Key Concepts in Economics

• Economics studies how agents make choices with scarce resources, and how those choices affect society.
• Choice, not money or wealth, is the unifying feature of economics.
• Economic agents are groups or individuals that make choices, for example, consumers, households, firms, and governments.
• Economic agents usually choose optimally.
• Scarce resources are goods that are not available in sufficient quantity to satisfy everyone's wants.
• Positive economics describes what economic agents actually do, using objective analysis and facts without value judgments.
• Examples of positive economics include determining the mean wage in different sectors or identifying a gender income gap.
• Normative economics involves decision-makers determining what economic agents should do, using subjective analysis.
• Examples of normative economics include determining the best job offer or deciding which public policies should be introduced and which would be most effective.
• Microeconomics studies how individuals, households, firms, and governments make choices and how these choices affect prices, resource allocation, and the well-being of other agents.
• Microeconomics studies an isolated piece of the whole economy.
• Microeconomics includes consumer choice, electricity markets design, and competitive behavior of firms.
• Macroeconomics studies the economy as a whole.
• Macroeconomics studies aggregate production, inflation, economic cycles, labor market performance, and monetary policy.
• Macroeconomics studies the effect of last labor reform on unemployment and GDP, and the adequacy of public economic programs to stimulate the economy.

Three Principles of Economics

• Three principles of economics include optimization, equilibrium, and empiricism.

Optimization

• Optimization involves making the best choice possible with given information.
• Optimization involves possible/feasible options that are available to an agent.
• Agents sometimes do not have full information about possible options; changing available information can change the optimal choice.
• The best choice depends on the agent's preferences.
• Trade-offs: In making a decision, something must be given up.
• Budget constraint: Limited budgets force choices, creating a trade-off.
• Opportunity cost: The best alternative use of a resource, usually expressed as monetary value.
• Cost-benefit analysis: An optimization method that compares benefits and costs in a common unit of measurement.

Equilibrium

• Equilibrium is a situation in which nobody would benefit by changing their own behavior.
• Decisions are optimally made given available information.
• Free-rider problem: An agent enjoys the benefits of a choice without assuming all of its costs.

Empiricism

• Empiricism involves analysis using data to figure out answers to interesting questions.
• Correlation does not equal causation
• Causation: When one thing directly affects another.
• Correlation: Positive correlation means both change in the same direction; negative correlation means they change in opposite directions.
• Omitted variables can cause inaccurate correlations if something that contributes to cause and effect is ignored.
• Reverse casualty can present the cause and effect in the opposite direction as what occurs.
• Controlled experiments: Subjects are randomly put into treatment and control groups by researchers.
• Natural experiments: Subjects end up in treatment or control groups due to something not purposefully determined by the researcher.
• Good economic questions should be relevant and important, and be answerable empirically.

What is a Model?

• A model is a simplified description of reality.
• Visually summarize numeric information
• Useful to represent models
• Equation of a line: y=mx +n
• m is the slope
• n is the y-intercept

Optimization (in levels)

• Optimization involves finding the greatest total benefit
• The optimization formula is total benefit – total cost (net benefit)

Optimization (in differences)

• Optimization involves finding the change in the net benefit of one option compared to another
• Some limits to optimization include limited information, the cost and complications of collecting information, inexperience, and trade-offs.
• Reasons in the cost of commuting in choosing an apartment include availability in public transportation, gasoline, parking, wear and tear on the car and the opportunity cost of time
• Can find total net benefit by calculating the benefits less costs for each option and choosing the option with the highest one

Optimization in Differences: Marginal Analysis

• This is found by calculating how the costs and benefits change as you move from option to another
• Choose the option that makes you better off by moving toward it, and worse off by moving away from it.
• Marginal cost is the additional cost incurred when choosing to make one decision over another

Topic 2: Markets

• A market is a group of economic agents who are trading a good or service, and the rules and arrangements for trading.
• Economic agents can be consumers, firms, governments, landlords, etc.
• Rules and arrangements include social rules, institutions, infrastructure, etc.
• Market price: The price at which buyers and sellers conduct transactions.
• Perfectly competitive market characteristics:
• All sellers sell an identical good or service.
• All participants are price-takers.
• The market sets the prices for goods and services.
• The objective of the consumer is to obtain the maximum satisfaction.

Concepts of the behavior of buyers

• Demand: The relationship between quantity demanded and price, holding all else equal, and reflecting how consumers behave in a market at different prices.
• "Demand" does not refer to a specific quantity, but to a relationship.
• Quantity Demanded: the amount of a good that buyers are willing to purchase at a certain price. This is a specific quantity.
• Demand Schedule: A table that reports the quantity demanded at different prices, holding all else equal
• Demand Curve: A graph that plots the quantity demanded at different prices, holding all else equal
• The law of demand: All else being equal or ceteris paribus: When the price increases, the quantity demanded decreases. When the price decreases, the quantity demanded increases.
• Changes in the quantity demanded are associated with changes in how much we are willing to consume of a good when the price changes and everything else remains constant.
• Changes in “demand” relate to changes in fundamentals affecting how much of a good at a given price people will demand.
• Market demand curve: The sum of the individual demand curves of all the potential buyers, and plots the relationship between the total quantity demanded and the market price, holding all else equal.

