Economic Definitions

"Economics" has been called "the science of how people make a living."
have to make a living! Shouldn't we all understand something
economics? Often, though, when people talk about Economics, the
seem to get all twisted around! How do we even know what's being
about?

We all
about
words
talked

Here's an exercise to give you a taste of how you'll approach things in our Understanding
Economics course. Below are twelve images of things one might encounter in our day-to-day
economy. There are four ranges on the screen, labeled Land, Capital, Labor and Other.
Drag each item into the range you think it ought to go in. But be careful! If you don't place it in
the correct range (according to our Economic Definitions), it won't stick there. You'll have to try
again. And there's another trick to watch out for: some of the items might incorporate two of the
factors. In that case, they'll only stick to the correct boundary line between those two factors.

Introduction to Elasticity
We've already studied how supply and demand curves act together to determine market equilibrium, and how shifts in these two curves are
reflected in prices and quantities consumed. Not all curves are the same, however, and the steepness or flatness of a curve can greatly alter
the affect of a shift on equilibrium. Elasticity refers to the relative responsiveness of a supply or demand curve in relation to price: the more
elastic a curve, the more quantity will change with changes in price. In contrast, the more inelastic a curve, the harder it will be to change
quantity consumed, even with large changes in price. For the most part, Goods with elastic demand tend to be goods which aren't very
important to consumers, or goods for which consumers can find easy substitutes. Goods with inelastic demands tend to be necessities, or
goods for which consumers cannot immediately alter their consumption patterns

Key Terms for Elasticity

Buyer - Someone who purchases goods and services from a seller for money.
Competition - In a market economy, competition occurs between large numbers of buyers and sellers who have the opportunity to buy or
sell goods and services. The competition among buyers means that prices will never fall very low, and the competition among sellers means
that prices will never rise very high. This is only true if there are so many buyers and sellers that none of them has a significant impact on the
market equilibrium.
Demand - Demand refers to the amount of goods and services that buyers are willing to purchase. Typically, demand decreases with
increases in price; this trend can be graphically represented with a demand curve. Demand can be affected by changes in income, changes
in price, and changes in relative price.
Demand Curve - A demand curve is the graphical representation of the relationship between quantities of goods and services that buyers
are willing to purchase and the price of those goods and services.
Elastic - Describes a supply or demand curve which is relatively responsive to changes in price. That is, a curve wherein the quantity
supplied or demanded changes easily when the price changes. A curve with an elasticity greater than or equal to 1 is elastic.
Elasticity - Refers to the degree of responsiveness a curve has with respect to price. If quantity changes easily when price changes, then
the curve is elastic; if quantity doesn't change easily with changes in price, the curve is inelastic. The numerical equation to determine
elasticity is:
Elasticity = (% Change in Quantity)/(% Change in Price)
If elasticity is greater than 1, the curve is elastic. If it is less than 1, it is inelastic. If it equals one, it is unit elastic.
Elasticity of demand - Refers to the degree of responsiveness a demand curve has with respect to price. If quantity drops a great deal
when price goes up, then the curve is elastic; if quantity doesn't drop easily with increases in price, the curve is inelastic.
Elasticity of supply - Refers to the degree of responsiveness a supply curve has with respect to price. If quantity increases a great deal
when price goes up, then the curve is elastic; if quantity doesn't increase easily with increases in price, the curve is inelastic.
Equilibrium Price - The price of a good or service at which quantity supplied is equal to quantity demanded. Also called the marketclearing price.
Equilibrium Quantity - Amount of goods or services sold at the equilibrium price. Because supply is equal to demand at this point, there is
no surplus or shortage.
Goods and Services - Products or work that are bought and sold. In a market economy, competition among buyers and sellers sets the
market equilibrium, determining the price and the quantity sold.
Inelastic - Describes a supply or demand curve which is relatively unresponsive to changes in price. That is, the quantity supplied or
demanded does not change easily when the price changes. A curve with an elasticity less than 1 is inelastic.
Long Run - The distant future, for which buyers and sellers make "permanent" decisions, such as exiting the market or permanently
decreasing consumption.
Market - A large group of buyers and sellers who are buying and selling the same good or service.
Market Economy - An economy in which the prices and distribution of goods and services are determined by the interaction of large
numbers of buyers and sellers who have no significant individual impact on prices or quantities.
Market Equilibrium - Point at which quantity supplied and quantity demanded are equal, and prices are market-clearing prices, leaving no
surplus or shortage.
Market-clearing Price - The price of a good or service at which quantity supplied is equal to quantity demanded. Also called the equilibrium
price.
Seller - Someone who sells goods and services to a buyer for money.
Shortage - Situation in which the quantity demanded exceeds the quantity supplied for a good or service; in such a situation, the price of a
good is below equilibrium price.
Short Run - The immediate future, for which buyers and sellers make "temporary" decisions, such as shutting down production or
increasing consumption, for the time being.
Supply - Supply refers to the amount of goods and services that sellers are willing to sell. Typically, supply increases with increases in
price, this trend can be graphically represented with a supply curve.
Supply Curve - A supply curve is the graphical representation of the relationship between quantities of goods and services that sellers are
willing to sell and the price of those goods and services.
Surplus - Situation in which the quantity supplied exceeds the quantity demanded for a good or service; in this situation, the price of a good
is above equilibrium price.

