Chapter summary note of chapter #1
Definition: David Simon - Economics is a social science that attempts to use scarce resources to attain a
maximum fulfillment of mans' unlimited wants.
Scarcity: All economic questions arise from a single and inescapable fact: you can't always get what you
want There has always been scarcity, and there always will be scarcity.
Scarcity is a relative concept in the sense that it relates the level of man's wants to the level of his ability to
satisfy those wants.
1) Good: Anything from which individuals receive utility or happiness or pleasure or satisfaction.
2) Bad: Anything from which individuals receive disutility or unhappiness or displeasure or
dissatisfaction.
Choice - The act of selecting among restricted alternatives.
Scarcity implies choice.
OPTIMIZING. To make a choice, we balance the benefits of having more of one thing against the costs of
having less of something else. The process of balancing benefits against costs and doing the best within
the limits of what is possible is called.
ECONOMIZING - making the best use of the resources available.
In making choices, we face costs. Whatever we choose to do, we could always have chosen to do
something else instead.
OPPORTUNITY COST - Choices imply opportunity cost. The opportunity cost of any action is the best
alternative forgone. The best thing that you choose not to do - the forgone alternative - is the cost of the
thing that you choose to do.
THE NATURE AND ROLE OF THEORY
Why Build Theories: Economists build theories in order to explain and predict real-world events.
What is a Theory: An abstract representation of the real word designed with the intent to better understand
that world.
Abstraction: The process (used in building a theory) of focusing on a limited number of variables to explain
or predict an event.
Building and Testing a Theory
Scientific Thinking: The fundamentals of scientific thinking:
1) The Association - Causation Issue: Association is one thing; causation is another. A problem arises
when we confuse the two.
2) The Fallacy of Composition: The erroneous view that what is good or true for the individual is
necessarily good or true for the group.
3) The Ceteris Paribus Condition: The Latin term meaning "all other things held constant.”
4) The Paradox of Thrift: When people intend to save, they often end up saving less.
Macroeconomics and Microeconomics
Macroeconomics: The branch of economics that deals with human behavior and choices as they relate to
the entire economy. Macroeconomics seeks to understand the big picture.
Microeconomics: The branch of economics that deals with human behavior and choices as they relate to
relatively small units - the individual, the firm, the industry, a single market
Positive Statements are statements of facts and based on what is.
Normative statements are matters of opinion. They are based on value judgment.
A rational choice: is one which, among all possible choices, best achieves the goals of the person making
the choice. Each choice, no matter what it is or how foolish it may seem to an observer, is still consider as
a rational choice.
Economic Model: A model is usually smaller than the real thing that it represents.
An economic model has two components:
1) Assumptions: They form the foundation on which a model is built.
2) Implication: These are the outcomes of a model
The Economy: is a mechanism that allocates scarce resources among competing uses, determining what,
how, and for whom the various goods and services will be produced.
The economy's two key components are decision makers and markets. Economic decision makers are
households, firms, and governments.
1) Households: They decide how much of their labor, land and capital to sell or rent and how much of the
various goods and services to buy.
2) Firms: They decide what factors of production to hire and which goods and services to produce and
sell to households.
3) Governments: They decide what goods and services to provide to households and firms and how much
to raise in taxes.
Chapter summary note of chapter #2
THE PRODUCTION POSSIBILITIES FRONTIER (PPF)
Land: All the gifts of nature. The forest, minerals, natural resources, proven & unproven land, the rivers,
seas, oceans and everything in them.
Labor : The physical & mental talents that people contribute to the production process.
Capital: Goods that are produced to be used to produce other goods.
a) Physical Capital Things like machines, tools, equipments, computers, etc.
b) Human Capital The accumulated skills/knowledge that people gain through their education/training.
Entrepreneur: The organizing factor of production. The entrepreneur is a risk taker and is someone that
has the foresight & ingenuity to bring together the other factors of production.
Capital Goods: Goods that can be use to produce other goods. Goods that can be reused.
Consumption Goods: Goods that when you consume them once, they are gone.
Intangible Goods: Goods that don’t have physical form or shape e.g. services
Divisible: Goods that can be bought or sold in whatever unit you want. e.g., gas
Indivisible: Goods that can only be bought and sold in whole units
Specialized: A resource that is better-suited in the production of a particular good.
Unspecialized: A resource that is equally-suited in the production of all goods.
THE PRODUCTION POSSIBILITY FRONTIER (PPF)
The PPF represents or depicts the various combinations of two goods that an economy can produce in a
certain period of time; with a given amount of resources, a given state of technology, no unemployed
resources and efficient production.
