Chapter 1: Introduction to Economics/Making and Using Graphs ...
Chapter 1: Introduction to Economics/Making and Using Graphs •
Scarcity is our inability to satisfy all our wants
•
Microeconomics is the study of the choices that individuals and businesses make, the way these choices interact in markets, and the influence of governments
•
Macroeconomics is the study of the performance of the national economy and the global economy
•
Choices made in economics determine what, how, and for whom goods and services are produced -
The what question is “What goods and services do we produce?”
-
The how question is “How do we use the factors of production to produce these goods/services?”
-
The for whom question is “Who consumes the goods and services that are produced?”
•
You make choices that are in your self-interest – choices that you think are best for you
•
Factors of production: -
Land earns rent; Labour earns wages; Capital earns interest; Entrepreneurship earns profit
•
Choices that are the best for society as a whole are said to be in the social interest
•
A tradeoff is an exchange – giving up one thing to get something else
•
A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice -
Only the wants of the person making a choice are relevant to determine its rationality
•
The opportunity cost of something is the highest-valued alternative that must be given up to get it
•
Choices respond to incentives – a change in marginal benefit or a change in marginal cost
•
-
If the marginal benefit of Option 1 is greater than its marginal cost then you will choose Option 1
-
If the marginal cost of Option 2 is greater than its marginal benefit than you will not choose Option 2
Positive statements are about what is -
•
A positive statement might be right or wrong but can be tested by checking it against facts
Normative statements are about what ought to be -
These statements depend on values and cannot be tested
•
An economic model describes some aspect of the economic world and includes only those features needed for the purpose at hand
•
To disentangle cause and effect, economists use economic models and look for natural experiments, conduct statistical investigations, and perform economic experiments to test the predictions of those models
•
A natural experiment is a situation that arises in the ordinary course of economic life in which one factor of interest is different and other things are equal (or similar)
•
A statistical investigation looks for correlations
•
An economic experiment puts people in a decision-making situation and varies the influence of one factor at a time to discover how they respond
Chapter 2: The Economic Problem •
•
The production possibilities frontier (PPF) shows the limits to production -
Points outside the frontier cannot be attained without technological change or capital accumulation
-
Any point inside the PPF and on the PPF can be produced, so they are attainable
-
The PPF illustrates scarcity by showing that that firm cannot produce at points outside the PPF, and as the firm moves along the PPF increasing production of Good A, it must decrease the quantity of Good B
We achieve production efficiency if we produce goods and services at the lowest possible cost -
•
Achieved at all points on the PPF
Opportunity cost equals the decrease in the quantity produce of one good divided by the increase in the quantity produce of another good as we move along the PPF -
Opportunity cost increases because not all resources are equally productive in all activities as shown by the bowed-out shape of the PPF
-
A ratio equal to the quantity of the good given up divided by the increase in quantity of the other good produced as we move along the PPF
•
Marginal cost of a good is the opportunity cost of producing one more unit of the good
•
The marginal cost is plotted at the x-value midway between the two values that generate it
•
Marginal benefit from a good or service is the benefit received from consuming one more unit of it -
Measured by the most that people are willing to pay for an additional unit of said good or service
-
The more we have of any good or service, the smaller is its marginal benefit and the less we are willing to pay for an additional unit of it
•
Allocative efficiency is achieved when we cannot produce more of any good without giving up some other good that we value more highly – the point on the PPF that we prefer above all other points
•
Economic growth comes from technological change and capital accumulation -
Technological change is the development of new goods and of better ways of producing existing goods and services
-
Capital accumulation is the growth of capital resources, which includes human capital
•
The opportunity cost of economic growth is greater the faster we make our production grow
•
In 1960, the production possibilities per person in Canada were more than 3x those in Hong Kong
•
Canada devotes 1/5th of its resources to accumulating capital and the other 4/5 th to consumption
•
Hong Kong devotes 1/3rd of its resources to accumulating capital and 2/3 rd to consumption
•
Social institutions such as firms, markets, property rights, and money are necessary to make decentralized coordination work and are required for society to enjoy the benefits of specialization and trade
•
A market is any arrangement that enables buyers and sellers to get information and to do business with each other
•
Markets have evolved because they facilitate trade
•
