Exam 1 Review (Chapters 1-3)

Chapter 1 Content

Microeconomics deals with firms and individuals

9 rules come from Microeconomics, 4 from individual choices and 5 from interaction

Economy - system to coordinate productive activities

Economics - study of economic activity (i.e. production consumption, distribution of goods, and svcs)

Market economy - economy where consumption and production decisions are made by individuals

Choice is the heart of economics

Resource - anything can be used to produce something else

Scarce - in short supply; a resource is scarce when there is not enough of it available to satisfy all the various ways a society wants to use it

Opportunity cost - what you must give up in order to get something or what you must give up by not choosing your next best alternative

Trade off - comparison of the costs and the benefits of doing something

Incentives - anything that offers rewards to people who change their behavior

Incentives can be good or bad

Specialization - the situation in which each person specializes in the task that he or she is good at performing

Equilibrium - an economic situation in which no individual would be better off doing something different

Efficient - taking all opportunities to make some people better off without making other people worse off

Equity - a condition in which everyone gets his or her “fair share”

Efficiency and equity are often at odds

The 9 Principles (Individual 1-4 & Interaction 5-9)

Principle #1 - choices are necessary because resources are scarce

Principle #2 - the true cost of something is its opportunity cost

Principle #3 - “How Much” is a decision at the margin

Principle #4 - people usually respond to incentives, exploiting opportunities to make themselves better off

Principle #5 - there are gains from trade

Principle #6 - markets move toward equilibrium

Principle #7 - resources should be used efficiently to achieve society’s goals

Principle #8 - markets usually lead to efficiency

Principle #9 - when markets don’t achieve efficiency, government intervention can improve society’s welfare

The 3 Economy-Wide Interactions

1. One person’s spending is another person’s income

2. Overall spending sometimes gets out of line with the economy’s productive capacity

3. Government policies can change spending

Chapter 2 Content

Model - a simplified representation of a situation that is used to better understand real-life situations

Production Possibilities Frontier (PPF) - diagram that shows the combos of two goods that are possible for a society to produce at full employment

Assumptions of PPF:

1. Economy produces only 2 goods

2. Resources are efficiently utilized

3. Technology is constant

Opportunity cost (PPF) - what must be given up in order to get a good

Opportunity cost calculation - sacrifice / gain

Two possibilities of causing economic growth :

1. An increase in factors of production - resources used to produce goods and services

2. Better technology - the technical means for producing goods and services

Factors of Production:

1. Land

2. Labor - the mental and physical abilities of the workforce

3. Physical capital - manufactured items used to produce other goods and services

4. Human capital - the educational achievements and skills of the labor force (which increases labor productivity)

Theory of Comparative Advantage - It makes sense to produce the things you’re especially good at producing and buy everything else from others

David Ricardo came up with the theory of comparative advantage and argued against British Corn Laws

Corn Laws - high tariffs on imported grain that protected British landowners

A country has a comparative advantage in producing goods for which it has the lowest opportunity cost

Absolute advantage - a country can produce more output per worker than other countries

Absolute advantage and comparative advantage are not the same thing

Positive economics - the branch of economic analysis that describes the way the economy actually works

Normative economics - makes prescriptions about the way the economy should work

Chapter 3 Content

Competitive Market - has many buyers and sellers of the same good or service, none of whom can influence the price

Supply and demand model - a model of how a competitive market behaves

Demand - represents the behavior of buyers

Demand curve shows the quantity demanded at various prices

Quantity demanded - the quantity that buyers are willing (and able) to purchase at a particular price

The Law of Demand - the higher the price for a good or service leads people to demand a smaller quantity

The change in demand and the change in quantity demanded are not the same thing

Decrease in demand - leftward shift

Increase in demand - rightward shift

Demand determinants:

1. Price(own) - change in quantity demanded

2. Non-price - change in demand

Important demand shifters:

• Changes in the prices of related goods or services

  • Two goods are substitutes if a decrease in the price of one leads to a decrease in demand for the other (or vice versa)

  • Two goods are compliments if a decrease in the price of one good leads to an increase in the demand for the other (or vice versa)

• Changes in income

  • Normal good - demand increases when income increases (and vice versa)

  • Inferior good - demand decreases when income increases (and vice versa)

• Changes in tastes

  • Subjective and vary among consumers

  • Seasonal changes or fads have a predictable effect on demand

• Changes in expectations

  • If consumers have a choice about the timing of a purchase, they buy according to expectations

  • Buyers will adjust current spending in anticipation of the direction of future prices in order to obtain the lowest price possible

• Changes in the number of consumers

  • As population of an economy changes, the number of buyers of a particular good also change which changes demand

Supply represents the behavior of sellers

Supply curve - shows the quantity supplied at various prices

Quantity supplied - quantity that producers are willing and able to sell at a particular price

Price and quantity supplied have a direct relationship meaning as price goes up then quantity supplied goes up (and vice versa)

Increase in supply - rightward shift

Decrease in supply - leftward shift

Important Supply Shifters:

• Input prices

  • A decrease in the price of an input increases profits and encourages more supply (and vice versa)

• Prices of related goods or services

  • Inputs used in production have opportunity costs

  • Sellers will supply less of a good if its profitability falls (and vice versa)

  • Substitutes of related goods and services if price goes up for one then the supply of the other goes down (and vice versa)

  • Compliments of related goods and services if price goes up for one then the supply of the other goes up (and vice versa)

• Technology

  • Innovation in technology lowers costs and increases supply

  • New and better technology makes sellers willing to offer more at a given price or sell their quantity at a lower price

• Expectations

  • expectation of a higher price for a good in the future decreases current supply of the good if they can store the good (and vice versa).

