unit 2 test macro

1. Costs and Benefits

**Self

Interest & Net Benefits**

Opportunity Cost

The cost of a decision — specifically, the value of the next best alternative given up. It is a marginal cost because it reflects the additional cost of choosing one option over another. Every decision has an opportunity cost, even if no money changes hands.

Sunk Cost

A cost that has already been paid (or must be paid regardless of what you decide next). Because it can't be recovered, it should not factor into future decisions — even though people are often tempted to let it influence them. ("Don't cry over spilled milk" = ignore sunk costs when deciding what to do next.)

Positive Economics

Objective analysis that describes the costs and benefits of a decision without value judgments. Example: "Raising the minimum wage will increase teen unemployment by X%."

Normative Economics

Analysis that includes value judgments about what should happen. Example: "The government should raise the minimum wage."

2. The Production Possibilities Frontier (PPF)

Production Possibilities Frontier (PPF)

A graph showing the maximum combinations of two goods an economy can efficiently produce with its existing resources and technology.

PPF and Opportunity Cost

Moving along the curve to produce more of one good means giving up some of the other good — that trade

Law of Increasing Opportunity Cost

As you produce more of one good, the opportunity cost of producing additional units rises, because resources aren't equally suited to producing both goods. This is why the PPF is usually bowed outward (concave).

Efficient Point (on the curve)

A point on the PPF itself, representing full and efficient use of available resources.

Inefficient Point (inside the curve)

A point inside the PPF, representing underused or inefficient use of resources (e.g., unemployment).

Unattainable Point (outside the curve)

A point outside the PPF that cannot currently be produced with existing resources and technology.

Outward Shift of the PPF

Economic growth caused by more or better resources or improved technology.

Inward Shift of the PPF

A loss of productive capacity caused by resource loss (disaster, war, etc.).

3. Absolute vs. Comparative Advantage

Absolute Advantage

The ability to produce a good or service using fewer resources (or more output with the same resources) than another producer.

Comparative Advantage

The ability to produce a good or service at a lower opportunity cost than another producer.

Specialization

When individuals or nations focus production on the good(s) they have a comparative advantage in, then trade for other goods and services (usually using money as the medium of exchange).

Gains from Trade

The extra total output/goods available to both parties when trade is based on comparative advantage rather than each party trying to produce everything themselves.

David Ricardo

The economist credited with originating the theory of comparative advantage.

International Trade (Positive View)

Free trade based on comparative advantage leads to more efficient global resource use and greater total output.

International Trade (Normative View)

The view that even though most economists favor free trade overall, it can still damage local communities, industries, or cultures — a real cost to weigh against the benefits.

Demand

The relationship between price and the quantity of a good or service consumers are willing and able to buy, usually shown as a downward

Law of Demand

As price increases, quantity demanded decreases (and vice versa), ceteris paribus (all else equal).

Change in Quantity Demanded

A movement along the existing demand curve, caused only by a change in the good's own price.

Change in Demand

A shift of the entire demand curve, caused by a factor other than price — income, tastes, prices of related goods, number of consumers, or future expectations. A shift right = increase in demand; a shift left = decrease in demand.

Price Elasticity of Demand

A measure of how sensitive quantity demanded is to a change in price. Elastic = consumers very sensitive to price changes; inelastic = consumers not very sensitive to price changes.

5. Supply

Supply

The relationship between price and the quantity of a good or service firms are willing and able to offer for sale, usually shown as an upward

Law of Supply

As price increases, quantity supplied increases (and vice versa), ceteris paribus.

Change in Quantity Supplied

A movement along the existing supply curve, caused only by a change in the good's own price.

Change in Supply

A shift of the entire supply curve, caused by a factor other than price — such as a change in production/input costs. A shift right = increase in supply; a shift left = decrease in supply.

Price Elasticity of Supply

A measure of how sensitive quantity supplied is to a change in price. Elastic = suppliers respond a lot to price changes; inelastic = suppliers respond very little.

6. Market Equilibrium

Equilibrium

The price and quantity at which quantity demanded equals quantity supplied; no natural market forces push the price up or down once here.

Equilibrium Price

The market

Equilibrium Quantity

The amount bought and sold at the equilibrium price.

Effect of a Demand Increase

Raises both equilibrium price and equilibrium quantity.

Effect of a Demand Decrease

Lowers both equilibrium price and equilibrium quantity.

Effect of a Supply Increase

Lowers equilibrium price and raises equilibrium quantity.

Effect of a Supply Decrease

Raises equilibrium price and lowers equilibrium quantity.

Simultaneous Shifts (Same Direction)

When demand and supply both increase or both decrease, the effect on equilibrium price is indeterminate, but the effect on quantity is known.

Simultaneous Shifts (Opposite Directions)

When demand and supply shift in opposite directions, the effect on equilibrium quantity is indeterminate, but the effect on price is known.

7. Government Price Controls

Price Ceiling

A legal maximum price. When set below the equilibrium price, it creates a shortage (quantity demanded exceeds quantity supplied).