Essential Principles of Economics and Market Dynamics

Student: Angel Argueta

Course: Eco 157 Final Cheat Sheet

Ten Principles of Economics

1. People face trade-offs: To get something we like, we usually have to give up something else.
2. The cost of something is what you give up to get it: This is known as opportunity cost.
3. Rational people think at the margin: Decisions are made by comparing marginal benefits and marginal costs.
4. People respond to incentives: Behavior changes when costs or benefits change.
5. Trade can make everyone better off: It allows countries and individuals to specialize in what they do best.
6. Markets are usually a good way to organize economic activity: The "invisible hand" guides households and firms.
7. Governments can sometimes improve market outcomes: This occurs during market failures or to promote equity.
8. A country’s standard of living depends on its ability to produce goods and services: Productivity is the primary determinant.
9. Prices rise when the government prints too much money: This leads to inflation.
10. Society faces a short-run trade-off between inflation and unemployment: Often illustrated by the Phillips Curve.

Chapter 4: Market Forces of Supply and Demand

A market is a group of buyers and sellers of a particular good or service. A perfectly competitive market has two main characteristics: 1) The goods offered for sale are all exactly the same. 2) The buyers and sellers are so numerous that no one buyer or seller can influence the price.

If a market is perfectly competitive, both buyers and sellers are price takers. If a market has only one seller, it is known as a monopoly.

Market Demand and Shifts

Market demand is the sum of the quantities demanded for each individual buyer at each price. The market demand curve is the horizontal sum of individual demand curves.

• Increase in demand: The demand curve shifts to the right.
• Decrease in demand: The demand curve shifts to the left.

Factors Affecting Demand

• Income: For a normal good, an increase in income leads to an increase in demand. For an inferior good, an increase in income leads to a decrease in demand.
• Prices of Related Goods:
  • Substitutes: An increase in the price of one leads to an increase in the demand for the other.
  • Complements: Goods used together; an increase in the price of one leads to a decrease in demand for the other.
• Tastes: Changes in preferences affect demand.
• Expectations: Future income or price expectations affect current demand.
• Number of Buyers: An increase in buyers increases market demand.

Key Economic Terms

• Scarcity: Limited resources and unlimited wants.
• Economics: The study of how society manages its scarce resources.
• Efficiency: Society getting the most from its scarce resources.
• Equality: Distributing economic prosperity uniformly among members.
• Rational people: Systematically doing the best to achieve objectives.
• Marginal change: An incremental adjustment to an existing plan.
• Incentive: Something that induces a person to act.
• Market economy: Allocation of resources through decentralized decisions of firms and households.
• Property rights: Ability to own and exercise control over resources.
• Invisible hand: Self-interest leading to desirable market outcomes.
• Market failure: Market fails to allocate resources efficiently.
• Externality: Impact of one person’s actions on a bystander.
• Market power: Ability to substantially influence market prices.
• Productivity: Goods and services produced per unit of labor.
• Inflation: Increase in the overall level of prices.
• Business cycle: Fluctuations in economic activity.
• Microeconomics: Study of households and firms.
• Macroeconomics: Study of economy-wide phenomena.

Supply Curve Dynamics

• Increase in supply: The curve shifts to the right.
• Decrease in supply: The curve shifts to the left.

Factors Shifting Supply:

• Input Prices: Lower input prices increase supply.
• Technology: Improvements reduce costs and increase supply.
• Expectations: Future expectations affect current supply.
• Number of Sellers: More sellers increase market supply.

Market Equilibrium and Laws

• Law of Demand: Quantity demanded falls when price rises.
• Law of Supply: Quantity supplied rises when price rises.
• Equilibrium: Quantity supplied equals quantity demanded.
• Surplus: Quantity supplied > quantity demanded.
• Shortage: Quantity demanded > quantity supplied.

Chapter 5: Elasticity and Its Application

Elasticity measures the responsiveness of quantity demanded or supplied to a change in determinants.

