Chapter 1: Introduction to Economics/Making and Using Graphs

Scarcity is our inability to satisfy all our wants

Microeconomics is the study of the choices that individuals and businesses make, the way these
choices interact in markets, and the influence of governments
Macroeconomics is the study of the performance of the national economy and the global economy
Choices made in economics determine what, how, and for whom goods and services are produced
- The what question is What goods and services do we produce?
- The how question is How do we use the factors of production to produce these goods/services?
- The for whom question is Who consumes the goods and services that are produced?
You make choices that are in your self-interest choices that you think are best for you
Factors of production:
- Land earns rent; Labour earns wages; Capital earns interest; Entrepreneurship earns profit
Choices that are the best for society as a whole are said to be in the social interest
A tradeoff is an exchange giving up one thing to get something else
A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost
for the person making the choice
- Only the wants of the person making a choice are relevant to determine its rationality
The opportunity cost of something is the highest-valued alternative that must be given up to get it
Choices respond to incentives a change in marginal benefit or a change in marginal cost
- If the marginal benefit of Option 1 is greater than its marginal cost then you will choose Option 1
- If the marginal cost of Option 2 is greater than its marginal benefit than you will not choose
Option 2
Positive statements are about what is
- A positive statement might be right or wrong but can be tested by checking it against facts
Normative statements are about what ought to be
- These statements depend on values and cannot be tested
An economic model describes some aspect of the economic world and includes only those features
needed for the purpose at hand
To disentangle cause and effect, economists use economic models and look for natural experiments,
conduct statistical investigations, and perform economic experiments to test the predictions of those
models
A natural experiment is a situation that arises in the ordinary course of economic life in which one
factor of interest is different and other things are equal (or similar)
A statistical investigation looks for correlations
An economic experiment puts people in a decision-making situation and varies the influence of one
factor at a time to discover how they respond

Chapter 2: The Economic Problem

The production possibilities frontier (PPF) shows the limits to production

- Points outside the frontier cannot be attained without technological change or capital
accumulation
- Any point inside the PPF and on the PPF can be produced, so they are attainable
- The PPF illustrates scarcity by showing that that firm cannot produce at points outside the PPF,
and as the firm moves along the PPF increasing production of Good A, it must decrease the
quantity of Good B
We achieve production efficiency if we produce goods and services at the lowest possible cost
- Achieved at all points on the PPF
Opportunity cost equals the decrease in the quantity produce of one good divided by the increase in
the quantity produce of another good as we move along the PPF
- Opportunity cost increases because not all resources are equally productive in all activities as
shown by the bowed-out shape of the PPF
- A ratio equal to the quantity of the good given up divided by the increase in quantity of the other
good produced as we move along the PPF
Marginal cost of a good is the opportunity cost of producing one more unit of the good
The marginal cost is plotted at the x-value midway between the two values that generate it
Marginal benefit from a good or service is the benefit received from consuming one more unit of it
- Measured by the most that people are willing to pay for an additional unit of said good or service
- The more we have of any good or service, the smaller is its marginal benefit and the less we are
willing to pay for an additional unit of it
Allocative efficiency is achieved when we cannot produce more of any good without giving up some
other good that we value more highly the point on the PPF that we prefer above all other points
Economic growth comes from technological change and capital accumulation
- Technological change is the development of new goods and of better ways of producing existing
goods and services
- Capital accumulation is the growth of capital resources, which includes human capital
The opportunity cost of economic growth is greater the faster we make our production grow
In 1960, the production possibilities per person in Canada were more than 3x those in Hong Kong
Canada devotes 1/5th of its resources to accumulating capital and the other 4/5 th to consumption
Hong Kong devotes 1/3rd of its resources to accumulating capital and 2/3rd to consumption
Social institutions such as firms, markets, property rights, and money are necessary to make
decentralized coordination work and are required for society to enjoy the benefits of specialization
and trade
A market is any arrangement that enables buyers and sellers to get information and to do business
with each other
Markets have evolved because they facilitate trade
The flows from firms to households are the real flows of goods and services and the income flows of
wages, rent, interest and profit
The flows from households to firms are the real flows of labour, land, capital, and entrepreneurship
and the flow of expenditure on goods and services

Chapter 3: Demand and Supply

A relative price is the ratio of one price to another

The opportunity cost of a good is the relative price of that good to another good

