ECON101: Principles of Microeconomics

Watch this video for examples of scarcity. We learn how to classify resources in economics and how to confront scarcity when making decisions on consumption and production.

Watch this video on the definition of economics, the essential role incentives play, and how studying economics shapes your mind. Make sure you understand the historical example.

Is there anything you need that you do not have? Is there anything that you want that you do not have? Why? Write down your answers. When you finish this course, you will enjoy looking at them. Understanding microeconomics will give you a different perspective on how things work.

The answer to the previous questions is that most of us do not produce the things we want or need; we buy them! While it may sound obvious, we need to have a source of income to buy these things. Yet, most of us never have enough to buy everything we want.

One possible solution would be to produce all the goods we consume. Would this make sense? Most of us would have to learn how to create these items and would likely conclude that it is just not worth it. In 1776, Adam Smith introduced the concepts of division and specialization of labor in his book The Wealth of Nations.

Watch this video, which explains how the division of labor enables workers to specialize in the tasks where they have an advantage.

Read this text on how the division and subdivision of tasks increase production and enable firms to reduce the average cost of producing each unit (economies of scale).

In a capitalist economy with scarce resources, the market allows us to trade the resources needed for production and the goods and services produced. The price system determines this trading or exchange. We will analyze how the market works in Unit 2. For now, think of prices as an incentive that drives the behavior of consumers and firms. For example, how would you react to an increase in the price of butter?

An increase in the price of butter is probably not a big deal. You can easily replace it with other products or consume less butter. Because your decisions are rational, many other consumers will make a similar decision. This rational behavior will impact the markets of butter, margarine, and cooking oils. However, these changes will probably not affect the national economy.

The differences between individual market behavior and the national economy exemplify why we study micro and macroeconomics. Read this text on the difference between microeconomics, which focuses on individuals, households, workers, and businesses, and macroeconomics, which studies the economy as a whole.

Microeconomics studies exchanges among individual consumers and firms in the market to purchase goods and services. In contrast, macroeconomics focuses on exchanges across all of the markets within a country. We consider the interrelated actions of consumers, businesses, government agencies, financial intermediaries, and global trading partners as they exchange resources, goods, and services and facilitate currency and quantity flows. Microeconomics examines how to achieve profit maximization. Macroeconomics explores how to achieve overall economic stability and growth nationally.

Watch this video on scarcity and choice. How do we make choices based on our self-interest when resources are scarce? We know that satisfying unlimited wants is impossible. Finding ways to use scarce resources to optimize society's well-being is one of the most important tasks of economics.

You are already familiar with the concepts of scarcity, choices, and incentives. Opportunity cost is one of the most valuable economic concepts: it is the value of the next best alternative. For instance, consider the value of your next best alternative to reading this unit. What would you be doing if you were not reading this unit? Your response will vary depending on age, socio-cultural background, family structure, and other factors.

Watch this video on opportunity costs and trade-offs. Opportunity cost and trade-offs are two fundamental economic concepts. They are all around us. Trade-offs arise from scarcity and choice. For instance, you face a trade-off when you decide between reading this unit or cooking dinner.

Opportunity cost is about what you give up when you make a choice, not just the money you spend. For example, when you go to college, you are not just spending money on tuition and books; you are also missing out on other things you could be doing with your time. Similarly, when you go to the doctor, the cost is not just the money for the visit; it is also what you could be doing instead of waiting in the office.

In economics, we often talk about scarcity and choice. Scarcity means we cannot have everything we want, so we have to make choices. The opportunity cost is what we give up when making those choices.

Economists use the idea of a "budget constraint" to talk about making choices when you have a limited amount of money. Understanding opportunity cost helps you make better decisions about how to use your time and money.

Pay attention to the example of Alphonso, which explores the concept of opportunity cost. For Alphonso, the opportunity cost of a burger is the four bus tickets he would have to give up to afford another one. He must decide whether or not to choose the burger depending on whether the value of the burger exceeds the value of the forgone alternative – in this case, bus tickets.

Drawing upon a simple analysis of the variables influencing the price of a cup of coffee, this video explains the fundamentals of budget constraints. You can use this resource to revisit the concept of opportunity cost introduced earlier.

Watch this video on the budget line and how to obtain it mathematically through equations.

The budget constraint framework helps us understand that most choices in the real world are not about getting all of one thing or all of another – choosing a point at one end of the budget constraint or all the way at the other end. Instead, most choices involve marginal analysis, comparing the benefits and costs of choosing a little more or a little less of a certain good.

Watch this video on marginal thinking to understand why it is a valuable tool for making optimal decisions. With everyday examples, Alex Tabarrok explains why thinking on the margin is one of the most fundamental economic concepts and how focusing on past decisions can lead to the sunk cost fallacy.

Read this text on how mathematics can help you in your study of economics.

