Economics Ch 1-5, 7, 10

perfectly competitive market

(1) sellers all sell an identical good or service, and (2) any individual buyer or any individual seller isn't powerful enough on his or her own to affect the market price of that good or service.

The Free Market: RESULTS

1. Buyers who value the good most (highest WTP) get to buy it. Cf. First come, first served. 2. Sellers who value most the right to sell the good (lowest cost, lowest WTA) get to sell it. Cf. Cronyism. 3. All buyers who buy value the good more than all the sellers who] sell, so all trades are voluntary and mutually beneficial. Successful sellers serve/please buyers! 4. No mutually beneficial trades are missed; for non-traders, buyer's WTP < seller's WTA, so no trade would have occurred. Price contains all of the info a buyer or seller needs to know! System can be decentralized, rather than having a central planner make decisions

The Free Market: CAVEATS

1. Efficiency differs from equity (fairness). Society might not be happy if the price of some important good (e.g., water or electricity) makes it unaffordable for a large segment of the population. Perhaps some buyers or sellers were born into privileged situations and have "unfair" market advantages. 2. Market failures can result in inefficiency. The world is full of market failures, though they vary in severity. The model of perfect competition assumes away problems such as market power, brands, entry barriers, externalities, public goods, buyer uncertainty, and trading costs. 3. While the market maximizes CS+PS, this is not the best result for each individual. Buyers would prefer to pay less, while sellers want to charge more.

inferior goods

A good is inferior if the quantity demanded is inversely related to income; when income rises, consumers buy less of an inferior good. When income rises and consumers buy less of a good, it is an inferior good.

normal goods

A good is normal if the quantity demanded is directly related to income; when income rises, consumers buy more of a normal good. When income rises and consumers buy more of a good, it is a normal good.

Ch 2 Key Ideas

A model is a simplified description of reality. Economists use data to evaluate the accuracy of models and understand how the world works. Correlation does not imply causality. Experiments help economists measure cause and effect. Economic research focuses on questions that are important to society and can be answered with models and data. The scientific method is the name for the ongoing process that economists and other scientists use to (1) develop models of the world and (2) evaluate those models by testing them with data. Empirical evidence is facts that are obtained through observation and measurement. Empirical evidence is also called data. Economists try to uncover causal relationships among variables. One method used to determine causality is to run an experiment—a controlled method of investigating causal relationships among variables. Economists now actively pursue experiments both in the laboratory and in the field. Economists also determine causality by studying historical data that have been generated by a natural experiment.

perfectly elastic demand

A very small increase in price causes consumers to stop using goods that have perfectly elastic demand. Highly responsive to prices. Remember, slope in econ is weird and is inverted; m=Q2-Q1/P2-P1 m=-∞ (perfectly horizontal line)

economic agent

An economic agent is an individual or a group that makes choices.

Pareto efficient

An outcome is Pareto efficient if no individual can be made better off without making someone else worse off.

Ch 1 Key Ideas

Economics is the study of people's choices. The first principle of economics is that people try to optimize: they try to choose the best available option. The second principle of economics is that economic systems tend to be in equilibrium, a situation in which nobody would benefit by changing his or her own behavior. The third principle of economics is empiricism—analysis that uses data. Economists use data to test theories and to determine what is causing things to happen in the world. Economics is the study of how agents choose to allocate scarce resources and how those choices affect society. Economics can be divided into two kinds of analysis: positive economic analysis (what people actually do) and normative economic analysis (what people ought to do). There are two key topics in economics: microeconomics (individual decisions and individual markets) and macroeconomics (the total economy). Economics is based on three key principles: optimization, equilibrium, and empiricism. Choosing the best feasible option, given the available information, is called optimization. To optimize, an economic agent needs to consider many issues, including trade-offs, budget constraints, opportunity costs, and cost-benefit analysis. Equilibrium is a situation in which nobody would benefit personally by changing his or her own behavior, given the choices of others. Economists test their ideas with data. We call such evidence-based analysis empirical analysis or empiricism. Economists use data to determine whether our theories about human behavior—like optimization and equilibrium—match actual human behavior. Economists also use data to determine what is causing things to happen in the world.

