ECON 1000 Mid Terms Review
Chapter 1: What is Economics?
• Definition of Economics
• Define Scarcity, Choices, Trade-offs, Opportunity Cost and Incentives
• Main branches; Micro and Macroeconomics
• Two Big Economic Questions:
• What, How and for whom to produce
• Define factors of production
• How can choices made in the pursuit of self-interest also promote the social
• The role of institutions
• Economics as a Social Science and Policy Tool
• Positive vs. Normative Statements
• Economic Models
• Personal Economic Policy, Business Economic Policy
Chapter 1: What is Economics?
Definition of Economics
Economics is a social science that studies how individuals, businesses, governments,
and entire societies cope with scarcity and make best possible choices/decisions given
the resources constraints that they face.
George Bernard Shaw “Economics is the art of making the most out of life
Define Scarcity, Choices, Trade-offs, Opportunity Cost and Incentives Scarcity is our inability to satisfy all our wants because wants are unlimited and
resources are limited. Thus everyone in the world faces scarcity and society must make
Choices that individuals, businesses and the entire society make in order to allocate
their limited resources, determine their economic future and their economic well-being.
Trade-offs involves giving up one thing to get something else. Scarcity > Choices >
Opportunity Cost is the highest-valued alternative that we must give up to get
something. Examples would be spending money for goods and services and foregoing
other goods and services and value of time foregone.
Incentives are rewards that encourage an action or a penalty that discourages an
action. Choices that agents make depend upon incentives that they face.
Main Branches; Micro and Macroeconomics
Microeconomics is the study of choices that individuals and businesses make, the way
those choices interact in markets, and the influence of governments.
Macroeconomics is the study of the performance of the national and global economies.
What, How, and for whom to produce
What we produce. What determines the quantities of timber, coal, automobiles, new
homes, cable TV service, and dental service that we produce?
How we produce -> Factors of Production are goods and service produced by using
Land are the “gifts of nature” that we use to produce goods and services Labor is the work time and effort that people devote to producing goods and services
Human Capital is the quality of labor which is the knowledge and skill that people obtain
from education, on the job training and work experience
Capital is the tools, machines, buildings, and other constructions that businesses use to
produce goods and services.
Entrepreneurship is human resource that organizes land, labor, and capital.
For Whom answers who get the goods and services depending on the incomes that
people earn. 20% of people with lowest income earn 5% of nation’s total income
20% of highest income earns 44% of nation’s total income
Land earns rent.
Labor earns wages.
Capital earns rental rate (interest)
Entrepreneurship earns profit
How can choices made in the pursuit of self-interest also promote the social interest
Most of the time, economic agents acting purely out of their own self-interest also
promote social interest.
Adam Smith: The Wealth of Nations “It is not from the benevolence of the butcher, the
brewer, or the baker that we expect our dinner, but from their regard to their own interest
The role of institutions Institutions are formal and informal rules and laws that define the incentive structure in
the society and govern the behavior of individuals and the governments.
Political Institutions: Democracy, accountability, human rights, freedoms (religious,
economic and political)
Economic Institutions: Enforcement of property rights and contracts, the conduct of
government’s monetary and fiscal policy.
Government will promote social interest, firms will perform better, and choices based on
Economics as a Social Science and Policy Tool
Normative Statements is how things ought to be (involves judgments) and cannot be
Positive Statements is how things are (the statement of facts) and can be tested by
checking it against facts.
Economic Model is a description of some aspect of the economic world that includes
only those features that are needed for the purpose at hand.
Economics is a way of approaching problems in all aspects of our lives. 3 areas are:
Personal, Business and Government economic policy. Chapter 2: The Economic Problem
• Production Possibilities Frontier (PPF)
• Measuring opportunity cost and marginal cost using PPF
• Trade off, opportunity cost and the slope of PPF
• Understanding the concept of Production Efficiency
• Understanding preferences through the concept of marginal benefit
• Applying marginal benefit and marginal cost principle to determine the point of
• Gains from Trade
• Comparative advantage and absolute advantage
• Dynamic comparative advantage
Chapter 2: The Economic Problem
Production Possibilities Frontier (PPF)
PPF is a simple economic model that helps us understand how society allocates
resources and decides what to produce and how much.
Illustrates the concepts of scarcity, opportunity cost, trade-offs and efficiency.
Boundary between combinations of goods and services that can be produced with the
given resources and those that cannot.
On the line – exhausts the resources, under the line – save some resources to produce
Measuring opportunity cost and marginal cost using PPF
The PPF determines opportunity cost.
The marginal cost of a good or service is the opportunity cost of producing one more
unit of it.
The opportunity cost of produce one more of (x) is the marginal cost of a (x). Trade off, opportunity cost and slope of PPF
Every choice along the PPF involves a tradeoff. Give up some (y) to get more (x) or
give up some (x) to get (y).
Outward bow of PPF means that as quantity produce of each good increases, so does
its opportunity cost.
Understanding the concept of Production Efficiency
Produce goods and services at the lowest possible cost.
Understanding preferences through the concept of Marginal Benefit
Marginal Benefit the benefit received from consuming one more unit of it.
