Weeks 1, 2, 3

Front 1

Scarcity

Back 1

Society has limited resources and therefore cannot produce all the goods and services people wish to have

Front 2

Economics

Back 2

The study of the allocation of scarce resources to competing uses.
How does an economy manage its scarce resources?

Front 3

Market

Back 3

(Broad definition) Consists of the buyers and sellers of a good or service.

Economists have increasingly realised that even subtle product differences matter a great deal to some consumers, and the trend in analysis has been towards ever narrower definitions of goods and markets.

Front 4

Competitive Market

Back 4

A perfectly competitive market is a market characterised by:
(1) Many buyers and sellers – there are so many buyers and sellers that their individual actions are negligible
(2) Firms are price takers – their effect on the overall price level is minute and therefore they cannot affect the price determined by the market
(3) Perfect information about price and quality of goods
(4) Low transaction costs: buyers and sellers can trade easily

Front 5

The Demand Curve

Back 5

Shows the quantity demanded – the largest quantity that consumers are willing to buy at each price, holding constant other factors that affect purchases.

A concise summary of what happens to quantity demanded as price changes.

Always described in real price of the good, which means its price relative to the prices of all other goods and services.

A summary of the various cost-benefit calculations that buyers make with respect to a good, where the cost side of the calculation is simply the price of the product (and implicitly the price of other goods and services that could be bought with the same money) while the benefit side is simply the satisfaction provided by the product.

Front 6

The Law of Demand

Back 6

The key property of the demand curve is that it is downward sloping, the quantity demanded of the good rises as the price of the product falls, all other things equal.

Front 7

Market Demand

Back 7

The sum of all the individual demand curves for a particular good or service.

Front 8

Equilibrium

Back 8

The market is at an equilibrium when:
(1) Buyers (and sellers) are “content” with the quantities they sell (and buy) at current prices
(2) Supply = demand
(3) “Content” has a specific meaning: any point on the supply or demand schedule represents the quantity buyers want to buy and the sellers want to sell, given the price they face.

Front 9

Equilibrium Quantity

Back 9

Quantity bought and sold at the equilibrium price.

Front 10

Equilibrium Price

Back 10

The price where, given what they’ve got:
(1) Consumers can buy as much as they want
(2) Sellers can sell as much as they want
(3) Also called the “market-clearing price”

Front 11

Quantity Demanded

Back 11

The amount of a good or service that consumers want to buy at a given price, holding constant other factors that affect demand.
• Affected by:
o Tastes or preferences
o Income
o Information or expectations
o Prices of related goods
o Number of buyers

Front 12

Movement along a demand curve

Back 12

A change in the price causes a movement along a demand curve, holding constant all other variables that affect demand.

Front 13

Normal good

Back 13

A good for which the law of demand holds.

If the price of the good increases, demand will decrease.

Front 14

Giffen Good

Back 14

A good that violates the law of demand. As the price rises, consumers consumer more of the good.

The income effect dominates over the substitution effect, leading people to buy more of a good when prices rise.

Front 15

Complementary goods

Back 15

when the price of good 1 increases, the demand for good 2 decreases.

Front 16

Substitute good

Back 16

When the price of good 1 increases, the demand for good 2 increases.

Front 17

Shift in the demand curve

Back 17

A change in any factor other than the price of the good causes a shift of the demand curve (not a movement along the demand curve).

A curve shifts only when there is a change in a relevant variable that is not named on either axis.

Front 18

Quantity supplied

Back 18

It is the amount of a good that firms want to sell at a given price, holding other factors constant that affect supply.
• Affected by:
o Input prices (costs of production)
o Technology
o Expectations
o Number of Sellers
o Government rules and regulations

Front 19

The supply curve

Back 19

A concise summary of what happens to quantity supplied as the price changes, holding all other factors constant.

Front 20

The law of supply

Back 20

Michaels argues that there is no law of supply in the same way that there is a law of demand (downward-sloping demand curve).

The market supply curve may be upward sloping, vertical, horizontal, or downward-sloping.

• Other economists argue that there is a law of supply because it reflects the idea that as prices rise, the quantity supplied also rises (therefore the curve is upward-sloping)

Front 21

Movement along a supply curve

Back 21

A change in the price of a commodity causes a movement along the supply curve, holding constant other variables that affect supply.