The quantity demanded of a good or service is the amount that consumers plan to buy during a
given time period at a particular price
- Not necessarily the same as the quantity actually bought
The law of demand states that, other things remaining the same, the higher the price of a good, the
smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity
demanded
A demand curve is a willingness-and-ability-to-pay curve and the willingness and ability to pay is a
measure of marginal benefit
- Tells us the maximum that someone is willing to pay for an additional unit of a good or service
A normal good is one for which demand increases as income increases
An inferior good is one for which demand decreases as income increases
The substitution effect displays that as the opportunity cost of a good rises, the incentive to
economize on its use and switch to a substitute becomes stronger
The income effect displays that as the price of a good either increases or decreases consumers can
either afford to buy less or more of a good relative to their income
A substitute is a good that can be used in place of another good
A complement is a good that is used in conjunction with another good
The quantity supplied of a good or service is the amount producers plan to sell during a given time
period at a particular price
- Not necessarily the same as the quantity actually sold
The law of supply states that, other things remaining the same, the higher the price of a good, the
greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied
A supply curve can be interpreted as a minimum-supply-price curve a curve that shows the lowest
price at which someone is willing to sell and this lowest price is marginal cost
The equilibrium quantity is the quantity at which the quantity demanded equals the quantity
supplied
The equilibrium price is the price at which the quantity demanded equals the quantity supplied
At any price below the equilibrium price, the quantity demanded exceeds the quantity supplied and a
shortage exists
At any price above the equilibrium price, the quantity supplied exceeds the quantity demanded and a
surplus exists

Chapter 4: Elasticity

The price elasticity of demand is a units-free measure of the responsiveness of the quantity
demanded of a good or service to a change in its price
Price elasticity of demand = % change in the quantity demanded % change in the price
The total revenue test is a method of estimating the price elasticity of demand by observing the
change in total revenue that results from a change in the price
Demand is elastic (>1) if a price cut increases total revenue
Demand is inelastic (<1) if a price rise increases total revenue
Demand is unit-elastic (=1) if a price rise or cut leaves total revenue unchanged
The fewer the substitutes for a good or service, the more inelastic is the demand for it
The smaller the proportion of income spent on a good, the more inelastic is the demand for it
The shorter the time that has elapsed since a price change, the more inelastic is demand

Along a straight-line demand curve, demand is unit-elastic at the midpoint, elastic at all prices above
the midpoint, and inelastic at all prices below the midpoint
The price 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
Price elasticity of demand =
% change in quantity demanded % change in price of a substitute or complement
Two goods are substitutes if the cross elasticity of demand between them is positive
Two goods are complements if the cross elasticity of demand between them is negative
The income elasticity of demand is a measure of the responsiveness of the demand for a good or
service to a change in income
>1 (normal good, income elastic); +<1 (normal good, income inelastic); - (inferior good)
The elasticity of supply is a units-free measure of the responsiveness of the quantity supplied of a
good or service to a change in its price
Elasticity of supply = % change in quantity supplied % change in price
Some goods and services can be produced by using unique or rare productive resources; these items
have a low, even perhaps a zero, elasticity of supply
The greater the amount of time available after a price change, the greater is the quantity supplied

Chapter 5: Efficiency and Equity

Markets need to possess the ability to allocate resources efficiently and fairly
Resources might be allocated by:
- Market price; people who are willing and able to pay the price
- Command; by the order of someone in authority
- Majority rule; by what the majority of voters choose
- Contest; to a winner or group of winners
- First-come, first-served; by whos first in line
- Lottery; to those who pick the winning number, luck
- Personal characteristics; people with the right characteristics get the resources
- Force; to the strongest
Value is what we get and the price is what we pay
The value of one more unit of a good or service is its marginal benefit
Consumer surplus is the marginal benefit of a good minus the price paid for it, summed over the
quantity bought
Producer surplus is calculated as the price received for a good minus its marginal cost summed over
the quantity sold
Equilibrium in a competitive market occurs when marginal social benefit equals marginal social cost
and total surplus is maximized
Deadweight loss arises when the quantity produced is greater than or less than the efficient quantity
- Equals the loss of the total surplus
All ideas about fairness can be divided into two broad groups:
- Its not fair if the result isnt fair
- Its not fair if the rules arent fair
Utilitarianism is a principle that states that we should strive to achieve the greatest happiness for the
greatest number
- It ignores the cost of making income transfers

