SUMMARY

CHAPTERS1-7

Defining Economics

EconomicsThe study of how people allocate their limited

resources to satisfy their unlimited wantsThe study of how people make choices

ResourcesThings used to produce other things to satisfy

people’s wantsWants

What people would buy if their incomes were unlimited

With limited income (resources), people must make choices to satisfy their wants.

We never have enough of everything, including time, to satisfy our every desire.

Individuals, businesses, and nations face alternatives, and choices must be made .Economics studies how these choices are

made…

Defining Economics

Factors of production :

The inputs into the process of production. Another term for resources.

Land

means all natural resources.

Labor is all the human time, effort, talent used to make products.

Capital is a producer’s physical resources; sometimes called

physical capital or real capital.

Entrepreneurshipvision, skill, ingenuity, willingness to take risks.

Factors of production :

Three factors of production: land, labor and capital, don’t always mean what we think they do:

Land Not just real estate.All resources, such as mined minerals,

native plants and animals.

Labor Not just physical strength.All human endeavors, such as mental

abilities.

Capital Not just money.All human creations that help produce

wealth, such as a car used as a taxi.

Factors of production and Corresponding Factor Payments

Natural resource

sRent

Human resource

sWages

Capital Interest

ProfitRisks

Three Basic Economic QuestionsEvery society must answer three basic economic

questions because of scarcity.What will be produced? How will it be produced?

Who will get what is produced?

Societies answer these questions differently, leading to a variety of

economic systems.

Economic SystemsThe economic problem:

Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic

questions?

Economic systems are the basic arrangements made by societies to solve

the economic problem.

They include:

Command economiesLaissez-faire economies

Mixed systems

Command economy• What to produce ? Determined by government preferences• How to produce? Determined by government and their employees• For whom to produce? Determined by government preferences

Laissez-faire economy• What to produce ? Determined by consumer's preferences• How to produce? Determined by producers seeking profits• For whom to produce? Determined by purchasing power

Mixed economyWhat to produce ? Determined partly by consumer preferences and partly by governmentHow to produce? Determined partly by producers seeking profits and partly by governmentFor whom to produce? Determined partly by purchasing power and partly by government preference

Differences Between Command Economies, Free Market Economies, And Mixed Economies

There are differences in terms of the ways they address the three basic economic questions:

Microeconomics versus Macroeconomics

MicroeconomicsThe study of decision making undertaken by individuals

(or households) and by firms. The effects of changes in gasoline prices A family’s choice of having a baby An individual firm’s decision to advertise

MacroeconomicsThe study of the behavior of the economy as a whole.

Deals with economywide phenomena. The national unemployment rate The rate of inflation The yearly output of goods and services in a nation

Opportunity cost is what you give up because you choose to do

something else.

orOpportunity cost

is value of next-best alternative a person gives up-not the value of all possible alternatives-

An idea closely related to opportunity cost is called comparative advantage.

Comparative advantagethe ability to produce a good at a lower opportunity

cost than another producer.

if you produce a good at a lower opportunity cost then you should specialize in it.

The production possibility frontier (PPF)

is a graph that shows all of the combinations of goods and services that can be produced if all of society’s resources

are used efficiently.

Capital goods Consumer goods

are goods used to produce are goods produced forother goods and services. present consumption.

The production possibility frontier curve has a negative slope, which indicates a trade-off between producing one

good or another.

The slope of the PPF curve is also called the marginal rate of transformation (MRT).

The negative slope of the PPF curve reflects the law of increasing opportunity cost. As we increase the

production of one good, we sacrifice progressively more of the other.

The production possibility frontier (PPF)

Consumer demand and price The relationship between price and quantity demanded is the starting point for building a model of consumer

behavior. 

The determinants of demandThe primary determinant is price.

Price and Quantity Demanded:The Law of Demand

The law of demand says that when the other determinants of demand remain constant, there is a

negative (or inverse) relationship between the quantity demanded of a good and its price.

Individual demand is how much of a product a consumer will buy at a given price.

Demand is based on the actual ability of consumers to purchase the product, not just what they would like but cant afford.

Demand curves slope down from left to right - this is because the higher the price the more of a consumers income must be spent on it & the

more satisfaction they must get from it to justify the opportunity cost.

Demand Curve

Shift of the Demand Curve

A shift of the demand curve

represents an increase or decrease of

demand at a given price level.

Price and Quantity Supplied:The Law of Supply

An increase in market price will lead to an increase in quantity supplied,

and a decrease in market price will lead to a decrease in quantity supplied.

Supply Curve

Supply curve - shows the

relationship between different

prices and the quantities that

sellers will offer for sale,

regardless of demand.

How Supply and Demand InteractMarket Equilibrium

Supply and demand curves meet at the equilibrium price.

Buyers and sellers make choices that restore the equilibrium price.

Changes affect both supply and demand. At equilibrium, there is no tendency for price to change .

