You are on page 1of 5


Chapter 1:

Economics revolves around the scarcity principle; wants are unlimited but
resources are not.
Economic decisions are concerned with maximising consumer surplus.
They involve opportunity costs (trade-offs)
o In determining the trade-offs, one must take into account the costbenefit principle; only undertake an action if the marginal benefit
equals or exceeds the marginal cost
Economic surplus: difference between benefit arising from an action and
the cost of its undertaking
Opportunity cost: what was given up/what was received
Ceteris paribus: all other things being equal (important in economic
Incentive principle: an individual is more likely to undertake an action if its
benefit rises and its cost falls
Positive economics: analysis that explains what will happen and why, but
not what should happen (i.e. what will happen because of human
Normative economics: analysis that states what should happen
(economically optimal)
o Failing to account for all opportunity costs
o Failing to account for all benefits
o Failing to consider time as a resource
o Failing to ignore sunk costs
o Failing to know when to use marginal benefits/costs vs average
o Failing to measure costs/benefits in absolute terms rather than

Chapter 2:

Absolute advantage: where one person is able to produce more than

another given the same amount of resources
Comparative advantage: where someone has a lower opportunity cost
than another
Specialisation occurs where an individual focuses on one area of
production. An individual should specialise in his area of lowest
comparative advantage to maximise total output of the economy
o The increase in total production is greater as the difference in
opportunity cost increases
Production possibility curve: graphical representation of the potential
output of one good in relation to another
o Attainable points: points along or within the PPC
o Unattainable points: points outside the PPC
o Efficient: points along the PPC
o Inefficient: points within the PPC

Many-person economy: PPC is represented as a curve rather than as a

straight line. Reflects the principle of increasing opportunity cost
Shift in the PPC reflects an increase in productive capacity (economic
growth). Factors than drive economic growth:
o Increase in amount of resources
o Increase in quality of resources/technology/knowledge

Chapter 3:

Market: a market is the collective of all buyers and sellers for a good or
Demand curve: slopes down due to law of demand as price increases,
demand for a product falls (i.e. consumer surplus falls). Relationship
between price and quantity demanded
Supply curve: slopes up due to law of supply as price increases, suppliers
are willing to provide more (i.e. producer surplus increases). Relationship
between price and quantity supplied
Substitution effect: change in demand for a good/service due to the
change in price of another good/service, causing said good to become
cheaper/more expensive relatively
Income effect: change in demand for a product due to a change in price,
causing the PPP of the consumer to change
Vertical interpretations:
o demand consumers reservation price (highest price willing to pay)
o supply suppliers reservation price (lowest price willing to sell)
Market equilibrium: occurs at a price where quantity demanded and
supplied is the same
Excess supply (surplus): price is too high, usually occurs due to price floor
Excess demand (shortage): price is too low, usually occurs due to price
Difference between demand/supply and quantity demanded/supplied
Cash on the table: unexploited gains from exchange, occurs when market
is in disequilibrium
Socially optimum quantity: quantity whereby the difference in total benefit
and total cost of producing+consuming a good is maximised. (the point at
which marginal cost and benefit are the same).
Efficiency: where all goods are produced at their socially optimal quantity
Equilibrium principle (no cash on the table): market is at equilibrium; there
are no unexploited opportunities

Chapter 4:

Elasticity: responsiveness of one variable in relation to a change in another

Demand elasticity: percentage change in quantity demanded over a one
percent change in price. The value of demand elasticity tells us whether
the good is elastic/inelastic
o <1: inelastic
o =1: unit elastic
o >1: elastic

Determinants of elasticity:
o Substitution: goods with substitutes will be more elastic than those
that dont
o Budget share: goods comprising a lower proportion of budget share
(salt) are likely to be less elastic than those of higher proportion
(plane tickets)
o Time: in the short term, products are less elastic than in the long
term as it takes time to seek out alternatives
o Luxury or necessity: necessities are less elastic than luxury items
Calculating demand elasticity:
o Percentage change quantity/percentage change price
o Point elasticity: P/Q x 1/slope

o Midpoint elasticity:


