Economics 1021 Exam Review
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
-Production is possible at any point inside the orange area on the frontier.
-Points inside the frontier are inefficient because resources are wasted or
Production efficiency is achieved if goods and services are produced at the lowest
-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
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
-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
-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.
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.
Decentralized coordination works best but to do so it needs four complementary
social institutions. They are
-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
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
If you demand something, then you:
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
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
Expected future income and credit
-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.
-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
-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
The state of nature
-A movement along the supply curve is known as a change in the quantity
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
-The equilibrium price is the price at which the quantity demanded equals the
-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
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
-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
-If the price elasticity of demand is between 0 and 1, the good is said to have an
-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
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
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
-Elasticity of supply=percentage change of quantity supplied/percentage change in
-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
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
Chapter 5- Efficiency and Equity
Resource Allocation Methods
-Resources might be allocated by:
First come-first served
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
Public Goods and common resources
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
-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:
First come first served
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
-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
-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
-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
-Economists have proposed two conflicting principles of fairness to apply to a tax
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
-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:
Other import barriers
-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
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
-Dumping occurs when a foreign firm sells its exports at a lower price than its cost
-There are many new arguments against globalization and for protection.
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:
Rent seeking-lobbying for special treatment by the government to create
economic profit or to divert consumer surplus or producer surplus away
Chapter 8-Utility and Demand
-There are two choices that you make as a buyer of goods and services. These are
-Consumption possibilities are limited to everyone; we describe this limit as the
-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 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