terms Flashcards
define: Economics
- The study of the choices people make and the actions they take in order to make the best use of scarce resources in meeting their wants and needs.
- Reminds us that economics = the study of people
- Study of choices made in the face of scarcity
- Economics is a social science that seeks to explain how people act and makes assumptions about peoples behaviour
- Economics is an empirical science
Based upon observations - Theories and models are tested against observed information
define: Economic Choices
Consider some activity X. Then a simple rule of economics is:
If Benefits (X) > costs (X), then do activity X
If Costs (X) > Benefits (X), then do not do activity X
- Marginal = additional/incremental
- Policy
What are the 2 main branches of economics?
Micro and Macro
define: Microeconomics
- The study of the choices and actions of individual economic units such as households, firms, consumers, etc.
- Small units
- Second page newspaper; the trees
define: Macroeconomics
- the study of the behavior of the entire economy, including issues like unemployment, inflation and changes in the level of national income
- Front page newspaper; the forest
define: Warm-glow bias
give an answer you think someone wants to hear. The answer you think surveyor wants to hear
How do we decide if a policy is a good one or not?
Practical and theoretical ways of doing this
What does efficiency relate to?
benefits vs. cost
How can the allocation of resources be evaluated?
- Efficiency: Allocative efficiency is present when society’s resources are so organized that the present value of net benefits are maximized
- Equity: Distributing goods and services in a manner considered by society to be fair.
- Moral and Political Consequences
define: Positive economics
- Involves statements about what is and can be tested by checking the statements against the observed facts
- Example: If the price of coffee rises, people will buy less coffee
Can be tested; observe what happens if the price of coffee is increased. Will people still buy?
define: Normative economics
- Involves statements about what ought to be
Depends upon values and beliefs and cannot be tested - Example: Taxes should be used to redistribute income from high income groups to low income groups
Nothing to test; depends on ur values
what is a model?
A model is a simplified description of the way things work
- It is NOT a complete description of every detail but rather a simplified description that covers a wide range of possibilities
- Simplified = relative term
- Models and theories are meant to provide an understanding and explanation
- They also should be useful in predicting behavior
define: The Correlation Fallacy
- Incorrect belief that correlation implies causation.
- Tells you if two variables move together, you believe one causes the other
- Eg. increase consumption of cigarette use = increase in lung disease
- Careful when using empirical evidence
define: The Post Hoc Fallacy
- A special case of the correlation fallacy.
- From the latin phrase “post hoc ergo propter hoc,” meaning after this therefore because of this
- An error of reasoning that a first event causes a second event because the first occurred before the second.
- Ex. shopping and Christmas
define: The Fallacy of Composition:
- Incorrect belief that what is true for the individual is also true for the group.
- Taking an earlier bus
What is a production possibility frontier?
The production possibility frontier is a graph that shows the combinations of goods that can be produced when the factors of production are utilized to their full potential.
- Factors of production (aka inputs) are things like labor, production
- Shows all the combinations we are CAPABLE of producing
- A production possibility frontier is drawn for a given level of the society’s inputs (labour, natural resources and capital) and for a given state of the society’s technology
define: Opportunity cost
The benefit given up by not using the resources in a next best alternative way.
- Opportunity cost = next best alternative
EXAMPLE: Suppose instead of getting a degree, you could work for $40,000/year. That is what you sacrifice by going to university
Opportunity cost of a 4 year degree = $160,000.
Total cost = $200,000, The tuition + opportunity cost.
What is the law of increasing costs?
- In order to produce extra amounts of one good, society must give up ever increasing amounts of the other good.
- If X increases, you have to sacrifice more on the Y
- Opportunity cost increases as you improve one commodity
define: Absolute advantage
A country or person has an absolute advantage over another country or person in the production of a good or service if it can produce it at a lower absolute cost.
define: Comparative advantage
- A country or person has a comparative advantage over another country or person in the production of a good or service if it can produce it with a lower opportunity cost.
