ECO10250 Economics for Decision

Making

Study Guide

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Contents

Introduction ………………………………………………………………………………………………………………………………………………………………………….. 7

Topic 1 Introduction to economics …………………………………………………………………………………………………………………………………. 9 Introduction…………………………………………………………………………………………………………………………………………………………………… 9 Objectives ………………………………………………………………………………………………………………………………………………………………………. 9 Microeconomics and macroeconomics………………………………………………………………………………………………………………………. 10 Fundamental economic concepts………………………………………………………………………………………………………………………………… 10 Opportunity cost………………………………………………………………………………………………………………………………………………………….. 11 Economics in practice …………………………………………………………………………………………………………………………………………………. 12 Economic theory………………………………………………………………………………………………………………………………………………………….. 12 Economic models ………………………………………………………………………………………………………………………………………………………… 12 Markets and trade………………………………………………………………………………………………………………………………………………………… 13 Economic systems ……………………………………………………………………………………………………………………………………………………….. 14 Summary ……………………………………………………………………………………………………………………………………………………………………… 14 Review activities…………………………………………………………………………………………………………………………………………………………… 14 Feedback to activities …………………………………………………………………………………………………………………………………………………… 15

Topic 2 Markets: Demand and supply …………………………………………………………………………………………………………………………. 16 Introduction…………………………………………………………………………………………………………………………………………………………………. 16 Objectives …………………………………………………………………………………………………………………………………………………………………….. 16 Demand ……………………………………………………………………………………………………………………………………………………………………….. 16 Supply …………………………………………………………………………………………………………………………………………………………………………… 17 Equilibrium price…………………………………………………………………………………………………………………………………………………………. 18 The free-market economy ……………………………………………………………………………………………………………………………………………. 19 Summary ……………………………………………………………………………………………………………………………………………………………………… 19 Review activities…………………………………………………………………………………………………………………………………………………………… 20 Feedback to Activities ………………………………………………………………………………………………………………………………………………….. 21

Topic 3 Markets: Elasticity……………………………………………………………………………………………………………………………………………….. 25 Introduction…………………………………………………………………………………………………………………………………………………………………. 25 Objectives …………………………………………………………………………………………………………………………………………………………………….. 25 Price elasticity of demand ……………………………………………………………………………………………………………………………………………. 26 Calculating price elasticity of demand………………………………………………………………………………………………………………………… 26 Investigating elasticity along the demand curve…………………………………………………………………………………………………………. 27 Determinants of price elasticity of demand………………………………………………………………………………………………………………… 28 Income elasticity of demand (denoted by ηy) …………………………………………………………………………………………………………….. 29 Cross price elasticity of demand (denoted by ηx) ………………………………………………………………………………………………………. 30 Price elasticity of supply ………………………………………………………………………………………………………………………………………………. 30 Short-run and long-run demand ………………………………………………………………………………………………………………………………… 31 Markets where prices are controlled …………………………………………………………………………………………………………………………… 31 Consumer surplus, producer surplus & total surplus ………………………………………………………………………………………………… 31 Summary ……………………………………………………………………………………………………………………………………………………………………… 32 Review activities…………………………………………………………………………………………………………………………………………………………… 33 Feedback to Activities ………………………………………………………………………………………………………………………………………………….. 33

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Topic 4 The supply decision …………………………………………………………………………………………………………………………………………… 37 Introduction…………………………………………………………………………………………………………………………………………………………………. 37 Concept review ……………………………………………………………………………………………………………………………………………………………. 38 What is a firm? …………………………………………………………………………………………………………………………………………………………….. 38 Economic profit……………………………………………………………………………………………………………………………………………………………. 39 Economic efficiency …………………………………………………………………………………………………………………………………………………….. 39 Markets and the competitive environment …………………………………………………………………………………………………………………. 40 Short-run cost ……………………………………………………………………………………………………………………………………………………………… 40 Long-run production and cost ……………………………………………………………………………………………………………………………………. 42 Excess capacity and over-utilisation ……………………………………………………………………………………………………………………………. 43 Profit and revenue ……………………………………………………………………………………………………………………………………………………….. 44 The firm’s decisions ……………………………………………………………………………………………………………………………………………………… 45 Profit-maximising output ……………………………………………………………………………………………………………………………………………. 46 The firm’s short-run supply curve ……………………………………………………………………………………………………………………………….. 46 Profit and losses in the short and long-run…………………………………………………………………………………………………………………. 47 Summary ……………………………………………………………………………………………………………………………………………………………………… 48 Review activities…………………………………………………………………………………………………………………………………………………………… 48 Feedback to activities …………………………………………………………………………………………………………………………………………………… 48

Topic 5 Market structure: Perfect competition & monopoly ………………………………………………………………………………….. 56 Introduction…………………………………………………………………………………………………………………………………………………………………. 56 Concept review ……………………………………………………………………………………………………………………………………………………………. 57 Objectives …………………………………………………………………………………………………………………………………………………………………….. 57 What is perfect competition? ………………………………………………………………………………………………………………………………………. 58 Short- and long-run equilibrium ………………………………………………………………………………………………………………………………… 58 Monopoly …………………………………………………………………………………………………………………………………………………………………….. 59 Summary ……………………………………………………………………………………………………………………………………………………………………… 61 Review activities…………………………………………………………………………………………………………………………………………………………… 62 Feedback to activities …………………………………………………………………………………………………………………………………………………… 62

