Economics: Principles, Demand, Supply, and Consumer Choice

Choices

Of buyers and sellers decided what gets made who gets it and the outcomes.

4 core Principles

Ways of analyzing choices.

Incentives

Motivation to make a choice; reward or penalty of a choice; prices are incentives.

Cost Benefit Principle

Costs and benefits are the incentives that shape choices; evaluate the full set of costs and benefits of the choice.

Full Set

Financial and non-financial costs and benefits.

Willingness to Pay

Most I'm willing to pay for benefit or avoid cost; converts nonfinancial costs of benefits into monetary equivalent.

Economic Surplus

Total benefits minus total costs from choice; AKA net benefit.

Cost Benefit Analysis

Compare each economic surplus.

Framing Effect

When a decision is affected by how a choice is described.

Scarcity

Resources are limited; any resources you spend means less resources for other things.

Opportunity Cost

The true cost of something is the next best alternative you have to give up.

Sunk Cost

A cost that has already happened and can't be taken back; NOT A PART OF OPPORTUNITY COST.

Marginal Principle

Decisions about quantities are best made incrementally.

Marginal Benefit

The extra benefit from one extra unit.

Marginal Cost

Extra cost from one unit.

Rational Rule

If something is worth it, keep doing it until marginal benefit = marginal cost.

Total Benefit

Sum of all marginal benefits across all units.

Total Costs

Sum of all marginal costs.

Total Analysis

Comparing economic surpluses to find the biggest one.

Marginal Benefit Analysis

Finding the closest to equality.

Interdependence Principle

Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future.

Individual Demand

Visually represents what consumers plan to buy based on price; one person.

Law of Demand

Tendency for quantity demanded to be higher when price is lower.

Ceteris Paribus

Hold all other things constant.

Demand vs Quantity Demanded

Demand is the willingness and ability of a buyer to purchase different quantities of goods at different prices; Quantity Demanded is the willingness and ability of a buyer to purchase a specific quantity at a specific price.

Demand Curve

Same thing as marginal benefit curve.

Diminishing Marginal Benefit

Marginal benefit goes down with every additional unit consumed.

Market Demand Curve

Graph plotting total quantity of an item demanded by entire market at each price.

4 Step Process for Market Demand Curve

1. Take a representative survey of the market. 2. For each price, add up total quantity demanded by all customers. 3. Scale up to size of whole market. 4. Plot the data.

Price, Movement, Quantity

Change in price causes movement along the quantity demanded (demand curve).

Other Factors, Shift, Demand

Other factors cause a shift in the demand curve.

Shifting the Demand Curve

Price can stay the same but the demand curve could shift left (decrease) or right (increase).

Normal Good

A good that when you get more income you buy more of.

Inferior Good

A good you don't buy so much of when you're rich; if you get poor, you buy more of.

Preferences

Factors such as life-altering events, marketing, influencers, fashion cycles, social pressure, and season/weather.

Complementary Goods

Goods you buy together (e.g., cereal and milk). If one raises in price, the other will shift with it.

Substitute Goods

Goods that replace each other; if one raises in price, the other will increase in demand.

Expectations

Expectations about future price or availability can influence current demand.

Network Effect

Good becomes more useful because everyone is using it.

Congestion Effect

Good becomes less useful because everyone is using it.

Demographics Composition

Change in demographics means market demand will also change.

Individual Supply Curve

Graph plotting relationship between quantity and price, visual summary of sellers' purchasing plans.

Law of Supply

Tendency for quantity supplied to be higher when price is higher.

Supply vs Quantity Supplied

refers to the entire line; refers to one point on the line.

Perfectly Competitive Markets

Markets with identical goods, many buyers and sellers, where sellers are price-takers.

Rational Rule for Sellers

Supply one more unit if price ≥ marginal cost.

Bottleneck

Diminishing marginal product occurs when hiring additional input yields less output than previous inputs.

