Econ 11 – Long Exam II

CHAPTER 5: DEMAND AND CONSUMER BEHAVIOR - fundamental condition of maximum satisfaction

- consumption is arranged in such a way that the
Choice and Utility Theory
last dollar spent on each good brings the same
Basic Assumption
marginal utility
- Consumers are rational in their choices and
preferences
- Rational choice
o Non-satiation (more is always preferred)
o Completeness (consumer must be able
to say what goods they prefer or
indifferent to)
o Transitivity (if a is preferred to B, and B is
preferred to C, then A must be preferred
to C)

Utility
- satisfaction derived from the consumption of a
good
- theory of demand: assume that people maximize
utility subject to the constraint of their income
and prices of goods

Marginal Utility
- increment of utility from one unit to the next
- additional utility derived from the consumption
of an additional unit of a commodity

Downward Sloping Demand

- A higher price for a good reduces the consumer’s
desired consumption of that commodity
- As price increases, demand decreases

Substitution and Income Effect

- Alternative approach to the analysis of demand
- Uses “indifference curves”

Substitution Effect
- Most obvious factor for explaining downward
sloping demand
- When price of a good increases, consumers tend
Law of diminishing marginal utility to substitute other goods for the more expensive
- marginal utility falls with increasing levels of one in order to satisfy their desires more
consumption inexpensively
- total utility increase at a decreasing rate
Income Effect
Total Utility - “real income” – quantity of goods that money
- overall level of satisfaction income can buy
- sum of the leading marginal utilities - Change in the quantity demanded that arises
- rises with consumption but at a decreasing rate because price change lowers consumer real
(shows diminishing marginal utility) incomes
- “income elasticity” – quantitative measure of
Derivation of Demand Curves income effect
Equimarginal Principle
- under the assumption that the consumer
maximizes utility
 Econ 11 – Long Exam II

- High income elasticity - staple goods (demand grows proportionally with

▪ i.e., yachts, airline travel income)
▪ demand rises rapidly as income
increases Economics of Addiction
- Low-income elasticity Free market
▪ i.e., potatoes, used furniture - government lets people decide what to do with
▪ weak response to increases in their money
income - in some cases, government decides to overrule
private decisions
Individual and Market Demand - merit goods – consumption is
Individual Demand intrinsically worthwhile (i.e., education;
- demand curve of a firm healthcare)
- demerit goods – consumption is deemed
Market Demand harmful (i.e., drugs, cigarettes, alcohol)
- sum of individual demands at each price
Addictive substances
- addiction – pattern of compulsive and
uncontrolled use of a substance
- demand is price inelastic
- market for addictive substances is a big business
- policy; prohibition of use and enforcement of
criminal sanctions
- prohibition = upward shift in the demand curve
= price increases

Consumer Surplus
- gap between the total utility of a good and its
Substitute Goods monetary value (measured as price times
- an increase in the price of one good, increases quantity, P*Q or TR)
the demand for the other - area between the demand curve and the price
- e.g., chicken and beef; coffee and tea line

Complement Goods
- an increase in the price of one good, decreases
the demand for the other
- e.g., car and gasoline; coffee and sugar

Independent Goods
- a price change for one good has no effect on the
demand for the other
- e.g., beef and textbooks

Price Elasticity
- high for goods with readily available substitutes - demand curve – amount consumers
(i.e., tomatoes, peas) would pay for each unit consumed
- low for essential goods or those that do not have - total area under the demand curve
close substitutes (i.e., electricity) (0REM) – total utility
- consumer surplus = total utility – market
Income Elasticity cost of water (0NEM) = NER
- high for luxuries (consumption grows rapidly - measure of the extra value that consumers
relative to income) receive above what they pay for a commodity
- negative for “inferior goods” (demand falls as
income as income rises)
 Econ 11 – Long Exam II

