Chapter 1 accident, but they are also more
likely to find themselves in an
Scarcity – There is not enough for everyone
Economics – Study of how society manages
its resources
Ten Principles of Economics
1. People Face Tradeoffs
 Making decisions requires trading
off one goal against another
 Guns VS Butter
 Efficiency VS Equity
o Efficiency – Maximizing
scarce resources
o Equity – Benefits of
resources are distributed
fairly among society
2. The Cost of Something is What
You Give Up to Get It
 Emphasizes the cost of whatever it is
you gave up
 Opportunity Cost – What you give
up to get that certain item
3. Rational People Think at the
Margin
 Marginal Changes
o Small incremental
adjustments to an existing
plan of action
o Only done around the edges
 Individuals and firms can make
better decisions by thinking at the
margin
 Take action if and only if the
marginal benefit exceeds the
marginal cost
4. People Respond to Incentives
 Behavior may change when the costs
or benefits change
 Prospect of a reward or punishment
 Public policymakers influence the
public’s behavior
o Sometimes its effects are not
obvious in advance
 Ex. Drivers who wear their seatbelts
are more likely to survive any given
accident
5. Trade Can Make Everyone Better
Off
 Trade allows a person to specialize
in the activities he or she does best
 Trade allows countries to specialize
in what they do best and enjoy a
greater variety of goods and services
6. Markets Are Usually a Good Way
to Organize Economic Activity
 Collapse of communism,
government as central planners in
economic activity
 Market Economy – The decisions of
a central planner are replaced by the
decisions of millions of firms and
households
 Competition is healthy; decentralized
decision-making surprisingly
promotes overall economic
wellbeing
 “Invisible hand”
o Individuals are usually best
left to their own devices
o Self-interest  (Invisible
hand)  General economic
wellbeing
7. Governments Can Sometimes
Improve Market Outcomes
 2 reasons for a government to
intervene in economic affairs
o Promote efficiency
 Market Failure –
Invisible hand does
not work, market on
its own fails to
allocate resources
efficiently
 Market Failure is
affected by 2 factors,
namely externality
and market power
o Promote equity
  The invisible hand is Chapter 2
even less able to
ensure that economic Model 1: The Circular-Flow Diagram
prosperity is  Households and firms
distributed fairly  Firms produce goods and services
8. A Country’s Standard of Living using inputs (factors of production,
Depends on its Ability to Produce e.g. land, labor, capital)
Goods and Services  Households own these inputs and
 Productivity – Amount of goods and purchase the goods and services
services produced from each hour of produced by firms
a worker’s time  Markets for Goods and Services –
 Productivity as the primary Households are buyers and firms are
determinant of living standards sellers
9. Prices Rise When the Government  Markets for Factors of Production –
Prints Too Much Money Households are sellers and firms are
 Inflation – Increase in the overall buyers
level of prices in the economy  Factors of Production
 When a government creates large o Labor
quantities of the nation’s money, the o Land
value of the money falls o Capital
10. Society Faces a Short-Run
Tradeoff Between Inflation and
Unemployment
 The Phillips Curve
o It’s impossible to keep
unemployment low and
inflation under control at the
same time
o Reduction in the quantity of
money raises unemployment
temporarily until prices have
fully adjusted to the change

Model 2: The Production Possibilities

Frontier (PPF)
 Shows the various combinations of
output that an economy can possibly
produce given limited resources
 The economy can produce at any
point on or inside the PPF
o On – Possible
o Inside – Possible but
inefficient
 o Outside – Impossible
 PPF presents both tradeoffs and
opportunity costs
𝑅𝑖𝑠𝑒
o Opportunity cost = 𝑅𝑢𝑛
o Comparative advantage
 Bow-Shaped PPF
o Different slopes along the
line
o Takes into account
specialization of labor
Chapter 3
Trade can benefit everyone as it allows
people to specialize in activities in which
they have a competitive advantage
 Allows interdependence and gains
from trade
 Lower opportunity cost = greater
competitive advantage
Imports – Produced abroad, sold
domestically
Exports – Produced domestically, sold
abroad

Microeconomics and Macroeconomics

Microeconomics – How households and

firms make decisions, the interactions
between them
Macroeconomics – Economy-wide
phenomena (e.g. inflation, economic growth,
unemployment)

