VWL Flashcards
Mankiws principles of economics
-> people face trade offs
-> the cost of something is what you give up to get it
-> rational people think at the margin
-> people respond to incentives
-> trade can make everybody better of
assumptions of competitive market model (perfect competition)
1) many buyers/sellers in the market
2) free market entry/exit
3) homogenous goods
4) full information on both sides
5) increasing marginal costs for the producer
6) profit maximization
-> no individual buyer/seller has the power to be able to influence the price
-> buyers and sellers act individually
-> only consider their own position in making decisions
-> clearly defined property rights
Advantages competitive market model
allocate efficiency
-> resources are allocated where they are most valued
-> goods are produced to the point where price = MC
-> ensuring the value consumers place on a good = cost of resources used to produce it
product efficiency
-> cost minimization because firms produce at the lowest point on their average cost curves (MC = AC)
-> goods produced at the minimum possible cost
absence of long term profits
-> in the long run firms earn only normal profit (economic profit = 0)
-> prevents firms from earning excessive profits at the expense of the consumer
disadvantages of competitive market model
unrealistic assumptions
-> perfect information and homogenous goods rarely exist
market failures
-> externalities: competitive markets fail to account for externalities leading to overproduction of harmful goods and underproduction of beneficial ones
Opportunity Cost
-> cost of something = what you have to give up to get it
-> money, time and other resources
marginal utlity
-> describes the change in utility (pleasure or satisfaction resulting from the consumption)
-> can be positive, negative and zero
Absolute utility
-> utility is a relative concept
-> differs from person to person
-> it is not standard and every individual will obtain a different level of satisfaction (utility) from the consumption of the same good
Incentives are key
-> government policies affect peoples life
-> lead to shifts in behaviour
-> not always reflects the original purpose of legislation (unintended consequences)
Benefits from trade
-> we can consume in a larger variety of goods which we cant produce
-> consumption at a cheaper price
Absolute advantage
when a producer can provide a good/service in greater quantity for the same cost
or
the same quantity at a lower cost than its competitors
Comparative advantage
-> the advantage over others in producing a particular good
-> can be produced at a lower relative opportunity cost
-> at a lower relative marginal cost prior to trade
limitations of comparative advantage
->ignoring transportation cost and trade barriers
-> considering only two countries and only two goods doesnt capture the complexity of global trade
-> model assumes countries are operating at full employment but unemployment/underemployment are common
trade off
loss of the benefits firm a decision to forego one option balanced against the benefits incurred from the choice made
efficiency
deals with ways society gets the most it can from its scarce resources
equity
looks at the extent to which the benefits of outcomes are distributed fairly among members of society
opportunity cost
making decisions requires comparing costs/benefits of alternative courses of action
-> measure of the options sacrificed
calculate opportunity cost
what must be given up in order to acquire something
sacrifice of a good x /gain in good y
marginal changes
incremental adjustments to an existing plan of action
-> based around the assumption that economic agents are seeking maximize/minimize the outcomes when making decisions
people respond to incentives
-> principle of rational behavior and that people make decisions by comparing costs/benefits
-> behavior may change when the costs/benefits change
-> intention of policymakers do not always lead to outcomes expected or desired
trade can make everyone better off
-> trade between economies can make all parties better off
-> trade allows specilization
-> some have skills that allow them to produce some things more efficiently
-> trade allows specializing in activities they do best
-> improves standard of living
assumptions of competitive market model
-> supply/demand refer to behavior of people as the interact in markets
-> market = group of buyers and sellers of a particular good/service
-> neither buyer/seller can influence the price
-> both are price takers
No influence on prices as sellers?
