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ECON 101
Eva Lau

Econ 101 Review Notes Chapter 1 Definitions  Scarcity: the inability to satisfy all of our wants and needs  Incentive: a reward that encourages an action or a penalty that discourages one  Economics: the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices  Microeconomics: the study of choices that individuals and businesses make, the way these choices interact in markets, and the influence of governments  Macroeconomics: the study of the performance of the national economy and the global economy Two Big Economic Questions  1. What, How, and For Whom to produce? o Goods and services are the objects people value and produce to satisfy human wants o What?  What we produce changes over time  It has moved from manufacturing to services o How?  Goods and services are produced using the factors of production:  Land – natural resources  Labour – work time and effort by people (quality depends on human capital)  Capital – tools, instruments, machines, buildings  Entrepreneurship – the human resource that organizes land, labour, and capital o For Whom?  It depends on the incomes that people earn  Land earns rent  Labour earns wages (70% of income)  Capital earns interest  Entrepreneurship earns profit  2. How can the Pursuit of Self-Interest Promote the Social Interest o Self-Interest  A choice that is the best one available to you o Social Interest  Self-interested choices promote the social interest if they lead to an outcome that is best for society as a whole – an outcome that uses resources efficiently and distributes goods and services equitably among individuals  Resources are used efficiently when:  Produced at the lowest possible cost  Produced in the quantities that give the greatest possible benefit o Self-Interest and the Social Interest  Globalization  The Information-Age Economy  Global Warming  Natural Resource Depletion  Economic Instability The Economic Way of Thinking  Choices and Tradeoffs o Tradeoff: giving up one thing to get more of another  What, How, and For Whom Tradeoffs o What Tradeoffs – how to spend income o How Tradeoffs – how to produce o For Whom Tradeoffs – distribution of buying power  The Big Tradeoff: Equality vs. Efficiency  Opportunity Cost: the highest valued alternative given up  Choosing at the Margin o Comparing benefits and costs o Marginal Benefit: the benefit that arises from an increase in an activity o Marginal Cost: the cost of increasing an activity  Economics as Social Science and Policy Tool o Economics as a Social Science  Positive Statements – about what is  Economists test them against facts  Normative Statements – what ought to be  They depend on values and cannot be tested  Economic Models: a description of some aspect of the economic world that includes only the features needed  Natural Experiments: a situation that arises in the ordinary course of economic life  Statistical Investigation: looks for correlation between two variables  Economic Experiment: puts people in a decision-making situation and varies the influence of factors to see how they respond o Economics as Policy Tool  Personal Economic Policy  Business Economic Policy  Government Economic Policy Chapter 1 Appendix  Time Series Graph: measures a variable over time, also reveals trends  Cross-Section Graphs: shows values of an economic variable for different categories at a point  Scatter Diagrams: one variable against another  Positive Relationship (direct relationship): two variables that move up and down together  Negative Relationship (inverse relationship): two variables that move in opposite directions Chapter 2 Production Possibilities and Opportunity Cost  The production possibilities frontier is the boundary between those combinations of goods and services that can be produced and those that cannot  It illustrates scarcity because not all points are attainable  Production Efficiency is achieved is we produce at the lowest possible cost (all points on the PPF)  Production inefficiency is due to unused or misallocated resources Opportunity Cost  As a Ratio: The decrease in the quantity produced of one good divided by the increase in the quantity produced of another  Opportunity cost increases as more of the x-variable are produced  The PPF is bowed outward because resources are not all equally productive in all activities Using Resources Efficiently  Allocative efficiency: when goods and services are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit]  Marginal Cost: the opportunity cost of producing one more unit (the slope of the PPF)  Preferences: a description of a person’s likes and dislikes  Marginal Benefit: the benefit received from consuming one more unit of it (the most that people are willing to pay for an additional unit)  Illustrate preferences using the marginal benefit curve  Allocative Efficiency: MC = MB Economic Growth  Economic growth: expansion of production, increase our standard of living  The Cost of Economic Growth: o Technological Change o Capital Accumulation Gains from Trade  Comparative Advantage: an activity that a person can perform at a lower opportunity cost than anyone else  Absolute Advantage: An activity in which the person is more productive than others  People should specialize in which they have a comparative advantage and then trade  Dynamic Comparative Advantage: a comparative advantage that has been acquired by learning- by-doing Economic Coordination  Firms o An economic unit that hires factors of production and organizes those factors to produce and sell goods and services  Markets o Any arrangement that enables buyers and sellers to get information and to do business with each other  Property Rights o The social arrangements that govern the ownership, use, and disposal of anything that people value  Real property – land  Financial Property – money  Intellectual Property – intangible products of creative efforts  Money – any commodity or