Nominal vs. Real (Wages, Income)

Nominal vs. Real (wages, income)

To understand Nominal and Real we must first understand the concepts of Inflation and Purchasing Power

Inflation is an increase in the average price level of goods and services in a nation over time.

(If the price of apples is increasing, and the reason is because of a flood or a drought, then this is not spoken of as inflation as the cause is specifically from a flood/draught) If the price of all goods in the country are rising then we have Inflation. (Often caused by increases in the supply of a country's currency)

Purchasing Power is the number of goods or services that can be purchased with a unit of currency.

Nominal wages = current wages    

Nominal wages (Income) is the amount of money I am paid at a certain period of time.  If I'm paid $12 an hour, then my nominal wage is $12 dollars and hour. A nominal wage is expressed in the country's currency.  If apples cost $1 each, then I have the ability (purchasing power) to buy 12 apples. 

Time Passes, (let's say a year) and Inflation occurs, Apples have risen in prices to $2 each. 

I'm in the US and my wage is $12 an hour, that is my nominal wage (income), and the purchasing power of my nominal wage is 6 apples at a cost of $2 each. Due to inflation my hourly wage of $12 has been reduced. I use to be able to purchase 12 apples for an hour's work but now I can only buy 6. My purchasing power has been reduced by 50%.

Real Wage = (purchasing power of wages, what it will buy, nominal wages adjusted for inflation)

• If your income stays the same and inflation (price level rises) occurs,  then your real wage has decreases. 
• If your income stays the same and instead of inflation there is deflation (price level falls), then your real wage has increased.
• If your income stays the same and there is no inflation, then your real wage is your nominal wage

Nominal Wages = Real Wages  (if there is no inflation = 0%)

If your wage (income) is $12 an hour, and there is no inflation (price level=no change) then $12 is your real wage.

Real Wages = Nominal Wages - Inflation

If your nominal wage is $12 an hour and inflation is 50% then your real wage would be equal to $6 an hour. A 50% increase in inflation will cause ones real wage to be 50% lower than the nominal wage.

So, lets look at this 2010 problem. If the workers nominal wage increased from $10 to $12 then the wage increased by 20%. Yet, at the same time inflation (price level) increased by 10%.

So, wages increased by 20% and inflation increased by 10%.

IF you gain 20% and inflation (eats) ten of that 20%, you are left with 10%, the answer is C.

Nominal Wages = Real Wages (Inflation = 0%)

                                                               $10 = $10

Real Wages = Nominal Wages - Inflation

                $9 = $10 - $1 (Inflation increased by 10%, this equals $1 of a $10 wage)

Real Wages = Nominal Wages - Inflation

                $8 = $10 - $2 (Inflation increased by 20%, this equals $2 of a $10 wage)

Real Income video - mjmfoodie

2004 AP Micro FRQ#1

This was a tough one. College Board, "You bastards"

watch me answer it here

https://youtu.be/yA4bYaeKhqA

2004 AP Micro FRQ#1 

My Understanding:

Answer from the college board 

As MSC > than MPC, the externality is a negative production externality.

At a quantity of Q2, MSB = MSC at a price of $12.

The government can incentivise the monopolist to produce more by providing a subsidy. A subsidy should be provided to the point where the monopolists MC (MPC) curve will be reduced until it intersects with the MR (MPB) curve at Q2 (social optimal quantity)

A Perfectly competitive firm would produce an overproduction of a negative production externality. Its market price is where MPC = MPB and this is at the price of $7 and at a quantity of Q3. To get the perfectly competitive firm to produce less a per-unit tax must be levied against the (industry). As the firm has no control over price (price-takers) the industry must have the tax imposed upon it. At a tax of $5 the price would rise to $12 and the quantity would be reduced to Q2. Or what I believe to be the socially optimal quantity and price.

Students were asking why the government would subsidise a monopoly to create more negative goods,,, I believe the answer is to recognise that even a negative production externality has a benefit to society. Pollution might be the problem,, but no pollution means no production and this would be much worse than the externality. So government recognises that there is a benefit in the production of the good. 

Understand that the marginal benefit should equal the marginal cost. (MB = MC) or the MSC = MSB.

We could spend trillions of dollars to clean all of the rivers and lakes but then the MSC > MSB. Society would have pristinely clean rivers but not much of anything else.

Thank you Michelle for bringing this to my attention,,

Such fun I've had today,, trying to figure this out.

Micro/Macro Pacing guide

My Micro/Macro class. Pacing

Output & Costs (Costs)

Output & Costs

This section has quite a few moving parts and therefore is best studied in sections. Lets start with costs.