-> no control because other sellers offer identical products
-> each one only provides a very small amount in relation to total supply of the market
-> if one charges more consumers will buy elsewhere
-> goods are homogenous
quantity demanded
= amount of the good that buyers are willing and able to purchase at different prices
Demand curve
-> quantity demanded falls as prices rise and vice versa
-> quantity demanded is negatively or inversely related to the price
determinants of household demand
-> price of the good
-> disposable income
-> utility for the good
-> price of other goods
-> psychological factors/expectations
law of demand
-> the amount demanded increases with a fall in price
-> diminishes with a rise in price
demand curve
-> shows how the quantity demanded changes as the price varies
-> because a lower price increases the quantity the curve slopes downwards
movement along demand curve
change in price of a good = change in quantity demanded
-> Steigung ändert sich
Reasons for movement: income effect
-> if income remains constant a fall in price means the consumer can afford more milk with their income
-> real income has increased
Reasons for increase: substitution effect
-> with a lower price some consumers will choose to substitute the more expensive good with the now cheaper good
-> more milk than apple juice
Shifts in the demand curve
-> if any factors other than a change in price demand change
-> will cause a shift in the position of the curve = shift of demand
-> Verschiebung nach rechts oder links
-> increase in demand = shift to the right
-> decrease in demand = shift to the left
substitutes
when a fall in price reduces the demand for another good too
-> the two goods are called substitutes
-> pairs of goods that are used in place of each other
complements
-> when the fall of price in one good raises the demand for another good
-> pairs of goods that are used together
e.g. milk and cereal
Effect of income on demand
-> lower income means less spending
-> more income and its likely demand will also rise
normal good
-> if demand for a good falls/rises when income falls/rises
inferior good
if demand for a good rises when income falls
e.g. bus rides rise in demand when people are less likely to buy a car
quantity supplied
amount that sellers are willing and and able to sell goods/services at different prices
-> with high prices selling is more profitable and sellers are willing to suplly more (and vice versa)
supply curve
-> shows how the quantity supplied of the good changes as its prices varies
-> therefore supply chain slopes upward
law of supply
-> quantity supply rises with the price and falls with the price
-> quantity is positively related to the price of the good
movement along supply curve
-> if the price of a good rises there is a change in quantity supplied
shifts in the supply curve
-> shift if factors affecting producers willingness and ability to supply, other than price, change
-> at any given price sellers are now willing to produce a larger quantity
= supply chain shifts to the right
causes of a shift in the supply curve
-> increase in supply = any change that raises quantity supplied at every price shifts the supply curve to the right
-> decrease in supply = any change that reduces the quantity supplied at every price shifts the supply curve to the left
Equilibrium
= state of rest, point where there is no force acting for change
-> supply/demand are both market forces
-> exert force on price
-> if supply >< price -> pressure on price to change
-> market equilibrium occurs when amount consumers wish to buy at a particular price = amount sellers are willing to offer
equilibrium price
-> also called market clearing price because at this price everyone in the market has been satisfied
-> if one/both curves shift at the existing equilibrium price there will be a surplus or shortage
-> market mechanism takes time to adjust
surplus
-> when amount sellers wish to sell > amount consumers which to buy
-> response is cutting prices
-> some consumers will then buy more
-> movement along supply curve
-> price continue to fall until the market reaches a new equilibrium
a shortage
-> occurs if the amount consumers are willing/able to purchase at a price is > amount sellers are willing/able to offer
-> with many buyer and too few goods sellers raise their prices without loosing sales
law of sales and demand
-> price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance
elasticity
-> measure of how much buyers and sellers respond to market conditions
price elasticity of demand
-> measures how much the quantity demanded responds to a change in price
-> businesses cannot directly control demand
-> consumers can be influenced through a change in prices
-> demand for a good is elastic if the quantity demanded only slightly responds to changes in price
-> measure of how willing consumers are to move away from the good as its price rises
availability of close substitutes
-> goods with close substitutes tend to have more price elastic demand
-> easier for consumers to switch from one good to another
calcute price elasticity of demand
percentage change in quantity demanded / percentage change in price