Rawls said that, taking all costs of income transfers into account, the fair distribution of the economic
pie is the one that makes the poorest person as well off as possible
The main idea of fairness is based on the following two rules:
- The state must enforce laws that establish and protect private property
- Private property may be transferred from one person to another only by voluntary exchange
According to the fair results view, a fair outcome is one that benefits the less well off
According to the fair rules view, all transactions are voluntary

Chapter 6: Government Actions in Markets

A price ceiling is a government regulation that makes it illegal to charge a price higher than a
specified level
When a price ceiling is applied to a housing market, it is called a rent ceiling
With an effective rent ceiling, the rent is determined at the intersection of the rent ceiling and the
supply curve
With an effective rent ceiling, some means for allocation of housing units other than by price
becomes necessary, the shortage of housing increases search activity, and a black market arises
When a price ceiling is set below the market equilibrium price, some consumers are better off and all
producers are worse off
A government imposed regulation that makes it illegal to charge a price lower than a specified level is
called a price floor
When a price floor is applied to a labour market, it is called a minimum wage
When a minimum wage is in place, scarce jobs are allocated by a method other than market price,
such as personal characteristics, first-come first-served, or discrimination
Tax incidence is the division of the burden of a tax between buyers and sellers
Perfectly inelastic demand buyers pay
Perfectly elastic demand sellers pay
Perfectly inelastic supply sellers pay
Perfectly elastic supply buyers pay
The greater the elasticity of demand, the smaller the tax revenue
The smaller the elasticity of supply, the greater the tax revenue
A tax is efficient when supply is perfectly inelastic or demand is perfectly inelastic so that the same
quantity is purchased because no tax falls on the buyers
The benefits principle is the proposition that people should pay taxes equal to the benefits they
receive from the services provided by the government
The ability-to-pay principle is the proposition that people should pay taxes according to how easily
they can bear the burden of the tax
A production quota is an upper limit to the quantity of a good that may be produced in a specified
period
It is difficult for production quotas to work when they are voluntary because each producer has an
incentive to cheat and produce a little bit more than the allotted quota
A subsidy is a payment made by the government to a producer
When a good is illegal, the cost of trading in the good increases
When a penalty is imposed on sellers of illegal goods, the marginal cost of the good decreases
When a penalty is imposed on buyers of illegal goods, the marginal cost of the good decreases

Chapter 8: Utility and Demand

The budget line marks the boundary between those combinations of goods and services that a
household can afford to buy and those that it cannot afford
A change in income shifts the budget line but leaves its slope unchanged
A change in price changes the slope of the budget line
Utility is the benefit or satisfaction that a person gets from the consumption of goods and services
Total utility is the total benefit that a person gets from the consumption of all the different goods and
services
Marginal utility is the change in total utility that results from a one-unit increase in the quantity of a
good consumed
The principle of diminishing marginal utility displays the tendency for marginal utility to decrease
as the consumption of a good increases
In consumer equilibrium, a consumer maximizes his or her total utility and since more consumption
brings more utility only completely exhausting income can maximize utility
Marginal utility per dollar is the marginal utility from a good that results from spending one more
dollar on it
- Calculated by dividing the marginal utility from the good by its price
Total utility is maximized by making the marginal utility per dollar of both goods equal to one
another
If the marginal utility per dollar from Good A exceeds that of Good B then buy more of Good A and
less of Good B
When the price of a good rises, the marginal utility per dollar from this good decreases
When the price of a good falls, the marginal utility per dollar from this good increases
The paradox of value asks why the price of water is low and the price of diamond is high, but water is
essential to life while diamonds are not
Utility is similar to temperature because both are abstract concepts which use arbitrary units of
measurement and neither can be observed

Behavioural economics studies the ways in which limits on the human brains ability to compute and
implement rational decisions influences economic behaviour both the decisions that people make
and the consequences of those decisions for the way markets work
- There are three impediments that prevent rational choice:
- Bounded rationality is rationality that is limited by the computing power of the human brain
- Bounded will-power is the less than perfect will-power that prevents us from making a decision
that we know, at the time of implementing the decision, we will later regret
- Bounded self-interest is the limited self-interest that results in sometimes suppressing our own
interests to help others
Neuroeconomics is the study of the activity of the human brain when a person makes an economic
decision
These sciences seek to explain why we do not always make rational economic decisions

