Principles of Microeconomics Final Exam Summary PDF

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Chapter 1: ● Cost and benefit is a big part about choice ● Economics is the study of how people manage resources ● Economics is the study of choices people make ● Not all about money ● Economists assume that people: ○ R aware of costs and benefits of all available options ○ Compares all available choices ○ Purposefully behave in the way that will best have goal ○ This is rational  behavior ○ This assumption is not perfect but helps to explain a lot about real world ● Economics is divided into 2 broad fields ○ microeconomics : study of choice individuals and firms make and the implications of these choices ○ Macroeconomics: study of the economy on a regional, national or international scale ● Scarcity ○ People make decisions aimed at getting the things they want ○ People want a lot of everything but, they are constrained by limited resources ○ Scarcity is the condition of people's’ wants always being greater than available resources ○ Scarcity is a fact of time ■ Individuals’ resources: time and money ■ Societies resources: factors of production, such as labor and tech ● Opportunity cost ○ Every decision in life involves weighing the tradeoff b/w costs and benefits ○ The direct cost includes both the direct  cost and opportunity  cost

○ The direct cost includes all associated costs ○ The opportunity cost is the value of what one g  ives up to get something ○ It includes the value of the n  ext best alternative, not the value of the possible alternatives ○ Your next best alternative may consist of more  than 1 part ○ Opportunity is about give up or are missing out on ● Marginal decisions ○ In economics we assume people make  choices at every step ○ People compare the additional(=marginal) benefits of a choice against the additional(marginal) costs(not total cost and benefit) ■ Referring to as marginal decision making ■ No consideration of past benefits or costs, both referred to as s unk ■ Sunk Costs: costs that already have been incurred and cannot be recovered ● (check slide for ex) ● Incentives ○ Rational behavior suggests that people respond the incentives ○ An incentive is something that c auses a change in the tradeoffs that people face ■ Pos incentives: makes people more likely to do something by lowering the opportunity cost ■ Neg incentive: makes people less likely to do something by raising their opportunity ○ It will change the cost and benefit for people. Aka type of movie ● Efficiency ○ Under normal circumstances, individuals and firms seek opportunities to get what they want(mas dinero) ■ If a profit-making opportunity exists, someone will provide the good or service

○ This leads the efficiency: resources are used to produce goods and services with the greatest economic value. ● Sometimes economics do not operate efficiently ○ Innovation: Yet to be discovered innovations/ideas increase efficiency. ○ Market failure: People and firms may be prevented from capturing the benefits of the opportunity or incur additional costs. ○ Intervention: Interventions in the economy cause transactions to not take place. ◦ Most often government policies. ○ Goals other than profit: Maybe there is no profit. Individuals and governments have goals other than Profit. ● Accurately spotting the fundamental economics concepts at work in the world is sometimes difficult ● Economic analysis requires: ○ Theory to be combined with observations ○ Scrutiny of both theory and observations before drawing conclusion ● In applying the 4 concepts pay attention to: ○ The difference b/w correlation and causation ○ Characteristics of a good economic model ○ Distinguish between pos and normative analysis ● when 2 events occur together there is a tendency to assume that 1 causes the other ● Economists differentiate b/w 2 relationships ○ Correlations: a consistently-observed relationship b/w 2 events ■ +: increase in a and b ■ -: increases in a and decreases in b

○ Causation: a relationship b/w 2 events in which 1 brings about the other ■ A causes b ● There r 3 reason why an assumed causal relationship may be false: ○ Correlation w/o causation: 2 events may be extremely correlated, making it appear that a causal relationship exists ○ Omitted variables: 2 events may be extremely correlated due to a 3rd event causing the 2 ○ Reverse causation: sometimes it is unclear whether event a causes event b or it event b causes event a ● Economic models show how people, firms and gov make decisions about managing resources and how their decisions interact ○ Models are a simplification of complex problems ○ Models include: ■ Groups of individuals and their choices ■ Markets to study ○ what makes it useful? ■ Makes clear assumptions ■ Describes the real worlds accurately ■ Predicts causes and effects ● Analyses b/w ○ + analysis: the way things are. A factual claim about how the real world actually works ■ Ex: income taxes reduce the # of hours people want to work ○ Normative analysis:the way things should be. ■ Income taxes should b reduced

