Chapter 10

·             Perfect competition- firms are numerous and small; a special type of market structure

·             Perfect competition- occurs in an industry where it is made up of many small firms producing homogeneous products, there is no impediment to the entry or exit of firms, full information is available

·             Numerous small firms and customers rules out trade associations in which firms work together to influence price

·             Homogeneity of product- products offered by sellers is identical

·             Freedom of entry and exit- new firms can easily enter and compete with old firms

·             Perfect information- firms/customers are well informed about prices

·             These things are rarely found in practice

·             Perfectly competitive firms use society’s scarce resources with maximum efficiency

·             Only perfect competition can ensure the economy turns out correct quantities of goods to match consumer preferences

·             Under perfect competition the firm has no choice but to accept the price that has been determined in the market (price taker)

·             A perfectly competitive firm faces a horizontal demand curve aka it can sell as much as it wants at the market price

·             Firms demand curve will generally not resemble that of the industry

·             Firms demand curve = its average revenue curve = the marginal revenue curve MR=P

·             If price does not depend on how much the firm sells (like in perfectly competitive) each additional unit sold brings in an amount of additional revenue (MR) = to market price

·             The profit maximizing output is that which marginal cost = marginal revenue

·             Because it is a price taker, the equilibrium of a profit maximizing firm in a perfectly competitive market occurs at an output where marginal cost = price = average revenue = marginal revenue

·             Sometimes the highest possible profit is still a negative number

·             Marginal cost = price gives us the output that maximizes the perfectly competitive firm’s profit, but it doesn’t tell us if a firm makes a profit or a loss, you have to compare price and cost for this

·             Variable cost- a cost whose total amount changes when the quantity of output of the supplier change

·             If the firm stops producing, its revenue and short run variable costs = 0

·             The firm will make a loss if total revenue is < total cost, then it should shut down

·             The firm should continue to operate in the short run if total revenue > total short run variable cost

o   The loss if the firm stays in business is total cost minus total revenue

o   The loss if the firm shuts down is nonvariable costs; total cost mine total variable cost

·             The firm will produce nothing unless price lies above the minimum point on the average variable cost curve

·             Supply curve of the perfectly competitive firm- shows the different quantities of output that the firm would be willing to supply at different possible prices during a given period of time

·             The short run supply curve of the perfectly competitive firm that is not going out of business is the corresponding portion of its marginal cost curve where price = average revenue = marginal revenue = marginal cost

·             Industry short run- a period of time to brief for new firms to enter the industry or old firms to leave

o   Number of firms is fixed

·             Long run- any firm can enter/leave as it desires

o   Each firm can adjust its output to its own long run cost

·             Supply curve of the perfectly competitive industry- shows the different quantities of output that the industry would supply at different possible prices during some given period of time

o   Add up quantities supplied by each firm

o   Summing the individual short run supply curves horizontally

·             Supply curves will shift right when a new firm enters the industry

·             Demand curve for perfectly competitive industry (unlike PC firm) slopes downward

·             Equilibrium in the long run may differ from equilibrium in the short run

o   Number is not fixed in the long run

o   Other things change in the long run

·             Long/short run cost curves differ

·             Profits encourage new firms to enter/leave the industry

·             Entry of new firms pushes prices down

o   Increase quantity supplied

o   Surplus

·             New firms will stop entering when profits have been competed away

·             At equilibrium each firms price = marginal cost

·             Economic profit- new earnings, in the accountant’s sense, minus the opportunity costs of capital and any other inputs supplied by the firms’ owners

o   Positive

·             Zero profit means that firms are earning a return but return is just the same as the normal, economy wide rate of profit in accounting sense

o   This is guaranteed in the long run under perfect competition

·             New firms enter/exit

o   Shifts short run supply curve toward the long run

·             Firms in the industry are freed from fixed commitments

o   Use long un cost curves not short run

·             Long run supply curve = average cost curve

·             Economic profit must = - because excess over long run average cost is a profit opportunity for others

·             Prices cannot be < long run average cost because firms would not supply that output driving price up to LRAC

·             Only when short run industry supply curve = LRAC will the entry of new firms cease and long run equilibrium can be attained

