Economics Definition

Yeong-Se ChangThe true lover of economics

Section 1- Introduction to

Economics

Microeconomics – is the study that focuses on individual markets and decisions by individual households and firms.

Macroeconomics – is the study that focuses on the economy as a whole. It considers the price level for the economy as a whole, rather than for one market.

Positive economics – is based on testable theories that can be proven to be right and wrong by looking at facts.

Real world example: the idea that higher interest rate lead to a fall in aggregate demand can be tested by looking at data like China today.

Normative economics – is based on opinion that can not be proven or tested. They involve value judgment.

Real world ex: In Japan, one party is saying the Government should consider unemployment its priority. This is one group’s view. Another group is saying it is more important to raise the tax.

Factors of Production

- Land is the physical factor of production. Natural resources such as air and water

- Labor is the human factor of production. All human resources including physical work of all type and it depends on the population

- Capital is the factor of production that is made by human and it gives man-made aids to production. Examples are factories and equipments

Entrepreneurship – is the ability to combine factors of production and take risks in establishing new ventures. Example: Innovation of human

Scarcity – The inability to provide sufficient services and goods to satisfy the society’s unlimited demand due to limited availability of economic resources.

Real world ex: Scarcity for natural resources.

Opportunity Cost – is the sacrifice made in the next alternative.

Real world ex: I used my allowance to buy WII not PS3. PS3 is the opportunity cost

Free goods – are gifts of nature supplied without labor and limits. It involves no opportunity cost.

Ex: Air

Economic goods – are scarce and their production involves opportunity costs.

Ex: diamonds

Production Possibility Curve – shows the maximum combination of goods and services which can be produced given the existing level of resources.

Economic Growth – is the growth of real output in an economy over time.

Economic development – a process where there is improvement in the lives of all people in the country. This involves not only living standards such as greater availability of goods and services but also promotion of attributes such as self-esteem and rights. EX: Liberia after civil war

Sustainable development – is one that meets the demands of present without compromising the ability of future generations for their demand.

Free market economy – is an economy where production are held by individuals and firms. Demand and supply determines. EX: UK

Planned economy – is one owned by the state. EX: Past soviet union or communist countries

Section 2: Microeconomics

Markets

Market – is where buyers/consumers and sellers/producers come together to establish an equilibrium price and quantity for a good or service. It doesn’t have to be a actual place.

Demand – the willingness and ability to purchase a quantity of a good or service at a certain price over a given time period.

The law of demand – states that as the price of a good or service rises, the quantity demanded decreases.

The demand curve – is a graphical representation of the law of demand.

Giffen good – is a good for which an increase in price result in an increase in demand for the good. EX: Stocks

Veblen good – is a good that has an upward-sloping demand curve. People buy more of the good because it is more expensive and therefore demand is higher when is is expensive.

Supply – the willingness and ability of a producer to produce a quantity of a good or service at a certain price over a given time period.

The law of supply – states that as the price of a good rises, the quantity supplied increase.

Supply Curve – a graphical representation of the law of supply.

Equilibrium price – the market clearing price that occurs when demand and supply are equal.

Specific Tax – is a fixed amount of tax charged on each unit. It will shift the supply curve vertically upwards by the amount of the tax.

Ad-valorem Tax – is levied as percentage of the selling price.

Subsidy – a payment made to firms or producers designed to encourage an increase in output.

Real world ex: Korean government giving subsidy to farmers.

Maximum price (ceiling price) – A price set by the government, above which the market price is not allowed to rise. It may be set to protect consumers from high prices, and it may be used in markets for essentials goods like house rental.

Real world ex: maximum price of house rental in Korea for student use.

Minimum Price (floor price) – A price set by the government, below which the market price is not allowed to fall. It may be set to protect producers producing essential products from facing prices that are felt too low. Examples: Part-time job wage in Korea

Shortage – It is a disparity between the amount demanded for a product or service and the amount supplied in a market causing not enough to be produced to meet the demand.

Surplus - It is a disparity between the amount supplied for a product or service and the amount demanded in a market creating extra.

Buffer Stock Scheme – It sets a maximum and minimum price in a market to stabilize prices

Real world example: U.S. government once bought a lot of material goods to stabilize price.

Section 2: Microeconomics

Elasticities

Price Elasticity of Demand (PED) – a measure of the responsiveness of the quantity demanded or a good or service to a change in its price.

