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What is Economics?
The study of the choices people make and the actions they take in order to make the best use of scarce resources in meeting their wants and needs.
How should you make an economic choice?
If the benefits of activity X are greater (>) than the costs, do activity X.
If the costs of activity X are greater than the benefits, do not do activity X.
thinking at the margin meaning
If the marginal benefits (X) are greater than the marginal costs, do X
What are the two branches of Economics?
microeconomics and macroeconomics
What is microeconomics?
The study of choices and actions of individual economic units such as households, firms, consumers, etc.
What is macroeconomics?
The study of the behaviour of the entire economy, including issues like unemployment, inflation, and changes in the level of national income.
What can the allocation of resources be evaluated on the basis of?
Efficiency, equity, and moral and political consequences.
What is efficiency?
Allocative efficiency is present when society's resources are so organized that the present value of net benefits (benefits minus costs) are maximized.
What is equity?
Distributing goods and services in a manner considered by society to be fair.
What is positive economics?
Positive economics involves a statement about what is. It can be tested by checking the statements against the observed facts. E.g., "if the prices of coffee rises, people will buy less coffee."
What is normative economics?
Normative economics involves a statement about what ought to be. It depends upon values and beliefs that cannot be tested. E.g., "Taxes should be used to redistribute income from high income groups to low-income groups."
What is economics as a science?
Economics is a social science that seeks to explain how people act. It uses models, theories, and assumptions.
What is a model?
A simplified description of the way things work. it is not a complete description of every detail but rather a simple description that covers a wide range of possibilities.
What is a neoclassical paradigm?
A framework that economists use for analyzing how the economy works.
What is correlation fallacy?
It is the incorrect belief that correlation implies causation, which is not true.
What is the post hoc fallacy?
An error of reasoning that a first event causes a second event because the first occurred before the second. From the latin phrase. Means "after this therefore because of this."
What is the fallacy of composition?
The incorrect belief that what is true for the individual be true for the group or the whole
What is the Production Possibilities Frontier (PPF)?
The production possibilities frontier is a graph that shows the combinations of goods that can be used when the factors of production are utilized to their full potential.
What is a PPF drawn for?
For a given level of the society's inputs (labor, natural resources, and capital) and for a given state of society's technology.
What is ceteris paribus?
Relevant factors or variables are held constant. "Holding all other things equal."
What points on the PPF are attainable?
Points on or inside the PPF are attainable
What points on the PPF are unattainable?
Points outside of the frontier are unattainable. Everything to the right of the curve is considered unattainable.
What does a PPF map out?
It maps out the economy's limits.
What else does a PPF illustrate?
Tradeoffs. If an economy operates at full employment on the PPF, producing more of one good requires producing less of the other.
What does a concave PPF indicate?
How opportunity cost rises due to diminishing returns. (increasing opportunity costs)
What does a linear PPF indicate?
Constant opportunity cost.
What is opportunity cost?
The loss of potential gain from other alternatives when one alternative is chosen. (what you give up to do something or purchase something).
What does opportunity cost represent?
The tradeoff required when an economy wants to increase its production of any single product.
What can economic growth be viewed as on the PPF?
An outward shift (right shift) of the PPF.
What are the 2 basic determinants of economic growth?
Expanding resources
Improving technologies
What are some reasons the curve would shift out?
Discovered more resources, capital accumulation (more machinery), technology, more labor (higher number of people/increasing population)
What are some reasons the curve would shift in?
Illnesses (pandemic), less labor, things that destroy capital or people, what your capable of producing.
What is the law of increasing costs?
In order to produce extra amounts of one good, society must give up ever increasing amounts of the other good. (giving up one good to get more of another)
What is Absolute Advantage?
A country or person has an absolute advantage over another country or person in the production of a good or service if it can produce it at a lower absolute cost.
What is comparative advantage?
the ability to produce a good at a lower opportunity cost than another producer
How do you determine which country has the absolute advantage?
For example, if haiti produces 16 cocoa and 20 coffee, and Dominican Republic produces 20 cocoa and 40 coffee, DR has the absolute advantage for both goods.
