Economics is study of the efficient allocation of scarce resources. It’s a social science.
Scarcity: the inability to satisfy all our wants.
Incentive: a reward or penalty that makes us make the choices that we scarce
Good: physical object
Service: tasks performed for people
TWO BIG QUESTIONS:
- What, How, and For Whom goods and services are produced
- How can choices in self-interest also promote the social interest
Microecon: study of choices for individuals.
Macroecon: study of national and global econ. (Countries dealing with each other)
Difference between micro and macro: Micro is more about relationship about values. But it is
absolutely not about money. It does not deal with money directly.
Efficient -> marginal benefit = marginal cost
Factors of production: (productive resources that produce goods and services)
- Land (natural resources) - > earns rent
- Labour -> earns wage
- Capital = physical goods. Like cars that we drive to work, machinery, computers, and… ->earns
- Entrepreneurship – human resource that organizes other factors above (or technology, it could
be management skills or education or …) -> earns profit
Human capital = Level of education and knowledge. Quality of labour depends on it.
Trade off: What to produce? How to produce? For whom to produce?
Some examples of tradeoff:
- Today vs tomorrow: with enjoying today we will trade off tomorrow.
- Leisure vs education. - Business produce less resources and invest in researching development
Big concept of economics:
Opportunity cost – highest valued alternative we give up to something.
Opportunity cost = what u give up / what you get
Optimal allocation: when marginal cost = marginal benefit
A model is tested by comparing its predictions with facts but economists also use:
Natural experiments, statical investigations, and economic experiments.
Statements could be:
- Positive – about what is, it could be right or wrong and checked by facts
- Normative – statements that ought to be. Depend on values and can’t be tested.
Three economic policies: personal, business, and government.
3 types of graphs:
- Time-series: discover something over time. one or two variable at a time (time in x-axis)
- Croess-section graphs: looking at something at a time. Eg: what’s going on right now
- Scatter diagrams: one variable against the other.
Slope is rise over run. Slope of a straight line is constant. It could be negative Chapter 2
PPF: Production Possibility Frontier: limits to the production of different goods. The boundary between
productions that are attainable and not attainable when all available resources are used efficiently.
- PPF enables us to calculate opportunity cost.
Marginal cost: opportunity cost of producing one more unit of it.
Marginal benefit: benefit received from consuming one more unit of a good or service.
More we have from a good, lesser the marginal benefit will be. (eg: having ice cream for
everyday) shown in marginal benefit curve.
Marginal benefit curve shows relationship between marginal benefit from a good and the
quantity consumed of that good
Production Efficiency: could be achieved if produce goods and services at the lowest possible cost
Allocative Efficiency: goods and services produced at the lowest possible cost and provide greatest
- Technological change – developing new goods and better ways of producing goods and services
- Capital accumulation – growth of capital resources
Cost of economic growth: less current consumption (save for tomorrow)
The decrease in today’s consumption is the opportunity cost of tomorrow’s increase in
Specialization: Producing only one good or a few goods and trade with others.
It will bring comparative advantage
Comparative advantage: when a person’s able to perform a job with lower opportunity cost.
Absolute advantage: if that person is more productive than others
Dynamic Comparative Advantage: when a person (or nation) becomes more productive by learning.
(get specialized, learning by doing) Economic Coordination: coordinating choices of people to specialize and gain comparative advantage. 2
types of it:
- Central economic planning – it expresses national priorities. Tested in Russia and china and failed.
- Decentralized economic planning
Four complementary social institutions to make decentralized coordination work:
- Firm: An economic unit that hires factors of production and organizes them to produce goods and
services. ( eg: Canadian Tire, Tim Horton’s)
- Market: a place or an arrangement that enables buyers and sellers to get info and do business with
each other. ( eg: Network of oil producers, or where people buy fish, vegetables, and meat)
Markets have evolved to facilitate trades.
Has two sides: buyer and seller
- Property Rights: arrangements that govern ownership, use, and disposal of anything that people
o Land, building, and …
o Stocks, Bonds, and money in bank
Intellectual Property : intangible property of creative effort
o Books, music, computer programs, and invention of all kinds protected by copyrights.
- Money: any commodity or token that is generally acceptable as a means of payment Chapter 3
Competitive market: many firms, many buyers and sellers. No single buyer or seller could influence the
Why price of oil and gas goes up? Supply and demand
Money price: number of dollars that must be given up in exchange for something
Relative price: ratio of one price to another which is an opportunity cost
- Coffee: $2 and gum: $1. Then the opportunity cost of a cup of coffee is 2 packs of gum which is the
ratio of prices.
If you demand something:
1. You want it
2. You can afford it
3. You’re planning to buy it (you could demand something and not end up buying it)
Quantity demanded: amount consumers plan to buy during a particular time period and at a particular
Law of demand:
- The higher price of a good, the smaller quantity demanded.
- The lower price of a good, the larger quantity demanded.
Law of demand results from:
- Substitution effect – when price rises move away and choose a cheaper alternative
- Income effect – when price raises people can’t afford buying it.
When price of a good goes up -> a change happened in supply
Demand curve -> shows relationship between quantity demanded and its price (all other influences held
Six main factors that change demand: (these factors cause the curve to shift)
- Price of related goods
o Complement – a good used in conjunction with another good. (ex: price of gas related to
- Expected future prices – if it’s expected to rise in future, current demand increases - Income – when income increases, consumer buys more of most goods and demand curve shifts
o Normal good: demand for it increases as income increases
o Inferior good: demand decreases for it as income increases
o Neutral good: demand remains the same as income increases
- Expected future income and credit
- Population – the larger the population, the greater is the demand for all goods.
