ECON Ch 1-3,6 Flashcards
Market
A group of buyers and sellers of a good or service and the institution or arraignment by which they come together to trade.
3 markets in an economy
Market for goods and services, labor market, money market.
Interact with another country’s economy by trading between the markets.
3 assumptions in a market:
- People are rational–> weight costs and benefits to make the best decision possible for them
- People respond to economic incentives–> as incentives change, people react.
- Optimal decisions are made at the margin. When marginal cost and marginal benefit are =, the optimal decision comes.
Marginal cost and marginal benefit
The additional cost or benefit association with a small amount extra of some action.
Marginal analysis
Comparing MB and MC. best decisions made when they’re equal
Economics
The study of the choices people make to attain their goals, given their scarce resources.
Scarcity
A situation in which unlimited wants exceed the limited resources available to fulfill those wants.
Trade off
The idea that, because of scarcity, producing more of one good or service means producing less of another good or service.
In a world of scarcity, we have limited economic resources to satisfy our desires, so we face trade offs
Opportunity cost
The highest valued alternative given up in order to engage in some activity
Since the increase in production of one good requires the reduction in production of some other good, there’s trade off, resulting from scarcity of productive resources.
Productive vs allocative efficiency
Productive is where goods or services are produced at the lowest possible cost
Allocative is where production is in accordance with consumer preferences, every food or service is productive until the last unit provides a marginal benefit to society = to marginal cost of producing it.
Equity
The fair distribution of economic benefits.
Compared with efficiency, when maximum economic activity
Trade off between the two.
Production possibility frontier (PPF)
Efficient level of production a country can make with its resources.
Efficient points on PPF
points are efficient when all of the possible labor has been used, efficient points are located on the PPF.
Inefficient points on PPF
When we could have more of one product and not less of the other. Possible to have more of both products. Points inside the PPF.
Infeasible points on PPF
Located outside the PPF. Impossible to get this much of bread and butter given our limited resources. Can’t have infinite amounts of both
Shape of PPF
Bowed out shape for the whole economy.
Linear for one person.
Slope magnitude starts off small and then increases as you go left to right.
At the beginning, for every increase in X, not losing as much Y because the best X workers will work on X. The worker with the comparative advantage goes to X first. As time goes on, for each increase in X, sacrificing more of Y
Growth on PPF
Invest in technology for both products will cause the whole PPF to shift up and right.
Just investing in technology for X product, shifts it to the right. No change in the top left corner, but bigger change as more of the X good is being produced.
Absolute advantage
Whoever can do more of one thing using his resources.
Neighbor can produce 30 apples and 60 cherries. You can produce 20 C and 20 A. Neighbor has AA in both apples and cherries because 30>20 and 60>20, so he has the AA in both.
Comparative advantage
What someone does better in relative terms.
Whoever has the lower opportunity cost for something.
For example, if you were to pick 1 A, you sacrifice 1 C (opportunity cost of 1 apple is 1 cherry)
If the neighbor were to pick 1 apple, he’d sacrifice 2 cherries (OC of 1 A is 2 C)
Since your opportunity cost for an Apple is less than the neighbors, you have the CA in apples, and THEREFORE he has the CA in cherries.
Specialization
Whichever good you have the comparative advantage in, you will specialize in.
Benefits of trade
Allow for people and economies to receive points on PPF that were once infeasible by using their comparative advantages and then trading.
Terms of trade
Amount of each good traded
Trade from neighbor (60 C, 30 A) and your point of view (20 C, 20 A)
Your point of view–
You have the comparative advantage in apples.
Say you specialize in apples and have 20 apples. If I give up 1 apple, I’m expecting 1 cherry at home. Therefore, a trade should give me at least 1 cherry for every apple I give up.
Neighbor POV–
CA in cherries. If I give up 1 cherry, I can produce 1/2 apple at home. Trade should give me at least 1/2 apple in return for 1 cherry.
TERMS OF TRADE – 1 Apple should get at least 1 cherry and 1 cherry should get at least 1/2 apple.
Trade benefits only you when 1 apple buys at least 2 cherries
Trade benefits only the neighbor when gives up 1 cherry and gets at least 1 apple.
Efficient total world production PPF
Take the individual PPFs of neighbor and you and put on the world graph.
Since the neighbor has the ca in cherries, the horizontal good, he specializes in cherries, so he will pick the first 60 cherries. You will pick the next 20 cherries.
Slope increases in magnitude as go on.
Efficient because the specialized person produces their good first.
At the beginning sacrificing 1/2 apple for every cherry made. Then sacrificing 1 apple for every cherry made
Axis totals are sum of apples and cherries, so goes to 50 and 80
Sunk cost
A cost that has already been paid and cannot be recovered.
Ignore the sunk cost when making a decision.