token that is generally acceptable as a means of payment Chapter 3 Markets and Prices  Competitive Market: a market that has many buyers and sellers, so no single buyer or seller can influence price  Money Price: the amount of dollars given up for a product  Relative Price: The ratio of one price to another = Opportunity Cost Demand  If you demand something: o Want it o Can afford it o Plan to buy it  Quantity Demanded: the amount that consumers plan to buy during a given time period at a particular price  The Law of Demand: o Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded  Substitution Effect o As opportunity cost rises, there is incentive to switch to a substitute  Income Effect o As price increases consumers must decrease demand for some products  Demand: refers to the entire relationship between the price of a good and the quantity demanded of that good  Change in Demand: when any factor other than the price of the good changes  Six main factors that change demand: o Prices of Related Goods o Expected Future Prices o Income  Normal Good: demand increases if income increases  Inferior Good: demand decreases if income increases o Expected Future Income and Credit o Population o Preferences  Change in Demand: Shifts the curve  Change in Quantity Demanded: Move along the curve Supply  If a firm supplies a good: o They have the resources and technology to produce it o Can profit producing it o Plans to produce and sell it  Quantity Supplied: the amount that producers plan to sell during a given time period at a particular price  The Law of Supply: o Other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied  Price increases because the marginal cost increases  Supply refers to the entire relationship between the quantity supplied of it.  It can be interpreted as a minimum-supply-price curve  A change in Supply: any factor that influences selling plans other than the price of the good changes  Six main factors that change supply: o The prices of factors of production o The prices of related goods produced  Substitutes in production – goods that can be produced by using the same resources  Complements in production – goods that must be produced together o Expected future prices o The number of suppliers o Technology o The state of nature  Change in Supply : shifts the curves  Change in Quantity Supplied: movement along the curve Market Equilibrium  Equilibrium Price: the price at which the quantity supplied equals quantity demanded  Equilibrium Quantity: the quantity bought and sold at the equilibrium price  A market moves towards Equilibrium because of: o 1. Price Regulates o 2. Price Adjustments  Shortage forces prices up  Surplus forces the price down Chapter 4 Price Elasticity of Demand  Price Elasticity of Demand: a units free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same  Price Elasticity of Demand = % Change in Quantity Demanded/%Change in Price  Price Elasticity of Demand = (Change in Q. Demanded/Average Q.)/(Change in P./Average P.)  The calculation always results in a negative value because as the price rises, the quantity demanded decreases.  Perfectly Inelastic Demand: quantity demanded stays constant when the price changes, PED = 0  Unit Elastic Demand: the change in quantity demanded equals the change in price, PED = 1  Inelastic Demand: the change in quantity demanded is less than the change in price,0 < PED < 1  Perfectly Elastic Demand: the quantity demanded changes by an infinitely large percentage in response to a tinky price change  Elastic Demand: PED > 1 Total Revenue and Elasticity  Total Revenue: price of a good multiplied by the quantity sold  Elastic Demand: ↓P increases the quantity sold by more than that change = ↑TR  Inelastic Demand: ↓P increases the quantity sold by less than that change = ↓TR  Unit Elastic Demand: ↓P increases the quantity sold by the same amount = No change in TR  Total Revenue Test: a method of estimating the PED by observing the change in Total Revenue o Elastic Demand: ↓P = ↑TR o Inelastic Demand: ↓P = ↓TR o Unit Elastic Demand: ↓P = No Change  Expenditure And Elasticity o Elastic Demand: Expenditure Increases o Inelastic Demand: Expenditure Decreases o Unit Elastic: Expenditure does not change  Factors the Influence the Elasticity of Demand: o Closeness of Substitutes o Proportion of Income Spent on the Good o Time Elapsed Since Price Change – More time more elastic More Elasticities of Demand  Cross Elasticity of Demand: a measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement, other things remaining the same o CED = % Change in Quantity Demanded/% Change in Price of a Substitute or Complement  Substitute: +  Complement: -  Income Elasticity of Demand: a measure of the responsiveness of the demand for a good or service to a change in income, other things remaining the same o IED = % Change in Quantity Demanded/% Change in Income  IED > 1 = Normal Good/Income Elastic  0 < IED < 1 = Normal Good/Income Inelastic  Negative = Inferior Good Elasticity of Supply  Elasticity of Supply: measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same o Elasticity of Supply = % Change in Quantity Supplied/ % Change in Price  Factors that Influence the Elasticity of Supply o Resource Substitution Possibilities o Time Frame for the Supply Decision  Momentary Supply  Quantity supplied immediately following the price change  Long-run Supply  All technological adjustments have been made  Short-run Supply  Only some of the technological adjustments have been made Chapter 8 Maximizing Utility  Utility: is the benefit or satisfaction that a person gets from the consumption of goods and services  Total Utility: the total benefit that a person gets from the consumption of all the different goods and services  Marginal Utility: the change in total utility that results from a one-unit increase in the quantity of the good consumed o Diminishing Marginal Utility: MU decreases as the consumption of the good increases  The