ECON 202: Exam #1 Study Guide
o Definition: a lack of enough resources to satisfy all desired uses of those resources
This means that someone’s wants will go unfulfilled
Scarcity forces/requires economic choices to be made
o Factors of Production:
∙ All natural resources
∙ Skills and abilities of all people at work
∙ Goods produced for use in further production
∙ Assembling of resources to produce new
o Limited Resources:
Requires choices and tradeoffs to be made
The science of economics helps us to frame these choices
“This tradeoff comes with a cost”
- Opportunity Cost
o Definition: The most desired goods or services forgone to obtain something else
These costs are associated with every decision we make
The “next best thing” is given up
- Production Possibilities Model
o Illustrates concepts of scarcity, tradeoffs, and opportunity costs - The combination of final goods and services that could be produced
- Production Possibilities Curve (PPC):
o Points outside the PPC are Unattainable
o Points on the PPC are Attainable AND Efficient
o Points inside the PPC are Attainable but NOT efficient
We also discuss several other topics like Do return strategies truly make consumers happy?
- Economic Growth will cause the PPC to shift outward
- Market Participants:
o Consumers: maximize the utility (satisfactions of unmet wants) then can get from available incomes
o Businesses: maximize profits by selling goods that satisfy while keeping costs low
o Government: maximize the general welfare of society
These motives explain most market activity
- Specialization and Trade:
o Most of us cannot produce everything that we want to consume: Time, talent, and resources constraints
o We should specialize and produce what we can at a lower opportunity cost than others
o Produce more than we need for ourselves and trade the excess for the goods we want to consume (which are produces by other specialists). - Locating Markets:
o A market exists wherever an exchange (transaction) takes place. o Every market transaction involves an exchange of dollars for goods and service (in produce markets) or resources (in factor markets). In the circular flow, goods and services or resources flow one way, and dollars flow the opposite way.
- The Circular Flow:
Two markets (factor market and product market) and four participants If you want to learn more check out Where are microglia produced?
They are owners of factors and production (e.g. labor) who
supply them to business firms in the factor market and earn
They purchase goods and services in the product market
o Business Firms:
The produce goods and services for the product market using the factors of production they bought from their owners in the
They acquire resources in the factor market and provide
services to both consumers and firms.
o International Participants:
They supply imports and purchase exports in the product
market and buy and sell resources in the factor market. Don't forget about the age old question of Which racial violence kept blocks from voting?
- Supply and Demand:
o Supply: the ability and willingness to sell specific quantities of a good at alternative prices in a given time period, ceteris paribus
o Demand: the ability and willingness to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus. o Ceteris Paribus: the assumption that nothing else is changing. - The Law of Demand:
o In a given time period, the quantity demanded of a good increases as its price falls, ceteris paribus (and vice versa).
Inverse relationship between price (P) and quantity demanded (Qd)
A downward-sloping curve on a market diagram
- Individual Demand and Market Demand:
Each of us has a demand for a good or service if we are willing and able to pay for it.
The amount we buy depends on its price
If the price goes up, we buy less.
If the price goes down, we buy more.
Market demand in the collective summation of all buyer’s individual demands
- Quantity Demanded is a single point on the demand curve or schedule - Demand is the entire schedule or curve
*A movement along the demand curve is a change in quantity demanded* - Movements vs. Shifts If you want to learn more check out What problems were created by the developments in the 19th century?
o Change in quantity demanded: movement along a demand curve in response to a change in price
o Change in demand: A shift of the demand curve due to a change in one ofr more of the determinants of demand, but Not in response to a change in price
- Movement along the curve: buyer’s behavior does not change, buyers only react to a price change
- Shift the curve: buyers’ behavior does change.
- Law of Supply
o The quantity of a god supplied in a given time period increases as its price increases, ceteris paribus, and vice versa
o Direct relationship between price (P) and quantity supplied (Qs). o It is an upward-sloping curve on a market diagram.
- Factors that Set Supply Behavior (Determinants of Supply)
2. Factor Costs If you want to learn more check out What is the basic idea of psychoanalytic theory?
3. Taxes and subsidies
5. Other goods
Substitute in production
6. Number of sellers
- If any of these factors change, supply behavior changes. This type of change is shown by shifting the supply curve.
o Increase in supply: shift the entire curve RIGHT
o Decrease in supply: shift the entire curve LEFT
- Individual Supply and Market Supply
o Each producer is willing and able to produce a good or service if he or she can make a profit.
o The amount produced depends on its price.
o If the price goes up, more will be produced.
o If the price goes down, less will be produced.
o Market supply is the collective summation of all producers’ individual supplies.
- Movements vs. Shifts
o Change in quantity supplied: movement along the supply curve due to a change in price. We also discuss several other topics like How effectively a population can adapt when the environment changes?
- Change in supply: a shift in the supply curve due to one or more changes in the determinants of supply, but NOT in response to a change in price.
