Econ chapters 1-5

Economics

the study of how humans allocate scarce resources (limited resources) 

• It’s a social science and studies human behavior

Scarcity

The limited nature of the society's resources

• Example: Land,  water, food, oil 

Basic Principles:

1) People behave rationally 

2) People respond to incentives 

• Example: tax on cigarettes ⇒ less smoking 

Tax on cigarettes = incentives

Less smoking = the rational behavior

Microeconomics

 the study of how individual households and firms make decisions and how they interact with one another 

• How someone/single individual spends their money OR how they distribute a scarce resource 

Macroeconomics

The study of the economy as a whole. The goal is to explain the economic changes that affect many households, firms, and markets simultaneously 

• Fiscal and Monetary policy 

Division of labor:

The production of a good or service is divided into a number of a good or service is divided into a number of tasks performed by different people

Specialization:

Workers concentrate on one part of the production process where they have an advantage

Economies of scale:

level of production increases the cost of producing each unit decreases

Two types of markets

1) Markets for goods and services

2) Labor Markets

Markets for goods and services

• households DEMAND

• Firms SUPPLY

Labor Markets

• Firms DEMAND

• Households SUPPLY

“The invisible hand”

A term coined by Adam Smith

• a natural phenomenon that guides markets economy

• it describes how consumers and producers interact in the economy

• Self-interest can lead to positive social benefits

EG} thinks of example of how two stands offer the same thing but one has ir for cheap which will you buy

Regulations

Sometimes market economies have inefficiencies or market failures = government is needed to correct for market failures

• some can be monopolies, income inequality, pollution

• regulations define the “rules of the game” in an economy

• regulations enforce private property laws, protect people, prevent fraud, collect taxes

Underground economy (black markets)

Buyers and sellers make transactions without government approval

What are the three economic systems?

• Traditional economy

• Command economy

• Market economy

Traditional economy:

these economies organize their affairs the same way they have always done

• economic decision s are made by individuals based on their own beliefs/customs rather than a written set of laws

Command economy

The government decides what goods and services will be produced and what prices will be charged

• one ENTITY (can be any person of power) working the majority of the economic decisions

Example - methods of production that will determine how much workers will be paid

Market economy

decision making is decentralized, economies are based on private enterprises

Example - Means of production (resources and businesses) are business owned and operated by private groups of individuals

Opportuntiy set:

all the possible opportunities for spending on two goods and services

Budget constraint

all the combinations of two goods that one can afford when the budget is exhausted (you’ve spent all your money)

• plots on a graph/line connecting them

Opportunity cost:

What must be given up to obtain the next best thing (something you desire)

What is the equation that equals opportunity cost

Implicit costs + Explicit costs = Opportunity cost

Implicit costs

(economics)

• sacrifice something valuable that is NOT money

Example: In college, an implicit cost is sleep, time, and social life

Explicit Costs:

(accounting)

• out of pocket expenses/ actual financial trasnactions

Sunk costs:

costs incurred in the past that cannot be recovered

• if you buy a concert ticket its final sale you can get your money back

Utility:

The satisfaction one gains from a good or service

• another word for HAPPINESS

Marginal Utility:

An extra satisfaction you get from consuming one more unit of something

• like an extra layer of happiness/utility

Law of diminishing marginal utility

As a person receives more of a good the additional (or marginal) utility from each additional unit of the good DECLINES

• think of the pizza example the more slices you eat the less utility you receive

Production Possibilities Frontier

Just as an individual cannot have everything they want and must instead make choices — society as a whole cannot have everything it may want

• PPF

Production Possibilities Curve

Illustrates the trade off facing an economy producing two goods

The law of diminishing opportunity cost:

holds that as production of one good or service increases the marginal opportunity cost producing it increases as well

• no matter what the cost of both will increase because what was sacrificed doesn’t make up for the cut of the other good or service

Example - If your preferred the production of clothes over food you will expand into lad used for food which may not be suited for it meaning now both food and clothes cost goes up

• PPF graph reflects this

The economic approach:

Economists make the careful distinction between

• positive statements and

• normative statements

Positive Statement:

DESCRIPTIVE

It’s a statement AND it can be verified

• “The unemployment rate is 4%”

Normative Statement:

PRESCRIPTIVE

It can’t be verified AND is more of an opinion/suggestive

• “The unemployment rate should be under 4%”