Assumptions:
The are only two goods that the society produces
All the resources are fully utilized
Production is taking place efficiently
Production Possibilities Schedule: A table or numerical tabulation of the various quantities of two goods
that a society can produce during a given time period.
A straight line PPF tells us the resources of this economy are unspecialized.
A straight line PPF is a situation where an economy is experiencing constant opportunity cost.
A concave PPF tells us the resources of this economy are specialized.
A concave PPF is a situation where an economy is experiencing increasing opportunity cost.
A concave PPF represents a situation where the opportunity cost is increasing.
The law of opportunity cost – in society where by resources are specialized, the increase production of one
good can only take place at the increasing cost of the other good.
When resources are specialized, increased production of one good comes at increased opportunity costs.
The Law of Increasing Opportunity Costs states that as more of a good is produced, the higher the
opportunity costs of producing that good.
Attainable region: Which consists of the points on the PPF and all points below it.
Unattainable region : Which consists of the points above the PPF. Scarcity implies that some things are
attainable and some things are unattainable.
Economic Growth: The increased productive capabilities of a society; it is illustrated by a shift outward in
the PPF. Sustainable growth over time.
EFFICIENCY vs. INEFFICIENCY
Efficiency:The condition where the maximum output is produced with given resources and technology. It
implies the impossibility of gains in one area without losses in another
Inefficiency: Producing less than the maximum output with given resources and technology.
Gain in your production of both goods
Lose in your production of both goods
Gain or lose in one good but stay the same in the other
Inefficiency implies that gains are possible in one area without losses in another.
Chapter summary note of chapter #3
DEMAND AND SUPPLY
Market: Any arrangement in which goods and services are exchange (can be anywhere). There are 2
sides to a market:
Market → 1) Buying Side → Demand is relevant
2) Selling Side → Supply is relevant
DEMAND: The word demand has a specific meaning in economics. It refers to
the willingness and ability of buyers to purchase different quantities of a good at different price during a
specific time period.
QUANTITY DEMANDED: Measures the number of units of a goods that buyers are willing and able to buy
at a particular price during a given time period.
LAW OF DEMAND: As the price of a good rises, the quantity demanded of the good falls and as the price
of a good falls, the quantity demanded of the good rises, ceteris paribus.
DEMAND SCHEDULE: It is the numerical tabulation of the quantity demanded of a good that buyers are
willing and able to buy at different prices during a given time period.
DEMAND CURVE: A demand curve is the graphical representation of the inverse relationship between
price and quantity demanded specified by the law of demand.
Individual Demand Curve: Demand Curve for an individual for particular good. For each good we each
have our individual demand schedule and thus demand curve.
Market Demand Curve: Sum total of all the individuals' demand curve for a particular good.
Determinants of Qd and D:
1) The price of the good itself
2) Income
3) The prices of related goods
4) Taste
5) Preferences
6) Quality
7) # of buyers
8) Future price expectations
A CHANGE IN QUANTITY DEMANDED vs. A CHANGE IN DEMAND
A change in Qd: This refers to a movement along a demand curve. If the price of a good itself changes
but everything else remains the same, there is a movement along the demand curve.
A change in D: This refers to a shift in the demand curve. A change in the demand for a product is
brought about by a change in all the other factors affecting demand with the exception of the price of the
good itself.
SUPPLY
SUPPLY (S): Supply refer to the willingness and ability of sellers to produce and offer for sale to the
market different quantities of a good at different price during a specific time period
QUANTITY SUPPLY (Qs): Measure of the number of units of a particular good that sellers are willing and
able to sell at a particular price during a given time period.
THE LAW OF SUPPLY: As the price of a good rises, the quantity supplied of the good rises, and as the
price of a good falls, the quantity supplied of the good falls, ceteris paribus. Note, the price of a good and
the quantity supplied of the good are directly related, ceteris paribus.
Exceptions:
The Supply Schedule: The numerical tabulation of the quantity supplied of a good at different prices.
The Supply Curve: Is a graphical representation of a supply schedule.
THE INDIVIDUAL vs. MARKET SUPPLY CURVE
An individual supply curve represents the price-quantity combinations for a single seller. The market
supply curve represents the price-quantity combinations for all sellers of a particular good.
Determinants of Qs and S:
Price of the good itself
Cost of production
Technology
Weather
Taxes
Subsidies
# of seller
Future price expectations
A CHANGE IN QUANTITY SUPPLIED vs. A CHANGE IN SUPPLY
A change in Qs: This refers to a movement along a supply curve. If the price of a good changes but
everything else remains the same, there is a movement along the same supply curve.
