Opportunity cost(oc): value of the next best alternative that is given up in order for other good or serviceInvisible Hand: institution work efficiently the action of individuals trying to max the
- If choice includes paying for something that cost is also considered in OC individual max benefit will result in best possible outcome for society
- You DO NOT include cost of necessary things (food) when calculating
Market economy: Production and consumption are result of decentralized choices made by individuals and firms
Command economy: Production and consumption are decided by central authority
PPF: Shows trade offs between producing 2 goods by identifying possible combinations of two goods a country can produce using all sources efficiently
- Point under curve (to left) INEFFICIENT - Slope measures opportunity cost
- Point above curve (to right) NOT ATTAINABLE - bowing PPF shows one good being produced more efficiently
- can become feasible with economic growth and trade - PPF = straight line OC is always the same
- Point on curve EFFICIENT
Comparative Advantage and Trade: There are benefits from trade Absolute vs Comparative Advantage
1. Voluntary trade makes people better off when their preferences differ Absolute: They can do it better than other people can
2. Allows individuals to specialize, increases knowledge and productivity Comparative: OC of producing good is lower
3. Specialization should occur based on comparative advantage
Types of Goods
Normal: Increase in demand with increase of income Complement: goods that consumers use together (Peanut butter and jelly)
Inferior: Decrease in demand with increase of income Substitute: same or similar to another product, can be used the same (coke and pepsi)
Demand: The lower price of a good, other The Demand Curve: Negative slope
things equal, leads to people demanding a - Shows how much of a good people will want and will be able to buy
higher quantity of a good. - Show QUANTITY DEMANDED at different prices
- Describes relationship between price and quantity holding all else equal
Shifts in demand: PRICE DOES NOT SHIFT DEMAND CURVE (demand Increases, moves up and right demand decreases, mover down and left)
- Increase in demand means: increase in quantity demanded for every given price and increases in willingness to pay for every quantity
Change in population (number of consumer)
- More potential buyers INCREASE —--------------------------------------------------------------
- Less potential buyers DECREASE Quantity Demanded v.s Demand
Change in Income Quantity Demanded refers to point on the curve,
- Normal good: demand INCREASE when income INCREASE caused by price. For each demand curve price can
- Inferior good: demand DECREASE when income INCREASE change but everything else is constant. Demand
Change in taste refers to the whole curve, change in any of the
- In favor INCREASE, not in favor DECREASE thing held constant
Change in expectations —---------------------------------------------------------------
- Expected decrease of price in future, demand DECREASE now
- Expected increase of price in future, demand INCREASE now affect the consumer
Changes in expectation (income)
- Expected income increase, normal good demand DECREASE —---------------------------------------------------------------
- Expected income decrease, normal good demand INCREASE Movement of curve
Change in the price of related goods (substitutes) demand increases: up and right
- Increase of a price of one good leads to INCREASE demand in other demand decreases: down and left
- Decrease in price of one good means DECREASE demand in other —---------------------------------------------------------------
Change in the price of related goods (compliments)
- Increase in price of one good leads to DECREASE demand for other
- Decrease in price leads to INCREASE demand for other
The Supply Curve: Positive slope
- Shows how much of a food or service sellers are willing and able to supply at different prices
- Shows QUANTITY SUPPLIED at different prices - higher price = higher quantity supplied
Shifts in supply curve (Quantityx supplied)
Changes in Input price: Input is any good or service which is used to produce a certain good or service
- Increase in price input : DECREASE supply
- Decrease in price input: INCREASE SUPPLY
Technological changes
- Advancements in technology will lower cost and INCREASE supply
Changes in taxes and Subsidies: Subsidy is the gov given money for each unit produced —-----------------------------------
- Increase in tax same as increase in cost: DECREASE supply Movement of Curve
- Increase in subsidies decreases firm cost: INCREASE SUPPLY
- increase: right and down
Changes in expectation decrease: left and up
- Increase in expected price: DECREASE supply now —-----------------------------------
- Decrease in expected price: INCREASE supply now
Changes in price of related good and service: substitute in production
- Increase in price of substitute good in production DECREASES supply