Chapter 11: Output and Costs

In the short-run, at least one factor of production is fixed. For most firms, capital, land, and
entrepreneurship are fixed factors of production and labour is the variable factor of production
- These are called the firms plant, in the short-run a firms plant is fixed
In the long-run, the quantities of all factors of production can be varied, this is a period in which the
plant can be changed
A sunk cost is the past expenditure on a plant that has no resale value and is irrelevant to the firms
current decisions
- The only costs that influence its current decisions are the short-run cost of changing its labour
inputs and the long-run cost of changing its plant
Total product is the maximum output that a given quantity of labour can produce
Marginal product of labour is the increase in total product that results from a one-unit increase in
the quantity of labour employed
Average product of labour is equal to total product divided by the quantity of labour employed
The marginal product of labour and average product of labour both initially increase and then
decrease
Diminishing marginal returns occur when the marginal product of an additional worker is less than
the marginal product of the previous worker
- The law states that as a firm uses more of a variable factor of production, with a given quantity of
the fixed factor of production , the marginal product of the variable factor eventually diminishes
When marginal product exceeds average product, average product is increasing
When average product exceeds marginal product, average product is decreasing
All points that lie below the TP curve are attainable but they are inefficient
The point at which MP intersects AP is the point at which AP begins decreasing
A firms production function shows the relationship between the maximum output attainable and the
quantities of both labour and capital
The marginal product of capital is the change in output resulting from a one-unit increase in the
quantity of capital
- Also, is the change in total product divided by the change in capital when the quantity of labour is
constant
Diminishing marginal product of capital occurs because as the quantity of capital increases and the
quantity of labour remains constant, the amount of additional output that can be produced by each
successive quantity of capital will become smaller and smaller
The LRAC is the relationship between the lowest attainable average total cost and output when both
the plant size and labour are varied made up of the segments of individual average total cost curves
Economies of scale are features of a firms technology that make average total cost fall as output
increases the main source is a greater specialization of both labour and capital
Diseconomies of scale are features of a firms technology that make average total cost rise as output
increases the main source is the challenger or managing a large enterprise
The smallest quantity of output at which long-run average cost reaches its lowest level is the firms
minimum efficient scale

Chapter 12: Perfect Competition

Firms in perfect competition are price takers because as individuals they produce a tiny portion of the
total output of a particular good and buyers are well informed about the prices of other firms

No single firm in this market can determine the price so the demand faced by the individual firm is
perfectly elastic and the curve is horizontal at the market price
In a perfectly competitive market:
- Firms sell identical products to many buyers
- There are no restrictions on entry into the market
- Established firms have no advantage over new ones
- Sellers and buyers are well informed about price
When marginal revenue equals marginal cost, economic profit is maximized
The shutdown point is the price and quantity at which a firm is indifferent between producing and
shutting down
- Occurs when price equals minimum average variable cost (AVC) because this is the price at
which the firm is only able to covers its variable costs and its fixed costs are the firms loss
- The firm can avoid losses that are greater than fixed costs by shutting down and not producing
A firms supply curve is the marginal cost curve above minimum average variable cost
The short-run market supply curve shows the quantity supplied by all the firms in the market at each
price when each firms plant and the number of firms remain the same
When firms in a competitive market are making an economic profit, new firms enter the market,
which increases supply. The price falls in the long run until all the firms are making normal profit.
- The increase in supply increase the market output but the fall in price decreases the quantity
produce by each firm
When firms in a competitive market are incurring an economic loss, some firms exit the market,
which decreases supply. The price rises in the long run until all the firms are making normal profit
- The decrease in supply decreases the market output but the rise in price increases the quantity
produced by each firm
In the long run firms make a normal profit whereas in the short run they can make an economic profit
When a new technology enters a competitive market, some firms adopt it and enter the market, some
that are already in the market adopt it, but firms who do not adopt it leave the market
When a change in demand occurs and the price does not change in the long run, the supply curve is
horizontal and the industry is a constant-cost industry

