PRINCIPLES OF ECONOMICS opportunity cost

- whatever must be given up to

CHAPTER 1: TEN PRINCIPLES OF
obtain some item
ECONOMICS
- It is the relevant cost for
scarcity decision making
- the limited nature of society’s Example:
resources - the opportunity cost of going
economics to college for a year is not just
- the study of how society manages the tuition, books, and fees, but
its scarce resources, e.g also the foregone wages
- how people decide what to buy, how Principle 3: Rational People
much to work, save and spend Think at the Margin
- how firms decide how much to rational people
produce, how many workers to hire - people who systematically and
- how society decides how to divide purposefully do the best they
its resources between national can to achieve their objectives
defense, consumer goods - make decisions by evaluating
HOW PEOPLE MAKE DECISIONS cost and benefits of marginal
changes
Principle 1: People Face Trade- - incremental adjustments to an
offs existing plan
- Society faces an important trade off:
Efficiency vs equality Example:
efficiency - when a managers considers
- the property of society getting the whether to increase output, she
most it can from its scarce resources compare the cost of the needed

equality Principle 4: People Respond

- the property of distributing to Incentives
economic prosperity uniformly among incentive
the members of society - something that induces a
- trade off: to achieve greater person to act
equality, could redistribute income - rational people respond to
from wealthy to poor. But this incentives
reduces incentives to work and
produce, shrinks the size of the Example:
economic “pie” - when cigarette taxes increase,
teen smoking falls
Example:
- Going to a party the night before
your midterm leaves less time for
studying
Principle 2: The Cost of
Something Is What You Give Up
to Get It
- Making decisions requires
comparing the cost and benefits of
alternative choices
 determines the prices
- Each price reflects the good’s
value to buyers
and the cost of producing the
HOW PEOPLE INTERACT good
- Prices guide self-interested
Principle 5: Trade Can Make
households and
Everyone Better Off
firms to make decision that,
- rather than being self-sufficient,
in many cases,
people can specialize it producing
maximize society’s economic
one good or service and exchange it
well-being
for other goods
- Countries also benefits from trade & Principle 7: Governments
specialization Can Sometimes Improve
- Get a better price abroad for Market Outcomes
goods they produce - Important role for govt:
- Buy other goods more cheaply enforce property rights (with
from police, courts)
abroad than could be produce at - People are less inclined to
home work, produce, invest or
purchase if large risk of their
Principle 6: Markets Are Usually a
property being stolen
Good Way to Organize Economic
Activity property rights
Market: - the ability of an individual to
- a group of buyers and sellers (need own and exercise control over
not be in a single location) scarce resources
- “Organize economic activity”means
market failure
determining
- a situation in which a market
- what good to produce
left on its own fails to allocate
- how to produce them
resources efficiently
- how much of each to produce
- who gets them Causes:
externality
market economy
- the impact of one person’s
- an economy that allocates resources
actions on the well-being of a
through the decentralized decisions
bystander (e.g. pollution)
of many firms and households as they
interact in markets for goods and market power
services - the ability of a single
- Insight by Adam Smith in The economic actor (or small group
Wealth of Nation (1776) of actors) to have a substantial
Each of these households and firms influence on market prices (e.g.
act as if“led by an invisible hand” monopoly)
- The invisible hand works through - Govt may alter market
the price system outcome to promote equality
- The interaction of buyers and - If the markets distribution of
sellers economic well-being is not
desirable, tax or welfare policies can unemployment in opposite
change how the economic “pie”is directions.
divided - Other factors can make this
trade off more or less favorable,
HOW THE ECONOMY AS A WHOLE
but the trade off is always
WORKS
present.
Principle 8: A Country’s Standard
of Living Depends on Its Ability CHAPTER 2: THINKING LIKE AN
to Produce Goods and Services ECONOMIST
- Huge variation in living standard Economist play two roles:
across countries and overtime 1. Scientist - try to explain the
- Average income in rich countries is world
more than ten time average 2. Policy advisor - try to
improve it
ASSUMPTIONS AND MODELS
Assumptions - simplify the
complex world and make it
income in poor countries easier to understand
- The most important determinant of Model - a highly simplified
living standards: productivity the representation of a more
quantity of goods and services complicated reality
produced from each unit of labor The Circular-Flow Diagram
input - a visual representation of the
- Productivity depends on the economy, shows how dollars
equipment, skills and technology flow through markets among
available to workers household and firm
- Other factors (e.g., labor unions, - offers a simple way of
competition from abroad) have far organizing the economic
less impact on living standards transactions that occur between
Principle 9: Prices Rise When the households and firms in the
Government Prints Too Much economy
Money
inflation
- an increase in the overall level of
prices in the economy
- in the long run, printing more
money almost always cost inflation
- the faster the govt creates money,
the greater the inflation rate
Principle 10: Society Faces a
Short-Run Trade-off between
Inflation and Unemployment
- In the short-run (1-2 years) many
economic policies push inflation and
 - The opportunity cost of an
- Inner loop represents the flow of item is what you give up to get
inputs and outputs that item.
- outer loop represents the - The slope of the PPF indicates
corresponding flow of dollars the opportunity cost of one
good in relation to another.
two types of decision maker
- Moving along a PPF involves
- firm
shifting resources from the
- household
production of one good to the
two markets other
- the market for goods and services
- the market for “factors of How to calculate slopes?
production
- resources that the economy use to
produces goods and services (e.g.
land, labors,capital)
The Production Possibilities
Frontier
- a graph depicting the possible
combinations of two goods that the
economy can generate given the
available resources and technology

