supa econ

SUPA ECONOMICS – COMPLETE IN-DEPTH NOTES

(Covers Introduction, Modeling Individual Choice, and Interdependent Choice & Market Coordination)

CHAPTER 1 — INTRODUCTION TO ECONOMICS

What Economics Is

Economics is a tool for analyzing a complex world.

Important ideas:

• It is not perfect

• It simplifies reality

• Economic theories evolve over time

Economics studies how people make choices under scarcity.

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MICRO vs MACRO ECONOMICS

Microeconomics

Microeconomics studies individual decision making.

Key questions:

• How do individuals make choices?

• How do markets coordinate those choices?

• What happens when markets fail?

Micro begins with individual choice under scarcity.

Macroeconomics

Macroeconomics studies the entire economy.

Major questions:

• What determines economic growth?

• Why do recessions happen?

• Why do unemployment and inflation occur?

• What is the government’s role?

Key policies:

• Monetary policy (central bank decisions)

• Fiscal policy (government spending and taxation)

• Trade policy

SCARCITY (FOUNDATION OF ECONOMICS)

Definition

Scarcity = unlimited wants but limited resources.

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Examples of scarce resources:

• Time

• Money

• Natural resources

• Labor

Because resources are limited, people must choose.

Choice

Whenever we choose one thing, we must give up another.

Example:
If you spend time studying, you give up time hanging out.

Opportunity Cost

Opportunity cost = the best alternative you give up when making a choice.

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Example:
If you go to college instead of working:

Opportunity cost =

• Tuition

• PLUS the salary you could have earned

Example calculation:

• College cost = $60,000/year

• Job salary = $30,000/year

Opportunity cost = $90,000

MARKETS

Markets help coordinate economic choices.

Example:
A grocery store market tells you:

• how much food costs

• how much people want to buy

Markets coordinate resources.

But markets can also be:

• inefficient

• unfair

• distorted

THE ROLE OF ASSUMPTIONS IN ECONOMICS

Why Economists Use Assumptions

The economy is too complex to analyze fully.

So economists simplify reality by making assumptions.

Definition:
Assumption = a simplified version of reality used to analyze a problem.

1 _ Introduction.pptx - Google …

Strong vs Weak Assumptions

Strong Assumptions

Very unrealistic but simple.

Example:

• no scarcity

• no risk

• no future

Advantages:

• easy to analyze

Disadvantages:

• unrealistic

Weak Assumptions

More realistic.

Advantages:

• better model of reality

Disadvantages:

• more complex

Relationship Between Assumptions and Models

Important rule:

Stronger assumptions → weaker model

Weaker assumptions → stronger model

Because weaker assumptions allow more realism.

CETERIS PARIBUS

Latin phrase meaning:

“All other things equal.”

Economists use it to isolate one variable.

Example:
If price rises, demand falls ceteris paribus
(assuming income and tastes stay constant).

SCARCE VS RARE

Important difference:

Rare:

• uncommon

• but demand might not exist

Scarce:

• desired

• limited supply

Example:

• A rare rock nobody wants is not scarce.

CHAPTER 2 — MODELING INDIVIDUAL CHOICE

This chapter studies how individuals make decisions.

The model begins with a simplified situation.

ROBINSON CRUSOE MODEL

Economists use a fictional example.

Robinson Crusoe lives alone on an island.

Characteristics:

• no other people

• no markets

• no trade

Therefore:

• his decisions are independent

Everything is coordinated in his own mind.

2 _ Modeling Individual Choice.…

BASIC ECONOMIC DEFINITIONS

Utility

Utility = satisfaction or happiness gained from consuming something.

2 _ Modeling Individual Choice.…

Example:
Eating pizza → gives utility.

Consumption

Consumption = using goods or services to gain utility.

Important note:
Consumption does not always destroy the good.

Examples:

Destroyed when consumed:

• food

• candy

Not destroyed:

• art

• music

Goods vs Services

Goods

Tangible items you can store.

Examples:

• food

• clothes

• electronics

Services

Intangible actions.

Examples:

• haircut

• education

• medical care

ASSUMPTIONS IN THE MODEL

Initial Strong Assumptions

1. No scarcity

2. No production required

3. No future

4. No risk

5. No interdependence

These simplify analysis.

2 _ Modeling Individual Choice.…

Maintained Assumptions

These remain true throughout the model.