Causes of shifts on the Demand Curve

• Tastes and preferences
• Income and wealth
• Normal goods. Ex sea food or taxis
• Inferior goods. Ex potatoes or buses
• Availability and prices of related goods
• Substitute goods: gin and vodka, coffee and tea -Complement goods: gin and tonic
• Number and scale of buyers
• Buyers' expectations about the future.

How do sellers behave

• Why producers have different willingness to accept
• Quantity supplied: The amount of a good that sellers are willing to sell at a certain price.
• Supply schedule: A table that reports the quantity supplied at different prices.
• Supply curve: A graph that plots the quantity supplied at different prices.
• Shifts of the Supply Curve are influence by: -Input prices
• Technology
• Number and scale of sellers
• Sellers

Equilibrium

• Competitive equilibrium: The point at which the market comes to an agreement about what the price will be (competitive equilibrium price) and how much will be exchanged (competitive equilibrium quantity).
• Excess demand: Occurs when consumers want more than suppliers provide at a certain price, resulting in a shortage.
• Excess supply: Occurs when suppliers provide more than consumers want at a given price, resulting in a surplus.
• In a competitive equilibrium the price is where supply and demand intersect
• Type of changes in the supply and demand: The Demand and Supply curves shift right.
• Price ceiling: Results in an excess in in demand where prices are set below the competitive price

Topic 3 - The Buyer's Problem

• Objective if to understand how each decision is made on the side of the consumers.

Factors influencing the problem

• What do you like?
• Taste and preferences
• How much does it cost?
• Prices (monetary cost)
• How much money/resources do you have?
• Budget set / Budget constraint

What do you like?

• The more of a good thing, the better
• What we buy reveals our taste and preferences
• Assumptions about preferences
• The more, the better (non-satiation): If in A you have more goods than in B, you prefer A
• For any two choices you have a preference (completeness)
• Preferences are internally consistent (transitivity): If you prefer A to B, and B to C, you prefer A to C

How much does it cost?

• Prices are the incentives that we face when making purchase decisions
• Prices allow to formally define the relative cost of goods
• We will assume that they are constant and given (buyers are price-takers)

How much money/resource do you have?

• Budget set: Budget set is the set of all possible bundles of goods and services that can be purchased with a consumer's income
• Budget constraint: The budget constraint represents the goods or activities that a consumer can choose which exhausts the entire budget. No saving or borrowing
• Putting it all together with the budget: As the quantity bought of the same type of goods increases, the marginal benefit decreases, that is because the consumer gets exhausted and enjoys less every extra good bought after the first one.
• Buyer's Equilibrium Condition: MBs|Ps= MBj/Pj “Equal bang for your buck” Why does this rule hold? Because if marginal benefits are not equal, then you can do better, be happier, by shifting consumption toward the good that has higher marginal benefits per dollar spent. When we have more than two goods: MBs/Ps=MBj|Pj= MBk/Pk

Consumer Surplus

• Consumer surplus: The difference between what you are willing to pay and what you have to pay, the market price.
• The slope of the constraint is negative because as one good increases, the other good decreases, and it comes from dividing Pgood1/Pgood2
• If the price of one good changes, you could buy a different amount and the slope would change
• If the price decreases, the quantity demanded increases

Demand Elasticities

• The demand elasticity is a measure of how sensitive one variable is to changes in another.
• Includes: -Price elasticity of demand -Cross-price elasticity of demand -Income elasticity of demand
• Price elasticity of demand: How much does quantity demanded change when the good's price changes?

Formula for Price Demand Elasticity

(Ep) = Percentage change in quantity demanded / Percentage change in price

• Example: Decrease of demand of 33% but increase in price of 50%. Abs(-0,33/0,5)=0.66

Cases of the Price Elasticity of Demand

• Ed>1: Elastic
• Ed<1: Inelastic
• Ed=1: Unit Elastic
• Ed=∞ : Perfectly elastic
• Ed=0: Perfectly inelastic.
• In general, price elasticity varies among the demand curve, with the revenue of the seller: TR=PxQ
• If demand is inelastic, when price increases, quantity decreases a little
• The price increases pushes total revenue, the quantity decrease pushes total revenue down, but the amount that grows is higher than the one that goes down
• If demand is elastic, when price decreases, quantity decreases in a higher amount

Cross-price elasticity of Demand Formula

• (ED) = Percentage change in quantity demanded / Percentage change in price of other good
• Income elasticity of demand: How much does quantity demanded change when income changes?

Income Formula

• Income elasticity = Percentage change in quantity demanded / Percentage change in income

Indifference Curve

• Indifference curve: represent preferences graphically and represent combinations of goods that give to consumers the same utility.
• In the case of jeans vs sweaters, when the price of jeans decreases:
• Substitution: Jeans become relatively cheaper with respect to sweaters->Buy more jeans but less sweaters
• Income effect: You are richer, so you can buy more
• Final effect depends on the specific preferences

Topic 4 - Sellers in a Perfectly Competitive Market

• In the definition of production function, very important “highest”
• The Seller's Problem
• From the Seller's Problem to the Supply Curve
• Producer Surplus
• Perfect Competition and the Invisible Hand