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ECN 204 Study Guide - Final Guide: Real Interest Rate, Gdp Deflator, Consumer Spending

Course Code
ECN 204
Thomas Barbiero
Study Guide

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Economics examines how individuals, institutions, and society makes choices under conditions of scarcity
The economic way of thinking stresses (a) resource scarcity and the necessity of making choices, (b) the
assumption of purposeful (or rational) behavior, and (c) comparisons of marginal benefit and marginal cost.
In choosing among alternatives, people incur opportunity costs
In choosing the best option, people incur opportunity costs the value of the next best option
Economists use the scientific method to establish economic theories, cause-effect generalizations about the
economic behavior of individuals and institutions
Microeconomics focuses on specific units of the economy; macroeconomics examines the economy as a
Positive economics deals with factual statements (―what is‖); normative economics involves value judgments
(―what ought to be‖)
Because wants exceed incomes, individuals face an economic problem: they must decide what to buy and
what to forgo
A budget line (budget constraint) shows the various combinations of two goods that a consumer can purchase
with a specific money income
Straight-line budget constraints imply constant opportunity costs associated with obtaining more of wither of
the two goods
Economists categorize economic resources as land, labour, capital, and entrepreneurial ability
The PPC illustrates the (a) scarcity of resources, implied by the area of unattainable combinations of output
lying outside the PPC; (b) choice among outputs, reflected in the variety of attainable combinations of goods
lying along the curve; (c) opportunity cost, illustrated by the downward curve of the slope; and (d) the law of
increasing opportunity costs, reflected in the bowed-outward shape of the curve
A comparison of marginal benefits and marginal costs is needed to determine the best or optimal output mix
on a PPC
Unemployment causes an economy to operate a point inside its PPC
Increases in resource supplies, improvements in resource quality, and technological advances cause economic
growth, which is depicted as an outward shift of the PPC
An economy’s present choice of capital and consumer goods helps determine the future location of its PPC
International specialization and trade enable a nation to obtain more goods than its PPC would indicate
Optimal Allocation: MB = MC
Optimal allocation requires the expansion of a
good's output until its marginal benefit (MB)
and marginal cost (MC) are equal. No resources
beyond that point should get allocated to the
product. Here, allocative efficiency occurs when
200,000 pizzas are produced.

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Unemployment, Productive Inefficiency, and the
Production Possibilities Curve
Any point inside the production possibilities curve,
such as U, represents unemployment or a failure to
achieve productive efficiency. The arrows indicate
that, by realizing full employment and productive
efficiency, the economy could operate on the curve.
This means it could produce more of one or both
products than it is producing at point U.
Economic Growth and the Production Possibilities Curve
The increase in supplies of resources, the improvements in resource quality, and the technological advances that
occur in a dynamic economy move the production possibilities curve outward and to the right, allowing the
economy to have larger quantities of both types of goods.

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Present Choices and Future Locations of a Production Possibilities Curve
A nation's current choice favouring ―present goods,‖ as made by Presentville in part (a), will cause a modest
outward shift of the curve in the future. A nation's current choice favouring ―future goods,‖ as made by
Futureville in part (b), will result in a greater outward shift of the curve in the future.
Macroeconomics studies long-run economic growth and short-run economic fluctuations.
Macroeconomists focus their attention on three key economic statistics: GDP, unemployment, and
inflation. GDP is the dollar amount of all final goods and services produced in a country during a given
period of time. The unemployment rate measures the percentage of all workers who are not able to find
paid employment despite being willing and able to work. The inflation rate measures the extent to which
the overall price level is rising in the economy.
Before the Industrial Revolution, living standards did not show any sustained increases over time.
Economies grew, but any increase in output tended to be offset by an equally large increase in
population, so that the amount of output per person did not rise. By contrast, since the Industrial
Revolution began in the late 1700s, many nations have experienced modern economic growth in which
output has grown faster than populationso that standards of living have risen over time.
Macroeconomists believe that one of the keys to modern economic growth is the promotion of saving and
investment (for economists, the purchase of capital goods). Investment activities increase the economy's
future potential output level. But investment must be funded by saving, which is possible only if people
are willing to reduce current consumption. Consequently, individuals and society face a trade-off
between current consumption and future consumption. Banks and other financial institutions help to
convert saving into investment by taking the savings generated by households and lending them to
businesses that wish to make investments.
Expectations have an important effect on the economy for two reasons. First, if people and businesses are
more positive about the future, they will save and invest more. Second, individuals and firms must adjust
to shockssituations in which expectations are unmet and the future does not turn out the way people
were expecting. In particular, shocks often imply situations where the quantity supplied of a given good
or service does not equal the quantity demanded of that good or service.
If prices were always flexible and capable of rapid adjustment, then dealing with situations in which
quantities demanded did not equal quantities supplied would always be easy since prices could simply
adjust to the market equilibrium price at which quantities demanded do equal quantities supplied.
Unfortunately, real-world prices are often inflexible (or ―sticky‖) in the short run so that the only way for
the economy to adjust is through changes in output levels.
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