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It’s Not Fair If the Rules Aren’t FairThis perspective relies on the symmetry principle—the requirement that people in similar situations should be treated similarly. In economics, this means equality of economic opportunity rather than equality of economic outcomes. 31. Maximizing Utility
Positive Marginal Utility
Diminishing Marginal Utility
· The theory of consumer behavior uses the law of diminishing marginal utility to explain how consumers allocate their incomes. The utility maximization model is built based on the following assumptions: · 1. Consumers are assumed to be rational, trying to get the most value for their money. · 2. Consumers’ incomes are limited because their individual resources are limited. They face a budget constraint. · 3. Consumers have clear preferences for various goods and services, thus they know their MU for each successive units of the product. · 4. Every item has a price tag. Consumers must choose among alternative goods with their limited money incomes. · The Utility Maximization rule states: consumers decide to allocate their money incomes so that the last dollar spent on each product purchased yields the same amount of extra marginal utility. · The algebraic statement is that consumers will allocate income in such a way that: · MU of product A / price of A = MU of product B / Price of B = MU of product C / price of C = etc. · It is marginal utility per dollar spent that is equalized. As long as one good provides more utility per dollar than another, the consumer will buy more of that good; as more of that product is bought, its MU diminishes until the amount of MU per dollar just equals that of the other products. 32. Predictions of Marginal Utility A Fall in the Price of a Movie A Change in the Quantity Demanded
A Change in Demand
A Rise in Income
Paradox of Value
Temperature: An Analogy
33. New Ways of Explaining Consumer Choices Behavioral Economics
Bounded Rationality
Bounded Will-Power
Bounded Self-Interest
The Endowment Effect
Neuroeconomics
Controversy
34. Consumption Possibilities A household’s consumption choices are constrained by its income and the prices of the goods and services available. A household’s budget linedescribes the limits to its consumption choices.
Budget Equation We can describe the budget line by using a budget equation, which states that income equals expenditure. Calling the price of a book PB, the quantity of books QB, the price of a pizza PP, the quantity of pizza QP, and income Y, we can write a budget equation as PB´ QB+ PP´ QP= Y, which can be rearranged into slope-intercept form as QB = Y/PB - (PP/PB) ´ QP. A household’s real income is the household’s income expressed as a quantity of goods the household can afford to buy. In the figure above, in terms of books, the household’s real income is Y/PB(5 books), which is the vertical intercept of the budget line. A relative price is the price of one good divided by the price of another good. The magnitude of the slope of the budget line, (PP/PB), is the relative price of a pizza in terms of a book. A relative price is an opportunity cost, so the relative price of a pizza in terms of books gives the opportunity cost of a pizza in terms of books forgone. When the price of the good measured along the horizontal axis (pizzas) changes, the budget line rotates around the vertical intercept. If the price of the good falls, the budget line rotates outward and becomes steeper; if the price of the good rises, the budget line rotates inward and becomes steeper. When income changes, the budget line shifts and its slope does not change. If income increases, the budget line shifts outward; if income decreases, the budget line shifts inward. 35. Preferences and Indifference Curves
· The consumer is indifferent among all the points on any particular indifference curve. · The consumer prefers points above any particular indifference curve to points on the curve. And the consumer prefers points on the indifference curve to points below the curve. In the figure, the consumer prefers any point on indifference curve I2 to any point on I1 and any point on I3 to any point on I2. Marginal Rate of Substitution
· The magnitude of the slope of the indifference curve at any point measures the marginal rate of substitution between the goods. If the indifference curve is steep, the MRS is high; if the indifference curve is flat, the MRS is small. · The diminishing marginal rate of substitution is the general tendency for a person to be willing to give up less of good y to get one unit of good x, and at the same time remain indifferent, as the quantity of x increases. This principle implies that indifference curves generally become flatter moving along them to the right. Degree of Substitutability
36. Predicting Consumer Choices
· is on the budget line, · is on the highest attainable indifference curve, · has a marginal rate of substitution between the two goods equal to the relative price of the two goods.