Chapter 2: Adam Smith: it is the maxim of every prudent master of a family never to attempt to make at home what it will cost him more to make than to buy. Production possibility: ● self -interest people( and countries) can cooperate and be better off ● Model analyzes who produces which goods. ● Assumptions: ○ 2 groups: producers and consumers ○ 2 goods being produced ○ Each producer has their own production tech Reminder: ● People and societies have limited resources and unlimited wants( scarcity) ● People and societies have to give up something to gain something else(trade-off) The production possibility frontier: a country’s production capabilities can be modeled using this. ( check slide for graph) ● it also is the line or curve that shows all possible combos of 2 outputs that can be produced using all available resources ● If the country is producing inside the ppf, producing more of one good doesn’t require giving up some of the other goods.( we call these points inefficient points bc we don’t use all available resources) PPFs and opportunity cost ● If the country is producing on the ppf, producing more of one good requires giving up some of the other goods ● Opportunity cost of a commodity is the amount of the other commodity a country has to give up, per unit O.C.=give  up/gain ● The trade-off b/w producing more of 1 good less of another is the opportunity cost Concave to the origin PPFs

● The previous PPFs assumed that all inputs are able to be transferred b/w production processes at a c onstant rate ● bowed-out ppf shows the law of increasing opportunity cost aka law of low hanging fruit. ● It is likely that some inputs are better suited for making shirts, while other inputs are better suited for farming ● What happened to the shape of the ppf transferring inputs b/w production processes is costly? ● PPf is b  owed out ● The opportunity cost of production an additional unit of a good typically increases as more resources are allocated to its productions ● At each point of the cured production possibilities frontier, the slope represents the opportunity cost of more t-shirts ● A concave to the origin ppf, ( bowed out ppf) represents the law of increasing oc, sometimes called the law of low hanging fruits ● The law says the more you want of something, the higher cost you have to pay for a unit(picking low fruit is easier than high fruit) Shifting the ppf ● The ppf shifts when resources are adjusted ○ An increase in available resources shift the entire frontier outward so does the change in tech that affect all activities ● The ppf shifts when resources are adjusted ○ An improvement i tech for one good rotates the frontier outward ● Show that it is possible to increase both wheat and shirt production with an increase in tech to produce shirts ● The PPf illustrates the key trade-offs faces by one economy ● If there is no trade b/w economies then what a country produces is what is consumes

● Using the understanding of pffs, the analysis can be extended to understand how countries decide what to produce ● Absolute advantage: is presented by the intercept of ppf and shows productivity. That a certain good can be produced better or produce more. ○ it does not aid in understanding how countries decide which goods to produce ○ It is presented by the intercept of ppf and shows productivity ○ Can have abadv in all things ● Comparative advantage: is  when a good can be produced at a lower opportunity cost than others ○ Opportunity costs: give up divided by gain and the one with the lower cost is the person who has a comparative advantage ○ No country has a comparative adv in everything and each country has a comparative advantage in producing something ○ Compadv is presented by SLOPES of 2 production possibility frontiers(slope is neg so OC is absolute value of it) ● Specialization: we are better off if we use it. Also increases trade and is all around better for specific groups to specialize. ○ Gains from trade: The improvement in outcomes that occurs when specialized producers exchange good and services. ○ Without specialization production , each party have to consume what they produce “ON” ppf ○ With specialization production, each party still ON ppf But can consume “outside” ppf

Chapter 3 ● markets ○

In an economy such as US economy resource(in out, goods and services) are mostly allocates through allocations

○ Non-market allocations ○ A market refers to the buyers and sellers who trade a particular good or service ■ Markets can be located locally, globally or even virtually ○ 1 special class of markets is the competitive market ● Perfectly competitive markets ○ Perfectly competitive market is a benchmark ○ 4 characteristics of perfectly markets ○ Standardized good: interchangeable ○ No transaction costs: free participation in exchange ○ Full information: about price and features ○ Participants are price takers no power to change price. Each participant is so small compared to the whole market that they can’t affect the price ● Demand ○ As a group, consumers determine the demand  for  a product ○ The quality  demand is the amount of a particular good or service that buyers are willing and able to buy at a given price ○ The law  of demand states that the lower the price, the higher the quantity demanded all other things equal ● The demand schedule ○ A demand schedule displays the quantities demanded at various prices ○ This demand schedule provides the quantity of cellphones demanded at specific prices ○ Notice that as price falls the quantity demanded increases

