MICROECONOMICS REVIEWER  The market allows you to learn a specialized set of

skills and then use the pay you receive to buy the
Scarcity - means that there are never enough resources goods and services you need or want.
to satisfy all human wants.  This is how our modern society has evolved into a
 Every society, at every level, must make choices strong economy
about how to use its resources.
Economics - is the study of the trade-offs and choices Macroeconomics - the branch of economics that
that we make, given the fact of scarcity. focuses on broad issues such as growth,
unemployment, inflation, and trade balance.
Opportunity cost - is what we give up when we choose
one thing over another. Microeconomics - the branch of economics that focuses
on actions of particular agents within the economy, like
Goods and Resources households, workers, and businesses. We learn about
the theory of consumer behavior and the theory of the
Economic Goods: goods or services a consumer must
firm
pay to obtain; also called scarce goods.
 Macroeconomic policy pursues its goals through
Free Goods: goods or services that a consumer can
monetary policy and fiscal policy.
obtain for free because they are abundant relative to
1. Monetary Policy - policy that involves altering the
the demand.
level of interest rates, the availability of credit in the
PRODUCTIVE RESOURCES economy, and the extent of borrowing
Productive Resources - the inputs used in the 2. Fiscal Policy - economic policies that involve
production of goods and services to make a profit: land, government spending
economic capital, labor, and entrepreneurship
Using Economic Models: Examples
 also called "factors of production"
Circular Flow Diagram - diagram indicating that the
4 Productive Resources economy consists of households and firms interacting in
1. Land - any natural resource, including actual land, a goods-and-services market and a labor market.
but also trees, plants, livestock, wind, sun, water. goods-and-services market - (also called the product
2. Economic capital - anything that's manufactured in market), in which firms sell and households buy
order to be used in the production of goods and
services .financial capital (which is not productive) labor market - in which households sell labor to
economic capital (which is). business firms or other employees
3. Labor - "human capital" any human service-physical real world - there are many different markets for goods
or intellectual. and services and markets for many different types of
4. Entrepreneurship - the ability of someone (an labor
entrepreneur) to recognize a profit opportunity, PURPOSE OF FUNCTIONS
organize the other factors of production, and accept
risk. Function - a relationship or expression involving one or
more variables.
CONCEPT OF OPPORTUNITY COST  describe cause and effect.
 on the left-hand side is ("the effect")
Opportunity Cost - the value of the next best  On the right-hand side ("the causes").
alternative. Ex: Budget = money spent on econ + books money
Individual Decisions - recognizing the opportunity cost spent on music
can alter personal behavior
Societal Decisions - Opportunity cost comes into play Order of Operations
with societal decisions
 When you solve an equation it's important to do each
LABOR, MARKETS, AND TRADE operation in the following order:
 Simplify inside parentheses and brackets.
The Division and Specialization of Labor  Simplify the exponent.
 Multiply and divide from left to right.
Division Of Labor - the way in which the work required  Add and subtract from left to right.
to produce a good or service is divided into tasks
Lines - equation for a line in graphs: y = b + mx
performed by different workers.
Specialization - when workers or firms focus on Variable - a quantity that can assume a range of values
particular tasks for which they are well suited within the represented by a letter or a symbol.
overall production process. For example: y = 9 + 3x
Why the Division of Labor Increases Production? Creating and Interpreting Graphs
Economies of Scale - when the average cost of Intercept - the point on a graph where a line crosses the
producing each individual unit declines as total output vertical axis or horizontal axis,
increases. Slope - the change in the vertical axis divided by the
TRADE AND MARKETS change in the horizontal axis.
 Specialization only makes sense if workers (and other
economic agents such as businesses and nations) can Variable: a quantity that can assume a range of values.
use their income to purchase the other goods and x-axis: the horizontal line on a graph, commonly
services they need. represents quantity (q) on graphs in economics.
 Specialization requires trade.
y-axis: the vertical line on a graph, commonly  show a relationship between two variables; one
represents price (p) on graphs in economics. measured on the horizontal axis and the other
measured on the vertical axis.
Equation for a Line: y = mx + b  The line graph measures length in inches on the
horizontal axis and weight in pounds on the vertical
In any equation for a line, m is the slope and b is the y-
axis.
intercept
 This kind of graph is widely used by health-care
Interpreting Graphs in Economics providers to check whether a child's physical
 It is rare for real-world data points to arrange development is roughly on track.
themselves as a perfectly straight line.
PIE GRAPHS - (sometimes called a pie chart) is used to
 It often turns out that a straight line can offer a
show how an overall total is divided into parts. A circle
reasonable approximation of actual data
represents a group as a whole. The slices of this circular
Interpreting Slope: Positive Slope "pie" show the relative sizes of subgroups
Some common examples of how pie graphs are used
Slope - the change in the vertical axis divided by the include dividing the population into groups by age.
change in the horizontal axis. Income level, ethnicity, religion, occupation: dividing
different firms into categories by size, industry,
Positive Slope - indicates that two variables are number of employees: and dividing up government
positively related; when one variable increases, so does spending or taxes main categories. or taxes into its
the other, and when one variable decreases, the other main categories
also decreases.
BAR GRAPHS - uses the height of different bars to
Negative Slope - indicates that two variables are compare quantities.
negatively related: when one variable increases, the  can be subdivided in a way that reveals information
other decreases, and when one variable decreases, the similar to that we can get from pie charts.
other increases  It is sometimes easier for a reader to run his or her
eyes across several bar graphs, comparing the shaded
Slope Of Zero - indicates that there is a constant areas, rather than trying to compare several pie
relationship between two variables: when one variable graphs.
changes, the other does not change
Types of Graphs: Comparison
Interpreting Slope: Calculating Slope
Bar graphs are especially useful when comparing
Calculating Slope quantities
 The slope of a straight line between two point can be
calculated in numerical terms. Pie graphs are often better than line graphs at showing
 To calculate slope, begin by designating one point as how an overall group is divided
the "starting point" and the other point as the "end
point" and then calculating the rise over run between Line graphs are often the most effective format for
these two points illustrating a relationship between two variables that
 Graphs of economic relationships are not always are both changing
straight lines but often nonlinear (curved) lines.
MODULE 2
 Can interpret nonlinear relationships similarly to the
way we interpret linear relationships. Budget Constraints and Choices
 Their slopes con be positive or negative. We can
calculate the slopes similarly also looking at the rise Budget Constraint - refers to all possible combinations
over the run of a segment of a curve. of goods that someone can afford, given the prices of
goods and the Income (or time) we have to spend.
Interpreting Slope
Sunk Costs - costs incurred in the past that can't be
NONLINEAR RELATIONSHIPS recovered.