Elastic demand- a change in the price of a good or service will cause a proportionately larger change in quantity demanded. EX: Beer

Inelastic demand – a change in a price of a good or service will cause a proportionately smaller change in quantity demanded. EX: Soap

Cross elasticity of demand (XED) – a measure of the responsiveness of the demand for a good or service to a change in the price of a related good. EX: Cheese and pizza

Compliment: good which are used together. They have negative XED

Substitute: good that can be used instead of each other. Positive XED.

Income elasticity of demand (YED) – a measure of the responsiveness of demand for a good to a change in an income.

Real world example: People buying more luxury good when their income increase.

Normal good has a positive YED. As income rises, demand increases.

Inferior good has a negative YED. Opposite of normal good.

Price elasticity of supply (PES) – a measure of the responsiveness of the quantity supplied of a good or service to a change in its price.

Indirect tax – is an expenditure tax on a good or service

Incidence (or burden) of tax – is the amount of tax paid by the producer or the consumer. Price inelastic good has the greater incidence fall on the consumers. Price elastic is the other way around.

Section 2: Microeconomics

Theory of Firm

Fixed costs- They are costs of production that do not change with the level of output. EX: renting the land

Variable costs- are costs of production that vary with the level of output. Ex: Labor costs

Total costs – are the total cost of producing a certain level of output: fixed costs plus variable costs.

Average costs – are the average cost of production per unit that can be calculated by dividing the total cost by the quantity produced.

Marginal costs – are the additional cost of producing an additional unit of output.

Short run – is the period of time in which at least one factor or production is fixed: the production stage.

The law of diminishing average returns states that as extra units of a variable factor are applied to a fixed factor, the output per unit of the variable factor will eventually diminish.

The law of diminishing marginal returns states that as extra units of a variable factor applied to a fixed factor, the output from each additional unit of the variable factor will eventually diminish.

Long run - is the period of time in which all factors of production are variable.

Economies of scales are any fall in long-run unit (average) costs that come about as a result of a firm increasing its scale of production (output).

Diseconomies of scale are any increase in long-run unit (average) costs that come about as a result of a firm increasing its scale of production (output)

Real world ex: The biggest ship

Total revenue – is the aggregate revenue gained by a firm from the sale of a particular quantity of output (equal to price times quantity sold). Average revenue is total revenue received divided by the number of units sold. Usually, price is equal to average revenue.

Marginal revenue – is the extra revenue gained from selling an additional units of a good or service.

Normal profit – are the amount of revenue needed to cover the total cost of production, including the opportunity costs

Real world example: modern companies

Abnormal profit – are any level of profit that is greater than that required to ensure that a firm will continue to supply its existing good or service. EX: Apple co.

Profit-maximizing level of output – is the level of output where marginal revenue is equal to marginal cost.

Shut-down price – is the price where average revenue is equal to average variable cost. The firm will shut down in short run. EX: JAL before government’s involvement.

The break-even price – is the price where average revenue is equal to average total cost. Shut down in long run.

Allocative efficiency – is the level of output where marginal cost is equal to average revenue, or price. The firm sells the last unit it produces at the amount that it costs to make it.

Productive efficiency – exists when production is achieved at the lowest cost per unit of output. This is achieved at the point where average total cost is at its lowest value.

Perfect competition – is a market structure where there is a very large number of small firms, producing identical products. No individual firm is capable of affecting the market supply curve and thus cannot affect the market price. The firms are price takers. No barriers to entry or exit and all firms have perfect knowledge of the market.

Real world ex: moving ice cream shop

Monopolistic competition – is a market structure where there are many buyers and sellers producing differentiated products, with no barriers to entry or exit.

Real world example: Street souvenir shops

Oligopoly – is a market structure where there is a small number of large firms that dominate the market.

Real world ex: 90% of petrol sold in most countries are accounted for by four large chains of petrol stations.

Monopoly – is a market form where there is only one firm in the industry; the firm is the industry

Real world ex: Iphone

Barrier to entry – are obstacles that may be in the way of potential newcomers to a market, such as economies of scale, production differentiation, and legal protection.

Real world ex: outsourcing in china

Price discrimination – occurs when a producer charges a different price to different customers for an identical good or service.

Real world example: Rokko Liner