·             In the long run perfectly competitive equilibrium, every firm produces at the minimum point on its average cost curve

o   Outputs are produced at lowest possible cost to society

·             For a given industry output, total industry cost will be as small as possible if average cost for each firm is as small as possible

·             A tax on emission of pollutants and a subsidy payment for reduction of emissions induce firms to cut emissions

·             Under perfect competition, a subsidy leads to more entries of polluting firms and increases in total emissions by the industry

Chapter 14

·             Efficient allocation of resources- one that takes advantage of every opportunity to make some individuals better off in their own estimation while not worsening the lot of anyone else

·             Many combinations can be efficient

·             On the frontier=efficient

·             Below the frontier=inefficient

·             Low prices for abundant resources and high prices for scarce ones

·             Can prices increases serve the public

o   Yes

·             A market system uses prices to coordinate economic activity

·             Laissez-faire- minimal government interference with the workings of the market system

·             Output selection- what/how much should be produced given law of supply and demand

·             In shortages, market increases price

·             In surpluses, market decreases prices

·             Allocation of society’s resources among different products depends on consumer demand and production cost

·             Profit lure guides

·             Production planning-what quantity of each of the available inputs should be used to produce each good; distribution to industries/firms

·             Inputs are assigned to firms that make the most profitable use of them

·             Distribution of products among consumers- decide who gets the produced goods

·             Price mechanism assigns highest prices o goods in greatest demand and lets consumers pursue self interest

·             This favors the rich

·             Production processes of various industries are interdependent

·             Planners can be sure that the various outputs will be sufficient to meet both consumer and industrial demands only by taking explicit account of this interdependence among industries

·             Input output analysis- a mathematical procedure that takes account of the interdependence among the economy’s industries and determines the amount of output each industry must provide as inputs to the other industries in the economy

·             This is carried out automatically in a free market economy

·             Price mechanism ensures those who want a scarce commodity must get it and sellers who supply it most efficiently will supply it

·             Favors the rich

·             In equilibrium under perfect competition the market drives toward optimum output level

·             Consumers surplus- the difference between the maximum amount the consumer would be willing to pay and the market price

o   Always positive if customer is rational

·             Producers surplus- difference between the market price of the item sold and the lowest price the supplier would sell it for

·             At perfectly competitive market output level the total surplus for all participants is as large as possible

·             When output quantity corresponds to the intersection of the supply/demand curves the net surplus is as large as possible

·             With outside influence such as monopoly, output will be smaller and public interest will be damaged

·             Government tax reduction

o   Suppliers produce an output too large

o   Misallocation of resources

·             Rule for efficient output selection- efficiency of output quantities requires that marginal cost = marginal utility for each output

o   Maximizes total utility to society

·             Under perfect competition marginal utility=price and marginal cost = price is optimal

·             The price system lets consumers pursue their own interests

·             Prices influence the distribution of income between buyers and sellers

·             Failure to achieve growth and prosperity brought about fall of communism

Chapter 20

·             Poverty line- an amount of income below which a family is considered poor

o   Black>white

o   Female>male

o   Less educated

o   Poorer health

o   1/3 children

·             absolute concept of poverty- if you fall short of a minimum standard of living you are poor

·             relative concept of poverty- those who fall too far behind the average income

·             the market system fosters inequality

·             the distribution of income in the US has grown more unequal since 1980

·             the US has more inequality than most industrialized countries

·             Reasons for unequal incomes

o   Differences in ability, intensity of work

o   Risk taking- gambling, dropouts

o   Compensating wage differentials- higher wages for night shifts, dangerous and unpleasant jobs etc.

o   Training/education- can be voluntary or involuntary

o   Work experience

o   Inherited wealth

o   Luck

·             Economic discrimination-equivalent factors of production receive different payments for equal contributions to output

·             Increase economic equality through policies, decrease efficiency and reduce incentive

·             Policies that harm incentive/efficiency the least are best

·             Complete laissez-faire and complete equality are not optimal

·             Some redistribution is needed

·             Education system is not made to alleviate poverty

·             Clinton enacted temporary assistance to needy families (TANF)

o   Provided better work incentives

·             Food stamps (SNAP)