Chapter 13: Monopoly

A monopoly is a market with a single firm that produces a good or service for which no close
substitute exists and that is protected by a barrier that prevents other firms from selling that good or
service
- A legal monopoly is a market in which competition and entry are restricted by the granting of a
public franchise, government license, patent, or copyright
- A natural monopoly is an industry in which economies of scale enable one firm to supply the
entire market at the lowest possible cost
- A single-price monopoly is a firm that must sell each unit of its output for the same price to all
its customers
- A price-discriminating monopoly sells different units of a good or service for different prices
A single-price monopoly maximizes profit by producing the quantity at which marginal cost equals
marginal revenue
- The profit-maximizing quantity is the quantity at the intersection of the marginal revenue curve
and the marginal cost curve

The price is taken from the demand curve at the profit-maximizing quantity in a monopoly,
price is greater than marginal revenue
A monopoly can make positive economic profit in the short run and long run because barriers to entry
prevent the monopoly firm from facing competition and sharing the profit
If a monopoly firm acts competitively, instead of producing where marginal revenue equals marginal
cost, the firm will produce where demand equals marginal cost (supply)
When a monopoly is broken up into many small competitive firms, the monopolys marginal cost
curve becomes the competitive industrys supply curve, and the competitive industry produces the
quantity at which the market supply curve intersects the market demand curve
When a monopoly firm takes over a perfectly competitive industry, the consumer surplus shrinks to
the triangular shape below the demand curve and above the new price where economic profit is
maximized
- The part of the consumer surplus that is transferred to the monopoly is the area on the graph
between the new monopoly price and the original perfectly competitive price, and between the yaxis and the new monopoly quantity
A single-price monopoly is inefficient because marginal social benefit (demand curve) is greater than
marginal social cost at the quantity produced
Any surplus consumer surplus, producer surplus, or economic profit is called economic rent and
rent seeking is the pursuit of wealth by capturing economic rent
The cost of rent seeking is a fixed cost that must be added to a monopolys other costs
- Rent seeking and rent-seeking costs shifts the average total cost curve upward and until it touches
the demand curve at which point economic profit becomes zero
- Consumer surplus is unaffected but the deadweight loss now includes the original deadweight
loss triangle plus the lost producer surplus
Price discrimination is selling a good or service at a number of different prices
- Price discrimination increases a monopolys economic profit by capturing consumer surplus
- For a perfect price-discriminating monopoly, the marginal revenue curve is the demand curve
When a natural monopoly is regulated using a marginal cost pricing rule, price is set to marginal
cost
- But because price is less than long-run average cost, the monopoly incurs and economic loss
An average cost pricing rule sets price equal to average total cost
- An average cost pricing rule is not an efficient way of regulating monopoly because at the
quantity produced marginal benefit exceeds marginal cost
A price cap is a price ceiling a rule that specifies the highest price the firm is permitted to set
Under a rate of return regulation, a firm must justify its price by showing that its return on capital
doesnt exceed a specified target rate
- This gives the firms managers incentive to inflate costs by spending on luxury expenses

Chapter 14: Monopolistic Competition

Monopolistic competition is a market structure in which a larger number of firms compete and each
firm produces a differentiated product
- Firms compete on product quality, price, and marketing, and are free to enter and exit
The four-firm concentration ratio is the percentage of the value of sales accounted for by the four
largest firms in an industry (range is from almost 0 for perfect competition to 100 for monopoly)

The Herfindahl-Hirschman Index (HHI) is the square of the percentage market share of each firm
summed over the largest 50 firms (range is from almost 0 for perfect competition to 10 000 for
monopoly)
In the short run, a firm in monopolistic competition produces the quantity at which marginal revenue
equals marginal cost
When a firm in monopolistic competition is making an economic profit in the short run, other firms
enter the industry which decreases the demand for the good from each individual firm until each firm
is making zero economic profit and the industry is in long-run equilibrium
A firm has excess capacity if it produces below its efficient scale, which is the quantity at which
average total cost is a minimum (where MC = ATC)
- The loss that arises because the quantity produced is loss than the efficient quantity is offset by
the gain that arises from having a greater degree of product variety
When in long-run equilibrium, firms would not decrease their quantity because this would result in
ATC being greater than the market price thus creating an economic loss
Advertising and packaging are the principal means firms use to achieve product differentiation if
actual differences are small
A brand name provides information to consumers about the quality of a product, and is an incentive
to the producer to achieve a high and consistent quality standard
- Consumers also prefer to buy good from a firm with a brand name they know because they will
know the quality they can expect

