ECON MIDTERM NOTES

HIGHLIGHT CONCEPTS ON THE MIDTERM EXAM 

Chapter 1: Limits, Alternatives, and Choices Lecture Notes

Definitions: 

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

• Microeconomics: The study of the individual consumer, firm, or market. 

• Macroeconomics: The study of the entire economy or a major aggregate of the economy.

• Positive economics: economic statements that are factual. •Normative economics: economic statements that involve value judgments.

• Scarcity: means that human wants for goods, services, and resources exceed what is available

• Opportunity cost: a relative price, representing the value of the next best alternative from what was chosen. 

• Budget: a financial plan for a defined period 

• Budget constraint: represents all possible consumption combinations of goods that someone can afford when all income is spent. (what is limited and can go to the highest income you have)

• Opportunity set: represents all possible combinations of consumption that someone can afford given the prices of goods and the individual’s income.

• Firm: Maximizing profit 

• Marginal analysis: the comparison between marginal benefits v. marginal costs

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

• PPF: an economic model that shows different combinations of two foods that an economy can produce 

• Law of Increasing Opportunity Costs: as more of a particular good is produced, its marginal opportunity cost increases

• Positive economics: statements that can be tested and proves true or false

• Negative economics: statements that cannot be tested or proven because they rely on value judgments and individual preferences 

Notes: 

• Scarcity leads to decision-making because we don't have free resources 

• Examples of scarce resources: toilet paper, groceries, water, and cleaning supplies 

• An opportunity cost example could be, What do you trade-off to be here in class? Or what did you sacrifice to be in class?

• What you give up is called a cost

• Economic problem: we have limited income and unlimited wants

• “We actually face thousands of choices every day, but modeling all possible choices is very complex... hence, let us focus on the simplest choice possible: binary (with only two options).”

• Opportunity cost represents what one is giving up to consume and extra unity of the desired good/service 

• In the presentation's example, note that the opportunity cost is the same for any burger Alphonso consumes. This is because the prices paid for consuming each unit of burgers and bus tickets are constant!

• To get one burger, Alphonso must give up 4 bus tickets 

• Scarcity—>choice—> trade-off—> opportunity cost

• The slope of a curve/line allows us to determine the opportunity cost between both choices 

• The objective of a firm and what drives a firm's decisions related to products offered, quantity produces, and pricing is maximizing profit 

• In order to maximize the profit, a business must cut their costs 

• One of the decisions-making frameworks we will use a lot in economics involves marginal analysis 

• marginal= extra or additional 

•  The four main categories of economic resources: 

• Land: Includes all natural resources used in the production process

• Labor: Physical actions and mental activities that people contribute to production 

• Capital (investment): All manufactured aids used in production 

• Entrepreneurial ability: Special human resource distinct from labor; this factor is associated with increases in productivity

• Why are entrepreneurs so important for the economy? 

• They take initiative 

• Make strategic business decisions

• Employ the other factors of production

• Innovate 

• Take risk 

• Can increase competition 

• Entrepreneurs are the driving force behind production and the agent that combines the other factors of production or inputs in a business venture. They risk their time, effort, ability and money because not all ideas or new products will be profitable.

• The PPF represents full employment 

• Full employment means all individuals looking for work can find work. 

2. The number of resources available are fixed unless mentioned otherwise 

3. Productivity is fixed unless mentioned otherwise 

4. To simplify our graphical analysis, we will assume an economy can only produce two goods (binary choice).

• We can test the law of increasing opportunity costs theory by estimating the slope at different points of the curve 

• Positive economics: “what is” ex: working more hours allows you to earn more money

• Normative economics: “what ought to be” ex: working more hours allows you to live better

• What if an economy wants to produce more of all goods? How can an economy increase its productive capacity? 

• Any of the factors below are valid answers: 

1.  Increase resource base 

2. Technological advancements 

3. Improvements in the institutional set up of the government and government programs.

• An economy can also face a negative shock to its productive capacity.

•  Any of the factors below are valid answers:  

1. More leisure, less work  

2. Less resources  

3. Negative institutional changes  

4. Negative technological shocks

How division of labor and specialization increase the productive capacity of a firm and economy: 

• One way to increase productivity is through division of labor.

•  Division of labor breaks down the production process into different tasks. 

• Therefore, there is an incentive for specialization. 

