Principles of Economics, S/D, Equilibrium

market

any situation that brings together buyers and sellers to exchange goods and services

individual demand

quantity of a good an individual plans to buy at each potential price

competitive market

price takers where buyers and sellers trade similar products and no individual can influence it

law of demand

inverse relationship between price and quantity demanded

ceteris paribus

holding all else constant (everything besides price that could change demand)

rational rule for buyers

buy as long as marginal benefit is greater than price and stop when it equals price

diminishing marginal benefit

as quantity increases marginal benefit decreases

market demand

total quantity demanded by all consumers at each price

horizontal summation

horizontally adding up all individual demand curves

6 demand shifters

income price of related goods preferences expectations network and congestion effects number of buyers

income (types of goods)

normal goods (increase in income = increase in demand) and inferior goods (increase in income = decrease in demand)

price of related goods (demand)

substitutes (price of one increases = demand of other increases) and complements (vice versa)

preferences

how much people like a good (direct correlation with demand)

expectations (demand)

what we expect to happen in the future influences decisions today

network effects

other people using the good makes it more valuable

congestion effects

other people using the good makes it less valuable

demand curve shift rule

only number of buyers shifts market demand directly while all other shifters shift individual demand curves first which then shifts the market curve

perfectly competitive market

many buyers and sellers identical goods free entry and exit price takers where firm's only decision is how much to make

pricing decisions in competitive markets

charging a lower price leaves money on the table while charging a higher price leads to selling nothing

price taker

firm must accept prevailing market price as given

individual supply

quantity a business plans to sell at each potential price

law of supply

price and quantity supplied are directly related

rational rule for sellers

sell as long as price is greater than or equal to marginal cost

market supply

add up all individual supply curves to get market supply

market economy

buyers and sellers decide freely

planned economy

central planner decides

three economic questions

every economy must decide what gets produced how by whom and who gets the good

supply shifters

input prices productivity/tech price of related curves expectations number of sellers

input prices

input price and supply have an inverse relationship

productivity and tech

productivity increase causes marginal cost decrease and supply increase

expectations (supply)

if firm believes price increases next year supply decreases today

number of sellers

affects market as a whole where more sellers equals increased market supply

price of related goods (supply)

substitute price increases supply of other decreases (inverse) while complement price increases supply of other increases (direct)

cost-benefit principle

costs and benefits are the incentives that shape decisions (only act if benefits outweigh costs)

evaluating cost-benefit principle

consider financial and non-financial consequences and convert costs and benefits into WTP to compare

WTP (willingness to pay)

the most you would pay to receive a benefit

economic surplus

net value created by decisions (positive if benefits outweigh costs)

framing

advertisers and marketers try to manipulate your perceived costs and benefits (e.g. free benefits or limited time offers)

opportunity cost principle

value of the next best alternative given up due to limited resources and unlimited wants (every choice has a cost of what you are giving up)

sunk costs

cost already incurred that cannot be reversed (do not factor irreversible sunk costs into current decisions)

production possibility frontier (PPF)

visual representation of opportunity costs showing different combinations of outputs attainable given scarce resources

shifts in PPF

increase in inputs/resources shifts PPF right

technology change in one good shifts slope

technology change in both goods shifts entire curve rightward

marginal principle

decisions about quantities are best made incrementally by breaking down quantity decisions into smaller "one more?" steps (only buy one more if marginal benefit is greater than marginal cost)

marginal benefit

change in benefit from buying one more unit

marginal cost

additional cost of producing one more unit

rational rule principle

if something is worth doing keep doing until marginal benefit equals marginal cost to maximize economic surplus

surplus maximization step

each unit acquired by following the rational rule principle increases economic surplus

interdependence principle

our best choice depends on our other choices choices made by others developments in other markets and expectations about the future

interdependence principle consequence

when any of these external or internal factors change your best choice may change too

equilibrium

when quantity supplied equals quantity demanded where you are always able to find a buyer/seller at this price

equilibrium state

serves as an absorbing state that the market is always moving towards

surplus

quantity supplied is greater than quantity demanded

shortage

quantity demanded is greater than quantity supplied

income shift effect

with a normal good an increase in income leads to a rightward demand shift (vice versa for an inferior good)

input price shift effect

when input prices decrease supply shifts right

productivity decrease effect

when productivity decreases supply shifts left because marginal cost goes up