Econ 101 Notes

Chapter 1

- All economic questions arise because we want more than we can get
- Scarcity: limited amount of resources
o The source of all economic problems is scarcity (unlimited human wants vs limited
resources)
- Choices: a decision made based on incentives
o Choices are made under the pressure of scarcity
o The choices we make depend on the incentives we face
- Incentive: a reward that encourages an action or a penalty that discourages an action
- Economics: the social science that deals with the allocation of limited resources (scarcity) to
satisfy unlimited human wants
o Two types of economics
- Microeconomics: economics focusing on the choices that individual and business make
- Macroeconomics: economics focusing on the choices and performances of the national
economy (aggregate values)
- Factors of Production (FOP): resources required to produce goods/services (limited in supply)
o Land: natural resources and land
o Labour: physical and intellectual services of people
o Capital: production plant and equipment used in production
o Entrepreneurship: the organizer of land, labour, and capital
o Money is not a FOP, it is a unit of exchange and it doesnt produce and goods or services
itself
- Returns to FOP
o Land -> rent
o Labour -> wages
o Capital -> interest
o Entrepreneur -> profit
- Scarcity of FOP means that we face constrained choices about goods/services we consume and
produce
- Agents of observation in an economic system can be simplifies into two groups of households
(HH) and firms
- Economic Cycle:
- HH provide FOP and satisfy their desires through consumption by using the returns of FOP to
purchase goods and services provided by firms
- The firms have a demand for FOP since they need it to produce goods and services
 - Three Important question: Allocation, Distribution, and Coordination
- Allocation: How can we efficiently use the FOP? & What should be produced?
- Distribution: For whom?
o Distribution of goods and services between HH
o Distribution of returns of FOP to the owners of FOP
- Coordination: Self-interest vs Social-Interest (equity vs efficiency)
o Consumption plan of all HH coordinated to maximize efficiency
o Production plan of all firms coordinated to efficiently use the FOP
o Is coordination of consumption and production required for supply to meet demand
- SOLUTION to three questions: planned economy vs market economy
- A choice is a trade off
o Can think of any choice as a tradeoff, giving up one thing to make the choice
- Rational Choice: one that compares costs and benefits and achieves the greatest benefit over
cost for the person making the choice
o Answers What goods and services will be produced and in what quantities? -> those that
people rationally choose to buy
- Benefit: the gain or pleasure that it brings and its determined by preferences
- Preferences: the likes and dislikes of a persona and the intensity of those feelings
- Opportunity Cost: the highest valued alternative that must be given up making a choice
o Two parts of opportunity cost
o Ex. Going to a concert -> time wasted and cost of ticket
o There is an implicit (next best choice) and explicit (cost of choice) opportunity cost
- Do not need to go all in on one choice
o Can separate into a mix and match of two choices
o When mix and matching you must compare marginal costs of doing a little bit of each
decision
- Marginal Benefit: the benefit from consuming one additional unit of an activity
- Marginal Cost: the Cost from consuming one additional unit of an activity
- A change in marginal costs and benefits will change the incentive leading to changes in choices
- Economics is designed to predict choices according to changes in incentives
- Normative Statements: statements reflecting peoples values (opinions)
- Positive Statements: statements that attempt to explain how an economic system works to
predict that will happened (fact) (can be statistically valued)
- Economic models are used to simplify and analyze complex world situations
- Economist are often hired to be policy advisers
- Exogenous variable: a variable whose value is taken as a given in a model (independent variable)
- Endogenous variable: a variable whose value is determined in the model (dependent variable)

Chapter 2

- Production possibilities Frontier (PPF): the boundary between those combinations of goods and
services that can be produced and those cannot
o We focus on two goods at a time and hold quantities of all other goods and services
constant (ceteris paribus)
- Production Efficiency: if we cannot produce more of one good without producing less of another
good
o Point of PPF are efficient
o The production of the highest possible output available with the FOP given
- Production Inefficiency: if we can produce the same quantity of goods with less resources used
or we can create more resources with the given resources
- Tradeoff along PPF and Opportunity cost
o Give up production of one resource to create another