• However, the division of labor is limited by the extent of the market. 

• Adam Smith was the genius behind this finding!

The Benefits of Specialization: 

• How does specialization increase output? 

1. Allows workers to focus on the area where they have an advantage 

2. Specialization leads to faster, higher quality outcomes 

3. Specialization generates economies of scale 

4. Specialization is especially effective when connected with trade. 

• You do not need to learn all the knowledge/skills required to produce everything you consume– just need to trade... 

• Trade, if done efficiently, allows both countries to increase total consumption. It allows them to consume outside their PPF (Production Possibilities Frontier). 

• The evidence that international trade is an overall benefit for economies is pretty strong!

Chapter 3: Demand, Supply, and Market Equilibrium

Definitions: 

• Price: Representation of how much one must pay to acquire a unit of a good or service 

• Market: an environment that allows buyers and sellers to interact and engage in exchanges 

• Demand: shows the various amounts of a product that consumers are willing and able to purchase at each price during a specified periods of time

• Law of demand: the inverse (negative) relationship between price and quantity demanded

• Demand schedule: a table that shows the quantity demanded at each price

• Supply: refers to the amount producers are willing and able to sell at a given price  

• Law of supply: the positive relationship between price and quantity supplied

• Supply schedule: a table that shows the quantity supplied at each price. We graph these points to make a supply curve

• equilibrium price: the only price where the plans of consumers and producers align 

• Equilibrium quantity: the market quantity where the amount of the product consumers want to buy (quantity demanded) is equal to the mount producers want to sell (quantity supplied) 

• Lower income tax = more money for households to use for consumption since they pay lower taxes on income earned. 

• Lower corporate tax = businesses can earn higher profit since they now pay lower taxes on profits.

• Market Disequilibrium: experienced in a market when quantity demanded does not equal quantity supplied at the current price level.

• Price controls: laws that governments enact to regulate prices.

• Price ceiling: keeps a price from rising above a certain level. A legal maximum price that one pays for some good or service (good for buyers) ex. Rent control

• Price floor:  keeps a price from falling below a given level. It is the lowest price that one can legally pay for some good or service (good for suppliers) ex. Minimum wage law

• Consumer surplus: the amount that individuals would have been willing to pay minus the amount that they actually paid. The area above the market price and below the demand curve 

• Producer surplus: the price the producer actually received minus the price the producer would have been willing to accept. The area between the market price and the segment of the supply curve below the equilibrium

• Deadweight loss:  the loss in social surplus that occurs when a market produces an inefficient quantity

Notes: 

Why are prices so important? 

1. They allow us to better understand the value of goods and services in the economy 

2. They allow us to play out finances more effectively, since we can better understand the trade-off we face when consuming goods/services 

• Examples of a market: market for bread, gas, books, loanable funds, labor, etc

• Demand for goods and services are based on consumers wants and needs 

• Demand is also based on consumers ability to pay

• Demand is not the same a quantity demanded

• Quantity demanded is the number of units purchased at a given price 

• In summary, demand is the relationship between possible price levels and the quantity demanded 

• Law of demand states that if price goes up them consumers will buy less

• The downward slope of the demand curve illustrates the law of demand

• NOTE: PRICE DOES NOT CHANGE OR SHIFT DEMAND CURVE, PRICE CHANGES QUANTITY DEMANDED 

Determinants of demand: 

• Change in consumer tastes and preferences 

• Change in the number of buyers 

Change in income: 

• Normal goods 

• Inferior goods 

Change in prices of related goods 

• Substitute good => When the price of one good increases, the quantity demanded also increases

• Complementary good => When the price of one product goes up, the quantity demanded decreases

Change in consumer expectations 

• Future prices => When the future price of a product increases, it causes an increase in quantity demanded in the present. When the future price of a product decreases, the quantity demanded in the present also decreases.

