Unit 2 - Supply and Demand

Module 2.1 - Demand

Market
● A group of producers and consumers who exchange a good or service for payment
● Assume the market is perfectly competitive. Perfect competition assumes that there are
many sellers in the market, so many that no one seller can influence the price of the
product.

Demand Curve
● Graphical representation of the demand schedule
● Downward sloping due to the law of demand

Demand Schedule
● displays the quantity demanded at different prices for a good or service.

Law of Demand
● All other things being equal, people demand less of a good or service at higher prices

Shifts of the Demand Curve

● Movement of the original demand curve to a new position
● Increase in demand → shift to the right
● Decrease in demand ← shift to the left

Market Demand Curve

● The horizontal sum of the individual demand curves of all consumers in that market

Five Factors for Shifts of the Demand Curve:

1) Changes in Tastes
2) Changes in prices of Related goods/services
3) Changes in Income
4) Changes in the number of Buyers
5) Changes in Expectations

TRIBE is a mnemonic device that can help you remember.

Changes in tastes are fads, changes in beliefs, or changes in culture that shift the demand curve
for a good or service.
- Example: At the beginning of the COVID-19 pandemic the Centers for Disease
Control and Prevention recommended that Americans wear masks. Government
 requirements soon followed. This caused the demand for masks to shift to the
right (increase in demand).
- Now, the mask mandate has been lifted, and COVID-19 is much less of a concern.
This causes the demand for masks to shift to the left (decrease in demand).

Changes in prices of a related good or service shift demand differently depending on whether
they are substitutes or complements.

Goods are substitutes if an increase in the price of one causes people to demand more of
the other.
- Example: When the price of jeans rises, people buy more khakis as a cheaper
alternative.
Goods are complements if a decrease in the price of one makes people buy more of the
other.
- Example: Cookies and milk are often consumed together. When the price of one
falls, people buy more of both.

Changes in income can shift demand for a good differently, depending on whether it is a normal
or inferior good.

When an increase in income raises the demand for a good, it is a normal good. Most
goods fall under this category.
● When people earn more income, they tend to buy tickets to Disney World.
Therefore, Disney tickets are a normal good.

When a decrease in income raises the demand for a good, it is an inferior good.
● When people earn less income, they may turn to thrifted or second hand clothing
to save money. Therefore, these types of goods are inferior goods.

Changes in the number of buyers or consumers can shift the demand curve.

Expectations of a coming fall in price cause a decrease in demand today.

- Shoppers who hear about a post-holiday sale on jewelry may wait until after the
holiday to buy–reducing the demand for it today.
- Consumers who think jeans will be more expensive next year may opt to buy
them now–increasing the demand for jeans today.
Module 2.2 - Supply
Quantity Supplied
● The amount of a good or service people are willing to sell at a specific price

Supply Schedule
● Shows how much of a good or service producers will supply at different prices

Supply Curve
● graphical representation of the supply schedule
● shows how much of a good or service producers are willing to supply at different prices

Shift of the supply curve

● Change in the quantity supplied at any price
● Increase in supply → shift to the right
● Decrease in supply ← shift to the left

Movement along the supply curve

● change in the quantity supplied of a good that is the result of a change in price

Five Factors for Shifts of the Supply Curve:

1) Changes in Input prices
2) Changes in Prices of Related goods/services
3) Changes in Producer Expectations
4) Changes in Number of producers
5) Changes in Technology

I-RENT is a mnemonic device that can help you remember.

Change in the price of an input, a good or service used to produce another good or service

- Sugar and cream are inputs for ice cream. If the price of sugar or cream rises, the
ice cream supply curve shifts left.
- Oil is one input for airline fuel. If the price of oil goes down, the supply curve for
flights shifts right.

A change in the price of a related good or service (substitutes or complements in production by

the same producer)
 Goods are substitutes if an increase in the price of one causes suppliers to supply less of
the other.
- If the price of heating oil rises, refiners supply less gasoline, shifting the supply
curve for gasoline to the left.
Goods are complements if an increase in the price of one causes suppliers to supply
more of the other.
- If natural gas is a byproduct of crude oil drilling, and the price of natural gas
goes up, suppliers may supply more of both products. Thus, they are complements
in production.

