Equations and Quick Summaries by Chapter:

Ch. 1 Opportunity Cost and Marginal Analysis

Vocab:
Scarcity – Situation where unlimited wants exceed the limited resources available to
fulfill those wants Opportunity Cost – the highest-value alternative that must be given
up to engage in an activity
Marginal Cost – the additional cost from consuming or producing one more unit of a
good
Marginal Benefit - the additional benefit or payoff from consuming or producing one
more unit of a good
Explicit Cost – actual, out-of-pocket costs
Implicit Cost – opportunity cost
Productive Efficiency – situation where a good or service is produced at the lowest
possible cost Allocative Efficiency - situation where production is in accordance with
consumer preferences
Equity – the fair distribution of economic benefits

Market Equilibrium is where Q = Q

d s

Slope = ΔY
ΔX

Ch. 3 The Market System

Vocab:
Income Effect – The change in the quantity demanded of a good that results from the
effect of a change in the good’s price on consumer’s purchasing power.
Substitution Effect – The change in the quantity demanded of a good that results from a
change in price making the good more or less expensive relative to other goods that are
substitutes.
Substitutes – Goods and services that can be used for the same purpose.
Complements – Goods and services that are used together.
Normal Goods – A good for which demand increases as income rises and decreases as
income falls.
Inferior Goods – A good for which demand increases as income falls and decreases as
income rises.
Surplus (excess supply) – A situation in which the quantity supplied is greater than the
quantity demanded.
Shortage (excess demand) – A situation in which the quantity demanded is greater than
the quantity supplied.
Substitutes in Production – alternative products that a firm could produce.

A shift in the demand curve = a change in demand:

An increase in... shifts the because...
demand
curve...

income (and the good is right consumers spend more of their higher
 normal) incomes on the good.

income (and the good is left consumers spend less of their higher
inferior) incomes on the good.

the price of a substitute right consumers buy less of the substitute

good good and more of this good.

the price of a left consumers buy less of the

complementary good complementary good and less of this
good.

taste for the good right consumers are willing to buy a larger
quantity of the good at every price.

population right additional consumers result in a greater

quantity demanded at every price.

the expected future right consumers buy more of the good today
price of the good to avoid the higher price in the future.

Movement along the demand curve = a change in the quantity demanded.

A shift in the supply curve = an increase or decrease in supply:

An increase in... shifts the because...
supply
curve...

the price of an input left the costs of producing the good rise.

productivity right the costs of producing the good fall.

the price of a left more of the substitute is produced and less

substitute in of the good is produced.
production

the number of firms in right additional firms result in greater quantity

the market supplied at every price.

the expected future left less of the good will be offered for sale
price of the product today to take advantage of the higher price
in the future.
Movement along the supply curve = change in the quantity supplied.

If the quantity demanded is > the quantity supplied, then there is a shortage.
If the quantity demanded is < the quantity supplied, then there is a surplus.
How shifts in Supply and Demand Affect Equilibrium Price (P) and Quantity (Q)

Supply Curve Supply Curve Supply Curve

Unchanged Shifts Right Shifts Left

Demand Curve Q Unchanged Q Increases Q Decreases

Unchanged P Unchanged P Decreases P Increases

Demand Curve Q Increases Q Increases Q Increases OR

Shifts Right P Increases P Increases OR Decreases
Decrease P Increases

Demand Curve Q Decreases Q Increases OR Q Decreases

Shifts Left P Decreases Decreases P Increases or
P Decreases Decreases

Ch. 6 Elasticity
Vocab:
Price Elasticity of Demand – the responsiveness of quantity demanded to a change in
price.
Elastic Demand – Demand or supply is elastic when the percentage change in quantity
demanded or supplied is greater than the percentage change in price.
Unit Elastic Demand – Demand or supply is unit elastic when the percentage change in
quantity demanded or supplied is the same as the percentage change in price.
Inelastic Demand – Demand or supply is inelastic when the percentage change in
quantity demanded or supplied is less than the percentage change in price.
Income Elasticity of Demand – the responsiveness of quantity demanded to a change in
income.
Cross-Elasticity of Demand – the responsiveness of quantity demanded to a change in
the price of a related good.
Price Elasticity of Supply – the responsiveness of quantity supplied to a change in price.