- getting more of one good compensates for

giving up some of the other
- consumer likes situation A as much as B, C, or D

GEOMETRICAL ANALYSIS OF CONSUMER

EQUILIBRIUM
Indifference Curve
- matter of preference; one is preferred while
indifferent to the other
- if both goods are equally good, one will be - Indifference map – movement from each curve
indifferent to which of the two one receives enjoys either increasing or decreasing
- points on the indifference curve represent the satisfaction
consumption bundles among which the - Shift to the right = increase
consumer is indifferent; all are equally desirable, - Shift to the left = decrease
all have the same level of utility - U1, U2, U3, U4 represent indifference curves
- slope of indifference curve is the measure of the Marginal Rate of Substitution (MRS)
good’s marginal utilities - Quantity of good Y a consumer is willing to give
up to get an additional quantity of good X and
Law of Substitution still remain as satisfied as before
- the scarcer the good, the greater the relative - MRS = Change in Y / Change in X
substitution value; marginal utility rises relative
to the marginal utility of the good that has Budget Line or Budget Constraint
become plentiful
- Consumer’s fixed income
- limit which the consumer can spend on a
particular combination of goods
- limits movement between different indifference
curves
 Econ 11 – Long Exam II

- Consumer equilibrium is attained at the point

where the budget line is tangent to the highest
indifference curve.
- At consumer equilibrium, the consumer’s
substitution ratio is just equal to the slope of the
budget line

Sample: Which bundles will be chosen by Bella if her

income is (a) 60, (b) 148, and (c) 252?

Changes in Income and Price

Income Change

Equilibrium Position of Tangency

- the budget line can be superimposed on the
indifference map
- consumer is free to move anywhere along the
NM (budget line)
- above = not allowed; out of budget;
customer cannot afford said condition
- below = irrelevant; consumer is assumed
to spend the entire budget
- consumer will move at the point that yields
maximum satisfaction (point that touches but
does not cross the indifference curve)
 Econ 11 – Long Exam II

Price Change

CHAPTER 6: PRODUCTION AND BUSINESS Returns to Scale

ORGANIZATION
- effects of scale increases of inputs on the
THEORY OF PRODUCTION AND MARGINAL PRODUCTS quantity produced
Basic Concepts Constant Returns to Scale
Production function - a change in all inputs leads to a proportional
- Maximum output that can be produced with a change in output
given quantity of inputs
Increasing Returns to Scale
Total Product - also called “economies of scale”
- Total amount of output produced in physical - an increase in all input levels leads to a more-
units than-proportional increase in the level of output

Marginal Product Decreasing Returns to Scale

- Extra output produced by 1 additional unit of - an increase in all inputs leads to a less-than-
input, while other inputs are held constant proportional increase in total output
- Used in the determination of factor prices - scaling up may eventually reach a point in which
inefficiencies set in
Average Product
- Total output divided by total units of input

Law of Diminishing Returns

- A firm will get less and less extra output when it
adds additional units of input
- marginal product of each unit of input will
decline as the amount of that input increases
 Econ 11 – Long Exam II

Short Run and Long Run - Only because the social costs of pollution
- production requires both labor and time are not included in the firm’s calculations
- two different time periods: (1) short run and (2) of the costs of production
long run - If they are accounted for (in the form of
taxation) regressive processes will no
Short Run longer be profitable
- period in which firms can adjust production by
changing variable factors (i.e., materials) but Productivity and the Aggregate Production Function
cannot change fixed factors (i.e., capital) Productivity
- Most important measure of economic activity
Long Run - Ratio of total output to a weighted average of
- period that is sufficiently long that all factors inputs
including capital can be adjusted - Two important variants:
- Labor productivity – output per unit of
Technological Change labor (i.e., hours worked)
- increase in total outputs may be attributed to - Total factor productivity – output per
increased inputs (i.e., labor and machinery), but unit of total inputs (labor, capital,
it is mostly from technological change materials)
- improves productivity and raises living standards
- Process innovation – new knowledge Productivity Growth
improves production techniques; shift in - Occurs when output is growing faster than inputs
the production function - Due to technological advances (i.e., process and
product innovation)
- Also due to economies of scale and scope