Changes in expectations of how the price of a good or service will change to the future
Expectations of a coming price increase can cause suppliers to decrease the amount they
supply today.
- Expecting gas prices to peak in the summer, producers may lower the supply of
gas in the spring.
Expectations of a coming price decrease can cause suppliers to increase the amount they
supply today.
- Expecting the price of heating oil to go down in the spring, producers of heating
oil may increase how much heating oil they supply during the winter in order to
be able to sell as much as possible during the present period of high prices.

Changes in the number of producers of a good or service can shift the supply curve.
- If many orange producers go out of business, the supply curve for oranges will
shift to the left.
- If new orange producers enter the market, the supply curve for oranges will shift
to the right.

Changes in the available technology used to produce a good or service.

- If a new irrigation technique doubles the amount of cotton producers can supply,
the cotton supply curve shifts to the right.
- If a pesticide widely used by cotton producers is banned for its health
effects–lowering the amount of cotton per acre producers can supply–the cottone
supply curve shifts to the left.

Market Supply Curve

● Horizontal sum of the individual supply curves of all producers in that market

Module 2.3 - Price Elasticity of Demand

Examples:
1. If the price of Nikes dropped by 25%, how likely would you be to buy more Nikes?
 2. If the price of a Starbucks latte increased by 25%, how likely would you be to buy fewer
lattes?
3. If the price of electricity in your home changed by 25%, how likely would you be to
change your electricity usage.

Substitution Effect of a change in the price of a good

● the change in the quantity of that good demanded as consumers substitute a different
good that has become relatively cheaper for the one whose price has increased
● Example: When hamburgers rise in price, the quantity demanded of hamburgers falls as
people buy pizza (which has become relatively cheaper) as a substitute.

Income Effect of a change in the price of a good

● The change in the quantity demanded of that good resulting from a change in the
consumer’s purchasing power when the price changes (consumers’ real income falls )

Elasticity - sensitivity to price changes

● Measures the consumer response to a change in price with more precision

Price Elasticity of Demand

● Measures the responsiveness of quantity demanded to changes in the price.
● The ratio of the percent change in the quantity demanded to the percent change in the
price as we move along the demand curve (dropping the minus sign)

Elastic - Consumers are very sensitive to a change in price

Inelastic - Consumers are not very sensitive to a change in price

We drop the minus sign because the demand curve already slopes downward. In other words,
a price elasticity of .2 means that for any increase in price, quantity demanded will fall by a
factor of .2.

Because .2 is a relatively small number, economists would say that the demand for vaccinations
is relatively inelastic. This means that even when the price changes dramatically, quantity
demanded would not fall by a lot.

Midpoint method
● A technique for calculating the percent change by dividing the change in a variable by the
average, or midpoint, of the initial and final values of that variable
The average value of x is defined as:

Perfectly inelastic
● When quantity demanded does not respond at all to change in price – represented by a
vertical line
Perfectly elastic
● When any price increase causes quantity demanded to drop to zero. – represented by a
horizontal line

● Elastic – price elasticity of demand > 1

● Inelastic – price elasticity of demand < 1
● Unit Elastic – price elasticity of demand = 1

Elastic or Inelastic?
1. Salt - Inelastic
a. No substitutes
2. New Cars - Elastic
a.
3. Pork Chops - Elastic
a. Many substitutes
4. European Vacation - Elastic
a. Not a necessity
b. Many substitutes
5. Insulin - Inelastic
a. Necessity
6. Insulin at one of four drug stores at a shopping mall - (More) Elastic
a. Go somewhere else
7. Gasoline purchased one day after a 20% price increase - Inelastic
a. Insensitive to price - urgent
8. Gasoline purchased one year after a 20% price increase - (More) Elastic
a. Take steps to purchase less gasoline

Factors for Determining Price Elasticity of Demand

 1. Close Substitutes
a. Increases if there are close substitutes (pizza)
b. Decreases if there are no close substitutes (bypass surgery)
2. Proportion / Share of income
a. Falls if spending is a small share of income (eggs)
b. Rises if spending is a large share of income (houses)
3. Necessity vs. Luxury
a. Low for necessities (EpiPens)
b. High for luxuries (Teslas)
4. Time
a. Increases as consumers have more time to adjust to price change, so long-run
elasticity is usually higher than short-run elasticity

SPLaT is a mnemonic device that can help you remember. - Substitutes, Proportion, Luxury,
and Time.