Watch this video to review how to interpret graphs. Graphs are essential for analyzing economic behavior because they enable us to understand the relationship between two or more factors. Feel free to skip this video if you feel comfortable interpreting graphs.

Watch this video on why economists need models and theories to simplify reality. Once economic reality is simplified, it is easier to understand and predict its future behavior.

Remember that economics is a social science. We must deal with an important restriction: we cannot conduct experiments in a laboratory. In this sense, we confront constantly changing variables while seeking to understand the impact of these changes. A useful tool with a weird name helps us conduct economic experiments and build models: ceteris paribus (with everything else remaining constant)

Watch this video on why economists must use ceteris paribus to build models and test theories.

Now that we have embraced an economic mindset, let's explore some simple economic models and theories. We start with the Production Possibilities Frontier (PPF), a straightforward model of the production of two goods (or two services). It helps simplify the reality of attainable efficient production within a specific time frame. The PPF shows the goods and services an economy can produce – the possibilities, given the factors of production and available technology. The model specifies what it means to use resources fully and efficiently when a combination of goods is represented on the line.

Read this text on the production possibilities frontier (PPF). Note the economic implications of the downward slope and the bowed-out shape of the PPF curve. Compare the meaning of producing on the curve versus inside the curve. What does it mean to move along the curve?

Watch this video on the PPF to review how the diagram is constructed and how to identify attainable and unattainable production points when economic agents face scarcity.

While the PPF appears to be a basic economic model, it finds applications in complex economic scenarios, including the analysis of international trade. Read this text on absolute and comparative advantage, which uses the PPF and opportunity costs to analyze the rationale of international trade and the benefits countries derive from specializing based on comparative advantage.

Watch this video to review the law of increasing opportunity cost as it applies when society moves between two different points in the PPF.

Watch this video on allocative efficiency and marginal benefit using the production possibilities frontier. The PPF can illustrate two kinds of efficiency: productive and allocative. Make sure you understand that while the PPF shows many combinations that are productively efficient, only one of the productively efficient choices will be the allocatively efficient choice for society as a whole.

We wrap up this unit by introducing another essential model in Economics: the circular flow model, which pictures the economy as consisting of two groups – households and firms – that interact in two markets: the goods and services market, where firms sell, and households buy, and the labor market, where households sell labor to business firms or other employees.

Watch this video on the circular flow model of income and expenditures. Make sure you understand the concepts related to the payments of the factors of production. Is income the same thing as revenue?

The circular flow model is a fundamental economic concept. Read this text to better understand this model and its interactions with the broader economy. It explores the flows of resources between firms and households and interactions with the environment.

Read this introduction to supply and demand.

Read this section. Make sure you understand the difference between the quantity demanded and the demand.

Watch this video to review the law of demand and how to graphically obtain the demand curve from a demand schedule that gives you information on the quantity demanded at each price.

While the information in the previous reading and video seems straightforward, confusing demand with quantity demanded is easy. Watch this video that reviews the difference and introduces the factors that change demand.

Now that you understand that demand represents the quantity of a good or service, consumers are willing and able to buy at each price (quantity demanded is the dependent variable reacting to changes in the independent variable – price), we can delve deeper into the factors influencing changes in demand for a product or service.

Read this section to ensure you understand why, for example, a rise in income, ceteris paribus, shifts the market demand for airplane tickets to Hawaii outward, resulting in a greater quantity demand at the same price. If you find yourself overwhelmed with new concepts, it is either time for a break or to review the concepts we have introduced so far in this course. If you decide to take a break, consider the opportunity cost!

When demand changes due to an income change, we must investigate how the quantity demanded reacts at the same price. If the quantity demanded of a product or service moves in the same direction as income, we call it a normal good or service. If it moves in the opposite direction, we call it an inferior good or service. Watch this video on normal and inferior goods.

Watch this video to ensure you understand that changes in the prices of related goods (substitutes or complements) affect the demand for a given product or service. Try to find examples that fit your consumption patterns and repeat the reasoning with your own examples.

Another factor that affects demand is the change in expected future prices. Have you ever delayed a purchase because you believed the price would drop? In this scenario, the current price remains unchanged, but your willingness to buy has shifted. Watch this video to understand how the distinction between current and expected prices can impact the demand curve.

How do you feel now about the egg question/challenge posed at the beginning of this unit? Make sure you can graph demand shifts. Figure 3.9 summarizes the factors that can change demand and shift demand curves. Read the section. Review changes to demand when the product price does not change.

Read this section. Make sure you understand the difference between the quantity supplied and the supply.

Watch this video to review the law of supply and how to obtain the supply curve from a supply schedule graphically. Make sure you understand that, as prices rise, producers are incentivized to produce more units.

