Test 1 Study Guide
Test 1 Study Guide EC 111
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This 7 page Study Guide was uploaded by Julie Palatella on Wednesday February 3, 2016. The Study Guide belongs to EC 111 at University of Alabama - Tuscaloosa taught by Zirlott in Spring 2015. Since its upload, it has received 90 views. For similar materials see Principles of Macroeconomics in Economcs at University of Alabama - Tuscaloosa.
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Date Created: 02/03/16
Macroeconomics Test 1 Study Guide Scarcity- the limited nature of society’s resources Economics- study of how society manages scarce resources CONCEPTS: CH1 Principle #1 People Face Tradeoffs All decisions involve tradeoffs Ex: going to a party the night before your midterm leaves less time for studying Society faces efficiency vs. equality Efficiency- society gets the most from its scarce resources Equality- uniform distribution among society’s members Tradeoff- in order to achieve equality, income can be redistributed from wealthy to poor. But this reduces incentive to work and produce and it shrinks the size of the economic “pie” Principle #2 The Cost of Something is What You Give Up to Get it Making decisions requires comparing the costs and benefits of alternative choices Opportunity cost of an item is whatever must be given up to obtain it Ex: going to college for a year is not just the tuition, books, and fees, but also the foregone wages Principle #3 Rational People Think at the Margin Rational people always try to make themselves better off They make decisions by evaluating the costs and benefits of marginal changes Ex: when a student considers whether to go to college for an additional year, he compares the fees & foregone wages to the extra income he could earn with the extra year of education Principle #4 People Respond to Incentives Incentive- something that induces a person to act Rational people respond to incentives Ex: when cigarette taxes increase, smoking fails Ex: You are selling a Mustang. You have already spent $1000 on repairs. At last minute, the transmission dies and you can pay $600 to have it repaired or sell it as is. Principle #5 Trade Can Make Everyone Better Off People can specialize in producing one good or service and exchange it for other goods Countries benefit from trade and specialization: get a better price abroad for goods they produce, buy other goods cheaper from abroad than produced at home Principle #6 Markets Are Usually a Good Way to Organize Economic Activity Market- group of buyers/sellers o Doesn’t need to be in a single place “Organize economic activity” = determining what goods to be produced, how to produce them, how much of each to produce, who gets them Market economy- allocates resources though the decisions of many households and firms as they interact in markets. o The invisible hand (Adam Smith) The invisible hand o Works through the price system o Interaction between buyers/sellers determine price If price is too high you aren’t going to buy it o Prices reflect the goods value to buyers & cost of producing the good Principle #7 Governments Can Sometimes Improve Market Outcomes Important role for gov: enforce property rights (police, courts) o No gov= no economy Market failure- when the market fails to allocate society’s resources efficiently Externalities- when the production or consumption of a good affects bystanders (pollution) Market power- single buyer/seller has substantial influence on market price (monopoly) Gov may alter market outcome to promote equity (social security) Principle #8 A Country’s standard of living depends on its ability to produce goods& services Productivity: amount of goods and services produced per unit of labor Productivity depends on the equipment skills, and technology Principle #9 Prices rise when the gov prints too much money Inflation- increases in the general level of prices Long run= inflation is caused by excessive growth in the quantity of $, which causes the value of money to fall The faster the gov creates money the greater the inflation rate Principle #10 Society faces a short- run tradeoff between inflation and unemployment Short run (1-2 yrs) many economic policies push inflation and unemployment in opposite directions CH2 Circular Flow Diagram- visual model of economy, shows how dollars flow through markets among households and firms Factors of Production- resources the economy uses to produce goods/services including labor, land, capital (buildings, machines), entrepreneurship Households- o Own the factors of production o Buy/consume goods/services o selling your input (work)- for a paycheck -then you go buy things Firms- o Buy/hire factors of production use them to produce goods o Sell goods/services The Production Possibilities Frontier (PPF)- o Graph that shows combinations of two goods the economy can possibly produce given the availability of resources and technology o The slope of PPF tells you the opportunity cost of one good in terms of the other How much do you give up? Can be straight line or bow shaped If opportunity cost remains constant PPF is a straight line If opportunity cost of a good rises the economy produces more of the good, PPF is bow shaped o slope= rise over run Microeconomics- study of how households and firms make decisions and how they interact in markets (lil sis) Macroeconomics- study of economics-wide phenomena, including inflation, unemployment, and economic growth (big bro) Positive statements- which attempt to describe the world as is (statement of fact) o EX- an increase in price of burritos will cause an increase in consumer demand for tacos Normative statements- how the world should be (value judgment) o Ex- the government should print more money Points on PPF= possible, efficient, materials utilized Points under PPF= possible, not efficient (workers