Exam 4 - Final

Principle 1: People face trade-offs

Making decisions requires trading off one goal against another by comparing the costs and benefits of alternative courses of action.

Consumption Possibilities Frontier

Shows the possible combinations of goods that can be produced and consumed (assuming there is no trade).

John Maynard Keynes

"The study of economics does not seem to require any specialized gifts of an unusually high order. Is it not ... a very easy subject compared with the higher branches of philosophy or pure science? An easy subject, at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts. He must be mathematician, historian, statesman, philosopher—in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past for the purposes of the future. No part of man's nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician."

Production Possibilities Frontier (PPF)

- A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. - People face trade-offs.

Model: Production Possibilities Frontier (PPF)

- A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. - Shows the trade-offs between the outputs of different goods at a given time. - Shows the opportunity cost of one good as measured in terms of the other good.

The Scientific Method

- A series of steps followed to solve problems including collecting data, formulating a hypothesis, testing the hypothesis, and stating conclusions. - The dispassionate development and testing of theories about how the world works.

Market Failure

- A situation in which a market left on its own fails to allocate resources efficiently. - Possible causes: Externality and market power.

Model: Circular Flow Diagram

- A visual model of the economy that shows how dollars flow through markets among households and firms. - 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.

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. - Rewards people according to their ability to produce things that other people are willing to pay for.

Inferior Good

- An increase in income leads to a decrease in demand. - A decrease an income leads to an increase in demand. Ex. Bus Rides

Normal Good

- An increase in income leads to an increase in demand. - A decrease in income leads to a decrease in demand.

Economic Models

- Consists of diagrams and equations. - Built with assumptions to exclude irrelevant information. - Simplified to improve our understanding.

Short-run effects of decreasing money in circulation

- Decreases demand for goods and services (less spending). - Encourages firms to hire less workers (less demand). - Raises unemployment.

Why Economists Disagree

- Difference in Scientific Judgments: Economists may disagree about the validity of alternative positive theories of how the world works, or about the size of important parameters that measure how economic variables are related. - Difference in Values: Economists may have different values and therefore different normative views about what government policy should aim to accomplish.

Economists in Washington

- Economic Report of the President: Discusses recent developments in the economy and presents the council's analysis of current policy issues. - Economists at the Office of Management and Budget help formulate spending plans and regulatory policies. - Economists at the Department of the Treasury help design tax policy. - Economists at the Department of Labor analyze data on workers and those looking for work to help formulate labor-market policies. - Economists at the Department of Justice help enforce the nation's antitrust laws.

Possible Points on PPF Graph

- Efficient: Economy utilizing all resources to maximize productions (points on the PPF). - Inefficient: Economy not utilizing all resources to maximize production (points inside the PPF). - Unattainable: Economy does not have enough resources to produce (points outside the PPF).

Inflation's effects on unemployment

- Higher inflation leads to lower unemployment. - Lower inflation leads to higher unemployment.

Variables that shift the demand curve

- Income - Price of related goods - Tastes - Expectations - Number of buyers Note: A change in the good's price will represent a movement in the demand curve, while the above variables will represent a shift in the demand curve.

Short-run effects of increasing money in circulation

- Increases demand for goods and services (more spending). - Encourages firms to hire more workers to supply demand. - Lowers unemployment.

Variables that shift the supply curve

- Input Prices - Technology - Expectations - Number of Sellers Note: A change in the good's price represents a movement along the supply curve, whereas a change in one of the other variables shifts the supply curve.

Principle 9: Prices rise when the government prints too much money

- Large and persistent inflation is caused by rapid growth in the quantity of money. - Because high inflation imposes various costs on society, keeping inflation at a low level is a goal of economic policymakers around the world.

Two rationales for government intervention in the economy

- Promote efficiency or equality (enlarge the economic pie or change how it is divided). - Efficiency does not equal equality. It is commonly a trade-off.

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. - Countries as well as families benefit from the ability to trade with one another.

Assumptions

- Simplify the complex world and make it easier to understand. - Allows focus on the essence of the problem.

Quantity Demanded

- The amount of a good that buyers are willing and able to purchase. - The price of the good plays the central role.

