ECON Midterm 1

the invisible hand

the price mechanism, the rise and fall of prices that guides our actions in a market 

economics

the study of how human beings coordinate their wants and desires, given the decision making mechanisms, social customs, and political realities of the society 

coordination

how three central problems (what and how much to produce, how to produce it, and for whom to produce it) are solved 

scarcity

the goods available are too few to satisfy individual’s desires

microeconomics

the study of individual choice, and how that choice is influenced by economic forces 

macroeconomics

the study of the market as a whole, looking at the aggregate

economic reasoning

making decisions on the basis of costs and benefits

marginal cost

the additional cost to you over and above the costs you have already incurred

sunk costs

costs that have already been incurred and can’t be recovered

marginal benefit

the additional benefit above what you’ve already derived

economic decision rules

if the marginal benefits of doing/buying something exceed the marginal costs, do it, and vice versa 

opportunity cost

the benefit that you might have gained from choosing the next best alternative; what you missed out on (aka the highest valued alternative opportunity forgone)

implicit costs

costs associated with a decision that often aren’t included in normal accounting costs

illusionary sunk costs

costs that show up in financial accounts but that economists argue should not be considered because they are already spent (ex. You buy a book that can’t be resold (sunk cost) economists argue that the price of the book shouldn’t affect your decision on whether to read it)

market force

an economic force that is given relatively free rein by society to work through the market; market forces ration by changing prices in response to the level of scarcity 

social forces

forces that guide individual actions even though those actions may not be in an individual's selfish interest 

political forces

legal directives that direct individual’s actions

experimental economics

branch of economics that studies the economy through controlled experiments

theorems

propositions that are logically true based on the assumptions in a model 

precepts

policy rules that conclude that a particular course of action is preferable 

invisible hand theorem

a market economy through the price mechanism (how items are priced based off scarcity), will tend to allocate resources efficiently

efficiency

achieving a goal as cheaply as possible

economic policies

actions (or inaction) taken by government to influence economic actions 

positive economics

the study of what is, and how the economy works; discovers empirical facts 

normative economics

the study of what the goals of an economy should be

the art of economics

the application of knowledge learned in positive economics to achieve the goals one has determined in normative economics; where most policy questions fall under

production possibility curve (PPC)

a curve measuring the maximum combination of outputs that can be obtained from a given input; it gives you a visual picture of the trade-off embodied in a decision 

comparative advantage

the ability to be better suited to the production of one good than to the production of another good 

productive efficiency

achieving as much output as possible from a given amount of inputs or resources

inefficiency

getting less outputs from inputs that, if devoted to some other activity, would produce more output 

inefficient

points inside the PPC are ____?

efficient

points along the PPC are ____?

unattainable

points outside the PPC are____?

laissez-faire

an economic policy of leaving coordination of individual’s actions to the market

globalization

The increasing integration of economies, cultures, and institutions across the world 

law of one price

the wages of workers in one country will not differ significantly from the wages of (equal) workers in another institutionally similar county

market economy

an economic system based in private property and the market in which individuals decide how, what, and for whom to produce 

central planning/socialism

an economic system based on individual’s goodwill towards others, not their own self interest, and in which (in principle) society decides what, how, and for whom

capitalism

an economic system based on the market in which the ownership of the means of production resides with a small group of individuals called capitalists 

profit

what is left over from total revenue after all the appropriate costs have been subtracted

sole proprietorships

 businesses that have only one owner (about 72% of US businesses)

partnerships

businesses with 2+ owners (roughly 10% of US businesses)

corporations

businesses that are treated as a person, and are legally owned by their stockholders, who are not liable for the actions of the corporate “person” (18% of US businesses)

households

groups of individuals living together and making joint decisions; the most powerful economic institution 

externalities

the effects of a decision on a 3rd party not taken into account by the decision maker; can be positive or negative (ex. pollution from a factory)

macroeconomic externalities

externalities that affect the levels of unemployment, inflation, or growth in the economy as a whole

public goods

 goods that if supplied to one person must be supplied to all and whose consumption by one individual does not prevent its consumption by another individual (ex. National defense)

private goods

a good that, when consumed by one individual, cannot be consumed by another (ex. apple)

demerit goods or activities

 Goods or activities that government believes are bad for people even though they choose to use the goods or engage in the activities 

merit goods or activities

those that government believes are good for you even though you may not choose to engage in them 

market failures

situations in which the market does not lead to a desired result

government failures

situations in which the government intervenes and makes things worse 

demand

a willingness and ability to pay OR the schedule of quantities of a good that will be bought per unit of time at various prices

law of demand

the quantity demanded rise as prices fall (other things constant) OR the quantity demanded falls as prices rise (other things constant)

demand curve

the graphic representation of the relationship between price and quantity demanded; slopes downward and to the right

movement along a demand curve

the graphical representation of the effect of a change in price on the quantity demanded 

shift in demand

The graphical representation of the effect of anything other than price on demand; the shift of the entire demand curve

quantity demanded

refers to a specific amount that will be demanded per unit of time at a specific price, other things constant

shift factors of demand

societies income, price of substitute goods, tastes, expectations, taxes and subsidies

market demand curve

the horizontal sum of all individual demand curves

law of supply

quantity supplied rises as price rises, other things constant OR quantity supplies falls as price rises, other things constant 

supply curve

the graphical representation of the relationship b/w price and quantity supplied; slopes upward and to the right

supply

refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant 

quantity supplied

refers to a specific amount that will be supplied at a specific price

movement along a supply curve

the graphical representation of the effect of a change in price on the quantity supplies 

shift in supply

the graphical representation of the effect of a change in a factor other than price on supply; a shift of the entire supply curve

shift factors of supply

price of inputs, technology, expectations, taxes/subsidies

market supply curve

the horizontal sum of all individual supply curves

equilibrium

a concept in which opposing dynamic forces cancel each other out; in supply/demand, equilibrium means that the upwards pressure on price is exactly offset by the downward pressure on price 

equilibrium quantity

the amount bought and sold at the equilibrium price, or the price at which the invisible hand drives the market

excess supply (surplus)

when quantity supplied is greater than quantity demanded 

excess demand (shortage)

when quantity demanded is greater than quantity supplied 

price ceilings

a government-imposed limit on how high a price can be charged; imposed when a government wants to hold prices down; generally below the equilibrium price (ex. rent control)

price floors

government imposed limits on how low a price can be charged; imposed when the government is trying to favor suppliers (ex. minimum wage)

excise tax

a tax that is levied on a specific good (ex. Luxury tax on expensive cars)

tariff

an excise tax on an imported good

third-party-payer markets

markets in which the person who receives the good differs from the person paying for the good (ex. Health care market where most people have insurance, that is the 3rd party payer in this example)

elasticity

how responsive consumers are to a change in price; defined as percentage change in quantity divided by percentage change in some variable that affects demand/supply or quantity demanded/quantity supplied

[q₁-q₂/(q₁+q_{2)/2]/ [}p₁-p₂/(p₁+p_2)/2]

what is the elasticity formula?

elastic

E>1( % change in quantity>% change in price)

inelastic

 E<1(% change in quantity<% change in price)

unit elastic

E=1(the % change in quantity equals the % change in price)

perfectly inelastic

E=0 (quantity does not respond at all to changes in price)

perfectly elastic

E=infinity (quantity responds enormously to changes in price)

income elasticity of demand

shows us the responsiveness of demand to changes in income

cross-price elasticity of demand

show us the responsiveness of demand to changes in price of a related good

normal goods

goods whose consumption increases with and increase in income; have positive income elasticities

inferior goods

goods whose consumption decreases as income increases; have a negative income elasticity

luxury goods

goods with an income elasticity greater than 1

necessities

goods with an income elasticity b/w 0 and 1

substitutes

goods that can be used in place of one another; have positive cross-price elasticities

complements

goods that are used in conjunction with other goods (ketchup and hot dogs); have negative cross price elasticities

consumer surplus

the net benefit a consumer gets from purchasing a good (the value the consumer gets from buying a product - its price)

producer surplus

net benefit a producer gets from selling a good (the price the producer sells a product for - the cost of producing it)

deadweight loss

the loss of consumer and producer surplus from taxes; graphically represented by the welfare loss triangle

rent-seeking activities

activities designed to transfer surplus from one group to another, such as price ceilings and floors

general rule of political economy

policies tend to reflect small group’s interests, not those of large groups because the small groups will lobby the government more effectively 

tradition economy

an economic system where goods production and distribution are driven by time-honored beliefs, customs, culture, and traditions

right to consume, right to sell, right to keep others from consuming

what three rights must owners of private property have?

lump sum fine

discussed in econ minute 1 ; a fine that charges a specific amount of $ no matter how much time has passed