Principles of Individual Choice
1. Resources are scarce; therefore, we must make decisions.
2. The true cost of an item is its opportunity cost, or what you must give up to get that item.
3. When deciding how much of something to consume, one engages in marginal analysis.
4. Incentives
Principles of the Interactions of Individual Choice
5. There are gains from trade.
6. Markets will move towards equilibrium.
7. Efficiency is desirable.
8. In markets and other economic situations, equilibrium is usually efficient.
9. When markets don't achieve efficiency, government intervention can creat
Principles of Market Failure
10. Individual actions have side effects that are not taken into account (air pollution)
11. One party prevents mutually beneficial trade from occurring in an attempt to capture a greater share of resources for itself
12. Some goods, by their very nature,
Principles of Economy Wide Interactions
13. One person's spending is another person's income.
14. Overall spending sometimes gets out of line with the economy's production capacity.
15. Government policies can change spending
Scarcity
There are limited resources to satisfy all of society's wants.
Opportunity Cost
The true cost of an item, what you must give up to have that item.
Marginal Value
The value of producing one more item.
Marginal Decision
Decision about whether to do a bit more or a bit less of an activity.
Marginal Analysis
The study of marginal decisions.
Incentive
Anything that offers rewards to those who change their behaviors.
Gains From Trade
Even if someone has absolute advantage in both of two goods, trade can wreak mutual benefits
Absolute Advantage
One can produce a good using fewer resources than someone else. One can in general produce more of said good than can someone else.
Comparative Advantage
One can produce a good at a lower Opportunity Cost (a smaller loss) than someone else. Even if someone may have absolute advantage in a certain good, he may be losing more to produce it.
Efficiency
Condition when an economy is using all its resources productively. Nothing can be moved around so that someone is made better off without harming someone else.
Equity
Everyone gets his or her fair share of something. (interferes with efficiency)
Trade-Off
A process of decision making, an exchange in which one is giving up something to get something else.
Market Equilibrium
Point of intersection between Supply and Demand curves. Usually efficient.
Production Possibility Frontier (PPF)
Graph that illustrates the trade-offs involved.
Economic Growth
Outward growth of PPF
Positive Economics
The study of how the economic world works (is currently functioning)
Normative Economics
Makes prescriptions about what A "should do" in relation to B. Economists can disagree on prescriptions based on a. choice of model and b. values
Demand Curve
The relationship between the price of a good, and its quantity demanded.
Demand Schedule
A table that shows the relationship between the price of a good and its quantity demanded.
Law of Demand
The higher the price of a good, the less the quantity demanded.
Causal Factors for Shifts in Demand
1. Prices of related goods/services
2. Changes in income
3. Changes in tastes (trends)
4. Changes in expectations
5. Changes in number of consumers.
Supply Curve
The relationship between the price of a good, and its quantity supplied.
Supply Schedule
A table that shows the relationship between the price of a good and its quantity supplied.
Law of Supply
The higher the price of a good, the more the quantity supplied
Causal Factors for Shifts in Supply
1. Changes of input prices
2. Changes in the prices of related goods
3. Changes in technology
4. Changes in expectations
5. Changes in the number of producers
Substitute
Good whose quantity demanded changes in response to price changes of goods similar to it. Inverse relationship.
Cross Price Elasticity > 0
Perfect Substitutes have a linear Indifference curve.
Complement
Good whose quantity demanded changes in response to price changes of goods it works well with. Direct relationship
Cross Price Elasticity < 0
Perfect Complements have an L shaped indifference curve.
Normal Good
Good whose demand is increased when a rise in income occurs.
Income elasticity > 0
As Budget line grows outward, point of tangency on the indifference curve moves proportionally outward.
Inferior Good
Good whose demand decreases when a rise in income occurs.
Income Elasticity < 0
As Budget line moves outward, point of tangency on indifference curve shifts away from the good.
Competitive Market
The most basic kind of market, one in which there are enormous amounts of buyers and sellers. One's actions do not have a significant impact in this type of market.
Economy
A system for coordinating society's productive activities.