Chapter 15: Oligopoly

Oligopoly is a market structure in which natural or legal barriers prevent the entry of new firms, and
a small number of firms compete
- Because barriers to entry exist, oligopoly consist of a small number of firms, each of which has a
large share of the market
- Firms are interdependent because with a small number of firms, each firms actions influence the
profits of all the other firms
A duopoly is an oligopoly with two firms
A cartel is a group of firms acting together colluding to limit output, raise price, and increase
economic profit
- Oligopoly firms can increase profits by forming a cartel
The market is efficient if the firms within the oligopoly can combine quantities produced to meet
market demand at their efficient scale
Game theory is a set of tools for studying strategic behaviour behaviour that takes into account the
expected behaviour of others and the recognition of mutual interdependence
- All games share four common feature: rules, strategies, payoffs, and an outcome
A collusive agreement is an agreement between two (or more) producers t firm a cartel to restrict
output, raise the price, and increase profits
In a collusive agreement, all firms have the incentive to cheat because the payoff is better if theyre
the only ones to cheat than if all firms were to comply

A dominant-strategy equilibrium is an equilibrium in which the best strategy of each player it to

cheat (confess) regardless of the strategy of the other player
A cooperative equilibrium might occur if cheating is punished but is one in which making and
sharing the monopoly profit is possible
A tit-for-tat strategy is one in which a player cooperates in the current period if the other player
cooperated in the previous period, but cheats in the current period if the other player cheated in the
previous period
A trigger strategy is one in which a player cooperates if the other player cooperates, but plays the
Nash equilibrium strategy forever thereafter if the other player cheats
A contestable market is a market in which firms can enter and leave so easily that firms in the
market face competition from potential entrants
Anti-combine law is the law that regulates oligopolies and prevents them from becoming monopolies
or behaving like monopolies
- Canadas anti-combine law is defined in the Competition Act of 1986
A merger is unlikely to be approve if the merger prevents competition or lessens competition
substantially

Chapter 16: Externalities

An externality is a cost or a benefit that arises from production and falls on someone other than the
producer, or a cost or benefit that arises from consumption and falls on someone other than the
consumer
- We call an externality that imposes a cost a negative externality; and we call and externality that
provides a benefit a positive externality
- We identify externalities as four types: negative production, negative consumption, positive
production, and positive consumption
A private cost of production is a cost that is borne by the producer of a good or service
A social cost of production is a cost that is borne by the producer and by everyone else on whom the
cost falls
An external cost is a cost of producing a good or service that is not borne by the producer but borne
by other people
Marginal private cost (MC) is the cost of producing an additional unit of a good or service that is
borne by its producer
Marginal external cost is the cost of producing an additional unit of a good or service that falls on
people other than the producer
Marginal social cost (MSC) is the marginal cost incurred by the producer and by everyone else on
whom the cost falls by society

The Coase theorem is the proposition that if property rights exist, if only a small number of parties
are involved, and if transactions costs are low, then private transactions are efficient. There are no
externalities because the transacting parties take all the costs and benefits into account. Furthermore,
it doesnt matter who has the property rights
With marketable permits, firms that have a low marginal cost of reducing pollution sell their permits,
and firms that have a high marginal cost of reducing pollution buy permits
- Each firm buys or sells permits until its marginal cost of pollution equals the market price of a
permit
- To find the price of a marketable permit take the total value of pollution an divide it by the
number of permits given out
A cap-and-trade scheme seeks an efficient outcome by assigning or selling pollution rights to
individual producers who are then free to trade permits with each other
- The price of a cap adjusts until it is equal to marginal external cost
Marginal private benefit (MB) is the benefit that the consumer of a good or service receives from an
additional unit of it
Marginal external benefit is the benefit from an additional unit of a good or service that people
other than its consumer enjoy
Marginal social benefit (MSB) is the marginal benefit by society by the consumer of a good or
service and by others
Research and development creates an external benefit with no intervention, we produce too little
research and development

Chapter 17: Public Goods and Common Resources

A good is excludable if it is possible to prevent someone from enjoying its benefits

