Economics Test

The Rational Rule

If something is worth doing, keep doing it until your marginal benefits equals your marginal costs. Using the rational rule maximizes economic surplus.

What Shifts Demand:

Income, preferences, prices of related goods, expectations and Congestions and network effects:

What Shifts Demand Curves?

Increase in demand: A shift of the demand curve to the right Decrease in demand: A shift of the demand curve to the left

What shifts the supply curve?

Increase in supply: A shift of the supply curve to the right Decrease in supply: A shift of the supply curve to the left

Golden Rule of the PPF

you can't produce more of one output unless you produce less of another

Marginal cost

The extra cost from one extra unit

When is the Marginal Principle Useful?

The marginal principle is useful for "how many" decisions but not for "either/or" choices

The Law of Demand

The total quantity demanded is higher when the price is lower

What is an individual demand curve?

A graph plotting the quantity of an item that someone plans to buy at each price. It reflects the question that you face as a buyer every day: At this price, what quantity should I buy? An individual demand curve holds other things constant.

The Opportunity Cost Principle

The true cost of something is the next best alternative you must give up to get it. Your decisions should reflect this opportunity cost, rather than just the out-of-pocket financial costs.

Factors that shift only market demand curves include the following:

The type and number of buyers

What can shift your PPF outward?

Gains in productivity

What question should we ask ourselves when applying the opportunity cost principle?

"or what?" because it forces you to consider your alternatives

The Four Types of Interdependencies:

1. Dependencies between each of your individual choices 2. Dependencies between people or businesses in the same market 3. Dependencies between markets 4. Dependencies through time

Principles in short: memory trick

1. One more? (the marginal principle) 2. Benefit beat cost? (the cost-benefit principle) 3. Or what? (the opportunity cost principle) 4. What else? (the interdependence principle)

Four Important Lessons About Opportunity Costs:

1. Some out of pocket costs are opportunity costs, such as the cost of MBA tuition and fees 2. Opportunity costs don't need to involve out of pocket financial costs 3. Not all out-of pocket costs are real opportunity costs 4. Some non-financial costs are not opportunity costs

Four Steps to Estimating Market Demand

1. Survey your customers, asking each person the quantity they will buy at each price 2. Add up the total quantity demanded by your customers for each price 3. Scale up the quantities demanded by the survey respondents so that they represent the whole market 4. Plot the total quantity demanded by the market at each price, yielding the demand curve

MCOI: Four step problem

1. Use the marginal principle by breaking down "how many" choices into simpler marginal choices. 2. Apply the cost-benefit principle by assessing whether the marginal benefit exceeds the marginal cost 3. Apply the opportunity cost principle to evaluate all relevant costs and benefits, and ask "or what?" 4. Use the interdependence principle to identify how changes in other factors might lead you to make a different decision.

The following shift individual AND market supply curves:

1. input prices 2. productivity and technology 3. prices of related goods 4. Expecations

Inferior good:

A good for which higher income causes a decrease in demand

Normal Good

A good for which higher income causes an increase in demand

Individual Supply Curve

A graph plotting the quantity of an item that a business plans to sell at each price. It summarizes a business's selling plans. An individual supply curve holds other things constant

Market Demand Curve

A graph plotting the total quantity of an item demanded, by the entire market, at each price. It is the sum of the quantity demanded by each person.

Movement along the supply curve:

A price change causes movement from one point on a fixed curve to another point on the same curve and so does change in the quantity supplied

What is a perfectly competitive market?

All firms in the industry sell an identical good. There are many buyers and many sellers, each of whom is small relative to the size of the market.

Substitutes-in-production:

Alternative uses of your production capacity

Why are individual supply curves upward sloping?

If each item brings a higher price, selling more would bring more profit!

The Rational Rule for Buyers

Buy more of an item if its marginal benefit is greater than (or equal to) the price.

Why is Your Demand Curve Downward-Sloping?