(Q1+Q2)/2 (P1+P2)/2

Special cases:
o Perfectly elastic: demand is infinite at one price, but is zero at any
price above it
o Perfectly inelastic: demand is infinite regardless of price
Elasticity and total expenditure: total expenditure/revenue varies with
elasticity of a product. Total revenue = price x quantity. Price and quantity
always move in opposite directions (law of demand). Increase in price does
not always result in increased revenue
o For a product with a straight line demand curve, the total revenue
curve is a parabola (there is a maximum revenue point)
For a product with elasticity > 1, price and total revenue changes move in
different directions
For a product with elasticity < 1, price and total revenue changes move in
the same direction
Income elasticity of demand: percentage change of quantity demanded in
relation to a 1 percent change in income
o Negative elasticity: good is inferior
o Positive elasticity: good is normal
Cross-elasticity: percentage change of quantity demanded in relation to a
1 percent change in the price of another good
o Negative elasticity: goods are complements
o Positive elasticity: goods are substitutes
Price elasticity of supply: percentage change in quantity supplied in
relation to a 1% change in price.
o Calculated same way as elasticity of demand
Determinants of price elasticity of supply:
o Flexibility of inputs: more flexible = more elastic
o Mobility of inputs: more mobile = more elastic
o Ability to produce substitute inputs: more easily = more elastic
o Time: less elastic in short term than in long term

Chapter 5:

Utility: satisfaction. Economics is about maximising utility/consumer


Marginal utility: extra utility that results from taking an extra action.
To maximise utility, consume until marginal utility is as close to 0 as
Law of diminishing marginal utility: tendency for marginal utility to
decrease as consumption of a good or service increases
MU1/P1 = MU2/P2. Want MU to be equal; buy more of the one that yields
higher MU until optimal combination of goods (yielding highest total utility)
is reached
Rational spending rule: spending should be allocated so that MU1/P1 =
Individual and market demand curves: market demand curve is the sum of
all individual demand curves
Consumer surplus: difference between reservation price and price actually
o Calculated as the area under the demand curve, upwards from the
price paid.

Chapter 6:

Market supply curve curves upwards due to increasing opportunity costs;

suppliers exhaust means of lowest opportunity cost first. Also because
different individuals have different opportunity costs. Market supply curve
is the sum of all individual supply curves
Firms will typically aim to maximise profit (difference between total
revenue and costs)
Perfect competition:
o Homogenous product
o No barriers to entry/exit
o Buyers and sellers are well informed
o Buyers and sellers comprise an insignificant proportion of the
o Suppliers are price takers; they have no influence on the market
price. I.e. the demand for the firms product is perfectly elastic.
Price is set by market demand and supply interaction
Short-term production: period where at least one factor of production is
Long-term production: all factors are variable
Law of diminishing returns: in the short-term, marginal product decreases
as variable inputs increase. Usually due to congestion (1 computer, more
workers will result in less increase)
o More inputs required to achieve outputs, resulting in increased
variable costs
Fixed cost: sum of payments made to fixed factors of production
Variable cost: sum of payments made to variable factors of production
Total cost: variable + fixed cost
Marginal cost: change in cost/change in output
o Maximum profit where marginal revenue = marginal cost (costbenefit)
Short-term shutdown: firm should shutdown if PQ < VC at all values of Q.
Alternately, firm should shut down if P < AVC

Firm assumes FC, but would not lose as much as it would if it stayed
open (VC)
Firms profit = total revenue total cost (PQ ATCxQ). Profitable if P > ATC
o Maximum profit where P = MC. Profit = (P-ATC)xQ

Chapter 7:

Pareto efficiency: situation in which trade is not possible such that one
person is made better off without making another worse off.
Pareto-improving transaction: transaction that betters one without
harming another
Whenever market is not in equilibrium, there is forgone economic surplus
Subsidies: reduce economic surplus since subsidy is not free (represents
an opportunity cost)
Compensation policy is more efficient than the first come first served
Event organisers underprice to maintain image of event or to garner
goodwill from patrons
o Leaves cash on the table ticket scalping
Tax: for a product with perfectly elastic supply, tax is completely borne by
consumer. For a product with perfectly inelastic supply, tax is borne by
Deadweight loss: reduction in total economic surplus that results market
operates at a point where marginal cost does not equal marginal
revenue/benefit. (surplus lost to the market)
o Deadweight loss is smaller if elasticity of demand/supply is low

Chapter 8:

Consumption possibility frontier (CPC): graphical representation of an

economys potential consumption of a good relative to another good.
o In a closed economy, CPC = PPC. In an open economy, CPC > PPC.
(tangent to PPC)
Economy opens up to international trade, world price becomes the
domestic price
o If original domestic price > world price, product will be imported
o If original domestic price < world price, product will be exported
(comparative adv.) Specialisation, will become net exporter
While opening up to free trade does result in some loss of economic
surplus, the gain is much greater.
Protection: policies that give domestic industries an artificial advantage
over foreign producers
o Tariffs and quotas are forms of protection; they cause market