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EC1101E

Revision SheetQu TingxuanNational University of Singapore | ANU

EC1101E Revision Sheet 1 | P a g e

Table of ContentsLecture 1.................................................................................................................................1

Five principles of economics.............................................................................................................1

Opportunity Cost= Explicit Cost+ Implicit Cost..................................................................................1

Positive & Normative Economics......................................................................................................1Positive: describe the world as it is [either be confirmed or refuted]..................................................................1Normative: prescribe how the world should be [many disagreements]..............................................................1

PPF...................................................................................................................................................2

Absolute advantage & Competitive Advantage.................................................................................2Two types of Questions.......................................................................................................................................2A tricky part---Trading price.................................................................................................................................2

Clarification on concepts..................................................................................................................2

Tea History-Tea & Chai.....................................................................................................................3

Becoming an Economist....................................................................................................................3

Lecture 2.................................................................................................................................4

Non-price determinants of Demand.................................................................................................4

Non-price determinants of Demand.................................................................................................4

Ambiguous Case...............................................................................................................................5

Clarification on concepts..................................................................................................................5

Lecture 3 Elasticity and Welfare Economics.............................................................................6

Price elasticity of demand (PED).......................................................................................................6Determinants of PED...........................................................................................................................................6

Cross price elasticity of demand (XED)..............................................................................................6

Income elasticity of demand (YED)...................................................................................................6

Price elasticity of supply (PES)..........................................................................................................7Determinants of PES............................................................................................................................................7

Welfare Economics...........................................................................................................................7Consumer Surplus:...............................................................................................................................................7Producer surplus:.................................................................................................................................................7Total Surplus:.......................................................................................................................................................7

Adam Smith and the Invisible Hand..................................................................................................8

Government intervention in markets.......................................................................................8

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Key definitions.................................................................................................................................8

Price ceiling......................................................................................................................................8Black market........................................................................................................................................................8

Taxes and subsidies..........................................................................................................................9Incidence of tax and subsidy..............................................................................................................................10

Tips for mid-term exam.........................................................................................................10



Lecture 1Five principles of economicsScarcity Implies Trade-Offs: Going to a party the night before an exam leaves you less time for studying.

Bargaining Strength Comes through Scarcity: Why are diamonds so much more expensive than water?

Compare Costs and Benefits: A student compares the fees and foregone wages before going college.

People Respond to Changes in Costs and Benefits: When cigarette taxes rise, teen smoking falls.

Focus on Your Comparative Advantage: The U.S. produces strawberries, India produces mangoes.

Opportunity Cost= Explicit Cost+ Implicit CostYou have won a free ticket to a Katy Perry concert. The ticket has no resale value. Rihanna is performing on the same night, and is your next best alternative. Tickets to the Rihanna concert cost $150, but you are willing to pay up to $200. Assume there are no other costs to attending either concert. What is the opportunity cost of attending the Katy Perry concert?

Explicit=0

Implicit=the value of the next best alternative=Benefit $200- Cost $150=50

When the alternatives to a choice are mutually exclusive, the implicit cost of the choice is the value of the next best alternative.

The opportunity cost of playing football is

A. the benefit derived from studying.

B. the enjoyment derived from watching TV.

C. the benefit derived from studying as well as the enjoyment derived from watching TV.

Obviously, C is wrong as you cannot study and watch TV in the same time. If you like study more, choose B.

Positive & Normative EconomicsPositive: describe the world as it is [either be confirmed or refuted]

Positive means the world has something. You have Anti-body if the test result shows positive! Eg. An increase in the price of Penang char koay teow will cause an increase in demand for iPhones.

Normative: prescribe how the world should be [many disagreements]

What should be the norm of society? Eg. The central bank should reduce the rate of growth of money.



PPF A straight-line PPF depicts constant opportunity cost. A concave PPF depicts increasing opportunity cost.

Because PPF is concave when different resources are suited for different uses, i.e., different workers have different skills.

Absolute advantage & Competitive AdvantageTwo types of Questions

In New Zealand, the opportunity cost of producing per

ton of wool is 1040

=0.25 rug because in that 10 hours’

time, you can make ¼ rug.

