Economics Exam I

*Trade-offs* Ask 3 essential questions

*What* goods and services will be produced? *How* will the goods and services be produces? *Who* will receive the goods and services produced?

*Human capital*

*accumulated training and skills* that workers possess. ex: college-educated workers have more human capital.

Externalities interfere with the economic efficiency of a market equilibrium.

*competitive market* achieves *economic efficiency* by maximizing the *sum of consumer surplus and producer surplus*. But that result holds only if there are *no externalities in production or consumption*. -An externality can cause a difference between the private cost of production and the social cost.

*Perfectly elastic*

*horizontal line* In this case, the quantity demanded is infinitely responsive to price, and the price elasticity of demand equals infinity.

Behavioral economists argue that it *does matter that consumers usually do not make optimal consumption choices.*

These economists believe that there are *benefits to analyzing how consumers actually make decisions.* When people shop, they have full information on the prices of products, including information on differences in prices across stores. People can make complicated calculations such as computing the ratios of marginal utilities to prices across many products.

*Factor Markets*

markets for the *factors of production*: the inputs used to make goods and services

*People respond to economic incentives*

As incentives change, so do the actions that people will take *Elasticity*: the degree to which people react people with health insurance will be more likely to be overweight than people without health insurance.

Intellectual Property rights

includes books, films, software, and ideas for new products or new ways of producing products. -the federal government grants a *patent* that gives an inventor—often a firm—the exclusive right to produce and sell a new product for a period of 20 years from the date the patent was filed.

*Demand Schedules*

Tables that show the *relationship between the price of a product* and the *quantity of the product demanded*

*Quantity Supplied*

The amount of a good or service that a firm is willing and able to supply at a given price

*Inelastic demand*

The case where the percentage change in quantity demanded is *less than the percentage change in price*, so the price elasticity is *less than 1 in absolute value.*

*Positive analysis*

concerned with *what is* economics is more focused on this, the FACTS

The idea of increasing marginal opportunity costs illustrates an important economic concept: *The more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity*

ex: The more hours you have already spent studying economics, the smaller the increase in your test grade from each additional hour you spend—and the greater the opportunity cost of using the hour in that way.

*Free market*

exists when the government *places few restrictions* on how goods and services can be produced or sold or on how factors of production can be employed.

*Rules of thumb*

guides to decision making that may not produce optimal choices.

*Law of Supply*

holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

*Negative Externality*

if fish and wildlife have disappeared from a lake because of acid rain generated by a utility, people who live near the lake incur a cost—even though they may not purchase electricity from that utility.

Consumer surplus measures the *net benefit* to consumers from participating in a market rather than the total benefit.

if the price of a product were *zero*, the consumer surplus in a market would be all of the area *under the demand curve.*

*command-and-control approach*

involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices

when the government imposes a price ceiling or a price floor, the amount of economic surplus in a market is *reduced*.

lacks market equilibrium

*Price Controls*

legally binding maximum or minimum prices

*Product markets*

markets for goods—such as smartphones—and services—such as medical treatment. households are demanders and firms are suppliers.

*Ceteris paribus condition*

"All else equal"; the necessity of *holding all variables other than price constant* in constructing a demand curve

*Change in supply* vs. *Change in quantity supplied*

*A change in supply* refers to a shift of the supply curve. The supply curve will shift when there is a change in *one of the variables—other than the price of the product*—that affects the willingness of suppliers to sell the product *Change in the quantity supplied*: refers to a movement along the supply curve *as a result of a change in the product's price.*

*Change in demand* vs. *Change in quantity demanded*

*Change in demand* refers to a shift of the demand curve. A shift occurs if there is a change in one of the variables—*other than the price of the product*—that *affects the willingness of consumers to buy the product*. *Change in quantity demanded* refers to a movement along the demand curve as a result of a *change in the product's price.*

*Price ceiling*

*Consumers* sometimes succeed in having the government impose this, which is a legally determined *maximum price* that sellers may charge. Common example: *Rent control* Rent control, which puts a legal limit on the rent that landlords can charge for an apartment, is an example.

*Private Cost*

the cost borne by the producer of a good or service.

*Capital*

*Financial capital* includes stocks and bonds issued by firms, bank accounts, and holdings of money. In economics, though, capital refers to *physical capital*, which includes manufactured goods that are used to produce other goods and services.

*Price floor*

*Firms* sometimes succeed in having the government impose this, which is a legally determined *minimum price* that sellers may receive. Common Examples: *Minimum wage and agricultural price controls* Example: In markets for farm products such as milk, the federal government has been setting these above the equilibrium market price since the 1930s.

