Economics Exam 1

MicroEconomics Exam 1 Study Guide

Chapter 1: Limits, Alternatives, and Choices

Key Concepts:

• Economics: social science concerned with making optimal choices under conditions of scarcity.

• Economic perspective: individuals and institutions making decisions by comparing marginal benefits and marginal costs

  • Scarcity and Choice: Resources are limited, requiring choices.

  • Opportunity Cost: The next best alternative foregone when a decision is made.

  • Utility: Satisfaction obtained from consuming a good or service.

  • Marginal Analysis: Decision-making by comparing marginal benefits and marginal costs. (ideally MB = MC)

• Microeconomics vs. Macroeconomics: Focus on individual units vs. the economy as a whole (aggregate of a company).

• Other things equal assumption (ceteris paribus): assumption that factors other than those being considered did not change 

• Positive vs. Normative Economics: Fact-based analysis vs. opinion-based analysis.

• Budget line: combinations of products a person can purchase with a specific amount of money, given products prices (know graph)

• Economizing problem: limited income and unlimited wants 

  • Four economic resources: 

    1. Land: natural resources

    2. Labor: mental or physical exertion used to produce product

    3. Capital (investments): manufactured aids used in production (machinery) 

    4. Entrepreneur ability: person who starts and runs the business (MOST IMPORTANT)--- cereal entrepreneur: innovations continue to many businesses

• Production Possibilities Curve (PPC): attainable occurs below the curve, unattainable is above the curve (rightward shift shows growth) 

• Law of increasing opportunity costs: more of a particular good produced, marginal opportunity cost increases 

Chapter 2: The Market System and the Circular Flow

Key Concepts:

• Economic Systems: who owns and controls everything.

• laissez-Faire Capitalism: government is uninvolved with economy 

• Command system: government owns everything; resources are publicly owned 

  • Ex: north korea

• Market System: individuals own most resources (MOST COMMON)

  • Characteristics: 

    • private property

    • freedom of enterprise- freedom to start businesses without permission

    • freedom of choice- choose what job you want

    • Self-interest- maximise utility 

    • Competition- regulatory mechanism of market system 

    • market and prices- regulate system

• Essay Question Define specialization and 3 ways it is good for the economy: specialization: use of resources to concentrate on one product

  • 3 ways its good for economy: fosters learning by doing, utilizes differences in ability, saves time 

• Monetary system: helps facilitate trade, replaced barter

• Barter: trading goods

  • 2 problems with barter: coincidence of wants and divisibility of value

• 5 fundamental questions:

  • What goods and services will be produced?

    • What will create profit? 

  • How will the goods and services be produced?

    • How can we produce in the least costly manner? 

  • Who will get the goods and services? 

    • Who is willing and able to buy?

  • How will the system accommodate change?

    • Are we in it for the long run or the quick buck?

  • How will the system promote progress?

    • How will society be a better place after business is created? 

    • Creative destruction: when there is an advancement, the new product destroys demand for the old one.

• Customer sovereignty: customer = king 

• Dollar votes: every $ spent on a product votes for the businesses success

• Creative destruction: new version 

• The Invisible Hand by Adam Smith: as you pursue profitability, there is an invisible hand guiding you to make society a better place 

• Circular Flow Model: Interaction between businesses and households in product and resource markets.

  • 4 components: 

    • Business: buy resources, sell products

    • resource market: households sell, businesses buy

    • Households: sell resources, buy products

    • product market: businesses sell, households buy

Chapter 3: Demand, Supply, and Market Equilibrium

Key Concepts:

• Market: place where potential buyers and sellers come together 

  • Ex: stock market, amazon, websites 

• Law of Demand (through the eyes of the consumer): Price and quantity demanded are inversely related. (price falls, demand rises) 

• Change in quantity demanded: move along existing curve vs change in demand: shifts entire curve 

• Essay question Describe the demand curve and give 3 reasons why it is sloped the way it is:                                                                                                                                                                              downward sloping, graphically represents inverse relationship between price and quantity demanded.                                                                                                                                       1. Law of diminishing marginal utility: as we consume more units, the satisfaction decreases           2. Income effect: income level stays the same, price levels go up so demand decreases.                3. substitution effect: buyers have more incentive to substitute a product whose price has fallen

