CHAPTER 1: Limits, Alternatives, and
Choices
Economics – the social science that examines
how individuals, institutions, and society make
optimal choices under conditions of scarcity
Economic Principle – a statement about
economic behavior or the economy that enables
prediction of the probable effects of certain
actions
Elements of Economic Perspective - Scarcity
and Choice, Purposeful Behavior, and Marginal
Analysis
. schedule or curve that shows various
Other-Things-Equal Assumption – the
assumption that factors other than those being
considered do not change
Scarcity – restriction of options and demands
choices
Opportunity Cost – comparable decisions ;
represent the sacrifice or what could have been
gained if the resources used in one way had
been used differently
Purposeful Behavior – people make decisions
with some desired outcome in mind
Marginal Analysis – additional or extra benefits
& costs ; comparisons of marginal benefits and
marginal costs, usually for decision making.
Microeconomics – concerned with decision
making by individual customers, workers,
households, and business firms.
Macroeconomics – examines the performance
and behavior of the economy as a whole
Aggregate – a collection of specific economic
units treated as if they were one unit
Positive Economics – scientific-based analysis
; focuses on facts and cause-and-effect
relationships
Normative Economics – subjective feelings ;
incorporates value judgments about what the
economy should be like
Economizing Problem – the need to make
choices because economic wants exceed
economic means
Limited Income – restricted or fixed amount of
money available
Unlimited Wants – the desire of various goods
and services that provide utility
Budget Line – aka Budget Constraint – a
combinations of two products a consumer can
purchase with a specific money income
Attainable Combinations – inside the budget
line
Unattainable Combinations – all combinations
beyond or outside the budget line
Trade-Offs – incomparable decisions with one
another ; it’s like a question of “what if” ; Ex: A
company decides to improve a product or make
a new product.
Choice – selection of the combination of 2
variables that you think is “best”
Income Changes – the location of the budget
line varies with money income
- an increase in money income shifts the budget
line to the right
- a decrease in money income shifts it to the left
Resource Categories: Land, Labor, Capital,
and Entrepreneurial Ability
Land – natural resources (“gifts of nature”) used
in the production process
Labor – consists of the physical actions and
mental activities that people contribute to the
production of goods and services
Capital – all manufactured aids used in
producing consumer goods and services
Entrepreneurial Ability – supplied by
entrepreneurs, who perform several critically
important economic functions
Investment – spending that pays for the
production and accumulation of capital goods
Consumer Goods – satisfy wants directly
Capital Goods – satisfy wants indirectly by
aiding the production of consumer goods
Economic Assumptions: Full employment,
fixed resources, fixed technology, and two goods
Full Employment – economy is employing all of
its available resources
Fixed Resources – the quantity and quality of
the factors of production are fixed
Fixed Technology – The state of technology
(the methods used to produce output) is
constant
Two Goods – The economy is producing only
two goods: Consumer goods & Capital goods
Production Possibilities Model – lists the
different combinations of two products that can
be produced with a specific set of resources,
assuming full employment.
Production Possibilities Curve – a curve that
displays the different combinations of goods and
services that society can produce in a fully
employed economy, assuming a fixed availability
of supplies of resources and fixed technology.
Maximum Output of the Two Products – each
point on the production possibilities curve
Ex:
Law of Increasing Opportunity Costs – As the
production of a particular good increases, the
opportunity cost of producing an additional unit
rises.
Shape of the Curve – refers to how a graph
representing the relationship between two things
looks.