Economics
Social science that studies the production, distribution, and consumption of goods and services.
Market Economy
An economy in which decisions about production and consumption are made by individual producers and consumers.
Command Economy
An economy in which there is a central authority making decisions about consumption and production.
Invisible Hand
Refers to the way in which the individual pursuit of self-interest can lead to good results for society as a whole.
Microeconomics
Branch of economics which studies how people make decisions and how these decisions interact.
Market Failure
When the individual pursuit of self-interest leads to bad results for society as a whole.
Recession
Downturn in the economy
Macroeconomics
Branch of economics concerned with overall ups and downs in the economy.
Resource
Something that can be used to produce something else.
Ex. Land, Labor, Human Capital, Technology
Barter
A form of trade in which goods are directly traded rather than through a system of currency.
Household
Person or group of people that share their income.
Firm
Organization that produces goods and services for sale.
Consumer Surplus
Net gain that buyers achieve from the purchase of a good. Area under demand curve and above Y=equilibrium price.
Producer Surplus
Net gain that producers achieve from the selling of a good. Are under Y=equilibrium price and above supply curve.
Economic Surplus
Producer Surplus + Consumer Surplus
Price Controls
Tactics such as price ceilings, floors, quotas, and taxes that governments employ to manipulate a certain market. Usually meant to encourage equity and good development, yet cause negative outcomes such as inefficiency, deadweight loss, and black market a
Price Ceiling
Upper limit on the price at which a good can be sold, often imposed in times of crisis in which prices shoot to abnormal levels. Cause shortages, inefficiency, and deadweight loss.
Price Floor
Lower limit on the price at which a good can be sold, often imposed to encourage equity. Cause surpluses, inefficiency, and deadweight loss
Quota
The total amount of a good that can be bought and sold. Employed using licences, and quota limits. Cause deadweight loss, wedge, and illegal activity
Tax Incidence
No matter how the government writes the tax, both sides suffer.
Producer Tax
Shifts left the supply curve, less is supplied at some price. Buyer pays $6, seller gets $4, government gets $2. ex Sales Tax
Consumer Tax
Shifts left the demand curve, less is demanded at the same price. Buyer pays $4, turns around and gives $2 to the government, seller gets $4.
Tax Government Revenue
(Quantity sold)(Gap between supply and demand at given quantity)
Elasticity
A measure of how one economic variable responds to changes in another economic variable.
Perfectly Elastic
Price Elasticity = infinity. Slope = 0. Quantity Demanded/Supplied responds infinitely much to price.
Perfectly Inelastic
Price Elasticity = 0. Slope = undefined or vertical line. Quantity Demanded/Supplied does not at all respond to price.
Unit Elastic
Price Elasticity = 1. Point at which profits are maximized. Because a square is the biggest rectangle when x+y=k
Midpoint Method
Income Elasticity
(% change in quantity demanded/supplied)/(% change in income)
Determines if good is Inferior or Normal.
Cross-Price Elasticity of Demand
(% change in quantity demanded of one good)/(% change in price of another good
Determines if goods are Complements or Supplements
Total Revenue
Total value of sales of a good or service. (Price)(Quantity sold)
Total Profit
Total Revenue - Total Costs
Marginal Analysis of Production
Raise quantity one unit at a time as long as Marginal Revenue > Marginal Cost
Variable Cost
Cost that changes with the amount of goods produced. Under total cost graphically
Fixed Cost
Input cost that cannot be reinvested.
Total Cost
Variable Cost + Fixed Cost
Accounting Profit
Profit that takes into account only literal revenues and expenses
Economic Profit
Profit that takes into account both literal revenues and opportunity costs such as wages forgone, depreciation, and opportunity cost of capital.
Depreciation
(market value at beginning of use) -- (market value at end of use)
Opportunity Cost of Capital
The profit one could have made if investing fixed cost values elsewhere.
Average Fixed Cost
(Fixed Cost)/(Quantity Produced)
Average Variable Cost
(Variable Cost)/(Quantity Produced)
Marginal Cost
(Change in Total Cost)/(Change in Quantity) The cost of producing one more item
Marginal Revenue
The market price of an item. The revenue from producing one more item.
