Simple Questions on Economics

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someotherguy

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Hi, I am new to finance, and have a few simple questions. Explanations and examples are welcome.(I am currently reading the CFA books provided)
These relate to Economics Study Session 1,2:
1.How exactly does an externality lead to underproduction?
2.How do public goods, common resources led to overproduction?
3.Compared to accounting costs, economic costs tend to be (a) higher, especially for large firms organized as corporations (b) higher, especially for small firms organized as proprietorship.
4.The greater the elasticity of demand for the good, the larger is the elasticity of demand for the labor use to produce it. (explain please)
5.On page 133, it is said that short run variables to output and costs are usually labor while long run variables are related plant. Later on, on page 143 it is given that shifts in the short run cost curves is due to technology. How is this possible, as technology most definitely relates to long run production function? How can technology be a factor for short run cost curves?
6. The long run supply curve for decreasing cost industries slopes downward to the right. True or False. (from Schweser questions)
7. A firm is likely to continue production in the short run as long as price is atleast equal to :
(a) marginal cost (b) average total cost (c) average variable cost. (my ans was a, but schweser says c )
8.”Real gross domestic product is the value of the total production of the country’s farms, factories, shops and offices, measured in the prices of a single year.” ” When all the economy’s labour, capital, land and entrepreneurial ability are fully employed, the value of production is called potential GDP. ” If this is so, then how can real GDP ever be greater than potential GDP? And how can they fluctuate around each other (as is given all over the text)?
Thanks for reading. Please go ahead and answer any part you like. It will be great help to me. Thanks again.
 
Q3: economic costs are higher because economic cost takes opportunity cost into account and accounting costs don’t.
Q7: in the short run, price must at least equal AVC because if price is below AVC, they should just shut down. if price is equal or above AVC, while their fixed costs are not covered, their variable costs are. if below AVC, fixed and variable both not covered.
 
#6) False. Using the AS-AD model, LAS is vertical.
#1) Externalities can generally lead to overproduction, not underprodcution….
#2) vice versa #2 above
 
@yohji
3. yes eco cost are higher(as both options give it) but then for small firms or large ones, and why?
7. your right, thanks.
@jay
6. the answer was true.
1,2. yes…my questions were incorrect. thanks.
 
some other guy:
schweser must be wrong then….the supply curve never slopes down and to the right. The supply curve always slopes down and to the the left; in the case of the AS-AD model the LAS is vertical and the SAS slopes down and to the right. In a decreasing cost industry, the average total costs may slope down and to the right….
 
correction: i meant the SAS slopes down and to the left in the above comment….
 
Think about it. You have Price and Quantity and your axis. The reason supply slopes down and to the left is because as the price goes up you supply more of a good. Nobody would supply more of a good when price goes down then when price goes up. It doesnt make sense.
Use your nogen! That what its there for!
 
4.) Three inter-ralated concepts need to be applied to answer this question:
(i) “Price elasticity of demand (PED or Ed)” is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. Generally, the demand is negatively correlated to price (higher demand at lower prices and vice versa).
(ii) “Price elasticity of supply (PES)” is an elasticity defined as a numerical measure of the responsiveness of the supply of a given good to a change in the price of that good.
(iii) “Factors of production (or productive inputs)” are the resources employed to produce goods and services. (side note: They facilitate production but do not become part of the product (as with raw materials) or become significantly transformed by the production process (as with fuel used to power machinery)). To the 19th century economists, the factors of production were land (natural resources, gifts from nature), labor (the ability to work), capital goods (human-made tools and equipment) and enterprise.
So highlight the “greater elasticity of demand” in your question and think what would the supplier do to react to the price changes that imply higher or lower quantity of demand/supply. For products/services with greatly elastic demand, LABOR is the only production factor which could be quickly controlled on a short-run (pertains to “variable” costs in accounting) hence the product price has a positive correlation with the elasticity/demand/supply of LABOR. Price increase means lower demand that implies firing LABOR force. The reverse is also true for this question.
 
sorry- the last three sentences in my post were consusing. Please correct as follows:
” … hence the product price has a “strong” correlation with the elasticity of demand for LABOR. Price increase means lower demand that implies firing LABOR force. The reverse is also true for this question.”
You should spend a few minutes to grasp the concept of “elasticity”. Economics has borrowed the concept from physics.
 