- Slope = rise/run

The Shape of PPF

- The PPF could be a straight
line or bow-shaped
- Depends on what happens to
opportunity cost as economy
shifts resources from one
industry to the other
- If opportunity cost remain
constant, PPF is a straight line
- If opportunity cost of a good
rises as the economy
produces more
of the good, PPF is bow-
shaped
Why the PPF might be bow-
shaped
The PPF and Opportunity Cost
- As the economy shift resources from
crabs to pineapples:
- PPF become steeper
- opportunity cost of pineapples
Increases

PPF Summary:
- The PPF shows all combination
of two goods that an economy
can produce, given its resources
and technology
- The PPF illustrates the
concepts of tradeoffs and
opportunity cost, efficiency and
- each point along our PPF (i.e. Point inefficiency, unemployment and
A) is efficient (in a one person economic growth
world) since there is no way to get - A bow-shaped PPF illustrates
more pineapples without giving up the concept of increasing
some crabs and vice-verse. opportunity cost
- If we are inside the PPF (i.e. Point Microeconomics and
B), we are not fully using our Macroeconomics
resources. In this case, we can - Microeconomics is the study of
produce more pineapples without how households and firms make
having to give up any more crabs. decisions and how they interact
This point is inefficient. in markets
- Macroeconomics is the study
- Points outside the PPF (i.e. Point C),
of economy-wide phenomena,
while preferable, are unattainable
including inflation,
given constraints in resources and
unemployment, and economic
time
growth
Positive vs. Normative
- As scientists, economists make
positive statements.
As policy advisors, economists make CHAPTER 3: INTERDEPENDENCE
normative statements. AND THE GAINS FROM TRADE
- A positive statement is a statement
that describes the world as it is, while INTERDEPENDENCE
a normative statement is a statement - relationship between two
that describes how the world should individuals, groups, or countries
be where each of them is
dependent over the other for
the supply of necessary goods
and services - “Tomasetii,
2023”
GAIN
- to get something that is
useful, that gives you an
advantage, or that us in some
way positive, especially over a
period of time
TRADE
- voluntary exchange of goods
or services between different
economic actors
PRODUCTION POSSIBILITIES
FRONTIER
- shows all the different output
combinations of two goods that can - A mutually advantageous
be produced using available trade can be struck at a price
resources. between 2 and 4.
THE LEGACY OF ADAM
SMITH AND DAVID RICARDO
- Father of Economics
- Propounded the Absolute
Advantage Theory in 1776
- An entity is more efficient in
SPECIALIZATION AND TRADE producing their products
compared to others
Comparative Advantage: The Driving
Force of Specialization
1. Absolute Advantage
- compare productivity of one
producer to another.
- producer that requires smaller
quantity of inputs to produce a good
has an absolute advantage in
producing that good.
2. Opportunity Cost and
Comparative Advantage SUMMARY
OC - whatever must be given up to - Interdependence and the
obtain some item gains from trade talks about
how countries depend on each
other for goods and services.
- The Production Possibilities
Frontier illustrates the
CA - the ability to produce a good at
different output combinations of
a lower opportunity cost than another
two goods produced using
producer
available resources
3. Comparative Advantage and - Absolute Advantage focuses
Trade on the amount of input needed
- Trade can benefit everyone in to produce goods or services,
society because it allows people to while Comparative
specialize in activities in which they Advantage focuses on the
have a comparative advantage lower opportunity cost.
4. The Price of the Trade - Adam Smith believed that for
- For both parties to gain from trade, trade to happen, one producer
the price at which they trade must lie must specialize in something.
between the two opportunity costs. David Ricardo believed
otherwise.
CHAPET 4: THE MARKET FORCES OF - a company that must accept the
SUPPLY AND DEMAND prevailing prices in the markets
of its products, its own
SUPPLY transaction being unable to affect
- Eager beaver of the market the market price.