How prices are determined in the market place
The consumer and the producer.
Demand curve
The relationship between the price of coffee and the quantity of coffee.
Everyone has their own demand curves but the trend of relationships holds.
Demand curve properties
Price is on the Y axis. Quantity is on the x axis.
We control the quantity, how much we purchase. The price is set.
NEGATIVE SLOPE. As quantity increases, price decreases.
Law of demand
There is a negative relationship between price and quantity.
If the price of the good on demand curve changes, what happens?
You move ALONG demand curve. So if price increases, you buy less. Still on the curve.
Say that other variables change, not the price of the good.
If my income increases, how will my demand for coffee change?
If income increases, then I’m willing to pay more. Same price of coffee, but I can afford more now.
Demand curve will shift to the right.
When will demand curve shift
When determinants other than the price move.
Only can shift left or right, NOT up or down
Normal good
If income increase causes increase in demand, then normal good
Inferior good
If income increase causes demand decrease.
For example, McDonalds
If I make more money, I’m less interested in McDonalds.
Say the price of tea goes up, how will my demand curve for coffee change?
What about the price of milk?
If price of tea, a substitute good, increases, then I will be less likely to buy tea, and consume more coffee even when the price of coffee is the same. My demand for coffee therefore increases, and my curve shifts to the right.
If the price of milk, a complementary good, increases, then my demand for coffee will decrease, and therefore the curve will shift left.
Change in demand vs change in quantity demanded
Change in quantity demanded–A change in the price of the product being examined causes a movement ALONG the demand curve.
Change in demand– any other change affecting demand causes the entire demand curve to shift right or left.
Quantity supplied
The amount of a good or service that a firm is willing and able to supply at a given price.
Law of supply
As the quantity supplied increases, the price increases.
Positive slope between price and quantity.
Supply curve
Relationship between price of good and amount supplied. Quantity on x axis and price on y axis.
Positive slope.
From a suppliers POV
Supply curve shift
Change in something other than price of the good.
Entire supply curve will shift to the right or the left.
Right is an increase in supply, left is a decrease in supply
Comparison of supply curves
Shifting left causes lowest supply. If x dollars, least amount of units.
Shifting right causes most supply. If x dollars, more units than before.
If the price of a substitute good (cocoa) increases, how will the supply curve (of coffee) change?
Price of cocoa increases, then there’s a lower quantity of coffee. Supply curve will shift to the left. Moved away from coffee production, want to supply more expensive good.
Supply curve shift–
How will increasing the price of an input (things used in production of a good, such as plastic while producing a watch) shift the supply curve?
Increasing price of an input causes less profitability of selling the good, causing a decrease in supply and a shift to the left
Decreasing price of an input causes more profitability and shifts to the right, increasing supply
How does a technological change affect supply curve?
New productive way of producing something increases supply, shift right.
Government restrictions of land use for agriculture will decrease supply of wheat, shift left.
How will prices of related goods in production affect supply curve
Say I can plant corn or soybeans. If the price of soybeans rises, then less corn will be supplied. Shift left.
How will the number of firms and expected future prices influence supply curve
More firms in the market will result in more product available at a given price. Shift supply curve right.
Fewer firms causes less supply.
If a firm anticipates that the price of its product will be higher in the future, less supply today to increase it in the future.
Change in supply vs change in quantity supplied
Change in quantity supplied– change in the price of the product being examined causes a movement along the supply curve.
Any other change affecting supply causes the entire supply curve to shift. Change in supply.
Market equilibrium
A situation in which quantity demanded = quantity supplied.
Competitive market equilibrium is when markets with many buyers and sellers are perfectly competitive markets.
Excess demand
Say that the price of coffee is $1. Then the quantity supplied is 2 and the quantity demand is 5. Since there is more demand than supply (excess demand), the price is too low, and the market will naturally raise it.
The gap between the quantity supplied and demanded is the excess demand, and is seen on the graph.
Excess supply
If there is more quantity supplied than demand, excess supply, market will lower the price.
How do supply and demand shifts influence equilibrium point?
Draw them on the graph!!! Notice how the point moves both vertically and horizontally!!!
Say the supply goes down and demand doesn’t change. Then at a given price, you produce less. Shift supply left.
Therefore, equilibrium is a higher price for less quantity
Elasticity
A measure of how much one economic variable responds to changes in another economic variable, based on percentage changes in the variables.
Measure of sensitivity. How much the demand is influenced by price.
Answers how much these changes affect our amount demanded.
Price elasticity of demand (PED)
How sensitive is my quantity demanded to changes in the prices?
PED formula
Percent change in quantity demanded / percent change in price
= % delta Q d / % delta P
Negative number, as price increases cause quantity decrease on demand curve.