Shifting and Moving a Demand Curve

A curve shifts when there is a change in a relevant variable that is not measured on either axis. 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.

Centrally-Planned Economy

A economic system in which the central government makes all decisions on the production and consumption of goods and services.

Supply Curve

A graph of the relationship between the price of a good and the quantity supplied. The supply curve slopes upward because, other things being equal, a higher price means a greater quantity supplied.

Market

A group of buyers and sellers of a particular product. The buyers determine the demand for the product, and the sellers determine the supply of a product.

Positive vs Normative Statements

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. By contrast, evaluating normative statements involves values as well as facts.

Competitive Market

A market in which there are many buyers and many sellers so that each has a negligible impact on the market price.

Monopoly

A market in which there are many buyers but only one seller who sets the price.

Perfectly Competitive Market

A market that meets two characteristics (1) all firms selling identical products (2) many buyers and sellers - no influence on market price.

Marginal Change

A small incremental adjustment to a plan of action.

Demand Schedule

A table that shows the relationship between the price of a good and the quantity demanded, holding constant everything else that influences how much of the good consumers want to buy. It illustrates the law of demand.

Supply Schedule

A table that shows the relationship between the price of a good and the quantity supplied. It illustrates how the quantity supplied of the good changes as its price varies (law of supply). Because a higher price increases the quantity supplied, the supply curve slopes upward.

What causes a shift in the PPF?

A technological advance in production shifts the production possibilities frontier outward. This is a demonstration of economic growth.

Absolute vs. Comparative Advantage

Absolute: Cheaper cost. Comparative: More efficient. - One can have an absolute advantage on everything, but cannot have a comparative advantage on everything because the opportunity cost of one good is the inverse of the opportunity cost of the other.

Trade

Allows countries to specialize in what they do best and to enjoy a greater variety of goods and services.

Trade Benefits

Allows people to specialize in activities in which they have a comparative advantage. Increases the total production of the economy hence making everyone better off.

Principle 8: A country's standard of living depends on its ability to produce goods and services

Almost all variation in living standards is attributable to differences in the countries' productivity.

Supply and Demand

An economic concept that states that the price of a good rises and falls depending on how many people want it (demand) and depending on how much of the good is available (supply).

Inflation

An increase in the overall level of prices in the economy.

Macroeconomic Models

Analyze how aggregate phenomena such as growth, inflation, and unemployment respond to policy decisions of governments and central banks, changes in aggregate spending or savings, and supply or demand shocks.

Shifts in the Supply Curve

Any change that raises quantity supplied at every price shifts the supply curve to the right and is called an increase in supply. Any change that reduces the quantity supplied at every price shifts the supply curve to the left and is called a decrease in supply.

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.

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. (Opportunity Cost)

Principle 4: People respond to incentives

Because rational people make decisions by comparing costs and benefits, they respond to incentives.

Price Takers

Buyers and sellers in a perfectly competitive market that must accept the price that the market determines.

How policymakers can influence the overall demand for goods and services

By changing the amount the government spends, the amount it taxes, and the amount of money it prints.

Positive Statements

Claims that attempt to describe the world as it is (objective).

Normative Statements

Claims that attempt to prescribe how the world should be (subjective).

Business Cycle

Fluctuations in economic activity, such as employment and production.

Gains from Trade

For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs.

Imports

Goods produced abroad and sold domestically.

Exports

Goods produced domestically and sold abroad.

Principle 6: Markets are usually a good way to organize economic activity

Households and firms interacting in markets act as if they are guided by an "invisible hand" that leads them to desirable market outcomes. - Free markets have proven to reach desirable outcomes, despite the self-interest of market participants (Adam Smith).

Supply and Demand

In any market, buyers look at the price when determining how much to demand, and sellers look at the price when deciding how much to supply. As a result of the decisions that buyers and sellers make, market prices reflect both the value of a good to society and the cost to society of making the good.

Principle 10: Society faces a short-run trade-off between inflation and unemployment

In the short run, an increase in the quantity of money stimulates spending, which raises both prices and production. The increase in production requires more hiring, which reduces unemployment. Thus, in the short run, an increase in inflation tends to reduce unemployment.