When the price of gasoline rises, the quantity demanded falls. So, the correct answer to this problem would *use a graph showing a typical downward-sloping demand curve rather than a vertical demand curve*

*Inelastic* NOT perfectly inelastic

*Optimal decisions are made at the margin*

*Marginal*: extra or additional, take the next step *Marginal benefit (MB)*: additional enjoyment *Marginal cost (MC)*: reduction in test score *Optimal decision*: to continue any activity up to the point where the marginal benefit equals the marginal cost *MB=MC* *Marginal analysis*: comparing marginal benefits, implies that you are always making a decision

An increase in production in one good requires reduction in the production of another, *what has to be given up in order to produce something is*....

*Opportunity cost*

*5 variables that shift market demand*

-*Income*: amount of income a consumer has available affects their willingness and ability to buy a good. -*Prices of related goods*: substitutes and complements -*Taste*: advertising and trends that consumers find appealing -*Population and Demographics*: demographics refer to characteristics, with respect to age, race, and gender. -*Expected Future Prices*: not just when to buy, but when to buy them.

*5 variables that shift market Supply*

-*Prices of Inputs*: most likely to cause the supply curve for a product to shift is a change in the price of an input -*Technological Change*: a positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs -*Prices of related goods in production*: Substitutes and complements -*Number of firms in the market*: *new firms enter* a market, the *supply curve shifts to the right*, and when *existing firms leave*, or exit, a market, the *supply curve shifts to the left*. -*Expected future prices*

Remember that elasticity is not the same thing as slope

-The demand curve with the smaller slope (in absolute value)—the flatter demand curve—is more elastic. -The demand curve with the larger slope (in absolute value)—the steeper demand curve—is less elastic.

*Microeconomics*

-the study of *how households (consumers) and firms make choices* -how they *interact in markets* -and how the *government attempts to influence their choices.* Examples: How consumers react to changes in product prices How firms decide what prices to charge for the products they sell Which government policy would most efficiently reduce obesity The costs and benefits of approving the sale of a new prescription drug The most efficient way to reduce air pollution

Two key groups participate in markets:

1) *Households are all the individuals in a home.* Households are suppliers of factors of production—particularly labor—employed by firms to make goods and services. -All firms are owned by households. *we can generalize by saying that in factor markets, households are suppliers and firms are demanders.* 2)*Firms* are suppliers of goods and services. Firms use the funds they receive from selling goods and services to buy or hire the factors of production needed to make the goods and services. *Circular-flow diagram* maps out how participants in markets are linked

*Factors of Production* in 4 categories

1) *Labor* includes all types of work, from the part-time labor of teenagers working at McDonald's to the work of senior managers in large corporations 2) *Capital* refers to physical capital, such as computers, office buildings, and machine tools, used to produce other goods. 3) *Natural resources* include land, water, oil, iron ore, and other raw materials (or "gifts of nature") that are used in producing goods. 4) *An entrepreneur* is someone who operates a business. *Entrepreneurial ability* is the ability to bring together the other factors of production to successfully produce and sell goods and services.

3 key economic ideas

1. *People are rational* 2. *People respond to economic incentives* 3. *Optimal decisions are made at the margin*

When the government imposes price floors or price ceilings, three important results occur:

1. *Some people win.* -The winners from rent control are the people who are paying less for rent because they live in rent-controlled apartments. - Landlords may also gain if they break the law by charging rents above the legal maximum for their rent-controlled apartments, provided that those illegal rents are higher than the competitive equilibrium rents would be. 2. *Some people lose.* -The losers from rent control are the landlords of rent-controlled apartments who abide by the law and renters who are unable to find apartments to rent at the controlled price. 3. *There is a loss of economic efficiency.* -Rent control reduces economic efficiency because fewer apartments are rented than would be rented in a competitive market -The resulting deadweight loss measures the decrease in economic efficiency.

*Economic Models*

1. Decide on the assumptions to use: behavioral assumptions about the motives of consumers and firms. 2. Formulate a testable hypothesis: a hypothesis is a statement about an economic variable that may be either correct or incorrect. *Economic variable*: Something measurable that can have different values, such as the number of people employed in manufacturing. 3. Use economic data to test the hypothesis. 4. Revise the model if it fails to explain the economic data well. 5. Retain the revised model to help answer similar economic questions in the future.

The *percentage change* is the change in some economic variable, usually from one period to the next, expressed as a percentage.

A key macroeconomic measure is the real *gross domestic product (GDP).*

*Elasticity*

A measure of how much one economic variable responds to changes in another economic variable.

There is a shortage of every good that is scarce. = FALSE!!!!

A shortage of a good occurs *only if* the quantity demanded is *greater than* the quantity supplied at the current price.

*Market equilibrium*

A situation in which quantity demanded equals quantity supplied. Competitive market equilibrium: A market equilibrium with many buyers and sellers.

