Economics EOCT Prep

Economics EOCT PrepMicroeconomics

Markets•In a Market Economy, SUPPLY and

DEMAND provide signals that trigger production and consumption of goods and services

•WE, as consumers, are the demanders•WE, as producers, are also the suppliers

Circular Flow of Economic Activity

What is DEMAND?•The willingness and ability to purchase

a good or service•The Law of Demand states:

▫Consumers will buy MORE of a good or service when its PRICE DECREASES

▫Consumers will buy LESS of a good or service when its PRICE INCREASES

(DUH!!! – Right???)

Imagine a product…Let’s say SODA (from the school drink machine)How many would you buy a week if they cost:

$1.00 ?$1.50 ?$2.00 ?$3.00 ?$ .50 ?

Demand SchedulePRICE

of a SodaQuantity of Soda

DEMANDED$ .50 10$1.00 5$1.50 4$2.00 2$3.00 1

Demand Curve

0 2 4 6 8 10 12$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

QUANTITY

PRIC

E

What might cause Demand to Shift?•INCOME – as income increases, consumers

purchase more (exception = inferior goods!)•CONSUMER EXPECTATIONS – if we

expect the price of a good to change in the future, it impacts our current demand for the good (example = gas)

•POPULATION – changes in the number of people impact demand for goods/services

•CONSUMER TASTES & ADVERTISING – influences trends so demand is impacted

Also…•Changes in the PRICE of RELATED

GOODS▫Complements are two goods that are

typically bought and used together (example = skis and ski boots)

▫Substitutes are goods used in place of one another (example = skis and snowboards)

What is ELASTICITY of DEMAND?•Elasticity of Demand is a measure of how

consumers react to a change in the PRICE of a good/service (how flexible they are)▫Demand for a good that consumers NEED

tends to be INELASTIC (not flexible)▫Demand for a good that consumers can do

without (perhaps there are substitutes) tends to be ELASTIC (flexible)

Reviewing DEMAND1. The law of demand states that

a. Consumers will buy more when a price increases

b. Price will not influence demandc. Consumers will buy less when a price

decreasesd. Consumers will buy more when a price

decreases

2. If the price of a good rises and income stays the same, what is the effect on demand?

a. The prices of other goods dropb. Fewer goods are boughtc. More goods are boughtd. Demand stays the same

3. Which of the following statements is accurate?a. When two goods are complementary, increased

demand for one will cause decreased demand for the other.

b. When two goods are complementary, increased demand for one will cause increased demand for the other.

c. If two goods are substitutes, increased demand for one will cause increased demand for the other.

d. A drop in the price of one good will cause increased demand for its substitute.

4. What does elasticity of demand measure?

a. An increase in the quantity availableb. A decrease in the quantity demandedc. How much buyers will cut back or

increase their demand when prices rise or fall

d. The amount of time consumers need to change their demand for a good

5. What effect does the availability of many substitute goods have on the elasticity of demand for a good?

a. Demand is elasticb. Demand is inelasticc. Demand is unitary elasticd. The availability of substitutes does not

have an effect

What is SUPPLY?•According to the Law of Supply,

suppliers will offer MORE of a good at a HIGHER PRICE.

Price As price

increases…

SupplyQuantity supplied increases Price

As price falls…

SupplyQuantity supplied

falls

Supply Schedule

Supply CurveRemember:If you are a PRODUCER, higher prices (as long as production costs remain constant) mean you make a bigger PROFIT!

What is ELASTICITY of SUPPLY?•Elasticity of Supply is a measure of the

way QUANTITY SUPPLIED reacts to a CHANGE in PRICE.▫If supply is not very responsive to changes

in price (perhaps it takes a long time to make the good), it is considered INELASTIC.

▫An ELASTIC supply is very sensitive to changes in price (the supply can be increased or decreased fairly easily).

How do businesses determine how many people to hire?

•They must know how the number of workers affects total production

•The marginal product of labor is the change in output from hiring one additional worker

Marginal Returns

Changes in Supply•Any change in the COST of an input (like

raw materials, machinery, or labor) will affect supply.

•New technology can decrease costs and increase supply.