○ Demand curve:illustrates the relationship b/w the quantity demanded and the price of the good, holding all of the ther non-price determinants constant ○ Everyone has a value for cellphone ○ It is called reservation price ○ Every point on demand curve represents the marginal value of cell phone for 1 person ● Changes in demand ○ The 5 most important non-price  determinants of demand are: ■ Preferences ■ # of buyers ■ Incomes ■ Expectations ■ Price of related goods ○ What happens when 1 of the non-price determinants change? ■ If +demand increases ■ If - demand decreases ■ Substitute goods: you may use 1 in place of the other ■ Complements: you usually use them together ● Shifting the demand curve ○ When demand increases, the demand curve shifts to the right ○ When demand decreases, the demand curve shifts to the left ○ Difference b/w a shift and movement along demand curve ■ If a non-price determinant change then the demand curve shifts with changes in the quantity demanded at every price ■ If the price decreases then quantity demanded increases and there is a movement along the demand curve ● Supply ○ As a group, producers determine the supply of product

○ The q  uantity supplied is the amount of a particular good that producers are willing and able to produce at a given price ○ The law of supply states that the higher the price, the higher the quantity supplies all other things equal ● Supply schedule ○ A supply  schedule displays  the quantities supplies at various prices ○ This supply schedule provides the quantity of cellphone supplies at specific prices ○ Notice that as prices increases the quantity supplied increases ● Interpretation of supple ○ Every producer has a cost for producing cell phone ○ It is called reservation price ○ Every point on the supply curve represents the marginal cost of producing 1 cellphone ● Changes in supply ○ 5 most important non-price determinants of supply: ■ Tech ■ #of produers ■ Price of inputs ■ Expectation ■ Price of related goods ○ What happens when 1 of the n0n-price determinants change? ■ + increases ■ - decreaces ■ Input: resources you producers use to produce a commodity ● There is an important dif b/w a shift in the supply curve and a movement along the supply curve ○ If a non-price determinant changes then the supply curve shifts with changes in the quantity supplies at EVERY price

○ If the price decreases, then quantity supplied decreases and there is movement along the supply curve ● Market exists ○ Demanders have demand(willing to pay) ○ Suppliers have supply(willing to accept money) ○ As long as there as there are demanders and suppliers, there will be market ● Equilibrium ○ Equilibrium price: is $100 ○ Equilibrium quantity is 150 million people who have value more than 100 ○ Market is Clear as $100 thus it is the equilibrium point ○ Equilibrium: where supply curve intersects the demand curve. No incentive to change. If there is no external force, equilibrium will not change ■ At this point consumers are willing to buy exactly what producers are willing to sell ● Disequilibrium ○ If market is not equilibrium the market price isn’t equal to the equilibrium price, then quantity demanded is not equal to quantity supplied ● Surplus ○ If the price is above equilibrium price, excess supply occurs and there is a surplus of the good or services. A  lower price alleviates the surplus ○ A surplus provides incentive for the price to decrease ○ As the price decreases… ■ The quantity supplied decreases ■ The quantity demanded increases ○ The price continues to decrease until QunatitySupply=QuantityDemand=Quantity ● Shortage

○ If the price is below equilibrium price, excess demand occurs and there is a shortage of the good or service. A  higher price alleviates the shortage ○ A shortage provides incentives for the price to increase ○ As the price increases ■ The quantity supplied increases ■ The quantity demanded decreases ○ The price continues to increase until QunatitySupply=QuantityDemand=Quantity ● Changes in market equilibrium ○ The equilibrium price and quantity are determined by the intersection of the demand and supply curves. ○ If a non-price  factor changes, this affects the market equilibrium ○ To determine the effect on market equilibrium, there are 3 questions that must be answered ■ Does the change affect demand? If so how? ■ Does the change affect supply?if so how? ■ What happens to equilibrium price and quantity? ○ Price increases so will quantity ○ Find new equilibrium where QuantitySupply=NewQuantityDemand  ● Shift in supply ○ Increased tech causes the supply curve to increase ○ The supply curve shifts right ○ The market equilibrium changes ■ Equilibrium price decreases ■ Equilibrium quantity increases ○ The cost of an input increases causing a decrease in supply ○ The supply curve shifts left ○ The market equilibrium changes: ■ Equilibrium price decreases

