Introduction to Economics I Kitap Alıntıları – Ahmet Tiryaki

A monopoly exists in a market when there are barriers to entry.
Barriers to entry are:

• Government regulations: Government may give one person or firm the exclusive right to sell some good or service.
• Ownership of a key resource
• Natural Monopoly: A natural monopoly occurs when economies of scale are so large that one firm can supply the entire market at a lower average cost than two or more firms.

Monopoly is a market structure with only one producer/seller of a good and this it does not act as a price taker but it is a price setter.

Oligopoly is a market structure with few firms. Each firm in the market produces a large share of the total market quantity and hence can influence the market price.

Monopolistic competition is a market structure where there are many firms that sell differentiated products. Each firm has a monopoly over the product it sells, but many other firms make similar products that compete for the same customers.

A sunk cost is a cost that has already been incurred and thus cannot be recovered.

Given the fixed factor prices, when all inputs are raised at the same time by the same percentage, if output increases more than the percentage increase in inputs, we call this increasing returns to scale. If output increases by the same percentage as increase in all inputs, this is named constant returns to scale. If output increases less than the percentage increase in inputs, then there are decreasing returns to scale.

The sum of all the fixed costs a firm has to pay for fixed inputs is called the total fixed cost (TFC). The total fixed cost does not vary with the level of output. The sum of all variable costs a firm pays for variable inputs is called total variable cost (TVC). The sum of TFC and TVC gives us the total cost (TC). The total cost is the economic cost of all the resources, including the cost of entrepreneurship which is called normal profit.

The average cost (AC) tells us the cost per unit. The average fixed cost (AFC) gives the fixed cost per output. The average fixed cost will continuously decrease as output produced increases.

The marginal cost (MC) is the cost of producing the last unit of output. It tells us how the total cost (and the total variable cost) changes as output changes.

The Production process converts resources which are called inputs or factors of production into new goods and services called outputs over a period of time. The basic factors of production available to a society are natural resources, labor, capital and entrepreneurship.

Production technology, i.e. how much output is produced when given amounts of labor and capital are used, is defined by a production function. Marginal Product of Labor (MPL) is the additional output produced when a small amount of additional labor is employed with all other inputs remaining the same. More formally, it is the ratio of the change in total product to the change in the amount of labor used.

As more and more labor is used, given everything else is the same, the change in total output for each additional unit of labor input first increases , referred to as increasing marginal returns. If we continue to add more and more labor, the marginal product will eventually become less and less, referred to as diminishing marginal returns.

If the price elasticity of supply is perfectly inelastic the supply curve will be vertical.

The sellers bear the tax burden when the demand is more price-elastic than the supply.

Producer surplus shows the benefits the sellers gain from participating in the market activity. PS is the difference between the amounts that a seller is paid for a good minus the cost to seller. That is; PS = Price-Cost. It increases with the rise of market price.

Consumer surplus shows the benefits the consumers gain from participating in the market activity. CS is the amount a buyer is willing to pay minus the buyer actually pays. That is, CS = WTP-P. It increases with the fall of the market price.

The tax incidence: Shows who pays the tax and how the tax burden is shared among the buyers and sellers. It is not affected by whether the tax is levied on buyers or sellers.

The tax burden goes more heavily on the side of the market that is less price elastic / less flexible to changes in market conditions.

When the supply is more price-elastic than the demand, sellers are relatively more responsive to price changes, and the suplly curve is flatter than the demand curve. It also indicates that the buyers have relatively fewer alternatives, so they have to accept most of the price increase and hence the burden caused by the imposition of the tax.

Effects of taxation on the market:

1) Taxes create a wedge between the price that buyers pay and the price that the sellers receive. The wedge is equal to the tax.

2) The price that the buyers pay rises and the price that the sellers receive falls.

3) Taxation reduces the market size by reducing the equilibrium quantity, creating a dead-weight loss for the market.

Price controls are applied as price ceiling (legal maximum) and price floor(legal minimum). (Rent controls, minimum wage).

