Intro econ Flashcards
Define Scarcity
The excess of human wants over what can actually be produced.
Links:
- opportunity costs
- Basic economic Problem
- limited resources
Opportunity costs
Benefits of the next best alternative forgone
Links;
- trade offs
- choice
- scarcity
Economics
Study of of how society allocate its scarce resources
- what to produce
- how to produce
- whom to produce for
links:
-scarcity
Production Possibility Frontier
Curve showing all possible combination of goods that can be produced in a period of time if all resources are used efficiently.
Inside- inefficiency
Outside- impossible
Shifts are possible if production gets more/less efficient
Opportunity costs( graph)
Comparative advantage
absolute advantage
Comparative advantage- when one country is producing a good at a lower opportunity cost
Absolute advantage- when one country is more efficient at producing a good
* full specialisation maximise output
Links:
-Trading
- PPF
Types of economies
- Command- All economic decisions are made centrally
- Mixed- government and public sector join together to solve economic problems
- Free- all economic agents would pursue their self- interest, market led by “invisible hands”
Positive and Normative statements
Positive economics studies objective or scientific (testable)
explanations of how the economy works.
Normative economics offers recommendations based on
(non-testable) value judgments.
Determinants of Demand
Price
Income
Price of complements/substitutes
Expectations
Government regulations
* Law of Demand (negative relationship between Price and quantity, except griffen goods)
non luxury good that demand increases with price
Demand functions (maths)
QD=D(P) (Direct)
Quantity demanded= demand relationship times price
in a linear relationship D becomes :
QD=a-bP
where a>0 and b>0 positive parameter
* non linear relationship, change the powers of P
Why demand function is downward facing
Substitution Effect: When the price of a good increases, some
consumers will substitute it with alternative goods that are
relatively cheaper.
Income effect: When goods becomes more expensive, consumer’s real income decreases, so they can purchase less goods
Shifts and movement along the demand curve
Movement: when price changes Shifts: any factors other than price QD=a-bP+cY A=a+cY QD=A-bP So changes in Y affect the intercept but not the slope
Consumer and Producer surplus
- think graphically
Consumer surplus: Difference between what the consumers are willing to pay and what they actually pay
Producer surplus: difference between what the producer were willing to supply at and what they actually supply at
Links: - welfare
Determinants of supply
- Price
- costs of production
- technology
- random shocks and other unpredictable events
- government regulations
- supply function inverse demand funtion
Market equilibrium ( maths)
QD=QS
a-bP=c+dP
Price elasticity of demand
Arc elasticity - between two different points
Point elasticity- on a point
arc- % change in quantity (average) / % change in price (average)
PED interpretations
When |PD | > 1 we say that the demand is elastic.
When |PD | = 1 we say that the demand is unit elastic.
When 0 < |PD | < 1 we way that the demand is inelastic.
Elasticity in relation to total revenue
TR= P x Q
if price changes, quantity demanded will goes down. What effect dominates depends on elasticity
Demand is elastic: An increase in P decreases TR.
Demand is unit elastic: An increase in P does not change TR.
Demand is inelastic: An increase in P increases TR
Cross elasticity of demand
Arc- %change in quantity demanded by A / % change in price of B (average)
interpretation of cross elasticity of demand
If the cross price elasticity is positive, then the two goods are
substitutes. This means that an increase in the price of B will
increase the demand of A (and decrease the demand for B).
If the cross price elasticity is negative the two goods are
complements. This means that an increase in the price of B
will decrease both the demand for B and A.
Income elasticity
arc- %change in quantity demanded / % change in income (average)
interpretation of income elasticity
A normal good has a positive income elasticity of demand.
(e.g., dairy products)
An inferior good has a negative income elasticity of demand.
(e.g., Tesco Value products)
A luxury good has an income elasticity that is greater than 1
(e.g., champagne).
Necessities have income elasticities less than 1 (but still
positive).
What is a specific and an ad valoran tax?
specific- tax dependant on quantity
ad valoran- VAT tax on percentage of price
tax effect on market equilibrium
It increases the price paid by consumers.
2 It decreases the price received by suppliers.
3 It reduces the equilibrium quantity in the market.
elasticity of supply and incidence of tax
The less elastic the supply curve, the greater the
producer’s burden of taxation, and vice versa
Consumer preference is based on (axioms)
Completeness: A consumer can rank bundles (A preferred to
B, B preferred to A, or indifferent).
2 Transitivity: A consumer’s preferences are logically consistent.
3 Monotonicity: Briefly, monotonicity implies that more is
better.
4 Local Nonsatiation: A weaker form of monotonicity; roughly,
it means that you can always find a bundle y that is similar to x,
but preferred to it.
5 Convexity: People prefer variety.
Consumer preference is based on
Completeness: A consumer can rank bundles (A preferred to
B, B preferred to A, or indifferent).