A good is nonexcludable if it is impossible (or extremely costly) to prevent anyone from benefitting
from it
A good is rival if one persons use of it decreases the quantity available for someone else
A good is nonrival if one persons use if it does not decrease the quantity available for someone else
A private good is both rival and excludable
A public good is both nonrival and nonexcludable
A common resource is rival and nonexcludable
A natural monopoly good is nonrival and excludable
The free-rider problem is that the market would provide an inefficiently small quantity of a public
good
Rational ignorance is the decision not to acquire information because the cost of doing so exceeds
the expected benefit
If voters are rationally ignorant, the bureaucrats will install more than the efficient capacity, because
the greater the capacity, the greater the budget
Bureaucrats want to maximize their departments budget because a bigger budget brings greater status
and more power
- Well-informed bureaucrats want to maximize their budget and rationally ignorant voters enable
the bureaucrats to go some way towards achieving their goal

The tragedy of the commons is the overuse of a common resource that arises when its users have no
incentive to conserve it and use it sustainably
A common resource is used efficiently when the marginal social benefit equals the marginal social
cost
Setting a production quota does not always achieve the efficient use of a common resource
- One reason is that marginal cost is not, in general, the same for every producer
- It is also in everyones self-interest to cheat and produce more than the quote
- Producers also have an incentive to lie to the government about their costs to get a bigger quota
An individual transferable quota (ITQ) is a production limit that is assigned to an individual who is
then free to transfer (sell) the quote to someone else
- Equals the marginal social benefit minus the marginal cost
The private property solution to the tragedy of the commons is available in some cases
- Property rights are sometimes difficult to assign and enforce

Chapter 18: Markets for Factors of Production

The price of labour services is the wage rate

The price in a capital services market is a rental rate
The price of the services of land is a rental rate
Entrepreneurs receive the profit or bear the loss that results from their business decisions
The price of capital equipment is the price paid to acquire the piece of capital equipment which is
determined by supply and demand in the market for that piece of capital equipment
- The rental rate of capital is the price of capital services
The value of marginal product of labour is the value to the firm of hiring one more unit of a factor of
production
- It equals the price of a unit of output multiplied by the marginal product of the factor of
production
- Tells us what an additional worker is worth to a firm and the revenue that the firm earns by hiring
one more worker
A firms demand for labour curve is derived from its value of marginal product curve because the
value of marginal product diminishes as the quantity of labour employed increases, the demand for
labour curve slopes downward
- To maximize profit, a firm hires the number of workers that sets the wage rate equal to the value
of marginal product of labour
A lower price for the firms output decreases the value of the marginal product of labour, which
decreases the demand for labour
The reservation wage rate is the rate that once exceeded makes people willing to work
A backward-bending labour supply curve is created by the substitution effect and the income
effect
- The substitution effect is the tendency for individuals to work longer hours at a higher wage rate
- The income effect induces individuals to increase demand for goods and services leisure being
one of those goods once a certain wage rate has been met, individuals are more prone to trade
longer working hours for more leisure time thus bending the labour supply curve backward
A market supply curve shows the quantity of labour supplied by all households in a particular job
market

Despite the fact that an individuals labour supply curve eventually bends backward the market
supply curve of labour slopes upward
Unions try to influence wage rates by changing the demand for labour and the supply of labour, some
of the methods used by unions to increase the demand for labour of its members are to:
- Increase the value of marginal product of union members
- Encourage import restrictions
- Support minimum wage laws
- Support immigration restrictions
A union can restrict supply by controlling entry into apprenticeship programs by influencing job
qualification standards
A monopsony is a market in which there is a single buyer of labour
- The monopsony hires the quantity of labour at the point where the marginal cost of labour equals
the value of marginal product
- In a monopsony, there is one employer and the wage rate is the lowest at which the firm can
attract the labour it plans to hire
Because a monopsony only demands the amount of labour where the MCL equals the VMP (D) then
it doesnt want to produce at the equilibrium point
In a monopsony, a minimum wage makes the supply of labour perfectly elastic and the marginal cost
of labour the same as the wage rate the firm hires the quantity of labour at which the minimum
wage line intersects the demand curve
The demand for capital is derived from the value of marginal product of capital
- Profit-maximizing firms hire the quantity of capital services that makes the value of marginal
product of capital equal to the rental rate of capital
The demand for land is derived from the value of marginal product of land
- Profit-maximizing firms rent the quantity of land at which the value of marginal product of land
is equal to the rental rate of land
- The supply of each particular block of land is perfectly inelastic because its quantity is fixed so
the quantity supplied cannot be changed by peoples decisions
The demand for a non-renewable natural resource is determined in part by the expected future price
of the resource and the value of marginal product of the resource
- The higher the expected future price of the resource, the greater is the present demand for the
resource
The supply of a non-renewable natural resource is determined by:
- The known reserves
- The scale of the current production facilities
- The expected future price
The market fundamentals price and the equilibrium quantity are determined at the intersection of the
VMP curve and the MC curve
If expectations about the future price of a non-renewable natural resource depart from what the
market fundamentals imply, speculation can drive a wedge between the equilibrium price and the
market fundamentals price creating a new equilibrium price at the intersection of S and D
The Hotelling Principle is the idea that the price of a non-renewable natural resource is expected to
rise at a rate equal to the interest rate