Price elasticity of supply measures how much quantity supplied responds to a change in price (the price sensitivity of sellers’ supply). Because of the law of supply, the price elasticity of supply always has a positive sign. An increase in price causes the quantity supplied to increase. The supply of a good is said to be inelastic if the quantity supplied responds only slightly to price changes while it is said to be elastic if the quantity supplied changes more than the price changes.

Price elasticity of supply (esp): Percentage change in quantity supplied / Percentage change in price

The price elasticity of supply is determined by the flexibility of producers/sellers to change in the amount of the good or service they produce in response to price changes. The flexibility of producers depends on two important factors: 1) availability of inputs to producers, 2) time horizon. The higher the availability of inputs to producers the higher the elasticity of supply. Supply is more elastic in the long run than in the short run. In the long run firms can change their plant/factory size or production in response to price changes, changing the quantity supplied.

If the demand is elastic, an increase in the price causes the total revenue to decrease while a decrease in price causes the total revenue to increase.

If the demand is inelastic, an increase in the price causes the total revenue to increase.

Determinants of the price elasticity of demand:

1) Is there an available substitute?: Goods with close substitutes have more elastic demand.

2) Is it a luxury or necessity?: Necessities have inelastic demand, luxuries have elastic demand.

3) Weight of the good’s cost in the consumers’ budget: Goods that represent a relatively small portion of our total budget tend to have inelastic demand.

4) Time period: Price elasticity of demand is higher in the long run because substitute availability increases in the long run.

Total surplus (TS) measures the total gains from trade in a market. Total surplus from a market is the sum of consumer and producer surpluses; that is, TS=CS+PS.

The market equilibrium wage and the quantity is determined by the labor supply and demand.

The flatter the supply curve, the larger the price elasticity and the steeper the curve, the smaller the price elasticity of supply. ( ) The perfectly inelastic supply curve has a vertical shape and the slope and the price elasticity of vertical supply curve is equal to zero.

Total revenue is the price of a good times the quantity sold. TR=PxQ

Unless the price and quantity are identical, demand curve is vertical its slope and price elasticity is zero or the demand curve is horizontal turning its slope and price elasticity infinite; the flatter the demand curve the higher the price elasticity and the steeper the demand curve is the lower the price elasticity of demand.

Demand is inelastic when the percentage change in quantity demanded is smaller than the percentage change in price. Inelastic demand always takes a value between zero and -1.

Demand is elastic when the percentage change (decrease) in quantity demanded is larger than the percentage change (increase) in price. Elastic demand has an absolute value greater than 1.

Elasticity can be defined as a measure that shows how much one variable responds to changes in another variable. ( ) Economists compute elasticity as the percentage change in, say, variable A, divided by the percentage change in variable B. That is,

Elasticity of A with respect to B = %∆A / %∆B

If we hold commodity prices constant, each level of money income results in an equilibrium market basket for the consumer. This analysis gives us the income-consumption curve.

The rational consumer will choose to in equilibrium to allocate his or her income between two goods (X and Y) at the point that the MRS x for y = Px / Py.

Related parts of consumer choice:

1) Consumer’s Utility (Total Utility, Marginal Utility, The Law of Diminishing Marginal Return),

2) The Budget Line

An increase in the interest rates makes net savers better off and net borrowers worse off.

If interest rates fall, the reward from saving falls. It becomes relatively more attractive to hold cash and/or spend. This is the substitution effect – with lower interest rates, consumers substitute saving for spending:

Saving rate = s0 (autonom saving rate) + ß1r (marginality or the slope coefficient representing the real interest rate)

However, if interest rates fall, savers see a decline in income because they receive lower income payments. A pensioner relying on interest payments from savings may feel he needs to save more in order to maintain the income from savings. Usually, the substitution effect dominates. Lower interest rates make saving less attractive. But, for some, the income effect may dominate, and people may respond to lower interest rates by saving more in order to maintain their standard of living.

Higher interest rates increase income from saving, so spending increases, (Income effect) but also they make saving more attractive than spending (Substitution effect). Outcome depends on which effect dominates.

Engel curves, named after 19th century German statistician Ernst Engel, illustrate the relationship between consumer demand and household income. Engel curves for normal goods slope upwards – the flatter the slope the more luxurious the good, and the greater the income elasticity. In contrast, Engel curves for inferior goods have a negative slope.