Preferences are a description of a person’s likes and dislike. We measure marginal
benefit of a good or service by the amount that a person is willing to pay for an additional
good or service. Marginal Benefit Curve shows
relationship between marginal benefit from a good and quantity consumed of that good.
Principal of Decreasing Marginal Benefit is the more we have of good or service,
smaller its marginal benefit and less we are willing to pay for an additional unit of it.
Applying marginal benefit and marginal cost principle to determine the point of allocative
Allocative Efficiency is when the goods and services are produced at the greatest
When we cannot produce more of one good without giving up another good it is called
Allocative Efficiency refers to the point on PPF that gives the maximum possible
benefit and which we prefer above all other points.
Comparative Advantage and Absolute Advantage
Comparative Advantage occurs when one can perform the activity at a lower
opportunity cost than anyone else.
Absolute Advantage occurs if one is more productive than others. Absolute
Advantage Involves comparing productivities while comparative advantage involves
comparing opportunity costs.
Dynamic Comparative Advantage occurs when one gains a comparative advantage
from learning-by-doing when one specializes and by repeatedly producing a particular
good or service becoming more productive and lowering its opportunity cost. Chapter 3: Demand and Supply
• Markets and Prices
• Relative Prices as Opportunity Costs
• Define demand and Law of Demand
• Distinction between Demand and Quantity demanded
• Shifts in demand vs. movement along the demand curve
• Factors responsible for shifts in demand curve
• Related goods in consumption
Substitutes vs. complements in consumption
• Define supply and Law of Supply
• Distinction between supply and quantity supplied
• Shifts in supply vs. movement along the supply curve
• Factors responsible for shifts in supply curve
• Related goods in production Substitutes and complements in production
• Market Equilibrium
Predicting Changes in market equilibrium
Chapter 3: Demand and Supply
Relative Prices as Opportunity Costs
The ratio of its money price to the money price of the next best alternative good is its
Define demand and Law of Demand
When you demand something, then you: want it, can afford it and have made a definite
play to buy it. Demand reflects a decision about which wants to satisfy. Demand refers
to the relationship between the price of the good and quantity demanded of the good.
The Law of Demand states that other things remaining the same the higher the price of
a good, the smaller is the quantity demanded and the lower price of a good, the larger is
the quantity demanded.
Income Effect – price of a good or serve rises relative to income, people cannot afford
these things anymore so quantity demanded decreases.
Substitution Effect – relative price or opportunity cost of good or service rise, people
seek substitutes for it so quantity demanded decreases.
Distinction between Demand and Quantity Demanded
Quantity demanded of a good or service is the amount that consumers are willing and
able to purchase during particular time period at particular price.
Demand is the relationship between price of the good and quantity demanded when all
other influences on buyers’ plans remain the same.
Increase or decrease in demand shifts demand curve right or left while increase or
decrease in quantity demanded moves point upward or downward along the demand
Shifts in demand vs. movement along the demand curve.
When demand increases, the demand curve shifts rightward.
When demand decreases, the demand curve shifts leftward.
A rise in price, decrease in quantity demanded move up along the demand curve.
A decrease in price, increase in quantity demanded move down along the demand
curve. Factors responsible for shifts in demand curve
Price of Related Goods
Substitute is a good that can be used in place of another good.
Complement is a good that is used in conjunction with another good.
When the price of a substitute for a good rises or the price of a complement of a good
falls, the demand for goods increases.
Expected Future Prices
If price of a good is expected to rise in the future, current demand for the good increases
and the demand curve shifts rightward.
Normal goods are for which demand increases as income increases.
Inferior goods are goods for which demand decreases as income increases.
When income increases, consumers buy more of most goods and demand curve shifts
Expected Future Income and Credit
When income is expected to increase in the future or when credit is easy to obtain,
demand increases right now.
The larger the population, the greater is the demand of all goods.
People with the same income have different demands if they have different preferences.
Define supply and Law of Supply
If a firm supplies a good or service, then the firm: has the resources and technology to
produce it, can profit from producing it and has made a definite plan to produce and sell
The Law of Supply states that: 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 Law of Supply results from the marginal cost of producing a good or service to
increase as the quantity produced increases and producers are willing to supply a good
only if they can at least cover their marginal cost of production.
Distinction between supply and quantity supplied
Supply refers to the relationship between the quantity supplied and the price of a good. Quantity Supplied of a good or service refers to the amount of that producers plan to
sell during a given time period at a particular price.
When supply increases or decreases, the supply curve shifts rightward or leftward.
When quantity supplied increases or decreases, there is a movement of a point upward
or downward along the supply curve.
Shifts in supply vs. movement along the supply curve
When supply increases, there is a shift rightward.
When supply decreases, there is a shift leftward.
When the price increases, results in increase in quantity supply, movement up along
When the price decreases, results in decreases in quantity supply, movement down
along the curve.
Factors responsible for shifts in supply curve
Prices of Factors of Production
A rise in the price of a factor of production decreases supply and shift the supply curve
Prices of Related Goods Produced
Substitute in Production for a good are another good that can be produced using the
Complements in production are goods that must be produced together.
The Supply of goods increases if the price of a substitute in product