Costs exist because resources are scarce and have alternative uses.

(This makes sense in that owners of resources are competing with other owners to sell their goods (labor) to the highest bidder) Employers and producers are competing with each other to buy the cheaper goods or hire labor at a lower price. Often the fallacious idea is that employers and employees are in competion with one another. This is false, employers are in competition with other employers and employees are in competition with other employees. The employee who pays more wins, (how does this translate to competition between employer and employee?) Don't think me daft, I do understand that employees would like to be paid more and employers would like to pay less but I would like to pay less for the potatoes at the grocery store and yet I don't feel I'm in competition with the grocer.

OK, so Economic Costs are the payments (for goods) or incomes it must offer (for people), to attract the resources from alternative production opportunities. 

(Simple yes, to get someone to work for you you must be willing to pay them and they must accept)

We can separate (for the AP) two broad categories of costs.

Explicit Costs - (Accounting costs) – Money actually paid for inputs for production. (Wages, electricity, input costs, transportation, etc) 

Implicit Costs – Think, opportunity cost – money that could have been earned by the entrepreneur with the next best alternative. Economists always take into account the implicit costs in evaluating choices.

Total Costs - Fixed Costs - Variable Costs

Total Fixed Costs – Costs that don’t vary with output. (Ex. Rent, interest on loans, insurance premiums) These costs must be paid even if output is zero. Even if the firm goes out of business these costs must be paid.

Total Variable Costs – Costs that change with the level of output. (Ex. Labor, materials, electricity, transportation) (For the AP when you see variable costs, think labor)

                                                     

Total Costs – The sum of variable and fixed costs. (TC = FC + VC) or (TC = ATC x quantity of output)

Marginal Costs – The additional cost of producing one more unit of output. 

Understand: the vertical distance between the TC & TVC curve is TFC.

Understand: the mathematical relationship between the cost curves.

TC = TVC + TFC     (5 = 3 + 2)

TVC = TC – TFC      (3 = 5 - 2)

TFC = TC – TVC         (2 = 5 - 3)

Be able to draw the Total Cost Graph - Understand: the vertical distance between the TC & TVC curve is TFC. (Obviously, if TC is TFC + TVC), then everything under the TVC is Total Variable Costs, while the difference between TVC and TC must be TFC

Think of the combination of the costs like this graph.

The area under the TVC curve is variable costs. (Labor, almost always the biggest part of a business)

and then the difference between TC and TVC is fixed costs.

Short-Run (Fixed & Variable Costs)Time Period

Short-Run – A time period in which a producer (a firm) is able to change the quantities of some, but not all of the inputs, factors of production or resources they employ.

(Resources that can be adjusted are labor, and purchase of raw materials)

(The short-run has some resources that are fixed, (Factory/Plant))

(Firms cannot enter or exit the industry in the short-run)

Long –Run (All Costs are Variable (Changeable))

Long Run – a time period in which producers can change all of the resources they employ.

(In the long-run firms can enter and exit the industry)

(In the long-run there is no fixed costs as all costs are changeable, thus variable)

Short-run Production Analysis (AFC, ATC, AVC)

Average Total Costs – A firms total costs divided by output. (TC/Q) or (AFC + AVC = ATC)

Understand: As production increases, initially there is a decrease in ATC at small levels of   production. As production increases with larger quantities of production ATC increases to produce a U shaped curve.

Average Variable Costs – A firms total variable costs divided by output. (TVC/Q) or (ATC – AFC = AVC)

Understand: As production increases, initially there is a decrease in AVC at small levels of   production. As production increases with larger quantities of production AVC increases to produce a U shaped curve.

Average Fixed Costs – A firms total fixed costs divided by output. (TFC/Q) or (ATC – AVC = AFC)

                                      Understand:  average fixed costs decease as production increases.

Total Fixed costs are (fixed) and therefore don’t change when production increases but average fixed costs decrease                 

Fixed costs per unit (average fixed costs) will change as the production/output changes.

U shaped Cost Curves (WHY?)

Diminishing Returns & the U Shape of the Curves – The Law of Diminishing Returns states that as additional inputs are added to fixed capital, returns will eventually decrease.

Initially the cost curves are decreasing as more input is added reflecting efficiency, but as more inputs are added costs increase as inputs become increasingly inefficient. Thus the rising cost curves with more output.

