ECON 201 Exam 1 Study Guide

What is the basic problem of economics?

The basic problem is scarcity: people have unlimited wants and needs but resources are limited, so choices must be made.

What is scarcity?

Scarcity exists when there are limited resources available to satisfy unlimited wants and needs.

Why does scarcity create the need for choices?

Because resources are limited, using resources for one purpose means they cannot be used for another purpose.

What is a trade-off?

A trade-off is giving up one thing to get something else.

What is opportunity cost?

The opportunity cost of a choice is the value of the next-best alternative that is given up.

How is opportunity cost different from out-of-pocket cost?

Opportunity cost includes the value of the next-best alternative, while out-of-pocket cost refers specifically to money spent.

What is an incentive?

An incentive is something that encourages or discourages a person to take a particular action.

What is a positive incentive?

A positive incentive rewards or encourages a behavior.

What is a negative incentive?

A negative incentive discourages a behavior by imposing a cost or penalty.

What is marginal thinking?

Marginal thinking compares the additional benefit of an action with its additional cost.

What is the difference between microeconomics and macroeconomics?

Microeconomics studies individual people, firms, and markets; macroeconomics studies the economy as a whole.

Give an example of a macroeconomic question.

What is the inflation rate, unemployment rate, or rate of economic growth?

Give an example of a microeconomic question.

What determines the salaries of professional soccer players or how many customers a restaurant should serve?

What is a positive statement?

A statement that can be tested as true or false using evidence.

What is a normative statement?

A statement involving a value judgment about what should or ought to be.

What is the scientific method in economics?

Economists develop theories or hypotheses and use experiments and real-world data to test them.

What is a model in economics?

A simplified representation of reality used to understand and analyze economic relationships.

What is comparative advantage?

A person or country has comparative advantage in producing a good when it can produce that good at a lower opportunity cost than another producer.

What determines comparative advantage?

Opportunity cost determines comparative advantage.

What does it mean if someone has a lower opportunity cost of producing a good?

That person has a comparative advantage in producing the good.

Why can specialization and trade benefit both parties?

Each party can specialize in what it produces at lower opportunity cost and trade for other goods, allowing both to gain.

What is a competitive market?

A market in which each buyer and seller is small relative to the overall market, so no individual buyer or seller can influence the market price.

What is market power?

The ability of a buyer or seller to influence the market price.

What happens when a market becomes less competitive?

Firms generally have more market power and may be able to influence prices.

What is a monopoly?

A market with a single seller that has substantial market power.

What is the law of demand?

Holding everything else constant, as the price of a good rises, the quantity demanded falls; as price falls, quantity demanded rises.

What is the law of supply?

Holding everything else constant, as the price of a good rises, the quantity supplied rises.

What is a demand curve?

A curve showing the relationship between the price of a good and the quantity demanded, holding other factors constant.

What is a supply curve?

A curve showing the relationship between the price of a good and the quantity supplied, holding other factors constant.

What causes a movement along the demand curve?

A change in the good's own price.

What causes a movement along the supply curve?

A change in the good's own price.

What causes a shift in demand?

A change in a factor other than the good's own price that affects buyers' willingness or ability to purchase.

What causes a shift in supply?

A change in a factor other than the good's own price that affects sellers' willingness or ability to produce.

What happens to demand for a normal good when income rises?

Demand increases and the demand curve shifts right.

What happens to demand for a normal good when income falls?

Demand decreases and the demand curve shifts left.

What is an inferior good?

A good for which demand decreases when income rises and increases when income falls.

What happens to demand for an inferior good when income falls?

Demand increases and the demand curve shifts right.

What are substitute goods?

Goods that can be used in place of one another.

What happens to demand for a substitute when the price of another good falls?

Demand for the substitute decreases.

What are complementary goods?

Goods that are typically consumed together.

What happens to demand for a complement when the price of another good rises?

Demand for the complement decreases.

What happens when more firms enter a market?

Market supply increases, shifting the supply curve to the right.

What happens when firms leave a market?

Market supply decreases, shifting the supply curve to the left.

How can improved technology affect supply?

Improved technology can lower production costs or increase productivity, shifting supply to the right.

What happens to supply when production becomes cheaper?

Supply increases and the supply curve shifts right.

What happens to supply when production becomes more expensive?

Supply decreases and the supply curve shifts left.

What is equilibrium price?

The price at which quantity demanded equals quantity supplied.

What is equilibrium quantity?

The quantity bought and sold at the equilibrium price.

What is a shortage?

A situation in which quantity demanded is greater than quantity supplied at a given price.

What is a surplus?

A situation in which quantity supplied is greater than quantity demanded at a given price.

What happens to price when there is a surplus?

There is downward pressure on price because sellers have more of the good than buyers want at that price.