 Nonlinear relationships can be interpreted. Opportunity Cost - measures cast by what is given up in
 Their slopes can be positive or negative. exchange: opportunity cost measures the value of the
 We can calculate the slopes similarly also, looking at forgone alternative.
the rise over the run of a segment of a curve.
 A higher positive slope means a steeper upward tilt to Types of Budget Constraints
the curve, which you can see at higher output levels.
 Limited amount of money to spend on the things we
 A negative slope that is larger in absolute value (that
need and want.
is, more negative) means a steeper downward tilt to
 Limited amount of time.
the line.
 A slope of zero is a horizontal line. Budget Constraint Results
 A vertical line has an infinite slope.  You have to make choices.
 If a line has a larger intercept, graphically, it would  Every choice involves trade-offs.
shift out (or up) from the old origin, parallel to the old  No matter how many goods a consumer has to
line choose from, every choice has an opportunity cost,
the value of the other goods that aren't chosen.
TYPES OF GRAPHS  The budget constraint framework assumes that sunk
costs costs incurred in the past that can't be
LINE GRAPH
recovered-should not affect the current decision.
Production Possibilities Frontier (or Curve) - a diagram  A society may be using its resources inefficiently, in
that shows the productively efficient combinations of which case by by Improving efficiency and producing
two products that an economy can produce given the on the production possibilities frontier, it can have
resources it has available. more of all goods for at least more of some and less of
none)
Production Possibilities Frontier: Similarities  As resources grow grow over over a a period period of
of years years (e (eg.. more labor and more capita),
Similarities with Individual Constraints
the economy grows. As it does, the production
 While individuals face budget and time constraints, possibilities frontier for a society will tend to shift
societies face the constraint of limited resources (e.g. outward, and society will be able to afford more of all
labor, land, capital, raw materials, etc.). goods.
 Because at any given moment, society has limited Productive Efficiency and Allocative Efficiency:
resources, if follows that there's a limit to the Comparative Advantage
quantities of goods and services it can produce. In
other words, the products are limited because the The PPF and Comparative Advantage
resources are limited.
 When a country can produce a good at a lower
Differences Between an Individual's Budget Constraint opportunity cost than another country, we say that
and a PPF this country has a comparative advantage in that
good.
 The PPF, because it's looking at societal choice, is
 When countries engage in trade, they specialize in the
going to have much larger numbers on the axes than
production of the goods in which they have
those on an individual's budget constraint.
comparative advantage and trade part of that
 A budget constraint is a straight line, while a
production for goods in which they don't have
production possibilities curve is typically bowed
comparative advantage in.
outwards, le, concave towards the origin.
 With trade, goods are produced where the
 The general rule is when one is allocating only a
opportunity cost is lowest, so total production
single scarce resource, the trade-off (e.g. budget line)
Increases, benefiting both trading parties
will be constant, but when there is more than one
 The slope of the PPF gives the opportunity cost of
scarce resources, the trade-off will be increasingly
producing an additional unit of wheat. While the
costly (e.g. the PPF).
slope is not constant throughout the PPFs, it is quite
Law of Diminishing Returns - as additional increments apparerit that the PPF in Brazil is much steeper than
of resources are devoted to a certain purpose, the in the U.S. and therefore the opportunity cost of
marginal benefit from those additional increments will wheat is generally higher in Brazil
decline.
Rationality and Self-Interest
Production Possibilities Frontier: Opportunity Cost
Assumption of Rationality - aiso called the theory of
Law of Diminishing Returns and the Curved Shape of rational behavior, it is the assumption that people will
the PPF Example make choices in their own self-interest
 a simpilfication that economists make in order to
 If few resources are currently committed to create a useful model of human decision-making.
education, then an increase in resources used can  The assumption that individuals are purely self-
bring large gains. interested doesn't imply that individuals are greedy
 If a large number of resources are already committed and selfish. People clearly derive satisfaction from
to education, then committing additional resources helping others, so "self-interest" can also include
will bring smaller gains. pursuing things that benefit other people.
 The curve of the PPF shows as additional resources
are added to education, moving from left to right on Rationality in Action
the horizontal axis, the initial gains are large, but Rationality suggests that consumers will act to maximize
those gains gradually diminish. self-interest and businesses will act fo maximize profits.
Bath are taking into account the benefits of a choice,
Productive Efficiency and Allocative Efficiency given the costs.

