Principles of Economics

Factors of Production

An economic term to describe the inputs that are used in the production of goods or services in the attempt to make an economic profit

Demand

An economic principle that describes a consumer's desire and willingness to pay a price for a specific good or service

Supply

A fundamental economic concept that describes the total amount of a specific good or service that is available to consumers

Microeconomics

Study of a single factor of an economy - such as individuals, households, businesses, & industries - rather than an economy as a whole.

Macroeconomics

Examines the costs and benefits of economic choices made at a societal level and how those choices affect overall economic well being

Consumer Expenditure

The amount of money spent

Opportunity Cost

Cost of the next best alternative use of money, time, or resources when one choice is made rather than another

Average Cost

The total cost divided by the quantity produced.

Average Benefit

The total benefit of undertaking n units of an activity divided by n

Marginal Cost

Extra cost of producing one additional unit of production.

Marginal Benefit

The additional benefit resulting from a small increase in some activity

Pitfall 1

Measuring costs and benefits as proportions rather than absolute money amount

Pitfall 2

Ignoring opportunity (i.e. implicit) costs

Pitfall 3

Failure to ignore sunk costs

Pitfall 4

Failure to understand the average - marginal distinction

Cost-Benefit Principle

An individual (or a firm or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs.

Sunk Cost

A cost that has already been committed and cannot be recovered

Principle of Comparative Advantage

Everyone does best when each person concentrates on the activities for which their opp cost is lowest

Sources of Comparative Advantage

Climate and resource distribution, labor and capital availability, technological factors, external economies

Comparative Advantage

The ability of an individual, firm, or country to produce a good or service at a lower opportunity cost than other producers.

Specialization

Goods and services are produced in better quality, quantity and speed when people focus on producing a few things instead of making everything they want by themselves.

Absolute Advantage

Exists if a producer can produce more of a good than all other producers

Production Possibilities Curve

A graph that describes the maximum amount of one good that can be produced for every possible level of production of the other good

Attainable Point

Any combination of goods that can be produced using currently available resources

Unattainable point

Any combination of goods that cannot be produced using currently available resources

Efficiency Point

Any combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of the other

Inefficiency Point

Any combination of goods for which currently available resources enable an increase in the production of one good without a reduction in the production of the other

Elasticity

A measure of how much one economic variable responds to changes in another economic variable.

Market

Consists of all buyers and sellers of that good or service

Demand Curve

A graph of the relationship between the price of a good and the quantity demanded

A graph showing the quantity of a good that buyers wish to buy at each price

Supply Curve

A graph of the relationship between the price of a good and the quantity supplied

A graph that tells us the quantity of a good that sellers wish to sell at each price

Substitution Effect

The change in the quantity demanded of a good caused by a price change of that good making buyers to switch to substitutes

Income Effect

The change in the quantity demanded of a good caused by a price change of a good since the buyers purchasing power changes

Buyer's Reservation Price

The largest amount of money the buyer would be willing to pay for a unit of a good

Seller's Equilibrium Price

The smallest money amount for which a seller would be willing to sell an additional unit (generally equal to marginal cost)

Market Equilibrium

All buyers (consumers) and sellers (producers) are satisfied with their respective quantities at the prevailing market price at the intersection of demand and supply in the market equilibrium price and equilibrium quantity

Equilibrium Price

The price at which a good will sell

Equilibrium Quantity

Where the quantity supplied and quantity demanded are equal

Price Ceiling

A maximum allowable price, specified by law

Price Floor

A minimum allowable price, specified by law

Complements

An increase (decrease) in the price of one causes a leftward (rightward) shift in the demand curve for the other

Substitutes

An increase (decrease) in the price of one causes a rightward (leftward) shift in the demand curve for the other

Normal Good

Demand curve shifts rightwards when the incomes of buyers increase and leftwards when the incomes of buyers decrease

Inferior Good

Demand curve shifts leftwards when the incomes of buyers increase and rightwards when the incomes of buyers decrease

Elasticity

Percent Changed in Quantity Demanded / Percent Change in Price

Redemption Price

The issue price is the price at which securities are originally sold; the price at which the issuer buys them back

Reservation Price

Minimum price needed to work a particular hour

Reservation Wage

Minimum necessary to get people to work

Increasing Opportunity Cost Principle

The opportunity cost of producing additional units of a good rises as society produces more of that good

Factor of Production

An input used in the production of a good or service

Short Run

A period of time sufficiently short that at least some of the firm's factors of production are fixed

Long Run

A period of time sufficiently long that all the firm's factors of production are variable

Law of Diminishing Returns

To increase output by a constant amount requires ever-larger increases in the variable factor , when some factors of production are fixed

Fixed Factor of Production

An input whose quantity cannot be altered in the short run

Variable Factor of Production

An input whose quantity can be altered in the short run

Fixed Cost

Total payments made to firm's fixed factors of production

Variable Cost

Total payments made to the variable factors of production

Total Cost

Fixed + Variable Costs

Marginal Cost

The change in total cost divided by the corresponding change in output as output changes from one level to another

Average Total Cost

Total cost divided by total output

Average Variable Cost

Variable cost divided by total output

Average Fixed Cost

Fixed cost divided by the quantity of output

Determinants of Supply

Technology, Input prices, Number of suppliers, Expectations, Changes in prices of other products

Economic Profit

Total revenue a firm receives from the sale of its products minus all costs (explicit & implicit) of production

Profit-Maximizing Firm

Usually assumed, not always the case e.g. "hobby businesses"

Perfectly Competitive Market

A market in which no individual supplier has significant influence on the market price of the product

Price Taker

A firm that has no influence over the price at which it sells its product

Imperfectly Competitive Firm

A firm that has at least some influence over the price at which it sells its product

Characteristics of Perfect Competition

All firms sell the same identical product, Many buyers and sellers, each of which buys or sells only a small % of total quantity, Productive resources are mobile, Buyers and sellers well informed

Firm's Shutdown Condition

A firm must cover its variable cost to minimize losses when producing at a loss

Must at least cover VC in short run

A Profitable Firm

A firm whose total revenue exceeds its total cost

Producer Surplus

The difference between the seller's reservation price and the market price

Pareto Efficiency

A situation is efficient if it is impossible to help some people without harming others

Sensitive to distribution of gains

Surplus Maximum

A situation is efficient if total surplus is maximized

(Consumer Surplus + Producer Surplus)

Not sensitive to distribution of gains

Pareto Improvement

Makes at least someone better off & no-one worse off

Potential Pareto Improvement

If total surplus increases. i.e. one can afford to compensate losers and still be better off

Harberger Triangle

Refers to the deadweight loss occurring in the trade of a good or service due to government intervention

Law of Unintended Consequences

Policies often have unintended consequences

Price Subsidies

Intent to keep the market price for a good higher than the competitive equilibrium level, can be government regulations on prices or assistance paid to an economic sector

Tax Incidence

The actual division of the burden of a tax between buyers and sellers in a market.

Dead Weight Loss

The lost net benefit to society caused by a movement away from the competitive market equilibrium

Invisible Hand

Market economies with self-interested individuals are good for everyone

Explicit Costs

The actual payments a firm makes to its factors of production and other suppliers

Implicit Costs

The opportunity costs of the resources supplied by the firm's owners

Accounting Profit

Total revenue - explicit costs

Economic Profit

Total revenue - explicit costs -implicit costs

Normal Profit

Accounting profit - economic profit

Economic Rent

That part of a payment for a factor of production that exceeds the owner's reservation price

Market forces will not push economic rent to zero because inputs cannot be replicated easily