economics an introductory lesson by jackson education support

EconomicsAn Introductory Lesson by Jackson Education Support

Mainstream Economics explains...o How price is determined in the

marketo What prevents perfect resolution

(economy organized for efficiency and growth)

o How wages are determinedo What causes

inflation/unemploymento How and why countries interact

through foreign trade and foreign investment

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Health Economics

Health Economics exists at the interface between healthcare and economics. It is the study of economics as applied to healthcare, which helps the industry improve allocation of resources to achieve maximum equity and efficiency. Health Economics plays a vital role in decision-making.

Equity & Efficiency

Equity asks, “How fair is resource distribution?”(greater equality ≠ greater equity)

Efficiency asks, “What is the best use of resources?”

Resources: Labor, Land, Capital

Opportunity CostOpportunity cost is the benefit associated with the best alternative use of resources.

Example: Each time we do ‘X’ we cannot do ‘Y’.

We make decisions based on opportunity cost when constructing a budget and deciding how to allocate money between competing uses.

Aims of Health Economics

1) That benefits of chosen activities outweigh the opportunity costs

a. Equity: How fair is distribution?b. Efficiency: What is the best use of

resources?

2) That benefits are maximized within the available resources (profit maximizing solution)

Profit Maximizing Solution

oIf price is too high, firms end up with unsold stock.oIf price is too low, firms run out of stock and still have to pay wages, light, heat, etc.oIf price just clears the market, firms sell all but the stock they need to hold. This option allows firms to maximize profits.

Real World Example

Why do restaurants stay open for lunch even if business is slow at lunchtime?

The firm has already committed to pay the fixed costs for rent of building, kitchen equipment, tables, plates, etc. These are sunk costs. When deciding whether to serve lunch, only variable costs are relevant {cost of waiters, cooks}. The restaurant will shut down at lunchtime if and only if variable cost exceeds revenue from lunchtime customers.

Equations that we need...

Profit = TR – TC TR depends on P of output, Q of output (TR = P x Q) TC depends on P of inputs, Q of inputs, productivity of

inputs, production technology used

TC = TFC + TVCOperating Profit = TR – TVC, ignores the sunk costs

TFC = AFC x Q AFC = TFC/Q costs that do NOT vary with changes in output (sunk costs) costs that have to be paid even if output = 0

TVC = AVC x Q AVC = TVC/Q costs that DO vary with changes in output 0, if output = 0

More equations...

AFC = TFC/Q (fixed costs per unit of output)

AVC = TVC/Q (variable costs per unit of output)

ATC = TC/Q = AFC + AVC (total costs per unit of output)

MR = ΔTC/ΔQ = ΔTVC/ΔQ MC = ΔTR/ΔQ (additional cost per unit of additional

output; slope of TC and slope of TVC curves)

Profit Maximizing Output LevelProfit = TR – TC

Operating Profit = TR – TVC, ignores the sunk costs

Profit Maximizing Output: MR = MC

Why Stop at 14 Units?

If a firm is thinking about producing the 15th unit of output and the MR > MC for this 15th unit, then the firm does better producing the 15th unit of output. For this additional unit of output, addition to revenue is greater than the addition to cost.

What about the 25th Unit of Output?The firm is better off increasing production to 15 units to add to the profit it already has. If MR < MC to produce the 25th unit of output, then addition to revenue for this 25th unit of output is less than the addition to cost, so it is not worth it to produce this unit of output.

AFC, AVC, & ATC Graphs

$

AFC1

q1

qAFCTFC

AVC1

q

AVC

TVC

$

q1

ATC1

q

ATC

TC

q1

$

Graph of Profit Maximization

Dollars

Quantity

A

B

C

ATC CurveMC Curve

Shutdown point

Breakeven point

Maximum Profits obtained when P = MC

AVC Curve

P = MR

P = MR = MC

Shutdown or Continue to Operate?A firm operating at MR = MC finds that it is still making a loss instead of a profit. One is inclined to say the firm should shut down. But that is not always the case. There are times when a firm is making a loss (i.e. TR – TC = negative number) and continuing to operate is the best thing that the firm can do in the short run. If TR > TVC, then the firm needs to continue to operate in the short run, even if TR < TC.

Try this example...TR = $4000 and TC = $5000; this firm is making a loss of $1000.

You might be inclined to advice this firm to shut down. But then when you look closely at the numbers and breakdown the TC we find that TC is made up of TFC and TVC.

TFC = $2400 and TVC = $2600; if the firm shuts down, it has to pay $2400 (lease for the space it uses).

If the firm shuts down it loses $2400.

If the firm continues to operate it loses $1000. Continuing to operate is the profit optimizing option.

Conclusion

The firm makes (TR – TVC) $4000 - $2600 = $1400 which it can use to pay off part of the $2400 TFC. The firm ends up losing less when it continues to operate than when it shuts down.

If the firm cannot cover TVC with the TR it makes from making the output, then the firm must shut down even in the short run.

Student ActivityTR = $5,000TC = $2,500TFC = $2,000

The firm is operating at MR = MC, and still taking a loss. Should this firm shutdown in the short run or continue to operate?

Decision Rule

a) Continue to Operate if TR > TVC

b) Shut Down if TR < TVC

In the long run, there are no fixed costs, and the firm can decide to just walk away.

This go-out-of-business option is not available to firms in the short run because they have fixed costs that they are obligated to pay.

Prices, Supply, and Demand

1. If we think of some item, X, and no one wants it at all, then it has no price because there is no demand for this item. (totaled car, broken cell phone)

2. If there are 3 old pianos for sale at auction and 12 people are bidding, then the price can get pretty high because there is high demand for the pianos as well as low supply.