Supply and Demand and Market Efficiency

consumer surplus The difference between the maximum amount a person is willing to pay for a good and its current market price.

Supply and Demand and Market Efficiency

producer surplus The difference between the current market price

and the full cost of production for the firm.

Supply and Demand and Market Efficiency

Competitive Markets Maximize the Sum of Producer and Consumer Surplus

Total Producer and Consumer SurplusTotal producer and consumer surplus is greatest where supply

and demand curves intersect at equilibrium.

Deadweight loss from underproduction

Deadweight loss from overproduction

Supply and Demand and Market Efficiency

deadweight loss The net loss of producer and consumer surplus from

underproduction or overproduction.

Concept of ElasticityElasticity is used to describe the behavior of buyers and

sellers in the market.

We know when P Qd and Qsbut how much?

Elasticity is a measure of the quantity demanded or supplied to

one of its determinants.

% change in quantity suppliedelasticity of supply % change in price

Concept of Elasticity

Initial Value method Midpoint method

Types of Elasticity if the result is > 1, demand is said to be elastic if the result is < 1, demand is said to be inelastic if the result is = 1, demand is said to be unitary

elastic if the result is = 0, demand is said to be perfectly

inelastic

Concept of UTILITY

utilitya numerical indicator of a person’s preferences in which

higher levels of utility indicate a greater preference.

marginal utility (MU) The additional satisfaction gained by the consumption or

use of one more unit of something.

total utility The total amount of satisfaction obtained from

consumptionof a good or service.

Marginal utility comes only from the last unit consumed; total utility comes from all units consumed.

When marginal utility is zero, total utility stops rising.

Income and Substitution EffectsOf A Price Change (For Normal Goods)

Income effect: When the price of a product

falls, a consumer has more purchasing power with the same amount of income.

When the price of a product rises, a consumer has less purchasing power with the same amount of income.

Substitution effect: When the price of a product

falls, that product becomes more attractive relative to potential substitutes.

When the price of a product rises, that product becomes less attractive relative to potential substitutes.

The Production Process: The Behavior of Profit-Maximizing Firms

firm is an organization that comes into being when a person

or a groupof people decides to produce a good or service

to meet a perceived demand.

The primary objective of a firm is to - maximize profits

Profit (economic profit)

is the difference between total revenue and total economic cost. cost economic total revenue totalprofit economic

Total revenue is the amount received from the sale of the product:

Total Revenue (TR) = Price per unit of output x Quantity of output sold

Marginal revenue (MR) is the additional revenue that a firm takes in when it

increases output by one additional unit.In perfect competition, P = MR.

 

The Production Process: The Behavior of Profit-Maximizing

Firms

MRTRq

TR P q

Total cost (total economic cost) is the total of

Accounting costs (Explicit or out-of-pocket costs):involve a direct money outlay for factors of production

(purchased inputs).

Economic costs (Implicit costs): do not involve a direct money outlay. They include the full

opportunity cost of every input (non-purchased inputs).

Total Cost (TC) = Total Variable Cost + Total Fixed CostTotal Variable Cost (TVC) = The cost of all Variable

Inputs.  Total Fixed Cost (TFC) = The cost of all Fixed Inputs.  

Variable Inputs are those inputs whose use does vary with the quantity of output

produced. Fixed Inputs 

are those inputs whose use does not vary with the quantity of output produced.

Two Decision Situations:  The Long-Run and The Short-Run

In economics, the Long-Run and the Short-Run are not defined in terms of time,

but rather in terms of how many things in a situation are considered parameters vs. variables.

Short-Run is a period of time in which the quantity of at least one input is fixed and the quantities of the other

inputs can be varied. Long-Run 

is a period of time in which the quantities of all inputs can be varied.

Production function is the technical relationship between inputs and

outputs over a given period of time

Mathematıcal Expressıon Of Productıon Functıon

Long-Run Q = F ( L , K , I , R ,E )  Short-Run  Q= F ( L , K )

Production technology refers to the quantitative relationship between

inputs and outputs.A labor-intensive technology

relies heavily on human labor instead of capital.A capital-intensive technology

relies heavily on capital instead of human labor.

Marginal and Average Costs

ISOQUANTSAn Isoquant is the set of all combinations of variable inputs

that could be used to produce a given quantity of output in the short run.   

Iso – «Equal»; Quant – «quantity»Isoquant – a line of equal quantity

With a fixing level of output Q at some quantity we have an implicit relationship between units labor ( L ) and capital (K)

Qc = F ( L , K ) It is possible to produce the same amount of output by

using different combination of input.

ISOCOSTISOCOST line is the budget line of a producer in terms of two

inputs.ISOCOST line is points of all the different combinations of labor and capital that firm can employ given the total cost and prices

of inputs.

ISOCOST lines expressed as C = w L + r K

Where price of labor is wage - w price of the capital is interest - r total cost is - C

Usually the ISOCOST line is linear with slope equal to ratio of the factor prices.