Econ notes and definitions

What is economics?

examines the choice that people, firms and societies make with their limited resources.

What is scarcity?

exists when the marginal cost of obtaining something is greater than zero

examples of objects that are scarce

water, diamonds, cars, dirt

examples of objects that are no scarce

air, gravity

five foundations of economics

marginal thinking, opportunity cost, trade off, incentive, value created from trade (MOTIVe)

What is incentives?

influences our actions in predictable ways. It can be positive or negative but can lead to unintended consequences.

example of incentive

Auto Insurance scams

Types of Incentives

postive, negative, indirect, direct

Positive incentive

encourages actions by offering rewards or payments

Negative incentives

discourages actions by providing undesirable consequences or punishments

direct incentives

clear, immediate rewards or penalties offered to influence specific actions. eg: people who normally don’t stop at a certain gas station stopping because the price is lower

indirect incentives

other behaviors that may change due to a change. eg: others feeling the need to get more gas because the gas price is lower though the firm lowered it for other reasons.

Incentives lead to what

innovation. in the US we have the patent system and copyright laws

What is a trade off?

This is the set of things we might have done.

What is the usual trade off?

time or money

What is opportunity costs?

This quantifies “what or how much” was given up. This is the highest in value alternative that was given up.

What is marginal thinking?

This requires decision-makers to evaluate whether the benefit of one more unit of something greater than its cost.

What is economic thinking?

The process of systematically evaluating a course of action

What does trade create?

This creates value and depends on specialization and comparative advantage.

What is voluntary trade?

rational individual creates value for everyone involved. win-win situation

What is comparative advantage?

refers to the situation in which an individual, business, or country can produce at a lower opportunity cost than a competitor can

What is trade?

This is the voluntary exchange of goods and services between two or more parties.

What is step one of the scientific method?

Observe an interesting phenomenon

What is step two of the scientific method?

Develop a hypothesis

What is step three of the scientific method?

Construct a model

What is step four of the scientific method?

Design experiments

What is step five of the scientific method?

Collect results

What is step six of the scientific method?

Assess the hypothesis

What is a positive statement?

This can be tested and validated

What is a normative statement

cannot be empirically tested or validated. matter of opinion- “should”

What is Ceteris paribus?

“other things being equal” or “all else equal”

What are endogenous factors?

These are factors inside the model because we can control them.

What are exogenous factors?

These are factors outside the model because we can’t control them.

What are the three factors of an economic model?

What we include in the model, the assumption we make when choosing what to include, and the outside conditions that can affect the model’s performance

What is the production possibilities frontier?

This shows the combination of outputs a society can produce if all of its resources are being efficiently used.

What do we do to preserve ceteris paribus?

We assume that the technology avaliable for production and the quantity of resources remain fixed or constant

What is the law of increasing opportunity cost?

This states that the opportunity cost of producing a good rises as a scoiety produces more of it.

What causes the PPF to shift up and outwards?

When more resources (or more workers) are avaiable for the production of either output the entire PPF shifts

What is specialization?

This is limiting of one’s work to a particular area.

What is an absolute advantage?

This refers to one producer’s ability to make more than another producer with the same quantiy of resources

What does specialization lead to?

Greater output

What is the short run?

We make decisions that reflect our immediate or short-term wants, needs or limitations.

What is the long run?

We make decisions over longer time horizon

What is consumer goods?

This is any good that is produced for present consumption

Examples of comsumer goods

Food, water, entertainment

What is capital goods?

This helps the production of other valuable foos and servies in the future

Examples of capital goods

Roads, facilities, trucks, computers

What are investments?

The process of using rsources ot create or buy new capital

Who determines the price of a good?

Buyer and seller

How do buyers set prices

through live auctions eg: ebay

How do sellers set prices?

adjust it based on well an item sells and how much inventory remains.

What is the market economy?

Resources are allocated among households and firms with little to no government interference

What is an invisible hand?

This guides resources to their highest-valued use.

Who coined the term invisible hand?