-> quantity demanded is negatively related to its price
meaning of elasticity values
between 0 -1 -> price inelastic
-> change in quantity demanded is less than change in price
> 1 -> price elastic
-> change in quantity is greater than change in price
change in quantity demanded = change in price -> unit elasticity
comparative advantage
-> compares inputs required for production
-> describes opportunity cost of two producers
-> producer who gives up less of other goods has the smaller OC and therefore the comparative advantage
-> only possible to have the comparative advantage for one good
absolute advantage
-> comparing the productivity of one person, firm, nation to another
-> producer that requires a smaller quantity of input has the absolute advantage
-> possible to have the absolute advantage for two goods
indifference curves
-> consumer preferences allow them to choose between different bundles
-> represent consumer preferences in relation to the utility
-> if two bundles yield the same utility the consumer is indifferent between them
-> curve shows bundles of consumption with same utility -> equal utility curve
-> points on a higher curve a preferred
definition indifference curves
=> represent all combinations of two goods that have the same utility for the consumer
-> every point on one curve represents one combination of goods
-> always have a negative slope
-> always parallel and never intersect because more is always better
-> convex shaped as they represent the desire to have a mix of both goods
pareto-optimum
-> higher endowment with one good only possible at the expense of the other good
-> movement on the indifference curve by changing
total utility
satisfaction consumer gains from consuming a product
marginal utility
increase in utility gained from one additional unit of that good
marginal rate of substitution
-> slope of the indifference curve
-> depends on the amount of each good the consumer is currently consuming
-> slope changes at every point
MRS = rate at which consumer is prepared to substitute one good for another
budget constraint
-> more is preferred to less
-> spending is constrained by a budget/income
-> constraint shows the consumption bundles the consumer can afford given a specific income
-> no points outside the constraint are possible
slope of the budget constraint = relative price of the two goods
change in income and budget constraint
more income = constraint shifts right
less income = constraint strains left
-> slope will remain the same because the prices dont change
change in prices and budget constraint
-> slope of the constraint changes
prices fall = constraint pivots inwards
-> consumer can afford more
externalities
-> when an economic agent engages in an activity that influences the well being of a third party who neither pays nor receives any compensation for that effect
-> linked to social cost and benefits that exist when making a decision
negative externality
-> if the impact is adverse
e.g. pollution
-> means extra cost to society
-> social cost of the good exceeds the private cost
-> optimal quantity is smaller than the equilibrium quantity
-> could be internalized through taxes
positive externality
-> if the impact is beneficial
e.g. education
-> additional gain to society from an additional unit
-> social value exceeds the private value
-> market failure can be corrected by internalization of the externality
-> therefore education is heavily subsidized by the government
assumptions of a perfectly competitive market
-> many sellers and buyers
-> homogenous goods
-> full information on both sides
-> free market entry and exit
-> increasing marginal cost for the producer
-> profit maximization
profit maximization rule
price = marginal cost
-> average cost sollen marginal cost entsprechen
monopoly - imperfect competition
-> monopoly if its the sole seller of its product
-> product doesnt have any close substitutes
-> barriers to market entry as fundamental cause of monopoly
e.g. a key resource is owned by a single firm, cost of production make a single producer more efficient than a large number of producers
natural monopolies
-> when a single firm can supply a good/service to an entire market at lower cost than more firms
-> a firms average cost curve decline as its production increases
e.g. distribution of water because a network of pipes has to be build
monopolies - pricing decision
-> monopoly is sole producer in its market
-> faces downward sloping market demand
-> if the monopolist raises the price the consumers buy less
-> if he reduces the quantity of output the price increases
welfare effect in monopoly
-> monopolist obtains a part of the consumer surplus
-> net welfare loss emerges
-> monopolist can call a higher price and therefore some consumers will leave the market
-> reduces the welfare of society
functions of money
= set of assets in an economy people regularly use to buy goods/services from other people
- medium of exchange
- unit of account
- store of value
kinds of money
commodity money -> takes the form of a commodity with intrinsic value (gold, silver)
gold standard -> value of the currency based on gold
fiat money -> money used by government degree (coins, currency etc.)
