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ECON 1000 exam notes.docx

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Department
Economics
Course
ECON 1000
Professor
John Paschakis
Semester
Fall

Description
ECON 1000 Ch. 1: Definition of Economics  Economics: the social science that studies the choice individuals, businesses, governments, and entire societies make as they cope with scarcity and he incentives that influence and reconcile those choices  Scarcity: inability to satisfy all wants/needs because of limited resource  Incentive: a reward that encourages an action or a penalty that discourages an action  Microeconomics: the study of the choices that individuals and businesses make, the way these choices interact in markets and influence the government  Macroeconomics: the study of the performance of the national economy and the global economy o Microeconomics vs. Macroeconomics: no money involved in microeconomics  Two big economics questions o How do choices end up determining what, how, and for whom goods and services get produced? o When do choices made in the pursuit of self-interest also promote the social interest?  Factors of production o Land: earns rent  Natural resources: minerals, oil, gas, coal, water, air, forests, fish, etc.  some renewable (can be recycled), some non-renewable (resources to make energy) o Labour: earns wages  work, time and effort that people devote to production goods and services  physical and mental efforts  quality depends on human capital (knowledge and skill that people obtain from education, training, and experience) o Capital: earns interest  tools, instruments, machines, buildings used to produce goods and services  financial capital used to buy physical capital, but is not a productive resource as it is not used to produce goods and services o Entrepreneurship: earns profit  human resources that organize labour, land and capital  Self-interest: if the choice is the best available for an individual. Using time and resources in ways that make sense to an individual. Don't think how choices affect society.  Social interest: self-interested choices promote social interest if they lead to an outcome that is the best for society as a whole. An outcome that uses resources efficiently and distributes goods and services equitably among individuals o used efficiently when goods and services produced:  at lowest possible cost 1  in quantities that give the greatest possible benefit  interaction of self-interest and social interest o Globalization  expansion of international trade, borrowing, lending , ad investment o The information-age economy  technological change of the 1990s and 2000s o Global warming  climate change and political issues associated o Natural resource depletion  Over-fishing in international waters, clear-cutting rainforests, etc. o Economic instability  Choices leading up to recession, etc.  tradeoff: an exchange, giving up one thing to get something else  as a society tradeoff current consumption and leisure time for economic growth and higher future consumption  saving, education, research and development o What: spending income on various things, what to produce o How: choosing among alternative production technologies o Whom: distribution of buying power(voluntary payment, theft, taxes and benefits)  big tradeoff: between equality and efficiency  opportunity cost: the highest valued alternative forgone o "There's no such thing as a free lunch"  margin: the consequences of making incremental changes in the use of resources o marginal benefit: the benefit that arises from an increase in an activity  decreasing function o marginal cost: the cost of an increase in an activity  increasing function o If marginal benefit exceeds marginal cost, incentive to do more of that activity. o If marginal cost exceeds marginal benefit, incentive to do less of that activity. o Incentives are the key to reconciling self-interest and the social interest.  Economists emphasize the role of institutions in creating incentives to behave in the social interest o Paramount: the rule of law that protects private property and facilitates voluntary exchange in markets.  Positive statements: what is  Normative statements: what ought to be  economic model: description of some aspect of the economic world - unscrambles cause and effect o natural experiment: situation that arises in the ordinary course of economic life, factors of interest is different, other things are similar o statistical investigation: looks for correlation 2 o economic experiment: puts people in decision-making situation and varies influence of one factor at a time to see response  Economics as a policy tool o Personal economic policy: marginal benefit and marginal cost for personal decisions o Business economic policy: marginal benefit and marginal cost for businesses, interaction of individuals with the firm o Government economic policy: marginal benefit and marginal cost of government decisions, interaction of individuals with businesses Graphs  time-series graph: time on x-axis, variable on y-axis  cross-section graph: value of variable of different groups at a particular point in time  scatter diagram: plots points to show relationship between to variables o positive/direct relationship: variables move in same direction  linear relationship: straight line o negative/inverse relationship: variables move in opposite directions  Ceteris paribus: if all other relevant things remain the same Ch. 2: The Economic Problem  Production possibilities frontier (PPF): boundary between combinations of goods and services that can and cannot be produced.  