ECON 2030 Charles Roussel Exam 1

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.

_____________ refers to how the three central problems facing any economy are solved.

Coordination

The three central problems facing any economy:

1. What, and how much, to produce

2. How to produce it

3. For whom to produce it

The quantity of goods, services, and usable resources depends on ______________ and __________ ____________.

The quantity of goods, services, and usable resources depends on *technology* and *human action*.

1. Microeconomics is the study of ___________________...

2. Microeconomics theory considers economic reasoning from the viewpoint of ____________..... and ________________....

3. Microeconomics studies such things as:

a. The ___________ ___________ of firms,

b. ______________ decisions on ______ ___ _______,

c. and how markets ___________ ____________ among _____________ ___________.

1. Microeconomics is the study *individual choice*, and how that choice is influenced by economic forces.

2. Microeconomics theory considers economic reasoning from the viewpoint of *individuals and firms* and *builds up* to an *analysis of the whole economy.*

3. Microeconomics studies such things as:

a. the *pricing policies* of firms,

b. *households'* decisions on *what to buy*,

c. and how markets *allocate resources* among *alternative ends.*

1. Macroeconomics involves first looking at the _______________, or ____________, then ________________________________.

2. Macroeconomics is the study of the ______________ as __________. It considers the problems of:

a. __________

b. __________

c. __________

d. __________

1. Macroeconomics involves first looking at the *aggregate, or whole*, then *breaking it down into components*.

2. Macroeconomics is the study of the *economy as a whole*. It considers the problems of:

a. *inflation*

b. *unemployment*

c. *business cycles*

d. *growth*

_________________ focuses on ___________ relationships such as how household consumption is related to income and how government policies can affect growth.

*Macroeconomics* focuses on *aggregate* relationships such as how household consumption is related to income and how government policies can affect growth.

Economic reasoning is making decisions on the basis of ________ and _________.

Economic reasoning is making decisions on the basis of *costs* and *benefits*.

What does TANSTAAFL stand for?

*T*here *A*in't *N*o *S*uch *T*hing *A*s *A* *F*ree *L*unch

What is the economic decision rule?

Economic decision rule:

*If the marginal benefits of doing something exceed the marginal costs, do it.* (and vice versa)

Economic reasoning is based on the premise that ________________________________.

Economic reasoning is based on the premise that *everything has a cost*.

Opportunity cost is:

Opportunity cost is *the benefit that you might have gained from choosing the next-best alternative*; it is the basis of cost/benefit economic reasoning.

________________ is the basis of cost/benefit economic reasoning.

*Opportunity cost* is the basis of cost/benefit economic reasoning.

Market

A *market* is a social process (people interacting) in which goods and services are exchanged for money. The buyer and seller *ALWAYS give AND receive.*

Economic forces

*Economic forces* are the necessary reactions to scarcity.

Market force

A *market force* is an economic force that is given relatively free rein by society to work through the market.

*Market forces* ration by changing prices, e.g. when there's a shortage, the price goes up.

The Invisible Hand

The *invisible hand* is the price mechanism; the rise and fall of prices that guides our actions in a market

Economic reality is controlled by three forces, which are:

*Economic reality* is controlled by three forces, which are:

1. Economic forces (the invisible hand)

2. Social and cultural forces

3. Political and legal forces

The following is an example of ____________________.

If a college has more men than women, there will be a number of men which cannot get a partner. Men in this category will be "excess supply" men. Theoretically, an "excess supply" man could solve his problem by using money or other resources to pay for a date. However, such a transaction offered would be demeaning to the woman and shameful for the man, so this will not happen.

This is an example of *social and cultural forces*.

The unacceptability of this idea is an example of the complex social and cultural norms that guide and limit our activities. People don't try to buy dates because social forces prevent them from doing so. Thus, social and cultural forces here squash the invisible hand.

The following is an example of ____________________.

Say you decide you want to start making money by delivering mail in your neighborhood. Suddenly you're confronted by a cease and desist notice in the mail, because the USPS has legal exclusive rights to mail delivery.

