Econ Test 1
When does a rational decision maker take action?
A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost.
Principle 8: A Country's Standard of Living Depends on Its Ability to Produce Goods and Services
What explains these large differences in living standards among countries and over time? The answer is surprisingly simple. Almost all variation in living standards is attributable to differences in countries' productivity
Marginal decision making example
Why is water so cheap, while diamonds are so expensive? Humans need water to survive, while diamonds are unnecessary. Yet people are willing to pay much more for a diamond than for a cup of water. The reason is that a person's willingness to pay for a good is based on the marginal benefit that an extra unit of the good would yield. The marginal benefit, in turn, depends on how many units a person already has. Water is essential, but the marginal benefit of an extra cup is small because water is plentiful. By contrast, no one needs diamonds to survive, but because diamonds are so rare, people consider the marginal benefit of an extra diamond to be large.
income elasticity of demand formula
% change in quantity demanded / % change in income
perfectly competitive. To reach this highest form of competition, a market must have two characteristics:
(1)The goods offered for sale are all exactly the same, and (2)the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price. Because buyers and sellers in perfectly competitive markets must accept the price the market determines, they are said to be price takers.
What price allows both parties to gain from trade
, the price at which they trade must lie between the two opportunity costs. Ex: In our example, Frank and Ruby agreed to trade at a rate of 3 ounces of potatoes for each ounce of meat. This price is between Ruby's opportunity cost (2 ounces of potatoes per ounce of meat) and Frank's opportunity cost (4 ounces of potatoes per ounce of meat). The price need not be exactly in the middle for both parties to gain, but it must be somewhere between 2 and 4.
Computing price elasticity of supply
- Percentage change in quantity supplied divided by percentage change in price - Always positive remember midpoint formula
You win $100 in a basketball pool. You have a choice between spending the money now or putting it away for a year in a bank account that pays 5% interest. Which of the following is included in the opportunity cost of spending $100 now? The $105 you would have a year from now if you put it in the bank There isn't an opportunity cost because you won the money The cost of entering the basketball pool
...The $105 you would have a year from now if you put it in the bank
The price of a good rises from $8 to $12, and the quantity demanded falls from 110 to 90 units. Calculated with the midpoint method, the price elasticity of demand is 1/5. 1/2. 2. 5.
1/2
monopoly.
A market in which there are many buyers but only one seller. He can set the price markets tend to fall between monopoly and perfectly competitive
Shifts in Curves versus Movements along Curves
A shift in the supply curve is called a change in supply. A movement along a fixed supply curve is called a change in quantity supplied. A shift in the demand curve is called a change in demand. A movement along a fixed demand curve is called a change in quantity demanded. Notice that when hot weather increases the demand for ice cream and drives up the price, the quantity of ice cream that firms supply rises, even though the supply curve remains the same. In this case, economists say there has been an increase in "quantity supplied" but no change in "supply." Supply refers to the position of the supply curve, whereas the quantity supplied refers to the amount suppliers wish to sell.
Which of the following might lead to an increase in the equilibrium price of jelly and a decrease in the equilibrium quantity of jelly sold? -an increase in the price of peanut butter, a complement to jelly -an increase in the price of Marshmallow Fluff, a substitute for jelly -an increase in the price of grapes, an input to jelly -an increase in consumers' incomes, as long as jelly is a normal good
An increase in the price of grapes,, an input to jelly If a change occurs in any of the factors that determine supply - such as an increase in the price of grapes, an input to jelly-the result is a shift of the supply curve. In this case, the change in he price of jelly causes the supply curve of jelly to fall. This leads to an increase in the equilibrium price of jelly, and a decrease in the equilibrium quantity of jelly sold (Question #6 graph)
During the Revolutionary War, the American colonies could not raise enough tax revenue to fully fund the war effort; to make up the difference, the colonies decided to print more money. Printing money to cover expenditures is sometimes referred to as an inflation tax. Who is being taxed when more money is printed? Banks only Anyone who is holding money Families of soldiers in active duty
Anyone who is holding money When the government prints money, it imposes a tax on anyone who is holding money. This is because printing money decreases the value of money by causing inflation, or an increase in the overall level of prices in the economy. See Section: Principle 9: Prices Rise When the Government Prints Too Much Money.
Things that influence elasticity
Availability of Close Substitutes (Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others.) Necessities versus Luxuries (Necessities tend to have inelastic demands, whereas luxuries have elastic demands.) Definition of the Market (The elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods.) Time Horizon (Goods tend to have more elastic demand over longer time horizons. )
Shifts in demand in the short and long run
Because firms can enter and exit in the long run but not in the short run, the response of a market to a change in demand depends on the time horizon
Suppose that in the United States, producing an aircraft takes 10,000 hours of labor and producing a shirt takes 2 hours of labor. In China, producing an aircraft takes 40,000 hours of labor and producing a shirt takes 4 hours of labor. What will these nations trade? China will export aircraft, and the United States will export shirts. China will export shirts, and the United States will export aircraft. Both nations will export shirts. There are no gains from trade in this situation.
China will export shirts, while the United States will export aircraft.
what allows specialization to work?
Comparative advantage
When policymakers fail to consider how their policies affect incentives, they often end up facing unintended consequences.
Consider how a seat belt law alters a driver's cost-benefit calculation. Seat belts make accidents less costly because they reduce the likelihood of injury or death. In other words, seat belts reduce the benefits of slow and careful driving. People respond to seat belts as they would to an improvement in road conditions—by driving faster and less carefully. The result of a seat belt law, therefore, is a larger number of accidents. The decline in safe driving has a clear, adverse impact on pedestrians, who are more likely to find themselves in an accident but (unlike the drivers) don't have the benefit of added protection.
when is demand considered elastic? inelastic? Unit elastic?
