Economics

Unit I: Principles of Economics
I. Basic Economics
A. Economy comes from the Greek word for "one who manages a household." The household is much
like an economic system in that decisions must be made to effectively run the household. The
household must decide which members of the household perform certain tasks and what they get in
return. The household must allocate its scarce resources among its various members taking into
account each member's abilities, efforts and desires.
B. Society must also face this decision; placing people in certain jobs in order maximize its resources and
survive. The management of resources is crucial to society because resources are scarce. Scarcity
means that society has limited resources and cannot produce all the goods and services that people
want. Goods can be classified into two types; capital goods used in the production of goods and
consumer goods, which are finished products sold in the market. Utility means the usefulness of a good
or service. Together they determine the value of a good.
C. Economics is the study of how society manages its scarce resources. There are two studies of
economics:
1. Macroeconomics: the study of economy wide phenomena, including inflation, unemployment, and
economic growth
2. Microeconomics: the study of how households and firms make decisions and how they interact in
markets
D. In society resources are allocated through the actions of millions of households and firms. Economists
study how people make decisions, what they buy, and how much they save. They also examine
interaction among buyers and sellers and finally they analyze forces and trends that effect the economy
as a whole.
E. There are ten basic unifying principles of economics:
1. People face tradeoffs: the basic idea that to get one thing you must give up another. For example: the
guns and butter tradeoff. The more we spend to protect our country the less we can spend to raise our
standard of living at home. Another example is the tradeoff between a clean environment and a high
level of income. Laws that require firms to reduce pollution raise the cost of producing goods and
services. Because of these higher costs, firms make less profit, which translates to lower wages and
higher prices. Another tradeoff is between efficiency and equity. Efficiency means that society is
getting the most it can from its scarce resources. Equity means that the benefits of those resources are
distributed fairly among the members of society. The classic example is welfare. When the government
redistributes money from the rich to the poor it reduces the reward for working hard. Thus increasing
equity but decreasing efficiency.
2. The cost of something is what you give up to get it: facing tradeoffs means making decisions, which
requires comparing costs and benefits of alternative actions. This is done through evaluating
opportunity cost. Opportunity cost is whatever must be given up to obtain an item.
3. Rational people think at the margin: economic decisions are not usually black and white but shades of
gray. In economics the term marginal change is used to describe small incremental adjustments to a
plan of action. Rational decision-makers take action if and only if the marginal benefit of the action
exceeds the marginal cost. Example: airline considering how much to charge passengers who fly
standby. Suppose that flying a 200 hundred seat plane across the country is $100,000/200, which is
$500 per passenger. Logically you would conclude that the airline should never sell a ticket for less
than $500. In fact the airline can raise its profits by thinking at the margin. What if the plane has ten
empty seats and a standby passenger is willing to pay $300 for a set. If the plane has empty seats the
cost of adding a passenger is minute. The average cost of flying the passenger is $500 but the marginal
cost is a bag of peanuts and a soda the passenger consumes. Marginal cost is the increase in total cost
that arises from an extra unit of production.
4. People respond to incentives: because people make decisions by comparing costs and benefits, their
behavior may change when the cost or benefits change, that is people respond to incentives. When the
price of an apple rises, people decide to eat fewer apples. The apple orchard though decides to hire
more workers and harvest more apples because the benefit of selling the apples is higher. The effect of
price on the behavior of buyers and sellers in a market is crucial to understanding how the economy
works.
5. Trade can make everyone better off: countries benefit from the ability to trade with another. Trade
allows countries to specialize in what they do best and to enjoy a greater variety of goods and services.
6. Markets are usually a good way to organize economic activity: the fall of communism in Russia
proved that the communist premise that central planners in government were in the best position to
guide economic activity was wrong. The theory was that only the government could produce an
economy that was beneficial to the whole country. Most planned economies have abandoned this idea
and are trying to develop market economies, in which the households and firms make the decisions and
the economy is guided by their decisions. It can be puzzling though because there is no one person
working to ensure economic success. In 1776 Adam Smith wrote a book called the Wealth of Nations,
in which he said that households and firms interact in markets as if they were guided by "invisible
hand" that leads them to the desirable market outcome. The instrument the invisible hand uses to guide
the economy is price. Prices reflect both the value of a good to society and the cost to society of
making the good. Because price is examined by households and firms they unknowingly take into
account the cost and benefits of their actions. This explains the failure of communist to control the
economy successfully because they prevented prices from responding to market forces.
7. Governments can sometimes improve market outcomes: there are two broad reasons for a government
to intervene in the economy; to promote efficiency and to promote equity. The term market failure
refers to a situation in which a market left on its own fails to allocate resources efficiently. One
possible cause of market failure is eternality, which is the impact of one person's actions on the well
being of a bystander. The classic example of an external cost is pollution. If a chemical factory does
not bear the entire cost of the smoke it emits, it will likely emit too much. A negative externality is
when the effect of the externality adversely affects bystander. To improve efficiency and reduce waste
several methods can be used. The first is a Pigovian tax which are taxes used to correct the effects of a
negative externality. This is known as internalizing the tax because the producer must take into account
the external effects of their actions. These are a preferred method because they are at a lower cost to
society. The higher the tax, the larger the reduction in pollution. The second method is a command and
control policy to eliminate or regulate the externality. A positive externality is a beneficial affect of an
externality to promote positive externalities subsidies are used, such as in education. In summary
negative externalities lead markets to produce a larger quantity than is socially desirable, positive
externalities can lead markets to produce a smaller quantity than is socially desirable. Another possible
cause is market power, which refers to the ability of a single person or small group to unduly influence
market prices. Monopolies are examples of this. A monopoly is the complete control of the production
of a product without close substitutes. (Discuss Carnegie, Rockefeller, Morgan and Trusts).
Monopolies can occur naturally in the market though.
8. A country's standard of living depends on its ability to produce goods and services: it is staggering to
look at the difference in the standard of living in the World. The average American income is $29,000
while the average Nigerian income is only $900. To explain these differences is surprisingly simple.
Almost all variations can be contributed to a country's productivity. Productivity is the amount of
goods and services produced from each hour of a worker's time. In an effort to achieve greater
productivity the world has begun to destroy many of its natural resources.
 Humans are destroying natural resources. This is occurring at an accelerating rate. The areas of
greatest alarm are forests, wetlands, coral reefs and the ocean bottom. More than half of the
world’s original area of forest has already been converted to other uses. This causes many different
problems including an increase in carbon dioxide and increased chance for forest fires. As
wetlands are drained for increased land usage, the possibility of water supplies becoming damaged
occurs. The destruction of coral reefs and ocean bottoms due to fishing create the possibility of
further species becoming extinct.
 Wild fish and shellfish, which constitute a large portion of human protein sources. Over two
billion poor people rely on these protein sources to survive, which are disappearing and fisheries
are in steep decline.
 A significant portion of wild species are going extinct. As various environments are altered or
destroyed by man. This is significant in the polar areas and tropical rainforests.
 Soils of farmlands used for growing crops are being carried away by water and wind erosion at
rates between 10 and 40 times the rates of soil formation. Salinizations of soils across the globe
have left areas that are no longer farmable.
 The world’s major energy sources are fossil fuels (coal, oil and natural gas). There is debate about
how much of these fuels still remain and what it will take to get to them.
 Most of the world’s freshwater sources are being used quicker than they can be replaced, due to
irrigation and other activities.
 The available amount of sunlight is being used by humans leaving smaller amounts to support the
growth of natural plant communities.
 There is an ever increasing amount of toxic chemicals entering the atmosphere due to factories.
These can greatly damage the economy.
 The transfer of unnatural species to habits they are not normally found. This can cause natural
species to become extinct and does include diseases.
 The increasing amount of greenhouse gases entering the atmosphere that damage the ozone layer.
 The continued growth of the human population creates further strain on the environment.
 The large number of people creates a significant impact on the environment.
9. Prices rise when the government prints too much money: (Germany post WWI) inflation is defined as
an increase in the overall level of prices in the economy. The problem is almost always a growth in the
quantity of money.
10. Society faces a short run tradeoff between inflation and unemployment: one of the reasons getting rid
of inflation is difficult is because it is thought to cause a temporary rise in unemployment. This is
illustrated by the Phillips curve, which shows the short run trade off between inflation and
unemployment. What this means is that if you try to reduce inflation you increase unemployment and
vice versa. It is thought that this occurs because prices are slow to adjust. For example if you attempt
to deflate the currency, in the long run the prices will decrease. But not all prices will adjust
immediately and during that time you have a rise in unemployment. As the currency is deflated it
reduces the amount people spend, this coupled with prices that have yet to adjust (sticky) reduces the
quantity of goods and services that firms sell, so they cut back.
Unit II: Economic Models
I. Factors of Production
1. Capital: this is the amount of money invested in the buildings and machines used for production.
2. Labor: employees provided by households
3. Land: provides the resources that are used in production. There are two types renewable, such as trees,
and non-renewable such as oil.
4. Entrepreneurship: individuals committed to entering into the business field
5. Information: the ability of individuals to gain information and improve their production of goods.
II. The Circular Flow Model
A. The circular flow model explains how the economy is organized and how participants in the economy
interact with one another. In the circular flow model the economy has two types of decision-makers:
households and firms. Firms produce the goods and services using factors of production.
B. Households and firms interact in two types of markets. In the markets for goods and services,
households buy the output of goods and services. In the market for the factors of production,
households are sellers and firms are buyers.
C. The government adds to the circular flow model through collecting taxes and their various
expenditures. The federal government’s major expenditures are to provide:
1. Goods and Services
2. Social Security and welfare payments
3. Transfers to state and local governments
D. The main taxes collected by the federal government are:
1. Personal income taxes
2. Corporate income taxes
3. Social security taxes
4. In 2005 the government spent $2.5 trillion
E. The state and local governments expenditures are:
1. Goods and services
2. Welfare benefits
F. There major sources of revenue are:
1. Sales tax
2. Property taxes
3. State income taxes
4. In 2005 state and local governments spent $1.6 trillion
III. The Production Possibilities Frontier
A. The production possibilities frontier is a graph that shows the combinations of output that the economy
can possibly produce given the available factors of production and the available production technology.
B. If using cars and computers as an example the two together use all factors of production. An outcome
is said to be efficient if the economy is getting all it can from the scarce resources it has available.
Points on rather than inside the curve represent efficient levels of production. Point A represents
efficient production while Point B represents inefficient production. The graph shows the opportunity
cost of one good as measured in terms of another good. (Marginal benefit graph represents the number
of CDs that people are willing to give up for an additional bottle of water. The marginal benefit of
water decreases as the quantity of water increases. Marginal cost of a bottle of water increases as the
quantity of bottled water increases. Marginal cost is the opportunity cost of producing one more unit
along the production possibilities frontier)
IV. Types of economies
A. Traditional economy: based on caste system, born into class, cannot move. Produces traditional low
technology items.
B. Command economy: Central planning by government determines production, consumption and
distribution of goods.
C. Free Enterprise economy: represents a true laissez-faire policy in which there is no government
intervention and the market governs itself.
D. Mixed economy: represents elements of different economies and is commonly found throughout the
world.
Unit III: Supply and Demand
I. Supply and Demand
A. Supply and demand are two words that are used frequently in economy because they are the forces that
make market economies work. Supply determines the quantity of each good produced and demand
determines the price at which it is sold. They refer to the behavior of people as they interact with one
another in markets. Markets are a group of buyers and sellers of a particular good or service.
B. There are various forms of markets from highly organized markets such as for agricultural goods to
less organized markets of street vendors. The price of the goods within the markets is however
established the same in every market buy the interaction of all buyers and sellers. Most markets are
competitive markets, in which there are many buyers and sellers so that each has a negligible impact on
the market price. What this means is that no single buyer or seller has an impact on the price. In order
to understand supply and demand we have to assume that markets are perfectly competitive. Prefect
competition is defined by two characteristics: 1) the goods being offered are all the same, and 2) the
buyers and sellers are so numerous that no single buyer or seller can influence the market price. Buyers
and sellers in perfectly competitive markets must accept the market price and are therefore known as
price takers.
II. Demand
A. Our first consideration is what determines the quantity demanded of a good, this is the amount of the
good that buyers are willing and able to purchase. There are several factors that may influence the
demand for a good.
1. Price: because the quantity demanded falls as the price rises and rises as price falls, it is known as
negatively related to the price. This relationship is known as the law of demand: other things remaining
equal, when the price of a good rises, the quantity demanded falls.
2. Income: income can effect the demand of many goods. If the demand for a good falls when income
falls, the good is called a normal good. Not all goods are normal goods though, if the demand rises
when the income falls, the good is called an inferior good. An example of an inferior good might bus
rides, because of your inability to purchase a car.
3. Price of related goods: when the fall in the price of one good reduces the demand of another good, the
two goods are called substitutes, an example would be CDs over tapes. When the fall in the price of
one good raises the demand for another good, the two goods are called complements.
4. Tastes
5. Expectations: your expectations about the future may determine your willingness to purchase a good or
service.
B. To show the relationship between demand and price, economists use a demand schedule, which is a
table that shows the relationship between the price of a good and the quantity demanded.
Price of ice cream cones Quantity of cones demanded
$0.00 12
0.50 10
1.0 8
1.50 6
II.0 4
2.50 2
3.00 0
C. Economists then graph the schedule as a demand curve, which shows the relationship between the
price and quantity demanded. The price is always of the vertical axis while QD is always on the
horizontal axis.
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10 11 12
D. To analyze how the market works, you have to determine the market demand, which is the sum of all
individual demands for a particular good or service. This is simply done by adding demand schedules
together to show market demand. Market demand depends on all factors that influence demand.
Price of ice cream cones Quantity of cones demanded
$0.00 7
0.50 6
1.00 5
1.50 4
2.00 3
2.50 2
3.0 1
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10 11 12
Market Demand
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
E. When a change occurs in demand caused by any factor other than price then demand curve shifts. An
increase in quantity demanded causes the curve to shift to the right. A change that causes a decrease in
demand causes the curve to shift to the left.
Change in Demand
$3.00 D1 D2
2.50
2.00 D3
Increase in
1.50 demand
Decrease
1.00 in demand
.50
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
III. Supply
A. The quantity supplied of any good or service is the amount that sellers are willing to and able to sell.
There are several factors that determine the quantity supplied.
1. Price: when the price of a good is high, selling it is profitable and so the quantity supplied is high. By
contrast, when the price of a good is low, your business is less profitable and so you will produce less
or go out business if the price becomes too low. Because the quantity supplied rises as the price rises
and falls as the price rises, quantity supplied is positively related to the price of a good. This
relationship is known as the law of supply: other things equal, when the price of a good rises, the
quantity supplied of the good also rises.
2. Price of Related goods: Related goods are either substitutes in production, which is another good that
can be produced in place of another good, or complements in production, which is a good that is
produced along with another good. The supply of a good decreases if the price of one of its substitutes
in production rises and the supply of a good increases if the price of one of its substitutes in production
falls. The supply of a good increases if the price of one of its complements in production rises, and the
supply of a good decreases if the price of one of its complements in production falls.
3. Input price: when the price of a good used to make a product rises it causes the quantity supplied at
each price to decrease.
4. Technology: the use of technology to increase efficiency can reduce the costs of production and
increase the supply of goods.
5. Expectations: the amount of a good supplied may depend on your expectations for future sales, as a
good may be going out of style.
B. To show the relationship between price and quantity supplied we use a supply schedule and supply
curve.
Supply Curve
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10 11 12
C. Market supply is determined in the same way as market demand is determined and does depend on all
factors.
Price of ice cream cones Quantity of cones supplied
$0.00 0
0.50 0
1.00 0
1.50 2
2.00 4
2.50 6
3.00 8
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10 11 12
Market Supply
$3.00
2.50
2.00
1.50
1.00
.50
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Change in supply
$3.00
2.50
Decrease
2.00 in supply Increase in
S2 supply
1.50
1.00 S1
.50 S3
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
IV. Equilibrium
A. Supply and demand when grafted together determine the quantity of a good sold in a market and its
price. The point at which the two lines intersect is known as the equilibrium. The equilibrium price is
the price that balances supply and demand. Equilibrium quantity is the quantity supplied and the
quantity demanded when the price has been adjusted to balance supply and demand. The Market
Equilibrium is when the quantity of the good that buyers are willing and able to buy exactly balances
the quantity that sellers are willing and able to sell. It is sometimes called the market-clearing price,
because everyone is satisfied.
Price
$3.00 D S
2.50
2.00
E
1.50 (2,10)
1.00
.50
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quantity
B. The actions of buyers and sellers naturally moves the market toward equilibrium. This because of what
occurs when the market is not in balance. When the market price is above equilibrium the quantity of a
supplied exceeds the quantity demand. There is a surplus of the good: suppliers are unable to sell all
they want at the going price. Suppliers respond to this situation by cutting prices to reach equilibrium.
Price Excess Surplus 13 - 4 = 7is your surplus
$3.00 D S
Surplus
2.50
2.00
E
1.50 (2,10)
1.00
.50
QD QS
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quantity
C. If the market price is below the equilibrium the quantity demanded exceeds the quantity supplied
leading to a shortage in the good. When this occurs suppliers raise the price of there goods because it
will not hinder sales.
Price Excess Demand 14 - 5 = 9 is your shortage

