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1、A-LEVEL Microeconomics basic,2,1 What is Economics about?The problem of scarcity,Economics is the study of how society chooses to allocate its scarce resources to the production of goods and services in order to satisfy unlimited wants.,Human wants are unlimited,butResources are limited(scarce)A cen
2、tral problem therefore existswe call this the problem of SCARCITY,4,3 Definition of economics,Economics is the study of societys decisions about productionconsumptionallocation of scarce resources in order to satisfy as many unlimited wants as possible.,5,4 Two branches of economics,Microeconomics i
3、s the branch of economics that studies decision-making by a single individual,household,firm,industry or level of government.Macroeconomics is the branch of economics that studies decision-making for the economy as a whole.,6,5 Macroeconomic Issues,aggregate demand,aggregate supplyeconomic growthune
4、mploymentinflationbalance of tradeexchange rates,7,6 Microeconomic Issues,demand and supply decisions of what to produce,how to produce,for whom to producethe concept of opportunity cost based on comparing what you have decided vs what is the next best alternative you have given uprational decision
5、making based on cost vs benefit;best value for moneyweighing up marginal costs and marginal benefits based on comparing the extra benefit with the extra costthe social implications of choice society i.e.taking into consideration how a certain choice may have an indirect cost on,Resources,Resources a
6、re the basic categories of inputs used to produce goods and services.Resources can also be called the factors of production.,Three categories of resources,LandLabourCapital,Resources:land,Any natural resource provided by nature used in the process of productionFor example:forests,minerals,wildlife,o
7、il,rivers,lakes,oceansMay be renewable or non-renewable,Resources:labour,The mental and physical capacity of workers to produce goods and servicesFor example:farmers,nurses,lawyersEntrepreneurship is a special type of labour the creative ability of individuals to manage the combination of resources
8、to produce products.,Entrepreneurship,Organises and manages the resources needed to produce goods and services,Resources:capital,Capital is the physical plant,machinery and equipment used to produce other goods.That is,human-made goods that do not directly satisfy human wants,for example:Earlier:axe
9、,bow and arrowNow:buildings,production equipment,software,factories.,A note about financial capital,Economists do not include money in their definition of capital money simply gives a measure to the value of assets.,Opportunity cost,The best alternative sacrificed for a chosen alternativeOpportunity
10、 cost applies to personal,group and national decision-making,for exampleWhat could you be doing if you were not currently studying?How many new roads have to be forgone if the government spends tax revenues on homeland security?,Marginal analysis,Marginal analysis examines how the costs and benefits
11、 change in response to incremental changes in actions.Any additional action by an individual or a firm,such as buying an additional pair of shoes or increasing production of a product by an additional unit,brings additional cost.The central question in marginal analysis is whether the expected benef
12、its of that action exceed the added cost,Marginal analysis,Marginal analysis helps businesses and individuals balance the costs and benefits of additional actions-whether to produce more,consume more,or other decisions-and determine whether the benefits will exceed costs,thus increasing utility.,Mar
13、ginal analysis,Marginal analysis benefits government policy makers,as well.Weighing the costs and benefits can help government officials determine if allocating additional resources to a particular public program will generate additional benefits for the general public,Short-Run v Long Run,Short-Run
14、:A time period in which at least one factor of production is fixed(i.e.cannot increase its amount)it is not defined in terms of number of days/weeks)Long Run:A time period long enough for all inputs to be variedIt is not a defined period of time;,Cost concepts,Total fixed costs are coststhat do not