Summary:
The Determinants of Elasticity:
 The availability of close substitutes → If a product has fewer substitutes available,
it will have a more elastic demand, whereas a product with fewer substitutes will
be more elastic.
 Passage of Time → The more time that passes, the more elastic the demand for a
product becomes.
 Luxuries vs. Necessities → The demand curve for a luxury is more elastic than the
demand curve for a necessity.
 Definition of the Market → The more narrowly we define a market, the more
elastic demand will be.
 Share of a Good in a Consumer’s Budget → The demand for a good will be more
elastic the larger the share of the good in the average consumer’s budget.
Price Elasticity of Demand =  % Change in Quantity Demanded
        % Change in Price
You use the midpoint equation to calculate the % change in the numerator and the
denominator:

New Value - Old Value_  X 100 _[(Q - Q )(Q + Q ) / 2]_

2 1 1 2

Midpoint of both Values    [(P - P )(P + P ) / 2]

2 1 1 2

Elasticity is not slope, but: If two linear demand (or supply) curves run through a
common point, then at any given quantity, the curve that is FLATTER is MORE
ELASTIC.
 If the |Ed| < 1, the demand curve is inelastic.
 If the |Ed| > 1, the demand curve is elastic.
 If the |Ed| = 1, the demand curve is unit elastic.
 If the |Ed| = 0, the demand curve is perfectly inelastic.
 If the |Ed| = ∞, the demand curve is perfectly elastic.

Total Revenue = Price x Quantity Demanded (sold).

The Relationship between Price Elasticity and Revenue:

If demand then... because...
is...

elastic an increase in price the decrease in quantity demanded is

reduces revenue proportionally greater than the increase in
price.

elastic a decrease in price the increase in quantity demanded is greater

increases revenue than the decrease in price.

inelastic an increase in price the decrease in quantity demanded is

increases revenue proportionally smaller than the increase in
price.

inelastic a decrease in price the increase in quantity demanded is

reduces revenue proportionally smaller than the decrease in
price.

unit elastic an increase in price the decrease in the quantity demanded is

does not affect revenue proportionally the same as the increase in
price.

unit elastic a decrease in price the increase in the quantity demanded is

does not affect revenue proportionally the same as the increase in
price.

Elasticity is not constant along a Linear Demand Curve:

Cross-price Elasticity of Demand: measures how sensitive the quantity demanded
of good A is to the price of good B.
Cross-price Elasticity of Demand = % change in quantity of A demanded
% change in price of B

If the products then the cross-price elasticity of Example

are... demand will be...

substitutes positive. 2 brands of

tablets

complements negative. Tablets and apps

unrelated zero. Tablets and

Peanuts

Income Elasticity of Demand: measures how sensitive the quantity demanded of a good
is to changes in income.
Income Elasticity of Demand = % change in quantity demanded
    % change in income

If income elasticity of demand is... then the good is... Example

positive but < 1 normal and a necessity. Bread

positive and > 1 normal and a luxury. Caviar

negative inferior. High-fat meat

Price Elasticity of Supply = % Change in Quantity Supplied

% Change in Price
 If the |Es| < 1, the supply curve is inelastic.
 If the |Es| > 1, the supply curve is elastic.
 If the |Es| = 1, the supply curve is unit elastic.
 If the |Es| = 0, the supply curve is perfectly inelastic.
 If the |Es| = ∞, the supply curve is perfectly elastic.

Ch. 4 Economic Efficiency

Vocab:
Marginal Benefit – The additional benefit to a consumer from consuming one more unit
of a good or service.
Marginal Cost – The additional cost to a firm of producing one more unit of a good or
service.
Consumer Surplus – The difference between the highest price a consumer is willing to
pay for a good or service and the actual price the consumer pays.
Producer Surplus – The difference between the lowest price a form would be willing to
accept for a good or service and the price it actually receives.
Price Floor – A legally determined minimum price that sellers may receive.
Price Ceiling – A legally determined maximum price that sellers may charge.
Deadweight Loss – The reduction in economic surplus resulting from a market not
being in competitive equilibrium.
Quota – A numerical limit a government (or industry) imposes on the quantity of a good
that can be supplied to the market.
Tax – A fee charged ("levied") by a government on a product, income, or activity.
Subsidy – A benefit given by the government to individuals, groups or firms usually in
the form of a cash payment or tax reduction. The subsidy is usually given to remove
some type of burden and is often considered to be in the interest of the public.