1. Rational behavior

2. Utility maximization

3. Known preferences

RATIONAL BEHAVIOR

Economists assume people are rational.

Meaning:
People try to maximize utility.

They choose the option that gives the most satisfaction.

PREFERENCE ORDERING

People can rank choices.

Example:
You might prefer:

1. Pizza

2. Burgers

3. Salad

This ranking determines choices.

DIMINISHING MARGINAL UTILITY

Key concept.

Definition:

Each additional unit of a good provides less satisfaction than the previous unit.

2 _ Modeling Individual Choice.…

Example:

If you are very thirsty:

1st sip of water → huge satisfaction
2nd sip → still good
10th sip → little satisfaction

Eventually:

Marginal utility = 0

MARGINAL ANALYSIS

Economics focuses on the margin.

Margin = the next unit.

Example:
Should you eat one more cookie?

This is marginal decision making.

MARGINAL UTILITY

Marginal Utility (MU) = additional satisfaction from one more unit.

Example table:

Total utility increases, but MU decreases.

BLISS POINT

If goods are unlimited:

Optimal consumption occurs when

MU₁ = MU₂ = MU₃ = ... = 0

This means total satisfaction is maximized.

This state is called the bliss point.

But this only works if:

• no scarcity exists.

RELAXING THE NO-SCARCITY ASSUMPTION

In reality resources are scarce.

This creates constrained optimization.

New rule:

MU₁ = MU₂ = MU₃ = ... = MUn

But they won’t equal zero.

SCARCITY OF TIME

Often time is the limiting resource.

Decision rule becomes:

MU₁ / time = MU₂ / time = MU₃ / time

Meaning:
Maximize satisfaction per unit of time.

PRODUCTION

In reality goods must be produced.

Key concept:

Endowment

Endowment = all resources available to produce goods.

2 _ Modeling Individual Choice.…

FACTORS OF PRODUCTION

Inputs used to produce goods.

1. Natural resources

2. Labor

3. Capital

Capital

Capital = produced means of production.

Two types:

Physical capital

• machines

• tools

Human capital

• education

• skills

MARGINAL PRODUCTIVITY

Marginal Product (MP) = extra output from one additional input.

Example:
One extra worker increases production.

Eventually MP declines.

This is called diminishing marginal productivity.

VALUE OF MARGINAL PRODUCT (V)

Economists combine productivity and satisfaction.

Value of marginal product measures:

Utility gained from the last unit of work.

Formula idea:

V = MP × MU (conceptually)

OPTIMAL RESOURCE ALLOCATION

Decision rule:

V₁ = V₂ = V₃ = ... = Vn

Meaning:
Allocate time across activities so each produces equal value.

INTERTEMPORAL CHOICE (TIME)

Now we relax the no future assumption.

Intertemporal = across time.

Example choices:

• Spend money now

• Save money for later

DISCOUNTING THE FUTURE

People value present rewards more than future rewards.

Example:
$100 today > $100 next year.

This is called discounting.

2 _ Modeling Individual Choice.…

DISCOUNT RATE

Discount rate = how much someone prefers the present over the future.

Example:

If someone requires $150 in a year instead of $100 today:

Discount rate = 50%.

Higher discount rate → less willingness to wait.

PRESENT VALUE (PV)

Present value = current value of future benefits.

Example:
$150 next year might equal $100 today.

Decision rule becomes:

PV₁ = PV₂ = PV₃ = ... = PVn

RISK AND UNCERTAINTY

Risk

Outcome has a known probability.

Example:
10% chance of losing money.

Uncertainty

Outcome has unknown probability.

Example:
Random events with unknown likelihood.

EXPECTED PRESENT VALUE

With risk, decision rule becomes:

EPV₁ = EPV₂ = EPV₃ = ... = EPVn

Expected value adjusts for risk.

FACTORS THAT AFFECT CHOICE

People differ because of:

1. Preferences

2. Productivity

3. Discount rates

4. Risk perceptions

Therefore:
People make different decisions.

CHAPTER 3 — INTERDEPENDENT CHOICE & MARKETS

This chapter removes the final assumption:

No interdependence.

Now individuals interact in markets.

INTERDEPENDENCE

People depend on others for goods and services.

Why?

1. Finite resources

2. Increasing population

3. Human cooperation

Interdependence creates complexity but also benefits.

DIVISION OF LABOR

Division of labor = splitting production tasks.

