic and luxuries - elastic )
• Definition of market (The narrower the definition of the market, the more likely to be elastic)
• Share of the good in consumers budget (If share is relatively small demand is likely to be inelastic)

Revenue

Total Revenue = Price x Quantity Sold (However, if price is decreased, more will be sold, but each at a lower price. Does
the total revenue increase of decrease? )

When demand prices is inelastic:

• A decrease in price leads to a decrease in total revenue.
• An increase in price leads to an increase in total revenue.

When demand price is elastic:

• A decrease in price leads to an increase in total revenue
• An increase in price leads to a decrease in total revenue.
 Topic 3: Elasticity / Economic Efficiency
Cross price elasticity of demand

Formula of “Cross price elasticity of demand” = percentage change in quantity demanded of one good / percentage change in
price of another good. (Positive or negative number here matters)

• Cross price elasticity of demand is positive for substitutes.

• Cross price elasticity of demand is negative for compliments
• Cross price elasticity of demand is zero for unrelated goods.

Income elasticity of demand

Formula of “Income elasticity of demand” = percentage change in quantity demanded / percentage change in income.

Income elasticity of demand is positive for normal goods.

• Luxuries goods are those with income elasticity greater than 1.
• Necessity goods are those with income elasticity between 0 and 1.
• Income elasticity of demands is negative for inferior goods.

Price Elasticity of Supply

Formula of “Price elasticity of Supply” = percentage change in quantity supplied / percentage change in price

Will always be positive.

• If greater than 1: Supply is elastic

• If it is less than 1: Supply is inelastic

Determinants of the price elasticity of supply

• Passage of time - If time of passage is relative short: Inelastic. If time of passage is relative long: Elastic
• Type of industry
• Availability of inputs - If inputs are easily available: elastic. If inputs are scarce and hard to find: Inelastic.
• Exisiting capacity
• Inventories held

Supply Curve

Price Price

Supply

perfectlylasticsucy=infiniteis
Perfectly inelastic supply
Price ofelasticity of supply
0
=

P, Supply

Qu Quantity
Quantity
 Topic 3: Elasticity / Economic Efficiency

Consumer surplus and Marginal Benefit

Consumer surplus: The difference between the highest price a consumer is willing to pay and the price the consumer actually
pays. Consumer surplus measures the net benefit (total benefit minus total price paid) to consume

Marginal Benefit: The additional benefit to a consumer from consuming one more unit of a god or service.

Producer surplus and marginal cost

Producer Surplus: The difference between the lowest price a firm would have been willing to accept and the price it actually
receives. Producer surplus measures the net benefit (total benefit minus total cost of production) to producers from participating
in a market.
·

Marginal Cost: The additional cost to a firm from producing one more unit of a good or service.

The efficiency of competitive markets

Equilibrium in a competitive market results in the economically efficient level of output where marginal benefit equals marginal
cost.

Economic efficiency: A market outcome in which the marginal benefit to consumers of the last unit consumed is equal to its
marginal cost of production, and where the sum of consumer surplus and producer surplus is at a maximum.

Economic Surplus: The sum of producer surplus and producer surplus.

Deadweight Loss: The reduction in economic surplus resulting from from a market not being in a competitive equilibrium.

Topic 4 Government Intervention in the Market

Price Ceilings
• A price ceiling is when gonverment regulation prevents the price of a good from being an above a certain level. ( EG Rent
Controls - where the price of renting a home is not allowed exceed some price. )
• If the price ceiling is above the market equilibrium price, it does not affect the market outcome.
• The downside of a price ceilings is that the quantity supplied is going to be less than the quantity demanded.

Price Floor
• A price floor is when government regulation prevents the price of a good from being below a certain level. ( EG minimum
wage).
• If he price floor is below the market equilibrium price, it does not affect the market outcome.
Price

"Coin
Price Floor
in

...
could rent
Area C: Firms would have
Area C:Consumers who

i
to hired more workers, inturn
before, are now able
not

canaran"isin iiiiiiii.
rent. Loss in consumers

surplus from people who now

don't
h ave a place to live.

Few :cass in producers

price who were willing to supply a

has in.Therewaws ere

room, when the price was $200.

I
I
I
I
!

Equilibrium Quantity Quantity

quantity quantity

no ceiling ceiling no floor floor

CS at b c+
a b
+
d
+ CS at b c+
a

PS d e f
+ +
f PS d 2
+

b d
+

a+b + c d e f a b d
+ +
f
+
a +b +c d + a b d
+ +

↑S
+ +

↑S
+ +

DWL C 2
= + DWL C+ 2
=
 Topic 4 Government Intervention in the Market

Alper-unit) Tax Alper-unit) Tax

Price
Price

S in"ina
S,
Consumer
Supply ($2 tax)

. say...in
Surplus

I BWL b
=

g
+

Producer

Surplus
E
Quantity

Who pays the tax?