- Decrease in price of substitute good in production INCREASES supply
- Producing a good has OC
Entry of Exit of producers
- Entry of producers INCREASE supply
- Exit of producers DECREASE supply
Equilibrium: Equilibrium price (Ep) is a price at which quantity demanded equals quantity supplied
- The only price where the price is stable - price will naturally return to equilibrium price
Price Above equilibrium SURPLUS Price below equilibrium SHORTAGE
- More producers want to sell the good then there are buyers - More buyers want to get good then supplies are willing and able to supply at sai
- Producers have to DECREASE price and market price falls price
If there is simultaneous increase in both S and D the EQ will increase for sue but price change is ambiguous
, Competitive Market: There are many buyers and sellers for the same good or service
Consumer Surplus(CS): Sum of individual CS of all buyers of a good Producer Surplus(PS): Sum of all individual PS of sellers of good
Individual CS: Difference between what the buyer would have been willing to pay and Individual PS: Actual price for good minus cost of production
what the buyer actually paid (Net gain) - Increase in price increases PS
Total Surplus (TS): Sum of all CS and PS (both have to benefit to have TS)
- Represents gains from trade
- Free competitive markets maximize the TS
Price ceiling: gov. set max price on good SHORTAGE Price floor: gov. set min price on good SURPLUS
- Inefficiently low quality (by binding PC) - Inefficiently high quality (binding PS)
- Decreases incentives of producers How does it create inefficiency
- Less of the good will be bought - Deadweight loss, illegal market, high quality, surplus
How does it create inefficiency
- Deadweight loss, illegal market, low quality, shortage Extra Notes
Deadweight loss: - Surplus and no Price control: Price goes down
- Not all gains from trade are realized - Gov removes Binding PC → increase in quantity of good bought and
- Some mutually beneficial transactions do not occur anymore sold in market
Wasted Resources with PC - Not true→ The quantity actually bought and sold on the market is
- Doesn't eliminate competition for scarce goods above the equilibrium quantity
- Wasting time is inefficient
PC and PF are binding is they prevent the market from getting to equilibrium price and nonbinding otherwise
C
P1
S
P
S
Q
1
Price Elasticity of Demand: responsiveness of quantity demanded to changes in price More responsive means more elastic
- Definition: Percent change in quantity demanded divided by the percent change in price. (%ΔQ / %ΔP) ALWAYS NEGATIVE
Elastic demand Inelastic demand Perfectly inelastic Perfectly Elastic
- Increase in price decreases the - Increase in price decreases the - Vertical demand curve - Horizontal demand
quantity by A LOT quantity by A LITTLE - Q demanded stays the same curve
Elasticity and slope of demand curve |EP| > 1 → Elastic demand
- Elasticity is related to the slope of the demand curve, but not the same |EP| < 1 → Inelastic demand
- The flatter the curve the more elastic the demand |EP| = 1 → Unit Elastic
- Changes when moving along the linear demand curve
Factors that determine elasticity of demand
Availability of subs: The more substitutes the more elastic the demand
- If there are a lot of subs, people can switch from the good easily if there is an increase in price
- When price goes up quantity demanded will change by A LOT
Time after change:
- The longer the time horizon, the more people can adjust and hence the more elastic the demand
- Immediately after the price change the demand will not change by a lot, it is inelastic
- In a long term more people adjust, find more subs for a good and demand becomes elastic
Share of the budget:
- If the good is a small share of the budget the consumers might not even notice a change in pierce, demand is elastic
- Bigger Purchases are more price sensitive/elastic
Necessity v.s Luxury good:
- If a consumer considers a good a luxury good, the demand for a good is more elastic
- If the good is a necessity, demand is inelastic
Cross price elasticity of demand Substitutes: POSITIVE cross price elasticity of demand Total revenue: Price x
. (percent change in quantity of x demanded) Quantity of a good sold
Exy = —------------------------------------------------------ Complements: NEGATIVE cross price elasticity of demand
(percent change in price of y)
Income elasticity: Perfect change in quantity demanded divided by perfect change in income (%ΔQ / %ΔI) Normal good: Positive Inferior good: Negative
Elasticity of Supply: measures how responsive the quantity supplied is to the change in price ALWAYS POSITIVE (%ΔQ / %ΔP) ((old-new)/old) x 100 → perfect change
Elastic supply Inelastic supply - Es > 1 → Inelastic supply
- Increase in price increases the quantity - Increase in price increases the quantity
supplied by A LOT supplied by A LITTLE
- Es < 1 → Elastic supply
- Es = 1 → Unit Elastic
Factors that determine elasticity of demand: How easy/costly it is to expand production
- The harder is it to expand production the more inelastic supply is