Positive VS Normative Analysis

Positive – Descriptive, make a claim,

involves values and facts
Normative – Prescriptive, recommendation
 Chapter 4
Supply and Demand
 Forces that make market economies
work
 Market – A group of buyers and
sellers of a particular product
o Buyers determine the demand
o Sellers determine the supply
Markets and Competition
 Competitive Markets – Market with
many buyers and sellers, each having
a negligible impact on the market
price
 Perfectly competitive
o Goods being offered are all
the same
o Buyers and sellers are so
numerous that no single
individual is influential
enough to change the market
price  Price takers
o E.g. Food, clothes
 Monopoly
o Market with only one seller
o Seller thus sets the price
o E.g. Meralco, Grab
 Oligopoly
o Between a perfect
competition and monopoly
o Does not compete
aggressively
o E.g. Airlines, communication
services
 Monopolistically competitive
o Many sellers, each offering a
slightly different product
o E.g. Software industry
Determinants of the Quantity Demanded
 Price
o Quantity demanded is
negatively related to the price
o Law of Demand: Other things
equal, price rises  Quantity
demanded falls
 Number of buyers
 Income
o Normal good – Income falls
 Demand for a good falls
o Inferior good – Income falls
 Demand for a good rises
 Prices of Related Goods
o Substitutes – Fall in the price
of one good  Reduces the
demand for another good
o Complements – Fall in the
price of one good  Raises
the demand for another good
 Tastes
 Expectations
o Expectations about the future
may affect the demand for a
good or service today
The Demand Schedule and Curve
 Shows the relationship between the
price of a good and the quantity
demanded
 Ceteris Paribus
o “Other things being equal”
o Refers to a hypothetical
situation in which some
variables are assumed to be
constant
Market Demand
 Sum of all the individual demands
for a particular good or service
 Sum the individual demand curves
horizontally
Shifts in the Demand Curve
 Increase in demand  Shifts the DC
to the right
 Reduce in demand  Shifts the DC
to the left
 Change in price does not shift the
curve but represents a movement
along it
Determinants of the Quantity Supplied
 Price
o Positively related: Quantity
supplied rises as the price
rises and falls as the price
falls
o Law of Supply: Other things
equal, price rises  Quantity
rises
 Number of sellers
 Input Prices
o The supply of a good is
negatively related to the price
of the inputs used to make the
good
 Technology
o Advance in technology raises
the supply
 Expectations
o The amount you supply today
may depend on your
expectations of the future
The Supply Schedule and Curve
 Higher price means a greater
quantity supplied
Market Supply
 Sum of all the supplies of the sellers
 Depends on all those factors that
influence the supply of individual
sellers
 Supply in a market depends on the
number of sellers
Shifts in the Supply Curve
 Increase in supply  Shifts the DC
to the right
 Reduce in supply  Shifts the DC to
the left
Supply & Demand
 Equilibrium
o One point at which the
supply and demand curves
intersect
o Also called the market-
clearing price because
everyone is satisfied
o Price at which these 2 curves
cross is called the equilibrium
price
o Quantity at which these 2
curves cross is called the
equilibrium quantity
 Surplus – Supply > Demand
o Response  Cut the prices
 Shortage – Demand > Supply
o Response  Raise the prices
 Law of Supply and Demand
o The price of any good adjusts
to bring the supply and
demand for that good into
balance
Analyzing Changes in Equilibrium
 Comparative Statistics – Involves
comparing an old and a new
equilibrium
1. Decide whether the event shifts the
demand curve or the supply curve (or
in some cases, both)
2. Decide whether the curve shifts to
the left or to the right
3. Examine how the shift affects the
equilibrium price and quantity
Shifts in Curves VS Movement along
Curves
 Supply – The position of the supply
curve
 Quantity supplied – The amount
suppliers wish to sell
 Shift in the supply curve  Change
in supply
 Movement along a fixed supply
curve  Change in the quantity
supplied
Chapter 5
Elasticities
 A change in one variable will result
to a change in another variable
%∆𝑄
 Price Elasticity  E = %∆𝑃
o PE is higher when close
substitutes are available
o PE is higher in the long run
than in the short run
Determinants of Price Elasticity
 Extent to which close substitutes are
available
 Is the good a necessity or a luxury?
 How broadly or narrowly the good is
defined
o Narrowly defined markets
tend to have more elastic
demand
 The time horizon
o Goods tend to have more
elastic demand over longer
time horizons
Midpoint Method
 Gives the same answer regardless of
the direction of change
Solution
𝐸𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 − 𝑆𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒
𝑥100%
𝑀𝑖𝑑𝑝𝑜𝑖𝑛𝑡
“Perfectly inelastic demand” – Regardless
of price change, the % change in Q remains
the same
 D curve: Straight vertical line
 Consumers’ price sensitivity: None
 Elasticity: 0