This is an example of *political and legal forces*.

Economic forces - the desire to make money - led you to want to enter this business. But political and legal forces squashed the invisible hand.

What happens in a society can be seen as a reaction to, and interaction of _______________________.

What happens in a society can be seen as a reaction to, and interaction of *three sets of forces*:

1. economic forces

2. social/cultural forces

3. political/legal forces

Economic model & economic principle

*Economic model* is a framework that places the generalized insights of an economic theory in a more specific contextual setting.

*Economic principle* is a commonly held economic insight stated as a law or principle.

Experimental economics & natural experiments

*Experimental economics* is a branch of economics that studies the economy through controlled laboratory experiments.

When laboratory experiments are not possible, economists look for natural experiments.

*Natural experiments* are naturally occurring events that approximate a controlled experiment where something has changed in one place but has not changed somewhere else.

Theorems vs Precepts

Economic models are less general than theories, but are usually still too general to apply in specific cases. Models lead to theorems.

*Theorems* are propositions that are logically true based on the assumptions in a model. Theorems are combined with knowledge of real-world economic institutions and value judgments, determining the goals for which one is striving, to arrive at policy precepts.

*Precepts* are policy rules that conclude that a particular course of action is preferable.

Models -> Theorems -> Combine theorems, knowledge, value judgments -> Precepts

Invisible Hand Theorem

The *invisible hand theorem* states that a market economy, through the price mechanism, will tend to allocate resources efficiently.

______________ is a shorthand way of telling a story.

*Theory* is a shorthand way of telling a story.

To apply economic theory to reality, you've got to have a sense of __________________.

To apply economic theory to reality, you've got to have a sense of *economic institutions*.

Economic institutions

*Economic institutions* are laws, common practices, and organizations in a society that affect an economy.

Corporations, governments, and cultural norms are all examples of ___________________.

Corporations, governments, and cultural norms are all examples of *economic institutions*.

Economic policies

*Economic policies* are actions (or inaction) taken by government to influence economic actions.

e.g. Should the government restrict mergers between firms? Should it run a budget deficit?

Positive economics

*Positive economics* is the study of what is, and how the economy works.

It explores the pure theory of economics and it discovers agreed-upon empirical regularities - often called empirical facts - e.g. large price fluctuations are usually followed by additional large price fluctuations.

__________________ asks questions such as:

How does the market for Nintendo Wiis work?

How do price restrictions affect market forces?

*Positive economics*

Normative economics

*Normative economics* is the study of what the goals of the economy should be.

__________________ asks questions such as:

What should the distribution of income be?

What should tax policy be designed to achieve?

*Normative economics*

Normative vs Positive Economics

*Normative economics* studies what the goals of the economy should be, while

*Positive economics* studies how the economy works in reality

The art of economics (AKA political economy)

The *art of economics*, AKA the *political economy*, is the application of the knowledge learned in positive economics to achieve the goals one has determined in normative economics.

The art of economics branch is specifically about policy; it is designed to arrive at ___________, or __________ for policy.

The art of economics branch is specifically about policy; it is designed to arrive at *precepts*, or *guides for policy*.

Classify the following topics as primarily macroeconomic or microeconomic:

1. The impact of a tax increase on aggregate output

2. The relationship between two competing firms' pricing behavior

3. A farmer's decision to plant soy or wheat

4. The effect of trade on economic growth

1. The impact of a tax increase on aggregate output - *macroeconomics*

2. The relationship between two competing firms' pricing behavior - *microeconomics*

3. A farmer's decision to plant soy or wheat - *microeconomics*

4. The effect of trade on economic growth - *macroeconomics*

You buy a share of Google for $100 and a share of Apple for $10. The price of each is currently $15. Assuming taxes are not an issues, which would you sell if you need $15?

Since the price of both stocks is now $15, it doesn't matter which stock you sell (assuming no differential capital gains taxation). The price you bought them for doesn't matter; it's a sunk cost. Marginal analysis refers to the future gain, so what you expect to happen to future prices of the stocks - not past prices - should determine which stock you sell.