How do you figure out opportunity cost (which country has the comparative advantage)?
If you want to determine which country has the comparative advantage in producing coffee, you would go:
Haiti: cocoa (20)/coffee (40) = 0.5
DR: Cocoa (16) / Coffee (20) = 0.8.
Haiti has the comparative advantage in producing coffee. (lower opportunity cost).
What does trade allow countries to do?
Trade allows both countries to move beyond their production possibility frontiers.
What do we assume about individuals in economics?
We assume that individuals act as if motivated by self-interest and in a rational way.
What is a rationality assumption?
The idea that individuals do not intentionally make decisions that will leave them worse off.
What is a market economy?
An institution that enables buyers and sellers to interact and transact with each other.
What is a market economy also called?
A price system.
Who are the players in the market?
3 groups. Households, Firms, and Government
What is households?
The consumers of goods and services. Can also be the suppliers of some factors. It is also where capital originates. Their objective is to maximize satisfaction.
What is firms?
These are the producers of goods and services. They are also the demanders of factors of production. Their objective is to maximize profit.
What is government?
This includes all public officials and their objective is unknown.
What are the 4 main characteristics of market economies?
Self-interest
Incentives
Market prices and quantities
Institutions
What is self-interest?
individual's pursue their own self-interest. They buy and sell what seems best for them and their families.
What are incentives?
Rewards that influence your decisions. People respond to incentives. Can be good or bad.
What are market prices and quantities?
Prices and quantities are determined in open markets in which sellers compete to sell their products to buyers.
What are institutions?
All of these activities are governed by a set of institutions largely created by government. These institutions include: (a) Individualist institutions of property and decision making (b) Social institutions of trust (c) Infrastructure for smooth flow of goods and services (d) money as a medium of exchange
What is Individualist institutions of property and decision making?
Before people can begin to think about making an exchange, they must be clear about what belongs to whom. For decentralized exchange to take place, people must have individually held private property which is the ownership of assets by nongovernmental economic agents.
What is social institutions of trust?
Trust must exist between buyers and sellers. this trust may be established through cultural norms, direct one-to-one relationships, or through the establishment of contracts
What is infrastructure for the smooth flow of goods and services?
We need infrastructure for the market to do well. This refers to physical infrastructure of transportation and storage
What is money as a medium of exchange?
To facilitate the flow of goods and services, we need a generally accepted means of payment.
Is private property an institution?
YES.
What are the natures of private property and contractual obligations defined by?
Legislature and enforced by the courts.
when productivity increases
prices decrease
What is demand?
The demand function shows the quantity demanded of a good for different levels of the good's price given the values of other relevant variables.
What is quantity demanded?
the amount consumers are willing to buy given the price (and other variables)
What is the law of demand?
As a product's price increases, the quantity demanded decreases.
As a product's price decreases, the quantity demanded increases.
This inverse effect is known as ceteris paribus.
What causes a change in quantity demanded?
The only variable that causes a change in quantity demanded is a CHANGE IN PRICE $$.
How is a change is price depicted on the curve?
A movement along the curve.
In the market economy, there is a negative relationship between ....
Price and quantity demanded.
What is a demand curve?
a curve that shows the relationship between the price of a good and the quantity demanded. A graphical illustration of the law of demand.
What are the determinants of demand?
Tastes & Preferences
Income
Prices of related goods
The Number of buyers
Expectations
How does taste and preferences affect demand?
As preferences and taste changes, demand changes.
How does income affect demand?
Normal good: As income increases, demand for a normal good increases. As income decreases, demand for a normal good decreases.
Inferior good: As income increases, demand for an inferior good decreases. As income decreases, demand for an inferior good increases.
How do expectations affect demand?
The consumer's expectations of what will happen to the price of a good in the future may cause the demand curve to shift. For example, if the price of a good is expected to increase in the future, consumers may try to stock up on the commodity today.
How does Prices of related goods affect demand?
Substitutes and Compliments.