Economies of scale and mass production

- Important elements of productivity growth since
the Industrial Revolution
- e.g., increasing returns to scale = large scale of
inputs and production = greater productivity

Economies of scope
- occurs when a number of different products can
be produced more efficiently together than apart
- e.g., specialization and division of labor =
increase productivity as economies become
larger and more diversified

- Product innovation – new or improved

products are introduced in the CHAPTER 7: ANALYSIS OF COSTS
marketplace ECONOMIC ANALYSIS OF COSTS
Total cost: Fixed and variable
- Market failures may result to technological
regress Total Cost
- Lowest total dollar expense needed to produce
Inferior Technologies each level of output, q
- Unprofitable and discarded in a functioning - TC rises as q rises
- TC = FC + VC
market economy
- Introduced by unregulated companies
Fixed Cost
- May still be profitable (i.e., polluting companies) - Total dollar expense paid out even when no
output is produced
 Econ 11 – Long Exam II

- “overhead” or “sunk costs”

- Unaffected by any variation in the quantity of
output

Variable Cost
- Expenses that vary with the level of output and
include all costs that are not fixed
- Increases as output increases
- i.e., raw materials, wages, fuel

Average Fixed Cost (AFC)

- total fixed cost divided by output
- AFC = FC/q
- Since total FC is constant, dividing it by an
increasing output gives a steadily falling AFC
- If a product is a best-seller, the AFC will be low;
and if the product is a failure, the AFC will be high
Marginal Cost Average Variable Cost (AVC)
- Variable cost divided by output
- one of the most important concepts of
- AVC = VC/q
economics
- additional cost of producing 1 extra unit of
Relationship between Average Cost and Marginal Cost
output

- Three rules:
(1) When marginal cost is below average cost,
it is pulling average cost down
▪ Last unit produced costs less than
average cost of all the previous units
produced
▪ New AC is less than old AC, thus AC
Average Cost is falling
Average Cost (AC) (2) When MC is above AC, it is pulling up AC
- total cost divided by the total number of units (3) When MC just equals AC, AC is constant. At
produced or outputs the bottom of a U-shaped AC, MC = AC =
minimum AC

All cost concepts derive from total cost schedule:

 Econ 11 – Long Exam II

variables to be changed (i.e., plant and

equipment)
- Long run – all inputs can be adjusted; all costs are
variable and none are fixed

Diminishing returns
- Diminishing returns to the variable factor will
imply an increasing short-run marginal cost

U-shaped Cost Curves

- Based on diminishing returns in the short run
- In the short run, when factors such as capital are
fixed, variable factors tend to show an initial
phase of increasing marginal product followed by
diminishing marginal product
- Corresponding cost curves show an initial phase
of declining marginal costs, followed by
increasing MC after diminishing returns have set
in

Choice of Inputs by the Firm

- Every firm must decide how to produce an
output. What output? With what resources?
Technology? At what cost?
- Fundamental assumption: firms minimize their
costs of production
- Applicable to perfectly competitive firms,
monopolies, and even nonprofit organizations

Least-cost rule
- To produce a given level of output at least cost, a
Link Between Production and Costs firm should buy inputs until it has equalized the
Factors that Determine Cost Curves: marginal product per dollar spent on each input
(1) Factor Prices - Analogous to what consumers do when they
(2) Firm’s Production Function maximize utilities

Substitution rule
- Corollary of the least-cost rule
- If the price of one factor falls while all other
factor prices remain the same, firms will profit by
substituting the now cheaper factor for the other
factors until the marginal products per dollar are
Cost analysis also distinguishes two different time equal for all inputs
periods:
- Short run – period of time long enough to adjust
variable inputs but too short to allow fixed
 Econ 11 – Long Exam II