Just like we did with demand, it is essential to highlight that supply (a function) is not the same as quantity supplied (a variable). Supply is the relationship between a range of prices and the quantities supplied at those prices. On the other hand, quantity supplied is a certain point on the supply curve that indicates the number of units produced at a given price.

We can interpret supply as a function representing the minimum price a firm will accept to produce a specific quantity of a good or service. This supply function can change, as producers may choose to offer more or fewer units at the same price based on various factors. Can you think of factors that encourage a firm to produce more units at the same price?

Watch this video to review the law of supply and to see how factors affecting supply shift the supply curve.

Figure 3.15 summarizes the factors that change the supply of goods and services. Read the section on Summing Up Factors That Change Supply. Use this section to review changes to supply when the price of the product does not change.

Watch this video on market equilibrium using a graph so you can see how the demand and supply curves come together in the market.

Read this text on the four-step process that identifies the equilibrium price. Do you understand the difference between a shift in demand or supply and a movement along the demand or supply curve? Can you think of real-world examples that can cause these to occur?

Watch this video on how changes in demand and/or supply affect the market price and/or the market quantity. In Unit 1, we discussed using graphs to represent a simplified economic reality. Changes in demand and/or supply will shift the relevant curve. Consequently, it will affect the price and quantity, and the market will reach a new equilibrium point.

Before we move on to the next section, try to solve the following questions, which cover central concepts in microeconomics you should understand.

Read this text and watch the video that follows on the interaction between demand and supply in labor markets. Think about what equilibrium wage and equilibrium quantity mean in the labor market. This framework enables us to analyze the impact of government regulations such as the minimum wage. It also helps us understand the impact of other real-world events, such as migration, the COVID-19 pandemic, and the trade-off between leisure and work.

Watch this video on the labor market equilibrium.

The Great Resignation refers to the large increase in the number of people who quit their jobs since the summer of 2021 in many high-income countries. Read this abstract and introduction from this study for a multidisciplinary introduction to what lies behind this phenomenon. Use the demand and supply framework applied to the labor market to reflect on how the Great Resignation affects the labor market in terms of quantity (number of workers and hours) and price (wages).

Besides the labor market, we can also apply the basic tools of supply and demand to analyze financial markets. Some students find the term "financial" intimidating because they associate it with complex financial instruments. However, if you think of the financial market as a place where borrowers and lenders come together, it will seem less intimidating and make much more sense.

Read this text introducing financial markets. Try to relate what you learn in this introduction to what you have already studied in this unit by answering this question: Why do firms need to do to raise funds when consumer demand is high?

Now, we can use the supply and demand framework to explore how financial markets function. Since we usually measure price on the Y-axis, let's start by introducing the concept of the interest rate. Watch this video, which explains what the interest rate is and offers tips for steering clear of financial troubles.

The demand side of a financial market is usually comprised of firms that seek to raise funds. Read this section to understand the relationship between financial capital and a firm's profits and analyze how firms choose between sources of financial capital.

On the supply side, we can find households and firms that have accumulated savings and expect a given rate of return for the supply of these savings. Read this text to study the relationship between savers, banks, and borrowers and understand the differences between bonds, stocks, mutual funds, and commercial banks' deposits. Make sure you understand the trade-offs between return and risk.

Ultimately, financial markets help allocate the economy's scarce resources to their most efficient uses by connecting borrowers (who demand financial capital) and savers (who supply financial capital).

Read this introduction to the concept of elasticity. It offers examples that make it easier to understand why we need an economic tool to measure the degree of responsiveness of one variable to changes in another variable.

In early 2019, Netflix announced its biggest price hike ever in the united States. Consequently, the company experienced a drop in subscribers for the first time since 2011. In April 2018, Amazon announced a 20 percent increase in the price of its Prime subscription, and... 53 percent of respondents to an eMarketer survey said the increase had no impact whatsoever on their subscription to the service.

We can attribute the different reactions from Netflix and Amazon clients to various factors. Nevertheless, both companies benefit from understanding how their consumers react to changes in the price of their products. Do you think we should introduce "ceteris paribus" into this discussion?

Watch this video on calculating the price elasticity of demand over the demand curve graph and with the elasticity formula.

Revisit the previous explanation by watching this video and further your understanding by interpreting the results of price elasticity of demand. Pay close attention to whether we are using the absolute value to calculate elasticity. Avoid memorizing the interpretation of the results; they are so intuitive that it is not worth occupying your brain's storage capacity with these details. Be sure to grasp the concept that elasticity is a unit-free measure.

Let's now delve into the analysis of income elasticity of demand. Watch this video to explore this concept, paying close attention to the interpretation of results. Income elasticity of demand results provide valuable information for both firms and the government. They help us understand how much consumers' quantity demanded reacts to a change in income at a specific price and determine whether, at that given price and within a particular income bracket, the analyzed good or service is normal or inferior.