What are substitutes?
Two goods are substitutes if these goods satisfy the same needs and desires. (examples: butter & margarine, or tea & coffee).
If the price of a substitute increases (decreases), the demand for the original commodity shifts out (in) which corresponds to an increase (decrease) in demand.
What are compliments?
Compliments are products that tend to be used jointly (examples: coffee & cream or butter & bread).
If the price of a compliment increases (decreases), the demand curve for the original commodity shifts in (out), which corresponds to a decrease (increase) in demand.
How does the number of buyers affect demand?
This includes population and demographics. When the number of buyers increases (decreases), demand increases (decreases).
What is supply?
The amount of goods available. The supply function shows the quantity of a good supplied at different prices given the technology, the prices of the inputs and other relevant variables.
What is quantity supplied?
The amount producers are willing to sell during a given time period.
What is the law of supply?
As the price of a commodity increases (decreases), the quantity supplied increases (decreases) --> ceteris paribus.
What do changes in the commodity's price correspond to on the supply curve?
Movements along the supply curve, which are referred to as changes in quantity supplied.
What variables affect supply?
Costs of inputs
Technology and productivity
Number of firms
Taxes and subsidies
expectations
prices of substitutes in production
prices of compliments in production
Changes in nature
How does costs of inputs affect supply?
Wages, interest rates, opportunity costs, etc. As cost increases (decreases), the supply curve for the commodity shifts in (out) which corresponds to a decrease (increase) in supply.
How does technology and productivity affect supply?
A better, cheaper production technology allows the producer to supply more of the product at every price level, thus increasing supply.
How does the number of firms affect supply?
If the number of firms increases (decreases), supply increases (decreases).
How do taxes and subsidies affect supply?
Taxes are an addition to production costs and result in decreased supply.
How do expectations affect supply?
The producer's view or expectations of the future may change the current supply.
How do prices of substitutes affect supply?
Substitutes in production are goods that can be produced using the same inputs or input. If the price of a substitute in production for good X increases (decreases), the supply of good X decreases (increases)
What is an example of substitutes in production?
Suppose wheat and corn can be grown on the same land. Then if price of corn rises, farmers switch to corn, away from wheat and thus, the supply of wheat falls.
How do prices of compliments affect supply?
Compliments are products, which by the nature of production, are produced together (e.g., apple juice and apple sauce). When the price of a compliment in production for good X increases (decreases), the supply of good X increases (decreases).
How do changes in nature affect supply?
Natural events such as frosts, floods, hurricanes, can have significant impacts upon the supply of a product. Good weather can also change the supply of a product.
What is equilibrium?
Equilibrium is achieved in the market when the supply curve intersects the demand curve. With equilibrium, the quantity supplied = the quantity demanded.
At equilibrium, the market ___
Clears. That is, there is no surplus and no shortage.
What is comparative statics?
Comparing one equilibrium to another.
What does the market work like?
An invisible hand guiding economic forces to coordinate individual actions and allocate scarce resources.
How do the invisible hand and individuals correlate?
All individuals acting only in their self-interest are guided by the invisible hand of the market to produce allocations that are best for society.
what does the price/market system work better through?
It works better through rationed/scarce resources.
What are some reasons the market doesn't work smoothly?
information problems
other forces operating in society
sometimes markets fail
What are information problems?
people make mistakes. consumers and producers do not possess perfect information.
what are the other forces operating in society?
sometimes they prevent markets from operating. Such as, social and historical forces (such as tradition) can prevent a market from operating: the invisible handshake.
Political and legal forces: the invisible foot
Why do markets sometimes fail?
Something going wrong with prices.
If these economic forces work so well, why do we need governments?
To ensure activities and markets conform to social, cultural, legal, and political norms (the acceptable answer).
To correct markets that fail
What are price floors?
The government sets the minimum price. The lowest price a govt will let you charge; however, not the price you HAVE to charge. An example of this is minimum wage.
What is an effective price floor?
Price floor is effective when the equilibrium is below the price floor (the price floor is above the equilibrium).
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