Chapter 19: Economic Inequality

Market income equals the wages, interest, rent, and profit earned in factor markets before paying
income taxes
Total income equals market income plus cash payments to households by governments
After-tax income equals total income minus tax payments by households to governments
Human capital is the knowledge and skill that people obtain from education, on-the-job training, adn
work experience
Wealth is the value of the things that it owns at a point in time, while income is the amount that the
household receives over a given period of time
- Wealth is distributed more unequally than income because wealth data does not include the value
of human capital, while the income data measures income from all wealth, including human
capital
Low-income cut-off is the income level below which a family normally spends 63.6% or more of its
income on food, shelter, and clothing
The Gini ratio equals the ratio of the area between the line of equality and the Lorenz curve to the
entire area beneath the line of equality
- As the Gini ratio increases, the distribution of income becomes more unequal
People who are most likely to earn large incomes have a post-graduate or professional degree, are
members of the labour force, and live in middle-aged households with a smaller number of children
People who are most likely to earn small incomes have not completed high school, receive their
income in the form of a payment from the government, and live in a household with a single female
parent
The increase in the gap between the real average income of the richest and poorest Canadians tells us
what happened on average but it does not tell us what happened to the distribution of income
- Income inequality might have increased, decreased, or not changed
A typical households income and wealth changes over its life cycle
- Income and wealth start out low, grow to a peak when the households workers reach retirement
age, and then fall after retirement
Technological change has decreased the value of marginal product of high-skilled workers and
decreased the value of marginal product of low-skilled workers
Incomes can become more unequally distributed within countries when urban middle classes become
richer at a faster pace than rural farmers
Incomes can become more unequally distributed within countries when average incomes in poorer
countries rise much faster than average incomes in rich countries
Currently. The gap between the rich and the poor is widening within countries and narrowing across
countries
The greater the human capital acquired, the smaller the supply of labour, the higher the wage rate
If a group is discriminated against, their value of marginal product decreases and the value of
marginal product curve shifts leftward the wage rate falls and employment decreases
Individuals who are prejudiced have more incentive to buy from those of whom they are prejudiced
against due to their generally lower prices
Winner-takes-all contests explain the trend toward greater inequality with an increasing share of total
income going to the super rich the key is that globalization has increased the market reach of the
winner and increased the spread between the winner and the runners-up
If a generation has a high income and saves a large part of that income and leaves wealth to a
succeeding generation that has a lower income, this transfer decreases the degree of inequality

A feature of intergenerational transfers of wealth that leads to increased inequality is wealth

concentration through marriage people tend to marry within their own socioeconomic class
(assortative marriage)
The three main ways in which government in Canada redistribute income are through income taxes,
income maintenance programs, and subsidized services
A progressive income tax is one that taxes income at an average rate that increases as income
increases
A regressive income tax is one that taxes income at an average rate that decreases as income
increases
A proportional income tax (flat-rate income tax) is one that taxes income at a constant average rate,
regardless of the level of income
Income redistribution in Canada increases the share of total income received by the lowest 60% of
households and decreases the share of total income received by the highest 40% of households
A major welfare challenge in Canada today is women who have not completed high school, have a
child (or children), and live without a partner
- Short-run solution is welfare, long-run solution is education and on-the-job training
Social Security ensure a minimum level of income for senior citizens as well as cash payments t
retired or disabled workers or their surviving spouses
Employment insurance provides an income to unemployed workers funded by employee and
employer contributions
Welfare provides income maintenance for low-income families and persons