microeconomics
Microeconomics: study of the economy at the small scale level.
Typically deals with individual households and markets
Ex: how imports and exports affect one market
Macroeconomics: study of the economy at the large scale level.
Entire economy of a state, country, or even the world.
Ex: total imports and exports and how they affect the economy.
Economics: study of how individuals and society’s allocate scarce resources among many competing uses.
→ looking at the benefits vs. the costs (you always want to make yourself better off)
→ if the marginal cost is greater than the marginal benefit don’t do it
→ if the marginal benefit is greater than the marginal cost do it
Resource: the inputs used to produce goods and services; also known as factors of production.
Land: all natural resources (except human resource)
Labor: all physical and mental activity devoted to producing goods and services → workers
Capital: the tools, machinery, infrastructure, and knowledge used to produce goods and services
Entrepreneurial ability: the talent or ability to combine land, labor, and capital to product goods and services → the managerial, organization and business skills
Money is NOT a resource
Scarcity: the condition in which wants are greater than the limited resources available to satisfy those wants
Scarcity will always exist.
Scarcity affects everyone
Relative scarcity compares the scarcity of one thing relative to that of another
Scarcity forces us to make choices about how we allocate our resources
Every time you choose to use resources for one activity, you are choosing not to use them for another activity
The activity or opportunity you gave up is the cost of your choice.
Relative scarcity: the comparison of the scarcity of one good, service, or resource to that of another.
Allocation: the process of assigning a good, service, or resource to one use instead of another.
Opportunity Cost: the value of the best alternative that you did not select.
What you gave up or sacrificed when you made your decision.
Opportunity costs exist because of scarcity
Notice that opportunity cost does not require a monetary expenditure, just a sacrifice.
There is no reason to expect the opportunity cost of a decision will be the same for everyone.
Example of Opportunity Cost: your friends are taking you somewhere for your birthday. You chose between going to the city for some nightlife or going into the mountains to go skiing → the opportunity cost is the benefits that couldn’t come from the other option
Rational Decision Making: When making choices, people will attempt to maximize their well being or happiness.
3 key concepts of rational decision making:
Self-interest: idea that people choose to do things that provide them some benefit.
Every decision has a cost
Every decision has a benefit.
Marginal decision making: process of making choices in increments by evaluating the marginal benefit against the marginal cost of an action
Marginal benefit is the additional benefit associated with one or more unit of an activity
Marginal cost is the additional cost associated with one or more unit of an activity
Optimization: people make choices in order to maximize the overall benefit, or utility, of an action subject to its cost
Maximum cost = maximum benefit
Assuming that people behave rationally does not mean that they never make mistakes.
The moment a choice is made, the decision maker believed it was the best choice available
The information that is available when making the decision is a key component
The decision-makers expectations is a key component
Marginal benefit and Marginal cost:
The marginal benefit of the next unit of a good or service consumed will decrease
As more of a good or service is consumed in a given period of time, the smaller the
Marginal benefit is that change in the total benefit divided by the change in quantity consumed
MB= Change in Total Benefit/Change in Quantity
Usually the marginal cost of the next unit produced will increase
As more of a good or service is produced in a given time period, the higher the cost of producing each additional unit
Marginal cost is the change in total cost divided by the change in the quantity produced
MC= change in total cost/change in quantity
Marginal analysis is the foundation of economic reasoning
Changes in the marginal benefits or marginal costs associated w/ an action will most likely change the behavior of those involved
It is important to have a good understanding of the marginal benefits and marginal costs that people face and how they respond to them
When marginal benefit = marginal cost, there is no incentive to either increase or decrease your level of activity; that is the equilibrium or optimal level of activity
Optimal level occurs when MB=MC
If MB > MC, the benefits are greater than the costs and you should expand your activity
You have too little
If MB < MC, the benefits are less than the costs and you should reduce your activity
You have too much
Positive analysis: based on facts- what it is
Ex: efficiency
Normative analysis: based on opinions- what it should be
Ex: equity
Production possibilities frontier: a graph that shows the possible combinations of two different goods or services that can be produced with fixed resources and technology. The PPF shows the production combinations that are both attainable and efficient.
Downward sloping → tradeoff
The line represents the limit of what we can produce →
anything to the right and outside of the line is impossible to produce
Anything to the left and inside/on the line is possible to produce
To make choices better in the future..
Constant opportunity costs: a characteristic of production whereby the opportunity cost associated with increasing the production of one good or service, in terms of another, is constant at every level of production.
To calculate opportunity cost, find the slope of the PPF using both end points.
Efficient allocation of resources: allocation of resources in such a way that is possible to increase the production of one good only by decreasing the production of another.
Inefficient allocation of resources: allocation of resources in such a way that it is possible to increase the production of one good without decreasing the production of another.