$3.00 D S
Surplus
2.50
2.00
E
1.50 (2,10)
1.00 Shortage
.50
QS QD
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quantity
D. This activity is known as the law of supply and demand: the price of any good adjusts to bring the
supply and demand for that good into balance.
E. When changes occur in the market the equilibrium changes accordingly. The analysis of these changes
is called comparative statics because it involves comparing two static situations and old and a new
equilibrium. When analyzing how markets are effected three steps are used: 1) determine whether the
supply, demand or both curves shift, 2) decide whether the curve shifts to the right or to the left, 3) use
the graphs to examine how the shifts effect equilibrium price and quantity.
Price D2 Changes is Supply and Demand
$3.00 D1 S2 S1
2.50
2.00 E2
E1 Increase
1.50
decrease
1.00
.50
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quantity
Unit IV: Elasticity
I. Elasticity of Demand
A. Elasticity is a measure of how much buyers and sellers respond to changes in market conditions. The
law of demand states that a fall in the price of a good raises the quantity demanded. The price elasticity
of demand measures how much the quantity demanded responds to a change in price. Demand for a
good is said to elastic if the quantity demanded responds substantially to changes in the price. Demand
is said to be inelastic if the quantity demanded responds only slightly to changes in the price. What
determines whether the demand for a good is elastic or inelastic depends on consumer preferences,
which means economic, social and psychological forces.
B. There are some general rules about what determines price elasticity of demand
1. Necessities versus Luxuries: necessities tend to be inelastic whereas luxuries tend to inelastic. When
the price of a necessity like gas rises the number of people buying gas does not change. However,
when the price of a luxury item goes up the number of people purchasing that item decreases. The
elasticity of course depends on the personal preference of the buyer.
2. Availability of close substitutes: goods with close substitutes tend to have more elastic demand because
it is easier for consumers to switch from that good to others.
3. Definition of the market: the elasticity of demand in any market depends on how we draw the
boundaries of the market. The narrowly defined market tends to be more elastic, because it easier to
find close substitutes for narrowly defined goods. For example food is broad market for which there is
no close substitute but within the market there are narrowly defined markets such as cheese or butter.
4. Time horizon: goods tend to have more elastic demand over longer horizons. When gas prices rise the
first few months the quantity of gas demanded is inelastic. However over a long period of time people
begin to buy more fuel efficient cars, or other things to cut fuel costs making it elastic.
C. To measure price elasticity of demand economists' compute it in terms of percentage change in the
quantity demanded divided by the percentage change in the price.
Price Elasticity of Demand = Percentage change in quantity demanded Example 20 = 2
Percentage change in price 10
In the example, the elasticity is 2, reflecting that the change in the quantity demanded is proportionately
twice as large as the change in price. Because the quantity demanded of a good is negatively related to its
price the percentage change in quantity will always have the opposite sign as the percentage change in
price. -20 = -2
10
II. Midpoint method and graphing price elasticity
A. If you try to calculate the price elasticity of demand between two points on a demand curve you find
one problem. The elasticity from point A to point B seems different from point B to point A.
Example: Point A: price = $4 quantity = 120
Point B: price = $6 quantity = 80
Going from point A to point B, the price rises by 50% and the quantity falls by 33%.
33/50 = 0.66
By contrast, going from point B to point A the price falls by 33% and the quantity rises by 50%
indicating that the price elasticity of demand 50/33 or 1.5.
B. To avoid this problem, economists use the midpoint method for calculating elasticities. The midpoint
method computes a percentage change a percentage change by dividing the change by the midpoint of
the initial and final levels.
Example: $5 is the midpoint of 4 and 6
(6-4)/5x 100 = 40% Midpoint: Price = $5 Quantity = 100
According to the midpoint method, when going from point A to point B the prices rises by 40% and the
quantity falls by 40%. When going from point B to point A the price falls by 40% and the demand rises
by 40%. In both directions, the price elasticity of demand equals 1.
Example: Price 1 = $4 Quantity 1 = $120
Price 2 = $6 Quantity 2 = $80
Price elasticity of demand = (Q2 -Q1) / [(Q2 + Q1)/2] (80 - 120) / [(80 + 120)/2] -40 / (200/2) -.4/-.4 = 1
(P2 - P1) / [(P2 + P1)/2] (6-4) / [(6 + 4)/2 2 / (10/2)
C. Elasticity becomes useful when calculating what effect price changes will have on the demand or
supply of a particular good. If cigarettes have an elasticity of .4, then if we want the demand for
cigarettes to go down by 20% we can establish the needed price increase. Economists classify demand
curves according to the their elasticity. Demand is elastic when the elasticity is greater than 1. Demand
is inelastic when the elasticity is less than 1. If the elasticity is exactly 1 then demand is said to have
unit elasticity. Since the slope of the curve is related to elasticity it is helpful to remember that the
flatter the demand curve the more elastic it is, whereas the steeper the curve then it is inelastic.
(a) Perfectly Inelastic Demand: Elasticity equals 0 (b) Inelastic Demand: Elasticity is less than 1
P An increase in price leaves P A 22% increase in price
$5 the quantity demanded $5 leads to an 11% decrease in
unchanged quantity demanded
$4 $4
Q Q
100 90 100
(c) Unit Elastic Demand: Elasticity equals 1 (d) Elastic Demand: Elasticity is greater than 1
P A 22% increase in price leads to P A 22% increase in price leads to
a 22% decrease in quantity demanded a 67% decrease in quantity demanded
$5 $5
$4 $4
80 100 Q 50 100 Q
(e) Perfectly Elastic Demand: Elasticity equals infinity
P
At any price above $4, quantity demanded is 0
$4
At $4 consumers will buy any quantity
Q
Below $4 quantity demanded is infinite
III. Total Revenue