You've just read the first chapter of a book that has 25 chapters. Your buddy concludes that the opportunity cost of studying that first chapter in the book is about 1/25 of the price you paid for the book, since the chapter is about 1/25th of the book. Is he right?

No, the opportunity cost of reading the chapter of the book is primarily the time you spend reading it. Reading the book prevents you from doing other things. Assuming you've already paid for the book, the original price is no longer part of the opportunity cost; it's a sunk cost.

Your buddy states that market forces are always operative. Is (s)he wrong? Why or why not?

Yes, the buddy is wrong. *Economic forces ARE always operative*, market forces are not.

True or false?

Economists should focus their policy on institutional changes because such policies offer the largest gains.

False.

While institutional changes offer the largest gains, they also have the largest losses. *The policies economists should focus on are those with the largest net gains - benefits minus costs - to society*.

Your study partner is a free market advocate. He suggests that the invisible hand theorem tells us that the government should not interfere with the economy. Do you agree? Why/why not?

He is wrong. *The invisible hand theorem is a positive economics theorem* and *tells us nothing about policy*. To do so would violate Hume's dictum that a "should" can not be derived from an "is".

Determine whether the following statements belong in positive economics, normative economics, or the art of economics:

1. We should support the market because it is efficient.

2. Given certain conditions, the market achieves efficient results.

3. Based on past experience and our understanding of markets, if one wants a reasonably efficient result, markets should probably be relied on.

4. The distribution of income should be left to markets.

5. Markets allocate income according to contributions of factors of production.

1. We should support the market because it is efficient. - *normative economics*

2. Given certain conditions, the market achieves efficient results. - *positive economics*

3. Based on past experience and our understanding of markets, if one wants a reasonably efficient result, markets should probably be relied on. - *the art of economics*

4. The distribution of income should be left to markets. - *normative economics*

5. Markets allocate income according to contributions of factors of production. - *positive economics*

Recall:

*Positive economics* deals with 'what is' in the economy.

*Normative economics* deals with 'what should be' in the economy.

*The art of economics* deals with applying knowledge learned from positive economics to assist in formation of normative economics.

Production possibility table

Production possibility curve (PPC)

Picture: http://imgur.com/a/Tuzdg

A *production possibility table* is a table that lists the trade-offs between two choices.

A *production possibility curve (PPC)* is a curve measuring the maximum combination of outputs that can be obtained from a given number of inputs.

The slope of a production possibility curve (PPC) tells you the trade-off between ____________________ in terms of _________________.

The slope of a production possibility curve (PPC) tells you the trade-off between *the cost of one good* in *terms of another*.

The production possibility curve (PPC) demonstrates that:

1.

2.

The production possibility curve (PPC) demonstrates that:

1. There is a *limit to what you can achieve*, given then existing *institutions, resources, and technology*.

2. *Every choice* you make *has an opportunity cost.* *You can get more of something only by giving up something else.*

An example of the ________________________ of having kids is two cars, a boat, more free time, etc. An example of the _____________________(same) of studying for class A would be study time for class B.

Opportunity cost

Sunk costs

Costs that have already been incurred and cannot be recovered.

Marginal costs

The additional costs to you over and above the costs you have already incurred. All costs minus the sunk costs.

Comparative advantage

Some resources have *comparative advantage*, meaning they are better suited to the production of one good than to the production of another.

Suppose resource X has usefulness in the production of both cell phones and paper towels. However, the amount of resource X that can be used to create 50 rolls of paper towels can also be used to create 10,000 cell phones. This resource has __________________ in the production of cell phones.

Comparative advantage

T/F

As we produce more and more of a good, we must use resources whose comparative advantage is in the production of another good.

True

This causes a decrease in the production of the second good, as well.