MONOPOLY
- Refers to the actual amount of goods - a market structure where a
and services single seller or producer assumes
- The act or process of filling a want or a dominant position in an
need industry or a sector

DEMAND DEMAND
- The quantity of a commodity or The Demand Curve: The
service wanted at a specified price and Relationship between Price and
time Quantity Demanded
- when the customer declares - The quantity demanded of any
something good is the amount of the good
- the life of the economic party that buyers are willing and able
to purchase. In the analysis of
What is Market? how markets work, one
- a group of buyers and sellers of a determinant plays a central role—
particular good or service the price of the good.

Market take many form If the price of ice cream rose to

- some markets are highly organized, $20 per scoop, you would buy
use specific times and places for less ice cream. You might buy
transaction to ensure quality and frozen yogurt instead. If the price
fairness of ice cream fell to $0.20 per
- market are less organized, allow scoop, you would buy more.
buyers and sellers to make
independent decisions, posting prices This relationship between price
and choices without centralized and quantity demanded is true
coordination. for most goods in the economy
and, in fact, is so pervasive that
What is competition? economists call it the law of
- a market in which there are many demand: Other things equal,
buyers and many sellers so that each when the price of a good rises,
has a negligible impact on market price the quantity demanded of the
good falls, and when the price
To reach the highest form of falls, the quantity demanded
competition, a market must have two rises.
characteristics
- the goods offered for sale are all
exactly the same
- The buyers and sellers are so
numerous that no single buyer or seller
has any influence over the market

PRICE TAKER
 The demand
schedule is a
table that shows
the quantity
demanded at
each price.

MARKET DEMAND VS INDIVIDUAL

DEMAND
INDIVIDUAL DEMAND
- Refers to the demand for a good or
services by an individual (or a
household)
MARKET DEMAND
- is the sum of all individual
demand for a particular good and
service