Movement Along Supply Curve

When price changes, quantity supplied changes, resulting in

Shift of Supply Curve

When other factors change, supply changes, resulting in a

Input Prices

When the cost of supplies changes, the supply changes (expensive → left, cheap → right).

Productivity and Technology

Improved production technology makes you more efficient, leading to more supply.

Prices of Related Outputs

Supply of a good will increase if the price of a complement in production rises.

Expectations in Supply

If you expect your product's price to rise next year, your supply of that product will decrease this year.

Equilibrium

Point at which no tendency for change; quantity demanded equals quantity supplied.

Equilibrium Quantity

Quantity demanded and supplied in equilibrium.

Equilibrium Price

Price at which market is in equilibrium.

Surplus

Price higher than equilibrium, where quantity supplied is more than quantity demanded.

Shortage

Price lower than equilibrium, where quantity supplied is less than quantity demanded.

Marginal Benefit Curve

Demand curve same thing as marginal benefit curve.

Market Demand Curve Process

4 step process: Step 1 - take a representative survey of the market; Step 2 - for each price add up total quantity demanded by all customers; Step 3 - scale up to size of whole market; Step 4 - plot the data.

Movement Along Demand Curve

Change in price causes movement along the quantity demanded (demand curve).

Shift in Demand Curve

Other factors (other than price) cause a shift in the demand curve.

Diminishing Marginal Product

Increase in output that arises from one additional unit of input, but the additional value decreases with each new input.

Demand

Willingness and ability of buyer to purchase different quantities of goods at different prices.

Quantity Demanded

Willingness and ability of a buyer to purchase a specific quantity at a specific price.

Factors that shift the demand curve

Income, Preferences, Prices of related goods, Expectations, Congestions and Network effects, The type and number of buyers.

Individual Supply

Graph plotting relationship between quantity and price; visual summary of sellers purchasing plans.

What Shifts Supply Curve

When price changes, quantity supplied changes; when other factors change, supply changes.

5 factors that shift supply curve

Input Prices, Productivity and Technology, Prices of related outputs, Expectations, The type and number of sellers.

Shift

entire curve moves left (decrease) or right (increase)

Supply and Demand Shift Same Direction

quantity shifts with it, price change unknown without exact number.

Supply and Demand Shift Opposite Direction

price shifts with it, quantity change unknown without exact number.

Consumer Choice

determine whats affordable; out of affordable options choose whats best.

Budget Line

shows consumer consumption abilities given income and prices.

Budget Line Equation

Income = (Price X Quantity X) OR (Price Y Quantity Y)

Price Change Effect on Budget Line

either the y intercept or x intercept gets extended or shortened.

Income Change Effect on Budget Line

whole line contracts or expands parallel to the original line.

Utility

measure of happiness or satisfaction a person receives from consuming a good or service.

Total Utility

total happiness someone gets from good.

Marginal Utility

Total utility increase from one additional unit increase in the good consumed.

Law of Diminishing Marginal Utility

Marginal Utility decreases with each additional unit consumed.

Indifference Curve

a line that shows combos of goods among which a consumer is indifferent; both goods give same amount of utility.

Indifference Curve Test Note

you have to be on highest indifference curve possible while staying within budget line.

Utility Maximization Method 1

1. find all bundles that are ON Budget Line; 2. Calculate total utility for each of then and pick biggest one.

Utility Maximization Method 2

1. Find all Bundles ON budget Line; 2. Equalize Marginal Utility per dollar for both goods.

Marginal Utility per Dollar

the additional Utility that you get from spending one more dollar on that good. (divide the marginal utility by the price of the good)

Equalizing Marginal Utility

as you buy more of the good that has better marginal utility, the marginal utility diminishes each time; so you STOP when they are equal.

Consumer Equilibrium

when consumer has allocated all income in a way that maximizes utility.

Best Bundle

Marginal utility per dollar = for both goods.

Deriving Demand

when price rises or falls of one of the goods you have to re-optimize by doing the whole method again and connecting the old optimization with the new optimization.