• Elastic: Elasticity > 1 (Significant response).
• Inelastic: Elasticity < 1 (Slight response).
• Unit Elastic: Elasticity = 1.
• Perfectly Inelastic: Elasticity = 0 (Vertical curve).
• Perfectly Elastic: Elasticity = ∞ (Horizontal curve).

Determinants of Price Elasticity

• Availability of close substitutes: More substitutes mean higher elasticity.
• Necessities versus luxuries: Luxuries are more elastic.
• Definition of the market: Narrowly defined markets are more elastic.
• Time horizon: Demand is more elastic over longer periods.

Total Revenue (P × Q): If demand is inelastic, price and total revenue move in the same direction. If elastic, they move in opposite directions.

Chapter 6: Supply, Demand, and Government Policies

Price Ceilings and Floors

• Price Ceiling: A legal maximum price. It is binding if set below equilibrium, causing a shortage.
• Price Floor: A legal minimum price. It is binding if set above equilibrium, causing a surplus.

Excise Taxes and Tax Incidence

Tax incidence is the study of who bears the burden of a tax.

• Tax on Sellers: Shifts supply curve up/left. Buyers pay more, sellers receive less.
• Tax on Buyers: Shifts demand curve down/left. Outcome is equivalent to a tax on sellers.
• Elasticity Rule: The tax burden falls more heavily on the side of the market that is less elastic.

Chapter 7: Consumers, Producers, and Market Efficiency

Welfare Economics

• Consumer Surplus: Willingness to pay minus amount paid. Area below demand curve and above price.
• Producer Surplus: Price received minus cost of production. Area above supply curve and below price.
• Total Surplus: Consumer Surplus + Producer Surplus.

An allocation is efficient if it maximizes total surplus. Perfectly competitive markets are generally efficient.

Chapter 8: The Costs of Taxation

Taxes cause a Deadweight Loss (DWL), which is the fall in total surplus resulting from a market distortion. It represents lost gains from trade.

• Determinants of DWL: The greater the elasticity of supply and demand, the greater the deadweight loss.
• Laffer Curve: As the size of a tax increases, DWL increases rapidly. Tax revenue first rises, then falls as the market shrinks.

Chapter 10: Externalities and Public Policy

An externality is the uncompensated impact of one's actions on a bystander.

• Negative Externality: Market quantity is larger than socially desirable (e.g., pollution). Remedy: Corrective Tax.
• Positive Externality: Market quantity is smaller than socially desirable (e.g., education). Remedy: Subsidy.

Policy Solutions

• Command-and-Control: Direct regulation.
• Market-Based: Corrective taxes or tradeable pollution permits.
• Coase Theorem: Private parties can solve externalities through bargaining if transaction costs are zero.

Chapter 11: Public Goods and Common Resources

• Free Rider: Someone who benefits without paying.
• Tragedy of the Commons: Common resources are overused because they are rival but non-excludable.

Chapter 12: The Costs of Production

Profit (π) = Total Revenue (TR) - Total Cost (TC)

• Explicit Costs: Require outlay of money (wages).
• Implicit Costs: Opportunity costs (foregone interest).
• Accounting Profit: TR - Explicit Costs.
• Economic Profit: TR - (Explicit + Implicit Costs).

Cost Formulas and Relationships

• Marginal Cost (MC): ΔTC / ΔQ
• Total Cost (TC): Fixed Cost (FC) + Variable Cost (VC)
• Average Total Cost (ATC): TC / Q
• Average Fixed Cost (AFC): FC / Q
• Average Variable Cost (AVC): VC / Q
• Marginal Product (MP): Increase in output from an additional unit of input.

Short Run (SR) vs. Long Run (LR): In the SR, some inputs are fixed (FC). In the LR, all inputs are variable.

Chapter 15: Firm Behavior and Market Structure

1. In competitive markets, Marginal Revenue (MR) = Price (P).
2. Profit Maximization: Choose quantity (q) where MR = MC.
3. Exit/Entry Decisions:
   • Exit if: TR < TC (or P < ATC).
   • Enter if: TR > TC (or P > ATC).