Micro Economics

Deliverable Length: 2–3-page Word document Suppose you are a painter, and the price of a gallon of paint increases from $3.00 a gallon to $3.50 a gallon. Your usage of paint drops from 35 gallons a month to 20 gallons a month. Perform the following: Compute the price elasticity of demand for paint and show your calculations. Decide whether the demand for paint is elastic, unitary elastic, or inelastic. Explain your reasoning and interpret your results. ****NO WIKIPEDIA PLEASE**** For assistance with your assignment, please use your text, Web resources, and all course materials. Please refer to the following multimedia course material(s): _______________________________________________________________ THE FOLLLOWING IS THE COURSE MATERIAL AND MAY HELP IN DEVELOPING THIS PAPER: ________________________________________________________________ Presentation Presentation:Economic Principles and Policy In microeconomics, the active presence of government in regulating competition, providing roads and education, and redistributing income is applauded by those who believe a free market simply does not work well if left to its own devices. Opponents of government intervention say it's the government, not the market that performs badly. Perhaps the one thing most people can agree on is that, like it or not, governments are important actors in the economies of virtually all countries. For this alone, it is worth our while to analyze the way government influences the functioning of the macroeconomy. We need to distinguish between variables that the government controls directly and those that are a consequence of its decisions combined with the state of the economy. For example, the government controls tax rates, but tax revenues are affected by the state of the economy. Similarly, government spending also depends both on government decisions and on the state of the economy. Thus we use the term discretionary fiscal policy to refer to changes in taxes or spending that are the result of deliberate changes in government policy. Fiscal policy is the manipulation of items in the federal budget. The budget is extremely complex and is really three different budgets: it is a political document, a reflection of goals the government wants to achieve, and an embodiment of beliefs about how the government should manage the macroeconomy. Money has three distinguishing characteristics: 1) a means of payment or medium of exchange, 2) a store of value; and 3) a unit of account. The alternative to using money is to barter, in which goods are exchanged directly for other goods. Barter is costly and inefficient in an economy with many different kinds of goods. Banks create money by making loans. When a bank makes a loan to a customer, it creates a deposit in that customer's account. This deposit becomes a part of the money supply. Banks can create money only when they have excess reserves - reserves in excess of the amount set by the required reserve ratio. The Federal Reserve System's most important function is controlling the nation's money supply. The Fed also performs several other functions: it clears interbank payments, is responsible for many of the regulations governing banking practices and standards, and acts as a lender of last resort for troubled banks that cannot find any other source of funds. The Fed also acts as the bank for the U.S. government. The demand for money depends negatively on the interest rate. An increase in the interest rate reduces the demand for money, and the money demand curve slopes downward. Furthermore, the volume of transaction in the economy affects money demand. The total dollar volume of transactions depends on both the number of transactions and the average transaction amount. The point at which the quantity of money supplied equals the quantity of money demanded determines the equilibrium interest rate in the economy. An excess supply of money will cause households and firms to buy more bonds, driving the interest rate down. An excess demand of money will cause households and firms to move out of bonds, driving the interest rate up. Article Article:Supply, Demand, Equilibrium, And Elasticity The Meaning Of Supply Supply describes the available goods and services in an economy. In a free-market economy like the United States, firms tend to be the economic agents producing goods and services for the general economy. Supply describes the number and variety of goods and services available at any given time. Because all entities are scarce, which means that there are only so many things in the world, firms can supply only a limited amount of goods and services. The resources used to produce these goods are considered costs. The greater the use of resources, the higher the cost of a product will be. Firms try to produce and supply desirable goods and services. When firms are successful, they may be able to charge a higher price for a product than it costs to produce it. When the revenue (or the money the firm receives for its product) exceeds costs, the firm is said to make a profit. The Law Of Supply The price of goods and services can change. Firms will respond to the changing prices by expanding or contracting the level of output. The law of supply explains how firms react because of changing prices When firms receive a lower price for a particular good or service, the firm will tend to reduce its output. Suppose a firm used to receive $10 for a good, but then the price changed to only $8. The firm is receiving $2 less per unit, so it will cut back on production and perhaps shift manufacturing resources to a more profitable type of good. When firms receive a higher price for a particular good or service, the firm will tend to increase