Macroeconomics and Microeconomics Mid-Term Review#1
Chapter 1 and 2 – What is Economics and The Economic Problem
Economics is the social science that studies the choices that individual, business, governments
and entire societies make as they cope with scarcity and the incentives that influence and
reconcile those choices.
Microeconomics is the study of choices that individuals and businesses make, the way those
choices interact in markets and the influence of governments. Example Question: Why are
people buying more e-books and fewer hard copy books?
Macroeconomics is the study of the performance of the national and global economies. Example
Question: Why is the unemployment rate in Canada so high?
Definitions of Economics:
- All economic questions arise because we want more than we can have
- Our inability to satisfy all our wants is called scarcity
- Because we face scarcity we make choices and the choices we make depend on the
incentives we face
- An incentive is a reward that encourages and action or a penalty that discourages an
- Abenefit that arises from an increase in an activity is called marginal benefit
- The opportunity cost of an increase in an activity is called marginal cost
- a rational choice is one that compares costs and benefits and achieves the greatest
benefit over cost for the person making the choice
- Ceteris Paribus means “if all other relevant things remain the same”
- For any activity, if marginal benefit exceeds marginal cost, people have an incentive to do
more of that activity.
- If marginal cost exceeds marginal benefit, people have an incentive to do less of that
- Incentives are also the key to reconciling self-interest and the social interest.
Two big economic questions summarize the scope of economics:
- How do choices end up determining what, how and for whom goods and services get
What, How and For Whom?
- Goods and services are the objects that people value and produce to satisfy human wants.
- What determines these patterns of production?
- How do the choices end up determining the quantity of each item produced in Canada
and around the world?
- Goods and services are produced by using productive resources that economists call
FACTORS OF PRODUCTION, which are grouped into four categories:
• Capital (including Human Capital)
• Entrepreneurship For Whom?
- Who gets the goods and services depends on the incomes that people earn.
• Land earns rent.
• Labour earns wages.
• Capital earns interest.
• Entrepreneurship earns profit.
When do choices made in the pursuit of self-interest also promote the social interest?
- Self-interest is choices that you think are best for you.
- Social interest is choices made for the best of society as a whole.
Social Interest has two dimensions:
Efficiency is achieved when the available resources are used to produce goods and services:
1. At the lowest possible price.
2. In quantities that give the greatest possible benefits.
Equity is fairness but economist’s view of fairness varies.
Positive and Normative Statements
Apositive statement is a fact. Example: It is difficult to find a job these days.
Anormative statement is what ought to be. We ought to cut our use of coal by 50 percent.
Roles of Intuitions
Formal and informal rules and laws that define the incentive structure in the society and govern
the behaviour of individuals and the governments.
Some ways to gauge the quality of institutions:
Political Intuition: Democracy, accountability, human rights, freedoms (religious, economic and
Economical Intuition: Enforcement of property rights and contracts, the conduct of government’s
monetary and fiscal policy
Others: Control of Corruption, Rule of Law and Order
An economic model is a description of some aspect of the economic world that includes only
those features that are needed for the purpose at hand.Agood economic model helps us to
understand the specific facts of an economic world that we are interested in without
overwhelming us with detail.An economic model is designed to reflect those aspects of the
world that are relevant to the user of the model and ignore the aspects that are irrelevant.A
typical model is a GPS map. It reflects only those aspects of the real world that are relevant in
assisting the user in reaching his or her destination and avoids using information irrelevant to
Slope = y/x
Production Possibilities Frontier
The production possibilities frontier (PPF) is the boundary between those
combinations of goods and services that can be produced within the given resources and
those that cannot. The production possibilities frontier, PPF, is a graph that shows the
combinations of output that the economy can possibly produce given the available factors
of production and the available production technology.
• It shows the best an economy can do if it uses all its resources efficiently, given the
• Production Possibilities Frontier • Figure 2.1 shows the PPF for two goods: cola and pizza.
• Any point on the frontier such as E and any point inside the PPF such as Z are attainable.
• Points outside the PPF are unattainable.
We achieve production efficiency if we cannot produce more of one good without producing
less of some other good. Points on the frontier are efficient.Any point inside the frontier, such as
Z, is inefficient. At such a point, it is possible to produce more of one good without producing
less of the other good. At Z, resources are either unemployed or misallocated.
Tradeoff Along the PPF
Every choice along the PPF involves a tradeoff. On this PPF, we must give up some cola to get
more pizzas or give up some pizzas to get cola.
As we move down along the PPF, we produce more pizzas, but the quantity of cola we can
produce decreases. The opportunity cost of a pizza is the cola forgone. In moving from E to F, the quantity of pizzas increases by 1 million. The quantity of cola
decreases by 5 million cans. The opportunity cost of the fifth 1 million pizzas is 5 million cans of
cola. One of these pizzas costs 5 cans of cola.
In moving from F to E, the quantity of cola produced increases by 5 million. The quantity of
pizzas decreases by 1 million. The opportunity cost of the first 5 million cans of cola is 1 million
pizzas. One of these cans of cola costs 1/5 of a pizza.
Note that the opportunity cost of a can of cola is the inverse of the opportunity cost of a pizza.
One pizza costs 5 cans of cola. One can of cola costs 1/5 of a pizza.