Ch. 5 Externalities
Vocab:
Negative Externality – a cost imposed on a third party not directly involved in the
production or consumption of a good.
Positive Externality – a benefit enjoyed by a third party who is not directly involved in
the production or consumption of a good.
Subsidy - A benefit given by the government to groups or individuals usually in the form
of a cash payment or tax reduction.
Public Goods - a good that is both nonrival and nonexcludable.
Private Goods – a good that is both rival and excludable.
Common Resources – goods that are rival but non-excludable.
Excludable – non-payment excludes individuals from consuming a good
Rival – one person consuming a good prevents others from consuming the same unit of
the good.
Free Rider Problem – a situation where individuals benefit from a good without paying
for it.
Tragedy of the Commons – the tendency for a common resource to be overused.
The Coase theorem: Private sector solutions are possible if there are clearly defined
property rights and/or costless bargaining (no transaction costs).
However… Private transactions don’t always work because of:
1. Transaction costs:  The costs parties incur in the process of agreeing to and
following through on a bargain.  These costs may make it impossible to reach a
mutually beneficial agreement.  Ex., hiring a lawyer.
2. Stubbornness:  Even if a beneficial agreement is possible, each party may hold
out for a better deal.
3. Coordination problems:If number of parties is very large, coordinating them may
be costly, difficult, or impossible.

Public policies towards externalities: Two approaches:

 Command-and-control policies regulate behavior directly.  Examples: limits on
quantity of pollution emitted requirements that firms adopt a particular
technology to reduce emissions
 Market-based policies provide incentives so that private decision-makers will
choose to solve the problem on their own.  Examples:corrective (Pigouvian) taxes
and subsidies, and tradable pollution permits (cap-and-trade)
Internalizing the externality:  altering incentives so that individuals and organizations
take account of the external effects of their actions.
 Ch. 10 (section 1 & 2) Consumer Choice
Vocab:
Income Effect – the change in the quantity demanded of a good that results from the
effect of a change in the price of a good on consumer purchasing power holding all
things constant.
Substitution Effect – the change in the quantity demanded of a good that results from
the effect of a change in the price of a good making the good more or less expensive
relative to other goods holding all things constant.
Marginal Utility – the change in total utility from consuming one additional unit of a
good or service.
Total Utility – the cumulative enjoyment or satisfaction received from consuming one or
more units of a good
or service.
Diminishing Marginal Utility – the principle that consumers experience diminishing
additional satisfaction as they consume more of a good or service during a given period
of time.
Inferior Goods – quantity demanded of the good decreases with an increase in the price
of the good.
Normal Goods – quantity demanded of the good decreases with an increase in the price
of the good.
Giffen Goods – quantity demanded of the good increases with an increase in the price of
the good.

Consumer surplus: the difference between market price and what consumers (as
individuals or the market) would be willing to pay.
Consumer Surplus Formula: The area beneath the demand curve and above the price.

Producer surplus: the difference between market price and the price at which firms
are willing to supply the product.
Producer Surplus Formula: The area above the supply curve but below the price that
firms are willing to supply the product at.

Total surplus: the sum of the producer and consumer surpluses. Formula: The area of
the producer and consumer surpluses combined.

The relationship between Total and Marginal Utility:

 When MU is positive, TU will increase
 When MU is zero, TU will reach its maximum
 When MU is negative, TU will decrease
Budget constraint: an income limitation on a person’s expenditures on goods and
services.

