Includes:
Chapter 1: The Big Ideas
Chapter 2: The Power of Trade and Comparative Advantage
Chapter 3: Supply and Demand
Chapter 4: Equilibrium - How supply and demand determine prices
Chapter 11: Costs and profit maximization under competition
Chapter 14: Price discrimination and pricing strategy
C...
Chapter 1: The Big Ideas
1. Incentives Matter
○ Rewards and penalties that motivate behavior
2. Good Institutions Align Self-interest with the Social Interest
3. Trade-offs Are Everywhere
○ There are always opportunity costs
○ The power of trade
○ Wealth and economic growth are important
Chapter 2: The Power of Trade and Comparative Advantage
3 benefits of trade
1. Trade makes people better off when preferences differ
○ creates more value by moving goods from people who value less to people
who value them more
2. Trade increases productivity through specialization and the division of knowledge
3. Trade increases productivity through comparative advantage
○ Comparative advantage: producing goods for which it has the lowest
opportunity costs
○ Opportunity costs: A benefit, profit, or value of something that must be given
up to acquire or achieve something else.
○ Absolute advantage: the ability to produce the same good using fewer
inputs than another producer.
○ Production Possibilities Frontier (PPF): shows all the combinations of
goods that a country can produce given its productivity and supply of inputs.
■ Producing more goods of one kind, results in producing less goods of
another kind
● Trade and globalization → not everyone does always benefit from increased trade
Chapter 3: Supply and Demand
Demand: the whole curve (change is a shift of the entire curve)
Quantity demanded: one certain point in the curve → the quantity that buyers are willing
and able to buy at a particular price (change is a movement along the curve)
Consumer surplus: consumer’s gain from exchange
Total consumer surplus: measured by the area beneath the demand curve and above the
price.
Demand shifters:
● income → when people get richer, they buy more stuff
○ normal good: increase in income → increase in demand (e.g. holiday in
Europe)
○ inferior good: increase income → decrease in demand (e.g. holiday in NL)
● population → more people, more demand
● price of substitutes (= a good that can be consumed instead of another good)
● price of complements
● expectations
● tastes
Supply shifters:
● technological innovations and changes in the price of inputs
● taxes and subsidies
● expectations
, ● entry or exit of producers
● changes in opportunitycosts
Chapter 4: Equilibrium - How supply and demand determine prices
Surplus: a situation in which the Qs is greater than Qd (lower price than equilibrium price)
Shortage: when Qd is greater than Qs (higher price than equilibrium price)
A free market maximizes the gains from trade:
1. Available goods are bought by buyers with the highest willingness to pay
2. Goods are sold by the sellers with the lowest costs
3. Between buyers and sellers, there are no unexploited gains from trade or
any wasteful trades
Chapter 11: Costs and profit maximization under competition
1. What price should be set in a competitive market?
○ similar products, many buyers and (potential) sellers
○ producers are price takers (it can only sell the products for the market price)
○ firm’s demand is perfectly elastic at market price
2. What quantities should be produced?
○ explicit costs: a cost that requires a money outlay
○ implicit costs: a cost that doesn't require a money outlay
○ economic profit: total revenue minus explicit and implicit costs
○ accounting profit: total revenue minus explicit costs
○ MR = MC or MR = P (perfect competition)
3. When should the industry be entered and when should it be left?
○ Enter a market → P is higher than A C
■ P is higher than MC and AC
○ Exit a market ASAP → P = A C (no incentive to enter the market)
■ P is between AC and AVC
○ Exit a market immediately → P is lower than AC
■ P is under AVC
Increasing cost industries: costs are rising at higher input prices
Constant cost industries (government): costs remain the same
Decreasing cost industries: costs decrease with higher output
Long run: the time after an entry or exit has taken
Short run: the period before an entry or exit
Chapter 14: Price discrimination and pricing strategy
Price discrimination: selling the same product at different prices to different
customers.
● requires some market power
○ it is more profitable to apply different prices when demand curves differ
○ the monopolist must set a higher price on markets with more inelastic
demand (lower change in demand when there is a higher price)
● must prevent arbitrage to successfully price-discriminate
○ Arbitrage: (illegal) trade between markets outside the company, buy low sell
high → the company is losing profits.
→ Price discrimination can increase profit and social welfare – from single price under
market power
→ The more a firm knows about its customers, the better it can price discriminate
Perfect price discrimination: consumers pay exactly what they are willing to pay
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