Name: Class:

G8 Economics
AARON GIRONA
Study Guide Q1
Unit 1: Scarcity, opportunity cost and PPC

• What is Scarcity? Unlimited wants but limited resources. We want a lot of things, but our
resources (time, money…) are limited, and we can’t have everything we want, so we need to
make decisions.

• What is Opportunity Cost? The value of the next best alternative. When we have to make a
decision between two possible alternatives, what we give up (we don’t take) is the
opportunity cost. For example, It is Saturday night, and two groups of friends sent me a
message with two plans.
o Plan A: Go to the movies to watch Black Adam and then have dinner at Shake Shack
o Plan B: Go to my friend’s house to play video games and order a pizza from Pizza
Hut.
If I take option A, the best alternative is option B, so that is the opportunity cost, what I
lose when I make a decision.

• What are the Factors of Production? These are the resources companies use to produce
goods and services and later sell them to consumers, and we have four different types:
o Land: These are the natural resources. (Oil, trees, minerals…)
o Labor: The workers from the companies
o Capital: The machines transform the natural resources into final products to sell to
consumers
o Entrepreneurship: The person or group of people who put together all three other
resources to create a company and produce goods and services.
 • What is the Production Possibilities Curve (PPC)? The PPC shows the limits in producing
two goods from a particular country or company.

In this example, the country of France can produce TVs and bottles of wine. The line (frontier)
shows the limit in production. Any point beyond the line is impossible, below the line is inefficient
and on the line is efficient.

The PPC can increase or decrease, shift right or left depending on changes in resources or
technology.

• Four Reasons for Growth:

• 1. Having more capital (machines)
• 2. Technological advances
• 3. Increase in population – immigrants, birth rates increase
• 4. Available land or improvements to land
• Three Reasons for Decline:
• 1. Decrease in population –disease, catastrophe, war, birth rates decline
• 2. Loss of land – war or natural disaster
• 3. Decrease in production due to aging population, more uneducated population, less
healthy population

ECONOMIC GROWTH ECONOMIC RECESSION

(DECLINE)
 Absolute Advantages, Comparative Advantages, Terms of Trade
Key Concepts:
• Trade problems will always be between 2 countries or people making two items
• Output analysis compares finished products
• For trade to occur, both partners must benefit from the trade range
• A trade range is any range where importing is better than paying the domestic opportunity
cost for that item
• Absolute advantage: which country can produce more with the same amount of resources
• Comparative Advantage: where is “relatively cheaper” to produce a determine good or
service in relation with the opportunity cost of that good or service.
• The opportunity cost of one good is: How many units of the other good you give up
producing your good or service?
• AA: Absolute Advantage. Using the same number of resources, the country that can
produce more has absolute advantage.
• CA: Comparative Advantage. Using the same number of resources, the country that can
produce at a lower opportunity cost (cheaper) has comparative advantage.

EXAMPLE 1: Output Problem

Country Delta can produce 1200 hats or 300 bicycles

Country Epsilon can produce 600 hats or 300 bicycles

1. Delta has the absolute advantage in hat production, but they are tied in bicycle production.
2. Now, we must find the comparative advantages.
3. Build the grid:

Delta Epsilon
1200 Hats or 300 Bicycles 600 Hats or 300 Bicycles

Assume each country makes 1 hat. What is their opportunity cost? Reduce the 1200 and 600 to one
each by dividing the numbers by themselves. Now divide the other number by 1200 for Delta and
600 for Epsilon in order to create opportunity cost:
Delta Epsilon
1200 Hats or 300 Bicycles 600 Hats or 300 Bicycles
1 Hat = ¼ Bicycle 1 Hat = ½ Bicycle

Note that Delta gives up the opportunity cost of ¼ of a bicycle every time they make a hat.
Epsilon gives up the opportunity cost of ½ of a bicycle every time they make a hat.
Delta has a lower opportunity cost, therefore has the comparative advantage and will make hats
Now reduce the other side of the equation, the bicycles:

Delta Epsilon
1200 Hats or 300 Bicycles 600 Hats or 300 Bicycles
1 Hat = ¼ Bicycle 1 Hat = ½ Bicycle
4 Hats = 1 Bicycle 2 Hats = 1 Bicycle

Note that Epsilon give up 2 hats when making bicycles and Delta gives up 4 hats.
Epsilon has the lower opportunity cost and comparative advantage and will make bicycles

Now find the potential trade range. Each country will offer a trade BETTER than their own
opportunity cost:
Delta (trade offer) Epsilon
1200 Hats or 300 Bicycles 600 Hats or 300 Bicycles
1 Hat = ¼ Bicycle 1 Hat for > ¼ Bicycle 1 Hat = ½ Bicycle
4 Hats = 1 Bicycle 1 Bicycle for > 2 Hats 2 Hats = 1 Bicycle
Remember that trade will always occur in whole goods. A trick is to look at the whole number
offer: 1 bicycle for more than 2 hats (from Epsilon). The next whole number after 2: Three.
1 bicycle for 3 hats will make Epsilon happy. Will that also make Delta happy, giving up 3 hats to
get 1 bicycle? Mathematically, 1 to 3 is the same as 1/3rd to 1. Would giving up 1 hat to get back
1/3rd of a bicycle be a good trade for Delta? Yes, since 1/3rd is better than 1/4th.

Acceptable trade is 1 bicycle for 3 hats: both countries gain.

