ECN REView

What is Economics?

The study of how people allocate scarce resources to satisfy unlimited wants.

Scarcity

The limited nature of resources, forcing choices and trade-offs.

Microeconomics

Study of individuals and firms.

Macroeconomics

Study of economy-wide phenomena (inflation, GDP, etc.).

Rational Behavior

People make decisions to maximize their benefit given their constraints.

Thinking on the Margin

Comparing marginal benefits and marginal costs to make decisions.

Trade-offs

Giving up one thing to get something else.

Opportunity Cost

The next best alternative forgone when making a choice.

Trade Makes Everyone Better Off

Specialization and exchange increase overall wealth.

Incentives

Factors that motivate individuals to act in a certain way.

Self-interest

Decisions made for personal gain.

Social Interest

Decisions benefiting society as a whole.

Production Possibilities Curve (PPC)

Shows different combinations of two goods that an economy can produce.

Law of Increasing Opportunity Cost

As production shifts from one good to another, opportunity cost increases.

Economic Growth & PPC

Economic growth shifts PPC outward due to more resources or better technology.

Unemployment & PPC

Unemployment leads to points inside the PPC, meaning resources aren’t fully utilized.

Law of Demand

As price decreases, quantity demanded increases (inverse relationship).

Individual Demand

One consumer’s demand.

Market Demand

Sum of all individual demands.

Determinants of Demand (TRIBE)

Tastes & preferences, Related goods, Income, Buyers, Expectations.

Law of Supply

As price increases, quantity supplied increases (direct relationship).

Determinants of Supply (ROTTEN)

Resource prices, Other goods’ prices, Technology, Taxes & subsidies, Expectations, Number of sellers.

Market Equilibrium

Where quantity demanded equals quantity supplied (no surplus or shortage).

Surplus

When quantity supplied is greater than quantity demanded (prices decrease).

Shortage

When quantity demanded is greater than quantity supplied (prices increase).

Consumer Surplus

Difference between what a consumer is willing to pay and what they actually pay.

Producer Surplus

Difference between price received and cost of production.

Total Surplus

Consumer Surplus + Producer Surplus = Total economic benefit.

Price Elasticity of Demand (Ed)

Formula: %ΔQd ÷ %ΔP; |Ed| > 1 is elastic, |Ed| < 1 is inelastic, |Ed| = 1 is unit elastic.

Determinants of Price Elasticity of Demand

Availability of substitutes, necessity vs. luxury, time horizon, definition of market.

Price Elasticity & Total Revenue

For elastic demand, if price increases total revenue decreases; for inelastic demand, if price increases total revenue increases.

Income Elasticity of Demand

Formula: %ΔQd ÷ %ΔIncome; Normal goods have Ei > 0 and inferior goods have Ei < 0.

Cross-Price Elasticity of Demand

Formula: %ΔQd of Good A ÷ %ΔP of Good B; substitutes yield a positive value, complements yield a negative value.

Price Elasticity of Supply (Es)

Formula: %ΔQs ÷ %ΔP; measures responsiveness of quantity supplied to price changes.

Budget Constraint

The combination of goods a consumer can afford with their income.

Indifference Curve

Shows combinations of two goods that give a consumer the same satisfaction.

Optimization

Rule: Slope of the indifference curve = Slope of the budget constraint.

Substitution Effect

When the price of a good increases, consumers switch to cheaper goods.

Income Effect

When the price of a good increases, purchasing power decreases, affecting demand.

Giffen Goods

Exception to the Law of Demand where as price increases, demand also increases.