Total Revenue
● Total value of sales of a good or service
●
● The net effect (whether revenue increases or decreases) depends on the price elasticity of
demand
● Change in price:
○ Price Effect - Net change in revenue due to price change
○ Quantity Effect - Net change in revenue due to quantity change

Elastic
● A price rise decreases total revenue.
● The price effect is weaker than the quantity effect.

Unit Elastic
● A price rise does not change total revenue.
● The price effect and the quantity effect exactly offset each other.

Inelastic
● A price rise increases total revenue.
● The price effect is stronger than the quantity effect.

At a low price,
- Raising the price increases total revenue.
- Demand is inelastic at low prices.
At a high price, however,
- A rise in price reduces the total revenue.
- Demand becomes more elastic at higher prices.

Inelastic demand
- P and TR move in the same direction

Elastic demand
- P and TR move in opposite directions

Price elasticity of demand = %change in quantity demanded/% change in

price

- Perfectly inelastic demand curve is straight line up

- Perfectly elastic demand curve is straight horizontal

Module 2.4 - Price Elasticity of Supply

Price Elasticity of Supply: measures the responsiveness of the quantity of a good supplied to
changes in price

Price elasticity of supply = % change in quantity supplied / % change in price

- If company is highly sensitive to price (elastic) → I would produce more
- If company is less sensitive to price (inelastic) → company would produce less

> 1 = elastic
< 1 = inelastic
= 1 → unit elastic

- Perfectly inelastic supply curve is straight line up

- Perfectly elastic supply curve is straight horizontal

Factors that determine the Price Elasticity of Supply (TEASE)

1. Availability of inputs
a. Rises when inputs can be put into or out of production at low cost
b. Low when inputs are fixed or when it is costly to put input into or out of
production
2. Substitutability of inputs
a. Increases as producers have more options available for substitutes when making a
product
 i. Eg: soda can be substituted with sugar or corn syrup
3. Time
a. Increases as producers have more time to respond to price changes. Long-run
elasticity is thus higher than short run elasticity
4. Existing inventories
a. Increases as producers have a larger quantity of products on hand. Inventories
refer to the stock of products available for sale
5. Excess capacity
a. Measures the producer’s ability to increase output in their current facilities
b. Higher degrees of excess capacity lead to a greater elasticity of supply

Module 2.5 - Elasticity of Demand

Cross price elasticity of demand
● Measures how the demand for a good is affected by prices of other goods

Income elasticity of demand

● Measures how the demand for a good is affected by changes in income

The cross price elasticity of demand between 2 goods measures the effect of the change in one
good’s price on the quantity demanded of the other good/

It equals the % change in the quantity demanded of one good divided by the % change in other
good’s price:

Cross price elasticity = % change in quantity of A demanded / % change in price of B

- Eg: if the cross price elasticity of demand between buns and hot dogs is -0.3 then a 1%
increase in the price of buns will cause a 0.3% decrease in quantity of hot dogs demanded

- A negative cross price elasticity identifies a complement (a good you buy less of when
the price of another goes up)
- A positive cross price elasticity identifies a substitute (a good you buy more of when the
price of the other good goes up)

Income elasticity of demand: the % change in the quantity of a good demanded when a
consumer’s income changes divided by the % change in the consumer’s income

Income elasticity of demand = % change in quantity demanded / % change in income

- If income elasticity of demand > 1: demand is income-elastic

- If income elasticity of demand < 1: demand is income-inelastic
 - Negative income elasticity identifies an inferior good (a good you buy less of when
income rises)
- Positive income elasticity identifies a normal good (a good you buy more of when
income rises)

Module 2.6 - Supply, Demand, and Equilibrium

A consumer’s willingness to pay for a good
● the maximum price at which a consumer would buy that good.
● Each step represents one consumer, and its height indicates that consumer’s willingness
to pay, also shown on the demand schedule.
Individual Consumer Surplus
● The difference between the buyer’s willingness to pay and the price paid
Total Consumer Surplus
● The sum of all the buyer’s individual consumer surpluses in a market
● The area under the demand curve and above the horizontal line representing the price