outward bowed-out shape reflects increasing opportunity cost  not all resources are equally productive in all activities o cannot attain points outside of frontier (scarcity) o points inside frontier are inefficient  resources are unused or misallocated  production efficiency: if goods and services produced at lowest possible cost  allocative efficiency: goods and services are produced at the lowest possible coast and in the quantities that provide the greatest possible benefit o intersection of marginal cost and marginal benefit  preferences: description of a person's likes and dislikes o illustrated on marginal benefit curve  Economic growth: expansion of production, PPF shifts right. Opportunity cost of economic growth is less current consumption o technological change: development of new goods and of better ways of producing o capital accumulation: growth of capital resources, including human capital  comparative advantage: a person can perform the activity at a lower opportunity cost than anyone else  Absolute advantage: a person who is more productive than others. Production per hour o gain from trade if specialization at comparative advantage  dynamic comparative advantage: gaining comparative advantage from learning-by-doing 3 o Learning-by-doing: specialize and by repeatedly producing a particular good or service become more productive in that activity and lower the opportunity cost of producing that good over time.  Economic coordination: decentralized economic planning o Firms: economic unit that hired factors of production to produce and sell goods and services o Markets: arrangement that enables buyers and sellers to get information and to do business with each other  facilitates trade o Property rights: social arrangement that govern ownership, use, and disposal of anything people value  Real property: land, buildings, equipment, etc.  Financial property: stocks, bods, money, etc.  Intellectual property: intangible product of creative effort: books, music, etc. o Money: any commodity or token that is generally acceptable as a means of payment  Circular flow through markets Ch. 3: Demand and Supply  competitive market: a market that has many buyers and sellers, so no single buyer or seller can influence the price  money price: the amount of money needed to buy an item  relative price: opportunity cost, the ratio of price over price of the forgone alternative 4 Demand  demand: relationship between price and quantity demanded  If demand exists then: o must want it o can afford it o plan to buy it  Wants: unlimited desired or wishes that people have for goods and services. Demand reflects which wants to satisfy  quantity demanded: amount that consumers plan to buy during a given time period at a particular price  Law of Demand o other things remain the same, the higher the price of a good, the smaller is the quantity demanded; the lower the price of a good, the greater is the quantity demanded  Substitution effect: when relative cost (opportunity cost) increases, people seek substitutes, thus quantity demand decreases  Income effect: when cost increases, and income remains the same, people cannot afford to buy all of the same things, thus quantity demanded decreases  Willingness and ability to pay: demand curve, the more quantity, the less people are willing to pay. The less the quantity, the more people are willing to pay.  Change in demand: movement of entire demand curve o prices of related goods  substitute: increase in price of substitute, increase in demand; decrease in price of substitute, decrease in demand  complement: increase in price of complement, decrease in demand; decrease in price of complement, increase in demand o expected future prices  increase in future price, increase in current demand; decrease in future price, decrease in current demand o income  normal good: increase in income, increase in demand; decrease in income, decrease in demand  inferior good: increase in income, decrease in demand; decrease in income, increase in demand o expected future income and credit  increase in future income and credit, increase in current demand; decrease in future income and credit, decrease in demand o population  increase in population, increase in demand; decrease in population, decrease in demand o preferences  change in preference affects demand in same way 5  Change in quantity demanded: movement along demand curve Supply  supply: relationship between the price of a good and the quantity supplied  If supply exists then: o firm has the resources and technology to produce o can profit from producing o plans to produce and sell  quantity supplied: the amount that producers plan to sell during a given time period at a particular price  law of supply o the higher the price of a good, the greater is the quantity supplied; the lower the price of a good, the smaller is the quantity supplied  marginal cost increases, so producers are willing to bear the increase if price is high enough  minimum supply price: lowest price is marginal cost, as production increases so does price  Change in supply: shift of the entire supply curve o prices of factors of production  increase in cost, decrease in supply; decrease in cost, increase in supply o prices of related goods produced  substitutes: increase in price of related good produced, decrease in supply; decrease in price of related good produced, increase in supply  complement: increase in price of complement, increase in supply; decrease in price of complement, decrease in supply o expected future prices  increase in future price, decrease in current supply; decrease in future price, increase in current supply o number of suppliers  increase in number of suppliers, increase in supply; decrease in number of suppliers, decrease in supply o technology  technology lowers price of factors of production o state of nature  weather and other natural phenomenon influence supply in various ways  Change in supply demanded: movement along supply curve Market Equilibrium  Equilibrium: situation in which opposing forces balance each other. In a marker, occurs when price balances the plans of buyers and sellers o price regulate buying and selling plans o price adjusts when plans don't match 6  equilibrium price: price at which the quantity demanded equals the quantity supplied  equilibrium quantity: quantity bought and sold at the equilibrium price  Price adjustments o a shortage forces the price up  consumers want more than is supplied  price increases, demand decreases, supply increases, equilibrium found o a surplus forces the price down  suppliers produce more than consumers demand  price decreases, supply decreases, demand increases, equilibrium found Ch. 4: Elasticity Elasticity of demand  price elasticity of demand: unit-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 ⁄ o ⁄  Percentages and proportions  unit-free measure  magnitude, no