Microeconomia Flashcards
WHAT IS ECONOMICS?
It is the social science that studies the choices that individuals, companies, governments, and entire societies do to deal with shortages, as well as incentives that influence those choices and conciliate them.
Fields of economics
Microeconomics.
Macroeconomics.
Incentive
Is a reward that encourages (to do) or a punishment that discourages (not to do) an action.
Microeconomics
Is the study of choices individuals and businesses make, the way in which these choices interact in the markets and the influence that governments exert on them.
Macroeconomics
Is the study of performance of the national and global economies.
Goods and services
The objects that people value and produce to satisfy human needs.
Goods
Physical objects, for example, golf balls, cars, etc
Services
Are tasks that people perform, such as a haircut, teaching or advising, etc.
Factors of production
The essential resources required to produce goods and services
The factors of production are grouped into four categories:
-Land: The natural resources
-Labor: The time and effort that people spend producing goods and services
-Capital: The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services
-Business skills: The human resource that organizes labor, land and capital
For whom to produce?
Whoever gets the goods and services produced depends on people’s income.
Exchange
Implies to give up one thing to get another.
How does the decision-making process of companies impact the production of goods and services?
The decisions made by companies influence the methods, technologies, and strategies employed in the production of goods and services, ultimately shaping the efficiency, quality, and sustainability of their output.
What do choices cause?
Change, changes over time
Opportunity cost
Is the most valuable alternative that we give up in order to get something.
Marginal benefit
The additional satisfaction or value you get from consuming or doing one more unit of something
Marginal cost
Is the additional cost incurred when producing one more unit of a product or providing one more unit of a service.
To what our choices respond?
To incentives
What’s the fundamental idea of economics?
Is that we can predict how choices will change just by analyzing changes in the incentives.
What are incentives key to?
To reconcile personal interest and social interest.
What’s one of the challenges for economists?
Is to devise incentive systems that result in self-interest-based choices that serve the social interest.
If human nature is already determined and people act based on their self-interest, how can we take care of the social interest?
Economists highlight the crucial role that institutions play in influencing the incentives
Primary institutions
Constitute a legal system that protects private property, as well as markets that allow voluntary exchange between people
What do Economists try to discover?
How the economic world works and, to achieve this goal (like all scientists), they make a distinction between two types of statements:
-What it is.
-What it should be.
Positive statements
Is a factual statement that can be objectively tested and verified. It describes what is, was, or will be without expressing a judgment or opinion.
Normative statements
Statements about what must be
Goal of the economic science
Is to discover the positive statements that are consistent with what we observe and help us understand the economic world.
This can be divided into three steps (economic science)
-Observation and Measurement
-Model-building
-Model-testing and Verification
The first step in understanding how the economic world works is:
to observe it.
The second step in understanding how the economic world works is:
To build a model.
Economic model
A brief explanation of the economy that highlights only the important parts for a particular use.
The third step in understanding how the economic world works is:
Testing the models.
Economic theory
It connects economic models with the real world.
How can we evaluate a model’s accuracy and develop economic theories by comparing its predictions to facts, which may either align or conflict with them?
The predictions of a model could correspond to the facts, or could also be in conflict with them. By comparing the predictions of the model with the facts, we can test the veracity of the model and develop an economic theory.
Year and who created Economics:
Born in 1776 with the publication of “The Wealth of Nations” by Adam Smith
ceteris paribus
“all other things being equal” or “holding other things constant”. It’s used to isolate the effect of one specific variable or factor while assuming that everything else remains unchanged.
Why is ceteris paribus important?
Maintaining stability in all other factors is crucial in many activities, including scientific progress. Economic models, like those in other sciences, let us isolate the impact of one variable at a time. However, in economics, the ‘ceteris paribus’ condition can pose challenges when testing such models.
What to do when Ceteris Paribus becomes a problem when trying to test a model?
1.They look for situations where everything else is similar except for the thing they want to study. For example, they might compare how unemployment benefits affect unemployment rates in the United States and Canada, assuming that other factors are mostly the same.
2.Economists use statistical tools, which are like math techniques, to analyze data.
3.When possible, economists do experiments. They put real people, often students, in situations where they have to make choices, and they change one thing at a time to see how it affects their decisions.
Fallacies
Errors of reasoning that can lead to erroneous conclusions.
Two common fallacies
-Fallacy of composition.
