Author: John Bouman

Consumer Surplus  In the graph below, the supply and demand curves intersect at an equilibrium price of $5 and an equilibrium quantity of 120 products. If the price had been $6, buyers would have purchased 110 products. If the price had been $7, buyers would have purchased 100 products. If the price had been $8, buyers would have purchased 90 products, and so forth. This means that quite a few buyers would have been willing and able to pay more for the product than they are actually paying at the equilibrium price of $5. At the equilibrium price of $5 everyone pays that price, including the buyers who would have been willing to pay a higher price. The difference between how much consumers value a product and how much they actually pay for it at the equilibrium price is called consumer surplus. The consumer surplus in the graph below is illustrated by the shaded triangle. Video Explanation For a video explanation of consumer surplus, and how consumer surplus increases when demand and supply simultaneously increase, please watch: Producer Surplus Just like there is consumer surplus, there is producer surplus. Producer surplus is the difference between the minimum price at which producers would have been willing to produce the product and how much they are actually receiving at the equilibrium price. The producer surplus in the graph below is illustrated...

Categories of Products Prices of some categories of goods increase in the long run as demand rises, while others do not. Here we distinguish between products that are in limited supply, such as land, labor, raw materials, and sports and concert tickets, and manufactured products. Manufactured products, such as grocery items, clothes, cars, and electronics, are ones whose supply can be increased relatively easily in the long run. Products in Limited Supply In the long run, prices of products that are in limited supply fluctuate much more with changes in demand than products that are in abundant supply. Examples of limited supply goods and services include land, labor, natural resources such as oil, gas and minerals, tickets to major sporting events (the World Series, the Superbowl, or the World Cup Soccer final), and products supplied by a monopoly. If, for example, the demand for land in a certain area rises because of increased population and increased housing activity, the price of the land will increase. Because the supply of land is limited, the price of the land can remain high for a long period of time as long as the demand remains high. Products supplied by a monopoly are limited because the firm may be the sole owner of a resource, or the firm may have a patent, a license, or other government approval to be the only supplier....

The Free Market In a free market economy, prices of goods and services, wages, interest rates, and foreign exchange values are determined by supply and demand. There is no interference from a government in the form of price controls, labor laws, or other regulations affecting the market price of the product. A free market is economically efficient (from a production and cost point of view) and generally leads to higher overall standards of living. In a free market system, even though it doesn’t interfere with prices and wages, there is an important role for the government. The government must protect private property, provide essential services such as infrastructure (roads, highways, etc.), provide oversight of key industries, provide a legal system and defend the country. So in a free market system, the role of the government is limited, but important. The following are specific advantages of a free market system. Advantages of a Free Market System 1. Products are priced at their true worth. The most important advantage of a free market system is that products are priced at their true “worth.” The product’s true worth is based on how much buyers and sellers value the product. This is reflected in the demand and supply of the product (and not on a government-determined price). When consumers value a product highly, then the demand for this product is high and consequently,...

What’s in This Chapter? Gross Domestic Product measures the value of final goods and services a country or region produces. The measure has its flaws, but nevertheless does a reasonably good job indicating how much a country’s economic activity changes from quarter to quarter and from year to year. This unit discusses the difference between real GDP and nominal GDP. Nominal GDP data includes price changes (it is calculated by multiplying prices times quantities of final products). So nominal GDP could rise merely because we have had inflation. Real GDP adjusts for price fluctuations and looks at production (quantity) changes only. Therefore, real GDP is more meaningful if we want to look at the economic health of a country. Knowing real GDP is important to a country, because it can provide a signal that its policies are effective (if it is increasing) or not effective (if it is decreasing). Households, businesses, investors and foreign countries also study GDP in order to make better decisions and plan for the future. Does real GDP measure happiness or standard of living? It helps if a country is productive and employment is high. However, a high GDP doesn’t necessarily mean that everyone in the country is happy. Other factors beyond production play a role. The last section in this unit touches on “Gross National Happiness” and focuses on the relationship between GDP growth...

The Definition of Gross Domestic Product Gross Domestic Product is defined as the value of all final goods and services produced in a country or area during a certain period of time. A final product is one that is sold in its final form (for example, a loaf of bread). It is not a smaller part (for example, flour to make bread) of another product. To illustrate how GDP is computed, let’s look at a simple, hypothetical country that produces only two products: yogurt and economics textbooks. Five thousand yogurt containers are produced and sold at $1 per containers in a certain year. And one hundred economics textbooks are produced and sold at $80 per book, that same year. Problem: What is the country’s GDP in the above example? Solution: Both products are final products, so both products are included in the calculation of GDP. The value of the yogurt is $5,000 (5,000 times $1) and the value of the textbooks is $8,000 (100 times $80). Adding the two values together gives us a nominal GDP of $13,000. Problem: Let’s say that the next year, the quantities produced remain constant, but the prices double. Yogurt now sells for $2, and textbooks for $160 (some textbooks are actually this expensive, ah!). How will nominal GDP change? Solution: The value of the yogurt is 5,000 times $2, or $10,000. The value...