Economics Chapter on Opportunity Cost

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Questions and Answers

What is opportunity cost?

The loss of potential gain from other alternatives when one is chosen.

What is marginal analysis?

Decision-making process that compares additional benefits to additional costs.

What shape does the Production Possibilities Curve (PPC) take and why?

Bowed outward due to increasing opportunity costs.

If the price of a good decreases, the quantity demanded will decrease.

False Signup and view all the answers

What happens to demand for a normal good when consumer income increases?

It increases. Signup and view all the answers

What does it indicate if a nation operates inside its production possibilities curve?

Inefficient use of resources. Signup and view all the answers

Define scarcity in economics.

The limited nature of resources versus unlimited human wants. Signup and view all the answers

What does the budget line represent?

The limit of a person’s income for purchasing different combinations of goods. Signup and view all the answers

The law of demand states that as the price of a good decreases, the quantity demanded decreases.

False Signup and view all the answers

What occurs at market equilibrium?

Quantity demanded equals quantity supplied. Signup and view all the answers

What is a surplus in economic terms?

A situation where quantity supplied exceeds quantity demanded. Signup and view all the answers

What does it mean if demand is elastic?

Demand significantly decreases when its price increases. Signup and view all the answers

What effect does a decrease in prices have on consumer purchasing power?

It increases. Signup and view all the answers

What happens to the demand for a complementary good when the price of another good increases?

It decreases. Signup and view all the answers

What characterizes a perfectly competitive market?

Identical products from many firms Signup and view all the answers

What occurs when quantity demanded exceeds quantity supplied?

Shortage. Signup and view all the answers

What is the impact of an increase in the price of one good on the demand for its substitute?

Demand for the substitute increases. Signup and view all the answers

What is the role of private ownership in market systems?

Encourages innovation and efficiency. Signup and view all the answers

What is laissez-faire capitalism?

Supports minimal government intervention. Signup and view all the answers

How is a command economic system characterized?

Government ownership of resources and centralized decision-making. Signup and view all the answers

What are price floors?

A minimum price set by the government. Signup and view all the answers

Study Notes

Opportunity Cost

When you choose one option, you give up the potential benefits of other options.

Marginal Analysis

Decision-making compares the extra benefits to the extra costs of an action.

Production Possibilities Curve (PPC)

A curve showing the maximum combinations of two goods a country can produce with its resources.
The curve's outward bow shape represents increasing opportunity costs: as you produce more of one good, you must give up increasingly larger amounts of the other.

Demand and Price Relationship

Law of Demand: As the price of a good decreases, the quantity demanded increases (assuming other factors remain constant).

Consumer Income and Demand

Normal Goods: Higher income leads to an increase in demand for these goods.

Underutilization of Resources

If a country operates inside its PPC, it means they are not using their resources efficiently.

Scarcity

Limited resources compared to unlimited human wants.
This forces us to make choices about how to allocate resources.

Budget Line

Represents the limit of a person's income for buying different combinations of goods.

Market Equilibrium

Occurs when quantity demanded equals quantity supplied.
There are no shortages or surpluses.

Surplus

Occurs when quantity supplied exceeds quantity demanded.
This often leads to price decreases.

Price Elasticity of Demand

- **Elastic Demand:**  A large decrease in quantity demanded when price increases.
- **Inelastic Demand:**  A small change in quantity demanded when price increases.

Income Effect and Substitution Effect

When prices decrease:
- Income Effect: Consumers feel an increase in purchasing power.
- Substitution Effect: The cheaper product becomes more attractive.

Complementary Goods

When the price of one good increases, the demand for its complementary good decreases.

Perfect Competition

Many firms produce identical products.
No single firm has significant control over prices.

Shortage

Occurs when quantity demanded exceeds quantity supplied, often causing prices to rise.

Opportunity Cost in Decision-Making

For a firm:
- Producing more of one good means giving up the opportunity to produce more of another.

Price Ceiling

Government-imposed limit on the maximum price a seller can charge.
When set below the equilibrium price, it can lead to shortages.

Income Elasticity of Demand

Measures how much quantity demanded changes in response to consumer income changes.

Cross-Price Elasticity of Demand

If the cross-price elasticity between two goods is negative, the goods are complements.

Price Elasticity of Demand (PED)

Measures how responsive quantity demanded is to price changes.
- Elastic Demand: PED > 1
- Inelastic Demand: PED < 1

Consumer Expectations

If consumers expect prices to rise in the future, they might buy more now, leading to increased current demand.

Market Surplus and Government Intervention

Governments might buy excess supply or offer subsidies to address persistent market surpluses.

Perfectly Competitive Market Efficiency

In the long run, firms in perfect competition produce at the lowest possible cost, where price equals the minimum point on the long-run average cost curve (LAC).

Marginal Cost and Revenue

Firms maximize profit by producing until marginal cost equals marginal revenue.
Producing beyond this point reduces profits.

Specialization

Workers focus on specific tasks, leading to increased efficiency.
Less time is wasted switching between tasks.

Substitute Goods

An increase in the price of one good leads to an increase in demand for its substitute.

Private Ownership in Market Systems

Encourages innovation and efficiency. Individuals and firms make decisions on how to use and dispose of resources.

Laissez-Faire Capitalism

Minimal government intervention.
Free markets are thought to best promote human welfare and economic efficiency.

Command Economic System

Government owns resources and makes centralized economic decisions.
Contrasts with the decentralized decision-making of market systems.

Market System

Decisions about production and consumption are guided by market signals (supply and demand) and competition.
Decentralized decision-making.

Price Floors

A minimum price set by the government.
When set above the equilibrium price, it often leads to surpluses.

Substitution Effect

When the price of a good increases, consumers might choose a cheaper alternative, reducing demand for the original good.

Effects of Consumer Tastes

Changes in consumer preferences can shift the demand curve for related products.
- For example, a shift towards healthier products could lead to a decrease in demand for fast food.

Rational Self-Interest

Economic assumption that individuals make decisions to maximize their own well-being.

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Description

This quiz explores essential concepts in economics, focusing on opportunity cost, marginal analysis, and the production possibilities curve. Understand the various relationships between demand, price, and consumer income while assessing resource utilization and scarcity. Test your knowledge on foundational economic principles and their real-world implications.