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ECO 1102 Exam Review.docx

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University of Ottawa
David Gray

ECO 1102 Ch. 1 • Scarcity: the limited nature of society’s resources • Society’s resources: people, land, buildings, machinery) • Economics: the study of how society manages these scarce resources • Efficiency: the property of society getting the most it can from its scarce resources • Equity: the property of distributing economic prosperity fairly among the members of society. • Opportunity cost: whatever you give up to obtain some item • Rational people: people who systematically and purposefully do the best they can to achieve their objectives • Marginal changes: small incremental adjustments to a plan of action • Incentive: something that induces a person to act • Market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services • Property rights: the ability of an individual to own and exercise control over scarce resources • Market failure: a situation in which a market left on its own fails to allocate resources efficiently • Externality: the impact of one person’s actions on the well-being of a bystander • Market power: the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices • Productivity: the quantity of goods and services produced from each hour of a worker’s time • Inflation: an increase in the overall level of prices in the economy • Business cycle: fluctuations in economic activity, such as employment and production • How people make decisions: o People face trade offs o The cost of something is what you give up to get it o Rational people think at the margin o People respond to incentives • How people interact: o Trade can make everyone better off o Markets are usually a good way to organize economic activity o Governments can sometimes improve market outcomes • How the economy as a whole works: o A country’s standard of living depends on its ability to produce goods and services o Prices rise when the government prints too much money o Society faces a short-run tradeoff between inflation and unemployment Ch. 2 • Circular flow model: a visual model of the economy that shows how dollars flow through markets among households and firms • Productions possibilities frontier: 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 • Economist as a scientist o The scientific method: observation, theory, and more observation  Experiments more difficult o The role of assumptions  To simplify complex stuff o Economic models  do not include all details, simplify to aide our understanding o first model: circular-flow diagram  p. 25 o second model: production possibilities frontier  points on the frontier represent efficient outcomes o micro and macro  microeconomics: the study of how households and firms make decisions and how they interact in markets  macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic growth • the economist as a policy advisor o when economists try to explain the world=scientists o when economists try to improve it=policy advisors o positive vs normative analysis:  positive statements: claims that attempt to describe the world as it is  normative statements: claims that attempt to prescribe how the world should be. o Economists in Ottawa • Why economists disagree o Disagree about validity of alternative positive theories o Have different values and therefore different normative views o Differences in scientific judgments o Differences in values o Perception vs reality Ch. 4 • Markets and competition o What is a market?  Market: a group of buyers and sellers of a particular good or service o What is competition?  Competitive market: a market in which there are many buyers and many sellers so that each has a negligible impact on the market price • Normal good: a good for which, other things equal, an increase in income leads to an increase in demand • Inferior good: a good which, other things equal, an increase in income leads to a decrease in demand • Substitutes: two goods for which an increase in the price of one leads to an increase in the demand for the other • Complements: two goods for which an increase in the price of one leads to a decrease in the demand for the other • Demand: o The demand curve: the relationship between price and quantity demanded  Quantity demanded: the amount of a good that buyers are willing and able to purchase  Law of demand: the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises  Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded  Demand curve: a graph of the relationship between the price of a good and the quantity demanded o Market demand vs individual demand  Sum of all individual demands = market demand o Shifts in the demand curve  Income: shift demand curve  Prices of related goods: shift demand curve  Tastes: shift demand curve  Expectations: shift demand curve  Number of buyers: shift demand curve  Price: movement along demand curve • Supply: o Supply curve: relationship between price and quantity supplied  Quantity supplied: amount of a good or service that sellers are willing and able to sell  Law of supply: the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises  Supply schedule: a table that shows the relationship between the price of a good and the quantity supplied  Supply curve: a graph of the relationship between the price of a good and the quantity supplied o Market supply vs individual supply  Sum of all supplies of individuals = market supplied o Shifts in the supply curve  Input prices: shift supply curve  Technology: shift supply curve  Expectations: shift supply curve  Number of sellers: shift supply curve  Price: movement along supply curve • Supply and demand together o Equilibrium  Equilibrium: a situation in which the price has reached the level where quantity supplied equals quantity demanded  Equilibrium