Macro: Midterm 1

Introduction + Demand and Supply

economics

the study of how individuals and organizations allocate scarce resources among alternative uses to satisfy unlimited human wants and needs

economic good

goods with scarcity, have positive price (e.g. cars)

free good

goods that are abundant, have zero price (e.g. oxygen)

4 factors of production

land

labor: time and physical/mental effort of humans in production process

capital: physical objects used for production (e.g. tools, machinery)

entreprenuership: willingness to take risks to combine resources in new ways, invent products, goods, or services (increased risk = increased S.O.L)

economic rent

a return to a factor that is fixed in production (i.e. wages to workers)

microeconomics

the study of individual economic behaviors and markets (O.C., PPC, PCA)

macroeconomics

the study of aggregate (total) economic behaviors and the economy on a national scale (GDP, unemployment, inflation, interest rates, exchange rates, money supply)

positive statements

can be backed up by evidence; concerned with what is (“descriptive”)

normative statements

an opinion that can be debated; concerned with what ought to be (“prescriptive”)

3 main assumptions of economic models

1. rational self-interest (decisions benefit the decision maker)

2. more is better (more income or countries w/ more GDP are better off as parties)

3. “ceteris paribus” (everything else stays constant)

opportunity cost

the benefit forgone from not choosing the next best alternative

production possibility curve (PPC)

a model that shows the maximum combinations of 2 goods that can be produced given a certain quantity of resources and state of technology

how to calculate OC

find slope of PPC

the law of increasing cost

as production of a good is increased the OC of additional units will also increase as long as resources used in production are specialized

the principle of comparative advantage (PCA)

each party to a trade should specialize in the production of that good in which it is relatively more efficient (or lower OC- meaning the value of the goods gained > value of goods lost)

absolute advantage

when one party has a lower resource cost than another

comparative advantage

when one party has a lower OC than another

terms of trade

the rate at which both parties would be willing to make a trade; terms depend on OC

consumption possibility curve (CPC)

shows the maximum combinations (of 2 goods) that can be consumed through trade 

*if CPC lies above PPC, trade = beneficial

free trade

an absence of trade barriers (e.g., tariffs or quotas)

fair trade

a trade between 2 countries with goal of social and economic justice

arguments against free trade

1. concerns about depletion (environmental degradation, child labor, sweat shops, etc.)

2. protect domestic jobs

3. loss of national sovereignty

arguments for free trade

1. comparative advantage (specialization)

2. lower consumer prices

3. greater variety of products

demand curve

a model that shows the quantity of output consumers in a market are willing and able to buy at different prices; ceteris paribus

supply curve

a model that shows the quantity of output that producers in a market are willing and able to sell at different prices; ceteris paribus

market

a collection of buyers and sellers where an exchange takes place

types of allocation mechanisms

1. government edict- merit based criteria, arbitrary criteria, egalitarianism (= share)

2. lottery- random

3. first come, first serve “queuing”

4. markets (i.e., biggest bidder)

law of demand

there is an inverse relationship between the price of a good and the quantity demanded of that good; ceteris paribus

determinants of demand

1. price of good x (Px)

2. prices of substitutes (Py)

3. income (I)

4. taste and expectations (T)

5. population (Pop)

law of supply

there is a direct relationship between the price of a good and the quantity supplied of that good; ceteris paribus

determinants of supply

1. price of good x (Px)

2. resource prices (Pr)

3. technology (Tech.)

4. business expectations (Exp.)

5. # of firms (N)

6. price of related goods (Pz)

Adam Smith

Wrote The Wealth of Nations (1776)

• self-interest, invisible hand, division of labor

traditional economies

economic decisions are based on what was done in the past

command + control (central planning) economies

economic decisions are made by gov. bureaucrats

market economy

economic decisions are decentralized through the price mechanism

communism

ruled by one party

socialism

means of production are owned by the state

capitalism

means of production are owned privately

democracy

ruled by the people

negative externalities

costs are imposed on others external to the market; because producers do not bear all the costs of production, too much is produced (i.e., pollution)

positive externalities

benefits are received by others external to the market; because consumers do not received all the benefits of consumption, too little is produced (i.e., education, vaccines)