15、vary as output varies and must be paid even if output is zero.Total variable costs are coststhat are zero when output is zero andvary as output varies.Total cost is the sum of fixed cost and variable cost.TC=TFC+TVC,Total costs,Note:The x and y axis units here are unrelated to the previous diagram,A
16、verage cost concepts,Average fixed cost(AFC)total fixed cost divided by the quantity of output produced:Average variable cost(AVC)total variable cost divided by the quantity of output produced:,AFC=TFC,AVC=TVC,Q,Q,Average total cost,Total cost divided by the quantity of output produced,ATC=AFC+AVC=T
17、C,Q,Marginal cost,Measures how much total cost increases when an additional unit of output is produced.MC:the change in total cost when one extra unit of output is produced,MC=TC=TVC,Q,Q,Total costs,Inverse relationship:MP&MC,Note:The x and y axis units here are unrelated to the previous diagram,Ave
18、rage and marginal costs,This graph uses information from the previous slide,Note the marginal-average rule,When MC AC,AC is rising.When MC=AC,AC is at its minimum point.,Long-run situation,All factors of production are variable.there is time for the firm to build a new factory to install new machine
19、s,to use different production techniques,to combine inputs in whatever proportion and quantities it chooses;the firm will need to decide about the scale of its operation and the production techniques that it uses;these decisions will affect production costs so it is important to get these decisions
20、right.,Relation between LRAC and SRAC Curves,A firm with just one factory and faces SRAC curve(following diagrams);In the long-run it can build more factories and experiences economies of scale due to administrative savings,each successive factory will allow it to produce with a new lower SRAC curve
21、;Thus with 2 factories it will have curve SRAC2 and with three then SRAC3,and so on;Each SRAC curve corresponds to a particular amount of the factor that is fixed in the short-run(in this case the factory);There are many SRAC curves as many different factories of different sizes or extensions to exi
22、sting one could be made.The LRAC curve is an ENVELOPE CURVE,Costs,Output,O,Examples of short-runaverage cost curves,SRAC2,SRAC3,SRAC4,SRAC5,Constructing a Long-run Average Cost Curve from Short-run Average Cost Curves,LRAC,Costs,Output,O,SRAC5,SRAC4,SRAC3,SRAC2,Constructing a Long-run Average Cost C
23、urve from Short-run Average Cost Curves,Scales of production,The long-run average cost curve is U-shaped.This reflects returns to scale three types are recognised:Economies of scale(LRAC falls as output rises)Constant returns to scaleDiseconomies of scale(LRAC rises as output rises).,Scales of produ
24、ction,Economies of scale,A situation in which the long-run average cost curve declines as the firm increases outputSources of economies of scale:Specialisation and Division of LabourGreater efficiency of larger machines(eg combine harvester,super photocopier.Eg machine A costs$1000 eliminate duplica
25、tion)Financial economies(bulk discounts)Economies of Scope(producing a range of products may increase sales and spread out overheads Eg:CD,DVD,players,amplifiers etc vs only CD)(Refer to Sloman p87,88 for more info),Constant returns to scale,A situation in which the long-run average cost curve does
26、not change as the firm increases output.,Diseconomies of scale,A situation in which the long-run average cost curve rises as the firm increases outputSources of diseconomies of scale:BureaucracyBarriers to communicationManagement difficulties(e.g.lack of coordination).Production-line processes and i
27、nterdependencies,Long-run Costs,“To Scale”means that all inputs increase by the same proportionDecreasing returns to scale are quite different from diminishing marginal returns(where only the variable factor increases)DMR(short-run)and DRS(long-run),Profit MaximisationSloman Ch 5,BUECO1507,Revenue,D
28、efining total,average and marginal revenuetotal revenue:TR=P Qaverage revenue:AR=TR/Q marginal revenue:MR=TR/Q,Revenue,Revenue curves when price is not affected by the firms output(horizontal demand curve)average revenue(AR)marginal revenue(MR),Examining revenue curves in 2 situations,1)If a firm is