The flows from firms to households are the real flows of goods and services and the income flows of wages, rent, interest and profit
•
The flows from households to firms are the real flows of labour, land, capital, and entrepreneurship and the flow of expenditure on goods and services
Chapter 3: Demand and Supply •
A relative price is the ratio of one price to another
•
The opportunity cost of a good is the relative price of that good to another good
•
The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price -
Not necessarily the same as the quantity actually bought
•
The law of demand states that, other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded
•
A demand curve is a willingness-and-ability-to-pay curve and the willingness and ability to pay is a measure of marginal benefit -
Tells us the maximum that someone is willing to pay for an additional unit of a good or service
•
A normal good is one for which demand increases as income increases
•
An inferior good is one for which demand decreases as income increases
•
The substitution effect displays that as the opportunity cost of a good rises, the incentive to economize on its use and switch to a substitute becomes stronger
•
The income effect displays that as the price of a good either increases or decreases consumers can either afford to buy less or more of a good relative to their income
•
A substitute is a good that can be used in place of another good
•
A complement is a good that is used in conjunction with another good
•
The quantity supplied of a good or service is the amount producers plan to sell during a given time period at a particular price -
Not necessarily the same as the quantity actually sold
•
The law of supply states that, other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied
•
A supply curve can be interpreted as a minimum-supply-price curve – a curve that shows the lowest price at which someone is willing to sell and this lowest price is marginal cost
•
The equilibrium quantity is the quantity at which the quantity demanded equals the quantity supplied
•
The equilibrium price is the price at which the quantity demanded equals the quantity supplied
•
At any price below the equilibrium price, the quantity demanded exceeds the quantity supplied and a shortage exists
•
At any price above the equilibrium price, the quantity supplied exceeds the quantity demanded and a surplus exists
Chapter 4: Elasticity •
The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a good or service to a change in its price
•
Price elasticity of demand = % change in the quantity demanded ÷ % change in the price
•
The total revenue test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price
•
Demand is elastic (>1) if a price cut increases total revenue
•
Demand is inelastic (1 (normal good, income elastic); +
Scarcity is our inability to satisfy all our wants
•
Microeconomics is the study of the choices that individuals and businesses make, the way these choices interact in markets, and the influence of governments
•
Macroeconomics is the study of the performance of the national economy and the global economy
•
Choices made in economics determine what, how, and for whom goods and services are produced -
The what question is “What goods and services do we produce?”
-
The how question is “How do we use the factors of production to produce these goods/services?”
-
The for whom question is “Who consumes the goods and services that are produced?”
•
You make choices that are in your self-interest – choices that you think are best for you
•
Factors of production: -
Land earns rent; Labour earns wages; Capital earns interest; Entrepreneurship earns profit
•
Choices that are the best for society as a whole are said to be in the social interest
•
A tradeoff is an exchange – giving up one thing to get something else
•
A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice -
Only the wants of the person making a choice are relevant to determine its rationality
•
The opportunity cost of something is the highest-valued alternative that must be given up to get it
•
Choices respond to incentives – a change in marginal benefit or a change in marginal cost
•
-
If the marginal benefit of Option 1 is greater than its marginal cost then you will choose Option 1
-
If the marginal cost of Option 2 is greater than its marginal benefit than you will not choose Option 2
Positive statements are about what is -
•
A positive statement might be right or wrong but can be tested by checking it against facts
Normative statements are about what ought to be -
These statements depend on values and cannot be tested
•
An economic model describes some aspect of the economic world and includes only those features needed for the purpose at hand
•
To disentangle cause and effect, economists use economic models and look for natural experiments, conduct statistical investigations, and perform economic experiments to test the predictions of those models
•
A natural experiment is a situation that arises in the ordinary course of economic life in which one factor of interest is different and other things are equal (or similar)
•
A statistical investigation looks for correlations
•
An economic experiment puts people in a decision-making situation and varies the influence of one factor at a time to discover how they respond
Chapter 2: The Economic Problem •
•
The production possibilities frontier (PPF) shows the limits to production -
Points outside the frontier cannot be attained without technological change or capital accumulation
