Economics Midterm 1 Review Notes

Exam Overview and Logistics

• Instructor & Institution: Dr. Jeffrey Levy, Michigan State University.

• Exam Format: 15 multiple-choice questions with a bubble sheet and attached scratch paper (~3–4 minutes per question).

• Required Items: Pen or sharpened pencil, Student ID card.

• Prohibited Items: Calculators, earphones, cheat sheets, notes, scratch paper, and electronic devices. Only pen/pencil, water, and ID card are allowed out.

• Study Content: Definitions, economic reasoning topics, typical exam questions, and basic mathematical operations.

Fundamental Economic Definitions

• Opportunity Cost: The value of the next best option not taken.

• Incentive: Something that induces a person to act.

• Marginal: The next unit of something.

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer.

• Absolute Advantage: The ability to produce goods or services more efficiently, using fewer resources or at lower costs than competitors.

Principles of Rational Decision Making

• True Cost: The true cost of something is what you give up for it (Opportunity cost).

• Self-Interest: People act in their own self-interests (Incentives).

• Marginal Decision Making: People act a little bit at a time, making incremental choices.

Comparative Advantage and Specialization Calculation

• Problem-Solving Strategy: Work through questions in small steps rather than attempting to compute the entire solution at once.

• Opportunity Cost Example (Kenny & Stan Cider Mill):

  • Kenny: Production options are $0\text{ Cider} / 40\text{ Doughnuts}$ or $10\text{ Cider} / 0\text{ Doughnuts}$.

  • Opportunity cost of $1\text{ Cider} = 4\text{ Doughnuts}$.

  • Opportunity cost of $1\text{ Doughnut} = \frac{1}{4}\text{ Cider}$.

  • Stan: Production options are $0\text{ Cider} / 25\text{ Doughnuts}$ or $25\text{ Cider} / 0\text{ Doughnuts}$.

  • Opportunity cost of $1\text{ Cider} = 1\text{ Doughnut}$.

  • Opportunity cost of $1\text{ Doughnut} = 1\text{ Cider}$.

• Specialization Rule: Producers should specialize in the good where they possess the lowest opportunity cost (Kenny in Doughnuts, Stan in Cider).

Market Demand and Supply

• Law of Demand: As the price of a good rises, the quantity demanded will fall, all else held constant.

• Law of Supply: As the price of a good rises, the quantity supplied will rise, all else held constant.

• Determinants of Demand: Normal vs. inferior goods, tastes and preferences, number of buyers, expectations, substitutes, and complements.

• Determinants of Supply: Resource costs, technology, price expectations, number of sellers, taxes, and subsidies.

• Demand and Supply Functions Example (Bananas):

  • Demand equation: $Q_D = 25 - 2P$

  • Supply equation: $Q_S = 3P$

Market Equilibrium and Shifts

• Equilibrium: A situation where nobody has an incentive to do something different.

• Surplus: A market condition in which the quantity supplied exceeds the quantity demanded.

• Shortage: A market condition in which the quantity demanded exceeds the quantity supplied.

• Simultaneous Market Shift Analysis (Pokemon Cards):

  • Demand Shift: Favorable reception of a new Pokemon movie increases buyer preferences, shifting demand right ($D \uparrow$), causing $P \uparrow$ and $Q \uparrow$.

  • Supply Shift: Advanced production technology lowers cost, shifting supply right ($S \uparrow$), causing $P \downarrow$ and $Q \uparrow$.

  • Combined Net Effect: Price change is ambiguous ($P ?$), while quantity increases ($Q \uparrow$).