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ECON 1000 Midterm: Midterm Review Chap 1-10 with graphs

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Carleton University
ECON 1000
Nick Rowe

Econ 1000; Micro Final December 20, 2016 Semester 1 Summary of Microeconomics and the Textbook Zoyer ClaydenTabobondung OneClass Note-Taker Chapter 1: Ten Principles of Economics Key Terms: • Efficiency: The property of society getting the most it can from scarce resources • Equity: The property of distributing economic prosperity fairly among the members of society. • Scarcity: The limited nature of society’s resources. • Economics: The study of how society manages its scarce resources. • Opportunity Cost: Whatever must be given up to obtain some item. • Rational People: People who systematically do the best they can to achieve their objectives. • Marginal Changes: Small Incremental adjustments to a plan of action • Incentive: something that induces a person to act. • Market Economy: An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. • Property Rights: The ability of an individual to own and exercise control over scarce resources. • Market Failure: A situation in which a market left on its own fails to allocate resources efficiently. • Externality: The impact of one person’s actions on the well-being of a bystander. • Market Power: The ability of a single economic actor to have a substantial influence on market prices. • Productivity: Quantity of goods and services produced from each hour of a worker’s time. • Inflation: an increase in the overall level of prices in the economy. • Business Cycle: Fluctuations in economic activity such as unemployment and production. Core Principles: 1. People Face Tradeoffs. a. Ways to organize scarce resources b. Spend 3 hours studying or do you spend 3 hours playing video games? c. There is no trade off if scarcity is non-existent. 2. The Cost of Something Is What You Give up to get it. a. Opportunity cost b. University or college? c. Nike shoes or Wal-Mart shoes? 3. Rational People Think at the Margin. a. Comparing marginal benefits and marginal costs. b. Marginal Changes to maximize benefit c. Airline has 10 empty seats before a flight; they lower the price of the remaining tickets to fill the plane and maximize the profits from that single flight. d. In order to make a decision the marginal benefit needs to outweigh the marginal cost. 4. People Respond to Incentives. a. Crucial to analyzing markets b. Prices are the largest incentives. c. Taxes incentivize a reduction of purchase. d. Laws can be made to reduce certain behaviors or increase others. 5. Trade Can Make Everyone Better Off. a. Trade facilitates specialization for the skills that people/economies excel at. b. Globalization has made the world interdependent on one another in order to have access to products that each country needs but may not necessarily be able to produce. 6. Markets Are Usually a Good Way to Organize Economic Activity. a. “markets are guided by an invisible hand” – markets lead to desirable outcomes b. Prices are the tool of the invisible hand – they coordinate households and firms c. Taxes distort prices thus affecting how firms and households behave. d. Firms and households interact through providing labor, buying and selling 7. Governments Can Sometimes Improve Market Outcomes. a. Invisible hand needs Governments to enforce the rules that maintain the social institutions that are key facilitators to market economies. b. In order to have a market you need property rights. c. Promotion of equity and efficiency by Governments. d. Centralized market power can cause market failure, Government can prevent or enhance this power. 8. A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services. a. Higher average income will lead to a better standard. b. All based off of productivity within a country, c. Laws on wage and unions can also affect this living standard. d. Prices can also reflect standards of living. 9. Prices Rise When the Government Prints Too Much Money. a. Over time cost for products has risen b. Growth in money causes inflation c. Inflation raises prices d. Over time quantity of money grows e. Inflation is also falling price in money 10. Society Faces a Short Run Tradeoff between Inflation and Unemployment a. Increasing amount of money in economy stimulates overall level of spending and thus increases the demand and supply of goods as well. b. Higher prices encourage increased supply of goods and services. c. More hiring from increased supply means less unemployment. d. The business cycle fluctuates, between prices, supply, unemployment and inflation. Chapter 2: Thinking Like an Economist Key Terms: • Autarky: No trading between countries or firms • Comparative Advantage: When one firm has a lower opportunity cost than a competitor. • Absolute Advantage: One firm has a lower resource cost than a competitor. • Circular-flow diagram: Visual model of the economy that shows how dollars flow through markets among households and firms. • Microeconomics: Study of how households and firms make decisions and how they interact in markets • Macroeconomics: Study of economy-wide phenomena, including inflation, unemployment, and economic growth. • Positive Statements: Claims that attempt to describe the world as it is. • Normative Statements: Claims that attempt to prescribe how the world should be. • Possibility Production Frontier: A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and technology. Key Principles: • Trading is useless without a comparative advantage. • Unemployment increases when imports are too competitive. 