Efficiency - refers to lack of waste. Rationality and Consumers

Productive Efficiency - given the available inputs and  When a consumer is thinking about buying a product,
technology, it's impossible to produce more of one what does he or she want? The theory of rational
good without decreasing the quantity of another good behavior would say that the consumer wants to
that's produced. maximize benefit and minimize cost.
 As the cost of the product increases, it becomes less
Allocative Efficiency - when the mix of goods being likely that the consumer will decide that the benefits
produced represents the mix that society most desires. of the purchase outweigh the costs.
Productive Efficiency and Allocative Efficiency: MARGINAL ANALYSIS: COST
Society's Choice
Marginal Analysis - examination of decisions on the
Why Society Must Choose? margin, meaning comparing costs of a little more or a
little less.
 Every economy faces two situations in which it may be
able to expand the consumption of all goods.
Marginal Cost - the difference (or change) in cost of a Planned (or Command) Economies - an economy where
different choice. economic decisions are passed down from government
 Marginal costs sometimes go up and sometimes go authority and where resources are owned by the
down, but to get the clearest view of your options, government.
you should always try to make decisions based on  Resources and businesses are owned by the
marginal costs, rather than total costs. govemment.
MARGINAL ANALYSIS: BENEFIT  Government decides what goods and ods and services
will be produced and what prices will be charged for
Marginal Benefit - the difference (or change) in what them.
you receive from a different choice.  Government decides what methods of production will
 The amount of benefit a person receives from a be used and how much workers will be paid.
particular good or service is subjective; one person ECONOMIC SYSTEMS: DISTINCTION
may get more satisfaction or happiness from a
particular good or service than another. Primary Distinction between a free and command
economy is the degree to which the government
Marginal analysis is an important part of economic determines what can be produced and what prices will
rationality and good decision-making. be charged.
Positive and Normative Statements Real World - most economies in the real world are
Positive Statement - are objective and conclusions are mixed; they combine elements of command and market
based on logic and evidence that can be tested. systems.

