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ECN 104 FINAL Review.docx

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Ryerson University
ECN 104
Halis Yildiz

Chapter 1: Limits, Alternatives and Choice • Economy comes from a Greek word for “one who manages a household” • Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have • Economics is the social science concerned with the efficient use of scarce resources to achieve the maximum satisfaction of economic wants • Principle 1: People Face Tradeoffs o To get one thing, we give up another thing • Efficiency means society gets the most that it can from its scarce resources • Equity: benefits of those resources are distributed fairly among people in society • 2: The cost of something is what you give up to get it o Opportunity cost of an item is what you give up to obtain that item • 3: Rational people think at the margin o People make decisions by comparing costs and benefits at the margin • 4: People respond to incentives o When apple prices rise, people decide to eat more pears and fewer apples • 5: Trade can make everyone better off o People gain from their ability to trade • 6: Markets are usually a good way to organize economic activity o Invisible hand = Prices! • 7: Governments can sometimes improve market outcomes o Market failure: market fails to allocate resources efficiently, government can intervene to promote efficiency and equity • Economic way of thinking: Involves thinking analytically and objectively • Scientific Method: Systematic pursuit of knowledge through the formulation and testing of hypotheses • Theoretical Economics: involves establishing economic theories by gathering, systematically arranging, and generalizing from facts. Process of deriving and applying economic theories and principles • Generalizations: Economic Theories, principles, and laws are generalizations relating to the economic behaviour or to the economy itself o Ex: Consumer spending rises when person income increases • Ceteris Paribus: It is assumed that all other variables except those under immediate consideration are held constant for particular analysis • Microeconomics focuses on the individual parts of the economy o How household/firm make decisions & how they interact in specific markets • Positive statements are statements that attempt to describe the world as it is: o Based upon facts & cause-and-effect relationships; without value judgments • Normative statements are statements about how the world should be: o Called prescriptive analysis & based on opinions and values (ex: ought to be) • Utility: Satisfaction a consumer obtains from the consumption of a good/service • Budget Line: finite amount of income to be distributed over two goods • Economic resources: all natural, human, and manufactured resources that go into production of goods and resources • Types of resources: Economic: all natural, human, and manufactured resources that go into production; property: land (forests, minerals), capital (human made resources, machines), investment (purchasing machinery); human resources: labour (physical and mental to produce), entrepreneurial ability (human resources that combine other resources to produce a product) • Consumer goods satisfy wants directly while capital goods do so indirectly by aiding the production of consumer goods • Efficiency: getting the most from available resources • Full employment: use of all available resources to produce want-satisfying goods and services • Full production: all employed resources should be used so that they provide the maximum possible satisfaction • Productive efficiency: production of goods and services in the least costly way • Allocative efficiency: production of goods and services most wanted by society • Production possibilities table: lists different combinations of two products that can be produced with available resources in a full employment & production economy • Production possibilities frontier (PPF): a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology (the table in a graph) • Opportunity cost: how much good you give up in order to obtain a specific good o Opportunity cost increases with amount produced: more pizza, less robots o PPF steeper: production possibilities curve is concave (bowed from origin) • Allocative efficacy is decided by comparing marginal cost (MC) to marginal benefit (MB) o Marginal Benefit: Extra benefit associated with consuming one more unit o Marginal Cost: Extra opportunity cost of that extra unit o Resources are efficiently allocated when MB=MC; MB>MC=too few is produced, MC>MB=too many is produced • An individual nation is limited by the production possibilities curve, but NOT when there is international specialization and trade • Positive relationship: variables move in same direction • Negative (inverse) relationship: variables move in opposite direction • Line: Slope is constant; Curve (non-linear): Slope changes • Slope= Change in y-axis value / Change in x-axis value • Society wants are unlimited and insatiable; Resources for producing goods and services are scarce (fundamental facts constituting economic problem and providing foundation of economics) Chapter 2: The Market System and the Circular Flow • Economic system: particular set of institutional arrangements and a coordinating mechanism –to respond to the economic problem • Determines what goods are produced, how they are produced, who gets them, how to accommodate and change and promote technological process • Two types: Command system and Market system • Characteristics of the Market system o Private property and firms, not the government, own cost of the property resources (land and capital) o Freedom of enterprise: Entrepreneurs/businesses are free to obtain and use economic resources to produce their choice of goods and services to sell them in their chosen markets o Freedom of choice: owners can use or sell property as they choose; workers can work where they like; consumers can buy what they want o Self-interest is the motivating force: businesses seek to maximize profits o Competition: Independently acting sellers & buyers operating in a particular product or factor market o Market: Institution or mechanism that brings buyers (demanders) and sellers (suppliers) together o Prices signal scarcity and surplus and guide resource allocation o Active, but limited government (for market failures) o Consumers are in command in determining the types of quantities of the goods produced • Invisible hand: independently acting sellers and buyers operating in a particular product or factor market • Characteristics of Command System: o Also known as socialism or communism: government owns most property and economic decision making occurs through a central economic plan o Coordination Problem: millions of individual decisions by consumers, resource suppliers and businesses.Any coordination problem leads to chain reaction o Incentive problem: no fluctuation in prices or profits to signal and no response to shortage and surplus Chapter 3: Demand, Supply, and Market Equilibrium • Prices are determined in a market system by interaction between buyers and sellers in markets • Markets: Institutions that bring buyers & sellers together for purpose of exchange • Demand: Schedule or a curve that shows the various amounts of a product consumers are willing and able to purchase at each of a series of possible prices, during some specified period of time • Demand table & demand curve reveal the relationship