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Economics 1021 Exam Review.docx

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Department
Economics
Course Code
Economics 1021A/B
Professor
Jeannie Gillmore

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Economics 1021 Exam Review Chapter 2 Production Possibilities and Opportunity Cost Production Possibilities Frontier-the boundary between those combinations of goods and services that can be produced and those that cannot. -The PPF illustrated scarcity because we cannot attain the points outside the frontier. -Production is possible at any point inside the orange area on the frontier. -Points inside the frontier are inefficient because resources are wasted or misallocated. Production efficiency is achieved if goods and services are produced at the lowest possible cost. -At points inside the PPF, production is inefficient because we are giving up more necessary of one good to produce a given quantity of another good. -Only when we produce on the PPF do we incur the lowest possible cost of production. Opportunity Cost-is the highest alternative foregone. -Opportunity cost is a ratio. It is the decrease in the quantity produced of one good divided by the increase in the quantity produced of another good as we move along the PPF. -Increasing opportunity cost for a good increases when the quantity produced of that good increase. Using Resources Efficiently Allocative Efficiency-when goods and services are produced at the lowest possible cost and in the benefits that provide the greatest possible benefit. Marginal Cost-the opportunity cost of producing one more unit of it. -The marginal cost of producing pizza increases as the quantity of pizzas produced increases. -Marginal cost is calculated from the slope of the PPF. Marginal Benefit-the benefit received from consuming one more unit of it. The benefit is subjective; it depends on people’s preferences. -The device we use to illustrate preferences is the marginal benefit curve. This curve shows the relationship between the marginal benefit from a good and the quantity consumed of that good. -The most you are willing to pay for something is the marginal benefit. -When marginal benefit equals marginal cost, resources are being used efficiently. Economic Growth The expansion of production possibilities is called economic growth. -Technological change is the development of new goods and of better ways to producing goods and services. -Capital accumulation is the growth of capital resources, including human capital. -The opportunity cost of economic growth is foregone current consumption. -Economic growth pushes the PPF outwards. Gains From Trade Comparative Advantage is an activity if that person can perform the activity at a lower opportunity cost than anyone else. Absolute Advantage-occurs when a person is more productive than others. -Absolute advantage involves comparing productivities-production per hour-where as comparative advantage involves comparing opportunity costs. -Comparative advantage occurs when one person’s opportunity cost of producing a good is lower than another person’s opportunity cost of producing that same good. Economic Coordination Decentralized coordination works best but to do so it needs four complementary social institutions. They are  Firms  Markets  Property Rights  Money -A firm is an economic unit that hires factors of production and organizes those factors to produce and sell goods and services. -Markets are any arrangements that enable buyers and sellers to get information and do business with each other. -The social arrangements that govern the ownership use, and disposal of anything that people value are called property rights. -Money is any commodity or token that is generally acceptable as a means of payment. Chapter 3 Demand and Supply Markets and Prices -A competitive market is a market that has many buyers and sellers, so no single buyer or seller can influence the price. -The price of an object is the number of dollars that must be given up in exchange for it. Economists refer to this price as the money price. -The ratio of one price to another is called a relative price, and relative price is an opportunity cost. Demand If you demand something, then you: 1.Want it 2. Can afford it 3.Plan to buy it -The quantity demanded of a good of service is the amount that consumers plan to buy during a given time period at a particular price. -The Law of Demand states: 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-When the price of a good rises, things remaining the same, it’s relative price-its opportunity cost-rises. Income Effect-When a price rises, other things remaining the same, the price rises relative to income. -When any factor that influences buying plans changes, other than the price of a good there is a change in demand. -Six main factors being changes in demand. They are changes in:  The prices of related goods  Expected future prices  Income  Expected future income and credit  Population  Preferences -Substitutes are goods that can be used to replace other goods. -Complements are goods that are used in conjunction with another good. -A normal good is one for which demand increases as income increases. -An inferior good is one for which demand decreases as income increases. Law of Demand-energy bars Decreases if: Increases if: -The price