opportunity cost
the cost of any good, service, or activity is the value of what must be given up to obtain it; the value of the next best thing
utility
the pleasure or satisfaction obtained from consuming a good or service; measured in "utils
marginal analysis
marginal cost of an action should not exceed its marginal benefit
scientific method
used to establish theories, laws, and principles
purposeful simplifications
theories, principles, and models
ceteris paribus
other things equal"; in order to judge the effect one variable has upon another, it is necessary to hold other contributing factors constant
microeconomics
looks at specific economic units; concerned with the individual industry, firm or household and the prices of specific products and resources
macroeconomics
examines the economy as a whole; includes measures of total output, total employment, total income, aggregate expenditures, and the general price level
positive economics
describes the economy as it actually is, avoiding value judgements and attempting to establish scientific statements about economic behavior
normative economics
involves value judgements about what the economy should be like and the desirability of the policy options available
wants
include both necessities and luxuries; they change, especially as new products are introduced
goods and services
satisfy wants
factors of production
also called economic resources; include all natural, human, and manufactured resources used to produce goods and services
resource categories
land or natural resources, labor or human resources, capital or investment goods, entrepreneurial ability
labor or human resources
include physical and mental abilities used in production
capital or investment goods
all manufactured aids to production like tools, equiptment, factories, and transportation
entrepreneurial ability
a kind of human resource that provides 4 functions: a)combines resources needed for production b)makes basic business policy decisions c)innovates new products, production techniques, and organizational forms d) bears the risk of time, effort, and funds
production possibilities tables and curves
used to illustrate and clarify society's economizing problem
consumer goods
directly satisfy wants
capital goods
used to produce consumer goods; indirectly satisfy wants
production possibilities curve
a graphical representation of choices; points represent maximum possible combinations of goods and services; points inside the curve are not using resources effectively; points outside the curve are unattainable
command economy
socialism or communism; public (state) ownership of resources; economic activity is coordinated by public planning
market system
capitalism; private ownership of resources, markets and prices coordinate and direct economic activity, each participant acts in his or her own self-interest, in pure capitalism the government plats a very limited role, in the US version the government pl
private property
private indiviuals and firms own most; enables those to obtain, control, use, and dispose of this property; encourages investment, innovation, exchange of assets, maintenance of property, and economic growth
freedom of enterprise and choice
entrepreneus and businesses have the freedom to obtain and use resources to produce products of their choice, and to sell thses products in the markets of their choice
freedom of choice
owners of property and money reosurces can use resources as they choose; workers can select the training, occupations, and job of their choice; consumers are free to spend their income in a way that best satisifies their wants
self-interest
driving force in market system; as each trues to maximize profits, income, or satisifcation, the economy will benefit if competition is present
competition among buyers and sellers
controlling mechanism; many sellers means that no single producer or seller can control the price or market supply; many buyers means that no single sonsumer or employer can control the price or market demand
market
an instituition or mechanism that brings buyers and sellers into contact
incentive for capital accumulation (investment)
competition, freedom of choice, self-interest, and the potential of profits
specialization
using resources to produce one or a few goods, rather than many goods; allowed through division of labor; saves time involved in shifting from one task to another
money as a medium of exchange
money substitutes for barter, which requires a coincidence of wants
five questions about economic systems
1) what goods and service will be produced 2) how will the goods and service be produced 3) who will get the goods and services 4) how will the system accommodate change 5) how will the system promote progress
What will be produced?
in order to be profitable, businesses must respond to consumers' wants and desires; consumer sovereignty-key to determining the types and quantities of the various products that will be produced; "dollar votes"; consumers decide
How will the goods and services be produced?
market systen encourages and rewads those producers who are achieving least-cost production including using the right mix of labor and capital, locating firms in the optimim location to hold down resource and transportation costs, using available technolo
Who will get the output?
related to how the income is distributed among indiviudals and households, and the tastes and preferences of consumers; goes to those who are willing and able to pay for them
How will the system accommodate change?
