AP micro - unit 1 vocab

Economics

Economics

the science of scarcity

Scarcity

we have unlimited wants but limited resources

What is economics the study of?

the study of choices

Textbook definition of economics

Social science concerned with the efficient use of scarce resources to achieve maximum satisfaction of economic wants

Microeconomics

Study of small economic units such as individuals, firms, and industries (ex: supply and demand in specific markets, production costs, labor markets, etc.)

Macroeconomics

Study of the large economy as a whole or economic aggregates (ex: economic growth, government spending, inflation, unemployment, international trade etc.)

How is economics used

Economists use the scientific method to make generalizations and abstractions to develop theories (theoretical economics)

Policy economics

These theories that they developed are then applied to fix problems or meet economics goals

Positive Statements

Based on facts/Avoids value judgements (what is)

EX of Positive Statements

gallon of gas at mobil is 3.70

Normative Statements

Includes value judgements (what ought to be/what people wish/what people think)

EX of Normative Statements

gas price are too high

5 Key economic assumptions

1. Society has unlimited wants and limited resources (scarcity)

2. Due to scarcity, choices must be made. Every choice has a cost (a trade-off)

3. Everyone’s goal is to make choices that maximize their satisfaction. Everyone acts in their own “self-interest”

4. Everyone makes decisions by comparing the marginal costs and marginal benefits of every choice

5. Real-life situations can be explained and analyzed through simplified models and graphs

What does marginal mean in economics

additional

marginal (additional) analysis:

making decisions based on increments (thinking on the margin)

What will you do when the marginal benefit is greater than the marginal cost?

You will continue to do something as long as the marginal benefit is greater than the marginal cost

what does ceteris paribus mean?

Hold everything else constant

Trade-offs:

ALL the alternatives that we give up when we make a choice

Opportunity Cost:

most desirable alternative given up when you make a choice

Definition of Utility in economics:

Satisfaction/happiness

definition of allocate in economics:

Distribute

What is price?

Amount buyer (or consumer) pays

What is cost?

Amount seller pays to produce a good

Investment meaning

the money spent by BUSINESSES to improve their production

What are consumer goods?

created for direct consumption (example: pizza) - economy depended on one good is bad

What are capital goods?

created for indirect consumption (oven, blenders, knives, etc)

Land (four factors of production):

All natural resources that are used to produce goods and services (Ex: water, sun, plants, animals)

Labor (four factors of production):

Any effort a person devotes to a task for which that person is paid (Ex: manual laborers, lawyers, doctors, teachers, waiters, etc.)

Physical Capital (four factors of production):

Any human-made resource that is used to create other goods and services ( Ex: tools, tractors, machinery, buildings, factories, etc.)

Human Capital (four factors of production):

Any skills or knowledge gained by a worker through education and experience

Entrepreneurship (four factors of production):

ambitious leaders that combine the other factors of production to create goods and services

What do Entrepreneurs do?

Entrepreneurs:

1. Take The Initiative

2. Innovate

3. Act as the Risk Bearers

So they can obtain Profit_.

How to calculate profits?

Revenue - Costs

What are the three questions every society must answer?

What do the answers to these questions determine?

1. What goods and services should be produced?

2. How should these goods and services be produced?

3. Who consumes these goods and services?

The way these questions are answered determines the economic system.

What is an economic system?

An economic system is the method used by a society to produce and distribute goods and services.

What are the three economic systems?

1. Centrally-Planned (Command) Economy

2. Free Market Economy

3. Mixed Economy

What does the government do in a centrally-planned (communist)?

1. owns all the resources

2. answers the three economic questions

Why do centrally planned economies face problems of poor-quality goods, shortages, and unhappy citizens?

There is little incentive to work harder and central planners have a hard time predicting preferences.

What is GOOD about Communism?

1. Low unemployment - everyone has a job

2. Great Job Security -  the government doesn’t go out of business

3. Less income inequality

4. “Free” Health Care

What is BAD about communism?

1. No incentive to work harder

2. No incentive to innovate or come up with good ideas

3. No Competition keeps quality of goods poor.

4. Corrupt leaders

5. Few individual freedoms

Characteristics of a Free Market (Capitalism):

1. Little government involvement in the economy. (Laissez Faire = Let it be)

2. Individuals OWN resources and answer the three economic questions.

3. The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently.

4. Wide variety of goods available to consumers.

5. Competition and Self-Interest work together to regulate the economy (keep prices down and quality up).

Example of how the free market regulates itself:

If consumers want smartphones and only one company is making them…

• Other businesses have the INCENTIVE to start making smartphones to earn PROFIT.

• This leads to more COMPETITION….

• Which means lower prices, better quality, and more product variety.

• We produce the goods and services that society wants because “resources follow profits”.

The End Result: Most efficient production of the goods that consumers want, produced at the lowest prices and the highest quality.

Example of why communism failed:

If consumers want smartphones and only one company is making them…

• Other businesses CANNOT start making computers.

• There is NO COMPETITION….

• Which means higher prices, lower quality, and less product variety.

• More phones will not be made until the government decides to create a new factory.

The End Result: There is a shortage of goods that consumers want, produced at the highest prices and the lowest quality.

How do producers and consumers act in a capitalist society?

Producers and consumers act in their own self-interest and make adjustments automatically

The Invisible Hand

The concept that society’s goals will be met as individuals seek their own self-interest

EX of The Invisible Hand:

Society wants fuel efficient cars…

• Profit seeking producers will make more.