liquidity
-> ease with which an asset can be converted into a medium of exchange
-> money is most liquid asset available
-> other assets vary in their liquidity
central bank
= institution designed to oversee the banking system
-> regulate the quantity of money in the economy
-> fiat money must be regulated
functions of a central bank
-> macroeconomic stability in maintaining stable growth and prices
-> avoidance of excessive and damaging swings in economic activity
-> maintenance of stability in financial system
-> monetary policy is the set of actions taken by the central bank in order to affect the money supply
open market operations
increase money supply by buying bonds from the public -> currency amount is increased
reduce money supply by selling bonds -> currency amount is reduced
lender of the last resort
-> liquidity is the cash needed to ensure transactions in the financial system are honored
-> to maintain financial stability central banks supply liquidity to the banking system
= lender of the last resort
how do banks make profit?
-> by accepting deposits and making loans
-> spread = difference between the average interest a bank earns and the average interest paid on its liabilities
-> bank holds a fraction of the money deposited as reserves and lend the rest to make their profit
banks balance sheet
-> assets include cash, securities, loans
-> liabilities are demand/saving deposits, borrowings from other banks
-> reserves must be kept
-> banks actively find ways of making new loans
new loan (asset) -> new money created -> money supply increases
bonds - balance sheet
-> banks buy/sell a range of assets including bonds
-> when a bond is purchased, the funds are credited to the sellers account -> increases the money supply and vice versa
central banks tool for monetary control
- open market operations
-> buys/sells government bonds - changing the refinancing rate
-> increasing the rate = decreases money supply
-> decreasing the rate = increasing money supply - quantitative easing
-> when the use of lowering interest rates is exhausted
-> buying of assets
-> in selling assets to the central bank it will hold more money in relation to other assets
inflation
-> prices rise when the government prints too much money
-> when the price level rises, the value of money falls and people pay more for goods/services
-> value of money is determined by supply/demand for money
measurement of GDP
-> measure of income/expenditure of an economy
-> total market value of all final goods/services produced within a country during a given period of time
components of GDP
Y = C + I + G + NX
Consumption C
-> spending by households on goods/services excluding purchases of new housing
Investment I
-> spending on capital equipment, inventories, structure including new housing
Government spending G
-> spending on goods/services by local and central governments
-> does not include transfer payments because they are note made in exchange for currently produced goods/services
net exports NX
-> exports - imports
GDP in a closed economy
Y = C + I + G
important identities
S = I
S = Y - C -G
S = (Y - T - G) + (T + G)
-> national saving is the total income that remains after paying for consumption and government purchases
private saving = (Y - T - G)
public saving = (T - G)
surplus and deficit q
if T > G -> budget surplus
if G > T -> budget deficit
multiplier effect
-> additional shift in aggregate demand
-> result of expansionary fiscal policy which increases income and therefore consumer spending
-> slope of the expenditure function is dependent on the multiplier effect
spending multiplier
M = 1/(1 - MPC)
-> marginal propensity to consume (MPC) is the fraction of extra income that a household rather consumes than saves
-> marginal propensity to save (MPS) is the fraction of extra income that a household rather saves than consumes
M = 1/MPS
Equilibrium MRS and price ratio
-> optimal consumption bundle (where consumer maximizes their utility subject to their budget constraint) is found where MRS = price ratio
-> rate at which consumer is willing to trade one good for another (MRS) = rate at which the market allows the to trade the good (price ratio)
->ensures that the consumer maximizes their utility given their budget constraint
revenue maximizing quantity
-> Marginal Revenue berechnen
MR = R’(x)
R(x) = demand function * x
-> maximale Menge in demand function einsetzen um maximalen Preis zu berechnen
maximal revenue
R(x) = maximaler Preis * maximale Menge
profit
profit = revenue - cost
monopoly price
marginal revenue = marginal cost
R’(x) = C’(x)
marginal revenue = Ableitung der Revenue Function
marginal cost = Ableitung der cost function