A. Total revenue is the amount paid by buyers and received by sellers of a good (P x Q). Graphed it is as:
P Revenue = $400
$4
100 Q
Total revenue changes as you move along the demand curve. If demand is inelastic then an increase in the
price causes an increase in total revenue. If demand is elastic an increase in price causes a decrease in
revenue.
P Revenue = 1 x 100 = 10 P Revenue = 4 x 50 = 200
3 x 80 = 240 5 x 20 = 100
$3 $5
$4
$1
Q Q
80 100 20 50
IV. Elasticity of Supply

A. The price of elasticity of supply measures how much the quantity supplied responds to change's in the
price. The price elasticity of supply depends on the flexibility of sellers to change the amount of the
good they produce. In most markets, a key determinant of the price elasticity of supply is the time
period being considered. Supply is usually more elastic in the long run than in the short run. To
compute the price elasticity of supply:
Price elasticity of supply = Percentage change in quantity supplied
Percentage change in price
Example: Increase in price of milk from $2.85 to $3.15 a gallon raises the amount that dairy farmers
produce from 9,000 to 11,000 gallons per month. Using the midpoint method:
Percentage change in price = (3.15-2.85)/3.00 x 100 =10 percent (3 is midpoint)
Percentage change in quantity supplied = (11,000 - 9,000)/10,000 x 100 = 20 percent (10,000 is midpoint)
Price elasticity of supply = 20%/10% = 2.0
Elastic Supply: Elasticity is greater than 1 Inelastic Supply

P P
$5 $5
$4 $4
100 200 Q 100 110 Q

A 22% increase in price leads to a 67% A 22% increase in price leads to a 10%
increase in quantity supplied increase in quantity supplied
V. Cross Elasticity of Demand and Income Elasticity

A. Cross elasticity of demand is a measure of the responsiveness of the demand for a good to a
change in the price of a substitute or complement when other things remain the same.
Cross elasticity of demand = % change in QD of a good

% change in the price of one of its
substitutes or complements
Suppose that when the price of a burger falls by 10%, the quantity of pizza demanded decreases by
5%.
CED = -5% = .5
-10%
The cross elasticity of demand for a substitute good is positive. A fall in the price of a substitute
brings a decrease, in the quantity demanded of the good. The quantity demanded of a good and the
price of one its substitutes change in the same direction.
B. Suppose that when the price of soda falls by 10%, the quantity of pizza demanded increases by
2%. The cross elasticity of demand for pizza with respect to the price of soda is
CED = +2% = -.2
-10%
The cross elasticity of demand for a complement is negative. A fall in the price of a complement
brings an increase in the quantity demanded of the good. The quantity demanded of a good and the
price of one its complements change in opposite directions.
C. The rate at which demand for different goods changes over time. Will the demand for some items
increase so rapidly that we spend an increasing percentage of our incomes on them or could the
demand for some items decrease? The answer to that question depends on the income elasticity of
demand, which is a measure of the responsiveness of the demand for a good to a change in income
when other things remain the same. Income elasticity of demand is calculated as:
IED = % change in QD
% change in income
Income elasticity of demand falls into three ranges:
- Greater than 1 (normal good, income elastic)
- Between 0 and 1 (normal good, income inelastic)
- Less than 0 (inferior good)
As our incomes increase: items that have an income elastic demand take increasing share of
income; items that have an income inelastic demand take a decreasing share of income; and
items that have a negative income elasticity of demand take an absolutely smaller amount of
income.
Unit V: Price Controls and Taxes
I. Price Ceilings
A. Price Ceilings: legal maximums on the price at which a good can be sold.
B. Both price floors and price ceilings are established by the government. Price ceilings can either be
non-binding or a binding constraint. A binding price ceiling would create shortages that would lead to
rationing of goods among many buyers. This also leads to discrimination as the seller may be biased
towards certain groups and they are inefficient as long lines waste time. In a free, competitive market
the price rations goods and ceilings are not needed.
(a) Non Binding (b) Binding

P P D S
D S
$4 $3
$3 $2
shortage
100 Q 75 Qs 125 Qd Q
C. In 1973 OPEC raised the price of crude in the world oil market. Because it is the major product for
gasoline production, the higher prices reduced gasoline supplies. The graphs show what happened.
(a) The price ceiling on gasoline is not binding (b) Price ceiling becomes binding
Price of gas Price of gas S2
D S S1
P2
PC
P1 P1
Q1 Qs Qd Q1
D. One of the most common price controls is rent control. The local government places a ceiling on rents
that landlords may charge. The goal of the policy is to help the poor by making housing more
affordable. Economists argue that rent controls are highly inefficient. The adverse effects of rent
control are less apparent to the general population because these effects occur over many years. In the
short run, landlords have a fixed number of apartments to rent and they cannot adjust this number
quickly as market conditions change. As the number of people looking for housing may not be
responsive to rents because people take time to adjust their rents. This means that the short run supply
and demand for housing are inelastic.
(a) Rent control in the short run (b) Rent control in the long run
P P
Rc
Q Q
Because supply and demand are inelastic in the short run , the initial shortage caused by rent control is
small. The primary effect is to reduce rents. The long run is very different though as buyers and sellers
respond more to market conditions. On the supply side, landlords respond to low rents by not building new
apartments and by failing to maintain existing ones. On the demand side, low rents encourage people to
find apartments. In cities with rent controls, landlords use different ways to ration housing. They keep
waiting lists or give preference to families with children. In the past landlords have used racial
discrimination.
II. Price Floors
A. Price floor: legal minimum on the price at which a good can be sold.
B. When the government places price floors on goods the outcome can either be non-binding or binding
and cause a surplus to occur.
(a) Non-binding price floor (b) Binding price floor
P P
$4 surplus
$3
Q 80 120 Q
C. An important price floor is the minimum wage. The first minimum wage laws were created in 1938 by
the Fair Labor Standards Act to ensure an adequate standard of living. In 1999 Congress raised the
level to $5.15 and hour with some states raising it further.
(a) Free Labor Market (b) Labor market with a binding minimum wage
Wage Wage
Labor Supply
Surplus
Labor demand
Quantity of labor Qd Qs Quantity of labor

