ap macro chapter 1

1.1 Scarcity

scarcity - having unlimited wants but limited resources

textbook definition of economics - social science concerned with the efficient use of scarce resources to achieve maximum satisfaction of economic wants

• the science of scarcity, the study of choices (individuals, firms, governments)

• study of how individuals and societies deal with scarcity

microeconomics - study of small economic units such as individuals, firms, and markets

• examples - supply and demand in specific industries, production costs, labor markets

macroeconomics - study of the large economy as a whole or economic aggregates

• examples - economic growth, government spending, inflation, unemployment, international trade

positive statements - based on facts; avoids value judgments (what is)

normative statements - includes value judgments (what ought to be)

theoretical economics - when economists use the scientific method to make generalizations and abstractions to develop theories

policy economics - applying economic theories to fix problems or meet economic goals

5 key economic assumptions

• society’s wants are unlimited, but ALL resources are limited

  • scarcity

• due to scarcity, choices must be made. every choice has a cost

  • every choice has a trade-off

• everyone’s goal is to make choices that maximize their satisfaction. everyone acts in their own “self-interest”

  • everyone’s goal is to maximize satisfaction. we act in our own self-interest

• everyone acts rationally by comparing the marginal costs and marginal benefits of every choice

  • everyone makes decisions by comparing marginal costs and marginal benefits

• real-life situations can be explained and analyzed through simplified models and graphs

marginal analysis - making decisions based on increments

• you will continue to do something as long as the marginal benefit is greater than the marginal cost

marginal benefit - the maximum amount of money a consumer is willing to pay for an additional good or service

marginal cost - the change in cost when an additional unit of a good or service is produced

trade-offs - all the alternatives that we give up when we make a choice

opportunity costs - the most desirable alternative given up when you make a choice

utility - satisfaction

marginal - additional

allocate - distribute

price - the amount the buyer (or consumer) pays

cost - the amount the seller pays to produce a good

consumer goods - created for direct consumption

capital goods - created for indirect consumption

• allows the potential for more resources to be made

four factors of production

• land - all natural resources that are used to produce goods and services

• labor - any effort a person devotes to a task for which that person is paid

• capital

• entrepreneurship - ambitious leaders that combine other factors of production to create goods and services

physical capital - any human-made resource that is used to create other goods and services

• examples - tools, tractors, machinery, factories, etc.

human capital - any skills or knowledge gained by a worker through education and experience

productivity - a measure of efficiency that shows the number of outputs per unit of input

• increasing productivity allows the production of more items with fewer resources

1.2 OC and PPC

production possibilities curve (PPC, frontier) - a model that shows alternative ways that an economy can use its scarce resources

• demonstrates scarcity, trade-offs, opportunity costs, and efficiency

4 key assumptions of the PPC

• only two goods can be produced

• full employment of resources

  • land

  • labor

  • capital

• fixed resources (ceteris paribus)

• fixed technology

point on the PPC curve - represents a specific combination that can be produced given full employment of resources

point inside of the PPC curve - inefficient because not all labor resources are being used (unemployment)

point outside of the PPC curve - not attainable because of scarcity, not enough materials at the moment

opportunity cost - the benefit missed out when choosing an alternative; the next best thing

constant opportunity cost - when resources are easily adaptable for producing either good

• results in a straight-line PPC, not common

law of increasing opportunity costs - as you produce more of any good, the opportunity cost (forgone production of another good) will increase

• happens because resources are NOT easily adaptable to producing both goods

• results in a bowed-out PPC

3 shifters of the PPC

• change in resource quantity or quality

• change in technology

• change in trade (allows more consumption)

change in demand does NOT shift the PPC

decrease in resources - decrease production possibilities for both

quality of resources improves - shifting the curve outward (change in technology)

unemployment is just a point inside the curve - no shift

quality of labor is improved - curve shifts outward

• human capital is impacted significantly, making capital more productive

1.3 Comparative Advantage

trading - everyone specializes in the production of goods and services and trades with others (we don’t produce anything ourselves); more access to trade means more choices and a higher standard of living (no trade = limited materials)

per unit opportunity cost = opportunity cost/units gained

• when calculating opportunity cost we give up what we get (down)

absolute advantage - the producer that can produce the most output or requires the least amount of inputs (resources)

comparative advantage - the producer with the lowest opportunity cost

goods that a country should specialize in - the good that is “cheaper” for them to produce (the one with comparative advantage)

• trade can occur if they have a relatively lower opportunity cost

output questions - the amount of inputs, like time, workers, or other resources, are the same for both countries. only the output of each country is different

• the same amount of workers - the US produces 10 planes, China produces 3 planes

output questions hack

• output

• other goes

• over

input questions - the amount of output, like cars, planes, or corn, are the same for both countries. only the inputs for each country are different

• the US takes 20 workers for 1 plane, China takes 40 workers for 1 plane

input questions hack (variable is resources, like time)

