Unit 1 : Introduction to Economics

1.1 : Scarcity

• Economics : study of scarcity and choice

• Individual choice : given scarcity, individuals make decisions about what to do and not to do

• Scarcity : unlimited wants, limited resources (example : land)

• Positive statement : true statement (what is)

• Normative statement : opinionated statement  (what should be)

1.2: Resource Allocation and Economic Systems

• Market economy : individual producers and consumers decide what/how/and for whom to produce (limited government intervention)

• Command economy : publicly owned, a central authority will make decisions for production and consumption (has government intervention)

• Property rights : establish ownership and grants individuals the right to trade goods/services with each other

• Resources : anything that can be used to produce something else

• Factors of production :

  • land (natural resources),

  • labor (the effort of workers),

  • capital (all manufactured resources),

  • entrepreneurship (risk taking, innovation, and organization)

• Opportunity cost : value of the next-best alternative that you give up to make another choice

• Microeconomics : individuals/households/firms making decisions and how those decisions interact (ex : college vs. a job)

• Macroeconomics : behavior of the economy as a whole (ex: employment)

1.3: Production Possibilities Curve

• Production possibilities curve (PPC) : illustrates the trade-offs that faces an economy, compares only two goods

• Trade-offs : giving up something for something else

• If the PPC is linear, it has a constant opportunity cost, if it is curved, it has increasing opportunity costs

• Economic growth : a sustained rise in aggregate output and an increase in standard of living (causes are developments in technology, or an increase in resources)

• Productive efficiency : lowest cost possible on the PPC

• Allocative efficiency : the economy allocates resources so consumers are well off as possible, producing what is demanded

1.4: Comparative Advantage and Trade

• Trade : people split up the work, and provide each other with a good in return for another

• Comparative advantage : lower opportunity cost in the production of a good (you cannot have a comparative advantage in both goods)

• Absolute advantage : higher output

1.5: Cost-Benefit Analysis

• Terms of Trade : the rate at which one good can be exchanged for another (if the price of a good obtained from trade is less than the opportunity cost of producing it, trade is beneficial)

• Capital goods: goods that make consumer goods (ex. machinery)

• Consumer goods : goods that are consumed (ex. food)

1.6: Marginal Analysis and Consumer Choice

• Utility : the measure of personal satisfaction (util is a unit of utility)

• Marginal utility : the change in total utility by consumer one additional unit of that good/service

• Principle of diminishing marginal utility : additional units of a good/service add less total utility than the previous units do

• Marginal utility per dollar : MUgood/Pgood (marginal utility of one unit of the good / price of one unit of the good)

• Optimal consumption rule : to maximize utility, marginal utility per dollar spend on each good = service in consumption bundle, MUc/Pc = MUt/Pt

Unit 2  : Supply and Demand

2.1: Demand

• Demand is downwards sloping

• Law of demand : As price increases, demand decreases, and as price decreases, demand increases

• Movement along the curve : change in price

• Shifters of demand :

  • Tastes,

  • related goods (substitutes + complements),

  • income (normal + inferior goods),

  • (# of) buyers,

  • expectation of future prices

  • (TRIBE)

• Substitution effect : as the price of a good increases, consumers substitute the good with another that is cheaper

• Substitutes : good/service that can be used in place of another, when price of one increases, consumers will buy more of the other (ex. coffee and tea)

• Complements : goods/services that are consumed together (ex. hamburgers and buns)

• Income effect : as income increases, people will buy more of normal goods, and less of inferior goods

• Normal good : increase in demand when consumer’s income increases (ex. oreos)

• Inferior good : increase in demand when consumer’s income decreases (ex. off brand oreos)

2.2 : Supply

• Supply is upwards sloping

• Law of supply : as price increases, quantity supplied also increases

• Movement along the curve : change in price

• Shifters of supply :

  • input prices,

  • (price of) related goods/services,

  • (producer) expectations

  • , number of producers

  • , technology

  • (I-RENT)

2.3: Price Elasticity of Demand

• Equation : %∆Qd/%∆P

  • 0 = perfectly elastic, <1 = inelastic, =1 unit elastic, >1 = elastic

• Midpoint formula : Qd2-Qd1/(Q2d+Qd1)/2 , replace with Qd with price for price

• Inelastic demand : TR correlates direct with price

• Elastic demand = TR correlates inversely with price

2.4: Price Elasticity of Supply

• Equation : %∆Qs/%∆P

• 0 = perfectly elastic, <1 = inelastic, =1 unit elastic, >1 = elastic

• Inelastic : unable to respond to price change

• Elastic : short run

• Extremely elastic : long run

2.5: Other Elasticities

• Cross price elasticity of demand : %∆Qd of Good A/%∆P of good B

• negative = compliments, positive = substitutes

• Income elasticity of demand : %∆Qd/%∆income

• 1 = income elastic, <1 = income inelastic, negative = inferior, positive = normal

2.6: Market Equilibrium and Consumer and Producer Surplus

• Equilibrium : occurs when no one is better off doing something else

• Equilibrium = Qs=Qd

• 

• Price below the equilibrium is shortage

• Consumer surplus : price consumers are willing to pay - actual price

• Producer surplus : actual price -price the producer is willing to sell for

• Demand increase : price and quantity increase

• 

• Demand decrease : price and quantity decrease

• Supply increase : price decreases, quantity increases

• Supply decrease : price increases, quantity decreases

• Double shift : either price or quantity will be unknown

• Deadweight loss (DWL) : transactions that should occur, but don’t because of government intervention (calculate the area = triangle formula, ½(base x height)

2.7: Market Disequilibrium and Changes in Equilibrium + 2.8: The Effects of Government Intervention in Markets

• Shortage : Qs < Qd, price is lower than equilibrium

• Surplus : Qs > Qd, price is above equilibrium

• Price floor : minimum price a supplier can charge, price is set above equilibrium (causes shortage)

• Price ceiling : maximum price a supplier can charge, price is set below equilibrium (causes surplus)

• Double shift rule : when supply and demand both shift, either price or quantity will be unknown

• Quota : upper limit of a quantity that can be bought or sold (known as quantity control)

• License : gives an owner the right to supply a good/service

• Demand price : the price at which consumers will demand that quantity

• Supply price : the price at which producers will supply that quantity

• Quota rent : difference between demand price and supply price

2.9: International Trade and Public Policy

• Tariffs : tax placed on a good that is imported or exported

• Import quota : restriction on the quantity of a good that can be imported

Unit 3: Production, Cost, and the Perfect Competition Model

3.1: The Production Function

• Production function : relation between the quantity of inputs a firm uses and the quantity of output it produces

• Fixed input : an input whose quantity doesn’t change

• Variable input : an input whose quantity can change

• Long run : time period in which all inputs can be variable

• Short run : time period in which at least 1 input is fixed

• Marginal product : change in overall output when input changes

• Marginal product of labor (MPL) : ∆Q/∆L

• Diminishing marginal returns : as input increases, the output of each input will be less than the previous input

• Output : quantity produced

• Rental rate : price of capital

• Capital : goods that are used to produce goods/services

3.2: Short-Run Production Costs

• Fixed cost : cost that doesn’t change with amount of output produced (ex. oven)

• Variable cost : cost that changes with amount of output produced

• Total cost : fixed cost + variable cost

• Marginal cost : cost difference of one additional unit of output (∆TC/∆Q)

• Average fixed cost (AFC) : FC/Q

• Average variable cost (AVC) : VC/Q

• Average total cost (ATC) : TC/Q

3.3: Long-Run Production Costs

• Long run average total cost (LRATC) : same as short run ATC, but bigger

• Economies of scale : LRATC declines as output increases

• Diseconomies of scale : LRATC increaess as output increases

• Constant returns to scale : output increase directly in proportion to an increase in all inputs (ex. input doubles, output also doubles)

3.4: Types of Profit

• Economic profit : revenue - explicit cost - implicit cost, or accounting profit - implicit cost

• Accounting profit : revenue - explicit cost

• Implicit cost : not an actual cost, a cost that you could’ve been earning (ex. if you own a restaurant, the implicit cost would be the salary you would have earned as being a chef working in a different restaurant)

3.5: Profit Maximization

• MR = MC

• If you cannot have MR=MC, MR>MC

3.6: Firms’ Short-Run Decisions to Produce and Long-Run Decisions to Enter or Exit a Market

Short Run:

• Shutdown rule : as long as P > AVC, continue to produce

• If AVC > P : shutdown

• Firms can make profit or losses

Long Run :

• Exit rule : if P < ATC, exit the market

• Firms make normal profit ($0), unless monopoly or oligopoly

3.7: Perfect Competition

• Many firms, identical products, low/no barriers to advertisement

• Price takers

• Long run will have normal profit

• Short run can have either profit or loss

Unit 4: Imperfect Competition

4.1: Introduction to Imperfectly Competitive Markets

• Common barriers to entry : control of scarce resources, legal barriers, high startup costs

4.2: Monopoly

• Only producer of a good, has no close substitutes

• Downwards sloping demand curve

• Quantity is produced : @ MR = MC

• Price is : MR=MC, up to demand

• Supply curve : where MC > AVC

• Allocatively efficient due to them producing at MR=MC

• Productively inefficient because they don’t produce at the minimum of the ATC

• Natural monopoly : has large fixed costs, and long economies of scale, has downward sloping ATC curve

• Natural monopoly production point : MR=MC

• Government will correct by forcing them to set price : @ ATC=D

4.3: Price Discrmination

• To be able to price discriminate, you need market power

• Imperfect price discrimination : chargine consumers different prices based on the buyer’s willingness to pay

• Perfect price discrimnation : charges all consumers the maximum they are willing to pay, no deadweight loss, produce @ P=MC

• Example : resellers, coupons, bulk buying (costco), etc.

4.4: Monopolistic Competition

Characteristics

• Combines features of both a monopoly and perfect competition

• Many sellers and differentiated products

• Will use advertising to make demand more inelastic + differentiate product

• Makes profit in short run, normal profit in long run

• Allocatively inefficient (P does not equal MC)

• Productively inefficient (does not produce @ minimum of ATC, until long run)

• Downwards sloping demand curve

• Produce at MR = MC, price is MR = MC up to demand

Long Run

• Normal profit in long run

• Short run profits will attract new firms to join, which decreases the demand until the demand Curve is tangent to ATC, causing normal profits in long run

• In long run, they produce in region where economies of scales exist, because they produce in declining portion of ATC

4.5: Oligopoly and Game Theory

Oligopoly Characteristics

• Small number of firms, standard or differentiated product

• Interdependent : all the actions that a firm takes will affect the other firms in the oligopoly (if They ask why the market is an oligopoly, say it’s because they’re interdependent)

• Cartels : a group that agrees to control the price and output of a product (often form in oligopoly)

• Collusion : working together to maximize profit

• Graph is almost identical to monopoly (you will never be asked to draw them)

• Also produce same quantity and price of monopoly

Game Theory

• Payoff matrix : represents the payoff to each player to show combinations of given strategies

• Dominant strategy : the strategy that has a better payoff regardless of what strategy the opponent chooses

• Nash equilibrium : point where both players can do no better than the other given the choice of their opponent

Unit 5: Factor Markets

5.1: Introduction of Factor Markets

• Derived demand : the demand from a resource is derived by product demand

• Marginal revenue product (MRP) : the additional revenue that is generated by an additional resource/worker

• Marginal factor cost (MFC) : the additional cost of an additional resource/worker

• Least cost rule : marginal product of labor/price of labor = marginal product of capital/price of capital (MPL/PL=MPK/PK)

• Buy more of the one with a higher sum, and less of the one with a smaller sum (to explain, as you increase, diminishing marginal returns kicks in)

• 

5.2: Changes in Factor Demand and Factor Supply

• Shifters of demand for labor

  • Change in demand for the product

  • Change in the productivity of the resource

  • Change in price of substitutes and complements

• Shifters of supply for labor

  • # of qualified workers (ex. immigrants)

  • Government regulation

  • Leisure (causes supply to shift to left)

5.3: Profit-Maximizing Behavior in Perfectly Competitive Factor Markets

• Market curve : standard supply and demand curve

• Equilibrium wage in the market : establishes the wage that firms will pay workers

• MRP=MRC!!!!

• will not hire if MRC>MRP

5.4: Monopsonistic Markets

• Many sellers, one buyer

• Monopsonies pay a lower wage and hire less than perfect competition

• MRP=MFC

• MFC > supply

• example of imperfect competition

• 

Unit 6: Market Failure and the Role of Government

6.1: Socially Efficient and Inefficient Market Outcomes

• Socially efficiency is when resources are allocated effectively

• MSB=MSC !!

