ECON 102 - Exam 1

Chapter 1: The Scope and Method of Economics

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What is economics?

the study of choices that people, firms, and societies make with their limited resources (scarcity)

Scarcity

availability is limited in some way

poverty

an income level below with people cannot afford basic means

Microeconomics:

• individual decisions

• how firms compete

• individual market

• how groups of consumers make decisions

Macroeconomics:

• how government decisions impact economics

• multiple markets

• interactions between multiple economies

_________ is limited (scarce) in some way.

EVERYTHING

5 Foundations of Economics:

1. Incentives

2. Life is about tradeoffs

3. Opportunity Cost

4. Marginal Thinking

5. Trade

5 Foundations of Economics: Incentives

People are motivated by both positive and negative incentives

• incentives can have unintended consequences

5 Foundations of Economics: Life is about tradeoffs

Ex: Cost of a heavy-duty bomber something —> Could have been 2 power plants, or 2 hospitals, or 50 miles of concrete highway, etc.

• for 1 new bomber that is constructed, there is another things that could have been built

5 Foundations of Economics: Opportunity Cost

The highest value alternative that must be given up to engage in an activity

• recognizing the best thing that you could have been doing

5 Foundations of Economics: Marginal Thinking

Evaluating whether the benefit of acquiring one more unit of something is greater than the cost

Marginal = The nest unit of something

5 Foundations of Economics: Trade

• Trade and specialization are the cornerstones of economics

• All parties involved are better off through specialization and trade

To build models we use the ___________________

scientific method

4 steps of building models:

1. Observe a phenomenon —> observations in economics are decisions that people make under scarcity

2. Based on observations, we develop a hypothesis —> which is a proposed explanation of that phenomenon

3. Construct a model to test the hypothesis

4. Design experiments that test how well the model works —> after data collection, scientists can revise, verify, or refute the hypothesis

Experimental Economics

economists collect data by looking at real world events or designing lab experiments to test them directly using human subjects

Models can _______________ but are meant to illustrate key concepts

oversimplify

Economists test models by changing one ___________ at a time __________________

• Variable

• Ceteris paribas

Variable

factor that could be in a model

ceteris paribas

holding all other things constant

Endogenous variable

it is controlled for in a model

• a variable within the model

Exogenous variable

it is outside the model

BEWARE of faulty assumptions

Economists focus of _________________

positive analysis

Positive statement

a statement that is testable and verified

• CAN be incorrect (EX: the sky is purple)

Normative statement

a statement that cannot be tested or verified

• an OPINION

Chapter 2: Scarcity and Choice

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Opportunity cost

the highest values next-best alternative that must be sacrificed to attain something

LOOK AT THE MATH

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Production Possibility Curve/Frontier (PPC or PPF)

shows the maximum amount of any 2 products that can be produced by a society/firm/person from a fixed amount of resources if all resources are used

The Production Possibility Curve (PPC) is generally ___________. This is due to ______________________

• non-linear

• increasing relative cost —> means the opportunity cost of producing a good rises as society/firms/people produce more of it

A linear Production Possibility Curve (PPC) has a _____________ opportunity cost

constant

The Production Possibility Curve (PPC) will:

1. Shrink if…

2. Expand if…

1. resources are destroyed

2. builds more factories for both products

Comparative advantage

a person/firm/country has a comparative advantage over another person/firm/country in producing a good if they can produce that good at a lower opportunity cost

Lower opportunity cost means that a person producing a different good is ______________

more costly

• Means that their “next best thing” is NOT worth that much, so they should stick to producing what they are producing and specialize/trade

Comparative advantage is DIFFERENT from Absolute advantage

when a person/country/firm produces at a lower cost

LOOK AT THE MATH

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Chapter 3: Demand and Supply

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Law of Demand

there exists an inverse relationship between the price of a good and the amount of it buyers are willing to purchase

• means demand will always be negative

Movement along the demand curve (A —> B) is a result of price/quantity change alone. This is known as a __________________.

Change is quantity demanded (Q_D)

• comes from changing variables in the model

A shift in the entire curve (D₁ —> D₂) occurs when something other than P or Q changes. This is called a ___________________________.

change in demand

Demand curve shifts when ________________ is violated.

ceteris paribas (holding all else constant)

• this is when we change a variable outside the model

Law of supply

there exists a direct relationship between the price of a good and the amount of it offered for sale

• means supply will always be positive

Movement along the supply curve (A —> B) is a result of price/quantity change alone. This is known as _____________________

a change in quantity supplied (Q_S)

A shift in the entire curve (S₁ —> S₂) occurs when something other than price/quantity changes. This is know as ___________________________

a change in supply

The supply curve shifts whenever _________________ is violated

ceteris paribas

________________________ pushes the market to equilibrium where Q_S=Q_D

Adam Smith’s “invisible hand of the marketplace”

LOOK AT THE MATH

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Chapter 5: Elasticity

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Elasticity

measures the % change in one variable with respect to a % change in another variable

Elastic = ?