·             Transfers in kind- Medicaid etc

·             Negative income tax- people below a certain income range receive money

o   With a 50% rate, the increase in total income as earnings rise is always half of the increase in earnings

·             Guarantee-tax rate x break even level

·             Guarantee must be close to poverty line to fix poverty problem, but then tax will push the level above poverty line

o   Not poor families start to receive benefits

·             NIT should raise work incentives but it also imposes disincentives for those too well of receiving the tax

·             NIT would increase equality and efficiency but still diminish nations output

·             Food stamps are similar to NIT

·             Earned income tax credit- federal government gives out grants to families proportional to their earnings up to a threshold

·             Progressive tax-more from the rich than the poor

·             Sales, payroll, and property taxes are regressive so overall the US tax system is only slightly progressive

·             Affirmative action- active efforts to locate/hire members of underrepresented groups

Chapter 35

·             Specialization- a country devotes its energies and resources to only a small proportion of the worlds productive activities

·             Every country lacks resources that it can gain through trade

·             Climate, labor, etc make countries efficient in some production and not others

·             Specialization permits larger outputs because of the advantages of large scale production

·             Both parties gain in voluntary exchange

·             US prohibits state tariffs but not international ones

·             Use/misuse of legal impediments of national trade is an issue

·             Variability in exchange rates brings complications

·             Absolute advantage- a country can produce a good using smaller quantities of resources than the other country

·             Comparative advantage- a country produces a good less efficiently

·             David Ricardo- 2 countries can gain from trade if 1 is more efficient in producing everything

·             If japan is lightly less efficient at TV production and drastically less efficient in computer production, Japan has comparative advantage in producing TVs

·             If every country produces what they’re most efficient in, all countries benefit because more can be produced without an increase in the amount of labor/resources used

·             In a production possibilities frontier for two countries

o   If the line lies above another countries line, the country above can manufacture more of both items even with the same amount of labor= absolute advantage

·             A country’s absolute advantage in production over another country is shown by its having a higher per capita production possibilities frontier

·             The difference in the comparative advantages between two countries is shown by differences in the slopes of their frontiers

·             If the slopes of two production possibilities frontiers of two countries are qual, then the opportunity cost is the same in each country, and no potential gains would arise from trade

o   Gains from trade arise from differences

·             If two countries voluntarily trade goods, the rate of exchange must fall between the price ratios that would prevail in the two countries in the absence of trade

·             In the real world you mostly find incomplete specialization

·             Mercantilism- a doctrine that holds that exports are good for a country whereas imports are harmful

·             Tariff- a tax on imports

o   US is a low tariff country

o   Some of the “profits” go as tax revenues, better than a quota for the country that gets the tax

o   Still allows firms that supply goods most efficiently to serve market

o   Allows government to rig prices in favor of domestic producers

o   Often raised to protect favored industries from foreign competition

·             Quota- the maximum amount of a good that is permitted into the country from abroad per unit of time

o   Profits from the higher price in the importing country usually go to foreign and domestic sellers

o   Customers in the importing country must pay more for every unit they sell

o   Suppliers receive more for every unit

o   Might not get most efficient sellers

·             Export subsidy- a payment by the government to exporters to permit them to reduce the selling prices of their goods so they can compete more effectively in foreign markets

·             US government offers temporary protection from sudden surges of imports for businesses and workers

·             Trade adjustment assistance- provides special unemployment benefits, loans, retraining programs, and other aid to workers and firms that are harmed by foreign competition

·             Trade protection can maintain national defense for making military products

·             Infant-industry argument- new industries need to be protected from foreign competition until they develop and flourish

·             Strategic argument for protection- a nation may sometimes have to threaten protectionism to induce other countries to drop their own protectionist measures

o   Risky

·             Dumping- selling goods in a foreign market at lower prices than those charged in the home market

o   Getting rid of goods

·             Higher wages are a result of higher productivity

·             For standard of living, absolute advantage not comparative advantage counts

o   Country most efficient in producing outputs can pay its workers more

o    

Chapter 29

·             The nation’s money supply is an important determinant of aggregate demand