of an energy bar rises -The price of an energy bar falls Changes in Demand-energy bars Decreases if: Increases if: -The price of a substitute falls -The price of a substitute rises -The price of a complement rises -The price of a complement falls -The expected future price of an energy bar fall-The expected future price of an energy bar rises. -Income falls* (inferior good) -Income rises*(normal good) -Expected future income falls of credit becomes -Expected future income rises or credit becomes harder to get harder to get. -the population decreases -The population increases. *Changes in the quantity demanded move along the demand curve while changes in demand shift the curve. Supply -If a firm supplies a good or service, the firm 1.Has the resources and technology to produce it 2.Can profit from producing it 3. Plans to produce it and sell it. -The quantity supplied of a good or service is the amount that producers plan to sell during a given period at a particular price. -The law of supply states: 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. -The term supply refers to the entire relationship between the price of a good and the quantity supplied of it. -A Change in supply occurs when there are changes in:  The prices of factors of production.  The prices of related good produced  Expected future prices  The number of suppliers  Technology  The state of nature -A movement along the supply curve is known as a change in the quantity supplied. Law of Supply-energy bars Decreases if: Increases if: -The price of an energy bar falls -The price of an energy bar rises Changes in Supply Decreases if: Increases if: -The price of a factor of production used to pro-The price of a factor of production used t produce -The price of a substitute in production rises -The price of a substitute in production falls -The price of a complement in production falls -The price of a complement in production rises -The expected future price of an energy bar rise-The expected future price of an energy bar falls -The number of suppliers of bars decreases -The number of suppliers of bars increases -A technology change decreases energy bar produc-A technology change increasesenergy bar production -A natural event decreases energy bar production-A natural event increases energy bar production Market Equilibrium -The equilibrium price is the price at which the quantity demanded equals the price supplied. -The equilibrium quantity is the quantity bought and sold at equilibrium price. -A market moves towards the equilibrium price because:  Price regulates buying and selling plans  Price adjusts when plans don’t match Chapter 4-Elasticity Price Elasticity of Demand -Price Elasticity of Demand-a units-free measure of the responsiveness of the quantity demanded of a good to change in its price when all other influences on buying plans remain the same. -We calculate the price elasticity of demand by using the formula: PE=percentage change in quantity demanded/percentage change in price. -If the quantity demanded remains constant when the price changes, then the price elasticity of demand is zero and the good is said to have a perfectly inelastic demand. -If the percentage change in the quantity demanded equals the percentage change in the price then the price elasticity equals 1 and the good is said to have a unit elastic demand. -If the price elasticity of demand is between 0 and 1, the good is said to have an inelastic demand. -If the quantity demanded changes by an infinitely large perfect, the good is said to have a perfectly elastic demand. -If the price elasticity is greater than 1, it is said to have an elastic demand. -The total revenue from the sale of a good equals the price of the good multiplied by the quantity sold.  If the price cut increases the total revenue, demand is elastic  If a price cut decreases total revenue, demand is inelastic  If a price cut leaves total revenue unchanged demand is unit elastic -When a price changes, the change in your expenditure on the good depends on your elasticity of demand.  If your demand is elastic, a 1 percent price cut increases the quantity you buy by more than 1 percent and your expenditure on the item increases.  If your demand is inelastic, a 1 percent price cut increases the quantity the quantity you buy by less than 1 percent and your expenditure on the item decreases.  If your demand is unit elastic, a 1 percent price cut increases the quantity you buy by 1 percent and your expenditure on the item does not change. -The elasticity of demand depends on  The closeness of substitutes  The population of income spent on the good  The time elapsed since the price change -The cross elasticity of demand is a measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement. Cross Elasticity=% change in qty demanded/% change in price of substitute or complement Income elasticity of demand-is a measure of the responsiveness of the demand for a good or service to change in income, other things remaining the same. -Income elasticity of demand=percentage change in the quantity demanded/percentage change in income -Income elasticity’s of demand can be classified by:  Greater than 1 (normal good, income elastic)  Positive and less than 1 (normal good, income elastic)  Negative (inferior good) Elasticity of Supply -The elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of the good when all other influences on selling plans remain the same. -Elasticity of supply=percentage change of quantity supplied/percentage change in price -The elasticity of supply of a good depends on:  Resource substitution possibilities  Time frame for the supply decision -To study the influence of the amount of time elapsed since a price change, we distinguish three time frames of supply:  Momentary Supply-when the price of a good changes, the immediate response of the quantity supplied is determined by the momentary supply of that good.  