ECON 2106 Midterm
the marginal principle
Decisions about quantity are best made incrementally
diminishing marginal benefits
Each additional item yields a smaller marginal benefit than the previous item
rational rule
If something is worth doing, keep doing it until your marginal benefits equal your marginal costs
network effect
The effect that occurs when a good becomes more useful because other people use it
opportunity cost
The true cost of something is the next best alternative you must give up to get it
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 changes, your best choice might change.
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
if demand is elastic
a higher price yields less revenue
if demand is inelastic
a higher price yields more revenue
price elasticity of demand
a measure of how responsive buyers are to price changes percent change in quantity demanded / percent change in price
cross-price elasticity of demand
a measure of how responsive the demand of one good is to price changes of another positive for substitutes negative for complement % change in quantity demanded/ % change in price of another good
income elasticity of demand
a measure of responsive the demand for a good is to changes in income positive for normal goods negative for inferior goods % change in quantity demanded/ % change in income
demand is inelastic when
absolute value of the price elasticity is less than 1
perfectly competitive market
all firms in the industry sell an identical good there are many buyers and many sellers
substitutes in production
alternative uses pf your production capacity
price-taker
an actor who charges the market price action do not affect the market price
at equilibrium, neither suppliers nor demanders have
an incentive to change
market
any setting that brings together potential demanders and suppliers
Economics is NOT
business administration/ finance or public administrations
import
buy goods or services from foreign seller
movement along the demand curve
caused by a change in price
change in quantity supplied
change in quantity associated with movement along a fixed supply curve
fixed costs
costs that do not vary with the quantity of output produced (sunk costs in the short term) property tax, insurance, machinery
variable cost
costs that vary with the quantity of output produced
underproduction creates
deadweight loss
If prices and quantities move in the same direction
demand curve shifted
decrease in demand
demand curve shifts left
increase in demand
demand curve shifts right
policy question
do the gains outweigh the costs? - import gains (more consumer surplus) are greater than import costs (loss of producer surplus) - import gains are diffuse across 100M consumers but import costs are concentrated amongst a few large firms
who support international trade
exporters and import-dependent businesses
trade costs
extra costs from buying or selling internationally rather than domestically trade costs are in opportunity costs - shipping and taxes
complements in production
goods that are produced together (by-products)
complementary goods
goods that go together
substitute goods
goods that replace each other
productivity growth
growth that occurs when businesses figure out how to produce more output with fewer inputs
the cure for high price is high price
high price cause consumer to consumer, less demanded, drop price
perfectly elastic
horizontal demand curve
price elasticity of supply depends on
how flexible your business can be
willingness to pay
how much a buyer values a good
Economics is
how we analyze choices and make decisions and the role of incentives
production possibilities frontier
illustrates the trade-offs you experience when deciding how to allocate scarce resources
who opposes international trade
import-competing businesses
technological change
invention of new machinery or new techniques
marginal vs cost-benefit
marginal: how many cost-benefit: either/pr apply marginal then cost-benefit
price elasticity of supply
measures how responsive sellers are to price changes (positive) % change in quantity supplied / % change in price
the midpoint formula
measures the percent change between any two points relative to the point midway between those two points
shift in demand curve
movement of the curve itself
the price elasticity is
negative price and quantity changes always move in opposite direction absolute value focuses on the magnitude of the price elasticity of demand
movement along supply curve
price change causes movement on the curve
perfectly competitive firms are
price takers
change in price vs factor
price: movement along demand curve factor: shift in demand curve
Why do we trade?
produce good or service for which you have comparative advantage and trade for everything else increases opportunities for everyone
economic surplus due to export
producer surplus rise and consumer surplus declines sellers magnify their gains by selling more while buyers mitigate their losses by buying less therefore economic surplus rises
When price is below equilibrium price
quantity demanded exceeds the quantity supplied, and a shortage results
equilibrium
quantity supplied = quantity demanded
when price is above equilibrium price
quantity supplied exceeds the quantity demanded, and a surplus results
export
sell good or services to foreign buyers
the rational rule for sellers in competitive markets
sell one more item if the price is greater than or equal to the marginal cost to maximize profit, sellers should continue to produce until price = marginal cost
decrease in supply
shift the supply curve to the left
increase in supply
shift the supply curve to the right
market demand
sum up individual quantities demanded at each price
if prices and quantities move in opposite directions
supply curve shifted
comparative advantage
the ability to produce a good at a lower opportunity cost than another producer
demand is elastic when
the absolute value of the price elasticity is greater than 1
the price elasticity of demand reflects
the availability of substitutes
congestion effect
the effect that occurs when a good becomes less valuable because other use it
marginal benefit
the extra benefit from one more unit
marginal cost
the extra cost from one extra unit
Economic surplus is maximized when
the marginal benefit of consumption is equal to the marginal costs of production
diminishing marginal product
the marginal product of an input declines as you use more of that input (too many cooks in the kitchen)
equilibrium price
the price at which the market is in equilibrium
world price
the price where a good or service is bought by the world market
equilibrium quantity
the quantity demanded and supplied at equilibrium
Law of Demand
the quantity demanded is higher when the price is lower (holding other things constant)
scarcity
the resources we use to produce goods and services are limited
law of supply
the tendency for the quantity supplied to be higher when the price is higher
total revenue
the total amount you receive from buyers price * quantity
economic surplus
the total benefits minus total costs flowing from a decision
world demand
total quantity demanded by all buyers around the world
world supply
total quantity supplied by all sellers around the world
in short run, a money-losing firm will continue to produce as long as it covers its
variable cost
markets determine
what gets produced how much gets produced who produces it who receives it at what price
consequences of imports
- price declines to the world price - the lower price reduces the quantity supplied by domestic sellers and increases the quantity demanded by domestic buyers - fill gap between supply and demand
impact of an increase in demand
1. # of consumers 2. consumer income 3. price of substitute 4. price of complement 5. future expectations 6. demographic changes 7. preference
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
three factors that shape comparative advantage
1. abundant inputs 2. specialized skills 3. mass production
price elasticity of supply increases
1. for firms that store inventories 2. when inputs are easily available 3. for firms with extra capacity 4. when firms can easily enter and exit the market 5. when there's more time to adjust
factors that shift supply curve
1. input price 2. productivity and technology 3. prices of related outputs 4. expectations 5. type and number of sellers (market supply curve only)
5 arguments for limiting trade
1. national security requires that we produce strategically import goods ourselves 2. protection can help infant industries develop 3. anti-dumping law prevent unfair competition 4. trade should not be a way to skirt regulations 5. foreign competition may lead to job losses
Four steps to estimate market demand
1. survey 2. add up total quantity demanded by customer for each price 3. scale up the quantities demanded by survey respondents to represent whole market 4. plot demand curve
5 tools of international trade policy
1. tariffs 2. red tape 3. import quotas 4. exchange rate manipulation 5. free trade
price elasticity increase when
1. there are more competing products 2. for specific brands rather than broad categories 3. for things that aren't necessities 4. when consumers search more 5. when there's more time to adjust (time increase availability) 6. price relative to budget
sunk cost
A cost that has already been incurred and that cannot be reversed (exist whether you make choice or not)
market supply curve
A graph plotting the total quantity of an item supplied by the entire market, at each price.
individual demand curve
A graph, plotting the quantity of an item that someone plans to buy, at each price.
percent change in price (midpoint)
(P2-P1)/(P1+P1/2)*100
percent change in quantity (midpoint)
(Q2-Q1)/(Q1+Q1/2)*100
Cost-Benefit Principle
An individual (or a firm or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs.