Ch 1 Ten principles of economics Economics The study of how society manages its scarce resources Efficiency The property of society getting the most it can from its scarce resources Rational People People who systematically and purposefully do the best they can to achieve their objects 1 People face trade offs 2 Opportunity cost Whatever must be given up to obtain some item 3 Rational people think at the margin 4 Incentives Something that induces a person to act 5 Trace can make everyone better off Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage 6 Market are good way to organize economic activity 7 Governments can improve market outcomes 8 Standard of living depends on its ability to produce goods and services 9 Price rises when government prints too much money 10 Society faces a short run trade off between inflation and unemployment Ch 2 Thinking like an economist Assumption can simplify the complex world and make it easier to understand Circular flow diagram A visual model of the economy that shows how dollars flow through markets among households and firms Production possibilities frontier PPF A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology A possible B max C impossible Microeconomics The study of how households and firms make decisions and how they interact in markets Macroeconomics Positive statements The study of economy wide phenomena including inflation unemployment and economic growth Claims that attempt to describe the world as it is Normative statements Claims that attempt to prescribe how the world should be Economists disagree due to Differences in scientific judgment Differences in values Perception versus reality Ch 3 Interdependence and the gains from trade Absolute advantage The ability to produce a good using fewer inputs than another producer Comparative advantage The ability to produce a good at a lower opportunity cost than another producer Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage Ch 4 The market forces of supply and demand Market A group of buyers and sellers of a particular good or service Competitive market A market in which there are many buyers and many sellers so that each has a negligible impact on the market price Monopoly Demand Quantity demanded The amount of a good that buyers are willing and able to purchase Law of demand The quantity demanded if a good falls when the price of the good rises Demand schedule A table that shows the relationship between the price of a good and the quantity demanded P a bQ d Shifts in demand Income Normal good increase in income increase in demand Inferior good increase in income decrease in demand Price of related goods Substitutes increase in the price of one increase in demand of another Complements increase in the price of one decrease in demand of another Tastes Historical and psychological forces Expectations Change in income or price will affect demand Number of buyers Supply Quantity supplied The amount of a good that sellers are willing and able to sell Law of supply Quantity supplied of a good rises when the piece of a good rises Supply Schedule A table that shows the relationship between the price of a good and the quantity supplied P c d Qs Shifts in supply Input prices Supply of a good is negatively related to the price of the inputs Technology Technology reduces firm s cost Expectations Number of sellers Equilibrium Equilibrium The market price has reached the level at which quantity supplied equals quantity demanded Market clearing price Law of supply and demand The price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance Surplus Quantity supplied is greater than quantity demanded Shortage Quantity demanded is greater than quantity supplied Three steps for analyzing changes in equilibrium Demand supply or both Direction New equilibrium price and quantity Shifts vs movements A shift in the supply curve change in supply A shift in the demand curve change in demand A movement along a fixed supply curve change in the quantity supplied A movement along a fixed demand curve change in quantity demanded No in demand in demand in demand No in supply P same Q same P Q P Q in Supply P Q P Q P Q in supply P Q P Q P Q Ch 5 Elasticity and its applications Elasticity A measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants Price elasticity of demand A measure of how much the quantity demanded of a good responds to a change in the price of that good Price elasticity of demand Qdemanded Price Elastic 1 Quantity changes easily when price changes Inelastic 0 1 Quantity does not change easily when price changes Unit elastic 1 Availability of close substitutes Goods with close substitutes tend to have more elastic demand Necessities luxuries These goods tend to have inelastic demands whereas luxuries have elastic demands Definition of the Market Narrowly defined markets tend to have more elastic demand Easier to find substitutes in broadly defined markets Time horizons Goods tend to have more elastic demand over longer time horizons Midpoint method Q2 Q1 Q2 Q1 2 P2 P1 P2 P1 2 Total revenue Price x Quantity Inelastic demand price and revenue move in the same direction Elastic demand price and revenue move in the opposite direction Unit elastic demand revenue remains constant Income elasticity of demand A measure of how much the quantity demanded responds to a change in consumers income Income elasticity of demand Q demanded Income Cross Price elasticity of demand A measure of how much the quantity demanded of one good responds to a change in the price of another good Cross price elasticity of demand Q Demanded of good 1 Price of good 2 Positive Substitutes 0 not related Negative Complements Price elasticity of supply A measure of how much the quantity supplied of a good responds to a change in the price of that good Price elast city of supply Q supplied Price OPEC Supply and demand of oil is inelastic in the short run Elastic in the long run Drug interdiction Because drugs are inelastic price rises Revenue rises Ch 6 Government Policies Price Ceiling Maximum on the price at which a good can be sold Binding ceiling causes