its output. The firm will be making more money per unit, and this usually translates into higher profits. The firm may then shift production resources to producing this more profitable product. Aside from a change in price, other factors can affect the overall supply situation for a good. These are called determinants of supply. Determinants of supply include components such as technology, the number of suppliers, and expectations of the future. If any one of these overarching determinants change, then any analysis based on the law of supply would have to be recalculated based on this new change. The Meaning of Demand Demand describes which goods and services consumers desire and need. Individuals have basic needs like food, clothing, and shelter and will consistently demand them over time. Other goods and services may be considered nonessential or luxuries, and their demand can change more easily than the basic needs. Individuals only have a certain amount of resources from which to purchase goods and services. This limitation on consumption is known as a budget. Given the wide variety of choices in the marketplace, consumers must prioritize their consumption based on their needs, desires, and financial constraints. When an individual manages to purchase a parcel of goods and services that provides the most useful list and satisfaction to him or her, he or she is said to maximize utility or happiness. Consumers generally have greater desires than what their budget can provide. The process of selecting the best parcel of goods and services is known as consumer choice theory. The Law Of Demand The price of goods and services can change. Consumers will respond to the changing prices by purchasing more or less of a particular good or service. The law of demand explains how consumers react because of changing prices. When consumers go to the store and find a recently lowered price of a good they demand, they tend to increase their consumption of that good. For example, if grapes are on sale for $0.99 a pound instead of the usual $3.99 a pound, consumers may react by purchasing more grapes. At the recently lowered price, grapes will consume less of their household budget. When consumers go to the store and find an increased price of a good that they usually demand, they tend to decrease their consumption of it. Consumers have a limited budget, so they may be unwilling or unable to purchase the good at the higher price. Consumers demand less of that good. Aside from a change in price, other factors can affect the overall demand situation for a good. These are called determinants of demand. Determinants of demand include components such as consumers' incomes, tastes and preferences, and expectations of the future. If any one of these overarching determinants change, then any analysis based on the law of demand would have to be recalculated. The Role Of Government In Supply And Demand In free-market economies like the United States, most production and consumption decisions are left to firms and individuals. The government does, however, exercise a large degree of control over the economy. The government is also a major purchaser of goods and services. The government can constrain or limit the ability to produce and consume goods and services through taxation policies. For example, if the government raises taxes on firms, the cost to produce goods will increase; likewise, if the government increases taxes on individuals, they will have a lower available budget and consequently can consume less. The government can also boost the ability of consumption and production. The government can directly stimulate the economy by purchasing goods and services. The government also can provide tax cuts to stimulate the free market. Ceteris Paribus Ceteris paribus is a Latin phrase that means “holding everything else constant.” Economists use this assumption to help apply the laws of supply and demand. Many factors can influence supply and demand, and it is difficult to describe them all. With this limiting assumption, economists can isolate the effect of just a change in price on supply and demand. One criticism of economics is that it relies upon too many assumptions. Just based on everyday observations, it is easy to identify many factors that can influence supply and demand beyond price. Using the ceteris paribus assumption, however, economists can look at each of those factors in isolation. More sophisticated economic models can be used to explain the interaction of many factors simultaneously. These models require a great deal of mathematical calculation, but they can yield particularly important information for large consumer product corporations. The government also uses these types of models to help manage the economy. The Meaning Of Equilibrium Equilibrium describes a state of balance. An everyday example of equilibrium is the use of a teeter-totter or seesaw. When two equally heavy children sit on each end of a teeter-totter, the plank balances in a form of equilibrium. In economics, equilibrium is an important concept because it describes when supply and demand are in balance. When consumers demand a certain amount of goods at a certain price and suppliers supply the same amount of goods at the same price, supply and demand are in equilibrium. Over time, markets tend to adjust to an equilibrium level. Equilibrium is a special state because consumers and producers exchange goods and services. When there is equilibrium, consumers and producers create a market for a particular good or service. Economists use models, or simplified abstractions, to explain how systems work. For example, a model train approximates how a commuter train runs. In economic models, mathematical tools are used to try and find the equilibrium level of a market. The models may be very complex. Government economists create and build complex models to try and explain equilibrium levels for the whole economy. There is no guarantee that a particular market will be formed for a good or service. The costs faced by producers may just be too high to satisfy the budgets of consumers. An obvious example would be a solid gold car. Although such a car might be desirable, the cost of manufacturing it would be too high to create a market. Sometimes goods are said to be in shortage. This can happen when there is no or a very limited supply of a good or service. After a major snowstorm or weather event, there may be a shortage of fresh milk. Consumers may also not know about a good or service. Although a product may be excellently produced and priced well, consumers may not be aware of its existence. Hence, no market will be created for the good, and there will be no equilibrium. One of the functions of marketing is to inform consumers about a good or service so that a market is created. Price Elasticity Price elasticity is a measure that economists use to try to explain how much demand will change when there is a change in price. For example, price elasticity answers the question: How much will demand change when the price of a good goes up a penny? When price elasticity is measured, economists assume that all other factors influencing demand are held constant and do not change. Price elasticity is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price. When the proportionate change in quantity demanded is greater than the proportionate change in price, the good is said to be price elastic. When the proportionate change in quantity demanded is less than the proportionate change in price, the good is said to be price inelastic. When the proportionate change in quantity demanded equals the proportionate change in price, the good is said to be unitary elastic. If the proportionate change in quantity demanded equals 2 and if the proportionate change in price equals 6, then elasticity can be calculated by dividing 2 by 6. The end result is one third, so the good is price inelastic. This means that a change in price will not have too much impact on the quantity demanded. Price elasticity can be influenced by several factors including the availability of substitute goods, luxury value, and proportion of the individual's budget consumed by the product, time, and expectation of price changes (Price Elasticity of Demand, n.d.). When more substitute goods are available, elasticity will be higher. If consumers can quickly and easily change from one good to its substitute, for example, change from drinking coffee to drinking tea, then the quantity demanded for coffee will be more sensitive to changes in prices. Luxury goods tend to have greater price elasticity because consumers can generally cut them out of their budgets. When a good is a large proportion of an individual's budget, it will tend to have higher price elasticity. For example, a consumer might not notice a 10% change in the price of table salt because it represents such a small part of the consumer's budget; however, a 10% change in price of a new automobile would certainly be more noticeable. Over longer periods of time, goods tend to be more price elastic because consumers can adjust their spending and search for substitutes. A temporary reduction in price will also generate a different response among consumers compared to a permanent price decrease. Reference Price elasticity of demand. (n.d.). Retrieved August 26, 2009, from QuickMBA Web site: http://www(dot)quickmba(dot)com/econ/micro/elas/ped.shtml Article Article: Microeconomics: The Basics Microeconomics Basics Microeconomics is the study of markets and choices of individuals over a period of different time intervals. This includes individual households, organizations (both for-profit and not-for-profit), and government agencies (Dolan & Lindsey, 1991; Boulding, 1950). According to David E. Laidler (1974), microeconomics is the behavioral study of individuals that develops foundations of the economic system: prices, outputs, and consumptions. On the other hand, macroeconomics is a general overview of the economy in a large-scale and broad viewpoint (Boulding, 1950). Melvin L. Greenhut (1963) notes that microeconomics is mainly considered to be comparing several different market types while revealing the economic laws. Microeconomics is not concerned about the fluctuations in total products (this would be considered macroeconomics); rather, it strives to analyze the market over different time periods. Price Elasticity Dolan and Lindsey (1991) define elasticity as the ratio of percentage change or a measure of a specific response of one variable or factor to a change within another variable or factor. The two types of elasticity are the price elasticity of demand, also known as demand elasticity, and the price elasticity of supply, also known as supply elasticity. Demand elasticity is the ratio of the percentage change in quantity of a good demanded to a given percentage change in its price (when all other factors are equal). The supply elasticity is the ratio of the percentage change in the quantity of a good supplied to a given percentage change in its price (when all other factors are equal) (Dolan & Lindsey, 1997). Long Run and Short Run Characteristics According to Chrystal and Lipsey (1997), the term short run is defined as the period of time over which a number of inputs (also referred to as fixed inputs) cannot be varied. The term fixed in a short run may consist of such things as resources (e.g., land, labor, and capital) within a corporation. A