ECON 103 Exam 2 Study Guide (from slides)

Chapter 4: Supply and Demand

Introduction to Supply and Demand

Supply and demand are fundamental concepts that form the backbone of market economics, crucial for understanding how consumers and producers interact in the marketplace. These interactions help determine the price of goods and services and the quantity that is traded.

Law of Demand

• Demand Curve: The demand curve illustrates the inverse relationship between price and quantity demanded. It typically slopes downward, indicating that as prices decrease, the quantity demanded increases.

• Factors Influencing Demand:

  • Consumer Preferences: Changes in tastes and preferences can significantly affect demand.

  • Income Levels: As individuals' incomes rise, they generally demand more goods and services.

  • Prices of Related Goods:

    • Substitutes: If the price of a substitute rises, the demand for the original good may increase as consumers switch.

    • Complements: Conversely, if the price of a complement rises, demand for the original good may decrease.

  • Future Expectations of Price: If consumers anticipate that prices will rise in the future, they may buy more now, increasing current demand.

Law of Supply

• Supply Curve: The supply curve depicts the positive relationship between price and quantity supplied. It generally slopes upwards, indicating that as prices increase, producers are willing to supply more goods.

• Factors Influencing Supply:

  • Production Costs: Lower production costs can lead to an increase in supply.

  • Technology Advancements: Innovations can lead to more efficient production processes, increasing supply.

  • Number of Suppliers: More suppliers in the market typically increase the overall supply of goods.

  • Future Price Expectations: If suppliers expect higher prices in the future, they may hold back supply now to sell more later at higher prices.

Market Equilibrium

• Equilibrium Price: The price at which the quantity of a good demanded equals the quantity supplied. At this price, the market is in balance, and buyer and seller interests are aligned.

Shortages and Surpluses:

• Shortage: Occurs when demand exceeds supply at a given price, leading to upward pressure on prices as consumers compete to purchase limited goods.

• Surplus: Exists when supply exceeds demand, resulting in downward pressure on prices as producers strive to sell their excess inventory.

Shifts in Supply and Demand Curves

• Changes in non-price factors can shift the entire demand or supply curves, leading to a new equilibrium price and quantity.

  • For instance, an increase in consumer income can shift the demand curve to the right, indicating an increase in demand at every price. Conversely, an increase in production costs can shift the supply curve to the left, indicating a decrease in supply at every price.

Chapter 5: The Wealth of Nations and Defining and Measuring Economic Aggregates

The Wealth of Nations

• Adam Smith’s Theory: This foundational classical economic theory posits that individuals pursuing their self-interest inadvertently promote the overall good of society through market mechanisms.

• Division of Labor: Specializing workers in specific tasks increases productivity, leading to greater efficiency and wealth creation.

Defining Economic Aggregates

Economic aggregates summarize economic activity and include:

• Gross Domestic Product (GDP): The total value of all final goods and services produced in a country within a specified period.

• Gross National Product (GNP): Measures the total economic output produced by nationals, regardless of where the production occurs.

• Net National Product (NNP): GDP minus depreciation, reflecting the net value produced by a country’s residents.

Measuring Economic Activity

GDP can be measured through three distinct methods:

• Production Approach: Total output value minus intermediate consumption.

• Income Approach: The sum of all incomes earned by factors of production — wages, rent, interest, and profits.

• Expenditure Approach: Total spending on final goods and services, computed as:

  • Y = C + I + G + (X - M)

    • C = Consumption

    • I = Investment

    • G = Government Spending

    • X = Exports

    • M = Imports

Chapter 6: Aggregate Incomes

Understanding Aggregate Incomes

Aggregate income refers to the total income earned in an economy, reflecting the earnings of all factors of production over a specified period.

Components of Aggregate Income

The four major components of aggregate income include:

• Wages and Salaries: Earnings received by workers for their labor contributions.

• Rent: Income generated from leasing physical capital or property.

• Interest: Payments received from the use of capital assets.

• Profits: The net earnings of businesses after deducting all costs from revenue.

Income Distribution

Distribution of income among households and individuals raises concerns regarding inequality. Factors such as education, skills, and inherited wealth can lead to significant disparities in income distribution between different population groups.

Measuring Income Distribution

Methods used include:

• Lorenz Curve: A graphical representation illustrating the proportion of total income earned by cumulative percentages of the population, demonstrating income inequality.

• Gini Coefficient: A numerical measure of income inequality ranging from 0 (perfect equality) to 1 (perfect inequality).

Chapter 7: Economic Growth

Definition of Economic Growth

Economic growth refers to the increase in a country’s output of goods and services, typically measured by the growth rate of real GDP over time.

Factors Contributing to Economic Growth

The primary drivers of economic growth include the following:

• Investment in Physical Capital: Higher investment levels in tangible capital assets boost productive capacity in an economy.

• Enhancements in Human Capital: Investments in education and skills training improve worker productivity, positively influencing economic output.

• Technological Innovation: Technological advancements promote efficiency and create new production and service opportunities.

Measuring Economic Growth

Economic growth is expressed as a percentage increase in real GDP, indicating whether the economy is expanding or contracting. Positive growth rates reflect a healthy economic environment; conversely, negative growth indicates recessions or economic contractions.

Long-term Economic Growth vs. Short-term Fluctuations

Long-term economic growth is characterized by structural improvements fostering sustainable increases in production, while short-term fluctuations can lead to cyclical movements in the economy driven by factors such as business cycles, economic policies, and global economic conditions.