Econ Study Guide.docx

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Department
Economics
Course Code
ECO 211
Professor
Spiegelman

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Econ Study Guide Chapters 1-9 Test Oct 4 Chapter 1- 10 Principles of Economics Vocabulary:  Scarcity- the limited nature of society’s resources  Economics- the study of how society manages its scarce resources  Efficiency- the property of society getting the most it can from its scarce resources  Equality- the property of distributing economic prosperity uniformly among the members of society  Opportunity cost-whatever must be given up to obtain some item  Rational people- people who systematically and purposefully do the best they can to achieve their objectives  Marginal change- a small incremental adjustment to a plan of action  Incentive- something that induces a person to act  Market economy- an economy that allocates resouces through the decentralized decision of many firms and households as they interact in markets for goods and services  Property rights- the ability of an individual to own and exercise control over scarce resources  Market failure- a situation in which a market left on its own fails to allocate resources efficiently  Externality- the impact of one persons actions on the well-being of a bystander  Market power- the ability of a single economic actor or small group of actors to have a substantial influence on market prices  Productivity- the quantity of goods and services produced from each unit of labor input  Inflation- an increase in the overall level of prices in the economy  Business cycle- fluctuations in economic activity, such as employment and production 10 Principles 1. People face trade offs 2. The cost of something is what you give up to get it 3. Rational people think at the margin 4. People respond to incentives 5. Trade can make everyone better off 6. Markets are usually a good way to organize economic activity 7. Governments can sometimes improve market outcomes 8. A country’s standard of living depends on its ability to produce goods and services 9. Prices rise when the government prints too much money 10.Society faces a short-run trade-off between inflation and unemployment Chapter 2- Thinking like an economist Vocabulary:  Circular flow diagram- a visual model of the economy that shows how dollars flow through markets among households and firms  Production possibilities frontier- a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and available production technology  Microeconomics- the study of how households and firms make decisions and how they interact in markets  Macroeconomics- the study of economywide phenomena, including inflation, unemployment, and economic growth  Positive statements- claims that attempt to describe the world as it is  Normative statements- claims that attempt to prescribe how the world should be  Reverse causality- thinking that A causes B, when B actually causes A Economic Models They do not include every feature of the economy They are built with assumptions Simplify reality to improve our understanding of it Circular Flow diagram •Capital- the physical inputs to the production process •Labor- the human input to the process in some amount of time Figure 1The Circular Flow This diagram is a schematic representation of the organization of the economy. Decisions are made by households and firms. Households and firms interact in the markets for goods and services (where households are buyers and firms are sellers) and in the markets for the factors of production (where firms are buyers and households are sellers). The outer set of arrows shows the flow of dollars, and the inner set of arrows shows the corresponding flow of inputs and outputs. Productions Possibilities Frontier  Points on the curve are possible and considered efficient  Points inside the curve are considered inefficient because they don’t utilize the resources completely.  Points outside the curve are unattainable  Opportunity cost is shown by points moving along the curve  Shifts in the ppf o Improvement in technology o Increase in labor force o Increase in scarce resources o Increase in human capital Figure The Production Possibilities Frontier The production possibilities frontier shows the combinations of output—in this case, cars and computers—that the economy can possibly produce. The economy can produce any combination on or inside the frontier. Points outside the frontier are not feasible given the economy's resources. Positive vs normative analysis  Positive statements are descriptive. They make a claim about how the world is  Normative statements are prescriptive. They make a claim on how the world ought to be.  