Economics Test #1

Study of how people, businesses and governments make choices with limited resources and unlimited wants.

Microeconomics

Study of individual choices and specific markets.

Macroeconomics

Analyzes entire economy and broad national trends.

Scarcity

Condition of wanting more than we can get with available resources.

Opportunity cost

Cost of your choice (what you must give up in order to get something).

Marginal decision-making

Comparing additional benefits against additional costs, without considering costs + benefits of past choices.

Incentives - Positive? Negative?

Causes people to behave a certain way by affecting the trade-offs they face.

• Positive: most likely to do something

• Negative: less likely to do something

Efficiency

Situation in which resources are used in the most productive way possible.

Positive correlation

If 2 events occur at the same time or move in the same direction.

Negative correlation

If one event or variable increases while a related event or variable decreases.

No correlation (uncorrelated)

If there is no consistent relationship between 2 events or variables.

Causation

One event brings about the other.

Correlation without causation

2 events or variables move/change together but do not cause the other to happen.

Omitted variables

Hidden factor left out of a study or statistical calculation, messing up the results.

• Ex. firefighters and people with burn injuries are seen together, but firefighters don’t cause burns, they come to fight the fire.

→ omitted variable = fire

Reverse causation

Mistake in logic where you think Factor A causes Factor B, but Factor B is actually causing Factor A.

• Ex. Wearing raincoats does not cause rain

→ rain causes more people to wear rain coats

Circular Flow Model

• Most basic model of the whole economy

• Flow of spending: households → markets → back to households

• Flow of goods and services: households → markets → back to households

Circular Flow Model - Each exchange has 2 directions*

• Money spent ←→ goods and services are bought

• Income earned ←→ labour, land or capital (usually for a period of time) are sold

Circular Flow Model - actors + what they do

• Households - supply land + labour, buy goods + services

• Firms - buy or rent labour + capital supplied by households, produce and sell goods/services

Exchange takes place in 2 markets*

• Markets for goods and services

• Market for factors of production

Model

Simplified representation of reality used to explain relationships between variables or predict future outcomes.

Features of a good model

1. Predicts cause and effct

2. Makes clear assumptions

3. Describes real world accurately

Positive statement

Factual declaration about how the world actually works (can be verified with data).

Normative statement

Claim about how the world should be (depends on beliefs/ethics).

Invisible hand*

Unseen economic force that helps a free market run smoothly through everyday people chasing their own self interest.

Absolute advantage

Ability of an individual, company, or country to produce a specific good or service more efficiently - using fewer resources or lower costs - than its competitors.

Comparative advantage

An economy’s ability to produce a specific good or service at a lower opportunity cost than its trading partners.

Gains from trade

• Extra output

• Economic value

• Consumption that countries/individuals achieve by specializing in what they produce best (specialization).

• Exchanging goods

Winners and losers from trade

• Winners

→ demand for your good does up, your price can also go up.

→ brands you can buy increase and with more competition the price you pay goes down.

• Losers

→ might lose some local business and will need to compete more.

→ you might see a price increase in the good that you purchase.

Comparative advantage over time

• Describes a country’s ability to produce goods at a lower opportunity cost evolves and shifts as an economy develops.

• Dynamic and changes over time rather than staying permanently fixed.

• When jobs move, it means comparative advantage has shifted.

Specialization

Concentrating labour, time, resources on producing a specific subset of goods/services where they hold a comparative advantage, rather than trying to be self-sufficient.

Market

Group of buyers and sellers who trade in a particular good.

Competitive market

Market in which a large number of fully informed, price-taking buyers and sellers easily trade a standardized good/service.

Price-taker

Individual or company that must accept the prevailing market price for a good/service because they lack the market share or power to influence it.

Demand

How much of something are people willing and able to buy under certain circumstances - and what is the price.

• Higher price: less people willing to buy

• Lower price: more people willing to buy

5 main determinants of demand

1. Consumer preferences - personal likes and dislikes

2. Prices of related goods

→ substitutes - serve similar enough purpose that a consumer might purchase one in place of the other (ex. coffee and tea).

→ complements - goods consumed together (ex. coffee and cream).

3. Income of consumers - the amount of income people earn affects their demand for goods/services.

→ normal good - increase in income causes increase in demand.

→ inferior good - increase in income causes decrease in demand (consumption).

→ when income increases, people replace inferior goods with normal goods.

4. Expectations of future prices - expectations about future prices can affect demand

5. Number of buyers - more buyers = demand

Shifts in demand curve

• Quantity demanded - shown by movement along the curve. Refers to response to a price change.

• Change in demand - shown by shift in the entire curve. Refers to a change originating from 1 or more non-price determinants of demand.

Supply

Describes how much of a good/service producers will offer for sale under given circumstance.

5 determinants of supply

1. Prices of related goods - shift in the supply curve.

2. Technology - enables firms to produce more efficiently, using fewer resources to produce.

3. Prices of inputs - if prices inputs change, supply curve is going to shift.

4. Expectations - supplier’s expectations about future prices also affect quantity supplied.

5. Number of sellers - constant on the market supply curve. Represent the existing number of sellers in the market.

Shift in supply curve

• Change in supply - represented by shift in the entire curve. Refers to a change originating from one or more non-price determinants of supply.

• Increase in supply - producers are willing to produce more at any given price.

• Decrease in supply - producers are willing to produce less at any given price.

• Change in quantity supplied - response to a price change. Represented by movement along the curve.

Equilibrium

• When quantity demanded = quantity supplied.

• Where supply curve meets demand curve.

Reaching equilibrium

• Sellers set prices by trial and error relying on past experiences to set their price).

• Incentives created by these prices will naturally drive the market to equilibrium.

Changes in equilibrium

• When the market equilibrium changes, it originates with a non-price factor.

• To determine the non-price factor, ask a few questions:

1. Does demand increase or decrease (does the whole demand curve shift)?

2. Does supply increase or decrease (does it shift to the right or left, on its own)?

3. How does the combination of changes in supply and demand affect the equilibrium price and quantity?

Intangible resources

Non-physical items that lack a material form but hold significant economic value and competitive advantage for a business.angible T

Tangible resources

Physical items with a real form that you can touch, see, and use to create economic value.

Concave curve

• Bows outward.

• Represents increasing opportunity costs.

Convex curve

• Bows inward.

• Represents decreasing opportunity costs.

Ceteris paribus

• All other things being equal

• Allows analysts to look at the direct cause-and-effect relationship between two variables (such as price and demand) by pretending every other external factor stands still