Master Review Flashcard Study Set

(kill me)

Define scarcity and differentiate microeconomics and macroeconomics.

• Scarcity is the condition that arises when resources are available in limited, finite amounts and we cannot use as much of them as we want to.

• Microeconomics is the branch of economics that studies how individual decision-makers behave and interact with each other, typically with a focus on firms and households.

• Macroeconomics is the branch of economics that studies the function and performance of a society’s “economy as a whole,” ex. GDP, unemployment rates, inflation, etc…

Differentiate positive and normative statements.

• Positive statements are claims that attempt to describe how the world is or how it actually functions. They are fact-based, provide observation or prediction, and can be confirmed or refuted by evidence.

• Normative statements are “ought” or “should” claims that aim to assess the desirability of how the world is or functions, often with suggestions of things that could be done to improve matters. They are opinion-based, express desirability on how the world should be, and involve value judgements and priorities.

What is a rational decision-maker and how does it relate to total benefits and total costs?

• Someone with a well-defined goal who takes actions to achieve the goal as best as possible.

• A rational decision-maker aims to balance total benefits with total costs (and aims to maximize total economic surplus)

Define total economic surplus and its relation to the cost-benefit principle.

• The difference between total benefits and total costs.

• The cost-benefit principle states that a rational decision-maker should only undertake an action if and only if the marginal benefit of doing so is greater than the marginal cost of doing so.

Define the incentive principle.

• If the marginal benefit increases, then a rational person will engage in more of that activity.

• If the marginal cost of an activity increases, then a rational person will engage in less of an activity.

Define goods and services and who their primary consumers & producers are.

• Goods and services are outputs of production.

• They are consumed by households and their primary producers are known as firms.

Define production and the factors of production.

• Production is the process by which inputs are transformed into an output (i.e. a good or a service).

• The factors of production are the inputs of the production process, broadly categorized as land, labor, and capital.

Define households and firms.

• Households are the decision-making entities whose primary economic objective is to obtain benefits from consuming goods and services.

• Firms are the decision-making entities whose primary role is to produce goods and services for consumption by households.

What are the three fundamental economic questions?

• What to produce i.e. the production decision — what mix of goods and services should be created?

• How to produce i.e. the resource use decision — what resources should be used to produce which goods and services?

• For whom to produce i.e. the distribution decision — who gets to consume which goods and services?

What is the PPF (production possibilities frontier)? Define an attainable/feasible and unattainable/unfeasible combinations of goods.

• A curve summarizing the limits of production that a society faces by illustrating the maximum amount of one good that may be produced for every possible level of production of another good.

• An attainable/feasible combination of goods means that it can, in some way, be produced with available resources.

• An unattainable/unfeasible combination of goods means that it cannot possibly be produced with available resources.

Define productive efficiency and productive inefficiency.

• Productive efficiency is a state in which it is not possible to increase the production of some good without decreasing the production of another good.

• Productive inefficiency is a state in which it is possible to increase the production of some good without decreasing the production of another good.

Differentiate absolute and comparative advantage and define opportunity cost.

• Absolute advantage means that one person has an advantage over another if they can produce more of a good with the same amount of inputs.

• Comparative advantage means that a person has an advantage in terms of having a lower opportunity cost for one good when they produce more of another good.

• Opportunity cost is the value of the next best alternative that must be foregone in order to undertake the activity.

Define the law of comparative advantage.

• When increasing the production of a good, a society should do so by using the available productive resource with the lowest opportunity cost (i.e. the resouce which possesses the comparative advantage at producing the good).

What is the value of the slope of the PPF?

• It is equal to “minus the opportunity cost of the good on the horizontal axis for the marginal worker” (no clue wtf that means)

Define an economic system.

The rules and methods put in place by a society to determine how the three economic questions will be answered.

Explain the three broad factors of production used by firms and what the main objective of firms is.

