Economics Key Concepts: Scarcity, Opportunity Cost, Market Dynamics, and Elasticity

Economics definition

Study of how society allocates scarce resources to satisfy unlimited wants

Scarcity

Resources are limited while wants are unlimited

Trade-off

Choosing one thing means giving up another

Efficiency vs equity trade-off

More equality may reduce total output

Opportunity cost

Value of the next best alternative forgone

Opportunity cost formula

Explicit costs + implicit costs

Implicit cost

Forgone income or benefit

Explicit cost

Direct monetary payment

Marginal analysis

Compare additional benefit vs additional cost

Marginal decision rule

Do it if marginal benefit > marginal cost

Incentives

Factors that motivate behavior

Total revenue formula

Price × Quantity sold

Circular flow model

Simplified model showing flow of goods and money between households and firms

Product market

Firms sell goods and services to households

Factor market

Households sell labor land and capital to firms

Microeconomics

Study of individual markets and decision makers

Macroeconomics

Study of economy as a whole

Positive statement

Testable claim about how the world is

Normative statement

Opinion about how the world should be

Economic model

Simplified representation to understand relationships

PPF

Curve showing maximum production combinations

Point on PPF

Efficient production

Inside PPF

Inefficient (unemployed resources)

Outside PPF

Unattainable

PPF slope

Opportunity cost

PPF outward shift

Increase in resources or technology

PPF inward shift

Loss of resources

Law of demand

Price ↑ → Quantity demanded ↓

Law of supply

Price ↑ → Quantity supplied ↑

Demand curve slopes down

Because lower prices increase quantity demanded

Supply curve slopes up

Because higher prices increase profitability

Movement along demand curve

Change in price causes change in quantity demanded

Shift in demand curve

Change in non-price factors

Demand shifters

Income tastes expectations substitutes complements

Substitute goods

Goods that replace each other

Complement goods

Goods used together

Supply shifters

Input costs technology taxes expectations number of sellers

Equilibrium

Where quantity demanded = quantity supplied

Shortage

Price below equilibrium (Qd > Qs)

Surplus

Price above equilibrium (Qs > Qd)

Elasticity formula

%ΔQd / %ΔP

Elastic demand

Elasticity > 1 (very responsive)

Inelastic demand

Elasticity < 1 (not responsive)

Unit elastic

Elasticity = 1

Midpoint formula

((Q2-Q1)/avgQ)/((P2-P1)/avgP)

Elastic demand revenue rule

Price ↑ → Revenue ↓

Inelastic demand revenue rule

Price ↑ → Revenue ↑

Determinants of elasticity

Substitutes necessity vs luxury time horizon market definition

Price elasticity of supply

%ΔQs / %ΔP

Consumer surplus

Value buyers get above price paid

Consumer surplus formula

1/2 × base × height

Producer surplus

Value sellers get above cost

Producer surplus formula

1/2 × base × height

Total surplus

Consumer surplus + Producer surplus

Marginal buyer

Willingness to pay equals price

Marginal seller

Cost equals price

Efficient market outcome

Maximizes total surplus

Deadweight loss

Lost surplus from inefficiency

Price ceiling

Maximum legal price

Binding price ceiling

Creates shortage

Nonbinding price ceiling

No effect

Price floor

Minimum legal price

Binding price floor

Creates surplus

Nonbinding price floor

No effect

Example price floor

Minimum wage

Example price ceiling

Rent control

Tax wedge

Difference between price buyers pay and sellers receive

Tax incidence

Who bears burden depends on elasticity

Inelastic side of market

Bears more tax burden

Tax revenue formula

Tax × quantity after tax

Deadweight loss formula

1/2 × Tax × ΔQ

Effect of tax

Reduces quantity traded

Elastic demand tax effect

Large DWL small revenue

Inelastic demand tax effect

Small DWL large revenue

Laffer curve

Tax revenue rises then falls with higher rates

Negative externality

Cost imposed on third parties

Example negative externality

Pollution

Negative externality outcome

Overproduction

Positive externality

Benefit to third parties

Example positive externality

Vaccination

Positive externality outcome

Underproduction

Coase theorem

Private bargaining can solve externalities if low transaction costs

Pigouvian tax

Tax equal to external cost to fix externality

Command and control policy

Government sets specific rules

Market based policy

Uses incentives like taxes or permits

Efficient tax system

Raises revenue with minimal DWL

GDP

The total market value of all final goods and services produced within a country's borders in a given time period

Final Goods

Goods purchased by end users; included in GDP

Intermediate Goods

Goods used to produce other goods; not counted separately in GDP

Double Counting

Counting intermediate and final goods separately which overstates GDP

Circular Flow

Model showing households provide labor land capital and receive wages rent profit

Income = Expenditure Principle

Every dollar spent is income to someone else

Transfer Payments

Government payments with no goods/services in return not included in GDP

Government Purchases

Spending on goods/services included in GDP

Household Production

Goods/services produced at home not included in GDP

Market Transaction

Required for inclusion in GDP

Externalities

Effects like pollution not reflected in GDP

Imports

Goods produced abroad subtracted from GDP

Nominal GDP

Sum of current price × current quantity

Real GDP

Sum of base-year price × current quantity