Difference is how we judge their validity  Normative statements are speaking as policy advisors  Positive statements are speaking as scientists Graphs  Demand curve- the effect of the good’s price on the quantity of the good consumers want to buy  The demand curve has a negative slope because as the price decreases the demand increases  Movements along the curve- caused by increase/decrease of the good’s price or quantity demanded  Shifts along the curve- moves the entire curve to the left or right  Slope- change in y/ change in x  Unless “all else equal”, omitted variables could play a part in the outcome of the curves Chapter 3- Interdependence and the gains from trade Vocabulary:  Absolute advantage- the ability to produce a good using fewer inputs than another producer  Opportunity cost- whatever must be given up to obtain some item. For two products it is the same time it takes to produce two different items  Comparative advantage- the ability to produce a good at a lower opportunity cost than another producer  Imports- goods produced abroad and sold domestically  Exports- goods produced domestically and sold abroad Production Possibilities Frontier and Trade-  Shows the possible production for all of one or the other good or half and half.  They must provide enough for their consumption curve  Trade between two ppfs will produce a point outside the curve  Trade can benefit everyone because it allows people to specialize in activities in which they have a comparative advantage  For both parties to gain from the trade, the price at which they trade must lie between the two opportunity costs Figure 2How Trade Expands the Set of Consumption Opportunities The proposed trade between the farmer and the rancher offers each of them a combination of meat and potatoes that would be impossible in the absence of trade. In panel (a), the farmer gets to consume at point A* rather than point A. In panel (b), the rancher gets to consume at point B* rather than point B. Trade allows each to consume more meat and more potatoes. Ceteris paribus- all else equal • David ricardo- credited with the theory of comparative advantage • He had a political agenda • He wanted continental Europe to reduce terrifs on british exports • Countries that are relatively well in debt in certain factors. The factor endowment should determine what you specialized in. • The way we grow the capital stock is through savings (growing at a strong rate for the past 100 years or so ) Compare usa vs japan • Autarky- the absence of trade • Usa has a steeper slope. -110 • Japan has -120 • Ceteris paribus- all else equal Absolute advantage- who can produce more Quantity and price are different Price is inverse to production ratio Price will always be x variable over y variable Price ratio is never negative Opportunity cost- 3c x 200r/10c = 60 R Chapter 4- The market forces of supply and demand Vocabulary:  Market- a group of buyers and sellers of a particular good or service  Competitive market- a market in which there are many buyers and many sellers so that each has a negligible impact on the market price. We assume that markets are perfectly competitive  Quantity demanded- the amount of a good that buyers are willing and able to purchase  Law of demand- the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises  Demand schedule- a table that shows the relationship between the price of a good and the quantity demanded  Monopoly- a market for a good with only one seller. Hence, this seller sets the price  Demand curve- a graph of the relationship between the price of a good and the quantity demanded  Market demand- the sum of all the individual demands for a particular good or service  Normal good- a good for which an increase in income leads to an increase in demand  Inferior good- a good for which an increase in income leads to a decrease in demand  Substitutes- two goods for which an increase in the price of one leads to an increase in the demand for the other  Complements- two goods for which an increase in the price of one leads to a decrease in the demand for the other  Quantity supplied- the amount of a good that sellers are wiling and able to sell  Law of supply- the claim that the quantity supplied of a good rises when the price of the good rises  Supply schedule- a table that shows the relationship between the price of a good and the quantity supplied  Supply curve- a graph of the relationship between the price of a good and the quantity supplied  Equilibrium- a situation in which the market price has reached the level at which quantity supplied equals quantity demanded  Equilibrium price- the price that balances quantity supplied and quantity demanded  Equilibrium quantity- the quantity supplied and the quantity demande at the equilibrium price  Surplus- a situation in which quantity supplied is greater than quantity demanded  Shortage- a situation in which quantity demanded is greater than quantity supplied  Law of supply and demand- the claim that the price of any good adjust to bring the quantity supplied and the quantity demanded for that good into balance Shifts in the demand curve:  Increase in demand- shift to the right  Decrease in demand- shift to the left  Income- income falls, the demand for most goods fall. Visa versa. o Normal goods o Inferior goods  Prices of related goods- substitutes and complements  Tastes  Market expectations  Number of buyers  Normal good: a good that when the income goes up you consume more of it  Inferior good : a good that when the income goes up you consume less of it  Substitute goods: goods that can be used interchangeably (ex: monster and redbull)  Compliment good: something that goes along with another good. If the price of a good goes down then increase in demand (ex: peanut butter and jelly) Figure 3- Shifts in the Demand Curve Any change that raises the quantity that buyers wish to purchase at any given price shifts the demand curve to the right. Any change that lowers the quantity that buyers wish to purchase at any given price shifts the demand curve to the left. Supply and shifts in the supply curve:  Increase in supply- shift to the right  Decrease in supply- shift to the left  Input prices  Technology  Expectations  Number of sellers  Figure 7Shifts in the Supply Curve Any change that raises the quantity that sellers wish to produce at any given price shifts the supply curve to the right. Any change that lowers the quantity that sellers wish to produce at any given price shifts the supply curve to the left. Equilibrium- 3 steps to analyzing changes in eq.  