It doesn’t matter who pays the tax, but who bears the burden of the tax.
• Firms are collecting the tax on behalf of the government and then they pass it on.

Tax Incidents or Tax Burdens (Same meaning) D

• When the tax was implemented, the quantity traded reduced, the consumer surplus reduced, and the producer surplus
reduced.
• What matters here is, ‘how big of a share of that reduction came from a reduction in consumer surplus and how big of a
reduction came from a reduction in producer surplus. This is all going to depend on elasticity.
• In a relatively inelastic demand curve the ‘consumers’ will bear the burden of the tax.
• If we have a perfectly inelastic demand the ‘consumers’ will bear the full burden of the tax.
• The opposite is true, if we have a relatively inelastic supply , the ‘producers’ will bear the burden of the tax.

(Per-Unit) Subsidies - Opposite of tax

• Supply curve shifts downwards. - Deadweight loss will exist.
• Deadweight loss opposite of tax.

Why the government might intervene?

• Maintaining and enforcing competition
• natural monopolies
• Externalities
• Merit Goods
• The legal system and the rule of law
• Public goods
• Common resources
• Asymmetric information
• Equity
• Stabilisation (macroeconomics) policy

Externalites
An externality where either the consumption or production of a good or service impacts on a third party other than the
consumers and the producer.

A negative externality exists when the production or consumption of a product results in a cost to a third party. Air and noise
pollution are commonly cited examples of negative externalities.

A positive externality exists when a benefit spills over to a third-party.

 Externalities

Negative production externality

• Electricity production, paper production, air and noise pollution

Positive production externality

• Production requiring R&D

Negative consumption externality

• Cigarettes, pollution from cars, traffic congestion

Positive consumption externality

• Vaccinations, education

The marginal private costs (MC) or marginal private benefits (MB) differ from the marginal social costs (MSC) or marginal
social benefits (MSB) by the amount of the externality.

• Negative production externality: MSC > MC

• Positive production externality: MSC > MC
• Negative consumption externality: MSB > MB
• Positive consumption externality: MSB > MB

Equilibrium is determined when the Demand (MB) and Supply (MC) intersect.

The intersection of MSB and MSC determines the efficient outcome. (Socially efficient outcome)

Negative Production Externality

Me is

The gapbetweenMC and

↑
Price
Price

MC MEC
+

MSC
=

yayilscene,
External
MEC
.
Marginal
S MC
= Cost
the

·
-in
casted on
of
cost
electricity,

/I
represents costo f
costo fworkers.
coal, costofwater, ----------

f --

Demand MB MSB
=
=

Quantity

riconepresen
)
a b c d
+ +
+

... DWL = -
e
 Topic 4 Government Intervention in the Market

The Coase Theorem: That if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities.

Limitations to the Coase Theorem:

• High transactions costs
• If there is a large number of parties involved in bargaining
• Unreasonable demands
• All parties must have full information about the costs and benefits of pollution reduction.

Using taxes to reduce the quantity traded, for a negative production externality.
• Negative production externality, a competitive market will deliver overproduction, and thus cause a dead weight loss.
• Taxes that are imposed in a competitive market with no problems before the tax, results in underproduction, and also causes a dead
weight loss.
• If we combine tax with a negative production externality come together and is called a Pigovian Tax.
• Using a tax to reduce the quantity produced. - EG Carbon tax
• Have firms pay for the pollution they produce.
• Negative Production Externality - Impose a tax equal to the marginal external cost of production at the efficient quantity.

This is called “Internalise the externality”. Firms paying for the waste they produce.

Topic 5 Firms, Productions and Costs

A Firm
An economic unit that hires factors of production and organises those factors to produce and sell goods and services
• A firms goal is to maximise profits.
• Profit = Total revenue - total costs
• Economic profit = total revenue - total economic cost.
• Explicit cost: A cost that involves spending money.
• Implicit cost: A non-monetary opportunity cost. - You should be paid for your ideas, your skill and ability.

Opportunity Costs
• Economic Depreciation
• Forgone Interest
• Business Owner’s time
• Normal Profit - The required profit to make you just willing to run the fries, given the risks. Including paying for forage interest, business
owners’s time etc.
• Zero economic profit is a not a bad thing.

Technology
The processes a firm uses to inputs into outputs of goods and services.

