Definitions Aggregation - the process of adding up individual behaviors Arc elasticity - a method of calculating elasticities that measures at the midpoint of the demand range. Formula: Behavioral economics - analyzes the economics and psychological factors that explain human behavior, when they choose optimally and when they don’t. Bilateral negotiation - a single buyer and a single seller privately negotiate with bids and asks Budget constraint - the set of things that a person to do wo breaking budget Budget set - the set of all possible bundles of goods and services that a consumer can purchase with her income Ceteris Paribus - with other things the same (holding all else equal) - All variables that can affect the demand for the good are heldconstant, except for price. Causation - occurs when one thing directly affects another Choice is the unifying feature of all the things that economists study. Competitive equilibrium - the crossing point of the supply curve and demand curve Competitive equilibrium price - equates the quantity supplied and quantity demanded (market clearing price) Competitive equilibrium quantity - quantity that corresponds to the competitive equilibrium price. Comparative advantage - the ability of an individual, firm, or country to produce a certain good at a lower opportunity cost than other producers Complements - when a fall in the price of one leads to a rightward shift in demand for the other Consumer surplus - the difference between the willingness to pay and price paid for the good, will definitely increase through better technology Correlation - two variables tend to change at the same time Cost benefit analysis - a calculation that identifies the best option by summing benefits and subtracting costs Deadweight loss - the decrease in social surplus from a market distortion Cross Price Elasticity of Demand - measure the percentage change in quantity demanded of a good due to a percentage change in another good’s price. Formula: Demand curve - each points represent the quantity demanded at a given market price, result of optimization by many consumers, market’s willingness to pay for a given unit of good Demand schedule - a table that reports the quantity demanded at different prices, while all else is held constant. Diminishing marginal benefit - as you consume more goods, your WTP for an extra unit declines Dominant strategy - best response to every possible strategy of the other players Economics - the study of how agents choose to allocate scarce resources & how those choices affect society Economic Agent - individual/group that makes choices Elastic Demand - price elasticity of demand greater than 1 (Shaped like – on the graph) Elasticity - measures the sensitivity of one economic variable to a change in another Empiricism - 3rd p of Econ - evidence based analysis which uses data Equity - concerned w the distribution of resources across society Equilibrium - 2nd p of Econ - a situation in which no agent believes they would benefit personally by changing their own behavior Income Elasticity of Demand: measures the percentage change in quant demanded due to percentage change in income. Formula: Excess supply - market price is above the competitive equilibrium price, quantity supplied exceeds quantity demanded Game theory - the study of strategic interactions Herding - a behavior of individuals who conform to the decision of others Impure altruism - behavior with a primary motivation to make oneself feel good Indoctrination - the process by which agents imbue society with their ideology or opinion Inelastic demand - price elasticity of demand less than 1 (shaped like I on the graph) Inferior Good - an increase in income shifts the demand curve to the left (canned goods) Information cascade - occurs when people make the same decisions as others, ignoring their own private information Law of Demand - the quantity demanded rises when price falls Law of Supply - the quantity supplied rises when the price rises (holding all else equal) Macroeconomics - the study of the economy as a whole - economy-wide Microeconomics - the study of how indiv, households, firms, gov make choices and how they affect prices, allocation, wellbeing Mixed strategy - choosing different actions randomly Movement along the demand curve - if a good’s own price changes and its demand curve hasn’t shifted Nash equilibrium - if each strategy is a best response to the strategies of others Natural experiment - an empirical study in which - out of the control of the experimenter - subjects are randomly assigned Negative correlation - two variables tend to move in opposite directions Net benefit - the sum of benefits of choosing alternative minus the sum of cost of choosing alternative Normal good - an increase in income shifts the demand curve to the right Normative economics - advises individuals and society on their choices - ought to do - personal feelings - subjective - “a rate of about 2% in the long term would be good for stability” Omitted variable - something left out of a study, if included, explains why two variables are correlated (Christmas, hard work) Opportunity cost - the best alternative use of a resource Optimization - 1st p of Econ - trying to pick the best feasible option given available info, exp, etc. Optimum - the best feasible option (optimal choice) Pareto efficient - no individual can be made better off without making someone else worse off Peer effects - the influence of the decisions of others on our own choices Positive Correlation - two variables tend to move in the same direction Positive economics - describes what has happened, predict what will happen - can be confirmed/tested with data - I predict inflation will be about 4 percent next year Producer surplus - the difference between the price and the sellers’ reservation values (marginal cost) Production possibilities curve - shows the relationship between max production of one good for a given level of production of another good Protectionism - the idea that free trade can be harmful, and government intervention is necessary to control trade Price Elasticity of Demand - measures the percentage change in quantity demanded of a good resulting from a percentage change in the good’s price - % change demand / % change price Pure altruism - a behavior with a primary motivation to help others Pure Strategy - always choosing one particular action for a situation Quantity Demanded - the amount of good/service buyers are WTP at a given price Quantity Supplied - amount of good/service sellers are willing to sell at a given price Reservation value - the price at which a person is indifferent between making the trade and not doing so Reverse causality - we mix up the direction of cause and effect (health & wealth Scarce resources - things people want, where quantity of want exceeds availability Scarcity - exists because people have unlimited wants in a world of limited resources Social surplus - the sum of consumer surplus and producer surplus Substitutes - a rise in the price of one leads to a rightward shift in demand curve for the other Trade-offs - arise when some benefits must be given up to gain others Tragedy of the Commons - the overuse of common pool resources resulting in a negative externality Unit Elastic Demand - price elasticity of demand equal to 1 (shaped like the first half of a parabola) Willingness to Accept - the lowest price that a seller is willing to get paid to sell an extra unit (same as marginal cost of production) Willingness to Pay - the highest price that a buyer is willing to pay for an extra unit of a good Zero correlation - the variables are not related Zero Sum Game - one player’s loss is another’s gain (sum of payoff is zero) Notes Demand curve shifts when there is a change in taste preferences, income, number of consumers, price of related goods, future expectations Demand curve moves only when there is a change in the price of the good itself Supply curve shifts when there is a change in prices of inputs used to produce the goods, number of sellers, technology, government action (taxes/subsidies), and expected future profit Supply curve moves only when there is a change in the price of the good itself and the supply curve hasn’t shifted A leftward shift of the supply curve raises the equilibrium price and lowers the equilibrium quantity. A rightward shift in the supply curve lowers the equilibrium price and raises the equilibrium quantity. A rightward shift in the demand curve would increase the equilibrium price. A demand curve shifts left and supply curve shifts right, the equilibrium price will always decrease but the competitive equilibrium quantityis ambiguous. A demand curve shifts right and supply curve shifts left, the equilibrium price will always increase but the equilibrium quantity will be ambiguous. ● ● ● ● ● ● ● ● ● ● ● ● ● ● Dictator and ultimatum games provide evidence that people are not exclusively interested in their own material payoffs. Nash equilibrium -> economic agents don't play NE strategies in real life -> neither player has an incentive to unilaterally change their behavior -> can have 0 || multiple NE in some games - there can only be one dominant strategy Opportunity cost of X = loss in Y / Gains in X In a perfectly competitive market, the market price, adjusts so that quantity demanded equals quantity supplied, determines how social surplus is split between producers and consumers, sends a signal to producers to increase their production when it rises Requirements for the invisible hand to organize activity in a complex market economy include competition, trust between buyers and sellers, property rights, but NOT prefs Strategic decision takes into account of information When the strong assumptions of a perfectly competitive market are in place, markets align the interests of self-interested agents and society. In this way, the market harmonizes individuals and society so that in their pursuit of individual gain, self-interested people promote the well-being of society. The remarkable tendency of individual self-interest to promote the well-being of society is orchestrated by the invisible hand. The invisible hand efficiently allocates goods and services to buyers and sellers, leads to efficient production within industry, and allocates resources efficiently across industries. The invisible hand is guided by prices. Prices incentivize buyers and sellers, who in turn maximize social surplus—the sum of consumer surplus and producer surplus—by simply looking out for themselves. We can measure the progress of an economy by measuring social surplus—how big the societal pie is. But we can also measure progress by considering questions of equity—how the pie is distributed among agents. Social surplus is maximized at the competitive market equilibrium Competitive market equilibrium is also Pareto efficient In a perfectly competitive market, the first distinct function of the equilibrium price is that it efficiently allocates goods and services to buyers and sellers ● Altruistic orpro-social preferences areconsistent with the principle of optimization because economic agents can have preferences for spending resources in any way they choose and still be optimizing according to those preferences. ● Self reported happiness increases based on % change in income ● Utilitarian - maximize the total social benefit ● Rawlsian - as long as the worst off benefits ● Behavioral economists - they believe that incentives play an important role in influencing behavior Moving from right to left in the table -> draw a line through any days that are ruled out