Demand is considered elastic when the elasticity is greater than 1, which means the quantity moves proportionately more than the price. Demand is considered inelastic when the elasticity is less than 1, which means the quantity moves proportionately less than the price. If the elasticity is exactly 1, the percentage change in quantity equals the percentage change in price, and demand is said to have unit elasticity.
Why do economists so often appear to give conflicting advice to policymakers? There are two basic reasons:
Economists may disagree about the validity of alternative positive theories of how the world works. Economists may have different values and therefore different normative views about what government policy should aim to accomplish.
Elasticity and Total Revenue along a Linear Demand Curve
Even though the slope of a linear demand curve is constant, the elasticity is not. This is true because the slope is the ratio of changes in the two variables, whereas the elasticity is the ratio of percentage changes in the two variables. he slope of a linear demand curve is constant, but its elasticity is not. The price elasticity of demand is calculated using the demand schedule in the table and the midpoint method. At points with a low price and high quantity, the demand curve is inelastic. At points with a high price and low quantity, the demand curve is elastic.
True or False: Labor unions are the primary reason the standard of living in the United States has changed over time. True False
False The increase in average income and thus the standard of living is mainly the result of increased productivity. In other words, an hour of work produces more goods and services than it used to in your grandparents' era. See Section: Principle 8: A Country's Standard of Living Depends on Its Ability to Produce Goods and Services.
When analyzing how some event affects the equilibrium in a market, we proceed in three steps.
First, we decide whether the event shifts the supply curve, the demand curve, or, in some cases, both. Second, we decide whether the curve shifts to the right or to the left. Third, we use the supply-and-demand diagram to compare the initial equilibrium with the new one, which shows how the shift affects the equilibrium price and quantity.
Exports
Goods and Services sold to other countries
The Long Run: Market Supply with Entry and Exit
If firms already in the market are profitable, then new firms will have an incentive to enter the market. This entry will expand the number of firms, increase the quantity of the good supplied, and drive down prices and profits. Conversely, if firms in the market are making losses, then some existing firms will exit the market. Their exit will reduce the number of firms, decrease the quantity of the good supplied, and drive up prices and profits. At the end of this process of entry and exit, firms that remain in the market must be making zero economic profit. Recall from the preceding chapter 13 that the level of production with lowest average total cost is called the firm's efficient scale. Therefore, in the long-run equilibrium of a competitive market with free entry and exit, firms must be operating at their efficient scale.
Why is the marginal-cost curve also the competitive firm's supply curve.
In essence, because the firm's marginal-cost curve determines the quantity of the good the firm is willing to supply at any price,
Pros and cons of international trade:
In reality, of course, the issues involved in trade among nations are more complex than this example suggests. Most important among these issues is that each country has many citizens with different interests. International trade can make some individuals worse off, even as it makes the country as a whole better off. ex When the United States exports food and imports cars, the impact on an American farmer is not the same as the impact on an American autoworker.
the short-run effects of monetary injections as follows:
Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services. Higher demand may over time cause firms to raise their prices, but in the meantime, it also encourages them to hire more workers and produce a larger quantity of goods and services. More hiring means lower unemployment.
Which of the following is a positive, rather than a normative, statement? Law X will reduce national income. Law X is a good piece of legislation. Congress ought to pass law X. The president should veto law X.
Law X will reduce national income Positive statements are descriptive; they make a claim about how the world is. However, normative statements are prescriptive; they make a claim about how the world ought to be. Therefore, in this case, the only positive statement is law X will reduce national income because it states what will happen if something is done rather than what should be done.
A 1996 bill reforming the federal government's antipoverty programs limited many welfare recipients to only 2 years of benefits. This change gives people the incentive to find a job ___ quickly than if welfare benefits lasted forever. The loss of benefits after 2 years will result in the distribution of income becoming ____ equal. In addition, the economy will be ____ efficient because of the change in working incentives.
More Less More If welfare benefits lasted forever, there would be little incentive to find work once unemployed. However, by only lasting for 2 years, there is a greater incentive for people to find work before the 2 years are up at which point they would receive no financial support from the government. This change in the government's antipoverty program reduces equality in the distribution of income, since those who cannot find a job will get no income at all; however, the economy is more efficient given the increased incentive for the unemployed to find work and contribute to the nation's output. See Section: Principle 4: People Respond to Incentives.
Principle 7: Governments Can Sometimes Improve Market Outcomes
One reason we need government is that the invisible hand can work its magic only if the government enforces the rules and maintains the institutions that are key to a market economy. Most important, market economies need institutions to enforce property rights so individuals can own and control scarce resources.
total revenue
Price x Quantity the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold
If the economy goes into a recession and incomes fall, what happens in the market for inferior goods? - Prices and quantities both rise - Prices and quantities both fall - Prices rise, quantities fall - Prices fall, quantities rise
Prices and quantities both rise If the demand for a good rises when income falls, the good is called an inferior good. An increase in demand results in a rise in both the equilibrium price and quantity of a good (question #5 graph)
profit formulas
Profit = TR - TC Profit = (P-ATC)xQ
Rational People
Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities.