The firm’s problem

Goal: Maximise economic profit.

Constraints:
Subject to the available technology. ( Our Focus in this topic)
Subject to consumer demand.

Short run and long run

Short Run: The period of time during which at least on of the firm’s inputs is fixed. (Coffee eg - rental agreement for size of cafe, fixed
input, Number of big expresso machines, Car manufacturing plant )

Long Run: A period of time long enough to allow a firm to vary all of its inputs, to adopt new technology and to increase or decrease the
size of its physical plant.

Short Run (Production function)

• The relationship between the amount of inputs used by a firm and the maximum output that can be produced with those inputs.
• Example - if ‘Labour’ is the one input we can vary in the short run, the it is a relationship between ‘labour’ and ‘output’.
Topic 5: Firms, Productions and Costs

Marginal Product and Average Product

Marginal Product
Marginal product is the additional output that a firm can produce for one additional unit of input.
• Marginal is important, as it helps us figure what quantity to make to maximise profits?
• (Should I hire an extra worker? / Should I produce on more unit of output ? / Is it actually good for me? )

Marginal Product = Change in total output / Unit change in input

( As we add one more worker, what extra output do I get?)

Average product is the total output divided by the number of units of the input.
• Average is important when we calculate what our profits would actually be at that level.
Average Product = quality of output / quantity of input

• Marginal product increases due to divans of labour and specialisation. Cafe example

Law of Diminishing Returns

• The principle that, at some points, adding more of a variable input, such as labour, to the same amount of a fixed input,
such as capital, will cause the marginal product of the bearable input to decline.

Fixed Costs and Variable Costs

• Fixed costs are costs that stay constant irrespective of the amount of produced. - Example rent must be payed no matter
what. Even if the remained closed or however amount of sales were made. Labour - is a variable cost.
• Labour costs may be variable costs, since to produce more output you imply more workers for more hours.

Total Costs , Fixed Costs and Variable Costs

Total costs are all costs, including both fixed and variable costs.
• TC = FC + VC

ATC, AFC, & AVC

• Average Total Cost = TC / Q of output
• Average Fixed Costs = FC / Q of output
• Average Variable Costs - VC / Q of output

Marginal Costs
• Marginal cost is the additional cost per unit of output.
MC = Change TC / Change Q = Change VC / Q

Long Run / Economies of Scale

Economies of scale are when the long run average costs fall as the quantity is increased.

This can occur for reasons such as:

• Technology in that industry can be such that it is cheaper per unit to produce more. (If store is small, no need for electronic
scanners)
• Staff can specialise better in task
• The firm’s bargaining power can increase

Constant Returns Scales

Sometimes we think that he long run average cost curve might be flat, or might have a flat region at the Botton, Along those
quantities of output, the scale of the firm does not affect the average cost.

Minimum efficient scale

If the minimum of the “Long Run Average Cost’ curve is just one point, that is called the efficient scale.

But if the minimum is a longer ‘flat’ part, we call the minimum quantity at which LRAC take its mimic value the ‘minimum
efficient scale’.

Diseconomies of Scale
Benefits of being a larger firm are being exhausted, and there could be some disadvantages. Thus meaning the LRAC curve
might increase again. When the LRAC is increasing, there are diseconomies of scale.
Topic 5 Firms, Productions and Costs

Its important to not confuse short run and long run.

Diminishing Returns
• A short run concept
• Marginal product of ONE input eventually decreases BECAUSE OTHERS ARE FIXED.
• Explains why Marginal Cost curve eventually slopes upwards.

Diseconomies of Scale
• A long run concept
• The firm can vary ALL its inputs - but even so at some points becomes too large to operate effectively.
• Explains why LRAC sometimes slopes upward.

Topic 6 Perfect Competition and Monopoly

Market Structure
4 types of Market Structure

1. Perfect Competition
• Many firms
• Produce a virtually identical product
• Its easy to enter and exit / Easy to change fixed inputs
• Easy to close
• ( Examples, Wheat or Apples, individual producer)
• Firms are ‘Price Takers’, meanings that they are unable to affect the market price. Meaning a new firm, can not change the
price market price.
• Firms have to choose quality produced to maximise profits, given the market price.
• Firms can and will enter (Or exit) the market if there are (aren’t) economics profits to be made.
• Perfectly elastic - even if you doubled production it wouldn’t change market price.