Short Run Supply-The response of the quantity supplied to a price change when only some of the possible adjustments to production can be made is determined by short-run supply.  Long run Supply-The response of the quantity supplied to a price change after all the technological possible ways of adjusting have been more exploited. Chapter 5- Efficiency and Equity Resource Allocation Methods -Resources might be allocated by:  Market price  Command  Majority rule  Contest  First come-first served  Lottery  Personal characteristics  Force Benefit Cost and Surplus -Resources are allocated efficiently and in the social interest when they are used in the ways that people value most highly. -The market demand is the horizontal sum of the individual demand curves and is formed by adding the quantities demanded by all the individuals at each price. -When people buy something for less that it is worth to them, they receive a consumer surplus-the excess of the benefit received from a good over the amount paid for it. -The market supply curve is the horizontal sum of the individual supply curves and is formed by adding the quantities supplied by all the producers at each price. -Producer surplus is the excess of the amount received from the sale of a good or service over the cost of producing it. -The sum of consumer surplus and producer surplus is called the total surplus. -When a market delivers an inefficient outcome it is a market failure. -We measure the scale of inefficiency by deadweight loss, which is the decrease in total surplus that results from an inefficient level of production. -Obstacles to inefficiency that bring market failure and create deadweight loss are:  Price and quantity regulations  Taxes and subsidies  Externalities  Public Goods and common resources  Monopoly  High transaction costs Chapter 6-Government Actions in Markets A Housing Market With a Rent Ceiling -A government regulation that makes it illegal to charge a price higher than a specified level is called a price ceiling or price cap. -When a price ceiling is applied to a housing market, it is called a rent ceiling. A rent ceiling set below the equilibrium creates:  A housing shortage  Increased search activity  A black market -The time spent looking for someone with whom to do business with is called a search activity. -A rent ceiling also encourages illegal trading with a black market, an illegal market in which equilibrium price exceeds the price ceiling. -When the rent is not permitted to allocate scarce housing, what other mechanisms are available, and are they fair? Some possible mechanisms are:  A lottery  First come first served  Discrimination A Labor Market With A Minimum Wage -A government regulation that makes it illegal to charge a price lower than a specified level is called a price floor. -A price floor set below the equilibrium price has no effect. -A price floor set above the equilibrium price has powerful effects on a market. The price floor attempts to prevent the price from regulating the quantities demanded and supplied. -When a price floor is applied to a labor market, it is called minimum wage. -In a labor market, when the wage rate is at the equilibrium level, the quantity of labor supplied equals the quantity of labor demanded: There is neither a shortage of labor nor a surplus of labor. -At a wage rate above equilibrium wage, the quantity of labor supplied exceeds the quantity of labor demanded. -In a labor market, the supply curve measures the marginal social cost of labor to workers. Taxes -Tax incidence is the division of the burden a tax between buyers and sellers. -When the government imposes a tax on the sale of a good, the price paid by buyers might rise by the full amount of the tax, by a lesser amount, or not at all. -A tax on sellers is like an increase in cost, therefore the good or service is supplied less. -To determine the position of the new supply curve, we add the tax minimum price that sellers are willing to accept for each quantity sold. -A tax burden lowers the amount consumers are willing to pay to sellers. -Buyers respond to the price that includes the tax and sellers respond to the price that excludes tax. -The division of the tax between buyers and sellers depends in part on the elasticity of demand. There are two extreme cases:  Perfectly inelastic demand-buyers pay.  