Shifts in the Demand Curve

- Because the market demand
curve holds other things
constant, it need not be stable over - market demand depends on the
time. If something happens to alter number of these buyers. More
the quantity demanded at any given buyers mean higher demand; if
price, the demand curve shifts. more people want ice cream, the
demand for it in the market
Suppose the American Medical increases.
Association discovered that people 4. Income
who regularly eat ice cream live - When you have less money
longer, healthier lives. The discovery due to a lower income, you'll
would raise the demand for ice likely buy fewer things.
cream. At any given price, buyers
would now want to purchase a larger 5. Taste
quantity of ice cream, and the - The most obvious determinant
demand curve for ice cream would of your demand is your tastes.
shift It is your personal preference
for a product. If you like ice
cream, you buy more of it.
6. Expectation
- The most obvious determinant
of your demand is your tastes.
It is your personal preference
for a product. If you like ice
cream, you buy more of it.
normal good
- a good for which, other things
being equal, an increase in
Shift in the Demand Curve income leads to an increase in
Increase in demand: Any changes demand
that increases the quantity demanded inferior good
at every prices, shifts the demand - a good for which, other things
curve to the right. being equal, an increase in
Decrease in demand: Any change income leads to a decrease in
that reduces the quantity demanded at demand
every price shifts the demand curve to substitutes
the left. - two goods for which an
Variables that can Shift the increase in the price of one
Demand Curve leads to an increase in the
1. Price of goods demand for the other
complements
2. Price of related goods - two goods for which an
- refer to how the cost of one product increase in the price of one
can affect the demand for another; for
leads to a decrease in the
example, if the price of coffee
demand for the
increases, people might buy more tea
instead. for the other

3. Number of buyers SUPPLY

The Supply Curve: The Relationship
between Price and Quantity Supplied
quantity supplied
- the amount of a good that sellers
are willing and able to sell
law of supply
- the claim that, other things being
equal, the quantity supplied of a good
rises when the price of the good rises
supply schedule
- a table that shows the relationship
between the price of a good and the
quantity supplied
supply curve
- a graph of the relationship between
the price of a good and the quantity
supplied

- As the price of ice cream cones

increases, the quantity supplied
increases
- This is because sellers are more
willing and able to produce and sell
ice cream cones when they can earn
a higher profit.
MARKET SUPPLY VS INDIVIDUAL
SUPPLY
INDIVIDUAL SUPPLY
- the amount of a commodity that a
certain company is willing and able to
sell at a specific price during a SHIFTS IN THE SUPPLY CURVE
specific period - A shift in the supply curve
MARKET SUPPLY happens when something
- the sum of the supply of all sellers. changes that makes businesses
want to produce more or less of
a product at all price points, without - Better and more efficient ways
considering the price itself of making a product can lead to
more of it being available
Suppose the price of sugar falls.
because it's easier and cheaper
Sugar is an input into producing ice
to produce.
cream, so the fall in the price of sugar
makes selling ice cream more 6. Expectation
profitable - Firms might change how much
they make and sell today based
on what they think will happen
in the future with prices or
demand for their product.

SUPPLY AND DEMAND

TOGETHER

Increase in supply: Any change that raises

quantity supplied at every price shift the
supply curve to the right.
Decrease is supply: Any change that reduces
the quantity supplied at every price shifts the
supply curve to the left.

Variables that can Shift the Supply The Equilibrium of Supply and
Curve Demand The equilibrium is
1. Price found where the supply and
demand curves intersect. At the
2. Population equilibrium price, the quantity
3. No. of seller supplied equals the quantity
- The more businesses there are demanded. Here the equilibrium
selling a product, the more of that price is $2.00: At this price, 7
product will be available in the ice-cream cones are supplied
market; if some businesses stop and 7 ice-cream cones are
selling, there will be less of the demanded.
product around. equilibrium
4. Input prices - a situation in which the market
- When the cost of the things needed price has reached the level at
to make a product goes up, which quantity supplied equals
companies make less of that product quantity demanded
because it's not as profitable. equilibrium price
5. Technology - the price that balances
quantity supplied and quantity
demanded
 3. Use the supply-and-demand
equilibrium quantity
diagram to see how the shift
- the quantity supplied and the
changes the equilibrium price
quantity demanded at the equilibrium
and quantity
price

