Scarcity & Choice
What is scarcity?
limited resources relative to unlimited wants.
What is absolute advantage?
Absolute advantage = ability to produce more of a good with the same resources.
What happens to equilibrium price and quantity when demand increases?
Equilibrium price ↑, equilibrium quantity ↑.
What is price elasticity of demand?
Price elasticity of demand = % change in Qd / % change in P.
What is consumer surplus?
Consumer surplus = difference between what buyers are willing to pay and what they actually pay.
Opportunity cost
the value of the next best alternative forgone.
What is comparative advantage?
Comparative advantage = ability to produce at a lower opportunity cost.
What are the main determinants of demand (non-price factors)?
Determinants = income, tastes, prices of related goods, expectations, number of buyers.
What does it mean if elasticity > 1, = 1, or < 1?
> 1 = elastic, = 1 = unit elastic, < 1 = inelastic.
What is producer surplus?
Producer surplus = difference between what sellers receive and their minimum willingness to accept.
Give an example of a trade-off in everyday life.
Choosing to study instead of going to a concert(opportunity cost is the concert.)
Why does specialization increase total output?
Specialization → allows each person/country to focus on what they do relatively best, increasing total production.
If supply shifts left but demand shifts right, what can happen to equilibrium quantity?
Equilibrium price is uncertain; equilibrium quantity ↑ (since demand pushes up, supply pulls down).
How does total revenue change when demand is elastic and price rises?
Elastic demand: price ↑ → TR ↓.
On a supply-demand graph, show how a tax affects consumer surplus, producer surplus and deadweight loss.
Tax reduces consumer and producer surplus and creates deadweight loss (triangle between supply & demand after tax).
What is the production-possibilities frontier (PPF)?
PPF = curve showing maximum output combinations of two goods given resources & technology.
If Country A can produce either 10 cheese or 5 wine, and Country B can produce 8 cheese or 4 wine, who has comparative advantage in cheese?
Country A (10 cheese or 5 wine → OC of 1 cheese = 0.5 wine). Country B (8 cheese or 4 wine → OC of 1 cheese = 0.5 wine). They tie in cheese. In wine: A’s OC = 2 cheese, B’s OC = 2 cheese. Tie here too. Trick: no comparative advantage → no gain from trade in this exact setup. (You can tweak numbers in practice so one clearly has advantage.)
Draw a supply-and-demand graph showing a price ceiling below equilibrium. What happens?
A price ceiling below equilibrium → shortage. Quantity demanded > quantity supplied.
What factors make demand more or less elastic?
Elastic if many substitutes, luxury, big share of budget, long run. Inelastic if few substitutes, necessity, small budget share, short run.
What happens to surplus if a price floor is imposed above equilibrium?
Price floor above equilibrium → surplus (unsold goods), reduces consumer surplus, increases some producer surplus, creates deadweight loss.
Explain “marginal cost vs. marginal benefit.”
Marginal cost = extra cost of one more unit;
marginal benefit = extra gain of one more unit. Rational decisions compare the two.
Show how trade can be beneficial even when one country has absolute advantage in both goods.
Even if one country is more efficient in both goods (absolute advantage), trade is beneficial if relative opportunity costs differ. Each specializes in the lower opportunity cost good.
What’s the difference between a movement along the curve vs. a shift of the demand curve?
Movement along the curve = caused by price change. Shift = caused by a non-price determinant (income, tastes, etc.).
Explain cross-price elasticity and income elasticity (give brief examples).
Cross-price elasticity = %ΔQd good A / %ΔP good B (positive = substitutes, negative = complements).
Income elasticity = %ΔQd / %Δ income (positive = normal goods, negative = inferior goods).
Explain in words why deadweight loss happens when the government restricts a market.
Deadweight loss = lost gains from trade that don’t benefit anyone, happens because tax/controls prevent some mutually beneficial trades.