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Econ 201 Chapters 1, 2, and 3 Study Guide

by: Kathryn Catton

Econ 201 Chapters 1, 2, and 3 Study Guide ECON 2010

Marketplace > Economcs > ECON 2010 > Econ 201 Chapters 1 2 and 3 Study Guide
Kathryn Catton

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About this Document

I created my own study guide based on the notes from class and added my own examples and side notes from the textbook. It has definitions, graphs of the PPF, and example problems of comparative adv...
Principles of Economics: Microeconomics
Dr. Zegeye
Study Guide
Economics, scarcity, Opportunity Cost, absolute advantage, comparative advantage, PPF
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This 5 page Study Guide was uploaded by Kathryn Catton on Wednesday February 3, 2016. The Study Guide belongs to ECON 2010 at a university taught by Dr. Zegeye in Winter 2016. Since its upload, it has received 72 views.

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Date Created: 02/03/16
ECON 201 Test #1 Study Guide: Chapters 1, 2, and 3 Chapter 1 : Economics: The study of how households, business firms, governments and the society as a whole attempts to allocate limited resources to satisfy unlimited wants. More simply; the scarcity- (the limited nature of society’s resources) of economic resources. They study of choice under conditions of scarcity. Not every individual can attain the highest standard of living. 1. How do we make decisions/choices? You must take into account individuals, business firms, governments, and the society as a whole. 1) TRADE-OFFS are important!! Examples: sleeping vs. doing homework, going to classes vs. working a job, spending money on food rather than saving etc. The biggest trade-off society faces is between efficiency and equality. Efficiency- the property of society getting the most it can from its scarce resources. Equality- the property of distributing economic prosperity uniformly among the members of society. It is narrowed down to efficiency being the size of the pie and equality referring to how the pie is divided into slices. Government policies cause these two to conflict. The more equality we try to provide to everyone, the “pie” or size of efficiency gets smaller. 2) Opportunity cost- the best alternative you can give up within a choice or decision. It should be considered with every action you take. 3) Rational people- (those who purposefully do the best they can to achieve goals) think and make decisions based off the idea of margins. Marginal change=additional, a small incremental adjustment to plan of action. Example: Company A produces 10 units of food. Total Cost= $100. Add another unit to Total Quantity (11) - (marginal change) and the new Total Cost is $125. Change of TC= 125-100= $25 Marginal Cost. Change in TC / TQ. 4) People respond to incentives! Something that induces a person to act. The public policy makers should never forget about incentives. Many policies change the costs or benefits that people face and as a result change their behavior. Should you raise the quantity and produce more? It narrows down to the relationship between Marginal Cost and Marginal Benefit. It all depends on how much you get in the marketplace= MC > MB= REDUCE/DON’T. MC < MB YES. MC=MB= INDIFFERENT. 2. How/where do people interact economically with each other? Example= the marketplace with both buyers and sellers. A) Trade can make everyone better off. When countries specialize in a certain area- there is more production and lower prices. B) Markets are generally a good way to allocate economic resources efficiently. C) Governments can sometimes improve market outcomes. Example: preventing monopolies, intervene when there is a market failure= a situation where the market fails to allocate economic resources efficiently. One instance would be the existence of an externality- impact of one person’s actions on the well-being of the by stander (smoking, factories near homes and pollution). A second instance would be market power- the ability of a single economic actor (or small group of actors) to have substantial influence on market prices. 3. How does the economy as a whole work? A) A country’s standard of living depends on its ability to provide goods and services. What explains differences in living standards amongst nations? The amount of work and income leads to the important part= PRODUCTIVITY- the quantity of goods and services produced from each unit of labor input. B) Government policies can increase growth of the economy with fiscal policy- actively government engaged spending using tax money. Monetary policy- increases quantity of money in circulation, reduces borrowing. (Interest rates decrease, demand increases) Short Run Trade-Off Inflatio- an increase in the overall level of prices in the econom. The analysis of the business cycle- fluctuations in activi.y Chapter 2: How do we study economics? 1) Attempts to understand human behavior 2) Human behavior is so complex, how do we even begin to understand such a big phenomenon? We begin by theorizing. Economic Theory- a statement or set of statements regarding cause/effect relationships amongst economic variables. Involves a lot of observation, collecting data and testing. Economic Models- abstract version of reality (ex. Road maps) Economists use them to learn about the world. Assumptions- they simplify the complex world and make it easier to understand. A. simplifying assumption= doesn’t change the outcome. B. crucial assumption= affects the conclusion. STEPS TO BUILD AN ECONOMIC MODEL 1. Decide the assumptions in development 2. Formulate a testable hypothesis 3. Use economic data to test the hypothesis 4. Revise the model if it fails to explain the data properly 5. Retain the revised data to help answer similar future questions. CIRCULAR FLOW MODEL HANDOUT- it is a visual model of the economy that shows how dollars flow through markets among households and firms. Firms use factors of production and households own them and consume goods/services that the firms produce. Households and firms interact within two markets, such as the markets for goods/services- houses buy and firms sell. The markets for the factors of production- households sell and firms buy. Example= A country has the following resources! It compares the economic relationship between clothing and food products. 