6.) Highlight the “long-run” phrase in your question. On a long-run, if production costs would decrease from lets say $5 to $3. Lets assume a given market price of $10 per unit. In a decreasing cost environment, take an example of Chinese suppliers, the competition will put a downward pressure on price. i.e. there will be some suppliers who will ambitiously supply the product at $9 instead of $10 because they would still make a decent margin (compared to $10-$5 = $5 and $10-$3=$7 to $9-$3 = $6). Eventually, competition will follow suit to supply more quantities at lower or unimaginable prices. In other words, more suppliers will be willing to supply greater quantities at lower prices in the decreasing cost environments.
In coclusion, over time, the competition will force the suppliers to sell more quantity at lower prices, stretching the supply curve further to the right. Draw a supply curve for this scenario if you need visual presentation.
Since you mentioned that you are new to Finance, I would suggest spending resouces on obtaining college level Economics textbooks. You can use them as reference materials to understand the concepts of demand, supply and production. Initially, it will take a lot of pencil sharpening to grasp the concepts.
 
5) Both pages are referring to different points. Highlight the “short run variables” versus “shift in the short run” phrases. As I alluded to labor in my answer for question 4 above, you can hire and fire consultants as per your production needs “on a short run”.
Imagine the “tele-conferencing” technology allowing executives to conduct interactive business meetings. Paying for a $150 a month high-speed broadband connection will cut down on air travel costs of lets say $1,500 a month. Thus radical technologies help shift the cost curves down.
Hope this helps.
 
Yes, competition will cause suppliers to supply more for a given price, however, the relationship between Price and Quantity using the AS-AD model still hold; with the supply curve upward sloping to the right and the demand curve downward sloping to the right…. The furthest you can get the supply curve to downward sloping is horizontal (perfectly elastic demand)
 
Eventually, there will be no market for a $10 per unit supplier. So the supply curve will slope downward to the right. Like a clock’s second arm ticking from 5 to 10.
So I hope you got the explanation for why the shweser answer says “True”.
 
So you are saying that the lower the price the more the Quantity supplied??? Doesnt make any sense. DO NOT rely on Schweser! You will get royaly screwed! The exam is based off of the CFA Curriculum readings!
If there is not a market for a $10/unit supplier, firms will leave the market. The aggregate supply will drop, but the supply of each firm will increase. When firms enter and exit the market, this does not change the slope of the curve. It will cause a SHIFT in the curve.
Sorry, but you have NO CLUE
 
No. I am not saying exactly what you quoted above. What you quoted does not make sense to me either. Because you are thinking short run. Shifts are a concept of short run.
Long run supply curve is produced by connecting short run changes to the equilibrium prices (at the intersections of D and S curves intersect) over long run.
What I am trying to say is that in decreasing cost industries, the long run supply curve slopes downward to the right.
Check out this link and learn about long run:
http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=long-run+industr...
 
I would like to reassert for “someotherguy” to pick up college level Economics books for a couple of weeks before delving into CFAI Economics book. The CFAI requires that a candidate has basic knowledge of Economics. The carriculum does not simplify or comprehend rudimentory and subtle concepts like the difference beetween short and long run.
Another suggestion is to try finishing the Quant, Financial Reporting and Corporate Finance readings before starting Economics. The details of these readings as a backdrop will help you understand Economics faster. I would also suggest that you pick up a GMAT/GRE book for two days and refresh your math. The Economics calculations will require you to be quick on your feet with Geometry/slopes/algebra etc.
 
Don’t forget to click on the “Long Run Supply Curve” button to get your answer on the “Decreasing Cost” chart.
 
Ja5150 - I think where you got stumped is “industry supply” vs “aggregate supply”. These are two different things.
Question 6 asked about “industry” supply.
 
hvb4096:
First of all, shifts are generally a concept of the long-run, while movements are generally concepts of the short-run.
Now, the website that you referenced above, explains and graphically depicts exactly what I am saying. The short-run supply curve shifts to the right (but is still upward sloping to the right) and the long-run supply curve is a horizontal line (perfectly elastic).
I think you may have the long-run average cost curve and the long-run supply curve confused. But, at NO point, does the supply curve slope down and to the right (not the short-run nor the long-run).
 
hvb4096:
correction, the LRS for the industry can slope becuase price will naturally be lower in the long-run since cost will be lower (competition will drive down price).
Understood now.
 
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