Flashcards Economics: Key Concepts, Models, and Principles for Students

Economics

The study of how people make choices when resources are scarce.

Scarcity

The condition that exists because wants are greater than the limited resources available.

Economic way of thinking

Making decisions by comparing costs, benefits, incentives, and alternatives.

Cost-benefit principle

Take an action when its benefits are at least as great as its costs.

Opportunity cost

The value of the next-best alternative given up when making a choice.

Marginal principle

Compare the additional benefit of an action with its additional cost.

Marginal benefit

The additional benefit from one more unit of an activity.

Marginal cost

The additional cost from one more unit of an activity.

Optimal decision

Occurs where marginal benefit equals marginal cost.

If marginal benefit is greater than marginal cost

Do more of the activity.

If marginal cost is greater than marginal benefit

Do less of the activity.

Sunk cost

A cost that has already occurred and cannot be recovered.

Sunk cost principle

Sunk costs should not affect current decisions.

Rationality assumption

The assumption that people choose actions they believe will provide the greatest net benefit.

Efficiency

Using resources in a way that creates the greatest possible total benefit.

Economic model

A simplified representation of reality used to understand economic relationships.

Why economists use assumptions

To simplify complicated situations and focus on important relationships.

Ceteris paribus

All other relevant factors are held constant.

Incentive

Something that encourages or discourages an action.

Tradeoff

Giving up one thing to obtain another.

Comparative advantage

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

Absolute advantage

The ability to produce more of a good using the same amount of resources.

What determines comparative advantage

Lower opportunity cost.

What determines absolute advantage

Greater productivity or greater output.

Comparative advantage principle

Producers can gain when they specialize in goods they produce at lower opportunity cost.

Specialization

Concentrating production on the good for which a producer has comparative advantage.

Gains from trade

Benefits obtained when producers specialize and trade.

Production Possibilities Frontier

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

PPF

Abbreviation for Production Possibilities Frontier.

What does a PPF illustrate?

Scarcity, tradeoffs, opportunity cost, efficiency, and productive capacity.

Point on a PPF

Attainable and productively efficient.

Point inside a PPF

Attainable but inefficient.

Point outside a PPF

Currently unattainable.

Straight-line PPF

Represents constant opportunity cost.

Bowed-out PPF

Represents increasing opportunity cost.

Slope of a PPF

Change in the vertical-axis good divided by change in the horizontal-axis good.

Why is PPF slope usually negative?

Producing more of one good requires giving up some of the other good.

Opportunity cost from a PPF

The amount of one good sacrificed to produce more of another.

Opportunity cost of X

Amount of Y given up divided by additional X produced.

How are the opportunity costs of two goods related?

They are reciprocals.

How do you find comparative advantage?

Compare opportunity costs and choose the lower one.

Terms of trade

The rate at which one good is exchanged for another.

Mutually beneficial trade rate

A trade rate that falls between the two producers' opportunity costs.

Increasing opportunity cost principle

The opportunity cost of a good increases as more of that good is produced.

Why does opportunity cost increase?

Resources are specialized and are not equally productive in every use.

Economic growth

An increase in an economy's productive capacity.

Effect of economic growth on the PPF

Shifts the PPF outward.

Improved technology and the PPF

Usually shifts the PPF outward.

Increase in productive resources and the PPF

Usually shifts the PPF outward.

Loss of productive resources and the PPF

Can shift the PPF inward.

Labor

Human effort used in production.

Physical capital

Tools, equipment, buildings, and machines used in production.

Human capital

Knowledge, education, skills, and training that increase worker productivity.

Natural resources

Resources supplied by nature and used in production.

Entrepreneurship

The organization of resources and risk-taking involved in production.

Market

An arrangement in which buyers and sellers exchange goods or services.

Supply and demand model

A model used to determine market price and quantity.

Demand

The quantities consumers are willing and able to buy at different prices.

Quantity demanded

The amount consumers are willing and able to buy at one particular price.

Law of demand

When price rises quantity demanded falls, and when price falls quantity demanded rises, all else equal.

Demand schedule

A table showing quantities demanded at different prices.

Demand curve

A graph showing the relationship between price and quantity demanded.

Shape of a demand curve

Downward sloping.

Change in quantity demanded

A movement along the demand curve caused by a change in the good's own price.

Change in demand

A shift of the entire demand curve caused by a non-price determinant.

Own price changes for demand

Move along the demand curve.

Non-price changes affecting buyers

Shift the demand curve.

Increase in demand

Shifts demand right.

Decrease in demand

Shifts demand left.

Normal good

A good for which demand rises when income rises.

Inferior good

A good for which demand falls when income rises.

Income rises for a normal good

Demand shifts right.

Income rises for an inferior good

Demand shifts left.

Substitutes

Goods that can be used in place of each other.

Price of a substitute rises

Demand for the other good rises.

Complements

Goods that are commonly consumed together.

Price of a complement rises

Demand for the related good falls.

More buyers in a market

Demand shifts right.

Fewer buyers in a market

Demand shifts left.

Consumer preference for a product increases

Demand shifts right.

Expected future price increase

Can increase current demand.

Main determinants of demand

Income, tastes, number of buyers, prices of related goods, and expectations.

Price elasticity of demand

Measures how responsive quantity demanded is to a change in price.

Demand elasticity formula

Absolute value of percentage change in quantity demanded divided by percentage change in price.

Elastic demand

Quantity demanded changes by a greater percentage than price.

Inelastic demand

Quantity demanded changes by a smaller percentage than price.

Unit elastic demand

Quantity demanded changes by the same percentage as price.

Elasticity greater than 1

Elastic.

Elasticity less than 1

Inelastic.

Elasticity equal to 1

Unit elastic.

Perfectly elastic demand

Quantity demanded is extremely responsive to price.

Shape of perfectly elastic demand

Horizontal.

Perfectly inelastic demand

Quantity demanded does not respond to price.

Shape of perfectly inelastic demand

Vertical.

More substitutes and demand elasticity

Makes demand more elastic.

More time and demand elasticity

Makes demand more elastic.

Narrowly defined product and elasticity

Usually more elastic.

Broadly defined product and elasticity

Usually less elastic.

Necessities and elasticity

Tend to have more inelastic demand.

Luxuries and elasticity

Tend to have more elastic demand.