BSSE Economics 1443 cheat sheet

Scarcity: wants are unlimited but resources are finite, so every choice carries an opportunity cost.

Opportunity cost = value of the single best forgone alternative, not the sum of all alternatives.

Production possibilities frontier (PPF): boundary of feasible output combinations given fixed resources and technology.

Points inside the PPF are inefficient; points on the PPF are productively efficient; points beyond are unattainable.

PPF slope equals the marginal rate of transformation = MCx / MCy; bowed-out shape reflects increasing opportunity cost.

Economic growth shifts the PPF outward; a change in the relative prices or technology of one good rotates it.

Positive statements are testable claims about what is; normative statements are value judgments about what ought to be.

Ceteris paribus: hold all other variables constant when isolating the effect of one variable.

Marginal analysis rule: take an action if marginal benefit exceeds marginal cost; the optimal point is where MB = MC.

Law of demand: price and quantity demanded move in opposite directions, ceteris paribus; demand curve slopes downward.

A change in price causes movement along the demand curve; changes in income, tastes, prices of related goods, or expectations shift the curve.

Normal good: income rise increases demand. Inferior good: income rise decreases demand.

Substitutes: a rise in the price of one raises demand for the other. Complements: a rise in one lowers demand for the other.

Law of supply: price and quantity supplied move together; supply shifts with input costs, technology, taxes, subsidies, and number of sellers.

Equilibrium: Qd = Qs. A price above equilibrium creates a surplus; a price below creates a shortage.

A simultaneous demand and supply shift leaves either equilibrium price or quantity indeterminate without knowing relative magnitudes.

Consumer surplus = area below demand and above price; producer surplus = area above supply and below price.

Total surplus is maximized at competitive equilibrium; a binding price ceiling or floor creates deadweight loss.

Price elasticity of demand Ed = (% change in Qd) / (% change in P); use the midpoint formula to avoid direction bias.

|Ed| > 1 elastic, |Ed| < 1 inelastic, |Ed| = 1 unit elastic.

Demand is more elastic with more substitutes, a larger share of budget, longer time horizons, and luxury status.

Total revenue test: price cut raises revenue when demand is elastic; price rise raises revenue when demand is inelastic.

Income elasticity = (% change in Qd) / (% change in income); positive for normal goods, negative for inferior goods.

Cross-price elasticity = (% change in Qd of X) / (% change in price of Y); positive for substitutes, negative for complements.

Price elasticity of supply = (% change in Qs) / (% change in P); larger when inputs are easily reallocated and time is longer.

Tax incidence falls more heavily on the side of the market that is less elastic.

Utility maximization: MUx / Px = MUy / Py; diminishing marginal utility makes the demand curve downward sloping.

Accounting profit = total revenue − explicit costs; economic profit = total revenue − explicit − implicit costs.

Short run: at least one input fixed. Long run: all inputs variable.

Marginal product eventually diminishes as a variable input is added to a fixed input (law of diminishing returns).

MC = ΔTC / ΔQ; it intersects ATC and AVC at their minimum points.

ATC = AFC + AVC; AFC falls continuously as output rises, so ATC and AVC converge.

Total cost = fixed cost + variable cost; average fixed cost = FC / Q.

Profit maximization occurs where MR = MC, provided price covers average variable cost in the short run.

Shutdown rule: shut down in the short run if price < minimum AVC; exit in the long run if price < minimum ATC.

Economies of scale push long-run ATC down; diseconomies push it up; the minimum efficient scale is the lowest output at which LRATC is minimized.

Perfect competition: many price-taking firms, homogeneous product, free entry and exit; P = MR = MC in equilibrium.

Long-run competitive equilibrium: P = minimum ATC, so firms earn zero economic profit.

Monopoly: single seller, barriers to entry, downward-sloping demand; MR < P because price must fall to sell more units.

Monopolist maximizes profit at MR = MC and sets price on the demand curve above MC, creating deadweight loss.

Monopolistic competition: many firms, differentiated products, easy entry; zero long-run economic profit with excess capacity.

