Microeconomics

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Week001- Introduction to Microeconomics

Welcome to the first module of this course on Microeconomics! For this lesson, you
will be introduced to the concepts and ideas of Microeconomics particularly the
much known principle of demand and supply. Moreover, you will analyze, identify
and differentiate the ideas, thoughts and components of Microeconomics. As a
future business administrator, you should be knowledgeable with the concepts and
terms along Microeconomics like demand, supply, price, cost, government policies,
competition, capitalism and others which can help you decide what kind of business
is potentially feasible in your given place of operation.

At the end of this module, you are expected to:

1. Define the terms and concepts attached to Microeconomics.
2. Define the terms of goods, demand, supply, opportunity costs, specialization,
trade, production possibilities, relative and nominal prices.
3. Identify the different thinkers who pioneered the terms of goods, demand,
supply, opportunity costs, specialization, trade, production possibilities,
relative and nominal prices.

Definition of Economics
The first thing that we should discuss is the definition of economics. Economists
generally define economics as the study of how individuals and societies use limited
resources to satisfy unlimited wants. To see how this concept works, think about
your own situation. Do you have enough time available for everything that you wish
to do? Can you afford every item that you would like to own? Economists argue that
virtually everyone wants more of something. Even the wealthiest individuals in
society do not seem to be exempt from this phenomenon (Perloff, 2014).

This problem of limited resources and unlimited wants also applies to society as a
whole. Can you think of any societies in which all wants are satisfied? Most societies
would prefer to have better health care, higher quality education, less poverty, a
cleaner environment, etc. Unfortunately, there are not enough resources available to
satisfy all of these goals. Thus, economists argue that the fundamental economic
problem is scarcity. Since there are not enough resources available to satisfy
everyone’s wants, individuals and societies have to choose among available
alternatives. An alternative, and equivalent, definition of economics is that
economics is the study of how such choices are made.

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Economic Good, Free Good and Economic Bad

A good is said to be an economic good if the quantity of the good demanded exceeds
the quantity supplied at a zero price. In other words, a good is an economic good if
people want more of it than would be available if the good were available for free. A
good is said to be a free good if the quantity of the good supplied exceeds the
quantity demanded at a zero price. In other words, a good is a free good if there is
more than enough available for everyone even when the good is free. Economists
argue that there are relatively few, if any, free goods. An item is said to be an
economic bad if people are willing to pay to avoid the item. Examples of economic
bad include things like garbage, pollution, and illness. Goods that are used to
produce other goods or services are called economic resources and are also known
as inputs or factors of production. These resources are often categorized into
the following groups: land, labor, capital, and entrepreneurial ability.

The category of land includes all natural resources. These natural resources include
the land itself, as well as any minerals, oil deposits, timber, or water that exists on or
below the ground. This category is sometimes described as the "free gifts of nature,"
those resources that exist independent of human action. The labor input consists of
the physical and intellectual services provided by human beings. The resource called
"capital" consists of the machinery and equipment used to produce output. Note that
the use of the term "capital" differs from the everyday use of this term. Stocks,
bonds, and other financial assets are not capital under this definition of the
term. Entrepreneurial ability refers to the ability to organize production and bear
risks.

Rational Self-interest
As noted above, scarcity results in the need to choose among competing
alternatives. Economists argue that individuals pursue their rational self-interest
when making choices. This means that individuals are assumed to select the
alternative(s) that they believe will make them happiest, given the information that
they possess at the time of the decision. Note that the term "self-interest" means
something quite different than "selfish." Self-interested people may donate their
time to charitable organizations, give gifts to loved ones, contribute to charities and
engage in other similarly altruistic activities. Economists assume, though, that
altruistic people select these actions because they find these activities more
enjoyable than available alternative activities (Perloff, 2014).

