PRINCIPLES Scarce Good: Desirable, but limited good Opportunity Cost: What you give up to get a certain item/do

item/do something Positive Statement: Statement about how the world is (they can be tested) Normative Statement: Statement about how the world ought to be Comparative Advantage: Producer who gives up less to produce good x has the comparative advantage (lower opportunity cost) Law of Comparative Advantage: When opportunity costs are different for different people/countries, trade is mutually advantageous Absolute Advantage: Making something uses fewer resources than other producers require Law of Increasing Opportunity Cost: As more and more of a good is produced, the opportunity cost of producing the good eventually rises

DEMAND (BUYERS SIDE OF MARKET) Demand: A relationship between price and quantity demanded, holding all other things constant Quantity Demanded: Amount buyers are willing and able to purchase at a particular price Law of Demand: Other things equal, when price increases, quantity demanded decreases; when price decreases, quantity demanded increases Normal Good: Other things equal, an increase in income leads to an increase in demand Inferior Good: Other things equal, an increase in income leads to a decrease in demand (Ramen noodles, Public Transportation) Complements: Pairs of goods that are used together. Increase in price of one leads to decrease in demand for other Substitutes: Goods used in place of one another. An increase in price of one leads to an increase in demand for other

SUPPLY (SELLERS SIDE OF MARKET) Supply: The relationship between price and quantity supplied, holding all other things constant Quantity Supplied: Amount of a good sellers are willing and able to sell at a particular price Law of Supply: Other things equal, the quantity supplied rises when price rises: quantity supplied falls when price falls

SUPPLY AND DEMAND Equilibrium: A situation in which market price has reached the level at which Quantity Supplied = Quantity Demanded Surplus: At a given price, a situation in which quantity supplied > quantity demanded (pushes down prices) Shortage: At a given price, a situation in which quantity demanded > quantity supplied (pushes up prices) Law of Supply and Demand: The price of any good adjusts to bring quantity supplied and quantity demanded for that good into balance. If Supply and Demand shift the same way: PRICE shift is ambiguous If Supply and Demand shift opposite ways: QUANTITY shift is ambiguous

ELASTICITY OF DEMAND Ed = 0, Perfectly Inelastic (Appendectomy) 0 < Ed < 1, Inelastic (gasoline) Ed = 1, Unit Elastic Ed > 1, Elastic Ed = Infinity, Perfectly Elastic Total Revenue = P x Q Total Revenue Increases if inelastic (Assuming price increase) Total Revenue Decreases if elastic (Assuming price increase) Inelastic has steep slope Elastic has shallow slope

ELASTICITY OF SUPPLY Es = 0, Perfectly Inelastic 0 < Es < 1, Inelastic Es = 1, Unit Elastic Es > 1, Elastic Es = Infinity, Perfectly Elastic Main determinant of Es: Supply is more elastic over a long period of time Inelastic has steep slope Elastic has shallow slope

INTERFERENCES IN THE MARKET Price Ceiling: Legal maximum on the price at which a good can be sold (Creates shortage, good must be rationed in some other way) Price Floor: Legal minimum on the price at which a good can be sold (Creates a surplus, not all sellers can sell) Production Quota: Government puts limit on total quantity of a good that can be produced (Quantity decreases, Price Increases; Right to produce becomes valuable, creates a black market) Taxes Levied on Buyers or Sellers has identical outcomes (Qtax< Qe; Pb>Pe; Ps <Pe) Tax Amount = Wedge If Supply more elastic than demand, tax falls more heavily on consumers If Demand more elastic than supply, tax falls more heavily on suppliers *Tax falls more heavily on side of market that is less elastic Subsidies Levied on Buyers or Sellers has identical outcomes (Qsub>Qe; Pb<Pe;Ps>Pe)