OPPORTUNITY COST
- Value of the most valuable good or service
forgone
- Based on the concept of scarcity; measure of
what has been given up when we make a decision
- In a well-functioning market, when all costs are
included, price equals opportunity cost
- Examples:
- Watching TV right before an exam has a
high opportunity cost, for the alternative
use of time (studying) has high value in
improving grade performance and
getting a good job. After exams, time has
a lower opportunity cost
- Economic costs include, in addition to explicit
money outlays, those opportunity costs incurred
because resources can be used in alternative
ways
- Most important application of opportunity cost
arises for nonmarket goods—those like clean air
or health or recreation—which may be highly Equal Product Curves
valuable even though they are not bought and - Also called isoquant
sold in markets. - Analogous to the consumer indifference curve

PRODUCTION, COST THEORY, AND DECISIONS OF THE

FIRM
Numerical Production Function
Production Function
- Shows the maximum amount of output that can
be produce with various combinations of inputs

Law of Diminishing Marginal Product

Marginal Product of Labor
- Extra production resulting from 1 additional unit
of labor when land and other inputs are held
constant

Law of Diminishing Returns

Equal-Cost Lines
- As we increase one input and hold other inputs - Also called isocost
constant, the marginal product of the varying - Used in the determination of the least-cost
input will, at least after some point, decline combination

Least-Cost Factor Combination for a Given Output

- Numerical function: there are different ways to
produce a level of output
- Least-Cost Factor Combination: determines
which of the many possibilities should one use
- The combination that costs the least
 Econ 11 – Long Exam II

CHAPTER 8: ANALYSIS OF PERFECTLY COMPETITIVE

MARKETS
SUPPLY BEHAVIOR OF THE COMPETITIVE FIRM
Behavior of a Competitive Firm
Two key assumptions:
- Competitive firms maximize profits
- Perfect competition is a world of atomistic firms
who are price-takers
Least-Cost Tangency
- Combining the equal-product and equal-cost Profit Maximization
lines, we can determine the optimal, or cost- - Profit = net earnings
minimizing, position of the firm - Firms maximize profits because that maximizes
the economic benefit to the owners of the firm

Perfect competition
- Price-takers – firm is so small relative to the
market that it cannot affect the market price
- Homogenous product – identical to the product
sold by others in the industry
- The perfect competitor faces a horizontal
demand curve
- Extra revenue gained from each extra unit sold is
therefore the market price

Profit maximization in a competitive firm

- Occurs at the output when marginal cost equals
price
- MC = P
- firm will always keep moving along the convex - Firm’s marginal cost curve is also its supply
curve as long as it is able to cross over to lower- curve
cost lines
- equilibrium will therefore be at C, where the
equal-product curve touches (but does not cross)
the lowest equal-cost line
- a point of tangency, where the slope of the
equal-product curve just matches the slope of an
equal-cost line and the curves are just kissing
- This tangency means that factor prices and
marginal products are proportional, with
equalized marginal products per dollar
 Econ 11 – Long Exam II

- Profit maximization point in the graph above is at supply curves of all the individual producers of
point B; which is also the zero-profit point or the that good
breakeven point
- Breakeven point – production level at which the
firm makes zero economic profits
- Price equals average cost
- P = AC
- Revenues just cover costs

Shutdown Condition
- A firm will shut down in the short run when it can
no longer cover its variable cost
- Does not entail that it should shut down when it Short-run equilibrium
is losing money - Output changes must use the same fixed amount
- Holds true when firms are heavily of capital
indebted and therefore have high fixed
costs (i.e., airline) Long run equilibrium
- as long as losses are less than fixed costs, - Capital and all other factors are variable
profits are maximized and losses are - There is free entry and exit of firms into and from
minimized when they pay the fixed costs the industry
and still continue to operate - Entry – newly formed; start production in
- It will be advantageous to continue a new sector
operations, with P at least as high as MC, - Exit – stop production (either voluntarily
as long as revenue covers variable costs when a production line becomes
unprofitable; or when it goes bankrupt)
Shutdown rule - Free entry – no barriers (i.e., government
- Occurs when revenues just cover variable costs regulations or intellectual property
- Losses = fixed cost rights) to entry or exit
- When the price falls below average variable
costs, the firm maximizes profits (minimizes
losses) by shutting down