To fully understand minimum wage you have to remember that the economy contains many labor markets
for different types of workers. The impact of minimum wage depends on the skill and experience of the
worker. The greatest effect is on teenage labor because there are the least experienced and least skilled
members of the labor force. They are also often willing to accept the lower wages.
III. Taxes
A. When discussing taxation one of the most important questions is who bears the burden of the tax.
Economist use the term tax incidence when studying who bears the burden. Suppose, for instance, that
our local government passes a law requiring buyers of hamburgers to send $0.50 to the government for
each hamburger they buy. How does this law affect the buyers and sellers of hamburgers. To answer
the question use the three steps from Unit III: 1) determine whether the supply, demand or both curves
shift, 2) decide whether the curve shifts to the right or to the left, 3) use the graphs to examine how the
shifts effect equilibrium price and quantity. The initial impact of the tax is on the demand for
hamburgers. The supply curve is not affected because for any given price of hamburger sellers have the
same incentive to provide hamburgers.
Price of hamburgers
Price buyer D1
pays D2 S
$3.30
$.50 Tax
$3.00 Equilibrium w/o tax
$2.80
Equilibrium with tax
90 100 Q
Price sellers receive
B. Because buyers look at their total cost including the tax they demand a quantity of hamburgers as if the
market were $.50 higher than it actually is. To induce buyers to demand any given quantity the market
price must be $.50 lower to make for the effect of the tax. In answering who bears the burden of the
tax, buyers and sellers share the burden. Buyers may pay the tax but sellers receive $.20 less for each
hamburger they sell to $2.80 + $.50 = $3.30
C. Now suppose that the government has passed a $0.50 tax on sellers for each hamburger they sell. In
this case the initial impact of the tax is on the supply of ice cream. The tax raises the cost of selling ice
cream and leads sellers to supply a smaller quantity at every price.
Price of hamburgers S2
Price buyer D1
pays S1
$3.30
$.50 Tax
$3.00 Equilibrium w/o tax
$2.80
Equilibrium with tax
90 100 Q
Price sellers receive
D. When looking at who bears the burden of the tax , both buyers and sellers bear the burdens regardless
of who the tax is placed on. When supply is more elastic than demand incidence of the tax falls more
heavily on the consumer than on the producers. When demand is more elastic that supply the incidence
of the tax falls more heavily on the producers.
E. We can apply this logic to everyday life by examining payroll taxes. Payroll taxes are taxes on wages
that firms pay their workers. One of these is FICA, which stands for Federal Insurance Contribution
Act. The FICA tax is used to pay for Social Security and Medicare, and in 1999 was 15.3% of
earnings. Congress attempted to share the burden of the tax equally among employers and employees,
this is not easily done though.
Wage Labor supply
Wage firms pay

tax
wage w/o tax
wage workers
receive
Labor demand
Quantity of labor
When the tax is enacted a wedge is created which lowers the wages received by the worker but the
wages the firms pays increases. For the most part the supply of labor is much less elastic that the
demand. These means that workers, rather the firms, bear most of the burden of the payroll tax.
Wage
tax employer pays

tax employee pays
Unit VI: The Costs of Taxation and International Trade
I. Economic Welfare
A. Having looked at how a tax affects a good's price and the quantity sold, we extend the analysis and
look at how taxes affect welfare, the economic well being of participants in a market. The government
enacts taxes to raise revenue. To understand how taxes affect the economic well being, we must
compare the reduced welfare of buyers and sellers to the amount of revenue the government raises.
Remember that it does not matter whether a tax on a good is levied on buyers or sellers of the good,
both share the burden of the tax. The key to taxation is that taxes place a wedge between the price
buyer's pay and the price sellers receive. Because of the tax wedge, the quantity sold falls below the
level that would be sold without a tax (the tax causes the market to shrink).
P
D
Tax
S
Q
B. To measure the gains and loses from a tax on a good you have to take into account how the tax affects
buyers, sellers, and the government. The benefit received by buyers in a market is measured by
consumer surplus: the amount buyers are willing to pay for the good minus the amount they actually
pay for it; thus it is a good measure of economic well being. The higher the consumer surplus the
greater the economic well being of the economy. The benefit received by sellers in a market is
measured by producer surplus: the amount sellers receive for the good minus their costs, which
measures the benefit to sellers of participating in a market. The governments revenue is measured by
(Tax x Quantity).
P
D Size of tax
Tax
Revenue
(T x Q) Quantity sold
S
Q w/ Tax Q w/o Tax Q
C. To analyze how taxes effect economic well being, we use tax revenue to measure the government's
benefit from the tax and how that revenue is spent. To see how a tax affects welfare, we begin by
considering welfare before the government has imposed a tax.
P
Price buyers pay = Pb

B C
Price w/o tax = P1

D E
Price sellers receive = Ps
F
Q2 Q1 Q
Without a tax, the price and quantity are found at equilibrium. Because the demand curve reflects buyers'
willingness to pay, consumer surplus is the area between the demand curve and the price, A +B + C.
Because the supply curve reflects sellers' costs, producer surplus is D + E + F. Because there is no tax, there
is no tax revenue. After a tax is enacted the price paid by buyers rises to Pb so that consumer surplus equals
only area A, the producer surplus now equals only area F. Quantity sold falls from Q1 to Q2 and the
government collects tax revenue equal to area B + D. Total surplus with the tax is A + B+ D +F. The fall in
total surplus that results when a tax distorts a market outcome is called deadweight loss. In this case
deadweight loss is: A + B + D + F - (C + E).
D. Taxes have deadweight losses because they cause buyers to consume less and sellers to produce less,
and this change in behavior shrinks the size of the market below the level that maximizes total surplus.
Because the elasticities of supply and demand measure how much market participants respond to
market conditions, larger elasticities imply larger deadweight losses.
E. As a tax grows larger, it distorts incentives more, and its deadweight loss grows larger. Tax revenue
first rises with the size of a tax. Eventually, however a larger tax reduces tax revenue because it
reduces the size of the market.
(a) Deadweight loss (b) Revenue
Tax
Revenue
Tax size Tax rate

II. The Principle of Comparative Advantage
A. Comparative advantage is the comparison among producers of a good according to their opportunity
costs. Remember that opportunity cost is whatever must be given up to obtain some item. Absolute
advantage is used when comparing the productivity of one person, firm or nation to that of another,
The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute
advantage in producing that good.
Example 1: 1lb. of meat 1lb. of potatoes
Farmer 2 lbs. potatoes 1/2 lb. of meat
Rancher 1/8 lb. of potatoes 8 lbs. of meat
In the example the farmer has a lower opportunity cost of producing potatoes than the rancher, it will only
cost him a 1/2 lb. of meat to produce 1 pound of potatoes as compared to 8 lbs. of meat for the rancher.
B. Differences in opportunity cost and comparative advantage create the gains from trade. When each
person specializes in producing the good for which they have the comparative advantage, total
production in the economy rises. Because of this trade can benefit everyone in society because it
allows people to specialize in activities, which they have the comparative advantage and trade for the
goods they cannot.
C. Many of the goods Americans consume are produced abroad and many goods made here are sold in
foreign countries. Goods produced in foreign countries and sold domestically are called imports.
Exports are goods produced domestically and sold abroad.
III. International Trade
A. To determine the comparative advantages that a country has economists compare the domestic price of
a good to the world price of a good. The world price is the price of a good that prevails in the world
market for that good. If the world price is higher than the domestic price then a country has a
comparative advantage in international trade. This will determine what goods countries decide to
produce. For example what if America held a comparative advantage in steel production.
Price of steel
Domestic demand Domestic supply
Price after trade World price
Price before trade
Exports
Quantity of steel
Domestic quantity Domestic quantity
demanded supplied
The supply curve shows the quantity of steel supplied by American sellers. The demand curve
shows the quantity of steel demanded by American buyers. Because the domestic quantity
supplied is greater than the domestic quantity demanded America would sell steel. Trade does
however raise the price of domestic steel; producers are still better off because they can sell steel
at a higher price.
B. To measure these gains and losses, we look at the changes in consumer and producer surplus. What the
graph shows is that even though trade has the negative of raising the price of the good domestically
economic well being of the nation increases because the gains of the nation exceed the loses.
Price of steel
A Exports
B D
Price before trade
C
Quantity of steel
Before Trade After Trade Change
Consumer surplus A+ B A -B
Producer surplus C B+C+D + (B+D)
Total Surplus A+B+C A+B+C+D +D
D represents the increase in total surplus and represents the gains from trade. America can then
sell total surplus on the world market.
C. If the reverse occurs and the domestic price is above the world price the comparative advantage does
not lie with America therefore steel should be imported.
Price of steel
Price before
trade
Imports
Quantity of steel
Domestic quantity supplied Domestic quantity demanded
In terms of gains and losses from trade, domestic consumers are better off as they can buy steel at
a cheaper price. However domestic producers loss as they must sell steel at a lower price. Trade
once again though does benefit countries as it raises the economic well being of the nation. Trade
does not benefit everyone though, as some participants in the economy are hurt.
IV. Tariffs
A. Tariffs are only relevant if countries are importing goods. In our example a tariff would raise the price
of imported steel above the world price by the amount of the tariff. Domestic suppliers of steel, who
compete with imports can now sell their steel for the world price plus the amount of the tariff and
makes the overall price closer to the equilibrium price without trade.
Price of steel
Equilibrium w/o trade
Price w/ tariff Tariff