Comparative advantage: the ability to produce a good or service at a lower relative opportunity cost than that of another producer.
Given the option of being self-sufficient or trading with others, as long as the comparative advantage exists, there will be potential for trade to make both parties better off.
Specialization: the practice of using available resources to produce a single good or service rather than producing multiple goods or services.
When all else is held constant, if the demand for the good or service you produce decreases, its price and your income will decrease too.
Terms of Trade: the price of one good, service, or resource in terms of another.
Producer: the price must be greater than the opportunity cost of the seller or producer of the item to make them better off.
Consumer: the price must be less than the opportunity cost of the buyer or consumer of the item to make them better off.
The terms of trade must be between the opportunity costs of the buyer and seller.
Gains from trade: the benefit, or wealth, that accrues to a buyer or seller as a result of trading one good, service, or resource for another.
The wealth, or additional well-being, created by trade does not have to be monetary.
Law of increasing opportunity cost: a principle in economics that holds that because some resources are better suited to producing one good or service than another, as the production of a good or service increases, the opportunity cost of each additional unit rises.
Circular flow model: a model that concisely describes how goods, services, resources, and money flow back and forth in an economy.
Market: any place where, or mechanism by which, buyers and sellers interact to trade goods, services, or resources.
Good: tangible product that consumers, firms, or governments wish to purchase
Service: an intangible product or action that consumers, firms, or governments wish to purchase
Resource: the inputs used to produce goods and services; also known as factors of production.
Resources fall into the 4 categories → land, labor, capital, and entrepreneurial ability.
In most markets prices are determined by interactions of numerous buyers and sellers
Competition between suppliers tends to drive prices down as sellers compete with each other to attract as many buyers as possible.
Competition between buyers tends to drive prices up as they compete for the scarce goods and services available to purchase.
Law of demand: a principle in economics that states that as the price of a good, service, or resource rises, the quantity demanded will decrease, and vice versa, all held constant.
If you lower the price of something, the law of demand states that more people will be willing to buy it and the demand will increase.
Demand schedule: a tabular representation of the relationship between the price of a good, service, or resource and the quantities consumers are willing and able to buy over a fixed period of time, all else held constant.
Demand curve: graphical representation of the relationship between the price of a good, service, or resource and the quantities consumers are willing and able to buy over a fixed period of time, all else held constant.
Quantity demanded: the quantity of a good, service, or resource that consumers are willing and able to buy at a given price.
Income effect: the effect that a change in the price of a good, service or resource has on the purchasing power of income
When price decreases, the purchasing power of income increases and consumers are able to purchase more.
Substitution effect: the effect that a change in the price of a good, service or resource has on the demand for another.
An increase in the price of one good will increase the demand for its substitutes.
Diminishing marginal utility: the negative relationship between the quantity of a good, service or resource and the marginal utility obtained from each additional unit consumed in a given period of time.
Market demand: the overall demand for a good, service or resource.
It represents the horizontal summation of the quantities demanded by individuals, firms, states, or even nations at each price over a fixed time period, all else held constant.
A change in demand for a given asset in one country will change total global demand, which changes asset prices around the world.
Change in demand: change in the quantity of a good, service or resource demanded at every price.
An increase in demand is represented by a rightward shift of the demand curve
A decrease in demand is represented by a leftward shift of the demand curve
Movement along the demand curve: a change in the quantity of a good, service or resource demanded due to change in its price.
This change is represented as a movement along an existing demand curve
Normal good: a good for which there is a direct relationship between the demand for the good and income.
An increase in income increases demand, and a decrease in income decreases demand; a good with a positive income elasticity of demand.
Inferior good: a good for which there is an inverse relationship between the demand for the good and income.
An increased income decreases demand, a decrease in income increases demand; a good with a negative income elasticity of demand.
Tastes and preferences: the perception of the desirability associated with consuming a good, service, or resource.
Buyers: market participants who seek to obtain goods, service, and resources.
Expectations: the anticipation by individuals and firms of costs and benefits that lie in the future.
Substitutes: goods, services, or resources that are viewed as replacements for one another.
Ex: margarine is a substitute for butter in cooking
Complements: goods, services, or resources that are used or consumed with one another.
Ex: peanut butter + jelly
Law of supply: As the price of a good, service or resource rises, the quantity supplied will increase, and vice versa, all else held constant.
Diminishing marginal productivity: if at least one input of production is fixed, the marginal productivity of additional variable resources will eventually fall, all else held constant.
Supply schedule: tabular representation of the relationship between the price of a good, service, or resource and the quantities producers are willing and able to supply over a fixed time period, all else held constant.
Supply curve: a graphical representation of the relationship between the price of a good, service, or resource and the quantities producers are willing and able to supply over a fixed time period, all else held constant.
Quantity supplied: the quantity of a good, service, or resource that producers are willing and able to supply at a given price.
