Microeconomics Test 1

Economy

System to coordinate production

Market Economy

Economy where decisions are made by the individual/firms

1st Principle

Choices are necessary because resources are scarce

2nd Principle

The true cost of something is the opportunity cost.

Explicit Cost

Monetary

Implicit Cost

Everything else

3rd Principle

“How much” is a marginal decision

2 Economic Decisions

“Either or” and “How much”

Marginal Decision

Decisions made at the margin of an activity to do a bit more/less of it

4th Principle

People usually respond to incentives

Individual Principles

For individual choices, 1-4

Interaction Principles

For choices between people, 5-9

5th Principle

There are gains from trade

6th Principle

Since people respond to incentives, markets move towards equilibrium

Equilibrium

Situation where no individual would be better off doing something else

6th Principle Example

When a new line opens at the store, people rush to fill it, which leads to all the lines reaching the same length

7th Principle

Resources should be used efficiently to achieve society’s goals

Efficiency

Taking all opportunities to make some better off without making others worse off

Equity

Condition where everyone gets their “fair share”

8th Principle

Since people exploit gains from trade, markets usually lead towards efficiency

Market Failure

When the pursuit of self-interest hurts society, making it inefficient

9th Principle

When markets don’t reach efficiency, gov’t intervention can improve societal welfare

Other Things Equal Assumption

All other relevant factors remain unchanged

Production Possibilities Frontier

Shows the combination of 2 goods that are possible for a society to produce at full employment

Theory of Comparative Advantage

Produce things you’re good at producing and buy everything else

PPF Assumptions

Only producing 2 goods, resources used efficiently, tech is constant

PPF Graph

Points under are possible but not efficient, points above aren’t possible, points on are possible and efficient

Efficient Allocation

When an economy allocates its resources so consumers are as well off as possible

PPF Economic Growth

Factors of Production Increase and Better Technology

Factors of Production

Land, Labor, Physical Capital, and Human Capital

Labor

Mental/physical abilities of the workforce

Physical Capital

Manufactured items used to produce goods/services

Human Capital

Educational achievements/skills of the workforce

Comparative Advantage

Country has the lowest opportunity cost of other countries for producing a good

Absolute Advantage

Country can produce more output per worker than other countries

If it’s cheaper for a country to produce shirts than its is for another country…

the other country will want to import from that country

Countries are only willing to trade if…

the price of the good each country obtains is less than their own opportunity cost

Circular-Flow Diagram

Represents the transactions in an economy with 2 kinds of flow

2 Flows

Physical things (labor, materials, goods/services) in 1 direction, money in the other

Household

Individual/group that shares income

Firm

Org that produces goods/services and employs household members

Factor Markets

Places where firms buy the resources needed to produce their goods/services

CF Problems

Distinction between household/firm isn’t always clear (family businesses), firms sell to other firms more often, and doesn’t include gov’t

Positive Economics

Describes how the economy works

Normative Economics

Describes how the economy should work

Competitive Market

Market with many buyers/sellers of the same good/service, none of whom control the price

Demand

Represents buyers’ behaviors

Quantity Demanded

The amount buyers are willing/able to purchase at a price

Law of Demand

Higher prices lead to demand for a smaller quantity

Demand Decrease

Leftward Shift

Demand Increase

Rightward Shift

Change in Demand

Left/Right Shift

Change in Quantity Demanded

Down the Graph Shift

Market Curve

Combination of Individual Curves

Demand Curve Shifters

Price of related goods/services, income, tastes, expectations, and number of consumers

Substitutes

2 goods are substitutes if a decrease in the price of 1 leads to a decrease in demand for the other

Complements

2 goods are complements if a decrease in the price of 1 leads to an increase in demand for the other

Normal Good

Demand increases when income increases

Inferior Good

Demand decreases when income increases

Buyers adjust current spending…

in anticipation of future prices to obtain the lowest prices

Supply

Represents sellers’ behaviors

Quantity Supplied

Quantity that produces are willing/able to sell at a price

Supply Curve Shifters

Input price, price of related goods/services, technology, expectations, and number of consumers

Input

Any good/service used to produce another good/service

A decrease in input price…

increases profits and encourages more supply

Inputs in production have opportunity costs

Sellers choose inputs with the highest profit/supply less of a good if profitability fails

New/better tech makes sellers…

willing to offer more/sell their quantity for lower

Tech innovations…

reduce costs/increase supply

The expectation of a higher price in the future…

decreases current supply, if they can store it

Consumer Entry

Implies more sellers in the market (Increases supply)

Consumer Exit

Implies less sellers in the market (Decreases supply)

Equilibrium (Supply/Demand)

Quantity Supplied = Quantity Demanded

Surplus

When quantity supplied exceeds quantity demanded, occurs when price is above equilibrium

Since surpluses don’t last…

employers reduce prices and make market price fall

Shortage

When quantity demanded exceeds quantity supplied

Since shortages don’t last…

employers increase prices and make market price rise

When price/quantity move together…

it’s a demand change

When price/quantity move opposite each other…

it’s a supply change

Small supply decrease and large demand increase

Price/Quantity Rises

Large supply decrease and small demand increase

Price Rises/Quantity Falls

Large supply decrease and large demand increase

Price Rises/Quantity Same