The next elasticity of demand we will discuss is the cross-price elasticity of demand. There is no need to be intimidated by the complex sound of its long name!

The cross-price elasticity of demand simply measures the percentage change in the quantity demanded of one good or service due to the percentage change in the price of a related good or service. We are sure Elon Musk would like to know how much the quantity demanded of the Tesla Cybertruck would change in percentage terms in response to a given percentage change in electricity prices.

You have already observed that elasticity calculations can yield diverse results. Economists classify results of zero, infinite, or one as extreme or polar cases. Read the explanation, and make sure you understand that while these outcomes are not common, they serve as valuable analytical benchmarks.

In conclusion, understanding the elasticity of demand is essential for businesses and policymakers alike. It provides valuable insights into how changes in prices and income can affect consumer behavior and market dynamics.
You should now be able to discuss complex questions such as:

• Why is food demand more income-elastic in low-income communities than in wealthier communities?
• How does the price elasticity of demand change in the long run?
• Why do you think airline seats in business class have an estimated elasticity of demand of 0.42, while seats in economy class have an estimated price elasticity of 0.60?
• What is the relationship between price elasticity and position on the demand curve? For example, what happens to the measured elasticity as you move up the demand curve to higher prices and lower quantities?

Well done! Price elasticity of supply measures the percentage change in quantity a firm supplies in response to a percentage change in price. Watch this video to review the concept of price elasticity of supply, master its calculation, and understand the interpretation of the possible results.

Here is some food for thought before we delve into the next section: Do you believe the housing supply in your city is price elastic or price inelastic? Does your perspective shift when you consider a longer time frame? Watch this video on the determinants of the price elasticity of supply.

At this stage, your mind is brimming with new concepts, challenges, and ideas. You have examined numerous diagrams, and it is quite common to mistake elasticity at a specific point for the slope. This reading will help you clarify the distinction.

Read this section that discusses the relationship between price elasticities of supply and demand, pricing strategies, and revenues. Consider inserting your own relevant examples when you study Table 5.3. Pay particular attention to the analysis of whether firms can pass higher costs on to consumers, depending on the price elasticity of demand.

Watch this video If you need additional explanations on the relation between total revenue and the price elasticity of demand for a product.

Watch these two videos on the relationship between taxes and two polar cases of demand elasticity: perfectly elastic and perfectly inelastic demand. You may need to go back to the end of section 3.2 and review the polar cases before you watch the videos.

Read this text to enhance your understanding of elasticity as it applies to labor markets. Wage elasticity allows firms to assess the extent to which workers respond by offering more work hours when wages increase. Use this analysis to revisit the labor market introduced in section 5 of Unit 2.

Watch this comprehensive video that summarizes most of what we have explored in this unit. Given its length, you may want to revisit it after completing the unit to ensure you have a thorough understanding of elasticity and its applications.

Read this text on consumer surplus, producer surplus, and social (total) surplus to familiarize yourself with these concepts that enable us to measure economic efficiency.

To understand the graphical analysis of consumer surplus, let's revisit the demand curve to interpret the relationship between price and quantity as a marginal benefit. You can watch this video on the demand curve as a measure of marginal benefit. If necessary, review the concept of marginal introduced in Unit 1. Pay special attention to the difference between value and price.

Watch this video, which explains consumer surplus using a graph to help you grasp the concept and the calculation. Complete the practice questions to make sure you understand the calculation.

Watch this video, which explains how an apple farmer decides the optimal number of apples to pick and sell. This explanation will help you understand how we measure producer surplus.

Watch this video, which explains consumer surplus using a graph to help you grasp both the concept and the calculation. Complete the practice questions to make sure you understand the calculation.

If you guess our next step is to combine consumer and producer surplus, you are right on track. We call the sum of consumer and producer surplus social surplus, total surplus, or economic surplus. Social surplus is greater at the equilibrium quantity and price than it would be at any other quantity.

This demonstrates the economic efficiency of the market equilibrium. Furthermore, at the efficient market quantity (the equilibrium quantity), it is impossible to increase consumer surplus without reducing producer surplus, and vice versa.

Watch this video, which reviews consumer and producer surplus and introduces total surplus in the context of efficiency.

Read this text on the economic inefficiency of price ceilings and price floors. We use deadweight loss to measure this inefficiency. Make sure you understand the concept of deadweight loss and how to measure it on the demand and supply graph.

The efficiency approach to price controls might be easier to understand if we use familiar examples, such as rent controls and minimum wage. Watch these two videos for an economic efficiency analysis of the adoption of a maximum price on rental housing (price ceiling) and the implementation of a minimum wage (price floor). You can use the minimum wage video to review the main features of the labor market from Unit 2.

Watch this video on President Nixon's wage and price controls in the 1970s to understand why governments enact price controls despite our economic analysis.