long run is "a period long enough for all the inputs to be varied" (Chrystal & Lipsey, 1997). The goal of a long run is to analyze the current available data prior to any changes that may have occurred from basic technological changes. Keep in mind that the short run and long run in economics are not based on actual time but instead are primarily based on the production changes via technology (i.e., new and improved products and new methods of production) (Chrystal & Lipsey, 1997; Greenhut & Scott, 1963). Economic Strategies One area of economic strategy is pricing. Firms can either price products aggressively with a low-cost strategy or differentiate on service/product quality and charge a price premium. Firms that pursue the low-cost strategy typically have a cost structure that is lower than that of competitors, and they have found a way to manufacture their goods, offer their service, or leverage their supply chains with less cost than the competition. These firms typically operate on thin margins (meaning that their gross or operating margins are not very high). Companies that pursue a differentiated service or product-offering strategy have typically developed a higher quality service offering a better product, or they are perceived to offer better quality than competitors. These firms may or may not have stronger margins, depending on their cost structure relative to competitors. Supply And Demand Market demand and supply explains the behavior and composition of markets for goods and services. Goods that are in strong demand or have few good substitutes typically offer supply firms an opportunity to charge a higher price, thus generating more revenue. Revenue is a major driver in cash flow. Firms with products that have a strong demand can generate significant cash flow and enhance firm value. On the supply side, producers can enhance cash flow by seeking to inhibit costs from growing more than the increase of profits or by driving costs down. This can be accomplished by employing more efficient production techniques through better technology or a more productive labor force, by purchasing lower cost goods, or by forming a better supply chain. All other things being equal, firms with more efficient production processes will have a lower unit cost than competitors, better profit margins, stronger cash flow, and higher valuations. References Boudling, K. E. (1950). A reconstruction of economics. New York: Wiley. Chrystal, K. A., & Lipsey, R. G. (1997). Economics for business and management. New York: Oxford University. Dolan, E. G., & Lindsey, D. E. (1991). Microeconomics (6th ed.). Chicago: Dryden. Greenhut, M. L. (1963). Microeconomics and the space economy: The effectiveness of an oligopolistic market economy. Chicago: Scott Forseman. Laidler, D. E. (1974). Introduction to microeconomics. New York: Basic. Article Article: Comparing Subsistence Strategies The governments of powerful nations, or core nations, are normally not directly involved in the changes associated with the imposition of Western economic models on local economies. Multinational corporations are the primary agent of change. In cooperation with local governments, corporations are able to obtain access to cheap labor and resources otherwise unavailable in core nations. In many cases, industrial development is seen as a forerunner of progress although that progress comes at a price, which has been paid by the environment. Global warming, pollution, ozone layer depletion, global pandemics, and deforestation are all exemplary cases of the cost of "progress." Third-world countries have now become the stage for a new bout of colonialism—neocolonialism. While global demands put pressure on the newly exploited resources, Western environmental laws are imposed on third-world countries. China's and up-and-coming nations' industrial expansion is blamed for recent environmental threats, while two centuries of Western industrial evolution and environmental devastation are forgotten. Clash of cultures brings contradictions and innovation. Although brought with good intentions, it may result in unwanted outcomes. The building of a dam may promote industrial development but can spell environmental destruction and lifestyle for thousands of people. Industrial exploitation of natural environments like the rainforest brings not only degradation of the ecosystem but also loss of cultural heritage. In a recent example, the Kaluli people of Papua, New Guinea, with the help of Mickey Hart of The Grateful Dead, recorded an album of pristine Kaluli sounds and music. The record is not only a testament to a living culture, but it has helped in the preservation of such culture with the royalties resulting from the sales of the recording (Feld, 1991). Ironically, all of this was successful because of modern Western networks of communication—the same networks that ultimately facilitate the overwhelming of indigenous culture. Subsistence strategies are losing their meaning in the context of a global economy. Although hunting and gathering, pastoralism, and horticulture have served humanity for millennia without fail, the local nature of their endeavor and enterprise is superseded by the imposition of demands from outside their immediate environment. In fact, economic imperialism and cultural imperialism have not only changed the means of productions but also have changed individual expectations at the local level. Indigenous cultures are being exposed to dominant global cultural values. The erosion and distortion of local values is unavoidable; more than a question of how it will happen, it becomes a question of when it will happen. Unless concerted efforts are made for preservation, diversity will become history.