8/29/23

What is eco?
Study of markets ( interaction between buyers and sellers)
Cause + effect
Flow of goods & services
How scarce resources are allocated
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Economy- a system for coordinating productive activities
Economics - the study of the production, distribution, and consumption of goods and services (
or the study of the allocation of scarce resources)
Micro eco - study of how individuals make decisions and how these decisions interact
Macro eco - the study of the overall fluctuations of an entire economy
Market economy - an economy in which production and consumption are the result of
decentralized decisions made by many firms and individuals
- The “invisible hand” - the way a market economy harnesses decisions made in self-
interest to result in efficient outcomes
- Market failure- the outcome when individual decisions made in self- interest make
society worse off
Economic tools are an “engine for discovery”
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Characteristics of thinking like an economist
- What does “thinking like an economist” look like, in general?
- Positive analysis
- Marginal analysis
- Model based analysis rooted in assumptions

- What are the three most important foundational concepts in our study of economics?
- Scarcity
- Efficiency
- Opportunity cost
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Positive analysis and marginal analysis
- Positive analysis is descriptive; it attempts to describe the world as it is
- Normative analysis is prescriptive; it attempts to describe the world as it should be
- Marginal analysis considers the cost and benefits of one more unit and involves
making decisions one unit at a time, looking forward rather than backward
Marginal analysis is the change as a result of one more unit
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Economic models - simplification of the world/system
Why do economists use models?
- Understand the effects of small changes

Why do economists assume “all else equal” in models?

- It isolates what we care about
Who are the economic actors
- Consumers, firms, government
What models will we be using in this class?
- Utility
- Production and costs
- Supply and demand and economic surplus
- Markets and imperfect competition
- Comparative advantage
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Assumptions about how individuals behave
- People must make choices because resources are scarce
- The opportunity cost of an item - what you must give up in order to get it - is its true cost
- “How much” decisions require making trade-offs at the margin: comparing the costs and
benefits of doing a little bit more of an activity versus doing a little bit less
- People respond to incentives, exploiting opportunities to make themselves better off

Assumptions about how markets work

- There are gains from exchange
- markets move toward equilibrium
- Resources “should” be used to efficiently to achieve society’s goals
- Markets usually lead to efficiency, but when they don't, government intervention can
improve society’s welfare
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8/31
What are the three most important foundational concepts in our study of economics?
- Scarcity
- Efficiency
- Opportunity cost
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Scarcity - resources are limited ( compared to unlimited wants)
- Reason that econ exists as a field
- All decisions necessarily come with a tradeoff
Efficiency - allocated resources such that total benefit is maximized
- Cannot reallocate resources and have an improvement in total benefit
- Point at which we Maximize number of mutually beneficial transactions
Opportunity costs - what is given up as a result of decisions
- Or the value of the second best option
- Not every other option is possible only the next best option
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Marginal analysis - idea of making decisions one unit at a time, making decisions looking
forward ( not backward) one unit at a time.
Sunk cost - a cost incurred prior to the next decision( that cannot be recovered)
Marginal cost
- Additional cost from one more unit
Marginal benefit
- Additional benefit of one more unit
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Graphs
Generally marginal cost increases with quantity
While Total cost increases at accelerating rate
Generally marginal benefit decreases along with quantity
Total benefit general increases at a decelerating rate

Optimal decision - gives us efficient outcome , makes us as well off as possible

When marginal benefit is > marginal cost do the thing

When marginal benefit is < marginal cost dont do the thing

Optimal quantity is the intersection point of both graphs ( MC = MB )

Optimal decision rule : MB≥MC , keep increasing quantity
Optimal Q is the highest quantity for which MB≥MC
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Consumers
MC - price or opp cost ( other thing they can buy )
MB - marginal utility(usefulness/happiness)

Firms
MC - opp cost of production
MB - price or revenue

Government
MC - opp cost
MB - sum of constituents’ MB

Optimality rule : MC = MB for all of them

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9/5
Consumer choice
- How do consumers make decisions?
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How do consumers make decisions
- Goal : maximize utility, limitation : budget
- Optimality rule?