Decide whether the event shifts the supply or demand curve or both  Decide in which direction the curve shifts  Use the supply and demand diagram to see how the shift changes the equilibrium price and quantity Figure 9 Markets not in Equilibrium In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price, the quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to increase sales by cutting the price of a cone, and this moves the price toward its equilibrium level. In panel (b), there is a shortage. Because the market price of $1.50 is below the equilibrium price, the quantity demanded (10 cones) exceeds the quantity supplied (4 cones). With too many buyers chasing too few goods, suppliers can take advantage of the shortage by raising the price. Hence, in both cases, the price adjustment moves the market toward the equilibrium of supply and demand. Figure 12 A Shift in Both Supply and Demand Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes are possible. In panel (a), the equilibrium price rises from P to 1 , an2 the equilibrium quantity rises from Q to Q . In1panel2(b), the equilibrium price again rises from P to P1, bu2 the equilibrium quantity falls from Q to Q . 1 2 Chapter 5- Elasticity and its application Vocabulary:  Elasticity- a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants  Price elasticity of demand- a measure of how much the quantity demanded of a good responds to a change in the price of the good, computed as the percentage change in quantity demanded divided by the percentage change in price  Total revenue- the amount paid by buyers and received by sellers of a good computed as the price of the good times the quantity sold  Income elasticity of demand- a measure of how much the quantity demanded of a good responds to a change in consumers income, computed as the percentage change in quantity demanded divide by the percentage change in income  Cross-price elasticity of demand- a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good (positive or negative depending on if its substitutes or complements)  Price elasticity of supply- a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price Midpoint method- divide the change by the initial level The elasticity of demand in any market depends on how we draw the boundaries of the market. Narrow markets have more elastic demand than broad markets because its easy to find close substitutes for defined goods. Goods tend to have more elastic demand over longer time horizons Demand  Considered elastic when the elasticity is greater than 1 (quantity moves more than the price)  Considered inelastic when the elasticity is less than 1 (quantity moves less than the price)  If it is exactly 1 it is unit elasticity  Zero elasticity is called perfectly inelastic- demand curve is vertical  Demand is perfectly elastic – demand curve is horizontal  On a linear curve, elasticity is not constant even though slope is.. it is the ratio of percent change  Figure 1The Price Elasticity of Demand  The price elasticity of demand determines whether the demand curve is steep or flat. Note that all percentage changes are calculated using the midpoint method.  Rules:  Demand is inelastic- price and total revenue move in the same direction  Demand is elastic- price and total revenue move in opposite directions  Unit elastic- total revenue remains constant when the price changes Supply  Elastic if the quantity supplied responds to changes in the price  Inelastic if the quantity supplied responds only slightly to changes in the price  Supply is perfectly inelastic when its vertical  Perfectly elastic- horizontal  Elastic is responsive.  There is only one kind of elasticity that can be negative- income elasticity o Percentage change of quantity demanded / percent change of income o It is positive with a normal good  Figure The Price Elasticity of Supply  The price elasticity of supply determines whether the supply curve is steep or flat. Note that all percentage changes are calculated using the midpoint method.  Perfectly inelastic I E,M I = 0  Inelastic 0< I E,M I <1  Unit elastic I E,M I =1  Elastic infinity > I E,M I > 1  Perfectly elastic I E,M I = infinity   When you divide by zero its infinity not undefined  Demand curve o Midpoint is always unit elastic o Above the midpoint is elastic o Above the y intercept is infinity o Below the midpoint is inelastic o Midpoint is maximum revenue  Firms use elasticity to find out how highly to price an item  Revenue = price x quantity  Figure How Total Revenue Changes When Price Changes  The impact of a price change on total revenue (the product of price and quantity) depends on the elasticity of
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