Chapter 1 (Ten Principles of Economics)
 Economics
 the study of how society manages its scarce resources
 Scarcity
 the limited nature of society’s resources
 Microeconomics
 Concerned with the behavior of
individual entities
 Two ways of thinking
 Positive Statement
 Descriptive
 Statement of Facts
 “what is”
 Advantages of using economic models
 Useful and simple guide/description
of reality that may be used to test
hypotheses about econ behavior
 Macroeconomics
 concerned with the overall
performance of the economy
 studies the economy as a whole
 Normative Statement
 Prescriptive
 “what should be”
 Involves value judgement
a. Ethics, Norms, values
 Disadvantages of using economic
models
 May yield wrong conclusions
 assumptions and relationships
involved may be implicit, perhaps
even subconscious.
10 Principles of Economics
 How People Make Decisions:
 1. People Face Tradeoffs
 “There is no such thing as a free lunch”
 Efficiency versus Equity
a. Efficiency- society gets the most that it can from its scarce resources
b. Equity- benefits of those resource are distributed fairly among the members
of society
 2. The cost of something is what you give up to get it
 In making decisions, we ensure that the benefits outweigh the costs
 Opportunity Cost - Cost of missed opportunity
 3. Rational People Think at the Margin
 Rational Individual - Makes optimal decision in pursuit of their goals
 A rational individual is more concerned with incremental adjustments.
 Marginal Change- small incremental adjustments to an existing plan of action
 4. People Respond to Incentives
 Incentive
a. Something that induces a person to act
 How People Interact:
 5. Trade can make everyone better off


People gain from their ability to trade with one another
Comparative advantage
a. an economy's ability to produce a particular good or service at a lower
opportunity cost than its trading partners
 6. Markets are usually a good way to organize economic activities
 In a market economy, the three problems of economic organizations are
answered by firms and households.
 Adam smith and the Invisible hand (from the Wealth of Nations)
a. The price
b. The unobservable market force that helps the demand and supply of goods in
a free market to reach equilibrium automatically
 7. Governments can Sometimes Improve Market Outcomes
 Government must protect property rights
a. Property rights- ability of an individual to own and exercise control over
scarce resources
 Government may intervene if there is market failure
a. Market Failure- the economic situation defined by an inefficient distribution
of goods and services in the free market
 How The Economy As A Whole Work:
 8. A country’s Standard of Living Depends on its ability to produce goods and
services
 9. Prices Rise When the Government Prints Too much money
 Inflation- increase in the overall price level
 10. Society Faces a Short-run trade-off between Inflation and unemployment
Chapter 2 and 4 (Market Forces of Supply and Demand)
 Market - Group of buyers and sellers for a particular commodity
 Competitive Market
 a market in which there are many buyers and many sellers so that each has a negligible
impact on the market price
 Perfectly Competitive Market
 Two Characteristics:
 (1) Goods being offered for sale are all the same
 (2) Buyers and Sellers are so numerous that no single buyer or seller can influence
the market price
 Monopoly
 One seller, many buyers
 Oligopoly
 Few sellers that do not always compete aggressively
 Monopolistically Competitive
 Many sellers, each offering a slightly different product
 Assumption
 We are operating in a competitive market
 Demand
 Determined by buyers
 Schedule of quantities of goods or services that will be bought per unit of time at various
prices, other things constant (ceteris Paribus)
 Ceteris Paribus
 all other things being unchanged or constant
 Quantity Demanded
 Amount of commodity that buyers are willing and able to purchase at a given price level
 Law of Demand
 The quantity demanded and the own price of the commodity are inversely related,
ceteris paribus.
 QD↑ = P↓
QD↓ = P↑
a. Reasons for this law
 Opportunity Cost
 whatever must be given up to obtain some item
 Purchasing Power
 Budget or income is limited
 Demand Equation
 QD = f (P)
 Quantity demanded is a function of the own price of the commodity
 QD = a-bP
 Demand Schedule - a table that shows the quantity demanded of a good or service at
different price levels.
 Demand Curve
 a graphic representation of the
relationship between product price
and the quantity of the product
demanded
 Shift in Demand Curve
 Will also shift the quantity
demanded given the price
 Shift Factors of Demand
1. Price
2. Income- The effect of income to demand depends on the type of the good
a. Normal Good- a good in which an increase in income increases the demand for
the good, ceteris paribus.
 Income↑ = Demand↑
Income↓ = Demand↓
 Example: Demand for Rice
b. Inferior Good- a good in which an increase in income decreases the demand for
the good
 Income↑ = Demand↓
Income↓ = Demand↑
a. Example: Demand for canned good
3. Prices of Related Goods - Effect depends on the relationship of the commodities
a. Substitute Goods- goods that are used in place of another
 Increase in price for A= Increase in demand for B
b. Complement Goods- goods used together
 Increase in price for A= Decrease in demand for B
4. Taste and Preferences
5. Expectations
 Ex: If you will expect an increase of price for rice next month, then the tendency is
you will buy more rice this month
6. Number of Buyers
 Increase in buyers = Increase in demand
 Supply
 Determined by seller
 Quantities of goods or services that will be sold per unit of time at various prices, ceteris
paribus.
 Quantity Supplied
 Amount of commodity that sellers are willing and able to sell at a given price level
 Law of Supply
 The quantity supplied and the own price of the commodity are positively related, ceteris
paribus.
 Supply Equation
 QS = f (P)
 Quantity supplied is a function of the own price of the commodity
 QS = a + bP
 Supply Curve
 Shift in Supply Curve (Decrease)

