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ECON 205: Mid-Term Exam Study Notes

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McGill University
Economics (Arts)
ECON 205
Tom Velk

ECON 205: Mid-Term Exam Study Notes Fall 2011 (1) Y = E + X - M (2) E = A + ßY∝ (3) M = µY (4) D = M - X (5) Y = (1 - ß + µ)^(-1) (A + X) (6) A = (1 - ß + µ) (Y - X) (7) D = µY - X (8) X = µY - D (9) W = aY - D^2 (10) W = aY - (µY - X)^2 (11) dW/dY = a - 2 µ (µY - X) ^2 (12) Y = a/(2 µ^2) + X/µ where: Y = income E = expenditure X = exports M = imports A = autonomous expenditure ß = marginal propensity to spend µ = marginal propensity to import D = balance-of-payments deficit W = welfare a > 0 Ten Key Elements of Economics: 1. incentives matter - if benefits of an option increase, people are more likely to choose it; if personal costs of an option increase, people are less likely to choose it - higher price discourages consumption, but encourages production - lower price discourages production, but encourages consumption - if demand is less than supply, inventory will accumulate and price will go down; lower price will encourage consumers to buy and stop production until the supply and demand balance again - markets are in sync because people alter their behaviour in response to incentives 2. there is no such thing as a free lunch - the use of resources to produce one thing reduces their availability to produce other things - the use of scarce resources always involves a cost, that’s why there’s no such thing as a free lunch - something is not free if the cost has simply been shifted to another person (education) 3. voluntary exchange promotes economic progress - mutual gain is the foundation of trade - three reasons why trade is productive: a) trade channels goods and services to those who value them the most - a good is worthless unless it is in the hands of someone who values it - a voluntary exchange exchanges goods to people who value them, thus increasing the value of both goods, and increasing the wealth of both trading partners b) exchange permits trading partners to gain from specializing in the production of things they do best - law of comparative advantage: specialization allows countries to expands total output by only producing things that they can do at a low cost, and using sales revenue to trade for desired goods it can provide at a high cost c) voluntary exchange permits us to realize gains derived from cooperative effort, division of labour, and the adoption of large-scale production methods - without trade, there would only be self-sufficiency and small-scale production - exchanges allow us to make more of a good, thus enables us to separate production processes into a series of smaller activities which increase individual worker output - divison of labour: separating a large task into smaller tasks; Adam Smith was first to stress the importance of division of labour through his investigation into the process of pin making - specalization: placing all your efforts into producing only one good; allows people to take advantage of their own personal talents and skills - voluntary trade enables complex, large-scale production which would be impossible for an individual household - involuntary trading: does not meet the Perado test 4. transaction costs are an obstacle to exchange; reducing this obstacle will help promote economic progress - transaction costs: time, effort and other resources necessary to search out, negotiate, conclude and exchange - they limit productive capacity and the realization of gains from mutually advantageous trades - transaction costs are sometimes high because of physical obstacles (oceans, rivers, mountains), man-made obstacles (taxes, licensing requirements, government regulations, price controls, tariffs, or quotas) - high costs reduce potential gains from trade - low costs increase gains from trade and thus promote economic progress - middlemen (real estate agents, stockbrokers, automobile dealers, publishers of classified ads) provide trading partners with information and services that help them arrange trades and make better choices - makes it easier for purchasers and sellers to exchange goods 5. increases in real income are dependent upon increases in real output - output: value of goods purchased - income: revenue paid to the people who supply the resources that generate the output - direct relationship between a country’s per capita income and per capita output - improve our standard of living by figuring out how to produce more output - more jobs do not promote economic progress; productive workers, productivity- enhancing machinery enhance economic progress - people think technology harms workers by making their jobs obsolete; technology actually allows workers to be more productive, thus earn more (computer helps accountant balance accounts) - some jobs will not be needed but this will allow workers to apply their energy into better jobs that give them higher standard of living - if minimum wage was increased, workers with low skill will not be able to work, thus reducing per capita output; although it would benefit some people, the overall per capita input will be lower because per capita output will be lower - without productivity of workers there is no wage, without growth in the production of goods there is no real growth in a country’s income 6. the four sources of income growth are (A) improvements in worker skills; (b) capital formation; (c) technological advancement, and; (d) better economic organization - improvements in the skills of workers will promote economic growth - skilled workers are more productive - improve skills, education, training and experience - capital formation can enhance the productivity of workers - workers can produce more if they work with more and better machines - need to invest in tools and machines to produce more in the future - technological advancements will permit us to achieve a larger future output - use brain power to discover new products and less costly methods of production - better economic organization can provide economic growth - legal system in a country influences the degree of economic cooperation - effective economic organization facilitates social cooperation and channels resources towards the production of goods that people value - economic organization that protects wasteful practices and fails to reward the creation of wealth will retard economic progress 7. income is compensation derived from the provision of services to others; people earn income by helping others - income: compensation received in exchange for productive services supplied to others - differences in productive abilities, preferences, opportunities, development of specialized skills, willingness to take risk and luck influence income - the more you help others, the greater your income - people are motivated by the pursuit of income, or to improve the world - the notion that people with a high income exploit others is a fallacy; people have a high income because they help a lot of people 8. profits direct businesses toward activities that increase wealth - if the sales of a business exceed the costs of all resources, the firm will make a profit - if the resources used by a business exceed the price consumers are willing to pay, there will be a loss - firms that are able to produce efficiently and anticipate correctly the products and services for which future demand will be most urgent, will make economic profits - those that are inefficient and allocate resources incorrectly into areas of weak future demand will be penalized with losses - profits and losses direct business towards projects that promote economic progress and away from those that squander scarce resources 9. the “invisible hand” principle - market prices bring personal self-interest and the general
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