Read this introduction to market failure and externalities. What role does government play in correcting market failure? How might externalities affect those not directly involved in a market transaction?

Watch this video for an introduction to externalities. Learn the difference between positive and negative externalities and understand that many activities have social and private benefits and costs.

Technology and innovation provide companies with a competitive edge and generate positive externalities. Read this text to explore why private firms in a market economy might underinvest in research and technology. This reading will enhance your understanding of positive externalities.

Watch this video on how additional production can generate positive externalities. When dealing with positive externalities, the government can enhance efficiency by implementing specific measures to reduce deadweight loss. As explained in the video, a tax credit for planting trees could offset the positive externality.

Read this text on how governments promote innovation. Intellectual property rights, such as patents and copyrights, promote innovation by granting creators and companies exclusive rights over their inventions and creative works for a limited time. There are alternative policies for enhancing the rate of return on new technology, including government spending on research and development (R&D), tax breaks for research and development, and cooperative research efforts between government-funded institutions and the private sector.

Now that we have explored externality and positive externalities let's examine negative externalities. Watch this video on negative externalities. A negative externality is a cost a third party bears that results from consumption or production.

Pollution is one of the most commonly used examples of negative externalities. Read this text on the additional external costs (negative externality) specific production processes create. Make sure you understand that when a firm pollutes due to its production process, the supply curve no longer represents all social costs.

If firms had to cover the social costs of pollution, they would reduce pollution levels. This might lead to higher prices and decreased production. Watch this video on how governments use taxes to reduce negative externalities.

Read this text, which applies the production possibility frontier we studied in Unit 1 to evaluate the trade-off between economic output and policies that protect and sustain the environment.

As we have studied, market failures occur when allocating resources in a market economy leads to an inefficient outcome. We have seen how positive and negative externalities can cause market failures. Now, we focus on public goods (goods or services that are non-excludable and non-rivalrous) as a source of an inefficient allocation of resources.

Read this text on the two defining characteristics of public goods – they are non-excludable and non-rival. We explore public goods and related government intervention in more detail in Unit 8.

Read this introduction to the topic of poverty and income inequality, which are examples of market failures.

Watch this video that explains poverty, a failure of society. We can only address this failure by creating a more inclusive society. "Poverty is often described as a problem of inequitable or unjust distribution of resources. But poverty raises questions of efficiency as well as equity." (Stout, 1993)

This text explains that poverty and income inequality are related yet distinct economic concepts. We determine poverty by the number of individuals who fall below a specific income threshold known as the poverty line, the income required for a basic standard of living. On the other hand, income inequality assesses how different groups in society share total income or wealth.

Read this text and watch this video on how government programs can create a poverty trap with the programs they implement to reduce poverty. Decisions on whether it is better to work or stay home and receive government subsidies are especially difficult for workers with young children who must weigh the costs of childcare, transportation to and from the workplace, and other expenses such as clothing. Make sure you can calculate a budget constraint line that represents the poverty trap.

Watch this video on why it is so difficult for individuals to escape poverty. Note that we will return to this topic in Unit 8.

While you are now familiar with poverty, its measurement, and its potential causes, there is still room for confusion between poverty and income inequality. As we have explained, these are related but distinct concepts. It is critical to establish clear definitions and measurements of income inequality as a separate issue, although it is related to poverty.

Read this text on the sources of income inequality in a market economy, such as the changing composition of American households and shifts in the distribution of wages. What is a quintile, and how do they help economists measure income inequality? How does the Lorenz curve measure income inequality?

Watch this video to review the Lorenz curve and learn how to calculate and interpret the Gini coefficient. Note that these concepts are usually described in more detail in macroeconomics. The video also explores whether a given society can avoid income/wealth inequality.

We close this section with an analysis of how an efficient labor market can discriminate against specific sectors of society. Discrimination in labor markets arises when workers with the same skill levels receive different pay or have different job opportunities due to their gender, race, or religion.

Read this text to analyze discrimination in the labor market, how to measure it, and its relation to the housing market. Make sure you understand the controversy that surrounds public policies to reduce employment discrimination.

Read this introductory text to understand how we organize the main concepts included in this unit.

Watch this video to explore the concepts of total utility and marginal utility. Make sure you understand that while total utility increases with consumption, marginal utility diminishes. The additional amount of happiness (marginal utility) consumers obtain from one more unit decreases with each additional unit.

Read this text on consumption choices. The budget line is built considering the constraint imposed by a limited budget and the utility and the marginal utility derived from the consumption of two goods. Remember, we introduced the concept and graph of the budget line in Unit 1.

Watch this video on equalizing marginal utility per dollar spent for two products to review the rule on maximizing utility. Remember, this method determines what products people prefer to spend their income on, given a budget.

Watch this video on depicting the budget line in a graph. Remember that the budget line for a consumer shows different combinations for purchasing two goods, given a fixed budget.