The Free Market: INEFFICIENCY

Efficiency-wise, it is harmful to: 1. Reallocate consumption among consumers. If you take a widget from a current buyer (with a relatively high WTP) and give it to someone currently priced out of the market (so his/her WTP<P*), then this will lower CS. Only the "best" buyers at the upper left end of the demand curve get to buy in a competitive market. 2. Reallocate sales among sellers. If you block a low-cost producer from selling and force a high-cost produced to sell, then this will lower PS and squander scarce, productive resources. Only the "best" sellers at the lower left end of the supply curve get to sell in a well-functioning competitive market. 3. Change the quantity traded from Q* to some other level. Blocking a trade to the left of Q* creates deadweight loss (from the mutually beneficial, forgone trade). Forcing a trade at Q>Q* also causes DWL because WTP<WTA (you're asking for production at a cost that is higher than what the buyer is WTP, like spending $15 to make a shirt sold for $10)

movement along the demand curve.

If a good's own price changes and its demand curve hasn't shifted, the own price change produces a movement along the demand curve

Ch 4 Key Ideas

In a perfectly competitive market, (1) sellers all sell an identical good or service, and (2) any individual buyer or any individual seller isn't powerful enough on his or her own to affect the market price of that good or service. The demand curve plots the relationship between the market price and the quantity of a good demanded by buyers. The supply curve plots the relationship between the market price and the quantity of a good supplied by sellers. The competitive equilibrium price equates the quantity demanded and the quantity supplied. When prices are not free to fluctuate, markets fail to equate quantity demanded and quantity supplied. A market is a group of economic agents who are trading a good or service plus the rules and arrangements for trading. In a perfectly competitive market, (1) sellers all sell an identical good or service, and (2) individual buyers or individual sellers aren't powerful enough on their own to affect the market price of that good or service. Quantity demanded is the amount of a good that buyers are willing to purchase at a given price. A demand schedule is a table that reports the quantity demanded at different prices, holding all else equal. A demand curve plots the demand schedule. The Law of Demand states that in almost all cases, the quantity demanded rises when the price falls (holding all else equal). The market demand curve is the sum of the individual demand curves of all potential buyers: the quantity demanded is summed at each price. It plots the relationship between the total quantity demanded and the market price, holding all else equal. The demand curve shifts only when the quantity demanded changes at a given price. If a good's own price changes and its demand curve hasn't shifted, the own price change produces a movement along the demand curve. Quantity supplied is the amount of a good or service that sellers are willing to sell at a given price. A supply schedule is a table that reports the quantity supplied at different prices, holding all else equal. A supply curve plots the supply schedule. The Law of Supply states that in almost all cases, the quantity supplied rises when the price rises (holding all else equal). The market supply curve is the sum of the individual supply curves of all potential sellers: the quantity supplied is summed at each price. It plots the relationship between the total quantity supplied and the market price, holding all else equal. The supply curve shifts only when the quantity supplied changes at a given price. If a good's own price changes and its supply curve hasn't shifted, the own price change produces a movement along the supply curve. The competitive equilibrium is the crossing point of the supply curve and the demand curve. The competitive equilibrium price equates quantity supplied and quantity demanded. The competitive equilibrium quantity is the quantity that corresponds to the competitive equilibrium price. When prices are not free to fluctuate, markets fail to equate quantity demanded and quantity supplied.

Law of Demand

In almost all cases, the quantity demanded rises when the price falls (holding all else equal).

Mutually-Beneficial trade

In every voluntary, mutually-beneficial trade, there is a unit traded, a buyer, and a seller. Both the buyer and seller are at least as well off if they agree to trade as if they declined. Interestingly, buyers don't care what sellers receive, and sellers don't care what buyers pay. We assume that each is self-interested and only cares about her/his private price signal, or equivalently, responds to her/his own incentives

Productive Subsitutes

In general, productive substitutes are produced with a common input, but not at the same time, because the input can be used for only one or the other output. ex. is a dairy cow, which can either provide a daily stream of milk OR can be converted (once) into beef.