- Nations/individuals should specialize in goods which they have a comparative advantage and then trade. This benefits all trading partners.
- This is the basis of free trade discussion
define: Demand
The demand function shows the quantity consumers are willing to buy given the price and other relevant variables.
- Shows what you are willing to purchase given the price and a bunch of other things
- Primarily focus = the relationship between how much youre willing to buy in prices
- Qd (quantity demanded) = Dx (good X; D = some function) (Px; …)
Qd = Dx (Px; …)
How do markets choose how many commodities to produce?
evaluating demand
define: Law of demand
As a product’s price increases, the quantity demanded decreases; As a products price decreases, the quantity demanded increases
- As the price goes up, willing to buy less. As price goes down, willing to buy more
- Changes in the commodity’s price correspond to movements along the demand curve which are referred to as changes in the quantity demanded
- 1, and only 1 variable causes a change in quantity demanded (the price)
Move in the demand curve =
change in quantity demanded
What variable causes a change in quantity demanded?
the PRICE
A change in price causes what kind of change to the demand curve
Changes in MOVEMENT along the CURVE
- Change in quantity demanded = moving along
What variables impact demand?
- Price of substitute: If the price of a substitute for good A increases, the demand for good A increases
- Price of complements: If the price of a complement of good A increases, the demand for good A decreases
- Number of buyers: If the number of buyers increases, demand increases.
- Preferences: If preferences change, demand changes. Slow and gradual changes; ex. Smoking cigarettes (aka fashions)
- Expectations: Consumers’ expectations of future prices and availability impact current demand. ex, toilet paper during cover
- income: As income increases, demand increases (not true for all goods, but true for some)
normal vs. inferior goods
- Normal goods: As income increases, demand increases
- Inferior goods: As income increases, demand decreases (Ex. not eating ramen noodles after grad, once you have money can get a new car rather than a used car)
define: Supply
- The supply function shows the quantity producers are willing to sell to given the price and other variables.
- upwards sloping curve
define: Law of supply
As the price of a commodity increases, quantity supplied increases
- As the price goes up, producers are willing to sell more
- As the price of a commodity/good/service decreases, the quantity supplied decreases
- One and only one variable causes a change in quantity supplied: THE PRICE (Movement along the curve)
What variable causes a change in quantity supplied?
The PRICE (to producers)
- causes movement along the curve
What variables influence supply?
- Technology: A better technology corresponds to an increase in supply (ex. can produce things cheaper and faster)
- costs of inputs: Things like wages, interest rates, opportunity cost, taxes, … anything that affects the cost of production
- Number of firms: As the number of firms increases, supply increases
- Expectations: Producers’ view of the future may change current supply
- Changes in nature: Can have dramatic impacts upon current supply situations (Floods, droughts, sudden frost)
- Price of a complement in production: Two goods are complements in productions if when one good is produced the other is also produced (ex. Complements in production: get apple juice when producing apple sauce)
- Price of Substitutes in Production: Two goods are substitutes in production if they can be produced using the same inputs
Is price the same as cost?
NO!
Cost = what you pay to produce something; how expensive tp produce it
Price = what you were able to sell it for
When do we see moving along supply curve?
Change in quantity supplied
When do we see the entire supply curve shift?
Supply = one of the variables is being changed (wages, interest rate) which would cause the entire supply curve to shift
define: Equilibrium
The equilibrium price occurs where quantity demanded equals quantity supplied
Qd = Qs
- forces of demand that tell u when pricre goes up, want to sell more. When cost goes up, want to produce less
Comparative statics: what happens to equilibrium price in quantity when a variable changes?
- Product: Butter
- Event: Price of margarine decreased
- Diagram in phone
- Price of margarine decreased = demand curve affected, causing it to move in
- Substitute decrease in price = buying less butter
- New equilibrium
- Eq price and quantity of butter has decreased
define: Consumer surplus
- the difference between what a consumer is willing to pay, and what the consumer has to pay. It is a benefit to the consumers (if they can keep it).
- Draw up demand curve (downward sloping) can show that when the price is P0, itll tell us how many units consumers are willing to buy
- example in phone
What is a continuous good?
- Can be broken into smaller and smaller units
- If price in the market is given by p, so that people buy Q units, the CS becomes the entire triangle since ppl are buying smaller and smaller units
- Ex. rent a car by the hour, selling juice - divisible. Cannot be something like a TV that must be sold wholly
define: Producers’ surplus
- the difference between what the producer is paid and what the producer is willing to accept. Measures the benefit to producers.
“Economic forces ration commodities and services through changing ______.”
Prices
Why is it that when we look at the real world, we don’t see these economic forces working as smoothly as the above discussion would suggest.
(1) Information problems. People make mistakes, don’t possess perfect information. Do not process info as fast as the market suggests
(2) Other forces operate in society. These forces prevent some markets from clearing and other markets from operating. Economic forces are not our only forces in the economy
(3) Sometimes, markets fail. Something goes wrong with price signals; don’t tell us the appropriate thing
Ex. air pollution; no price on clean air, so we don’t measure it
Why do we need govts?
- We need govts to make sure activities conform to social, political, and legal norms; To make sure market gives us the answer we want and is acceptable
- We need govts to correct markets that fail; Be careful: govts can fail too, but our hope is that they will give us the answer and correct a failing market
What is the invisible handshake?
Social and historical forces. These are called the Invisible Handshake
Tradition; other culture forces still exist. There are things that are not culturally acceptable
What is the invisible foot?
Legal and political forces. These are called the Invisible Foot.
Prevent you from doing certain activities. Ex. selling your own liquor from home. Politics deciding free healthcare
define: Price floors
Government sets the minimum price
This is the lowest price they will allow
Ex. Minimum wage laws
ineffective vs effective: in phone
what is the purpose of an effective price floor?
created for a social goal (ex. Minimum wage)
- Have to account for surplus (ex. Social services or trading programs)
- Must do something with the surplus
Govt can try to create a market system but then fail
define: Price ceilings
- Government sets a maximum price. This is the highest price you can charge. Ex. Rent controls
- Distortion distorts market signals; that is the issue with rent controls
- Some states still use these under short term problems. Long term can cause too much distortions
What is the purpose of a quota?
Control on quantity. Government sets the maximum quantity
- Can be a protection, but a cost to consumers
- Quota bent the supply curve
an increase in demand causes the curve to shift ____
out
define: Price elasticity of demand
Measures the responsiveness of quantity demanded to a change in price. AKA elasticity of demand
Nd is non positive Number (it is negative or 0; almost always negative). Why?
- By law of demand = has to be negative
- Downward sloping demand curve
- Elasticity of demand will be a negative number
When elasticity of demand is less than 1, we say the demand is ______ (responsive)
When elasticity of demand is >-1, demand is _______ (unresponsive)
When elasticity of demand is = -1, demand is ________
- elastic
- inelastic
- unit elastic
a special case to elasticity: As increase price, quantity does not change. What will the curve look like>
- vertical
- Elasticity demand = 0
- Perfectly inelastic demand
a special case to elasticity: Perfectly elastic demand
- Value of elasticity of demand = - infinity
- Horizontal
What influences the size of AdasubD?
(elasticity)
- The number of substitutes. The more substitutes good A has, the more elastic is the demand for good A
The more you can respond, the more you will respond. - Time. Demand becomes more elastic over time
- Demand for luxuries is more elastic than demand for necessities. Total revenue and the elasticity of demand
The Total Revenue Rule states: If demand is elastic, total revenue moves in the _______ direction of a price.
opposite
The Total Revenue Rule states: If demand is inelastic, total revenue moves in the _______ direction as price.
same
The Total Revenue Rule states: If demand is unit elastic, total revenue _________ as price changes.
does not change