A change in S: This refers to a shift in the supply curve. A change in the supply for a product is brought
about by a change in all the other factors affecting supply with the exception of the price of the good itself.
Chapter summary note of chapter #4
Equilibrium: Equilibrium is the price-quantity combination in a market from which there is no tendency for
buyers or sellers to move away. Graphically, equilibrium is the intersection point of the supply and demand
curves.
1) Equilibrium Price: The price at which quantity demanded of the good equals quantity supplied. Both
buyers and sellers agree on that price.
2) Equilibrium Quantity: The quantity that corresponds to equilibrium price
Disequilibrium: A state of either surplus or shortage in a market.
4) Surplus: A condition in which quantity supplied is greater (excess supply) than quantity demanded.
Surpluses only occur at prices above equilibrium price. Qs > Qd
5) Shortage: A condition in which quantity demanded is greater (excess Demand) than quantity supplied.
Shortages only occur at prices below equilibrium price. Qd > Qs
What happens to Price when there is a Surplus or a Shortage?
If a Surplus exists, lower prices; if a shortage exists, raise prices.
GOVERNMENT INTERVENTION IN THE MARKET
a) Price Ceiling: A government mandated maximum price above which no legal trade can take place. A
price ceiling will normally be set below the equilibrium price.
b) Price Floor: A government mandated minimum price below which no legal trade can take place. (e.g.,
minimum wage law). A price floor will normally be set above the equilibrium price.
Chapter summary note of chapter #6
ELASTICITY
The law of demand states that price and quantity demanded are inversely related, ceteris paribus. What
we don't know is by what % quantity demanded changes as price changes. Suppose price rises by 3%
and as a result, quantity demanded falls. But by what % does it fall? The answer to this question lies in
the notion of price elasticity of demand.
PRICE ELASTICITY OF DEMAND - A measure of the responsiveness of quantity demanded to changes in
price. Ed = % ∆ in Qd / % ∆ in P
MIDPOINT ELASTICITY FORMULA
Ed = % ∆ in Qd =
% ∆ in P
Ed = ∆ in Qd /(Qd1 + Qd2)/2
∆ in P/ (P1 + P2)/2
Elastic Demand - The % ∆ in Qd is greater than the % ∆ in P → Ed > 1
Inelastic Demand - The % ∆ in Qd is less than the % ∆ in P → Ed < 1
Unit Elastic Demand - The % ∆ in Qd is equal to the % ∆ in P → Ed = 1
Perfectly elastic Demand - Qd is extremely responsive to even very small or no change in P → E d = ∞
Perfectly Inelastic Demand - Qd is irresponsive to changes in P → Ed = 0
PRICE ELASTICITY OF DEMAND AND TOTAL REVENUE
Total Revenue (TR) = P x Q
If demand is elastic: P↑ → TR↓
P↓ → TR↑
If demand is inelastic: P↑ → TR↑
P↓ → TR↓
If demand is unit-elastic: P↑ → TR (does not change)
P↓ → TR (does not change)
Price Elasticity of Demand along a Demand Curve
DETERMINANTS OF PRICE ELASTICITY OF DEMAND
The number of substitutes
Percentage of One's budget spent on the good
Time
OTHER ELASTICITY CONCEPTS
Cross Elasticity of Demand - Measures the responsiveness in Qd of one good to changes in the price of
another good.
Ec = % ∆ in Qd of good X
% ∆ in P of good Y
1) If Ec > 0 → Substitutes
2) If Ec < 0 → Complements
Income elasticity of demand - Measures the responsiveness in Qd of a good to changes in income.
Ey = % ∆ in Qd
% ∆ in Y
PRICE ELASTICITY OF SUPPLY - Measures the responsiveness of quantity supplied to changes in price
Es = % ∆ in Qs
% ∆ in P
PRICE ELASTICITY OF SUPPLY AND TIME - The longer the period of adjustment to a change in price,
the higher the price elasticity of supply. Implying Es is higher in the long run than in the short run.
TIME FACTOR
Momentary Supply
Short Run
Long Run
WHY PAY THE TAX: ELASTICITY MATTERS
Government can place a tax on whomever it wants, but the determination of who ends up paying the tax
depends on the laws of economics
Perfectly Inelastic Demand - Full tax is paid by the consumers
Perfectly Elastic Demand - Full tax paid by producers
Perfectly Elastic Supply - Consumers pay full tax
Perfectly Inelastic Supply - Producers pay the full tax
Degree of Elasticity and Tax Revenue - If the objective of the government were to maximize tax revenue,
then she would tax products of inelastic demand instead of elastic demand