• Natural assets — natural resources including minerals (i.e. ores, gemstones, etc..), fossil fuels, naturally occurring vegetation, water resources, etc..

• Produced assets — the currently available machines, factories, and inventories of finished goods available as industrial capital, as well as social capital such as transportation, infrastructure, etc..

• Human capital — the skills, education, and training which individuals in the labor force possess.

• The main objective of firms is profit.

Explain the four components to an economic system. Explain how government differs from households and firms.

• Households — consumers of goods and services

• Firms — producers of goods and services via the factors of production.

• Markets — the collection of all potential buyers/sellers of a good/service; it is more of an environment of interaction than a decision-making entity'

• Government — a decision-making institution with the legal authority to impose restrictions/mandates on behavior of other decision-makers, i.e. to use legal coercion. The last part is what separates it from households and firms.

Define a contract.

• A contract is a legal document which specifies what parties must do, whatever the external circumstances, and provides enforcement or compensation for non-performance.

List some fundamental government-imposed laws of significance for a functioning economy, even in free markets.

• Establishment/enforcement of contracts, definition of property rights, bankruptcy law, health codes, labor laws/regulations, etc..

Differentiate capitalism and socialism, and the relationship between capitalism and feudalism.

• Capitalism is an economic system in which the factors of production are privately owned and operated for a profit, where capitalists may freely use the factors of production that they own.

• Socialism is an economic system in which the factors of production are controlled by the government.

• Feudalism (a system of land ownership involving peasants/serfs at the bottom and inherited land ownership) came before capitalism.

What are the three rights for private ownership of property?

• Right to control, i.e. the right to decide how to use your property

• Right to transfer, i.e. the right to obtain ownership of property from or relinquish ownership of property to another person

• Right to restitution, i.e. the right to be compensated by another person when he damages your property or infringes upon your rights

Define consumer sovereignty.

• The freedom of an individual to choose to purchase (or to choose not to purchase) a good or service at a price determined in a free, unfettered market

Define the idea of the “invisible hand” and how it relates to free market forces and economic surplus.

• It is the idea that the behavior of self-interested decision-makers will lead to outcomes which are “better” for all parties, and this “hand” is another name for free market sources.

• It (in theory) leads to the maximization of total economic surplus in society.

Explain the overall theory of socialism as a precursor to communism as it was depicted by Karl Marx.

• Marx observed a growing inequality between the bourgeoisie (i.e. the business owners) and the proletariat (i.e. the working class) and Marx believed that the proletariat were being exploited by the bourgeoisie.

• His solution was to have the state seize wrongfully accumulated property and assets of the bourgeoisie, thus destroying the capitalist system.

• Communism would involve collective ownership of goods by all people in a society with no need for a government. Marx believed that capitalism would be the prelude to this economic system.

Differentiate the new soviet man and the economic man.

• The new soviet man is a person who is primarily motivated by selfless benevolence.

• The economic man is a person who is both self-interested and rational.

Differentiate planning and free markets.

• Planning means that the government determines (or imposes policies which determine) the answers to the “three fundamental economic questions.”

• Free markets involve the rational actions of self-interested decision-makers leading to a set of outcomes, therefore indirectly answering the three economic questions.

Differentiate command planning from indicative planning.

• Command planning means that the government directly controls near all economic activity, and almost all production takes place within enterprises owned/controlled by the government (e.g. the former Soviet Union)

• Indicative planning is where the government guides the behavior of individuals in regard to economic decisions by establishing policies which alter costs and benefits.

What are the three types of economic incentives?

• Material rewards — monetary rewards or direct increases in consumption which result from engaging in an activity (market economies rely heavily upon these)

• Moral suasion — attempts to persuade people to commit to a certain path of action because it is “the right thing to do.”

• Coercion — the use of force or intimidation to obtain compliance.

Define a mixed economy.

• An economic system in which some factors of production are owned and controlled by individuals, while some factors of production are controlled and owned by the state

Define money and its three functions.