Marginal decision making:

choosing whether the extra unit of something is worth it based on cost and benefits

Market

A group of buyers and sellers of a particular good or service

4 Market Structures

1) Monopoly = One seller

• Standard oil, Alcoa

2) Oligopoly = few sellers

• mobile networks (Verizon, T-Mobile), Supermarkets

3) Monopolistic Competition = Many sellers / Goods are differentiated

• Restaurants, Clothing stores

4) Perfect Competition = Many Sellers / Goods are identical

• Agricultural goods, metals, oils, water

Law of Demand

Ceteris Paribus (all other things held constant)

• when the price of a good rises = demand falls

• When the price goes down, = demand goes up

Quantity demanded:

The amounts buyers are willing and able to purchase

When is there a shift in demand curve (entire curve moves)

Happens when something other than price changes: Income, preference

When is there movement along the demand curve (along the same line)

Occurs when only the price changes

Normal good:

Increase in income leads to an increase in demand

• Steak, korean BBQ, Nike

The more money you get the more you want to but these goods

Inferior Goods:

An increase in income = leads to a decrease in demand for these goods

and a decrease in income = will increase demand

• Rice, Cup o’ Noodles, Mcdonald’s, Walmart shoes

Substitutes:

Two goods for which an increase in the price of one leads to an increase in the demand for the other (SIMILAR GOODS)

• Example: Sierra Mist and Sprite

• If the price increased, the demand for Sierra Mist would decrease, and the demand for Sprite would increase

• If the price decreased, the demand for Sierra Mist would increase, and the demand would decrease

Complements:

Two goods for which an increase in the price of one leads to a decrease in demand for the other

(TWO GOODS BOUGHT TOGETHER)

• Example: Ribs and BBQ Sauce

• If the price increased for ribs, the demand would decrease for both ribs and BBQ sauce

• If the price decreased for ribs, the demand for both ribs and bbq sauce would increase

Exception to the Law of Demand:

very rare, usually happens with:

• Luxury goods - the more expensive a luxury good, the more desirable it is

Example: Jewelry, sports car, designer clothes

• Giften good - low income goods for which there are little or no substitutes

Example: Potatoes, salt, bread

Law of Supply:

Ceteris Paribus, the quantity supplied of a good rises as the price of the good rises

• price rises = want to supply more of it

• price falls = supply less of that good

A positive relationship between price and quantity supplied

Inputs

Things needed to make outputs/run a business

Example - Capital and Labor (they cause a shift in supply)

• so if wages rise, there will be less oil supply, so that would shift the supply line to the left because it’s decreasing

Equilibrium

A station in which the price has reached the level at which quantity supplied equals quantity demanded

• the moment they intersect

Equilibrium Price (P*)

Equilibrium Quantity (Q*)

1) The market clearing price buyers have bought all they want to buy and sellers have sold all they want

2) Where the amount of the product consumers want to buy (quantity demand) is equal to the amount producers want to sell (quantity supplied)

Consumer surplus

is the benefit that consumers get when they are able to buy something for less than the maximum price they are willing to pay.

Consumer surplus = What consumers are willing to pay - (minus) What they actually pay

• Imagine you were willing to pay $20 for a concert ticket, but you only had to pay $15. The extra $5 is your consumer surplus because you got the ticket for cheaper than you were willing to pay

Producer Surplus

is the benefit that producers (sellers) get when they are able to sell something for more than the minimum price they are willing to accept.

Producer surplus = What producers actually receive - What they were willing to accept.

• For example, a seller might be willing to sell a product for $10, but they end up selling it for $15. The extra $5 is the producer surplus because the seller got more than they were willing to accept.

Total Surplus

CS + PS = TS

The triangle is the total surplus

• In this case if Q* was any number but 1 you would multiply it to the total surplus ???

Surplus

A situation in which the quantity supplied is greater than the quantity demanded

Qs > Qd

Shortage

A situation in which quantity demanded is greater than quantity supplied. EXCESS DEMAND

Qd > Qs

Price ceiling

Legal maximum; prevents price from climbing “too high”

• think of it as ceiling is high the highest point in a house

Price Floor

Minimum price; prevents price from falling “too low”

• think of it as the floor is the lowest part of the house prevents you from falling into the basement