2 Types of Positive Statements Demand for Goods and Services

1. Hypothesis - like "unemployment is caused by a Demand - the relationship between the price of a
decrease in GDP." This claim can be tested empirically certain good or service and the quantity of that good or
by analyzing the data on unemployment and GDP. service someone is willing and able to buy.
2. A statement of fact - such as "It's raining." or Price - what a buyer pays for a unit of the specific good
"Microsoft is the largest producer of computer or service.
operating systems in the world."
Note also that positive staternents can be false, but as Quantity Demanded -the total number of units of a
long as they are testable, they are positive. good or service consumers wish to purchase at a given
price.
Normative Statement - involves value judgments of the
speaker and the conclusions are based on value Law of Demand - the common relationship that a
judgments that cannot be tested. higher price leads to a lower quantity demanded of a
certain good or service and a lower price leads to a
 Normative Examples higher quantity demanded, while all other variables are
 We ought to do more to help the poor. held constant.
 Corporate profits are too high.
 Because people have different values, normative Demand Schedule - a table that shows the quantity
statements often provoke disagreement. demanded for a certain good or service at a range of
prices.
Know the Difference
Example: Price is measured in dollars per gallon of
 It's not uncommon for people to present an argument
gasoline. The quantity demanded is measured in
as positive, to make it more convincing to an audience,
millions of gallons over some time period and over
when in fact it has normative elements.
some geographic area.
 That's why it's important to be able to differentiate
between positive and normative claims. Demand curve - a graphic representation of the
relationship between price and quantity demanded of a
MODULE 3 SUPPLY AND DEMAND certain good or service, with price on the vertical axis
and quantity on the horizontal axis.
Economic Systems: Free
Ceteris Paribus - a Latin phrase meaning "other things
Market - any situation that brings together buyers and being equal."
sellers of goods or services.
 Any given demand or supply curve is based on the
3 Types of Economies System ceteris paribus assumption that all else is held equal.
 When changing one variable in a function (e.g.
1. Market Economy - an economy where economic demand for some product). We assume everything
decisions are decentralized, resources are owned by else is held constant.
private individuals. and businesses supply goods and  A demand curve or a supply curve is a relationship
services based on demand between two, and only. two, variables when all other
2. Competitive Market - a market in which there is a variables are held equal. If all else is not held equal,
large number of buyers and sellers, so that no one then the laws of supply and demand will not
can control the market price. necessarily hold.
3. Free Economy - a market in which the government
does not intervene in any way. Demand Curves Affected By:

ECONOMIC SYSTEMS: PLANNED

 "Willingness to purchase" suggests a desire to buy, certain good or service, with price on the vertical axis
and it depends on what economists call tastes and and quantity on the horizontal axis
preferences. It you neither need nor want something,
you won't be willing to buy it. Factors Affecting Supply: Lowered Costs
 "Ability to purchase" suggests that income is
Production Costs Affect Supply
important. Professors are usually able to afford better
housing and transportation than students, because If other factors relevant to supply do change, then the
they have more income. entire supply curve will shift.
 Prices of related goods. If you need a new car, the A shift in supply means a change in the quantity
price of a Honda may affect your demand for a Ford. supplied at every price.
 Size or composition of the population. The more If a firm faces lower costs of production, while the
children a family has, the greater their demand for prices for the good or service the firm produces
clothing. The more driving-age children a family has, remain unchanged, a firm's profits go up.
the greater their demand for car insurance and the When a firm's profits increase, it's more motivated to
less for diapers and baby formula. produce output (goods or services), since the more it
produces the more profit it will eam.
Factors Affecting Demand: Other Factors
When costs of production fall, a firm will costs of
Shift in demand happens when a change in some product tend to supply a larger quantity at any given
economic factor (other than price) causes a different price for its output. This can be shown by the supply
quantity to be demanded at every price. curve shifting to the right.
 changing tastes or preferences
Factors Affecting Supply: Higher Costs
 changes in the composition of the population
 changes in the prices of related goods Shift in Supply Due Increased Production Costs
 changes in expectations about future prices
 If a firm faces higher costs of production, then it will
Factors Affecting Demand: Goods or Services earn lower profits at any given selling price for its
products.
Good or Services Terms - the demand for a product can
 As a result, a higher cost of production typically causes
be affected by changes in the prices of related goods
a firm to supply a smaller quantity at any given price.
such as substitutes or complements.
In this case, the supply curve shifts to the left.
Substitutes - goods or services that can be used in place
of one another
Supply factors also affected by subsidies
Complements - goods or services that are used
together because the use of one enhances the use of Subsidy - A government payment to firms to encourage
the other. production of some good or service. From a firms
Inferior Good - good or service whose demand perspective it reducing the cost of production.
decreases when a consumer's Income increases and
demand increases when income decreases. EQUILIBRIUM, SURPLUS, AND SHORTAGE

Normal Good - good or service whose demand Demand and Supply

increases when a consumer's Income increases and
demand decreases when income decreases.  Graphs for demand and supply curves both have price
on the vertical axis and quantity on the horizontal
Supply of Goods and Services
axis, the demand curve and supply curve for a
Supply - the relationship between the price of a certain particular good or service can appear on the same
good or service and the quantity of that good od or graph.
service producers are willing to offer for sale.  Together, demand and supply determine the price and
the quantity that will be bought and sold in a market.
Law of Supply - the common relationship that a higher
price leads to a higher quantity supplied of a certain Surplus Or Shortage - when the quantity demanded
good or service and a lower price leads to a higher and the quantity supplied aren't the same
quantity supplied, while all other variables are held
Surplus (or excess supply) - situation where the
constant.
quantity demanded in a market is less than the quantity
Quantity Supplied - the total number of units of a good supplied; occurs at prices above the equilibrium.
or service producers are willing to supply at a given
Equilibrium - price and quantity combination where
price.
supply equals demand.
Supply is not the same as quantity supplied.
Shortage (or excess demand) - situation where the
Supply refers to the curve, and quantity supplied refers quantity demanded in a market is greater than the
to the (specific) point on the curve. quantity supplied; occurs at prices below the
equilibrium.
Supply Schedule - a table that shows the quantity
demanded for a certain good or service at a range of  Generally any time the price for a good is below the
prices. equilibrium level, incentives built into the structure of
demand and supply will create pressures for the price
Supply Curve - a graphic representation of the to rise.
relationship between price and quantity supplied of a
 Similarly, any time the price for a good is above the  Governments typically set a price ceiling to protect
equilibrium level, similar pressures will generally consumers by making necessary products affordable,
cause the price to fall. but you'll come to see how this sometimes backfires
Equilibrium: Where Supply and Demand Intersect by creating a market shortage.
 Consumers, who are also potential voters, sometimes
Equilibrium - price and quantity combination where unite behind a political proposal to hold down a
supply equals demand. certain price.
 Five major consequences of price ceilings:
Equilibrium Price - the (only) price where the quantity  Shortages
supplied in a market equals the quantity demanded.  Reduced quality
 Wasted time and resources
Equilibrium Quantity - the quantity both supplied and  Deadweight loss, or a loss of gains from trade
demanded at the equilibrium price.  Misallocation of resources
Equilibrium and Economic Efficiency Price Floor - a legal minimum price for a product.