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Economics is the study of how individuals and economies deal with the fundamental
problem of scarcity. Since there are not enough available resources to satisfy the
wants of individuals and societies, individuals and societies must make choices
among competing alternatives. The opportunity cost of any alternative is defined as
the cost of not selecting the next-best alternative. Let's consider a few examples of
opportunity cost: suppose that you own a building that you use for a retail store. If
the next-best use of the building is to rent it to someone else, the opportunity cost of
using the building for your business is the rent you could have received. If the next-
best use of the building is to sell it to someone else, the annual opportunity cost of
using it for your own business is the foregone interest that you could have received
(e.g., if the interest rate is 10% and the building is worth $100,000, you give up
$10,000 in interest each year by keeping the building, assuming that the value of the
building remains constant over the year -- depreciation or appreciation would have
to be taken into account if the value of the building changes over time).

Another examples, the opportunity cost of attending college includes: the cost of
tuition, books, and supplies (the costs of room and board only appear if these costs
differ from the levels that would have been paid in your next-best
alternative), foregone income (this is usually the largest cost associated with college
attendance), and psychic costs (the stress, anxiety, etc. associated with studying,
worrying about grades, etc.). If you attend a movie, the opportunity cost includes not
only the cost of the tickets and transportation, but also the opportunity cost of the
time required to view the movie.

When economists discuss the costs and benefits associated with alternative
activities, the discussion generally focuses on marginal benefits and marginal costs.
The marginal benefit from an activity is the additional benefit associated with a one-
unit increase in the level of an activity. Marginal cost is defined as the additional cost
associated with a one-unit increase in the level of the activity. Economists assume
that individuals attempt to maximize the net benefit associated with each activity. If
marginal benefit exceeds marginal cost, net benefit will increase if the level of the
activity rises. Therefore, rational individuals will increase the level of any activity
when marginal benefit exceeds marginal costs. On the other hand, if marginal cost
exceeds marginal benefit, net benefit rises when the level of the activity is
decreased. There is no reason to change the level of an activity (and net benefit is
maximized) at the level of an activity at which marginal benefit equals marginal
cost.

Production Possibilities Curve

Scarcity implies the existence of tradeoffs. These tradeoffs can be illustrated quite
nicely by a production possibilities frontier. For simplicity, it is assumed that a firm
(or an economy) produces only two goods (this assumption is needed only to make

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the representation feasible on a two-dimensional surface -- such as a graph on paper

or on a computer screen). When a production possibilities curve is drawn, the
following assumptions are also made: there is a fixed quantity and quality of
available resources, technology is fixed, and there are no unemployed or
underemployed resources (Perloff, 2014).

Very shortly, we'll also see what happens when these assumptions are relaxed. For
now, though, let's consider a simple example. Suppose that a student has four hours
justified studying for exams in two classes: introductory microeconomics and
introductory calculus. The output in this case is the exam score in each class. The
assumption of a fixed quantity and quality of available resources means that the
individual has a fixed supply of study materials such as textbooks, study guides,
notes, etc. to use in the available time. A fixed technology suggests that the
individual has a given level of study skills that allow him or her to translate the
review materials into exam scores.

A resource is unemployed if it is not used. Idle land, factories, and workers are
unemployed resources for a society. Underemployed resources are not used in the
best possible way. Society would have underemployed resources if the best brain
surgeons were driving taxis while the best taxi drivers were performing brain
surgery. The use of an adjustable wrench as a hammer or the use of a hammer to
pound a screw into wood provides additional examples of underemployed
resources. If there are no unemployed or underemployed resources, efficient
production is said to occur.

Notice that each additional hour spent studying either calculus or economics results
in smaller marginal improvements in the grade. The reason for this is that the first
hour will be spent studying the most essential concepts. Each additional hour is
spent on the "next-most" important topics that have not already been mastered. For
this, it is important to note that a good grade on an economics examination requires
substantially more than four hours of study time. This is an example of a general
principle known as the law of diminishing returns. The law of diminishing returns
states that output will ultimately increase by progressively smaller amounts as
additional units of a variable input (time in this case) are added to a production
process in which other inputs are fixed (the fixed inputs here include the stock of
existing subject matter knowledge, study materials, etc.).

To see how the law of diminishing returns works in a more typical production
setting, consider the case of a restaurant that has a fixed quantity of capital (grills,
broilers, fryers, refrigerators, tables, etc.). As the level of labor use increases, output

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may initially rise fairly rapidly (since additional workers allow more possibilities for
specialization and reduces the time spent switching from task to task). Eventually,
however, the addition of more workers will result in progressively smaller increases
in output (since there is a fixed amount of capital for these workers to use). It is
even possible that beyond some point workers may start getting in each other’s way
and output may decline (too many cooks may spoil the broth).

The increase in the marginal opportunity cost of points on the economics exam as
more time is devoted to studying economics is an example of the law of increasing
cost. This law states that the marginal opportunity cost of any activity rises as the
level of the activity increases. This law can also be illustrated wherein notice that
the opportunity cost of additional points on the calculus exam rises as more time is
devoted to studying calculus. You can also see that the opportunity cost of additional
points on the economics exam rises as more time is devoted to the study of
economics.

One of the reasons for the law of increasing cost is the law of diminishing returns.
Each extra hour devoted to the study of economics results in a smaller increase in
the economics grade and a larger reduction in the calculus grade because of
diminishing returns to time spent on either activity. A second reason for the law of
increasing cost is the fact that resources are specialized. Some resources are better
suited for some types of productive activities than for other types of production.
Suppose, for example, that a farmer is producing both wheat and corn. Some land is
very well suited for growing wheat, while other land is relatively better suit for
growing corn. Some workers may be more adept at growing wheat than corn. Some
farm equipment is better suited for planting and harvesting corn.

To produce more wheat, the farmer must transfer resources from corn production
to wheat production. Initially, however, he or she will transfer those resources that
are relatively better suited for wheat production. This allows wheat production to
increase with only a relatively small reduction in the quantity of corn produced.
Each additional increase in wheat production, however, requires the use of
resources that are relatively less well suited for wheat production, resulting in a
rising marginal opportunity cost of wheat. Now, let's suppose that this farmer either
does not use all of the available resources, or uses them in a less than optimal
manner (i.e., either unemployment or underemployment occurs). In this case, the
farmer will produce at a point that lies below the production possibilities curve.

In practice, all firms and all economies operate below their production possibilities
frontier. Firms and economies, however, generally attempt to get as close to the
frontier as possible. Points above the production possibilities cannot be produced
using current resources and technology. An increase in the quantity or quantity of
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resources will cause the production possibilities curve to shift outward. This type of
outward shift could also be caused by technological change that increases the
production of both goods. In some cases, however, technological change will only
increase the production of a specific good.
Specialization and Trade
In The Wealth of Nations, Adam Smith argued that economic growth occurred as a
result of specialization and division of labor. If each household produced every
commodity it consumed, the total level of consumption and production in a society
will be small. If each individual specializes in the productive activity at which they
are "best," total output will be higher. Specialization provides such gains because it
allows individuals to specialize in those activities in which they are more
talented, individuals become more proficient at a task that they perform repeatedly,
and less time is lost switching from task to task (Perloff, 2014).

Increased specialization by workers requires a growth in trade. Adam Smith argued

that growing specialization and trade was the ultimate cause of economic
growth. Adam Smith and David Ricardo argued that similar benefits accrue from
international specialization and trade. If each country specializes in the types of
production at which they are best suited, the total amount of goods and services
produced in the world economy will increase.

Let's examine these arguments a bit more carefully. There are two measures that
are commonly used to determine whether an individual or a country is "best" at a
particular activity: absolute advantage and comparative advantage. These two
concepts are often confused. An individual (or country) possesses an absolute
advantage in the production of a good if the individual (or country) can produce
more than the other individuals (or countries). An individual (or country) possesses
a comparative advantage in the production of a good if the individual (or country)
can produce the good at the lowest opportunity cost.

Let's examine an example illustrating the difference between these two concepts.
Suppose that the U.S. and Japan only produced two goods: CD players and wheat.
Notice that the U.S. has an absolute advantage in the production of each commodity.
To determine who has a comparative advantage, though, it is necessary to compute
the opportunity cost for each good. It is assumed that the PPC is linear to simplify
this discussion. The opportunity cost of one unit of CD players in the U.S. is 2 units of
wheat. In Japan, the opportunity cost of one unit of CD players is 4/3 of a unit of
wheat. Thus, Japan possesses a comparative advantage in CD player production. The
U.S. however, has a comparative advantage in wheat production since the
opportunity cost of a unit of wheat is 1/2 of a unit of CD players in the U.S., but is

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3/4 of a unit of CD players in Japan. If each country specializes in producing the

good in which it possesses a comparative advantage, it can acquire the other good
through trade at a cost that is less than the opportunity cost of production in the
domestic economy.

For example, suppose that the U.S. and Japan agree to trade one unit of CD players
for 1.6 units of wheat. The U.S. gains from this trade because it can acquire a unit of
CD players for 1.6 units of wheat, which is less than the opportunity cost of
producing CD players domestically. Japan gains from this trade since it's able to
trade one CD player for 1.6 units of wheat while it only cost Japan 4/3 of a unit of
wheat to produce a unit of CD players. If each country produces only those goods in
which it possesses a comparative advantage, each good is produced in the global
economy at the lowest opportunity cost. This result in an increase in the level of
total output (Perloff, 2014).

Demand and Supply

In this part of the lesson, we will examine how markets determine the price of goods
and the quantity sold or consumed. A market is a set of arrangements for the
exchange of a good or a service. A barter system is a market system in which goods
or services are traded directly for other goods or services. If you agree to repair
your neighbor's computer in return for his or her assistance in painting your house,
you have engaged in a barter transaction. While a barter system may be able to
function effectively in a simple economy in which a limited variety of goods are
produced, it cannot function well in a complex economy that produces an extensive
collection of goods and services. The primary problem associated with a barter
system is that any trade requires a double coincidence of wants. This means that
trade can only take place if each person wants what the other person is willing to
trade and is willing to give up what the other person wants. In a developed economy
in which a diverse collection of goods and services are produced, locating someone
willing to make the trade that you desire may be quite difficult and costly. If you
repair TVs and are hungry, you must find someone with a broken TV who is willing
to trade food for TV repairs. Because it is costly to arrange such a transaction,
economists note that barter transactions have relatively high transactions costs.

For this reason, throughout recorded history, virtually all societies have used some
form of money to facilitate trade. In a monetary economy, individuals trade goods or
services for money and then use this money to buy the goods or services that they
wish to acquire. Since money can be traded for any good or service, the use of
money eliminates the need for a double coincidence of wants and lowers the
transaction costs associated with trade.
Relative and nominal prices
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The opportunity cost of acquiring a good or a service under either barter or a

monetary economy may be measured by the relative price of the commodity. The
relative price of a commodity is a measure of how expensive a good is in terms of
units of some other good or service. Under a barter system, the relative price is
nothing more than the trading ratio between any two goods or services. For
example, if one laser printer is traded for 2 ink-jet printers, the relative price of the
laser printer is two ink-jet printers. Alternatively, the relative price of an inkjet
printer is one-half of a laser printer in this case. In a monetary economy, relative
prices can also be easily computer using the ratio of the prices of the commodities.
If, for example, a soccer ball costs $20 and a portable CD player costs $60, the
relative price of a portable CD player is 3 soccer balls (and the relative price of a
soccer ball is 1/3 of a CD player). Economists argue that individuals respond to
changes in relative prices since these prices reflect the opportunity cost of acquiring
a good or service.

In a market economy, the price of a good or service is determined through the

interaction of demand and supply. To understand how market price is determined,
it is important to know the determinants of both demand and supply. Let's first
examine the demand for a good.

The demand for a good or service is defined to be the relationship that exists
between the price of the good and the quantity demanded in a given time period,
ceteris paribus. One way of representing demand is through a demand schedule.
Note that the demand for the good is the entire relationship that is summarized.
This demand relationship may also be represented by a demand curve. Both the
demand schedule and the demand curve indicate that, for this good, an inverse
relationship exists between the price and the quantity demanded when other
factors are held constant.

This inverse relationship between price and quantity demanded is so common that
economists have called it the law of demand: an inverse relationship exists between
the price of a good and the quantity demanded in a given time period, ceteris
paribus. As noted above, demand is the entire relationship between price and
quantity, as represented by a demand schedule or a demand curve. A change in the
price of the good results in a change in the quantity demanded, but does not change
the demand for the good. An increase in the price from $2 to $3 reduces the quantity
of this good demanded from 80 to 60, but does not reduce demand.

Let's examine some factors that might be expected to change demand for most
goods and services. These factors include: tastes and preferences, the prices of

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related goods, income, the number of consumers, and expectations of future prices
as well of income. Obviously, any change in tastes that raise the evaluation of a good
will result in an increase in the demand for a good. Those who remember the short-
term increases in demand that occurred with slap bracelets, pogs, hypercolor t-
shirts, beanie babies, Tickle-Me-Elmos, etc., can attest to the effect of changing tastes
on demand. Fads will often increase the demand for a good for at least a short
period of time. Demand will also decline if tastes change so the consumption of a
good becomes less desirable. As fads fade away, the demand for the products falls.

Goods may be related in consumption as either: substitute goods, or complementary

goods. Two goods are said to be substitute goods if an increase in the price of one
results in an increase in the demand for the other. Substitute goods are goods that
are often used in place of each other. Chicken and beef, for example, may be
substitute goods. Coffee and tea are also likely to be substitute goods. A higher price
of coffee reduces the quantity of coffee demanded, but increases the demand for tea.
Note that this involves a movement along the demand curve for coffee since this
involves a change in the price of coffee. Remember, a change in the price of a good,
ceteris paribus, results in a movement along a demand curve; a change in demand
occurs when something other than the price of the good changes.

Economists say that two goods are complementary goods if an increase in the price
of one results in a reduction in the demand for the other. In most cases,
complementary goods are goods that are consumed together. Examples of likely
pairs of complementary goods include: peanut butter and jelly, bicycles and bicycle
safety helmets, cameras and film, CDs and CD players, and DVDs and DVD
players. Note that an increase in the price of DVDs would reduce both the quantity
of DVDs demanded and the demand for DVD players.

It is expected that the demand for most goods will increase when consumer income
rises. Think about your demand for CDs, meals in restaurants, movies, etc. Is it likely
that you would increase your consumption of most commodities if your income
increases? Of course, it is possible that the demand for some goods -- such as generic
foods, Ramen noodles, and other similar commodities may decline as your income
rises. Since the market demand curve consists of the horizontal summation of the
demand curves of all buyers in the market, an increase in the number of buyers
would cause demand to increase.

As the population rises, the demand for cars, TVs, food, and virtually all other
commodities, is expected to increase. A decline in population will result in a
reduction in demand. Expectations of future prices and income are also important
determinants of the current demand for a good. First, let's talk about the effect of a
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higher expected future price. Suppose that you have been considering buying a new
car or a new computer. If you acquire new information that leads you to believe that
the future price of this commodity will increase, you are probably going to be more
likely to buy it today. Thus, a higher expected future price will increase current
demand.

In a similar manner, a reduction in the expected future price will result in a

reduction in current demand (since you'd prefer to postpone the purchase in
anticipation of a lower price in the future). If expected future income rises, demand
for many goods today is likely to rise. On the other hand, if expected future income
falls (perhaps because of rumors of future layoffs or the beginning of a recession),
individuals may reduce their current demand for goods so that they can save more
today in anticipation of the lower future income.

International effects
When international markets are taken into account, the demand for a product
includes both domestic and foreign demand. An important determinant of foreign
demand for a good is the exchange rate. The exchange rate is the rate at which the
currency of one country is converted into the currency of another country. Suppose,
for example, that one dollar exchanges for 5 French francs. In this case, the dollar
value of one French franc is $.20. Notice that the exchange rate between dollars and
francs is the reciprocal of the exchange rate between francs and dollars. If the value
of the dollar rises in terms of a foreign currency, the value of the foreign currency
will fall relative to the dollar. This is a quite intuitive result. An increase in the value
of the dollar means that the dollar is worth more relative to the foreign currencies.

In this case, the foreign currencies have to be worth less in terms of dollars. When
the value of the domestic currency rises relative to foreign currencies, domestically
produced goods and services become more expensive in foreign countries. Thus, an
increase in the exchange value of the dollar results in a reduction in the demand for
U.S. goods and services. The demand for U.S. goods and services will rise, however, if
the exchange value of the dollar declines.

Supply
Supply is the relationship that exists between the price of a good and the quantity
supplied in a given time period, ceteris paribus. The supply relationship may be
represented by a supply curve or a supply schedule.

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Just as there is a "law of demand" there is also a "law of supply." The law of supply
states that a direct relationship exists between the price of a good and the quantity
supplied in a given time period, ceteris paribus. To understand the law of supply, it's
helpful to remember the law of increasing cost. Since the marginal opportunity cost
of supplying a good rises as more is produced, a higher price is required to induce
the seller to sell more of the good or service. The law of supply indicates that supply
curves will be upward sloping.

As in the case of demand, it is important to distinguish between a change in supply

and a change in quantity supplied. A change in the price of a good result in a change
in the quantity supplied. A change in the price changes the quantity supplied. A
change in supply occurs when the supply curve shifts. Note that a rightward shift in
the supply curve indicates an increase in supply since the quantity supplied at each
price increases when the supply curve shifts to the right.

Determinants of supply
The factors that can cause the supply curve to shift include: the prices of
resources, technology and productivity, the expectations of producers, the number
of producers, and the prices of related goods and services. An increase in the price
of resources reduces the profitability of producing the good or service. This reduces
the quantity that suppliers are willing to offer for sale at each price. Thus, an
increase in the price of labor, raw material, capital, or other resource, will be
expected to result in an upward shift in supply. Technological improvements and
changes that increase the productivity of labor result in lower production costs and
higher profitability. Supply increases in response to this increase in the profitability
of production.

As in the case of demand, expectations can play an important role in supply

decisions. If, for example, the expected future price of a gasoline rises, refiners may
decide to supply less today so that they can stockpile gas for sale at a later date.
Conversely, if the expected future price of a good falls, current supply will increase
as sellers try to sell more today before the price declines. An increase in the number
of producers results in an increase (a rightward shift) in the market supply curve.

Since firms generally produce (or, at least, are able to produce) more than one
commodity, they have to determine the optimal balance among all of the goods and
services that they produce. The supply decision for a particular good is affected not
only by the price of the good, but also by the price of other goods and services the
firm may produce. For example, an increase in the price of corn may induce a farmer
to reduce the supply of wheat. In this case, an increase in the price of one product
(corn) reduces the supply of another product (wheat).

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It is also possible, but less common, that an increase in the price of one commodity
may increase the supply of another commodity. To see this, consider the production
of both beef and leather. An increase in the price of beef will cause ranchers to raise
more cattle. Since beef and leather are jointly produced from cows, the increase in
the price of beef will also be expected to result in an increase in the supply of
leather.

International effects
In our increasingly global economy, firms often import raw materials (and
sometimes the entire product) from foreign countries. The cost of these imported
items will vary with the exchange rate. When the exchange value of a dollar rises,
the domestic price of imported inputs will fall and the domestic supply of the final
commodity will increase. A decline in the exchange value of the dollar will raise the
price of imported inputs and reduce the supply of domestic products that rely on
these inputs.

Let's combine the market demand and supply curves. It can be seen that the market
demand and supply curves intersect at a price for example of $3 and a quantity of
60. This combination of price and quantity represents equilibrium since the quantity
demanded equals the quantity supplied. At this price, each buyer is able to buy all
that he or she desires and each firm is able to sell all that it desires to sell. Once this
price is achieved, there is no reason for the price to either rise or fall (as long as
neither the demand nor the supply curve shifts). If the price is above the
equilibrium, a surplus occurs (since quantity supplied exceeds quantity demanded).
This situation is illustrated in the diagram below. The presence of a surplus would
be expected to cause firms to lower prices until the surplus disappears (this occurs
at the equilibrium price of $3). If the price is below the equilibrium, a shortage
occurs (since quantity demanded exceeds quantity supplied). This possibility is
illustrated in the diagram below. When a shortage occurs, producers will be
expected to increase the price. The price will continue to rise until the shortage is
eliminated when the price reaches the equilibrium price of $3. If the price is below
the equilibrium, a shortage occurs (since quantity demanded exceeds quantity
supplied). This possibility is illustrated in the diagram below. When a shortage
occurs, producers will be expected to increase the price. The price will continue to
rise until the shortage is eliminated when the price reaches the equilibrium price of
$3. Let's examine what happens if demand or supply changes. First, let's consider
the effect of an increase in demand. As the diagram below indicates an increase in
demand results in an increase in the equilibrium levels of both price and quantity. A
decrease in demand results in a decrease in the equilibrium levels of price and

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quantity as illustrated below. An increase in supply results in a higher equilibrium

quantity and a lower equilibrium price. Equilibrium quantity will fall and
equilibrium price will rise if supply falls as illustrated below. Another important
concept is price ceiling, in which it is a legally mandated maximum price. The
purpose of a price ceiling is to keep the price of a good below the market
equilibrium price. Rent controls and regulated gasoline prices during wartime and
the energy crisis of the 1970s are examples of price ceilings. An effective price
ceiling results in a shortage of a commodity since quantity demanded exceeds
quantity supplied when the price of a good is kept below the equilibrium price. This
explains why rent controls and regulated gasoline prices have resulted in shortages.

Another concept is the price floor which is a legally mandated minimum price. The
purpose of a price floor is to keep the price of a good above the market equilibrium
price. Agricultural price supports and minimum wage laws are example of price
ceilings. An effective price floor results in a surplus of a commodity since quantity
supplied exceeds quantity demanded when the price of a good is kept below the
equilibrium price.

Glossary
Capital stocks are the buildings, machinery, equipment and software used in
producing goods and services.

Consumption possibility frontier (CPF) is the combination of goods that can be

consumed as a result of a given production choice.

Economy-wide PPF is the set of goods combinations that can be produced in the
economy when all available productive resources are in use.

Full employment output is the number of workers at full employment as to the

output per worker.

Macroeconomics studies the economy as system in which feedback among sectors

determines national output, employment and prices.

Microeconomics is the study of individual behavior in the context of scarcity.

Mixed economy is a system where the goods and services are supplied both by
private suppliers and government.

Model is a formalization of theory that facilitates scientific inquiry.

Opportunity cost of a choice is usually an application that must be sacrificed when

a choice is made.

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Production possibility frontier (PPF) defines the combination of goods that can
be produced using all of the resources available.

Productivity of labor is the output of goods and services per worker.

Recession is a situation when output falls below the economy’s capacity output.

Theory is a logical view of how things work, and is frequently formulated on the
basis of observation.

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