Ch 10 Key Ideas

In the United States, governments (federal, state, and local) tax citizens and corporations to correct market failures and externalities, raise revenues, redistribute funds, and finance operations. Through direct regulation and price controls, governments can intervene to influence market outcomes. Although government intervention sometimes creates inefficiencies, it often results in improved social well-being. Weighing the trade-offs between equity and efficiency is one task of an economist. It is up to each individual to decide when and where government intervention makes the most sense. Government can play an important role in ensuring that markets are competitive, efficient, and equitable. Key roles of the government include: taxation to raise funds to provide public goods, such as national defense, policing, and infrastructure investments that would not be provided adequately by the market; the use of tax and transfer programs to achieve a more equitable distribution of resources in society; and the use of taxes and subsidies as well as regulation to correct market failures. The costs of government interventions must be compared carefully with their benefits. Economics is most useful not as a value judgment on whether government is good or bad, but for understanding what sorts of activities require government intervention.

Optimal Purchasing Rule

MB(1)/P(1)=MB(2)/P(2)

Shifts in Supply Curve

N- Number of Suppliers T- (changes in) Technology I- inputs (the cost of goods used to produce the products) G- Govt (price ceilings, price floors, taxes) E- Expectations R- costs of related goods

Key Drivers of Price Sensitivity

Necessity & Substitution Opportunities Can consumers readily do without the good? Do they have readily available substitutes to which they can switch? Expense Relative to Budget Do expenditures on the good count for a large fraction of the buyer's budget? 4 Cases: 1. If expense is a large portion of their and consumers can do without it, the d will be very price sensitive. ex. mkt-level D for high-end discretionary consumer durables such as boats or motorcycle 2. If expense is a large portion of the budget but consumers can't do without it and there aren't ready substitutes, the d will be moderately price sensitive. ex. mkt-level D for autos or consumer appliances 3. If expense isn't a large portion of the budget and consumers can do without it, d is moderately price sensitive. ex. brand-level D for consumer packaged goods such as ketchup or yogurt 4. If expense/good isn't a large portion of budget and consumers can't do without it, d is very price insensitive. ex. mkt-level D for electricity for residential users

The Revenue Test: How Business Uses PED

P increase increases Revenues if and only if Demand is Price-INELASTIC (not sensitive) P decrease increases Revenues if and only if Demand is Price-Elastic (sensitive) P increase leaves Revenues unchanged if and only if Demand is UNIT-ELASTIC P increase decreases Revenues if and only if Demand is Price-ELASTIC (sensitive) P decrease decreases Revenues if and only if Demand is Price Inelastic (not sensitive) E.g., diabetics aren't very sensitive to insulin prices, so insulin sellers cd charge a high price. E.g., vacationers who crave intense sunlight have many options and are sensitive to prices

Tax Incidence Buyers

P(paid)-P*

Subsidy Cost

P(paid)=P(received)-subsidy

Tax Incidence Suppliers

P*-p(recd)

Five Government Interventions

PER-UNIT (EXCISE) TAX When Q "too high," use PER-UNIT (EXCISE) TAX to discourage production and consumption PRICE FLOOR When P "too low," set PRICE FLOOR to stop price from falling to eqm P*. PER-UNIT SUBSIDY When Q "too low," use PER-UNIT SUBSIDY to encourage production and consumption PRICE CEILING When P "too high," set PRICE CEILING to stop price from rising to eqm P*. OUTPUT QUOTA When Q "too high," use OUTPUT QUOTA to limit production (and therefore, consumption)

Slope in Economics

Price is the independent variable, but on y-axis to show what happens as price changes.

Optimal Production

Produce where MR=MC

Surplus due to Sellers

Q(s)[P]-Q*

Surplus due to Buyers

Q*-Q(d)[P]

Economics Point-Slope Form

Q=mP+b where b is an integer, and m=(Q2-Q1)/(P2-P1)

perfectly inelastic demand

Quantity demanded is unaffected by prices of goods with perfectly inelastic demand. m=-0 (perfectly vertical line) Remember, slope in econ is weird and is inverted; m=Q2-Q1/P2-P1 TIP: Inelastic curves are vertical, like the "I" in Inelastic.