Unit elastic - Describes a supply or demand curve which is perfectly responsive to changes in price. That is, the quantity supplied or
demanded changes according to the same percentage as the change in price. A curve with an elasticity of 1 is unit elastic.

Summary and Introduction of Demand

In microeconomics, demand refers to the buying behavior of a household. What does this mean? Basically, microeconomists want to try to
explain three things:
1.

Why people buy what they buy

2.

How much they're willing to pay

3.

How much they want to buy

Instead of looking at all consumers in the world, however, they try and model
how smaller units function: instead of asking, "How does the American market
function?" they ask, "What will one household do?" Each household, or smallscale decision-making unit, is affected by different factors when making
choices about what to buy and how much to buy. For instance, if one
household lives in Florida and another lives in Michigan, they might have
different preferences for clothing, since the climates are so different.
Consumer preferences weigh heavily in a household's buying decisions.
Another factor that affects such decisions is income: a millionaire and an
average citizen will have very different purchasing choices, since they have
different budgets to work on. All buyers will try to maximize their utility, that is,
make them selves as happy as possible, by spending what money they have
in the best way possible. By considering both their preferences and their
budget, they ensure that they end up with the best combination of goods
possible. Because the household is such a small unit, no household has a
significant impact on the market, and so the actions of any single household
are its best effort to react to the market price and the goods available. to
Demand
Summary and Introduction to Supply
At the other side of every transaction is a seller. Economists refer to the behavior of sellers as that market force of supply. It is the combined
forces of supply and demand that make up a market economy. In microeconomics, the smallest unit of supply is the firm, which is analogous
to the demand unit of the household. Firms operate independently of each other, making decisions about what to sell, and how much to sell,
depending on the price. How do firms make their selling decisions? Once they have decided what to sell, a decision they make based on
what they believe buyers will want to buy, their decision is then influenced by the market price of the goods. If a firm in Boston decides to sell
warm hats, they will want to sell more hats if the going price is high than if the going price is low. Just like households, firms try to maximize
their utility when making selling decisions. Whereas a buyer's utility is a complex combination of preferences, needs, and happiness,
economists usually assume that sellers derive utility from profit, that is, the more money a seller makes from a sale, the happier it will be.
Firms will maximize their utility by selling whatever will make them the most money. In this way, sellers' utility is somewhat easier to study
and understand, since we don't have to take personal preferences into account (in theory). Instead, we look purely at price and profit.

Introduction to Course and Economics

Economics Defined - Economics is the study of the ALLOCATION of SCARCE resources to
meet UNLIMITED human wants.
Microeconomics - is concerned with decision-making by individual economic agents such as
firms and consumers.
Macroeconomics - is concerned with the aggregate performance of the entire economic system.
Empirical economics - relies upon facts to present a description of economic activity. d.
Economic theory - relies upon principles to analyze behavior of economic agents.
Goals and their Relations
POSITIVE economics is concerned with what is

NORMATIVE economics is concerned with what should be. 1. Economic goals are value
statements, hence normative
Economics is not value free, there are judgments made concerning what is important: 1.
Individual utility maximization versus social betterment
Efficiency versus fairness
More is preferred to less
Most societies have one or more of the following goals, depending on historical context, public
opinion, and socially accepted values:
1. Economic efficiency, 2. Economic growth, 3. Economic freedom, 4. Economic security,
5. Equitable distribution of income, 6. Full employment, 7. Price level stability, and 8.
Reasonable balance of trade.
Goals are subject to:
interpretation - precise meanings and measurements will often become the subject of
different points of view, often caused by politics. b. goals that are complementary are
consistent and can often be accomplished together. c. conflicting - where one goal precludes,
or is inconsistent with another. d. priorities - rank ordering from most important to least
important; again involving value judgments. 6. The Formulation of Public and Private Policy
- Policy is the creation of guidelines, regulations or law designed to affect the
accomplishment of specific economic goals.
Economic Problems
1. The economizing problem involves the allocation of resources among competing wants.
There is an economizing problem because there are:
a. unlimited wants
b. limited resources
2. Resources and factor payments:
land - includes space (i.e., location), natural resources, and what is commonly thought of as
land.
Land is paid rent
capital - are the physical assets used in production - i.e., plant and equipment.
capital is paid interest
labor - is the skills, abilities, knowledge (called human capital) and the effort exerted by
people in production.
labor is paid wages
entrepreneurial talent - (risk taker) the economic agent who creates the enterprise. .
entrepreneurial talent is paid profits
3. Economic Efficiency consists of the following three components:
a. allocative efficiency - is measured using a concept known as Pareto Superiority (or
Optimality
b. technical efficiency - for a given level of output, you minimize cost or (alternatively) for a
given level of cost you maximize output.
c. full employment - for a system to be economically efficient then full employment is also
required.
4. Allocations of resources imply that decisions must be made, which in turn involves choice.
Every choice is costly; there is always the lost alternative -- the opportunity cost: a.
opportunity cost - the next best alternative that must be foregone as a result of a particular
decision.
5. The production possibilities curve is a simple model that can be used to show choices:
Assumptions necessary to represent production possibilities in a simple production
possibilities curve model:
1. efficiency

2. fixed resources
3. fixed technology
4. two products