ECON200 Outline Economics is the study of how society manages its scarce resources People face trade offs There s no such thing as a free lunch o o Efficiency vs equality Efficiency refers to the size of the economic pie and equality refers to how the pie is divided into individual slices An opportunity cost is whatever must be given up to obtain some item A sunk cost is a cost that has already been committed and cannot be recovered o Cost sunk cost remaining marginal benefit Rational people think at the margin o A rational decision maker takes an action if and only if the marginal benefit of the action is at least as large as the marginal cost of the action Individuals and firms can make better decisions by thinking at the margin o Rational people respond to incentives o A higher price in a market provides an incentive for buyers to consume less and an incentive for sellers to produce more Market economies promote overall economic well being o Market prices reflect both the value of a good to society and the cost to society of making the good o Market economies need institutions governments to enforce property rights so individuals can own and control scarce resources 2 possible causes of a market failure an externality or market power o They affect efficiency and equality o Quantity of output produced is less than the efficient quantity When a government creates large quantities of the nation s money the value of money falls inflation o Society faces a short run trade off between inflation and unemployment Circular flow diagrams allow people to visualize how dollars flow through markets among Many economic policies push inflation and unemployment in opposite directions households and firms o 2 types of markets Markets for goods and services Firms sell households buy Markets for factors of production Households sell firms buy The production possibilities frontier illustrates all the combinations of output that the economy can possibly produce o Not every conceivable outcome is feasible o Sometimes resources aren t allocated efficiently o The graph shows how society faces trade offs In a market the buyers as a group determine the demand for a product and the sellers as a group determine the supply of a product o Competitive market The demand curve represents the relationship between the price of a good and the quantity demanded o Price shifts the quantity demanded o The law of demand claims that other things equal the quantity demanded of a good falls when the price of the good rises o Variables that shift demand Income Normal goods are goods for which other things equal an increase in income leads to an increase in demand o Normal goods have positive income elasticities of demand Inferior goods are goods for which other things equal an increase in income leads to a decrease in demand o Inferior goods have negative income elasticities of demand Price of related goods Substitutes are 2 goods for which an increase in the price of one leads to an increase in the demand for the other Complements are 2 goods for which an increase in the price of one leads to a decrease in the demand for the other Tastes and preferences Expectations Number of buyers The supply curve represents the relationship between the price of a good and the quantity supplied o Price shifts the quantity supplied o The law of supply claims that other things equal the quantity supplied of a good rises when the price of a good rises o Variables that shift supply Input prices The supply of a good is negatively related to the price of the inputs used to make it o In other words when the price of one or more inputs rises producing the good is less profitable and firms supply less of it Technology Advances in technology can reduce a firms cost raising the supply of a good Expectations Number of sellers At equilibrium quantity supplied is equal to quantity demanded o At the equilibrium price the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell o The actions of buyers and sellers naturally move markets toward the equilibrium of supply and demand o When a market is in disequilibrium there s either a surplus or a shortage of a good When there s a surplus suppliers are unable to sell all they want at the going When there s a shortage demanders are unable to buy all they want at the price there s excess supply Quantity supplied quantity demanded More sellers than buyers Causes the market price to fall going price there s excess demand Quantity demanded quantity supplied More buyers than sellers Causes the market price to rise The law of the supply and demand claims that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance Consumers usually buy more of a good when its price is lower when their incomes are higher when the price of substitutes for the good are higher or when the prices of complements of the good are lower Elasticity measures the responsiveness of quantity demanded quantity supplied to a change in one of its determinants Price elasticity of demand measures how much the quantity demanded responds to a change in the price o Demand is said to be elastic if the quantity demanded responds substantially to a change in price Whereas demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price o Factors that influence the price elasticity of demand Availability of close substitutes A good with close substitutes tends to be more elastic A good without any close substitutes tends to be more inelastic since consumers cannot easily switch a substitute good if the price of the good rises Necessities inelastic vs luxuries elastic Necessities tend to have small income elasticities Luxuries have large income elasticities because consumers feel as if they can do without these goods if their incomes are too low Definition of the market Narrowly defined markets tend to have more elastic demand than broadly defined markets because it s easier to find close substitutes for narrowly defined goods Time horizon Goods tend to have more elastic demand over long time horizons change in quantity demanded o Price elasticity of demand change in price o Midpoint method Q2 Q1 Q2 Q1 2 Price elasticity of demand P2 P1 P2 P1 2 o Variety of demand curves Elastic demand is when elasticity is greater than 1 Perfectly elastic demand is when elasticity approaches
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