SPECIAL CASES OF COMPETITIVE MARKETS

General Rules
Demand Rule
(a) Increase in demand raises price
(b) An increase in demand will also increase the
quantity demanded; decrease in demand will
have the opposite effects
Supply rule:
(c) Increase in supply lowers price and increases
SUPPLY BEHAVIOR IN COMPETITIVE INDUSTRIES quantity bought and sold
Firm to Market Supply (d) Decrease in supply increases price and lowers
- Market supply curve in a perfectly competitive quantity
market is obtained by adding horizontally the
 Econ 11 – Long Exam II

Constant Cost
- The price of producing a good does not change
regardless of changes in the production
- i.e., textiles

Backward-bending supply curve

- Application of income and substitution effects in
the supply curve
- Substitution effect: labor supply increases as
higher wages coax out more labor
Increasing Costs and Diminishing Returns - Income effect: higher wages lead people to work
- Case of items with limited supply fewer hours to take more leisure
- As a result of diminishing returns, the marginal
cost of producing a good increase as production
rises

Shifts in Supply
(a) An increased supply will decrease P most when
Fixed Supply and Economic rent demand is inelastic
- Some goods are completely fixed in amount (b) An increased supply will increase Q least when
regardless of price demand is inelastic
- When quantity supplied is constant at every
price, the payment for the use of such a factor of
production is called rent or pure economic rent
- Increase in demand will only affect the price,
quantity supplied is unchanged
 Econ 11 – Long Exam II

EFFICIENCY AND EQUITY OF COMPETITIVE MARKETS - Net utility gain from the production and
consumption of a good
Evaluating the Market Mechanism
Efficiency
Producer surplus
- One of the central concepts of economics
- Area above the supply curve and below the price
- Provision of the most desired set of goods and
line at equilibrium
services given the available resources and
- Excess of revenues over cost of production
technology
Consumer surplus
Pareto Efficiency
- Area below the demand curve and above the
- Allocative efficiency or pareto optimality
price line
- Occurs when no possible reorganization of
production/distribution can make anyone better
Market Failures
off without making someone else worse off
Imperfect Competition
- A person’s satisfaction can only be increased by
- Firms can raise produce above marginal cost
lowering someone else’s utility
- Consumers buy less and satisfaction is reduced
Competitive equilibrium:
Externalities
- S = D; MU = MC
- Arise when some of the side effects of production
or consumption are not included in market prices

Imperfect Information
- Invisible-hand theory assumes that buyers and
sellers have complete information about the
goods and services they buy and sell; idealized
world
- Firms know about all the production functions for
operating in their industry
- Consumers know about the quality and prices of
good

CHAPTER 9: IMPERFECT COMPETITION AND

MONOPOLY
- Perfect competition is an idealized market
- Easy to analyze but hard to find

PATTERNS OF IMPERFECT COMPETITION

Imperfect Competition
- Prevails in an industry whenever individual
sellers can affect the price of their output
- Major kinds: (a) monopoly, (b) oligopoly, and (c)
monopolistic competition
(a) The perfectly competitive firm can sell all
it wants along its horizontal dd curve
without depressing the market price
(b) The imperfect competitor will find that
its demand curve slopes downward as
higher price drives sales down

Economic surplus
- Area below the supply (MC) and demand (MU)
curves at the equilibrium
- Sum of the producer and the consumer surplus
 Econ 11 – Long Exam II

- i.e., patent, entry restrictions, and foreign-trade

tariffs and quotas

MONOPOLY BEHAVIOR
- may lead to inefficiently high prices and low
outputs therefore reducing consumer welfare