1) Land (natural resources) 1) Labor services 3) Capital (physical- buildings and those that help produce outputs and human- knowledge/expertise) 4) Entrepreneurship. Below is the Production Possibilities Curve (frontier) - shows the various mixes of output an economy can produce. Clothes Food 50 0 40 20 30 30 20 40 10 45 0 50 Point A to Point B on graph expresses the change in Clothing Products over the Change in Food Products. Change in C/F from 50 to 40 is -10/20 *(-1) = ½ unit of clothes. Change in C/F from 40 to 30 is -10/10 *(-1) = 1 unit of clothes. Change in C/F from 20 to 10 is -10/5 *(-1) = 2 units of clothes. It is curved because not all economic resources are easily adaptable in the production of all goods and services. The Law of Increasing Opportunity Cost- as you move up the curve, the higher the Opportunity Cost. Point Y is unattainable. Point X is attainable but inefficient. What causes production to take place inside the curve or shift left? Unemployment, un-used products and underemployment- hired but not working to your best ability or potential. They are found in both public and private firms. In addition, natural disasters, decrease in resources and man-made disasters like war and spending. Can we produce at point Y? Known as Economic Growth! In the short run, it is NOT possible. In long run, YES, because it can shift to the right on behalf of new technology, increased population, higher employment, discovery of new resources, international trade (everyone benefits) investments in human and physical capital (education). The PPF illustrates: 1. Scarcity and Opportunity Cost 2. Production inefficiency “X” 3. Law of Increasing OC 4. Economic growth 5. Specialization from trade= trade allows specialization in what nations do best- consumption and production trade-off. Two Main Branches of Economics: Microeconomics= studies the behavior of individual households, business firms, and governments in terms of choices they make and specific market interactions. Macroeconomics= study of the economy as a whole. Focuses mostly on 1. Inflation 2. Economic growth 3. Trade deficits/surpluses 4. Unemployment 5. Quantity of money in circulation. Some Specialized Fields of Economics: 1. International Economics 2. Comparative Economic System 3. Labor Economic System 4. History of Economic Thoughts (all over) 5. Economic History of the U.S. 6. Econometrics Positive vs. Normative Analysis: Positive= (descriptive in nature) can be tested and either rejected/accepted (how the world is). Includes data and evidence. Normative= (prescriptive in nature) can be a value judgement (how the world should be) Includes values and views. Why Economists Disagree: They disagree on the validity of alternative theories about the world. What we know is very little relative to what we don’t know. Differences in scientific judgement and values lead to disagreement and the idea of perception vs. reality. Why do you study Economics? To understand a way of thinking and their language, to understand world affairs, to become an economist, prepare for another field, to gain self-confidence and to be an informed voter. Chapter 3 : Gains of Trade Production Possibilities with Specialization and Trade: If two countries can both efficiently produce different products- that is specialization. If they want to invest in each other’s products, then trade will always be beneficial. It is first examined with A. Absolute Advantage- the ability to produce a good using fewer inputs than another producer (i.e. - time, requires less time to produce products than others). B. Opportunity Cost/Comparative Advantage- OC= whatever must be given up to obtain some item, measures the trade-off between two goods that each producer faces. Comparative Advantage- ability to produce a good at a lower opportunity cost than other producers (i.e. - one who gives up less of other goods to produce different goods). C. Comparative Advantage/Trade- ** When each person specializes in the comparative advantage, economic production rises. Trade is beneficial. D. the Price of Trade- for parties to gain from trade, the price at which they trade must lie between 2 opportunity costs close but not exact. Both can’t be buyers or sellers, someone has to take the opposite side. Applications of Comparative Advantage: Example= A. Should Tom Brady mow his lawn? He plays well at football and mows his lawn fast, within 2 hours. However in that time he can film a TV commercial for $20,000. His neighbor John can mow in 4 hours, but earns $40 at McDonald’s. Brady has an absolute advantage in mowing because he uses lower input of time than John. YET, the opportunity cost is $20,000 for mowing the lawn and $40 for John, so John has a comparative advantage in mowing lawns because he gives up the least to mow compared to Brady. B. Should the U.S. trade with other countries? 1) Goods produced abroad and sold domestically are imports. Goods produced domestically and sold abroad are exports. Example= America and Japan produce food and cars. Both can produce 1 car per month. However, America can make 2 tons of food per month, where as Japan can produce only 1 ton of food. Because the opportunity cost of 1 car is 2 tons of food in America but only 1 ton of food in Japan, Japan has a comparative advantage in cars. The opportunity cost of 1 ton of food is 1 car in Japan but only ½ of a car in America, the U.S. has a comparative advantage in food. Specialization : 1reduces the unproductive “downtime” that results from switching from one operation to another. 2. Principle of comparative advantage. Cuts logs Gather food Colleen has an absolute advantage in logs and Bill in food. ∆ ∆ ∆ Collen 7 8 ∆F/ L= 8/7= 1.14 food/log; L/ F= 7/8=0.875 log/food ∆ ∆ ∆ Bill 4 9 Bill: F/ L= 9/4= 2.25 food/log; ∆L/ F= 4/9= 0.44 log/food Comparative Advantages: Colleen- logs, Bill- food. Colleen gives up less food to produce logs, therefore she should specialize in logs. Bill gives up less logs to produce food, therefore he should specialize in food. Paper Wood Canada has AA in paper, and Mexico in paper. ∆ ∆ Canada 5 4 W/ P= 4/5= 0.8 units of wood/paper ∆ ∆ P/ W=5/4=1.25 p/w ∆ ∆ Mexico 3 6 W/ P= 6/3= 2 units of wood/paper ∆ ∆ P/ W= 0.5 papers/wood Comparative Advantages: Canada-paper, Mexico- wood. Apples Bananas Norway 2 hrs 3 hrs ∆ B/∆ A = 1.5 units of apples, ∆ A/∆B = 0.66 units of bananas Sweden 1 hr 4 hrs ∆ B/∆ A= 4 units of apples,∆ A/∆B = 0.25 units of bananas Norway has a comparative advantage in bananas and Sweden does with apples. Here it is almost like you switch the ratios, or do the opposite of the previous two problems.


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