Econ Unit 1

Chapter 1

3 Basic Economic Questions:

1. What and how much will be produced?
   • ex. 2 pairs of airpods
2. How will items be produced?
   • ex. mechanized factory
3. For whom will items be produced?
   • ex. how is the product split between a number of people?

3 Types of Economic Systems

1. Centralized Command and Control Economic System
   • central gov answers economic questions
2. Price System
   • individuals/families own all resources
   • they choose how resources are used to produce goods
   • labor used to make stuff owned and managed by workers
   • factories owned by companies
   • workers determine how much will be produced
   • %%prices of resources and goods produced impact decision of individuals/families%%
3. Mixed Economic System
   • most common
   • either centralized system or individuals/families can answer economic questions

^^acting rational^^ - acting in one’s own self-interest and not taking decisions that would make one worse off

^^positive analysis^^ - identifies objective truths; describes how the world is; utilize economic models in this one

^^normative analysis^^ - imposes ethical/moral beliefs; describes how world should be

^^bounded rationality^^ - people are all nearly rational so cannot examine every possible choice so use simple rules of thumb to sort among alternatives

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Chapter 2

Graphing:

• points inside line = inefficient
• points outside line = not feasible

^^absolute advantage^^ - when one party can produce more of a certain service than the other

^^comparative advantage^^ - when one party can produce a service at a lower opportunity cost

• find which party has fewer slope

^^opportunity cost^^ - the value of what is being given up

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Chapter 3

%%law of demand%% - price up = buyers less; price down = buyers more

^^demand^^ - the schedule of all purchase plans for each possible price of the good

• change in demand = shifting entire demand curve
  • increase in demand = rightward shift
  • decrease in demand = leftward shift
• ^^normal goods^^ - income up = demand rises
• ^^inferior goods^^ - income up = demand falls
• change in demand depends on income, preferences, prices of related goods, expectations of future prices/incomes, market size

^^quantity demanded^^ - how many units consumers would plan to purchase at a particular price

• represented by a single point on demand curve
• change in quantity demanded = movement from one point to another point on the curve
• change depends on change in price of its own good/service

%%law of supply%% - high price = high quantity; low price = low quantity

^^supply^^ - the schedule of all supply plans for each possible price of the good

• change in supply = shifting entire supply curve

^^quantity supplied^^ - how many units suppliers plan to offer at a particular price

• single point on the supply curve
• change in quantity supplied = movement from one point to another point on the curve
• change depends on its own price changes and willingness of suppliers to produce a good/service

^^relative price^^ - a commodity’s price in terms of another commodity

^^money price^^ - the price you pay at any point in time

^^market clearing price^^ - price that has no surplus or shortage (equilibrium)

• ^^shortage^^ - quantity demand > quantity supply

• ^^surplus^^ - quantity demand < quantity supply

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^^complements^^ - price of smtg inversely affects demand of another

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Chapter 4

Price Controls:

%%price ceiling%% - the max price allowed in an exchange

• price ceiling below equilibrium = shortage
• rental rates held below equilibrium = property owners cannot recover maintenance costs

%%price floor%% - the min price below which a good/service may not be sold

• price floor above equilibrium = surplus
• gov has to buy surplus
• guarantees earnings for low-income farmers

Rent Controls:

• discourage construction of new rentals
• goal is to keep rent below levels usually observed

Minimum Wage Effects:

• higher minimum wage = unemployment increases

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Chapter 5

Advantages of a Price System:

• economic efficiency
• allows all resource to become high valued via voluntary exchange
• consumers have freedom to purchase whatever
• protects sellers from coercion by one consumer

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^^market failures^^ - where too few or too many resources go to specific economic activities

• prevent price system from reaching economic efficiency

^^externality^^ - a consequence of economic activity that spills over and affects third parties

• ex. benefits of vaccinations spill over and benefit others who interact with the vaccinated patient
• ex. cost or harm of vaping spill over and harm those who experience second hand smoke
• %%how can gov fix negative externalities?%%
  • special taxes
  • effluent/pollution tax: makes price = cost to society
  • regulation
  • max rate of pollution enforced
  • negative externalities = market yields too much at too low of a price
• %%how can gov fix positive externalities?%%
  • gov financing/production
  • if externality is big, gov can finance additional production facilities so “right“ amount is produced
  • regulation
  • gov requires by law individuals must take a certain action
  • subsidies
  • a negative tax/reimbursement
  • positive externalities = market under produces and under prices the good

Economic Functions of Government:

