Key Concepts in Economics: Demand, Supply, and Utility

Rational consumers and firms

Weigh costs and benefits to make the best decisions.

Example of rational decision-making

Apple chooses iPhone prices to maximize profit.

Economic incentives

Actions change as incentives change.

Examples of economic incentives

Cash for Clunkers program, COVID-19 stimulus checks.

Unintended consequences of incentives

Changes to the Federal Student Loan Program may incentivize colleges to increase tuition.

Opportunity for borrowing

Students might borrow more, knowing they may not have to repay it all.

Optimal decisions at the margin

Most decisions involve doing a little more or less of something.

Marginal cost (MC)

The additional cost of a small amount extra of some action.

Marginal benefit (MB)

The additional benefit of a small amount extra of some action.

Marginal analysis

Comparing marginal benefits and marginal costs.

Economic questions every society must answer

What goods and services will be produced? How will the goods and services be produced? Who will receive the goods and services produced?

Scarcity leads to trade-offs

Producing more of one good or service means producing less of another.

Trade-off

The idea that, because of scarcity, producing more of one good or service means producing less of another good or service.

Opportunity cost

The highest-valued alternative that must be given up to engage in an activity.

Example of opportunity cost

Increased space exploration funding might mean less funding for cancer research.

Different production methods

Example 1: Music production: Hire a great singer vs. using Auto-Tune. Example 2: Manufacturing: Use more machines or move to a location with cheaper labor.

Distribution of goods and services

In the U.S., people with higher incomes obtain more goods and services.

Tax and welfare policies

Affect income distribution, leading to debates about the desirability of redistribution.

Centrally planned economy

The government decides how economic resources will be allocated.

Market economy

Decisions of households and firms determine the allocation of economic resources.

Mixed economy

Most economic decisions result from the interaction of buyers and sellers in markets, but the government plays a significant role in the allocation of resources.

Productive efficiency

Every good or service is produced at the lowest possible cost.

Allocative efficiency

Production is in accordance with consumer preferences; every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

Voluntary exchange

A situation that occurs in markets when both the buyer and the seller of a product are made better off by the transaction.

Caveats of market efficiency

Markets may not immediately be efficient. Governments might interfere with market outcomes. Market outcomes might ignore the desires of people not involved in transactions, like avoiding pollution.

Equity

The fair distribution of economic benefits.

Trade-off between efficiency and equity

Policies that promote equity, such as income taxes, may reduce efficiency by discouraging work and investment.

Economic models

Economists use models to analyze economic events and government policies.

Steps to build an economic model

Decide on assumptions. Formulate a testable hypothesis. Use economic data to test the hypothesis. Revise the model if it fails to explain the economic data well.

Behavioral assumptions in economic models

Consumers maximize well-being. Firms maximize profits.

Hypothesis

A statement about an economic variable that may be correct or incorrect.

Economic variable

Something measurable that can have different values, such as the number of people employed in manufacturing.

Causal relationships in economics

Most economic hypotheses are about causal relationships.

Statistical methods in economics

Used to evaluate hypotheses using relevant data.

Causal relationships

Most economic hypotheses are about causal relationships.

Statistical methods

Statistical methods are used to evaluate hypotheses using relevant data.

Causality

Difficult to establish causality.

Economic model

Economists accept and use an economic model if it leads to hypotheses that are confirmed by statistical analysis.

Positive analysis

Analysis concerned with what is.

Normative analysis

Analysis concerned with what ought to be.

Economics as a social science

Economics as a social science studies individuals' actions and how they affect outcomes.

Economic analysis

Governments use economic analysis for policy decisions.

Tariff

Economic theory can identify winners and losers from a tariff.

Microeconomics

The study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices.

Macroeconomics

The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth.

Economic Skills

Economists can describe how choices are made, explain the consequences, and advise on better decisions.

Economics majors

Economics majors develop decision-making skills and earn higher-than-average incomes.

Self-selection

Future high earners may be more attracted to fields like economics.

Technology

The processes a firm uses to produce goods and services.

Capital

Manufactured goods that are used to produce other goods and services.