Long-run effects of increasing money in circulation

Inflation

Macro vs Micro Economics

It is impossible to understand macroeconomic developments without considering the associated microeconomic decisions.

Microeconomics Models

Models that analyze the decisions of firms (such as pricing) and those of consumers (such as shopping choices), as well as how government policies affect those decisions.

Calculating Opportunity Cost

OC = What you give up / What you want

Law of Demand

Other things being equal, when the price of a good rises, the quantity demanded of the good falls, and when the price falls, the quantity demanded rises.

Law of Supply

Other things being equal, when the price of a good rises, the quantity supplied of the good also rises, and when the price falls, the quantity supplied falls as well.

Rational People

People who systematically and purposefully do the best they can to achieve their objectives by making decisions based on the comparison of marginal benefits and marginal costs (Benefit must exceed the cost).

Input Prices

Prices of the necessary materials to produce a good. Supply is negatively related to the prices of inputs. Higher input prices will decrease supply.

Equality

Property: Distributing economic prosperity uniformly among the members of society. (How the pie is divided)

Efficiency

Property: Society getting the most it can from its scarce resources. (Size of the economic pie)

How to boost living standards

Raise productivity by ensuring that workers are well educated, have the tools they need to produce goods and services, and have access to the best available technology.

Principle 3: Rational people think at the margin

Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities.

Straight PPF

Represents constant opportunity costs (increased production of one good comes at a constant opportunity cost).

Bowed PPF

Represents increasing opportunity costs (increasing production of one good comes at an increasing opportunity cost).

Incentive

Something that induces a person to act.

Economists

Study how people make decisions and how they interact with one another. Analyze the forces and trends that affect the economy as a whole, including growth in average income, unemployment, and inflation.

Market Power

The ability of a single economic actor (or small group of actors) to have a substantial influence on market prices (monopoly).

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.

Quantity Supplied

The amount of a good that sellers are willing and able to sell.

Externality

The impact of one person's actions on the well-being of a bystander.

Principle 7: Governments can sometimes improve market outcomes

The invisible hand that guides markets can only function if the government enforces the rules and maintains the institutions that are key to a market economy. This sometimes requires intervention and reallocation of resources.

Scarcity

The limited nature of society's resources.

Why is the PPF bowed out?

The production possibilities frontier is bowed outward because the opportunity cost of producing more of a good increases as we near maximum production of that good. This is because we use resources better suited toward production of the other good in order to continue to expand production of the first good.

Market Demand Curve

The quantity demanded in a market is the sum of the quantities demanded by all the buyers at each price.

Productivity

The quantity of goods and services produced from each unit of labor input.

Market Supply Curve

The quantity supplied in a market is the sum of the quantities supplied by all the sellers at each price.

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.

Economics

The study of how society manages its scarce resources.

Market Demand

The sum of all the individual demands for a particular good or service.

Market Supply

The sum of the quantities supplied by each seller in the market at each price

Circular Flow Diagram (Visual)

The two loops of the circular-flow diagram are distinct but related. The inner loop represents the flows of inputs and outputs. The households sell the use of their labor, land, and capital to the firms in the markets for the factors of production. The firms then use these factors to produce goods and services, which in turn are sold to households in the markets for goods and services. The outer loop of the diagram represents the corresponding flow of dollars. The households spend money to buy goods and services from the firms. The firms use some of the revenue from these sales to pay for the factors of production, such as the wages of their workers. What's left is the profit of the firm owners, who are themselves members of households.

Complements

Two goods for which an increase in the price of one leads to a decrease in the demand for the other.

Substittes

Two goods for which an increase in the price of one leads to an increase in the demand for the other.

Opportunity Cost

Whatever must be given up to obtain some item.

Oppurtunity Cost

Whatever must be given up to obtain some item.

What causes inflation

When a government creates large quantities of the nation's money, the value of money falls.

Common Trade-Off: Efficiency vs Equality

When the government redistributes income from the rich to the poor, it reduces the reward for working hard; as a result, people work less and produce fewer goods and services. In other words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller.