Untitled Flashcards Set

Economics Study Guide

1. Opportunity Cost

Definition:

The value of the next best alternative is foregone when making a decision.

Examples:

• A farmer using land for wheat instead of corn (opportunity cost = corn yield).

• A student choosing a gap year (cost = one year’s potential earnings).

• A government allocating funds to defense over education (cost = educational improvements).

2. Institutions Supporting Good Incentives

• Property rights: Encourage investment and innovation.

• Rule of law: Ensures contracts are enforced and reduces uncertainty.

• Competitive markets: Promote efficiency and consumer choice.

• Patent systems: Incentivize innovation by protecting intellectual property.

• Independent judiciary: Ensures fairness in dispute resolution.

3. Trade and Surplus Creation

Trade reallocates goods to those who value them more, enhancing total surplus via comparative advantage (e.g., trading wine for cloth between countries).

4. Death Penalty for Rapists Increasing Murders

If both rape and murder carry the death penalty, rapists may be incentivized to kill victims to avoid witnesses, as the marginal punishment for murder remains unchanged.

5. Specialization and Trade

Specialization occurs based on comparative advantage (lower opportunity cost). Countries and individuals focus on producing goods they can make most efficiently.

6. Incentives and Behavioral Changes

• Tax hikes reduce consumption of taxed goods.

• Subsidies increase production of subsidized goods.

• Price controls create shortages or surpluses.

7. Trade as a Value Creator

By transferring goods to higher-value users, both parties gain surplus (e.g., selling a book you value at $10 to someone who values it at $20).

8. Thinking at the Margin

Decisions should be made by evaluating marginal benefit vs. marginal cost (e.g., studying one more hour vs. getting extra sleep).

9. Opportunity Cost of College

Total cost = tuition + forgone earnings from not working full-time.

10. Supply and Demand Curve Shifters

Supply Curve Shifters:

• Input prices, technology, number of sellers, taxes/subsidies, expectations.

Demand Curve Shifters:

• Income, prices of substitutes/complements, tastes, population, expectations.

11. Market Equilibrium and Price Adjustments

• Decrease in demand: Leftward shift in the demand curve (e.g., lower income for normal goods).

• Decrease in supply: Higher equilibrium price, lower quantity (e.g., drought reducing crop supply).

• Shortage: Price rises until quantity demanded (QD) = quantity supplied (QS).

12. Consumer and Producer Surpluses

• Consumer Surplus = ∑(Willingness to Pay - Market Price).

• Producer Surplus = ∑(Market Price - Cost to Produce).

13. Complements and Substitutes

• Complements: Peanut butter (if price rises, jelly demand decreases).

• Substitutes: Coke (if price rises, Pepsi demand increases).

14. Loanable Funds Market

• Supply: Savers (households, banks).

• Demand: Borrowers (firms, government).

• Price: Interest rate.

• Government borrowing increases demand, raising interest rates and crowding out private investment.

15. Investment and Risk Factors

• Diversification reduces unsystematic risk.

• Bond rates and prices are inversely related (higher interest rates → lower bond prices).

• Mutual fund fees reduce investor returns.

• Active vs. passive investing: Active funds seek to outperform markets (higher fees), while passive funds track indexes (lower fees).

16. Economic Growth and Innovation

• Rule of 72: Years to double = 72 / interest rate.

• Capital: Produced goods used in production (machinery, infrastructure).

• Innovation: Drives productivity and long-run growth.

17. Government Interventions and Market Outcomes

• Price ceilings (e.g., rent control) create shortages.

• Price floors (e.g., minimum wage) create surpluses.

• Tariffs and quotas raise prices and reduce imports.

• Subsidies and lobbying benefit concentrated groups at society's expense.

18. Rational Ignorance in Voting

People avoid costly information when benefits are low (e.g., voters not researching policies).

19. Economic Theories and Thinkers

• Adam Smith: Advocated for free markets and division of labor.

• James Buchanan: Public choice theory; politics as exchange.

• Median Voter Theorem: Politicians target the preferences of the median voter to win elections.

20. Key Economic Concepts

• Scarcity: Limited resources vs. unlimited wants.

• PPF (Production Possibility Frontier): Shows trade-offs and efficiency.

• Ceteris Paribus: “All else equal” assumption to isolate variables.

• Economic efficiency: Maximizing total surplus in markets.

• Voluntary exchange: Both parties gain in a trade.

• Marginal analysis: Optimal decisions occur where marginal benefit = marginal cost.

21. Market Structures and Competition

• Perfect competition: Many firms, identical products.

• Monopoly: Single seller, high barriers to entry.

• Oligopoly: Few firms, interdependent pricing.

• Monopolistic competition: Many firms, differentiated products.

22. Government and Market Failures

• Public goods: Non-rival, non-excludable (e.g., national defense).

• Externalities: Third-party effects (e.g., pollution).

• Market power: Leads to inefficiencies (e.g., monopolies).

23. The Role of Money and Banks

• Money functions: Medium of exchange, unit of account, store of value.

• Banks: Channel savings to borrowers and create money via lending.

24. Economic Fallacies and Trade-offs

• “No solutions, only trade-offs”: Every policy has costs (Thomas Sowell).

• “Every man a knave”: Institutions assume self-interest to create robust systems (David Hume).

• Economics as prophylactic: Helps prevent fallacies by highlighting unintended consequences.