Combined Income and Substitution Effects:

Price Decrease:
 Substitution Effect – QD increases
 Income Effect – Purchasing power increases
 QD increases if normal good
 QD decreases  if inferior good
 NORMAL GOOD
o Substitution Effect – QD increases
o Income Effect – QD increases
 INFERIOR GOOD
o Substitution Effect – QD increases
o Income Effect – QD decreases
o HOWEVER, the substitution effect > the income effect
 GIFFEN GOOD
o Substitution Effect – QD increases
o Income Effect – QD decreases
o HOWEVER, the income effect > the substitution effect
Price Increase:
 Substitution Effect – QD decreases
  Income Effect – Purchasing power decreases
 QD decreases if normal good
 QD increases  if inferior good

Utility maximization: the idea that people try to achieve the highest level of utility given
their budget constraint.
Utility maximization occurs where:

1)  

2)And, where the full budget is being spent.

(P x Q ) + (P x Q ) = BUDGET
c c M M

Ch. 2 (section 1 & 2) Opportunity Cost and Trade

Vocab:
Production Possibilities Frontier – curve showing the maximum possible combinations
of two products that can be produced with available resources and current technology.
Absolute Advantage – the ability of an individual, firm or country to produce more of a
good or service than competitors using the same resources.
Comparative Advantage – the ability of an individual, firm or country to produce a good
or service at a lower opportunity cost than competitors.
Autarky – a situation of no trade between countries
Specialization – production of the good or service in which an individual, firm or
country has a comparative advantage
Terms of Trade - the rate of exchange of one good or service for another when two
countries trade with each other.

Summary:
Opportunity Cost as Slope on a PPF
The slope is opportunity cost of the horizontal axis, while inverse slope is opportunity
cost of vertical axis.
Causes of Economic Growth:
1. An increase in factors of production: resources used to produce goods and services.
2. Better technology: the technical means for producing goods and services.

Factors of Production:
1. Land includes natural resources, such as mineral deposits, oil, natural gas, water, and
actual land acreage.
2. Labor is the mental and physical abilities of the workforce.
3. Physical capital is manufactured items used to produce other goods and
services.
4. Human capital is the educational achievements and skills of the labor force
(which increase labor productivity).

Theory of Comparative Advantage:

It makes sense to produce the things you’re especially good at producing... and buy
everything else from others.
Positive economics is the branch of economic analysis that describes the way the
economy actually works.
Normative economics makes prescriptions about the way the economy should work.
 Ch. 9 Trade and Trade Restrictions
Vocab:
Autarky – a situation in which a country does not trade with other countries.
Imports – goods and services bought domestically but produced in other countries.
Exports – goods and services produced domestically but sold in other countries.
Free Trade – trade between counties that is without government restrictions.
Tariff – a tax imposed by a government on imports.
Quota – a limit a government imposes on the quantity of a good that can be imported
into the country.
Voluntary Export Restraint – an agreement negotiated between two countries that
places a numerical limit on the quantity of a good that can be imported by one country
from the other country.
Protectionism – the use of trade barriers to shield domestic firms from foreign
competition.
World Trade Organization (WTO) – an international entity that oversees international
trade agreements.
Globalization – the process of countries becoming more open to foreign trade and
investment.
Dumping – selling a product for a price below its cost of production.
 Ch. 11 Costs
Vocab:
Marginal Product of Labor – the additional output a firm produces as a result of hiring
one more worker.
ATC – total cost divided by the quantity of output produced.
AVC – total variable cost divided by the quantity of output produced.
AFC – total fixed cost divided by the quantity of output produced.
MC – the change in a firm’s total cost from producing one more unit of a good or
service.
Economies of Scale – when a firm’s long-run average costs fall as the quantity of output
it produces increases.

