Economics Fundamentals: PPF, Market Structures, and Demand-Supply Analysis

Why do economists make assumptions to study economics?

To simply the complex world and make it easier to understand.

Who are the buyers in markets for goods and services?

Households are the buyers.

Who are the sellers in markets for goods and services?

Firms are the sellers.

Who are the buyers in markets for factors of production?

Firms are the buyers.

Who are the sellers in markets for factors of production?

Households are the sellers.

What is the production possibilities frontier (PPF)?

It is a graph that shows the combinations of output that the economy can maximum produce.

What do we know about the points on the PPF?

Points on the PPF are possible and efficient.

What do we know about the points under the PPF?

Points under the PPF are possible but not efficient.

What do we know about the points above the PPF?

Points above the PPF are not possible.

What lesson do we learn when we move along a PPF?

The society faces a trade-off: getting more of one good requires sacrificing some of the other.

What is opportunity cost?

The opportunity cost of something is what you give up to get it.

How do we calculate opportunity cost?

First, we calculate the slope of the PPF. The opportunity cost of the good on the horizontal axis is the slope. The opportunity cost of the good on the vertical axis is 1/slope.

Why is some PPF bowed outward?

Some resources are better at producing one good, while others are better at producing the other good.

What does microeconomics study?

It studies how households and firms make decisions and how they interact in markets.

What does macroeconomics study?

It studies economy-wide phenomena, including inflation, unemployment, and economic growth.

What is a positive statement?

A statement that describes the world as it is.

What is a normative statement?

A statement that prescribes what we should do.

What is absolute advantage?

The ability to produce a good using fewer inputs than another producer.

What is comparative advantage?

The ability to produce a good at a lower opportunity cost than another producer.

What is the principle of comparative advantage?

Each good should be produced by the individual that has the smaller opportunity cost of producing that good (specialize according to comparative advantage).

What are the three conditions of a perfectly competitive market?

1. The goods offered for sale are all the same. 2. There are many buyers and sellers. 3. Both buyers and sellers are price-takers.

What is the law of demand?

Other things being equal, when the price of a good rises, the quantity demanded of the good falls.

What can cause the quantity demanded of lattes to change?

Only a change in the price of lattes itself.

What can cause the demand for lattes to change?

There are 5 determinants of demand (demand shifters). 1. A change in income. 2. A change in the price of related goods (substitutes/complements). 3. Tastes 4. Expectations about future income/price. 5. The number of buyers.

An increase in income causes the demand for lattes to ________.

An increase in income causes the demand for lattes to increase (because latte is a normal good).

An increase in income causes the demand for instant ramen noodles to ________.

An increase in income causes the demand for instant ramen noodles to decrease (because instant ramen is an inferior good).

An increase in the price of frozen yogurt causes the demand for ice cream to ________.

An increase in the price of frozen yogurt causes the demand for ice cream to increase (substitutes).

An increase in the price of peanut butter causes the demand for jelly to ________.

An increase in the price of peanut butter causes the demand for jelly to increase.

Increase in the price of peanut butter

Causes the demand for jelly to decrease (complements).

Increase in expected future income

Causes the (current) demand for lattes to increase.

Increase in expected future price of Nintendo Switch

Causes the (current) demand for Switch to increase.

Increase in the number of buyers

Causes demand to increase.

Change in quantity demanded on a graph

A movement along a fixed demand curve.

Change in demand on a graph

A shift in the demand curve.

Law of supply

Other things being equal, when the price of a good rises, the quantity supplied of the good rises.

Change in quantity supplied of lattes

Only a change in the price of lattes itself.

Change in supply of lattes

There are 4 supply shifters (determinants of supply): 1. A change in the input price. 2. A cost-reducing technology. 3. A change in the number of sellers. 4. A change in expected future price of lattes.

Decrease in the price of peanuts

Causes the supply of peanut butter to increase (input price).

Cost-reducing technology

Causes the supply of peanut butter to increase.

Decrease in the number of sellers

Causes the supply of peanut butter to decrease.

Decrease in the expected future price of peanut butter

Causes the (current) supply of peanut butter to increase.

Price above equilibrium

There will be a surplus, which makes sellers to cut the price.

Price below equilibrium

There will be a shortage, which makes sellers to raise the price.

Price ceiling

A legal maximum on the price of a good.

Price floor

A legal minimum on the price of a good.

Price ceiling above equilibrium price

Not binding.

Price ceiling below equilibrium price

Binding.

Price floor above equilibrium price

Binding.

Price floor below equilibrium price

Not binding.

Binding price ceiling

Causes a shortage.

Binding price floor

Causes a surplus.

Tax on buyers

Shifts demand curve down by the amount of tax.

Tax on sellers

Shifts supply curve up by the amount of tax.

Incidence of a tax

How the burden of a tax is shared among market participants.