• Shift right = increase in demand 

• Shift left = decrease in demand 

• Essay Question Name and explain determinants of demand and supply        Determinants of Demand:

  • Consumer tastes

  • Number of buyers: larger # of buyers, increases demand 

  • Income: rise in income, increase in demand 

    • Normal goods: goods you buy if you have income (brand names) 

    • Inferior goods: goods you buy when income is low (offbrand) 

  • Prices of related goods

    • Complementary good: goods consumed together (ex: pasta and sauce, demand for one goes up, so does demand for the other)

    • Substitute goods: goods that replace on another (ex: sprite or starry, demand for one goes up, demand for another goes down)

  • Expectations

    • Future prices: future prices go up, demand goes up 

    • Future income: future income goes up, demand goes up 

• Law of Supply (through the eyes of the business owner): Price and quantity supplied are directly related. (price goes up, business supplies more) 

• Supply curve: upward sloping

• Productive efficiency: producing goods in the least costly way

• Allocative efficiency: producing the right mix of goods 

• Shift right = increase in supply

• Shift left = decrease in supply

• Determinants of Supply:

  • Resource prices: higher prices, raise production costs

  • Technology: advancement in technology makes production faster and quicker

  • Taxes and subsidies: higher taxes decrease supply, higher subsidies increase supply

  • Prices of related goods: takes resources away from one item so the supply of the other decreases 

  • Producer expectations: if you think price increase in future, cut back on production for more money in future 

  • Number of sellers: increase in sellers, supply goes up 

• Market Equilibrium: Point where quantity demanded equals quantity supplied.

  • Surplus: above equilibrium

  • Shortage: below equilibrium

• Price Ceilings: max legal price seller will charge for a good ex: rent 

• Price floor: min legal price seller can charge for a good ex: agriculture 

Chapter 4: Market Failures: Public Goods and Externalities

Key Concepts:

• Consumer surplus: difference between what a customer is willing to pay and what they actually pay

• Producer surplus: difference between the actual price a producer receives and the min price they would accept

• Efficiency loss: 

  • Underproduced, the price of a product goes up, purchasing power goes down (takes up too much of our income)

  • Overproduced, price goes down, business makes smaller profits (wasted resources) 

• Externalities: effects you even if you weren’t involved with buying or selling

  • Positive Externalities: Benefits to third parties (ex: education, vaccinations).

  • Negative Externalities: Costs to third parties (ex: pollution).

Chapter 5: Government’s Role and Government Failure

Key Concepts:

• Public good vs. private good 

  • Private good: manufactured by for-profit company ex: legos 

    • Rivalry: the individual who bought the good is the only one who has it and is benefitting from it 

    • Excludability: targeting small groups of not everyone can have the product (ex: higher price point- lamborgini)

  • Public good: good provided by government- for benefit of all people ex: park, police, fire department 

    • Non-rivalry: many people can benefit from good at same time 

    • Non-excludability: people are not excluded if they “pay” or not 

    • Free-rider problem: people who don’t pay, can still benefit ex: seeing fireworks from disney parking lot

• Cost-benefit analysis: lower taxes, more money in pocket, buy more private goods 

• Quasi-public goods: both public and private goods ex: education (public and private schools) 

• Government failure: inefficient outcomes caused by government

  • Voting problems

  • Principal agent problem: once in office, keep powerful groups in favor of you to stay elected

  • Special interest effect: small groups with large influence to sway public opinion ex: NRA

  • Collective-action problem 

  • Earmarks 

  • Rent seeking behavior 

• Limited and bundled choice: a few choices for candidates and all in one side (no way to mix ideas) ex: trump and biden 

• Regulatory capture: at some point government gets involved 

• Political corruption: absue of powers from elected officals 

Essay Questions

16. Define specialization and explain three ways it benefits the economy.

17. Describe the demand curve and provide three reasons why it is downward sloping.

18. Identify and explain the determinants of supply and demand.

19. Define public and private goods and examples. And 2 basic characteristics and explain