Summary:
1. THE PRODUCTION FUNCTION
1. Production is the process of turning inputs into outputs.
1. The cost structure of a firm depends on the nature of the production
process.
ii. A production function is the relationship between the quantity of inputs a
firm uses and the quantity of output it produces.
b. 2. INPUTS AND OUTPUTS
i. A fixed input is an input whose quantity is fixed for a period and cannot be
varied.
ii. A variable input is an input whose quantity the firm can vary at any time.
iii. The Time Horizon
1. The long run is the period in which all inputs can be varied.
2. The short run is the period in which at least one input is fixed.
ii. The total product curve shows how the quantity of output depends on the
quantity of the variable input for a given quantity of the fixed input.
b. PRODUCTION IN THE SHORT RUN
i. Marginal product (MP) is the change in output resulting from a one-unit
increase in the amount of labor input (ΔQ/ΔL)
ii. Marginal product may initially rise as more workers are hired; then it
declines.
1. Example: Past a certain point, another field worker will be so
crowded that his marginal product will be lower than the last
worker’s.
b. PRODUCTION FUNCTION AND TP CURVE
i. The relationship between inputs and output is positive but not constant:
marginal product of labor changes along the production function.
ii. Marginal Product of Labor: the additional quantity of output that is
produced by using one more unity of that input.
1. MPL= Change in quality of output/Change in quantity of labor =
ΔQ/ΔL
2. PL= Change in quantity of output generated by one additional unity
of labor
b. TOTAL PRODUCT, MARGINAL PRODUCT, AND FIXED INPUT
i. With more land (fixed input) each worker can produce more. This shifts
the total product curve up. So the MPL of each worker is higher when the
farm is larger; the MPL curve shifts up also.
b. FROM THE PRODUCTION FUNCTION TO COST CURVES
i. A fixed cost is a cost that does not depend on the quantity of output
produced. It is the cost of the fixed input.
ii. A variable cost is a cost that depends on the quantity of output produced.
It is the cost of the variable input.
 iii.The total cost and its curve.
1. The total cost of producing a given quantity of output is the sum of
the fixed cost and the variable cost of producing that quantity of
output.
2. TC=FC+VC
3. The total cost curve becomes steeper as more output is produced, a
result of diminishing returns. It shows how total cost depends on
the quantity of output.
b. MARGINAL COST & AVERAGE COST
i. Marginal Cost
1. The marginal cost is the change in total cost generated by one
additional unit of output.
2. MC = ΔTC/ΔQ
3. Where Δ = change, TC = total cost and Q = quantity of output
ii. Average Cost
1. Average total cost (often referred to simply as average cost) is the
total cost per unit of output produced
1. ATC = TC/Q
2. Average fixed cost is the fixed cost per unit of output produced
1. AFC = FC/Q
3. Average variable cost is the variable cost per unit of output
produced
1. AVC = VC/Q
ii. Minimum Average Total Cost
1. The minimum-cost output is the quantity of output at which
average total cost is lowest—the bottom of the U-shaped average
total cost.
2. The Three Principles of MC & ATC Curves
1. At the minimum-cost, ATV is equal to MC
2. At output less than the minimum-cost, MC is less than ATC
and ATC is falling.
3. At output greater than the minimum-cost output, MC is
greater than ATC and ATC is rising.
ii. More on the Average Total Cost Curve
1. A U-shaped ATC falls at low levels of output, then rises at higher
levels.
2. Average fixed cost is the fixed cost per unit of output. Average
variable cost is the variable cost per unit of output.
3. Increasing output has two effects:
1. The spreading effect: The larger the output, the more output
over which fixed cost is spread, leading to lower average
fixed cost.
2. The diminishing returns effect: The larger the output, the
more variable input required to produce additional units,
which leads to higher average variable cost.
b. PUTTING THE COST CURVES TOGETHER
i. Note that:
 1. marginal cost is upward sloping because of diminishing returns.
2. Average variable cost also is upward sloping but is flatter than the
marginal cost curve.
3. Average fixed cost is downward sloping because of the spreading
effect.
4. The marginal cost curve intersects the average total cost curve from
below, crossing it at its lowest point.
b. SHORT RUN V. LONG RUN COSTS
i. All inputs are variable in the long run. This means that in the long run,
fixed cost (like factory size) may also vary.
ii. The firm will choose its fixed cost in the long run based on the level of
output it expects to produce.
iii. The long run average total cost curve.
1. The long-run average total cost curve shows the relationship
between output and average total cost when fixed cost has been
chosen to minimize average total cost for each level of output.
2. (We assume the firm has chosen the cheapest plant size for each
output level.)
ii. Returns to Scale
1. There are increasing returns to scale (economies of scale) when
long-run average total cost declines as output increases.
2. There are decreasing returns to scale (diseconomies of scale) when
long-run average total cost increases as output increases.
3. There are constant returns to scale when long-run average total cost
is constant as output increases.