- Straight Line: opportunity cost doesn't change
as you produce more of one thing.
- Bowed-Out Curve: increasing opportunity
costs – producing more of one thing means
giving up more of the other.
- Bowed-In Curve: decreasing opportunity costs
– producing more of one thing means giving up
less of the other.
Economic Rationale – resources are not
universally adaptable but have specific
strengths.
Hence, when an economy shifts from producing
one good to another, it must use less productive
resources, leading to increasing opportunity
costs.
Optimal Allocation – distributing resources in a
way that maximizes satisfaction
Achieved when MB = MC
Increases in Resource Supplies – lead to the
ability to produce more consumer and capital
goods in the future
Advances in Technology – brings both new
and better goods and improved ways of
producing them
International Trade – enables a nation to obtain
more goods from its limited resources than its
production possibilities curve indicates
Economic Growth – the result when we
consider that resources and technology can
change and the production possibilities curve
shifts
Chapter 2: The Market System and the
Circular Flow
Economic system — a particular set of
institutional arrangements and a coordinating
mechanism—to respond to the economizing
problem
Laissez-faire capitalism or “pure capitalism”
– in which government intervention is at a very
minimum and markets and prices are allowed to
direct nearly all economic activity.
- is a hypothetical economic system in which
government’s role would be restricted to
protecting private property and enforcing
contracts
The term “laissez-faire” is the French for “let it
be,” that is, keep the government from
interfering with the economy.
The Command Systems - in which
governments have total control over all
economic activity. The government owns most
property resources and economic decision
making is set by a central economic plan
created and enforced by the government
The command system is also known as
socialism or communism.
Countries that are using the command system
are Turkmenistan, Laos, Belarus, Myanmar, and
Iran.
The Market System also known as capitalism or
mixed economy - A mixture of centralized
government economic initiatives and
decentralized actions taken by individuals and
firms.
Main Characteristics of the Market System
Private Property - enables individuals and
businesses to obtain, use, and dispose of
property resources as they see fit
Freedom of Enterprise - ensures that
entrepreneurs and private businesses are free to
obtain and use economic resources to produce
their choice of goods and services and to sell
them in their chosen markets
Freedom of Choice - enables owners to employ
or dispose of their property and money as they
see fit. It ensures that consumers are free to buy
the goods and services that best satisfy their
wants and that their budgets allow
Self Interest - the motivating force of the
various economic units as they express their
free choice
Competition - The effort and striving between
two or more independent rivals to secure the
business of one or more third parties by offering
the best possible terms
Market - an institution or mechanism that brings
buyers (“demanders”) and sellers (“suppliers”)
into contact
Specialization - using the resources of an
individual, firm, region, or nation to produce one
or a few goods or services rather than the entire
range of goods and services
Division of Labor - The separation of the work
required to produce a product into a number of
different tasks that are performed by different
workers; specialization of workers.
Medium of Exchange - Any item sellers
generally accept and buyers generally use to
pay for a good or service; money; a convenient
means of exchanging goods and services
without engaging in barter.
Barter - swapping goods for goods, say, wheat
for oranges. It requires a coincidence of wants
between the buyer and the seller
Money - a convenient social invention to
facilitate exchanges of goods and services.
How will a market system decide on the society even when each individual or firm is only
specific types and quantities of goods to be attempting to pursue its own interests.
produced?