The discovery of a large new reserve of crude oil will shift the ___ curve for gasoline, leading to a ___ equilibrium price. -Supply, higher -Supply, lower -Demand, higher -Demand, lower
Supply, lower The supply curve for gasoline shows the relationship between the price of gasoline and the quantity of gasoline supplied by production, assuming that all the determinants of supply are held constant. The following list displays determinants of supply, which are the factors that affect the quantity of gasoline producers want to sell at a given price: FACTORS THAT DETERMINE SUPPLY -Price of inputs -Production technology -Number of producers -Expectations of producers Therefore, if the price of gasoline changes, the result is a movement along the supply curve from the old place to the new one. However, if a change occurs in any of the factors that determine supply, such as the discovery of a large new reserve of crude oil, the result is shift of the supply curve. In this case, the supply of gasoline increases because of the new oil reserve causing the equilibrium price to decline. (Question #4 for graph)
An increase in ___ will cause a movement along a given demand curve, which is also called a change in ___. - Supply, demand - Supply, quantity demanded - Demand, supply - Demand, quantity supplied
Supply, quantity demanded Demand refers to the position of the demand curve Quantity demanded refers to the amount consumers wish to buy Supply refers to the position of the supply curve Quantity supply refers to the amount of supplies you wish to sell In this case, an increase in supply will cause the equilibrium price to decrease, resulting in a movement along the demand curve. The demand curve itself remains unchanged, but the quantity demanded is affected. (Question 2 to see graph)
How does total revenue change as one moves along the demand curve?
The answer depends on the price elasticity of demand. If demand is inelastic, then an increase in the price causes an increase in total revenue. We obtain the opposite result if demand is elastic: An increase in the price causes a decrease in total revenue.
Cost curves and their shapes
The average total-cost curve is U-shaped. At very low levels of output average total cost is high because fixed cost is spread over only a few units. Average total cost declines as output increases. Average total cost starts rising because average variable cost rises substantially
who determines demand? who determines supply?
The buyers as a group determine the demand for the product, and the sellers as a group determine the supply of the product.
Costs as opportunity costs
The cost of something is what you give up to get it explicit and implicit costs
Movie tickets and DVDs are substitutes. If the price of DVDs increases, what happens in the market for movie tickets? - The supply curve shifts to the left - The supply curve shifts to the right - The demand curve shifts to the left - The demand curve shifts to the right
The demand curve shifts to the right When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. If movie tickets and DVDs are substitutes and the price of DVDs increases, this means he demand for movie tickets will also increase. This results in the demand curve shifting to the right.
The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
The elasticity from point A to point B seems different from the elasticity from point B to point A.
There are, however, two reasons that the long-run market supply curve might slope upward.
The first is that some resources used in production may be available only in limited quantities. A second reason for an upward-sloping supply curve is that firms may have different costs. Because firms can enter and exit more easily in the long run than in the short run, the long-run supply curve is typically more elastic than the short-run supply curve.
IN a competitive market the price line is....
The price line is horizontal because a competitive firm is a price taker: The price of the firm's output is the same regardless of the quantity that the firm decides to produce.
A change in which of the following will NOT shift the demand curve for hamburgers - The price of hot dogs - The price of hamburgers - The price of hamburger buns - The income of hamburger consumers
The price of hamburgers The demand curve for hamburgers shows the relationship between the price of hamburgers and the quantity of hamburgers demanded by consumers, assuming that all the determinants of demand are held constant. The following list displays determinants of demand, which are the factors that affect the quantity of hamburgers consumers want to buy at a given price: FACTORS THAT DETERMINE DEMAND -Price of a related good (complement or substitute) -Income of consumers -Tastes of consumers -Number of consumers -Expectations of consumers Therefore, if the price of hamburgers changes, the result is a MOVEMENT along the demand curve from the old price to the new one. However, if a change occurs in any of the factors that determine demand - such as the price of hot dogs ( a substitute), the price of hamburger buns (a complement), or the income of hamburger consumers - the result is a shift of the demand curve
When does the process of entry and exit end?
The process of entry and exit ends only when price and average total cost are driven to equality.
Kayla can cook dinner in 30 minutes and wash the laundry in 20 minutes. Her roommate takes half as long to do each task. How should the roommates allocate the work? Kayla should do more of the cooking based on her comparative advantage. Kayla should do more of the washing based on her comparative advantage. Kayla should do more of the washing based on her absolute advantage. There are no gains from trade in this situation.
There are no gains from trade in this situation.
When two individuals produce efficiently and then make a mutually beneficial trade based on comparative advantage, they both obtain consumption outside their production possibilities frontier. they both obtain consumption inside their production possibilities frontier. one individual consumes inside her production possibilities frontier, while the other consumes outside hers. each individual consumes a point on her own production possibilities frontier.
They both obtain consumption outside their production possibilities frontier.
when do shutdown
Thus, the firm shuts down if the revenue that it would earn from producing is less than its variable costs of production. or if the price is less than the average variable cost The firm still loses money (because it has to pay fixed costs), but it would lose even more money by staying open. The firm can reopen in the future if conditions change so that price exceeds average variable cost.
Price of Related Goods: Complements
When a fall in the price of one good raises the demand for another good, the two goods are called complements
Price of Related Goods: Substitutes
When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes.
General demand elasticity rules
When demand is inelastic (a price elasticity less than 1), price and total revenue move in the same direction: If the price increases, total revenue also increases. When demand is elastic (a price elasticity greater than 1), price and total revenue move in opposite directions: If the price increases, total revenue decreases. If demand is unit elastic (a price elasticity exactly equal to 1), total revenue remains constant when the price changes.