Equilibrium is important to create both a balanced sometimes called "price supports", because they
market and an efficient market. support a price by preventing it from falling below a
certain level.
Efficiency - when the optimal amount of goods are An example of a price floor is the minimum wage,
produced and consumed. minimizing waste. which is based on the view that someone working full
Efficiency in the demand and supply model has the time should be able to afford a basic standard of living.
same basic meaning: the economy is getting as much Most common way price supports work is the
benefit as possible from its scarce resources, and all the government enters the market and buys up the
possible gains from trade have been achieved product, adding to demand to keep prices higher than
they otherwise would be.
Finding Equilibrium using the Four-Step Process
Price Control - government laws to regulate prices
Step 1: Draw demand and supply curves showing the instead of letting market forces determine price.
market before the economic change fook place.  Neither price ceilings nor price floors cause demand
or supply to change.
Step 2: Decide whether the 600 conomic change being  They simply set a price that limits what can be legally
analyzed affects demand or supply. charged in the market.
Step 3: Determine whether the effect on demand or Trade and Efficiency
supply causes the curve to shift to the right or to the
left. and sketch the new demand or supply curve on the Getting a Good Deal or Making a Good Deal
diagram.
People make transactions because they value the same
Step 4: Identify the new equilibrium, and then compare goods differently at the margin.
the original equilibrium price and quantity to the new
Marginal Analysis - comparing the benefits and costs of
equilibrium price and quantity.
choosing a little more or a little less of a good.
Understand How Supply and Demand Shift a Graph
Law of Diminishing Marginal Utility - as we consume
Demand - the relationship between the price and the more of a good or service, the utility we get from
quantity demanded of a certain good or service. additional units of the good or service tend to become
smaller than what we received from earlier units.
Quantity Demanded - the total number of units of a
good or service consumers are willing to purchase at a Allocative Efficiency - when benefits of trade are
given price. maximized and the mix of goods being produced
represents the mix that society most desires.
Quantity Supplled - the total number of units of a good
or service producers are willing to sell at a given price. Consumer Surplus, Producer Surplus, Social Surplus

Shift in Demand - when a change in some economic Consumer Surplus - if we add up the gains at every
factor (other than price) causes a different quantity to quantity, we can measure the consumer surplus as the
be demanded at every price. area under the demand curve up to the equilibrium
quantity and above the equilibrium price.
Shift in Supply - when a change in some economic
factor (other than price) causes a different quantity to Producer Surplus - the value to producers of their sales
be supplied af every price. above their cost of production.

Supply - the relationship between price and the Social (or economic or total) Surplus - the sum of
quantity supplied of a certain good or service consumer and producer surplus at some quantity and
price of output.
MODULE 4
The market is efficient and both consumer and
Price Ceilings - a legal maximum price for a product. producer surplus are maximized at the equilibrium
point of $5.
 Keeps a price from rising above a certain level (the
"ceiling").
If the government establishes a price ceiling, a shortage
results, which also causes the producer surplus to
shrink, and results in inefficiency called deadweight loss

Deadweight Loss - the loss in social surplus that occurs

when a market produces an inefficient quantity.

If government implements a price floor, there is a

surplus in the market. the consumer surplus shrinks,
and inefficiency produces deadweight loss.

Calculate Consumer Surplus

Step 1 Define the base and height of the consumer

surplus triangle.

Step 2 Apply the values for base and height to the

formula for the area of a triangle.

Inefficiency of Price Floors and Price Ceilings

Price Ceiling Inefficiency

An inefficient outcome occurs and the total surplus of

society is reduced.

Loss in social surplus occurs when the economy

produces at an inefficient quantity. called deadweight
loss.

When deadweight loss exists, it is possible for both

consumer and producer surplus to be higher, in this
case because the price control is blocking some
suppliers and demanders from transactions that would
be beneficial to both.

Like a law establishing rent controls, it will transfer

some producer surplus to consumers which helps to
explain why consumers often favor them.

The imposition of a price floor prevents a market from

adjusting to its equilibrium price and quantity, and will
create an inefficient outcome.

Price floor will transfer some consumer surplus to

producers, which explains why producers often favor
them.

Consumer Surplus - The gap between the price that

consumers are willing to pay, based on their
preferences, and the market equilibrium price.

Labor and Financial Markets

The theories of supply and demand do not apply just to

markets for goods. They apply to any market, even
markets for labor and financial services.

Labor Markets - supply and demand for jobs.

Financial Markets - supply and demand for financial

services; i.e. saving & borrowing.