ECN 104

All Chapters

Scarcity

We can’t have everything because everything is limited money, time and energy

Oppourtunity Cost

The cost of the best alternative given up

(Give up/Get)

Smart choice (Voluntary Trade)

The value of what you get must be greater than the value of what you give up

Absolute Advantage

The ability to produce a product/service at a lower absolute cost than another producer

No basis for trade

Comparative Advantage

The ability to produce a product/service at a lower Oppourtunity cost than another producer (more efficiently)

Basis for trade

Trades

Make induviduals better off when each specializes in producing a product/service with comparative advantage

Production Possibility Frontier

A graph that shows the maximum combinations of products/services that can be produced with existing inputs

Points Above the PPF

Not attainable and not efficient

Points Under the PPF

Attainable but not efficient (all resources are not being used)

Points on The PPF

Attainable and efficient (all resources are being used)

Economic Model (Circular Flow Model)

Consists of 3 players-Consumers, producers and the government who interact in 2 markets-Input and Output

In input markets, households are sellers, businesses are buyers
In output markets, households are buyers, businesses are sellers

Inputs

Productive resources-labour, natural resources, capital equipment and entrepreneurial ability used to produce products and services

Marginal

‘’Additional” benefits from the next choice

Marginal Benefits= Δ Total benefit/ Δ Total quantity

Marginal Opportunity Cost

‘’Additional” Oppourtunity costs from the next choice

Marginal Opportunity cost= Δ Opportunity cost/ Δ Total quantity

Implicit Cost

Opportunity costs of investing your own money/time

When marginal benefit is larger than marginal opportunity cost (MB>MOC)

Consume or produce more (wanted)

When marginal opportunity cost is larger than marginal benefit (MB

Consume or produce less (not wanted)

When Marginal benefit equals marginal oppourtunity cost (MB=MOC)

Indifference-consume or produce more (wanted)

The Law of Demand

If the price of a product/service rises, quantity demanded decreases (all other factors remaining the same)

Quantity demanded

The amount you actually plan to buy at a given price

Market demand

The sum of demands of all induviduals willing/able to buy a particular product/service

Demand curve

Illustrates the relationship between price and quantity demanded (all other factors remaining the same)

To read a demand curve

Read over and down

To read a marginal benefit curve

Read up and over

Change in Quantity Demanded

An increase in quantity demanded is a movement down the demand curve

A decrease in quantity demanded is a movement up along the demand curve

Increase in demand

Increase in consumers willingness/ability to pay-rightwards shift of the demand curve

Decrease in demand

Decrease in consumers willingness/ability to pay-leftward shift of the demand curve

Substitutes

Prouducts/Service used in -lace of each other to satisfy the same want

Complements

Products/Services used together to satisfy the same want

Substitutes and Demand

As the price for one substitute increases, the demand for the other substitute will increase
As the price for one substitute decreases, the demand for the other substitute will decrease

As the demand for one substitute increases, the demand for the other substitute will decrease
As the demand for one substitute decreases, the demand for the other substitute will increase

Complements and Demand

As the price for one complement increases, the demand for the other complement will decrease
As the price for one complement decreases, the demand for the other complement will increase

As the demand for one complement increases, the demand for the other complement will increase
As the demand for one complement decreases, the demand for the other complement will decrease

Normal Goods

Products/services you buy more of when your income

Inferior Goods

Products/Services you buy less of when your income increases

Normal goods and Demand

As income increases, demand increases
As income decreases, demand decreases

Inferior Goods and Demand

As income increases, demand decreases
As income decreases, demand increases

Future Prices and Demand

As the expected future price increases, the demand today increases
As the expected future price decreases, demand today decreases

Marginal Cost

Additional opportunity cost of increasing quantity supplied

Marginal Cost= Δ Total cost/ Δ Quantity

Marginal Cost for Supply

Marginal cost is the opportunity cost of time
Marginal cost increases as your quantity supplied increase
Marginal benefit is measured in ($)

Marginal Benefit for Demand

Marginal benefit is the satisfaction you get
Marginal benefit decreases as your quantity demanded increases
Marginal cost is measured in ($)

Supply

Businesses willingness to produce a particular product/service because price covers all opportunity costs

Quantity Supplied

The quantity you actually plan to supply at a given price

Market Supply

Sum of supplies of all business willing to produce a particular product/service

Law of Supply

If the price of a product/service increases, quantity supplied increases

Supply curve

Illustrates the relationship between price/quantity supplied (other things remaining the same)

Change in Quantity

An increase in quantity supplied is a movement up along a supply curve
A decrease in quantity supplied is a movement down along a supply curves

Change in Supply

An Increase in supply is a rightwards shift of the supply curve
A decrease in supply is a leftwards shift of the supply curve

Future Price and Supply

As the expected future price increases, supply now decreases
As the expected future price decreases, supply now increases

Input Price and Supply

As the price of an input increases, the supply decreases
As the price of an input decreases, the supply increases

Market

The interactions between buyers and sellers

Shortage (excess demand)

When quantity demanded exceeds quantity supplied
Shortages create pressure for prices to rise
Rising prices provide signals to business to increase quantity supplied and for consumers to decrease quantity demanded, elimating the shortage

Frustrated Buyers

Market price too low

Frustrated Sellers

Market price too high

Surplus (excess supply)

Where quantity supplied exceeds quantity demanded
Surpluses create pressure for prices to fall
Falling prices provide signals to business to decrease quantity supplied and for consumers to increase quantity demanded, eliminating the surplus

