Thinking Like an Economist & Market Forces Review

Flashcards covering core economic concepts, models, and market forces from Chapters 2, 3, 4, and 5 of the lecture notes, including the scientific method, economic models, the circular-flow diagram, the production possibilities frontier, micro/macroeconomics, positive/normative statements, comparative advantage, market types, supply and demand, and elasticity.

How do economists use the scientific method?

Economists use the scientific method where observation leads to theory, which is then tested by more observation.

What challenges do economists face in running controlled experiments?

Economists cannot easily run controlled experiments and must rely on natural experiments or historical episodes.

What is the primary role of assumptions in economic models?

Economists use assumptions to simplify the complex world and focus on the essence of a problem.

What is an economic model?

Economic models are built with assumptions and consist mostly of diagrams and equations, simplifying reality to improve understanding.

What is the purpose of the circular-flow diagram?

It is a visual model showing how dollars flow through markets among households and firms.

In the circular-flow diagram, who are the 'firms'?

Firms produce and sell goods/services and hire and use factors of production.

In the circular-flow diagram, who are the 'households'?

Households buy and consume goods/services and own and sell factors of production (land, labor, capital).

What is the Production Possibilities Frontier (PPF)?

A graph that shows the combinations of output an economy can possibly produce given available resources and technology.

What do points on the Production Possibilities Frontier (PPF) represent?

Points on the PPF represent efficient levels of production where the economy is getting all it can from scarce resources.

What does the slope of the PPF measure?

The slope of the PPF measures the opportunity cost of one good in terms of the other.

What causes the Production Possibilities Frontier (PPF) to shift outward?

A technological advance or increase in resources causes the PPF to shift outward, representing an expansion of opportunities or economic growth.

What is microeconomics?

Microeconomics is the study of how households and firms make decisions and how they interact in specific markets.

What is macroeconomics?

Macroeconomics is the study of the economy as a whole.

What is a positive statement in economics?

A positive statement is a descriptive claim about how the world is, which can be confirmed or refuted by examining evidence.

What is a normative statement in economics?

A normative statement is a prescriptive claim about how the world ought to be, involving values and not solely judged on scientific grounds.

What are two basic reasons why economists frequently offer conflicting advice?

Differences in scientific judgments about how the world works and differences in values about what government policy should accomplish.

According to the principle of specialization and trade, how do people benefit?

Trade allows people and countries to specialize in what they do best and then exchange with others, leading to increased total consumption of both goods.

What is absolute advantage?

A producer has an absolute advantage if they require a smaller quantity of inputs (e.g., time) to produce a good.

What is opportunity cost?

The opportunity cost of an item is what you give up to get that item.

What is comparative advantage?

A producer has a comparative advantage in producing a good if they have a lower opportunity cost of producing that good compared to another producer.

What is the driving force behind the gains from specialization and trade?

The gains from specialization and trade are based on comparative advantage.

What is a market in economics?

A market is a group of buyers and sellers of a particular good or service, where buyers determine demand and sellers determine supply.

What are the two characteristics of a perfectly competitive market?

The goods offered are exactly the same, and buyers and sellers are so numerous that no single one can influence the market price.

What is the meaning of 'price takers' in a perfectly competitive market?

In perfectly competitive markets, participants are price takers, meaning they accept the market price and have no influence over it.

What is 'quantity demanded'?

Quantity demanded is the amount of a good buyers are willing and able to purchase.

What is the Law of Demand?

The Law of Demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises, causing the demand curve to slope downward.

What causes a 'shift' in the demand curve?

A shift in the demand curve is caused by a change in a variable other than the price of the good itself, indicating a change in demand.

How do income changes affect the demand for a 'normal good'?

For a normal good, demand increases with income.

How do income changes affect the demand for an 'inferior good'?

For an inferior good, demand decreases with income.

How do 'substitutes' affect the demand for a good?

If two goods are substitutes, an increase in the price of one good raises the demand for the other good.

How do 'complements' affect the demand for a good?

If two goods are complements, an increase in the price of one good lowers the demand for the other good.

What is 'quantity supplied'?