The Relationship between Marginal Cost and Average Total Cost
Whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising.
sunk cost
a cost that has already been committed and cannot be recovered
income: inferior good
a good for which, other things being equal, an increase in income leads to a decrease in demand
income: normal good
a good for which, other things being equal, an increase in income leads to an increase in demand
supply curve
a graph of the relationship between the price of a good and the quantity supplied
Model 2: The Production Possibilities Frontier
a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available production technology that firms use to turn these factors into output.
market
a group of buyers and sellers of a particular good or service
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 divided by the percentage change in income As we discussed in Chapter 4, most goods are normal goods: Higher income raises the quantity demanded. Because quantity demanded and income move in the same direction, normal goods have positive income elasticities.
price elasticity of demand
a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price Inelastic=more vertical elastic=more horizontal
price elasticity of demand
a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price The price elasticity of demand for any good measures how willing consumers are to buy less of the good as its price rises.
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 price of the second good The cross elasticity of demand for substitute goods is always positive because the demand for one good increases when the price for the substitute good increases. Alternatively, the cross elasticity of demand for complementary goods is negative.
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 The price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce. In most markets, a key determinant of the price elasticity of supply is the time period being considered. Supply is usually more elastic in the long run than in the short run.
elasticity
a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants
shortage
a situation in which quantity demanded is greater than quantity supplied
surplus
a situation in which quantity supplied is greater than quantity demanded Suppliers are unable to sell all they want at the going price. A surplus is sometimes called a situation of excess supply. When there is a surplus in the ice-cream market, sellers of ice cream find their freezers increasingly full of ice cream they would like to sell but cannot. They respond to the surplus by cutting their prices. Falling prices, in turn, increase the quantity demanded and decrease the quantity supplied. These changes represent movements along the supply and demand curves, not shifts in the curves. Prices continue to fall until the market reaches the equilibrium.
equilibrium
a situation in which the market price has reached the level at which quantity supplied equals quantity demanded
A life-saving medicine without any close substitutes will tend to have a small elasticity of demand. a large elasticity of demand. a small elasticity of supply. a large elasticity of supply.
a small elasticity of demand
Marginal Change
a small incremental adjustment to a plan of action margin means "edge," so marginal changes are adjustments around the edges of what you are doing. Rational people often make decisions by comparing marginal benefits and marginal costs.
demand schedule
a table that shows the relationship between the price of a good and the quantity demanded
supply schedule
a table that shows the relationship between the price of a good and the quantity supplied
MODEL 1- Circular Flow Diagram
a visual model of the economy that shows how dollars flow through markets among households and firms In this model, the economy is simplified to include only two types of decision makers—firms and households. Firms produce goods and services using inputs, such as labor, land, and capital (buildings and machines). These inputs are called the factors of production. Households own the factors of production and consume all the goods and services that the firms produce. Households and firms interact in two types of markets. In the markets for goods and services, households are buyers, and firms are sellers. In particular, households buy the output of goods and services that firms produce. In the markets for the factors of production, households are sellers, and firms are buyers. In these markets, households provide the inputs that firms use to produce goods and services.
what costs do accountants count? economist?
accountants: explicit costs economist: both explicit and implicit
Market Economy
an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services
inflation
an increase in the overall level of prices in the economy
Positive statements
claims that attempt to describe the world as it is
Normative statements
claims that attempt to prescribe how the world should be A policy might increase efficiency at the cost of equality. It might help future generations but hurt current generations.
fixed costs
costs that do not vary with the quantity of output produced
variable costs
costs that vary with the quantity of output produced
Economic/Accounting Profit
economic profit total revenue minus total cost, including both explicit and implicit costs accounting profit total revenue minus total explicit cost
2 reasons for market failure
externality and market power Fixed by public policies
A point on the production possibilities frontier is
feasible, and efficient
A point inside the production possibilities frontier is
feasible, but not efficient
Average fixed cost
fixed cost divided by the quantity of output
business cycle
fluctuations in economic activity, such as employment and production the irregular and largely unpredictable fluctuations in economic activity, as measured by the production of goods and services or the number of people employed.
imports
goods produced abroad and sold domestically
Economics is best defined as the study of how society manages its scarce resources. how to run a business most profitably. how to predict inflation, unemployment, and stock prices. how the government can stop the harm from unchecked self-interest.
how society manages its scarce resources.
shifts in the demand curve
income, prices of related goods, tastes (Preferences) expectations (Your expectations about the future may affect your demand for a good or service today.) number of buyers (more buyers = a higher demand)
A marginal change is one that is not important for public policy. incrementally alters an existing plan. makes an outcome inefficient. does not influence incentives.
incrementally alters an existing plan. Economists use the term marginal change to describe a small incremental adjustment to an existing plan of action. Recall that margin means "edge," so marginal changes are alterations around the edges of what you are doing. See Section: Principle 3: Rational People Think At the Margin.