- Quantity Supplied > Quantity Demanded = Surplus
- Quantity Supplied < Quantity Demanded = Shortage
- Price floors: the lowest price that a good or service could be sold at in a particular market
o “non- binding price floor” = the price will not exceed equilibrium price There will be a shortage
o “binding price floor” = the price can exceed the equilibrium price There will be a surplus
- Price ceilings: the maximum that can be charged for a particular good/service o “non-binding ceiling” = the price can exceed the equilibrium price There will be a surplus
o “binding ceiling” = The price will not exceed equilibrium price There will be a shortage
We refer to people as consumers when thinking about how they spend their income
Everyone is both a producer and a consumer, but we study producer and consumer choice differently
- Consumer Choice:
o Factors that affect consumer decisions:
How do we decide how much of any good to buy?
Why do we feel so good about our purchases?
Why do we buy certain products but not others?
- Wants vs. Demands
o Why do we want to consume goods?
Out of necessity
To display status or identity
We can’t buy all the things that we want
As economists we study demand:
Demand = willingness and ability to buy specific quantities of goods at a given time across a range of prices, all else equal
- Determinants of Demand:
o Four factors determine an individual’s demand for a product: Tastes – a desire for this and other goods
Income – of the consumer
Expectations – of income, prices, and tastes
Related goods – their availability and prices
o The more pleasure (satisfaction, utility) we get from the product, the higher the price we’re willing to pay for it.
Utility – the pleasure or satisfaction obtained from using a good or service
Total utility – the amount of satisfaction obtained from the consumption of a series of products
Marginal utility – the change in total utility obtained by
consuming one additional (marginal) unit of a product
- Diminishing Marginal Utility:
o Law of diminishing marginal utility: the marginal utility of a good decreases as more of it is consumed over a given time period o Additional quantities of a good yield smaller and smaller increments of satisfactions.
o If marginal utility > 0, total utility increases. When marginal utility reaches zero, total utility maxes out, and when marginal utility becomes negative, total utility decreases.
- Choosing among products:
o As consumers, we face a budget constraint
We don’t have enough income to consume everything that would give us positive MU
o To get the most utility from our limited income, always buy the good that gives us the highest marginal utility per price (MU/P)
- Utility Maximization Rule:
o As we consume successive unit, the MU/P between our two options equalizes
o Why does this maximize utility?
If MU/P of pizza > MU/P of tacos, we could do better by
consuming pizza rather than tacos.
o What are some factors that might cause a consumer to fail to follow the u-max rule?
- Individual Demand:
o To recap, the quantity demanded by an individual depends on: The price of the good
The utility the consumer gets from the goo
Other factors such as the consumer’s income
o If the price of the good goes up, the MU/P goes down, so the consumer will buy less
o If the price goes down, the MU/P goes up, so the consumer will buy more
- Price and Quantity
o The individual demand curve slopes downward because of diminishing marginal utility
o To justify buying more, the price must be lower
The willingness to pay diminishes along with marginal utility
- Individual and Market Demand
o The market demand curve is the sum of the individual demand curves for all consumers in the market for a particular good/service
o Willingness to pay:
The market demand curve tells us the maximum amount each consumer in the market is willing and able to pay for a good
∙ We call this their willingness to pay (WTP)
o Remember, this depends on factors such as income, preferences, demand, utility
- Consumer Surplus
o At any price, there will be some consumers for whom:
WTP > p
WTP = p
WTP < p
Consumer Surplus: the difference between what a consumer is willing to pay and what they actually paid for the good (WTP – Price = Consumer Surplus/ How much money they have left after the purchase)
Determinants of Elasticity:
1. Necessities vs. Luxuries
2. Availability of Substitutes
3. Relative Price to Income
- Demand for low-priced goods is relatively inelastic
- Demand for high-priced goods is relatively elastic
- The more time you have to adjust to a price change, the more elastic is your response
o No time to adjust? Highly inelastic demand.
The goal of sales it to receive total revenue:
- Total revenue = Price x Quantity Sold
- If Demand is elastic, price increase the price the total revenue will decrease
- If demand is inelastic, price increase = total revenue increase - If demand is unitary elastic, total revenue won’t change
Price Effect & Quantity Effect
- Price Effect = the change in revenue due to change in price
- Quantity Effect = the change in revenue due to a change in quantity Elasticity on the Demand Curve
- Cross-Price Elasticity of demand = the % change in quantity demanded of X divided by the % change in price of Y
- Substitute Goods: goods that can replace each other; when the price of good X rises, the demand for good Y increases
o Cross-Price should positive (same direction)
- Complementary Goods: goods frequently consumed in combination o Cross-Price should be negative (opposite directions)
- As income increases, people have more money to spend. Demand for goods will shift rightward
- Income elasticity of demand: %change in quantity demanded divided by %change in income.
o Your income rises by 10%. You go to the movies more and buy 20% more popcorn.
Icome elasticity of demand for popcorn is 20%/10% or 2.0.
- Normal Goods and Inferior Goods:
o An increase in demand for a good when income rises is true for a normal good. Most goods are normal goods.
o For some goods the demand decreases as income rises. They are inferior goods.
For example, Ramen Noodles. As income increases, people
upgrade to higher quality substitutes for inferior goods such
as ramen noodles.
Elasticity of Supply
- The law of supply: an increase in price causes an increase in quantity supplied. But how much more will be produced as the price rises? - Elasticity of supply: the % change in quantity supplied divided by the % change in price.
o If it is highly elastic, producers are very responsive to a price change.
o If it is highly inelastic, producers do not have much of a response to a price change