Utility - usefulness, benefit from consumption

Utility function - relationship between quantity and total utility
More quantity = more total utility ( as quantity increases so does utility)
Marginal utility = extra satisfaction from one more unit
Diminishing marginal utility - each additional unit brings less satisfaction
Principle of diminishing marginal utility - each additional unit brings less additional satisfaction
than the unit before
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Goal is to maximize utility
Limitation : budget ( +prices)
When making “how to buy” decisions
Look at MU/P ( marginal utility per dollar spent)

Opportunity costs (MC): MU/P of the next best good

If MU/P oreos > MU/P of kale Buy oreos

IF MU/P oreos < MU/P of kale Buy Kale

MU/P of oreos = MU/P of kale -> optimal quantity of oreos

A and B

Consume more B: MU/P goes down

Consume less A : MU/P Goes up

This happens until MU/p for b = Mu/p for A

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How do we go from consumer choice to demand?
Demand: relationship between price of a good and the quantity consumers are willing/able to
purchase

MU/low P = high -> QD high

Ex MU:10 P = 1 -> MU/P = 10

MU/ High P= low -> Qd low

Ex MU: 10, P = 5 -> MU/P = 2

Demand = full relationship between all P & all QD ( line on graph)

Quantity demanded is the specific quantity purchased at a specific price ( point on graph)
Change P → change QD not demand ( move along curve to new point)

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Market demand - the sum of all individual demands
Change in price -> change in QD (along)
What might cause demand itself ( full relationship to change )

Increases
Increase ( at every price, Quantity we are willing and able to purchase goes up)
Is preferred
Income Increases( oreos are normal goods)
Income decreases(oreos are inferior goods)
Substitute price increases
Complement price decreases
Change in expectations
Quality increases
# of buyers increases

Decreases
Decrease ( at every price , quantity we are willing and able to purchase goes down)
Aren't preferred
Quality decreases
Incomes goes down( normal good)
Income goes up ( good is inferior)
Substitute price goes down
Complement price rises
Change in expectations
# of buyers decreases

Demand slopes downward because consumers make decisions based on marginal utility per
dollar spent, if P increases MU/P decrease so QD decreases(Opp cost )
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9/7
Goal: shape of demand curve
Elasticity
Measure of responsiveness to changes in price -> Price elasticity ( of demand)
Compares % change in price to % change in QD
% change in QD > % change in P -> sensitive to changes in price : Elastic

% change in QD < % change in P -> not sensitive to changes in price : Inelastic

Elastic
- wants/luxuries
- Long time period
 - Many substitutes
- Large portion of total income

Inelastic
- Necessities
- Short time period
- Few or no close substitute
- Small portion of total income
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How do we calculate price elasticity of demand
% change in QD/ % change in Price

If % change in QD > % change in Price , | % change in QD / Percent change in price|> 1

Elastic

If % change in QD < % change in P , | % change in QD / %change in price | < 1

Inelastic

Relatively elastic demand curve ( sensitive to changes in P ) ( Change in Q big, change in

P small) Flat graph

Relatively inelastic demand curve ( not sensitive to change in P ) change in Q is smaller

then change in P) Very steep graph

Perfectly elastic - horizontal

If price changes at all quantity goes to 0 or Infinity

Perfectly inelastic - vertical

No matter what the price is you always buy the thing
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Elastic : % change in Q big, % change in P small
Total revenue = total expendetirue = P x Q

If P decreases TR increases
If P increases TR decreases

If demand for a good is elastic they should decrease their price to increase revenue
Inelastic % change in Q small , % change in P big

If demand for a good is inelastic they can increase price because they only lose a few Q but you
increase TR
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If demand for a good is elastic and they increase the price the TR will decrease
IF the demand for a good is inelastic and they increase the price the TR will increase

Over long periods of time demand for a good tends to become more elastic
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9/12

How do firms make supply decisions

- Compare marginal cost and marginal benefit
- For today Marginal benefit -> price ( breaking that later)

1) Production function + inputs

2) Costs + cost curves (1-2 today)
3) Compare MC + MB + to choose Q
4) Short run + Long run (3-4 thurs)

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Production function - explanation of how inputs are combined to produce outputs
General inputs
- Land
- Labor
- Physical capital
- Human capital

Labor has diminishing marginal productivity- every additional unit of input adds less output then
the unit before

0
1000
800
600
400

^ MP of ice making company per each additional unit.

