| Line 1: |
Line 1: |
| | {{Economics_Lectures}} | | {{Economics_Lectures}} |
| | | | |
| − | At this point we have covered most of what is taught in "Microeconomics", and most of what is on the CLEP exam for college credit. We have only five lectures left, and then a final exam. | + | At this point we have covered most of what is taught in "Microeconomics", and most of what is on the CLEP exam for college credit. There are still some important topics that we need to cover in the remainder of this course, such as: |
| − | | |
| − | There are still some important topics that we need to cover in the remainder of this course, such as: | |
| | | | |
| | *externalities | | *externalities |
| Line 16: |
Line 14: |
| | *capital and banking | | *capital and banking |
| | | | |
| − | About 10% of the CLEP Microeconomics exam questions are on government policy, a much higher percentage than one would expect for a course about individual market-based decisions. Also, nearly 5% of the exam asks about "production possibilities," which is not a particularly important concept in Microeconomics. But we'll cover all these topics so that you will be prepared if you want to take the CLEP and earn college credit. | + | About 10% of the CLEP Microeconomics exam questions are on government policy, a higher percentage than one would expect for a course about individual market-based decisions. Also, nearly 5% of the exam asks about "production possibilities," which is not a particularly important concept in Microeconomics. But we'll cover all these topics so that you will be prepared if you want to take the CLEP and earn college credit. |
| − | | |
| − | We will also spend much of the remainder of the course reviewing and learning better the key concepts already introduced in earlier Lectures. Several homework questions each week will be review questions.
| |
| − | | |
| − | '''''You should use your midterm exam as a learning tool to make sure you understand the material in questions you answered incorrectly. Those questions are the heart of this course, and the more that you can learn from your mistakes, the better you will do on the final exam here and on the CLEP'''''. Each year I put on the final exam an identical question that was on the midterm exam. Don't answer it incorrectly again!
| |
| − |
| |
| − | First we will review a concept from the midterm exam, and then we will begin to learn some of the remaining new concepts listed above.
| |
| − | | |
| − | == Marginal Analysis ==
| |
| − | | |
| − | Virtually every single student in our class missed the question relating to the relationship between total revenue and marginal revenue. This question tests whether the student understands marginal analysis. Let's review this so no one misses it again.
| |
| − | | |
| − | Marginal "something" is how much that "something" is increasing or decreasing at a particular time or amount of output. Your marginal increase in height, for example, is how much you are growing at this time.
| |
| − | | |
| − | Marginal revenue is how much the total revenue of a firm increases or decreases at a certain amount of output. If the firm produces 5 units, its marginal revenue is the amount that total revenue increased when it produced and sold that 5th unit.
| |
| − | | |
| − | The question on the midterm asked what the marginal revenue is when the total revenue is at its maximum. If you don't know the answer, then try a few possibilities. What if marginal revenue were positive? Then producing another unit of output would generate additional total revenue by an amount equal to the positive marginal revenue. But the problem said that total revenue is at its maximum, so it is not possible to increase it. Therefore marginal revenue cannot be positive.
| |
| − | | |
| − | What if marginal revenue were negative? Then reducing the output by one unit would have the effect of eliminating the negative marginal revenue for that unit. This would increase the total revenue. But that is not possible because total revenue is at its maximum. So marginal revenue cannot be negative.
| |
| − | | |
| − | If marginal revenue cannot be positive, and it cannot be negative either, then there is only one possibility left: marginal revenue must be zero.
| |
| | | | |
| | ==Externalities== | | ==Externalities== |
| Line 188: |
Line 166: |
| | | | |
| | There is a Latin phrase: "nitor in adversum." It means "strive in opposition." It's a good motto. | | There is a Latin phrase: "nitor in adversum." It means "strive in opposition." It's a good motto. |
| | + | |
| | + | == Review: Price Elasticity of Demand == |
| | + | |
| | + | Last class one student asked this question: what are some example price elasticities of demand? Recall the cutoff of 1: price elasticity less than 1 is inelastic, and more than 1 is elastic. Here are specific examples (price elasticity is always negative due to the Law of Demand, but its absolute (positive) value is used for convenience): |
| | + | |
| | + | *rice in Japan: 0.2 (inelastic because it is a basic food there) |
| | + | *travel by bus: 0.2 (inelastic because it is a necessity for bus travelers) |
| | + | *cigarettes: 0.5 (inelastic because of the addiction) |
| | + | *gambling: 0.8 (inelastic because of the addiction) |
| | + | *movies: 0.2 for teenagers (inelastic), but 2 for adults (elastic) |
| | + | *beef: 1.6 (elastic because there are substitutes like chicken) |
| | + | *soda: about 4 (elastic) |
| | + | |
| | + | As review, recall that if price elasticity of demand is greater than 1, then the quantity demanded changes by more than the price change. Revenue, which is price times quantity, then decreases when the price increases. When the price elasticity is less than 1, then the quantity demanded changes by less than the price change. Revenue then increases when the price increases. When price elasticity is precisely 1, then the quantity demanded changes by the same percentage as the price change. Revenue then remains constant when the price increases. |