A Change In Price
Substitution Effect and Income Effect
· The income effect is the effect on the quantity bought of a change in income sufficient to shift the hypothetical budget line used to measure the substitution effect so that it is the same as the actual new budget line. This process is the movement from point b to point d in the figure. For a rise in price, this change requires a decrease in income. For a normal good, the decrease in income decreases the quantity consumed. So for a normal good, the substitution effect and the income effect reinforce each other: both demonstrate that the quantity consumed decreases. 37. Work-Leisure Choices Labor Supply
· The increase in the wage rate has a substitution effect and an income effect. The substitution effect occurs because an increase in the wage rate increases the opportunity cost of leisure, so people respond by substituting away from leisure. But the higher wage rate also increases the household’s income and the income effect leads to an increase in the demand for leisure, which is a normal good. · Between points a and b in the figure, the substitution effect dominates, so an increase in the wage rate increases the quantity of labor supplied. But if the wage rate increased more, so that the household could reach indifference curve I3, the income effect would dominate and the increase in wage rate would decrease the quantity of labor supplied. 38. The Firm and Its Economic Problem · A firm is an institution that hires factors of production and organizes those factors to produce and sell goods and services · The firm’s goal is to maximize its profit. If a firm fails to maximize profit it is either eliminated through competition or bought out by other firms seeking to maximize profit. Accounting Profit and Economic Profit · A firm’s accounting profit is the firm’s revenues minus expenses and depreciation. · A firm’s economic profit is equal to total revenue minus total cost, with total cost measured as the opportunity cost of production. A Firm’s Opportunity Cost of Production · A firm’s decisions respond to opportunity cost and economic profit. A firm’s opportunity cost of production is the value of the best alternative use of the resources that a firm uses in production. · Opportunity costs of production include the cost of resources that are bought in the market, owned by the firm, or supplied by the firm’s owner. 39. A Firm’s Opportunity Cost of Production · A firm’s decisions respond to opportunity cost and economic profit. A firm’s opportunity cost of production is the value of the best alternative use of the resources that a firm uses in production. · Opportunity costs of production include the cost of resources that are bought in the market, owned by the firm, or supplied by the firm’s owner. a. For example, renting capital means the firm is paying a rental cost reflecting the opportunity cost to the owner of the capital when someone else using the capital. However, if the firm buys capital it incurs an opportunity cost of using its own capital, which is called the implicit rental rate of capital.The implicit rental rate includes economic depreciation, which is the change in the market value of capital over a given period, and the interest forgone, which is the lost potential return on the funds that were used to acquire the capital. The return to the owner for the owner’s entrepreneurial ability is profit. The return for this input that an entrepreneur can expect to receive on the average is called normal profit. The normal profit is part of the firm’s opportunity cost. Economic profit is a firm’s total revenue minus its opportunity cost. Because normal profit is part of the firm’s opportunity costs, economic profit is profit over and above normal profit. 40. Technological and Economic Efficiency · There typically are many different combinations of inputs that can produce a specific level of output. Technological efficiency occurs when a firm produces a given output by using the least amount of inputs. Economic efficiency occurs when the firm produces a given output at the least possible cost. An economically efficient production process is always technologically efficient. But, a technologically efficient process might not be economically efficient. · The table has 4 different methods of producing a unit of output. The columns show the number of units of labor and capital needed to produce 1 unit of output. b. Method 2 is technologically inefficient because it uses the same amount of capital but more labor than does Method 1. c. Which method is economically efficient depends on the prices of labor and capital. If labor is $10 per unit and capital is $1, then Method 1 is economically efficient (with a cost of $60 per unit of output). If labor is $1 per unit and capital is $10 per unit, then Method 4 is economically efficient (with a cost of $30 per unit of output). 41. Information and Organization A firm organizes production by combining and coordinating productive resources using a mixture of command systems and incentive systems. · Acommand system uses a managerial hierarchy. Commands pass downward through the hierarchy and information (feedback) passes upward. · An incentive system uses a market-like mechanism inside the firm. · The principal-agent problem is the problem of devising compensation rules that induce an agent to act in the best interests of a principal. For example, the stockholders of a firm are the principals and the managers of the firm are their agents. Stockholders wish to provide incentives to the managers to bring the manager’s decisions in line with profit maximization. Firms cope with the principal-agent problem in many ways: d. Ownership: Firms’ owners often offer managers partial ownership of the firm to give the managers an incentive to maximize the firm’s profits, which is the goal of the owners. e. Incentive pay: Firms’ owners can links managers’ or workers’ pay to the firm’s performance, such as its sales, to help align the managers’ and workers’ interests with those of the owners. f. Long-term contracts: Firms’ owners can tie managers’ or workers’ long-term rewards to the long-term performance of the firm. 42. Types of Business Organization A proprietorship is a firm with a single owner. This owner has unlimited legal liability, which means the owner has legal responsibility for all debts incurred by the firm up to an amount equal to the entire wealth of the owner. The proprietor is the only one who makes management decisions and is the sole claimant of the firm’s profit. Profits are taxed the same as the owner’s other income. A partnership is a firm with two or more owners. Each partner has unlimited legal liability. The partners must agree upon a management structure and agree how to divide up the profits from the firm. Profits from partnerships are taxed as the personal income of the owners. A corporation is a firm that