ECON201 Exam 1

Economics

The study of how humans make decisions in the face of scarce resources.

Scarcity

Human wants for goods, services, and resources exceed what is available; limited resources cannot satisfy unlimited wants.

Opportunity Cost

Whatever must be given up to obtain something else; it measures the trade-off between two alternatives.

Trade-off

The idea that due to limited resources, producing more of one good or service means producing less of another.

Microeconomics

The study of how households and firms make decisions and how they interact in markets (e.g., supply of water).

Macroeconomics

The study of economy-wide phenomena including inflation, unemployment, and economic growth (e.g., monetary or fiscal policy).

Allocation of Resources

The process by which every level of society decides how to best use its limited resources to achieve desired outcomes.

Rational Behavior

The assumption that individuals, given information, weigh costs and benefits and choose the action where benefits outweigh costs.

Incentive

Something that induces a person to act (e.g., the incentive to attend college is to receive a degree).

Thinking at the Margin

Rational people make decisions by evaluating marginal (additional) benefits vs. marginal costs; act only if MB > MC.

Division of Labor

Introduced by Adam Smith; production of a good is divided into many tasks performed by different workers rather than one person doing all tasks.

Specialization

Workers focus on tasks where they have an advantage, leading to faster production, higher quality, and economies of scale.

Economies of Scale

As the level of production increases, the average cost of producing each unit declines.

Adam Smith

Scottish economist (1723–1790) who published 'The Wealth of Nations' in 1776 and introduced the concept of division of labor and the 'invisible hand.'

Invisible Hand

Adam Smith's idea that households and firms interacting in the market, guided by prices and self-interest, lead to desirable market outcomes.

Circular Flow Diagram

A visual model of the economy showing that firms produce goods/services using inputs from households, and households buy goods/services from firms.

Factors of Production

Inputs used to produce goods and services: land, labor, and capital. Owned and supplied by households to firms.

Market for Goods and Services

A market where firms are sellers and households are buyers of outputs (goods and services).

Market for Factors of Production

A market where firms are buyers and households are sellers of inputs (land, labor, capital).

Positive Statement

A descriptive statement about the world as it is (e.g., "Minimum-wage laws cause unemployment").

Normative Statement

A prescriptive statement about how the world ought to be (e.g., "The government should raise the minimum wage").

Traditional Economy

The oldest economic system where economic decisions are based on tradition; found in parts of Asia, Africa, and South America.

Command Economy

An economic system where the government decides how resources are allocated, what to produce, and what prices to charge (e.g., Cuba, North Korea).

Market Economy

A decentralized economic system based on decisions of many firms and consumers; private individuals own means of production.

Economic Model

A simplified representation of the real world (theory) built on assumptions to understand economic problems; often explained with diagrams and equations.

Production Possibilities Frontier (PPF)

A graph showing the various mixes of output an economy can produce given its available resources at a certain period of time.

Autarky

A closed economy with no trade; a situation of complete self-sufficiency.

Feasible Region (PPF)

The area on or within the PPF; production combinations that are attainable given current resources.

Not Attainable Region (PPF)

Points outside (to the right of) the PPF; cannot be reached because resources are insufficient.

Inefficient Production (PPF)

Points inside (left of) the PPF where resources are not fully employed.

Productive Efficiency

Given current resources, it is impossible to produce more of one good without decreasing production of another; occurs on the PPF.

Allocative Efficiency

The combination of goods on the PPF that best represents the most desired combination of production for society.

Law of Diminishing Returns

As additional increments of resources are added to producing a good, the marginal benefit from those additional increments declines; explains why the real-world PPF is concave.

Concave PPF

The curved (bowed-out) shape of the real-world PPF caused by the law of diminishing returns.

Budget Constraint

The maximum combination of items one can purchase given a fixed income; represented as a straight line because relative prices are fixed from the consumer's point of view.

Absolute Advantage

The ability to produce a good using fewer resources (or more output) than another producer.

Comparative Advantage

The ability to produce a good at a lower opportunity cost than another producer; the basis for specialization and trade.

David Ricardo

English economist who developed the Theory of Comparative Advantage in 'On the Principles of Political Economy and Taxation' (1817).

Complete Specialization

Producing only one good in which a producer has a comparative advantage (e.g., Frank only produces potatoes).

Partial Specialization

Producing both goods but focusing more on the good in which one has a comparative advantage (e.g., Ruby produces both but more meat).

Gains from Trade

Trade based on comparative advantage increases total production and allows everyone to consume more than without trade.

Price of Trade

Must lie between the two producers' opportunity costs for trade to benefit both parties.

Market

A group of buyers and sellers of a particular good or service who interact to determine price and quantity.

Competitive Market

A market with many buyers and many sellers, each having a negligible impact on market price; price and quantity are set by all buyers/sellers interacting.

Demand

The amount of a good or service consumers are willing AND able to purchase at each possible price.

Quantity Demanded

The specific amount a consumer will buy at one particular price; a single point on the demand curve.

Law of Demand

Other things equal (ceteris paribus), when the price of a good rises, quantity demanded falls; when price falls, quantity demanded rises. Inverse relationship.

Ceteris Paribus

Latin for "other things being equal"; the assumption that all variables except the one being studied remain constant.

Demand Schedule

A table showing the relationship between the price of a product and the quantity demanded at each price.

Demand Curve

A graph of the demand schedule; downward sloping, showing the inverse relationship between price and quantity demanded. Price on Y-axis, quantity on X-axis.