as tastes, technology, and resource supplies change, prices help signal those changes
How will the system promote progress?
introduction of a popular new producr will be rewarded with increased revenue and profit; new technologies will spread throughout the industry (reduce production cost and product price)
creative destruction
occurs when new producrs and production methods destroy the market positions of firms that are not able or willing to adjust
the "invisible hand
Adam Smith; promotes public interest through a market system where the primary motivation is self-interest; by attempting to maximize profits, forms will also be producing the goods and services most wanted by society
merits of the market system
promote efficiency in the allocation of resources; provide incentives for people to be productive through work effort and acquiring skills; provide a lot of personal freedom in making economic decisions
decision makers in the private economy
households and businesses
household
one or more persons occupying a housing unit; all resources in an economy are owned by households; therefore, all income flows to household as payment for providing resources
business
commercial establishment that seeks profit by selling goods and services
What happens in resource markets?
households sell resources directly or indirectly; businesses buy resources in order to produce goods and services; the flow of payments from businesses for the resources constitutes costs for business and income for resource owners
What happens in product markets?
Households are on the buying side of these markets, purchasing goods and services; businesses are on the selling side, offering products for sale; the flow of consumer expenditures constitutes sales receipts for businesses
demand
a schedule or curve that shows the various amounts of a product that consumers are willing and able to buy at each specific price in a series of possible prices during a specified time period
law of demand
other things being equal, as price increases, the quantity demanded falls
diminishing marginal utility
the decrease in added satisfaction that results as one consumes addition units of a good or service
income effect
a lower price increases the purchasing power of money income, enabling the consumer to buy more at the lower price (or less at a higher price) without having to reduce consumption of other goods
substitution effect
a lower price gives an incentive to substitute the lower-priced good for now relatively higher-priced goods
demand curve
downward slope indicates a lower quantity at the higher price and a higher quantity at the lower price
what can cause an increase in demand
favorable change in consumer tastes, increase in the number of buyers, rising income if the product is a normal good, falling income if the product is an inferior good, increase in the price of a substitute good, decrease in the price of a complementary g
what can cause a decrease in demand
unfavorable change in consumer tastes, decrease in number of buyers, falling income if the product is a normal good, rising income if the product is an inferior good, decrease in the price of a substitute good, increase in the price of a complementary goo
distinction between a change in quantity demanded and a change in demand
change in quantity demanded is caused only by a change in the price of the product and represented by a move along the fixed demand curve from one point to another; change in demand is changed by another determinant (not the price of the product) and repr
supply
a schedule or curve that shows amounts of a product that a producer is willing and able to produce and sell at each specific price in a series of possible prices during a specified time period
law of supply
producers will produce and sell more of their product at a high price than at a low price, meaning there is a direct relationship between price and quantity supplied; given production costs, a higher price means greater profits and thus an incentive to in
supply curve shifts
increase in supply involves a rightward shift, and a decrease in supply involves a leftward shift
determinants of supply
resource prices, technology(more efficient production and lower production costs), taxes and subsidies(tax=cost=decrease; sub=low price of prod=increase), prices of other goods, producer expectations(future prices), number of sellers(greater the market su
distinction between a change in quantity supplied and a change in supply
change in quantity is caused only by a change in the price of the product and represented by a move along the fixed supply curve from one point to another; change in supply is caused by another determinant (not the price of the product) and represented by
equilibrium price
where the quantity supplied equals the quantity demanded; market clearing price
rationing function of prices
the ability of the competitive forces of supply and demand to establish a price where buying and selling decisions are consistent
productive efficiency
the production of any particular good in the least costly way; ma occur without allocative efficiency
allocative efficiency
producing the particular mix of goods and service most highly value by society; requires productive efficiency
price elasticity of demand
the degree of consumer responsiveness or sensitivity to a change in price; if consumers are relatively responsive to price changes, demand is said to be elastic; if consumers are relatively unresponsive to price changes, demand is said to be inelastic
price elasticity coefficient formula
quantitative measure of elasticity; Ed=percentage change in quantity demanded/percentage change in price
midpoint formula
calculates the average elasticity over a range of prices to alleviate that problem; Ed=[(change in Q)/(sum of Q's/2)] divided by [(change in P)/(sum of P's)/2)]
why is the actual elasticity of demand a negative number?
