EC 111 Exam 1 Study Guide
EC 111 Exam 1 Study Guide Econ 111
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This 5 page Study Guide was uploaded by Matt Cutler on Friday February 5, 2016. The Study Guide belongs to Econ 111 at University of Alabama - Tuscaloosa taught by Kent 0. Zirlott in Fall 2016. Since its upload, it has received 100 views.
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Date Created: 02/05/16
Study Guide Exam 1 Monday, February 1, 2016 4:06 PM MOST IMPORTANT, NEED TO KNOW - Difference between a shift in a curve and movement along the curve (only a change in price of the specified good causes movement along curve) Change in supply: a shift in the S curve • Occurs when a non-price determinant of supply changes (like technology or costs) Change in Quantity supplied: A movement along a fixed S curve • Occurs when Price changes Change in Demand: a shift in the D curve • Occurs when a non-price determinant of demand changes (like income or # of buyers or compliments) Change in the quantity demanded: a movement along a fixed D curve • Occurs when Price changes 1. Chapter 1- Principles of Economics Definitions: • Scarcity- the limited nature of society's resources • Economics- the study of how society manages its scarce resources • Opportunity Cost- What you give up to get something a. Microeconomics i. The study of how households and firms make decisions and how they interact in markets b. Macroeconomics i. The study of economy-wide phenomena, including inflation, unemployment,and economic growth. c. Equality: when prosperity is distributed uniformly among society's members i. Tradeoff: to achieve greater equality, could redistribute income from wealthy to poor. But this reduces incentive to work and produce, shrinks the size of the economic "pie" d. Efficiency: when society gets the most from its scarce resources e. Rationality- Systematically and purposefully doing the best one can to achieve their objectives f. Thinking at the Margin i. Goes hand in hand with being rational. People evaluate costs and benefits of incremental adjustments to an existing plan (Marginal changes) g. Benefits of trade i. Rather than being self-sufficient,people can specialize in producing one good or service and exchange it for other goods. h. Market i. A group of buyers and sellers (not have to be in a specified location) i. Market Economy i. Allocates resources through the decisions of many households and firms as they interact in markets. j. Invisible Hand (Adam Smith) i. Works through the price system: 1) The interaction of buyers and sellers determines prices. 2) Each price reflects the good's value to buyers and the cost of producing the good 3) Prices guide self-interested households and firms to make decisions that, in many cases, maximize society's economic well-being. k. Market Failure i. When the market fails to allocate society's resources efficiently 1) Causes: a) Externalities, when the production or consumption of a good affects bystanders (i.e. pollution) b) Market Power, a single buyer or seller has substantial influence on market price (i.e. monopoly) ii. In such cases, public policy may promote efficiency iii. Govt may alter market outcome to promote equity (equality) iv. If the market's distribution of economic well-being is not desirable, tax or welfare policies can change how the economic "pie" is divided. 2. Chapter 2- Thinking like an Economist a. Economic models EC 111 Page 1 a. Economic models i. Help illustrate economic activity through diagrams such as: 1) The Circular-Flow Diagram a) A visual model of the economy; shows how dollars flow through markets among households and firms. b) Two markets i. Goods and services ii. Factors of production (inputs) 1) Labor 2) Land 3) Capital (buildings, machinery, equipment) 4) Entrepreneurship (the idea) c) Households i. Own the factors of production, sell them to firms for income ii. Buy and consume goods and services d) Firms i. Buy/hire factors of production, use them to produce goods and services ii. Sells goods and services b. Production Possibility Frontier (PPF) ○ A graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology a. Points on the PPF i. Efficient, possible, and all resources are fully utilized b. Points under the PPF i. Possible, not efficient c. Points above the PPF i. Currently unobtainable with the current resources and technology ○ A model of opportunity costs Moving along a PPF involves shifting resources from the production of one good to the other Society faces tradeoff: getting more of one good requires sacrificing some of the other The slope of the PPF tells you the opportunity cost of another. d. PPF could be: i. Straight line 1) Opportunity cost is constant ii. Bowed outwards 1) Opp. Cost of a good rises as the economy produces more of the good. 2) Resources are not specialized and not easily adaptable