unemployed) CH4 know all Competitive market: Has many buyers and sellers, each has a negligible effect on price Quantity demanded: (the point on the demand curve) Amount of the good buyers are willing and able to purchase at a specific price. Law of Demand: quantity demanded of a good falls when the price of the good rises When price goes up, quantity goes down When price goes down, quantity goes up Demand Schedule: A table showing the relationship between the price of a good and the quantity demanded On the curve the price is always on the vertical axis and the quantity is always on the horizontal Demand Curve Shifters: Shows how price affects quantity demanded. A change in the price of the good changes the quantity demanded and results in a movement along the demand curve. Demand curve shifts right because of the increase in demand Demand curve shifts left because of decrease in demand Change in income shifts demand curve Normal good = positive relation to income (ex: eating out at a restaurant) o Increase in income causes increase in quantity demanded at each price which shifts the demand curve to the right Inferior good= negative relation to income o An increase in income shifts the demand curve for inferior goods to the left. Substitutes: an increase in the price of one causes an increase in the demand for the other. Ex: increase in the price of Coke increases the demand for Pepsi, shifting the demand curve to the right. Complements: an increase in the price of one causes a fall in the demand of the other. (Things you consume together) Ex: if the price of peanut butter rises, people will buy less peanut butter, therefore less jelly. Jelly demand curve shifts left. Quantity Supplied: (a point on the supply curve) the amount that sellers are willing and able to sell at a specific price. Law of Supply: quantity supplied of a good rises when the price of the good rises Supply Curve Shifters: A change in the price of the good changes quantity supplied and results in a movement along the supply curve. Shift left= decrease in supply Shift right= increase in supply Input prices: fall in input price= more profitable at output price, firms supply large quantities at each price so the supply curve shifts to the right. Ex: wages, price of raw materials Technology/Production: Advancement in technology or anything that increases efficiency automatically shifts the supply to the right. Always makes production better off. Equilibrium: Price has reached the level where quantity supplied = quantity demanded Equilibrium price: the price = quantity supplied with quantity demanded Equilibrium quantity: quantity supplied and quantity demanded at equilibrium price Surplus: Quantity supplied is greater than Quantity Demanded On a graph surplus is above equilibrium- caused by price being too high If there is a surplus the price will automatically start to fall until hitting equilibrium Sellers want to increase sales by cutting price Equilibrium = market clearing (same thing) Ex: Walmart after Halloween, Walmart lowers the price of Halloween candy so they can sell it Shortage: quantity demanded is greater than quantity supplied On a graph it is below equilibrium A shortage is caused by the price being too low Ex: Black Friday ---items being sold too low (only a limited # of people in line get the cheap TV because of the high demand) Prices rise until market hits equilibrium Supply & demand Market is always changing Events = determinants of demand o Taste and preference takes over (even substitutes) Example: Hybrid Cars o If the price of gas rises, people will prefer more fuel efficient vehicles o Demand curve Shifts to the right o Price and quantity both go up o (Know difference between a shift and movement on the curve) Example: Frozen Yogurt o They are substitutes o Milk is an input to ice cream o Price and quantity drops o Milk is cheaper- input price lower- shift to the right because you can make more o Price falls, quantity rises Fall in froyo and fall in milk When Supply and Demand are shifting in the same direction price will be unknown or ambiguous. Quantity has to be changed When Supply and Demand are shifting in opposite directions quantity is unknown/will be unknown Shift vs. Movement Along Curve 1. Change in Supply: shift in supply curve when a non-price determinant of supply changes (technology/costs) 2. Change in quantity supplied: movement along a fixed supply curve occurs when price changes 3. Change in demand: shift in demand curve when non-price determinant of demand changes (income/ # of buyers) 4. Change in quantity demanded: movement along a fixed demand curve only when price changes 5. When supply and demand are shifting in opposite directions quantity will be ambiguous but price will have to change CH 5 Elasticity- numerical measure of the responsiveness of Qd or Qs to one of its determinants Price Elasticity of Demand- measures how much Qd responds to change in P Calculating Percentage Changes End value- start value/start value x100% Or new – old/old x100% Midpoint Method- halfway between start and end values---the average Inelastic demand is less than one Elastic demand is equal to one Perfectly inelastic demand is equal to 0 (extreme case) Perfectly elastic demand is equal to infinity Necessities = elastic (food, insulin) Luxuries = inelastic (yacht) Price elasticity is higher in the long run than the short run (because you have more options) Price elasticity of demand depends on- availability of close substitutes, whether the good is a necessity or luxury, how broad/narrow the good is defined, the time horizon Price elasticity of demand= percentage change in Q/percentage change in p Elasticity of supply measures how much Qs responds to change in p Less than 1= inelastic, equal to 1 =unit elastic, greater than 1= elastic, perfectly elastic = infinity
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