Economics Exam 1

Supply, demand, market failure, price controls, PPF, ETC...

Scarcity

implies choice = stuff is limited

Resource

things we use to produce goods and services

What is Economics?

The study of how people choose to allocate scare goods and resources to acieve their unlimited desires.

Opportunity Cost

Value of the best thing we give up to get something.

Economizing Behavior

We assume that people behave rationally.

Rational Self interest

Useful simplifying assumptions- rational decision makers respond to incentives to make decisions.

Marginal

a little bit more, a little bit less.

How are scarcity and Choice related?

Scarcity forces us to choose among available alternatives.

How are scarcity and poverty different?___________________________________________

We may someday eliminate poverty, but scarcity
will always be with us.

Positive Economics

“is” the study of how the world is.

Normative Economics

“output” beliefs about how the world should be.

Positive economics example

The inflation rate rises when the money supply is increased.

Normative economics example

The inflation rate should be lower

Ceteris Paribus

other things stay the same

Fallacy of Composition

The erroneous view that what is true for the individual (or the part) is also true for the group (or the whole).

Number 1: Violation of the Ceteris Paribus condition

When describing the effect of a change, a failure to
hold other things constant might lead to erroneous
conclusions

Number 2: Good intentions do not guarantee desirable outcomes

An unsound proposal will lead to undesirable
outcomes even if it is supported by proponents with
good intentions

Number 3: Association is not causation

Statistical association alone cannot establish
causation.

Number 4: Fallacy of Composition

The erroneous view that what is true for the
individual (or the part) is also true for the group
(or the whole).

Economizing

gaining a specific benefit at the least possible cost.

MArginal benefits

utility

The value of a good is subjective and varies with
individual preferences.

The test of an economic theory is its ability to predict
and explain events in the real world.

Opportunity Cost are incurred

when a choice is made

Can opportunity cost be objectively measured?

No, they are subjective and very across person.

Transaction Cost

the time, effort, and other resources needed to search
out, negotiate, and consummate an exchange

Private Property Rights

right to exclusive use.

legal protection

the right to transfer to another

Property rights

The right to use, control, and obtain benefits from
a resource, good, or service

Production Possibilities Curve

a line.All output combinations on the frontier curve are efficient.

inside ppf

inefficent

An increase in the economy’s resource base will expand
our ability to produce goods and services

1st factor that can shift ppf

Advancements in technology can expand the economy’s
production possibilitie

2nd factor that can shift ppf

An improvement in the rules (laws, institutions, and
policies) of the economy can increase output

3rd factor that can shift ppf

By working harder and giving up current leisure, we can
also increase our production of goods and services.

4th factor that can shift ppf

on ppf

efficient

outside ppf

unattainable

Law of comparative advantage

when two countries , firms, individuals or other entities specialize according to their comparative advantage , and then trade both are better.

What are three basic questions faced by all economist?

What goods will be produced?
How will goods be produced?

For whom will goods be produced?

Specialization

increases the amount if stuff produced, so that when they trade, they can have more goods than they can produce on their own.

Division of labor

breaks down the production of a good into a series
of tasks performed by different workers

Specialization and the division of labor increase output

• Specialized workers become more skilled with time.
• Specialization permits individuals to take advantage
of their existing skills.
• Specialization leads to gains through comparative
advantage

Absolute Advantage

The ability to produce more of something than someone else.

Market organization

A method of organization that allows for unregulated
prices and the decentralized decisions of private property
owners to resolve the basic economic problems.

Law of Demand

the inverse relationship between the price of a good and the quantity of the consumers are willing to purchase.

• as the price of a good rises, the quantity demanded decreases.

substitutes

goods, services, or resources that are viewed as replacements for one another.

When the price of a good increases, why do you usually buy less of it?

because the availability of substitutes

Complements

goods, services, or resources that are used or consumed with one another.

What is the difference between demand and quantity demanded?

Demand is the entire cure. It is a relationship between price and quantity demanded. Quantity demanded is the horizontal axis, or a point on the horizontal axis.

demand

entire curve shifts left or right

quantity demanded

point on the line moves up and down.