■ Equilibrium quantity increases ● Four Rule ○ 1. Increase in demand will lead to increase in both equilibrium price and quantity ○ 2. A decrease in demand will lead to decrease in both equilibrium price and quantity ○ 3. An increases in supply will lead to a decrease in the equilibrium price and an increase in the equilibrium price and an increase in the equilibrium quantity ○ 4. An decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity ● Shift in both supply and demand ○ It is possible for non-price factors that influence both demand and supply at the same time. ○ This leads to shifts in both demand and supply. ○ The new equilibrium occurs at the new intersection. ○ Suppose that landline phone service prices increase and an input price to make cellphones decreases. ■ Demand increases. ■ Supply increases. ○ What happens to equilibrium price and quantity?

Chapter 4: Elasticity ● What is elasticity? ○ Elasticity: is a measure of the responsiveness or sensitivity to a change in a market condition ○ The concept applies to supply and demand ○ It measures the response to a change in: ■ The price of the good ■ The price of a related good ■ Income ● Price elasticity demand ○ The price  elasticity of demand measures the magnitude of change in the quantity demanded from a change in its price. In other words, it estimates price sensitivity

● Definition of price elasticity of demand NEED TO KNOW

● Calculating price elasticity(NEED TO KNOW) ○ % change in price if the price change from P1(old price) to P2(new price):

○ % change in quantity if the price change from P1 to P2 and as a result, quantity demanded changes from Q1(old quantity) to Q2(new quantity):

■ Once do this divide price/quantity and make sure its negative  ○ The direction of change affects the elasticity ○ We dont like this to happen so we use midpoint method ○ The midpoint method calculates the elasticity at the midpoint of any 2 points. (USE THIS FROM NOW ON)The formula is:

○ Midpoint elasticity is the dif of any 2 #s divided by their average ○ Elasticity is unitless  ● Determinants of price elasticity of demand ○ Consumers are more sensitive to price changes from some goods and services than for others ○ Many factors determine consumers’ responsiveness to price changes ■ Availability of substitutes ■ Degree of necessity  ■ Cost relative to income ■ Adjustment time ■ Scope of the market( how broad or narrow we define markets) ● Categorizing elasticities ○ All good and services can be broadly categorized based on elasticity ■ Elastic(sensitive): a change in price causes a relatively large % change in quantity demanded

■ Inelastic( not sensitive): a change in price causes a relatively small % change in quantity demanded ○ At the extremes, demand can either perfectly elastic or perfectly inelastic

○ Slope maters

● Elasticity on linear demand curve ○ In a linear demand curve, the middle point of the line has unit elasticity ○ Points at higher prices represent elastic part

○ Points at lower prices represent inelastic part

● Unit price elasticity of demand ○ Knowing whether the demand for a good is elastic or inelastic is extremely useful in business ■ Allows managers to determine whether a price increase will cause total rev to rise or fall ○ Total rev is the amount that a firm receives from the sale of goods and services ■ Total rev(TR) equals price paid(p) multiplies by quantity sold(q) or TR=P.Q

○ An increase in price affects total rev in 2 ways

○ The magnitude of the price and quantity effects are determined by the elasticity of demand

● Price elasticity of supply ○ The concept of elasticity can also be applied to supply ○ The price elasticity of supply measures producers’ response( in quantity) to a change in price ■ Uses same midpoint formula but replaces quantity demanded with quantity supplied ■ Elasticity is always positive ■ Same interpretation:

● Determinants of price elasticity of supply ○ Producers are more sensitive to rpice changes for some goods and services than for others ○ Many factors determine producers’ responsiveness to price changes ■ Availability of inputs ■ Flexibility of the production process ■ Adjustment time ● Cross price elasticity of demand ○ The cross price elasticity of demand is a measure of how the quantity demanded of 1 good changes when the price of a dif good changed

○ The midpoint formula calculates the elasticity b/w the quantity demanded for good a and price of good b

○ The cros...