Principles of Economics

• Economics is the study of how societies allocate scarce resources to satisfy unlimited wants and needs.
• It involves analyzing production, distribution, and consumption of goods and services.
• Microeconomics focuses on individual agents, such as households, firms, and markets.

Core Principles

• Scarcity: Resources are limited, but wants are unlimited, leading to choices and trade-offs.
• Opportunity Cost: The value of the next best alternative forgone when making a choice.
• Rationality: Individuals make decisions by weighing costs and benefits to maximize their well-being.
• Incentives: People respond to incentives, both positive and negative, which affect behaviour.

Supply and Demand

• Demand: The quantity of a good or service that consumers are willing and able to purchase at various prices during a specific period.
• Law of Demand: As price increases, quantity demanded decreases, holding other factors constant.
• Factors shifting the Demand curve: Income, tastes, expectations, prices of related goods (substitutes and complements), number of buyers.
• Supply: The quantity of a good or service that producers are willing and able to offer for sale at various prices during a specific period.
• Law of Supply: As price increases, quantity supplied increases, holding other factors constant.
• Factors shifting the Supply curve: Input costs, technology, expectations, number of sellers.
• Market Equilibrium: The point where quantity demanded equals quantity supplied; the market clears.
• Surplus: When quantity supplied exceeds quantity demanded, leading to downward pressure on price.
• Shortage: When quantity demanded exceeds quantity supplied, leading to upward pressure on price.
• Price Elasticity of Demand: Measures the responsiveness of quantity demanded to a change in price.
  • Elastic Demand: > 1, quantity demanded is highly responsive to price changes.
  • Inelastic Demand: < 1, quantity demanded is not very responsive to price changes.
  • Unit Elastic Demand: = 1, percentage change in quantity demanded equals percentage change in price.
• Price Elasticity of Supply: Measures the responsiveness of quantity supplied to a change in price.
  • Elastic Supply: > 1, quantity supplied is highly responsive to price changes.
  • Inelastic Supply: < 1, quantity supplied is not very responsive to price changes.
  • Unit Elastic Supply: = 1, percentage change in quantity supplied equals percentage change in price.
• Income Elasticity of Demand: Measures the responsiveness of quantity demanded to a change in consumer income.
  • Normal Goods: Positive income elasticity.
  • Inferior Goods: Negative income elasticity.
• Cross-Price Elasticity of Demand: Measures the responsiveness of quantity demanded of one good to a change in the price of another good.
  • Substitutes: Positive cross-price elasticity.
  • Complements: Negative cross-price elasticity.

Consumer Behavior

• Utility: The satisfaction or pleasure derived from consuming goods and services.
• Marginal Utility: The additional satisfaction from consuming one more unit of a good or service.
• Law of Diminishing Marginal Utility: As consumption increases, the extra utility from an additional unit decreases.
• Budget Constraint: The limit on consumption bundles that a consumer can afford, based on income and prices.
• Consumer Equilibrium: The point where a consumer maximizes utility, given their budget constraint.
• Indifference Curve: A curve showing consumption bundles that give the consumer the same level of utility.
  • Properties: downward sloping, do not cross, convex to the origin.
• Marginal Rate of Substitution (MRS): The rate at which a consumer is willing to trade one good for another while maintaining the same level of utility.

Production and Costs

• Production Function: The relationship between inputs (e.g., labor, capital) and output.
• Marginal Product: The additional output from adding one more unit of an input.
• Law of Diminishing Marginal Returns: As more of one input is added (holding other inputs constant), the marginal product of that input eventually decreases.
• Fixed Costs: Costs that do not vary with the level of output.
• Variable Costs: Costs that vary with the level of output.
• Total Cost (TC): The sum of fixed and variable costs.
• Average Fixed Cost (AFC): Fixed cost divided by quantity of output.
• Average Variable Cost (AVC): Variable cost divided by quantity of output.
• Average Total Cost (ATC): Total cost divided by quantity of output.
• Marginal Cost (MC): The additional cost of producing one more unit of output.
• Economies of Scale: ATC decreases as output increases.
• Diseconomies of Scale: ATC increases as output increases.
• Constant Returns to Scale: ATC remains constant as output increases.

Market Structures

• Perfect Competition: Many buyers and sellers, homogeneous product, free entry and exit, perfect information.
  • Price Takers: Firms have no control over market price.
  • Profit Maximization: Firms produce where marginal cost equals market price (MC = P).
• Monopoly: Single seller, unique product, barriers to entry.
  • Price Maker: Firm has significant control over market price.
  • Profit Maximization: Firms produce where marginal cost equals marginal revenue (MC = MR).
• Monopolistic Competition: Many buyers and sellers, differentiated products, relatively easy entry and exit.
  • Product Differentiation: Firms compete on quality, features, and branding.
  • Profit Maximization: Similar to monopoly in the short run, but entry erodes profits in the long run.
• Oligopoly: Few sellers, homogeneous or differentiated products, significant barriers to entry.
  • Strategic Interaction: Firms' decisions depend on the actions of other firms.
  • Game Theory: Used to analyze strategic behavior in oligopolies.
  • Collusion: Firms agree to restrict output and raise prices.
  • Cartel: A formal organization of firms that collude.

Factor Markets

• Demand for Labor: Derived from the demand for the product the labor produces.
• Marginal Revenue Product of Labor (MRPL): The additional revenue from employing one more unit of labor.
• Supply of Labor: The willingness of workers to supply their labor at various wage rates.
• Wage Determination: Determined by the interaction of labor supply and demand.
• Capital Market: The market for financial capital, such as stocks and bonds.
• Interest Rates: The price of borrowing capital.

Market Failures

• Externalities: Costs or benefits that affect third parties who are not involved in the production or consumption of a good or service.
  • Negative Externalities: Costs imposed on third parties (e.g., pollution).
  • Positive Externalities: Benefits conferred on third parties (e.g., education).
  • Government Intervention: Taxation, subsidies, regulation.
• Public Goods: Non-excludable and non-rivalrous goods (e.g., national defense).
  • Free-Rider Problem: Individuals can benefit from the good without paying for it.
  • Government Provision: Often provided by the government and funded through taxes.
• Asymmetric Information: One party has more information than the other.
  • Adverse Selection: The tendency for people with more information to self-select in a way that disadvantages the less informed party.
  • Moral Hazard: The tendency for people to behave recklessly when they are insured or otherwise protected from the full consequences of their actions.

Government Intervention

• Price Controls: Government-imposed limits on prices.
  • Price Ceiling: A maximum price (often leads to shortages).
  • Price Floor: A minimum price (often leads to surpluses).
• Taxes: Government levies on goods and services.
  • Incidence: The burden of the tax, which may fall on consumers or producers.
  • Deadweight Loss: A loss of economic efficiency that occurs when the equilibrium for a good or service is not Pareto optimal.
• Subsidies: Government payments to producers or consumers.
• Regulations: Rules imposed by the government to control behavior.