Maximising Profit in a Perfectly Competitive Market

• Profit = Total Revenue - Total Cost
• Maximise profits -> Marginal Revenue = Marginal Cost ( The one extra product or service provided must equal to the extra
cost of producing that product or service)
• Marginal Revenue - The extra revenue that the firm can get from one more sale.
• If the MR > MC then Quantity of output will increase profits.
• If the MR < MC then decreasing the Quantity of output will increase profits.

Price Setter
• Profit = P(Q) x Q - TC(Q) (Price is some function of quantity)

Price Taker (Competitive Market)

• Profit = P x Q - TC(Q) (Price is fixed)
• Marginal Revenue = Market Price ‘P’
• Profit = (P - ATC) x Q
• If price is below the ATC, profit will be negative.

Break even (Short Term)

• If P > ATC, positive economic profit.
• if P < ATC, economic loss.
• If P = ATC, firm breaks even, Total cost = total revenue. No loss or profit.
• Firms make negative profits / break even making zero profits is good. - Short term
• A Cost that has already been paid and cannot be recovered is also called a ‘sunk cost’. (examples
• Even at negative profits, keep producing cause fixed costs, would make an even larger loss if you shut down. (Reasoning
producing at P < ATC, better than producing zero). As shutting down you would still have to pay fixed costs.
• Firms will be willing to operate for zero economic profits. (LONG RUN)
•
SHUTDOWN in the SHORT RUN
• P > AVC, firm should produce. (Still making a loss, not being able to afford fixed cost, but can cover variable cost, firm will
stay open in short run, but long run they should shutdown.)
• P < AVC, firm should shut down. (Paying for fixed cost, and variable cost, but not being able to afford either)
• P = AVC, ‘Shut down point’.
Topic 5: Perfect Competition and Monopoly

Perfect Competition
• In the long run, in a perfect competition market, the supply curve will be perfectly elastic.
Constant cost industry (Horizotonal long-run supply curve)
Increasing cost industry (Up-ward sloping long-run supply curve)
Decreasing cost industry (downward-sloping long-run supply curve)

Productive Efficiency
• Good or service produced using the lest resources

Allocative Efficiency
• Goods are produced that consumers value the most
• marginal cost = marginal benefit

Dynamic Efficiency
• Changes and new technologies are adopted over time to improve productive and allocative efficiency.

2. Monopoly
• There is only one seller of a good or service that has no close substitutes.
• Natural Monopoly - Comes from having really high fixed cost. Usually government takes over, and provides services or
products at times. Government will charge at ATC, means that the profit will be zero. This also means the quantity provided
will also be close to the socially efficient quantity.

Reasons for a monopoly

• Intellectual property protections (reader author, pirate movies)
• Government mandated monopoly (Aus post)
• Control (almost) all of a certain resource (
• Network externalities
• Natural Monopoly (Very high fixed costs, not worth it for a second firm to enter the market.

• One firm
• Unique product / Cause only one firm making it
• Difficult to enter /
• Example - Open a waste management provision service, might be restrictions on who can enter the market)

• Profit = Total Revenue - Total Cost

• Profit maximisation occurs where MR = MC
• But MR is now a more complex function of quantity.
• A monopolist will aways charge the highest price they can for the quantity sold, so they will be on the downwards sloping
market demand curve.
• Monopolist can set their own price.

• MR has the same vertical intercept as D

• MR has double the slope of D
• This means that at any given P, the MR curve will take half the value that D does.
• Demand Curve = a-bQ
• MR(Q) = a-2bQ
Topic 6: Perfect Competition and Monopoly

In Comparison between Perfect Competition and Monopoly

• In perfect competition each individual firm takes the price from the market as given, which results in a efficient quantity
being produced. Where demand curve equals marginal cost of supply curve. An equilibrium quantity and price that
maximises total surplus (Both producer and consumer) and zero economic profits in the long run.

• With a monopoly, firm still makes the same choice, in order to maximise profits. That quantity is determined where marginal
revenue = marginal cost. Difference is marginal revenue is lower than demand, as a monopolist, if they want to sell more
goods or services, they must lower the price of the units. Monopolist will be inefficient as they produce to little (quantity),
because the efficient choice would be where marginal benefit = marginal cost. Marginal benefit coming from the consumers.

3. Monopolistic Competition
• Many firms
• Easy to enter (There are no barriers to entry or exit.)
• Products are some what differentiated based on price, quality, branding, features etc
• Key difference is that because products are differentiated, there are always some consumers that prefer your product even if
increase the price. ( Individual firm’s demand curves slope downwards. )
• Examples (Clothing stores, restaurants, cafe - location)(Normal black t-shirt compared to Ralph Lauren black t-shirt)

• MR will also have twice the slope of D. (Same as monopoly)

• Difference is, easy to enter in to market, and also due to positive economic profit will cause competitor firm entry.
• Positive economics profits will encourage more firms to enter, now we have many firms which will cause a decrease in
demand for the firms. (Firms imitate their innovations, or compete with their own different improvements) Demand curve will
shift inwards until there is zero economic profit in the long run. Demand will become more elastic.
• In the long run, zero economic profit because of easy entry and exit.