Utility Maximizing Choice o Consumer Equilibrium: a situation in which the consumer has allocated all of his or her available income in the way that maximizes his or her total utility  Choosing at the Margin o Spend All the Available Income o Equalize Marginal Utility per Dollar  Marginal Utility Per Dollar: the marginal utility from a good obtained by spending one more dollar on that good Predictions of Marginal Utility Theory  The Paradox of Value o Water vs. Diamonds o Water = Low Marginal Utility, High Total Utility o Diamonds = High Marginal Utility, Low Total Utility New Ways of Explaining Consumer Choices  Behavioural Economics o Studies the ways in which limits on the human brain’s ability to compute and implement rational decisions influences economic behaviour  Bounded Rationality: We can’t always work out the rational choice  Bounded Will-Power: not enough will power to make a rational choice  Bounded Self-Interest: Limited self-interest (suppress our own interests to help others  The Endowment Effect: a tendency to value something more highly because you own it  Neuroeconomics o The study of the activity of the human brain when a person makes an economic decision  Economic Decisions – prefrontal cortex/hippocampus  Controversy o Most believe economics should be about observing the decisions that people make not about what goes on inside their heads Chapter 9 Consumption Possibilities  Budget Line: describes the limits to a person’s consumption choices o Affordable Quantities: they can consume anywhere on the line or inside of it  Budget Equation: o Y = P*Q + P*Q o Real Income: its income expressed as a quantity of goods that the household can afford to buy (where the budget line crosses the y-axis) o Relative Price: is the price of one good divided by the price of another good. = Opportunity Cost = Slope of the Budget Line o A Change in Prices  Lower the price of the good on the x-axis the flatter is the budget line o A Change in Income  Slope remains the same, but the budget line shifts Preferences and Indifference Curves  Indifference Curve: is a line that shows combinations of goods among which a consumer is indifferent  Preference Map: A series of indifferent curves  Marginal Rate of Substitution o MRS: is the rate at which a person will give up good y to get an additional unit of good x while remaining indifferent o MRS = Slope of the Indifference Curve o Diminishing MRS: a general tendency for a person to be willing to give up less of good y to get one more unit of good x, as the quantity of good x increases  Degree of Substitutability o Close Substitutes o Complements Predicting Consumer Choices  Best Affordable Choice: Point where the budget line intersects the indifference curve o MRS = Relative Price Work Leisure Choices  More leisure, less income, m = Wage Rate  Higher wage increases the opportunity cost of leisure which leads to a substitution effect away from leisure  Higher wage rate increases income and leads to an income effect towards more leisure Chapter 10 The Firm and Its Economic Problem  Firm: an institution that hires factors of production and organizes those factors to produce and sell goods and services  The Firm’s Goal o To maximize economic profit  Accounting Profit = Revenues – Expenses  Economic Accounting o Economic Profit = Total Revenue – Total Cost (Opportunity Cost of Production)  Opportunity Cost of Production o The value of the best alternative use of the resources that a firm uses in production  Resources Bought in the Market  Owned by the firm  Implicit Rental Rate of Capital o Economic Depreciation  Fall in the market value of capital o Forgone Interest  Supplied by the firm’s Owner  Entrepreneurship o Normal Profit: profit earned on average  Owner’s Labour Services o Wages forgone  The Firm’s Constraints o Technology Constraints  Increase in profit is limited by the technology available o Information Constraints  We never possess all the information we would like to have to make decisions  There is a lack of information about the present and future o Market Constraints  Prices, marketing efforts of other firms Technological and Economic Efficiency  Technological Efficiency: occurs when the firm produces a given output using the least amount of inputs  Economic Efficiency: occurs when the firm produces a given output at the least cost  A technologically inefficient method is never economically efficient  A firm that is not economically efficient does not maximize profit Information and Organization  Command Systems: managerial hierarchy – Commands ↓ Information ↑ o Used when easier to monitor performance  Incentive Systems: market-like mechanism within a firm – compensation schemes that induce workers to maximize profit  The Principal-Agent Problem o The problem of devising compensation rules that induce an agent to act in the best interests of the principal  Solutions: o Ownership – responsibility, incentive o Incentive Pay – pay related to performance o Long-term contracts – tie the long-term fortunes to the success of the principal Markets and the Competitive Environment  Markets o Perfect Competition – many firms, identical product, many buyers (grain, crops) o Monopolistic Competition – large number of firms, differentiated products (pizza) o Oligopoly – Small number of firms compete, might produce identical products 0p;  > 60 = Oligopoly  <60 = Monopolistic Competition o Herfindahl-Hirschman Index: the square of the percentage market share of each firm summed over the largest 50 firms  0 = Perfect Competition  10,000 = Monopoly  < 1,000 = Competitive  1,000 < x < 1800 = Monopolistic Competition  > 1800 = Oligopoly o Limitations of a Concentration Measure  Geographical Scope – national/regional/global  Barriers to Entry/Firm Turnover – highly concentrated, but easy entry  Market and Industry Correspondence – markets are narrower, make several products, switch markets Mar
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