positive/negative values  Elastic demand: percentage change in quantity demanded is greater than the percentage change in price. elasticity > 1  Inelastic demand: percentage change in quantity demanded is less than the percentage change in price. elasticity = between 0 and 1  Perfectly inelastic demand: quantity demanded remains constant when price changes. elasticity = 0 (vertical line)  Unit elastic demand: percentage change in quantity demanded equals the percentage change in price. elasticity = 1  Perfectly elastic demand: quantity demanded changes by an infinitely large percentage in response to a tiny price change. elastic∞ty=(horizontal line)  Elasticity along a straight-line demand curve  at midpoint: unit elastic  above midpoint: elastic  below midpoint: inelastic 7  total revenue: price of good multiplied by the quantity sold o If demand is elastic, a 1% price cut increases quantity sold by more than 1% and total revenue increases o If demand is inelastic, a 1% price cut increases quantity sold by less than 1% and total revenue decreases o If demand is unit elastic, a 1% price cut increases quantity sold by 1% and total revenue does not change  total revenue test: method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price  Expenditures o If your demand is elastic, a 1% price cut increases the quantity you buy by more than 1% and your expenditures on the item increases o If you demand is inelastic, a 1% price cut increases the quantity you buy by less than 1% and your expenditures on the item decreases o If your demand is unit elastic a 1% price cut increases the quantity you buy by 1% and your expenditures on the item does not change  Factors that influence the elasticity of demand o closeness of substitutes  the closer the substitutes for a good/service, the more elastic the demand is  necessities are inelastic  luxuries are elastic o proportion of income spent on the good  the greater the proportion of income spent on the good, the more elastic the demand is o time elapsed since price change  the longer the time has elapsed since a price change, the more elastic the demand is  cross elasticity of demand: measure of the responsiveness of the demand for a good to a change in the price of a substitute o complement ⁄ o ⁄ o substitutes: positive relationship: increase in price of substitute shifts demand curve right o complement: negative relationship: increase in price of complement shifts demand curve left  income elasticity of demand: responsiveness of the demand for a good/service to a change in income o o Greater than 1: normal good, income elastic (luxury)  percentage increase in quantity demanded exceed the percentage increase in income  percentage of income spent on the good increases as income increases o Positive and less than 1: normal good, income inelastic (necessities) 8  percentage increase in quantity demanded is positive but less than the percentage increase in income  percentage of income spend on the good decreases as income increases o Negative: inferior good  quantity demanded of an inferior good and the amount spent on it decreases when income increases Elasticity of Supply  elasticity of supply: measures the responsiveness of the quantity supplied to a change in the price of a good ⁄ o ⁄  Perfectly inelastic supply: quantity supplied remains constant when price changes. elasticity = 0 (vertical line)  Unit elastic supply: percentage change in quantity supplied equals the percentage change in price. No matter of slope, if it is linear and passes through origin, it is unit elastic  Perfectly elastic supply: If there is a price at which sellers are willing to offer any quantity for sale. elasticit∞= (horizontal line)  Factors that influence the elasticity of supply o resource substitution possibilities  The easier it is to substitute among the resources used to produce a good or service, the greater is its elasticity of supply. o time frame for the supply decision  The more time that passes after a price change, the greater is the elasticity of supply.  Momentary supply is perfectly inelastic. The quantity supplied immediately following a price change is constant  Short-run supply is somewhat elastic  Long-run supply is the most elastic 9 Ch. 5: Efficiency and Equity Resource Allocation Methods  market price o people who are willing and able to pay get the resource  people can choose not to pay, or people are too poor to afford it  command o command system: allocated resources by the order of someone in authority o works well in firms (job allocation) with clear lines of authority, but badly in an entire economy  majority rule o allocates resources in the way that a majority of voters choose o Works best when decisions being made affect large number of people and self-interest must be suppressed (decisions on taxes, etc.)  contest o allocates resources to a winner (or group of winners) o works well when the efforts of the "players" are hard to monitor and reward directly  first-come, first-served o allocated resources to those who are first in line o works best when a scarce resource can serve just one user at a time in a sequence  minimizes the time spent waiting for the resource to become free  sharing equally o everyone gets the same amount o works best for small groups that share a common goal  lottery o allocate resources to those that win (unlike contest, no skill is involved; luck) o works best when there is no effective way to distinguish among potential users  personal characteristics o allocates resources on the basis of personal characteristic  can be discriminatory on certain basis like job selection  force o allocated resource by force o war, theft o effective in transferring wealth from the rich to the poor  provides legal framework in which voluntary exchange in markets takes place Demand and Marginal Benefit  value: what we get o value of one more unit is marginal benefit  price: what we pay  willingness to pay determines demand 10 o a demand curve is a marginal benefit curve  individual demand: relationship between the price of a good and the quantity demanded by one person  market demand: relationship between the price of a good and the quantity demanded by all buyers o market demand cure is the marginal social benefit cure  consumer