Conventional demand curve is that the lower the price, the higher the quantity demanded. This relationship stays the same as long as the four determinants of demand don’t change:

1. Price of related goods or services
2. Income of the buyer
3. Tastes and preferences of the buyer
4. Expectation of the buyer, especially about future prices

Marshalian Demand: Price goes up, demand goes down

Giffen Type Demand: Price goes up, demand goes up (famines such)

The substitution effect is the change in consumption that results when a price change moves the consumer along an indifference curve to a point with a different marginal rate of substitution. When the price of good Y declines, consumers will substitute cheaper goods for expensive ones.

The income effect is the change in consumption that results when a price change moves the consumer to a higher or lower indifference curve.

The consumer chooses between the consumption of the two goods so that the MRS equals the relative price. At the consumer’s optimum, the consumer’s valuation of the two goods equals the market’s valuation.

Two goods are perfect substitutes when the marginal rate of substitution of one good for the other is constant. ( ) For a perfect substitute, the MRS of the indifference curve is a straight line.

MRS (x for y) = ∆Y/∆Y = MUx/MUy

The marginal rate of substitution (MRS) is defined as the number of units of good Y that must be given up if the consumer, after receiving an extra unit of good X, is to maintain a constant level of satisfaction or utility.

Marginal Utility, (MUx) = change in the total utility of good X / change in quantity of good X = ∆TU / ∆X

Indifference Curves

1) More goods are prefferable to fewer goods, thus, bundles on indifference curves lying farthest to the northeast of a diagram are always preffered.

2) Goods are substitutable, therefore, indifference curves slope downward to the right.

3) Indifference curves cannot cross each other, if they did, the rational ordering among preferences would be violated.

4) Indifference curves are everywhere dense. We can draw an indifference curve through any point on the diagram.

5) The valuation of a good declines as it is consumed more intensively, therefore, indifference curves are always convex. The slope of an indifference curve represents the willingness of the individual to substitute one good for the other. This is also defined as the marginal substitution rate (MRS) which refers to the amount of good X that is just sufficient to compensate the consumer for the loss of a unit of the good Y.

Total Utility: The total satisfaction you derive from consumption; this could refer to either your total utility of consuming a particular good or your total utility from all consumption.

Marginal Utility: The change in your total utility from a one-unit change in your consumption of a good.

An indifference curve can be derived when there are two elements in every choice: 1) preferences and 2) opportunities (attainability of various goods) It is related to the former, preferences. It separates better (more preferred) bundles of goods from inferior (less preferred) bundles, providing a diagrammatic picture of how an individual ranks alternative consumption bundles.

Ordinal Utility Function places market baskets in the order of most preferred to least preferred, but it does not indicate how much one market basket is preferred to another.

Cardinal Utility Function says utility is measurable and can be expressed in quantitative term; describes the extent to which one market basket is preferred to another.

Principles of consumer behaviour:

1- Limited income necessitates choice.
2-Consumers make their decisions purposefully.
3-One good can be substituted for another.
4-Consumers must make decisions without perfecr information, but knowledge and past experiences will help.
5-The law of diminishing marginal utility applied; as the rate of consumption increases, the total utility will increase at decreasing rate or marginal utility derived from consuming additional units of a good will decline.

If the price of one good increases, the budget line shifts inward, pivoting from the other good’s intercept.

Let’s consider the budget constraint facing an individual who has a fixed level of income (I) that can be used to buy two goods (X and Y) at fixed prices (Px and Py). The budget constraint facing this individual can be expressed as: Px.X + Py.Y = I

A positively sloped demand curve implies that the buyers are willing to pay for a good if the price is higher. This is against the rationality assumption.

Goods are cheaper in competitive markets than in a monopoly.

In a particular market, if the supply is fixed, the price will be determined by the demand curve.

According to the law of demand there is a negative relationship between the quantity demanded and the price.

Resource Allocation: Scarce resources are allocated in response to changes in price. If there is an increase in the price of a good ( ) then this signals to producers that consumers wish to buy this good at greater amounts. This will lead to an upward shift in the demand curve and raise the equilibrium price. As producers are rational and wish to maximize their profits, the higher price will provide the incentive needed to convince producers to produce more of the good.