because of the inverse relationship between price and quantity demanded; ignore the minus sign and use absolute value of both percentage changes
elastic demand
if a specific percentage change in price results in a larger percentage change in quantity demanded (E>1)
inelastic demand
if a specific percentage change in price results in a smaller percentage change in quantity demanded (E<1)
unit elastic
if the percentage changes in price and quantity demanded are equal (E=1)
perfectly inelastic
if a price change causes absolutely no change in quantity demanded (E=0); perfectly vertical demand curve
perfectly elastic
if any increase in price causes the quantity demanded to fall to zero, or if any decrease in price causes the quantity demanded to increase from zero to as many as can be produced (E=infinity); perfectly horizontal demand curve
total revenue
easiest way to judge whether demand is elastic or inelastic; total revenue=price x quantity sold
elastic demand and TR test
if a decrease in price results in a rise of total revenue, or if an increase in price results in a decline in TR; moving in opposite direction
inelastic demand and TR test
if a decrease in price results in a fall in TR, or an increase in prices results in a rise in TR; move in same direction
unit elasticity and TR test
if TR does not change when the price changes
determinants of price elasticity of demand
substitutability (the more substitutes, the more elastic the demand); the proportion of price relative to income (larger the expenditure the more elastic the demand b/c buyers notice the change in price more); whether the product is a luxury or necessity
price elasticity of supply
Es=percentage change in quantity supplied/percentage change in price
market period elasticity of supply
inelastic
short-run supply elasticity
more elastic than market period; depends on the ability of producers to respond to price change
long-run supply elasticity
most elastic; more adjustments can be made over time and quantity can be changed more relative to a small change in price
cross elasticity of demand
the effect of a change in a product's price on the quantity demanded for another product; Exy=percentage change in quantity of X/percentage change in price of Y
positive cross elasticity
X and Y are substitutes
negative cross elasticity
X and Y are compliments
zero cross elasticity
X and Y are unrelated, independent products
income elasticity of demand
the change in quantity demanded that results from a change in consumer incomes; Ei=percentage change in quantity demanded/percentage change in income
positive income elasticity
normal or superior good
negative income elasticity
inferior good
market failure
occurs when the competitive market system produces the "wrong" amounts of certain goods or services fails to provide any at all
demand-side market failure
happen when demand curves do not reflect consumers' full willingness to pay for a good or service
supply-side market failure
occur when supply curves do not reflect the full cost of producing a good or service
consumer surplus
the difference between the maximum price a consumer is willing to pay for a product and the actual price; reflects the extra utility gained from paying a lower price than what is required to obtain the good
consumer surplus measurement
measured by calculating the difference between the maximum willingness to pay and the actual price for each consumer, and then summing those differences; area under the demand curve and above the equilibrium price; (1/2 base times height)
producer surplus
the differences between the actual price a producer receives and the minimum acceptable price
producer surplus measurement
calculating the difference between the minimum acceptable price and the actual price for each unit sold, and then summing those differences; area above the supply curve and below the equilibrium price
efficiency
attained at equilibrium where the combined consumer and producer surplus is maximized
allocative efficiency occurs where
a)marginal benefit=marginal cost b)maximum willingness to pay=minimum acceptable price c)combined consumer and producer surplus is at a maximum
efficiency (deadweight) losses
underproduction reduces both consumer and producer surplus and efficiency is lost; overproduction causes inefficiency because at quantities greater than the equilibrium quantity
private goods
produced and sold in competitive markets and have 1)rivalry in consumption 2)excludability
public goods
goods that are nonrival and nonexcludable
externalities
occcur when some of the benefits or costs of production are not fully reflected in market demand or supply schedules
negative externalities
supply-side market failures
positive externalities
demand-side market failures