Microeconomics 1-4 Test Study Guide

What did Adam Smith believe and what book did he write?

• Believed in laissez‑faire, limited government, and that individuals pursuing their own self‑interest unintentionally benefit society (“invisible hand”).

• Wrote The Wealth of Nations (1776).

What are the basic ingredients of economic decisions?

• Scarcity

• Trade‑offs

• Opportunity cost

• Marginal thinking

• Incentives

What would happen if scarcity were eliminated?

• Economics would not exist.

• No trade‑offs, no opportunity cost, no need to choose.

What would Mick Jaggers song You Can’t Always Get What You Want indicate?

Illustrates scarcity and opportunity cost — you must choose because you can’t have everything.

What is the primary study of Economics?

How people make choices under scarcity.

What is the Economic way of thinking?

• People respond to incentives.

• People make decisions at the margin.

• People face trade‑offs.

What is an economic theory?

• A simplified model used to explain or predict economic behavior.

What does “there is no such thing as a free lunch” mean?

• Everything has an opportunity cost, even if it seems free.

Understand the concept of opportunity costs.

• The value of the next best alternative you give up.

• Always about what you sacrifice, not all possible options.

What does utility mean?

• Satisfaction or happiness gained from consuming a good or service.

What is the most fundamental concept in economics?

Scarcity.

What is voluntary exchange?

• Both parties trade because they expect to be better off.

What are transaction costs?

Costs of making a trade: time, effort, information, transportation, etc.

What is a middleman?

Someone who reduces transaction costs (e.g., Amazon, real estate agents).

How does government enforce property rights?

• Courts, police, legal system, contracts — prevents theft and fraud.

Understand the production possibilities curve

• Shows trade‑offs and opportunity cost.

• Inside curve = inefficient

• On curve = efficient

• Outside curve = impossible

• Bow‑shaped because of increasing opportunity cost.

What are entrepreneurs?

• Risk‑takers who combine resources to create goods/services.

What is creative destruction?

• New innovations destroy old industries (e.g., Netflix vs. Blockbuster).

What does a demand schedule show?

• A table showing quantity demanded at each price.

What does willingness to pay measure?

• The maximum amount a consumer is willing to pay for a good.

What is the law of demand?

• As price ↓, quantity demanded ↑ (inverse relationship).

What is consumer surplus?

• Difference between willingness to pay and actual price.

What does it mean when consumer purchases of a good are relatively elastic?

• Quantity demanded changes a lot when price changes.

• Elasticity > 1.

What does it mean when consumer purchases of a good are relatively inelastic?

• Quantity demanded changes very little when price changes.

• Elasticity < 1.

What happens when there is a decrease of the price of a good?

• Quantity demanded increases (movement along the curve).

What do economists mean when they say the demand for a good has decreased?

The entire curve shifts left

When are two goods considered to be substitutes?

• Goods that replace each other (Coke vs. Pepsi).

• If price of one ↑, demand for the other ↑.

28. How do profits and losses help us?

• Profits signal producers to enter markets.

• Losses signal producers to exit markets.

What does the law of supply tell us?

• As price ↑, quantity supplied ↑ (direct relationship).

What do economists mean when they say the supply of a product has decreased?

Entire supply curve shifts left.

What is a market?

• A place (physical or digital) where buyers and sellers exchange goods.

What happens when the price of a resource increases?

• Supply decreases (higher production cost).

What is the result of the imposition of a price ceiling?

• A legal maximum price.

• Causes shortages.

What happens when the demand for a product increases?

• Curve shifts right → higher price & higher quantity.

Why do economists oppose government price controls?

• They create shortages, surpluses, black markets, and inefficiency.

How does the pricing system correct excess supply?

• Price falls until quantity supplied = quantity demanded.

What does the minimum wage do?

• A price floor on labor.

• Can cause unemployment if above equilibrium.

How does the legal system enhance market efficiency?

• Protects property rights, enforces contracts, reduces uncertainty.

What is a black market?

• Illegal market created when price controls cause shortages.

What does a “deadweight loss” or “excess burden” describe?

• Lost total surplus from taxes, price controls, or inefficiency.

Know the difference between a progressive income tax, a regressive income tax proportional income tax.

• Progressive tax — higher income → higher % paid

• Regressive tax — lower income → higher % paid

• Proportional tax — everyone pays same %