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ECON 1B03 Midterm 1 study notes.docx

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McMaster University
Usman Hannan

ECONOMICS NOTES: CHAPTER 1: TEN PRINCIPLES OF ECONOMICS 1. all decisions involve tradeoffs a. efficiency vs. equality i. efficiency: when society gets the most from its scarce resources ii. equality: when prosperity is distributed uniformly among society members b. this is a tradeoff, because by promoting equality, we decrease the incentive to work hard, and therefore decrease efficiency 2. The cost of something is what you give up to get it a. opportunity cost i. whatever you must give up to get something 3. Rational people think at the margin a. make decisions by evaluating costs and benefits of marginal changes 4. People respond to incentives a. these are things that induce a person to act 5. Trade can make everyone better off a. international trade allows countries to sell goods abroad and get a higher price, and to buy goods from abroad more cheaply than they could produce them 6. Markets are usually a good way to organize economic activity a. a market is a group of buyers and sellers b. A market economy allocates resources through decisions of the many households and firms as they interact in the market place c. each household and firm acts as if it is being lead by an invisible hand d. interaction of buyers and sellers determines prices e. price reflects good’s value to buyers and cost of producing the good 7. Governments can sometimes improve market outcomes a. enforce property rights i. people are less likely to work, produce, purchase if there is a big risk of property theft 1. i.e. a music company won’t produce music if too many people are illegaly downloading music b. Market failure is when the market fails to allocate society’s resources efficiently i. could be externalities: when the production of a good affects bystanders (ex. pollution) ii. could be market power: a single buyer or seller has a monopoly iii. in market failure, public policy will promote efficiency CHAPTER 1 QUESTIONS: 4. The $5 that you could have had in a year 5. yes, you should complete it, up until it is going to cost you $3million to finish. 6. Hermione is right, as she evaluated both the costs and benefits 7. a) this lowers incentive to save money, and lowers incentive to work 8. this would increase incentive to work, it increases efficiency, but sacrifices equity. 9. trade is good 10. a) you need to investigate the music tastes of Canadians, who has cd players vs. record players, how much it costs to produce a cd b) CDs are complimentary with CD players, so more cds=more cd players. CDs are competing with cassettes, so more CD making=less cassette making 11. people are less sure that their property won’t be stolen, so they are less inclined to work, thus decreasing productivity and efficiency 12. a) efficiency: market failures would be caused by a monopoly on cable prices by a single company. b) equity c)efficiency d) efficiency: a monopoly would cause a market failure, which affects efficiency e) equity f) efficiency 13. a) this would maximize equity, as everyone would get exceptional health care, but it would be inefficient, as all of the country’s scarce resources would be allocated only to health care. b) this maximizes equity, as it ensures that even the unemployed get money, but it lessens incentive to find new work, thus decreasing efficiency 15. if the businesses use this money to build factories, this increases production, and thus increases efficiency, but Canadians had the opportunity cost of not spending their money. 16. reducing inflation (printing less money, thus everything seems to cost less) will increase unemployment in the short run. Increasing inflation (printing more money, thus everything seems to cost more) will decrease unemployment in the short run. CHAPTER 2:  economists act as scientists, trying to explain the world, and as policy advisors, trying to improve it  circular flow diagram o households, firms o market for goods and services, market for factors of production  Factors of production: resources the economy uses to produce goods and services  ex. labour, land, capital  Households: own factors of production  sell/rent them to firms for income  buy and consume goods and services  Firms: buy/hire factors of production  use them to produce goods and services  sell goods and services  Production Possibilities Frontier o shows the combinations of 2 goods the economy can possibly produce  given available resources and technology o if it is under the line, it is not efficient o if it is above the line, it is unattainable o if it is on the line, it is possible, and efficient, as all resources are fully utilized.  