for producing in either industry 3) Such as Beer and Mountain bikes e. Economic Growth Means the economy is doing well. When we discover new resources or technology Economic Growth shifts the PPF curve outward • Positive statements- attempt to describe the world as it is (scientists) ○ Ex: prices rise when the gov increases the quantity of money ○ Ex: a tax cut can stimulate the economy • Normative statements- attempt to prescribe how the world should be (policy advisors) ○ Ex: the government should print less money ○ Ex: a tax cut is needed to stimulate the economy 3. Chapter 4- Supply and Demand ○ Price is always on the vertical axis, Quantity is always on the horizontal axis! ○ Demand a. Quantity demanded: i. A specific amount of a specific good that buyers are willing and able to purchase at a specific price ii. QD is a point on the demand curve b. Demand curve: i. A SET of various quantities demanded at corresponding prices. It is the curve itself ii. Downward sloping, because of Law of Demand. c. Law of Demand: i. The claim that the quantity demanded falls when the price of the good rises: other EC 111 Page 2 i. The claim that the quantity demanded falls when the price of the good rises: other things equal. d. Demand Schedule: i. A table that shows the relationship between the price of a good and the quantity demanded. 1) Ex: Mikes demand for video games e. Market Demand: i. Add up the Quantity Demands in the market to get the market demand. Price Changes Quantity Demand, not DEMAND! Quantity Demand is a point on the demand curve so movement along the demand curve represents a change in quantity demand Non-price determinants affect the demand curve, not price. They are as follows: a. Non-price determinants Shift the demand curve Increase in demand shifts curve to right Decrease shifts curve to the left i. # of buyers (population) 1) Increase number of buyers, shifts D curve to the right ii. Income 1) Increase in income causes shift to the right 2) Demand for an inferior good is negatively related to income. a) i.e. an increase in income causes D to shift to the left. iii. Prices of Related goods 1) Substitutes: move in the same direction. a) Increase in the price of one causes an increase in the demand for the substitute. b) Ex: Coke and Pepsi 2) Complements: move in the opposite direction a) Increase in the price of one causes a decrease in demand for the complement. b) Ex: Peanut Butter and Jelly iv. Tastes 1) Anything that causes a shift in tastes towards a good will increase demand for that good and shift its D curve to the right. And Vice Versa. v. Expectations 1) Ex: if people expect gas prices to rise in the future, Demand will increase for gas now. 2) Ex: if people expect gas prices to fall in the future, demand will fall for the time being, because they are holding out until the price drops. PRICE causes movement on the curve, all these determinants ^^ cause a shift! Inferior goods are generally low priced goods that you'd buy if you had a low income. Demand for inferior goods are inversely proportional to income b. Supply i. Quantity Supplied: i. Amount of a good that sellers are willing and able to sell at a specific price; Point on supply curve ii. Supply Curve: i. Set of various quantities supplied at corresponding points iii. Law of Supply: i. The claim that the quantity supplied of a good rises when the price of a good rise, other things equal ii. Supply always slopes up and to the right iii. Price acts as an incentive. iv. Supply Schedule i. A table that shows the relationship between the price of a good and the quantity supplied. 1) Ex: Video game store's supply of video games v. Quantity Supplied i. Sum of all quantities supplied by all sellers at each price. 1. Supply Curve Shifters ○ Only a change in price will move the point on the curve. ○ Other things are non-price determinants of supply and shift the curve a. Input Prices (Wages, prices of raw materials) i. A fall in input prices makes production more profitable at each output price; S curve shifts right. b. Technology (production technology) EC 111 Page 3 shifts right. b. Technology (production technology) i. A cost saving technological improvement (increase in production technology) always shifts S curve to the right c. Number of sellers i. Increase in number of sellers increases the quantity supplied at each price; shifts S curve to the right d. Expectations i. Middle east events lead to expectations of higher oil prices ii. Suppliers would reduce supply now in anticipation for future profits they could get by waiting for the higher prices. • Supply and Demand determine price by where they cross: equilibrium. ○ Equilibrium price- the price that equates quantity supplied with quantity demanded ○ Equilibrium quantity- where quantity supplied and demanded are equal ○ Surplus- when quantity supplied is greater than