Perfectly elastic demand-sellers pay. The division of the tax between buyers and sellers also depends, in part, on the elasticity of supply. Again, there two extreme cases:  Perfectly inelastic supply-sellers pay  Perfectly elastic supply-buyers pay -A tax drives a wedge between the buying price and the selling price and results in inefficient underproduction. -Economists have proposed two conflicting principles of fairness to apply to a tax system:  The benefits principle  The ability-to pay principle -The benefits principle is the proposition that people should pay taxes equal to the benefits they receive from the services provided by the government. -The ability to pay principle is the proposition that people should pay taxes according to how easily they can bear the burden of the tax. Chapter 7-Global Markets in Action How Global Markets Work -The good and services we buy from other countries are our imports; and the goods and services we sell to people in other countries are our exports. -Comparative advantage is the fundamental force that drives international trade. -The national comparative advantage is a situation in which a nation can perform an activity or produce a good or service at a lower opportunity cost than another nation. -The opportunity cost of producing a T-shirt in China is lower than in Canada, therefore the China has the national comparative advantage in producing T-shirts. -The opportunity cost of producing regional jets is cheaper in Canada than it is in China; therefore Canada has the national comparative advantage in this case. -Producers gain producer surplus in both case and make more money. Winners, Lowers, and the Net Gain from Trade -We measure the gains and losses from imports by examining their effect on consumer surplus, producer surplus and total surplus. -In the importing country the winners are those whose surplus increases and the losers are those whose surplus decreases. -The gains and loses from exports just like we measured those imports, by their effect on consumer surplus, producer surplus, and total surplus. -One’s country’s exports are other countries’ imports; international trade brings gain for all countries. International trade is a win-win game. International Trade Restrictions -Governments use four sets of tools to influence international trade and protect domestic industries from foreign competition. These consist of:  Tariffs  Import quotas  Other import barriers  Export Subsidies -Tariffs are taxes on goods that are imposed by the importing country when an imported good crosses its international boundary. -Tariffs have a number of effects on a good, these include.  Rise in price of a T-shirt  Decrease in purchases  Increase in domestic Production  Decrease in imports  Tariff Revenue Winners, Losers and Social Loss from a Tariff -Canadian consumers of the good lose. -Canadian producers of the good gain. -Canadian consumers lose more than Canadian producers gain. -Society loses: A deadweight loss arises. -Import Quotas are restrictions that limit the maximum quantity of a good that may be imported in a given period. -When the government imposes an import quota,  Canadian consumers of the good lose  Canadian producers of the good gain  Importers of the good gain  Society loses: A deadweight loss arises (Other Imports)-Two sets of policies that influence imports are  Health, safety, and regulation barriers  Voluntary export restraints (Export subsidy)-A subsidy is a payment by the government to a producer. You studied the effects of a subsidy on the quantity produced and the price of a subsidized farm product. -An export subsidy is a payment by the government to producer of an exported good. Export subsidies are illegal under a number of international agreements, including NAFTA. The Case Against Protection Two classical arguments for restricting international trade are:  The infant-industry argument  The dumping argument -The infant-industry argument for protection is that it is necessary to protect a new industry to enable it to grow into a mature industry hat can compete in world markets. -Dumping occurs when a foreign firm sells its exports at a lower price than its cost of production. -There are many new arguments against globalization and for protection.  Saves jobs  Allows us to compete with cheap foreign labor  Penalizes lax environmental standards  Prevents rich countries from exploiting developing countires -(offshoring) A firm in Canada can obtain the goods and services that it sells in any of four ways: 1.Hire Canadian labor and produce in Canada. 2.Hire foreign labor and produce in other countries. 3. Buy finished goods, components, or services from other firms in Canada. 4. Buy finished goods, components or services from other firms in other countries. -Why, all despite all the arguments against protection, is trade restricted? There are two key reasons:  Tariff revenue  Rent seeking-lobbying for special treatment by the government to create economic profit or to divert consumer surplus or producer surplus away from others. Chapter 8-Utility and Demand Consumption choices -There are two choices that you make as a buyer of goods and services. These are summarized by:  Consumption possibilities  Preferences -Consumption possibilities are limited to everyone; we describe this limit as the budget line. -A deeper way in describing preferences is the use of utility. Utility is the benefit or satisfaction that a person gets from the consumption of goods and services. Two utility concepts are:  Total utility  Marginal utility -Total Utility is the total benefit that a person gets from the consumption of all the different goods and services. -Marginal Utility is the change in total utility that results from a one-unit increase in he quantity of a good consumed. -Positive
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