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1 CHAPTER 1 THE CENTRAL IDEA 1.1 Scarcity and Choice for Individuals SCARCITY PRINCIPLE Scarcity principle (no free lunch principle): Although we have boundless needs and wants, the resources available to us are limited. Consequently, having more of one good/thing usually means having less of another. People benefit from economic interactions trading goods and services with other people. Gains from trade occur because goods and services can be allocated in ways that are more satisfactory to people. OPPORTUNITY COST Opportunity cost: The value of the next best forgone alternative that was not chosen because something else was chosen. Example: The opportunity cost of going to a tutorial class is having lunch with friends. Personal, as everyone has different alternatives that they are giving up. SPECIALISATION Having people produce the good for which they have a comparative advantage. Enables the economy to achieve productive efficiency by producing at minimum cost. Therefore, maximising the level of output produced from its scarce resources. COMPARATIVE ADVANTAGE: THE BASIS FOR TRADE Absolute advantage: When one person is able to produce a good or service with less resources then another person (JUST BETTER). Comparative advantage: When one person s opportunity cost of producing a good or service is lower than another person s opportunity cost. Law of Comparative Advantage: The individual or country with the lowest opportunity cost of producing a particular good should specialise in producing that good. Opportunity Costs when production is in quantity per/hr = 1.2 Scarcity and Choice for the Economy as a Whole PRODUCTION POSSIBILITES CURVE Loss in Good B Gain in Good A A graph that describes the maximum amount of one good that can be produced for every possible level of production of another good. PPCs slope downward because the scarcity principle that states that the only way a person can produce more of one good is to produce less of another. An increasing opportunity cost is depicted by a PPC that is bowed away from the origin. 1

2 Different people in the group have different opportunity costs, hence there is diminishing marginal returns for people who do a particular thing which they are not suited to, decreasing efficiency. A straight line PPC depicts a constant opportunity cost of producing both goods. The PPC shifts out as resources increase. FACTORS THAT CAUSE THE PPC TO SHIFT OVER TIME Economic growth is represented by an outward shift of the PPC: Increases in the amount of productive resources available. Investment in new factories and equipment Increases productivity Improvements in knowledge or technology Existing resources more productive (labour, capital) Population growth CHAPTER 2 OBSERVING AND EXPLAINING THE ECONOMY 2.1 Variables, Correlation and Causation CORRELATION VS. CAUSATION Correlation: One event usually occurs with another Correlation does not imply causation. Example: High readings on a thermometer are correlated with hot weather. But the thermometer readings do not cause the hot weather. Economics is the study of the production, distribution and consumption of goods and services. It is the study of how people make choices under conditions of scarcity and of the results of those choices for society. Microeconomics: The study of individual choices and of group behaviour in individual markets. Macroeconomics: The study of the performance of national economies and of the policies that governments use to try to improve economic performance. THE CETERIS PARIBUS ASSUMPTION All other things being equal. Refers to holding all other variables constant or keeping all other things the same when on variable is changed. POSITIVE VS. NORMATIVE STATEMENTS Positive statements are what is factual statements. Normative statements are what should be statements that involve value judgements that cannot be tested. 2

3 CHAPTER 3 THE SUPPLY AND DEMAND MODEL 3.1 Demand DEMAND Demand describes consumers. DIAGRAM Law of demand: Price and quantity demanded are negatively related. Movements along demand curve occur: o When price rises and quantity demanded falls. o When price falls and quantity demanded rises. Shifts in demand are due to: o Preferences (changes in consumers tastes) o Number of consumers in market o Consumers information (about smoking, or faulty products, for example) o Consumers income (normal goods vs. inferior goods) o Expectations of future prices (consumers will buy more now if prices are expected to rise in the future) o Prices of related goods (both substitutes, like butter and margarine, and complements, like gasoline and SUVs) Complements: Two goods are complements in consumption if an increase (decrease) in the price of one causes a fall (rise) in demand for the other, as shown by a leftward (rightward) shift in the demand curve for the other. Example: Tennis court fees and tennis balls Substitutes: Two goods are substitutes in consumption if an increase (decrease) in the price of one causes a rise (fall) in demand for the other, as shown by a rightward (leftward) shift in the demand curve for the other. Example: Beef and chicken Normal good: A good for which demand increases when income rises and decreases when income falls. Examples: Shoes, clothing, jewellery 3

4 Inferior good: A good for which demand decreases when income rises and increases when income falls. 3.2 Supply SUPPLY Supply describes firms. DIAGRAM Law of supply: Price and quantity supplied are positively related. Movements along supply curve occur: o When price rises and quantity supplied rises. o When price falls and quantity supplied falls. Shifts in supply are due to: o Technology (new inventions) o Weather (especially for agricultural products) o Number of firms in market o Price of goods used in production (inputs such as fertiliser, labour) o Expectations of future prices (firms will sell less now if prices are expected to rise; for example, farmers may store goods to sell next year) o Government taxes, subsidies, regulations (commodity taxes, agricultural subsidies, safety regulations) 3.3 Market Equilibrium MARKET EQUILIBRIUM Where all buyers and sellers are satisfied with quantities at the market price. The situation in which the price is equal to the equilibrium price and the quantity traded equals the equilibrium quantity. EP = EQ Surplus (excess supply): The amount by which the quantity supplied exceeds quantity demanded. Caused by the price being higher than the EP as buyers will want to buy a lower quantity of the good than the sellers can sell at that price. 4

5 Shortage (excess demand): The amount by which quantity demanded exceeds quantity supplied. Caused by the price being lower than the EP as buyers demand more than the sellers can sell. CHAPTER 4 PRICE FLOORS, PRICE CELINGS AND ELASTICITY 4.1 Interference with Market Prices REGULATING MARKETS Price ceiling: A maximum allowable price specified by law. If a price ceiling is above equilibrium price then no effect. Price floor: A minimum allowable price specified by law. If a price floor is below equilibrium price then no effect. 4.2 Elasticity of Demand ELASTICITY OF DEMAND A measure of the sensitivity of the quantity demanded of a good to the price of the good. Price elasticity of demand = percentage change in quantity demanded e d = percentage change in price Q d Qd P P Midpoint formula change in quantity e d = average of old and new quantities change in price average of old and new prices Elastic demand: A demand for which the price is greater than one. Inelastic demand: A demand for which the price elasticity is less than one. Perfectly inelastic demand: The price elasticity is 0, indicating no response to a change in price and therefore a vertical demand curve. Example: People who need insulin will pay whatever they have for it as long as there are no substitutes. Perfectly elastic demand: The price elasticity is infinite, indicating an infinite response to a change in price and therefore a horizontal demand curve. Example: Goods that have a lot of competitive substitutes. Examples: Instant noodles, bus services PRICE ELASTICITY AT DIFFERENT POINTS ALONG A GIVEN STRAIGHT LINE DEMAND CURVE Price elasticity has a different value at every point along a straight line demand curve. The elasticity of demand declines steadily as we move downward along the curve. 5

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