A seller’s cost for a good

● the lowest price at which they are willing to sell a good
● For a manufacturer of textbooks, cost is easy to understand as the total cost of producing
the book.
● In the case of a student selling a used textbook after a course is over, that student/seller
still bears an opportunity cost of selling the book.
The supply curve illustrates sellers’ cost, the lowest price at which a potential seller is willing to
sell the goods, and the quantity supplied at that price.
Individual Producer Surplus
● Net gain to an individual seller from selling a good
● Equal to price received minus cost
Total Producer Surplus
● Sum of the individual producer surpluses of all the sellers in a market
● The area above the supply curve and under the horizontal line representing the price

In competitive markets, the forces of supply and demand move price and quantity toward
equilibrium.
● Equilibrium occurs when no individual would be better off doing something different. It
is found at the intersection of the supply and demand curves.
Module 2.7 - Market Disequilibrium and Changing Market Decisions
Price and quantity in a competitive market are determined by equilibrium.
1. Why do all sales and purchases in a market take place at the same price?
2. Why does the market price fall if it is above the equilibrium price?
3. Why does the market price rise if it is below the equilibrium price?

When the same goods are sold for different prices–such as in the market for souvenirs in
different “tourist traps”--buyers either lack information, or the market isn’t fully competitive.
In a competitive market, however, all sellers receive (and all buyers pay) approximately the
same price–called the market price.

A price above equilibrium creates a surplus.

● In a surplus, quantity supplied exceeds quantity demanded.
● The price falls in order to clear the surplus and to return the market to the equilibrium
price and quantity.

A price below equilibrium creates a shortage.

● In a shortage, quantity demanded exceeds quantity supplied.
● The price rises in order to clear the shortage and to return the market to the equilibrium
price and quantity.

A shift in demand or supply causes the areas of producer and consumer surplus to change.

Module 2.8 - Government Intervention

A - Taxes, Subsidies, and Market Efficiency

Total Surplus
● The sum of consumer and producer surpluses
● The total net gain to consumers and producers from trading in a market.
● The total benefit to society from the production and consumption of the good.
Efficient Market
● Once the market has produced its gains from trade, there is no way to make some
people better off without making other people worse off.
● What happens to surpluses if we try to “improve” the outcome of an efficient
market by:
○ Reallocating consumption among consumers
○ Allocating sales among sellers
○ Changing the quantity traded
Market Equilibrium
● Generates the highest possible consumer surplus by ensuring that those who
consume the good are those who most value it.
● Equilibrium price and quantity maximize total surplus.

When a market is in equilibrium, there is no way to increase the gains from trade. Any
other outcome reduces total surplus.

Three caveats about efficient markets:

1) Efficient markets are not always fair or equitable:
2) Some markets fail to deliver efficiency
3) Maximizing total surplus does not mean everyone benefits. Buyers with low
willingness or ability to pay and sellers with high cost will lose out.

Trade-off between equity and efficiency

● Policies that promote equity can sometimes decrease efficiency
● Policies that promote efficiency can sometimes decrease equity.
Improving equity can be difficult because equity is harder to define than efficiency. What
is equitable to some may not be to others.

Policies of Taxation

Regressive tax
● A tax in which high-income taxpayers pay a smaller % of income than
low-income taxpayers
● The hope is that wealthy individuals will put tax savings back into the economy -
consume more, purchase more, generate more growth for the economy
Proportional tax
● A tax in which all taxpayers pay the same % of income
Progressive tax
● A tax in which high-income taxpayers pay a larger % of income than low-income
taxpayers
● The current U.S. income tax system is progressive. The wealthier pay a higher %
of their income.

