Econ 102 Final Exam Study Guide.docx

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ECON 102
Austin Boyle

Econ 102 Final Exam Study Guide I. Test 1 Topics A. What is economics? 1. Economics is the study of how people make choices depending on scarce resources to satisfy their unlimited wants B. The three basic economic questions are: 1. What/how much will be produced? 2. How will items be produced? 3. For whom will these items be produced? C. The two opposing economic answers are: 1. A centralized control/command system a. One person makes all of the economic decisions b. Capital is owned by the government c. This system makes it difficult to obtain information that would be captured by prices 2. A price/market system a. Millions of people make decisions in this system b. Individuals and families own the means of production c. Prices serve as signals that provide info such as why something got more or less expensive i. Example: rising gas prices signal that gasoline supply is low and vice versa D. The foundations of economic thinking are: 1. Tradeoffs 2. Individuals choose purposefully 3. Incentives matter 4. Individuals make decisions at the margin 5. Info is costly but helps make better decisions 6. Secondary effects 7. Value is subjective 8. The test of a theory is its ability to predict 9. Hold all else equal 10. Good intentions don’t always equal good outcomes 11. Association is NOT always causation 12. What is good for the individual is not always good for the group E. Production Possibilities Curve 1. Shows possible combos of output for 2 goods in a country (or firm/industry) at a given time 2. They are used to observe the opportunity cost of production 3. Shifts in the PPC are caused by: a. Increases in an economy’s resource base b. Advances in technology c. Improvements in rules governing an economy d. Giving up leisure and working harder e. Giving up consumption to invest more 4. Think of the Bloody Mary example! F. Trade 1. People trade in order to get the most value possible from their items  in order to make themselves better off 2. Comparative advantage: a. The ability to produce a good of service at a lower opportunity cost compared to other producers b. You have a comparative advantage in one activity whenever you have a lower opportunity cost of performing that activity 3. Absolute advantage: a. The ability to produce more units of a good or service using a given quantity of labor or resource inputs b. The ability to produce the same quantity of a good or service using fewer units of labor or resource inputs G. Law of Supply: 1. The law of supply states that there is a direct relationship between the price of a good or service and the quantity of it that suppliers are willing and able to produce 2. In order to count towards supply, producers must be willing and able to produce some quantity at a given price H. Supply Curve: 1. The supply curve shows how much producers are willing and able to supply at a given cost 2. Suppliers must be paid at least the opportunity cost of production to be willing to produce an item 3. The supply curve shifters include: a. Changes in resource prices (cost of inputs) b. Changes in number of producers (# of firms in industry) c. Changes in technology i. Example: As opposed hand-picking strawberries, a firm uses a new high-tech machine that picks the berries for them, thus creating more supply d. Natural disasters i. Example: A fire that destroyed the largest bicycle producer in the country e. Political disruptions i. Changes in taxes/subsidies f. Price expectations i. Expect future price to rise  wait to sell  reduction in current supply g. NOT CAUSED by own-price change I. Law of Demand: 1. The observation that there is a negative, or inverse, relationship between the price of any good or service and the quantity demanded, holding other factors constant. a. As the price of a product increase, the demand will decrease b. As the prices decreases, the demand increases 2. Changes in the demand curve are caused by: a. Changes in consumer income (normal goods vs. inferior goods) b. Changes in the number of consumers in market c. Changes in the price of related goods i. Complement price up  demand for original good up ii. Substitute price up  demand for original good down d. Changes in expectations i. Expect future price to rise  want to buy it now  demand increases e. Demographic changes (old people need more medical care) f. Changes in consumer tastes & preferences g. NOT caused by an own-price change J. Changes in Supply & Demand 1. When demand increases, both price and quantity increase, thus causing the whole demand curve to shift right 2. When demand decreases, both price and quantity decrease, thus causing the whole demand curve to shift left 3. When supply increases, price decreases and quantity demanded increase, thus causing the whole supply curve to shift right 4. When supply decreases, price increases and quantity demanded decreases, this causing the whole supply curve to shift left 5. Sometimes both supply and demand change, which sometimes results in ambiguity K. Opportunity Cost: 1. The highest-valued, next-best alternative that must be sacrificed to obtain something or satisfy a want If you choose 2. Opportunity costs are specific to every individual to make 75 guitars, you a. Basically, it’s what you give up can only make 3. Opportunity cost can be measured many ways: 25 Ukeleles a. Dollar amounts b. Value amounts c. Experience amounts L. Shortages & Surpluses 1. Shortage: A situation in which quantity demanded is greater than quantity supplied at a price below the market clearing price 2. Surplus: A situation in which quantity supplies is greater than quantity demanded at a price above the market clearing price 3. Shortages/surpluses lead to price controls: a. Price controls are government mandated min or max prices for goods & services 4. Price controls include: a. Price ceilings: i. The legal maximum price that can be charged for a good or service ii. Considered to be “binding” if set below market price iii. Causes shortages (quantity demanded > quantity supplied) iv. Think of rent control b. Price floors: i. The legal minimum price that can be charged for a good or services ii. Considered to be “binding” if set above market price iii. Causes surpluses (quantity supplied > quantity demanded) iv. Think of minimum wage c. Non-price rationing devices: i. Whenever the price