Topic 6 Market failure and government policy …………………………………………………………………………………………………………. 66 Objectives …………………………………………………………………………………………………………………………………………………………………….. 66 The economic theory of government ………………………………………………………………………………………………………………………….. 67 Externalities …………………………………………………………………………………………………………………………………………………………………. 68 Public goods…………………………………………………………………………………………………………………………………………………………………. 68 Monopoly …………………………………………………………………………………………………………………………………………………………………….. 69 Government intervention ……………………………………………………………………………………………………………………………………………. 70 Property rights …………………………………………………………………………………………………………………………………………………………….. 70 External costs: The environment…………………………………………………………………………………………………………………………………. 70 Progress in microeconomic reform …………………………………………………………………………………………………………………………….. 71 Trade practices legislation …………………………………………………………………………………………………………………………………………… 72 Summary ……………………………………………………………………………………………………………………………………………………………………… 74 Review activities…………………………………………………………………………………………………………………………………………………………… 74 Feedback to activities …………………………………………………………………………………………………………………………………………………… 74

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Topic 7 Introduction to macroeconomics…………………………………………………………………………………………………………………… 79 Introduction…………………………………………………………………………………………………………………………………………………………………. 79 Objectives …………………………………………………………………………………………………………………………………………………………………….. 80 Economic growth ………………………………………………………………………………………………………………………………………………………… 81 Jobs and unemployment ……………………………………………………………………………………………………………………………………………… 82 Inflation ……………………………………………………………………………………………………………………………………………………………………….. 83 Governments and deficits ……………………………………………………………………………………………………………………………………………. 84 The circular flow of economic activity ………………………………………………………………………………………………………………………… 85 Australia’s national accounts ……………………………………………………………………………………………………………………………………….. 87 The price level and inflation ………………………………………………………………………………………………………………………………………… 89 Real GDP and associated limitations ………………………………………………………………………………………………………………………….. 91 Labour market indicators and unemployment definitions ………………………………………………………………………………………… 91 The labour market ……………………………………………………………………………………………………………………………………………………….. 93 Summary ……………………………………………………………………………………………………………………………………………………………………… 95 Review activities…………………………………………………………………………………………………………………………………………………………… 95 Feedback to activities …………………………………………………………………………………………………………………………………………………… 95

Topic 8 Gross domestic product ………………………………………………………………………………………………………………………………….. 100 Introduction……………………………………………………………………………………………………………………………………………………………….. 100 Aggregate demand……………………………………………………………………………………………………………………………………………………… 101 Aggregate supply………………………………………………………………………………………………………………………………………………………… 102 Macroeconomic equilibrium …………………………………………………………………………………………………………………………………….. 104 The multiplier …………………………………………………………………………………………………………………………………………………………….. 104 Fluctuations in economic activity resulting from shocks …………………………………………………………………………………………. 104 Summary ……………………………………………………………………………………………………………………………………………………………………. 105 Review Activities………………………………………………………………………………………………………………………………………………………… 105 Feedback to Activities ………………………………………………………………………………………………………………………………………………… 105

Topic 9 Money, interest rates & inflation …………………………………………………………………………………………………………………… 108 Introduction……………………………………………………………………………………………………………………………………………………………….. 108 Money markets…………………………………………………………………………………………………………………………………………………………… 109 Types of inflation ……………………………………………………………………………………………………………………………………………………….. 111 Inflation policy …………………………………………………………………………………………………………………………………………………………… 113 Summary ……………………………………………………………………………………………………………………………………………………………………. 114 Review activities…………………………………………………………………………………………………………………………………………………………. 114 Feedback to activities …………………………………………………………………………………………………………………………………………………. 114

Topic 10 The global economy………………………………………………………………………………………………………………………………………. 116 Introduction……………………………………………………………………………………………………………………………………………………………….. 116 Global interdependence and the gains from trade……………………………………………………………………………………………………. 117 Arguments for restricting trade…………………………………………………………………………………………………………………………………. 117 Trading blocs ……………………………………………………………………………………………………………………………………………………………… 118 The balance of payments ……………………………………………………………………………………………………………………………………………. 118 Foreign exchange markets and the dollar …………………………………………………………………………………………………………………. 119 Exchange rate determination: Flexible exchange rates……………………………………………………………………………………………… 120 Summary ……………………………………………………………………………………………………………………………………………………………………. 121 Review activities…………………………………………………………………………………………………………………………………………………………. 122 Feedback to activities …………………………………………………………………………………………………………………………………………………. 122

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Topic 11 Fiscal and monetary policy ………………………………………………………………………………………………………………………….. 123 Introduction……………………………………………………………………………………………………………………………………………………………….. 123 The Commonwealth Government budget ………………………………………………………………………………………………………………… 124 The effectiveness of fiscal policy ………………………………………………………………………………………………………………………………… 125 The Reserve Bank and monetary policy ……………………………………………………………………………………………………………………. 125 The relative effectiveness of fiscal and monetary policy …………………………………………………………………………………………… 126 Summary ……………………………………………………………………………………………………………………………………………………………………. 127 Review activities…………………………………………………………………………………………………………………………………………………………. 128 Feedback to activities …………………………………………………………………………………………………………………………………………………. 128

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