Benefits:

1. Greater skill (practice)

2. Time savings

3. Innovation

This dramatically increases productivity.

3 Interdependent Choice and Mar…

ADAM SMITH PIN FACTORY

Example:

1 worker → 20 pins/day

10 workers specialized → 48,000 pins/day

Huge productivity increase.

SURPLUSES

Specialization causes people to produce more than they need.

Example:
A farmer produces extra food.

This surplus enables trade.

GAINS FROM TRADE

Trade allows everyone to benefit.

Each person specializes in what they do best.

This increases total production.

ABSOLUTE ADVANTAGE

Absolute advantage = producing something more efficiently than others.

Example:
Wayne produces more gun racks than Garth.

COMPARATIVE ADVANTAGE

Even if one person is better at everything, trade can still help.

Comparative advantage depends on opportunity cost.

Who gives up less?

That person should specialize.

COORDINATION SYSTEMS

Societies coordinate production in three ways.

1. Tradition

“Do things the way we always have.”

Advantages:

• stable

• predictable

Disadvantages:

• no innovation

• fragile

2. Command

Government decides production.

Example:
North Korea
USSR

Advantages:

• centralized planning

Disadvantages:

• inefficient

• limited choices

3. Free Markets

Individuals choose freely.

Markets coordinate decisions through prices.

THE INVISIBLE HAND

Adam Smith's idea:

Individual self-interest unintentionally benefits society.

Markets coordinate actions without central planning.

MONEY

Money evolved from barter.

Barter = direct exchange of goods.

Example:
Chair for candles.

Barter is inefficient.

FUNCTIONS OF MONEY

Money serves three roles.

1. Medium of exchange

2. Store of value

3. Unit of account

TYPES OF MONEY

Commodity money

• has intrinsic value

• example: gold

Fiat money

• has value because government declares it legal tender

SUPPLY AND DEMAND

Markets are represented by supply and demand curves.

Demand = desire to buy.

Supply = desire to sell.

LAW OF DEMAND

As price decreases → quantity demanded increases.

Demand curve slopes downward.

DEMAND FUNCTION

QD = D(p | shift variables)

Meaning:
Quantity demanded depends on price and other factors.

DEMAND SHIFT VARIABLES

Major ones:

1. Tastes

2. Income

3. Prices of related goods

Other variables:

• population

• expectations

SUBSTITUTES

Goods used in place of each other.

Example:
Coke and Pepsi.

Price of Coke rises → demand for Pepsi rises.

COMPLEMENTS

Goods used together.

Example:
Hot dogs and buns.

If hot dog price falls → demand for buns increases.

SUPPLY

Supply shows how much producers are willing to sell.

Supply curve slopes upward.

Higher price → more quantity supplied.

SUPPLY SHIFT VARIABLES

1. Input prices

2. Technology

3. Government policies

4. Number of producers

5. Expectations

MARKET EQUILIBRIUM

Equilibrium occurs when:

Quantity demanded = Quantity supplied.

At equilibrium:

• price stabilizes

• no surplus or shortage.

DISEQUILIBRIUM

Excess Supply (Surplus)

QS > QD

Result:
Price falls.

Excess Demand (Shortage)

QD > QS

Result:
Price rises.

MARKET SIGNAL

The key signal in markets is price.

People respond to price changes, not directly to each other.

CIRCULAR FLOW MODEL

Two key participants:

Individuals
Firms

Factor Market

Individuals sell:

• labor

• land

• capital

Firms buy these inputs.

Product Market

Firms sell goods and services.

Individuals buy them.

PERFECT COMPETITION

Ideal market condition where:

1. No market power

2. Equal access to information

3. Equal access to markets

4. No market failures

Under these conditions markets are efficient.

PARETO OPTIMALITY

A state where:

You cannot make someone better off without making someone else worse off.

This represents maximum efficiency.

MARKET FAILURES

Markets may fail when:

• pollution exists

• information is unequal

• markets do not form

MARKET POWER

Market power occurs when individuals or firms gain unfair advantages.

Examples:

• monopolies

• discrimination

This reduces efficiency.

KEY BIG IDEAS OF THE UNIT

1. Scarcity forces choices.

2. Opportunity cost measures the cost of choices.

3. Individuals maximize utility.

4. Marginal thinking guides decisions.

5. Markets coordinate individual choices through prices.

6. Specialization and trade increase productivity.

7. Under ideal conditions markets reach efficient equilibrium.