| | + | |
| | + | Now we can expand on what we learned by asking this obvious question: what affects the price elasticity of demand? Here are the major factors: |
| | + | |
| | + | *the availability of substitutes, because if there are substitutes then customers will switch to them when price increases, causing a big decrease in demand |
| | + | *the cost of switching to substitutes without paying a penalty or incurring large transaction costs |
| | + | *whether the good is a necessity or a luxury |
| | + | *the percentage of one's income allocated to the good: if it is a large percentage, then it will have higher price elasticity |
| | + | *the longer the time period, the more price elastic it will be, because in the long run demand can more fully respond to a price change |
| | + | *whether the good is addictive, because an addictive good is inelastic due to how the buyers are hooked on it even when its price increases |
| | + | *whether the market is at "peak" or "off-peak" demand; people want airline tickets the day before Thanksgiving, when many people traveling, even if the price increases |
| | + | *the more narrowly defined a good is (e.g., a specific brand of hamburger rather than all hamburgers), the more price elastic it will be due to the availability of substitutes |
| | + | |
| | + | == Review: Returns to Scale == |
| | + | |
| | + | Next let's review “returns to scale.” Imagine using a scale of one foot in measuring the dimensions of a room. Then change to a scale of inches. All dimensions increase by a factor of 12, because there are 12 inches to a foot. That is what “scale” means: it affects everything. In economics, changing the scale means changing all inputs by the same proportion. Increasing the scale means increasing all inputs. The “returns to scale” are then what happens to the output of a company when all inputs are increased. Is "bigger" better for the business? |
| | + | |
| | + | The phrase that something is "scalable" means its proportions increase in a similar way in all respects, like "similar triangles" in geometry. Some things are "scalable", while others are not. A software database program that works the same for 100 entries as it does for 1 million entries is "scalable"; a program that needs to be reworked and reprogrammed as the database grows larger is not scalable. One of the terrific features of "wiki" software used by Conservapedia is that it is scalable: almost no adjustments were needed as the number of its entries increase from 1 to 1000 to over 30,000 now, or even to a million entries in the future. |
| | + | |
| | + | “Increasing returns to scale” means that when you increase all the inputs, then your company’s output increases by an even greater proportion. For example, if you double your inputs then perhaps your output triples. That would be extremely profitable for your business. Your costs only double, but your revenue triples. Your profits skyrocket. It is a formula for success. |
| | + | |
| | + | Wal-Mart’s “secret” to its success would is its “increasing returns to scale.” The bigger it gets, the more efficient it becomes, the cheaper it can buy goods for (because it is obtaining volume discounts), and the more output it can produce. It is not simply that Wal-Mart's output increases as it grows bigger, but its output (and revenue) increase by more than its costs do. That greater proportional increase becomes profits. |
| | + | |
| | + | Meanwhile, there is nothing special about constant returns to scale, which is to be expected. But decreasing returns to scale is a disaster for a business that is growing. So is diminishing returns to labor. |
| | + | |
| | + | ''Simple rule'': If "bigger is better," and it is for Wal-Mart, then there are increasing returns to scale.” |
| | + | |
| | + | What are the returns to the scale for the world population? It likely has increasing returns to scale. Twice as many people means more than twice as much output. Humans are creative, and twice as many humans would probably mean more than twice as many inventions like the light bulb, as people build on the work of others. |
| | + | |
| | + | ===Review: Law of Diminishing Returns=== |
| | + | |
| | + | What is the Law of Diminishing Returns? That is a rule that applies to ONLY ONE input. It is when a company keeps its assembly line and factor size constant, for example, but keeps hiring more and more of one input, such as labor. Eventually each added employee will have less and less to do. The returns on the additional employees decline. But if all inputs were increased at the same time, then the Law of Diminishing Returns does not apply. Then it is a question about returns to scale. |
| | + | |
| | + | Consider this question: |
| | + | |
| | + | “The more someone has, the more he wants in order to be satisfied!” What economics principle would best explain that phenomenon? |
| | + | |
| | + | (a) Law of Demand |
| | + | |
| | + | (b) Law of Diminishing Returns |
| | + | |
| | + | (c) Law of Diminishing Marginal Utility |
| | + | |
| | + | (d) Coase Theorem |
| | + | |
| | + | Choices (a) and (d) can be eliminated immediately, but selecting between (b) and (c) is more difficult. The key here is that “marginal utility” refers to consumer satisfaction, while “returns” refers to output of a company. The question is geared towards consumer satisfaction, not output by a firm. It refers to what someone wants, not what a company produces. The correct answer is therefore (c). |
| | + | |
| | + | Know these concepts like the back of your hand, and learn from your mistakes. There will be a final exam when you can prove how much you learned. |
| | | | |
| | ==Assignment== | | ==Assignment== |