Answer: The goods and services that can be

produced at a continuing profit will be produced, Three virtues of the market system:
while those whose production generates a
continuing loss will be discontinued. · Efficiency

Continuing economic profit (TR > TC) in an · Incentives

industry results in expanded production and the
movement of resources toward that industry. · Freedom

Continuing losses (TC > TR) in an industry lead

to reduced production and the exit of resources
from that industry FIG 2.2 Circular flow diagram questions

Consumer sovereignty 1. The resource market is the place where:

What combinations of resources and
technologies will be used to produce goods
and services? How will the production be
organized?
households sell resources and businesses
buy resources.
2. Which of the following would be
determined in the product market?

Answer: In combinations and ways that minimize a manager’s salary.

the cost per unit of output. This is true because
b. the price of equipment used in a bottling plant.
inefficiency drives up costs and lowers profits.
As a result, any firm wishing to maximize its
c. the price of 80 acres of farmland.
profits will make great efforts to minimize
production costs. d. the price of a new pair of athletic shoes.

Creative destruction - The creation of new 3. In this circular flow diagram:

products and production methods completely
destroys the market positions of firms that are a. money flows counterclockwise.
wedded to existing products and older ways of
doing business. (i.e., The advent of compact b. resources flow counterclockwise.
discs largely demolished long-play vinyl records,
and iPods and other digital technologies c. goods and services flow clockwise.
subsequently supplanted CDs.)
d. households are on the selling side of
Capital Accumulation the product market.

Who counts the dollar votes for capital 4. In this circular flow diagram:
goods? Answer: Entrepreneurs and business
owners a. households spend income in the
product market.
“Invisible hand” - The tendency of competition
to cause individuals and firms to unintentionally b. firms sell resources to households.
but quite effectively promote the interests of
 c. households receive income through
the product market.

d. households produce goods.

The Circular Flow Diagram illustrates the flows

of resources and products from households to
businesses and from businesses to households,
along with the corresponding monetary flows.

Households - Economic entities (of one or more

persons occupying a housing unit) that provide
resources to the economy and use the income
received to purchase goods and services that
satisfy economic wants.

Businesses

· Sole proprietorship - An unincorporated

firm owned and operated by one person

· Partnership - An unincorporated firm

owned and operated by two or more
persons.

· Corporation - A legal entity (“person”)

chartered by a state or the federal
government that is distinct and separate
from the individuals who own it

Product Market - the place where the goods

and services produced by businesses are
bought and sold.

Resource Market – A market in which

households sell and firms buy resources or the
services of resources
Chapter 3 : Demand, Supply and Market
Equilibrium
Demand - a schedule or a curve showing the
amount of a product that buyers are willing and
able to purchase, in a particular time period, at
each possible price in a series of prices.
The law of demand states that, other things
equal, the quantity of a good purchased varies
inversely with its price.
• The demand curve shifts because of changes
in
(a) Preferences and consumer tastes
(b) Number of buyers in the market
(c) Consumer income
(d) Prices of substitute or complementary goods
(e) Expectations of consumer
• A change in demand is a shift of the demand
curve; a change in quantity demanded is a
movement from one point to another on a fixed
demand curve.
Supply schedule or curve shows that, other
things equal, the quantity of a good supplied
varies directly with its price.
• The supply curve shifts because of changes in
(a) Resource prices
(b) Technology
(c) Taxes or subsidies
(d) Prices of other goods
(e) Expectations of future prices
(f ) Number of suppliers
• A change in supply is a shift of the supply
curve; a change in quantity supplied is a
movement from one point to another on a fixed
supply curve.
Law of Supply - Direct Relationship of Price
and Quantity
• In competitive markets, prices adjust to the
equilibrium level at which quantity demanded
equals quantity supplied.
• The equilibrium price and quantity are those
indicated by the intersection of the supply and
demand curves for any product or resource.
Increase in demand increases equilibrium price
and quantity; a decrease in demand decreases
equilibrium price and quantity.
Increase in supply reduces equilibrium price
but increases equilibrium quantity; a decrease in
supply increases equilibrium price but reduces
equilibrium quantity.
• Over time, equilibrium price and quantity may
change in directions that seem at odds with the
laws of demand and supply because the
other-things-equal assumption is violated.
• Government-controlled prices in the form of
ceilings and floors stifle the rationing function of
prices, distort resource allocations, and cause
negative side effects.
• A change in either demand or supply changes
the equilibrium price and quantity. Increases in
demand raise both equilibrium price and
equilibrium quantity; decreases in demand lower
both equilibrium price and equilibrium quantity.
Increases in supply lower equilibrium price and
raise equilibrium quantity; decreases in supply
raise equilibrium price and lower equilibrium
quantity.
Price ceiling is a maximum price set by the
government and is designed to help consumers.
Effective price ceilings produce persistent
product shortages, and if an equitable
distribution of the prod- uct is sought, the
government must ration the product to
consumers.
Price floor is a minimum price set by the
government and is designed to aid producers.
Effective price floors lead to persis- tent product
surpluses; the government must either purchase
the product or eliminate the surplus by imposing
restrictions on pro- duction or increasing private
demand.