Factors that shift Demand

• change in income

• inferior goods

• change in the number of consumers

• changes in taste and preferences

• change in product quality

• changes in prices of substitutes and compliments

• change in weather, natural disasters

• changes in taxes, subsides, and regulation

Opportunity Cost of production

The sum of the producer’s costs of employing each
resource required to produce the good.

Profit

occurs when a firm revenues exceed its cost.

losses

are a penalty imposed on firms that use resources in ways that reduce their market value.

Law of supply

there is a positive relationship between the price of a product and the amount of it that will be supplied.

price goes up quantity supplied goes up.

What is the role of profits and losses in a market economy?

Firms making profits will expand, while those making losses will contract.

When the price of a good increases, why is a firm usually willing to make more of it?

profits are a reward for producing products that are valued more than the resources required for their production.

What is the difference between supply and quantity supplied?

supply is the entire curve relationship between price and quantity. Quantity supplied is movement of a point along the supply curve.

Change in supply

curve shifts to the left or the right

change in supply of quantity supplied

movement along the supply curve

Factors that shift supply

• changes in tech

• change in the # of firms and businesses

• Change in input prices

• Natural disasters, weathers, etc

• change in expectations

• changes in prices of related goods

• changes in taxes, subsidies, and regulations

equilibrium

is a resting place, is a place to which things return

economic efficiency

There is no reallocation of goods and resources that has benefits greater than cost. No way to make total surplus bigger, you’ve got efficiency.

shortage

line of P1 is below the equilibrium point

surplus

P1 line is above the equilibrium point

elastic

means responsive to change, and inelastic means not responsive to change.

Elastic Mathematical Formula

[ % change quantity/ % change price ] drop negative

Greater than 1 Demand or supply is

Elastic

Less than 1 Demand or supply is

inelastic

equal to 1 demand or supply is

unite elastic

Goods with many substitutes will have

elastic demand

Goods with few substitutes will have

inelastic demand

If price goes up but quantity doesn’t change much

demand is inelastic

if quantity changes a lot

demand is inelastic

an increase in demand

demand shifts to the right

a decrease in demand

demand shifts to the left

an increase in supply

supply shifts to the right

a decrease in supply

supply shifts to the left

an increase in demand and an increase in supply

Price goes up, quantity goes up Price goes down, quantity goes up

Price is indeterminant, quantity rises

a decrease in demand and a decrease in supply

price is indeterminant, quantity falls

an increase in demand and a decrease in supply

price goes up, quantity is indeterminant

. a decrease in demand and an increase in supply

price falls, quantity is indeterminant

Provide an example of the invisible hand working in a market.

the tendency of market prices to direct
individuals pursuing their own self
interests into productive activities that
• also promote the economic well-being of society

Market Prices

reflecting the forces of demand and
supply, coordinate their actions and bring their choices
into harmony.

Price ceiling

a maximum legal price at which a good, service, or resource at which a good, service, or resource can be sold.

Price control

legal restrictions on prices

Price floor

legal minimum price

non binding price ceiling

A price ceiling above the equilibrium price. No change

non binding price floor

a price floor below the equilibrium price - no change non-binding

Deadweight loss

lost consumer and producer surplus

Producer surplus

the difference between the price producers receive for a good or service and the minimum price they are willing and able to accept .

Producers surplus can also be thought of the

as the wealth that trade creates for producers in a market.

consumer surplus

difference between the maximum price consumers are willing and able to pay for a good or service and the price they actually pay. wealth that trade creates for consumers in a market.

good intentions don’t make a policy beneficial

good results make policy beneficial

Externalities

spill over effect These occur when benefits or costs fall on a third party

Negative externality

buyer and seller impose a cost on a third party. As people do too much of a harmful thing.

Negative Externalities Ex:

Coughing on everyone like a jerk, pollution

Negative Externality Solution:

Pigouvian taxes

Positive Externality

Buyer and seller impose a benefit on a third party. As a result people do too little of a good thing.

Positive externality EX:

Getting Vaccinated

Positive Externality Solutions:

Pigouvian Subsidies and Cap and Trade.