• Allocatively Efficient Points

  • Perfectly competitive market : S=D, MB=MC

  • Perfectly competitive firm : P=MC

  • Perfectly competitive labor market : W=MRP (total economic surplus : MSC=MSB)

• Causes of Market Failure

  • Market power (imperfectly competitive markets)

  • Asymmetric information (lack of info provided by buyers and sellers)

  • Positive and negative externalities

  • Insufficient production of public goods

• Government policies used to get rid of DWL

  • Taxes

  • Subsidies

  • Reguations

  • Public prodivions

• Market failure : exists when firms produce @ MPC=MPC, S=D

• The government tries to get them to produce @ MSC =MSB

6.2: Externalities

• Externality : when external cost/benefit is placed on members of society who did not pay for them

• MSB does not equal MSC

• Negative externality : when someone uses a product, it decreases the benefit of others (ex. smoking), MSC > MPC (correct with per unit tax)

• Positive externality : when one uses a product, others benefit  (ex. education) MSC < MPC (correct with subsidy)

6.3: Public and Private Goods

• Rivalrous good : if someone consumers a product, others cannot

  • Rivalrous : food, shoes, etc

  • Nonrivalrous : national defense, fireworks, etc

  • Somewhere in middle : schools, roads, etc

• Excludable good : non payers can be prevented from enjoying the benefits

  • Excludable : food, school, etc

  • Nonexcludable : national defense, air, etc

• Public goods : underproduced due to freeloader problem

• Examples : national defense, law enforcement, etc

• Freeloader problem : people can enjoy the benefit of a good/service without paying

• Government will provide subsidies to producers

• Private goods : goods produced by private markets, can be excludable

6.4: The Effects of Government Intervention in Different Market Structures

• Causes of inefficient markets

  • Market power

  • Externalities

  • Nonrival and nonexcludable goods (public goods)

• Forms of government intervention

  • Taxes

  • Subsidies

  • Price floors/ceilings

  • Regulation

• Per unit subsidy : gives benefits per unit

  • Perfect competition : MC, ATC, AVC decreases, price doesn’t change (price taker)

  • Monopolistic competition : MC, ATC, price decreases (price maker @ MR=MC)

• Lump sum subsidy : gives benefit no matter how many units

• Taxes will always shift supply curve to the left in long run, profits decrease

• Per unit tax : increase MC, ATC, and AVC

  • Perfect competition : MC, ATC, AVC increases, price doesn’t change (price taker)

  • Monopolistic competition : MC, ATC, price increases (price maker @ MR=MC)

• Lump sum tax : only increase ATC

• won’t change output level

• Non price regulation : works like taxes, they ensure competition/environmental protection/health and safety

• Antitrust policy : promote competition and prevents monopolies

• Antitrust laws

  • Lawsuits

  • Price controls

  • Subsidies

• Price ceiling : sets minimum price

  • Perfect competition : causes shortage

  • Monopolistic competition : becomes MR curve, price and output decreases

• Price floor : sets maximum price

  • Perfect competition : leads to surplus

  • Monopsony : wages go up and workers go up

6.5: Inequality

• Income distribution : measures % of income that goes to individuals in different percentiles/brackets

• In a system with perfectly equality : everyone would receive equal shares of income

• Income : wages, rent, interest, profit

• Lorenz curve : measures the distribution of income equality  (you want to be as close of possible to the perfect equality line as possible)

• 

• Gini coefficient : A/(A+B)

  • Closer to 0, more equality

  • Closer to 1, the more inequality

• Causes of income inequality

  • Supply + demand in labor market

  • Human capital

  • Discrimination

  • Inheritance

  • Bargaining power

  • Etc

• Policies to address inequality

  • Taxes + transfers

  • Minimum wage laws

  • Anti-poverty program

  • Income protection program

  • Scholarships

• Taxes :

  • Proportional : everyone pays the same percentage of their income (no impact on income distribution)

  • Progressive : taxes are higher % on people earning a higher income (reduces income inequality)

  • Regressive : taxes are lower % on people earning a higher income (increases income inequality)