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Final

ECON 1010 (Macroeconomics): Final Exam Study Guide


Department
Economics
Course Code
ECON 1010
Professor
Steven Edwards
Study Guide
Final

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xScarcity means that society has limited resources and therefore cannot produce all the goods
and services people wish to have
xEconomics is the study of how society manages its scarce resources
Chapter 1 Ten Principles of Economics
How People Make Decisions
Principle #1 People Face Tradeoffs
xMaking decisions requires trading off one goal against another
xExamples of tradeoffs:
o“guns for butter”-spending national money on defence or consumer goods
oStudy time between subjects
oEfficiency vs. equity
Efficiency- the propensity of society getting the most it can from its scarce
resources
Equity- the property of distributing economic prosperity fairly among the
members of society
“when government tries to slice pie into equal slices, the pie gets smaller”
oIt is important to acknowledge tradeoffs because people are likely to make good
decisions only if they understand the options they have available
Principle #2: The Cost of Something Is What You Give Up to Get It
xOpportunity cost of an item is what you give up to obtain the item
xE.g. the cost of going to university is often the time you could have put into a job and the wages
you would have earned
Principle #3: Rational People Think at the Margin
xRational people systematically and purposefully do the best they can to achieve their objectives,
given the opportunities they have
xMarginal changes-small incremental adjustments to a plan of action
oMost rationalizations/ decisions occur at the smaller level- people often make decisions
by comparing marginal benefits and marginal costs
oExamples:
spending the extra hour reviewing or watching TV
If airline company has empty seats, and a passenger is willing to pay a lower
price to board, it is worth it for them- they are thinking at the margin
xCost of flying the passenger may be $500 ($100 000/ 200 seats), but the
marginal cost is merely what the food costs for the passenger
People are willing to pay more for diamonds than water because the marginal
benefit of one diamond is greater than the benefit of a cup of water which is
more plentiful (even though more vital to life)
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xA rational decision maker takes an action if and only if the marginal benefit of the action
exceeds the marginal cost
Principle #4: People Respond to Incentives
xIncentive- something (such as the prospect of punishment or a reward) that induces a person to
act
xPeople respond to incentives because they often make decisions by comparing costs and
benefits
xExamples:
oSupply and demand: low priceÆincentive to buy an item, high priceÆincentive to sell
an item
oSeatbelt law- since people feared prosecution, they wore seatbelts more , but accidents
increased because they drove less carefully
How People Interact
Principle #5: Trade Can Make Everyone Better Off
xAlthough countries, families, companies, etc. compete with each other, they can all benefit from
trade
xTrade allows each person (or country, company, etc.) to specialize in the activities they do best
and by trading with others, they get a greater variety of goods of a higher quality
xE.g. American and Canadian Economy compete but trade with each other
Principle #6: Markets Are Usually a Good Way to Organize Economic Activity
xIn a market economy, the decisions of a central planner are replaced by the decisions of millions
of firms and households
xFirms decide whom to hire and what to makeand households interact in the marketplace,
where prices and self-interest guide their decisions
xAs a result of decisions made by buyers and sellers, market prices reflect both the value of a
good to society and the cost to society of making the good
xPrices adjust to guide buyers and sellers to reach outcomes that maximize welfare of society as
a whole
xGovernments impede on the invisible hand
oE.g. taxes effect price
oWhy communism fell?
Principle #7: Governments Can Sometimes Improve Market Outcomes
xMarket economies still require the influence of the government to enforce the rules and
maintain the institutions that are key to a market economy
xGovernments must enforce property rights, the ability of an individual to own and exercise
control over scarce resources
xGovernments need to promote efficiency
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oMarket failure-situation in which a market left on its own fails to allocate resources
efficiently
Causes:
externality, the impact of one person’s actions on the well-being of a bystander
xE.g. pollution
Market power- ability of a single person (or small group of people) to unduly
influence market prices (i.e. monopoly)
xE.g. if there is only one well in a town
xGovernment needs to promote equity
oE.g. welfare systems, healthcare, etc.
How the Economy as a Whole Works
Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and
Services
xAlmost all variation in living standards between countries is attributable to differences in
countries’ productivity
xProductivity- the quantity of goods and services produced from each hour of a worker’s time
xNations with more goods and services produced per unit of timeÆhigh standard of living
xGrowth rate of productivity= growth rate of average income
xExamples of implications:
oIncreasing min. wageÆmore producedÆhigher standard of living
oMore competition from JapanÆless producedÆincome growth slows
xPolicy makers need to find ways to boost productivity to indirectly improve standard of living,
education, health, etc.
Principle #9: Prices Rise When the Government Prints Too Much money
xInflation-an increase in the overall level of prices in the economy
xhigh inflation leads to increased costs for society, so economic policy makers try to keep it at a
low level
xinflation is often caused by the growth in the quantity of money- when a government creates
large quantities of the nation’s money, the value of the money falls
Principle #10: Society Faces a Short-Run Tradeoff between Inflation and Unemployment
xreasons for why governments produce more money (“short -term injections”) n the first place
omore money stimulates spendingÆmore demand for goods and services
ohigher demandÆencourages firms to increase quantity of goods and services they
produce and hire more workers to produce the goods and services
omore hiringÆlower unemployment
xLeads to short-run tradeoff between inflation and unemployment- economic policies push
inflation and unemployment in opposite directions
xBusiness cycle- the irregular and largely unpredictable fluctuations in economic acitivity, as
measured by the production of goods and services or the number of people employed
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