• Future income => When the future income increases, then the demand increases. When the Future income decreases, then the quantity decreases as well

• Supply is not the same as quantity supplied 

• Quantity supplied is the relationship between a range of prices and the quantities supplied

• Supply is the relationship between a range of prices and the quantities supplied 

• As quantity supplied increases, the marginal cost of production tends to increase as well; therefore, to remain profitable a firm must raise prices to supply more units

• In summary, to maintain profitability levels, firms charge higher prices to produce more 

• If price goes upm producers are willing to supply more quantity since it allows them to maintain profitability (ceteris paribus) 

• The upward slope of the supply curve illustrates the law of supply

• Supply refers to the curve 

• Quantity supplied refers to specific points on the supply curve 

• Market Equilibrium= Qd=Qs

• There are three ways to derive the market equilibrium through this analysis: using the demand and supply schedule, graph of demand and supply, and using the demand and supply equations 

The Analysis of How World Events Can Impact the Equilibrium of Markets:

Changes in Equilibrium Price and Quantity: 

The Four-Step Process Four-step process to determine how an economic event affects equilibrium price and quantity: 

Step 1. Determine the market being analyzed and draw a demand and supply model before the economic change took place. 

Step 2. Decide whether the economic change affects demand or supply. 

Step 3. Decide whether the effect causes a curve to shift to the right or to the left, then sketch the new curve(s) necessary on the diagram. 

Step 4. Identify the new equilibrium and then compare to the original.

​​Four-step process to determining how an economic event affects equilibrium price and quantity: 

• Step 1. Determine the market being analyzed and draw a demand and supply model before the economic change took place.

• Step 2. Decide whether the economic change affects demand or supply.

• Step 3. Decide whether the effect causes a curve to shift to the right or to the left, then sketch the new curve(s) necessary on the diagram.

• Step 4. Identify the new equilibrium and then compare to the original.

Determinants of Demand: Summary

1. Change in the prices of related goods: A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of printers increases the demand for ink cartridges (complementary goods).

2. Change in income: A rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as ramen noodles and cheap wine.

3. Change in consumer expectations: Inclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans. 

4. Change in the number of buyers: A decline in the birthrate reduces the demand for children’s toys. 

5. Change in buyers’ tastes: Physical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; smartphone popularity rises, reducing the demand for landline phones.

6. Change in resource prices: A decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline.

7. Change in the number of suppliers: An increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games. 

8. Change in technology: The development of more effective wireless technology increases the supply of smartphones. 

9. Change in taxes and subsidies: An increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education. 

10. Change in prices of other goods a producer can produce: Assuming the producer can produce both chairs and stools. If there is an increase in the price of chairs, the producer will increase the supply of chairs and decrease the supply of stools. 

11. Change in producer expectations: An expectation of a substantial rise in future lumber prices decreases the supply of logs today.

Multiple Choice questions: 

1. Which of the following will cause a decrease in market equilibrium price and an increase in equilibrium quantity? 

a) an increase in supply 

b) an increase in demand 

c) a decrease in supply 

d) a decrease in demand

2. Which of the following statements is correct? 

a) If supply increases and demand increases, equilibrium price will rise. 

b) If supply increases and demand increases, equilibrium quantity will fall. 

c) If supply increases and demand remains constant, equilibrium price will rise. 

d) If supply decreases and demand remains constant, equilibrium price will fall. 

e) If supply increases and demand increases, equilibrium quantity will rise.

• Excess supply or surplus 

• Occurs when the quantity supplied exceeds quantity demanded 

• This happens when the price is above the equilibrium price level 

• Excess demand or shortage 

• Occurs when the quantity demanded exceeds the quantity supplied 

• This happens when the price is below the equilibrium price level

• Note that the surplus in this market indicates the existence of unemployment in the economy!

• Surplus = 𝑄𝑆 − 𝑄D

• Social surplus/economic surplus/total surplus = consumer surplus + producer surplus

Midterm review sample questions and notes

Q1. For the PPC curve, any point inside the curve is attainable yet inefficient, any point on the line is attainable, and any point outside the curve is unattainable

Q2. For this question, identify the equilibrium on the table. See where the quantity demanded and quantity supplied are equal then look at the price. If the price is lower than $50, it would be a price floor, and if the price is above $50, it is a price ceiling. So in this question the answer is price floor

Q3. Look on the graph and see what points show the capital goods increasing but not the consumer goods. Meaning the point B on the graph is not moving on the consumer goods line but the capital goods line is increasing. The answer for this question is a.) BE

Q5. Look at the graph and see what point represents the economy experiencing unemployment. When the line is in the graph, it shows the point is attainable yet inefficient, making it so that the point is representing unemployment. The correct answer if a.) D, the point inside the graph