• Money is any asset that is socially and legally accepted as payment for goods and services.

• Its three functions are to act as a medium of exchange (an asset used as a payment when purchasing goods/services), a store of value (i.e. a means of holding wealth), and a unit of measure (i.e. a measure of economic activity that can be compared with the values of other goods/services).

Differentiate the market for finished goods and services and the market for factors of production.

• The market for finished goods and services is where outputs from the production process are traded, where firms are sellers and households are buyers.

• The market for factors of production is where the inputs of the production process are traded, where households act as the sellers and firms act as the buyers.

Define supply and demand. Give their depictions on a graph.

• Supply is the relationship between price of a good and the quantity that firms are willing and able to sell, all other factors fixed; depicted as an upward curve.

• Demand is the relationship between the price of a good and the quantity that consumers demand, all other factors fixed; depicted as a downwards curve.

Define the law of demand and the law of supply.

• The law of demand says that all other factors fixed, a greater quantity of a good will be demanded at lower prices (demand curves are downward sloping).

• The law of supply says that, all other factors fixed, a greater quantity of a good will be supplied at higher prices (i.e. supply curves are upward sloping).

Define buyer and seller’s reservation price and how to identify them on a graph.

• Buyer’s reservation price is the maximum dollar amount that a buyer is willing to give up in order to acquire an item. The height of the demand curve illustrates the reservation price of the buyer of that unit.

• Seller’s reservation price is the minimum dollar amount that a seller is willing to accept in order to part with an item. The height of the supply curve illustrates the reservation price of the seller at that unit.

Define equilibrium and what it means in the context of a market. Give its three important properties.

• A stable state that persists so long as external factors do not change.

• In the context of a market, equilibrium is a price/quantity pair that is stable in the sense that no individual buyer and no individual seller can alter their own behavior in such a way as to increase their own surplus.

• Its three important properties are: stable, unique (i.e. there is one and only one equilibrium), and self-enforcing (i.e. at higher prices there is a downward pressure on price; at lower prices there is an upwards pressure on price)

Talk about what increases and decreases in demand and supply mean and what they look like on a graph.

• An increase in demand means that consumers are willing to purchase the same amount of goods at the same price; a decrease in demand means that consumers will purchase less of the same amount of goods at the same price. An increase is depicted as a rightward shift on the graph and a decrease is depicted as a leftward shift.

• An increase in supply means that firms are willing to sell more of a good at the same price. A decrease in supply means that firms are willing to sell less of a good at the same price. An increase is depicted as a rightmost shift and a decrease is depicted as a leftward shift.

Define a complement and substitute good and how they impact the demand curve.

• A complement is a good purchased with something else (ex. patties and buns), and a substitute good is a good that replaces something else (ex. pepsi and coca-cola).

• An increase or decrease in demand for a complement good (be it due to a decrease or increase in price) will also cause an increase/decrease in demand for the good which it complements, whereas the demand of substitute goods are inversely related. Ex. demand for hotdogs would increase if the price of hotdog buns went down, and demand for pepsi would increase if the price of coca-cola increased.

Define normal and inferior goods and how they relate to changes in demand.

• Normal goods are goods that you purchase more of if you make more income and less of if you make less income.

• Inferior goods are goods whose demands drop as consumer income rises or experience increases in demand as consumer income decreases. (ex. generic cola store-bought cola would have an increase in demand over coca-cola if people’s incomes suddenly went down).

How does the equilibrium price and quantity change with shifts in demand or supply?

• Equilibrium price and quantity both increase when demand increases, and equilibrium price and quantity both decrease when demand decreases.

• Increases in supply decrease equilibrium price and increase equilibrium quantity; decreases in supply increase equilibrium pice and decrease equilibrium quantity.

(Ch. 8) [Market Provision of Public Goods]

(Ch. 8) [Market Provision of Public Goods]

Define the two categories of goods and define rival/non-rival goods and excludable/non-excludable goods.