Production possibility curve (PPC):

i. Points *on* the PPC line are __________________

ii. Points *inside* the PPC line are __________________

iii. Points *outside* the PPC line are __________________

i. Points *on* the PPC line are *efficient*. (A,B,C)

ii. Points *inside* the PPC line are *inefficient*.(D)

iii. Points *outside* the PPC line are *unattainable* (too efficient to be real), given existing technology, resources, and labor force. (E)

The two types of Technological Change in the Production Possibility Curve (PPC) both shift the curve ______________. The two types are:

1. ________________, which indicates __________________

2. ________________, which indicates __________________

The two types of Technological Change in the Production Possibility Curve (PPC) both shift the curve *outwards*. The two types are:

1. *Neutral Technological Change*, which indicates more efficiency in both outputs.

2. *Biased Technological Change*, which indicates more efficiency in only one output.

See diagram: http://imgur.com/a/tnH1o

Productive efficiency

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

Adam Smith argued that it is humankind's proclivity to ___________ that leads to individuals using their comparative advantage.

Adam Smith argued that it is humankind's proclivity to *trade* that leads to individuals using their comparative advantage.

Laissez-faire

An economic policy of leaving coordination of individual's actions to the market.

In French, "let events take their course; leave things alone".

T/F

Laissez-faire is a theorem in economics.

False.

*Laissez-faire is a precept*, not a theorem, because it extends the implications of a model to reality and draws conclusions about the real world.

Specialization and trade create ___________ that make all ________________.

Specialization and trade create *gains* that make all *better off*.

Globalization

Globalization is the increasing integration of economies, cultures, and institutions across the world.

Two effects of globalization on a firm

1. The *positive* effect of globalization on a firm is that the larger global economy allows for much larger gains when successful.

2. The *negative* effect of globalization on a firm is the increased number of competitors of the firm.

Essentially, globalization is just another name for increased __________________.

Essentially, globalization is just another name for *increased specialization*.

The Law of One Price

The Law of One Price states that the wages of workers in one country will not differ significantly from the wages of (equal) works in another institutionally similar country.

The United States has been living better than it could have because of _________________ and _________________.

The United States has been living better than it otherwise could have because of *trade* and *outsourcing*.

More specifically, because of *trade deficits* and *IOUs* to other countries, promising future payments.

T/F

The United States imports more than it exports.

True

The US has been running trade deficits (importing more than it is exporting) for quite a while.

What is nicknamed "the dismal science"?

*Economics* is nicknamed "the dismal science".

If no resource had a comparative advantage in the production of any good, what would the shape of the production possibility curve be? Why?

If no resource had a comparative advantage in the production of any good, the PPC would be a straight line connecting the points of maximum production of each product.

Think: the graph of y=(-x)

Your firm is establishing a trucking business in Saudi Arabia, and the managers have noticed that women get paid significantly less than men there. They suggest that hiring women would thus be more efficient than hiring men. How should you respond?

Remind them of the importance of cultural forces - women in Saudi Arabia are not allowed to drive.

T/F

All jobs in the US will eventually be outsourced abroad.

False.

By definition, if one country has comparative advantage in the production of a certain good, then another country will have comparative advantage in the production in the other set. Jobs will be needed to support this production. Additionally, many jobs cannot be moved abroad effectively because they require physical proximity to the point of sale.

The Law of Demand

The Law of Demand states that:

*Quantity demanded rises as price falls, assuming other things constant*.

Note: This only applies when all other factors remain constant. E.g. if over the next 5 years the price of cars and the number of cars purchased rise, this would seem to contradict the law of demand. However, in this scenario, household income averages have increased, meaning other things did not remain constant.

This law is fundamental to the invisible hand's ability to coordinate individuals' desires; as prices change, people change how much they're willing to buy.

Demand Curve

A demand curve is the graphical representation of the relationship between price and quantity demanded. As price goes down, the demand goes up, and vice versa.

