MACRO/MICRO exam 1

Basic Economic Concepts

• Scarcity → Limited nature of resources; choices must be made.

• Economics → Study of how society allocates scarce resources.

• Microeconomics → Study of individual decision-making and markets.

• Macroeconomics → Study of overall economy-wide phenomena.

• Trade-offs → Giving up one benefit to gain another.

• Opportunity Cost → The next best alternative given up when making a choice.

• Marginal Benefit → The additional benefit of consuming/producing one more unit.

• Marginal Cost → The additional cost of consuming/producing one more unit.

• Rational Decision Rule → Take action if marginal benefit ≥ marginal cost.

• Incentives → Factors that motivate individuals to act.

• Market Economy → Economy where supply and demand determine prices.

• Command Economy → Economy where government controls production/pricing.

Supply & Demand

• Law of Demand → When price increases, quantity demanded decreases.

• Demand Curve → Downward-sloping; shows inverse relationship between price & quantity demanded.

• Normal Goods → Demand increases as income increases (e.g., organic food).

• Inferior Goods → Demand decreases as income increases (e.g., fast food).

• Substitutes → An increase in price of one good increases demand for another (e.g., Coke vs. Pepsi).

• Complements → An increase in price of one good decreases demand for another (e.g., gas & cars).

• Law of Supply → When price increases, quantity supplied increases.

• Supply Curve → Upward-sloping; shows direct relationship between price & quantity supplied.

• Equilibrium Price (P)* → Where supply and demand intersect.

• Equilibrium Quantity (Q)* → Quantity bought and sold at P*.

• Shortage → Demand exceeds supply → Prices rise.

• Surplus → Supply exceeds demand → Prices fall.

• Shifts in Demand Curve:

  • Right Shift → Increase in demand (e.g., higher income, positive trends).

  • Left Shift → Decrease in demand (e.g., lower income, negative trends).

• Shifts in Supply Curve:

  • Right Shift → Increase in supply (e.g., technological advances, lower production costs).

  • Left Shift → Decrease in supply (e.g., higher input costs, natural disasters).

Elasticity & Consumer Behavior

• Price Elasticity of Demand (PED) → Measures responsiveness of demand to price changes.

  • PED Formula: (% Change in Quantity Demanded) ÷ (% Change in Price)

  • |PED| > 1 → Elastic Demand (consumers highly responsive to price changes).

  • |PED| < 1 → Inelastic Demand (consumers barely respond to price changes).

  • |PED| = 1 → Unit Elastic Demand (total revenue remains the same).

• Total Revenue Test →

  • If price ↑ & total revenue ↓ → demand is elastic.

  • If price ↑ & total revenue ↑ → demand is inelastic.

• Income Elasticity of Demand → Measures demand response to income changes.

  • Normal Goods → Positive YED (e.g., demand for luxury cars rises with income).

  • Inferior Goods → Negative YED (e.g., demand for ramen decreases with income).

• Cross-Price Elasticity of Demand → Measures demand response to the price change of another good.

  • Substitutes → Positive XED (Coke & Pepsi).

  • Complements → Negative XED (Gas & SUVs).

Elasticity of Supply

• Price Elasticity of Supply (PES) → Measures responsiveness of supply to price changes.

  • PES Formula: (% Change in Quantity Supplied) ÷ (% Change in Price)

  • PES > 1 → Elastic Supply (producers respond quickly to price changes).

  • PES < 1 → Inelastic Supply (producers respond slowly).

  • Perfectly Inelastic Supply (PES = 0) → Fixed quantity (e.g., limited stadium seats).

  • Perfectly Elastic Supply (PES = ∞) → Any price change leads to infinite supply response.

Market Efficiency & Government Intervention

• Consumer Surplus → Difference between the highest price a consumer is willing to pay and the price actually paid.

• Producer Surplus → Difference between the lowest price a seller is willing to accept and the price received.

• Deadweight Loss (DWL) → Lost total surplus due to market inefficiencies (e.g., taxes, price controls).

• Price Ceiling → Government-imposed maximum price (e.g., rent control, can lead to shortages).

• Price Floor → Government-imposed minimum price (e.g., minimum wage, can lead to surpluses).

• Tax Incidence → The burden of a tax is shared between buyers & sellers depending on elasticity.

  • More inelastic side of the market pays more tax.

• Subsidies → Government payments to encourage production or consumption.

Graphing Rules & Market Adjustments

• Demand Increase → Price ↑, Quantity ↑

• Demand Decrease → Price ↓, Quantity ↓

• Supply Increase → Price ↓, Quantity ↑

• Supply Decrease → Price ↑, Quantity ↓

• Both Demand & Supply Increase → Quantity ↑, Price ambiguous.

• Both Demand & Supply Decrease → Quantity ↓, Price ambiguous.

• Demand ↑ & Supply ↓ → Price ↑, Quantity ambiguous.

• Demand ↓ & Supply ↑ → Price ↓, Quantity ambiguous.

Production Possibilities Frontier (PPF)

• PPF Definition → Graph showing maximum possible production combinations of two goods.

• Points on PPF → Efficient use of resources.

• Points inside PPF → Inefficiency (unemployment, underutilization of resources).

• Points outside PPF → Unattainable with current resources.

• PPF Shifts Right → Economic growth (e.g., tech advancements, labor force growth).

• PPF Shifts Left → Economic decline (e.g., natural disasters, war, loss of labor force).

Market Structures & Government Policies

• Perfect Competition → Many firms, identical products, price-takers.

• Monopoly → Single seller, high barriers to entry, price-setter.

• Oligopoly → Few firms dominate, strategic interactions (e.g., airlines).

• Monopolistic Competition → Many firms, differentiated products, some pricing power (e.g., restaurants).

• Externalities → Costs or benefits affecting third parties (e.g., pollution, education).

  • Negative Externality → Causes overproduction; corrected with taxes.

  • Positive Externality → Causes underproduction; corrected with subsidies.