Understanding Economics: Scarcity, Choices, and Incentives
Scarcity
– Is the condition that arises because wants exceed the ability of resources to satisfy them.Choices we make…
– Depend on the incentives we face.Economics
Economics way of thinking
- Choice is a tradeoff
- Cost is what you must give up to get something
- Benefit is what you gain from something
- People make rational choices by comparing benefits and costs
- Most choices are ‘how much’ choices made at the margin
- Choices respond to incentives
Opportunity Cost
– The best things that you must give up to get something – The highest-valued alternative forgone.Benefit
– The gain or pleasure that something brings.– Measured by what you are willing to give up.
Rational Choice
– Choice that uses the available resources to best achieve the objective of the person making the choice.Incentive
– A reward or a penalty – a ‘carrot’ or a ‘stick’ – that encourages or discourages an action.Consumption Goods and Services
– Goods and services that are bought by individuals and used to provide personal enjoyment and contribute to a person’s standard of living.Capital Goods
– Goods that are bought by businesses to increase their productivity resources.Factors of Production
– Land, Labor, Capital, and EntrepreneurshipProduction Efficiency
– A situation in which we cannot produce more of one good or service without producing less of something else.Tradeoff – An exchange – giving up one thing to get something else.
Specialization – When one person (or nation) is more productive than another – needs fewer inputs or takes less time to produce a good or perform a production task – we say that this person (or nation) has an absolute advantage.
Comparative Advantage – The ability of a person to perform an activity or produce a good or service at a lower opportunity cost than someone else.
Quantity Demanded – The amount of a good, service, or resource that people are willing and able to buy during a specified period and at a specified place.
Demand – The relationship between the quantity demanded and the price of a good when all other influences on buying remain the same.
Demand Schedule – A list of the quantities demanded at each different price when all the other influences on buying plans remain the same.
Demand Curve – A graph of the relationship between the quantity demanded of a good and its price when all other influences on buying remain the same.
Market Demand – The sum of the demands of all the buyers in the market.
– That there is a new demand schedule and demand curve
Comparative Advantage – The ability of a person to perform an activity or produce a good or service at a lower opportunity cost than someone else.
Market
– Any arrangement that brings buyers and sellers together.Competitive Market
– One where the numbers of buyers and sellers are large enough that no individual buyer or seller can influence the price.Quantity Demanded – The amount of a good, service, or resource that people are willing and able to buy during a specified period and at a specified place.
Demand – The relationship between the quantity demanded and the price of a good when all other influences on buying remain the same.
Demand Schedule – A list of the quantities demanded at each different price when all the other influences on buying plans remain the same.
Demand Curve – A graph of the relationship between the quantity demanded of a good and its price when all other influences on buying remain the same.
Market Demand – The sum of the demands of all the buyers in the market.
Change in Demand
– A change in the quantity that people plan to buy when any influence other than the price of the good changes.– That there is a new demand schedule and demand curve
Demand Decreases
– Demand curve shifts leftward.Demand Increases
– Demand curve shifts rightward.Demand Shift Factors
- Prices of goods related in consumption
- Income
- Number of buyers
- Tastes/Preferences
- Expectations: future prices, expected future income, and credit market
Substitute
– A good that can be consumed in place of another good.Complement
– A good that is consumed with another good.Normal Good
– A good for which the demand increases if income increases and demand decreases if income decreases.Inferior Good
– A good for which the demand decreases if income increases and demand increases if income decreases.Change in the Quantity Demanded
– A change in the quantity of a good that people plan to buy that results from a change in the price of the good.Quantity Supplied
– The amount of a good, service, or resource that people are willing and able to sell during a specified period at a specified price.Supply
– Relationship between the quantity supplied of a good and the price of the good when all other influences on selling plans remain the same.Supply Schedule
– List of the quantities supplied at each different price when all other influences on the selling plan remain the same.Supply Curve
– Graph of the relationship between the quantity supplied and the price of the good when all other influences on selling plans remain the same.Market Supply
– Sum of the supplies of all sellers in a market.Substitute in Production
– Is a good that can be produced in place of another good.If the [own] price of a good rises… – The quantity demanded of that good decreases.
