CH 1+2+3 Flashcards
economic interaction
how my choices affect other’s choices and vice versa
The 4 Principles that underlie individual choice: core of economics
- people must make choices because resources are scarce
- opportunity cost of an item
- “How much” decisions require trade-offs at the margin
- people respond to incentives
resource
anything that can be used to produce somthing else
scarce
not enough of resource
overal choice
sum of individual decisions
People must make choices because resources are scarce (explanation)
societies as a whole needs to make choices when resources are scarce
Example:
- what purchase has priotity–> limited income
- buy at more expensive local store because it’s closer by–> limited time
opportunity cost
what you haveto give up in order to get it
trade-off
comparison of costs and benefits
marginal decisions
comparing the costs and benefits of doing a little more of an activity vs doing a bit less
incentives
anything that offers rewards to people to change their behaviour
4 principles underlying economics of interaction of individual choices:
- there are gains from trade
- markets move towards equilibrium
- resources should be used efficiently to achieve society’s goals
- markets usually lead to efficiency, but if not: government intervention can improve society’s welfare
There are gains from trade (explanation)
people get more of what they want if they’re selfsufficient–> arises because of specialisation–> therefore more products can be produced than if in autarky
markets move towards equilibrium (explanation)
markets move to equilibrium because people tend to respond to incentives–> after using up the incentives they are in the same boat as the rest of the people–> equilirbium usually reached because changes of prices–> rises+fall so no opportunities for individual to be better off than others–> EVERY TIME THERE’S A CHANGE, MARKET MOVES TO EQUILIBRIUM
Resources should be used efficiently to achieve society’s goals (explanation)
resources are used in a way that has fully exploited all opportunities to make everyone better off, so not some people worse–> not rearanging resources so some better off, other wise inefficient
Problem: efficiency not always in line with goal society–> for example if they want equity–> equity promoting policies at the cost of efficiency and vice versa
equity
everyone gets a fair shae, what’s fair is subjective so not a well defined concept
markets usually lead to efficiency, but if not: government intervention can improve society’s welfare (explanation)
most of time invisible hand does the trick, incentives built into market economy to ensure resources are usually put to good use because in market economy people usually take opportunities for mutual gain (gains from trade)
BUT in case fo market failure: individual pursuit of self interest found in markets makes society worse off (because no incentives) –> market outcom einefficient–> in that case government can intervene with for example providing incentives which changes how resources are used
Principles of Economy-Wide interactions:
- one person’s spending is another person’s income
- overall spending sometimes gets out of line with economy’s productive capacity; when it does governmengt policiy can change spending
- increase in economy’s potential leads to economic growth pver time
One person’s spending is another person’s income (explanation)
if spend less, other their incomes will fall and vice versa–> chain reaction of changes in spending behaviour tends to have repercussions that spread economy wide
IMPORTANT ROLE IN UNDERSTANDING CYCLE OF RECESSIONS&RECOVERIES!!!!
overall spending sometimes gets out of line with economy’s productive capacity; when it does government policy can change spending (explanation)
- if spending falls short: causes unemployment which results in economic slump
- if spending too high: causes inflation, occurs when demand is higher than supply–> demand will still buy it even if prices rise
When slump/inflation occurs government policies can help to addres the inbalances: think linke taxes, control of amount of money in circulation etc
increase in economy’s potential lead to economic growth over time (explanation)
Technological advancement leads to the rising of economic potential –> increases in economy’s potential leads to economic growth in the long term, while short term creating winners and losers
economic growth
an increase in the amount of goods+services produced per head of the population over a period of time
IN SHORT: the increase of living standards over time
economy’s potential
total amount of goods/services economy can produce
–> can rise due to technological advancememt
model
a simplified respresentation of an economic reality–> allows us to understand the variety of economic issues
other things equal assumption/Ceteris paribus
all other relevant factors remain unchanged
Production Possibility Frontier (PPF)
illustrates the tarde-offs facing an economy that produces only two goods–> shows the maximum quantity of one good that can be produced for ant given quantity produced of the other product
- resources are scarce–> trade offs–> on eproduct takes away resources of other products that also need it
- production feasible or non feasible
- illustrates the general economic concept of efficiency+inefficiency
- opportunity cost
- economic growth
efficient in production (in PPF)
economy as a whole couldn’t produce more of product without producing less of something else
efficiency in allocation (PPF)
economy allocates its resources so consumers are as well off as possible–> production is aligned with consumers preferences
opportunity cost (PPF)
if producing more of one good (a) other good (b) is less produced–> thus good (a) has an opportunity cost of good (b)
- If PPF straighht slope–> means constant slope–> constant opportunity cost
- if bowed out curve insted straightline–> increasing opportunity cost
economic growth (PPF)
when economic growth occurs–> more can be produced of everything–> so outward shift of the frontier
2 sources of economic growth
- increase in economy’s factors of production
- progress in technology
factors of production
resources used to produce goods+services–> refers to resources that are NOT used up in production: land, labour, physical capital (machines, buildings), hunman capital (education, skills of labour force–> enhance productivity)
comparative advantage (definition)
country/person has comparative advantage in producing good/service if its opportunity cost of producing is lower that the other country’s/person’s cost–> voluntarily willing to trade if price of product each country obtains in the trade is less than own opportunity cost if would produce the product themselves domestically
NOTE: everyone has a comparitive advantage+disadvantage in something!!!!
absolute advantage (definition)
country/individual can produce more output per worker for certain production than other countries/individuals
NOTE: what matter in trade is opportunity cost–> if other country’s opportunity cost is lower even though you have an absolute advantage, still beneficial to trade with them because they have the comparative advantage!!!
