econ exam one

scarcity

Condition in which humans’ wants are forever greater than the average supply of time, goods, and resources. Forces us to make choices

3 major econ questions

What to produce, how to produce, for whom to produce

economics

study of how society chooses to allocate its resources due to scarcity

macro

branch studies decision making as a whole

micro

branch studies single decision on individual level

resoruces

basic categories of inputs used to produce goods and services

land resources

natural resources provided by nature that are used to produce a good or service

labor resoruces

mental and physical capacity of workers to produce goods and services

capital resoruces

human-made goods used to produce other goods and services

money

not a resource, does not provide goods and services, it’s only a means to facilitate the purchase and sale of resources and consumer products

entrepreneurship

creative ability of individuals to seek profits by taking risks, combining resources to produce innovative products

methodology of economics

1) identify a problem, 2) develop a model, 3) gather data and test whether the theory can be supported by data, 4) formulate a conclusion

model

simplified description of reality used to understand and predict the relationship between variables

hazards of econ way of thinking

failing to understand the ceteris paribus, correlation does not equal causation (one event does not cause another)

ceteris paribus

all other things remain unchanged

economics disagree

explained by tradeoff between efficiency and equity or the difference between positive and normative economics

equity

fairness in the way production is distributed among members of society

efficiency

refers to maximizing the size of the economic pie

positive econmoics

“What is” can be tested and determined to be true or false

normative economics

Analysis based on subjective value judgments regarding “what should be”, can’t be tested

opportunity cost

best alternative that was sacrificed when making a choice.

How is opportunity cost measured

The highest valued good or use of time given up for the chosen good or use of time measures the opportunity cost

marginal analysis

examination of the effects of incremental additions to or subtractions from a current situation (e.g., decide to study for a better grade instead of sleeping)

production possibilities model (curve)

shows the maximum combination of two outputs an economy can produce in a given period of time with its available resources and technology

Assumptions of production possibilities curve

fixed resources, fully employed resources, fixed technology

what is technology

body of knowledge applied to how goods are produced

productive efficiency

situation where society is producing the most it can with its existing resources and technology

allocative efficiency

allocates or channels its limited resources into the production of those products most desired by society

law of increasing opportunity cost

principle that the opportunity cost increases as production of one output expands (resources are not equally well suited)

economic growth

ability of an economy to produce greater levels of output, represented by an outward shift of its production possibilities curve

investment

accumulation of capital used to produce goods and services (as more capital goods are produced, it creates more economic growth)

economic systems

organizations and methods used to determine what goods and services are produced, how and for whom

traditional economic system

answers questions the way they always have been, believed that what was good yesterday and years ago, minimized friction among members, restricts individual initiative (ex: Amish of Pennsylvania)

command economic system

answers questions by dictator, politically selected committees decided on everything, pyramid structure, economic change faster, absolute power (ex: Soviet Union)

market economic system

answers questions using pricing determined by the interaction of supply and demand, no central body, very effective, lack of competition

Adam Smith

Father of modern econ → felt free markets provided incentive for everyone to follow self-interest and was controlled by “invisible hand”

mixed economy

Answer questions through a mix of traditional, command, and market systems (all economic systems are a mixture)

capitalism

economic system characterized by private ownership of resources and decentralized decision-making using markets

consumer sovereignty

freedom of consumers to cast their dollar votes to buy, or not to buy at prices determined in a competitive market

conclusion of capitalism

no nation in the world precisely fits the two criteria for

strengths of capitalism

capacity to achieve economic efficiency and economic freedom because economic power is widely dispersed

weaknesses of capitalism

tends towards unequal distribution of income, private market can fail to produce adequate amount of public goods, leads to macroeconomic instability, fails to protect the environment

socialism

economic system characterized by government ownership of resources and centralized decision-making → public ownership and centralized decision-making