Market Clearing Price

The price that equalizes quantity demanded and quantity supplied

Equilibrium Price

The price that balances forces of competition and cooperation, there is no tendency for change

Effect of Demand on Quantity Supplied

As demand increases, equilibrium price increases and quantity supplied increases

As demand decreases, equilibrium price decreases and quantity supplied decreases

Effect of Supply on Quantity Demanded

As supply increases, the equilibrium price decreases and quantity demanded increases

As supply decreases, the equilibrium price increases and quantity demanded decreases

Increase in both demand and supply

Quantity increases
Price is ambiguous

Decrease in both demand and supply

Quantity decreases
Price is ambiguous

Increase in demand and decrease in supply

Price increases
Quantity is ambiguous

Increase in supply and decrease in demand

Price decreases
Quantity is ambiguous

Consumer Surplus

The difference between the amount a consumer is willing and able to pay and the price actually paid-the area under the marginal benefit curve but above market price

CS=(Willing-Actual)xQunantity

Producer Surplus

The difference between the amount a producer is willing to accept and the price actually received-the area below market price but above the marginal cost curve

PS=(Equilibrium price-marginal cost)

Efficient Market Outcome

Consumers only buy products/services where marginal benefit is greater than price
Products and services are produced at the lowest cost-prices just cover all opportunity costs of production
Marginal benefit=Marginal cost
Total surplus is at a maximum

Deadweight Loss

Decrease in total surplus compared to an economically efficient outcome

Deadweight Loss= loss of CS+loss of PS

Elasticity (price elasticity of demand)

m= % change in quantity demanded/ % change in price

Elastic Demand

Large response in quantity demanded when prices increase
Where m>1 (larger than 1)
Demand curve is nearly flat
Usually for Luxury items Thant are not necessary to buy perfectly inelastic\

Inelastic Demand

Small response to quantity demanded when prices increase
Where 0

Perfectly Inelastic Demand

Quantity demanded does not respond to change in price
Where m=0
Demand curve is vertical
Completely unresponsive to price changes

Perfectly Elastic Demand

Quantity demanded has infinite response to change in price
Where m=infinity
Demand curve is horizontal
Completely responsive to price changes

Influences on Elasticity

Available substitutes-more substitutes mean more elastic demand
Time to adjust-longer time to adjust means more elastic demand
Proportion of Income Spent-greater proportion of income spent on a product/service means more elastic demand

Total Revenue (TR)

All money a business receives form sales

For businesses facing elastic demand (m>1), price cuts increase total revenue
For business facing Inelastic demand (m

Elasticity of Supply

Measures by how much quantity supplied responds to a change in price

m= % change in quantity supplied/ % change in price

Inelastic Supply

Small response in quantity supplied when prices rise
Where m

Elastic Supply

Large response in quantity supplied when prices rise
Where m>1
Easy and inexpensive to increase production

Perfectly Inelastic Supply

Quantity Supplied does not respond to change in price
Where m=0
Supply curve is vertical

Perfectly Elastic Supply

Quantity supplied has infinite response to change in price
Where m=infinity
Supply curve is horizontal

Influences on Elasticity of supply

Availability of additional inputs-more available inputs men more elastic supply
Time production takes-less time means more elastic supply

Cross elasticity of demand

Measures responsiveness of the demand for a product/service to a change in price of a substitute/complement

m= % change in quantity demanded/ % change in price of substitute/complement

Cross elasticity of Demand Substitutes

Cross elasticity of demand is a positive number for substitutes
The larger the number, the larger the change in demand, the larger the shift of the demand curve and the closer the products/services are to perfect substitutes

Cross elasticity of demand complements

Cross elasticity of demand is a negative number for complements
The larger the number, the larger the change in demand, the larger the shift of the demand curve and the closer the products/services are to perfect complements

Income elasticity of demand

Measures responsiveness of the demand for a product/service to a change in income

m= % change in quantity demanded/ % change in income

Income elasticity of demand for Normal goods

Positive for normal goods-increase in income increases demand for normal goods

Income elasticity of demand for Inferior goods

Negative for inferior goods-increase in income decreases demand for inferior goods

Income Inelastic Demand

% change in quantity is less than the % change in price
Where 0

Income Elastic Demand

% change in quantity is greater than % change in price
Where m>1
Normal goods that are luxuries

Tax Incidnece

The division of a tax between buyers and sellers-depends on elasticities of demand and supply

Tax Incidence of Perfectly Inelastic Demand

Buyers Pay all

Tax incidence of perfectly elastic demand

Sellers pay all

Tax Incidence on more Inelastic demand

Buyers pay more

Tax incidence on more elastic demand

Sellers pay more

Tax incidence on perfectly Inelastic supply

Sellers pay all

Tax incidence on more Inelastic supply

Sellers pay more

Tax incidence on more elastic supply

Buyers pay more

Tax incidence on perfectly elastic supply

Buyers pay all

When price is fixed below market-clearing

Shortages develop-quantity demanded > quantity supplied
Consumers are frustrated

When price is fixed above market clearing

Surpluses develop-quantity supplied > quantity demanded
Businesses are frustrated

Governments can fix prices

But can’t force businesses/consumers to produce/buy at the fixed price
Businesses can reduce output or move resources elsewhere
Consumers can reduce purchases or buy something else

Price ceiling

Maximum price set by the government-making it illegal to charge a higher price
Ex.rent controls

Robin Hood Principle

Take from the rich (landlords) and give to the poor (tenants)