In Chicago, the opportunity cost of producing a pair of

red socks is 2w1 r

=2 white socks. (PS1 Q8)

(Always make sure numerator is right)

A tricky part---Trading priceThe opportunity cost of red socks is 1 pair of white socks in Boston and 2 in Chicago. Boston will produce red socks wholly and trade them with Chicago for white ones. Boston will take any price more than 1 red=1 white to cover its cost, while Chicago will take any price less than 1 red=2 white because if the price is too high, Chicago may produce on their own.

Clarification on conceptsCertain talented people have a comparative advantage in everything they do, don’t they?

No. No one can have a comparative advantage in everything. Comparative advantage reflects the opportunity cost of one activity in terms of another. If you have a comparative advantage in one activity, you must have a comparative disadvantage in another activity. (PS 1 Q9)

However, sometimes no country has comparative advantage since their opportunity costs are the same.

Suppose a worker in Pineapplia can grow either 40 tons of pineapple or 10 tons of mango a year, and a worker in Mangia can grow either 20 tons of pineapple or 5 tons of mango a year. There are 99 workers in each country. Can both countries gain from trade?

No. One country will gain whereas the other will definitely lose. (pos01 Q4)



Economic growth

The PPF may expand on one or two sides because we can assume growth only in certain industry. (Q2.1)

Tea History-Tea & Chai------------The world’s most consumed beverage (except water)

Both versions come from China. How they spread around the world offers a clear picture of how globalization worked before “globalization” was a term anybody used. The words that sound like “cha” spread across land, along the Silk Road. The “tea”-like phrasings spread over water, by Dutch traders bringing the novel leaves back to Europe.

Why teas leaves are plucked by women?

Their fingers are nimbler! Males may be better at picking tea leaves and they are also good at ploughing the field?

Becoming an EconomistIt is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy . . . What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.

Adam Smith (1723-1790)

It is quite as important to the happiness of mankind, that our enjoyments should be increased by the better distribution of labour, by each country producing those commodities for which by its situation, its climate, and its other natural or artificial advantages, it is adapted, and by their exchanging them for the commodities of other countries, as that they should be augmented by a rise in the rate of profits.

David Ricardo (1772-1823)



Lecture 2Non-price determinants of DemandNumber of Buyers

An increase in the number of buyers ↑ QD at each price.

Income

Demand for a normal good is positively related to income. ↑income-↑ QD at each price, D shifts right.

Demand for an inferior good is negatively related to income. ↑income-↓ QD at each price, D shifts left.

Price of related goods: Substitutes or complements

Two goods are substitutes if an increase in the price of one good causes ↑ in the demand for the other good. Eg. iPhones and Android phones, Coke and Pepsi.

Two goods are complements if an increase in the price of one good causes ↓ in the demand for the other good. Eg. Burgers and fries, Cars and gasoline.

Tastes

A shift in tastes toward a good will ↑ demand for that good and shift its D curve to the right. Eg. McDonald’s marketing campaign kindled powerful preference among teenagers for Matcha ice cream.

Expectations of consumers

If people expect their incomes to rise, their demand for meals at expensive restaurants may ↑ now.

If the economy sours, people worry about future job security, their demand for new cars may ↓ now.

Non-price determinants of DemandNumber of Sellers

An increase in the number of sellers increases quantity supplied at each price, shifts S curve to the right.

Input Prices (prices of raw material, wages, prices of machinery, rental prices of retail space.)

A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts rightward.

Technology

A cost-saving technological improvement has the same effect as a reduction in input prices, and shifts the S curve to the right.

Weather (in agricultural commodities)

Freezing temperatures in California damage the state’s citrus crops.



Ideal weather conditions brings a bumper harvest of sweet and rosy apples.

Expectations of suppliers

Eg. Events in the Middle East lead to expectations of higher oil prices. In response, oil fields in Brunei reduce supply now, saving some inventory to sell later when prices are higher. The S curve shifts ↓.

In general, sellers may adjust supply (of non-perishable goods) when their expectations of future prices change.

Ambiguous CaseWhen supply and demand both increase, Q ↑, but effect on P is ambiguous.

Depends on relative magnitude of increase in Demand and Supply.

D>S: Price ↑

D<S: Price ↓

In exam, draw ONE graph only, sand state it is ambiguous and the criteria.

Clarification on conceptsHousing supply

Supply should be inelastic-Vertical line. Eg. When we compare Singapore and Norway housing price.