Karl Marx

rejected capitalism and wants communism → believed the market would destroy its self

communism

stateless and classless system factors of production, owned by the workers, people share according to their needs

communism strengths

rapid economic growth, non-disproportionate share of the nation’s wealth

communism weakness

economic inefficiency, absence of profit motive, suppress economic growth

privatization

turning a government enterprise into a private one

nationalization

act of transforming a private enterprise assets into a government enterprise

demand curve

shows the different qualities of products consumers are willing to purchase at various prices during a specified period

law of demand

inverse relationship between the price of a good and the quantity buyers are willing to purchase

demand

various quantities people are willing to buy

What causes a change in the price demanded

caused by a change in price, movement along a demand curve (decreases move to the left)

non price determinates that shift demand curve

number of buyers, price of related goods, taste and preference, income, expectations of buyers

normal goods

any good for which there is a direct relationship between changes in income and its demand curve

inferior goods

any good for which there is an inverse relationship between changes in income and its demand curve

substitute goods

Good that competes with another good for consumer purchase

price increases for a good that has a substitute

demand curve for the substitute good increases (shifts to the right)

complementary good

good that is jointly consumed with another good

increases for a good that has a complementarity

demand curve shifts to the left

supply curve

shows the different quantities of a product sellers are willing and able to produce and offer for sale during a specified period of time, ceteris paribus

law of supply

direct relationship between the price of a good and the quantity sellers are willing to offer for sale

supply curve and positive slope

sellers have incentive to offer more for sale → profit more

market sypply

horizontal summation of the individual supply curves in a market

changes in quantity supplied

caused by a change in price and movement along a supply curve

non-price determinants of supply that could shift the supply curve

number of sellers in the market, technology, expectations of sellers, resource prices, prices that firms can produce

increase in supply (rightward shift) caused by

increase number of sellers in the market, increase in production of technology, decrease in resource prices, expectations of lower future prices, decrease in prices of another good

market

any arrangement in which buyers and sellers interact to determine the prices and quality of goods and services exchanged

surplus

market condition existing at any price where quantity supplied is greater than the quantity demanded

shortage

market condition existing at any price where the quantity supplied is less than the quantity demanded

equilibrium

market condition that occurs at any price and quantity at which the quantity demanded and quantity supplied are equal

price system

mechanism that uses the forces of supply and demand to create an equilibrium through rising and falling prices

change in market equilibrium causes

change in demand and change in supply

efficiency

“doing the best it can” with its resources

rational amount any activity to undertaake

keep doing an activity for as long as the marginal benefit exceeds the marginal cost

competitive market

produced a quantity in which the marginal benefit of the last unit consumed just equals its marginal cost of production

supply curve shows marginal cost

shows the price required by sellers to produce various quantities

underproduced

when the marginal benefit of consuming the product exceeds the marginal cost of its production

overproduced

When the marginal benefit of consuming the product is less than the marginal cost of its production

market failure

situation in which market equilibrium results in too few or too many resources being used in the production of a good/service

sources of market failure

lack of competition, externalities, public goods

competition importance

There must be competition among both producers and consumers for markets to function properly

Few firms rig the market and restrict competition

By restricting supply through artificial limits on the output of a good, firms can enjoy higher prices and profits → non-competitive markets cause too few resources to be devoted to the production of the good

externality

cost or benefit imposed on people other than the consumers and producers of a good or service (3rd party)

negative externalities

(external cost), something detrimental to 3rd parties → ex: steel firm that burns coal and pollutes the environment

positive externalities

(external benefit), something that is beneficial to 3rd parties → ex: vaccination to present diseases spread

presence of externalities distorts market outcomes

The market supply curve underestimates marginal cost (external cost), market demand curve underestimates marginal benefit (external benefits)

conclusion regarding external cost

supply curve fails to include external costs, the equilibrium price is artificially low, and the equilibrium quantity is artificially high

conclusion regarding external benefit

demand curve fails to include external benefits, the equilibrium price is artificially low, and equilibrium quantity is artificially low

public goods

good or service with 2 properties → users collectively consume benefits, and there is no way to bar people who don’t pay from consuming

public good examples

national defense, judicial system, prisons, dams, city roads, etc

conclusion regarding public goods

public good available only in the marketplace, people wait for someone else to pay, and as a result is and underproduction

government ties to correct market failures

regulation, price control, taxes and subsidies → enact legislation to create rules or laws people must follow

two types of price contorls

price ceilings and price floors

price ceilings

legally establish max price a seller can charge → rent controls (provide an essential service that would otherwise be unaffordable) → results in shortage of rental units

price ceilings creates

shortages

price floors creates

surplus

price floor

Minimum wage law is an example (the lowest a price can be)

result of a price floor in wages paid to labor

minimum wage creates surplus of labor

Conclusion on price ceilings and floors

prevents market adjustment in which competition among buyers and sellers bids the price upward or downward to equilibrium prices.