(Ex. If you have a coffee cart out in front of the school and it is only big enough for two people. Hiring one person will lower your average costs as you can actually produce a good that will be sold. Hiring two people will allow a division of labor that will increase your output. Hiring a third person will slow down the production process as the coffee cart (fixed capital) isn’t big enough for three people to operate effectively in the short run.)

Relationship between Marginal Costs and Average Total Costs

                                   

·       Marginal Cost curve cuts the ATC & AVC curves at their minimum

·       When the MC curve is less than the ATC/AVC, ATC & AVC curves are decreasing

·       When the MC curve is greater than the ATC/AVC curves, the ATC/AVC are increasing

·       Marginal Cost curve eventually rise with increased output

·       The ATC/AVC curves are U shaped due to the Law of Diminishing Returns

1995 AP Micro Exam

#6 Answer - C
The question asks for average total costs,
so, AFC + AVC = ATC
       50   +    45  = 95


#7 Answer - D
Profit Max  (MR = MC)
at output/quantity 5 the MC's are 80.00
if you produced 1 more unit, at a quantity of 6 you would be incurring a higher cost than the revenue brought in for that unit.

#8 Answer - A

An increase in wages (a variable cost) will shift the cost curves up. Understand that a shift implies at every level of output. A decrease in the price of energy would shift the curve down.

Happy Econo-ween

YED - Income Elasticity

YED - Income Elasticity

YED - is the responsiveness of the Qd, of a good, to the change in the incomes, (Y) of people demanding the good. Income, (Y) elasticity determines whether the good is normal or inferior.

Formula 

Formula for computation

Graph for Reference.

• If YED is negative the good is an inferior good.
• If YED is positive the good is a normal good.
• If YED is positive but below one, the good is income inelastic (necessity)
• If YED is positive but above one, the good is income elastic (luxury)
• If YED = 0, a % change in income does not effect the Qd of the good
• If YED = 1, a % change in income = a % change in Qd of the good (Unitary Elasticity)

Another graph for reference is the Engel's curve.

As income increase the Qd for a normal good is positively related, Qd increase.

AS income increases the Qd for an inferior good is negatively related, Qd decrease

Examples

Answer - (B) An increase in the average income f consumers and an increase in the price of a variable input.

So, YED of a normal good (positive and increasing with incomes) drives up price as demand increases (shifts right) and as an input cost/resource cost increases (Determinant of Supply) supply shifts leftward increasing the price of the good more.

Example 2)

Answer is (D) X is an inferior good and is a compliment to Y.

as the cross-price elasticity is negative, we understand that means the two goods are compliments

and as the YED (income elasticity of demand) is negative the good is an inferior good

Example 3)

(b) You must know that a negative coefficient is an inferior good and that as incomes rise less of the good is demanded. (leftward shift of the demand curve)

XED Cross Price Elasticity - Substitutes

XED Cross Price Elasticity - Substitutes

XED - responsiveness of the Qd of a good (Good A) to a change in the price of another good (Good B). Cross elasticity determines whether the goods are substitutes or complements.

Formula - 

Understand: That you will be given a price change of one good (Good A) and then will compare it with the quantity change of another good (Good B).

Understand: You should be able to recognise that a positive XED (more than zero) is a substitute.

Substitutes are like Coke and Pepsi, Beef and Chicken. Goods that are substituted for one another.

If the price of Coke increases then people will switch to the cheaper good (Pepsi)

Price of Coke Increases and the Quantity Demand for Pepsi Increases

Notice the positive relationship.

Opposite is also true, if the price of Coke decreases the Quantity demanded for Pepsi decreases

again the formula:

8 - 6/6     OR    .333 = 1.333

5 - 4/4                .25

SO, no absolute value for XED (like PED) and more than zero (positive) and therefore a substitute.

Weakly related or strongly related substitutes I haven't seen tested in the AP Exam but references were there in some questions.

To Know: Substitutes

1) XED - responsiveness of the Qd of a good (Good A) to a change in the price of another good (Good B). Cross elasticity determines whether the goods are substitutes or complements.

2) No absolute value for XED

3) XED > 0 -  Substitutes

4) Positive = Substitutes

5) Price of Good A increase the Quantity Demand of Good B increases or the price of good A decreases and the Quantity Demand of good B decreases

Examples -

Look at (b) (ii) one point is earned for explaining that peanuts and bananas are substitutes and since the price of bananas increased it would cause the demand for peanuts to increase.

Also look at (c) (i) One point is earned for stating that the substitution effect causes the quantity of bananas demanded to decrease.

The Substitution Effect - one of the three reasons the demand curve slopes down - as the price of one good rises, consumers will switch to the cheaper good.