P (Choke)

the price at which consumers stop buying a product. i.e., if demand curve is P(d)=180-Q, then choke price (when quantity demanded is 0)

Shifts in Demand Curve

T- Tastes and Preferences R- Related Goods (Complements and Substitutes) I- Income (normal and inferior goods) C- # of consumers E- Expectations

Pigouvian Tax

T=MEC[Qsoc]

Total Revenue

TR=PQ

Tax

Tax=P(paid)-P(received)

Ch 5 Key Ideas

The buyer's problem has three parts: what you like, prices, and your budget. An optimizing buyer makes decisions at the margin. An individual's demand curve reflects an ability and willingness to pay for a good or service. Consumer surplus is the difference between what a buyer is willing to pay for a good and what the buyer actually pays. Elasticity measures a variable's responsiveness to changes in another variable. As a consumer, you optimize by solving the buyer's problem, which dictates that you make decisions at the margin, recognizing both financial and nonfinancial incentives. Individual demand curves are derived from the three components of the buyer's problem: what we like, prices, and how much money we have to spend. Consumer surplus measures the difference between an individual's willingness to pay and what the consumer actually pays for a good or service. Policymakers often use consumer surplus to measure how proposed legislation impacts consumer surplus. An elasticity measures the sensitivity of one economic variable to a change in another. Important elasticity measures include the price elasticity of demand, the income elasticity of demand, and the cross-price elasticity of demand. Elasticity measurement is especially important for businesses and policymakers who want to understand how consumer behavior changes in response to a price or policy change. Combining knowledge of the decision-making rules that result from the buyer's problem with an understanding of elasticities, we can more reliably understand how we ourselves will respond to incentives, and we can more effectively create the proper incentives to change the behavior of others in a predictable way.

P (shutdown)

the price at which suppliers shut down production of a product. i.e., if supply curve is P(s)=60+Q(s), then shutdown price is 60 (when quantity produced is 0.

Ch 7 Key Ideas

The invisible hand efficiently allocates goods and services to buyers and sellers. The invisible hand leads to efficient production within an industry. The invisible hand allocates resources efficiently across industries. Prices direct the invisible hand. There are trade-offs between making the economic pie as big as possible and dividing the pieces equally. When the strong assumptions of a perfectly competitive market are in place, markets align the interests of self-interested agents and society as a whole. In this way, the market harmonizes individuals and society so that in their pursuit of individual gain, self-interested people promote the well-being of society as a whole. The remarkable tendency of individual self-interest to promote the well-being of society as a whole is orchestrated by the invisible hand. The invisible hand efficiently allocates goods and services to buyers and sellers, leads to efficient production within an industry, and allocates resources efficiently across industries. The invisible hand is guided by prices. Prices incentivize buyers and sellers, who in turn maximize social surplus—the sum of consumer surplus and producer surplus—by simply looking out for themselves. We can measure the progress of an economy by measuring social surplus—how big the societal pie is. But we can also measure progress by considering questions of equity—how the pie is distributed among agents.

Aggregation

The process of adding up individual behaviors

complements

Two goods are complements when a fall in the price of one leads to a rightward shift in the demand curve for the other.

substitutes

Two goods are substitutes when a rise in the price of one leads to a rightward shift in the demand curve for the other.

Ch 3 Key Ideas

When an economic agent chooses the best feasible option, she is optimizing. Optimization using total value calculates the total value of each feasible option and then picks the option with the highest total value. Optimization using marginal analysis calculates the change in total value when a person switches from one feasible option to another, and then uses these marginal comparisons to choose the option with the highest total value. Optimization using total value and optimization using marginal analysis give identical answers. Economists believe that optimization describes, or at least approximates, many of the choices economic agents make. However, economists don't take optimization for granted. A large body of economic research attempts to answer the questions: when do people optimize (or nearly optimize) and when do people fail to optimize? Using optimization to describe and predict behavior is an example of positive economic analysis. Optimization also provides an excellent toolbox for improving decision making that is not already optimal. Using optimization to improve decision making is an example of prescriptive economic analysis. Optimization using total value has three steps: (1) translate all costs and benefits into common units, like dollars per month; (2) calculate the total net benefit of each alternative; and (3) pick the alternative with the highest net benefit. Marginal analysis evaluates the change in net benefits when you switch from one alternative to another. Marginal analysis calculates the consequences of doing one step more of something. Marginal cost is the extra cost generated by moving from one alternative to the next alternative. Optimization using marginal analysis has three steps: (1) translate all costs and benefits into common units, like dollars per month; (2) calculate the marginal consequences of moving between alternatives; and (3) apply the Principle of Optimization at the Margin by choosing the best alternative with the property that moving to it makes you better off and moving away from it makes you worse off. Optimization using total value and optimization using marginal analysis yield the same answer. These techniques are two sides of the same coin.