• input

• other goes

• under

terms of trade - agreed upon conditions that benefit both countries

• both benefit from trade if they each have relatively lower opportunity costs

5 comparative advantage hacks

• spotting output vs input questions

  • output - want higher numbers

  • input - want lower numbers

• o.o.o and i.o.u

  • output other goes over - 1/5

  • input other goes under - 5/1

• it’s 50/50

  • one country can only have one comparative advantage

• finding the terms of trade

  • one country wants another country’s item. if produced in the country, it’s expensive so trading benefits both

1 plane for 4 cars 1 car for ¼ plane basically 1p for any number between 5 and 3/2 c

• quick and dirty

  • multiply across to see which two have the comparative advantage

  • 3 × 1 = 3 comparative advantage for input

  • 5 × 2 = 10 comparative advantage for output

  • input would be smaller number, output higher

1.4 Demand

demand - different quantities of goods that consumers are willing and able to buy

law of demand - there is an inverse relationship between price and quantity demanded

• price goes up, quantity goes down, etc.

why does the law of demand occur?

• substitution effect - if the price goes up for a product, consumers buy less of that product and more of another substitute product (and vice versa)

  • pepsi vs coke - if pepsi goes up, people buy more coke

• income effect - if the price goes down for a product, the purchasing power increases for consumers — allowing them to purchase more

• law of diminishing marginal utility - states that as you consume anything, the additional satisfaction that you receive will eventually start to decrease

  • the more you buy of any good, the less satisfaction you get from each new unit consumed

  • we buy goods because we get utility from them

demand curves

• graphical representation of a demand schedule

• downward sloping, showing the inverse relationship between price (y-axis) and quantity demanded (x-axis)

  • the x-axis is always quantity and the y-axis is always price; if switched then the graph is wrong

• when reading a demand curve, assume all outside factors, such as income, are held constant (ceteris paribus)

shifts in demand

• when the ceteris paribus assumption is dropped

  • movement no longer occurs along the demand curve. the entire demand curve shifts

  • shift means that at the same prices, more people are willing and able to purchase that good

  • change in demand, not quantity demanded - PRICE DOESN’T SHIFT THE CURVE

• difference between a change in demand and a change in quantity demanded

  • change in demand - the whole curve shifts (inward/outward, all points shift)

  • change in quantity - only one point shifts, moving along the existing curve

  • change in price - moves along the curve

causes of shift in demand

• market size (number of consumers)

• expectations

• related prices

  • substitutes

  • complements

• income

  • normal goods

  • inferior goods

• tastes and preferences

prices of related goods - the demand curve for one good can be affected by a change in the price of ANOTHER related good

• substitutes - goods used in place of one another

  • if the price of one good increases, the demand for the other will increase (or vice versa)

• complements - two goods that are bought and used together

  • if the price of one increases, the demand for the other will fall (or vice versa)

    • falls are different

income - the incomes of consumers change the demand, but how depends on the type of good

• normal goods (proportional)

  • as income increases, demand increases

  • as income falls, demand falls

  • ex. luxury cars, seafood, jewelry, homes

• inferior goods (inverse)

  • demand is higher when income is low

  • as income increases, demand falls

  • as income falls, demand increases

  • ex. Top Ramen, used cars, used clothes

  • different behavior than normal goods

impacts on the demand curve

changes in market size (number of consumers)

changes in expectations

changes in the prices of related goods or services

changes in income

changes in tastes

1.5 Supply

supply - the different quantities of a good or service that sellers are willing and able to sell (produce) at different prices

law of supply - there is a DIRECT (or positive) relationship between price and quantity supplied

• price increases, quantity (made by producers) increases

• price falls, quantity (made by producers) falls

• at higher prices, profit-seeking firms have an incentive to produce more

difference between change in supply and change in the quantity supplied

• change in supply - shift the whole curve (inward/outward, all points shift)

• change in quantity - movement along the curve (one point shifts)

causes of shift in supply

• technology

• inputs - prices/availability of resources

  • land

  • labor

  • capital

• number of sellers

• government action: taxes and subsidies

  • subsidy - government payment to a business or market. subsidies cause the supply of a good to increase

• expectations of future profit

impacts on the supply curve

changes in technology

changes in input prices

number of sellers

government action - taxes and subsidies

changes in expectations

1.6 Equilibrium

surplus - quantity demanded is less than quantity supplied

shortage - quantity demanded is greater than quantity supplied

supply and demand analysis

• before the change

  • draw supply and demand

  • label original equilibrium price and quantity

• the change

  • did it affect supply or demand first?

  • which determinant caused the shift?

  • draw increase or decreases

• after the change

  • label new equilibrium?

  • what happens to price? (increase or decrease)

  • what happens to quantity? (increase or decrease)

impact of simultaneous shifts of supply and demand on equilibrium price and quantity