29、 very small relative to the whole market.2)If a firm has a relatively large share of the market,O,O,AR,MR($),Pe,S,D,D=AR=MR,Q(millions),Q(hundreds),(a)The market,The firmBeing so small,its output,whatever it is,does not affect market price at all,Average Revenue and Marginal Revenue curves(1)of a fi
30、rm that is very SMALL relative to the whole market.(Price-taking firm),Price($),TR,Quantity(units),020040060080010001200,Price=AR=MR($),5555555,TR($),0100020003000400050006000,Total Revenue curve(1)of a firm that is very SMALL relative to the whole market.(Price-taking firm),Q,TR($),Q(units),1234567
31、,P=AR($),8765432,TR($),8141820201814,MR($),6420-2-4,MR,AR,MR($),Quantity,AR,Average Revenue and Marginal Revenue curves(2)of a firm that has a relatively LARGE share of the whole market.,If such a firm wants to sell more,it can only do so by lowering price.If it chooses to raise its price,it will ha
32、ve toaccept lower sales.Therefore AR(price)slopes downward.How about the MR curve?,Q(units),1234567,P=AR($),8765432,TR($),8141820201814,MR($),6420-2-4,MR,AR,MR($),Quantity,AR,Average Revenue and Marginal Revenue curves(2)of a firm that has a relatively LARGE share of the whole market.,Supposing firm
33、 is selling 2 units at$7each.It can sell the 3rd unit only by reducing the price of all units to$6.Selling the 3rd unit gains$6 but reducing theprice of units 1&2 loses$1x2=$2.MR therefore=$6-$2=$4,TR,TR($),Quantity(units),1234567,P=AR($),8765432,TR($),8141820201814,Total Revenue curve(2)of a firm t
34、hat has a relatively LARGE share of the whole market.,Quantity,Revenue curves and price elasticity of demand,AR,MR($),Quantity,MR,AR,Revenue curves and price elasticity of demand,Recall:a)When demand is elastic and priceis reduced,total revenue increases.Total revenue increasing means MR is positive
35、b)When demand is inelastic and price is reduce,totalrevenue decreases.Total revenue decreasing meansMR is negative,TR,Elastic,Inelastic,TR($),TR Curve for a Firm Facing a Downward-sloping Demand Curve,Quantity,Revenue,Revenue curves when price varies with output(downward-sloping demand curve)average
36、 revenue(AR)marginal revenue(MR)total revenue(TR)revenue curves and price elasticity of demandShifts in revenue curves,Hidden,Determining a)Output where profit is maximisedb)Profit at that output,1)Using total curvesmaximising the difference between TR and TC2)Using marginal and average curves,TR,TC
37、,TP($),TP,TR,TC,Quantity,1)Using total curves,a)Profit is maximized when output is 3b)Maximum profit is d-e,Quantity,Costs and revenue($),MR,MC,2a)Using marginal and average curvesto determine profit maximising output,a)Profit is maximized at output of 3Below 3 units,the firm should increase output
38、because there will be a bigger addition to revenue(MR)than to cost(MC).Beyond 3 units additional cost(MC)is bigger than additional revenue(MR)therefore shouldnt go beyond it,Quantity,Costs and revenue($),MC,AC,AR,Total profit=$1 x 3=$4.00,2b)Using marginal and average curvesto measure maximum profit
39、,Total Profit,MR,O,Costs and revenue($),Quantity,MR,2b)Using marginal and average curvesto determine loss minimising output,The shutdown rule,If price drops below the AVC curve,the revenue from each unit produced does not even cover the variable cost/s of production.The firm should shut down.,Illust
40、ration:(A)(B)(C)(D)Sales$60 0 60 60VC(40)0(70)(60)Gross profit 20 0(10)0FC(30)(30)(30)(30)Loss(10)(30)(40)(30),The shutdown rule(cont.),(MR),Need to change,Revenue,Costs and Profit,Some qualificationslong-run profit maximisationthe meaning of profitloss minimising:still produce where MR=MCshort-run
41、shut-down point:P=AVClong-run shut-down point:P=LRAC,Hidden,Normal,Supernormal,Economic profit,Normal profit:The minimum profit necessary to keep a firm in operation(i.e.$85,00 in the example)A firm that earns normal profit has earned enough to cover its opportunity cost.If you earn more than opportunity cost you are earning Supernormal(or Economic)profit.,Accounting profit,Normal profit,Supernormal profit,Economic profit,