The Concept of Marginal Revenue

Total Revenue, TR
- price times quantity, P x Q
- inelastic demand: A decrease in price increases
sales, so total revenue falls
Varieties of Imperfect Competitors
Monopoly Average Revenue, AR
- Single seller with complete control over an - price per unit, P = AR
industry - AR = TR/q
- In the long run, no monopoly is completely
secure from attack by competitors Marginal Revenue, MR
- Change in revenue generated by an additional
Oligopoly unit of sales
- “few sellers”; 2 to 15 - MR = TRnew – TRold
- Each individual firm can affect the market price - With downward sloping demand, P>MR = P –
reduced revenue on all positive units
Monopolistic Competition - For perfect competitors, P = MR = AR
- Large number of sellers produce differentiated
products
- Resembles perfect competition in terms of the
number of sellers but differs in the way that the
products sold in the industry are not identical
- Differentiated products – products whose
important characteristics vary (i.e., personal
computers)

- For monopolist

Barriers to Entry
- Prevents effective competition
- Factors that make it hard for new firms to enter
an industry
- i.e., economies for scale, legal restrictions, high
cost of entry, advertising, and product
differentiation

Legal Restrictions
- Governments may restrict competition in certain
industries Elasticity and Marginal Revenue
 Econ 11 – Long Exam II

- MR is positive when demand is elastic The Marginal Principle

- MR is zero when demand is unit-elastic - People will maximize their profits or incomes or
- MR is negative when demand is inelastic satisfactions by counting only the marginal costs
and marginal benefits of a decision

CHAPTER 12: HOW MARKETS DETERMINE INCOMES

INCOME AND WEALTH
Income
- total receipts of cash earned by a person or
household during a given time period
- Flow of wages, interest payments, dividends, and
other things of value accruing during a period of
time
- Aggregate of all incomes = national income
- Biggest share of national income goes to
labor, either as wages, salaries, or wage
benefits
Profit-Maximizing Conditions
- Remainder of the shares goes to the
Total Profit
different types of property income –
- Equals to total revenue minus total costs
rent, net interest, corporate profits, and
proprietor’s income
- TP = TRC – TC = (P x q) – TC
- Earnings in a market economy are distributed to
the owners of the economy’s factors of
Maximum Profit
production in the form of wages, rent, and
- Occurs when marginal revenue equals marginal
interest
cost
- MR = MC; at maximum-profit price (P*) and
Role of government
quantity (q*)
- Form the largest source of wages, rent, and
- As long as each additional unit of output provides
interest payments at interest level
more revenue than its costs, the firm’s profit will
- Collect a sizable portion of national income
increase as output increases.
through taxation
- MR > MC: additional profits can be made
by increasing output
Transfer payments
- MR < MC: additional profits can be made
- Payments by governments to individuals that are
by decreasing output
not made in return for current goods or services

Personal income
- Market income + Transfer payments

Wealth
- Net dollar value of assets owned at a given point
in time
- Net = stock (i.e., volume of a lake); Income = flow
per unit time (i.e., flow of a stream)
- Assets – items of value
- Liabilities – items owed
- Net worth – difference between total assets and
total liabilities

INPUT PRICING BY MARGINAL PRODUCTIVITY

Theory of income distribution
- Also known as distribution theory
- Study of how incomes are determined in a
market economy
 Econ 11 – Long Exam II

- demands for the various factors of production

are derived from the revenues that each factor
yields on its marginal product

Nature of Factor Demands

(1) Factor demands are derived demands
- Demand for inputs is derived indirectly
from the consumer demand for its final
product
- means that when firms demand an input,
they do so because that input permits
them to produce a good which
consumers desire now or in the future
(2) Factor demand are interdependent demands

Distribution Theory and Marginal Revenue Product Distribution of National Income

Marginal Revenue Product, MRP
- Money value of the additional output generated
by an extra unit of input
- Perfect Competition
- MRP = P x MP