Price w/o tariff World price
Imports w/ tariffs
Quantity of steel
Imports w/o tariffs
B. Opponents of free trade argue that trade with other countries reduces domestic jobs. This is true
however, as a country shifts to producing the goods in which it has a comparative advantage they can
hire more people to produce the good and sell it abroad. So in the long run the standard of living
increases.
Unit VII: Market Types
I. Perfect Competition
A. Perfect Competition exists when:
- Many firms sell an identical product to many buyers
- There are no restrictions on entry into (or exit from) the market
- Established firms have no advantage over new firms
- Sellers and buyers are well informed about prices
C. The firm’s objective is to maximize economic profit. Profit is determined by subtracting total cost
from total revenue. The firm achieves its objective by deciding the quantity to produce. The firm
does not however choose the price at which to sell its output, because it is a price taker and cannot
influence the price of its products. In perfect competition, market demand and market supply
determine the price. Calculating total revenue is easy (PxQ) but calculating total cost is different.
A firm’s marginal revenue is the change in total revenue that results from a one unit increase in the
quantity sold, in a competitive market marginal revenue equals price because price is fixed by the
market. Total cost is the market value of the inputs a firm uses in production. Total cost is
calculated by adding fixed costs to variable costs.
D. As output increases total revenue increase but so does total cost. Because of decreasing marginal
returns (less productivity results over time from increased workers) total cost eventually increases
faster that total revenue. There is one output level that maximizes economic profit, and a perfectly
competitive market chooses this output level. (economic profit graph)
P Economic loss
6 TC TR
5
4 Profit maximizing quantity
3
2
1 Economic loss
0 1 2 3 4 5 6 Q
Total Revenue = 4.5 x 5.5
Total Cost = 3
E. It is economic profit which is an incentive for new firms to enter a market, but as they do so, the
price falls and the economic profit of each existing firm decreases. This may lead so firms to exit
the market as they incur economic losses. When they do so, the price rises and the economic loss
of each remaining firm decreases.
II. Monopoly
A. A monopoly is a market with a single supplier of a good or service that has no close substitutes
and in which a barrier to entry prevents competition from new firms. If a good has a close
substitute, even though only one firm produces it, that firm effectively faces competition from the
producers of substitutes. The three basic barriers to enter are natural, ownership, or legal. A
monopoly faces a tradeoff between price and the quantity sold. To sell a larger quantity, the
monopoly must set a lower price. But there are two price setting possibilities that create different
tradeoffs: single price and price discrimination.
B. A single price monopoly is a firm that must sell each unit of it output for the same price to all it
customers. A price discrimination monopoly is a firm that is able to sell different units of a good or
service for different prices. When a firm price discriminates, it appears to be doing its customers a
favor. In fact, it is charging each group of customers the highest price it can get them to pay and is
increasing its profit. The main obstacles to price discrimination is resale by customers which limits
price discrimination to monopolies that sell services that cannot be resold. Because in a monopoly
there is only one firm, the demand for the firm’s output is the market demand (Slide 3). Marginal
Revenue is placed between the two rows to emphasize that marginal revenue relates to the change
in the quantity sold. At each output, marginal revenue is lower that price because when price is
lowered to sell one more unit, two opposing forces affect total revenue. The lower price results in
a revenue loss, and the increased quantity sold results in a revenue gain.
C. When you examine the output level and price that maximize a monopoly’s profit, you study the
behavior of both revenue and cost as output varies. Slide 4 shows that the number of cuts made per
hour times the cost of each cut and the profit made from each cut. Thus giving three haircuts per
hour at $14 per cut generates the greatest amount of profit.
D. Slide five shows a comparison between perfect competition and a monopoly. Compared to perfect
competition, a single price monopoly produces a smaller output and charges a higher price. A
competitive industry produces the quantity at Qc at Price Pc. A single price monopoly produces
the quantity Qm at which marginal revenue equals marginal cost and sells that quantity for the
price Pm. Compared to perfect competition, a single price monopoly restricts output and raises the
price. The monopolist will receive economic profits as long as price is greater than average total
cost. According to slide 8 monopolies are inefficient because they create a deadweight loss. The
producer gains and the consumer’s lose.
E. Price discrimination is the selling of a good or service at a number of different prices to different
people. Price discrimination allows producers to make greater profits than previously assumed.
This gives the monopoly an incentive to discriminate and charge each buyer the highest possible
price. To do this a firm must 1) identify and separate different types of buyers, 2) Sell a product
that cannot be resold. The key idea behind price discrimination is to convert consumer surplus into
economic profit. To do so firms discriminate by offering different prices to different buyers or
charge the same price to all its customers but offers a lower price per unit for a larger number of
units bought.
III. Monopolistic Competition
A. Most real world markets lie between the extremes of perfect competition and monopolies. Most
firms possess some power to set their prices as monopolies do, and they face competition from the
entry of new firms as the firms in perfect competition do. The market in which such firms operate
are called monopolistic competition.
B. Monopolistic competition is a market structure in which a large number of firms compete. The
presence of a large number of firms has three implications for the firms in the industry. The first is
that each firm supplies a small part of the market. While each firm can influence the price of its
own product, it has little power to influence the average market price. Each firm must be sensitive
to the average market price of the product, however no single firm can dominate the market. Firms
will also at times attempt to create greater profits through collusion. Collusion is impossible when
the market has a large number of firms, as it does in monopolistic competition.
C. Monopolistic competition works under the idea that each firm produces a differentiated product,
which is slightly different from the products of competing firms. Production differentiation allows
competition among firms in terms of quality, price and marketing.
D. Finally, in monopolistic competition, there are no barriers to entry. The problem is that firms
cannot make an economic profit in the long run. When firms make economic profits, new firms
enter the industry. This entry lowers prices and eventually eliminates economic profits. When
losses occur firms leave the market thus increasing profits. Two main indexes are used to identify
monopolistic competition. The first is the four firm concentration ratio, which is the percentage of
the total revenue in an industry accounted for by the four largest firms in the industry. Zero would
represent perfect competition while 100 would represent a monopoly (Slide 9). A four firm
concentration ratio that exceeds 60% is regarded as an indication of a market that is dominated by
a few firms. A ratio of less that 40% is regarded as an indication of monopolistic competition. The
second index is the Herfindahl-Hirschman Index (HHI) which is the square of the percentage
market share of each firm summed over the largest 50 firms (or summed over all the firms if there
are fewer that 50) in a market. For example, if there are four firms in a market and the market
shares of the firms are 50%, 25%, 15%, and 10% (slide 10). The HHI is a popular measure of the
degree of competition during the 1980s, when the Justice Department used it to classify markets. A
market in which the HHI is less than 1,000 is regarded as being competitive and an example of
monopolistic competition. Any merger that creates an HHI of over 1,800 would be challenged by
the Justice Department.
E. The two main limitations of concentration measures alone as determination of market structure are
their failure to take proper account of 1) the geographical scope of the market, 2) barriers to entry
and firm turnover. Concentration measures take a national view of the market. Many goods are
sold in a national, regional or global market. Some industries are highly concentrated but have
easy entry and an enormous amount of turnovers of firms. Like monopolies, monopolistic
competition creates deadweight loss and is therefore inefficient. On other hand compared to
having complete productivity uniformity, monopolistic competition is efficient.
IV. Oligopoly
A. Oligopoly is a type of market that lies between perfect competition and monopoly. The firms in
oligopoly might produce might produce an identical product and compete only on price, or they
might produce a differentiated product and compete on price, product quality, and marketing.
What distinguishes them is a small number of firms compete and natural or legal barriers prevent
the entry of new firms. With a small number of firms each firm’s actions influence the profits of
the other firms. Your profit depends on the actions of other firms, and their profit depends on your
actions. Thus the firms are independent. The problem is that the firms face the temptation to
collude.
Unit VIII: Measuring a Nation's Income
I. Income and Expenditures

A. Remember that macroeconomics is the study of economy wide phenomena. The goal is to explain the
economic changes that affect many households, firms and markets at once. One of the closest studied
figures in macroeconomics is gross domestic product, which measures the total income of a nation and
is thought to be the best measure of economic well being. GDP measures two things at once: the total
income of everyone in the economy and the total expenditure on the economy's output of goods and
services. This reason for the dual measure is that income must equal expenditures in the economy.
B. Transaction's that take place within the market always have two parties; a buyer and a seller. Every
dollar spent is a dollar earned. The circular flow model is ideal for showing the equality of income and
expenditure.
Revenue Market Spending
(= GDP) for goods (= GDP)
Goods
Goods sold Bought
Firms Households
Land
Labor
Inputs for production
Market for
Factors of production
Wages, rent, profit (= GDP) Income (= GDP)
C. GDP can be computed in one of two ways: by adding up the total expenditures by households, or by
adding up the total income paid by firms. The circular flow model is a very simplified version of the
economy, as households do not spend all their income. Some of household income goes to taxes, other
is saved or invested. GDP is defined as the market value of all final goods and services within a
country in a given period of time.
D. When broken down it is easier to understand. Market value is the market price people are willing to
pay for different goods. It is a measure of all goods and services from vegetables to rental property. By
final economists mean the finished product which is called a final good. It includes the price of
intermediate goods, which are used to make the final good, but only goods that are currently being
produced. Finally this measure is taken only within the country. Business owned by Americans and
produced in foreign countries are not a part of America's GDP but of that country's. GDP is measured
in quarterly intervals adjusted seasonally and then multiplied to show annual GDP.
II. The Components of GDP
A. Economists divide GDP into four components. The first component is consumption, which is spending
by households on goods and services, with the exception of purchases of new housing. Investment is
spending on capital equipment, inventories (treated as purchases by company) and structures, including
purchases of housing. Since houses increase in value over time they are included in investment rather
than consumption. Government purchases include spending on goods and services by local, state, and
federal governments. Net Exports equal the purchases of exports by foreigners minus the purchases of
imports.
Formula: GDP = C + I + G + NX
1998 GDP (U.S) Total (Billions) Per person Percent of total
GDP 8,511 31,522 100%
Consumption 5,808 21,511 68
Investment 1,367 5,063 16
Govt. purchases 1,487 5,507 18
Net Export -151 -559 -2
1998 GDP was about $8.5 Trillion, which is divided by 270 million people in the U.S.
B. If total spending rises from one year to the next, one of things must be true: (1) the economy is
producing a larger output of goods and services or (2) goods and services are being sold at higher
prices. When economists want to study changes over time, they separate these two effects. To do this,
economists use real GDP, which answers a hypothetical question. What would be the value of the
goods and services produced this year if we valued these goods and services at the prices that prevailed
in a specific past year. Real GDP is the production of goods and services valued at constant prices.
Example of Real and Nominal GDP
Year Price of tape Quantity of tapes Price of CD's Quantity of CD's
2001 $1 100 $2 50
2002 $2 150 $3 100
2003 $3 200 $4 150
Calculating Nominal GDP
2001 ($1 per tape x 100 tapes) + ($2 per CD x 50 CD's) = $200
2003 ($3 per tape x 200 tapes) + ($4 per CD x 150 CD's) = $1,200
Calculating Real GDP (base year 2001)

Calculating GDP Deflator

2001 ($200/$200) x 100 = 100
2002 ($600/$350) x 100 = 171
2003 ($1,200/$500 x 100 = 240
C. Nominal GDP is the production of goods and services valued at current prices. In the example nominal
GDP rose each year. The rise is attributable to both an increase in price and an increase in quantities.
To obtain a measure of the amount produced that is not affected by changes in prices, real GDP is used.
GDP deflator reflects the prices of goods and services but not the quantities produced. It is calculated:
GDP deflator = Nominal GDP x 100
Real GDP
D. GDP deflator measures the current level of prices relative to the level of prices in the base year.
Looking at the example you can see how GDP deflator rose from 100 to 171, which means that the
price level increased by 71%. Even though GDP is a good measure of economic well being it is not a
perfect measure of well being. For example, GDP excludes the value of leisure and the value of a clean
environment.
III. Other measures of income
A. When the U.S Department of Commerce computes GDP quarterly they also compute other measures
that include or exclude other categories.
1. Gross National Product is the total income earned by a nation's residents. It differs from GDP by
including income that our citizens earn abroad and excluding income that foreigners earn here.
2. Net national product is the total income of a nation's residents minus the losses from depreciation.
Depreciation is the wear and tear on the economy's equipment and structures.
3. National income is the total income earned by a nation's residents in the production of goods and
services. It excludes indirect business taxes such as sales tax, and includes business subsidies.
IV. Consumer Price Index
A. Next we want to measure the overall cost of living. Economists use the consumer price index to
measure the value of a dollar over time. The CPI is a measure of the overall cost of the goods and
services bought by a typical consumer.
B. To calculate the CPI the Bureau of Labor Statistics use the prices of thousands of goods and services.
They follow five steps to determine the CPI.
1. Fix the basket: The first step in computing the CPI is to determine which prices are most important to
the typical consumer. If the typically consumer buys more CD's than tapes then the price of CD's is
more important than the price of tapes and therefore is weighted heavier. The Bureau of Labor sets
these weights by surveying consumers and establishing a basket of goods that the consumer buys.
2. Find the Prices: The second step is to find the price of the goods in the basket for each point in time.
3. Compute the basket's cost: The third step is to use the data on prices to calculate the cost of the basket
of goods and services at different times.
4. Choose a base year and compute the index: To calculate the index the price of the basket of goods and
services in each year is divided by the price of the basket in the base year and then the ratio is
multiplied by 100.
Example of CPI
Step 1: Survey consumers
4 CD's, 2 Tapes
Step 2: Find the price of each good in each year
Year Price of CD's Price of Tapes
2001 $1 $2
2002 $2 $3
2003 $3 $4
Step 3: Compute the cost of the basket of goods in each year
2001 ($1 Per CD x 4 CD's) + ($2 per tape x 2 tapes) = $8
Step 4: Choose one year as a base
2001 ($8/$8) x 100 = 100
2002 ($14/$8) x 100 = 175
2003 ($20/$8) x 100 = 250
Step 5: Compute inflation rate
2002 (175-100)/100x100=75%
2003 (250-175)/175x100=43%
5. Compute the inflation rate: the inflation rate is the percentage change in the price index from the
preceding period. The inflation rate between the two years is computed:
Inflation rate in year 2 = CPI in year 2 - CPI in year 1 x 100
CPI in year 1
Computing Inflation:
Present Year dollars = Past year dollars x Price level in present year
Price Level in past year
Past year dollars = Present year dollars x Price level in past year
Price level in present year
Percentage change: P2 – P1 x 100
P1
In addition to consumer price index for the overall economy the Bureau also calculates producer price
index, which is a measure of the cost of a basket of goods and services bought by firms. Because firms
eventually pass on their costs to consumers in the form of higher consumer prices, changes in the PPI
predict changes in CPI.
V. Problems measuring the cost of living

A. There are three problems with the index as a perfect measure of the cost of living. The first is called the
substitution bias. When prices change year to year they do not change proportionately, some rise more
than others. When the price of goods rise consumers substitute goods, which the CPI does not take into
account.
B. The second problem is the introduction of new goods. New goods entering the market mean more
variety making each dollar more valuable, because it takes fewer dollars to maintain their standard of
living.
C. Third problem is the unmeasured quality change. If the quality of a good deteriorates from one year to
the next, the value of a dollar falls, even if the price of the good stays the same.
VI. The GDP deflator vs. the CPI
A. Economists study both to gauge how quickly prices are rising. Usually the two tell the same story but
there are two important differences that cause them to differ. The first is the that the GDP deflator
reflects the prices of all goods and services produced domestically whereas the CPI reflects prices of
all goods and services bought by consumers. The second difference concerns how various prices are
weighted to yield a single number for the overall levels of prices. The CPI compares the price of a
fixed basket of goods and services to the price of the basket in the base year. The GDP though
compares the price of currently produced goods and services to the price of the same goods and
services in the base year. What this means is that the group of goods and services used to compute the
GDP deflator changes automatically over time.
B. The purpose of measuring the overall level of prices in the economy is to permit comparison between
dollar figures from different points in time. Here are three examples:
1. In 1931 Babe Ruth was paid $80,000; the question is how that relates to present figures. To do that we
need to inflate Ruth's salary to those of today's dollars. A price index determines the size of this
inflation correction. In 1931 the CPI was 15.2 and 166 for 1999.The overall level of prices has risen by
a factor 10.9. (11%)
Salary in 1999 dollars = Salary in 1931 dollars x Price level in 1999
Price level in 1931
= $80,000 x 166
15.2
= $ 873,684
Ruth's salary adjusted is less than average player's salary and know where near the 50 to 60,000 some
players get every trip to the plate.
2. In 1931 President Hoover was paid $75,000. If you translate that into 1999 dollars he would have
made $819,079, well above the Clinton salary of $200,000.
3. Movie popularity is gauged by box office receipts. By that measure Titanic is number one followed by
Star Wars and Stars Episode I and ET. This ignores the increase in ticket prices over time. When
adjusted for inflation the lists changes considerably.
Film Year of Release Total Domestic Gross in Millions

1999 2001
1. Gone with the Wind 1939 $920 $1,002
2. Star Wars 1977 $798 866
3. The Sound of Music 1965 $638 695
4. Titanic 1997 $601 687
5. E.T 1982 $601 640
C. When dollar amounts are automatically corrected for inflation by law or contract, the amount is said to
be indexed for inflation. For example, many long-term contracts between firms and unions include
partial or complete indexation of wages to the CPI. This is called a cost of living allowance.
Unit IX: Production and Growth
I. Economic growth around the world
A. Standard of living varies around the world. The average person in the U.S or Japan has ten times the
income of a person in India, or Nigeria. The large difference in standard of living is reflected in the
quality of life. Within countries the standard of living can change significantly over time. In the U.S
GDP per person has grown about 2% per year. This growth rate implies that the average income
doubles every 35 years. The question is what determines and explains the varying levels of economic
growth. A good gauge is the long run determinants of the level of growth of real GDP.
B. The first step is to examine international data on real GDP per person.
Country Period Real GDP per person at Real GDP per person Growth Rate per
beginning of period* at end of period* Year
Japan 1890-1997 $1,196 $23,400 2.82%
Brazil 1900-1997 $619 $6,240 2.41%
Mexico 1900-1997 $922 $8,120 2.27%
Germany 1870-1997 $1,738 $21,300 1.99%
Canada 1870-1997 $1,890 $21,860 1.95%
China 1900-1997 $570 $3,570 1.91%
Argentina 1900-1997 $1,824 $9,950 1.76%
U.S 1870-1997 $3,188 $28,740 1.65%
Indonesia 1990-1997 $708 $3,450 1.34%
India 1900-1997 $537 $1,950 1.34%
* Real GDP is measured in 1997 dollars
C. The second step is to examine the role of productivity, which is the amount of goods and services
produced from each hour of a worker's time. A good way to study productivity is to examine the novel
Robinson Crusoe. Crusoe was stranded on a desert island. To survive he catches his own fish, grows
his own vegetables and makes his own clothes. This is a simple economy that can be studied. Crusoe's
standard of living is determined by his ability to do these things. His living standard is directly tied to
what he can produce. For Crusoe productivity is a key determinant because the more he can produce
the more he can eat. The same principles apply to nations as well, because an economy's income is the
economy's output. The question for nations is why are some economies better at producing goods and
services than others.
D. Productivity is determined by a set of determinants.
1. The first determinant is physical capital, which is the stock of equipment and structures that are used to
produce goods and services (capital). Capital is important because it is used to produce many goods
and services including more capital.
2. Human Capital: is the knowledge and skills that workers acquire through education, training and
experience.
3. Natural resources: differences in natural resources are one reason for differences in standards of living.
This was especially true of past development but countries can succeed in today's economy without
natural resources if it is highly developed industrially.
4. Technological knowledge: is the understanding of the best way to produce goods and services. Workers
have always sought ways to become more efficient. For example mankind has always sought ways to
produce large amounts of food with a small part of the population leaving others to work in other
fields.
II. Economic growth and public policy
A. In Unit I we looked at the ten principles of economics, one of which is that people face tradeoffs. This
becomes very important when understanding economic growth. In order for countries to grow they
must invest in capital but in order to do that it must consume less and save more of its income. This
temporary sacrifice of goods will lead to higher consumption in the future.
(a) Growth Rate 1960-1991 (%) (b) Investment 1960-1991 (percent of GDP)
South Korea 7 25
Singapore 6.8 32
Japan 5.4 35
Israel 3.3 27
Canada 2.7 24
United States 1.9 22
India 1.6 14
Chile 1.4 20
Rwanda 1.1 5
B. The debate is how long does this growth rate of GDP stay high. Capital is subject to diminishing
returns, meaning that as the stock of capital rises, the extra output produced from an additional unit of
capital falls. Essentially when workers already have a large quantity of capital to produce goods giving
them additional capital will only increase their productivity slightly. Another application of
diminishing returns is that it is easier for a country to grow fast if it starts out relatively poor. This
effect on initial conditions on growth is called the catch-up effect.
C. Government policies can also influence the economy's growth rate.
1. Encouraging saving and investment
2. Encouraging foreign investment
3. High educational standards
4. Maintaining political stability and property rights
5. Allowing for free trade
6. Promoting the research and development of new technologies
7. Reducing population growth. In highly industrialized countries the population growth rises about 1%
per year, by contrast some African nations have population growth rates of 3% causing population to
double every 23 years.
Unit X: The Monetary System
I. The Meaning of Money
A. Economists use the word money in a specific sense: it is the set of assets in the economy that people
regularly use to buy goods and services from other people. What this means is money includes only
those few types of wealth that are exchanged by buyers and sellers for goods and services. Money has
three functions in the economy. It is these functions which distinguish money from stocks, bonds or
any other form of wealth.
1. Medium of exchange: an item that buyers give to sellers when they purchase goods or services.
2. Unit of account: the yardstick people use to post prices and record debts.
3. Store of value: an item that people can use to transfer purchasing power from the present to the future.
Wealth is used to refer to the total of all stores of value, including both monetary and non-monetary
assets. When converting an asset into a medium of exchange the term liquidity is used to describe the
ease with which an asset can be converted.
II. Kinds of money
A. When money takes the form of a commodity with intrinsic value, it is called commodity money.
Intrinsic value means that the item would have value even if it were not used as money. An example
would be gold, because it is used in the jewelry industry. For centuries gold was a standard medium of
exchange. Countries doing this were said to be on the gold standard. The problem with the gold
standard is that there is a set amount of gold in the world and that limits the amount of money in the
world. Money without intrinsic value is known as fiat money because it is only backed by the promise
of the government. The success of fiat money is largely governed by the success of the economy.
B. The amount of money in the economy is called the money stock and has a powerful influence on the
economy. In order to measure the amount of money you have to measure several different assets. The
first being currency, which is the paper bills and coins in circulation. The second would be demand
deposits, which are the balances in bank accounts that depositors can access on demand by writing a
check.
III. The Federal Reserve System
A. The Federal Reserve System (Fed) is responsible for regulating our monetary system. The Fed is the
central bank for the U.S and is responsible for controlling the amount of money and credit in the
economy. The Fed was created in 1914. Serious banking panic during the late 1800s and early 1900s
made it clear that if commercial banks were left to operate on their own without their actions being
supervised and their policies coordinated, the system could collapse. The Fed is run by a Board of
Governors, which has seven members appointed by the President. The governors are given 14-year
terms. The most member of the board is the chairman, who directs the staff, presides over meetings and
testifies regularly about Fed policy. The chairman serves a four year term, and is currently Alan
Greenspan. The Federal Reserve System is made up of the Federal Reserve Board and twelve regional
Federal Reserve Banks. The Fed has two related jobs. The first is to regulate banks and ensure the
health of the banking system. This task is largely the responsibility of the regional banks. The Fed
monitors each bank's financial condition and facilitates bank transactions by clearing checks. The Fed
also makes loans to banks when banks themselves want to borrow. The second job is very important
and that is to control the quantity of money in circulation, which is called the money supply. Decisions
made by the Fed concerning the money supply make up the monetary policy. The monetary policy is
made up by the Federal Open Market Committee. The FOMC is made up of the seven governors plus
five of the 12 regional presidents. The primary way in which the FOMC controls the supply is through
the buying and selling of bonds which is called open market operations.
IV. Banks and the money supply
A. Because demand deposits are held in banks, the behavior of banks can influence the quantity of
demand deposits in the economy and therefore the money supply. To begin with imagine that there is
only on bank in this country. The bank is only a depository institution, meaning that it does not loan
money. The purpose of the bank is simple to hold money for people until they withdraw it. Deposits
that have been received but no loaned out are called reserves. In this instant the system is called 100%
reserve banking. This can be expressed in what is called a T-account, which is simple accounting
statement showing changes in a bank's assets.
Example 1: First National Bank
Assets Liabilities (amount owed to its depositors)
Reserves $100.00 Deposits $100.00
B. If the bank holds all its deposits in reserve, it does not influence the money supply. Suppose that the
bank decides that it should expand by loaning money in reserve to people. It must keep some of the
reserves so depositors can make withdraws but if the flow of new deposits is roughly the flow of
withdrawals then the bank only needs to keep a fraction of its deposits in reserve. This is known as
Fractional Reserve Banking. The fraction of total deposits that a bank holds as reserve is called the
reserve ratio. This ratio is determined by a combination of government regulation and bank policy. The
Fed places a minimum on the amount of reserves that banks hold called the reserve requirement. In
addition banks can hold limits above the reserve requirement called excess reserves. For example if
First National has a reserve ratio of 10% then it must keep 10% of its deposits in reserve and can loan
out the rest. When banks make loans, the money supply increases because the money supply equals
$190. The money supply equals currency plus demand deposits.
Example 2: First National Bank
Assets Liabilities
Loans $90.00
C. The creation of money of does not stop with the banks though. Suppose that the borrower uses the $90
to buy something from someone who then deposits the money into Second National Bank.
Example 3: Second National Bank
Assets Liabilities
Loans $81.00
After the deposit the bank has liabilities of $90. If they also have a reserve ration of 10, it keeps assets of $9
in reserve and loans $81 creating an additional supply of money. If the $81 is deposited in Third National
Bank, this bank keeps $8.10 in reserve and makes $72.90 in loans. To determine how much money is
eventually created in the economy:
Example 4:
Original deposit = $100.00
First National lending = $ 90.00
Second National lending = $ 81.00
Third National lending = $ 72.90
Fourth
Fifth
Sixth
Total money supply = $1000.00
The amount of money the banking system generates with each dollar of reserves is called the money
multiplier. In this economy the money multiplier is 10 because $100 of reserves generates $1000 of money.
The money multiplier is the reciprocal of the reserve ratio. If R is the reserve ratio for the economy, then
each dollar of reserves generates 1/R dollars of money. For example if the reserve ratio were only 1/20
(5%) then the banking system would have 20 times as much in deposits as in reserves, meaning a multiplier
of 20. Each dollar of reserves would generate $20 of money. Thus, the higher the reserve ratio, the less of
each deposit banks loan out and the smaller the money multiplier. The reserve ratio is 1/x , x being the
money multiplier. To convert a fraction to a percent the formula is 1/x * 100.
D. When the Fed decided to change the money supply it has three tools to do so. The first is open market
operations, the second is reserve requirements, which regulate the minimum amount of reserves that
banks must hold against deposits. The third is the discount rate, which is the interest rate on the loans
that the Fed makes to the banks. The higher the discount rate discourages banks from borrowing
reserves whereas an increase in the discount rate reduces the quantity of reserves, which in turn
reduces the money supply.
E. The Fed's control of money though is not precise, because they must deal with two problems created
by fractional reserve banking. The first is that the Fed does not control the amount of money deposited
in banks. The more money deposited the more in reserve, the less deposited the money supply falls
without Fed action. The second problem is that the Fed does not control the amount banks lend.
Causing the same problems. Because of this the Fed keeps weekly data on bank deposits and loans.
Unit XI: Macroeconomic Problems
I. Inflation
A. Over the course of time prices across the globe have risen. Products which for many years you could
buy for less than a quarter now costs over a dollar. This increase in prices is called inflation. The price
indexes we examined earlier show that prices have risen on average about 5% per year since 1930.
This however is not always the norm as many periods during the 19th century prices fell, which is
known as deflation. The average of prices in 1896 was 23% lower than in 1880 and became a major
presidential election issue with the Populist Party a large third party made up of Midwestern farmers
and Union workers who were angry that the fall in prices had caused them to go bankrupt. They
wanted the government to increase the amount of silver purchased by the government to inflate the
money supply.
B. A five percent rise in prices is not necessarily the norm though as prices only rose about 2% a year in
the 1990s but 7% per year in the 1970s leading to a doubling of prices by 1980. In some parts of the
world inflation has rose at unbelievable rates. Post WWI Germany suffered the worst inflation in
history when the mark fell to $4.2 trillion to one American dollar in less than two years. This
phenomenon is known as hyperinflation. The effect on Germany was so profound that they have one of
the lowest inflation rates in the World today.
II. Classical Theory of Inflation
A. The term classical is used because it was developed by some early economists. Earlier we viewed the
price level as the price of a basket of goods and services. When the price levels rise people have to pay
more for goods and services. We can however also view the price level as a measure of the value of
money. A rise in the price level means a lower value of money because each dollar you have now buys
a smaller quantity of goods and services.
B. The determinant of the value of money is supply and demand. In this it is more specifically money
supply and money demanded. The money supply is controlled by the Fed, which uses the buying and
selling of bonds to control the money supply, this of course can be altered by fractional reserve
banking. The money demanded is determined by many factors. One of the major factors is how much
money is actually deposited into accounts. One variable however does stand out, the average level of
prices in the economy. This means that a higher price increases the demand for money. The
determining factor in the amount of money the Fed supplies is the time horizon being considered. In
the long run, the overall level of prices adjusts to the level at which demand for money equals the
supply. If the price level is above the equilibrium, people will want to hold more money than the Fed
has created, so the price level must fall. If the price level is below equilibrium, people will want to hold
less money, and the price level must rise.
Example 1:
Value of money, 1/P Price level, P
(high) money supply 1 (low)
3/4 1.33
1/2 2 Equilibrium price level
1/4 4
(low) (high)
Quantity fixed Quantity of money
by Fed
Equilibrium value of money
The quantity of money demanded balances the quantity of money supplied so the equilibrium determines
the price level and the value of money.
C. Suppose there is a change in monetary policy and the Fed changes the supply of money.
Example 2:
Value of money, 1/P Price level, P
(high) 1 1 (low)
3/4 1.33
1/2 2
1/4 4
(low) (high)
0 M1 M2
This explanation of how the price level is determined and why it might change over time is called the
quantity theory of money. This states that the quantity of money available determines the price level and
that the growth rate in the quantity of money available determines the inflation rate.
D. Since the amount of money in circulation determines the inflation rate why is that countries have
hyperinflation. The answer is that governments create money to pay for spending. Most of the money
the government needs to pay for things is raised by taxes, but in some cases the government has had to
print money to pay for stuff. When this occurs it is known as an inflation tax because the government
raises revenue by creating money. This has occurred in many countries including the U.S. During the
American Revolution and the Confederacy during the Civil War printed money to pay for the war. The
Confederate inflation rate reached 9,000% by 1865. The German government during the 1920s printed
money to pay the reparation payments to the Allies. They had to do this because they had lost their
industrial areas to France and Poland and had no way to generate enough revenue to make the
payments and provide for the country.
III. Unemployment
A. The problem of unemployment is usually divided into two categories: the long run problem and the
short run problem. The economy's natural rate of unemployment refers to the amount of unemployment
the economy normally experiences. Cyclical unemployment refers to the year to year fluctuations in
unemployment around its natural rate and is associated with short fluctuations in economic activity.
B. Unemployment is measured by the Bureau of Labor Statistics, which produces unemployment data
each month. Based on their surveys they place each adult (16+) into one of three categories:
1. Employed
2. Unemployed
3. Not in labor force: students, homemakers, retired
C. Once the Bureau has placed people into categories if computes the statistics to provide a summary of
the labor market. The labor force is defined: Number employed + number of employed
Example 1: 1998 Breakdown of population
Employed
(131.5 million)
Labor force
(137.7 million)
Adult Population
(205.2 million) Unemployed (6.2 million)
Not in labor force

