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Budget Constraint

• The budget constraint encompasses all possible consumption combinations of goods within a consumer's affordability, assuming all income is spent
• It forms the boundary of the opportunity set

Opportunity Set

• Encompasses all possible consumption combinations affordable, given the prices of goods and an individual's income
• It should be noted that all income does not need to be spent

Graphical Illustration of Budget Constraint

• Given the price of two goods and a budget amount, a budget constraint can be graphically illustrated
• Consumers must decide their needs and wants given a limited amount of income

Opportunity Cost

• Opportunity cost indicates what someone gives up to obtain what they desire
• The cost of one item is the lost opportunity to do or consume something else
• The opportunity cost represents the value of the next best alternative
• Every choice has an opportunity cost and this represents a fundamental principle of economics

Marginal Analysis

• Involves examining the benefits and costs of choosing a little more or a little less of a good

Utility

• Satisfaction, usefulness, or value one obtains from consuming goods and services

Law of Diminishing Marginal Utility

• States that as a person consumes more of a good, the additional (or marginal) utility from each additional unit of the good declines

Law of Diminishing Returns

• As additional increments of resources are added to producing a good or service, the marginal benefit from those additional increments will decline

Productive Efficiency

• Occurs when it is impossible to produce more of one good (or service) without decreasing the quantity produced of another good (or service

Comparative Advantage

• When a country can produce a good at a lower opportunity cost than another country

Demand

• Demand refers to the amount of some good or service consumers are willing and able to purchase at each price

Price

• What a buyer pays for a unit of the specific good or service

Quantity Demanded

• The total number of units of a good or service consumers are willing to purchase at a given price

Supply

• The amount of some good or service a producer is willing to supply at each price

Quantity Supplied

• The total number of units of a good or service producers are willing to sell at a given price

Price Controls

• Laws that governments enact to regulate prices

Price Ceiling

• Keeps a price from rising above a certain level, establishing a legal maximum price that one pays for some good or service

Price Floor

• Keeps a price from falling below a given level, setting the lowest price that one can legally pay for some good or service

Law of Supply

• Assuming all other variables that affect supply are held constant

Law of Demand

• Assuming all other variables that affect demand are held constant

Labor Market

• The supply and demand for labor

Law of Demand in Labor Markets

• Higher salary or wage (price) in the labor market decreases in the quantity of labor demanded by employers
• Lower salary or wage (price) increases in the quantity of labor demanded

Law of Supply in Labor Markets

• Higher price for labor correlates with a higher quantity of labor supplied
• Lower price for labor correlates with a lower quantity of labor supplied

Equilibrium

• Exists when the quantity supplied and the quantity demanded are equal
• At the equilibrium wage, employers can find workers, and workers can find jobs

Elasticity

• An economics concept that measures the responsiveness of one variable to changes in another variable

Price Elasticity

• It is the ratio between the percentage change in the quantity demanded or supplied, and the corresponding percent change in price

Price Elasticity of Demand

• It is the percentage change in the quantity demanded of a good or service divided the percentage

Price Elasticity of Supply

• The percentage change in quantity supplied divided by the percentage change in price

Elastic Demand or Elastic Supply

• Elasticity is greater than one, indicating a high responsiveness to changes in price

Inelastic Demand or Inelastic Supply

• Elasticities are less than one, indicating low responsiveness to price changes

Unitary Elasticities

• Indicate proportional responsiveness of either demand or supply

Infinite Elasticity or Perfect Elasticity

• Either the quantity demanded or supplied changes by an infinite amount in response to any change in price at all
• In both cases, the supply and the demand curve are horizontal
• The quantity supplied or demanded is extremely responsive to price changes, moving from zero for prices close to P to infinite when price reach P

Zero Elasticity or Perfect Inelasticity

• A change in price, no matter how large, results in zero change in quantity
• The vertical supply curve and vertical demand curve show that there will be zero percentage change in quantity supplied or demanded, regardless of the price

Constant Unitary Elasticity

• Occurs when a price change of one percent results in a quantity change of one percent
• Note that a demand curve with constant unitary elasticity will be a curved line
• Notice how price and quantity demanded change by an identical amount in each step down the demand curve

Constant Unitary Elasticity curve

• Straight line reaching up from the origin
• Between each point, the percentage increase in quantity demanded is the same as the percentage increase in price

Tax Incidence

• The way the tax burden is divided between buyers and sellers
• If demand is more inelastic than supply, consumers bear most of the tax burden
• If supply is more inelastic than demand, sellers bear most of the tax burden

Elasticities

• Often lower in the short run than in the long run
• On the demand side of the market, it can sometimes be difficult to change quantity demanded in the short run, but easier in the long run
• On the supply side of markets, producers of goods and services typically find it easier to expand production in the long term of several years rather than in the short run of a few months
• In the short run, prices bounce up and down more than quantities
• In the long run, quantities often move more than prices

Cross-Price Elasticity of Demand

• The percentage change in the quantity of good A that is demanded because of a percentage change in the price good B

Wage Elasticity of Labor Supply

• The percentage change in labor supplied divided by the percentage change in wages

Wage Elasticity of Labor Demand

• The percentage change in labor demanded divided by the percentage change in wages

Interest Rate Elasticity of Savings

• The percentage change in the quantity of savings divided by the percentage change in interest rates

Interest Rate Elasticity of Borrowing

• The percentage change in the quantity of borrowing divided by the percentage change in interest rates

Budget Constraint

• Shows the possible combinations of two goods that are affordable given a consumer's limited income

Total Utility

• Satisfaction derived from consumer choices