Adam Smith

What is a competitive marker?

This is where there are so many buyers and sellers that each has only a small impact on the market price and output

What is an imperfect market?

These are ones in which either the buyer or the seller can influence the market price

What gives sellers substantial pricing power

Specialized products

What is market power?

This is the firm’s ability to influence the price of a goods or service by exercising control over its demand, supply or both

What is a monopoly?

This is when a simply company sypplies the enitre market for a particular goods or service

What determines demand?

This exist when an indicual or group wants something badly enough to pay or trade for it.

What is the quantity demanded?

This is the amount of a good or service that buyers are willing and able to purchase at the current price

What is the law of demand

This states that there is a negative correlation between price and quantity demanded.

What causes a movement along a demand/ supply curve?

Price

What causes a shift in the whole curve

taste and preferance, changes in buyer’s income, the price of related goods, price expectations, the number of buyers, and taxes

What is the lalw of supply?

This states that there is a positive correlaton between price and quantity supplied

What is a demand schedule?

A table showing the relationship of the price and quantity demanded

What is a demand curve?

This is the graph that shows the relationship between the price in the demand schedule and the quantity demanded at those prices.

What is the market demand?

This is the sum of all the individual quanities demanded by each buyer in a market at each price

How does change in buyer’s income shift the demand curve?

When income increases, consumers have more money to spend. Demand for normal goods increase and inferior goods decrease

What are the two types of goods?

Normal goods, and inferior goods

What are complements?

These are two goods that are used together

What are subsitiutes?

These are two goods that are used in place of each other

How does taste and preference shift the demand curve?

When a style goes out of fashion the demand of it declines

How does price expectation shift the demand curve?

If the price is rumored to increase in the future, the current demand will increase

How does number of buyers shift the demand curve?

Market demand is the sum of all demand

What are the types of taxes?

Excise and Sales

What is excise taxes?

taxes on a single product or service

What is sales taxes?

taxes on a general taxes on most good and services

What is a subsidy?

This is a payment made by the government to encourage the consumption or production of a goood or a service. eg: tax break

What are some factors that can shift the supply curve?

the cost of input, change in tech or the production process, taxes and subsidies, the number of firms and price expectations

How does cost of input shift the supply curve?

As the cost of input rises, the firms would be less willing to supply

How does change in technology shift the supply curve?

improved technology would allow firms to supply more

How does number of firms shift the supply curve?

Each additional firm that enters the market increases the available supply of a good

How does price expectation shift the supply curve?

A seller who expects higher prices for a product in the future may wish to delay ales until the time comes

What is the equilibrium price?

The price at which the two curvees cross

What is another name for equilibrium price

market-clearing price

What is a shortage?

Otherwise known as excess demand occurs when the quantity supplied is LESS than the quantity demanded

What is a surplus?

Other known as excess supply occurs when the quantity supplied is MORE than the quantity demanded

How is shortages and surpluses resolved in a compeititve market?

Through a process of price adjustment

What is elasticity?

This is the responsiveness to a change in market conditions

What are some determinants of price elasticity of demand?

subsitutes, share of budget, necessity vs luxury goods, is the market broadly or narrowly defined, time and adjustment process

How does substitutes affect price elasticity?

Demand can be elastic or inelastic depending on the buyer’s preference

How does budget affect price elasticity?

demand is more inelastic for inexpensive items on sale

How does necessity vs luxury affect price elasticity?

Necessities are inelastic

How does market broadly vs narrowly defined affect price elasticity?

the more broadly we define a market for a good, the harder is to live without

How does time and adjustment process affect price elasticity?

immediate run- consumers have no time to adjust

short run- consumers have time to partially adjust

long run- consumers have enough time to fully adjust

Price of Elasticity =

% change in quantity demanded/ % change in price

What is the midpoint method?

change in Q + avg Q / change in P + avg P

Perfectly inelastic demand equals (Demand elasticity)

0

Relatively inelastic demand equals (Demand elasticity)

0 to 1