Microeconomics Study Guide: Scarcity, Economic Systems, Demand, Supply, Price, and Elasticity

Scarcity, Economic Issues, and Concepts

Introduction to Scarcity and Economics

Scarcity refers to the fundamental economic problem of having limited resources to satisfy unlimited human wants. Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people.

• Scarcity: Existing supplies of resources are inadequate to fulfill all desires.

• Economics: The study of the use of scarce resources to satisfy unlimited human wants.

Factors of Production

Resources used to produce goods and services are called factors of production, typically divided into:

• Land: Natural endowments.

• Labour: Human and physical resources, including the number of workers and their skills.

• Capital: Manufactured aids to production.

Production, Goods, Services, and Consumption

• Production: The act of making goods or services.

• Goods: Tangible products.

• Services: Intangible products.

• Consumption: The act of using goods or services to satisfy wants.

Opportunity Cost

Opportunity cost is the value of the next best alternative that is forgone when one alternative is chosen.

• Example: If you spend time studying economics instead of working a part-time job, the opportunity cost is the wage you could have earned.

Production Possibility Boundary (PPB)

The PPB is a curve showing which alternative combinations of output can be attained if all resources are used efficiently. It separates attainable from unattainable output combinations.

• Points on the line use all resources.

• Anywhere inside the curve is attainable.

• Anywhere outside the curve is unattainable.

Types of Economic Decision Makers

• Consumers: Purchase goods and services with their income.

• Producers: Firms interested in profits, purchase inputs, and sell products.

• Government: Provide goods and services at no direct cost.

Economic Systems and Specialization

Types of Economic Systems

• Traditional: Decisions based on tradition (e.g., feudal system).

• Command: Decisions made by a central authority (e.g., USSR).

• Free-Market: Decisions made by individuals and producers.

Most economies are mixed, combining elements of all three systems.

Specialization and Division of Labour

• Specialization of labour: Specialization of individual workers in particular goods/services.

• Division of labour: Breaking up production into specialized tasks.

Economic Theories and Data

Positive vs. Normative Statements

• Positive statements: Describe what is, was, or will be; based on facts.

• Normative statements: Describe what ought to be; based on value judgments.

Theory and Economic Variables

• Theory: Rational framework to explain phenomena, consisting of variables, assumptions, and predictions.

• Variables: Well-defined items (e.g., price, quantity).

• Assumptions: Motives, directions of causation, and conditions.

• Predictions: Forecasts deduced from theory.

Correlation and Causation

• Positive correlation: Variables move together.

• Negative correlation: Variables move in opposite directions.

• Correlation does not imply causation.

Index Numbers

Index numbers measure the value of a variable relative to a base period (assigned value 100).

• Formula:

$\text{Index number} = \frac{\text{Absolute value at time t}}{\text{Absolute value in base period}} \times 100$

Demand, Supply, and Price

Demand

Demand is the amount of a good or service that consumers want to purchase during a given time period.

• Quantity demanded: Amount consumers wish to buy at a given price.

• Law of demand: As price increases, quantity demanded decreases (inverse relationship).

• Demand schedule: Table showing relationship between price and quantity demanded.

• Demand curve: Graphical representation of the demand schedule.

Factors that Shift the Demand Curve

• Consumer income

• Prices of other goods

• Consumers' preferences

• Population

• Significant change in weather

Types of Goods

• Normal goods: Quantity demanded increases as income rises.

• Inferior goods: Quantity demanded decreases as income rises.

Related Goods

• Complements: Goods consumed together (e.g., bread and butter).

• Substitutes: Goods consumed in place of each other (e.g., tea and coffee).

Demand Shifts

• Rightward shift: Increased income, increased price of substitutes, increased preferences, increased population, favorable weather.

• Leftward shift: Decreased income, increased price of complements, decreased preferences, decreased population, unfavorable weather.

Supply

Supply is the amount of a good or service that producers want to sell during a given time period.

• Quantity supplied: Amount producers wish to sell at a given price.

• Law of supply: As price increases, quantity supplied increases (direct relationship).

• Supply schedule: Table showing relationship between price and quantity supplied.