• Competition between firms results in low prices, high quality, and greater efficiency.

• The government doesn’t need to get involved since the needs of society are automatically met.

Competition and self-interest act as an invisible hand that regulates the free market.

What is a Mixed Economy?

A system with free markets but also some government intervention.

(Almost all countries, including the US, have mixed economies)

Does Productivity create Wealth?

Yes, countries with free markets, property rights, and The Rule of Law, have historically seen greater economic growth because they are more productive

What do we use economic models for?

Step 1: Explain concept in words

Step 2: Use numbers as examples

Step 3: Generate graphs from numbers

Step 4: Make generalizations using graph

What is a production possibilities curve?

A production possibilities curve (or frontier) is a model that shows alternative ways that an economy can use its scarce resources

What does a production possibilities curve demonstrate?

This model graphically demonstrates scarcity, trade-offs, opportunity costs, and efficiency

4 Key Assumptions of a production possibilities curve:

1. Only two goods can be produced

2. Full employment of resources

3. Fixed Resources (Ceteris Paribus)

4. Fixed Technology

What does each point on the Production “Possibilities” Table represent?

Each point represents a specific combination of goods that can be produced given full employment of resources.

What does it mean if the point is inside the graph?

It is inefficient/unemployment

What does it mean if the point is on the graph?

It is efficient

What does it mean if the point is outside the graph?

Impossible/unattainable (given current resources)

Constant Opportunity Cost

Resources are easily adaptable for producing either good

How does a Constant Opportunity Cost graph look like?

Result is a straight line PPC (not common)

Law of Increasing Opportunity Cost and why

As you produce more of any good, the opportunity cost (forgone production of another good) will increase because Resources are NOT easily adaptable to producing both goods.

How does a Law of Increasing Opportunity Cost graph look like

Result is a bowed out (Concave) PPC

Productive Efficiency

1. Products are being produced in the least costly way.

2. This is any point ON the Production Possibilities Curve

Allocative Efficiency

• The products being produced are the ones most desired by society.

• This optimal point on the PPC depends on the desires of society

3 Shifters of the PPC

1. Change in resource quantity or quality

2. Change in Technology

3. Change in Trade

Why do people trade?

it is mutually beneficial and are able to get things you don’t produce yourself

What does more access to trade mean?

It means more choices and a higher standard of living

What would life be like if cities couldn’t trade with cities or states couldn’t trade with states?

Limiting trade would reduce people’s choices and make people worse off

What is specialization?

country only making one thing they are good at one thing

What does Per Unit Cost equal to?

Opportunity cost/units gained

Assume it costs you $50 to produce 5 t-shirts. What is your PER UNIT cost for each shirt?

$10 per shirt

What is your PER UNIT OPPORTUNITY COST for each shirt in terms of hats given up? (Instead of producing 5 shirts you could have made 10 hats)

1 shirt costs 2 hats

What is your PER UNIT OPPORTUNITY COST for each hat in terms of shirts given up? (Instead of producing 5 shirts you could have made 10 hats)

1 hat costs half a shirt

Absolute Advantage

The producer that can produce the most output OR requires the least amount of inputs (resources)

EX: Papa John has an absolute advantage in pizzas because he can produce 100 and Ronald can only make 20.

Comparative Advantage

The producer with the lowest opportunity cost

EX: Ex: Ronald has a comparative advantage in burgers because he has a lowest PER UNIT opportunity cost.

How to do Output Questions

OOO (Output: Other goes Over)

How to do Input Questions

IOU (Input: Other goes Under)

What does Inside the Curve mean?

Inefficient/unemployment

What would happen if technology improves in pizza oven in a society where they produce pizza and computers

the production of computers would stay the same but the production of pizza would increase

what if there is new computer making technology in a society where they produce pizza and computers

Increase in production of computers but pizza stays the same

What if there is a decrease in the demand for pizza in a society where they produce pizza and computers

The Curve doesn’t shift! A change in demand doesn’t shift the curve

(If you see demand, it’s movement among the curve)

What if madcow kills 85% of the population of cows in a society where they produce pizza and computers

A shift inward only for Pizza

what if there was a Destruction of power plants in a society where they produce capital goods and consumer goods?

decrease in resources and decrease in production

What if there was faster computer hardware in a society where they produce capital and consumer goods?

Quality of a resource improves shifting the curve outward

what if many people were unemployed in a society where they produce capital and consumer goods?

The curve doesn’t shift! Unemployment is just a point inside the curve

What if there was an increase in education in a society where they produce capital and consumer goods?

The quality of labor is improved. Curve shifts outward

The Product Market

The “place” where goods and services produced by businesses are sold to households

The Resource (Factor) Market

The “place” where resources (land, labor, capital, and entrepreneurship) are sold to businesses

Private Sector

Part of the economy that is run by individuals and businesses

Public Sector

Part of the economy that is controlled by the government

Factor Payments

Payment for the factors of production, namely rent, wages, interest, and profit

Transfer Payments

When the government redistributes income (ex: welfare, social security)

Subsidies

Government payments to businesses

Do individuals supply or demand?

Both, they demand products and supply resources

Do business supply or demand?

Both, the supply products and demand resources

Who demands in the product market?

Individuals and the government

Who supplies in the product market?

Businesses