Intro to Economics A

Junior Fresher, Intro to Economics A

Scarce Resources (4)

time, land, labor, capital

Tradeoffs

the alternatives that must be given up when making a choice

Efficiency

society gets the most that it can from scarce resources

Equity

benefits of resources get distributed fairly among the members of society

Opportunity Cost

the implicit cost of something is what you give up to obtain that item

Thinking at the margin

decision-making process which focuses on the additional cost/benefit of one more unit of a good or action

Response to incentives

behavior may change if costs/benefits change

Market Failure

occurs when the market fails to allocate resources efficiently

Externality

impact of firm’s action affects bystanders

Price

quantity of payment from one party to another in return for one unit of good/service

Market

group of buyers/sellers of a particular good/service

Quantity Demanded

amount of a good/service that buyers are willing and able to purchase at different prices

Law of Demand

quantity demanded falls when price of good rises

Quantity Supplied

amount of a good/service that sellers are willing and able to sell at different prices

Law of Supply

the quantity supplied of a good/service increases when the price increases

Income Effect

Lowered price leads to increase in demand because of increased consumer purchasing power

Substitution Effect

consumers switch to cheaper alternatives when price increases

Factors affecting demand (6)

consumer income, prices of other goods, tastes/preferences, advertising, population size/structure, expectations of consumers

Normal Goods

as income increases, demand for good increases

Inferior Goods

as income increases, demand for good decreases

Market Demand

sum of all individual demands for a good/service

Complements

goods used together, demand moves in tandem

Substitutes

goods that can be exchanged for one another, demand moves in opposite directions

Factors Affecting Supply (6)

production input prices, technology, prices of other goods in joint supply, natural/social factors, entry/exit of firms, expectations of producers

Shortage

quantity demanded is greater than quantity supplied

Surplus

quantity supplied is greater than quantity demanded

Equilibrium

quantity demanded is equal to quantity supplied

Allocative Efficiency

value of output by sellers matches value placed on that good by consumers; equilibrium maximizes total welfare

Willingness to pay

max amount a buyer will pay for a good; measures value of good to consumer

Willingness to sell

minimum amount a seller will receive for a good

Consumer Surplus

willingness to pay - amount actually paid

Producer Surplus

amount a seller is paid for a good - production costs

Cost

everything a seller myst give up in order to produce a good

Total Surplus

consumer surplus + producer surplus

Equity

fairness of distribution of well-being among various buyers/sellers

Elasticity

how responsive is supply/demand to a change in market conditions

Price elasticity of demand

measure of how much quantity demanded of a good responds to a change in the price of a good

PED formula

% change in Qd / % change in price

Price elasticity of supply

how much the quantity supplied responds to a change in the price of a good

PES formula

% change in Qs / % change in price

Total Revenue

price x quantity

TR if demand is P-inelastic

increases with price increase

TR if demand is P-elastic

decreases with price increase

Determinants of PED (5)

availability of substitutes, necessity vs. luxury good, how much of income is spent on good, market definition, time frame

Determinants of PES (5)

ability of sellers to change amount produced, size of firm/industry, ease of storing stock, productive capacity, time horizon

Market Power

ability of a single person or firm to unduly influence market prices

Price Ceiling

legal max on price at which a good can be sold (binding when below equilibrium price)

Price Floor

legal minimum on price at which a good can be sold (binding when above equilibrium price)

Price Ceiling - unexpected outcomes (5)

shortages, inefficient distribution among buyers, wasted resources, lowered quality, illegal behavior

Price Floor - unexpected outcomes (2)

inefficient allocation of sales among sellers, sellers waste time and effort searching for buyers

Perfect Competition (4)

many firms, homogenous products, low barriers to entry, price takers

Imperfect Competition

exists when firms can differentiate their products in some way thus have influence over price

Monopoly

sole seller or dominant firm in the market, differentiated product, high barriers to entry, price makers

Causes for high barriers to entry (4)

ownership of a key resource, government granted exclusivity, natural monopoly, external growth

Natural Monopoly

Occurs when there is economies of scale over the relevant range of output

Economies of Scale

cost benefits that come with producing goods in larger numbers

Deadweight Loss

potential gains that didn’t go to the producer nor consumer

Monopoly inefficiency (2)

produces less than socially optimal quantity, charges too high a price and loses customers + creates deadweight loss

Government action against monopolies (3)

promote competition, regulate monopoly behavior, turn into public enterprises

Price Discrimination

selling the same good at different prices to different customers even if production costs are the same

Oligopoly (4)

few firms in the market, either differentiated or homogenous products, limited entry, strategic behavior

Duopoly

oligopoly where there are only two members

Cartel

group of firms acting in unison

Collusion

agreement among firms in a market about output and prices

Requirements for collusion (3)

relatively inelastic demand for product, few substitutes, members must play by the rules

Tacit Collusion

collusion with no formal agreement in place

Game Theory

study of how economic agents behave in strategic situations (see: prisoner’s dilemma)

Dominant Strategy

best strategy regardless of the other party’s decision

Nash Equilibrium

no player can improve their positon by changing their decision

Monopolistic Competition

many firms in the market, differentiated products,

Advertising

intended to inform or influence consumers (differentiation creates incentive)

Branding

creating a strong and positive perception of a company

Externality

uncompensated positive or negative impact of one party’s actions on the wellbeing of a bystander

Negative Externality

cost to society > cost to producer; free market produces too much

Positive Externality

benefit to society > benefit to producer; free market produces too little

Government externality regulation (5)

pigovian tax, subsidies, government regulation, patents, command and control policies

Private solutions to externalities (3)

moral codes/social sanctions, charitable organizations, contracting between parties

Coase Theorem

if private parties can bargain without cost over allocation of resources, they can solve the problems of externalities on their own

Transaction Costs

the costs that parties incur in the process of agreeing to and following through on a bargain; may lead to failure of private solutions

Excludability

refers to the property of a good whereby a person can be prevented from using it

Rivalry

refers to the property of a good whereby one person’s use diminishes other people’s use

Types of goods (4)

private goods, public goods, common resources, club goods

Private Goods

excludable and rival

Public Goods

neither excludable nor rival

Common Resources

rival but not excludable

Club Goods

excludable but not rival

Free-Rider

person who received the benefit of a good without paying for it

Cost-benefit analysis

a study that compares the costs/benefits to society by providing a good

Tragedy of the commons

public resource is overused and depleted by individuals acting out of self-interest; marginal cost < marginal benefit

Asymmetric Information

when one party knows more about something than the other

Adverse Selection

buyers/sellers use their private knowledge to maximize their outcomes at the expense of other parties

Moral Hazard

the tendency of a person who is imperfectly monitored to engage in dishonest and otherwise undesirable behavior

Government intervention to imperfect info (2)

information bodies, consumer rights legislation

Reasons governments levy taxes (2)

raise revenue to pay for government provided services, influence behavior and achieve better market outcomes

How taxes affect wellbeing

overall decreases market wellbeing; raises prices buyers pay and lowers price seller receives

Tax revenue formula

TxQ = GTR

Tax Wedge

wedge between price buyers pay and price seller receives; Q sold with tax < Q sold without tax → market size shrinks

Lorenz Curve

shows the relationship between the cumulative % of households and the cumulative % of income; more bowed curve indicated more income inequality

Gini Coefficient

measures degree of inequality and income in a country

Poverty Rate

% of the population whose family income is lower than an absolute level called the poverty line