trade-off

When an economic agent needs to give up one thing to get something else.

price-taker

a buyer or seller who accepts the market price—buyers can't bargain for a lower price, and sellers can't bargain for a higher price.

Complementary Goods:

a decrease in the price of one good increases demand for the other. an increase in the price of good decreases demand for another. ex. if the price of razors goes down, you're more likely to buy shaving cream

price control

a government restriction on the price of a good or service.

market

a group of economic agents who are trading a good or service plus the rules and arrangements for trading.

demand schedule

a table that reports the quantity demanded at different prices, holding all else equal.

inferior good

an increase in income shifts the demand curve to the left (holding the good's price fixed), causing buyers to purchase less of the good.

normal good

an increase in income shifts the demand curve to the right (holding the good's price fixed), causing buyers to purchase more of the good.

Positive economics

analysis that generates objective descriptions or predictions, which can be verified with data.

Normative economics

analysis that recommends what an individual or society ought to do.

Diminishing marginal benefit (MB)

as you consume more of a good, your willingness to pay for an additional unit declines.

Cost-benefit analysis

calculation that identifies the best alternative, by summing benefits and subtracting costs, with both benefits and costs denominated in a common unit of measurement, like dollars.

Deadweight loss

decrease in social surplus from a market distortion.

inelastic demand

don't respond very much to changes in price. m= (-1, 0) Remember, slope in econ is weird and is inverted; m=Q2-Q1/P2-P1 TIP: Inelastic curves are vertical, like the "I" in Inelastic.

unit elastic demand

have a price elasticity of demand equal to -1. A 1 percent price change affects quantity demanded by exactly 1 percent Remember, slope in econ is weird and is inverted; m=Q2-Q1/P2-P1 m=-1

elastic demand

have a price elasticity of demand greater than 1. (means demand responds to prices) Remember, slope in econ is weird and is inverted; m=Q2-Q1/P2-P1 m=(-∞ ,-1)

income elasticity of demand

how changes in income change quantity demanded

negatively related

if two variables move in opposite directions.

Holding all else equal

implies that everything else in the economy is held constant. The Latin phrase ceteris paribus means "with other things the same" and is sometimes used in economic writing to mean the same thing as "holding all else equal."

cross-price elasticity of demand (CPED)

measures the percentage change in quantity demanded of a good due to a percentage change in another good's price. Shows if there's any relation between the two goods. If you get a negative value, the two goods are complements (complements go hand in hand); if you get a positive value, the two goods are substitutes. ex. an iPad would be a substitute for a Microsoft Surface. Thus, if the price of an iPad increases substantially, instead of spending your money on the iPad, you might buy a Microsoft Surface instead.

arc elasticity

method of calculating elasticities that measures at the midpoint of the demand range. εD=[(Δq/[(q1+q2)/2])100]/[(Δp/[(p1+p2)/2]100] same as above formula, just different format

demand curve shifts

only when the quantity demanded changes at a given price. T R I C E

Optimization

picking the best feasible option, given whatever (limited) information, knowledge, experience, and training the economic agent has. Economists believe that economic agents try to optimize but sometimes make mistakes.

demand curve

plots the quantity demanded at different prices. A demand curve plots the demand schedule.

supply curve

plots the quantity supplied at different prices. A supply curve plots the supply schedule.

budget constraint

shows the bundles of goods or services that a consumer can choose given her limited budget.