- If production can increase with constant costs, supply is elastic
- If choice includes paying for something that cost is also considered in OC individual max benefit will result in best possible outcome for society
- You DO NOT include cost of necessary things (food) when calculating
Market economy: Production and consumption are result of decentralized choices made by individuals and firms
Command economy: Production and consumption are decided by central authority
PPF: Shows trade offs between producing 2 goods by identifying possible combinations of two goods a country can produce using all sources efficiently
- Point under curve (to left) INEFFICIENT - Slope measures opportunity cost
- Point above curve (to right) NOT ATTAINABLE - bowing PPF shows one good being produced more efficiently
- can become feasible with economic growth and trade - PPF = straight line OC is always the same
- Point on curve EFFICIENT
Comparative Advantage and Trade: There are benefits from trade Absolute vs Comparative Advantage
1. Voluntary trade makes people better off when their preferences differ Absolute: They can do it better than other people can
2. Allows individuals to specialize, increases knowledge and productivity Comparative: OC of producing good is lower
3. Specialization should occur based on comparative advantage
Types of Goods
Normal: Increase in demand with increase of income Complement: goods that consumers use together (Peanut butter and jelly)
Inferior: Decrease in demand with increase of income Substitute: same or similar to another product, can be used the same (coke and pepsi)
Demand: The lower price of a good, other The Demand Curve: Negative slope
things equal, leads to people demanding a - Shows how much of a good people will want and will be able to buy
higher quantity of a good. - Show QUANTITY DEMANDED at different prices
- Describes relationship between price and quantity holding all else equal
Shifts in demand: PRICE DOES NOT SHIFT DEMAND CURVE (demand Increases, moves up and right demand decreases, mover down and left)
- Increase in demand means: increase in quantity demanded for every given price and increases in willingness to pay for every quantity
Change in population (number of consumer)
- More potential buyers INCREASE —--------------------------------------------------------------
- Less potential buyers DECREASE Quantity Demanded v.s Demand
Change in Income Quantity Demanded refers to point on the curve,
- Normal good: demand INCREASE when income INCREASE caused by price. For each demand curve price can
- Inferior good: demand DECREASE when income INCREASE change but everything else is constant. Demand
Change in taste refers to the whole curve, change in any of the
- In favor INCREASE, not in favor DECREASE thing held constant
Change in expectations —---------------------------------------------------------------
- Expected decrease of price in future, demand DECREASE now
- Expected increase of price in future, demand INCREASE now affect the consumer
Changes in expectation (income)
- Expected income increase, normal good demand DECREASE —---------------------------------------------------------------
- Expected income decrease, normal good demand INCREASE Movement of curve
Change in the price of related goods (substitutes) demand increases: up and right
- Increase of a price of one good leads to INCREASE demand in other demand decreases: down and left
- Decrease in price of one good means DECREASE demand in other —---------------------------------------------------------------
Change in the price of related goods (compliments)
- Increase in price of one good leads to DECREASE demand for other
- Decrease in price leads to INCREASE demand for other
The Supply Curve: Positive slope
- Shows how much of a food or service sellers are willing and able to supply at different prices
- Shows QUANTITY SUPPLIED at different prices - higher price = higher quantity supplied
Shifts in supply curve (Quantityx supplied)
Changes in Input price: Input is any good or service which is used to produce a certain good or service
- Increase in price input : DECREASE supply
- Decrease in price input: INCREASE SUPPLY
Technological changes
- Advancements in technology will lower cost and INCREASE supply
Changes in taxes and Subsidies: Subsidy is the gov given money for each unit produced —-----------------------------------
- Increase in tax same as increase in cost: DECREASE supply Movement of Curve
- Increase in subsidies decreases firm cost: INCREASE SUPPLY
- increase: right and down
Changes in expectation decrease: left and up
- Increase in expected price: DECREASE supply now —-----------------------------------
- Decrease in expected price: INCREASE supply now
Changes in price of related good and service: substitute in production
- Increase in price of substitute good in production DECREASES supply
- Decrease in price of substitute good in production INCREASES supply
- Producing a good has OC
Entry of Exit of producers
