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the study of the efficient allocation of limited resources for unlimited wants
4 factors of production (resources)l
- capital - man-made products used to produce something else more efficiently
- entrepreneurial skills - creating and managing human and other resources to provide desired goods or services at a profit
a simplified description of reality -- should only include important factors, predict future events precisely and can be validated
when an increase in the independent variable also increases the dependent variable (or decrease/decrease) (if x↑, y↑) or (if x↓, y↓)
when an increase in the independent variable decreases the dependent variable (or decrease/increase) (if x↑, y↓) or (if x↓, y↑)
ceteris paribus assumption
when a certain variable changes, "all other variables remain unchanged" ... "all things being equal"
a statement of fact; can be verified... statements with "is", "was", "will be". without opinions or value judgements
a statement of opinion or value judgements. "high" "low" "good" "bad" "better" "worse" etc
4 pitfalls in economic thinking
- the fallacy of composition; what is good for one person is good for everyone
- the post hoc fallacy; because event A precedes event B, event B must have been caused by event A. "after this, therefore because of this"
- cause and cure; proposing a cure for a problem without proper testing. [supply will create its own demand]
- predicting human behavior; inability to test in a lab
"let it be"
the "Invisible Hand"
the market system leads all individuals, in search of their own self-interests, to produce the greatest benefit for society as a whole. --Adam Smith
2 required conditions for the invisible hand to work:
- clearly defined property rights [provides certainty about future]
- economic freedom to produce or consume what people wish [benefit those around them; cooperation and communication by means of market prices]
opportunity cost (O.C.)
the cost of the best alternative foregone or sacrificed ... [when an economy produces one product, it has to proportionately limit or forego production of another product]
the production possibilities curve (PPC)
- represents the maximum combination of any two goods a country can produce given today's limited resources.
- the curve illustrates the boundary of production
- ceteris paribus assumed
region outside of PPC (production possibilities curve)
- there are neither sufficient resources nor enough know-how to operate
region inside of PPC (production possibilities curve)
- unemployment of resources exists
actions for government to take in a recession
- raise gov't spending --> more jobs
- lower taxes --> more disposable income
- raise money supply --> interest rates drop
to determine the time it will take to double, triple, or quadruple an investment or standard of living based on an interest rate...
- doubling: 72/x; where x = % (not decimal)
- tripling: 114/x
- quadrupling: 144/x
allocation of resources is efficient only when one can make those involved in one activity better off without making those involved in another activity worse off.
the amount of a product or service that a person is willing or able to buy, at a particular price, over a specified period of time
as P goes up what happens to Qd?
P↑ ⇒ Qd↓ (or vice versa)
how the price of one product or service will effect the demand for another similar product [red OR green grapes, Starbucks OR Coffee Bean]
real income effect
- consumers' purchasing power increases as prices for regularly bought goods decreases.
- If you always buy x at $10 and its price is reduced to $3 you are effectively $7 richer. This is an increase in real income.
- This will also raise the demand for x.
the law of diminishing marginal utility
the more of a product that is consumed, the less satisfaction (utility) the consumer will derive
Law of Demand
- there is an inverse relationship between the price level of a good and its quantity demanded, ceteris paribus.
- P↑ ⇒ Qd↓
- P↓ ⇒ Qd↑
5 factors of shifting demand curve:
- normal good--> positive relationship I↑ -->D↑
- inferior good--> negative relationship I↓ --> D↑
- price expectation:
- expectation ↑, D↑, P↑... price fulfilling prophecy
- prices of other (related) goods:
- substitute good.... good A OR good B [Pepsi P↑-->Qd↓-->Coke D↑]
- complementary good... good A AND good B [coffee P↑-->Qd↓-->half&half D↓]
When quantity supplied exceeds quantity demanded
When quantity demanded exceeds quantity supplied
When Qd = Qs
Opportunity cost formula
- Δx/Δy = x sacrificed for one unit of y
- * the OC of one unit that you seek goes in denominator
Factors that shift supply curve
- Number of producers
- technology/capital goods
- cost of production
- government policies
- Prices of related goods substitute: [rice to wheat; Pr↑-->Qr↑-->Sw↓] complementary: [chickens to organs; Pc↑-->Qc↑-->So↑]
Elasticity of demand, % and mid point formulas
Price elasticity of demand
Buyers' response to a change in price
Price elasticity of supply
Producers' response to a change in price
- a 1% change in price will lead to a more than 1% change in quantity demanded.
- *remember: inverse relationship, a 1% increase in price will lead to a more than 1% decrease in Qd.
- Unit elastic
- 1:1 ratio
- if seller increases price by 1%, there will be exactly a 1% decrease in Qd, or vice versa
- a 1% change in price will lead to a less than 1% change in Qd
- * remember inverse relationship
Factors determining price elasticity of demand
- number of substitutes
- necessity or luxury?
- level of income
- price of product relative to income
- length of period of adjustment
income elasticity of demand
- measures the buyer's responsiveness to change in income as the demand curve shifts to the right or left
income elasticity: meaning of + and >1, +and <1, and -
- + = normal goods. *direct relationship b/t I and Qd
- -=inferior goods. *indirect relationship b/t I and Qd
Cross elasticity of demand (
Measures the percentage change in demand of one good to the percentage change in price of another related good.
If cross elasticity of demand is positive or negative or zero...
- When positive (direct), the goods are substitutes [gasoline and hybrid cars]
- when negative (indirect), the goods are complements [electricity and air conditioners]
- when is zero the goods are independent, or unrelated [books and homes]