A progressive tax is the most equitable form of taxation–it forces those with more to
pay a higher tax rate, relieving the tax burden on the poorest taxpayers.
But some argue that by disincentivizing workers to earn more (because their taxes then
go up), the progressive tax is an inefficient form of taxation.
Excise tax
● Tax on the sales of a particular good or service
● In the absence of taxes, the equilibrium price of hotel rooms is $80 per night, and
the equilibrium number of rooms rented is 10,000 per night
● A $40 room tax imposed on hotel owners shifts the supply curve from S1 to S2, an
upward shift of $40.
● Rooms become more expensive → demand decreases

Scenario: BCA wants to build a new football field and will need to raise taxes to fund the
construction. Should Bergen County tax soda or gasoline?
● Gasoline – necessity, relatively inelastic

Price-inelastic demand – relatively steep demand curve - bear more burden of tax
Price-elastic demand – relatively shallow demand curve - bear less burden of tax

A tax leads to deadweight loss because it creates inefficiency: some mutually beneficial
transactions will never occur due to the tax.

Lump-Sum Tax
● Tax of a fixed amount paid by all taxpayers.
● Unless they cause a producer to go out of business, lump-sum taxes do not affect
price or quantity, so they do not create deadweight loss.
● The administrative costs of a tax are the resources used by the government to
collect the tax, and by taxpayers to pay (or to evade) the tax. These costs are in
addition to the normal costs and benefits of the tax.

Subsidy
● A government payment made to assist or incentivize producers and consumers.
● It can be a lump-sum subsidy, which doesn’t depend on the quantity produced or
consumed.
● Or, it could be a per-unit subsidy, a specific amount provided for each unit
produced or consumed.

In the case of a $100 Subsidy to the producers of sunflower seeds, the supply curve shifts
downward (to the right) by $100.
Since the market is pushed beyond the point of efficiency at equilibrium, the subsidy
causes an overproduction in the market which results in deadweight loss
B - Price and Quantity Controls
Price Controls
● Legal restrictions on how high or low a market price may go
● Price Ceiling
○ Maximum price sellers are allowed to charge for a good or service
● Price Floor
○ Minimum price buyers are required to pay for a good or service

Price Ceilings - Examples:

● Rent-controlled Housing
○ Price cannot rise higher than a certain level even if renters are willing to
pay for it.
● Other Price Ceilings
○ Usually imposed when crises like war or natural disasters cause sudden
price increases that hurt consumers but enrich suppliers.

The inefficiencies as a result of a price ceiling include:

 1. Inefficiently Low Quantity: A price below equilibrium causes less of a good to
be supplied than is demanded at that price.
2. Inefficient Allocation to Consumers: A price below equilibrium causes less of a
good to be supplied than is demanded at that price
3. Wasted Resources: People expend money, effort, and time to cope with the
shortages caused by the price ceiling.
4. Inefficiently Low Quantity: Sellers offer low-quality goods at a low price even if
buyers prefer a higher quality at a higher price.
5. Black Markets: TO avoid the price ceiling, goods are illegally sold at high
prices.

However, for a few consumers, price ceilings make certain important goods more
affordable than they would be in an unregulated market.

In Figure 2.8-15, the government has imposed a $1,200 price ceiling on rent. This results
in:
● Deadweight loss (price + quantity lower than market equilibrium)
● Shortage (lower price = higher quantity demanded + lower quantity supplied)

Price Floors - Examples

● Minimum wage laws
○ Price floor set on the hourly wage rate of workers.
In Figure 2.8-17, the government has imposed a $1.20 price floor.
● At a price of $1.20, the quantity supplied exceeds the quantity demanded, causing
a surplus.
● Because of the price floor, the price is unable to fall.

The inefficiencies as a result of a price floor include:

● Inefficiently Low Quantity: A price floor raises the price of a good, reducing the
quantity of that good demanded
● Inefficient Allocation of Sales Among Sellers: Those willing to sell a good at
the lowest price are not always those who manage to sell it
● Wasted Resources: The surpluses caused by price floors are often simply
destroyed.
● Illegal Activity: Price floors can incentivize illegal activity

For a few influential suppliers, price floors make a good more profitable than it would be
in an unregulated market.

Quantity Control or Quota

● An upper limit on the quantity of some good that can be bought or sold

License
 ● Gives an owner the right to supply a good or service

New York City Taxicabs

● Intending to raise the quality of its taxicabs, NYC limits the quantity of taxicabs
on its streets by issuing a limited number of “medallions”.
● Only drivers with a medallion can offer taxicab rides, so the medallion serves as a
license.

What happens to the market with a quota set at 8 million rides?

Buyers pay more than what sellers would normally accept.
A quota drives a wedge between the demand price and supply price.