Music downloads Market

Royalty is a payment made to writers and musicians every time their books or songs are bought or used by others. It is paid by sellers of music downloads so it is an input price.

Why Chinese eat seafood during Chinese New Year?

馀, which stands for abundance in next year, rhymes with 魚, which means fish.

Chinese like homophones.

English Discovery



Kindle=spark



Lecture 3 Elasticity and Welfare EconomicsPrice elasticity of demand (PED)Mid-point Formula

The flatter the curve, the greater the elasticity.

The steeper the curve, the smaller the elasticity.

Determinants of PED1. How broadly or narrowly the good is defined: PED is greater for narrowly defined goods2. Whether the good is a luxury or a necessity3. The extent to which close substitutes are available: PED is greater when close subs are available4. How expensive the good is: PED is greater for expensive goods5. The time horizon —elasticity is higher in the ______ run than in the ______ run

Cross price elasticity of demand (XED)Substitutes: XED Positive

Complements: XED Negative

Income elasticity of demand (YED)Inferior good: YED<0

Normal good: YED>0



Price elasticity of supply (PES)

Determinants of PES The more easily sellers can change the quantity they produce, the greater the price elasticity of

supply.

Eg. The supply of submarines is harder to vary and thus less elastic than the supply of a small boat.

For many goods, the price elasticity of supply is greater in the long run than in the short run.

Eg. Because firms can build new factories, or new firms may be able to enter the market.

Welfare EconomicsConsumer Surplus: CS = WTP – P

Producer surplus: PS = P – Cost

Total Surplus: TS= CS + PS

= Value to Buyers – Cost to Sellers

= total gains from trade

An allocation of resources is efficient if it maximizes

total surplus.

If only CS or PS is max, TS may not be max.(photo30/9)



Adam Smith and the Invisible Hand Adam Smith, The Wealth of Nations, 1776: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest … Every individual … neither intends to promote the public interest, nor knows how much he is promoting it … He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”

Government intervention in marketsKey definitionsPrice ceiling: a legal maximum on the price of a good or service, e.g., rent control.

Price floor: a legal minimum on the price of a good or service, e.g., minimum wage.

Tax: payment by buyers/sellers to the government on each unit bought or sold.

Subsidy: payment by the government to buyers/sellers on each unit bought or sold.

Price ceilingExample: Between 1970 and 1994, Cambridge, Massachusetts had a rent control law in place for rental properties built in 1969 or earlier. The rent-controlled properties had rents 25 to 40 percent below the level of non-controlled properties nearby. The maintenance of rent-controlled properties was subpar, with a higher incidence of issues like holes in walls or floors, chipped or peeling paint, and loose railings.

A price ceiling is binding if it is below the equilibrium price.

A binding price ceiling leads to a shortage, and possibly a black market.

Black marketA price ceiling may result in a black market, where goods are sold illegally at prices above the legal ceiling. $950 is the black market price.

A price floor is binding if it is above the equilibrium price.

A binding price floor leads to a surplus.

Price no longer acts as a rationing device in a binding price ceiling/floor.

Taxes and subsidies


When the government taxes a good:

the equilibrium quantity of the good ↓ the price paid by buyers ↑ the price received by sellers ↓

When the government subsidizes a good:

the equilibrium quantity of the good ↑ the price paid by buyers ↓ the price received by sellers ↑


Deadweight loss is defined as the fall in total surplus that results when a tax/subsidy distorts a market outcome.

WHAT DETERMINES THE S IZE OF THE DWL?

The price elasticity of supply and demand.

The greater the price elasticities of supply or demand,

the greater the deadweight loss of a tax/subsidy.

A tax prevents some mutually beneficial trades, while a subsidy induces some mutually wasteful trades.

Incidence of tax and subsidyTax:Demand inelastic-Consumer bad luck~

Demand elastic-Supplier bad luck~

Subsidy:If demand is inelastic, benefit is on consumer since Price changes is more dramatic than Quantity changes.



If demand is elastic, benefit is on producer since Price changes is less dramatic than Quantity changes.

Conclusion: the party who get bad luck in a tax will regain their fortune in a subsidy

Tips for mid-term examAlways ask “is this a binding price ceiling/floor”

There are some special cases to consider: Demand/Supply is inelastic or elastic

When tax doubles, tax revenue will be less than double because Q will fall. See PS4


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