• Goods in terms of their rivalness in consumption…

  • Non-rival goods are goods for which consumption by one person does not diminish the quantity or quality of consumption by others.

  • Rival goods are goods for which consumption by one person does diminish the quantity or quality of consumption by others. (Ex. eating a hamburger from McDonalds means there is one less hamburger for someone else)

• Goods in terms of their excludability

  • A non-excludable good is a good for which it is difficult to prevent consumption by those who do not pay

  • An excludable good is a good for which it is easy to prevent consumption by those who do not pay

Define a private good, public good, club good, and common good.

• A good that is both excludable and rival in consumption; these are typically quite efficient. Ex. big macs from McDonalds (i.e. buying a big mac is excludable but it competes with others who want to also buy that big mac).

• A good that is non-excludable and non-rival in consumption, ex. public roads, national defense, etc…

• A good that is excludable and non-rival in consumption, ex. satellite radio or TV broadcast.

• A good that is non-excludable and rival in consumption, ex. stock of fish in the ocean

Why is the provision of pure public goods considered inefficient?

• Because of the Free Rider problem.

Define the free-rider problem and how it was solved in the U.S.

• It is the problem of consumers attempting to enjoy the benefits of units purchased by others without purchasing any units themselves, leading to the amount provided being less than the efficient amount.

• It was solved by establishing a government that created those public goods and then made budgetary and taxation decisions to cover the costs of production.

Define external cost/negative externality and external benefit/positive externality and their relationship to the efficiency of the market.

• External cost/negative externality refers to the cost of an activity borne by someone not engaging in the activity. (leading to free markets providing more than the optimal amount)

• External benefit/positive externality refers to a benefit from an activity realized by someone not engaging in the activity (leading to free markets providing less than the optimal amount)

• Market provision of a good for which there is an externality is generally inefficient.

How does the graph of a negative externality look like?

• It is when the marginal social cost exceeds the marginal private cost (or supply), creating deadweight loss.

What are some policies that may remove the deadweight loss from a negative externality? Explain how “the last three” function.

• Ban the activity entirely

• Establish minimum compliance standards for manufacturers

• Cap and trade — i.e. issue a certain number of “permits” among individuals of society as a whole and then allow people to trade these permits among themselves

• Offer subsidies to manufacturers that reduce pollution

• Charge manufacturers a fee for each unit of pollution emitted

• The last three “internalize the externality” by creating a cost or foregone gain that comes from continuing to engage in the externality.

What kind of good is “information” and how do governments handle a lack of it?

• It is a club good, non-rival and excludable.

• It is handled by providing people with the important information needed to make good decisions and markets, as well as minimizing the costs to society of providing the information

Define the three common justifications for government intervention in markets.

• Allocation Function — government production of goods or regulation of business, often aimed at improving the economy’s allocative efficiency

• Distribution Function — government policies aimed at changing the final distribution of goods/services across consumers, with the goal of realizing a “fairer” apportionment of consumption/income/wealth

• Stabilization Function — government aims to minimize fluctuations in macroeconomic activity

Define market failure and its four causes.

• It is when the free market is inefficient and deadweight loss is positive.

• The four causes include. . .

  • Profit maximization by a firm with market power

  • Market provision of public goods

  • Market provision of goods generating externalities

  • Lack of information by market participants

Define market power and monopoly.

• Market power is when a firm has “some control over the price of their output” in that they can increase price without losing all customers or must decrease price in order to increase sales.

• A monopoly is a market structure in which there is one single seller of a unique good with no close substitutes, which is the polar opposite of perfect competition.

What does profit maximization for a monopolist look like on a graph and where would the efficient quantity of trade be?

• It is the distance from where the profit-maximizing quantity is sold all the way up to the demand curve, essentially where marginal revenue exceeds marginal cost.

• The efficient quantity of trade would be where the demand curve meets the marginal cost curve.