What happens to price when there is a shortage?

There is upward pressure on price because buyers want more than sellers are offering at that price.

What is ceteris paribus?

Latin for “all else equal”; it means holding other relevant factors constant.

What happens to the equilibrium price of a substitute if the price of the original good falls?

Demand for the substitute decreases, shifting its demand curve left and lowering its equilibrium price, ceteris paribus.

What happens when supply shifts right?

Equilibrium quantity increases and equilibrium price generally decreases.

What happens when supply shifts left?

Equilibrium quantity decreases and equilibrium price generally increases.

What happens when demand shifts right?

Equilibrium quantity increases and equilibrium price generally increases.

What happens when demand shifts left?

Equilibrium quantity decreases and equilibrium price generally decreases.

What is GDP?

Gross domestic product is the market value of final goods and services produced within a country during a given period.

What does “domestic” mean in GDP?

Production occurs within the country's borders, regardless of who owns the resources or firm.

What does “final goods and services” mean?

They are goods and services sold to their final users rather than being used as inputs into another product.

Why are intermediate goods excluded from GDP?

To avoid double counting the value of goods that are incorporated into final products.

How does GDP count a product moving through several stages of production?

GDP counts the value of the final product rather than adding the values of all intermediate transactions.

What is the expenditure approach to GDP?

GDP = Consumption + Investment + Government Purchases + Net Exports, or Y = C + I + G + NX.

What is consumption (C)?

Spending by households on final goods and services.

What is investment (I) in GDP accounting?

Business spending on capital goods, new residential construction, and changes in inventories.

What are inventory changes in GDP?

Unsold goods produced during the period are counted as investment because they add to inventories.

What are government purchases (G)?

Government spending on currently produced goods and services.

Are transfer payments included in government purchases?

No. Transfer payments such as Social Security and unemployment benefits are not payments for currently produced goods or services.

Are military wages included in government purchases?

Yes. Wages paid to military personnel are payments for government-provided services.

What are net exports (NX)?

Exports minus imports: NX = Exports − Imports.

What happens to GDP when a previously owned good is resold?

The resale itself is generally not included in current GDP because the good was produced in an earlier period.

What happens to GDP when a used video game is sold to a store?

The transaction itself does not count as current GDP because the video game was produced in a previous year.

What is real GDP?

GDP measured using constant prices, allowing changes in production to be separated from changes in prices.

What is nominal GDP?

GDP measured using current prices.

Why is real GDP useful?

It allows economists to measure changes in the quantity of production without confusing them with changes in prices.

What is the GDP deflator?

A price index measuring the price level of goods and services included in GDP.

GDP deflator formula

GDP Deflator = (Nominal GDP ÷ Real GDP) × 100

Real GDP formula

Real GDP = (Nominal GDP ÷ GDP Deflator) × 100

Nominal GDP formula

Nominal GDP = (Real GDP × GDP Deflator) ÷ 100

What does a GDP deflator of 100 mean?

The current price level is equal to the base-year price level.

What is inflation?

A sustained increase in the overall price level of goods and services.

Inflation rate formula

Inflation Rate = [(New Price Level − Old Price Level) ÷ Old Price Level] × 100

If the price level rises from 120 to 122.4, what is the inflation rate?

2.0%, because (122.4 − 120) ÷ 120 × 100 = 2.0%.

What is average living standard in the context of the exam?

Real GDP per person, or real GDP divided by population.

Real GDP per capita formula

Real GDP per capita = Real GDP ÷ Population.

If Country A has real GDP of $150,000 and population of 200, what is its real GDP per capita?

$750 per person.

If Country B has real GDP of $120,000 and population of 150, what is its real GDP per capita?

$800 per person.

If Country C has real GDP of $120,000 and population of 200, what is its real GDP per capita?

$600 per person.

If Country D has real GDP of $100,000 and population of 100, what is its real GDP per capita?

$1,000 per person.

If Country E has real GDP of $75,000 and population of 100, what is its real GDP per capita?

$750 per person.

Which country in the exam data has the lowest real GDP per capita?

Country C, with $600 per person.

Which country in the exam data has the highest real GDP per capita?

Country D, with $1,000 per person.

What is an economic expansion?

A period in which economic activity and output are increasing.

What is an economic contraction?

A period in which economic activity and output are decreasing.

What is the business cycle?

Fluctuations in economic activity around the economy's long-run growth trend, including expansions and contractions.

Who is considered employed?

A person who is working, including people working part-time.

Who is considered unemployed?

A person without a job who is available for work and actively searching for a job.

Who is not in the labor force?

A person who is neither employed nor unemployed, such as someone who is not working and not actively seeking work.

Is a full-time student working part-time officially unemployed?

No. A person who is working is classified as employed, even if working part-time.