ECC1000 1/2

ECC1000 1/2

1. Opportunity cost

   • The opportunity cost is the value of what ou give up in order to get an item

2. Trade

   • PPF - production possibilities frontier
     • Gradient is the opportunity cost
       • The opportunity cost of two items will be the reciprocal of eachother
   • Gains from trade: If two parties specialise in what they are best at and trade then both with end up with more than if they didn’t trade
     • Absolute advantage: Ability to produce a good using fewer inputs than other producers
     • Comparative advantage: The producer with the smaller opportunity cost to produce a good has comparative advantage
   • INTERNATIONAL TRADE
     • Export vs import? If the world price is higher than the domestic price then country should export If world price is lower than domestic then country should import
       • Winners and losers As a whole the country gains from international trade however individuals may gain or lose
         • If exporting a good Producers win since they are able to sell their good for a higher price (world price) Consumers lose since they now have to pay a higher price than before Exported quantity is difference in Qsupplied and Qdemanded
         • If importing good Consumers win since they get to pay a lower price (world price) for the good Producers lose since they have to sell their product at the world price to remain competitive
       • TARIFF A tax on good that is produced abroad but sold domestically
         • Tariff will reduce quantity imported and move market closer to equilibrium In this case producers are better off however overall country loses due to a deadweight loss (gains to producer is not greater than the losses)
       • IMPORT QUOTA A limit on quantity of good produced abroad that can be sold domestically
         • A license gives holder the right to import a certain amount
         • Just like a tariff, import quotas reduces quantity of exports and moves market closer to equilibrium (w/o trade) the only difference is tax will raise a tax revenue

3. MARKET

   • Perfectly competitive market: -Goods offered are all exactly the same. -Buyers and sellers as individuals have no influence over the market price
   • DEMAND
     • Quantity demanded is the amount of a good that customers are willing and able to pay
     • Law of demand: other things being equal, when price of a good rises the quantity demanded falls
       • Because when a price rises you only buy it if necessary otherwise can buy something else OR you only have a certain amount of money so have to buy less than you usually would
     • Demand curve shifts (NOTE: price increase is NOT a shift)
       • Income: if you have a higher income you are able to buy more. Normal goods: goods where demand increases when income increases. Inferior goods: goods whose demand decreases when income increases
       • Complements When a decrease in price of one good leads to an increase in demand for another good these two items are complements
       • Substitues When a decrease in price of one good leads to the decrease in demand for another
       • Tastes if you like something you ill buy more of it
       • Expectations Expectations of the future may affect your demand for a good or service now. If you know price of avocados will increase in a week you may buy more now
       • Number of buyers. If more people start wanting your good then the quantity demanded at each price would shift the curve
   • SUPPLY
     • Law of supply: All things being equal quantity supplied o a good rises when price rises
     • SHIFT IN SUPPLY CURVE
       • Input prices If price of inputs increases then supply decreases
       • Technology As technology gets better we become more productive so supply goes up
       • Expectations
       • Number of sellers

4. ELASTICTY Measure of the responsiveness of quantity demanded or supplied to one of its determinants

   • Own price elasticity Percentage change in quantity demanded/ percentage change in price
     • It’s always negative because law of demand says a fall in price leads to increase in demand and vice versa so we usually just exclude the negative
   • ELASTIC means quantity demanded responds substantially to price INELASTIC means price only has a slight affect on quantity demanded
     • Perfectly elastic = elasticity of infinity Elastic if elasticity >1 Inelastic if elasticity <1 Unit elastic if elasticity =1 Perfectly inélasticité if elasticity = 0
   • CROSS PRICE ELASTICITY OF DEMAND Percentage change in demand of product Y/percentage change in price of product X
     • If elasticity is positive then items are substitutes If elasticity is negative the two items are complements
   • INCOME ELASTICITY Percentage Change in quantity demanded/percentage change in income
     • If elasticity is positive item is a normal good If elasticity is negative then I them is an inferior good
   • INFLUENCES OF ELASTICITY
     • Availability of close substitutes Goods with close substitues have higher elasticity because its easy for customers to switch from that good to others if price increases
     • Necessities VS luxuries Necessities have more inelastic demands because regardless of price the consumer needs the good Luxuries have more elastic demand since its a choice
     • Definition of market A narrow market has more elastic demand A broad market has inelastic demand because there are less substitutes
     • Time horizon Goods have a more elastic demand over long periods of time as people have time to make adjustments and find substitues
   • For inelastic demand - a rise in price increases revenue For elastic demand - rise in price decreases revenue (since R=P*Q and P increases and Q will not change by much)

5. ECONOMIC WELFARE

   • Price ceiling - a legal maximum on the price at which a good can be sold Is binding only if price ceiling is below equilibrium price
   • Price floor- a legal minimum on the price at which a good can be sold Only binding if price is above the equilibrium price
   • TAXES Used to create revenue for public purposes
     • A tax of consumers will shift the demand curve to the left A tax on produces shifts the demand curve to the left The amount shifted is the amount of tax
       • No matter who the tax is put on tax burden is shared by both buyers and sellers the only difference is who the government get the money from
         • A tax burden falls more heavily on the side of the market that is more INELASTIC
     • SUBSIDIES Opposite of a tax
       • Shifts demand and supply curves to the right by the price of the subsidy
     • COST OF TAXATION Taxes reduce consumer and producer surplus The more elastic the curves the more deadweight loss
       • Deadweight loss is the reduction in total surplus that arises from market distortion
   • Efficiency - maximising surplus Equity is also important (how you divide up the pie) which is why surplus may not be maximised
     • Consumer surplus: willingness to pay - amount paid Consumer surplus is the area above the price and under the demand curve up until q
     • Producer surplus: amount seller is paid for good - sellers cost to produce good Producer surplus = area above the supply curve under price until Q
     • Total surplus = Value to buyers - Cost to sellers = producer surplus + consumer surplus
     • Free markets produce Q of good that maximises total surplus (assuming competitive and only considering buyers and sellers in market)