Read the first two sections of this text on how income, prices, and preferences influence consumer choices. Make sure you grasp that changes in product prices prompt consumers to adjust their consumption of related goods, not just the affected product.

We have analyzed how prices, budget constraints, and consumer preferences interact to shape household decisions.

Before we move on to the next section, try to solve the following to ensure you are prepared for the next section.

Watch this video on how to build and interpret indifference curves. Make sure you understand the math and microeconomics behind the slope of the indifference curve.

Now, we can apply the indifference curve analysis to the types of goods and services identified in Unit 2, such as complements, substitutes, normal, and inferior goods. Review the section on the slope of the indifference curve in the previous video to better grasp the various shapes of indifference curves presented here.

Watch this video to review indifference curves and obtain consumer equilibrium. This equilibrium shows the optimal consumer choice and is mathematically determined by the tangency condition between the budget line and the indifference curve.

Watch this video on how to draw the demand curve from working with the marginal utility per dollar.

If you are deeply involved in the analytical framework of consumer choice and do not mind mathematics and diagrams, it might be beneficial to watch this demonstration of the derivation of different demand curves from the consumer's equilibrium. While not required for this course, it may help you review the concepts and relationships introduced in this unit.

Watch this video, which explains the difference between the short run and the long run. Consider how long it takes firms to change their factors of production.

A firm's decision regarding the quantity of output to produce depends on the market structure where it operates (we learn about market structures in Unit 7) and the cost of production. The analysis of production costs takes us back to Unit 1 – we need to consider the direct costs and the opportunity costs of production, also known as implicit costs.

Watch this video on the difference between accounting costs (direct costs) and economic costs (explicit and implicit costs). You might have to readjust your thinking about what cost means in economic analysis.

Read this text to review the factors of production introduced in Unit 1 and to learn how to obtain and interpret the production function in the short run. Understanding the production function will pave the way for grasping concepts like total and marginal product (or output). The text also introduces the critical law of diminishing marginal returns.

The previous reading introduced several new concepts. Watch this video on total, average, and marginal products and the law of diminishing marginal returns to labor to ensure a solid understanding of these essential economic ideas and relationships.

As you know, a firm's costs depend on the quantities of factors of production the firm uses and the cost of those factors of production. We now focus on the analysis of costs in the short run. Why do you think costs differ in the short and the long run?

Read this text, which explores short-run costs. Make sure you can define, calculate, and graph total cost, average total cost, average variable cost, and marginal cost.

Let's watch the following four videos to further clarify the new concepts introduced in the reading. We start by reviewing the concepts of fixed versus variable costs and then dive into a dynamic explanation of the cost curves. And because we understand that all those diagrams can make you dizzy, we have included a video on why it is crucial to grasp them all.

Once you complete the videos, you should be well-prepared to answer the following review questions.

You have just completed a challenging section packed with new concepts. With the relevant information in your hands, you should be able to answer the question posed at the beginning: how many units of pizza to prepare daily if you can only change the number of workers you hire?

Read this short section, which compares short-run and long-run production and introduces the long-run production function.

You should now be able to explain why the long-run production function represents the most efficient way to produce any level of output. If the answer readily comes to your mind, you are prepared to explore the analysis of costs in the long run.

Read this text on how to calculate the long-run total cost. Compare the long-run average cost curve with the short-run average cost curve. Make sure you can differentiate economies of scale, diseconomies of scale, and constant returns to scale. You should also be able to compare economies of scale and diminishing marginal returns.

Watch this video to review how we obtain and graph the long-run average total cost curve and its relation to the short-run average total cost curve.

To finish this unit, watch this video to review the essential economic concept of economies of scale. By the end, you should be well-prepared to address the question posed: "Why are people and economic activity concentrated in cities rather than distributed evenly across a country?"

We started this unit by asking these questions:

• What should be produced?
• How should it be produced? (considering the amount of each input used)
• How much should be produced?
• Where should it be produced?

As previously mentioned, the answers to these questions depend on several factors, including the time frame considered, the costs of the firm, and the market structure within which the firm operates. In this unit, we have delved into the first two aspects. In the upcoming unit, we explore the various market structures where a firm can conduct its business.

These types of markets are probably the best real-world analogy for our study in this section: perfectly competitive markets. Perfectly competitive markets are best understood within the context of the various market structures. Watch this video, which explains the market structure spectrum, including perfectly competitive markets.

A market is only considered perfectly competitive if it fulfills four conditions:

1. Many companies produce the same or identical products;
2. Many buyers are available to buy the product, and many sellers are available to sell the product;
3. Buyers and sellers have the relevant information they need to make rational decisions about the product they are buying and selling; and
4. Companies can freely enter and leave the market without any restrictions.