CHAPTER 6: Supply, Demand,

and Government Policies
Economists Play Two Roles
surplus Scientist - develop and test
- a situation in which quantity theories
supplied is greater than quantity Policy markers - use the
demanded theories
“The price is too high, we can ’t
afford it”
“The price is too low, how can
we earn a sale?”
Control on Prices
price ceiling
- a legal maximum on the price
at which a good can be sold
price floor
- a legal minimum on the price
at which a good can be sold

shortage
- a situation in which quantity
demanded is greater than quantity
supplied

Three Steps to Analyzing

Changes in Equilibrium
1. Decide whether the event shifts
the supply or demand curve (or
perhaps both).
2. Decide in which direction the curve
shifts.
How Price Floors Affect Market
Outcomes

Evaluating Price Control

Principle 6: Markets are ways to
arrange economic event
Principle 7: Government
sometimes improve market
outcomes
Other Ways than Controlling
Prices
- Government paying a fraction
of a price
- Wage Subsidies
Example: Earned income tax credit 3. By comparing previous and
new equilibrium, tax reduces the
Taxes size of a market.
- Government use taxes to raise
revenues for public projects
tax incidence
- the manner in which the burden of a
tax is shared among participants in a
market
How Taxes on Sellers Affect To SUM UP:
Market Outcomes - Taxes discourage market
1. We decide whether the law affects activity.
the supply curve or demand curve. - Buyers and sellers share the
2. We decide which way the curve burden of taxes
shifts
\

HOW TAXES ON BUYERS

3. We examine how the shift affects AFFECT OUTCOMES?
the equilibrium price and quantity.
A Tax on Buyers When a tax of $0.50
A Tax on Sellers When a tax of $0.50 is levied on buyers, the demand
is levied on sellers, the supply curve curve shifts down by $0.50 from D1
to D2. The equilibrium quantity falls
shifts up by $0.50 from S1 to S2. The
from 100 to 90 cones. The price that
equilibrium quantity falls from 100 to sellers receive falls from $3.00 to
90 cones. The price that buyers pay $2.80. The price that buyers pay
rises from $3.00 to $3.30. The price (including the tax) rises from $3.00 to
that sellers receive (after paying the $3.30. Even though the tax is levied
tax) falls from $3.00 to $2.80. Even on buyers, buyers and sellers share
the burden of the tax.
though the tax is levied on sellers,
buyers and sellers share the burden
of the tax

Implications:
1. Taxes levied on sellers and
taxes levied on buyers are
How Taxes on Buyers Affect Market equivalent.
Outcomes 2. The wedge shifts the relative
1. Demand curve does not change position of the demand and
whereas supply curve shifts. supply curves
2. Supply curve shifts to the left. Supply
curve moves upward from S1 to S2
3. In the new equilibrium, buyers and
sellers share the burden of tax.
Elasticity and Tax Incidence
- “When a good is taxed, buyers and
sellers share the burden of the tax. But
how exactly is the tax burden divided?
How the Burden of a Tax Is Divided
In panel (a), the supply curve is
elastic, and the demand curve is
inelastic. In this
case, the price received by sellers
falls only slightly, while the price paid Sellers are not very responsive.
by buyers rises substantially. Thus, Buyers are responsive to price
buyers bear most of the burden of the changes.
tax. In panel (b), the supply curve is Sellers bear most of the
inelastic, and the demand curve is problem on tax.
elastic. In this case, the price Buyers bear only a small burden
received by sellers falls substantially, on tax
while the price paid by buyers rises
only slightly. Thus, sellers bear most Summary
of the burden of the tax. - A price ceiling is a legal
maximum on the price of a
good or service
- a price floor is a legal
minimum on the price of a good
or service
- A tax on the market shrinks
the size of the market
- buyers pay more for the good
and sellers receive less thus,
buyers and sellers share the tax
burden.
Seller is responsive to changes in - the incidence of a tax depends
price. on the price elasticity of a
Buyers are not very responsive. supply and demand
Sellers bear only a small burden on
tax.
Buyers bear most of the burden on CHAPTER 7: Consumers,
tax Producers, and the Efficiency of
Markets
welfare economics
- the study of how the allocation
of resources affects economic
well-being
- In any market, the equilibrium, or
the point where the demand and
supply meets, maximizes the total
benefits received by all buyers and
consumers combined.
DID YOU KNOW?
- Maximized welfare is not actually
the ultimate goal of consumers and
sellers in the market? Both parties
engage in a transaction because they Using the Demand Curve to
have separate personal intentions Measure Consumer Surplus
to fulfill.
Consumer Surplus
willingness to pay
- the maximum amount that a buyer
will pay for a good

