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Economics
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the study of how society manages its scarce resources.
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Scarcity
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The limited nature of societies resources.
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Efficiency
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Maximum output from minimum input.
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Equality
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Resources are distributed evenly among members of an economy.
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Principle 1
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People face trade-offs
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Principle 2
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The cost of something is what you give up to get it
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Principle 3
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Rational people think at the margin
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Principle 4
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People respond to incentives
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Principle 5
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Trade can make everyone better off
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Principle 6
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Markets are usually a good way to organize economic activity
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Principle 7
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Governments can sometimes improve market outcomes
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Externality
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When the consumption or production of a good effects bystanders.
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Market Power
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the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices.
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Role of Economists
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Scientist and Policy adviser.
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Model
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a highly simplified representation of a more complicated reality.
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Circular flow diagram
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a visual model of the economy that shows how dollars flow through markets among households and firms.
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Production Possibilities Frontier (PPF)
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A diagram that shows the possible combinations of output given available input factors.
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Opprotunity Cost
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The loss of potential gain from other alternatives when one alternative is chosen.
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Linear PPF
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Constant opportunity cost.
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Bowed out PPF
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Increasing opportunity cost
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Bowed in PPF
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Decreasing opportunity cost.
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Positive statements
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Statements that describe the world as it is.
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Normative statements
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Statements that prescribe how the world should be.
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Interdependence
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The technical term for when countries rely on each-other to produce goods that they both need.
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Specialization
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When actors focus on producing goods and services that they have an absolute or comparative advantage in producing.
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Absolute advantage
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The ability to produce a good using fewer inputs than another producer.
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Comparative advantage
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The ability to produce a good at a lower opportunity cost than another producer.
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Market
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A group of buyers and sellers of a particular good or service.
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Competitive market
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A market in which there are many buyers and many sellers so that each has a negligible impact on the market price.
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Quantity demanded
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The amount of a good that buyers are willing and able to purchase.
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Law of demand
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Quantity demanded and price move in opposite directions.
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Demand curve
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A graph of the relationship between the price of a good and the quantity demanded.
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Market demand
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Sum of all individual demand curves.
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Income (demand curve shifter)
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Demand for normal goods increases positively with income. Demand for inferior goods relates inversely with income.
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Normal Goods
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Goods for which demand goes up when income is higher and for which demand goes down when income is lower.
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Inferior Goods
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Goods for which demand tends to fall when income rises.
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Substitute goods
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Goods or services that can be used in place of each-other.
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Substitute goods (Demand curve shifter)
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When the price of one good increases, the demand for one good falls and demand for the other rises.
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Complimentary goods
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Goods that are often used together.
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Complimentary goods (Demand curve shifter)
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When the price of one good increases, the demand for both goods falls.
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Tastes and Expectations (Demand curve shifter)
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Have an ambiguous, entirely situational effect on demand.
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Number of buyers (Demand curve shifter)
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An increase in the total number of buyers corresponds to a net increase in demand.
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Quantity supplied
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The amount of a good that sellers are willing and able to sell.
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Law of supply
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Quantity supplied and price are directly related. When the price of a good rises, sellers have an incentive to produce more of it.
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Supply Curve
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A graphical representation of the law of supply.
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Input prices (Supply curve shifter)
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The cost of materials and labor are inversely related to the market supply of a good.
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Technology (Supply curve shifter)
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Technological efficiency is positively related to market supply.
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Expectations (Supply curve shifter)
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Expectations have an ambiguous effect on quantity supplied.
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Equilbrium
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A situation where market price has reached the level where quantity demanded is equal to quantity supplied.
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Surplus
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A situation where quantity supplied is greater than quantity demanded. (Excess supply)
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Shortage
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A situation in which quantity demanded is greater than quantity supplied. (Excess demand)
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Elasticity
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A measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants.
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Elasticity of demand
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A measure of how consumers react to a change in price.
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Demand is elastic
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Demand curve is relatively flat. Price elasticity of demand is greater than 1. Buyers are relatively sensitive to changes in price.
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Demand is inelastic
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Demand curve is relatively steep. Price elasticity of demand is less than 1. Buyers are relatively insensitive to changes in price.
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Demand is unit elastic
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Demand curve is intermediately steep. Price elasticity of demand exactly equals 1. Buyers are intermediately sensitive to changes in price.
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Demand is perfectly elastic
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Demand curve is perfectly flat. Price elasticity of demand is functionally infinite. Buyers are extremely sensitive to changes in price.
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Demand is perfectly inelastic
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Demand curve is perfectly vertical. Price elasticity of demand equals 0. Buyers are not sensitive to changes in price at all.
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Formula for elasticity of demand
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% change in quantity demanded / % change in price
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Total revenue & elasticity of demand
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When demand is elastic, a price increase causes total revenue to fall. When demand is inelastic, a price increase causes total revenue to rise.
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Elasticity of supply
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Measures sellers sensitivity to a change in price.
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Formula for elasticity of supply
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% change in quantity supplied / % change in price
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Supply is elastic
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Supply curve is relatively flat. Price elasticity of supply is greater than 1. Sellers are relatively sensitive to changes in price.
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Supply is inelastic
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Supply curve is relatively steep. Price elasticity of supply is less than 1. Sellers are relatively insensitive to changes in price.
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Supply is unit elastic
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Supply curve is intermediately steep. Price elasticity of demand exactly equals 1. Sellers are intermediately sensitive to
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Supply is perfectly elastic
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Supply curve is totally horizontal. Price elasticity of supply is functionally infinite. Sellers are extremely sensitive to price.
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Supply is perfectly inelastic
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Supply curve is totally vertical. Price elasticity of supply is 0. Sellers have no sensitivity to price.
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Production capacity
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The maximum amount of a good that a firm can supply given limited time and resources.
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Income elasticity
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A measure of how sensitive consumption of a good or service is to a change in a consumer's income.
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Formula for income elasticity
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% change in quantity demanded / % change in income
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Cross price elasticity
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the percentage change in the quantity of Product A demanded compared with the percentage change in price in Product B
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Formula for cross price elasticity
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% change in quantity of good x / % change in price of good y
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Price ceilings
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A legal limit which defines the maximum price at which a good can be sold.
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Price floors
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A legal limit which defines the minimum price at which a good can be sold.
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Price ceilings above equilibrium
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This type of price ceiling is non-binding because it imposes no limit on the natural forces of the market. It does not prevent the market from reaching equilibrium.
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Price ceilings below equilibrium
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This type of price ceiling is binding because it restricts the natural forces of the market from reaching equilibrium and creates a shortage.
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Price floor below equilibrium
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This type of price floor is non-binding because it imposes non limit on the natural forces of the market. It does not prevent the market from reaching equilibrium.
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Price floor above equilibrium
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This type of price floor is binding because it restricts the natural forces of the market from reaching equilibrium and creates a surplus.
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Labor surplus
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A situation when supply of labor is greater than demand for labor because of a price floor above the equilibrium price of labor.
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Taxes
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An additional imposed cost per unit for the production or consumption of an undesired good.
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Tax incidence
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The manner in which the burden of a tax is shared among participants in a market.
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Subsidy
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An additional imposed reward per unit for the production or consumption of a desired good.
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Subsidy incidence
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The manner in which the benefit of a subsidy is shared among participants in a market.
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