Unit 2: Supply and Demand Basics

Sequence:
• P on the Y axis, Q on the X axis
• Law of Demand: If price increases, quantity demanded will decrease and vice versa
• Law of Supply: If price increases, quantity supplied will increase and vice versa.
• Substitute Goods: two goods with similar characteristics that can be replaced by consumers
o If the price of one good increases, the demand of its substitute will also increase.
o If the price of one good decreases, the demand of its substitute will also decrease.

• Complement Goods: two goods that are different, but the consumers need to purchase
together.
o If the price of one good increases, the demand of its complement will decrease.
o If the price of one good decreases, the demand of its complement will increase.
• Normal goods: Higher Income leads to higher demand of the good
• Inferior goods: Lower Income leads to higher demand of the good.
 Basic Graphing of Supply and Demand Changes
Assume a Market Already Exists (Supply and Demand Curves)

Price is Price is Demand is Demand is Supply is Supply is

Increased Decreased Increased Decreased Increased Decreased
First First First First First First
Graph A: Graph B: Graph C: Graph D: Graph E: Graph F:

Circle the Circle the Circle the Circle the Circle the Circle the
correct correct correct correct correct correct
responses: responses: responses: responses: responses: responses:
QD will QD will D will D will S will S will
increase increase increase increase increase increase
decrease decrease decrease decrease decrease decrease
QS will QS will Qe will Qe will Qe will Qe will
increase increase increase increase increase increase
decrease decrease decrease decrease decrease decrease
Therefore: Therefore: Pe will Pe will Pe will Pe will
a a increase increase increase increase
surplus surplus decrease decrease decrease decrease
shortage shortage
will be will be
created created
 Basic S and D Graphs
Select the FIRST CHANGE
Apply Ceteris Paribus
Watch for Substitute and Complement Effects
There are two examples of each of the six basic S and D graphs

Scenario Market to graph Which thing Which Graph

changed 1st? (From the chart:
A-F)
1. General Motors shuts down major Overall US car market Supply
plants that produce 4 door sedans Number of producers Decrease F

2. The European Union wants to expand Wine market

French and German wine production and Price of Input/ Tax/ Supply
E
add a subsidy that gives producers an Subsidy Increases
extra 5 Euro per sale.
3. It is the morning of February 14th in Flowers
Demand
the US, Valentine’s Day Number of Consumers C
Increases
4. The New York city government Apartments
decides that apartment rents are too high Shortage Price B
and limits the price (price ceiling)
5. PepsiCo announces that all of their Coca Cola sodas
soda products will be half price for a Substitute price decreases Demand
D
month Decreases

6. The price of crude oil falls All plastic products that

Supply
dramatically for several months are made from oil E
Increases
Price of input
7. The US government wants a major Electric Cars
change. They legislate that all gasoline Surplus Price A
cars must be sold for more than $50,000
per unit
8. A major hurricane enters the Gulf of Batteries in Louisiana and
Mexico, heading west destroying a Texas Demand
C
power plant. Number of consumers Increases

10. In the US, it is December 26th and Toys Demand

the holiday season ended yesterday Number of consumers Decreases D
 Factors that change the equilibrium:

Outside the Equilibrium. (NOT SHIFTS)

• Price increases leading to surpluses (usually due to a government price floor) Qs > Qd
• Price decreases leading to shortages (usually due to a government price ceiling) Qd > Qs

Shifts of the demand curve

• Price of a complement increases. D

• Price of a complement decreases. D
• Price of substitute increases. D
• Price of substitute decreases. D
• People likes this good more than before. D
• People likes this good less than before. D
• More consumer buying this good. D
• Less consumers buying this good. D
• Consumers have more money (normal good). D
• Consumers have more money (inferior good). D

Shifts of the supply curve

• Price of resources increases or tax increase. S

• Price of resources decreases or subsidy. S
• Better Technology. S
• More producers in a market. S
• Fewer producer in a market. S
 SUPPLY AND DEMAND SHIFTS

Increase in Demand Decrease in Demand

Increase in Supply Decrease in Supply

Unit 3: Price Elasticity of Demand (PED)
The price elasticity of demand measures the responsiveness of the quantity demanded when there is
a price change. The idea is this: the law of demand states that when price increases, quantity
demanded decreases, but how much decreases?

This is what we are trying to answer, how much quantity decreases when price increases, or vice
versa? We can organize the goods according to their PED in three categories:

• Relatively Elastic goods: PED > 1. These foods have many substitutes, is easy to replace
them, so a small change in the price causes a great change in quantity. Example: pencils,
toothpaste, bottles of water (brands).

• Relatively Inelastic goods: PED < 1. These goods are necessities and/or don’t have many
substitutes, so an increase in price, doesn’t change much the quantity demanded. These
could be goods like oil, houses, medicine…

• Unit Elastic goods: PED = 1. The change in price equals the change in quantity.

• Perfectly Elastic demand. PED = ∞. These goods are so easy to replace that a small change
in the price causes the quantity to become 0.

• Perfectly Inelastic demand. PED = 0. These goods are necessities impossible to replace, so a
change in price causes no change in quantity.

Relatively Relatively Perfectly Perfectly

Inelastic Elastic Inelastic Elastic

- Calculating Price Elasticity of Demand (PED)

PED = %ΔQuantity demanded/%ΔPrice
EXAMPLE – Market for apples
Q1 = 2 apples P1 = 4 RMB
Q2 = 3 apples P2 = 1 RMB
ΔQ = 3-2 = 1 apple ΔP = 1-4 = -3 RMB

% ΔQ = (ΔQ/Q1) x 100 = (1/2) x 100 = 50%

% ΔP = (ΔP/P1) x 100 = (-3/4) x 100 = -75%
PED = 0.5/-0.75 = -0.6 = 0.6 < 1. Relatively Inelastic.