A linear, downward-sloping demand curve is inelastic unit elastic. elastic. inelastic at some points, and elastic at others.
inelastic at some points, and elastic at others
implicit costs
input costs that do not require an outlay of money by the firm ex: An important implicit cost of almost every business is the opportunity cost of the financial capital that has been invested in the business. Suppose, for instance, that Caroline used $300,000 of her savings to buy the cookie factory from its previous owner. If Caroline had instead left this money in a savings account that pays an interest rate of 5 percent, she would have earned $15,000 per year. To own her cookie factory, therefore, Caroline has given up $15,000 a year in interest income. This forgone $15,000 is one of the implicit opportunity costs of Caroline's business.
explicit costs
input costs that require an outlay of money by the firm
shifts in supply curve
input prices, (ex:To produce their output of ice cream, sellers use various inputs: cream, sugar, flavoring, ice-cream machines, the buildings in which the ice cream is made, and the labor of workers who mix the ingredients and operate the machines. When the price of one or more of these inputs rises, producing ice cream is less profitable, and firms supply less ice cream.) technology, ( The invention of the mechanized ice-cream machine, for example, reduced the amount of labor necessary to make ice cream. By reducing firms' costs, the advance in technology raised the supply of ice cream.) expectations, (if a firm expects the price of ice cream to rise in the future, it will put some of its current production into storage and supply less to the market today.) number of sellers
A key difference between positive and normative statements
is how we judge their validity. We can, in principle, confirm or refute positive statements by examining evidence. evaluating normative statements involves values as well as facts. Deciding what is good or bad policy is not just a matter of science. It also involves our views on ethics, religion, and political philosophy. it's also hard to implement policies
market v individual demand
market demand, the sum of all the individual demands for a particular good or service. to find the total quantity demanded at any price, we add the individual quantities, which are found on the horizontal axis of the individual demand curves. The market demand curve shows how the total quantity demanded of a good varies as the price of the good varies, while all other factors that affect how much consumers want to buy are held constant.
market v individual supply
market supply is the sum of the supplies of all sellers.
An economy produces hot dogs and hamburgers. If a discovery of the remarkable health benefits of hot dogs were to change consumers' preferences, it would expand the production possibilities frontier. contract the production possibilities frontier. move the economy along the production possibilities frontier. move the economy inside the production possibilities frontier.
move the economy along the production possibilities frontier. The production possibilities frontier is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology. In this case, the trade-off between producing hot dogs and hamburgers doesn't change, because resources remain the same. However, the consumption point along the production possibilities frontier has changed, because consumers now prefer to consume more hot dogs. This is represented by a movement along the production possibilities frontier to a point with more hot dog production and less hamburger production.
short run market supply graph
n the short run, the number of firms in the market is fixed. As a result, the market supply curve, shown in panel (b), reflects the individual firms' marginal-cost curves, shown in panel (a). Here, in a market of 1,000 firms, the quantity of output supplied to the market is 1,000 times the quantity supplied by each firm.
movement on demand curve
price of the good quantity Because the price is on the vertical axis, a change in price represents a movement along the demand curve. By contrast, income, the prices of related goods, tastes, expectations, and the number of buyers are not measured on either axis, so a change in one of these variables shifts the demand curve.
Supply and demand together determine the ________ of the economy's many different goods and services _________ in turn are the signals that guide the allocation of resources.
prices
invisible hand
term economists use to describe the self-regulating nature of the marketplace A phrase coined by Adam Smith to describe the process that turns self-directed gain into social and economic benefits for all
market power
the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices
property rights
the ability of an individual to own and exercise control over scarce resources
comparative advantage
the ability to produce a good at a lower opportunity cost than another producer
absolute advantage
the ability to produce a good using fewer inputs than another producer
total revenue
the amount a firm receives for the sale of its output
quantity supplied
the amount of a good that sellers are willing and able to sell
The terms supply and demand refer to
the behavior of people as they interact with one another in competitive markets.
If a nation has high and persistent inflation, the most likely explanation is the central bank creating excessive amounts of money. unions bargaining for excessively high wages. the government imposing excessive levels of taxation. firms using their monopoly power to enforce excessive price hikes.
the central bank creating excessive amounts of money. The usual suspect in cases of large or persistent inflation is growth in the quantity of money. When a government's central bank creates large quantities of money, the value of that money falls, causing prices to rise and resulting in inflation. See Section: Principle 9: Prices Rise When the Government Prints Too Much Money.
marginal revenue
the change in total revenue from an additional unit sold Because a competitive firm is a price taker, its marginal revenue equals the market price.
law of supply and demand
the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance
Law of Demand
the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises
law of supply
the claim that, other things being equal, the quantity supplied of a good rises when the price of the good rises
Principle 6: Markets Are Usually a Good Way to Organize Economic Activity
the decisions of a central planner are replaced by the decisions of millions of firms and households. Firms decide whom to hire and what to make. Households decide which firms to work for and what to buy with their incomes. These firms and households interact in the marketplace, where prices and self-interest guide their decisions.
An increase in the supply of a good will decrease the total revenue producers receive if the demand curve is inelastic. the demand curve is elastic. the supply curve is inelastic. the supply curve is elastic.
the demand curve is inelastic. This is because if the supply increases, then the price decreases. And the change in total revenue is related to the elasticity of demand.
