Economics 101: Key Concepts and Market Analysis

Posted on Sep 6, 2024 in Economy

Opportunity Cost

Opportunity Cost: The next best alternative foregone when a decision is made. It is the real cost of any decision and represents the other good or service that could have been produced with the same resources. The slope of the Production Possibility Curve (PPC) represents the opportunity cost.

Scarcity

Scarcity: Describes the condition of limited resources relative to unlimited wants.

Assumptions of the PPC

Assumptions of the PPC:

• Production of only two goods
• Fixed resources
• Given level of technology

The PPC shows the maximum output combinations achievable when resources are used efficiently with the best possible application of existing technology and resources.

• Any point inside the curve indicates underutilization of resources.
• Any point on the curve indicates that resources and technology are fully utilized.
• An outward shift of the curve signifies the discovery of new resources or an improvement in technology.

There is no opportunity cost associated with moving from a point inside the PPC to another point closer to the PPC.

Straight-line PPC

Straight-line PPC: Illustrates resources that are equally suited to the production of either good.

Production Efficiency

Production Efficiency: Occurs when resources are fully employed and utilized in the best possible way. Represented by any point on the PPC.

Allocative Efficiency

Allocative Efficiency: Requires both production efficiency and the production of the combination of goods that consumers actually desire.

PPC and Scarcity

PPC illustrates scarcity: The curve demonstrates the maximum attainable combination of two goods given a specific level of technology and resources, highlighting the inability to satisfy all wants.

Bowed-Out PPC

PPC bowed out from the origin: This shape occurs because inputs are allocated to favor the production of one good over another due to increasing costs resulting from diminishing returns.

Law of Demand

Law of Demand: States that as the price of a good or service decreases, the quantity demanded increases, and vice versa.

Price Elasticity of Demand (Ep)

Price Elasticity of Demand (Ep): Measures the responsiveness of the quantity demanded of a good or service to changes in its price.

• Ep > 1: Demand is elastic, and total revenue (TR) and price (P) change in opposite directions.
• Ep = 1: Demand is unitary elastic, and TR remains unchanged when P changes.
• Ep < 1: Demand is inelastic, and TR and P change in the same direction.

Factors Affecting Elasticity

Elastic Demand:

• Many substitutes (luxury goods)
• Consumes a higher proportion of total income

Inelastic Demand:

• Few substitutes (necessity goods)
• Consumes a small proportion of total income

Cross Elasticity of Demand (Ecross)

Cross Elasticity of Demand (Ecross): Measures the responsiveness of the quantity demanded of one good to changes in the price of another good.

• Positive coefficient: Goods are substitutes.
• Negative coefficient: Goods are complements.

Income Elasticity of Demand (Ey)

Income Elasticity of Demand (Ey): Measures the responsiveness of quantity demanded to changes in income.

• Ey is negative: Inferior good (normal necessity).
• Ey is positive: Normal good (normal luxury).

Law of Supply

Law of Supply: States that as the price of a good or service increases, the quantity supplied increases, and vice versa.

Price Elasticity of Supply (Es)

Price Elasticity of Supply (Es): Measures the responsiveness of the quantity supplied of a good to changes in its price.

• Es > 1: Supply is elastic.
• Es = 1: Supply is unitary elastic.
• Es < 1: Supply is inelastic.

Time Horizons and Supply Elasticity

Momentary Supply Curve	Short-run Supply	Long-run Supply
The quantity supplied is fixed and cannot respond to changes in price (perfectly inelastic). Firms are unable to change any inputs (factors of production).	At least one input is fixed, restricting the firm’s ability to change supply/output levels. Supply is more inelastic and less elastic.	All inputs are variable, allowing firms to be more adaptable and efficient. Supply is more elastic and less inelastic.

Market Equilibrium

Market equilibrium is:

• The price at which quantity demanded equals quantity supplied.
• The price at which there is neither a surplus nor a shortage, and the market clears.

Shortage

Shortage: Occurs at any price below the equilibrium where the quantity supplied by producers is less than the quantity demanded by consumers. The market will react by raising the price, leading to a decrease in quantity demanded and an increase in quantity supplied until equilibrium is reached and the market clears.

Surplus

Surplus: Occurs at any price above the equilibrium where the quantity supplied by producers is greater than the quantity demanded by consumers. The market will react by decreasing the price, leading to an increase in quantity demanded and a decrease in quantity supplied until equilibrium is reached and the market clears.

Consumer Surplus (CS)

Consumer Surplus (CS): The difference between what consumers are willing to pay for a commodity and what they actually pay rather than go without it.

Producer Surplus (PS)

Producer Surplus (PS): The difference between the total earnings of suppliers for a certain quantity sold and the total costs required to bring that quantity to the market.

Deadweight Loss (DWL)

Deadweight Loss (DWL): A loss of welfare experienced by an individual or group that is not offset by a welfare gain to another individual or group.

The intersection of demand and supply represents the point of allocative efficiency, where total consumer and producer surplus is maximized.

Subsidy and the Market

Tax and the Market

International Trade

CS before 1 PS before 2 and 4 CS after 1,2 and 3 PS after 4 Gain on CS 2 and 3 Loss on PS 2 Imports

CS before 1 and 2 PS before 4 CS after 1 PS after 2,3 and 4 Loss on CS 2 Gain on PS 2 and 3 Exports