Graphs and formulas

Graphs and formulas help analyze economic situations.

Time-series graphs

Time-series graphs can be influenced by truncated scales.

Slope of a line

Change in value on the vertical axis divided by the change in value on the horizontal axis.

Percentage change formula

\text{Percentage change} = \frac{\text{Value in the second period} - \text{Value in the first period}}{\text{Value in the first period}} \times 100

Area of a rectangle

\text{Area} = \text{Base} \times \text{Height}

Area of a triangle

\text{Area} = \frac{1}{2} \times \text{Base} \times \text{Height}

Rationality

People make decisions using available information to achieve their goals.

Market

A group of buyers and sellers of a good or service facilitating trade.

Obesity

Obesity is linked to diseases like heart disease and diabetes, posing a major health problem.

Body Mass Index (BMI)

Used to measure weight relative to height; a BMI of 30 or more indicates obesity.

Obesity rates

Have increased significantly; explanations include high-calorie diets, lack of exercise, and less physical activity in jobs.

Health insurance and weight

May create an incentive to gain weight by reducing the costs of obesity.

BMI increase by insurance type

Research indicates people with health insurance are more likely to be overweight; private insurance increased BMI by 1.3 points, while public insurance increased it by 2.3 points.

BMI formula

The formula for calculating BMI is: BMI = (Weight \, in \, pounds/Height \, in \, inches^2) \times 703

Questions societies must answer

What goods and services will be produced? How will the goods and services be produced? Who will receive the goods and services produced?

Income in a market economy

Determined by payments for what one sells; higher training and longer hours generally result in higher income.

Inefficiency causes

Can arise from government interference or environmental damage.

College Football Attendance

Declining attendance is attributed to rising ticket prices and increased opportunity costs.

Opportunity cost of attending games

Includes ticket price plus the value of alternative activities.

Steps to develop a model

Decide on assumptions, formulate a testable hypothesis, test hypothesis with economic data, revise the model if it fails, retain the revised model.

Economics

Analyzes choices made by individuals, businesses, and governments.

Production Possibilities Frontier (PPF)

A curve showing the maximum attainable combinations of two goods that can be produced with available resources and current technology.

Increasing Marginal Opportunity Costs

Some resources are better suited to one task than another; the more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity.

Economic growth

The ability of the economy to increase the production of goods and services, represented by shifts in the PPF.

Trade

The act of buying and selling.

Absolute advantage

The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources.

Comparative advantage

The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors.

Graphs

Simplify and concretize economic ideas.

Types of graphs

Bar graphs, pie charts, and time-series graphs.

Coordinate grids

Have vertical (y-axis) and horizontal (x-axis) axes.

Slope

Indicates how much the y-axis variable changes as the x-axis variable changes.

Slope formula

Measured as slope = \frac{\Delta y}{\Delta x}, also known as rise over run.

Nonlinear curves

Few relationships are linear, but linear approximations can be useful.

Slope of a tangent line

Measured by the slope of the tangent line at a point on a nonlinear curve.

Area of a rectangle formula

Base \times Height

Area of a triangle formula

\frac{1}{2} \times Base \times Height

Summary of using formulas

Understand the economic concept, use the correct formula, ensure the result is economically reasonable.

Points on the PPF

Attainable.

Points below the PPF

Inefficient.

Points above the PPF

Unattainable with current resources.

Households

Individuals who provide factors of production (labor, capital, natural resources, etc.).

Firms

Entities that purchase factors of production from households and use them to create goods and services.

Labor

All types of work.

Natural Resources

Land, water, oil, iron ore, etc.

Entrepreneurial Ability

The ability to bring together the other factors of production to successfully produce and sell goods and services.

Factor Market

A market for the factors of production.

Product Market

A market for goods or services.

Circular-flow Diagram

A model that illustrates how participants in markets are linked.

Free Market

One with few government restrictions on how a good or service can be produced or sold, or on how a factor of production can be employed.

Market Mechanism

Markets with flexible prices allow the collective actions of households and firms to signal the relative worth of goods and services.