• Supply curve: Graphical representation of the supply schedule.

Factors that Shift the Supply Curve

• Price of inputs (land, labour, capital)

• Technology

• Government taxes or subsidies

• Prices of other products

• Significant changes in weather

• Number of suppliers

Examples

• Increase in input prices: Decreases supply.

• Technological improvement: Increases supply.

• Government taxes: Decreases supply.

• Favorable weather: Increases supply (especially in agriculture).

Determination of Price

• Market: Where buyers and sellers negotiate exchange.

• Excess demand: Quantity demanded exceeds quantity supplied.

• Excess supply: Quantity supplied exceeds quantity demanded.

• Equilibrium price: Price at which quantity demanded equals quantity supplied.

Variables in Price Determination

• Endogenous variable: Explained within the theory.

• Exogenous variable: Determined outside the theory.

Elasticity

Price Elasticity of Demand

Price elasticity of demand measures how responsive quantity demanded is to a change in price.

• Elastic demand: Quantity demanded is very responsive to price changes.

• Inelastic demand: Quantity demanded is relatively unresponsive to price changes.

Formula:

$\text{Price elasticity of demand} = \frac{\%\ \text{change in Q}}{\%\ \text{change in p}}$

• $n = 0$: perfectly inelastic

• $0 < n < 1$: inelastic

• $n = 1$: unit elastic

• $n > 1$: elastic

• $n = \infty$: perfectly elastic

Determinants of Elasticity of Demand

• Importance in consumers' budgets (income)

• Availability of substitutes

• Time period

Examples

• If the price of a product increases, consumers may buy a lot less ($n > 1$) or keep buying about as much ($n < 1$).

• Close substitutes (e.g., Pepsi vs. Coke) lead to elastic demand.

• No close substitutes (e.g., electricity) lead to inelastic demand.

• Demand for solar panels is inelastic in the short run, elastic in the long run.

Price Elasticity of Supply

Price elasticity of supply measures how responsive quantity supplied is to a change in price.

Formula:

$\text{Price elasticity of supply} = \frac{\%\ \text{change in Q}}{\%\ \text{change in p}}$

Determinants of Elasticity of Supply

• Ease of substitution

• Time period

Examples

• If the price of a product increases, producers may produce a lot more ($n > 1$) or keep producing about as much ($n < 1$).

• Supply of agricultural products is often inelastic in the short run.

Summary Tables

Factors Affecting Demand and Supply

Factor	Effect on Demand	Effect on Supply
Income	Increases for normal goods, decreases for inferior goods	No direct effect
Price of other goods	Increases for substitutes, decreases for complements	May increase or decrease depending on related products
Preferences	Increases with favorable preferences	No direct effect
Population	Increases with population growth	No direct effect
Weather	May increase or decrease	May increase or decrease, especially in agriculture
Price of inputs	No direct effect	Decreases supply if input prices rise
Technology	No direct effect	Increases supply with improvements
Taxes/Subsidies	No direct effect	Decreases supply with taxes, increases with subsidies
Number of suppliers	No direct effect	Increases supply with more suppliers

Unit Summaries

Unit 1 Summary

• Scarcity is a fundamental problem faced by economies.

• Opportunity cost emphasizes the problem of scarcity and choice.

• Market economy is self-organizing; consumers and producers act in their own self-interest.

• Consumers seek to maximize well-being; producers seek to maximize profits.

• Modern economies are based on specialization and division of labour.

• Governments play an important role in mixed economies.

Unit 3 Summary

• The amount consumers want to purchase is called quantity demanded. A shift in demand represents a change in the quantity demanded at each price.

• The amount producers wish to sell is called quantity supplied. A shift in supply indicates a change in the quantity supplied at each price.

• Equilibrium price is where quantity demanded equals quantity supplied.

• Excess demand at lower prices and excess supply at higher prices.

• Comparative statics can determine the effects of shifts in demand or supply.

Unit 4 Summary

• Price elasticity of demand and supply measure responsiveness to price changes.

• Elasticity is determined by factors such as income, availability of substitutes, and time period.

• Elastic demand/supply responds strongly to price changes; inelastic responds weakly.