Principles of Microeconomics Final Exam

Economics

The study of choices or of how society manages these scarce resources

Scarcity

Limited resources - humans have unlimited needs and wants, but we have limited resources, which leads to scarcity. Because of limited resources, we have trade-offs.

3 Economic Ideas:

1. People are rational - people who systematically and purposefully do the best they can to achieve their objectives

2. People respond to incentives - incentives induce people to act

3. Optimal decisions are made at the margin

Marginal

Small, incremental changes (it’s not all or nothing)

Trade-offs

Because of scarcity, producing/consuming more of one good means producing/consuming less of another (the general decision)

Opportunity Cost

Whatever must be given up to obtain some item (the specific cost); it is the result of trade-offs

Optimal decision occurs when:

Marginal Benefit = Marginal Cost

Market Economy

Decisions of households and firms interact in markets and allocate resources with little or no government interference

Centrally Planned Economy

The government decides how economic resources will be allocated

Mixed Economy

Most economic decisions result from the interaction of buyers and sellers, but the government plays a significant role in the allocation of resources

Efficiency

Achieving the maximum benefit from a society’s scarce resources

Production Possibilities Frontier (PPF)

A curve showing the maximum attainable combinations of two goods that can be produced with available resources and current technology

Inputs in production

Labor, Natural Resources, Entrepreneurial Ability, Technology, Physical Capital, Human Capital

Output

Final product: goods and services

Economic Growth

Ability of an economy to increase production of goods and services

Law of Increasing Marginal Opportunity Cost

Opportunity cost of production in a good rises as society produces more of it

Autarky

Against trade

How do we create gains in society?

Through specialization and trade

Absolute Advantage

The ability of one producer to make more than another producer with the same quantity of resources

Comparative Advantage

The ability of a firm/individual/country/etc. to produce a good or service at a lower opportunity cost than another

Competitive Market

Multiple buyers and sellers that each has a negligible impact on the market price

Quantity Demanded

Amount of a goof or service that a consumer is willing and able to purchase at a given price

Law of Demand (given Ceteris Paribus)

1. Quantity demanded falls when prices rise

2. Quantity demanded increases when prices fall

Demand

The relationship I have with price and quantity

Income Effect

Change in quantity demanded of a good that results from the effect on the change of a good’s price on the consumer’s purchasing power

Substitution Power

Change in quantity demanded due to a change in price, making other goods more or less expensive relative to other goods that are substitutes

Changes in Income (Normal Good and Inferior Good)

Normal Good: Increase in Income - Increase in Vacations

Inferior Good: Increase in Income - Decrease in Ramen

Normal Good

The more money you make, the more you buy more of