Demand for Factors of Production

- To maximize profits, MR = MC

Marginal Productivity Theory

- In competitive markets, demand for input is
determined by the marginal products of factors
- Wage – marginal product of labor
Determination of Factor Prices by Supply and - Rent – marginal product of land
Demand
Factor Prices CHAPTER 13: THE LABOR MARKET
- Determined by the interaction of factor supply FUNDAMENTALS OF WAGE DETERMINATION
and demand
The General Wage Level
- For given factor prices, profit-maximizing firms
Real wage
would choose input combinations according to
- Represents the purchasing power of an hour’s
their marginal revenue products
work
- Money wages divided by the cost of living
 Econ 11 – Long Exam II

Wage Differentials
A. Labor Situation
(1) People are all alike – jobs are all alike
(2) People are all alike – jobs differ in
attractiveness
(3) People differ, but each type of labor is in
unchangeable supply (non-competing
groups)
➢ Difference in specialization
➢ i.e., economists vs doctors
(4) People Differ, but there is some mobility
among groups (partially competing groups)
➢ Differences in skills and expertise
➢ i.e., butchers vs doctors

B. Wage Result
Demand for Labor (1) No wage differentials
(2) Compensating wage differentials
- Marginal Productivity of Labor
(3) Wage differentials that reflect supply and
- Wage Bill = Wage x Quantity of Labor
demand for segmented markets
- To increase wage:
(4) General-equilibrium pattern of wage
- Increase demand, Increase marginal
differentials as determined by general
productivity thru increasing skills,
demand and supply
training, technology, and capital
- Decrease supply – occurs in the long run;
(a) is therefore more ideal LABOR MARKET ISSUES AND POLICIES
The Economics of Labor Unions
Supply of Labor - 600 labor unions in the PH
- Number of hours that the population desire to - 10% of the 38.8 M workforce in PH (now 42M)
work - Labor unions - monopoly suppliers of labor”
- Backward bending supply - Goal: want decent work and decent pay
- Collective bargaining – process of negotiation
between representatives of firms and of workers
for the purpose of establishing mutually
agreeable conditions of employment
- Economic package
- Work rule

How Unions Raise Wages

- Unions gain market power by obtaining a legal
monopoly on the provision of labor services to a
particular firm or industry
- Provide wages, benefits, and working conditions
that are above competitive level

- As wages rise, the worker is pulled in two

directions:
(1) Substitution effect – work in favor of leisure
(2) Income effect – increase in wage, increases
income, increases desire for leisure
- If substitution effect is stronger, S increases with
a wage rise
- If income effect is stronger, S decreases
 Econ 11 – Long Exam II

Economic Analysis of Discrimination

- involves either:
(a) disparate treatment of people on the
basis of personal characteristics
(b) practices (i.e., tests) that have an
“adverse impact” on certain groups
- types of determination:
(a) exclusion
(b) taste
(c) statistical determination
▪ individuals are treated on the
basis of the average behavior of
members of the group to which
they belong rather than on the
basis of their personal
characteristics

CHAPTER 14: LAND, NATURAL RESOURCES, AND THE

ENVIRONMENT
THE ECONOMICS OF NATURAL RESOURCES
2 Perspectives:
(1) Environmentalist – philosophy of fines and
merits; economic growth is the villain
(2) Cornucopians – technological optimists;
economic growth is the savior

Resource Categories
2 Categories:
(1) Appropriable and Inappropriable
Effects on Wages and Employment (2) Renewable and Nonrenewable
Classical Unemployment
- Real wages > Competitive Level Appropriable Resources
- unions raise real wages to artificially high levels, - Consumers can capture its full economic value
the result is an excess supply of labor - E.g., Land, Mineral resources (oil and gas), and
trees
Keynesian Unemployment
- results from insufficient aggregate demand Inappropriable Resource
- Some costs and benefits do not accrue to its
Higher Minimum Wage (LMWs): owner
(1) reduced work hours of average workers - Involves externalities
(2) disadvantageous against groups that LMWs - Markets produce too much of goods that
are supposed to protect generate negative externalities (firm does not
(3) reduced employment probability of the carry cost)
young, inexperienced, less-educated, - Markets produce too little of goods generate
women and laborers positive externalities (firm does not get
(4) lower average income and higher household revenue?)
poverty rate
Renewable Resource
Discrimination - Ones whose services are replenished regularly
- unfair treatment of people and groups based on - Challenge: maintenance
race, gender, age, sexual orientation, religion
Nonrenewable Resource
- Supply is essentially fixed
- i.e., fossil fuels
 Econ 11 – Long Exam II