consumer surplus
- the amount a buyer is willing to pay
for a good minus the amount the
buyer actually pays for it
For instance, if Taylor bids 80$, all
the other three have already dropped
out. Therefore, Taylor receives a $20
benefit from participating in the
auction because she pays only $80
for a good she values at $100. At any quantity, the price given
In this situation, the bidding stops by the demand curve shows the
when Taylor and Carrie bid $70. willingness to pay of the
Taylor and Carrie each receive marginal buyer, the buyer who
consumer surplus equal to her would leave the market first if
willingness to pay minus the price. the price were any higher
So, if the price is between 70 to
80 dollars, the quantity
demanded for the album is 2,
because it is where Taylor and Carrie A lower price gives initial buyers
' s willingness to pay lies additional consumer surplus and
also increases the number of
How a Lower Price Raises consumers buying a product
Consumer Surplus

1. When the price falls from P1

Consumer Surplus to P2, as in panel (b), the
- is measured as the area above the price quantity demanded rises from
and below the demand curve. Q1 to Q2 and the consumer
Observations surplus rises to the area of the
- The area below the demand curve and triangle ADF.
above the price measures the consumer 2. The increase in consumer
surplus in a market. surplus (area BCFD) occurs in
- The difference between this willingness
part because existing
to pay and the market price is each buyer
‘s consumer surplus.
consumers now pay less (area
- Thus, the total area below the demand BCED) and in part because new
curve and above the price is the sum of consumer enter the market at
the consumer surplus of all buyers in lower price.(area CEF)
the market for a good or service.
- The goal in developing the
What Does Consumer Surplus concept of consumer surplus is
Measure? to make judgments about
the desirability of market
outcomes.
- In some circumstances,
policymakers might choose to
disregard consumer surplus because
they do not respect the preferences
that drive buyer behavior. Example:
Drug addicts
- Consumers are the best judges of
how much benefit they receive from
the goods they buy

Producer Surplus
- If the consumer surplus analyzes
the amount a buyer is willing to pay
for a good less the actual amount the
buyer has paid for the good,
producer surplus is the amount a
seller is paid for a good less the seller
’ s cost of providing it.
- measures the benefits that sellers
receive from participating in a market
- amount a seller is paid for a good less
the seller ’ s cost of providing it. Marginal seller
Cost - refers to a seller who leaves
- the value of everything a seller must the market first once the price
give up to produce a good goes lower than their cost of
RELATIONSHIP OF PRICE, COST TO production
THEIR WILLINGNESS TO SELL Using the Supply Curve to
IF THE PRICE IS: Measure Producer Surplus
1. GREATER THAN THE COST
- the seller would be enthusiastic to - If the price set for the good
perform the job if the price is greater than amounts to 600$ then we can
his cost already determine that the
producer surplus for Andy is
2. EQUAL TO THE COST
- the seller would be lukewarm about the 100$ which is also the area
offer, or they show no particular interest below the price and above the
in doing the task. supply curve
3. LESS THAN THE COST
- the seller will refuse to do the task if the
price does not exceed the cost
 sellers already in the market as
compared to the previous
example wherein four sellers
only compete in one market.

