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MICRO- Exam Notes.docx

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University of Maryland
ECON 200
Peter Coughlin

MICROECONOMICS Chapter 1: Ten Principles of Economics Adam Smith- used scientific method on social phenomenon - wrote “The Wealth of Nations” (nation is wealthier when people are free to make decisions) HOW PEOPLE MAKE DECISIONS 1. People Face Trade- Offs - economics decisions based on resources being limited in nature- Scarcity (time and money) - Efficiency- society is getting maximum benefits from its scarce resources - Equality- benefits distributed uniformly among society [distribute income evenly can cause people to work less and lower prosperity] - Doesn’t by itself tell us what decisions people will make 2. The Cost of Something is What you Give up to Get it - Opportunity Cost- what you give up to get an item 3. Rational People think of the Margin - Rational people systematically do the best they can to achieve their objectives, given available opportunities - Often make decisions by comparing marginal benefits/ costs o Marginal Changes- incremental adjustments to existing plan o Marginal Cost- extra costs resulting from dec/ inc in production/ consumption [monthly electric bills if decide to keep store open] o Marginal Benefit- extra benefit from inc/ dec in production/ consumption 4. People Respond to Incentives - Incentive- something that induces a person to act [prices, punishment or reward] o Ex. Tax on gas encourages people to drive hybrid cars o Ex. Income (firms get revenue and households get personal income) HOW PEOPLE INTERACT 5. Trade Can Make Everyone Better Off - People can specialize in producing one good/ service and exchange for other goods instead of being self- sufficient - Countries benefit from trade- get better price for goods they produce 6. Markets are usually a Good Way to Organize Economic Activity - insight by Adam Smith in “wealth of nations” o consumers/ producers act as if “led by an invisible hand” to promote economic well- being - central planning- used by communist countries, government choice of what, who got, and how produce goods so all economic activity organized by government - market economy- decisions made by firms and households (firms- who to hire, what to make and households- who to work for and what to buy) 7. Governments can Sometimes Improve Market Outcomes - government enforces rules and maintains institutions key to market economy o provide basic national security and public safety (safety net for the poor, defend workers from employers, protect weak firms using antitrust laws- keep firms from exploiting monopoly status) o directly or indirectly provides goods and services (healthcare, education, mail) o establishes rules about property and enforces them (police, courts)  property rights- right to own and control scarce resources HOW ECONOMY WORKS AS A WHOLE 8. Country’s Standard of Living Depends on its Ability to Produce Goods/ Services - variations in living standard attributable to differences in countries’ productivity - growth rate of nation’s productivity determines rate of average income 9. Prices Rise when the Government Prints too much Money - inflation- increase in overall level of prices in economy - occurs when large quantities of money produced, so value of money falls 10. Society Faces a Short Run Trade off Between Inflation and Unemployment - inc amount of money stimulates level of spending and demand for goods/ services - High demand over time can cause firms to raise prices and encourage hiring and producing more - Business cycle- irregular and unpredictable fluctuations in econ activity (good production, employed) CHAPTER 2: Thinking Like An Economist - Social scientists- trying to explain the world (devise theories, observe to verify/ refute theories) - Policy Advisors- trying to improve the world - Model- simple representation of a more complicated reality Circular Flow Diagram - Firms and Households are the decision makers Production Possibilities Frontier - PPF shows combinations of output that economy can possibly produce given available factors of production - Combination of goods: quantity of first and second good - Efficiency (optimal use of resources), Inefficient, Impossible - Steeper graph has higher slope (inc x- axis variable is always negative slope) - Ex. Opportunity cost of x rises as economy produces more x - Top/ bottom point of curve  most workers producing one of 2 goods, even those better suited to make the less produced good (opportunity cost of y- axis good is low at high point Microeconomics- study of small, specific goods/ services, industries, individuals and firms Macroeconomics- study of large and how overall economy behaves Policy Advisor- recommend policies to improve economic outcomes - Positive Econ- descriptive, make claim about how the world is, can be confirmed/ refuted based on evidence - Normative Econ- prescriptive, claim about how the world should be, cannot be judged using data alone Economists Disagree: about validity of alternative positive theories of how world works & have diff values dictating views about what policies should accomplish - Scientific Judgements: validity of alternative theories or how economics variables are related [disagree- tax household income or consumption b/c could encourage households to save more and not be taxed] - Values: fairness of policies - Perception Versus Reality: often agree more than sometimes understood, might all disagree on policies [rent control and trade barriers] but doesn’t stop policies from being implemented CHAPTER 3: Interdependence and the Gains from Trade Exchange- both parties voluntarily trade and can mutually benefit Source of Trade Gains: - 2 countries good at producing 2 different goods - Each selling other one the good it’s good at producing - Absolute advantage- the producer that requires smaller quantity of inputs to produce good (labor time) - Comparative Advantage- the producer with smaller opportunity cost (gives up less) when producing good Both individuals can benefit through voluntary trade - But trade between countries, individuals may lose (winners and losers) CHAPTER 4: The Markets Forces of Supply & Demand Market- group of buyers/ sellers of particular good/ service - Highly organized (New York Stock Exchange) - Less organized (ice cream market b/c no central location) Competitive Market- so many buyers and sellers that each has a negligible impact on market price - Perfect competition- goods offered at same price, buyers/ sellers so numerous that no single one has influence over market price o If seller chargers more than going price then will lose all its sales o Each firm is a price taker- and must accept market price - Monopoly- sets price b/c is the only seller in market Basic Competitive Model- builds on 3 assumptions - Government ignored in basic model to isolate private decision making 1. Consumers are rational- decision makers 2. Profit maximizing firms- decision makers 3. Competitive Markets- how buyer/ seller interact and how market mediates Demand- how quantity of g/s bought can change w/ changes in # of variables (income, population, trends) - Quantity demanded- amount of good buyers are willing/ able to purchase (price influences) - Law of demand- demand increases when price falls - Demand schedule- relationship between price and quantity demanded (all else held constant) - Market Demand- sum of all individual demands for particular good/ service Demand Shifters: 1. Income- demand falls if income falls b/c less to spend - Normal good- if demand for a good falls when income falls - Inferior good- if demand for a good rises when income falls [when income falls, less likely to buy car and more likely to ride a bus] 2. Prices of Related Goods- - Substi
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