Diminishing marginal benefit: Each additional item yields a smaller marginal benefit than the previous item.

What principle is good for either/or choices?

Cost Benefit Principle

Four core principles

Cost-Benefit Principle Opportunity Cost Principle The Marginal Principle The Interdependence Principle

The Cost Benefit Principle

Costs and benefits are the incentives that shape decisions. You should evaluate the full set of costs and benefits of any choice and only pursue those whose benefits are at least as large as their costs

The Marginal Principle

Decisions about quantities are best made incrementally. You should break "how many" decisions down into a series of smaller, or marginal, decisions. Then you weigh the marginal benefits and marginal costs to make good decisions!

Complements-in production:

Goods that are made together

Complementary Goods

Goods that go together. Your demand for a good will decrease if the price of complementary goods rises (Ex: hotdogs and hotdog buns)

Substitute Goods

Goods that replace each other - Your demand for a good will increase if the price of substitute goods rises (Examples: driving, walking, cycling, ride-sharing, taking the bus)

Productivity growth:

Growth that occurs when businesses figure out how to produce more output with fewer inputs (often driven by technological change)

Framing

How different alternatives are described or framed

How do we put the core principles together to determine the quantity supplied?

How many units should I supply? Should I sell one more unit (marginal principle)? Selling one more unit depends on price versus marginal cost (cost-benefit principle). Calculate the marginal cost (opportunity cost principle) If the price is greater than the marginal cost, sell one more unit!

What is the ultimate goal of all decision making?

Maximizing your economic surplus

What do benefits reflect?

Preferences and budgets

What else is the Demand Curve?

The Marginal Benefit Curve

Congestion Effect:

The effect that occurs when a good becomes less valuable because other people use it - If more people buy such a product, your demand for it will decrease (Example: roads)

Network Effect:

The effect that occurs when a good becomes more useful because other people use it - If more people buy such a good, your demand for it will also increase (Example: popular social media platforms)

Marginal benefit

The extra benefit from one unit (of goods purchased, hours studied, etc.)

Movement Along the Demand Curve:

The movement from one point on a fixed demand curve to another point on the same curve that is caused by a PRICE CHANGE

The Law of Demand

The quantity demanded is higher when the price is lower -- holding other things constant! this explains why the individual demand curve was downward sloping

Macroeconomics

The study of decisions making across the whole economy

Microeconomics

The study of individual decision making and the implications for specific markets

Economic surplus

Total benefits minus the total costs flowing from a decision

When does scarcity occur?

When resources are limited

Rule of Thumb regarding shifts vs. movements along a demand curve

When the PRICE changes: you're thinking about a MOVEMENT ALONG the demand curve When other factors change: you need to think about SHIFTS in the demand curve

Rule of thumb in regard to Shifts versus Movements Along Supply Curves:

When the price changes: you're thinking about a movement along the supply curve When other factors change: you need to think about shifts in the supply curve

The Interdependence Principle

Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of these factors change, your best choice might change.

Money

a common measuring stick that allows you to compare a wide variety of costs and benefits

Sunk Cost

a cost that has been incurred and cannot be reversed

price taker

an actor who charges the market price

What do framing effects lead to?

bad decisions

Framing effects

can lead you astray and can make identical choices seem different

Variable costs

costs that vary with the quantity of output, such as labor and raw materials

The PPF

illustrates the trade-offs you experience when deciding how to allocate scarce resources

Costs and benefits

incentives that shape decisions

Fixed costs

incurred regardless of level of output

costs

opportunity costs

How can we visualize opportunity costs?

production possibilities frontier (PPF)

Individual demand

quantity an individual is willing to purchase at each price, holding everything else constant

Diminishing marginal product:

the marginal product of an input declines as you use more of that input

The Law of Supply

the tendency for the quantity supplied to be higher when the price is higher. THE HIGHER THE PRICE, THE HIGHER THE QUANTITY SUPPLIED

scarce resources

time, money, raw inputs and production capacity