Front 22

Excess demand

Back 22

Quantity demanded exceeds quantity supplied at a specified price.
• Many consumers chase few goods: upward pressure on price.
• A situation in which price lies below its equilibrium price (aka. Shortage)

Front 23

Excess supply

Back 23

Quantity supplied exceeds quantity demanded at specified price
• Suppliers willing to reduce price to sell.
• A situation in which price exceeds its equilibrium value (aka. Surplus)

Front 24

Rationing function of price

Back 24

Prices ration existing supplies of goods.
• Scarcity is the universal feature of economic life.
• Equilibrium prices ration scarce supplies to the users who place highest value on them.
• A short-run function in the sense that its focus is the distribution of output that already exists.

Front 25

Allocative function of price

Back 25

Prices act as a signal to direct productive resources among the different sectors of the economy.
• Guides resources away from the production of goods whose prices lie below cost towards production of goods whose prices exceed cost.
• A long-run function in the sense that its focus is to induce resources to migrate from industries with excess supply to those with excess demand.

Front 26

Pareto-Efficiency

Back 26

An allocation is Pareto-efficient if in order to make any person better off we need to make someone else worse off.
• If there is no alternative allocation that makes everyone at least as well off and makes some people strictly better off, then it is a Pareto-efficient allocation.
• It is concerned with the efficiency of trade: whether all of the trades have been made.
• It is not concerned with the distribution of gains from trade.

Front 27

Pareto-Inefficient

Back 27

If we can find a way to make some people better off without hurting anyone else, then we have an allocation that is Pareto-inefficient.

Front 28

Pareto-Improvement

Back 28

The improvement in a Pareto-Inefficient outcome that makes some people better off without hurting anyone else.

Front 29

First Welfare Theorem

Back 29

Under certain assumptions (on preferences, technology, competition, information etc) the market equilibrium is Pareto-efficient.
• This focuses on the efficiency of the market. Under the market equilibrium, all possible trades have been made.

Front 30

Consumer Surplus

Back 30

The area under the demand curve and above the market price line. (Denoted CS)

• The monetary gain that consumers acquire when they pay a price for a product or good that is less than the price they are willing to pay.
• A method of measuring the welfare that consumers acquire from economic outcomes.

Front 31

Producer Surplus

Back 31

The area above the supply curve and below the market price line (denoted PS)
• The benefit that suppliers acquire when they sell a good or service for higher than the price they would be willing to sell it at.
• A method of measuring the welfare that suppliers acquire from economic outcomes.

Front 32

Welfare

Back 32

In the market, welfare is equal to consumer surplus plus producer surplus. (W = CS + PS)
• This measure weighs consumers and producers equally.
• A value judgement (normative rather than positive)

Front 33

Deadweight loss

Back 33

The loss in total welfare from an action that alters the market equilibrium.

Front 34

A consumer’s maximisation problem

Back 34

A consumer allocates money to the purchase of goods.
(1) Maximise pleasure (“utility”) from consumption
(2) Subject to budget constraints

Front 35

Indifference curve

Back 35

A set of bundles along which the consumer is indifferent.
• Economists take tastes as given but make a few assumptions about preferences:
(1) Completeness
(2) Transitivity
(3) More-is-better (and Free disposal)
(4) Convexity (Michaels doesn't include this in his slides but other economists do)

Front 36

An Indifference (Or Preference) Map

Back 36

A representative sample of the set of a consumer’s indifference curves, used as a graphical summary of her preference ordering.

Properties:
(1) Bundles on indifference curves farther from the origin preferred to those on indifference curves near origin (More-is-better)
(2) There is an indifference curve through every possible bundle (Completeness)
(3) Indifference curves cannot cross (Transitivity and More-is-Better)
(4) Indifference curves slope downward (Convexity property and More-is-Better)

Front 37

Completeness

Back 37

A consumer can rank any two bundles of goods.

Front 38

Transitivity

Back 38

A consumer’s preferences over bundles is consistent
• If a consumer prefers A to B, and B to C, then s/he prefers A to C.
• This is one of the properties that ensures that indifference curves cannot cross.

Front 39

More-is-better

Back 39

More of a good is better than less of it.
• Assumption of “free disposal” which says that as long as people can freely dispose of goods they don’t want, having more of something cannot make them worse off.
• Economists assume that we have not reached a consumer’s satiation point (where more-is-better would not hold).

Front 40

Convexity

Back 40

Mixtures of goods are preferred to extremes, which convey the sense that we like balance in the mix of our consumption of goods.
• Indifference curves with diminishing marginal rates of substitution are convex and bowed outwards when viewed from the origin: therefore if we have a lot of good 1, we would be willing to give up more of good 1 to acquire a little more of good 2.