Movement along a demand curve vs. Shift in demand

A *change in the price* of a product *causes a change in quantity demanded*, which is graphically represented by *movement along a demand curve*.

change in PRICE -> change in QUANTITY DEMANDED -> MOVEMENT along DEMAND CURVE

A change in *anything other than price* that *affects demand* changes the *entire demand curve*, which is graphically represented by a *shift in demand*.

change in ANYTHING but PRICE -> change in ENTIRE DEMAND CURVE -> SHIFT in DEMAND

Shift factor

Any factor related to a product *other than price* that will *cause a shift in demand*.

Five shift factors of demand:

Five *shift factors* of *demand* include:

1. *P*rices of other goods

2. *T*astes

3. *E*xpectations

4. *S*ociety's income

5. *T*axes and *s*ubsidies

ACRONYM for five SHIFT FACTORS of DEMAND:

*P-TESTS*

The Law of Supply

The Law of Supply states:

*Quantity supplied rises as price rises, other things constant*

The Law of Supply is based on a firm's ability to switch from producing one good to another - that is, to *substitute* - and the *expectation* (profit) from doing so.

Supply Curve

A graphical representation of the law of supply; tells us that the quantity supplied varies directly (in the same direction) with the price.

Four shift factors of supply:

The four *shift factors* of *supply* are:

1. Price of inputs

2. Expectations

3. Technology

4. Taxes and subsidies

Remember acronym for *SUPPLY* shift factors:

*PETTS*

The law of supply is based on two phenomena:

The law of supply is based on two phenomena:

1. *At higher prices, existing suppliers supply more*.

2. *At higher prices, new suppliers enter the market*.

Equilibrium, equilibrium price, equilibrium quantity

*Equilibrium* is a concept in which opposing dynamic forces cancel each other out.

*Equilibrium price* is the price in which the quantity supplied equals the quantity demanded.

*Equilibrium quantity* is the amount bought and sold at the equilibrium price.

T/F

Excess supply and excess demand both cause movement toward equilibrium.

True.

The fallacy of composition

The fallacy of composition is the false assumption that what is true for a part will also be true for the whole.

Explain the effect of each of the following on the demand curve for new computers:

1. The price of computers falls by 30 percent.

2. Total income in the economy rises.

1. This will cause a downward-right *movement along the demand curve*, as the price which increases demand as well as the quantity of new computers.

2. This will cause an *outward-right shift* of the demand curve, as income in the economy is a shift factor and increase in income in the economy will increase demand.

T/F

When determining the effect of a shift factor on price and quantity, markets that make up smaller percentages of the total economy have higher possibility of other things remaining constant.

True.

Factors that affect larger markets will have ripple effects that must be taken into account in any analysis.

The cross-price elasticity for complements is ___________.

The cross-price elasticity for substitutes is ___________.

The cross-price elasticity for *complements* is *less than zero (< 0)*.

The cross-price elasticity for *substitutes* is *greater than zero (> 0)*.

Autarky trade

Autarky trade is a policy of *no trade*; one in which production = consumption.

Normal vs inferior goods

*Normal goods* are goods that the individual wants; e.g. steak, nice car, computer, etc.

*Inferior goods* are goods that the individual uses because they have to, e.g. public transit. As individual's *income rises*, the individual *uses fewer inferior goods* - not gonna use public transit if you can afford a car.

Substitutes

*When the price of a product rises, the demand for its substitute whose price has remained the same will increase.*

A product that can replace another in a buyer's mind based on the price of the other product. E.g. if you go to the store to buy jeans, but jeans cost $40 at the store and khaki pants cost $25, you may go with the khaki pants instead of the jeans. Khaki pants would be the substitute.

Complements

*When the price of a good declines, the demand for it complement rises.*

Two products are complements if the demand/price for product A affects the demand for product B. E.g. if the price of movie theater tickets drops significantly, more people would go. This would increase sales of popcorn, thus movie tickets and popcorn are complements.

_____________ goods cost less and thrive when consumer income is lower.

*Inferior* goods cost less and thrive when consumer income is lower.

T/F

No shift factor influences how much of a good people buy as consistently as price.

True.