Complement the text with the explanations in this video for a comprehensive understanding of the distinction between the supply and demand graph for a perfectly competitive market and a perfectly competitive firm. What is the relationship between the firm that is a price taker and the fact that its demand curve in a perfectly competitive market is a horizontal line? What is the price elasticity of demand of a fully horizontal demand curve?

In any market structure, firms must determine their optimal output level to maximize profits. This also applies in a perfectly competitive market, where products are homogeneous, allowing consumers to easily substitute one firm's product with an identical one from another company.

Read this text on how perfectly competitive firms decide the amount of units they need to produce to maximize profits. Firms can find the profit-maximizing output level by comparing total revenue and total cost or marginal revenue and marginal cost. Make sure you understand the written explanations and the graphs. Why is total revenue an upward-sloping line while marginal revenue is a straight line?

Once you have fully understood that a firm maximizes profit by producing the quantity of output at which marginal revenue equals marginal cost, you are well-equipped to calculate the economic profit for that level of output by simply subtracting total cost from total revenue for that specific quantity. You can follow the explanation in the text above or in the following video. You may need to review the cost curves in Unit 6 (section 6.2.).

Students are usually taken aback by the concept that the output level that maximizes profit may result in losses (negative economic profit). How does this happen? Is it a sustainable scenario in the long run?

Revisit "Shutdown Point at How Perfectly Competitive Firms Make Output Decisions" in the text you just read in this section, "How Perfectly Competitive Firms Make Output Decisions," and analyze it carefully. You can also review the shutdown point by watching this video on how a baker decides whether to keep their bakery open or closed in the short run.

We have now concluded our analysis of how a firm makes output decisions in the short run in a perfectly competitive market. But will the results change if the firm can modify all factors of production and all costs become variable, indicating a shift in the long run? Read this text on entry and exit decisions in the long run to find the answer and delve into the interaction between the firm's profit level and the market's supply and demand in the long run. Why do entry and exit lead to zero profits in the long run?

We can define a monopoly as a firm that produces a good or service for which no close substitute exists. In fact, a monopoly is a market where a single firm is shielded from competition by barriers that prevent the entry of new firms. Read this introductory text to analyze monopolies. Can a monopoly charge any price it wishes?

In line with the long-term dynamics we discussed in the previous unit, you may expect that when a monopoly generates a positive profit, it would naturally draw other firms into its market. However, that is not the case. Monopolies are safeguarded by barriers to entry, effectively blocking other companies from entering this attractive market. Read this text on how monopolies form. Make sure you understand how economies of scale can give rise to a natural monopoly.

Watch this video on how a monopoly chooses the amount of output that maximizes profit and how to identify the profit obtained when such an amount is produced. The analysis extends to the long run. Make sure you understand the shape of all the curves we use to graph a monopoly and the relations between those curves.

Read this section to make sure you understand the distinctions between demand curves for perfectly competitive firms and monopolies. This text will also help you review the calculation of a monopoly's profit, which should be familiar since the process is similar to what you have already studied for perfect competition.

Since a monopoly leads to a reduction in market efficiency (resulting in higher prices and lower output compared to perfect competition), governments are sometimes compelled to intervene and limit their economic power. In the last section of this unit, we will analyze these government policies.

Read this introductory text, which defines two forms of imperfect competition: monopolistic competition and oligopoly. How do differentiated products promote monopolistic competition? What are the benefits of variety and product differentiation? Do governments need to protect consumers from monopolistic competition?

We begin our analysis of imperfect competition with monopolistic competition. Monopolistic competition, as described, is a unique market structure where multiple firms compete among themselves while offering products that possess some degree of distinctiveness. It is probably the single most common market structure in the U.S. economy.

We begin our analysis of imperfect competition with monopolistic competition. Monopolistic competition, as described, is a unique market structure where multiple firms compete among themselves while offering products that possess some degree of distinctiveness. It is probably the single most common market structure in the U.S. economy.

Watch this video on monopolistic competition to strengthen your grasp of this market structure after reading the previous section. Pay attention to the note that you have what it takes to analyze a monopolistically competitive market since you have already looked at perfect competition and monopoly. If this does not sound right to you, you may need to revisit the section on perfect competition.

Now that you have a comprehensive understanding of monopolistic competition, let's shift our focus to oligopoly, where a small number of dominant firms shape the market landscape. Oligopoly is considered the most complex market structure. Can you guess why?

American Airlines introduced its AAdvantage frequent flyer program in 1981. Within days, United Airlines launched its Mileage Plus program, and that same year, Delta Airlines and TWA offered similar programs. This is a clear example of the complexities that can arise in a market with just a few firms that compete fiercely against each other. It illustrates one of the key characteristics of an oligopolistic market: the interdependence among the firms.