Front 41

A Good

Back 41

A commodity for which more is preferred to less.

Front 42

A Bad

Back 42

A commodity for which less is preferred to more (e.g. pollution)

Front 43

Marginal Rate of Substitution

Back 43

The slope of the indifference curve which reflects the rate at which consumers are willing to trade off one good for another without changing total satisfaction.
• (ΔY/ΔX)
• We generally assume diminishing marginal rates of substitution.

Front 44

Utility

Back 44

The numerical value that reflects relative rankings of various bundles of goods.

Front 45

The utility function

Back 45

The relationship between the utility measure and every possible bundle of goods.

Front 46

Ordinal Utility

Back 46

The number assigned to a utility curve only reflects relative ranking.
• The only important property is that it ranks different consumption bundles, enabling a consumer to order their preferences rationally.

Front 47

Cardinal Utility

Back 47

Maintains and allows absolute comparisons.
• Attaches significance to the magnitude of utility
o Not feasible to attach the “magnitude” of how much someone prefers one bundle to another, therefore ordinal utility values are used.

Front 48

Marginal utility

Back 48

The rate at which total utility changes as the quantities of good 1 and good 2 change.
• Marginal utility is analogous to the marginal rate of substitution.
• If we shift from the consumption of one bundle to the consumption of another that lies on the same indifference curve, the utility we lose from having less of good 1 must be exactly offset by the utility we gain from having more of good 2.
• ΔK*MUk + ΔF*MUf = 0
• MRS = MUk/MUf = -(ΔF/ΔK)

Front 49

The marginal utility of a good

Back 49

A ratio that measures the change in utility (ΔU/ΔX) associated with a small change in the amount of good 1, holding the consumption of good 2 constant.
• MUx = (ΔU/ΔX)

Front 50

The budget constraint

Back 50

Requires that the amount of money spent on the two goods does not exceed the total amount that the consumer has to spend.
• p1x1 + p2x2 = M
• The slope of the budget constraint also provides the relative price of the two goods, which is the rate at which the market is willing to trade one good for the other or the “opportunity cost”.

Front 51

Interior solution

Back 51

An outcome in which a consumer buys some units of all goods (two in most of our examples)
• The tangency condition: the optimal bundle is where the highest indifference curve just touches the budget line.
o The MRS equals the slope of the budget line

Front 52

Corner solution

Back 52

An outcome in which only one of the goods is consumed.
• The optimal bundle is at a point where the highest indifferent curve touches the budget line.
• The indifference curve is at the budget line is not tangent at the optimal bundle
• The market prices in this outcome are such that a consumer would have to give up too much of one good to make the purchase of even one unit of the other good worthwhile.

Front 53

Elasticity

Back 53

The elasticity of Y with respect to X is the percentage change in Y divided by the percentage change in X.
• Unit-free concept designed to measure the ‘responsiveness’ of a good to the change in another good (changes could be price, income etc)

Elasticity is written in its absolute value (even if it is negative most of the time)

Front 54

Perfectly elastic

Back 54

Elasticity equals negative infinity and is drawn as a horizontal line on a graph.

Front 55

Perfectly inelastic

Back 55

Elasticity equals 0 and is drawn as a vertical line on a graph.

Front 56

Unit elastic

Back 56

Elasticity equals 1

Front 57

The Engel Curve

Back 57

Describes a change in expenditure on various goods with respect to household income

• Upward-sloping curve
o Assumes that as income rises, individuals consume more goods.

Front 58

The Income Effect

Back 58

The change in consumption that results when a price change moves the consumer to a higher or a lower indifference curve. (Change in the indifference curve)
• Income and substitution effects work in opposite directions.

Front 59

The Substitution Effect

Back 59

The change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution. (Movement along an indifference curve)
• Income and substitution effects work in opposite directions.

Front 60

The Labour Supply Model

Back 60

Determines how much people choose to work based on the allocation of their time between paid employment and leisure.
• Assumes that labour and leisure are goods
• An individual’s income is endogenous to the model, based on their decision of how much to work.
• Operates under three constraints:
(1) L + R = 24 (labour plus rest = 24 hours/day)
(2) R ≥ Rmin (person needs minimal rest)
(3) R ≤ 24 (Can’t rest more than 24 hours)

Front 61

Exogenous

Back 61

Determined outside the model

Front 62

Endogenous

Back 62

Determined within the model