o E -> F
Quantity of pizza increase by 1 million
Quantity of cola decrease by 5 million
One pizza costs 5 colas
 o F -> E
Quantity of pizza decrease by 1 million
Quantity of cola increase by 5 million
Cost of one cola is 1/5 of a pizza
- Not that the opportunity cost is a ratio
o Opportunity cost of a can of cola is the inverse of the opportunity cost of one pizza
- Opportunity Cost on a PPF: the decreases of one quantity produced of one good divided by the
increase in the quantity produced of another good
- The PPF can be a straight line or bow-shaped
o Depends on what happens when the economy shifts resources form industry to another
- Outward Bow PPF: occurs when the quantity produced of each good increase, so does its
opportunity cost
- Inward Bow PPF: occurs when the quantity produced of each good increased, but its
opportunity cost decreases
- Constant PPF: occurs when cost remains constant
- PPF determines opportunity cost
- We measure marginal benefit by the amount that a person is willing to pay for an additional unit
of a food or service
- Marginal benefit curve: a curve showing the relationship between the marginal benefit of a
good and the quantity of that good consumed
- Decreasing Marginal Benefit: the falling satisfaction we derive from consumption of more and
more of a good or service

- Allocative Efficiency: when we cannot produce more of any one good without giving up some
other good that we value more highly
o We are producing at the point on the PPF that we prefer above all other points
o Where marginal benefit equals marginal cost
o The point is determined at which the marginal benefit curve intersects the marginal cost
curve
- Economic Growth: the expansion of production and increase in the standard of living
o Can be caused by technological change or capital accumulation
o Technological change: the development of new goods and of better ways of producing
goods and services
o Capital accumulation: the growth of capital resources, which includes human capital
- Cost of economic growth: using resources for research and development and to produce new
capital, we must decrease our production of consumption goods and services
o So economic growth is not free and does not abolish scarcity
o The opportunity cost of economic growth is less current consumption

- Comparative Advantage: when a person can perform the activity at a lower opportunity cost
than anyone else
o Involves comparing opportunity costs
- Absolute advantage: when a person is more productive than others
o Involves comparing productivities
- Example
o Lizs Smoothie Bar
In an hour, Liz can produce 30 smoothies or 30 salads
Liz's opportunity cost of producing 1 smoothie is 1 salad and vice versa
Lizs customers buy salads and smoothies in equal number, so she produces 15
smoothies and 15 salads an hour.
o Joes Smoothie Bar
In an hour, Joe can produce 6 smoothies or 30 salads
Joe's opportunity cost of producing 1 smoothie is 5 salads and vice versa
Joes spend 10 minutes making salads and 50 minutes making smoothies, so he
produces 5 smoothies and 5 salads an hour.
o Lizs comparative advantage
Lizs opportunity cost of one smoothie is one salad & Joes opportunity cost of
one salad is 5 salads
Liz has a comparative advantage in producing smoothies
o Joes comparative advantage
Lizs opportunity cost of one salad is one smoothie & Joes opportunity cost of
one salad is 1/5 smoothie
Joe has a comparative advantage in producing salad
 - When trading it is possible to produce outside of your PPF