*Surplus*

A situation in which the *quantity supplied is greater than the quantity demanded*. When the *market price is ABOVE the equilibrium*

for the market mechanism to *work in response* to changes in consumers' wants, prices must be *flexible.*

Adam Smith's metaphor of the invisible hand to describe how the market leads firms to provide consumers with the goods they want. Firms respond *individually to changes in prices by making decisions that collectively end up satisfying the preferences of consumers.*

*People are rational*

Consumers and firms *use all available information before as they act to achieve their goals; they weigh the benefits and the costs.* *This assumption does not mean that economists believe everyone knows everything or always makes the "best" decision, good or bad. It means that economists assume that consumers and firms use all available information as they act to achieve their goals.* ONLY if the benefits outweigh the costs -not maximizing *price* but maximizing *profit* This works as a benchmark to see how people deviate from it and how people's non rational choices can cancel out.

Equilibrium in a competitive market results in the *greatest amount of economic surplus*, or *total net benefit to society*, from the production of a good or service.

Equilibrium in a competitive market results in the *economically efficient level of output*, at which *marginal benefit equals marginal cost.*

*Complements*

Goods and services that are used together—such as hot dogs and hot dog buns. -the more consumers buy of one, the more they will buy of the other. A *decrease* in the price of a complement causes the demand curve for a good to shift to the *right*. An *increase* in the price of a complement causes the demand curve for a good to shift to the *left.*

*Substitutes*

Goods and services that can be used for the same purpose. An *increase in the price of a substitute causes the demand curve for a good to shift to the right.*

*Anchoring*

If people are uncertain about a value, such as a price, they often relate—or anchor—that value to some other known value, even if the second value is irrelevant.

*The price elasticity of demand is always negative*

In comparing elasticities, though, we are usually interested in their relative size. So, we often drop the minus sign and compare their absolute values.

*Unit Elastic*

In the special case where the percentage change in quantity demanded is *equal to the percentage change in price*, the price elasticity of demand equals − 1 (or 1 in absolute value).

*Perfectly Inelastic*

In this case, the quantity demanded is completely unresponsive to price, and the price elasticity of demand equals zero. *Vertical line*

*Law of Demand*

The inverse relationship between the *price of a product and the quantity of the product demanded* -Holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.

Price elasticity for a DEMAND INCREASE

The percentage change in price will be positive, and the percentage change in quantity demanded will be negative.

*Deadweight loss*

The reduction in economic surplus resulting from a market not being in competitive equilibrium

*Unless there is an externality, the private cost and the social cost are equal.*

Unless there is an externality, the private benefit and the social benefit are equal.

When There Is a Negative Externality, a Tax Can Lead to the Efficient Level of Output

When There Is a Positive Externality, a Subsidy (or payment equal to the externality) Can Bring about the Efficient Level of Output

*Shortage*

When the *quantity demanded is greater than the quantity supplied*

When there is a *negative externality* in *producing* a good or service, too much of the good or service will be *produced at market equilibrium*.

When there is a *positive externality* in *consuming* a good or service, too little of the good or service will be *produced at market equilibrium.*

*Externality*

a benefit or cost that *affects someone who is not directly involved* in the production or consumption of a good or service When there is a *negative* externality, the market may produce a quantity of the good that is *greater* than the efficient amount. When there is a *positive* externality, the market may produce a quantity that is *less* than the efficient amount. -*Pollution is the most common example of this* the person creating the pollution gets to manipulate the marginal costs and benefits of it.

*Production Possibilities Frontier (PPF)*

a curve showing the *maximum attainable combinations of two goods* that can be produced with available resources and current technology.

*Market*

a group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.

*Economic efficiency*

a market outcome in which the *marginal benefit to consumers* of the last unit produced is *equal to its marginal cost of production* and in which the *sum of consumer surplus and producer surplus is at a maximum.*

*Perfectly Competitive Market*

a market where there are many buyers and sellers, all the products sold are identical, and there are no barriers to new firms entering the market.

*Scarcity*

a situation in which *wants exceed the limited resources available*

*Market Failure*

a situation where the market fails to produce the efficient level of output. -might invite government intervention

*Supply Schedule*

a table that shows the relationship between the price of a product and the quantity of the product supplied

*Firm, company, or business*

an organization that produces a good or service.

*Normative analysis*

analysis concerned with *what ought to be*

*Input*

anything used in the production of a good or service

*Trade-off*

because of scarcity, *producing more of one good or service means producing less of another good or service* the concept of giving and getting

*Voluntary exchange*

both the buyer and the seller of a product are made better off by the transaction.

People make *choices* as they try to attain their *goals*

choices are necessary because of scarcity

*Productive efficiency*

occurs when a good or service is produced at the *lowest possible cost.*

*Allocate efficiency*

occurs when production is *in accordance with consumer preferences.*

*Reverse casualty*

occurs when we conclude that changes in variable X cause changes in variable Y when, in fact, it is actually changes in variable Y that cause changes in variable X.

Omitted variable

one that affects the other variables in the analysis, and its omission can lead to false conclusions about cause and effect.

*Positive Externality*

people who do not pay for them will nonetheless benefit from them. ex: the production of college educations

If Uber is required to start paying the value added tax (VAT) in Great Britain, this will have the potential to ________ the equilibrium price in this market and, therefore, ________ efficiency.

raise decrease

*Property Rights*

refer to the rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it. -Governments need to guarantee property rights in order for a market system to function well

*The Substitution Effect*

refers to the change in the quantity demanded of a good that results because a change in price makes the good more or less expensive *relative* to other goods that are *substitutes* Ex: When the price of premium bottled water falls, people will substitute buying premium bottled water for other goods.

Market shares

show the percentage of industry sales accounted for by different firms.

*Supply curve*

shows the relationship between the price of a product and the quantity of the product supplied.

*Market failure*

situations in which the market *fails to produce the efficient level of output.*

*Economics* is the study of *choices* people make to attain their goals given their *scarce* resources

size, choice, and scarcity

*Opportunity Cost*

the *highest valued alternative that must be given up to engage in that activity* -often do NOT involve actual payments of money

*Technology*

the *processes it uses to produce* goods and services.

*Economic Surplus*

the *sum of consumer surplus and producer surplus*. -economic surplus is at a maximum when the market is in equilibrium

*Social benefit*

the *total benefit from consuming a good or service*, and it is *equal to the private benefit plus any external benefit* Example: the benefit to others resulting from your college education.

*Social cost*

the *total cost of producing a good or service*, and it is *equal to the private cost plus any external cost* Example: the cost of pollution.

*Absolute advantage*

the ability of an individual, a firm, or a country to produce *more of a good or service than competitors*, using the same amount of resources.

*Comparative advantage*

the ability of an individual, a firm, or a country to produce a good or service at a *lower opportunity cost than competitors.*

*Trade*

the act of buying and selling -makes it possible for people to become better off by increasing both their production and their consumption.

*Quantity Demand*

the amount of a good or service that a consumer is *willing and able* to purchase at a given *PRICE* *Demand curve*: shows the relationship between the price of a product and the quantity of the product demanded

*Private benefit*

the benefit received by the consumer of a good or service.

*The Income Effect*

the change in the quantity demanded of a good that results because a change in the good's price increases or decreases consumers' *purchasing power.* *Purchasing Power*: the quantity of goods a consumer can buy with a fixed amount of income. When the price of a good *falls*, the *increased purchasing power* of consumers' incomes will usually lead them to purchase a *larger quantity* of the good. When the price of a good *rises*, the *decreased purchasing power* of consumers' incomes will usually lead them to purchase a *smaller quantity* of the good.

*Profit*

the difference between its revenue and its costs.

*Consumer Surplus*

the difference between the *highest price a consumer is willing to pay* for a good or service and the actual price the consumer pays. Consumers are willing to purchase a product up to the point where the marginal benefit of consuming a product is equal to its price. equal to the *total benefit consumers receive* minus the total amount they *must pay* to buy the good or service. when its not zero: consumer surplus is the area below the demand curve and above the market price.

*Producer Surplus*

the difference between the *lowest price a firm would be willing to accept* for a good or service and the price it *actually receives* *the total amount of producer surplus in a market is equal to the area above the market supply curve and below the market price.* when its not zero... producer surplus is the area below the market price and above the supply curve.

Price elasticity for a DEMAND CUT

the percentage change in price will be negative, and the percentage change in quantity demanded will be positive.

*Innovation*

the practical application of an invention. -may also be used more broadly to refer to any significant improvement in a good or in the means of producing a good.

*Price Elasticity of Demand*

the responsiveness of the quantity demanded to a change in price.

*Property rights*

the rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. Can be property or intangible/an idea.

*Macroeconomics*

the study of the *economy as a whole, including topics such as inflation, unemployment, and economic growth.* Why economies experience periods of recession and increasing unemployment Why, over the long run, some economies have grown much faster than others What determines the inflation rate What determines the value of the U.S. dollar in exchange for other currencies Whether government intervention can reduce the severity of recessions

*Revenue*

total amount received for selling a good or service.

*Inferior good*

when the demand for it *decreases* following a *rise in income* and *increases* following a *fall in income.* You might buy fewer cans of tuna or packages of instant noodles and buy more salmon or whole grain pasta. So, for you, canned tuna and instant noodles would be examples of inferior goods—not because they are of low quality but because *you buy less of them as your income increases.*

*Normal good*

when the demand for the good *increases* following a *rise in income*, and *decreases* following a fall in income.

Smith's argument is the assumption that individuals usually act in a rational, self-interested way

when we analyze people in the act of buying and selling, the motivation of financial reward usually provides the best explanation for the actions people take.

*Black market*

which buying and selling take place at prices that violate government price regulations.