Inelastic = ?

• Flexible

• Inflexible

LOOK AT THE MATH

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Determinants of Price Elasticity of Demand:

1. Substitutes —> more substitutes = more elasticity

2. Bigger % of budget —> more elastic demand (not willing to spend any more)

3. More time allowed for something —> more elastic because mor substitutes are available over time

What are the 2 methods for calculating Price Elasticity of Demand?

1. % Formula

2. Midpoint Formula

LOOK AT THE MATH

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Revenue

amount of $ made

• P x Q

For Price Elasticity of Demand:

0>E_D>-1 —>

E_D<-1 —>

—> Relatively inelastic

—> Relatively elastic

According to the Law of Demand, E_D should always be _________

negative

Perfectly inelastic graph:

E_D=0

• Ex: emergency hospital care, insulin, etc.

Relatively inelastic graph:

-1<E_D<0

• Ex: gas, electricity, etc.

Relatively elastic graph:

-infinity<E_D<-1

• Ex: apples, etc.

Perfectly elastic graph:

E_D= -infinity

• Ex: money

Unitary elasticity

E_D=1

• NOT a 45% line

Income elasticity of demand

measures how a change in income affects quantity demanded

Unlike before where E_D had to be negative, E_I can be _______________________

positive or negative

What the different values of E_I mean:

• E_I>0 = Normal

  • 0<E_I<1 = Necessity

  • E_I>1 = Luxury

• E_I<0 = Inferior

Cross price elasticity of demand

measures the responsiveness of the quantity demanded of one good to the change in price of another good

E_C can be _____________________

positive or negative

What the different values of E_C mean:

• E_C>0 = Substitute good

• E_C<0 = Complementary goods

Price elasticity of supply

measures how Q_S changes with respect to a change in P

According to the Law of Supply, E_S must be_______________

greater than or equal to 0

Perfectly inelastic supply graph:

E_S=0

• Ex: ocean front land, etc.

Relatively inelastic supply graph:

0<E_S<1

• Ex: cell phone towers, etc.

Relatively elastic supply graph:

E_S>1

• Ex: hot dog vendor, etc.

Perfectly elastic supply curve does _______ exist because of _________

• NOT

• scarcity

Chapter 4: Demand and Supply Application

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LOOK ST THE MATH

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Consumer surplus (CS)

difference between willingness to pay and the amount paid for a good across all consumers

willingness to pay = most a buyer is willing to pay

Producer surplus (PS)

difference between price sellers are paid and willingness to sell a good

willingness to sell = least amount necessary for a seller to sell a good

Total surplus (TS)

Consumer surplus + producer surplus + tax revenue

The outcome is _________ when an allocation of resources maximizes __________________

• efficient

• total surplus

The _____________________________ is efficient!

Adam Smith’s Invisible Hand of the marketplace

Economists sometimes care about ___________

equity

• fair distribution of goods

  • hard to measure

Levy

who is legally responsible (supply or demand) for paying the tax

Incidence

who actually pays the tax (both parties pay some % of the tax as a result of market adjustment)

Deadweight loss (DWL)

decline in economic activity, and the lost surplus from that decline

• taxes cause inefficiency

Taxes in competitive markets causes DWL, so there needs to be other incentives such as:

1. raise $ for the government

2. stop/decline economic activity intentionally

Tax revenue

collected by the government and are counted in total surplus

Calculating % tax incidence for consumers and suppliers

(difference in what they pay)/(tax)

tax incidence does NOT depend on which side the tax was _________ on

levied

Tax incidence depends on ___________________

relative elasticity

• the more INELASTIC side pays a higher % of tax

Price controls

price ceilings and floors

Price ceiling

a legally imposed maximum price on a good

shortage

too little supplied and too much demanded

surplus

too little demanded and too much supplies

A price ceiling is binding if it is set __________ the equilibrium price because…

• below

• because the invisible hand of the market wants to push the market to equilibrium but it cannot

nonbinding price ceiling is set __________ the equilibrium price

• above

  • no impact on the market

a binding price ceiling can lead to ____________

black markets

Price gouging

when a seller increases the price of goods in response to a demand shock in an emergency

• Price gouging is illegal following a declared state of emergency

  • Acts as a price ceiling!

Price floor

legally mandated minimum price of a good

• main example is minimum wage

Minimum wages are binding if the minimum wage is __________ than wage at equilibrium

greater