  • Sellers will adjust their current offerings in anticipation of the direction of future prices in order to obtain the highest possible price.

  • Future price is predicted to be up - supply decreases

  • Future price is predicted to be down - supply decreases

• Number of producers

  • Entry - more sellers in the market which increases supply

  • Exit - less sellers in the market which decreases supply

Market is in equilibrium when quantity supplied and quantity demanded equal each other at a certain price

Meaning the amount consumers are willing to buy and the amount sellers are willing to sell are matched exactly

Quantity supplied is greater than quantity demanded - there is a surplus

Quantity demanded is greater than quantity supplied - there is a shortage

To get out of a surplus sellers will reduce price

To get out of a shortage sellers will increase price

What happens when supply stays still but demand shifts - if it is a rightward shift then price and quantity rise but if it is a leftward shift then price and quantity fall

What happens when demand stays still but supply shifts - if it is a rightward shift then price will fall and quantity will rise but if it is a leftward shift then price rises and quantity will fall

Demand change - price and quantity move together

Supply change - price and quantity move in opposite directions

If supply and demand both move in the same direction - can predict something about the quantity but not the price unless you know the subcase

If supply and demand both move in opposite directions - can predict something about the price but not the quantity unless you know the subcase

Important Info from the Articles

1. Trade with China and Labor Markets

• Key Points:

  • Trade with China has hurt U.S. workers, especially lower-skilled workers, leading to wage declines and higher unemployment.

  • Labor market adjustments are slower than expected, challenging the traditional view that displaced workers quickly transition to new sectors.

  • Trade imbalances (U.S. imports more from China than it exports) contribute to economic issues like unemployment and asset bubbles.

  • Policy solutions: Tariffs, currency manipulation penalties, and diplomatic negotiations.

• Key Terms:

  • Trade Deficit: When a country imports more than it exports.

  • Currency Manipulation: Artificially devaluing a currency to make exports cheaper.

  • Labor Market Adjustment: The process of workers moving from declining industries to growing sectors.

  • Distributional Effects: How trade benefits some groups (e.g., consumers) while harming others (e.g., workers).

2. C-sections and Physician-Induced Demand

• Key Points:

  • Physician-Induced Demand (PID): Doctors may recommend unnecessary procedures (e.g., C-sections) to increase profits, exploiting information asymmetry.

  • Informed patients (e.g., physician mothers) are less likely to undergo unnecessary C-sections.

  • Payment models: In fee-for-service (FFS) systems, doctors are paid per procedure, creating incentives for unnecessary treatments. In HMOs, doctors are salaried, reducing such incentives.

• Key Terms:

  • Information Asymmetry: When one party (e.g., a doctor) has more information than the other (e.g., a patient).

  • Fee-for-Service (FFS): Payment model where doctors are paid per procedure.

  • HMO (Health Maintenance Organization): Payment model where doctors are salaried, reducing incentives for unnecessary treatments.

  • Malpractice Risk: The risk of being sued for medical errors, which may lead to defensive medicine (e.g., unnecessary C-sections).

3. Game Theory and Leaks in the Trump White House

• Key Points:

  • Prisoner’s Dilemma: Explains why leaking is a dominant strategy in the Trump White House. Staffers leak to protect themselves or undermine rivals.

  • Factionalism: The White House is divided into warring factions, creating a culture of distrust and backstabbing.

  • Nash Equilibrium: The current state where leaking is rampant because it’s the rational choice for each individual, even though it harms the group.

• Key Terms:

  • Prisoner’s Dilemma: A game theory scenario where individuals acting in self-interest produce a worse outcome for all.

  • Dominant Strategy: The best choice for a player, regardless of what others do (e.g., leaking).

  • Nash Equilibrium: A situation where no player can benefit by changing their strategy while others keep theirs unchanged.

  • Factionalism: Division into competing groups, leading to a toxic environment.

4. Prison Market and Captive Consumers

• Key Points:

  • Captive Market: Inmates are a captive market for goods and services like phone calls, healthcare, and commissary items, leading to high prices and exploitation.

  • Private Prisons: Criticized for lobbying for longer sentences and providing substandard conditions.

  • Prison Phone Industry: Charges exorbitant rates for calls, earning $1.2 billion annually, often sharing revenue with prisons.

  • Healthcare in Prisons: Companies like Corizon Health face lawsuits for malpractice and neglect.

• Key Terms:

  • Captive Market: A market where consumers have limited choices, leading to exploitation.

  • Monopoly: A single company dominates the market, allowing it to set high prices (e.g., prison phone companies).

  • Perverse Incentives: Incentives that lead to negative outcomes (e.g., prisons restricting in-person visits to promote costly video calls).

  • Corporate Transparency: Publicly traded companies (e.g., private prisons) are more scrutinized than privately held ones.