Economics
The science of making decisions in the presence of scarce resources
Goal of a firm
Is to maximize profits
Accounting profit
Total revenue - explicit cost (total revenue = price * quantity) (explicit cost = dollar cost to produce a good/service)
Economic profit
Total revenue - explicit cost - opportunity cost, (Opportunity cost is taken into account),
Applications of opportunity cost
R&D on new products, opening new locations, M&A.
At the margin
The additional or incremental unit (small one unit changes)
Marginal benefit
Additional benefit from producing/consuming one more unit
Marginal cost
Additional cost from producing/consuming one more unit
Marginal principle
If marginal benefit is greater than marginal cost, you should do it. If marginal benefit is less than marginal cost, you don’t do it. Continue to do until marginal benefit = marginal cost, this is where net benefits are maximized.
Quantity demanded
The amount of a product/service that consumers are willing & able to purchase at each price.
Law of demand
Price & quantity demanded are inversely related, as price increases quantity demanded goes down.
Aggregating demand curve
Typically, a firm is concerned with market demand curve, this is a measure of the buying plans for the entire population of potential consumers in the market.
Movement along the demand curve (quantity demanded)
Caused by the change in that own goods price.
Quantity supplied
The amount of a product that suppliers are willing & able to sell at each price.
Aggregating supply curves
We can aggregate individual supply curves to generate the overall market supply curve. (Horizontal summation)
Market Eqbm.
Eqbm in a complete market is determined by the interaction of both supply and demand. (occurs when quantity supplied = quantity demanded). (At Eqbm price no individual buyers or sellers have an incentive to change their behavior)
Measuring benefits of market exchange
In free markets trade is voluntary, no government/agency is forcing people to make or buy things.
Both consumers and producers benefit from participating in the market exchange.
Consumer surplus
The difference between the amount consumers would be willing to pay & the actual amount they pay. (Above the price but below the demand curve)
Producer surplus
The difference between the price producers actually receive for the good & the price at which they are willing to accept when they sell it. (Below price but above the supply curve)
Price Floor
Government sets a minimum price at which the good/service can be sold in the market (To be effective the price floor must be above the market price)
Price ceiling
Government sets maximum price at which the good/service can be sold for in the market (rent controls, taxi fares, gasoline) (To be effective they must be set below the market price)
Demand
Refers to the buyer’s side of a market (consumers side)
Market demand curve
Is derived from individual consumers demand curves. (Can sum horizontally individual demand curves, horizontal summation)
Demand shifters
Change in income: (Normal good = when income increases so does demand, Inferior good = when income goes up demand goes down),
Price of related goods: (Substitutes = an increase in the price of one good cause an increase in demand for the other, Complements = an increase in the price of one good cause a decrease in the demand for the other)
Advertising & consumer tastes: As this increases so should demand
Number of buyers: (population) As the number of buyers increases the demand should increase
consumer expectations: If consumers think prices are going to increase in the future the current demand should increase now.