“Inelastic demand” – If the price changes
by [ ] %, the Q rises to less than [ ] %
 D curve: Relatively steep
 Consumers’ price sensitivity:
Relatively low
 Elasticity: < 1
“Unit elastic demand” – % change in price
is equal to the % change in quantity
 D curve: Intermediate slope
 Consumers’ price sensitivity:
Intermediate
 Elasticity: 1
“Elastic demand” – If the price changes by
[ ] %, the Q rises to more than [ ] %
 D curve: Relatively flat
 Consumers’ price sensitivity:
Relatively high
 Elasticity: > 1
“Perfectly elastic demand” – No percent
change in price results to absolutely any
percent change in quantity
 D curve: Straight horizontal line
 Consumers’ price sensitivity:
Extreme
 Elasticity: Infinity

The slope of a linear demand curve is
constant, but its elasticity is not.
Total Revenue
 Amount paid by buyers and received
by sellers of the good
 Depends on the price elasticity of the
demand
 Revenue = P x Q
Summary
 Elastic –  P,  R
 Inelastic –  P,  R
 Elastic –  P,  R
Elasticity & Total Revenue Along A
Linear Demand Curve
 The slope of a linear demand curve
is constant but its elasticity is not
o Slope – Ratio of changes in 2
variables
o Elasticity – Ratio of
percentage changes in 2
variables
Other Elasticities
1. Income elasticity of demand
 Measures the response of Qd to a
change in consumer income
o Normal goods have positive
income elasticities
o Inferior goods have negative
income elasticities
 Normal goods have positive income
elasticities
 Inferior goods have negative income
elasticities
 Necessities tend to have small
income elasticities
 Luxuries tend to have large income
elasticities
Solution
𝑃𝑒𝑟𝑐𝑒𝑛𝑡 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄 𝑑
𝑃𝑒𝑟𝑐𝑒𝑛𝑡 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
2. Cross-price elasticity of demand
 How the quantity demanded of one
good changes as the price of another
good changes
Solution
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄 𝑑 𝑓𝑜𝑟 𝑔𝑜𝑜𝑑 1
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑔𝑜𝑜𝑑 2
(Whether the answer is a positive or
negative number depends on whether the
goods are substitutes or complements.)
Price Elasticity of Supply & Its
Determinants
 Depends on the flexibility of sellers
to change the amount of the good
they produce
 Supply is usually more elastic in the
long run than in the short run
 Elastic supply – Quantity supplied
responds substantially to changes in
the price
o Increase in D =  P >  Q
 Inelastic supply – Quantity supplied
responds only slightly to changes in
the price
o Increase in D =  Q >  P
 Chapter 6

Price Ceiling – A legal maximum on the

price of a good
Price Floor – A legal minimum on the price
of a good

Effect of Price Ceilings on Market

Outcomes
 Price equilibrium < Price ceiling =
Not binding

Effects of Price Floors on Market

Outcomes
 Price floor < Price equilibrium = Not
binding

 Price equilibrium > Price ceiling =

Binding constraint
o Market price which hits the
ceiling can rise no further 
Market price = Price ceiling
o Binding price ceiling on a
competitive market leads to a
shortage of the good, which
in turn leads sellers to ration
the scarce goods  Price floor > Price equilibrium =
Binding constraint
o Market price = Price floor
o Causes a surplus
Evaluating Price Controls
 Prices are crucial in balancing supply
and demand, in coordinating
economic activity
 Legal decrees on prices disrupt the
natural allocation of society’s
resources

Taxes
 Both buyers and sellers therefore
share the burden of taxes
o Tax places an equal wedge
between the price that buyers
pay and the price that sellers
receive
o Only difference is who sends
the money to the government

Elasticity & Tax Incidence

 Tax burden is rarely ever shared
equally
 Falls more heavily on the side of the
market that is less elastic
o Side of the market with fewer
good alternatives cannot
easily leave the market 
Bigger burden of the tax