·             Bank regulation is for the safety of depositors

·             Run on a bank- many depositors withdraw cash from their accounts all at once (dangerous for banks)

·             Barter- a system of exchange in which people directly trade one good for another without using money as an intermediate step

·             Money makes exchange faster and makes economy more productive

·             Money- the standard object used in exchanging goods and services; medium of exchange

·             Unit of account- the standard unit for quoting prices (money becomes this)

·             Store of value- an item used to store wealth from one point in time to another

o   Savings

·             Commodity money- an object used as a medium of exchange that also has substantial value in nonmonetary uses

o   Ex: cattle, cigarettes

·             Fiat money- money that is decreed as such by the government; little value as a commodity

·             M1- the narrowly defined money supply, sum of all coins and paper money in circulation, plus certain checkable deposit balances at banks and savings institutions

o   Completely liquid

·             M2- the broadly defined money supply, sum of all coins and paper money in circulation, plus all types of checking account balances, plus most forms of savings account balances, plus shares in money market mutual funds

o   Money market deposit accounts

o   Money market mutual funds

o   Savings account

§  Less liquid

·             Near moneys- liquid assets that are close substitutes for money

·             Liquidity- the ease with which it can be converted to cash

·             “Money” is still only coins paper money, and checkable deposits

·             fractional reserve banking- a system under which bankers keep as reserves only a fraction of the funds they hold on deposit

·             Bankers’ decisions on how much money to hold in reserves influences the supply of money

·             Deposit insurance- a system that guarantees that depositors will not lose money even if their bank goes bankrupt

·             Moral hazard- the idea that when people are insured they will engage in riskier behavior

o   People will not bother to shop around for a safer bank if they are insured

·             Regulatory authorities conduct bank examinations to keep tabs on financial conditions and business practices of banks

·             Laws limit the kinds and quantities of assets in which banks may invest

o   Can only own limited amounts of common stock

·             Required reserves- the minimum amount of reserves required by law; normally required reserves are proportional to the volume of deposits

·             Systemic risk-risks to the entire system of banks or financial institutions; arises because these institutions are interlinked in many ways

o   Inhere mainly in the largest financial institutions

o   “fire sales” if a bank suffers losses and has to sell a large volume of assets quickly; risks to the entire economy

·             systemically important “too big to fail”- financial institution that by virtue of its size or interconnectedness, can threaten the entire system if it runs into trouble

·             asset- an item of value that an individual or firm owns

·             liability- an item of value that the individual or business firm owes; debts

·             balance sheet- an accounting statement listing the values of all assets on the left side and the values of all liabilities and net worth on the right side

o   banks assets should exceed liabilities

·             net worth- the value of all assets minus the value of all liabilities

·             assets= liabilities + net worth

·             deposit creation- the process by which a fractional reserve system turns $1 of bank reserves into several dollars of bank deposits

·             excess reserves- any reserves held in excess of the legal minimum

·             money creation can gather momentum**

·             620-621

·             the chain of deposit creation ends only when there are no more excess reserves to be loaned out, when its all tied up in required reserves

·             if the required reserve ratio is some fraction, m, the banking system as a whole can convert each $1 of rserves into $1/m in new money; the money multiplier is given  by: change in money supply = (1/m) x change in reserves

·             money multiplier- the ratio of newly created bank deposits to new reserves

·             the over simplified money multiplier is accurate only when

o   every recipient of cash must redeposit the cash into another bank rather than hold it

o   every bank must hold reserves no larger than the legal limit

·             if individuals/firms decide to hold more cash, the multiple expansion of bank deposits will be curtailed because fewer dollars of cash will be available for us se as reserves to support checking deposits; money supply will be smaller

·             each $1 held inside a bank can support several dollars of money

·             each $1 held outside the banking system constitutes exactly $1 of money

o   supports no deposits

·             if banks wish to hold excess reserves, the multiple expansion of bank deposits will be limited

o   a given amount of cash will support a smaller supply of money than in the case when banks hold no excess reserves

·             banks will most likely keep excess reserves in a recession when business conditions are depressed

·             during economic boom, profit oriented banks will make the money supply expand, adding undesirable momentum to the booming economy and paving the way for inflation

Chapter 7