Economics chapters summary
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Diseconomies of scale are a new term. As a business firm grows larger, it can usually cut its costs by taking advantage of quantity discounts, the use of expensive but highly productive equipment, and the development of a highly specialized and highly skilled workforce. We call these economies of scale. But as the firm continues to grow, these economies of scale are eventually outweighed by the inefficiencies of managing a bloated bureaucracy, which might sometimes work at cross-purposes. Most of the day could be spent writing memos, answering memos, and attending meetings. Labor and other resources be- come increasingly expensive, and not only are quantity discounts no longer available, but now suppliers charge premium prices for such huge orders. As costs begin to rise, diseconomies of scale have now overcome economies of scale.
Production of capital goods will lead to a rightward shift in the PPC. Improving technology, better and higher capital and labor will also lead to a rightward shift in the PPC.
1. List and explain the three questions of economics.
What shall we produce? How shall these goods and services be produced and for whom shall the goods and services be produced? >>What, how and who? 2. Explain the concepts of the profit motive, the price mechanism, competition, and capital. Adam Smith coined the term invisible hand which refers to one’s self-interest, which guides a person to promote the social interest, however unintentionally. “By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.” 3. Describe and illustrate market failure and externalities. An external cost occurs when the production or consumption of some good or service inflicts costs on a third party without compensation. (Pollution) An external benefit occurs when some of the benefits derived from the production or consumption of some good or service are enjoyed by a third party. (Education) 4. Describe and explain government failure.
Government can intervene by taxing companies that has external costs and providing subsidies for companies that has external benefits. Public good is something whose consumption by one person does not prevent its consumption by one person does not prevent its consumption by other people. (Roads/national defense) 7. Define and describe the “isms”: capitalism, fascism, communism, and socialism. Capitalism is characterized by private ownership of most of the means of production. Individuals are moved to produce by the profit motive. Production is guided by the price system. The government’s role is kept to a minimum – legislation and production of public goods. Communism is when the government dictates exactly what is produced, how it is produced and for whom these goods are produced. The
state owns and operates nearly all of the means of production and distribution. No price system Fascism can be named as corporatism since it is the merger of state and corporate power. It is almost similar to communism. Socialism (Sweden, Great Britain and Canada) has three characteristic – government ownership of some of the means of production, a substantial degree of government planning and a large-scale redistribution of income from the wealthy to the poor. Medical care and education and retirement benefits taken care by government through high taxes.
Price floor used for agriculture commodities. Government will buy the surplus.
Two important price ceilings are rent control laws and usury laws (putting a ceiling on interest rate). Price ceilings leads to shortage.
Tax incidence is the way in which the burden of a tax is shared among the market participants. Taxes will typically constitute a greater burden for whichever party has a more inelastic curve. For example if the supply is inelastic and demand is elastic, the burden will be greater on the producers.
Supply curve will shift left due to taxes. The triangle due to the change in prices represents the deadweight loss due to taxation because there are fewer mutually beneficial exchanges between buyers and sellers. It is a permanent decrease to consumer and/or producer surplus.
A subsidy shifts either the demand of supply curve to the right depending upon whether the buyer or seller receives the subsidy.
Gross domestic product (GDP) is the nation’s expenditure on all the final goods and services produced in the country during the year at market prices.
The largest sector of GDP is consumption. The consumption function states
that as income rises, consumption rises but not as quickly.
Average propensity to consume (APC) is the percentage of disposable income spent. Average propensity to save (APS) is the percentage of disposable income saved. APC + APS = 1
Marginal propensity to consume (MPC) is the change in consumption divided by the change in income. Marginal propensity to save is the change in savings divided by the change in income.
Autonomous consumption is our level of consumption when disposable income is 0. Induced consumption is the part of consumption which varies with the level of disposable income.
Determinants of consumption :
1. Disposable income
2. Credit availability
3. Stock of liquid assets and durable goods in the hands of consumer
4. Keeping up with the joneses/ standard of living
5. Consumer expectation
6. The wealth effect
There are three types of business firms – Proprietorship, partnership and corporation.
Proprietorship is an unincorporated business firm owned by one person. Advantage: company wont be taxed/ you are own boss
Disadvantage: Tough to raise capital/responsible for everything (legal issues)
Partnership is a business firm owned by two or more people.
Advantage: better at raising capital and divide responsibilities Disadvantage: all partners are liable for debts.
Corporation is a business firm that is a legal person.
Advantage: Limited liability/best at raising capital
Disadvantage: There are procedures to set up a corporation/corporations are taxed.
Two types of corporate stock: common and preferred
Common get to vote but preferred don’t get to.
Net domestic product (NDP) is the sum of consumption, net investment, government purchases, and net exports. GDP – Depreciation = NDP
Gross investment – depreciation = Net investment
Determinants of the level of investment
Capacity utilization rate (% of plant and equipment that is actually used) Interest rate
Expected rate of profit
Transfer payments are not included in government spending.
Average Tax Rate (ATR) is the taxes paid divided by the taxable income. Marginal Tax Rate (MTR) is dividing the additional taxes paid by the additional taxable income.
Direct tax is tax on a particular person while indirect tax is tax on goods or services.
Progressive tax places a greater burden on the rich and little burden on the poor. Example: Personal income tax >> earn more pay more %
Proportional taxes place an equal burden on the rich, middle class and the poor. Example: Flat income tax of 15%
Regressive taxes falls more heavily on the poor than on the rich. Example: Gst(?) social security tax
Sources of government revenue include: Personal income tax, Sales tax, property tax, investment etc.
Role of government is to
Provide public good and services (national defense/ roads etc.) Redistribute income
Stabilization (Healthy inflation rate/ Low unemployment rate) Economic regulation (legal framework both politically and socially)
Balance of trade is the difference between the value of imports and exports.
Absolute advantage is the ability of one country to produce a good/service using fewer resources than another country. (Comparison of two country)
The law of comparative advantage states that the total output is greatest when each product is made by the country that has the lowest opportunity cost. (comparison of all countries)
Outsourcing: when company contract out some of their jobs to other firms. Offshoring: When all the jobs are outsourced and are performed abroad
US has a negative balance of trade. Negative current account >> positive capital account. Other countries are paid in Us dollars and use them to invest in US economy, more ownership of US capital goods/company.