• correcting externalities
• providing a legal system
• promoting competition
  • ^^antitrust legislation^^ - laws that restrict the formation of monopolies and regulate certain anticompetitive business practices
  • ^^monopoly^^ - firm that can determine the market place of the goods they sell
• providing public goods
  • %%rival goods%% - a good where if one person consumes it the amount available for consumption by others is reduced
  • %%excludable goods%% - when suppliers can design a system to exclude non-payers
  • ^^private goods^^ are goods that are both rival and excludable
  • ^^public goods^^ - are goods that are neither rival nor excludable; can be consumed by multitudes of ppl
    • provision of these in market is problematic
    • no additional opportunity cost
    • %%free-rider problem%% - some ppl take advantage of the fact that others will assume the burden of paying for public goods
    • ex. if ppl taxed by how much they value national defense, ppl who say they don’t value are free riders
• ensuring economywide stability
  • full employment, price stability, econ growth

Political Functions of Government

• gov-sponsored and gov-inhibited goods
  • %%gov sponsored goods%% - any good gov deemed worthy of public support
  • ex. sport stadiums, museums, ballets, etc
  • %%gov inhibited goods%% - goods deemed by gov as undesirable for human consumption
  • ex. heroin, gambling, cigs
• income redistribution
  • ^^transfer payment^^ - payments made to ppl for which no services or good are rendered in return
  • ex. disability benefits, unemployment insurance benefits, etc
  • ^^transfer in kind^^ - payments in the form of actual goods and services
  • ex. food stamps

Healthcare Subsidies:

• patients pay deductible while gov pays the subsidies
• health-related spending is significant portion of total gov expenditures
• %%Medicare%% - provides subsidies to 65+ ppl’s hospital bills
  • upsurge in doctor incomes, med school applications, private for profit hospitals, proliferation of new med tests and procedures
  • medicare spending is growing faster than total employer/employee contributions → future spending guarantees outstrip the taxes collected to pay for the system
• %%Medicaid%% - provides subsidies for those who have lower incomes

Public Education:

• public schools provide services at price below market price with funds from taxpayers
• public spending on education has increased, while student performance has remained constant/declined

Markets and Collective Decision-Making:

%%collective decision making%% - area of econ that focuses on this is public choice; how politic decisions influence nonmarket decisions'

Similarities in market and public-sector decision

• opportunity cost

  • every gov action has an opportunity cost

• competition

• similarity of individuals

  • gov ppl face diff incentive structure

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Differences in market and public-sector decision

• gov goods/services at zero price
  • ^^gov/political goods^^ - goods provided by the public sector
• use of force
  • expropriation
• voting vs. spending
  • private = dollar voting system
  • political system = majority rule
  • market system = proportional rule

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Chapter 19

Price Elasticity of Demand:

%%price elasticity of demand (Ep)%% - measures the responsiveness of the quantity demanded to changes in the price of a good/service

• tells us the relative amount by which the quantity demanded will change in response to a change in the price of a particular good

• equation: % change in quantity demanded / % change in price

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^^elastic^^ - >1 percent change in quantity demanded; consumers are relatively responsive to price changes; inverse relationship between total revenue and market price

^^unitary elastic^^ - =1 percent change in quantity demanded; consumers are relatively unresponsive to price changes; total revenue never changes

^^inelastic^^ - <1 percent change in quantity demanded; doesn’t mean totally unresponsive; direct relationship

Extreme Elasticities:

%%perfectly inelastic demand/zero elasticity%% - 0 responsiveness to price changes; no matter the price quantity demanded remains the same

• graph is just vertical line

%%perfectly elastic demand/infinite elasticity%% - even a slight increase in price leads to 0 quantity demanded

• graph is horizontal line

Elasticity vs. Total Revenue:

1. multiply price and quantity demanded to find total revenue
2. use revenue to find elasticity
3. using that data, find at what happens to the total revenue when price increases and declines

Determinants of the Price Elasticity of Demand:

• existence and number of substitutes
  • more substitutes = greater price elasticity of demand
  • perfect substitute = infinity elasticity of demand
• share of a consumer’s total budget devoted to purchases of that commodity
  • greater part of budget spent on smtg = greater price elasticity of demand
• the length of time allowed for adjustment to changes in the price of commodity
  • longer price change persists = greater elasticity of demand
  • greater in long run

Cross Price Elasticity of Demand:

%%cross price elasticity of demand%% - responsiveness of the amount of an item demanded to the prices of related goods

equation:

• utilized to see if 2 products are substitutes or complements
• if substitute then positive
• if complement then negative
• if goods are unrelated than 0

Income Elasticity of Demand:

%%income elasticity of demand%% - the responsiveness of the amount of a good demanded to a change income

equation:

Price Elasticity of Supply:

%%price elasticity of supply%% - generally positive; the responsiveness of the quantity supplied of a product to a change in its price

equation:

Types of Supply Elastics:

• %%perfectly elastic supply%% - >1 percent increase; slight decrease in price = quantity supplied to 0
• %%perfectly inelastic supply%% - <1 percent increase; quantity supplied always remains the same
• %%unit-elastic supply%% - % change in quantity supplied = % change in price

longer time for adjustment = more elastic supply curve

Chapter 20

^^utility^^ - satisfaction \n ^^utility analysis^^ - analysis of consumer decision making based on utility maximization

%%marginal utility%% - change in total utility due to a change in the quantity of a good/service consumed

equation:

%%diminishing marginal utility%% - as additional units of a good/service are consumed, the extra benefit of each additional unit eventually declines after originally satisfaction increased

• ^^how to calculate marginal utility per $^^
  • marginal utility/price

%%consumer optimum%% - the choice of a set of goods/services that maximizes the level of satisfaction for the consumer subject to their limited income

• can only reach when set marginal utility per dollar spent on all goods/services equal
• if prices of 2 items consumed are 0 = individuals will consume each as long as marginal utility is positive
• individual with unlimited income will continue to consume goods until the marginal utility of each is equal to 0
  • no constraint on consumption

How to Attain the Consumer Optimum:

• consumer’s money income should be allocated so that the last dollar spent on each good purchased yields the same amount of marginal utility

equation:

Price Changes’ Influence on Consumer Optimum:

• amount purchased inverse to price
• if price decreases → ppl consume more
• %%substitution effect%% - tendency for ppl to substitute cheaper commodities for expensive ones
• %%principle of substitution%% - consumers shift away from goods that are higher priced and shift towards goods priced lower
• ^^purchasing power^^ - the value of money for buying goods
  • income same, price increased → purchase power falls
  • income same, price decreased → purchase power rises
  • aka ^^real income effect^^

Diamond Water Paradox

^^marginal utility^^ determines what ppl are willing to pay for a unit of a certain good

• total utility of water > total utility of diamonds
• marginal utility of diamonds > marginal utility of water
• diamonds sell at a higher price than mouth

Why Utility Analysis?

• belief that ppl behave rationally to put them better off supports utility analysis
• makes clear predictions abt how ppl adjust their consumption based of prices and incomes
• people claim “bounded rationality” supports utility theory better

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Chapter 21

%%economic rent%% - a payment for the use of any resource over and above its opportunity cost; minimum payment needed to call forth production of a resource

Land Rent:

• supply of land is completely inelastic
• quantity supplied = always the same

Allocation of Resources:

• economic rent allocated resources to their highest-valued use

Firms and Profits:

• ^^firm^^ - an organization that brings together factors of production (labor, land, physical capital, human capital, and entrepreneurial skill) to produce a product it hopes to sell at a profit

Organization of Firms -

1. %%proprietorship%%

   • makes up 2/3 of all firms in US
   • owned by single individual
   • usually small businesses
   • account for 4% of all business revenue
   • advantages
     • easy to form and dissolve
     • all decision-making power resides with proprietor
     • profit only taxed once
   • disadvantages
     • ^^unlimited liability^^ - where the personal assets of the owner of a firm can be deuces to pay off the firm’s debts
     • limited ability to raise funds
     • ends with death of proprietor leaving uncertainty for employees

2. %%partnership%%

   • business owned by 2 or more joint owners
   • less than 10% of all businesses
   • can earn 20x more revenue than proprietors
   • advantages
     • easy to form
     • limits cost of monitoring job performance
     • permits more effective specialization
     • subject only to personal taxation
   • disadvantages
     • unlimited liability
     • decision making = more costly
     • dissolution of partnership occurs when one leaves/dies → uncertain future

3. %%corporations%%

   • owners are shareholders
   • ^^limited liability^^ - personal property is shielded from claims by the firm’s creditors; shareholders have this
   • < 20% of all US firms
   • responsible for 80% of all business ventures in US
   • advantage
     • limited liability
     • corporation doesn’t cease to exist after owners cease to be owners
     • can raise large sums of financial capital
   • disadvantages
     • double taxation
     • after tax profits distributed to shareholders as dividends
     • ^^dividends^^ - payments that are treated as personal income and subject to personal taxation
     • problems with separation of ownership and control

   %%limited liability company%% - (LLC) offers limited liability of a corporation and tax advantages of a partnership

profit calculated by: total revenues - total cost

• ^^accounting profits^^ - total revenue - total explicit costs
• ^^economic profits^^ - total revenue - total explicit and implicit costs

Interest Rates’ Determinants:

• length of loan
• risk
  • more risky ppl pay more
  • creditworthy and collateral providers pay less
• cost of handling the loan
  • resources + time needed to provide loan

How to Find Present Value of a Future Payment:

Equation: PresentVt = FutureVt / (1+interest)^t

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