Random Economics Notes Chapter 1 Ten Principles of Economics People face trade offs o National defense vs consumer goods o Efficiency society gets maximum benefit from scare resources o Equality benefits are distributed uniformly among members The cost of something is what you give up to get it o Compare costs and benefits of alternative courses of action o Opportunity cost what you give up to get that item Rational people think at the margin o People want to achieve their objectives o Marginal change small incremental change to existing plan of action Already doing but increase decrease small changes Marginal benefit needs to exceed the marginal cost People respond to incentives o Incentive something that induces a person to act reward Trade can make everyone better off o Trade allows each person to specialize in what they do best o Market economy decisions of central planner are replaced by decisions of millions of firms and households Contain many buyers and sellers of goods and all of them are mainly interested in their own well being o Adam Smith wrote Wealth of Nations Invisible hand laissez faire prices are the main determinant Market prices reflect both the value of a good to society and Governments can sometimes improve market outcomes the cost to society of making the goods o Property rights individuals can control and own scarce resources Aims to promote equality and efficiency o Market failure market on its own fails to produce an efficient allocation of resources of a bystander Externality impact of one person s actions on the well being o Market power ability of a single person to influence market prices Chapter 2 Thinking Like an Economist Economist as a scientist trying to explain the world o Devise theories collect data and analyze data Circular flow diagram visual model of the economy that shows how dollars flow through markets among households and firms o Firms produce goods and services using inputs Factors of production inputs land labor capital o Markets for goods and services households buyers firms sellers o Markets for factors of production households sellers firms buyers Production Possibilities Frontier graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available technology firms use to turn these factors into output o Cannot produce points outside the frontier o Points on the production frontier represent efficiency Efficient if economy is getting all it can from the scarce resources it has available Inefficient points points inside the frontier o Only way of producing more of one good is to produce less of other o Opportunity cost slope of the production possibilities frontier Steep if OC is high flat if OC is small Microeconomics study of how households and firms make decisions and how they interact in specific markets Economists as policy advisers when they are trying to improve the world o Positive statements claims that attempt to describe the world as it is o Normative prescriptive make a claim about how world should be Chapter 4 The Market Forces of Supply and Demand Demand Market group of buyers and sellers of a good or service o Buyers determine the demand for the product o Sellers determine the supply of the product Competitive market describes market in which there are so many buyers and so many sellers that each doesn t have an impact on the market price Law of demand when price of a good increases the demand decreases o Price takers must accept the price the market determines Price of good mainly determines how much quantity is demanded When the quantity demanded is altered the demand curve shifts Normal good increase in income leads to an increase in demand steak Inferior good increase in income leads to a decrease in demand spam Substitutes increase in the price of one causes increase in other s demand o Pizza and hamburgers used in place of one another Increase in price of pizza increases demand for hamburgers shifting the demand curve to the right more now want other Pizza increases price quantity decreases hamburger demand increases quantity hamburger increases opp Complements increase in price of one causes a decrease in other s demand o Peanut butter and jelly used together Increase in the price of peanut butter less amounts of jelly will be sold shifting the demand curve to the left Decrease in Q of PB decrease in the Q of jelly Taste future expectations income and number of buyers all effect demand Supply Law of supply when the price of a good increases the quantity supplied of the good will increase when price falls quantity supplied falls too Shifts in the supply curve are caused by input prices technology expectations and number of sellers Equilibrium Equilibrium where quantity demanded and supplied are equal o Surplus quantity supplied quantity demanded o Shortage quantity demanded quantity supplied Chapter 5 Elasticity and it s Application Elasticity measure of the responsiveness of the quantity demanded or quantity supplied to a change in one of its determinants o How much the quantity demanded responds to price change Elastic responds to the change in price Inelastic quantity barely responds to price change o Things that effect elasticity Availability of close substitutes necessities vs luxuries definition of the market time horizon More elastic if there are substitutes more luxury narrow market more elastic in the long run Price elasticity change in quantity demanded change in price o Change in demand divided by change in price Always positive numbers use absolute value o Elastic greater than 1 Perfectly elastic horizontal o Inelastic less than 1 Perfectly inelastic vertical o Unit elasticity equal to 1 Revenue amount paid by buyers and received by sellers of good o Revenue price X quantity R PQ Normal goods have positive inferior goods have negative elasticity Income elasticity how quantity demanded changes as consumer income changes calculated same way just with change in income Cross price elasticity measures how much the quantity demanded of one good responds to changes in the price of another good o Substitutes have positive complements have negative Price elasticity of supply is same as above just with supply Chapter 7 Consumers Producers and the Efficiency of Markets Welfare economics study of how the allocation of resources affects economics well being Willingness to pay measures how much the buyer values the good Consumer
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