 Shift Factors of Supply
1. Price
2. Input Prices
a. Inputs- materials that will be used to produce output/commodity
b. Increase in price Inputs = Decrease in Supply
3. Technology
4. Expectations of Future PricesHigher future prices= Increase in the current supply
5. Number of Sellers- Increase in sellers= Increase in the market supply
 Elasticity
 The measure of how much buyers and sellers respond to changes in market conditions
 Price Elasticity of Demand
𝑃2−𝑃1
 Midpoint Formula
 %∆𝑄𝑃 = 𝑄𝐷1
%∆𝑄𝐷
 EPD= %∆𝑄𝑃
 Price Elastic Demand

%∆𝑄𝐷 =
𝑄𝐷2−𝑄𝐷1
𝑄𝐷1
 EPD>1= %QD  %P
 Price Inelastic
 EPD<1 = %QD  %P
 Unit Elastic Demand
 EPD=1 = %QD = %P
 Cross-price elasticity of demand

%∆𝑄𝐷𝐴
EABD= %∆𝑃𝐵
 EABD>0= Substitute
 EABD<0= Complements
 Income Elasticity of Demand


EYD=
%∆𝑄𝐷
%∆𝑌


 Necessity = EYD<1
 Inferior Good = EYD <0
Price Elasticity of Supply
 Measure of responsiveness of
quantity supplied to changes in
the own price of a commodity.
Price Elastic Demand
 EPS>1= %QS  %P
Price Inelastic
 EPS<1 = %QS  %P
Unit Elastic Demand
 EPS=1 = %QS = %P
Normal Good =EYD>0

 Luxury = EYD>1
 Welfare Economic
 The study of how the allocation of resources affects economic well-being

 Surplus – quantity of good supplied exceeds the quantity demanded
 Consumer Surplus
 The difference between buyer’s willingness to pay and the amount he or she
actually paid
 The additional benefit that the consumer gains by making his or her purchase via
the market
 Producer Surplus



Additional benefits received by producers by selling their produce in the market
The amount a seller is paid for a good minus the seller’s cost
 Deadweight Loss
 Reduction in total surplus as a result of market distortion
 Shortage
 Quantity demanded is greater than quantity supplied