-Post hoc fallacy.
Fallacy of Composition
It consists of the (false) statement that what is true for the parts is also true for the whole, or that what is true for the whole is true for the parts.
Post-hoc Fallacy
Latin phrase, post hoc, ergo propter hoc, which means “after this” or “then, as a result of this”.
The post hoc fallacy is an error of reasoning according to which a first event causes a second event only because the first occurred before the second.
Market
Is any set of mechanisms in which buyers (consumers) and sellers (producers) of a good (product) come into contact to trade it.
All markets have a common basic economic core:
The model of supply and demand
Demand
Is a diagram or curve that shows the various quantities of a product that buyers are able and willing to buy at each possible price during a specific period of time
Law of Decreasing Demand
When the price of a good goes up, holding everything else constant, buyers tend to buy less.
When the price of a good drops, holding everything else constant, the quantity demanded increases.
There are two reasons why the quantity demanded tends to fall when the price rises.
Income effect.
Substitution effect.
Determinants of demand.
Factors that influence consumers to modify their purchases.
The basic determinants that cause market demand shifts are:
-Tastes or preferences.
-The number of consumers.
-Income.
-The prices of related goods.
-Expected future prices.
Shifts in the demand curve
A move to the right of the demand curve indicates an increase of the demand.
A move to the left indicates a decrease of the demand.
Taste and preferences
They constitute one of the main factors that determine the quantity demanded of each good.
They are shaped in part by society, by habits, by education and by advertising.
The number of consumers
An increase in the number of buyers in the market increases demand.A decrease in the number of buyers in the market decreases demand.
Income
When a consumer’s income rises, he or she typically wants to spend more, and demands more of most (but not all) goods.
Normal or superior good
Is one whose quantity demanded at each of the prices increases when income increases.
Inferior good
Is the one whose quantity demanded decreases when income increases.
Of what depends the quantity demanded of a good?
depends on the changes in the prices of other goods related to it.
Substitutes or complementary.
Goods are substitutes if the increase in the price of one of them increases the quantity demanded of the other, whatever the price.
Goods are complementary if an increase in the price of one of them reduces the quantity demanded of the other.
Supply
Is a diagram or curve that shows the various quantities of a product that sellers are able and willing to sell at each possible price during a specific period of time.
Change in the quantity supplied
Is the movement from one point to another on a fixed supply curve.The cause of that movement is a change in the price of the specific product we are analyzing.
Shifts in the supply
An increase in supply shifts the curve to the right; a decrease in supply shifts the curve to the left.
The cause of such shifts is a change in one or more determinants of supply.
The basic determinants that cause market supply shifts are:
-Input prices.
-Existing technology.
-Prices of related goods.
-The number of sellers.
-Taxes and subsidies.
Market equilibrium
A point where the forces of supply and demand come together, resulting in a specific price and quantity for a particular product or service. It’s the balance point where the quantity of a product that suppliers are willing to offer matches the quantity that consumers are willing to buy at a given price.
Assumptions Related to Consumer Preferences
1.Rationality. It is assumed that consumers are rational beings.
2.Consistency. The consumer is consistent in choosing a selection of goods, that is, you can order them from a higher or lower degree
3.Research. The consumer investigates and becomes fully aware of the availability of goods, of its qualities, of an average price, etc.
4.Insatiability. More is preferable than less, no individual is fully satisfied because needs are limitless.
Indifference Curve
Represents all the different combinations of X and Y that report to the consumer the same level of satisfaction.
Marginal rate of substitution
Measures the amout of good Y that a consumer is willing to give up to obtain additional unit of good X, so that his level of satisfaction does not vary. It is meassured by the slope of the indiference curve.
Utility
The benefit or satisfaction that an individual gets from the consumption of a good or service.Each indifference curve represents a Utility Function of a basket of goods (X,Y)
Saturation point
A point where a market or a product reaches a level of maximum demand or growth
Overall Utility.
It is the total satisfaction derived from the consumption of a certain amount of a product. That is, it’s the sum of all individual “Utils“ resulting from the consumption.
Marginal utility.
It is defined as the change in total utility due to the change in the consumption of one additional unit of a good or service.
Law of Diminishing Marginal Utility.
“As a person consumes an additional unit of the same good per unit of time, the utility or extra benefit derived from that consumption decreases”
THE BUDGET CONSTRAINTS
The amount of goods that the consumer can buy is limited by the prices they must pay for them and the amount of income that they earn.