The Firm's Long-Run Decision to Exit or Enter a Market
the firm exits the market if the revenue it would get from producing is less than its total cost. He will enter When price is above the average total cost
externality
the impact of one person's actions on the well-being of a bystander
marginal product
the increase in output that arises from an additional unit of input
marginal cost
the increase in total cost that arises from an extra unit of production
All of the following topics fall within the study of microeconomics EXCEPT the impact of cigarette taxes on the smoking behavior of teenagers. the role of Microsoft's market power in the pricing of software. the effectiveness of antipoverty programs in reducing homelessness. the influence of the government budget deficit on economic growth.
the influence of the government budget deficit on economic growth. Microeconomics is the study of how households and firms make decisions and how they interact in specific markets. Macroeconomics is the study of economy-wide phenomena. Therefore, the influence of the government budget deficit on economic growth is a macroeconomic topic, while the others are all microeconomic topics.
total cost
the market value of the inputs a firm uses in production
Computing the Price Elasticity of Demand
the percentage change in quantity demanded divided by the percentage change in price
equilibrium price
the price that balances quantity supplied and quantity demanded
a higher level of prices is, in the long run,
the primary effect of increasing the quantity of money
economies of scale
the property whereby long-run average total cost falls as the quantity of output increases
diseconomies of scale
the property whereby long-run average total cost rises as the quantity of output increases
constant returns to scale
the property whereby long-run average total cost stays the same as the quantity of output changes
diminishing marginal product
the property whereby the marginal product of an input declines as the quantity of the input increases ex At first, when only a few workers are hired, they have easy access to Caroline's kitchen equipment. As the number of workers increases, additional workers have to share equipment and work in more crowded conditions. Eventually, the kitchen becomes so overcrowded that workers often get in each other's way. Hence, as more workers are hired, each additional worker contributes fewer additional cookies to total production. Because factory size is fixed in the short run
productivity
the quantity of goods and services produced from each unit of labor input
At the equilibrium price,
the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell. The equilibrium price is sometimes called the market-clearing price because, at this price, everyone in the market has been satisfied:
equilibrium quantity
the quantity supplied and the quantity demanded at the equilibrium price
production function and total cost curve
the relationship between quantity of inputs used to make a good and the quantity of output of that good The production function gets flatter as the number of workers increases, reflecting diminishing marginal product. The total-cost curve shows the relationship between the quantity of output produced and total cost of production. The total-cost curve gets steeper as the quantity of output increases because of diminishing marginal product.
production function
the relationship between the quantity of inputs used to make a good and the quantity of output of that good
Macroeconomics
the study of economy-wide phenomena, including inflation, unemployment, and economic growth
Microeconomics
the study of how households and firms make decisions and how they interact in markets
The ability of firms to enter and exit a market over time means that, in the long run, the demand curve is more elastic. the demand curve is less elastic. the supply curve is more elastic. the supply curve is less elastic.
the supply curve is more elastic.
What is the long run market supply curve price?
there is only one price consistent with zero profit—the minimum of average total cost. As a result, the long-run market supply curve must be horizontal at this price,
The Short Run: Market Supply with a Fixed Number of Firms
to derive the market supply curve, we add the quantity supplied by each firm in the market.
average total cost
total cost divided by the quantity of output
average revenue
total revenue divided by the quantity sold
Profit
total revenue minus total cost
average variable cost
variable cost divided by the quantity of output
when do we increase/decrease output.
where do these marginal adjustments to production end? Regardless of whether the firm begins with production at a low level (such as q1) or at a high level (such as a2), the firm will eventually adjust production until the quantity produced reaches qmax. This analysis yields three general rules for profit maximization: If marginal revenue is greater than marginal cost, the firm should increase its output. If marginal cost is greater than marginal revenue, the firm should decrease its output. At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal.
Over time, technological advance increases consumers' incomes and reduces the price of smartphones. Each of these forces increases the amount consumers spend on smartphones if the income elasticity of demand is greater than and if the price elasticity of demand is greater than . zero, zero zero, one one, zero one, one
zero, one
Which of the following statements support the reality that your standard of living is different from that of your parents or grandparents when they were your age? Check all that apply. Many families have at least two cars per household, whereas having a vehicle was a luxury in the early 20th century. A cutting-edge television comes with HD, 3D, and SmartTV technology, while your grandparents likely enjoyed a black-and-white television in the early years. In the United States, the average person's life expectancy was roughly 78 years old in 2010, but only 70 years old in 1960.
All Average income in the United States has roughly doubled every 35 years. Therefore, you are likely to have a better standard of living than your parents, and an even better standard of living than your grandparents. This includes having access to safer cars, better technology, and improved health care. See Section: Principle 8: A Country's Standard of Living Depends on Its Ability to Produce Goods and Services.
Governments may intervene in a market economy in order to protect property rights. correct a market failure due to externalities. achieve a more equal distribution of income. All of the above.
All of the above One reason we need government is that the invisible hand relies on the enforcement of property rights so individuals can own and control scarce resources. In addition, although the invisible hand can often guide market participants to a desirable market outcome, sometimes government intervention is necessary to correct for market failures. This term refers to a situation in which the market on its own will fail to produce an efficient allocation of resources. One example of a market failure is an externality; this occurs when one person's action inadvertently affects another person's well-being. Finally, the efficient outcome attained by the invisible hand doesn't necessarily result in equality among its participants. Depending on your political philosophy, this disparity in economic well-being may lead you to believe that government intervention is necessary. See Section: Principle 7: Governments Can Sometimes Improve Market Outcomes. in progress indicator Points: 1 / 1
why can someone have the absolute advantage over 2 goods but can't have the comparative advantage?
Although it is possible for one person to have an absolute advantage in both goods (as Ruby does in our example), it is impossible for one person to have a comparative advantage in both goods. Because the opportunity cost of one good is the inverse of the opportunity cost of the other, if a person's opportunity cost of one good is relatively high, the opportunity cost of the other good must be relatively low. Comparative advantage reflects the relative opportunity cost. Unless two people have the same opportunity cost, one person will have a comparative advantage in one good, and the other person will have a comparative advantage in the other good.
An economic model is a mechanical machine that replicates the functioning of the economy. a fully detailed, realistic description of the economy. a simplified representation of some aspect of the economy. a computer program that predicts the future of the economy.