1. Observation a. Scientists of relationships b. Scientific method is used when thinking and scheming c. We can only use data and knowledge that has already been provided. d. Can’t do trial and error because economics cannot work like that. 2. Role of Assumptions a. Assumptions allow us to isolate and simplify problems. b. Need to choose between what assumptions to make. c. Different assumptions lead to different affects. 3. Economic Models a. Diagrams and equations help us learn about the relationships of the world of economics b. Assumptions are used with these models. 4. Positive and Normative Analysis a. Polly – how things are, and came to be b. Norma – A observation of how things ought to be. c. Most of economics is made of positive observations. 5. Policy and Economics a. Policies have to benefit the most people, sometimes the right economics move only benefits a few. b. “If all economists were laid end to end, they would not reach to a conclusion” – George Bernard Shaw. c. Different values and opinions can lead different normative statements which can cause disagreement 6. Curves on the Coordinate System a. The demand curve shows the relationship between quantity demanded and price. b. The supply curve shows the relationship between the quantity sold or produced and price. c. Price and demand are negatively related – as price increases, demand decreases. d. Price and supply are positively related – as price increases so does supply. e. Movements along a curve and shifts in a curve are two different things. f. A shift could be a change in income, and a movement could just be a simple price change in a unit. g. Normal goods have increase purchases when income increases. h. 7. PPFs a. Shows tradeoffs and can explain the opportunity cost of producing a single unit. b. Can allow us to discover the most efficient way in organizing resources, or efficient way of production. c. Can also show the inefficient production points of a given economy/firm. 8. Slope. a. Tells us the relationship between buying/selling and prices of given demand or supply curves. Chapter 3: Interdependence and The Gains From Trade Key Terms: • Comparative advantage: the comparison among producers of a good according to their opportunity cost. • Opportunity Cost: whatever must be given up to obtain some item. • Absolute advantage: the comparison among producers of a good according to their productivity. • Imports: Goods and services produced abroad and sold domestically • Exports: Goods and services produced domestically and sold abroad. Key Principles: 1. Production and Specialization a. Self-sufficiency vs trade b. If you try to do everything on your own you will run out of resources for production (time, labour, energy) c. If you specialize, two different parties can produce two separate goods that both parties need and trade with one another so they can maximize their outputs of both goods. 2. Production Possibilities i. Opportunity cost forces you to choose a unit over another ii. Trade can benefit multiple parties. iii. Self-sufficiency means you consume exactly what you produce iv. PPFs show efficiency and how to organize resources for maximized profits. 3. Specialization and Trade a. Benefits from trade are; specialization in best production method for resources. b. Spend less to grow more of one product, to consume more of both types of produce without spending more time by doing both productions individually. 4. Comparative Advantage a. Comparative advantage allows us to see who can produce more with less b. Comparative advantages are given to those who have lower opportunity costs for production. c. Trading is useless without comparative advantage. d. 5. Absolute Advantage a. Whoever produces something with lower inputs has an absolute advantage. b. Absolute advantage works in hand with comparative advantage to organize trade between parties who differ in production ability. c. Failure to compete with imports results in increased unemployment. 6. Comparative Advantage and Trade a. Gains from trade and specialization are measured in terms of comparative advantage. b. Trade allows us to gain goods at a lower cost than the opportunity cost for us to produce said good. c. Trade allows people in society to participate in specialization at the things they are good at. 7. The Price of Trade a. The price for parties to gain in trade is the price at which they trade depends on the two opportunity costs. b. Specialization in in production of the good that has the comparative advantage and trading makes both better off. Chapter 4: The Market Forces of Supply and Demand Key terms: • Substitution Effect: When prices for substitute goods are cheaper than the normal good, consumers choose the cheaper choice. • Income Effect: When income increases so does the purchase of normal goods. When prices go down the same happens. • Market: A group of buyers and sellers of a particular good or service. • Competitive market: a market in which there are many buyers and sellers so that each has a negligible impact on the market place. • Quantity demanded: the amount of a good that buyers are willing and able to purchase. • Law of demand: the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises. • Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded. • Normal Good: a good for which, other things equal, an increase in income leads to an increase in demand. • Inferior Good: a good for which, other things equal, an increase in income leads to a decrease in demand. • Substitutes: two goods for which an increase in the demand for the other. • Compliments: two goods for which an increase in the