as you move along the PPF, you shift resources from the production of one good to another o this is an opportunity cost o we can analyse it numerically using the slope of the line  Economic growth: o with additional resources, PPF shifts outward  economy can produce more of any combination of goods  PPF Shape: o straight: means constant opportunity cost (no specialization of workers, they all are equal at producing a given good) o bowed out: opportunity cost changes as you shift along the PPF  ex. If you produce milk and lawnmowers, when you are producing only milk, at first, opportunity cost to send some workers over to lawnmowers is low, as you send the bad milkers, but as you keep sending more and more workers over to lawnmowers, you lose your experienced milkers, and the opportunity cost increases o could also be bowed out if the resources that you are referring to are differently suited  ex. you are referring to plastic pellets, and some are better suited to make tons of headphones, but the others are better suited to make garbage cans. As you shift pellets from headphones to garbage cans, you will shift the garbage can- suited ones, thus opportunity cost is low, but when you shift lots to garbage cans, you have no choice but to also shift headphone ones.  Types of Statements: o POSITIVE: describe the world as it is  more factual, or theory-based  ex. prices rise when the government prints more money o NORMATIVE: give the reccomendations for what should be done  very opinion based  ex. a tax cut is needed to stimulate the economy  Propositions that Most Economists Agree About: o a ceiling on rent reduces the quantity and quality of housing available o tariffs reduce economic welfare o federal budget deficit negatively impacts economy o flexible exchange rates offer an effective international monetary arrangement o cash payments increase welfare more than direct trades o minimum wage increases unemployment for young, unskilled workers o marketable pollution and taxes would better control pollution than imposition of pollution ceilings CHAPTER 3 INTERDEPENDANCE AND THE GAINS FROM TRADE  exports: goods produced domestically and sold abroad  imports: goods produced abroad and sold domestically  if one country has an ABSOLUTE ADVANTAGE in a product, they are able to produce a good using less resources than another producer o ex. Canada produces wheat in 10 hours, Japan in 25, so Canada has absolute advantage o note: this measure is NOT important for trade  if one country has a COMPARATIVE ADVANTAGE: they are able to produce a good at a lower opportunity cost than another producer o ex. Canada produces 10tons of wheat for every computer sacrificed, Japan produces 100 tons of wheat for every computer sacrificed  Canada has comparative advantage in computers, japan has comparative advantage in wheat  Gains from trade happen when a country specializes in a good in which it has comparative advantage, and imports the other goods from other countries o this allows the country to reach beyond its PPF  ex. Argentina vs. Brazil example: argentina sacrifices 2lbs coffee per bottle wine, brazil sacrifices 5 lbs coffee per bottle of wine, so Argentina has comparative advantage in coffee, and brazil has comparative advantage in wine CHAPTER 3 QUESTIONS: 1. for every 1kg of meat, it takes the farmer 4 hours, in which time, he could have produced 4kg of potatoes. For every 1kg of meat, it takes the rancher 2 hours, in which he could have produced 2kg potatoes 2. Opportunity cost for reading 100 pages of sociology is 40 pages of economics 3. Japan: grain = 500million tonnes per year, cars = 400million per year, slope = 4cars/5grains, you give up 5 grains to make 4 cars (there are 0.8 cars per grain) Canada: grain = 1000 million tonnes per year, cars = 400million per year, slope = 4 cars / 10 grains, you give up 10 grains to make 4 cars, (there are 0.4 cars per grain) they have equal absolute advantage in producing cars Canada has absolute advantage in producing grain if half of the production went to grain, half to cars, Canada would produce 500million grain, 200million cars, japan would produce 250million grain, 200million cars Canada should trade grain for cars, japan should trade cars for grain 4. PAT: 4/5 hour per liter root beer, 2 hours per pizza: opp cost: 2/(4/5) = 10/4 = 2.5 -> you give up 2.5L root beer per pizza KRIS: 6/5 hours per liter root beer, 4 hours per pizza: opp cost: 4/(6/5) = 20/6 = 3.33 ->he gives up 3 1/3 L root beer per pizza Pat has absolute pizza advantage, Pat also has comparative pizza advantage Pat will trade pizzas away for root beer, and the minimum price she should do this for is 2.5L root beer, and the maximum price is 3 1/3 L root beer. 5. O.C. of producing a car: 2/30 = 1/15, O.C. of producing wheat: 15/1 6. yes, as the opportunity cost is less for the student to do these things, because they do not have the same knowledge to use for other things 7. England has absolute scone advantage, Scotland has absolute sweater advantage. England OC scones: 50/1, Scotland OC. scones: 20/1, so England has comparative scone advantage, Scotland has comparative sweater advantage yes 8. a) montreal: 1 red sweater/ blue sweater, Toronto: 2 red sweaters/ blue sweater b) Montreal has absolute adv. in both c)Toronto has comparative adv. in red, montreal has comparative adv. in blue d) Toronto could trade red sweaters for a max. of 1 blue sweater, min of 1 blue sweater, and montreal could trade blue sweaters for a max. of 2 red sweaters, min of 1 red 9. a) all goods require less time to produce in Germany b) France may specialize in some goods, so they sacrifice fewer of one good to produce some of another, thus making it wise for Germany to trade