Chapter 3

- If you demand something, you want it, can afford it, and have a definitive plan to buy it
- Wants: unlimited desires or wishes people would have for goods and services.
o Demand reflects a decision about which wants to satisfy
- Quantity Demanded: the amount that consumers plan to buy during a particular period and a at
a particular price of a good
- The Law of Demand: Other things remaining the same, the higher the price of a good, the
smaller is the quantity demanded; and the lower the price of a good, the larger is the quantity
demanded
- Changes in price that affect quantity demanded
o Substitution Effect: when the relative price (opportunity cost) of a good or service rises,
people seek substitutes for it, so the quantity demanded of the good or service
decreases.
o Income Effect: when the price of a good or service rises relative to income, people
cannot afford all the things they previously bought, so the quantity demanded of the
good or service decreases
- Willingness and Ability to pay
o A demand curve is also a willingness-and-ability-to-pay curve
o Willingness to pay measures marginal benefit
o The smaller the quantity available, the higher is the price that someone is willing to pay
for another unit
- Change in demand: when some influence on buying plans other than the price of the good
changes, there is a change in demand for that good
o A new demand curve is created from the new quantities of demand
o When demand increases, the demand curve shifts rightward
o When demand decrease, the demand curve shifts leftward
- Factors that change demand:
o The prices of a related good: substitutes and complementary goods
o Expected future prices: if the expected future prices of a good rises, current demand for
the good increases and the demand curve shifts rightward
o Income: when income increases, consumers buy more of most good demand curve
shifts rightward
Normal good: the demand increases as income increases
Inferior good: the demand decreases as income decreases
o Expected future income and credit: when expected future income increases or when
credit is easy to obtain, the demand might increase now
o Population: the larger the population, the greater is the demand for all goods
o Preferences: people with the same income have different demands if they have
different preferences
- If a firm supplies a good or service, then the firm has the resources and the technology to
produce it, can profit from producing it, and has made a definite plan to produce and sell it
- Resources and technology determine what is possible to produce
o Supply reflects a decision about which technologically feasible items to produce
- Quantity Supplied: the amount producers plan to sell during a given time period at a particular
price of a good or service
- The Law of Supply: other things remain the same, the higher the price of a good, the greater
quantity supplied; and the lower the price of a good, the smaller the quantity supplied
- Supply: the relationship between the quantity supplied and the price of a good
- Supply Curve: shows the relationship between the quantity supplied of a good and its price
when all other influences on producers planned sales remain the same
- Minimum supply price: a supply curve is also a minimum-supply-price curve
- As the quantity produced increases, marginal cost increases
- The lowest price at which someone is willing to sell an additional unit rises
- The lowest price is marginal cost
- Change in supply: when some influences on selling plans other than the price of good changes,
there is a change in supply of that good
o The quantity of the good that producers plan to sell changes, so a new supply curve is
created
o When supply increases, supply curve shifts rightward
o When supply decreases, supply curve shifts leftward
- Factors that change supply:
o The prices of factors of production: If the price of a FOP used to produce a good rises,
the minimum price that a supplier is willing to accept for producing each quantity of
that good rises
A rise in the price of a factor of production decreases supply and shifts the
supply curve leftward
o The prices of related goods produced: a substitute in production for a good is another
good that can be produced using the same resources
The supply of a good increases if the price of a substitute in production falls
Goods are complements in production if they must be produced together
The supply of a good increases if the price of a complement in production rises
o Expected future prices: if the expected future price of a good rises, the supply of the
good today decreases and the supply curve shifts leftward
o The number of suppliers: the larger the number of suppliers of a good, the greater is the
supply of the good. An increase in the number of suppliers shifts the supply curve
rightward
o Technology: advances in technology create new products and lower the cost of
producing existing products
Advances in technology increase supply and shift the supply curve rightward
o State of nature: natural forces that influence production
natural disasters decrease supply and shifts the supply curve leftward
- Market Equilibrium: a situation in which opposing forces balance each other
o Occurs when demand and supply curves meet at one point
 o Equilibrium price: the price that the quantity demanded equals the quantity supplied
o Equilibrium quantity: the quantity bought and sold at the equilibrium price

- Price adjustments: adjustments needed to make the price meet the point where quantity
demanded and quantity supplied meet
o At any price below equilibrium price, a shortage forces the price up
o At any price above equilibrium price, a surplus forces the price down
o At the equilibrium price, buyers plan and sellers plans doesnt change until some event
changes either demand or supply
Chapter 4

- Price elasticity of demand: a unit-free measure of the responsiveness of the quantity demanded
of a good to a change in its price when all other influences on buying plans remain the same.
o A measure of the responsiveness of the quantity demanded to a price change
- Average price and quantity: we get the same elasticity value regardless of whether the price
rises or falls
- A units-free measure: elasticity is a ratio of percentages, so a change in the units of
measurement of price or quantity leaves the elasticity value the same
- Minus sign and elasticity: the formula yields a negative value, because price and quantity move
in opposite directions
o The magnitude or absolute value is what reveals how responsive the quantity change
has been to a price change

- Perfectly inelastic demand: the price elasticity of demand is zero

o The quantity demanded doesnt change when the price changes
o Quantity demand is completely insensitive to price
o (Q,P = 0)
- Unit elastic demand: the price elasticity of demand equals 1
o The quantity change in the quantity demanded equals the percentage change in price
o When a one-percent change in price leads to an exactly one-percent change in quantity
demanded, the demand curve
o (Q,P = -1)
- Perfectly elastic demand: the price elasticity of demand is infinite
o The percentage change in the quantity demanded is infinitely large when the price
barely changes
 o quantity demanded is highly sensitive to changes in price increase in price causing zero
quantity demanded and decrease in price causing an increase in quantity demanded to
infinity
o (Q,P = -)
- Inelastic demand: when the price elasticity is lower than 1
o The percentage change in quantity is smaller than the percentage change in price
o When a one-percent change in price leads to a less than one-percent change in quantity
demanded, the demand curve
o (0 > Q,P > -1)
o
- Elastic demand: the price elasticity of demand is greater than 1
o The percentage change in the quantity demanded is greater than the percentage change
in price
o When a one percent change in price leads to a greater than one-percent change in
quantity demanded
o (between -1 and -)
-