Maximizing Profits
Marginal Revenue= Marginal Cost
Production Function
The relationship between the inputs employed by a firm and the maximum output it can produce with those inputs
Law of Diminishing Marginal Utility/Returns
Principle that consumers derive diminishing additional satisfaction/supply as they consume/produce more of a good or service during a span of time.
Marginal Product of Labor
The additional output a firm produces as a result of hiring one more worker
Explicit Cost
A cost that involves spending money
Implicit Cost
Cost that involves taking the sum of all opportunity costs.
Short Run
The span of time in which at least one of a firms inputs is a fixed cost.
Long Term
The span of time in which a firm can manipulate its fixed costs such as plant size, technology, and any other inputs.
Price Taker
A buyer or seller is unable to manipulate change in the market price.
Shutdown Point
When the firm falls below the minimum point on its Average Variable Cost curve
Monopoly
An industry controlled by a monopolist, or a producer who is the sole supplier of a good with no close substitutes.
Market Power
The ability to control the market price by raising/lowering output.
Barriers to Entry
1. Control of a natural source or input
2. Increasing returns to scale
3. Technological Superiority
4. Network Externality
5. Government Rules such as Patents and Copyrights
Natural Monopoly
A monopoly formed from increasing returns to scale. Ex. Netflix has one operating base where it keeps dvd supply; Blockbuster had a store in each city and had to stock up each one. Cost was way lower for operating Netflix than it was Blockbuster.
Price Discrimination
Firms that charge different rates to different customers. Methods include price vs timing, price vs age, and etc.
Network Externality
The value of a good is greater when many others use the same good or service. ex Facebook.
A barrier to entry.
Monopoly Profit Maximizing Output and Price
Quantity at which MR=MC. Price at Demand of Profit Maximizing Quantity
Proportional Tax
Tax is a flat percent rate.
Progressive Tax
Tax percent rises as income rises.
Regressive Tax
Tax percent rises as income falls.
Quantity Effect
One more unit is sold, increasing the total revenue by the price at which the unit is sold.
Price Effect
In order to sell last unit, the monopolist must cut the market price on all units sold. This decreases total revenue.
Public Ownership
To solve the monopoly issue in certain industries, governments often buy out an industry unsuited for a competitive market.
Price Elasticity of Demand
(% change in demand)/(% change in price)
Determines if a good is a Necessity or Luxury. Always Negative
Necessity
Item that is necessary for daily life.
Price Elasticity of Demand = Inelastic = 0
Luxury
Item that is not necessary for daily life.
Price Elasticity = Elastic = infinity
Price Elasticity of Supply
(% change in supply)/(% change in price)
Always Positive
Sunk Cost
Cost that cannot be recovered and is irrelevant towards the current decision.
Principles of Rationality
1. Concerns About Fairness
2. Bounded Rationality
3. Risk Aversion
Principles of Irrationality
1. Misperceiving Opportunity Costs
2. Being Overconfident
3. Unrealistic Future Expectations
4. Counting Dollars Unequally
5. Being Loss-Averse
6. Having a Bias Towards the Status-Quo
Standardized Product
A Commodity, or a product regarded to be the same despite the producer, by the consumer.
Break-Even Price
Minimum point of the Average Total Cost Curve.
Income Effect
When the price of a good goes up, one "feels" poorer even though his or her income did not change. Less of each good is purchased.
Substitution Effect
When the price of a good goes up, one will be more inclined to purchase more of the cheaper good.
Net Effect (Substitution and Income)
Many times cannot be determined, unless one good is normal and the other inferior.
Utility
The satisfaction experienced from consuming a good or service.
Marginal Utility
The satisfaction experienced from consuming one more of a good or service.
Negative- The consumption of one more of a good or service makes the person worse off.
Diminishing Marginal Utility
When the consumption of one extra good or service provides the consumer with less satisfaction than of the previous unit.
Utility Maximizing Rule