Q (Giveaway)

the overall quantity of a product consumers will demand of a product once the price has hit 0. i.e., if demand curve is P(d)=180-Q, then Q giveaway is 180 (when P=0)

Principle of Optimization at the Margin

states that an optimal feasible alternative has the property that moving to it makes you better off and moving away from it makes you worse off.

supply schedule

table that reports the quantity supplied at different prices, holding all else equal.

Quantity supplied

the amount of a good or service that sellers are willing to sell at a given price.

Quantity demanded

the amount of a good that buyers are willing to purchase at a given price.

Opportunity cost

the best alternative use of a resource.

producer surplus

the difference between the price received for the good and the willingness to accept (WTA).

consumer surplus

the difference between the willingness to pay (WTP) and the price paid for the good.

Tax Incidence

the division of a tax burden between buyers and sellers

Marginal cost (MC)

the extra cost generated by moving from one feasible alternative to the next feasible alternative.

Willingness to pay

the highest price that a buyer is willing to pay for an extra unit of a good.

Gross domestic product

the market value of final goods and services produced in a country in a given period of time.

elasticity

the measure of sensitivity of one variable to a change in another.

budget set

the set of all possible bundles of goods and services that can be purchased with a consumer's income.

Scarcity

the situation of having unlimited wants in a world of limited resources.

Equilibrium

the special situation in which everyone is simultaneously optimizing, so nobody would benefit personally by changing his or her own behavior, given the choices of others.

Economics

the study of how agents choose to allocate scarce resources and how those choices affect society.

Microeconomics

the study of how individuals, households, firms, and governments make choices, and how those choices affect prices, the allocation of resources, and the well-being of other agents.

Macroeconomics

the study of the economy as a whole. Macroeconomists study economy-wide phenomena, like the growth rate of a country's total economic output, the inflation rate, or the unemployment rate.

Social surplus/ Social Welfare

the sum of consumer surplus and producer surplus.

Net benefit

the sum of the benefits of choosing an alternative minus the sum of the costs of choosing that alternative.

market demand curve

the sum of the individual demand curves of all potential buyers. It plots the relationship between the total quantity demanded and the market price, holding all else equal.

Scarce resources

things that people want, where the quantity that people want exceeds the quantity that is available.

price elasticity of demand (PED)

εD=% change in qD/% change in p OR εD=[(Δq/q midpoint)100]/[(Δp/p midpoint)100] is done by percentage changes so we're seeing how the percentage increase of a good affects demand, since the addition of two dollars to a good's price might change demand radically differently if it's toothpaste (probably) vs a sportscar (not at all). PED is ALWAYS negative

General Determinants of PED

• Availability of Close Substitutes (butter vs. insulin) If customers can easily and affordably switch to a substitute, PED higher • Expenses Relative to Budget; % of Disposable Income ( $.25 gum vs. $250K condo) If price of good is larger compared to person's income, PED higher • Necessities vs. Luxuries (want a botox injection, but immediately need bypass surgery) Unnecessary wants have higher PED than "needs," though this depends on preferences • Length of Time Horizon (rushing to airport in Uber/cab vs. slowly taking the "L" train) The longer the time horizon, the more opportunity to adapt, so higher PED • Breadth of Market Definition (cereal generally is a staple, but there are many sugary cereals) The narrower the market definition, the more substitutes, so higher PED IN GENERAL, PEOPLE RESPOND MUCH LESS TO PRICE CHANGES IN THE SHORT RUN THAN IN THE LONG RUN

Determinants of Price-Elasticity of Supply

• Availability of Inputs If it is easy/quick/cheap to hire workers, then PES large (can be very responsive) If one needs highly specialized, rare, expensive workers, then PES small E.g., pizza inputs are plentiful, but cell phone frequencies are based on limited radio spectrum Natural resources may be limited: metal ore, ocean fish, land for growing coffee • Flexibility in Increasing Output It's hard to build more beachfront hotels if land is scarce and already full of hotels It's often easy to add an extra shift and raise factory output (manufactured goods) • Length of Time Horizon The more time one has to respond, the larger is PES In short run, it's hard to grow more fields of corn or flu vaccine cultures In SR, stuck with certain # of factories In LR, can build more factories