Deadweight Loss
● The value of forgone mutually beneficial transactions

Quota Rent
● Difference between demand and supply prices at the quota amount.
● Represents the increased earnings of a license-holder in a marker with a quota.
Unit 1 - Basic Economic Concepts
Module 1.1
Marginal Analysis - “Marginal”, “Incremental”, “Extra”
● The study of the costs and benefits of doing a little more of an activity vs. a little less.
● Marginal Benefit
○ The gain from doing something once more.
● Marginal Cost
○ The cost of doing something once more
● Opportunity Cost
○ value of the next best alternative that you must give up when making a particular
choice
○ The real cost of something is what you must give up to get it

Microeconomics
● The study of how individuals, households, and firms make decisions and how those
decisions interact
Macroeconomics
● The behavior of the economy as a whole, therefore, it focuses on economic aggregates
(Look at table 1.1-1 in the textbook)

Positive Economics
● The branch of economic analysis that describes the way the economy actually works
Normative Economics
● Makes prescriptions about the way the economy should work
“In economics,
positive statements about about what is (description)
While normative statements are about what should be (prescription)”

Module 1.2 - Economic Systems

How to allocate a dozen donuts to the class – at least 5 ways
1. First come first serve
2. Don’t
3. Highest bidder/Best trade
 4. Random
5. How long since you last ate
6. Bribe
7. Who you like the most

1. FIrst come first served

2. Markets and price system
3. Democracy
4. Random
5. All to Mr. Gutierrez

How to allocate resources?

● Example: COVID vaccines first distributed to those at highest risk:
○ Elderly
○ Pre-existing conditions
○ Essential workers

Economy
● System for coordinating a society’s productive and consumptive activities
● Every economy must address three basic questions about resource allocation:
a. What goods and services will be produced?
b. How will those goods and services be produced?
c. Who will receive the goods and services?
● Systems
○ Traditional
○ Market - US
○ Command
○ Mixed
Economic Systems:
● Traditional
○ Economic questions answered based on precedent or tradition
○ Ex: Amish community in the United States
○ Ease, familiarity, and predictability lead to elements of tradition in every
economy.
○ *Not so critical for our purposes
● Market - Focus!
○ Production and consumption are decisions made by firms and individuals
○ No central authority telling people what to produce or who can receive it
○ Also described as capitalist or free enterprise, when there is minimal government
intervention.
 ● Command
○ Factors of production (resources) are publicly owned (by the government).
○ Central authorities do make production and consumption decisions.
○ Command economies have been tried, but they don’t work very well.
○ Communism (in its purest sense)
■ Political/Social overlay, but from an economic perspective
○ *Not so critical for our purposes
● Mixed (or Mixed Market)
○ Pure forms of traditional, market, and command economies leave something to be
desired.
○ Most countries today have a mixed economy.
○ Mixed economies have a blend of traditional, market, and command economies.
○ Socialism (individuals/companies and governments work together)

Video Question Responses:

1. Why is a struggle underway in Cuba between socialism and the free market?
2. Why did Cuba permit free markets?
3. Who in the video wants Cuba to remain socialist? Why?
4. Who in the video prefers

Incentives
● Rewards or punishments that motivate particular choices
● In a market economy, incentives such as the profit motive encourage suppliers to meet
the needs of consumers, such as increasing the supply during a shortage
● In a command economy, little incentive to meet the economic needs of producers and
consumers

Property rights
● establish ownership and grant individuals the right to trade goods and services with each
other.

Favorite Hi-Chew flavor:

● Strawberry
Rank the candy flavors from most to least favorite:
1. Strawberry
2. Orange
3. Green Apple
4. Grape
How was the candy initially distributed?
● By Mr. Gutierrez’s command
How was it redistributed?
● By the market

How do we define where a country’s economy sits?

● Index of Economic Freedom

Module 1.3 – The Production Possibilities Curve Model

Models
● simplified representations of reality that play a crucial role in almost all scientific
research, economics included.