Reviewing SUPPLY:1. What is the law of supply?

a. The lower the price, the larger the quantity supplied

b. The higher the price, the larger the quantity supplied

c. The higher the price, the smaller the quantity supplied

d. The lower the price, the more manufacturers will produce the good

2. What happens when the price of a good with elastic supply goes down?

a. Existing producers will expand and some new producers will enter the market

b. Some producers will produce less and others will drop out of the market

c. Existing firms will continue their usual output but will earn less

d. New firms will enter the market as older ones drop out

3. What are diminishing marginal returns of labor?

a. Some workers increase output but others have the opposite effect

b. Additional workers increase total output but at a decreasing rate

c. Only a few workers will have to wait their turn to be productive

d. Additional workers will be more productive

4. What affect does a rise in the cost of raw materials have on the cost of a good?

a. It lowers the overall cost of productionb. The good becomes cheaper to producec. The good becomes more expensive to

produced. This does not have any affect on the

eventual price of a good

Combining Demand and Supply•The point at which quantity demanded

and quantity supplied come together is known as equilibrium

Interactions between buyers and sellers will always push the market back toward

EQUILIBRIUM.

Price Ceilings•In some cases, the government steps in to

control prices. ▫A PRICE CEILING is a maximum price

that can be legally charged for a good▫An example is rent control, a situation

where the government sets a maximum amount that can be charged for rent in an area

Price ceilings create excess DEMAND.

The difference between the artificial price and the equilibrium price is a SHORTAGE.

Price Floors•A PRICE FLOOR is a minimum price,

set by the government, that must be paid for a good or service.

•An example is the minimum wage, which sets a minimum price that an employer can pay a worker for an hour of labor.

Price floors create excess

SUPPLY.

The difference between the

artificial price and the

equilibrium price is a

SURPLUS.

The Role of Prices•Prices provide a language for buyers

(consumers/demanders) and sellers (producers/suppliers)▫They act as an INCENTIVES – help

indicate relative scarcity ▫They act as SIGNALS – like a traffic light▫They are more FLEXIBLE than production

Reviewing D x S:1. Equilibrium in a market is the point at

whicha. Quantity supplied and quantity demanded

are the sameb. Unsold goods begin to pile upc. Suppliers begin to reduce pricesd. Prices fall below the cost of production

2. What happens when any market is in disequilibrium and prices are flexible?

a. Market forces push toward equilibriumb. Sellers waste their resourcesc. Excess demand is createdd. Unsold perishable goods are thrown out

3. What prompts efficient resource allocation in a well-functioning market system?

a. Businesses working to earn a profitb. Government regulationc. The need for fair allocation of resourcesd. The need to buy goods regardless of price

MARKET STRUCTURES•These are ways production of goods and

services in particular markets are organized (they mainly differ in terms of the # of firms in the market)▫Perfect Competition▫Monopolistic Competition▫Oligopoly▫Monopoly

Perfect Competition•A market structure in which a LARGE

NUMBER of firms all produce the SAME product – this type of structure tends to be most efficient▫Many buyers and sellers▫Identical products▫Informed buyers and sellers▫Free market entry and exit

BARRIERS to ENTRY•These are factors that make it difficult for

new firms to enter a market▫START-UP COSTS – the $ a business must

pay before the product reaches customers▫TECHNOLOGY – some markets require a

high degree of technological sophistication (knowledge that inhibits entrepreneurs from entering the market)

Monopolistic Competition•A market structure in which MANY

companies compete to sell products which are SIMILAR but not identical.▫Many firms▫Few barriers to entry▫Slight control over price▫Differentiated product

Monopolistically Competitive Companies often use NON-PRICE Competition to attract customers:

•Characteristics of the product – size, color, shape, taste, etc.

•Location of the sale – busy corner versus isolated

•Level of service – better customer service•Advertising image – to create apparent

differences; use of celebrities or fads

Oligopoly•A market structure dominated by a FEW,

LARGE, PROFITABLE firms.▫Collusion may occur – when companies

work together to set prices and production levels Price-fixing – like Coke and Pepsi

▫Cartels may be established – producers formally coordinate prices and production

Monopoly•A market dominated by a SINGLE seller of a

product or service▫Monopolies form when barriers prevent firms

from entering the market with a single supplier Start-up costs are high

▫They can take advantage of their power and charge higher prices

▫Natural Monopolies – like power and water; we allow these because they are more efficient

▫New technology can destroy the power of a monopoly

Government and Competition•Government policies keep firms from

controlling the prices and supply of important goods.