Read this text on why oligopolistic firms exist and whether they should cooperate to function as a monopoly. Given the complexities introduced by oligopolistic interaction, there is no single model that can explain the oligopoly. Pay attention to the explanation of game theory as a tool to analyze the dynamics of oligopolistic behavior.

Watch the video on the Prisoners' Dilemma and Nash Equilibrium to improve your understanding of these two game theory tools.

Now that you have studied monopolistic competition and oligopoly as imperfectly competitive market structures, watch this video that compares the two so you can assess your understanding of the materials.

Read this short text introducing this section on competition policy (antitrust measures). Make sure you understand why the author states that imperfect competition can generate a loss of potential consumer surplus, a concept that we introduced in Unit 4.

Policymakers need tools to measure the level of competition in an industry or market and enhance allocative efficiency while safeguarding consumer welfare from potential losses in consumer surplus due to firms' market power. Read this text on how to calculate concentration ratios and the Herfindahl-Hirschman Index. Why does the text start describing corporate mergers? What is the relationship between mergers (or mergers and acquisitions) and the degree of competition in an industry?

Antitrust legislation is complex and must evolve with changing market dynamics. Read this text to learn how certain firm strategies, which may have saved you money, can be anti-competitive. Examples of these potentially restrictive practices include exclusive dealing, tying sales, bundling, and predatory pricing.

A natural monopoly creates yet another challenge for competition policy because it makes a single firm more cost-effective than multiple firms. Read this text, which explores how to create an appropriate competition policy for a natural monopoly. Make sure you fully understand the graph depicted in Figure 11.3. If you find it challenging to follow the explanation, revisit Section 7.2 to review the theory and accompanying graphs that explain the economic behavior of a monopoly.

We wrap up this section and chapter with a video that explains how policymakers deal with monopoly power in a particular market. Make sure you can understand the graphs.

Note that there is no consensus on whether government regulation and taxation are necessary to rectify inefficient market outcomes. Some economists argue that such intervention is essential, as market failures often result from private decision-making. They propose taxing negative externalities to internalize costs and subsidizing positive externalities for the common good. Conversely, some argue that market mechanisms can naturally resolve these externalities (Coase theorem). They believe that mutually beneficial contracts between parties, such as agreements between landlords and polluters, can lead to efficient outcomes, thus questioning the need for extensive government involvement.

Read this text to review the definition of a public good. Compare this definition with the free rider problem and identify sources of public goods. You can use the Prisoner's Dilemma introduced in Unit 7 to analyze the free rider problem. Why do we consider the public sanitation system a public good? Should the government pay for public goods? Why can governments provide public goods more successfully when they have strong institutions?

Watch this video to review the concepts of rival and excludable goods to better understand the characteristics of a public good. What is the "Tragedy of the Commons"?

Analyzing goods and services in terms of their rivalry and excludability helps us determine their optimum allocation. Read this short text on a 2 × 2 matrix to classify goods according to this criteria.

Read this text that explains government revenues and government expenditures. The text places the data on government revenues and expenditures in a historical context. You can find more recent official data on these variables from sources like the International Monetary Fund. Why are transfer payments a tool to redistribute income? Are you willing to pay higher State taxes to improve income distribution in the state where you live?

Government agencies need a source of revenue to provide public goods (government expenditures), subsidize innovation, and/or transfer Social Security checks. In most countries, taxation is the primary source of government revenue or funding. Although you have been paying taxes since your first store visit, the jargon surrounding taxes might be confusing. Watch this introductory video to grasp the main concepts.

Read this text to study the main principles of taxation and understand the differences between regressive, proportional, and progressive taxes within the context of the different types of taxes. Is the U.S. income tax progressive? What benefits do you receive from the taxes you pay?

Drawing upon what you have learned in this section and in the last section of Unit 3, explain the challenges in creating a tax system that is simultaneously fair and efficient.

Public Interest Theory says that government officials should make decisions that are best for everyone. They use tools like cost-benefit analysis to find the most efficient solutions for public goods like parks or schools. Sometimes, markets do not show the real value of these goods, so it is up to the government to figure that out. 

On the flip side, Public Choice Theory argues that people in the government are also looking out for themselves. This theory explains why many people do not vote. Voting takes time and effort, and many feel their single vote won't make a difference. This is called rational abstention. Because not everyone votes, the outcome may not truly represent what the community wants.

Ronald Coase suggested that private negotiations might be more advantageous than government interference when addressing external impacts. He contended that the individuals engaged in the exchange typically possess more information required to achieve an efficient resolution than governmental entities.

Read this text, which explains the Coase theorem, why private bargaining might not work, and the principle of "the polluter pays." Note that Ronald Coase recognized the limitations of private bargaining due to unclear property rights and high transaction costs.

Watch this video on the Coase theorem and how, under specific conditions, the market can effectively manage externalities. Do you think the market system can address the climate emergency?