A trade-off occurs when you give up one thing to get something else.
The production possibilities curve (PPC)
shows the trade-offs that an economy that produces only two goods faces.
● The PPC shows the maximum quantity of one good that can be produced for each
possible quantity of the other.
● Below the curve – possible/attainable but inefficient, Above the curve –
impossible/unattainable (exceeding available resources)
● Every point on the curve is both feasible and efficient (using all possible resources)

An economy is efficient if there are no missed opportunities–meaning that there is no way to

make someone better off without making at least one person worse off.
● achieves productive efficiency if it produces at any point on its production possibilities
curve
● achieves allocative efficiency if it produces at a point along the production possibilities
curve that makes consumers as well off as possible.
The production possibilities curve shows the increasing opportunity cost of producing fish in
terms of coconuts lost.
The concave or bowed out shape of the PPC reflects an increasing opportunity cost.
Economic Growth
● A sustained rise in aggregate output and an increase in a standard of living
● An expansion of an economy’s production possibilities
● If an economy’s production possibilities curve shifts inward, the economy has become
smaller.
● This could happen if the economy loses resources or technology, which could result from
natural disasters or war.

● After growth, the PPC shifts outward – production possibilities have expanded
○ The economy can now produce more of everything
Two main sources of growth:
● Increase in available resources
○ Example: a person stranded on a deserted island may suddenly discover a new
coconut grove full of low-hanging fruits
● Improvements in technology
○ The technical means for producing goods and services
○ Example: a person stranded on a deserted island might discover or build a fishing
net

Module 1.4 - Comparative Advantage and Trade

Gains from trade come from specialization:
● Each person specializes in the task that they are good at performing.
● Allows for the mass production of most of the devices and appliances we use today

An individual has an absolute advantage in production if they can make more of it with a given
amount of time and resources
Absolute advantage is not the same as comparative advantage.

The production possibilities curve model illustrates gains from trade based on comparative
advantage.
An individual has a comparative advantage in producing a good or service if they face the
lowest opportunity cost of producing it.

Example:
Country/Output per hour PCs Pounds of Beef

Japan 20 (¼) 5 (4)

Mexico 30 (½) 15 (2)

1. Which nation has an absolute advantage in producing PCs?

a. Mexico
2. Which nation has an absolute advantage in producing beef?
a. Mexico
3. Which nation has a comparative advantage in producing PCs?
a. Japan
4. Which nation has a comparative advantage in producing beef?
a. Mexico
5. Which country should specialize in PC production?
 a. Japan
6. Which country should specialize in beef production?
a. Mexico

By specializing in the good they have a comparative advantage in and by trading for the other
good, both castaways can consume more of each good. In other words, there are gains from
trade.

Gains from trade – difference between consumption without trade and consumption with trade

Terms of Trade
● Indicate the rate at which one good can be exchanged for another,
● Any price between the opportunity cost of the producer and the opportunity cost of the
buyer will make both sides better off than in the absence of trade.
● In other words, if the “price” of a good obtained from trade is less than the opportunity
cost of producing it, trade is beneficial.

Comparative Advantage
● Allows for gains from trade not just between individuals, but also between countries.
● Just as with individuals, even if a country has an absolute advantage in both goods,
because one country will always have a comparative advantage in one of the goods,
trade is beneficial.

Module 1.5
Opportunity Costs
● The value of the next-best alternative forgone when a decision is made

Explicit Costs - paid with dollars:

● Money spent on one purchase can’t be spent on something else
Implicit Costs - paid with time and missed opportunities:
● Time spent on one activity can’t be spent on another activity

Example:
Suppose Isha earns a salary of $50,000 per year to manage an ice cream shop.

Someone offers her a $60,000 per year job to deliver seafood. THe delivery job would require
renting a truck for $7,000

She would also have to start working weekends, a fate she would be willing to pay $5,000 per
year to avoid. What should Isha do?
$60,000 - $7,000 - $5,000 = $48,000 < $50,000

Profit (π)
● The difference between the total amount of money received in exchange for the goods
and services total cost.

Total Revenue
● The price (P) of the product multiplied by the quantity sold (Q)

Revenue - Cost = Profit

Accounting profit = Total revenue - explicit costs (calculate how much money a firm is making)
Economic profit = Accounting profit - implicit costs
● In other words:
● Economic Profit
= Total Revenue - Economic Cost
= Total Revenue - Explicit Costs - Implicit Costs

Utility
● Measure of satisfaction
● Consumers seek happiness and satisfaction from the purposes they make

Utils
● Numerical measure of satisfaction, but the numbers are used to highlight the concept that
when making purchases, a higher number is better

Consumers and firms share the common objective of maximizing the difference between their
total benefit and total cost.

