ECONOMICS 4th Ed.

(STIGLITZ)
Chapter reviews
Chapter 1: modern economics
1. Economics is the study of how individuals, firms, and governments within our society
make choices. Choices, and therefore trade-offs are unavoidable because desired
goods, services, and resources are inevitably scarce.
2. Economists study how individuals, firms, and governments within our society make
choices by focusing on incentives. People respond to changes in incentives by altering
the decisions they make.
3. Exchange occurs in markets. Voluntary exchange can benefit both parties.
4. Making choices requires information. Limited or imperfect information can interfere with
incentives and affect the ability of the private market to ensure an efficient use of
societys scarce resources.
5. The incomes people receive are determined by the market economy. Concerns over the
equitable distri bution of wealth and income in the economy lead to government
programs that increase income equality.
6. The United States has a mixed economy, one in which there is a mix of public and
private decision making. The economy relies primarily on the private interaction of
individuals and firms to determine how resources are allocated, but government plays a
large role as well. A central question for any mixed economy is the balance between the
private and public sectors.
7. The term market is used to describe any situation where exchange takes place. In the
U.S. market economy, individuals, firms, and government interact in product markets,
labor markets, and capital markets.
8. The two major branches of economics are microeconomics and macroeconomics.
Microeconomics focuses on the behavior of the firms, households, and individuals that
make up the economy. Macroeconomics focuses on the behavior of the economy as a
whole.
9. Economists use models to study how the economy works and to make predictions
about what will happen if something is changed. A model can be expressed in words or
equations and is designed to mirror the essential characteristics of the particular
phenomena under study.
10. A correlation exists when two variables tend to change together in a predictable way.
However, the simple existence of a correlation does not prove that one factor causes
the other to change. Additional outside factors may be influencing both.

11. Positive economics is the study of how the economy works. Disagreements in positive
economics center on the appropriate model of the economy or market and the
quantitative magnitudes characterizing the models.
12. Normative economics deals with the desirability of various actions. Disagreements in
normative economics center on differences in the values placed on the various costs
and benefits of different actions.

Chapter 2: Thinking Like an Economist

1. The basic competitive model consists of rational, self-interested individuals and profitmaximizing firms, interacting in competitive markets.
2. The profit motive and private property provide incentives for rational individuals and
firms to work hard and efficiently. Ill-defined or restricted property rights can lead to
inefficient behavior.
3. Society often faces choices between efficiency, which requires incentives that enable
people or firms to receive different benefits depending on their performance, and
equality, which entails people receiving more or less equal benefits.
4. The price system in a market economy is one way of allocating goods and services.
Other methods include rationing by queue, by lottery, and by coupon.
5. An opportunity set illustrates what choices are possible. Budget constraints and time
constraints define individ uals opportunity sets. Both show the trade-offs of how much
of one thing a person must give up to get more of another.
6. A production possibilities curve defines a firm or societys opportunity set, representing
the possible combinations of goods that the firm or society can produce. If a firm or
society is producing below its production pos sibilities curve, it is said to be inefficient,
since it could produce more of either good without producing less of the other.
7. The opportunity cost is the cost of using any resource. It is measured by looking at the
next-best use to which that resource could be put.
8. A sunk cost is a past expenditure that cannot be recovered, no matter what choice is
made in the present. Thus, rational decision makers ignore them.
9. Most economic decisions concentrate on choices at the margin, where the marginal (or
extra) cost of a course of action is compared with its extra benefits

Chapter 3: Demand, Supply and Price

1. An individuals demand curve gives the quantity demanded of a good at each possible
price. It normally slopes down, which means that the person demands a greater
quantity of the good at lower prices and a lesser quantity at higher prices.

2. The market demand curve gives the total quantity of a good demanded by all individuals
in an economy at each price. As the price rises, demand falls, both because each
person demands less of the good and because some people exit the market.
3. A firms supply curve gives the amount of a good the firm is willing to supply at each
price. It is normally upward sloping, which means that firms supply a greater quantity of
the good at higher prices and a lesser quantity at lower prices.
4. The market supply curve gives the total quantity of a good that all firms in the economy
are willing to produce at each price. As the price rises, supply rises, both be cause
each firm supplies more of the good and because some additional firms enter the
market.
5. The law of supply and demand says that in competitive markets, the equilibrium price is
that price at which quantity demanded equals quantity supplied. It is represented on a
graph by the intersection of the demand and supply curves.
6. A demand curve shows only the relationship between quantity demanded and price.
Changes in tastes, in demographic factors, in income, in the prices of other goods, in
information, in the availability of credit, or in expectations are reflected in a shift of the
entire demand curve.
7. A supply curve shows only the relationship between quantity supplied and price.
Changes in factors such as technology, the prices of inputs, the natural environment,
expectations, or the availability of credit are reflected in a shift of the entire supply
curve.
8. It is important to distinguish movements along a demand curve from shifts in the
demand curve, and movements along a supply curve from shifts in the supply curve.

Chapter 4: Using Demand and Supply

1. The price elasticity of demand describes how sensitive the quantity demanded of a
good is to changes in the price of the good. When demand is inelastic, an increase in
the price has little effect on the quantity demanded and the demand curve is steep;
when demand is elastic, an increase in the price has a large effect on the quantity
demanded and the curve is flat.
2. The price elasticity of supply describes how sensitive the quantity supplied of a good is
to changes in the price of the good. If price changes do not induce much change in
supply, the supply curve is very steep and is said to be inelastic. If the supply curve is
very flat, indicating that price changes cause large changes in supply, supply is said to
be elastic.
3. The extent to which a shift in the supply curve affects price or affects quantity depends
on the shape of the demand curve. The more elastic the demand, the more a given shift
in the supply curve will be reflected in changes in equilibrium quantities and the less it
will be reflected in changes in equilibrium prices. The more inelastic the demand, the

more a given shift in the supply curve will be reflected in changes in equilibrium prices
and the less it will be reflected in changes in equilibrium quantities.
4. Likewise, the extent to which a shift in the demand curve affects price or affects quantity
depends on the shape of the supply curve.
5. Demand and supply curves are likely to be more elastic in the long run than in the short
run. Therefore a shift in the demand or supply curve is likely to have a larger price effect
in the short run and a larger quantity effect in the long run.
6. Elasticities can be used to predict how much consumer prices will rise when a tax is
imposed on a good. If the demand curve for a good is very inelastic, consumers in
effect have to pay the tax. If the demand curve is very elastic, the quantities produced
and the price received by producers are likely to decline considerably.
7. Government regulations may prevent a market from moving toward its equilibrium price,
leading to shortages or surpluses. Price ceilings lead to excess demand. Price floors
lead to excess supply