with them c)They could be, as long as France’s comparative advantage for that product was greater than Germany’s 10. a) true: as long as each country has comparative advantage in one product, trade is advantageous b) False: If you have a comparative advantage in one good, the other country automatically has a comparative advantage in the other good. c) False: Trade can be beneficial for both sides. CHAPTER 4: THE MARKET FORCES OF SUPPLY AND DEMAND  market: a group of buyers and sellers of a particular product  competitive market: many buyers and sellers, each one has a negligible effect on price o Perfectly competitive market:  all goods are exactly the same  no one can affect the market price  Quantity Demanded: amount that buyers are willing and able to purchase  Law of Demand: quantity demanded rises when price falls, falls when price rises  Quantity demanded in the market is the sum of the quantities demanded by all buyers at each price  DEMAND CURVE SHIFTERS: o number of buyers  more buyers increases quantity demanded at all prices  shifts curve to the right o Income  For a normal good, increased income increases quantity demanded  shifts curve right  for an inferior good, increased income decreases quantity demanded  shifts curve left o Prices of Related Goods  substitutes: if an increase of price in one good causes an increase in demand for the other  ex. coke and pepsi o if coke prices increase, pepsi demand will increase, shift curve right  compliments: if an increase of price in one good causes a decrease in demand for the other  ex. hotdogs and ketchup o if hotdog price increases, ketchup demand will decrease for all prices, shift curve left o Tastes  tastes change to favour a good  quantity demanded increases  curve shifts right  tastes change against a good  curve shifts left o Expectations  if it is expected that price of a good will increase, curve shifts right  if it is expected price will decrease, curve shifts left  if income is expected to rise, people will demand more quantity now (right)  if people expect to lose their job, people demand less (left)  SUPPLY: o quantity supplied: amount sellers are willing and able to sell o law of supply: when price rises, quantity supplied of a good rises o Quantity supplied in the Market: sum of the quantities supplied by all sellers at each price  SUPPLY CURVE SHIFTERS: o Input Prices  fall in input prices means production is more profitable  companies are willing to sell more at all prices  S curve shifts right o Technology  cost-saving technology is developed  production is more profitable, companies are willing to sell more at each price o S curve shifts right o Number of Sellers  more sellers increases quantity supplied at each price  shifts S curve right o Expectations  there is a war in the middle east, sellers expect gas price to rise  they won’t sell as much gas now, as they want to sell at a higher price  S curve shifts left  EQUILIBRIUM o equilibrium is reached when the price is at the point where quantity supplied equals quantity demanded  this price is the equilibrium price  the equilibrium quantity is the amount supplied and the amount demanded at this price o SURPLUS  when more quantity is supplied than demanded  in this case, sellers will try to reduce the price in order to increase sales  this causes quantity demanded to rise, thus decreasing the surplus o prices fall until the market has reached equilibrium o SHORTAGE  Quantity demanded is greater than quantity supplied  in this case, sellers will increase their price in order to lower the quantity demanded and raise the quantity supplied until the equilibrium point is reached  TERMS: o Change in supply  the shift in the S curve that occurs as a result of non-price factors o Change in quantity supplied:  a movement along the S-curve that occurs when the price changes o Change in demand:  A shift in the demand curve that occurs when non-price demand changes occur o Change in quantity demanded:  the movement along the D-curve when price changes CHAPTER 4 QUESTIONS: 1. a) the quantity supplied of oranges decreased, the curve shifted to the left, so the new equilibrium price was higher b) when the weather is nice in quebec, quantity demanded for quebec hotels increases (curve shifts right), and quebec hotels and carribean hotels are substitutes, so the carribean demand curve shifts left, thus decreasing equilibrium price c)price of gas rises, as due to expectations, quantity supplied falls, thus the curve shifts left, so gas equilibrium price rises. Also, because gas and an suv are complimentary, increase in gas price shifts the demand curve for suv to the left, and decreases equilibrium price 2. false, as with increased quantity demanded, the equilibrium quantity supplied increases 3. a) more children means more buyers, so the demand curve shifts right, and thus eqm price increases b) increased input costs makes it more expensive to produce vans, so sellers aren’t willing to sell for such low prices. Supply curve shifts to the left, equilibrium price increases, quantity supplied decreases c)new automated machinery decreases input costs, supply curve shifts right, quantity supplied for each price
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