notes

Opportunity Cost and Scarcity

Opportunity Cost: Opportunity cost = The value of the next best alternative foregone = Explicit costs +
Implicit costs

Marginal Analysis: If MB > MC, an agent is better off doing that activity
If MB < MC, an agent is worse off by doing it

Gains from Trade

Trade = Economic interaction (where goods/services are exchanged)

Absolute Advantage: Party A has an absolute advantage over Party B in the production of a good if, for a
given amount of resources, A can produce a greater number of that good than B.

Comparative Advantage: Party A has a comparative advantage over Party B in the production of a good
if A’s opportunity cost of producing that good is lower than B’s opportunity cost.



Production Possibility Frontier




Slope of a PPF: The slope of the PPF measures the opportunity cost of producing an extra unit of a good
(in terms of the other), for a particular point on the frontier.




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,Demand

Benefit and Willingness to Pay: Benefit from item = Willingness to pay (WTP)

Maximum price a consumer will pay for good = benefit they anticipate from getting the item (P = MB)

Total and Marginal Benefit: Total benefit = total benefit derived from consuming certain amount of g/s
Marginal benefit = extra benefit derived from consuming extra unit of g/s
(diminishing)

Individual Demand: Individual demand curve = MB curve

Law of Demand: Holds that a consumer consumes fewer units when the price is higher

Movement Along Demand Curve: Change in P or Q only = movement along demand curve
● Movement downwards along demand curve = increase in
quantity demanded




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, ● Movement upwards along demand curve = decrease in quantity
demanded

Change in Demand: Change in demand (change in factors other than P and Q) = Shift in demand curve
● Rightward shift = increase in demand
● Leftward shift = decrease in demand

Market Demand: Market demand curve = Horizontal summation of individual demand curves in market

The Firm

Production Function: Y = A F(K, L) where Y is total output, K is capital, L is labour and A is the level of
technology

Short Term Total Product of Labour:

Small amount of labour, more labour input =
increasing returns

Medium-high amount of labour, more labour
input = diminishing returns

Large amount of labour, output decreases




Average Product of Labour: (average output each worker can produce)

Marginal Product of Labour: (additional output when employing additional worker; slope of
production function)

Short Run Production Function:




MPL = APL when APL is maximised




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, When MPL > APL, average is increasing with L
When MPL < APL, average starts falling too with L

Output is Maximum When: MPL = 0 or

Production in the Long Run

Returns to Scale:

Constant returns to scale = Output increases by the same proportional increase in inputs
Increasing returns to scale = Output increases by more than proportional to increases in inputs
Decreasing returns to scale = Output increases by less than proportional to increases in inputs

Economic Profit

Profit: Economic Profit = Revenues – Total Opportunity Cost


Total Revenue: TR = Amount a firm receives for the sale of its output

Total Cost: TC = Amount a firm pays to buy the inputs of production + forgone opportunities = total
opportunity cost of producing goods/services
● Opportunity costs include
○ explicit costs (that are not sunk)
= direct payments for inputs or factors of production
○ implicit costs (value of foregone opportunities)

Short-Run Costs

Cost Function: TC = f(q) where TC is total cost and q is quantity of output

Total Costs in the Short Run: TC = Total fixed costs + total variable costs

Average Fixed Costs:

Average Variable Costs:

Average Total Costs:

Relationship Between ATC, AVC and MC:




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