•Antitrust laws encourage competition in the marketplace.▫Regulates business practices▫Breaks up monopolies▫Blocks mergers▫Preserves incentives

Comparison of Market Structures:

Reviewing Market Structures:1. Which is NOT a condition for Perfect

Competition?a. Many buyers and sellers participateb. Identical products are offeredc. Market barriers are highd. Buyers and sellers are well-informed

about goods and services

2. A monopoly isa. A market dominated by a single sellerb. A license that gives the inventor of a new

product the exclusive right to sell it for a certain amount of time

c. An industry that runs best when one firm produces all the output

d. An industry where the government provides all the output

3. An oligopoly isa. An agreement among firms to charge one

price for the same goodb. A formal organization of producers that

agree to coordinate price and outputc. A way to attract customers without

lowering the priced. A market structure in which a few large

firms dominate a market

4. The purpose of both deregulation and antitrust laws is to

a. Promote competitionb. Promote government controlc. Promote inefficient commerced. Prevent monopolies

BUSINESS ORGANIZATIONS•Businesses can be owned by individuals,

families, or large groups of people.▫Sole Proprietorship▫Partnership▫Corporation▫Franchise

Sole Proprietorship•A business owned and managed by a

single individual•The most common form of business

organization•Most are small•Few earn large profits

Advantages of Sole Proprietorships:•Easy to start up•Relatively few regulations•Sole receiver of profits•Full control•Easy to discontinue

Disadvantages of Sole Proprietorships:•Limited access to resources like

physical capital•Lack permanence•Unlimited liability – legal obligation for

ALL debts related to a business

Partnership•A business organization owned by two or

more people who agree on division of responsibilities▫General partnerships – partners share

equally▫Limited partnerships – only one partner

has unlimited liability▫Limited liability partnerships – all

partners are limited

Advantages of Partnerships:•Easy to start up•Shared decision making and

specialization•Larger pool of capital•Limited taxation

Disadvantages of Partnerships:•Typically at least one partner has

unlimited liability•Potential for conflict

Corporation•A legal entity owned by individual

stockholders•Stocks (shares) represent a stockholder’s

portion of ownership of a corporation•Can be closely or publicly held

Advantages of Incorporation:•Individual investors don’t carry

responsibility for corporate actions•Shares of stock are transferable•Potential for more growth than others•Can borrow money by selling bonds•Have longer lives

Disadvantages of Incorporation:•Difficulty and expense of start-up•Double taxation – on income and

dividends•Loss of control•More regulation

Franchise•A semi-independent business that pays

fees to a parent company in return for the exclusive right to sell a certain product or service in a given area▫Individual McDonald’s restaurants▫American Eagle store at the Mall of

Georgia

Franchise Advantages/Disadvantages•Management

training and support•Standardized quality•National advertising

programs•Financial assistance•Centralized buying

power

•High franchising fees and royalties

•Strict operating standards

•Purchasing restrictions

•Limited product line

Reviewing Business Organizations:1. Any establishment formed to carry on

commercial enterprises is a a. Partnershipb. Business organizationc. Sole proprietorshipd. Corporation

2. Sole proprietorshipsa. Are complicated to establishb. Make up about 50% of all businessesc. Are the most common form of business in

the U.S.d. Offer owners little control over operations

3. What advantage does a partnership have over a sole proprietorship?

a. The responsibility for the business is shared

b. The business is easy to start upc. The partners are not responsible for the

business debtsd. The business is easy to sell

4. All of the following are advantages of incorporation EXCEPT

a. The responsibility for the business is shared

b. Capital is easier to raise than in other business forms

c. Corporations face double taxationd. Corporations have more potential for

growth

5. A business franchisea. Attempts to improve the image and

working conditions of people in a particular occupation

b. Operates without the aim of profitc. Is a semi-independent business tied to a

parent companyd. Is not required to pay income taxes