price of one leads to a decrease in demand for the other. • Quantity Supplied: the amount of a good that sellers are willing and able to sell. • Law of Supply: the claim that, other things equal, the quantity supplied of a good rise when the price of the good rises. • Supply Schedule: A table that shows the relationship between the price of a good and the quantity supplied. • Supply Curve: A graph of the relationship between the price of a good and the quantity supplied. • Equilibrium: A situation in which the price has reached the level where quantity supplied equals quantity demanded. • Equilibrium Price: The price that balances quantity supplied and quantity demanded. • Equilibrium quantity: The quantity supplied and the quantity demanded at the equilibrium price. Key Principles: 1. What is a market? a. Group of buyers and sellers competing for prices of goods and services, purchasing and selling to one another. 2. What is competition? a. A place where price and quantity are determined by the buyers and sellers as they interact with one another. b. Competitive markets where each individual has a negligible effect on the market pricing. c. Perfectly competitive: the goods offered are all the exactly the same, and buyers and sellers are so numerous that no single buyer or seller has an influence over market pricing. 3. Demand curves a. Law of demand b. Quantity demanded falls as price raises, rises as the price falls – negatively related to price. c. Downward sloping line, is the demand curve (not always downward slope) 4. Market Demand versus Individual Demand a. Market demand is the sum of all the individual demands for a particular good or service. b. Demand curve shows demand in relation to price. c. Individual demand curves is just the willingness to pay for each firm/individual. 5. Shifts in the Demand curve a. When the variables we hold constant change, so does the demand curve. b. Externalities and outside variables can shift the demand curve. c. Shifts to the right that increases the quantity demanded at every price – increase in demand d. Shifts that decrease the demand at every price – decrease in demand e. Income i. lower income is less total money to spend, demand for normal goods decrease when income decreases. ii. If demand for a good rises, when income falls it is a inferior good. f. Prices of Related goods i. Substitutes – when price falls for one good decreases demand for another. ii. Pairs of goods used in conjunction with another. (hot dog, ketchup) iii. A fall in the price of one good raises demand for another – complement goods. a. Tastes a. Some changes occur with tastes. b. Expectations a. Expectations of the future can affect demand. Expect higher income, more goods purchased. c. Number of buyers a. Quantity demanded in the market increases as the number of buyers increases. 6. Supply Curve: Relationship between Price and Quantity Supplied. a. Quantity supplied of any good or service is the willingness and ability to sell at the given price. b. Quantity supplied raises as price raises – they are positively related. c. Law of supply – as price raises so does supply. d. Supply curve slopes upwards – prices raise so does supply 7. Market Supply vs. Individual Supply a. Market supply is the sum of all the individuals and firms supply curves. b. Supply curves shows how total supplies varies as the prices of goods varies. 8. Shifts in the Supply Curve a. When the variables we hold constant shift, so does the supply curve. b. Anything that increases supply at every price is an increase in supply. c. Any change that reduces supply at every price is a decrease in supply. d. Input prices i. Resources used to produce the good. ii. Negatively related with quantity supplied – input cost raise > decrease in supply because of reduced profits. e. Technology i. Advance in technology can reduce the labour costs of a firm thus raising the supply of ice cream. f. Expectations i. Expectations of price will force firms to adjust their supply. g. Number of Sellers i. The more sellers there are in a market the more supply of those goods in the same market. If less suppliers, than less supplies as well. 9. Equilibrium a. Point where demand and supply curves intersect. b. This is the equilibrium price, the quantity is the equilibrium quantity. c. At equilibrium price the quantity of a good that buyers are willing to buy equals the quantity that sellers are willing to sell. Or known as the market clearing price because everyone in the market has been satisfied. d. You could make the argument that all resources in the market are used efficiently as well. e. 10. Three Steps to Analyzing Changes in Equilibrium a. Does the shift occur in the demand curve, supply curve or both? b. Does the curve shift to the left or the right? c. Supply/demand diagram to compare the initial equilibrium and the new equilibrium, which shows the effect on equilibrium price and quantity. Chapter 5: Elasticity and Its Application • Elasticity can also be: E= (1/slope) x (P/Q) • Slope and elasticity are negatively related; big slope results in small elasticity, or small slope will result in a bigger elasticity. • Larger P and Q will result in larger elasticity. • Smaller P and Q will result in smaller elasticity. • Perfectly elastic: E = infinity. • Straight supply curves that form from the origin have elasticities of 1. • Supply: E > 0 ‘normal good’ , E < ‘Inferior good’ • If both price and income elasticity is 1, than you are always spending the same income percentage for the good. • Supply: E > Luxury good or normal good. • Supply: 0 < E < 1 , necessity or normal good. • Cross