ECONMidterm 1 Study Guide

Introduction & Key Principles of Economics

What is Economics?

• Economics: The study of how society manages its scarce resources.

• It addresses the production, distribution, and consumption of goods and services, analyzing how limited resources are allocated to satisfy unlimited wants.

What is Microeconomics?

• Microeconomics: The branch of economics focusing on individual consumers and businesses.

• It examines decision-making processes and resource allocation at the micro-level, highlighting market interactions and consumer behavior.

Society’s 3 Major Questions

1. What to produce?: Decisions on which goods and services should be created based on consumer preferences and resource availability.

2. How to produce it?: The methods utilized in the production process, balancing cost-efficiency and technological methods.

3. For whom to produce?: Determining who receives the goods and services, often influenced by income distribution and societal needs.

The 10 Principles of Economics

1. People face trade-offs: Choosing one option often means giving up another.

2. Opportunity cost: The value of the next best alternative foregone when making a decision.

3. Rational decisions at the margin: People make decisions based on the additional benefits vs. additional costs.

4. Response to incentives: Behavioral changes based on rewards or penalties created by policies or market changes.

5. Benefits of trade: Trade enhances overall welfare, allowing specialization and increased efficiency.

6. Markets organize economic activity: Markets generally provide a structured environment for buyers and sellers, facilitating trade.

7. Government intervention: Occasionally necessary to improve market outcomes and address market failures.

8. Standard of living benefits: A country's ability to produce goods and services directly correlates with its citizens' living standards.

9. Inflation & money supply: Prices typically rise when there is excessive money printing by the government.

10. Short-run trade-off: The relationship between inflation and unemployment, where reducing inflation might lead to increased unemployment in the short term.

Interdependence & Gains from Trade

• Production Possibilities Frontier (PPF): A graphical representation showing the maximum feasible production of two goods.

  • Assumptions in PPF Model:

    • Resources and technology are fixed.

    • All resources are fully employed.

    • Efficient production is achieved.

• Graphing PPF: Ability to create a PPF graph based on tabulated data, identifying attainable and efficient points.

Opportunity Costs

• Opportunity Cost: The cost associated with not choosing the next best alternative.

• Understanding how to calculate opportunity costs using graphical and tabular data, with the slope of the PPF representing opportunity costs between goods.

• Types of PPF:

  • Constant opportunity costs - resources can be shifted without changing efficiency.

  • Increasing opportunity costs - as production of one good increases, the opportunity cost rises.

Economic Growth

• Shifts in the PPF can occur due to:

  • Technological advancements.

  • Increases in resources, leading to economic growth.

• Ability to illustrate economic growth graphically for one or both goods.

Gains from Trade

• Absolute Advantage: The capability of one party to produce more of a good or service with the same resources compared to another.

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than others, emphasizing the benefits of trade and specialization.

• Determine absolute and comparative advantages using tables, and apply the Law of Comparative Advantage to show specialization benefits through graphical and tabular representations.

• Understanding trade scenarios and the graphical depiction of final good distribution.

What is a Market?

• A market is any arrangement that facilitates the exchange of goods and services between buyers and sellers, encompassing various forms such as physical marketplaces and virtual platforms.