Essentials of Economics Review: Core Concepts, Microeconomics, and Macroeconomics

Comprehensive practice flashcards for the Economics midterm and final review, covering core microeconomic principles (market structures, consumer demand, supply costs, elasticity) and macroeconomic foundations (fiscal and monetary policy, business cycles, growth, and trade).

What are the three core economic questions that every society must resolve given its scarce resources?

Every society must resolve WHAT to produce, HOW to produce, and FOR WHOM to produce.

What does the discipline of economics examine, and how do microeconomics and macroeconomics differ?

Economics is the study of how goods and services are produced, distributed and consumed in a society given scarcity. Microeconomics focuses on the individual behavior of consumers, firms, and government agencies, whereas macroeconomics examines the behavior and performance of the economy as a whole, including aggregate goals such as GDP growth, inflation, and unemployment.

What are the key differences among a market economy, a planned economy, and a mixed economy?

In a market economy, decentralized sales and price signals (the market mechanism, or 'invisible hand') determine resource allocation. In a planned (command) economy, a central government decides what is produced, at what prices, and for whom. A mixed economy uses a combination of market forces and government directives to determine economic outcomes.

What is the difference between market failure and government failure?

Market failure occurs when the market mechanism generates suboptimal outcomes, failing to achieve the best possible mix of output, society doesn’t go for what’s being sold. Government failure occurs when government intervention fails to improve, or actually worsens, economic outcomes.

What are the four factors of production?

The four basic factors of production are: 1. Land (including all natural resources) 2. Labor (the number and skills of workers) 3. Capital (manufactured goods used to produce other goods, such as machinery, buildings, and equipment) 4. Entrepreneurship (the skill and initiative to combine resources into new products and processes)

What are the primary market structures along the competition spectrum, and what defines a corporation?

Market structures range from perfect competition (many small firms with no market power) to monopoly (one firm dominating the entire market), with imperfect competition in between: duopoly (two firms), oligopoly (a few large firms), and monopolistic competition (many firms with product differentiation). A corporation is a legal business entity owned by stockholders whose personal liability is limited to the value of their shares.

What is the distribution of income, and how can the government intervene to make it more equitable?

The distribution of income measures how total personal income is divided among households or income classes (such as quintiles). To make income distribution more equitable, governments intervene through progressive income taxes (taxing higher incomes at higher rates) and income transfers (direct payments such as Social Security, welfare, and unemployment benefits).

What is the definition of a market, who are its participants, and what does each participant strive to achieve?

A market is any place or mechanism where economic exchanges occur between buyers and sellers. The participants and their goals are: 1. Consumers, who strive to maximize personal satisfaction (utility) 2. Business firms, which strive to maximize total profits 3. Governments, which strive to maximize general social welfare 4. Foreign market participants, who pursue consumer, business, or government objectives through international trade

What are the primary determinants of market demand and market supply?

The determinants of market demand are consumer tastes, consumer income, prices and availability of other goods (substitutes and complements), expectations, and the number of buyers. The determinants of market supply are technology, factor costs, taxes and subsidies, price expectations, other goods (alternative production opportunities), and the number of sellers.

How are market equilibrium, market shortages, and market surpluses determined in supply and demand analysis?

Market equilibrium occurs at the price where quantity demanded equals quantity supplied ($Q_d = Q_s$), shown at the intersection of the demand and supply curves. A market shortage occurs at prices below equilibrium, where quantity demanded exceeds quantity supplied ($Q_d > Q_s$). A market surplus occurs at prices above equilibrium, where quantity supplied exceeds quantity demanded ($Q_s > Q_d$).

What is the difference between total utility and marginal utility, and what does the law of diminishing marginal utility state?

Total utility is the overall satisfaction obtained from consuming an entire quantity of a product. Marginal utility is the additional satisfaction obtained from consuming one more unit of that product. The law of diminishing marginal utility states that each successive unit of a good consumed in a given time period yields less additional satisfaction.

What does the price elasticity of demand measure, and what is its calculation formula?