3. If there are 30 old pianos for sale at auction and 12 people are bidding, then the price will be lower demand is lower and there is a high supply.

Student Activity: Design a scenario for each of the following.

1. Low Demand2. High Supply3. No Demand4. No Supply

Law of Demand

Ceteris paribus, the lower the price of a good (or service) the greater the quantity of that good (or service) will be offered for sale in a particular period.

1. D = P ( QD = P, constant S)

2. D = P ( QD = P, constant S)

Shifts in a Demand Curve

If other determinants of demand (consumer income, price of other goods, consumer tastes, etc.) change, then the curve shifts. a) An increase in demand for substitute

goods, which can be used in place of one another (corn, green beens), causes an increase in quantities demanded or a right shift.

b) An increase in demand for complementary goods, which are used along with the product (i.e., cars and gas), causes a decrease in quantities demanded or a left shift.

Demand Curve

(-) SlopeDownward slope

Determinants of DemandIf there is a change in price of a good, then there will be movement along the demand curve. If other determinants of demand change, then the curve shifts. Determinants of demand are consumer income, price of other goods, consumer tastes, and number of potential consumers in the market or population.

a) An increase in demand for substitute goods, which can be used in place of one another (corn, green beans), causes an increase in quantities demanded or a right shift.

b) An increase in demand for complementary goods, which are used along with the product (i.e., cars and gas), causes a decrease in quantities demanded or a left shift.

Demand Shift Example

For example, suppose new research indicates that eating strawberries will make you more attractive to members of the opposite sex.  Will consumers react to this news? 

Of course! It will change the perceived value of strawberries and increase the quantity of strawberries people are willing to buy at every price.  The demand curve will shift to the right. 

Law of Supply

Ceteris paribus, the lower the price of a good (or service) the smaller the quantity of that good (or service) will be offered for sale in a particular period.

1. S = P ( QS = P, constant S)

2. S = P ( QS = P, constant S)

Shifts in Supply Caused by...Changes in input prices; goods used to

produce another good.◦An increase in the price of steel will lower

the supply of automobiles.Changes in technology.

◦Better engineering can increase the supply of computers, and more computers will be supplied at a given price.

Changes in expectations.◦Changing diet fads will reduce the supply of

products like “low carbohydrate bread and pasta.”

Supply Curve

(+) SlopeUpward slope

Student Activity: Answer the following.1. Define demand; draw a demand curve

and explain its shape.2. Distinguish between substitute and

complementary goods, and give examples.

3. Identify factors that will cause demand curves to shift.  Illustrate graphically and explain.

4. Distinguish between a change in demand (a shift in the curve) and a change in the quantity demanded (a movement along the curve) and give examples.

Student Activity: Answer the following.1. Define supply; draw a supply

curve and explain its shape. 2. Identify factors that will cause

supply curves to shift.  Illustrate graphically and explain.

3. Distinguish between a change in supply (a shift in the curve) and a change in the quantity supplied (a movement along the curve) and give examples.

Price Mechanism

What if firms choose not to profit maximize?...Competition will eventually force them out of business.a) If a firm believes it can profit by

selling ‘X’ at a high price, it moves in and does so.

b) This increases supply of ‘X’.c) So price decreases.

Who has control of the market?1. Perfect competition

(well allocated resources, lowest price, unrestricted output)

2. Monopoly (poorly allocated resources, highest price, restricted output)

3. Imperfect competition(reasonably allocated resources, middle price, some output restriction)

What prevents the free market from reaching perfect resolution?

1. Monopoly2. Information failure3. Unequal income distribution4. Factor immobility5. Merit/Demerit goods6. Public goods without exclusion7. Externalities

(diseconomies/economies)

What factors affect Supply?1. Noncompeting groups2. Trade union/government

restrictions3. Labor immobility4. Time lags5. Nonmonetary awards

ElasticityA measure of the degree of the

responsiveness of one variable to changes in another.

Price Elasticity of Demand for a particular good is the relative degree of responsiveness of QD relative t osmall changes in P.

Elasticity of Demand

Roughly assessed by eyeballing the steepness of the slope

1. A very steep slope (nearly vertical) indicates that a given %↑P induces a small %ΔQD. (relatively inelastic demand)

2. A gentle slope indicates that a given %↑P induces a large %ΔQD.

(relatively elastic demand)

Quantifying ElasticityElasticity depends on slope and the portion of the curve under consideration. This value is not generally identical for each segment of a given curve.

Elasticity = (ΔP/ΔQ) * (Q/P)

Ignoring (+/-), a) Elasticity > 1 (elastic)

b) Elasticity ≈ 1 (inelastic)c) Elasticity = 1 (unitary elastic)

Elasticity of Demand ExampleThe price of X rose from $7 to $9 and consumption falls from 25 to 15. Calculate the price elasticity of demand of X. What can be said about the price elasticity of demand? Is it elastic, inelastic, or unit elastic? Why? (Use the midpoint formula and show work.)

Midpoint = [(ΔX/2), (ΔY/2)]

The Law of Diminishing ReturnsAfter an initial period the amount added to total output by each extra person must fall.

For example, in a vegetable garden one person can produce a lot. The 2nd person can do more. The 3rd person adds a little more. By the 4th addition, total output increases a bit. At 200 people, the garden is shoulder to shoulder and no vegetables are produced.

Extremely high input = Zero output

Demand Curve for Labor

From the law of diminishing returns, we derive the demand curve for labor, which is needed in wage theory.

People vs. Capitala) Labor intensive technique

induced by an abundance of cheap labor.

b) Capital intensive technique induced by an industrialized environment.