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Midterm

ECON 1000 Mid Terms Review.docx

21 Pages
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Department
Economics
Course Code
ECON 1000
Professor
Sadia Malik

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Description
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 interest • 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. 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 > Tradeoffs 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 productive resources. 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 incentive structure.  Economics as a Social Science and Policy Tool Normative Statements is how things ought to be (involves judgments) and cannot be tested. 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 allocative efficiency • 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 goods  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 efficiency Allocative Efficiency is when the goods and services are produced at the greatest possible benefit. When we cannot produce more of one good without giving up another good it is called production efficiency. 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 • Demand • 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 • Supply • 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 opportunity cost.  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 curve.  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. Income 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 rightward. 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. Population The larger the population, the greater is the demand of all goods. Preferences 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 it. 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 the curve. 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 leftward. Prices of Related Goods Produced Substitute in Production for a good are another good that can be produced using the same resources. Complements in production are goods that must be produced together. The Supply of goods increases if the price of a substitute in product
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