is owned by one or more stockholders with limited liability, which means the owners have legal liability only for the initial value of their investment so the personal wealth of the stockholders is not at risk if the firm goes bankrupt. The profit of corporations is taxed twice—once as a corporate tax on the firm’s profits, and then again as income taxes paid by stockholders receiving their after-tax profits distributed as dividends. Proprietorships are the most common form of business organization but corporations account for the majority of revenue received by all types of business organization 43. Markets and the Competitive Environment The competitive environment, also known as the market structure, is the dynamic system in which your business competes. The state of the system as a whole limits the flexibility of your business. World economic conditions, for example, might increase the prices of raw materials, forcing companies that supply your industry to charge more, raising your overhead costs. At the other end of the scale, local events, such as regional labor shortages or natural disasters, also affect the competitive environment. Direct Competitors Indirect Competitors A competitive environment is where there are several similar firms that are competing for the same market segment. These firms normally produce products of the same nature and form and whose uses are more or less the same. However, because of the competition that exists for the market, these firms are likely to differentiate their products to endear them to a larger number of consumers compared to their rivals. 44. Markets and Firms The theory of the firm consists of a number of economic theories that describe, explain, and predict the nature of the firm, company, or corporation, including its existence, behavior, structure, and relationship to the market In simplified terms, the theory of the firm aims to answer these questions: 1. Existence. Why do firms emerge, why are not all transactions in the economy mediated over the market? 2. Boundaries. Why is the boundary between firms and the market located exactly there as to size and output variety? Which transactions are performed internally and which are negotiated on the market? 3. Organization. Why are firms structured in such a specific way, for example as to hierarchy or decentralization? What is the interplay of formal and informal relationships? 4. Heterogeneity of firm actions/performances. What drives different actions and performances of firms? 5. Evidence. What tests are there for respective theories of the firm? Firms exist as an alternative system to the market-price mechanism when it is more efficient to produce in a non-market environment. For example, in a labor market, it might be very difficult or costly for firms or organizations to engage in production when they have to hire and fire their workers depending on demand/supply conditions. It might also be costly for employees to shift companies every day looking for better alternatives. Similarly, it may be costly for companies to find new suppliers daily. Thus, firms engage in a long-term contract with their employees or a long-term contract with suppliers to minimize the cost or maximize the value of property rights
45. Short-Run Technology Constraint The Short Run is a time frame in which the quantity of one or more resources used in production is fixed.For most firms the capital is fixed in the short run. Other resources used by the firm (such as labor, raw materials, and energy) can be changed in the short run. Short-run decisions are easily reversed. The marginal product of labor is the change in total product that results from a one-unit increase in the quantity of labor employed, with all other inputs remaining the same.Almost all production processes are like the one shown here and have: Initially increasing marginal returns When the marginal product of a worker exceeds the marginal product of the previous worker, the marginal product of labor increases and the firm experiences increasing marginal returns. Eventually diminishing marginal Returns When the marginal product of a worker is less than the marginal product of the previous worker, the marginal product of labor decreases and the firm experiences diminishing marginal returns. 46. Product Schedules, Product Curves, The law of diminishing returns Total product is the maximum output that a given quantity of labor can produce. The marginal product of labor is the increase in total product that results from a one-unit increase in the quantity of labor employed with all other inputs remaining the same. The average product of labor is equal to the total product of labor divided by the quantity of labor. The table to the right has examples of these product schedules. Product Curves The total product curve illustrates the total product schedule. The slope of the total product curve equals the marginal product of labor at that quantity of labor. The marginal product curve shows the additional output generated by each additional unit of labor. The marginal product of labor curve (MP) has an upside-down U shape. Increasing marginal returns occurs when the marginal product of an additional worker is greater than the marginal product of the previous worker. At low levels of employment, increasing marginal returns is likely because hiring an additional worker allows large gains from specialization. Eventually these gains become small or nonexistent and diminishing marginal returns set in. Diminishing marginal returns occur when the marginal product of an additional worker is less than the marginal product of the previous worker. The law of diminishing returns states that as a firm uses more of a variable factor of production, with a given quantity of the fixed factor of production, the marginal product of the variable factor eventually diminishes. The average product curve shows the average product that is generated by labor at each level of labor. As the figure shows, the average product of labor curve (AP) has an upside-down U shape. As the figure shows, the marginal product curve and the average product curve are related: when the marginal product of labor exceeds the average product of labor, the average product of labor increases; when the marginal product of labor is less than the average product of labor, the average product of labor decreases; and the marginal product of labor equals the average product of labor when the average product of labor is at its maximum.
47. Short-Run Cost Total Cost · Total cost (TC) is the cost of all the factors of production a firm uses. Total fixed cost (TFC) is the cost of the firm’s fixed factors. Total variable cost (TVC) is the cost of the firm’s variable factors. Total cost is the sum of total fixed cost plus total variable cost so TC = TFC + TVC. Date: 2015-12-11; view: 1943
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