Oligopoly: few firms, strategic interdependence; collusion raises joint profit but is unstable because each firm gains by cheating.

Game theory: a dominant strategy is best regardless of rivals' choices; Nash equilibrium is a strategy profile where no player gains by unilaterally deviating.

Prisoner's dilemma shows individual rationality can yield a worse joint outcome than cooperation.

Herfindahl-Hirschman Index = sum of squared market shares; higher values indicate greater concentration.

Derived demand: demand for a factor comes from demand for the output it produces.

Marginal revenue product of labor MRPL = MPL × MR; a competitive firm has MR = P, so MRPL = MPL × P.

Profit-maximizing hiring rule: hire until MRPL = wage (factor price).

The labor demand curve is the downward-sloping MRPL schedule; it shifts with output price, worker productivity, and technology.

Labor supply slopes upward because a higher wage raises the opportunity cost of leisure; the income effect can bend it backward.

In competitive factor markets the wage equals MRPL; a monopsonist hires where MRPL = marginal factor cost and pays a wage below MRPL.

Economic rent is the payment to a factor above its transfer earnings (its next-best alternative).

Human capital investment raises productivity and earnings; the return is the present value of the earnings differential.

Income inequality is measured by the Lorenz curve and summarized by the Gini coefficient (0 = perfect equality, 1 = perfect inequality).

Market failure occurs when free markets fail to allocate resources efficiently: externalities, public goods, common resources, market power, asymmetric information.

Negative externality: marginal social cost exceeds marginal private cost; the market overproduces relative to the social optimum.

Positive externality: marginal social benefit exceeds marginal private benefit; the market underproduces relative to the social optimum.

Pigouvian tax equal to the marginal external cost internalizes a negative externality; a Pigouvian subsidy corrects a positive externality.

Coase theorem: with well-defined property rights and low transaction costs, bargaining can internalize externalities regardless of who holds the rights.

Public goods are non-rival and non-excludable, so private markets undersupply them; the free-rider problem defeats voluntary provision.

Common resources are rival but non-excludable, producing overuse (tragedy of the commons); quotas, fees, or privatization address it.

Cap-and-trade sets a total quantity of pollution and lets firms trade permits, achieving a given abatement at least cost.

Adverse selection occurs before a transaction (hidden type); moral hazard occurs after (hidden action).

Expenditure approach: GDP = C + I + G + (X − M).

Income approach: GDP = wages + rents + interest + profits + indirect taxes − subsidies + depreciation.

GDP counts final goods only within a country's borders in a given period; GNP counts output by a country's residents.

Nominal GDP uses current prices; real GDP uses base-year prices. GDP deflator = (nominal GDP / real GDP) × 100.

Real GDP per capita is the standard rough measure of living standards.

Inflation rate between periods = [(CPI2 − CPI1) / CPI1] × 100; CPI uses a fixed basket and overstates inflation by ignoring substitution.

Unemployment rate = (unemployed / labor force) × 100; labor force = employed + unemployed.

Frictional unemployment is short-term job search; structural reflects skill or location mismatch; cyclical tracks the business cycle.

Natural rate of unemployment = frictional + structural; full employment occurs when actual unemployment equals this rate.

Real interest rate ≈ nominal interest rate − inflation rate (Fisher approximation).

Functions of money: medium of exchange, unit of account, store of value, standard of deferred payment.

M1 = currency in circulation + checkable deposits + traveler's checks; M2 = M1 + savings deposits, small time deposits, and money market funds.

Money multiplier = 1 / reserve requirement ratio; total deposit creation = initial excess reserves × multiplier.

Excess reserves = total reserves − required reserves; banks create deposits by lending excess reserves.

Central bank tools: open market operations, the discount rate, and reserve requirements.

Expansionary policy: buy securities, lower the discount rate, or lower reserve requirements, raising the money supply and lowering interest rates.

Contractionary policy: sell securities, raise the discount rate, or raise reserve requirements.

Money demand is inversely related to the interest rate; equilibrium in the money market sets the interest rate.

Quantity theory: MV = PY; if velocity and real output are stable, sustained money growth raises the price level.