An economic model is a simplified representation of some aspect of the economy. Because including every detailed, realistic aspect of an economy would result in something that isn't tractable and informative, economists use models to learn about the world. Just as an airplane model does not include all of the interior details of a plane, an economist's model does not include every feature of the economy.
Incentive
An incentive is something (such as the prospect of a punishment or reward) that induces a person to act.
Principle 2: The cost of something is what you give up to get it
Because people face trade-offs, making decisions requires comparing the costs and benefits of alternative courses of action. Ex: education requires going to college paying for it, housing and food.
Policymakers can exploit the short-run trade-off between inflation and unemployment using various policy instruments.
By changing the amount that the government spends, the amount it taxes, and the amount of money it prints, policymakers can influence the overall demand for goods and services.
Principle 3: Rational People Think at the Margin
Economists normally assume that people are rational. Rational people know that decisions in life are rarely black and white but usually involve shades of gray. At dinnertime, the question you face is not "Should I fast or eat like a pig?" More likely, you will be asking yourself "Should I take that extra spoonful of mashed potatoes?"
How does comparative advantage work?
Economists use the term comparative advantage when describing the opportunity costs faced by two producers. The producer who gives up less of other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it. Opportunity costs: Now consider Frank's opportunity cost. Producing 1 ounce of potatoes takes him 15 minutes. Because he needs 60 minutes to produce 1 ounce of meat, 15 minutes of work would yield ¼ ounce of meat. Hence, Frank's opportunity cost of 1 ounce of potatoes is ¼ ounce of meat.
Efficiency V Equality Which principle does this represent?
Efficiency means that society is getting the maximum benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society's members. In other words, efficiency refers to the size of the economic pie, and equality refers to how the pie is divided into individual slices. Demonstrates Trade off
when is the production possibility frontier and the consumption possibilities frontier the same?
If Frank and Ruby choose to be self-sufficient rather than trade with each other, then each consumes exactly what he or she produces. In this case, the production possibilities frontier is also the consumption possibilities frontier.
In an hour, Mateo can wash 2 cars or mow 1 lawn, and Tyler can wash 3 cars or mow 1 lawn. Who has the absolute advantage in car washing, and who has the absolute advantage in lawn mowing? Mateo in washing, Tyler in mowing. Tyler in washing, Mateo in mowing. Mateo in washing, neither in mowing. Tyler in washing, neither in mowing.
Tyler in washing, neither in mowing.
The Social Security system provides income for people over age 65. If a recipient of Social Security decides to work and earn some income, the amount he receives in Social Security benefits is typically reduced. The provision of Social Security gives people the incentive to save _____ while working. Moreover, the reduction in benefits associated with higher earnings gives people the incentive to _____ past age 65.
Less not work The provision of Social Security benefits lowers an individual's incentive to save for retirement because it provides income to retired individuals once they've reached age 65. This means that even if an individual hasn't been saving for retirement while working, he can still count on Social Security benefits to support himself through the retirement years. Moreover, because a person gets fewer after-tax Social Security benefits the greater his earnings are, there is also an incentive not to work (or not work as much) once he has hit the retirement age of 65. See Section: Principle 4: People Respond to Incentives.
Example of specialization and Trade
RUBY: Frank, my friend, have I got a deal for you! I know how to improve life for both of us. I think you should stop producing meat altogether and devote all your time to growing potatoes. According to my calculations, if you work 8 hours a day growing potatoes, you'll produce 32 ounces of potatoes. If you give me 15 of those 32 ounces, I'll give you 5 ounces of meat in return. In the end, you'll get to eat 17 ounces of potatoes and 5 ounces of meat every day, instead of the 16 ounces of potatoes and 4 ounces of meat you now get. If you go along with my plan, you'll have more of both foods. [To illustrate her point, Ruby shows Frank panel (a) of Figure 2.] FRANK: (sounding skeptical) That seems like a good deal for me. But I don't understand why you are offering it. If the deal is so good for me, it can't be good for you too. RUBY: Oh, but it is! Suppose I spend 6 hours a day raising cattle and 2 hours growing potatoes. Then I can produce 18 ounces of meat and 12 ounces of potatoes. After I give you 5 ounces of my meat in exchange for 15 ounces of your potatoes, I'll end up with 13 ounces of meat and 27 ounces of potatoes, instead of the 12 ounces of meat and 24 ounces of potatoes that I now get. So I will also consume more of both foods than I do now. [She points out panel (b) of Figure 2.]
Principle 5: Trade can make everyone better off
Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods EX: consider how trade affects your family. When a member of your family looks for a job, she competes against members of other families who are looking for jobs. Families also compete against one another when they go shopping because each family wants to buy the best goods at the lowest prices. In a sense, each family in an economy competes with all other families. Despite this competition, your family would not be better off isolating itself from all other families. If it did, your family would need to grow its own food, make its own clothes, and build its own home. Clearly, your family gains much from its ability to trade with others. Trade allows each person to specialize in the activities she does best, whether it is farming, sewing, or home building. By trading with others, people can buy a greater variety of goods and services at lower cost.
demand curve.
