LAW AND ECONOMICS OUTLINE HARRISON SPRING 2014
ECONOMIC TOOLS AND CONCEPTS
I. When considering the relationship between economics and law:
a. Economics deals with efficiency (or allocation of resources to the best uses): making the pie as big as possible
b. Law deals with what is “fair” (or distributive uses)
II. “Opportunity Cost:” Next best alternative
The cost of any activity measured in terms of the value of the next best alternative forgone. In other words, the sacrifice related to the second best choice available to someone who has picked among several mutually exclusive choice
III. Discounting and Present Value
Money now is worth more than money in the future.
a. The value of money may decline in the future – even the possibility of inflation makes it preferable to have the money now
b. There is always some probability that you will not get the money unless you have it in hand.
Ex. – Harrison was fairly certain that he would receive $10 in a year. Dawson decided to sell Harrison the “right” to the $10. Harrison might offer $9.80.
i. Here, Harrison “discounted” the value of the $10, because it will not be received for some time.
ii. The “present value” of $10 to be received a year from now is $9.80.
IV. “Production Possibilities:”
a. Two goods
b. Fixed resources
c. Fixed technology
d. Assuming full employment and productive efficiency (lowest cost possible) on the curve
V. “Price Theory”
Includes the concepts of supply and demand, elasticity, and perfect and imperfect conditions.
Demand, Supply, and Market Equilibrium
I. DEMAND
A “range” of prices and the amount of a good or service that individuals are willing and able to purchase in a given market at given time at those prices.
i. Note – Demand does NOT account for those who either can’t afford the good or are unwilling to pay it.
a. Equilibrium
Where the supply curves meets the demand curve
i. Demand Curve: buyer’s side of the market
ii. When you go out and buy stuff, I am willing to buy more stuff as the price falls
b. “Law of Demand”
a. Inverse Relationship – As price (P) increases, quantity demanded (QD) decreases. As P decreases, QD increases.
c. Change in D v. a Change in QD
i. Shift of the Curve – change in D
a. See below (Determinants of Demand—Shift Factors)
b. P NEVER shifts the curve
ii. Movement along the Curve – change in QD
A change in price changes QD (the ONLY thing that changes QD)
d. Demand can be described by:
i. Diminishing Marginal Utility
a. As we consume more units of a good, our marginal satisfaction will fall, so we will buy additional units only if the price falls.
b. The more I consume of anything, the less satisfaction I am going to get.
c. So, if firms think I will go buy more of something, they will lower the price. Otherwise, I won’t buy more stuff.
ii. Income Effect
At lower prices, our income has greater purchasing power so we can purchase more units.
a. When P goes up, now we can buy less stuff (purchasing power decreases) even though we have the same amount of money
iii. Substitution Effect
At higher prices, we start to consider alternatives
a. If P goes up, people buy less of that product, because they will start buying other substitute products
e. Rightward Shift of Demand Curve
a. When D increases (shifts to R), then price and quantity will increase, IF SUPPLY STAYS THE SAME
f. Leftward Shift of Demand Curve
a. Complimentary Goods – If a complimentary good P goes up, then D for its compliment will go down
i. Causes P and Q to decrease
g. Determinants of Demand (Shift Factors)
i. Tastes and preferences (H)
a. If there is an increase in tastes and preferences, D will shift to R (increases)
ii. Income (normal good v. inferior good)
a. If there is an increase in income (for normal good), D will shift to R (also increases). However, if there is an increase in income (for inferior good), D will shift to L (decrease).
iii. Price expectations
a. If we expect the P to be higher in the future, our D in current time will increase
iv. Market size (number of buyers in the market)
a. If more buyers in the market, then D will increase
v. Price of substitute good (H)
a. If price for substitute good increases, then D will increase
vi. Price of complimentary good (H)
a. If price for complimentary good increases, then D will decrease
h. Giffen Goods vs. Veblen Goods
i. Giffen Goods
A type of inferior good – or, a good that people buy more of when their income goes down (e.g., substitutes for a more expensive good that people buy more of when they cannot afford a superior good)
Curve are identical
“A producer will be willing to sell an additional unit of output as long as the price offered for the unit is at least equal to the MC of producing that unit.”
d. Rightward shift of S curve
i. Market price falls, but market quantity increases
ii. When S curve shifts to R (increases), P will fall and Q will rise
e. Leftward shift of S curve
i. Market P increases and market quantity decreases (demand curve stays the same)
f. Determinants of Supply (Shift Factors)
i. Raw Materials Costs (H)
If resource costs go up (costs of production increase), then S will decrease. “E.g., Huge increases in the price of coffee beans in recent years. So, at each price along S2, sellers are willing to sell a lower quantity than they were before the increase in costs.”
“Or, at each quantity, it will now take a higher price to get the producer to make that quantity available for sale.”
“A decrease in the price of coffee beans will result in a shift from S1 to S3 (to the R and down) – an increase in supply.”
ii. Response to an increase of decrease in the cost of inputs (H)
If an item involves the use of labor and the cost of labor on an hourly basis increases, you would expect the supply curve to shift upward and to the left
iii. Productivity/Technology
If technology improves, S will shift to R (increases)
iv. Taxes/Subsidies
If government increases taxes or reduces subsidies to sellers, that will raise the cost of production and reduce the S
v. Number of Sellers
If increase in sellers in the market, then S will shift to R
vi. Price Expectations
If sellers expect future prices to be higher, they will reduce current supply in the present
vii. Price of Other Good (use same resources)
If price of other good using same resources increases, then supply of this good will decrease
g. Labor v. Leisure
i. Tradeoff between labor and leisure
a. When P is low to produce something, producer won’t make that much, so opportunity cost is low
b. So when P goes up, the QS increases
