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Why is economics a decision science?
Because it analyses how people and firms make consumption and production decisions and the consequences of those decisions.
What is the role of households?
To buy goods and services in markets and supplies the inputs that are used by firms.
What is opportunity cost?
The opportunity cost of an item is what you give up to get that item.
WHat are marginal costs?
The extra cost involved in increasing production by one unit from any current level
MC is above AV when ACs are increasing. Why?
Because it is getting progressively more expensive to produce.
MCs are below ACs when ACs are decreasing. Why?
Because it's getting progressively less expensive to produce.
What is the refutation criterion by Karl Popper?
Popper argued tha twhen we test theories in science and ecnomics we do not try to show that they are true. We try to show that tey are wrong by confronting them with evidence. If we can;t show they are wrong we tentatively accept the theories- they arent inconsistent with evidence. Thus, science consists of propositions set out so they can be falsified but which have not yet been falsified.
In the circular flow model, what is the role of firms?
Firms produce and sells goods and services. They also hire and use factors of production.
In the circular flow model, what is the role of households?
Households buy and consume goods and services. They also own and sell gfactors of production.
What are factors of production?
- Inputs used to produce goods and services (land labour and capital)
- They are paid for in land rents, wages and rental returns on capital.
What are the 4 concepts ullustrated by the production possibility frontier (PPF)?
- Efficiency: the max amount of each output given levels of other output. Points on PPF.
- Tradeoffs: of PPF we can only get more of one output by fiving up some of the other.
- Opportunity cost: the rate at which tradeoffs are made
- Economic growth: a shift in PPF.
What is a positive statement?
Claims that describe the world as it is. This is called descriptive analysis.
What is a normative statement?
Claims that attempt to describe how the world SHOULD be. This is called prescriptive analysis.
What is the PPF curve?
The PPF or production possibilities frontier curve is a graph showing the combinations of output that the economy can possibly produce given available factors of prodyction and the available production technology.
Who should specialise in what to maximise gains from trade?
Each are better off specialising in the product with lower opportunity cost and then trading with each other.
What is comparitive advantage?
The producer who has the smaller opportunity cost has a comparative adavantage in producing that good.
What is absolute advantage?
The producer requiring less inputs to produce a good is said to have an absolute afvantage in producing that good.
What is the principle of comparative advantage and how does it affect trade?
Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.
When, using the PPF, would trade not occur?
If the slope of the two PPF curves is the same, trade is pointless.
What are the characteristics of perfect competition?
- Products are the same
- Buyers and sellers are so numerous that no single buyer or seller can influence market price.
- Buyers and sellers are price takers
What are the characteristics of a monopoly?
- One seller
- The seller is a price maker - they set the price
What are the characteristics of an oligopoly?
- Few sellers
- Not always aggressive competition.
- Sometimes collusion or cooperation
What are the characteristics of monopolistic competition?
- Many sellers
- Slightly differentiated products (eg. retailing)
- Each seller may set the price for their own product
What is the law of demand?
All other things equal, the quantitiy demanded of a good falls when its price rises
What is a supply or demand schedule?
A table showing the relation between price of a good and quantity supplied or demanded.
What is the supply or demand curve?
A graph of the relationship between the price and quantity supplied or demanded
Quantity demanded depends (positively OR negatively) on price.
Quantity supplied depends (positively OR negatively) on price.
As income increases what will happen to the demand for a normal good?
It will increase. Examples are going to the movies, or travel.
As incomes increases, what will happen to demand for an inferior good?
It will decrease. Examples include second hand clothing
What is the law of supply?
All other things being equal, the quantity supplied of a good rises when its prices rises.
When goods are related, a fall in the price of one good that reduces demand for another good, means that the goods are...
When goods are related, a fall in the price of one good that increases demand for another good, means that the goods are...
When does surplus occur?
When market price > equilibrium price, and thus quantity supplied > quantity demanded.
When will shortage occur?
When market price < equilibrium price, then quantity demanded > the quantity supplied
How do we do comparative statics (working out the effects of a market shock)?
- 1. Decide whether the event shifts the supply or demand curve (or both)
- 2. Decide whether the curve(s) shift(s) to the left or right.
- 3. Use the supply and demand diagram to see how the shift affects equilibrium price and quantity.
What is the price elasticity of demand?
A measure of how quantity demand of a good respons to a change in the price of that good. It has the formula:
PEofD = % change in quantity demanded / % change in price
What is the formula of the midpoint method?
- PEofD (midpoint method) =
What is inelastic demand?
PEofD between 0 and -1
What is elastic demand?
PEofD of less than -1
What is perfectly inelastic demand?
PEofD of exactly 0
What is unit elastic demand?
PEofD of exactly -1
What is perfectly elastic demand?
- PEofD is equal to negative infinity.
- This is the case where the good has a perfect substitute.
What is the formula for income elasticity?
% change in demand / % change in income
What is the formula for the elasticity of supply?
% change in quantity supplied / % change in price
When are crossprice elasticities positive?
If the goods are substitutes
When are crossprice elasticities negative?
If the goods are complements
If a demand curve is elastic, what happens to the total revenue when the price rises?
If a demand curve is inelastic, what happens to the total revenue as the price rises?
When is supply most elastic in most markets, in the SR or the LR?
In the LR
What is the willingness to pay (WTP)?
The maximum amount a buyer will pay for a good or service. It measures how much the buyer values the good or service.
What is social surplus?
Consumer surplus + producer surplus
What is consumer surplus?
Economic welfare in dollars from the buyers side. It is equal to the buyers WTP for a good minus the amount the buyer actually pays for it
What is producer surplus?
Economic welfare in dollars from the sellers side. It is equal to the amount a seller is paid for a good minus the sellers cost.
Which area on a graph is the producer surplus?
The area below the price and above the supply curve
When is a resource allocation pareto efficient?
When it is impossible to make somebody better off without making someone else worse off
What is a price ceiling?
A legal maximum on the price a good can be sold at
What is a price floor?
A legal minimum on the price a good can be sold at
A price surplus or price floor inflicts a DWL
Who bears a tax?
The tax falls most heavily on the party whose behaviour is most inelastic (steeper curve)
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