The line relating price and quantity demanded
opportunity cost
The opportunity cost of an item is what you give up to get that item. (could be time, money, resources, etc)
You were planning to spend Saturday working at your part-time job, but a friend asks you to go skiing. Which of the following are included in the true cost of going skiing? Check all that apply. The rental of any ski equipment you need The cost of your ski jacket you purchased last year The cost of a lift ticket The wages you forego by going skiing
The rental of any ski equipment you need The cost of a lift ticket The wages you forego by going skiing The opportunity cost of an item is what you give up to get that item. The opportunity cost of going skiing when your plan was to go to work includes the cost of a lift ticket, the wages you forego by going skiing, and the rental of any ski equipment you need. Since you already own a ski jacket, this is not included in the cost of going skiing since you don't have to give up anything to use the jacket you already own. See Section: Principle 2: The Cost of Something Is What You Give Up To Get It.
Now suppose you had been planning to spend the day studying at the library. What is the cost of going skiing in this case? Check all that apply. The value of your time spent studying The wages you forego by going skiing The cost of your ski jacket you purchased last year The cost of a lift ticket The rental of any ski equipment you need
The value of your time spent studying The cost of a lift ticket The rental of any ski equipment you need In this case, the opportunity cost of going skiing when your plan was to study at the library again includes the cost of a lift ticket and the rental of any ski equipment you need. However, because you are giving up study time rather than work, your opportunity cost also includes the value of your time spent studying, rather than the wages you forego. See Section: Principle 2: The Cost of Something Is What You Give Up To Get It.
Which goods will a nation typically import? those goods in which the nation has an absolute advantage those goods in which the nation has a comparative advantage those goods in which other nations have an absolute advantage those goods in which other nations have a comparative advantage
Those goods in which other nations have a comparative advantage.
Principle 1: People Face Trade-offs
To get something that we like, we usually have to give up something else that we also like. Making decisions requires trading off one goal against another. what to do with our time, our money ect. ex: lower pollution causes higher costs of goods ect.
How is trade beneficial?
Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage.
Once again, in an hour, Mateo can wash 2 cars or mow 1 lawn, and Tyler can wash 3 cars or mow 1 lawn. Who has the comparative advantage in car washing, and who has the comparative advantage in lawn mowing? Mateo in washing, Tyler in mowing. Tyler in washing, Mateo in mowing. Mateo in washing, neither in mowing. Tyler in washing, neither in mowing.
Tyler in washing, Mateo in mowing.
The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development and make the product, _____ go ahead and do so. The most you should pay to complete development is $_ million.
You SHOULD 3 million Because the $5 million your company invested in a new product has already been spent, it should not be considered in the decision of whether to finish development, according to the principle of thinking at the margin. In this case, the additional cost to finish development is $1 million, whereas the expected additional benefit of the new product is $3 million in profit (assuming that the company receives zero profit if the product remains unfinished). Therefore, your company should go ahead and finish the product. In fact, your company should be willing to pay up to $3 million to finish development since that is the marginal benefit from doing so. See Section: Principle 3: Rational People Think at the Margin.
why would the production possibilties frontier be straight and not bowed
You may recall that the production possibilities frontier in Chapter 2 was drawn bowed out. In that case, the rate at which society could trade one good for the other depended on the amounts that were being produced. Here, however, Frank's technology for producing meat and potatoes (as summarized in Figure 1) allows him to switch between the two goods at a constant rate. Whenever Frank spends 1 hour less producing meat and 1 hour more producing potatoes, he reduces his output of meat by 1 ounce and raises his output of potatoes by 4 ounces—and this is true regardless of how much he is already producing. As a result, the production possibilities frontier is a straight line.
competitive market
a market in which there are many buyers and many sellers so that each has a negligible impact on the market price
market failure
a situation in which a market left on its own fails to allocate resources efficiently
The circular-flow diagram illustrates that, in markets for the factors of production, households are sellers, and firms are buyers. households are buyers, and firms are sellers. households and firms are both buyers. households and firms are both sellers.
households are sellers, and firms are buyers. The circular-flow diagram simplifies the economy by including only two types of decision makers: firms and households. Firms produce goods and services using inputs, such as labor, land, and capital. These inputs are called the factors of production. Households own the factors of production and consume all the goods and services that the firms produce. Therefore, in the markets for the factors of production, households are sellers, and firms are buyers.
Adam Smith's "invisible hand" refers to the subtle and often hidden methods that businesses use to profit at consumers' expense. the ability of free markets to reach desirable outcomes, despite the self-interest of market participants. the ability of government regulation to benefit consumers, even if the consumers are unaware of the regulations. the way in which producers or consumers in unregulated markets impose costs on innocent bystanders.
the ability of free markets to reach desirable outcomes, despite the self-interest of market participants. In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, economist Adam Smith acknowledged that households and firms act as if they are guided by an "invisible hand" that leads to a desirable market outcome. Although participants in the market act with their own self-interest in mind (for example, households seek to maximize their happiness while firms seek to maximize profits), free markets can reach desirable outcomes without additional intervention under certain assumptions and market conditions. See Section: Principle 6: Markets Are Usually a Good Way to Organize Economic Activity.
quantity demanded
the amount of a good that buyers are willing and able to purchase one determinant plays a central role: the price of the good.
Your opportunity cost of going to a movie is the price of the ticket. the price of the ticket plus the cost of any soda and popcorn you buy at the theater. the total cash expenditure needed to go to the movie plus the value of your time. zero, as long as you enjoy the movie and consider it a worthwhile use of time and money.
the total cash expenditure needed to go to the movie plus the value of your time. The opportunity cost of an item is what you give up to get that item. In this case, the opportunity cost of going to a movie includes both the total cash expenditure needed to go to the movie plus the value of the time you gave up in order to watch the movie. See Section: Principle 2: The Cost of Something Is What You Give Up To Get It.