Our Budget Constraint will be modified by the following:
-By Changes in Income.: It occurs when income increases but the prices of goods remain constant, it means that the purchasing power of consumers has increased and this translates into more consumption of both goods, the new budget line will move parallel upwards.
-By Changes in the Prices of Goods.
The Law of Demand:
says that consumers respond to a reduction in price by buying more of the product.
Of what depends how much more do they buy?
That amount varies considerably from one product to another and between different price ranges of the same product.
Elasticities:
The response or sensitivity of consumers to a in the price is measured by the price elasticity of demand.
Elastic Demand:
Demand for some products is such that consumers have a strong reaction to price changes. Small shifts in price lead to large shift in the quantity they buy .Demand is elastic when a percentage change in price results in a larger percentage change in quantity demanded.ℰd > 1
Inelastic Demand:
consumers hardly react to price changes.Large price changes only result in very small changes in the quantity they buy. Demand is inelastic when a percentage change in price results in a smaller percentage change in quantity demanded.ℰd < 1
Coefficient of Elasticity:
Economists measure the degree of price elasticity or price inelasticity of demand by the coefficient ℰd , which is defined as the coefficient ℰd: “ℰd”=(∆% 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑋)/(∆% 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑋)
Why are percentages and not absolute quantities used to measure elasticities?
There are 2 reasons: 1.Choice of units 2.Comparison of products
Product Comparisons:
With the use of percentages we can make a proper comparison of the response of consumers to changes in the prices of different products.
Omission of the minus sign:
The downward sloping demand curve indicates that price and quantity demanded are inversely related. Therefore, the coefficient of price elasticity of demand ℰd is always a negative number.
Interpretation of ℰd:
We can interpret the coefficient of price elasticity of demand as follows:
1. Price-elastic demand.
2. Price-inelastic demand.
3. Unit-elastic demand.
4. Extreme Cases: Perfectly elastic demand/ Perfectly inelastic demand.
Perfectly inelastic demand:
In the extreme situation in which a change in price does not produce any change in quantity demanded
Unit Elasticity:
The situation that separates elastic demand from inelastic demand occurs when the percentage change in price and the percentage change in quantity demanded are equal.ℰd = 1
Perfectly elastic demand:
In the extreme situation where a small reduction in price leads buyers to increase their purchases from zero to as much as they can get or an increase in price leads the quantity demanded to decrease from a finite quantity to zero.
“The Total Revenue Test.”:
An alternative way of knowing whether demand is elastic, inelastic or unitary, is by what is called
Total revenue (TR)\
is the total amount received by the seller of a product; it is calculated as follows: TI = P X Q
Determinants of ℰd:
Substitutability, Income ratio, Luxury goods and necessary goods, Time.
Substitutability:
the greater the number of available substitutes, the greater the elasticity of demand
Luxury goods and necessary goods:
The demand for necessary goods tends to be inelastic and that for luxury goods elastic.
Proportion of Income:
Other things being equal, the higher the price in relation to a person’s income and budget, the higher the elasticity of demand for that product.
Time:
Time: Generally speaking, demand for a product is more elastic the longer the period of analysis.
Application of ℰd:
Abundant harvests: the demand for agricultural products is very inelastic. Consumption taxes: the government has to pay attention to the elasticity of demand when selecting the b and s it taxes on consumption. Drugs and street crime: The demand for cocaine and heroin is believed to be highly inelastic.
Price elasticity of supply:
The concept of elasticity also applies to supply. Elastic supply: when producers are very responsive to prices.Inelastic supply: when they are less responsive to prices.
Determinants of the elasticity of supply:
Determinants of the elasticity of supply: The main determinant of ℰo is the time that producers have to respond to the change in the price of the product. The longer the response time, we can expect the ℰo to be higher.
3 periods are distinguished:
- Immediate or market: is the period immediately after the in P of market during which the producers cannot respond with a in the amount
- Short term?.
- Long term.?
Government Controlled Price:
the government can intervene by setting the maximum or minimum ceiling that a price can reach. The justification is that consumers obtain an “essential” good or service that they could not buy at the equilibrium price
Ceiling Prices and Scarcity:
a) It is the maximum legal price that a seller can charge for a good or service.
b) A price equal to or less than the ceiling is legal.
c) A higher price is illegal.
