Intro to Econ
Econ 1011 Study Guide
Opportunity Cost
The opportunity cost is the cost of the forgone alternative. (If you have many alternative it is the one which has the highest value)
Total opportunity cost / economic cost = Explicit cost + Implicit cost
Production Possibilities Frontier
- Points inside the PPF vs. outside the PPF
- Shape of the PPF
- Economic growth and PPF
Law of Demand
Other things remaining constant, the quantity demanded of a good rises when the price of the good falls
Income and Substitution Effect
The two concepts are trying to explain the law of demand. Let’s define the ‘price effect’ as the impact of a change in price on quantity demanded. We expect the price effect to have a negative sign, signifying the inverse relationship between P and Q / the downward slope of DD.
When price of a good changes, it does two things (a) makes it relatively expensive or cheaper with respect to other goods in the market, and (b) changes our purchasing power.
The substitution effect is always negative i.e. when price rises then the good becomes relatively expensive and quantity demanded decreases. (Both P and Q go in opposite direction)
The income effect can be negative or positive: when the price of a good rises and if it reduces your purchasing power (in turn reducing the quantity demanded) then income effect will have a negative sign and such goods are called ‘normal goods’.
However, if a decrease in price of a good, increases your purchasing power and you decide to increase quantity demanded then the income effect has a positive sign (both P and Q go in same direction) and such goods are called inferior goods.
Now, inferior goods mess up our calculations. A negative plus a positive number could be either negative (inferior good type 1) or it could be positive (inferior good type 2). The latter are called ‘Giffen goods’ and that they are kind of bizarre because they have a positive price effect. In other words, when
Opportunity Cost
The opportunity cost is the cost of the forgone alternative. (If you have many alternative it is the one which has the highest value)
Total opportunity cost / economic cost = Explicit cost + Implicit cost
Production Possibilities Frontier
- Points inside the PPF vs. outside the PPF
- Shape of the PPF
- Economic growth and PPF
Law of Demand
Other things remaining constant, the quantity demanded of a good rises when the price of the good falls
Income and Substitution Effect
The two concepts are trying to explain the law of demand. Let’s define the ‘price effect’ as the impact of a change in price on quantity demanded. We expect the price effect to have a negative sign, signifying the inverse relationship between P and Q / the downward slope of DD.
When price of a good changes, it does two things (a) makes it relatively expensive or cheaper with respect to other goods in the market, and (b) changes our purchasing power.
The substitution effect is always negative i.e. when price rises then the good becomes relatively expensive and quantity demanded decreases. (Both P and Q go in opposite direction)
The income effect can be negative or positive: when the price of a good rises and if it reduces your purchasing power (in turn reducing the quantity demanded) then income effect will have a negative sign and such goods are called ‘normal goods’.
However, if a decrease in price of a good, increases your purchasing power and you decide to increase quantity demanded then the income effect has a positive sign (both P and Q go in same direction) and such goods are called inferior goods.
Now, inferior goods mess up our calculations. A negative plus a positive number could be either negative (inferior good type 1) or it could be positive (inferior good type 2). The latter are called ‘Giffen goods’ and that they are kind of bizarre because they have a positive price effect. In other words, when