Y axis - Vertical
X axis - Horizontal
Decrease in supply is greater than the decrease
in demand, equilibrium price will rise. If the
reverse is true, equilibrium price will fall.
Because the decreases in supply and demand
each reduce equilibrium quantity, we can be
sure that equilibrium quantity will fall.
What will happen to the demand of the
product when the price falls?
Answer: Demand doesn’t change but the
quantity demanded will increase.
Change in Price doesn’t shift the curve, but it will
move along with the curve.

increase in demand raises both equilibrium price

and equilibrium quantity. Conversely, a decrease
in demand reduces both equilibrium price and
equilibrium quantity.

An increase in supply reduces equilibrium price

but increases equilibrium quantity and a
decrease in supply, equilibrium price will rise and
equilibrium quantity declines.

Productive Efficiency - The production of any

particular good in the least costly way.

Allocative Efficiency - Particular mix of goods

and services most highly valued by society.

Demand - Downward Sloping

If Demand Increase, the Price and Quantity will

also Increase ; Demand curve will shift right

If Demand decrease, the Price and Quantity will

also decrease ; Demand curve will shift left

Supply - Upward Sloping

If Supply Increase, the Price will decrease and

Quantity will Increase ; Supply curve will shift
right

If Supply decrease, the Price will increase and

Quantity will decrease ; Supply curve will shift
left
CHAPTER 6:ELASTICITY
Price Elasticity of Demand - The
responsiveness (or sensitivity) of consumers to
a price change measured by a product.
Relatively Elastic - Substantial price changes
cause only small changes in amount purchased.
THE PRICE-ELASTICITY COEFFICIENT AND
FORMULA
Ed= percentage change in quantity demanded
of product X / percentage change in price of
product X
Ed = change in quantity demanded of X /
original quantity demanded of X
Change in price of X / original price
Ed = change in quantity / sum of quantities/2 ÷
change in price / sum of prices/2
Elimination of Minus Sign - This means that
we should disregard the minus sign in either of
the numerator and denominator. Price and
quantity demanded have an inverse relationship,
meaning when price goes down, demand goes
up, and vice versa. So, the price-elasticity
coefficient of demand will always be a negative
number.
Elastic Demand - a specific percentage change
in price results in a larger percentage change in
quantity demanded.
- Coefficient will always be greater than
1.
Inelastic Demand - a specific percentage
change in price results in a smaller percentage
change in quantity demanded.
- Coefficient will always be less than 1.
Unit Elasticity - a percentage change in price
and the resulting percentage change in quantity
demanded are the same.
- Coefficient will always be equal to 1.
Total Revenue - Total revenue (TR) is the total
amount the seller receives from the sale of a
product in a particular time period; it is
calculated by multiplying the product price (P) by
the quantity sold (Q). In equation form:
TR = P x Q
NOTE: if total revenue changes in the opposite
direction from price, demand is elastic.
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
Substitutability - The larger the number of
substitute goods that are available, the greater
the price elasticity of demand.
Proportion of Income - The higher the price of
a good relative to consumer’s incomes, the
greater the price elasticity of demand.
Luxuries versus Necessities - The more that a
good is considered to be a “luxury” rather than a
“necessity”, the greater is the price elasticity of
demand.
Time - Product demand is more elastic the
longer the time period under consideration.
Price Elasticity of Supply - Indicates how
quickly producers shift production levels in
response to price changes.
Is a measure of how sensitive the
quantity supplied of a good is to changes in
price. It is calculated as the percentage change
in quantity supplied divided by the percentage
change in price. If the elasticity is greater than
one, supply is considered "elastic," while if it is
less than one, supply is "inelastic."
Ed = percentage change in quantity supplied of
product X / percentage change in price of
product X
Price elasticity of supply: The Immediate
Market Period
The length of time over which producers
are unable to respond to a change in priced with
a change in quantity supplied.
Price elasticity of supply: The Short Run - A
future period during which one input is fixed
while others are variable. The variation in the
inputs is owing to the fact that the time available
is not enough for all inputs to be changed,
hence, some inputs are fixed while others are
changed
Price elasticity of supply: The Long Run - A
long period of time after the beginning of
something.
In microeconomics is a time period long
enough for firms to adjust
Ei = percentage change in quantity demanded /
percentage change in income
Normal Goods - Have a positive income
elasticity of demand, where a change in demand
and a change in income move in the same
direction
Inferior Goods - Have a negative income
elasticity of demand; as consumers' income
rises, they buy fewer inferior goods.

