Economic Way of Thinking

Economic Way of Thinking:

1. What are the basic economic questions that every society must answer?

-What goods and services should be produced, how should they be produced and who consumes them/

1. What are the core ideas that combine to make up the economic way of thinking?

-Logical frame work for organizing your thought & understanding economics, scarcity and choice.

1. How can we analyze production to determine if it is efficient or inefficient and to understand the tradeoffs involved?

-Use of the PPF,

-If we are producing inefficiently, we will be able to produce more of one thing without having to give up some of the other thing.
-If we are producing efficiently, we will NOT be able to produce more of one thing, without giving up some of the other thing.

1. How do absolute advantage, comparative advantage, and specialization affect trade?

-Absolute advantage- when one is more productive than others (needs fewer inputs/take less time)

-Comparative advantage- performs or produces at lower opportunity cost

-Specialization- Roles are broken up to each person

Consumer Choice:

1. How do consumers determine the quantities goods they can consume given their budget (income) and prices?

-Budget line – consumption possibilities

1. Allocate the entire available budget
2. Make the marginal utility per dollar equal for all goods
Marginal utility per dollar is the marginal utility from a good relative to the price paid for the good
Divide the change in marginal utility # (by the total utility change in the good as it goes from one quantity to another) by the price of the good to get the Marginal Utility per Dollar

1. What is the diamond-water paradox and what does marginal utility theory tell us about it?

You have to be able to distinguish between TOTAL Utility and MARGINAL Utility.
Total utility tells us about relative VALUE.
Marginal Utility tells us about relative PRICE.
We use so much water that its marginal utility - the benefit we get from one more glass of water - diminishes to a small value.
Diamonds have a small total utility relative to water, but b/c we buy few diamonds, they have a large marginal utility.
Diamonds have a high price and high marginal utility; water has a low price and low marginal utility - when the high marg utility of diamonds is divided by their high price, the result is a marginal utility per dollar that equals the low marginal utility of water divided by the low PRICE of water.
Therefore, their marginal utilities per dollar are the same. Short Run and Long Run Costs:

1. How do we calculate economic profit given revenue and cost data?

-A firms economic profit equals total revenue minus total cost

1. How do costs affect a firm’s output in the short run?

In the Short Run, fixed costs do not vary with output, but variable costs (labor) DO go up as output increases

1. What is the long-run average cost curve?

-Curve that shows lowest average total cost at which it is possible to produce each output when the firm has had sufficient time to change both its plant size and labor employed

Looking at perfect competition

1. How does a firm in a perfectly competitive market maximize profit?

- Either at the point where Marginal Revenue = Marginal Cost (straight horizontal line Demand curve)...OR...where the difference between the Total Revenue and Total Cost curves is greatest

      2.         How are equilibrium output, price, and economic profit determined in a perfectly competitive market in the short-run?

-For perfect competition, the equilibrium market output is based on supply and demand which determines price and quantity in a perfectly competitive market.
-Each firm takes the price the market gives and produces its profit-maximizing output.
-Normal times can produce 0 economic profit; Good Times can produce some economic profit (price = marginal revenue), Bad Times can produce loss - as long as it's not more than fixed cost and it's just variable cost, firm won't shut down (but normal, good and bad times don't last forever)

     3. How are equilibrium output, price, and economic profit determined in a perfectly competitive market in the long-run?

- In the Long Run, market forces operated to move price toward the lowest possible price and supply and demand, depending on how many suppliers are freely entering and exiting the market (which determines supply curve) but ultimately
- In Long Run, market price equilibrium is where MC = ATC's minimum! (where they intersect)
-In the Long Run, MR = MC = ATC
-In the long run, a perfectly competitive firm will earn 0 economic profit.

Understanding monopoly markets

1. What are the characteristics of monopoly?

~ There is ONE firm in the market
~ The goods are unique with no close substitutes
~ They are a price MAKER
~ Blocked entry
~ Use PR and advertising for non-price competition
~ Examples are: electric utilities, water companies

1. What are the different price setting strategies that can be employed by a monopolist?

Single-Price strategy: charge all customers the same price (DeBeer's diamonds)
Price-Discrimination: try to get all different classes of people to pay the most they're willing to pay, by class (airline tix at all diff prices)

      3. How does a single-price monopoly set price?

The monopoly looks at the intersection of the MR and MC curves (where MR = MC) - this is its profit-maximizing point; then draws a line up to the demand curve and sets price there.

1. What are the different methods of monopoly regulation?

1. Marginal Cost Pricing rule - sets price where MC = D (efficient)

2. Average Cost Pricing rule - sets price where AC = D (but there's a deadweight loss b/c it's further up D curve than MC intersection, & zero economic profit) - preferred to a subsidy tho

3. Rate of Return regulation - tries to set price @ the level @ which the firm can earn a specified target rate of return on its CAPITAL (but firm's can tend to overspend capital to achieve greater returns)

4. Price Cap regulation - places a cap on the highest price a firm is allowed to charge customers; basically a price ceiling; lowers the price and increases quantity up to price cap quantity demanded

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