Quantity supplied is the amount of a good sellers are willing and able to sell.

What is the Law of Supply?

The Law of Supply states that, ceteris paribus, the quantity supplied of a good rises when the price of the good rises, causing the supply curve to slope upward.

What causes a 'shift' in the supply curve?

A shift in the supply curve is caused by a change in a variable other than the price of the good itself, indicating a change in supply.

How do input prices affect the supply of a good?

A fall in input prices increases the supply of a good (shifts the supply curve right).

What is 'equilibrium' in a market?

Equilibrium is the point where the supply and demand curves intersect, indicating the market-clearing price and quantity where quantity supplied equals quantity demanded.

What is a 'surplus' (excess supply)?

A surplus occurs when the price is above equilibrium, causing the quantity supplied to be greater than the quantity demanded.

What is a 'shortage' (excess demand)?

A shortage occurs when the price is below equilibrium, causing the quantity demanded to be greater than the quantity supplied.

What is the Law of Supply and Demand?

The Law of Supply and Demand states that the price of any good adjusts to bring the quantity supplied and demanded into balance.

What are the three steps to analyzing changes in equilibrium?

1. Decide which curve(s) shift (supply, demand, or both). 2. Decide the direction of the shift. 3. Use the diagram to compare the initial and new equilibrium to see how price and quantity are affected.

How do prices guide the allocation of scarce resources in market economies?

Prices serve as signals that adjust to ensure that the quantity supplied equals the quantity demanded, effectively rationing resources to those willing and able to pay.

What is 'elasticity' in economics?

Elasticity measures the degree of responsiveness of buyers and sellers to changes in market conditions, making economic analysis quantitative.

What is the Price Elasticity of Demand?

The Price Elasticity of Demand measures how much the quantity demanded responds to a change in price.

When is demand considered 'elastic'?

Demand is considered elastic (E > 1) when the quantity demanded responds substantially (more than proportionally) to a change in price.

When is demand considered 'inelastic'?

Demand is considered inelastic (E < 1) when the quantity demanded responds only slightly (less than proportionally) to a change in price.

Name one determinant of the Price Elasticity of Demand.

Determinants include the availability of close substitutes, whether the good is a necessity or luxury, the definition of the market, and the time horizon.

How is price elasticity of demand calculated?

Price Elasticity of Demand = Percentage change in quantity demanded / Percentage change in price.

What does a 'perfectly inelastic' demand curve look like?

A perfectly inelastic demand curve is vertical (E = 0).

What happens to total revenue when demand is inelastic and price increases?

When demand is inelastic (E<1) and price increases, total revenue (P×Q) moves in the same direction as price, so total revenue will increase.

What happens to total revenue when demand is elastic and price increases?

When demand is elastic (E>1) and price increases, total revenue (P×Q) moves in the opposite direction as price, so total revenue will decrease.

What is the Income Elasticity of Demand?

The Income Elasticity of Demand measures the responsiveness of quantity demanded to changes in consumer income.

What is the sign of the Income Elasticity of Demand for a normal good?

The Income Elasticity of Demand is positive for normal goods.

What is the sign of the Income Elasticity of Demand for an inferior good?

The Income Elasticity of Demand is negative for inferior goods.

What is the Cross-Price Elasticity of Demand?

The Cross-Price Elasticity of Demand measures the responsiveness of Good 1's quantity demanded to the price of Good 2.

What is the sign of the Cross-Price Elasticity of Demand for substitutes?

The Cross-Price Elasticity of Demand is positive for substitutes.

What is the sign of the Cross-Price Elasticity of Demand for complements?

The Cross-Price Elasticity of Demand is negative for complements.

What is the Price Elasticity of Supply?

The Price Elasticity of Supply measures how much the quantity supplied responds to changes in the price.

How does the time horizon affect the price elasticity of supply?

Supply is more elastic in the long run (giving firms more time to adjust production) than in the short run.

How can good news for farming (e.g., a technological advance) be bad news for farmers as a whole?

A technological advance increases supply, and because demand for food is typically inelastic, the resulting fall in price can lead to a decrease in total revenue for farmers collectively.