Chapter 10 (Externalities)
 Externalities
 arises when a person engages in an activity that influences the well-being of a bystander
and yet neither pays nor receives any compensation for that effect.
 Causes the market equilibrium to be not efficient
 Negative Externality in Production
 Positive Externality in Production
 Negative Externality in Consumption
 Positive Externality in Consumption
 Positive Externalities examples:
 Being vaccinated against contagious diseases protects not only you, but people who
visit the salad bar or produce section after you.
 R&D creates knowledge others can use (Technology Spillover)
 Renovating your house increases neighboring property values
 Education yield more educated population
 Building bus station may provide shelter for homeless people
 Negative Externalities examples:
 Use of Pesticides in Farming damages water resources and causes harm to people
 Consumption of Alcohol yield more consumers to drive under influence and risk
others’ lives
 noise pollution is a negative externality of consumption that consumers may cause
with lawn care machines or sound systems.
 Internalizing the Externality – to remedy the problem
 Negative Externality – Tax Goods
 Positive Externality – Subsidize goods
 Public Policies toward Externalities:
a. Command and Control Policy - regulate behavior directly.
i.
Regulation - The government can remedy an externality by making certain
behaviors either required or forbidden
b. Market Based Policy - provide incentives so that private decisionmakers will
choose to solve the problem on their own.
i.
Pigovian Taxes and Subsidies - the government can use market-based
policies to align private incentives with social efficiency.
ii.
Tradable Pollution Permits - a market-based policy that allows firms to
buy and sell permits to emit a certain amount of pollutants.
 Coarse Theorem – suggests that the interested parties can bargain among themselves and
agree on an efficient solution
Chapter 13 (The Cost of Production)
 Industrial Organization – the study of how firms’ decisions regarding prices and quantities
depend on the market conditions they face
 The Goal of firms is to maximize profict, which equals to total revenue minus cost
 Total Revenue – amount a firm receives for the sale of its output
 Total Cost – market value of the inputs a firm uses in production
2. the total-cost curve gets steeper
as the quantity of output
increases because of
diminishing marginal product
1.
Profit – total revenue minus total cost
Economic Profit – total revenue minus total costs, including both explicit and implicit costs
Accounting Profit – total revenue minus total explicit cost
Explicit Cost – input costs that require an outlay of money by the firm
1. Ex. wages a firm pays its workers
 Implicit Cost – input costs that do not require an outlay of money by the firm
1. Ex. wages the firm owner gives up by working in the firm rather than taking another
job




 Average Cost and Marginal Cost Curves:
1. Marginal cost rises with the quantity of output.
2. Average-total-cost curve is U-shaped.
3. Marginal-cost curve crosses the average-total cost curve at the minimum of average
total cost (efficient scale)
4. Whenever marginal cost is less than average total cost, average total cost is falling.
5. Whenever marginal cost is greater than average total cost, average total cost is
rising
 Production Function – relationship between quantity of inputs used to make a good and the
quantity of output of that good
 Shows the relationship
between quantity of output
and number of workers hired
 Marginal Product – increase in output that arises from an additional unit of input
 Diminishing Marginal Costs – property whereby the marginal product of an input declines as
the quantity of the input increases

 Economies of Scale – when long-run average total cost declines as output increases
 Diseconomies of Scale – when long-run average total cost rises as output increases
1. Arises due to coordination problems that are inherent in any large organization
 Constant Return to Scale - when long-run average total cost do not vary with the output
 Principle #2: The Cost of Something is what you give up to get it.
Chapter 17 (Monopolistic Competition)
 Monopolistic Competition – many firms sell product that are similar but not identical
1. Many sellers
2. Product differentiation
3. Free entry
4.
 Monopolistic Competitor in the Long Run
1. price exceeds marginal cost
2. price equals average total cost. This conclusion arises because free entry and exit
drive economic profit to zero