price: the price that balances quantity supplied and quantity demanded  Equilibrium quantity: the quantity supplied and the quantity demanded at the equilibrium price  Surplus: a situation in which quantity supplied is greater than quantity demanded  Shortage: a situation in which quantity demanded is greater than quantity supplied  Law of supply and demand: the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance o Three steps to analyzing changes in equilibrium  1. Shift supply, demand, or both  2. Shifts right or left  3. Compare initial equilibrium with new one Ch. 5 • the economy’s income and expenditure o income and expenditure are always equal because there is always a buyer and a seller • the measurement of gross domestic product o gross domestic product (GDP): the market value of all final goods and services produced within a country in a given period of time o “GDP is the market value…” prices o “… of all…” all items sold legally, can underestimate o “… final…” does not include intermediate goods (things used to make final goods) o “… goods and services…” includes tangible and intangible things o “… produced…” when GM sells a car it is included, if the car is later sold used it is not included o “…Within a country…” regardless of nationality if it is done within Canadian borders it is included o “… in a given period of time.” Usually quarterly or yearly • the components of GDP o GDP=consumption+investment+government puchases+net exports o Consumption  Consumption: spending by households on goods and services, with the exception of purchases of new housing o Investment  Investment: spending on capital equipment, inventories, and structures, including household purchases of new housing o Government purchases  Government purchases: spending on goods and services by local, territorial, provincial, and federal governments o Net exports  Net exports: the value of a nation’s exports minus the value of its imports; also called the trade balance • Real vs nominal GDP o A numerical example  Nominal GDP: the production of goods and services valued at current prices  Real GDP: the production of goods and services valued at constant prices o The GDP deflator  GDP deflator: a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100 (nominal/real)*100  Inflation rate in year 2=(GDP deflator in year 2-GDP deflator in year 1)/(GDP deflator in year 1)*100 • GDP and economic well-being Ch. 6 • Consumer price index o Consumer price index (CPI): a measure of the overall cost of the goods and services bought by a typical consumer o How the CPI is calculated  The quantity of the goods and services (determine the basket)  Find the prices  Compute the basket’s cost  Choose a base year  CPI=[(price of basket of goods or services in the current year)/price of basket in base year]*100  Compute the inflation rate  Inflation rate: the percentage change in the price index from the preceding period  Inflation rate in year 2=CPI in year 2-CPI in year 1/CPI in year 1*100  Core inflation: the measure of the underlying trend of inflation o Problems in measuring the cost of living  Commodity substitution bias: price changes do not change proportionally, therefore overestimates  Introduction of new goods  Unmeasured quality change o The GDP deflator vs the CPI  Gdp deflator monitors goods and services produced domestically, cpi monitors goods and services baught by consumers  Cpi keeps a fixed basket, gdp changes constantly • Correcting economic variables for the effects of inflation o Dollar figures from different times  Older time price in newer time dollars=older time price*(CPI in newer time/CPI in older time) o Indexation  Indexation: the automatic correction of a dollar amount for the effects of inflation by law or contract o Real and nominal interest rates  Nominal interest rate: the interest rate as usually reported without a correction for the effects of inflation  Real interest rate: the interest rate corrected for the effects of inflation  Real interest rate=nominal interest rate-inflation rate Ch. 7 • Economic growth around the world • Productivity: its role and determinants o Why is productivity so important?  In a simple economy, your productivity at doing certain things determine your living standards (alone doing everything yourself) same for a nation o How productivity is determined  Physical capital per worker • Physical capital: the stock of equipment and structures that are used to produce goods and services  Human capital per worker • Human capital: the knowledge and skills that workers acquire through education, training, and experience  Natural resources per worker • Natural resources: the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits  Technological knowledge • Technological knowledge: society’s understanding of the best ways to produce goods and services • Economic growth and public policy o The importance of saving and investment  Accumulating capital now rewards with better productivity later o Diminishing returns and the catch-up effect  Diminishing returns: the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases  Catch-up effect: the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich o Investment from abroad  Foreign direct investment: a capital investment that is owned and operated by a foreign entity  Foreign portfolio investment: an investment that is financed with foreign money but operated by domestic residents  GNP: income earned domestically and abroad o Education  Investment in human capital  Brain drain: most educated people from poo countries move to rich countries o Health and nutrition  Healthier workers are more productive o Property rights and political stability  No worries about stealing  When there is political instability, there is worry about property rights being kept o Free trade  Inward-oriented policies: attempts to raise