2 Transitivity: A consumer’s preferences are logically consistent.
3 Monotonicity: Briefly, monotonicity implies that more is
better.
4 Local Nonsatiation: A weaker form of monotonicity; roughly,
it means that you can always find a bundle y that is similar to x,
but preferred to it.
5 Convexity: People prefer variety.
Indifference curve
Definition: An indifference curve is the combination of all bundles
that a consumer views as being equally desirable. Or in other words,
the combination of all bundles that give the consumer the same level
of utility.
Properties of an indifference curve
- Bundles on the indifference curves further from the origin are
preferred to those on indifference curves close to the origin
(because of monotonicity of preferences); - 2 There is an indifference curve through every possible bundle
(because of completeness of preferences); - 3 Indifference curves cannot cross (because of transitivity of
preferences); - 4 Indifference curves slope downward (because of strong
monotonicity); - 5 Indifference curves cannot be “thick” (because of local
non-satiation / monotonicity);
what is the marginal rate of substitution (MRS)
: The maximum amount of
one good a consumer will sacrifice to obtain one more unit of another
good and to maintain the same level of utility.
change in y / change in x
If MRS is negative
The MRS is negative as yb − ya < 0. It reflects a trade-off
between two goods. In order to maintain one utility
Why is the MRS decreasing? -> downward slope for indifference curve
The slope of the indifference curve is not constant. It is decreasing
along an indifference curve (meaning that the curve becomes flatter
and flatter).
This property is known as: Diminishing Marginal Rate of
Substitution.
When people have a lot of one good, they are willing to
give up a relatively large amount of it to get a good of which they
have relatively little
Marginal Utility
The marginal utility of a given good tells us what the
gain in utility is if we increase the consumption of that good by a tiny
amount.
Income effect
Consumers are able to consume more with increased in income
Substitution effect
as price of one good increase, consumer will substitute it for a cheaper good
Economic growth
Increases in real GNP, an indication of the
expansion of the economy’s total output.
what are the 3 measures of national output?
Expenditure: The sum of expenditures in the economy, Y = C
+ I + G + X - Z
Income: The sum of incomes paid for factor services (wages,
profits, etc.)
Output: The sum of output (value added) produced in the
economy
What is GNP deflator and why do you use it?
alternative to CPI, measures the changes in all prices of goods and services, use to compare real economic activity.
* GNP per capita is better used to take into population when talking about welfare
what is potential output and actual output
Potential output: The output the economy would produce if
all factors of production were fully employed. It is a long-run
concept.
Actual output: What is actually produced in a period. This
may diverge from the potential level. (For now we focus on what
happens in an economy if actual output is below potential
output.)
Why is savings = investments?
this is because investments depends on savings in a closed economy, as banks can only lends out as much as amount of savings to firms to invest
what is fiscal policy?
and stabilisation policy?
government decisions about spending and taxes
government policies to keep actual output close to the potential output
What budget deficit and national debt?
Budget deficit: The excess of government outlays over
government receipts
National debt: The stock of outstanding government debt
What are the effect of taxes on AD?
Direct proportional taxes:
Affect the slope of the consumption function…
and hence the slope of the AD schedule.
Government expenditure or lump-sum taxes:
Affect the position of the AD schedule
government budget
lump sum tax
proportional tax
How do they differ?
If government spending is independent of income….
but net taxes increase with income…
then the budget will be in deficit at low levels of income and in
surplus at high levels of income.
lumpsum : rev independent of income
proportional : rev increases with income
What are discretionary fiscal policy?
Changes in tax rates and government spending to lower fluctuations in output.
What are automatic stabilisers and examples?
Alternatively, there are automatic stabilizers. For example:
High tax rates reduce the multiplier, which reduces the effects of
shocks on output.
High VAT rates imply that consumption reacts less to positive
shocks in income.
Unemployment benefits increase in recessions, which counteracts
the effect of a negative shock on income.
what are the function of money?
Medium of Exchange: Money eliminates the trouble of finding a
double coincidence of needs. As a consequence it reduces transaction
costs and promotes specialization.
Unit of Account: Money is used to measure value in the
economy. The value of a good or service is expressed in terms of
money. Again, this reduces transaction costs.
Store of Value: The third main function of money is that it is
a store of value as it allows us to save purchasing power over
time. This, naturally, makes money useful because you do not
necessarily have to spend it all at the time you receive it. It links
to money’s function as a medium of exchange: it should not
deteriorate quickly.
what are the properties of money?
It must be easily standardized. It must be widely accepted. It must be divisible (so you can have “change”). It must be easy to carry. It must not deteriorate quickly.
What is the definition of the LM curve?
Definition of the LM curve: A schedule that gives us all the
combinations of Y and r that insure the equilibrium in the money
market. It can be derived from the money market equilibrium:
