I Introduction A THE ECONOMIC PROBLEM how to allocate resources to the use that best benefits society 1 The Market Solution price directs resources Adam Smith s invisible hand benevolent mutually agreed price 2 Centrally Planned Solution resources are directed by a governing body ex gov t legislation dictator 3 Island Economy Solution very little exchange most goods and services are self produced II Production Possibilities A PRODUCTION POSSIBILITIES FRONTIER the maximum amount of any combination of goods that can be produced 80 1 Attainability and Efficiency any level of production within the PPF is attainable any point on the PPF is an efficient use of resources production efficiency 2 Scarcity the reason that production is limited is because resources are scarce 3 Marginal Cost the cost of producing one additional unit of output ex From point A to point B the cost of changing production of corn from 4 to 6 is 4 units of timber approximate marginal cost of moving from point A to B marginal cost 4 timber 2 corn 2 4 Changes in PPF there are economic consequences for certain events 5 Opportunity Cost the value of the next best forgone opportunity Allocative Efficiency the preferences of consumers in an economy determine the actual level of production that is desired Supply Consumption Maximized 6 Consumption and III Markets Market a mechanism of exchange of goods and services A PERFECTLY COMPETITIVE MARKETS 1 Many buyers and sellers no single consumer producer can influence price 2 Full information about goods services exchanged consumers know what they are buying sellers know the value of money received or the value of serving a customer Markets are two sided price is determined by the interaction of supply and demand B DEMAND Demand the willingness and ability to pay for a good or service if a buyer doesn t have the money on hand they don t demand it if you don t have the ability to pay you don t have economic demand must have willingness AND ability 1 Law of Demand at higher prices consumers demand lower quantities of each good or service DEMAND CURVES ARE DOWNWARD SLOPING 2 Demand v Quantity Demanded Demand willingness and ability to pay at ANY PRICE Quantity Demanded the amount of a good or service consumers are willing and able to pay at A GIVEN PRICE 3 Determinants of the Demand Curve Changes in Demand Preferences Consumer incomes likes and dislikes ability to pay The price of other goods EX ii iii C SUPPLY 1 Law of Supply at prices firms are willing able Supply the willingness and ability to goods to the market at given price higher and supply any to supply more units of output SUPPLY CURVES ARE UPWARD SLOPING 2 Supply vs Quantity Supplied Supply the entire relationship between price and quantity of goods delivered to the market i e the schedule of production Quantity Supplied the amount produced or sold at a GIVEN PRICE 3 Determinants of the Supply Curve Knowledge and technology Input costs Outside opportunities of the firm ex the cost of labor rises ex Ford invents assembly line D MARKET EQUILIBRIUM 1 Equilibrium in a competitive market equilibrium is a price where no supplier or consumer wants to change their behavior satisfied with choice E MARKET REGULATION i Price Ceiling ii Price Floor IV Elasticity Elasticities tell us the magnitude size of responses to certain economic phenomena i income changes income elasticity of demand ii price changes of alternative goods cross price elasticity iii price change of particular good own price elasticity of demand iv price change of particular good price elasticity of supply A PRICE ELASTICITY OF DEMAND measures the change in quantity demanded as a result of an increase in price 1 Determinants of the Elasticity of Demand 1 Availability of Substitutes 2 The proportion of income spent on a good larger proportion more elastic demand 3 the amount of time since the price change more time more elastic demand 2 Total Revenue Elasticity of Demand Total Revenue P x Q when the demand for a good is elastic an increase in the price will decrease when the demand for a good is inelastic an increase in the price will raise the total revenue total revenue B Cross Price Elasticity When the cross price elasticity is negative we say that the goods are complements When the cross price elasticity is positive we say that the goods are substitutes C Income elasticity of demand definition it measures the responsiveness of consumption behavior to changes in income EI When the income elasticity is negative we say that it is an inferior good When the income elasticity is positive we say that it is a normal good