surplus: value of a good minus the price paid for it, summed over the quantity bought o area of green triangle is sum of all surpluses = consumer surplus o area of blue rectangle shows price paid Supply and Marginal Cost  cost: what a producer gives up o cost of producing one more unit is the marginal cost  price: what a producer receives  marginal cost is the minimum price a producer must receive to offer one more unit for sale  minimum supply-price determines supply o a supply curve is a marginal cost curve  individual supply: relationship between the price of a good and the quantity supplied by one producer  market supply: relationship between the price of a good and the quantity supplied by all producers o market supply curve is the marginal social cost curve  producer surplus: price received for a good minus its minimum supply-price (marginal cost), summed over quantity sold 11 o area of blue triangle sum of all surpluses = producer surplus o red area shows cost of production Is the Competitive Market Efficient?  Efficient if o marginal social benefit = marginal social cost o total surplus (sum of consumer surplus and producer surplus) is maximized  The Invisible Hand: Adam Smith's Wealth of Nations o competitive markets send resources to their highest valued use in society o consumers and producers pursue their own self-interest and interact in market o market transactions generate and efficient (highest valued) use of resources  Inefficiency occurs if too little of an item is produced (underproduction) or too much is produced (overproduction) o Deadweight loss: the decrease in total surplus (gray triangle). It is a social loss  underproduction: surplus is lower than maximum level  overproduction: resources are wasted, reducing surplus  Obstacles to efficieny o price and quantity regulations  blocking price adjustments leads to underproduction  limiting amount of production leads to underproduction o taxes and subsidies  taxes increase prices paid by buyers and lowers prices received by seller  leads to underproduction  subsidies lower prices paid by buyers and increases prices received by sellers  leads to overproduction o externalities  cost or benefit that affects someone other than the seller or buyer o public goods and common resources  public goods benefit everyone and no one can be excluded 12  common resources are owned by no one but available to everyone,  tragedy of the commons: overuse of the resource o monopoly  a sole provider of a good or service  typically under produces and charges high price o high transaction costs  transaction costs: opportunity cost of making trades in the market  Alternatives to market: no efficient mechanism for resources efficiently o majority rule o first-come, first-served Is the Competitive Market Fair?  It's not fair if the result isn't fair o utilitarianism: principle that states that we should strive to achieve "the greatest happiness for the greatest number"  transferring income from the rich to the poor increases total benefit  the rich have a lower benefit of income than the poor  utilitarian ideal ignore the cost of making income transfers  John Rawls solution: make the poorest as well off as possible  It's not fair if the rules aren't fair o symmetry principle: requirement that people in similar situation be treated similarly  equality of opportunity  Robert Nozick suggests fairness based on two rules:  the state must enforce laws that establish and protect private property  private property may be transferred from one person to another only by voluntary exchange  for resource to be allocated efficiently they must be allocated fairly Ch. 6: Government Actions in Markets A Housing Market with a Rent Ceiling  price ceiling (price cap): a government regulation that makes it illegal to charge a price higher than a specified level o price ceiling above equilibrium price has no effect o price ceiling below equilibrium price has powerful effects on a market  rent ceiling: when a price ceiling is applied to a housing market o create a housing shortage  quantity demanded at ceiling price exceeds the quantity supplied o search activity: time spent looking for someone with whom to do business  a shortage increases search activity  opportunity cost = rent + time and resource spent searching o black market: an illegal market in which the equilibrium price exceeds the price ceiling 13  ex. scalpers overcharging for tickets  Sneaky tactics like charging renters for keys, etc.  level of black market depends on level of enforcement of price ceiling  inefficiency of a rent ceiling o inefficient underproduction of housing services o marginal social benefit exceeds marginal social cost  deadweight loss shrinks consumer and producer surplus  fairness o according to fair rules: unfair because it blocks voluntary exchange o according to fair results: unfair because it does not generally benefit the poor  decreases quantity so resources allocated through: lottery, first-come-first- served, discrimination A Labour Market with a Minimum Wage  price floor: a government-imposed regulation that makes it illegal to charge a price lower than a specified level o price floor below equilibrium price has no effect o price floor above equilibrium price has powerful effects on a market  minimum wage: when a price floor is applied to a labour market o minimum wage creates unemployment  quantity of labour exceeds the quantity of labour demanded  surplus of labour  quantity of labour hired at minimum wage is less than quantity that would be hired in unregulated labour market  inefficiency of minimum wage o supply curve measures the marginal social cost of labour to workers  leisure forgone o demand curve measures the marginal social benefit from labour  value of goods and service produced 14 o marginal social benefit exceeds marginal social cost  deadweight loss shrinks the firms' and workers' surplus  Is the minimum wage fair? o those with jobs keep them and benefit from minimum wage o increased job search = increase in incurred costs o most economists believe a minimum wage increases the unemployment rate of low- skilled younger workers Taxes  tax incidence: the division of the burden of tax between buyer
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