Movement Along the Demand Curve

A change in quantity demanded caused solely by a change in the price of that good; NOT a shift of the curve.

Shift in Demand (Increase)

The entire demand curve shifts to the right due to a non-price factor; buyers wish to purchase more at every price.

Shift in Demand (Decrease)

The entire demand curve shifts to the left due to a non-price factor; buyers wish to purchase less at every price.

Market Demand Curve

The horizontal summation of all individual demand curves in a market; shows the total quantity demanded by all buyers at each price.

Normal Good

A good for which demand increases when consumer income increases, and decreases when income falls.

Inferior Good

A good for which demand increases when consumer income decreases, and decreases when income rises (e.g., generic-brand products).

Substitutes

Two goods where an increase in the price of one leads to an increase in the demand for the other (e.g., Coke and Pepsi).

Complements

Two goods where an increase in the price of one leads to a decrease in the demand for the other (e.g., jam and bread).

Tastes (Demand Shifter)

A shift in consumer preferences toward a good increases its demand (curve shifts right); away from a good decreases demand (curve shifts left).

Expectations (Demand Shifter)

If consumers expect income to rise or prices to increase in the future, current demand for goods may increase now.

Number of Buyers (Demand Shifter)

An increase in the number of buyers in the market increases market demand (shifts curve right); a decrease reduces demand.

Five Demand Shifters

Income, Prices of related goods (substitutes/complements), Tastes, Expectations, Number of buyers.

Supply

The relationship between the price of a good and the quantity that sellers are willing and able to sell.

Quantity Supplied

The specific amount sellers will sell at a particular price; a single point on the supply curve.

Law of Supply

Other things equal (ceteris paribus), when the price of a good rises, quantity supplied rises; when price falls, quantity supplied falls. Positive (direct) relationship.

Supply Schedule

A table showing the relationship between the price of a product and the quantity supplied at each price.

Supply Curve

A graph of the supply schedule; upward sloping, showing the direct (positive) relationship between price and quantity supplied.

Movement Along the Supply Curve

A change in quantity supplied caused solely by a change in the price of that good; NOT a shift of the curve.

Market Supply Curve

The horizontal summation of all individual supply curves; shows the total quantity supplied by all sellers at each price.

Shift in Supply (Increase)

The entire supply curve shifts to the right; sellers wish to sell more at every price due to a non-price factor.

Shift in Supply (Decrease)

The entire supply curve shifts to the left; sellers wish to sell less at every price due to a non-price factor.

Input Prices (Supply Shifter)

Supply is negatively related to input prices; higher input prices increase production costs and decrease supply (shift left).

Technology (Supply Shifter)

Advances in technology reduce production costs and increase supply (shift the supply curve right).

Expectations (Supply Shifter)

If a firm expects prices to rise in the future, it may reduce current supply to sell more later (supply curve shifts left now).

Number of Sellers (Supply Shifter)

More sellers in the market increases market supply (shifts curve right); fewer sellers decreases supply.

Four Supply Shifters

Input prices, Technology, Expectations about the future, Number of sellers.

Market Equilibrium

The situation where quantity supplied equals quantity demanded (Qs = Qd); occurs at the intersection of the supply and demand curves.

Equilibrium Price

The market-clearing price at which Qs = Qd; there is neither a shortage nor a surplus.

Equilibrium Quantity

The quantity bought and sold at the equilibrium price, where Qs = Qd.

Shortage (Excess Demand)

Qs < Qd; occurs when price is below equilibrium. Creates upward pressure on price as suppliers raise prices to reach equilibrium.

Surplus (Excess Supply)

Qs > Qd; occurs when price is above equilibrium. Creates downward pressure on price as suppliers cut prices to reach equilibrium.

Shortage/Surplus Formula

Qs – Qd: Negative result = shortage; Positive result = surplus; Zero = equilibrium.

Upward Pressure on Price

Occurs during a shortage (Qd > Qs); buyers compete for goods, pushing price up toward equilibrium.

Downward Pressure on Price

Occurs during a surplus (Qs > Qd); sellers cut prices to move excess inventory, pushing price down toward equilibrium.

Price Controls

Laws enacted by government to regulate prices; two types: price ceiling and price floor.

Price Ceiling

A legal maximum price for a good or service; must be set BELOW equilibrium to be binding; results in a shortage (e.g., rent control).

Price Floor

A legal minimum price for a good or service; must be set ABOVE equilibrium to be binding; results in a surplus (e.g., minimum wage).

Comparative Statics

The comparison of two equilibria — the initial equilibrium and a new equilibrium — after a change in supply, demand, or both.

Three Steps for Analyzing Equilibrium Changes

1) Determine which curve shifts. 2) Determine direction of shift (right/left). 3) Compare old and new equilibria for changes in price and quantity.

Shift in Demand + No Supply Shift

Rightward demand shift → both equilibrium price and quantity increase. Leftward demand shift → both equilibrium price and quantity decrease.

Shift in Supply + No Demand Shift

Rightward supply shift → equilibrium price falls, quantity rises. Leftward supply shift → equilibrium price rises, quantity falls.

Both Curves Shift: Demand Up & Supply Down

Equilibrium price definitely rises; equilibrium quantity is ambiguous (depends on magnitude of each shift — could rise, fall, or stay same).

Ambiguous Outcome Rule

When both curves shift simultaneously, one of the two variables (P or Q) will be ambiguous. Draw at least two graphs to identify which variable is indeterminate.