- Entry of producers INCREASE supply
- Exit of producers DECREASE supply
Equilibrium: Equilibrium price (Ep) is a price at which quantity demanded equals quantity supplied
- The only price where the price is stable - price will naturally return to equilibrium price
Price Above equilibrium SURPLUS Price below equilibrium SHORTAGE
- More producers want to sell the good then there are buyers - More buyers want to get good then supplies are willing and able to supply at sai
- Producers have to DECREASE price and market price falls price
If there is simultaneous increase in both S and D the EQ will increase for sue but price change is ambiguous
, Competitive Market: There are many buyers and sellers for the same good or service
Consumer Surplus(CS): Sum of individual CS of all buyers of a good Producer Surplus(PS): Sum of all individual PS of sellers of good
Individual CS: Difference between what the buyer would have been willing to pay and Individual PS: Actual price for good minus cost of production
what the buyer actually paid (Net gain) - Increase in price increases PS
Total Surplus (TS): Sum of all CS and PS (both have to benefit to have TS)
- Represents gains from trade
- Free competitive markets maximize the TS
Price ceiling: gov. set max price on good SHORTAGE Price floor: gov. set min price on good SURPLUS
- Inefficiently low quality (by binding PC) - Inefficiently high quality (binding PS)
- Decreases incentives of producers How does it create inefficiency
- Less of the good will be bought - Deadweight loss, illegal market, high quality, surplus
How does it create inefficiency
- Deadweight loss, illegal market, low quality, shortage Extra Notes
Deadweight loss: - Surplus and no Price control: Price goes down
- Not all gains from trade are realized - Gov removes Binding PC → increase in quantity of good bought and
- Some mutually beneficial transactions do not occur anymore sold in market
Wasted Resources with PC - Not true→ The quantity actually bought and sold on the market is
- Doesn't eliminate competition for scarce goods above the equilibrium quantity
- Wasting time is inefficient
PC and PF are binding is they prevent the market from getting to equilibrium price and nonbinding otherwise
C
P1
S
P
S
Q
1
Price Elasticity of Demand: responsiveness of quantity demanded to changes in price More responsive means more elastic
- Definition: Percent change in quantity demanded divided by the percent change in price. (%ΔQ / %ΔP) ALWAYS NEGATIVE
Elastic demand Inelastic demand Perfectly inelastic Perfectly Elastic
- Increase in price decreases the - Increase in price decreases the - Vertical demand curve - Horizontal demand
quantity by A LOT quantity by A LITTLE - Q demanded stays the same curve
Elasticity and slope of demand curve |EP| > 1 → Elastic demand
- Elasticity is related to the slope of the demand curve, but not the same |EP| < 1 → Inelastic demand
- The flatter the curve the more elastic the demand |EP| = 1 → Unit Elastic
- Changes when moving along the linear demand curve
Factors that determine elasticity of demand
Availability of subs: The more substitutes the more elastic the demand
- If there are a lot of subs, people can switch from the good easily if there is an increase in price
- When price goes up quantity demanded will change by A LOT
Time after change:
- The longer the time horizon, the more people can adjust and hence the more elastic the demand
- Immediately after the price change the demand will not change by a lot, it is inelastic
- In a long term more people adjust, find more subs for a good and demand becomes elastic
Share of the budget:
- If the good is a small share of the budget the consumers might not even notice a change in pierce, demand is elastic
- Bigger Purchases are more price sensitive/elastic
Necessity v.s Luxury good:
- If a consumer considers a good a luxury good, the demand for a good is more elastic
- If the good is a necessity, demand is inelastic
Cross price elasticity of demand Substitutes: POSITIVE cross price elasticity of demand Total revenue: Price x
. (percent change in quantity of x demanded) Quantity of a good sold
Exy = —------------------------------------------------------ Complements: NEGATIVE cross price elasticity of demand
(percent change in price of y)
Income elasticity: Perfect change in quantity demanded divided by perfect change in income (%ΔQ / %ΔI) Normal good: Positive Inferior good: Negative
Elasticity of Supply: measures how responsive the quantity supplied is to the change in price ALWAYS POSITIVE (%ΔQ / %ΔP) ((old-new)/old) x 100 → perfect change
Elastic supply Inelastic supply - Es > 1 → Inelastic supply
- Increase in price increases the quantity - Increase in price increases the quantity
supplied by A LOT supplied by A LITTLE
- Es < 1 → Elastic supply
- Es = 1 → Unit Elastic
Factors that determine elasticity of demand: How easy/costly it is to expand production
- The harder is it to expand production the more inelastic supply is
- If production can increase with constant costs, supply is elastic