Market supply: the overall, or total, supply of a good, service, or resource. It represents the horizontal summation of the quantities supplied by individuals, firms, states, or even nations at each price over a fixed time period, all else held constant.
Shift in supply: a change in the quantity of a good, service, or resource supplied at EVERY PRICE.
Graphically, an increase in supply is represented by a rightward shift.
Decrease in supply is represented by a leftward shift.
Movement along the Supply Curve: a change in the quantity of a good, service, or resource supplied due to a CHANGE IN PRICE.
Graphically, this change is represented as a movement along an existing supply curve.
Subsidy: a payment made by the government that does not necessarily require an exchange of economic activity in return.
Often take the form of payments to businesses
Tax: a payment made to the government that is the result of economic activity.
Generally collected from both individuals and firms
Resources: the inputs used to produce goods and services; also known as factors of production.
Fall into one of 4 categories:
Land, labor, capital, and entrepreneurial ability
Technology: the knowledge, inventions, and innovations that can potentially increase resource productivity.
Sellers: market participants who are willing and able to sell goods, services, or resources.
Seller expectations: the anticipated future outcomes, including prices, that sellers associate with the production of a good, service or resource.
Equilibrium Price: the price at which the quantity supplied of a good, service, or resource equals the quantity demanded; the price at which the demand and supply curves intersect. (aka market-clearing price)
When both demand and supply change simultaneously.. We can determine the effect on either price or quantity- but not both
Price is equal to both marginal benefit and marginal cost
Equilibrium Quantity: the quantity traded when the quantity supplied of a good, service, or resource equals its quantity demanded.
Quantity Supplied = Quantity Demanded
Qs = Qd
Shortage: the quantity demanded is greater than the quantity supplied at the current market price. Also called excess demand
Shortage = Qs - Qd < 0
Incentive for buyers to increase supply
Surplus: the quantity supplied is greater than the quantity demanded at the current market price. Also called excess supply.
Surplus = Qs - Qd > 0
Price decreases
Non Price Determinant (Demand): a characteristic of the demand for a good, service, or resource other than its own market price. A change in a non price determinant of demand changes the relationship between price and quantity demanded, either increasing or decreasing quantity demanded at every price. Sometimes referred to as a non-own-price determinant.
Change (shift) in Demand: a change in the quantity of a good, service, or resource demanded at every price. Graphically, an increase in demand is represented by a rightward shift of the demand curve, while a decrease is represented by a leftward shift of the demand curve.
Non price Determinant (Supply): a characteristic of the demand for a good, service, or resource other than its own market price. A change in a non price determinant of demand changes the relationship between price and quantity supplied, either increasing or decreasing quantity supplied at every price. Sometimes referred to as a non-own-price determinant.
Change (shift) in Supply: a change in the quantity of a good, service, or resource supplied at every price. Graphically, an increase in supply is represented by a rightward shift of the supply curve, while a decrease is represented by a leftward shift of the supply curve.
Price Ceiling: a maximum legal price at which a good, service, or resource can be sold.
Non Binding Price Ceiling: a maximum legal price that is set below the existing equilibrium price. Because the market equilibrium price is lower than the price ceiling, the ceiling has no effect on the market and is said to be nonbinding.
Binding Price Ceiling: a maximum legal price that is set above the existing equilibrium price. Because the market equilibrium price is greater than the price ceiling, the ceiling restricts trade and is said to be binding.
Price Floor: a minimum legal price at which a good, service, or resource can be sold.
Changes the incentives that both buyers and sellers face
Non Binding Price Floor: a maximum legal price that is set below the existing equilibrium price. Because the market equilibrium price is greater than the price floor, the floor has no effect on the market and is said to be nonbinding.
Binding Price Floor: a minimum legal price that is set above the existing equilibrium price. Because the market equilibrium price is lower than the price floor, the floor restricts trade and is said to be binding.
Market price is set higher than what would occur in a market without price controls.
Minimum Wage: the lowest wage firms can legally pay employees in the labor market.
Excise Tax: a tax based on the number of units purchased, not on the price paid for a good or service.
Tax Revenue (TR) = Tax x Qt, where Qt is the quantity traded.
Taxes change market outcomes
Taxes increase the price of goods sold… shifts supply curve to the left
On the tax of suppliers…
The cost of producing the good or service increases
Role of the government: includes..
Enforcing contracts
Defining and enforcing property rights
Determining rules of commerce
Punishing dishonest behavior
Consumer Surplus: the difference between the maximum price consumers are willing and able to pay for a good or service and the price they actually pay.
Can be thought of as the wealth that trade creates for consumers in a market.
Measured in dollars.
Graphically, consumer surplus is the area below the demand curve and above the equilibrium price, from zero to the quantity traded.