quantity demanded (majority of the time when price is too high) (on a graph: above equilibrium) ○ Shortage- when quantity demanded is greater than quantity supplied (majority of the time when price is too low) (on a graph: below equilibrium) ○ Market cleared=equilibrium 2. Changes in Equilibrium a. Decide whether event shifts S curve, D curve, or both. b. Decide in which direction curve shifts. c. Use supply-demand diagram to see how the shift changes EQ P and Q. i. Ex: market for hybrids 1) Increase in price of gas When S and D are shifting in the same direction; a) Causes shift right in demand curve for hybrids price will be unknown. b) Price and quantity go up When S and D are shifting in opposite directions; 2) New technology reduces cost of producing hybrid cars. quantity will be unknown a) Supply curve shifts right b) Price falls, quantity rises 3) Price of gas rises AND new technology reduces production costs a) Both curves shift right b) Quantity rises, price is uncertain (because we don’t know how far the curves shifted) ii. Market for Ice Cream 1) Fall in the price of frozen yogurt a) Frozen yogurt is a substitute so demand curve shifts b) Demand curve shifts left c) Price and quantity drop 2) Fall in milk prices a) Input price: supply shift b) Supply curve shifts right c) Price falls, quantity rises 3) Fall in price of frozen yogurt AND fall in milk prices a) D shifts left, S shifts right b) Price falls, effect on Q is unknown 4. Chapter 5- Elasticity • Definition: Elasticity is a numerical measure of the responsiveness of Q or Q to one of its determinants • Basic idea: Elasticity measures how much one variable responds to changes in another variable. a. Price elasticity of Demand ○ Price elasticity of demand= Percentage change in Quantity Demand/ Percentage Change in Price Ex: price rises by 10%; Q falls by 15% Price elasticity of demand= 15%/10%=1.5 (pure number, no units) Always take the absolute value for elasticity of demand. ○ Percent change= (New-old)/old: CANNOT use <---- for elasticity ○ Midpoint method: (New-Old)/ Average= percentage change for Elasticity!! ○ Slope and elasticity are related but not the same thing Midpoint method is better ○ The flatter the curve, the bigger the elasticity ○ The steeper the curve, the smaller the elasticity for calculating elasticity because it doesn’t matter b. Five different classifications of D curves which order the values are i. Elastic demand used EC 111 Page 4 ○ The flatter the curve, the bigger the elasticity ○ The steeper the curve, the smaller the elasticity for calculating elasticity because it doesn’t matter b. Five different classifications of D curves which order the values are i. Elastic demand used 1) Curve: relatively flat 2) Price sensitivity: relatively high (means Quantity demand changes a lot, more than price change) 3) Elasticity: greater than 1 ii. Inelastic demand 1) Curve: relatively steep 2) Price sensitivity: relatively low (Quantity only changes a little bit, changes less than price) 3) Elasticity: less than 1 iii. Unit elastic 1) Percentage change in price EQUALS the percentage change in quantity 2) Elasticity of 1 iv. Perfectly inelastic demand 1) Curve: Vertical 2) Price sensitivity: none (Q changes by 0% Price changes) 3) Elasticity: 0 v. Perfectly elastic demand (Demand curve for perfect competition: commercial fisherman, farmers) 1) Curve: Horizontal 2) Price sensitivity: Extreme (Q changes when price stays the same) 3) Elasticity: infinity c. Determinantsof Elasticity of Demand (in order of how powerful they are) i. Elasticity is higher when close substitutes are available. ii. Price elasticity is higher for narrowly defined goods than broadly defined ones 1) Ex: lucky brand jeans vs clothing (higher for jeans) iii. Price Elasticity is higher for luxuries than for necessities 1) Ex: Cruise vs insulin (higher for cruise) iv. Price elasticity is higher in the long run than the short run 1) Ex: gasoline in the short run vs gas in the long run (gas in long run is higher because more choices) d. Price Elasticity and Total Revenue Revenue= Price x Quantity Price effect= more price per unit Quantity effect= less units sold Elasticity will tell you which one is bigger i. If demand is elastic (greater than 1) 1) A price increase causes revenue to fall (lost revenue due to lower Q exceeds increase revenue due to higher P) ii. If demand is inelastic (less than 1) 1) A Price increase causes revenue to increase (Price effect is larger than the quantity effect) ○ income elasticity of demand measures the responsiveness of the quantity demanded for a good or service to a change in the income of the people demanding the good ○ The cross-price elasticity of demand measures the responsiveness of the quantity demanded for a good to a change in the price of another good EC 111 Page 5
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