Price elasticity of demand ($E$) measures the responsiveness of consumer quantity demanded to a change in the price of a good. Its formula is: $E = \frac{\text{percentage change in quantity demanded}}{\text{percentage change in price}}$. Demand is elastic if $E > 1$, inelastic if $E < 1$, and unitary elastic if $E = 1$.

How does the price elasticity of demand impact total business revenue when prices change?

If demand is elastic ($E > 1$), a price increase decreases total revenue, and a price cut increases total revenue. If demand is inelastic ($E < 1$), a price increase increases total revenue, and a price cut decreases total revenue. If demand is unitary elastic ($E = 1$), price changes do not alter total revenue.

What is a production function?

A production function is a technological relationship expressing the maximum quantity of output that can be produced from alternative combinations of factor inputs with existing technology.

What is marginal physical product (MPP), and how is it calculated?

Marginal physical product (MPP) is the change in total output that results from employing one additional unit of an input, calculated as: $\text{MPP} = \frac{\Delta \text{Total Output}}{\Delta \text{Variable Input}}$.

What is the law of diminishing returns?

The law of diminishing returns states that as more units of a variable input (such as labor) are added to a fixed quantity of other inputs (such as land and capital), the marginal physical product (MPP) of the variable input will eventually decline.

What is the difference between the short run and the long run, and how does this affect production decisions?

The short run is a time horizon where some inputs and costs are fixed (e.g., existing plant and machinery), requiring a production decision on how intensively to use existing facilities. The long run is a time horizon where all inputs can be varied and no fixed costs exist, allowing an investment decision to build, expand, lease, or exit facilities.

What are the definitions of total cost, average total cost, and marginal cost?

Total cost (TC) is the sum of fixed costs and variable costs ($\text{TC} = \text{FC} + \text{VC}$). Average total cost (ATC) is total cost divided by the rate of output ($\text{ATC} = \frac{\text{TC}}{q}$), producing a U-shaped curve. Marginal cost (MC) is the increase in total cost when one additional unit of output is produced ($\text{MC} = \frac{\Delta \text{TC}}{\Delta q}$).

How are scarcity and opportunity cost defined in economic analysis?

Scarcity refers to the condition where human desires for goods and services exceed the available resources needed to produce them. Opportunity cost is the most desired good or service forgone when making an economic choice.

What does a production possibilities curve describe, and what causes it to shift outward?

A production possibilities curve (PPC) describes the alternative combinations of final goods and services that can be produced in a given time period with all available resources and technology. It shifts outward, indicating economic growth, when an economy acquires more resources (e.g., labor and capital) or better technology.

What are price ceilings and price floors, and what predictable market effects do they produce?

A price ceiling is an upper legal limit on a price (e.g., rent control); when set below equilibrium, it increases quantity demanded, reduces quantity supplied, and causes a market shortage. A price floor is a lower legal limit on a price (e.g., minimum wage); when set above equilibrium, it increases quantity supplied, reduces quantity demanded, and causes a market surplus.

What are the unique characteristics of a perfectly competitive firm, and what is its profit-maximizing rule?

A perfectly competitive firm is a price taker that faces a perfectly horizontal demand curve for its output because its individual volume has no influence on the market price. It produces homogeneous goods in a market with low entry barriers and maximizes profits where price equals marginal cost ($p = \text{MC}$). In the long run, entry and exit drive economic profits to zero ($p = \text{minimum ATC}$).

Why does a monopolist's marginal revenue fall below its price, and how does it determine its profit-maximizing price and output?

Because a monopolist faces the downward-sloping market demand curve, it must reduce the unit price of all units sold to sell an additional unit, making marginal revenue less than price ($\text{MR} < p$). The monopolist identifies the profit-maximizing rate of output where $\text{MR} = \text{MC}$ and sets the price at the highest amount consumers are willing to pay for that quantity along the demand curve.

Why is the demand for labor referred to as a derived demand, and how does a firm decide how many workers to hire?

Labor demand is derived from the consumer demand for the goods and services that labor produces. A profit-maximizing firm hires workers up to the point where the marginal revenue product of labor ($\text{MRP} = \text{MPP} \times p$) equals the market wage rate ($\text{MRP} = W$).

What are public goods and externalities, and why do they cause market failure?

Public goods are non-excludable and jointly consumed, leading consumers to free-ride rather than demand them in the market, which results in market underproduction. Externalities are spillover costs or benefits imposed on third parties; the market overproduces goods that generate external costs (negative externalities) and underproduces goods that generate external benefits (positive externalities).

What are the three primary gauges of macroeconomic performance, and how is the unemployment rate calculated?

The three basic measures of macroeconomic performance are real GDP growth, the unemployment rate, and the inflation rate. The unemployment rate is calculated as: $\text{Unemployment Rate} = \frac{\text{Number of Unemployed}}{\text{Civilian Labor Force}} \times 100$, where the labor force includes individuals over age 16 who are employed or actively seeking work.

What are the four types of unemployment, and what constitutes full employment?

The four types of unemployment are: 1. Seasonal (joblessness due to seasonal changes) 2. Frictional (brief job search between jobs or upon labor market entry) 3. Structural (mismatch between worker skills and available jobs) 4. Cyclical (joblessness caused by a general deficiency in aggregate demand). Full employment is the lowest unemployment rate compatible with price stability, typically defined as an unemployment rate between $4\%$ and $6\%$.

Why does the aggregate demand (AD) curve slope downward, and why does the aggregate supply (AS) curve slope upward?

Aggregate demand slopes downward due to the real balances effect (lower prices increase the purchasing power of cash/wealth), the foreign trade effect (cheaper domestic goods increase exports and decrease imports), and the interest rate effect (lower price levels reduce loan demand and lower interest rates). Aggregate supply slopes upward because in the short run, higher prices widen profit margins against sticky costs, and expanding output strains capacity and raises production costs.

What is fiscal policy, and how is the cumulative change in aggregate spending calculated using the multiplier?

Fiscal policy is the use of federal taxes and government spending to alter macroeconomic outcomes. The multiplier is calculated as $\text{Multiplier} = \frac{1}{1 - \text{MPC}} = \frac{1}{\text{MPS}}$. The cumulative change in total spending from an initial change in government expenditure ($\Delta G$) equals $\text{Multiplier} \times \Delta G$.

What is included in the basic money supply ($M1$), and how do commercial banks create money?

$M1$ consists of currency held by the nonbank public plus balances held in transactions accounts (e.g., checking accounts). Commercial banks create money by making loans; when a bank issues a loan, it credits the borrower's transactions account with newly created deposit dollars. The total lending capacity of the banking system is equal to excess reserves multiplied by the money multiplier ($\frac{1}{\text{Required Reserve Ratio}}$).

What are the three primary monetary policy tools utilized by the Federal Reserve?

The Fed alters bank reserves, lending capacity, and aggregate demand using three main tools: 1. Reserve requirements: Adjusting the required fraction of deposits banks must keep as reserves 2. Discount rate: Changing the interest rate charged on reserve loans made directly to commercial banks by the Fed 3. Open market operations: Buying government bonds to inject bank reserves (expansionary) or selling government bonds to withdraw reserves (restrictive)

How does the principle of comparative advantage establish gains from international trade?

A nation has a comparative advantage in producing a good if its domestic opportunity cost of producing that good is lower than that of its trading partners. By specializing in products of comparative advantage and trading at a terms-of-trade ratio between their respective opportunity costs, total world output increases, allowing each country's consumption possibilities to exceed its domestic production possibilities.

What are the four primary obstacles that impede macroeconomic policymakers from fine-tuning the economy?

The four main obstacles to effective policy intervention are: 1. Goal conflicts (trade-offs between competing targets, such as inflation and unemployment) 2. Measurement problems (economic data are dated, incomplete, and rely on imperfect forecasts) 3. Design problems (uncertainty regarding how consumers and businesses will respond to tax or spending initiatives) 4. Implementation problems (legislative and administrative delays, time lags, and political business cycles)