productivity and living standards by avoiding contact with other countries  Outward-oriented policies o Research and development  Knowledge is a public good, once one has it anyone can learn about it  Patents allow public goods to become private goods for a period of time o Population growth  Stretching natural resources  Diluting the capital stock  Promoting technological progress Ch. 8 • Financial system: the group of institutions in the economy that help to match one person’s saving with another person’s investment • Financial institutions in the Canadian economy o Move’s the economy’s scarce resources from savers to borrowers o Financial markets  Financial markets: financial institutions through which savers can directly provide funds to borrowers  The bond market • Bond: a certificate of indebtedness • Bond’s term is the length of time until the bond matures • Credit risk is the probability that the borrower will fail to pay some of the interest or principal  The stock market • Stock: a claim to partial ownership in a firm • Sale of stocks to raise money is called finance equity • Sale of bonds to raise money is called debt finance o Financial intermediaries  Financial intermediaries: financial institutions through which savers can indirectly provide funds to borrowers  Banks • Deposits are used for loans • Interest on loans are higher than deposits to cover the banks’ costs and returns some profit to the owners of the bank • Medium of exchange (cheques)  Mutual funds • Mutual fund: an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds • Managers in the institutions automatically buy in stocks that may be profitable and sell those that are not • Index funds buy and sell less often and you don’t need to pay a money manager’s salary • Saving and investment in the national income accounts o Some important identities  Recall GDP=C+I+G+NX  In closed economy GDP=C+I+G • GDP-C-G=I • National saving (saving): the total income in the economy that remains after paying for consumption and government purchases • Saving=GDP-C-G=I • S=I • S=GDP-C-G OR S=(GDP-T-C)+(T-G) • T is the amount the government collects from households in taxes minus the amount it pays back the households in the form of transfer payments  Private saving: the income that households have left after paying for taxes and consumption • Households receive income of GDP, pay taxes of T, and spend C, private saving is GDP-T-C  Public saving: the tax revenue that the government has left after paying for its spending • Government receives T in tax revenue and spends G on goods and services.  Budget surplus: an excess of tax revenue over government spending  T-G is public saving  Budget deficit: a shortfall of tax revenue from government spending o The meaning of saving and investment • The market for loanable funds o Market for loanable funds: the market in which those who want to save supply funds and those who want to borrow to invest demand funds o Supply and demand for loanable funds  Saving is the source of the supply of loanable funds  Investment is the source of the demand for loanable funds  Model is on page 176 o Policy 1: Saving Incentives o Policy 2: Investment Incentives o Policy 3: Government Budget Deficits and Surpluses  Government debt: the sum of all budget deficits and surpluses  Crowding out: a decrease in investment that results from government borrowing  Vicious circle: cycle that results when deficits reduce the supply of loanable funds, increase interest rates, discourage investment, and result in slower economic growth; slower growth leads to lower tax revenue and higher spending on income-support programs, and the result can be even higher budget deficits  Virtuous circle: cycle that results when surpluses increase the supply of loanable funds, reduce interest rates, stimulate investment, and result in faster economic growth; faster growth leads to higher tax revenue and lower spending on income-support programs, and the result can be even higher budget surpluses Ch. 9 • Identifying unemployment o How is unemployment measured  Adults aged 15 and over: • Employed • Unemployed • Not in the labour force  Labour force: the total number of workers, including both the employed and the unemployed  Unemployment rate: the percentage of the labour force that is unemployed  Labour-force participation rate: the percentage of the adult population that is in the labour force o Does the unemployment rate measure what we want it to?  Discouraged searchers: individuals who would like to work but have given up looking for a job o How long are the unemployed without work? o Why are there always some people unemployed?  Natural rate of unemployment: the rate of unemployment to which the economy tends to return in the long run  Cyclical unemployment: the deviation of unemployment from its natural rate  Frictional unemployment: unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills  Structural unemployment: unemployment that results because the number of jobs available in some labour markets is insufficient to provide a job for everyone who wants one • Job search o Job search: the process by which workers find appropriate jobs given their tastes and skills o Why some frictional unemployment is inevitable  Economy is always changing o Public policy and job search  Internet search, employment agencies o Employment insurance  Employment insurance (EI): a government program that partially protects workers’ incomes when they become unemployed • Minimum-wage laws • Unions and collective bargaining o Union: a worker association that bargains with employers over wages and working conditions o The economics of unions  Collective bargaining: the process by which unions and firms agree on the terms of employment  Strike: the organized withdrawal of labour from
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