If a firm supplies a good or service:
1. has resources and technology to supply it
2. gains benefit from it
3. has infinite plans
Law of supply: other things the same, the higher the price of a good, the greater quantity supplied; and
the lower the price of a good, the smaller is the quantity supplied. (look at marginal cost)
Five factors that change supply curve:
- Price of Factors of production – if factor of production of a good raises, minimum price of good
- Price of related goods produced – supply increases if price of a substitute in production falls
- Expected future prices
- Number of suppliers – the larger number of suppliers, the greater is the supply of a good.(Shifts
supply curve rightward)
- Technology – increasing technology of something, cost goes down. (supply curve shifts rightward)
- State of nature
Equilibrium – once you get there, you stay there. When opposing forces balance each other, (price
adjusts itself until it reaches this point)
Equilibrium Price - when quantity supplied equals quantity demanded
Equilibrium Quantity – quantity bought and sold at the equilibrium price
Surplus: quantity supplied exceeds quantity demanded. Too much is being produced
Shortage: quantity demand exceeds the quantity supplied. Too less is being produced Predictions in demand:
1. When demand increases, both the price and quantity increases
2. When demand decreases, both the price and the quantity decrease.
Predictions about supply:
1. When supply increases, the quantity increases and the price falls.
2. When supply decreases, the quantity decreases and the price rises.
Predictions about both demand and supply:
1. Increase in both demand and supply: increase in quantity, changes of price is uncertain and we
need to know magnitudes of changes in demand and supply to predict the price.
2. Decrease in both demand and supply: quantity decreases and direction of price is uncertain
3. Decrease in demand and increase in supply: decrease in price but quantity is uncertain unless
we know the magnitude of changes in demand and supply
4. Increase in demand and Decrease in supply: price rises but direction of quantity is uncertain Chapter 4
Price Elasticity of Demand: units-free measure of the responsiveness of the quantity demanded of a
good to a change in its price when all other influences remain the same. How much price changes when
Demands could be elastic, inelastic, or unit elastic.
Price elasticity of demand = % change in quantity demanded / % change in price
- We use average price and average quantity to measure percentage change.
- With using average price we get the same elasticity if price or quantity goes up or down.
- Relationship between price and quantity is negative but we use absolute values.
- The steeper the curve is, the more inelastic it is.
Perfectly inelastic demand: when the price doesn’t change at all. The curve is inelastic and perfectly
Inelastic demand: when price elasticity of demand is between 0 and 1. Percentage change in quantity
demanded is greater than the percentage change in price.
Perfectly elastic demand: when the percentage change in quantity demanded is huge when price
doesn’t change much. It has a horizontal curve.
Unit elastic demand: when percentage change in quantity demanded equals percentage change in
price, price elasticity =1.
Total revenue: Price * Quantity
Price elasticity is a units-free measure because the percentage change in each variable is independent
of the units in which the variable is measured.
- If demand elastic -> 1 percent price cut increases quantity sold by more than 1 percent -> total
- If demand inelastic->1 percent price cut decreases quantity sold by more than 1 percent-> total
- If demand unit elastic ->1 percent price cut increases quantity sold by one->total revenue
Total revenue test is a method of estimating price elasticity of demand by observing the change in total
revenue that results from a price change.
Factors that influence elasticity of demand: - Closeness of substitutes – the closer the substitutes for a good or service, the more elastic is the
demand for it
- Proportion of income spent on the good - the greater the proportion of income spent on the good,
the more elastic is the demand for it
- Time elapsed since a price change – the longer the time that has elapsed since a price change, the
ore elastic is demand. (it becomes elastic through the time)
Cross elasticity of demand: measure of responsiveness of a good to a change in the price of a substitute
or a complement
= percentage change in quantity demanded / percentage change in price of substitute or complement.
Income elasticity: measures how quantity demanded of a good responds to a change in income.
= percentage change in quantity demanded / percentage change in income
- If income elasticity of demand greater than 1 = income elastic good = normal good
- If income elasticity of demand between 1 & 0 = income inelastic good = normal good
- If income elasticity of demand less than 0 = an inferior good
Elasticity of supply: responsiveness of quantity supplied to a price change
= percentage change in quantity supplied / percentage change in price
Necessities such as food and clothing are income inelastic
Luxuries such as airline and foreign travel are income elastic
Level of income has a big effect on income elasticity. e.g: food and clothing could be luxuries
and income elastic
What effects elasticity of supply:
- Resources substitution possibilities – some goods and services can be produced by some unique or
rare productive resources only
- Time frame for supply decision
Momentary supply – response of quantity supplied to price change at the instant price changes
Long-run supply – response of quantity supplied to price change when all technologically
feasible adjustments in production have been made
Short-run supply – response of the quantity supplied to a price change after some the
technologically feasible adjustments in production have been made Chapter 5
Scarce resources might be allocated by:
- Market price
- Command – allocate resources by the order of someone in authority
- Majority rule -
- Contest – allocates resources to a winner or a group of winners (ex: Oscar)
- First-come, first served- (ex: restaurants, if you don’t get a reservation you will not sit)
- Sharing equally – everyone gets the same amount of it
- Personal characteristics – (ex: below or above certain ages, got married or not, etc.)
- Force – Theft, taking property of others without contest
Value is what we get, Price is what we pay.
The value of one more unit of a good is its marginal benefit
Demand curve is a marginal benefit curve
Individual Demand: The relationship between the price of a good and the quantity demanded by all
Market Demand Curve: The horizontal sum of the individual demand curves
Consumer Surplus: The value of a good minus the price that you actually paid for it
Cost is what the producer gives up; Price is what the producer receives.
Cost of one more unit of a good or service is marginal cost.
Marginal cost is