price elasticity of demand” E > O is a substitute good , E < 0 is a compliment good. Key Terms: • Elasticity: A measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants • Price elasticity of demand: a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. • Total revenue (in a market): The amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold. • Income elasticity of demand: a measure of how much the quantity demanded of a good responds to a change in consumers’ income. Computed as the percentage change in quantity demanded divided by the percentage change in income. • Cross-price elasticity of demand: a measure of how much the quantity demanded of one good responds to a change in the price of another good. Computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good. • Price elasticity of supply: a measure of how much the quantity supplied of a good respond to a change in the price of that good. Computed as the percentage change in quantity supplied divided by the percentage change in price. Key Principles: • Elasticity can also be represented as: E= 1/Slope x P/Q 1. Price Elasticity of Demand and Its Determinants a. Price elasticity of demand measures how much the quantity demanded responds to a change in price. b. Demand is elastic if demand responds significantly to price changes. c. Demand is inelastic if demand responds slightly to price changes. d. Elasticity measures how willing consumers are to buy less of the good as its price raises. • Availability of close substitutes: o Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others. • Necessities versus luxuries: o Necessities tend to have inelastic demands. o Luxuries have elastic demands. • Definition of the market: o Elasticity depends on boundaries of the market. o Narrow markets have more elastic demands than broad defined markets because it is easier to find close substitutes for narrowly defined goods. • Time horizon: o Goods have more elastic demand over longer time horizons. 2. Computing the Price Elasticity of Demand a. The number we get is change in Qd proportionate to change in price. b. If E=2 than change in Qd is twice as large as change in P. c. Use absolute value with Elasticity, (drop minus sign if it appears.) d. 3. Midpoint Method: 4. Variety of Demand Curves: a. Demand is elastic when elasticity is greater than 1. b. Demand is inelastic when the elasticity is less than 1. c. If elasticity is exactly 1, so demand and price change equally than it is unit elasticity. d. Flatter the demand curve as it passes through a point the greater the price elasticity of demand. e. The steeper that demand curve through a point, the smaller the price elasticity of demand. f. Vertical demand curve, zero elasticity = perfectly inelastic. 5. Total revenue and the Price Elasticity of Demand a. TR = PxQ b. Total revenue change depends on the price elasticity of demand. c. If demand is inelastic then an increase in the price causes an increase in total revenue. d. An increase in price raises TR because the fall in Q is proportionately smaller than the rise in P. i. In other words, the extra revenue from selling units at a higher price more than offsets the decline in revenue from selling fewer units. e. If demand is elastic, an increase in the price cause a decrease in total revenue. f. Demand is elastic, the reduction in quantity demanded is so great that it more than offsets the increase in the price. g. To summarize: h. When demand is inelastic (less than 1) price and total revenue move in the same direction. i. When demand is elastic (greater than 1) price and total revenue move in opposite directions. j. If demand is unit elastic (equal to 1) total revenue remains constant when the price changes. 6. Elasticity and Total Revenue along a linear demand curve. a. Straight line has a constant slope. b. Elasticity is not constant. 7. Other Demand Curves. a. Income elasticity of demand i. Measures how the quantity demanded changes as consumer income changes. ii. b. Cross-price elasticity of demand i. Measures how the quantity demanded of one good changes as the price of another good changes. ii. Whether the cross-price elasticity is a positive or negative number depends on whether the two goods are substitutes or complements. iii. If prices of good x increases and the quantity of good y increases in demand then the cross-price elasticity is positive. iv. If both goods are compliments, cross-price elasticity is negative. – Indicating that an increase in the price of good x reduces the quantity in good y. v. • 8. The price elasticity of supply and its determinants a. Price elasticity measures how much quantity supplied responds to changes in the price. b. Supply of a good is said to be elastic if the quantity supplied responds substantially to changes in the price. c. Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price. d. Price elasticity depends on the flexibility of sellers to change the amount of the good they produce. e. A key determinant of the price elasticity of supply is the time period being considered. Supply is generally more elastic in the long run than in the short run. f. Firms cannot easily change the size of the factories to make more or less of a good. In the short run the quantity supplied is not very responsive to the price. g. Over longer periods of times, firms can build new factories or close old ones, new firms can also enter a market and old firms can shut down. h. In the long run quantity supplied can respond substantially to price changes. 9. Computing the Price Elasticity of Supply 10. The Variety of Supply Curves a. Price elasticity of supply measures the responsiveness of quantity supplied to the price, which is reflected in the appearance of the supply curve. b. Perfectly inelastic – quantity supplied is the same regardless of price. c. As elasticity rises the supply curve gets flatter, which shows that the quantity supplied responds more to changes in the price. d. Perfectly inelastic – the price elasticity of supply approaches infinity and the supply curve becomes horizontal, meaning that very small changes in the price lead to very large changes in the quantity supplied. e. Low levels of supply – the elasticity of supply is high (limited capacity for production) – indicates that firms have respond substantially to changes in price. – firms have capacity of production that Is not being used. f. Small increases in price make it profitable for firms to begun using the idle capacity, g. As quantity supplied rises firms begin to reach capacity. h. Once capacity is maximized increasing production further requires the construction of new factories. i. To add this extra expense the price must rise substantially so supply becomes less elastic. Chapter 6: Supply, Demand and Government Policies Key Terms: ➢ Price Ceiling: a legal maximum on the price at which a good can be sold. ➢ Price Floor: a legal minimum on the price at which a good can be sold. ➢ Tax incidence: the manner in which the burden of a tax is shared among participants in a market. ➢ Competitive Equilibrium: The point on a PPF where both outputs are creating equal amounts. Key principles: 1. Controls on Prices a. Lobbying can force governments to impose price ceilings to keep b. Successful firms can have Governments impose price floors so their price doesn’t fall below a certain level. 2. How Price Ceilings Affect Market Outcomes a. The price ceiling is not binding when the price that balances both the demand and supply curves is below the price cellings. – Market forces naturally move the economy to the equilibrium, and the price ceiling has no effect on the price or quantity sold. b. When the equilibrium price is above the price ceiling, it is a binding constraint on the market. c. Forces of supply and demand tend to move towards the equilibrium price, but when the market hits the ceiling it can no longer raise further, thus the market price equals the market ceiling. This means that the quantity demanded exceeds the quantity supplied which creates a shortage. Buyers past this point cannot purchase the good. d. A mechanism will develop to challenge shortages – rationing. e. Markets can sell to biases, friends, colleagues or relatives etc. f. The motivation of the ceiling was there to benefit the buyers however not all buyers benefit from the policy. g. When the government imposes a binding price ceiling on a competitive market, a shortage arises and sellers must ration the scarce goods among the large number of potential buyers. h. Free markets ration by adjusting prices. 3. How Price Floors Affect Market Outcomes a. Price floors are a mechanism that governments use to maintain prices at point other than the equilibrium price. – Legal minimum price. b. If the equilibrium price is above the floor than it is not binding. c. Market forces naturally move the economy to the equilibrium, and a price floor will have no affect if not binding. d. When prices are below the price floor, the floor is a binding constraint. e. Binding price floors cause surpluses, because the supply exceeds demand, meaning not everyone can sell their goods. 4. Evaluating Price Controls a. Prices balance supply and demand, which coordinates economic activity and the allocation of resources. b. Price controls generally try to help the poor. c. Price control can discourage people from maintaining their goods, which can in turn hurt consumers. (Housing price controls, force Landlords to not maintain house because of lowered rent so everyone can afford housing. 5. Taxes a. Lobbying groups can persuade governments to have buyers bare the tax burden, because all the suppliers in the market are suffering. b. Other lobbyists can argue that Buyers should bare the tax burden for a similar argument. c. Who burdens the tax? d. Supply and demand help us figure out tax incidences. 6. How Taxes on Buyers Affect Market Outcomes a. Does the law (passed) affect supply or demand curve? i. Immediate impact of a tax is on the demand curve. ii. Supply is unaffected if for any given price of the good, sellers have the same incentive to provide to provide their good. iii. Buyers now have to pay a tax to the government (as well as price to sellers) whenever you purchase the good. iv. Thus the tax shifts the demand curve for the good. b. What way does the curve shift? i. Tax on purchased good makes buying less attractive, buyers demand a smaller quantity at every price. – demand curve shifts to the left. ii. Depending on tax price that’s how much the curve will shift exactly. c. How does the shift affect the equilibrium? i. Implications 1. Who pays the tax burden? 2. Buyers and sellers share the burden, because the market price falls when a tax is introduced, sellers receive less and buyers have to pay more. 3. Taxes discourage market activity. When a good is taxed, the quantity of the good sold is smaller in the new equilibrium. 4. Buyers and sellers share the burden of taxes. In the new equilibrium, buyers pay more for the good and sellers receive less. 7. How Taxes on Sellers Affect Market Outcomes a. Step 1: i. If the tax is not levied on buyers, the quantity of the good demanded at any given price is the same. ii. The demand curve does n
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