Price > Marginal Cost - Is Inefficient - Reason is to cover the Development Costs.
Output not at minimum of Average Total Cost. (Excess Capacity)

4. Oligopoly
• Few Firms
• Firms behave strategically
• Barriers to entry
• Identical or different products
• Relatively difficult to enter. (Petrol station, would be challenging, and a lot of legal stuff)
• Examples (Banking, airlines or petrol)(Petrol pump changing prices, knowing other petrol pumps will also changes prices)

Game Theory
• The study (and in particular the models) of how people of firms make decisions in situations where the outcome depends
importantly on interactions with others.

Dominant Strategy
• A strategy that is best for a player, no matter what other strategies their opponents use.

Nash Equilibrium
• A set of strategies where each player is choosing the best strategies chosen by other players. We don’t always need
dominant strategy for Nash equilibrium to occur.
Topic 8: GDP, Unemployment and Inflation

GDP: The market value of all final goods and services produced in a country during a period of time. (GDP should not include
intermediate goods or services).

• Second hang goods are NOT included in GDP.

• Gross = means value of production including the replacement of capital, it does not subtract deprecation.

GDP Problems
• Household production
• The Underground Economy (paying via cash)
• Does not measure distribution of income / inequality
• Education and health care may not be adequately represented
• Pollution, crime or other negatives are not included

Measuring GDP

• The Production Method

The sum of the value all goods and services produced by industries in the economy in a year minus the cost of goods and
services used in the productive process, leaving the value added by the industries.

• The Expenditure Method

The sum of total expenditure on final goods and services by households, investors governments and net exports (the
expenditure on exports minus the expenditure on imports).

• The Income Method

The sum of income generated from the production of goods and services, which includes profits, wages and other employee
payments, income from rent and interested earned.

Components of Expenditure

Y = C + I +G NX

• Y: GDP

• C: Consumption
Spending on households on goods and services. New houses is excluded and included instead in Investment.

• I: Investment (Increasing the productive capacity of the company).

• G: Government Purchases
Spending by any level of government (local, state, federal) on goods or services.

• NX: Net Exports (Net Exports = Exports - Imports)

Exports are goods or services produced in Australia and purchased by foreigners.
Imports are goods and services produced in foreign countries and purchased by Australians.

GDP Deflator = Nominal GDP / Real GDP x 100

Real GDP = Nominal GDP / GDP Deflator x 100

Percentage Change in X = New / Cold x 100

Economic Growth Rate: Growth Rate 2019 to 2020 = RealGDP2020 - RealGDP 2019 / RealGDP 2019 x 100

Unemployment and the Unemployment rate

• Unemployment rate = Number of unemployed / Labour force x 100

The Labour force participation rate

• Labour force participation rate = Labour force / working age population x 100
Topic 8: GDP, Unemployment and Inflation

Unemployment and the Unemployment rate

Cyclical unemployment
• Unemployment caused by a business cycle contraction. (GDP falling)
• Known as ‘demand deficient’ unemployment.
• Comes from firms wanting to produce less. Falling sales leads to firing workers. Might not fire and reduce hours
significantly. (Under employment rate goes up)

Structural unemployment
• Unemployment arising from persistent mismatch between the skills and characteristics of workers and the requirements of
jobs.
• Example ( New technology and changes in consumer tastes may make some workers redundant.)

Frictional unemployment
• Natural change, people moving jobs, moving houses, different job or different location.
• Short term unemployment arising from the process of matching workers with jobs.

Seasonal Unemployment
• Unemployment due to factors such as weather, vacations in tourism and other careener-related events.

Full Employment
• Is the situation when cyclical unemployment is zero.
• Sum of frictional and structural; unemployment. Called the ‘ Natural rate of unemployment rate”. This rate can be changed.

Inflation: The sustained increase in the general level of prices in the economy.

Price Level: A measure of the average prices of goods and services in the economy.

Inflation Rate: The percentage increase in the general price level in the economy from one year to the next.

Consumer Price Index (CPI): A measure of changes in retail prices of a basket of goods and services representative of
consumption expenditure by typical Australian households in capital cities.

CPI = Cost of basket in current year / Cost of basket in base year x 100