 Monopolistic Vs Perfect Competition
1. Excess Capacity
2. Markup over Marginal Costs
 Externalities:
1. Product-Variety Externality - Because consumers get some consumer surplus from
the introduction of a new product, entry of a new firm conveys a positive externality
on consumers.
2. Business-stealing externality: Because other firms lose customers and profits from
the entry of a new competitor, entry of a new firm imposes a negative externality on
existing firms.
 Advertising
1. Critics of Advertising:
 Argue that firms advertise in orfer to manipulate people’s tastes
 Argue that advertising impedes competition
2. Defense of Advertising:
 Defense that firms use advertising to provide information to customers
 Defense that advertising fosters competition
Chapter 23 (Measuring a Nation’s Income)
 Gross Domestic Product (GDP) – measures total income of everyone in the economy;
measure total expenditure on the economy output of good and services
 Indicator of a country’s economic wellbeing
 An economy's income must equal its expenditure, because every transaction has a buyer
and a seller. Thus, expenditure by buyers must equal income by sellers.
 Circular Flow Model - This diagram is a schematic representation of the organization of the
economy; depiction of the macroeconmy
1. Does not include:
 Government – collects
taxes and purchases
goods and services
 Financial System –
matches savers’ supply
of funds with borrowers’
demand for loans
 Foreign Sector – trades
goods and services,
financial assets, and
currencies with the
country’s resident
 Component of GDP (Y):
1. Consumption – total spending by households on goods and services
2. Investment – total spending on goods that will be used in the future to produce
more goods (capital equipment, structures, and inventories)
3. Government Purchases – all spending on the goods and services purchased by
the government (exclused transfer payment like social security or
unemployment insurance benefits)
4. Net Exports = Export – Import
a. Export – represent foreign spending on the economy’s g&s
b. Import – portion of consumption, investment, and government purchases
spent on the g&s produced abroas
Examples:
 Nominal GDP
 Values output using current prices
 Not corrected for inflation
 Real GDP
 Values output using of a base year
 Is corrected for inflation
 GDP Deflator – measure of the overall level of prices; percentage increase in GDP measure
the economy;s inflation rate
 = 100 x (nominal GDP/real GDP)
 GDP Does Not Value:
 Quality of environment
 Leisure time
 Non-market activity (child care)
 Equitable distribution of income
 Having a large GDP enables a country to afford better school, environment, health care, etc.

Chapter 29 (Monetary System)
 Without money, trade would require barter, the exchange of one good or service for another.
 Every transaction would require a double coincidence of wants – the unlikely occurrence
that two people each have a good the other wants
 Functions of Money
1. Medium of Exchange - use money to buy stuff.
2. Unit of Account - price or monetary value of virtually everything is measured in the
same units
3. Store of Value - holds its value over time, so you don’t have to spend it immediately
upon receiving it.
 Liquidity – ease at which an asset can be converted to a medium of exchange
 Two Kinds of Money:
1. Commodity – takes the form of a commodity with intrinsic value - means the
commodity would have value even if it weren’t being used as money.
 Ex. Gold coins,
2. Fiat – Money without intrinsic value
 Ex. U.S dollar
 Money Supply (Money Stock) - the quantity of money available in the economy
 Parts of Money Supply:
o Currency: the paper bills and coins in the hands of the (non-bank)
public
o Demand deposits: balances in bank accounts that depositors can
access on demand by writing a check
 Central bank: an institution that oversees the banking system and regulates the money
supply
 Monetary policy: the setting of the money supply by policymakers in the central bank
 Federal Reserve (Fed): the central bank of the U.S.
 Money multiplier: the amount of money the banking system generates with each dollar of
reserves
1. The money multiplier equals 1/R.
 Ex. While cleaning your apartment, you look under the sofa cushion find a
$50 bill (and a half-eaten taco). You deposit the bill in your checking
account. The Fed’s reserve requirement is 20% of deposits.
 A. What is the maximum amount that the
money supply could increase?
o If banks hold no excess reserves, then
money multiplier = 1/R = 1/0.2 = 5
o The maximum possible increase in deposits is
5 x $50 = $250
o But money supply also includes currency,
which falls by $50. Hence, max increase in money supply =
$200.
 B. What is the minimum amount that the
money supply could increase? If your bank makes no loans from
your deposit, currency falls by $50, deposits increase by $50, money
supply does not change.
 Fed’s 3 Tools of Monetary Control:
1. Open-Market Operations (OMOs): the purchase and sale of U.S. government bonds
by the Fed.
2. Reserve Requirements (RR): affect how much money banks can create by making
loans.
 To increase money supply, Fed reduces RR. Banks make more loans from
each dollar of reserves, which increases money multiplier and money supply.
 To reduce money supply, Fed raises RR, and the process works in reverse.
 Fed rarely uses reserve requirements to control money supply: Frequent
changes would disrupt banking.
3. The Discount Rate: the interest rate on loans the Fed makes to banks
 When banks are running low on reserves, they may borrow reserves from
the Fed.


To increase money supply, Fed can lower discount rate, which encourages
banks to borrow more reserves from Fed. Banks can then make more loans,
which increases the money supply.
To reduce money supply, Fed can raise discount rate.