-
Any point inside the PPF and on the PPF can be produced, so they are attainable
-
The PPF illustrates scarcity by showing that that firm cannot produce at points outside the PPF, and as the firm moves along the PPF increasing production of Good A, it must decrease the quantity of Good B
We achieve production efficiency if we produce goods and services at the lowest possible cost -
•
Achieved at all points on the PPF
Opportunity cost equals the decrease in the quantity produce of one good divided by the increase in the quantity produce of another good as we move along the PPF -
Opportunity cost increases because not all resources are equally productive in all activities as shown by the bowed-out shape of the PPF
-
A ratio equal to the quantity of the good given up divided by the increase in quantity of the other good produced as we move along the PPF
•
Marginal cost of a good is the opportunity cost of producing one more unit of the good
•
The marginal cost is plotted at the x-value midway between the two values that generate it
•
Marginal benefit from a good or service is the benefit received from consuming one more unit of it -
Measured by the most that people are willing to pay for an additional unit of said good or service
-
The more we have of any good or service, the smaller is its marginal benefit and the less we are willing to pay for an additional unit of it
•
Allocative efficiency is achieved when we cannot produce more of any good without giving up some other good that we value more highly – the point on the PPF that we prefer above all other points
•
Economic growth comes from technological change and capital accumulation -
Technological change is the development of new goods and of better ways of producing existing goods and services
-
Capital accumulation is the growth of capital resources, which includes human capital
•
The opportunity cost of economic growth is greater the faster we make our production grow
•
In 1960, the production possibilities per person in Canada were more than 3x those in Hong Kong
•
Canada devotes 1/5th of its resources to accumulating capital and the other 4/5 th to consumption
•
Hong Kong devotes 1/3rd of its resources to accumulating capital and 2/3 rd to consumption
•
Social institutions such as firms, markets, property rights, and money are necessary to make decentralized coordination work and are required for society to enjoy the benefits of specialization and trade
•
A market is any arrangement that enables buyers and sellers to get information and to do business with each other
•
Markets have evolved because they facilitate trade
•
The flows from firms to households are the real flows of goods and services and the income flows of wages, rent, interest and profit
•
The flows from households to firms are the real flows of labour, land, capital, and entrepreneurship and the flow of expenditure on goods and services
Chapter 3: Demand and Supply •
A relative price is the ratio of one price to another
•
The opportunity cost of a good is the relative price of that good to another good
•
The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price -
Not necessarily the same as the quantity actually bought
•
The law of demand states that, other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded
•
A demand curve is a willingness-and-ability-to-pay curve and the willingness and ability to pay is a measure of marginal benefit -
Tells us the maximum that someone is willing to pay for an additional unit of a good or service
•
A normal good is one for which demand increases as income increases
•
An inferior good is one for which demand decreases as income increases
•
The substitution effect displays that as the opportunity cost of a good rises, the incentive to economize on its use and switch to a substitute becomes stronger
•
The income effect displays that as the price of a good either increases or decreases consumers can either afford to buy less or more of a good relative to their income
•
A substitute is a good that can be used in place of another good
•
A complement is a good that is used in conjunction with another good
•
The quantity supplied of a good or service is the amount producers plan to sell during a given time period at a particular price -
Not necessarily the same as the quantity actually sold
•
The law of supply states that, other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied
•
A supply curve can be interpreted as a minimum-supply-price curve – a curve that shows the lowest price at which someone is willing to sell and this lowest price is marginal cost
•
The equilibrium quantity is the quantity at which the quantity demanded equals the quantity supplied
•
The equilibrium price is the price at which the quantity demanded equals the quantity supplied
•
At any price below the equilibrium price, the quantity demanded exceeds the quantity supplied and a shortage exists
•
At any price above the equilibrium price, the quantity supplied exceeds the quantity demanded and a surplus exists
Chapter 4: Elasticity •
The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a good or service to a change in its price
•
Price elasticity of demand = % change in the quantity demanded ÷ % change in the price
•
The total revenue test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price
•
Demand is elastic (>1) if a price cut increases total revenue
•
Demand is inelastic (1 (normal good, income elastic); +
