Econ Review 3 General Econ 4 Scarcity society has limited resources and therefor cannot produce all the goods and services people wish to have 4 7 principles 5 People face trade offs a Giving up something we like to get something we like b THINK about this definition Why are trade offs an inevitable feature of decision making ECONOMICS answer Trade offs result from c Efficiency vs Equity scarce resources i Efficiency is the property of society getting the most it can from its ii Equity is the property of distributing economic prosperity uniformly among the members of society iii To achieve greater equality could redistribute income from wealthy to poor But this reduces incentive to work and produce shrinks the size of the economic pie 5 The cost of something is what you give up to get it a Decision making requires comparing the costs and benefits of b The opportunity cost of any item is whatever must be given up to alternative options obtain it c Example Going to college for a year is not just the tuition books and fees but also the foregone wages 5 Rational people think at the margin a Systematically taking the best possible course of action to achieve b Marginal change is a small and incremental adjustment to a plan or objectives course of action c Example When a student considers whether to go to college for an additional year he or she compares the tuition fees foregone wages to the extra income he or she could earn with the extra year of education 5 Incentives matter a An incentive is something that induces a person to act b Because rational people make decisions by comparing costs and benefits they respond to incentives c Example Extra pay for winning the Super Bowl motivates players to work harder Maybe an extra 41 000 doesn t matter to big time NFL players 4 Positive vs normative economics 5 As scientists economists make positive statements which attempt to describe the world as it is 5 As policy advisors economists make normative statements which attempt to prescribe how the world should be 5 Positive statements can be confirmed or refuted 3 A market is a group of buyers and sellers of a particular product 4 Markets have two sets of actors a Call this the demand side of the market 5 Buyers 5 Sellers a Call this the supply side of the market 4 A competitive market is one with many buyers and sellers each has a negligible effect on price 5 Perfectly competitive market a All goods exactly the same b Buyers sellers so numerous that no one can affect market price each is a price taker 4 Demand Side 5 Determinants of demand Demand shifters a Price of good simply a determinant b Price of other goods c Income d Preferences e Demographic factors f Expectations foresight 5 Substitutes Two goods are substitutes if an increase in the price of one causes an increase in demand for the other a Example pizza and hamburgers i An increase in the price of pizza increases demand for hamburgers shifting hamburger demand curve to the right b Other examples i Coke and Pepsi ii Car and metro 5 Compliments Two goods are complements if an increase in the price of one causes a fall in demand for the other a Example computers and software i If price of computers rises people buy fewer computers and therefore less software i Software demand curve shifts left b Other examples i College tuition and textbooks ii Peanut butter and jelly iii 5 Demand Schedule is a table that shows the relationship Bagels and cream cheese between the price of a good and the quantity demanded at that price a Individual demand schedule displays the demand of a specific buyer b Market demand schedule displays the demand of the market demand all buyers 5 Demand Curve is a graph of the relationship between the price of a good and the quantity demanded a Individual demand curve graphs the demand of a specific buyer b Market demand curve graphs the demand of the market demand all buyers 5 Law of demand a Claims that the quantity demanded falls when the price rises other things being equal 5 A normal good is a good for which other things being equal an increase in income leads to an increase in demand 5 An inferior good is a good for which other things being equal an increase in income leads to a decrease in demand 4 Supply Side 5 Supply Determinants Shifters a Price simply a determinant b Price of inputs c Expectations d Technology 5 Supply Schedule is a table that shows the relationship between the price of a good and the quantity supplied 5 Supply Curve is a curve that shows the relationship between the price of a good and the quantity supplied 5 Law of Supply claims that when the price of a good rises the quantity supplied of the good also rises and when the price of the good falls the quantity supplied falls as well other things being equal 4 Equilibrium Price and Quantity 5 Equilibrium is a situation in which supply and demand have been brought into balance a Equilibrium price is the price that balances supply and demand b Equilibrium quantity is the quantity supplied and the quantity demanded when the price has adjusted to balance supply and demand 5 Excess Supply and Demand a Excess Supply b Excess Demand 3 Elasticity 4 The price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good computed as the percentage change in quantity demanded divided by the percentage change in price 5 Example If price goes up by 6 and the quantity demanded goes down by 3 the price elasticity of demand is 0 5 5 Calculating the Price Elasticity of Demand a The numerator is the percentage change in quantity b The denominator is the percent change in quantity c i i Q2 Q1 Q2 Q1 2 P2 P1 P2 P1 2 c Q 2 Q1 Q2 Q1 2 P 2 P1 P2 P 1 2 X 100 5 Different Types of Elasticity a Inelastic Demand is when the elasticity is less than 1 The demand curve is very steep i Perfectly Inelastic Demand is when the elasticity is 0 the demand curve is vertical with no slope b Elastic Demand is when the elasticity is greater than 1 the demand curve is not very steep i Perfectly Elastic Demand is when the elasticity the demand curve is horizontal with no slope 5 Implications of Elasticity a Expenditure Price X Quantity 5 Cross Price Elasticity of Demand is a measure of how much the quantity demanded of one good responds to a change in the price of another good computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good a The
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