Antiques and Reproductions - can serve as Insights - Coefficient of income elasticity of

an interesting example of the application of price demand provide insights into the economy.
elasticity of supply because they demonstrate
how different goods can have varying supply
responses to changes in price.

Volatile Gold Prices (Changing) - The price

elasticity of supply for gold is dynamic and
depends on various factors, including short-term
constraints of mining operations, long-term
industry investments, speculative actions, and
the recycling of existing gold. Therefore, the
volatility in gold prices provides an excellent
example of how supply elasticity can vary in
response to changing market conditions and
time frames.

Cross Elasticity of Demand - Is an economic

concept that measures the responsiveness in
the quantity demanded of one good when the
price for another good changes. Also called
cross-price elasticity of demand, this
measurement is calculated by taking the
percentage change in the quantity demanded of
one good and dividing it by the percentage
change in the price of the other good.

Exy = percentage change in quantity demanded

of product X / percentage change in price of
product Y

Income Elasticity of Demand - Refers to the

sensitivity of the quantity demanded for a certain
good to a change in the real income of
consumers who buy this good.
Chapter 7: Utility Maximization
• Law of diminishing marginal utility -
added satisfaction declines as a consumer
acquires additional units of a given product.
• Utility - is want-satisfying power;
satisfaction or pleasure.
• utils - unit of utility
• Total utility - the total amount of
satisfaction or pleasure a person derives
from consuming some specific quantity.
• Marginal utility - the extra satisfaction a
consumer realizes from an additional unit of
the product. It is a change in total utility that
results from the consumption of 1 more unit
of a product.
• Consumer Choice and the Budget
Constraint:
a. Rational behavior - tries to use his or
her money income to derive the greatest
amount of satisfaction, or utility, from it.
b. Preferences - each consumer has
clear-cut preferences for certain goods and
services that are available in the market.
c. Budget constraint - the consumer has a
fixed, limited amount of money income.
d. Prices - Goods are scarce relative to the
demand for them, so every good carries a
price tag.
• Utility-maximizing rule - the consumer
should allocate his or her money income so
that the last dollar spent on each product
yields the same amount of extra (marginal)
utility.
• Consumer equilibrium - the consumer
has "balanced his margins" using the
utility-maximizing rule.
• Theory of consumer behavior - with
limited income and a set of product prices,
consumers make rational choices on the
basis of well-defined preferences.
• Downsloping demand curve - can be
derived by changing the price of one
product in the consumer-behavior model
and noting the change in the
utility-maximizing quantity of that product
demanded.
• Consumer's equilibrium position -
utility-maximizing combination will be the
combination lying on the highest attainable
indifference curve.
• Marginal-utility theory - utility is
numerically measurable, that is, that the
consumer can say how much extra utility he
or she derives from each extra unit of A or
B.
• Indifference curve approach to
consumer behavior - is based on the
consumer's budget line and indifference
curves.
• Budget line - shows all combinations of
two products that the consumer can
purchase, given product prices and his or
her money income.
• Indifference curve - shows all
combinations of two products that will yield
the same total utility to a consumer. It is
downsloping and convex to the origin.
• Indifference map - consists of a number
of indifference curves; the farther from the
origin, the higher the total utility associated
with a curve.