Fixed Land and Rents Environmental Economics

Land Externalities
- single most valuable natural resource
Externality
- quantity supplied is fixed
- activity that imposes involuntary costs or
- unresponsive to price changes
benefits on others; not completely reflected in
- supply curve is perfectly inelastic
the market price
- value of land derives entirely from the value of
the product
Public Good
- extreme case of positive externality
Rent
- benefits are indivisibly spread among the entire
- pure economic rent
community
- payment for the use of factors of production that
- nonrival and non-excludable
are fixed in supply
Private Good
- goods that can be divided up and provided
separately to different individuals with no
external benefits or costs to others

Global Public Goods

- externalities whose impacts are indivisibly
spread across the entire globe
- thorniest of all market failures because no
markets, no global government
- i.e,. global warming

Market Inefficiency with Externalities

- externalities lead to inefficiencies because in an
unregulated environment firms will determine
Taxing Land their most profitable pollution levels by equating
- tax on pure economic rent will lead to no the marginal private benefit from abatement
distortions or inefficiencies with the marginal private cost of abatement
- solution: Balance MSB with MC

Efficient pollution levels

- not zero pollution
- MC = MSB
Marginal Private Benefits vs Marginal Social Benefits
- Unregulated firms compare the marginal benefits
of abatement with the marginal costs
 Econ 11 – Long Exam II

- However, efficiency requires that the marginal Interest rate (i)

social benefits of abatement equal the marginal - rate of return on financial assets (percent per
costs. year)
- Proper pricing of natural and environmental
resources involves ensuring that market Real interest rate
participants face the full social costs of their - yield on funds corrected for inflation
activities - Real interest Rate = Nominal Interest Rate – Rate
of Inflation
Policies to Correct Externalities
How does government achieve socially efficient level of The Present Value of Assets
abatement? - The value today of an asset’s stream of future
(1) Direct controls returns
(2) Market Solutions
- Emission fees THE THEORY OF CAPITAL, PROFITS, AND INTEREST
- Emission permits
Basic Capital Theory
(3) Private Approaches
- Investment in capital goods involves forgoing
- Liability laws
present consumption to increase future
- Negotiations
consumption
- Roundabout
Direct controls cost 10x more than market solutions

Climate Change: To Slow or Not to Slow

Demand curve for capital

CHAPTER 15: CAPITAL, INTEREST, AND PROFITS - Similar to other factors of production; a derived
demand
BASIC CONCEPTS OF INTEREST AND CAPITAL - MP of capital – extra output yielded by additions
Capital to capital stock
- Durable produced items that are in turn used as
productive inputs for further production In a competitive economy…
- Both tangible and intangible assets - r = market interest rate
- Essential property: both and input and output - market interest rate serves two functions:
- Bought and sold in capital markets; payments for (1) rations supply of capital goods for uses that
temporary use of capital goods are called rentals have the highest rate of return
- Financial assets = monetary claims (2) induces people to sacrifice current
consumption in order to increase stock of
Rates of Return and Interest Rates capital
Rate of return on investments (r) - if r > i, firm will invest on capital
- net annual receipts on capital divided by peso - if r < i, firm will not invest
value of capital (percent per year)
 Econ 11 – Long Exam II

- price of capital = interest

- D curve = rate of return of capital

Profits as a Return to Capital

Profits
- TR – TC
- Business profits are generally larger than
economic profits (economic costs are larger due
to the inclusion of implicit or opportunity costs)
- No economic profits in the long run

Determination of Profits
(1) Profits as implicit returns
(2) Profits as reward for risk-bearing
(3) Profits as reward for innovation/invention