Welfare Economics: a branch of economics that focuses on measuring the welfare of market participants and how changes in the market change their well-being.
Producer Surplus: the difference between the price producers receive for a good or service and the minimum price they are willing and able to accept.
Can be thought of as the wealth that trade creates for producers in a market.
Measured in dollars.
Graphically, producer surplus is the area below the equilibrium price and above the supply curve, from zero to the quantity traded.
Economic Surplus: the sum of consumer and producer surplus; a measure of the total welfare, or wealth, that trade creates for consumers and producers in a market.
Also known as social welfare or total surplus.
Deadweight Loss: the value of the economic surplus that is forgone when a market is not allowed to adjust to its competitive equilibrium.
Society is worse off with a price floor because of deadweight losses
Productive Efficiency: producing output at the lowest possible average total cost of production; using the fewest resources possible to produce a good or service.
Allocative Efficiency: producing the goods and services that are most wanted by consumers in such a way that their marginal benefit equals the marginal cost.
Marginal Benefit of Last Unit = Marginal Cost of Last Unit
MB = MC
Private market: a market in which the demand and supply curves represent the benefits and costs to only the consumers and producers in the market.
Private marginal cost: the cost to the producer of an additional unit of a good or service,
Private marginal benefit: the benefit to the consumer of an additional unit of a good or service.
External marginal cost: the cost of an additional unit of a good or service that is imposed on people other than the producer.
External marginal benefit: the benefit of an additional unit of a good or service that is enjoyed by people other than the direct consumer of the good or service.
Externality: the benefit enjoyed by or cost imposed on a third party not directly involved in the production or consumption of a good or service.
The outcome observed may not be the most efficient outcome
Outside intervention may be able to improve the market outcome, increasing efficiency and economic surplus.
Marginal Failure: a situation in which a market fails to produce the efficient output that maximizes total surplus.
Social Marginal Cost: the cost to society of producing an additional unit of a good or service; the sum of private marginal cost and external marginal cost.
Social marginal cost = private marginal cost + external marginal cost
MCsocial = MCprivate + MCexternal
Social Marginal Benefit: the full benefit to society of consuming an additional unit of a good or service; the sum of private marginal benefit and external marginal benefit
Social marginal benefit = private marginal benefit + external marginal benefit
MBsocial = MBprivate + MBexternal
Socially Optimal Production/Consumption: the level of production and consumption of a good or service such that the marginal social benefit is equal to the marginal social cost.
Social marginal cost = social marginal benefit + external marginal cost
MCsocial = MBsocial
Encouraging the production of goods that generate positive externalities will result in the socially optimal output level.
Positive Externality: the unpaid benefit enjoyed by a third party not directly involved in the production or consumption of a good or service.
The output will be greater than that resulting from a private market.
Governments may use public policy to encourage the production of goods that generate positive externalities.
Private Demand: the demand for a good or service that considers only the private benefits of its consumption.
Social Demand: the demand for a good or service that reflects both the private and external benefits of its consumption.
Negative Externality: the uncompensated cost imposed on a third party not directly involved in the production or consumption of a good or service.
Many of the goods that are taxed by the government, such as cigarettes, gasoline, and alcohol generate this.
Private Supply: the supply of a good or service that reflects only the private costs of its production.
Social Supply: the supply of a good or service that reflects both the private and external costs of its production.
Rival: the characteristic of some goods and services whereby the consumption of the good or service by one person reduces the quantity available for consumption by others. Sometimes referred to as a rival in consumption.
Nonrival: the characteristic of some goods or services whereby the consumption of the good or service by one person does not diminish the amount available to someone else. Sometimes referred to as nonrival in consumption.
Excludable: a characteristic of some goods or services whereby people can be prevented, or excluded, from consuming the good or service. Sometimes referred to as excludable in consumption.
Companies that produce excludable goods can prevent people from consuming their products unless they pay for the right to do so.
Nonexcludable: a characteristic of some goods or services whereby people cannot easily be prevented from consuming the good or service, even if they don’t pay for it. Sometimes referred to as non excludable in consumption.
Private Good: any good or service that is rival and excludable.
Public Good: any good or service that is both nonrival and nonexcludable.
Free- Rider Problem: the idea that when a good is nonexcludable, people will choose to consume the good without paying for it, making it difficult for private companies to profitably provide the good.
Property Right: the exclusive right to determine how a resource is used.
Market Failure: a situation in which a market fails to produce the efficient level of output that maximizes total surplus.
Coase Theorem: if a property right is well-defined and transaction costs are low, resources will naturally gravitate to their highest-valued use, regardless of who owns the property right.
Doesn't matter who you give the property right to, giving property rights will solve problems.
Dealing with externalities
Transaction Costs: the costs, in terms of time, energy, and resources, associated with searching out, negotiating, and completing a transaction.