Let us assume that 800$ is the

settled price for the good. Looking at
the area below the price and above
Andy ’ s determined cost, 300$ will
be the producer surplus of Andy.
Whereas, the area below the price
and above Pablo ’ s determined cost
amounts to 200$, considering that
600$ is Pablo ’ s determined cost to P1 = Initial Price
render the service. Q1 = Initial quantity produce
For us to obtain the total producer Red line = supply curve
surplus, we will simply add Andy ’ s
Upon determining the quantity
and Pablo ’ s producer surplus. So, it
of products produced relative to
will result in 500$
a certain price, it formed
REMEMBER: Triangle ABC, which is the
The area below the price and above the producer surplus
supply curve measures the producers
surplus in the market. It can be
determined through:
The height of the supply curve that
1.

measures the sellers ’ costs

2. The producer surplus which is
the difference between the price and
the cost of production
3. The total area that sums up the
producer surplus of all sellers.
How a Higher Price Raises
Producer Surplus
- The shape of the supply curve
change from the previous ladder-like
curve because there are innumerable
P2 = new price - the property of a resource
allocation of maximizing the total
Q2 = new quantity produced surplus received by all members
Red line = supply curve of society
- If an allocation of resources
- After the increase in price, the maximizes total surplus, we say
producer surplus is now equivalent to that the allocation exhibits
Triangle ADF, which implies that an efficiency.
increase in price will result in increase
in both quantity supplied and Equality
producer surplus. - the property of distributing
- Those sellers who were already economic prosperity uniformly
selling in Q1 of the goods at a lower among the members of society
price now benefit from the increase in - One of the concepts
price because they now get more for policymakers consider when
what they sell (Rectangle BCED) creating and implementing
- The increase in price results in new policies
sellers entering the market. EFFICIENCY AND EQUALITY
- They see the potential to earn a lot - Gains from market trade are
because there was an increase in like sharing a pie among the
price. market participants.
- Since more sellers are added to the Efficiency is concerned if the
market, more goods are produced pie is as big as possible,
and in turn the producer surplus whereas equality is concerned
increases. (Triangle CEF) with how the pie is sliced and
Market Efficiency how the portions are distributed
- the allocation of resources evenly to the members.
determined by free markets desirable Evaluating the Market
The Benevolent Social Planner Equilibrium
- an all-knowing, all-powerful, well-
intentioned dictator

1. Free markets allocate the

Efficiency supply of goods to the buyers
who value them most highly, as
measured by their willingness to pay. Markets are perfectly
competitive.
2. Free markets allocate the demand
- But, in reality, competition is
for goods to the sellers who can
not really as perfect as it
produce them at the lowest cost.
seems, because in some
3. Free markets produce the quantity markets, monopolistic
of goods that maximizes the sum of competition prevails
consumer and producer surplus. - In monopolistic competition,
only a single seller or a small
MARKET EFFICIENCY group of buyers may have the
The planner wants to maximize the market power or the ability to
economic well-being of everyone in control the market prices.
society. What should this planner do?
The outcome in a market
Should she just leave buyers and
matters only to the buyers and
sellers at the equilibrium that they
sellers who participate in that
reach naturally on their own? Or can
market; however, the decisions
she increase economic well-being by
of both participants affect those
altering the market outcome in some
who do not participate in that
way?
particular market, also known
The benevolent social planner as externalities.
must leave them on their own.
The economy is led by an
SUMMARY
invisible hand. (Adam Smith, The
- Consumer surplus equals
Wealth of Nations)
buyers ’ willingness to pay for a
Laissez faire - let people do as they good minus the amount they
will actually pay.
- Producer surplus equals the
MARKET EFFIECIENCY AND
amount sellers receive for their
MARKET FAILURE
goods minus their costs of
Buyers who have a high appreciation production.
of the value of goods because they
- An allocation of resources that
are more willing to pay a large
maximizes total surplus is said
amount of money in exchange for
to be efficient.
what they want to buy
- The equilibrium of supply and
Sellers who can produce goods at
demand maximizes total
the lowest cost are the focus and
surplus.
q1large demand of this market
because they have the capacity to - Markets do not allocate
produce a product of high quality resources efficiently in the
despite low production costs and presence of market failures
limited resources such as market power or
externalities.
TWO MOST IMPORTANT
ASSUMPTION