midterm study guide

Chapter 1: Limits, Alternatives, and Choices

Scarcity: The fundamental economic problem of having seemingly unlimited human wants in a world of limited resources.

Purposeful behavior: The idea that individuals and firms make decisions with some desired outcome in mind.

Marginal analysis: Comparing the additional benefits of an action to the additional costs incurred.

Microeconomics vs. Macroeconomics:

Microeconomics: The study of individual economic units, such as consumers, firms, and markets.

Macroeconomics: The study of the economy as a whole, including topics like inflation, unemployment, and economic growth.

Budget Line: A graphical representation of all possible combinations of two goods that a consumer can afford given their income and the prices of goods.

Economic Resources: Also called factors of production, these include:

Land: Natural resources used in production.

Labor: Human effort used in production.

Capital: Manufactured goods used to produce other goods and services.

Entrepreneurship: The ability to bring together resources and take risks to create goods and services.

Production Possibilities Curve (PPC): A graph that shows the maximum possible output combinations of two goods given limited resources and technology.

Opportunity Cost: The value of the next best alternative that is forgone when making a choice.

How to calculate: slope of the line 

Full Employment and Growth on PPC:

Full employment: When all available resources are being used efficiently. 

Economic growth: Shown as an outward shift of the PPC, indicating an increase in resources or technological advancements. ( a move to the right ) 

Law of increasing opportunity cost: 

Chapter 2: The Market System and the Circular Flow

Economic Systems:

Market Economy (Capitalism): Economic decisions are made by individuals and businesses with little government intervention.

Command Economy: The government makes all economic decisions.

Mixed Economy: A combination of market and government control.

Characteristics of a Market Economy:

Private property, freedom of enterprise, self-interest, competition, prices as signals, and limited government involvement.

Five Fundamental Questions:

What to produce?

How to produce?

Who gets the output?

How will the system accommodate change?

How will the system promote progress?

Invisible Hand: A concept by Adam Smith suggesting that individuals pursuing their self-interest unintentionally benefit society.

Creative Destruction: The process where innovation and new technologies replace outdated industries and jobs.

Circular Flow Model: A diagram that shows the flow of goods, services, and money between households and businesses in a market economy. 

Chapter 3: Demand, Supply, and Market Equilibrium

Law of Demand: As the price of a good increases, quantity demanded decreases, and vice versa.

Demand vs. Quantity Demanded: Inverse relationship (downslope)

Demand: The overall relationship between price and quantity demanded, shown as a demand curve.

Quantity demanded: A specific amount demanded at a particular price.

Determinants of Demand: Factors that shift the demand curve, including income, tastes, prices of related goods, expectations, and population.

Law of Supply: As the price of a good increases, the quantity supplied increases, and vice versa.

Supply vs. Quantity Supplied:

Supply: The overall relationship between price and quantity supplied.

Quantity supplied: The specific amount supplied at a given price.

Determinants of Supply: Factors that shift the supply curve, such as input prices, technology, expectations, and the number of sellers.

Income Effect and Substitution Effect:

Income Effect: The change in demand due to a consumer’s real income changing with price changes.

Substitution Effect: The change in demand due to consumers switching to cheaper alternatives.

Normal Good vs. Inferior Good:

Normal Good: Demand increases as income rises (e.g., steak).

Inferior Good: Demand decreases as income rises (e.g., instant noodles).

Complements vs. Substitutes:

Complements: Goods that are used together (e.g., coffee and cream).

Substitutes: Goods that can replace each other (e.g., Coke and Pepsi).

Market Equilibrium: The price and quantity at which demand equals supply.

Price Floor: A minimum legal price, causing a surplus if above equilibrium (e.g., minimum wage). (top P on graph) 

Price Ceiling: A maximum legal price, causing a shortage if below equilibrium (e.g., rent control). (bottom P on graph)

Chapter 6: Elasticity

Elasticity: A measure of how much quantity demanded or supplied responds to price changes.

Price Elasticity of Demand (PED):

Formula: % change in quantity demanded / % change in price. Or / AVG Qty /  

 change in price/ avg price 

Interpretation: If PED > 1, demand is elastic; if PED < 1, demand is inelastic.

Total Revenue Test: If price and total revenue move in opposite directions, demand is elastic.

Cross-Price Elasticity of Demand: % change in qty demanded of x / % change in price of y

Positive: Goods are substitutes.

Negative: Goods are complements.

Income Elasticity of Demand: % change in qty dmded / % change in income 

Positive: Normal good.

Negative: Inferior good.

Chapter 7: Utility Maximization

Utility: The satisfaction gained from consuming a good.

Law of Diminishing Marginal Utility: As consumption increases, the additional satisfaction (marginal utility) decreases.

MU (Marginal Utility) vs. TU (Total Utility):

MU: The additional utility from consuming one more unit. Change in tu/change in quantity 

TU: The total satisfaction from consuming all units.

Utility Maximizing Rule: Consumers allocate income so that the marginal utility per dollar spent is equal across all goods. Mu of a / price of a = Mu of b/ price of b 

Chapter 9: Business and the Costs of Production

Explicit cost: 

Implicit cost: 

Accounting Profit: Formula: Total Revenue - Explicit Costs.

Economic Profit:

Formula: Total Revenue - (Explicit + Implicit Costs).

Costs:

Fixed Cost: Costs that don’t change with output (e.g., rent).

Variable Cost: Costs that change with output (e.g., wages).

Total Cost: Fixed Cost + Variable Cost.

Average Total Cost: Total Cost / Quantity.

Average fixed cost: fixed cost/ quantity 

Average variable cost: Variable cost/quantity 

Marginal cost: change in total cost/ change in quantity 

Short Run vs. Long Run Costs:

Short Run: At least one input is fixed.

Long Run: All inputs are variable.

Economies of Scale: Cost per unit decreases as production increases.

Diseconomies of Scale: Cost per unit increases as production increases.

Law of Diminishing Returns: Adding more of one input while holding others constant eventually leads to decreasing marginal product.

(at some point efficiency decreases)  

MPL: Change in total product/ change in quantity 

Chapter 26: International Trade

Trade and Specialization: Countries focus on goods they can produce efficiently and trade for others.

Absolute Advantage: The ability to produce more of a good with the same resources.

Comparative Advantage: The ability to produce a good at a lower opportunity cost.

Gains from Trade: Both countries benefit by specializing and trading based on comparative advantage.