Chapters 2 and 3 AP Econ Test

economic system 

a set of institutional arrangements that deal with the economising problem.

• what is produced?

• how is it produced? 

• who gets the output? 

• how to deal with change and promote technology? 

  • who owns factors of production 

  • how to motivate or direct economic activity? 

command system

• aka social communism

• gov own property 

• decision making is centralized

• gov owns firms and directs desicions 

• capital goods are allocated based on gov plan  

market system

• aka capitalism 

• private ownership 

• markets and prices determine activity 

• self interest - individuals make choices 

• competition 

• decision making is widely dispersed 

• gov protects private property and operation of market system  

• laissez faire - “let it be”

• ex: mostly everyone else

free enterprise and choice

• free to obtain/use resources to produce and sell goods that they choose

• consumers are able to buy whatever they want w money

choice

• owners can do what they want with property and money 

• workers can choose their work 

• consumers buy what they want 

self interest

• each group tries to achieve its own goal

  • owners want to maximize profits 

  • workers want to maximize utility 

21st century paradox

we are powerful consumers but powerless workers 

specializaton

• uses resources to produce one specific good and sell/trade it instead of making everything

• human specialization = division of labor

• ex: chipotle

how do we decide what a dollar is worth?

money is agreed upon social agreement

active but limited government: “the tragedy of the commons”

• when there are common resources available, how do you stop people from abusing them? 

• things that belong to all are cared for by none 

  • Example: ocean and fishing → too much of it to stop the population from doing it 

what will be produced?

• production will occur when Total Revenue (TR) exceeds Total Costs (TC). 

  • tells you what to make not how many to make 

    • if TR > TC → its profitable → make it 

    • if TR < TC → its not profitable → don’t make it 

how will goods/services (g/s) be produced?

• cheapest and most efficient way possible 

• ideal mix of land labor capital 

• labor is often the most expensive 

demand 

curve that shows the quantity of a product that consumers are willing and buy at a specific point of time

• always willing - not always able 

• depends on time → must be specific

  • immediate short run 

  • short run

  • long run  

immediate short run

• all factors of production are fixed → no changes can be made 

short run 

• one or more are fixed → can make some changes but not a lot 

long run

• depends on variable inputs 

• theoretical construct 

• period of time long enough to change resources

change in demand

• indicates shift on the curve (left or right)

change in price

• indicates movement on the curve 

law of demand 

• negative/ inverse relationship

• as price rises, demand drops

• as price drops, demand rises 

law of demand cont.

1) consistent with common sense

2) buyers derive less benefit for each unit consumed (diminished marginal utility -? additional utility only if price is lower) 

3) income effect

• price of good falls → purchasing power increases → buyers can afford more → Qd rises 

4) substitution effect

• lower prices makes other products relatively more expensive, so buyers substitute towards the cheaper good 

determinants of demand

• T - tastes/preferences

• I - income 

• M - market size 

• E - expectations of consumers

• R - prices of RELATED goods 

T- tastes/ preferences

•  favorable change in consumer tastes 

• shifts curve left or right depending on reaction 

I - income

• usually as income increases → demand increases 

• normal goods: when income increases, you buy more of it (new clothes, restaurant meals etc.) 

• inferior goods: when income increases, you buy less of it (ramen noodles, bus rides, used cars) 

  • depending on the good and my situation, demand will either increase or decrease 

M - market size/number of buyers

• more buyers = more demand

• less buyers = less demand 

E - expectations of consumers

what people expect to happen influences their behavior today 

• when prices are expected to rise soon → they’ll buy now (current demand increases)

• when prices are expected to fall soon → they’ll buy later (or after prices have dropped) → the current demand decreases

R - prices of Related goods

• substitute goods: goods that can be in place of each other 

  • good 1 (coke): price increases 

  • good 2 (pepsi): demand increases 

• complementary goods: goods that are used together 

  • good 1 (ice cream): price increases 

  • good 2 ( ice cream cones): demand decreases 

supply (upward/ positive relationship) 

a curve showing various amounts of a product that producers are willing and able to make available for sale during a period 

law of supply (movements)

• producers are motivated by profit 

  • price of good rises → selling it would be more profitable → producers supply more of it 

  • price of good falls → selling it would be less profitable → producers supply less of it 

determinants of supply

• T - technology

• O - other goods

• N - number of sellers in the market

• E - expectactions of producers

• R - resource prices

• S - subsidies and taxes

T - technology

• allows production at a lower cost of inputs 

  • production price drops (bc of tech) → supply rises 

O - prices of Other goods  ( not on test ?) 

• substitutes in production 

  • higher price of one → lower supply of other

N- number of sellers 

• like the demand determinant 

• if market increases → supply increases 

P - producer expectations

• much trickier than consumer expectations 

• what producers think will happen to the price of their product in the future 

  • future price increases → current supply decreases (wait to sell after prices increase) 

  • future price decreases → current supply increases (sell now before prices decrease)  

R- resource prices

• higher resource prices raise production costs → supply decreases 

• lower resource prices lower production costs → supply increases 

S - Subsidies and taxes

• taxes → increase production cost → supply decreases (shifts left)

• subsidies → decrease production cost → supply increases (shifts right)

equilibrium price Qd = Qs 

price where intention of buyers and sellers match

equilibrium quantity Qd = Qs 

quantity demand and quantity supply at equilibrium price 

draw a demand/supply graph