system is not allowed to work, non- price rationing devices will evolve to ration the affected goods and services ii. Examples include waitlists or discrimination II. Test 2 Topics: A. Externalities: 1. Externalities are consequences of economic activity that affect the utility of people not involved in that activity (aka third parties) a. “Spillovers” 2. Negative Externalities: a. A cost that a producer or a consumer imposes on another producer or consumer who Social is not involved in the transaction Private b. Common example: If you drive a car, the air and water will both become Market polluted, which can make others sick c. In this case, the market over- produces and the price of goods is too cheap relative to socially optimal price and quantity 3. Positive Externalities: a. A benefit that someone gains because of someone else's action without being directly involved in the transaction Market b. Common example: If you get a flu Social shot, you are less likely to get sick thus you are less likely to get Private others sick c. In this case, the market under- produces and the price of goods is too cheap relative to socially optimal price and quantity 4. Externalities are market failures because both produce dead weight loss (DWL) 5. Correcting Negative Externalities: a. Effluent Fees (Pollution Taxes): a charge to a polluter that gives the right to discharge a certain amount of pollution into the water or air b. Regulation: In the instance of pollution, the government could specify a maximum allowable rate of pollution as a way to regulate for negative externalities 6. Correcting Positive Externalities: a. Subsidies: payments made either to a business or a consumer when the business produces or the consumer buys a good or a service aka a negative tax b. Regulation: In some cases involving positive externalities, the government can require by law that individuals in the society undertake a certain actions i. For example, regulations require that all school-aged children be inoculated before they enter public schools c. Financing and Production: If the positive externalities seem extremely large, the government has the option of financing the desired additional production facilities so that the “right” amount of the good will be produced B. Public Goods: 1. Public goods are goods for which the principle of rival consumption does not apply. They can be jointly consumed by many individuals simultaneously at no additional cost and with no reduction in quantity or quality. a. No one who fails to help pay for the good can be denied the benefit of the good 2. Characteristics of public goods include: 3. Non-rival in consumption a. Public goods can be used by more and more people at no additional opportunity cost and without depriving others of any of the services or goods 4. Non-excludable a. It is difficult to design a collection system for a public good on the basis of how much individuals use it 5. Free-rider problem a. A problem that arises when individuals presume that others will pay for public goods so that, individually, they can escape paying for their portion without causing a reduction in production 6. Some goods are not public just because they’re provided by the government a. Examples include farm subsidies and public schools C. Elasticity: 1. Elasticity measures relative response of a quantity (either supplied or demanded) to a change in something else 2. In order to find the percentage changes, you must use the midpoint formula a. B-A/(B+A/2) 3. Price elasticity of demand: a. Percentage change in quantity demanded/Percentage change in price b. Aka % ΔQ / dΔP c. These results will be negative; we’re concerned with absolute values 4. Price elasticity of supply: a. Percentage change in quantity supplied/Percentage change in price b. Aka %ΔQ / SΔP c. These results will be positive 5. Nomenclature: a. Elasticity <1 = Inelastic b. Elasticity =1 =Unit elastic c. Elasticity >1 = Elastic 6. If price goes up: a. Revenue increases if PED is inelastic b. Revenue decreases if PED is elastic c. Revenue stays the same if PED is unit elastic 7. Income elasticity of demand: a. Percentage change in quantity demanded/Percentage change in income b. Aka %ΔQ / dΔI c. If income elasticity is negative (<1)  inferior good d. If income elasticity is positive≥0)  normal good e. If income elasticity is < 1  necessity good f. If income elasticity is >1  luxury good 8. Cross-Price elasticity of demand: a. Cross price elasticity of demand measures the responsiveness of the demand for a good compared to a change in the price of another good. b. It is measured as the percentage change in demand for the first good that occurs in response to a percentage change in price of the second good. c. Used to determine if goods are complements or substitutes d. Percentage change in quantity demanded of X/Percentage change in price of Y e. %ΔQD of X/%ΔP of Y f. When the cross price elasticity of X & Y is negative, X & Y are complements i. Price of Y and QD of X move in opposite directions ii. If Pygoes down, QD goey up and QD goes upx g. When the cross price elasticity of X & Y is positive, X & Y are substitutes i. Price of Y and QD of X move in same direction ii. If Pygoes up, QD goys down and QD goes upx D. Consumer Choice 1. Fundamentals of consumer choice: a. Limited income necessitates choice b. Consumers make decisions purposefully (to maximize total utility) c. One good can be substituted for another d. Consumers must make decisions without perfect information, but knowledge and past experience will help e. Law of diminishing marginal utility f. Only relative prices matter 2. Consumer Equilibrium with Many Goods (Equimarginal Rule/Optimum) a. With only one good, we stop consuming when Price = Marginal Benefit (P=MB) b. The real world has so many goods that you would run out of money if you followed the advice above c. New rule when dealing with many goods: equalize the marginal utility on the last dollar spent on each good d. MU AP =AMU /P B …BMU /P etc,zetz i. Example: Say there are 2 goods that cost the same. Which do you buy? ii. The one that you like more because its marginal utility is higher than the other good and the prices are the same, so MU /A iA higher for the good you like more. iii. Say there are 2 goods that you like the same. Which do you buy? iv. The one that is cheaper because the marginal utilities
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