Perfect Competition: It is a (hypothetical) market in which (1) the good or service being exchanged has exactly the same qualities no matter who the seller is; (2) there are a high number of potential buyers and sellers, all of whom act independently of each other; (3) buyers and sellers readily and freely have access to information with regards to the prices at which other buyers and sellers are exhanging the good

Equilibrium is a situation in which the supply and demand equals to each other.

An increase of the number of sellers will increase quantity supplied, shifting the supply curve to the right.

In general, the expectations and confidence of the producers, with regards to market booms or busts in the future may influence their current production decisions.

An improvement in the production technology will lead to an increase in the quantity supplied, shifting the supply curve down to the right.

(If the) input prices go up, the firm will no longer be willing to supply the product in the same amount as before, shifting the supply curve to the left.

Reservation price: At that price level and below, producers can at best cover their opportunity costs and they will not be willing to supply a positive quantity. Only when the market price exceeds their respective reservation prices, will the firms be able to start supplying increasingly more as prices go up.

The law of supply indicates that when the price of a good goes up, the sellers’ quantity supplied also goes up, and vice-versa.

Supply is the willingness and the ability of producers to produce a quantity of a good or a service at a given price in a given time period. ( ) This is known as the effective supply and this is what is shown on a supply curve.

Complements are goods that go together. A decrease in the price of one causes an increase in the demand for the other.

Substitute goods serve as replacements for one another. When the price of one rises, the demand for the other increases.

Normal goods are goods for which the demand increases when income is higher and decreases when income is lower. ( ) A product is said to be inferior if the demand for that product goes down when the income of the consumers increases.

A shift in consumer preferences towards a product translates into higher market prices which, in turn, provide incentives for new sellers to enter the market. This will eventually lead to an increase in the quantity supplied as well.

Substitution Effect: When the price of product Y falls, this will make product Y relatively more attractive than other products, whose prices have stayed unchanged. As a result, consumers will want to purchase more Y, while lowering the consumption of some of the other products.

Income Effect: When the price of a product, say, product Y, falls, people consuming the product will experience an increase in their purchasing power or real income , which reflects the amount of different products that they can buy with their incomes. With this increase in real income, the people will be able to buy more of product Y whose prce has declined, or more of the other products.

Market demand is the sum of all the quantities of a product demanded per period by all the buyers in the market.

Utility that the individual obtains from each additional or marginal unit consumed of a good declines, as more and more of that good is consumed. The consumer is said go be satiated after consuming a large enough quantity.

A demand schedule is a table that shows the relationship between the price and quantity demanded of a product.

Demand is the quantity of a good or service that consumers are willing and able to purchase at a given price in a given time period at any given market. The important terms here are the willingness and ability of buyers. It is not sufficient for potential buyers to be willing to purchase a good or service, they must be able to purchase it. ( ) This is known as effective demand and it what we show on a demand curve.

The extreme cases of imperfect competition are monopoly and monopsony. ( ) Monopsonist markets are the ones in which there exist only one buyer and many sellers.

Broadly speaking, there are two types of markets: Product markets and factor markets. In the first one, all sprts of goods and services from cars to movie tickets are bought and sold. The other one involves factors of production such as land, labor and capital. ( ) Probably the most famous markets are stock markets and foreign exchange markets. In stock markets such as Turkey’s BIST (Borsa İstanbul) shares of companies are bought and sold. In foreign exchange markets, international currencies are traded.

Consumers (households) and producers (firms) are the main players in the markets. The households are the consuming units in a market and also in an economy. On the production side, the firms are the organizations that transform inputs into outputs. Firms are the primary producing units in a market economy and they are led by entrepreneurs. An entrepreneur is a person who organizes, manages, and takes the risks of a firm, by blending the inputs to transform them into a new product.

We make decisions at the margin not at the total or at the average.

We should make our decisions by thinking at the margin. Rational decision makers take an action if and only if the marginal benefit of the action is greater than the marginal cost.

The production possibilities frontier implements the limit that an economy could produce.