Because resources are not equally productive in all activities, the PPF bows outward—is
concave. The outward bow of the PPF means that as the quantity produced of each good
increases, so does its opportunity cost.
It is also possible that opportunity costs are constant.An economy always gives up the same
amount of one good for more of another at the same rate. If opportunity costs are constant, the
PPF will be linear.
Chapter 3 – Supply and Demand
Markets and Prices
• Amarket is any arrangement that enables buyers and sellers to get information and do
business with each other.
• The money price of a good is the amount of money needed to buy it.
• The relative price of a good—the ratio of its money price to the money price of the next
best alternative good—is its opportunity cost.
• If you demand something, then you
• 1. Want it,
• 2. Can afford it, and
• 3. Have made a definite plan to buy it.
• Wants are the unlimited desires or wishes people have for goods and services. Demand
reflects a decision about which wants to satisfy.
• The quantity demanded of a good or service is the amount that consumers are willing
and able to purchase during a particular time period, and at a particular price.
The Law of Demand
The law of demand states:
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 larger is the quantity demanded.
The law of demand results from
When the relative price (opportunity cost) of a good or service rises, people seek
substitutes for it, so the quantity demanded of the good or service decreases.
When the price of a good or service rises relative to income, people cannot afford all the
things they previously bought, so the quantity demanded of the good or service decreases.
Ademand curve shows the relationship between the quantity demanded of a good and
its price when all other influences on consumers’planned purchases remain the same. Arise in the price, other things remaining the same, brings a decrease in the quantity demanded
and a movement along the demand curve. When some influence on buying plans other than the
price of the good changes, there is a change in demand for that good.
When demand increases, the demand curve shifts rightward.
When demand decreases, the demand curve shifts leftward.
Six main factors that change demand are
The prices of related goods
Expected future prices
Expected future income and credit
Asubstitute is a good that can be used in place of another good.
Acomplement is a good that is used in conjunction with another good.
When the price of substitute for an energy bar rises or when the price of a complement of
an energy bar falls, the demand for energy bars increases.
Anormal good is one for which demand increases as income increases.
An inferior good is a good for which demand decreases as income increases.
Because an energy bar is a normal good, an increase in income increases the demand for
The Law of Supply
The law of supply states:
Other things remaining the same, the higher the price of a good, the greater is the quantity
the lower the price of a good, the smaller is the quantity supplied.
The law of supply results from the general tendency for the marginal cost of producing a good or
service to increase as the quantity produced increases (Chapter 2, page 35).
Producers are willing to supply a good only if they can at least cover their marginal cost of
production. Supply Curve and Supply Schedule
The term supply refers to the entire relationship between the quantity supplied and the price of a
The supply curve shows the relationship between the quantity supplied of a good and its price
when all other influences on producers’planned sales remain the same.
Minimum Supply Price
Asupply curve is also a minimum-supply-price curve.
As the quantity produced increases, marginal cost increases.
The lowest price at which someone is willing to sell an additional unit rises.
This lowest price is marginal cost.
When some influence on selling plans other than the price of the good changes, there is a change
in supply of that good.
The quantity of the good that producers plan to sell changes at each and every price, so there is a
new supply curve.
When supply increases, the supply curve shifts rightward.
When supply decreases, the supply curve shifts leftward.
The five main factors that change supply of a good are
The prices of factors of production
The prices of related goods produced
Expected future prices
The number of suppliers
State of nature
If the price of a factor of production used to produce a good rises, the minimum price that
a supplier is willing to accept for producing each quantity of that good rises.
So a rise in the price of a factor of production decreases supply and shifts the supply
Asubstitute in production for a good is another good that can be produced using the same
The supply of a good increases if the price of a substitute in production falls.
Goods are complements in production if they must be produced together.
The supply of a good increases if the price of a complement in production rises.
An advance in the technology for producing energy bars increases the supply of energy
bars and shifts the supply curve rightward.
If the price remains the same but some other influence on sellers’plans changes, supply
changes and the supply curve shifts. Equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market
occurs when the price balances the plans of buyers and sellers.
The equilibrium price is the price at which the quantity demanded equals the quantity supplied.
The equilibrium quantity is the quantity bought and sold at the equilibrium price.
Price regulates buying and selling plans.
Price adjusts when plans don’t match.
Illustrates the equilibrium price and equilibrium quantity.
If the price is $2.00 a bar, the quantity supplied exceeds the quantity demanded.
There is a surplus of
6 million energy bars. If the price is $1.00 a bar, the quantity demanded exceeds the quantity supplied.
There is a shortage of 9 million energy bars.
If the price is $1.00 a bar, the quantity demanded exceeds the quantity supplied.
There is a shortage of 9 million energy bars.
At prices above the equilibrium price, a surplus forces the price down.
At prices below the equilibrium price, a shortage forces the price up.
At the equilibrium price, buyers’plans and sellers’plans agree and the price doesn’t change until
some event changes either demand or supply.
Figure 3.8 shows that when demand increases the demand curve shifts rightward.
At the original price, there is now a shortage.
The price rises, and the quantity supplied increases along the supply curve. An Increase in Supply
Figure 3.9 shows that when supply increases the supply curve shifts rightward.
At the original price, there is now