Demonstrates diminishing marginal productivity
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Inputs can be classified along two characteristics:

explicit or implicit
Fixed or variable

Explicit: have to pay money for it

Implicit: lost opportunity ( don't have to pay money for it )

Fixed: does not change with quantity of output

Variable : does change with quantity of output

Ice machine

Fixed explicit - machine

Variable explicit - water, electricity, maintenance

Fixed implicit- profit from other use of money that you used to buy machine, other machine that
could have been there

Variable implicit - alternate uses of variable input

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In short run Some costs are fixed

In long run , all costs are variable

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Costs
Total cost ( total opportunity cost ) = explicit cost + implicit cost
= Fixed cost + variable cost
TC = FC + VC

Total cost - increasing in quantity

Average total cost = Total cost / quantity

ATC = TC/Q

Average variable cost = variable cost / quantity

AVC = VC/Q

Average fixed cost = Fixed cost / quantity

AFC = FC/Q

ATC = AVC + AFC

Marginal cost = Change in total cost / change in quantity = change in variable cost / change in
quantity
^ = change in
MC = ^TC/^Q = ^VC/ ^ Q
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Marginal cost is increasing as Q increases due to the diminishing marginal productivity of inputs
AFC approaches but never hits 0
AVC Rises over time
ATC is sum of two other averages
ATC and AVC get closer together
For smaller Quantities Falling AFC drags down average total
For higher quantities rising AVC brings up ATC
MC goes through both min of both ATC and AVC
FC does not impact MC at all
MC intersects AVC and ATC at their minima
If the cost of one more unit is below average it brings it down
If the cost of one more unit is above average it pulls its up
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9/14

Recap
- AFC doesn't affect MC
- If MC is above AVC/Atc it rises , if it is below it pulls it down
- MC intersects AVC at minimum
- ATC is sum of AFC and AVC
- MC intersects ATC at min

Put graph from phone

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Revenue and Profit Definitions
Total revenue - is the total amount earned by firms ( price times quantity)
Marginal revenue - is the additional amount earned by a firm as the result of selling one more
unit of output
Profit - is the total revenue minus total cost
Accounting profit - is total revenue minus total opportunity cost ( explicit cost plus implicit cost)
Economic profit refers to opp cost lost one.
(In this class, “profit” refers to “economic profit” and “total cost” refers to “total opportunity cost”)
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Example
Accounting profit of school = 50, 000 - 35,000 = 15,000
Economic profit of school = 50,000 -35,000 -30,000
economic profit is his accounting profit minus the opportunity cost associated with not working
for his brother.
The primary difference between accounting profits and economic profits concerns implicit costs.
Accounting profit is taken after subtracting explicit costs from revenue and then adjusting the
amount for depreciation. Thus, it deals only with funds that have actually been given and
received. Economic profit, however, considers all opportunity costs, including both explicit
payments and implicit costs. As a result, the economic profit of an enterprise is almost always
smaller than its accounting profit.
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0 100 0 -100
1 121 21 25 25 -96
2 136 15 50 25 -86
3 160 24 75 25 -85
4 200 40 100 25 -100

Put picture from phone

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Tuesday - Costs
Today - revenue + profit
Short run graph

Put picture from phone

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Put graph from phone

Short run graph

If price is lower than ATC you're making a loss

As Long as price is higher than AVC you might as well produce because your stuck paying fixed
cost in short run
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Loss is minimized when MC = MR ( optimal)
The loss is the yellow area between P line and ATC
Put short run graph here
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MC = MR profit maximizing
Put graph
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P = 14
Profit max q = 9
Atc @ profit max quantity = 11
Profit = TR- TC = (PxQ) - (Atc x q) or ( P - ATC)(Q)
= (14-11)(9) = 27

Put graph
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Dont produce because P= MR is below the AVC
Put graph

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In short run: if the MR < AVC : dont produce ( shut down )

If AVC < Mr < ATC : no profit but can cover variable costs ( Should produce where MC = MR)
Note : make an economic loss ( might still have accounting profit, but could do better with a
different use of resources)
If MR > ATC : you are making a profit so you should produce at MC = MR
Note: Make an economic profit ( both an accounting profit and this is a better use than the next
one)
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Illustrate firms decision making w/ a supply curve : relationship between P + Q firm willing ( and
able) to sell
Firms supply curve is MC ( above min of AVC )

Supply curve is optimal as long as its above AVC just mc = mr

Change in price leads to movement along Supply curve to new optimal Quantity supplied

Put supply graph

To shift supply, change marginal cost , itself

- Cost of inputs
- Change in technology
- Anything that might change Variable cost

Add up indiv supply to get market supply

- Changes also with cost of inputs
- With technology
- Number of sellers
- Expectations about future
- Also with profit that could be made in other industries

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If economic profit is 0 then accounting profit is positive

9/19

1. Inc - Dec
2. Decrease - Decrease

C
80
B
a