If the [own] price of a good falls… – The quantity demanded of the good increases.
Demand for a good increases… – If the price of one of its substitutes rises.
Demand for a good decreases… – If the price of one of its substitutes falls.
Demand for a good increases… – When the price of one of its complements falls.
Demand for a good decreases… – If the price of one of its complements rises.
Greater number of buyers in a market… – The larger is the demand for any good.
If the price of a good rises… – The quantity supplied of that good increases.
If the price of a good falls… – The quantity supplied of that good decreases.
The supply of a good increases… – If the price of one of its substitutes in production falls.
The supply of a good decreases… – If the price of one of its substitutes in production rises.
Complement in Production – A good that is produced along with another good.
The supply of a good increases… – If the price of one of its complements in production rises.
The supply of a good decreases…
– If the price of one of its complements in production falls.Resource and Input Prices – Influence the cost of production.
– The more it costs to produce a good, the smaller is the quantity supplied of that good.
Greater number of sellers in a market…
– The larger is supply.Productivity
– Is output per unit of input.Increase in productivity…
– Lowers costs and increases supply.Decrease in Productivity…
– Raises costs and decreases supply.Change in Quantity Supplied
– A change in the quantity of a good that suppliers plan to sell that results from a change in the price of the good.Market Equilibrium
– Occurs when the quantity demanded equals the quantity supplied.– Buyers’ and sellers’ plans are consistent.
Equilibrium Price
– The price at which the quantity demanded equals the quantity supplied.Equilibrium Quantity
– The quantity bought and sold at the equilibrium price.Shortage
– When the quantity demanded exceeds the quantity supplied.– Rise in price.
Surplus
– When the quantity supplied exceeds the quantity demanded.– Fall in price.
When Demand Changes – Supply curve does not shift.
– There is a change in the quantity supplied.
– Equilibrium price and equilibrium quantity change in the same direction as the change in demand.
When Supply Changes – Demand curve does not shift.
– There is a change in the quantity demanded.
– Equilibrium price changes in the opposite direction to the change in supply.
– Equilibrium quantity changes in the same direction as the change in supply.
Buyers Distinguish – Between value and price.
Value – What the buyer gets.
Price – What the buyer pays.
– Above the equilibrium mark on the graph.
Sellers Distinguish – Between cost and price.
Cost – What a seller must give up to produce the good.
Price – What a seller receives when the good is sold.
– for which it can be sold exceeds or equals its marginal cost.
– Below the equilibrium mark on the graph.
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– There is a change in the quantity supplied.
– Equilibrium price and equilibrium quantity change in the same direction as the change in demand.
When Supply Changes – Demand curve does not shift.
– There is a change in the quantity demanded.
– Equilibrium price changes in the opposite direction to the change in supply.
– Equilibrium quantity changes in the same direction as the change in supply.
Buyers Distinguish – Between value and price.
Value – What the buyer gets.
Price – What the buyer pays.
Consumer Surplus
– The marginal value from a good or service minus the price paid for it, summed over the quantity consumed.– Above the equilibrium mark on the graph.
Sellers Distinguish – Between cost and price.
Cost – What a seller must give up to produce the good.
Price – What a seller receives when the good is sold.
Marginal Cost
– The cost of producing one more unit of a good or service.– for which it can be sold exceeds or equals its marginal cost.
Producer Surplus
– The price of a good minus the opportunity cost of producing it, summed over the quantity produced.– Below the equilibrium mark on the graph.
Total Gain From Trade (GFT)
– The sum of consumer surplus and producer surplus.The Invisible Hand
– Adam Smith, in the Wealth of Nations (1776), suggested that competitive markets send resources to the uses in which they have the highest value.2