Cost-benefit analysis
● The process of comparing costs with benefits to inform a decision.

For all questions of “Should I do this?”, a comparison of total cost and total benefits will indicate
the answer.

Sunk Costs
● Although it is important to measure costs when making a decision, some costs should be
ignored
 ● Example:

Suppose you just replaced the brake pads on your car for $250.
The mechanic then informs you that the entire brake system is defective and must be replaced at
a cost of $1,500.
You also have an option to sell the car and buy a comparable one with no problems for $1,600.
What should you do?

In this example, the $250 spent on the brake pads is a sunk cost.
The $250 is nonrecoverable. So, if you keep or sell your car, you are not getting the $250 back.
The real cost at this point is whether to spend $1,500 on your car or $1,600 on the new one.
Spending $1,500 to fix your car is the right choice in this case.

Module 1.6 - The Principle of Diminishing Marginal Utility

Utility
● Measure of satisfaction
● Consumers seek happiness and satisfaction from the purposes they make

Utils
● Numerical measure of satisfaction, but the numbers are used to highlight the concept that
when making purchases, a higher number is better

“How do you know when one more is too much?”

Marginal Utility
● Change in total utility generated by consuming one additional unit of a good or service

Marginal utility curve

● Shows that marginal utility depends on the quantity of a good or service consumed

Principle of Diminishing Marginal Utility

● Successive units of a good or service adds less total utility than do previous units.

In rare cases, diminishing marginal utility doesn’t hold. However, it does apply in the majority
of cases, so it will form the foundation of our analysis of consumer behavior.

For example:
The first few times you go skiing, your utility may increase as you become more skilled and able
to enjoy rather than fear the experience.
For other goods,
It is better to have none than to have not enough. For example, too little wallpaper to paper a
room would provide less utility than no wallpaper at all–because you would have to store a
useless amount of the good.

Budget Constraint
● Limits the cost of a consumer's consumption bundle to no more than the consumer’s
income.

Consumption Possibilities
● The set of all affordable consumption bundles given the consumer’s income and
prevailing prices

Budget Line (BL)

● Shows the consumption bundles available to a consumer who spends all of his or her
income.

Why don’t you have to pay for an extra community newspaper?

A consumer’s optimal consumption bundle is the consumption bundle that maximizes total
utility given their budget constraint.

The marginal utility per dollar spent on a good or service is the additional utility from
spending one more dollar on that good or service. (Marginal utility ÷ price)

Note that marginal utility per dollar declines with each additional unit due to diminishing
marginal utility.

Optimal Consumption Rule

● In order to maximize utility, a consumer must equate the marginal utility per dollar spent
on each good and service in the consumption bundle.
● The optimal consumption bundle occurs where the marginal utility per dollar spent on
each good is equal.
𝑀𝑈𝑐 𝑀𝑈𝑇
●
𝑃𝑐
= 𝑃𝑇
The Economic Way of Thinking
● The Economic Way of Thinking
○ Everything has a cost
○ People choose for good reasons
○ Incentives matter
○ People create economic systems to influence choices and incentives
○ people gain from voluntary trade
○ Economic thinning is marginal thinking
○ The value of a good or service is affected by people's choices
○ Economic actions have secondary effects
○ The test of a theory is its ability to make accurate predictions
● Economics is the study of scarcity and choice
○ Each individual faces trade-offs. You make a trade-off when you give up
something to get something else
○ Every economic issue involves individual choice – decisions by individuals
about what to do and what not to do.
● Scarcity and Choice - Resources are scarce
○ A resource is anything that can be used to produce something else
○ Scarce Resource
■ Not available in sufficient quantities to satisfy all the various ways a
society wants to use it.
■ Scarce resources are divided into 4 main categories:
● Land – all natural resources
● Labor - the effort of workers
● Capital – all manufactured resources
○ Machinery
● Entrepreneurship – risk taking, innovation, and organization
○ tenacity, creativity, passion
○ not all about the money – there is no money in the
beginning