The Circular flow diagram
diagram that represents the transactions in an economy by two kinds of flow around in a circle:
1. flows of physical things like goods/services/labour/raw material in one direction
2. flow of money to pay for these physical things in the opposite direction
income distribution
how total income that is created in an economy is divided among less/high skilled workers, aowners of capital/land etc
households
individual, family etc
firm
organisation that produces goods/services for sale and that employs members out of households
markets for goods+services
where househol buys goods/services they want from firms
Criticism CFD and its ignoring of real world complications with it’s simplicity:
- distinctions between firms+households not always clear cut–> family run business–> is it a firm or a household?
- many sales firms make goes to other firms–> intermediate goods–> more complete would be to include flows of goods, services and money within the business sector
- doesn’t show government–> does divert lot of moeny out of CFD–> think of taxes+government spending–> thus taking money in+out of the flow
positive economics
economic analysis that tries to answer questions about the way world actually works–> has definite right and wrong answers
–> models play a big role
normative economics
makes prescriptions about how the world should work
–> economists engage+give policy advice but may be no “right” answer –> economic analysis can be used to show objectively that some policies clearly better than others
competitive market
market in which many buyers+sellers of same good/service
Key feature: no individuals action can influence price good/service is sold at
supply&demand model (function)
model that shows how a competitive market behaves
5 key elemenyts supply+demand model:
- demand curve
- supply curve
- the set of factors that cause the demand curve+supply curve to shift
- market equilibrium–> includes equilibrium price+quantity
- way market equilibrium changes when supply/demand curve shifts
demand curve
shows relationship between quantity demanded+price
x-axis: shows amount of quantity
y-axis: shows price
quantity demanded
actual amount good/service consumers willing to buy at specific price:
- falls when price rises
- rises when price falls
law of demand
as price rises–> quantity of goods demanded falls
as price falls–> rise in quantity demanded
–> therefore demand curve downwards sloping
shift of demand curve
change in quantity demanded at any given price–> represented by shift of original demand curve to a new position
NOTE: not the same as movement along!!!!
movement along the demand curve
moving down from one point to another point on the demand curve–> results of fall in price of good+rise of quantity at that price
NOTE: not the same as shift!!!
rightward shift of demand curve when:
increase in demand–> at any given price, consumers demand larger quantity of good/service than before
leftward shift of the demand curve when:
decrease in demand–> at any given price, consumer demands less quantity of good/service than before
changes in demand
shift of demand curve
changes in Quantity of demand
movement along demand curve
5 factors that shift demand curve for a good/service
- changes in prices of related goods/services
- changes in income
- chnages in taste
- changes in expectations
- changes number of consumers
substitutes
if rise in price of one good leads to increased demand other good
–> substitutes are alternative goods that serve in a similar function
complements
if a rise of price of one good leads to decrease in demand other good
–> because consumers like to consume good and its complement together, so if one falls in demand, so does the other
normal goods
demand for these goods increases when consumer income rises
inferior goods
goods which demand decreases when income rises–> usually considered less desirable than more expensive alternatives–> example: bus vs taxi
individual demand curve
shows relationship between quantity demanded+price for individual customer (market) demand curve
quantity supplied
amount of good/service people willing to sell at a specific price
supply curve
shows relationship between quantity supplied and price–> higher price leads to higher quantity supplied–> naturally slopes upward
shift of the supply curve
change in quantity supplied good/service at any given price
rightward shift supply cirve
increase in supply
leftward shift supply curve
decrease in supply
5 factors of shift supply curve
- changes in input prices
- changes in prices of related goods/services
- changes in technology
- changes in expectations
- changes in number of producers
input
any good/service that is used to produce other good/service
individual supply curve
shows relationship between quantity supplied and price for individual producer
competitive market is in equilibiurm when:
price has moved to level where quantity demanded=quantity supplied
equilibrium price
price that matches quantity supplied+quantity demanded
market-clearing price
price that clears the market by ensuring every buyer willing to pay that price, finds a seller willing to sell at that price and vice versa
equilibrium quantity
quantity bought+sold at equilibrium price
3 reasons sure market will arrive at equilibrium price:
- all sales and purchases in market take place at same price–> aka the market price
- market price fall if its above the quilibrium price
- the market price rises if below equilibirum price
surplus
when quantity supplied exceeds quantity demanded–> happens when price is above equilibrium level
shortage
when quantity demanded exceeds quantity supplied–> occurs when price is below equilibiurm level
when demand good/service increase (right shift) the equilibrium…
equilibrium price +quantity of good/service both rise
when demand for good/service decreases (left shift) the equilibrium…
the equilibrium price+quantity of good/service both fall
when supply of good/service increases (right shift) equilibrium…
equilibrium price of good falls and equilibrium quantity good rises
when supply good/service decreases (shift left) the equilibrium…
equilibrium price of good rises and equilibrium quantity falls
When demand decreases+supply increases (2 shift in opposite direction)
equilibrium price falls but change in equilibrium quantity is ambigious (not clearly decided)
When demand increases+supply decreases (2 shift in opposite direction)
equilibrium price rises but change in equilibrium quantity is ambigious (not clearly decided)
Commparitive advantage model (illustrates…)
- there are gains from trade
- each country has a comparative advantage in producing something, and everyone has a comparative disadvantage in something
increase/decrease in demand means
shift of demand curve to left or right!!!
why does the supply slope upwards?
because the higher the price, the higher the quantity supplied is
why does the demand curve slope downwards?
because the higher the price, the less demanded quantity
changes in prices related goods/services supply (explanation)
- When goods complements of production: higher price of one good, more willing to supply other good at any given price
- when goods substitutes of production:
if one price falls, more willing to supply other product at any price given
which curve shifted if both quantity sold+price shift in the same direction?
the demand curve
which curve shifted if quantity+price move opposite directions?
supply
