These are important revision notes to be studied in conjunction with the other study materials. Once understood your chances of passing this module is greatly enhanced.
NB- Get all the notes from microeconomics first year boy.
The word economy comes from a Greek word for “one who manages a household.
Definition of Economics: the study of how society manages its scares resources.
How do we go from managing a household to managing an economy?
- A household and an economy face many decisions:
o Who will work?
o What goods and many of them should be produced?
o What resources should be used in production?
o At what price should the goods be sold?
Society and scare resources:
The management of society’s resources is important because resources are scare.
Scarcity: means that society has limited resources and therefore cannot produce all the goods and
services people with to have.
Decision-making is at the heart of economics. The individual must decide how much to save for retirement,
how much to spend on different good and services, how many hours a week to work. The firm must decide
how much to produce, what kind of labour to hire. Society as a whole must decide how much to send on
national defence versus how much to spend on consumer goods.
How people make decisions: “there is no such thing as a free lunch!” - and ALL decisions involve tradeoffs.
Society faces and important tradeoff: Efficiency vs Equality
Efficiency: when society gets the most from its scarce resources
Equality: when prosperity is distributed uniformly among society’s members/
Tradeoff: to achieve greater equality cold redistribute income from wealthy to poor. But this reduces incentive
to work and produce, shirks the size of the economic “pie”.
“The cost of something is what you give up”
- Making decisions requires comparing the costs and benefits of alternative choicecs
- The Opportunity cost of any item is whatever must be given up to obtain it.
- It is the relevant cost for decision making.
Rational people
- Systematically and purposefully do the best they can to achieve their objectives.
- Make decisions by evaluating costs and benefits of marginal changes – which mean incremental
adjustments to an existing plan
Incentive: something that induces a person to act i.e. to prospect of a reward or punishment.
- Rational people respond to incentive.
, o Examples: when gas prices rise, consumers buy more hybrid cars and fewer gas guzzling
SUVs.
o When cigarette taxes increase, teen smoking falls
“Trade can make everyone better off”
- Rather than being self-sufficient, people can specialize in production one good or service and
exchange it for other goods.
- Countries also benefit from trade and specialization:
o Get a better price abroad for goods they produce
o Buy other goods more cheaply from abroad than could be produced at home
“Markets are usually a good way to organize economic activity
- Market: a group of buyers and sellers
- “organize economic activity” means determining
o What goods to produce
o How to produce them
o How much of each to produce
o Who gets them
- A market economy: allocates resources through the decentralized decisions of many households and
firms as they interact in markets
- The invisible hand works through the price system:
o The interaction of buyers and sellers determines prices.
o Each price reflects the good’s value to buyers and the cost of producing the good.
o Prices guide self-interested households and firms to make decisions that, in many cases,
maximize society’s economic well-being.
“Governments can sometimes improve market outcomes”
- Important role for government: enforce property rights (with courts and police)
- People are less inclined to work, produce, invest, or purchase if large risk of their property being
stolen.
- Market failure: when the market fails to allocate society’s resources efficiently.
o Causes:
Externalities, when the production or consumptions of a good affects bystanders
(i.e. pollution)
Market power, a single buyer or seller has substantial influence on market price (i.e
monopoly)
o In such cases, public policy may promote efficiency.
o Government may alter market outcome to promote equity
o If the market’s distribution of economic well-being is not desirable, tax or welfare policies
can change how the economic “pie” is divided
“A country’s standard of living depends on its ability to produce goods and services”
- Huge variation in living standards across countries and over time:
o Average income in rich countries is more than ten times average income in poor countries.
- The most important determinant of living standards: productivity, the amount of goods and services
produced per unit of labour.
- Productivity depends on the equipment, skills, and technology available to workers.
- Other factors (e.g. labour unions, competition from abroad) have far less impact on living standards.
“Prices rise when the government prints too much money”
- Inflation: increases in the general level of prices.
- In the long run, inflation is almost always caused by excessive growth in the quantity of money, which
causes the value of money to fall.
, - The faster the government creates money, the greater the inflation rate.
”Society faces a short-run tradeoff between inflation and unemployment”
- In the short-run (1-2 years), many economic policies push inflation and unemployment in opposite
directions.
- Other factors can make this tradeoff always present.
Chapter 1 Preliminaries
Microeconomics: branch of economics that deals with the behaviour of individual economics units – consumers,
firms, workers, and investors – as well as the markets that these units comprise
Macroeconomics: Branch of economics that deals with aggregate economic variables such as the level and
growth rate of national output, interest rates, unemployment, and inflations.
Microeconomics describes the trade-offs that consumers, workers, and firms face, and shows how these trade-
offs are best made.
Positive analysis: analysis describing relationships of cause and effect.
Normative analysis: analysis examining questions of what ought to be.
Market: collection of buyers and sellers that, through their actual or potential interactions, determine the
price of a product or set of products.
Market definition: Determination of the buyers, sellers, and range of products that should be included in a
particular market.
Arbitrage: practice of buying at a low price at one location and selling at a higher price in another.
Perfectly competitive market: market with many buyers or seller, so that no single buyer or seller has a
significant impact on price.
Noncompetitive markets: this where firms can jointly affect the price. The world of oil is one example.
Market price: price prevailing in a competitive market.
Extent of a market: boundaries of a market, both geographical and in terms of range of products produced and
sold within it.
Nominal price: absolute price of a good, unadjusted for inflation.
Real price: price of a good relative to an aggregate measure of prices; price adjusted for inflation.
Consumer price Index: measure of the aggregate price level.
Producer Price index: measure of the aggregate price level for intermediate products and wholesale goods.
Calculating real price formulas:
- Real Pricez = (Nominal Pricez ) x (Adjustment Factor)
- Real Pricez = (Nominal Pricez ) x (CPIbase year / CPIz)
Percentage change in real price =
, (real price in 2010 - real price in 1970)/
- (real price in 1970)
Chapter 2 The basics of supply and demand
Supply curve: relationship between the quantity of a good that producers are willing to sell and the price of
the goods. Thus the supply curve is a relationship between the quantity supplied and the price. We can write
this relationship as an equations:
Qs = Qs(p)
- THE SUPPLY CURVE
- The supply curve, labeled S in the figure, shows how the quantity
- of a good offered for sale changes as the price of the good
- changes. The supply curve is upward sloping: The higher the
- price, the more firms are able and willing to produce and sell.
- If production costs fall, firms can produce the same quantity at
- a lower price or a larger quantity at the same price. The supply
- curve then shifts to the right (from S to S’).
Other variables that affect supply: the quantity supplied can depend on other variables besides price. For
exampple, the quantity that producers are will to sell depends not only on the price they receive but also
on their produciton costs, including wages, interest charges, and the cost of raw materials. A change in the
values of one or more of these variables translates into a shift in the supply curve. We know that the
response of quanitity supplied to changes in price can be repreented by movement along the supplu
curve. However, the response of supply to changes in other supply-determining varianles is shown
graphically as a shift of the supply curve itself.
- Change is supply = shift in supply curve
- Change in quantity supply = movement along the supply curve
Demand curve: relationship betweein the quanityt of a good that consumers are will to buy and the price of
the good. We can write this relationship between quantity demanded and price as an equation:
- Qd = Qd(P)
The demand curve, labeled D, shows how the quantity of a good
demanded by consumers depends on its price. The demand
curve is downward sloping; holding other things equal, consumers
will want to purchase more of a good as its price goes down.
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