(67.5 million)
The unemployment rate is defined as the percentage of the labor force that is unemployed:
Unemployment rate = Number of unemployed x 100
Labor force
The Bureau uses the same survey to measure the percentage of the total adult population that is in the
labor force:
Labor force participation rate - Labor force x 100
Adult population
This statistic tells the fraction of the population that has chosen to participate in the labor markets .
Using these formulas on the 1998 data:
Unemployment rate = 6.2/137.7) x 100 = 4.5%
Labor force participation rate = 137.7/205.2) x 100 = 67.1%
D. The data on the labor market allows economists to monitor the changes in the economy over time. The
normal rate of unemployment around which unemployment fluctuates is called the natural rate of
unemployment and the deviation of unemployment from its natural rate is called cyclical
unemployment.
E. The difficult factor is in determining who is actually unemployed and who is not in the labor force.
More than 1/3rd of the unemployed are recent entrants into the labor force. These include recent college
graduates, people looking for their first jobs, older workers returning to the workforce.
F. There are two ways to explain unemployment in the long run as most unemployment is for the short
run. The first is that it takes time for workers to search for the jobs that are best suited for them. The
unemployment that results from this matching of job and worker is called frictional unemployment.
The next three explanations revolve around the fact that there may not be enough jobs in the market for
everyone who wants one. This occurs when the quantity of labor supplied exceeds the quantity
demanded, and is called structural unemployment. This kind of unemployment results when wages are
set above the level that brings supply and demand into equilibrium. Three possible explanations are
minimum wage laws, unions and efficiency wages.
G. Minimum wages were first discussed in Unit V. Minimum wages laws can really only explain
unemployment among the least experienced and least skilled members of the labor force. The example
below shows the effects of a minimum wage law but illustrates the general lesson that if wages are
kept above the equilibrium level for any reason, the result is unemployment.
Example 2:
Wage
Surplus of labor Labor supply
Minimum wage
We
Labor demand
Ld Le Ls Quantity of labor
H. A union is a worker association that bargains with employers over wages and working condition.
Union where extremely important in the late 1800s 1960s, today only 16% of the population belongs to
a union. The process by which unions and firms agree on the terms of employment is called collective
bargaining. If the union and the firm cannot agree on specific terms the union may organize a strike,
reducing production and sales. However the firm may decide to lockout the union workers and higher
replacements causing serious conflict between workers that in some cases has caused violence and
death. On average though union workers are paid 10% to 20% higher wages.
I. The fourth explanation for unemployment is efficiency wages, which are above equilibrium wages paid
by firms in order to increase worker productivity. The difference between union and minimum wage
laws which prevent firms from lower wages, efficiency wage theory states that may be better off
keeping wages above equilibrium. There are four possible reasons why firms would want to keep
wages high:
1. Worker health: the better paid a worker is the healthier they are as they can eater better food and be
productive. This theory typically applies more to third world or underdeveloped countries.
2. Worker turnover: the more a firm can pay its workers the less likely they are to leave the firm and find
a new job.
3. Worker effort: higher wages cause worker to think more about their responsibilities at work and may
cause them not to be lazy under the threat of being fired.
4. Worker quality: by paying higher wages the firm attracts a better qualified pool of applicants.

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Unit I: Principles of Economics

Price Excess Demand 14 - 5 = 9 is your shortage

III. Total Revenue

IV. Elasticity of Supply

Elastic Supply: Elasticity is greater than 1 Inelastic Supply

100 200 Q 100 110 Q

V. Cross Elasticity of Demand and Income Elasticity

Cross elasticity of demand = % change in QD of a good

(a) Non Binding (b) Binding

Quantity of labor Qd Qs Quantity of labor

Equilibrium with tax

Equilibrium with tax

Wage Labor supply

Wage firms pay

tax employer pays

Price buyers pay = Pb

Price w/o tax = P1

Tax size Tax rate

Price after trade World price

Price before trade

Equilibrium w/o trade

Price w/ tariff Tariff

I. Income and Expenditures

Calculating Real GDP (base year 2001)

Calculating GDP Deflator

V. Problems measuring the cost of living

Film Year of Release Total Domestic Gross in Millions

1/2 2 Equilibrium price level

Not in labor force

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