between various prices and quantity a consumer would be willing and able to purchase at each of these prices • Law of demand: all else equal, price falls, quantity demanded rises and as price rises, quantity demanded falls, downward of slope of a demand curve reflects law of demand • Diminishing marginal utility: Consumer increases the consumption of a good service, the marginal utility obtained from each additional unit decreases o Ex: Second big mac yields less satisfaction to the consumer than the first, and the third less than the second • Income effect: Indicates that a lower price increases the purchasing power of a buyer’s income, enabling buyer to purchase more of the products than before • Substitution effect: Suggests that at a lower price, buyers have the incentive to substitute what is now less expensive product for similar products that are now relatively more expensive • Price is the most influential on the amount of any product purchased o Change in price yields a movement along the demand curve & change in Q D o Determinants of Demand: Tastes, number of buyers, income, prices of goods o Change in determinants  change in demand o Positive change makes product more desirable: more will be demanded at each price, increasing demand, shifts demand curve right, unfavorable • Changes in income: when income increases demand for normal goods increases • Normal goods: products for which demand varies directly with money income are called Normal goods (price and other variables remaining constant) • Income increases  demand for inferior goods decrease: leftward shift D curve • Inferior goods: goods for which demand varies inversely with the income o Ex: Used cars vs. new car; used clothing vs. new clothes • Changes in price of related product may either increase or decrease the demand for a product, depends on whether the related good is a substitute or complement • Substitutes: price of one and demand for the other are positively related o Beef and chicken; coke and pepsi; coffee and tea; Toyotas and Hondas o Increase in price of one will increase the demand for the other (rightward) o Decrease in the price of one will decrease the demand for the other (left) • Complements: price of one and demand for other are inversely related o Movies and popcorn; cameras and film; tea and sugar; cereal and milk o Increase in price of one will decrease demand for other (leftward) o Decrease in price of one will increase demand for other (rightward) o When products are unrelated, there is no effect (ex: butter and golf balls) • Change in price of product (other determinants are constant)=change in quantity demanded=movement along the demand curve • Change in determinants of demand=Change in demand • Supply: schedule/curve showing amounts that producers are willing and able to make available for sale at each of a series of possible prices, during some specified period of time • Law of supply: direct relationship between price and quantity supplied o Determinants constant, price rises, quantity supplied rises (price decreases, quantity supplied falls) o Higher the price, greater the incentive to produce o Higher price necessary to induce higher supply, cover costs of production • Supply curve: relationship between price and quantity supplied • Supply schedule: table that shows the relationship between the price of the good and the quantity supplied • Market supply curve is a horizontal summation of individual supply curves • Price is the most important influence on the quantity supplied o Change in price results in a change in the quantity supplied not supply o Change in Q supplied=movement from one point to another on a supply curve • Determinants of supply: factor prices; technology; taxes; prices of other goods • Shifts in the supply curve = change in supply • Shift in the supply curve, left or right, is caused by change in supply determinants • Costs are major factor underlying the supply curves.Anything that affects costs usually shifts the supply curves • Changes in factor prices: decrease will increase supply and shift curve right, more will be supplied at each price o Ex: Decrease in price of microchips increase supply of computers o Increase in input prices will decrease supply and shit curve left • Increases in taxes will reduce supply, decrease in subsidy will reduce supply • New technology will decrease costs and increase supply • Change in quantity supplied is a movement from one point to another on a fixed supply curve • Price of good changes, other determinants are constant, there is change in quantity supplied, but no change in supply • If any determinant changes, there is a change in supply & shift in the supply curve • Equilibrium refers to where the price has reached the level where quantity supplied equals quantity demanded • Equilibrium price: price that balances Qs and Q D Intersect point of curve • Equilibrium quantity: Qs and Q aD theequilibrium price. Intersect point of where the supply and demand curves meet • Productive efficiency: competition among producers forcers them to sue the best technology and right mix of resources • Allocative efficiency: particular mix of goods & services most highly valued by society; demand reflect marginal benefit, supply represents marginal cost • Changes in demand or supply will affect the equilibrium price and quantity • Increase in demand will cause: shortage at the original price P1 • Decrease in demand will cause a surplus at the original price P1 • Price up, Q Sill decrease, Q Dill increase • Price down, Q wSll increase, Q wDll decrease • Decrease in supply will cause a shortage at the original price P 1 • Consumers bid price up to P ,2Qs will increase, Q Dill decrease • If both demand and supply shift, one of either price or quantity cannot be predicted Chapter 4: Elasticity, Consumer Surplus and Producer Surplus • Elasticity allows us to analyze supply and demand with greater precision • Measures how much buyers and sellers respond to changes in market conditions • Elasticity: measure of responsiveness of D or Qs to one of its determinants • Law of demand says increase in price decreases quantity demanded (vice-versa) • Elasticity gives us a measure of responsiveness • When Q rDsponds strongly to change in price, demand is relatively elastic • When Q rDsponds weakly to change in price, demand is relatively inelastic • Price elasticity of demand is a measure of how much the QDof a good responds to a change in the price of that good • Price elasticity of demand is the % change in D given a percent change in price • ED=change in quantity demanded/percentage change in price=%Q / PDice • Midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change • Demand is price inelastic over a given price range o Q doDs not respond strongly to price changes o Price elasticity of demand is less than one • Demand is price elastic over a given range o Q responds strongly to changes in price D o Price elasticity of demand is greater than one • If price elasticity is equal to one, it is unitary elastic • Perfectly Inelastic: D does not respond to price changes • Perfectly Elastic: D changes infinitely with any change in price • Unit Elastic: D changes by the same percentage as the price • Total revenue is the amount paid by buyers and received by sellers of a good • Computed as the price of the good times the quantity sold: TR = P x Q • With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases • Wit
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