microecon mastery check

scarcity

unlimited wants exceed limited resources

economics

the study of choices people make to attain their goals, given scarce resources

economic model

a simplified version of reality used to analyze real-world situations

market

buyers and sellers of a good or service, plus the arrangement by which they trade

three key ideas

people are rational, people respond to incentives, and optimal decisions are made at the margin

rational

uses all available information to weigh benefits and costs and make the best decision

incentives

when incentives change, behavior changes. policies can create unintended consequences (ex: student-loan repayment caps may encourage colleges to raise tuition)

marginal analysis

compare marginal benefit (MB) and marginal cost (MC), the extra benefit or cost of a little more of an action

rational rule

act only if MB > MC

trade-off

because of scarcity, more of one good means less of another

opportunity cost

the highest-valued alternative given up

three economic questions

WHAT is produced, HOW is it produced, and WHO receives it

centrally planned economy

government decides how resources are allocated

market economy

households and firms interacting in markets decide

mixed economy

mostly market decisions, with a significant government role.

the US is one

productive efficiency

every good is produced at the lowest possible cost. it comes from competition

allocative efficiency

production matches consumer preferences, up to the point where MB = MC. it comes from voluntary exchange

voluntary exchange

both buyer and seller are better off

market caveats

people may not act efficiently, governments may interfere, and outcomes can ignore third parties (ex: pollution)

equity

fair distribution of benefits

efficiency vs equity

a key tradeoff, efficient does not mean fair.

microeconomics

households, firms, markets, the govt influence on their choices

macroeconomics

the whole economy: inflation, unemployment, growth, recessions

quantity demanded

amount buyers are willing and able to buy at a given price

law of demand

holding all else constant, price ↑ ∴ Qd ↓ and price ↓ ∴ Qd ↑.

movement along demand curve

caused only by a change in the good’s own price. change in Qd (quantity demanded)

shift of demand curve

caused by anything else. it is a change in demand. right is increase, left is decrease

demand shifters

income, price of related goods, tastes, expected future prices, population

income as a demand shifter for normal goods

income ↑ ∴ demand ↑

income as a demand shifter for inferior goods

income ↑ ∴ demand ↓

price of related goods as a demand shifter for substitutes

other price ↑ ∴ demand ↑

price of related goods as a demand shifter for complements

other price ↑ ∴ demand ↓

normal goods

new clothes, eating out, vacations

inferior goods

second-hand clothes, instant noodles

quantity supplied

amount firms are willing to sell at a given price

law of supply

holding all else constant, price ↑ ∴ Qs ↑

movement along supply curve

a change in the good’s own price (change in quantity supplied)

shift of supply curve

caused by anything else. right is increase, left is decrease

supply shifters

input prices, technology, prices of related goods,, number of firms, expected future prices

input prices as a supply shifter

input price ↑ ∴ supply ↓

prices of related goods as a supply shifter for substitutes

soybean price ↑ ∴ corn supply ↓

prices of related goods as a supply shifter for complements

beef price ↑ ∴ leather supply ↑

market equilibrium

Qd = Qs, the price at that point is the equilibrium price

surplus

excess supply, Qs > Qd.

when price is above equilibrium, price falls.

shortage

excess demand, Qd > Qs.

when price is below equilibrium, price rises.

size of a surplus or shortage

the horizontal distance between Qs and Qd at that price

elasticity

responsiveness of one variable to another

price elasticity of demand (PED) formula

% change Qd / % change P

midpoint formula for elasticity

[ (Q2 - Q1) / avg Q] / [ (P2 - P1) / avg P]

PED greater than 1, flatter graph

elastic

PED less than 1, steeper graph

inelastic

PED equal to 1, down normal

unit elastic

PED equal to 0, perfectly vertical (inc/dec in price does not change Qd)

perfectly inelastic

PED equal to infinity, perfectly horizontal (any inc/dec in price makes Qd fall)

perfectly elastic

demand is more elastic if…

more close substitutes available, longer time passes, good is a luxury, market is more narrowly defined, good takes larger share of the budget

total revenue (TR)

P * Q

price effect vs quantity effect

a price cut has a negative price effect (lower price on the old unit) and a positive quantity effect (more units sold)

elastic demand means the quantity effect wins.

cross price elasticity (CPE) formula

% change Q of good A/% change P of good B

CPE positive

substitutes

CPE negative

complements

CPE zero

unrelated

income elasticity of demand (IED) formula

% change Q / % change income

IED positive and less than 1

normal necessity (bread)

IED positive and greater than 1

normal luxury (caviar)

IED negative

inferior good

price elasticity of supply (PES) formula

% change Qs / % change P

PES greater than 1, flatter graph

elastic

PES less than 1, steeper graph

inelastic

PES equal to 1

unit elastic

PES equal to 0, horizontal graph

perfectly inelastic (ex: parking spaces)

PES equal to infinity, vertical graph

perfectly elastic

main determinant of elasticity of supply

time because firms can adjust more in the long run

consumer surplus (CS)

highest price a buyer would pay minus the price actually paid

below demand and above price

producer surplus (PS)

price received minus the lowest price the seller would accept

above supply and below price

demand curve

shows willingness to pay and marginal benefit (MB)

supply curve

shows marginal cost (MC), the lowest acceptable price

price and consumer/producer surplus

price ↑ ∴ PS ↑ and CS ↓

economic surplus

CS + PS

economic efficiency

MB = MC

deadweight loss (DWL)

the lost economic surplus from not being at equilibrium (the amount of inefficiency). it is zero at equilibrium

binding price floor + price above EQBR

Qs > Qd so there is a surplus. CS ↓

binding price ceiling + price above EQBR

Qd > Qs so there is a shortage. PS ↓

tax wedge

buyers pay more and sellers keep less

tax revenue

tax per unit x new quantity

excess burden

another name for the tax’s DWL

efficient tax

raises revenue with a small excess burden

tax incidence

the actual split of the burden between buyers and sellers. does NOT depend on who legally pays.

what determines tax incidence?

relative elasticity. the MORE inelastic (steeper) side bears more of the tax burden.

positive vs normative analysis

positive: what is, w/ data

normative: what ought to be