Elastic vs inelastic vs unit elastic
Elastic is when the magnitude of PED is > 1
Inelastic is when magnitude < 1
Unit elastic is when magnitude = 1
How to calculate PED
EX: say I’m on a demand curve at point A (1000,6) and going to point B (1400,4)
Use the midpoint formula–>
% change in P = (4-6) / 5 = -2/5
% change in Q = (1400-1000)/1200 = 1/3
PED = % delta Q d / % delta P =
(1/3)/(-2/5) = -5/6
Since this magnitude is less than 1, it is inelastic.
Note that it is the same going from A to B as B to A because we use the midpoint formula.
Inelastic
When PED magnitude < 1
Insensitive.
When the price goes up by 1%, the reaction (quantity demanded) increases by less than 1%
Perfectly inelastic
When there is complete insensitivity.
I’m consuming the same amount of coffee regardless of the price.
Demand curve is downward sloping to the most extreme (vertical line)
Ex: medication, addictions
Elastic
Magnitude of PED > 1
When we are more elastic, when price goes up by 1%, quantity will decrease a lot
Perfectly elastic
Horizontal line. Change in price won’t influence quantity.
For long term things.
Determinants of PED:
Availability of close substitutes
If a product has more substitutes available, it will have more elastic demand.
For example: few substitutes for gasoline. So it’s PED is low
Many substitutes for Nike, so PED is high.
PED factors:
Passage of time
Over time, people adjust their buying habits more easily.
Elasticity higher in long run than short run.
Ex:
If price of gas rises, takes a while to adjust their gasoline consumption.
PED factors:
Whether the good is a luxury or necessity
More flexible with luxuries. PED is higher for luxuries.
PED factors:
Definition of the market
More narrowly defined market, more substitutes are available, more elastic is demand.
If no good substitute for jeans, demand is inelastic.
If I consider other brands, more sensitive to price of a particular brand, inelastic.
PED factors:
Share of a good in a consumers budget
If a good is a small portion of your budgets likely not very sensitive, inelastic.
When something has a higher magnitude PED, what’s that show about our relation to the good
Something with higher magnitude PED is easier for us to give up. Can give up books (-4) more easily than gasoline (-.06)
Give up elastic goods more easy than inelastic.
Cross price elasticity of demand
The percentage change in the quantity demanded of one good divided by the percentage change in the price of another good.
Measures the strength of substitute or complement relationships between goods
For example, if we’re looking at coffee, = % change in quantity of coffee / % change in price of tea.
For a substitute product, it will be > 0. So for this example with tea, it’s > 0. As price of tea increases, quantity of coffee demanded increases.
For compliment product (milk), negative. As price of milk increases, less demand for coffee.
= 0 if unrelated (smart watches and peanut butter are unrelated)
Income elasticity of demand
Measure of the responsiveness of the quantity demanded to changes in income, measured by the percentage change in the quantity demanded divided by the percentage change in income.
Percent change in quantity of coffee / percent change in income.
If >0 but <1, normal good and a necessity (bread).
If >0 and >1, normal good and a luxury (caviar)
If < 0, inferior good (McDonald’s)
Elasticity changes along the demand curve
NOT THE SLOPE. SLOPE IS SAME, BUT PED CHANGES.
As you go down and to the right, PED decreases.
Top left has more elasticity than bottom right. Some point where =1, unit elasticity.
Price elasticity of supply
% change in quantity supplied / % change in price.
Always >0
Inelastic if < 1 and elastic if >1
Same properties as PED
Perfectly inelastic PES
upward slope to the extreme. Quantity supplied is the same regardless of the price. For example, seats in an auditorium or number of parking spots at a beach resort. Supply is limited, can’t increase capacity when demand increases.
Perfectly elastic PES
horizontal line
Supply is infinitely responsive to price.
Long run production of agricultural products. At prices above the cost of production, farmers will supply as much as demanded.
More elastic in long term, less in short term
How demand and PES relate
When demand increases, we know equilibrium price and quantity will increase.
If the supply is inelastic, quantity supplied cannot change much if response to the demand changes, so price will rise a lot.
For example, parking spaces on a summer weekend at a beach resort. Demand will increase on July 4th, but the supply is inelastic, so the price increase will be large. Supply curve is almost vertical. Causes big price increase with not much quantity increase.
If supply is elastic, price will rise much less.
Total revenue
The total amount of funds received by a seller of a good or service. P*Q
Say demand is relatively inelastic or elastic. How will changing your price change total revenue
If inelastic, then customers aren’t very sensitive to the price of your product. As you decrease price, just gain a few additional customers, don’t compensate for lost revenue, so overall revenue goes down. Want to increase price if you’re inelastic.
If elastic, customers are very sensitive to the price of your product.
As you decrease the price, you expect to gain many more customers.
Added customers more than compensate for lost revenue, so overall revenue goes up.
