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Macro Exam 1 Study Guide

by: Carter Cox

Macro Exam 1 Study Guide EC 111

Carter Cox

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Cover chapter 1, 2, 4 and 5 The most important chapter is 4
Principles of Macroeconomics
Study Guide
Macroeconomics, Economics
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This 12 page Study Guide was uploaded by Carter Cox on Sunday February 7, 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 160 views. For similar materials see Principles of Macroeconomics in Economcs at University of Alabama - Tuscaloosa.


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Date Created: 02/07/16
Macro Economics Exam 1 Study Guide Chapter 1 What is the study of economics? - The study of how society manages its scarce resources o How people decide what to buy, how much to work, save, and spend o How firms decide how much to produce, how many workers to hire o How society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs - What is microeconomics? - Microeconomics- is the study of how households and firms make decisions and how they interact in markets What is macroeconomics? - Is the study of economy- wide phenomena, including inflation, unemployment and economic growth These two branches of economics are closely intertwined, yet distinct- they address different questions What is equity/ equality? - When prosperity is distributed uniformly among society’s members: Every one gets an equal share What is scarcity? - the limited nature of society’s resources What is efficiency? - When society gets the most from its scarce resources Principle 1: People Face Tradeoffs All Decisions involve tradeoffs. Examples: - Going to a party the night before your midterm leaves less time for studying - Having more money to buy stuff requires working longer hours, which leaves less time for leisure - Protecting the environment requires resources that could otherwise be used to produce consumer goods Society faces an important tradeoff - Efficiency VS. Equality 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  The Opportunity Cost (OP) of any item is whatever must be given up to obtain it o OP- cost of decision-making: EX. College. Tradeoff is working  It is the relevant cost for decision making Examples: The opportunity cost of… going to college for a year is not just the tuition, books, and fees, but also the foregone wages. … Seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater Principle 3: Rational People Think at the Margin Rational People - Systematically and purposefully do the best they can to achieve their objectives - Make decisions by evaluating costs and benefits of marginal changes- incremental adjustments to an existing plan - We assume people are rational. It is not always black and white o Donating to Charity o Going to Auburn o Unprotected Sex Examples:  When gas prices rise, consumers buy more hybrid cars and fewer gas guzzling SUVs  When cigarette taxes increase, smoking fall  What is the incentive for having a playoff system in college football? Money and Ratings Principle 4: People Respond to Incentives  Incentive: something that induces a person to act, i.e. the prospect of a reward or punishment o Going to the NFL- to get millions of dollars Rational People respond to incentives 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 also benefit from trade and specialization (you do what you do best): o Get a better price abroad for goods they produce  Buy at a cheaper price o Buy other goods more cheaply from abroad than could be produced at home What is a market and market economy? - Market: A group of buyers and sellers (need not be in a single location) o Example: Internet, Stock Exchange - Market Economy allocates resources through the decisions of many households and firms as they interact in markets What is the “invisible hand”? - invisible hand works through the price system o Created by Adam Smith o The interaction of buyers and sellers determines prices o Each price reflects the good’s value to buyers and the cost of producing the good o Prices guide self- interested (looking out for yourself) household’s and firms to make decisions that in many cases maximize society’s economic well being What is market failure?  Market Failure: When the market fails to allocate society’s resources efficiently  Causes: o Externalities: When the production or consumption of a good affects bystanders (pollution from cars) o Market Power: a single buyer or seller has substantial influence on market price (monopolies)  They want competition- because its how we get lower prices Chapter 2 - - Model: a highly simplified representation of a more complicated reality o Economists use these models to study economic issues Used to make something easier to understand and comprehend The Circular Flow Diagram - The Circular Flow Diagram: a visual model of the economy o Shows how dollars flow through markets among households and firms - Two types of “actors o Households- which are the consumers o Firms- which are the businesses - Two markets: o The market for goods and services o The market for “factors of production” - Households o Own the factors of production. They sell/ rent them to firms for income o Buy and consume goods and services - Firms o Buy/ hire factors of production, and use them to produce goods and services o The firms sell the goods and services to consumers Factors of Production - Factors of Production: o The resources the economy uses to produce goods and services, including (inputs) o Put into three categories 1. Labor- the people 2. Land- the raw materials or natural resources  Example: If you are producing coke: the water, caffeine, corn syrup, etc. are all considered land 3. Capital- the buildings and machines used in production 4. Entrepreneurship- the ideas (Apple the company) The Productions Possibilities Frontier (PPF) - The PPF: a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology o Maximum we can get from what is given o Always has tradeoffs - The opportunity cost of an item is what must be given up to obtain that item - Moving along the PPF involves shifting resources (labor) from the production of one good to the other - Society faces a tradeoff: Getting more of one good requires sacrificing some of the other. - The Slope of the PPF tells you the opportunity cost of one good in terms of the other The Shape of the PPF - The PPF could be a straight line, or bowed- shaped (bow outward) - Depends on what happens to the opportunity cost as the economy shifts its resources from one industry to another o If the Opportunity cost remains constant= a straight line, essentially the same resources are equally useful for producing in either industry 1. Example: Coke and Pepsi- they have tradeoffs o If the opportunity cost of a good rises as the economy produces more of the good, the PPF is bow- shaped (Rounded). Essentially, the resources are specialized and not easily adaptable for producing in either industry. 1. This is the majority of all PPF’s Slope – if a line equals rise over run With additional resources or an improvement in technology, the economy can produce more of (i.e computers, or wheat, or any combination in between). Why the PPF might be Bow- Shaped - As the economy shifts resources from beer to mountain bikes: o The PPF becomes steeper o Opportunity cost of mountain bikes increases o As you move down the curve the more money - The PPF is bowed- shaped when different workers have different skills, different opportunity costs of producing one good in terks of the other. - The PPF would also be bowed- shaped when there is some other resource, or mix of resources with varying opportunity costs o Different type of land suited for different uses The PPF: Important Notes - The PPF shows all combinations of two goods that an economy can possibly produce, given its resources and technology - The PPF illustrates the concepts of tradeoff and opportunity cost, efficiency and inefficiency, unemployment, and economic growth - A bow- shaped PPF illustrated the concept of increasing opportunity cost. A straight line PPF illustrates constant opportunity costs Chapter 4 (THIS CHAPTER IS THE MOST IMPORTANT) Markets and Competition Market: is a group of buyers and sellers of a particular product Competitive Market: has many buyers and sellers, each has a negligible effect on price - Can’t argue over price and can’t negotiate Market Types include: - Perfect competition - Monopoly - Monopolistic competition Demand Quantity Demanded (QD) - is the amount of the good that buyers are willing and able to purchase at a specific price - Specific amount at a specific price Demand curve- is a set of various quantities demanded at corresponding prices. It is also the curve itself Law of Demand- the claim that the quantity demanded of good falls when the price of the good rises - Inverse The Demand Schedule This is a table that shows the relationship between the price of a good and the quantity demanded Price of Lattes Quantity of Lattes Demanded $0.00 16 $1.00 14 $2.00 12 $3.00 10 Then you plot the points on a graph and it will make a demand curve Market Demand VS. Individual Demand - The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price Demand Curve Shifters - It shows how price affects quantity demanded. - A change in the price of the good changes quantity demanded and results in a movement along the demand curve - “other things” are non- price determinants of demand which determines a buyers demand for a good Demand Curve Shifters: Number of Buyers - Increase in the number of buyers increase quantity demanded at each price shifts the demand curve to the right - Right = increase in demand - Left = decrease in demand Demand Curve Shifter: Income - Demand for a normal good is positively related to income o Increase in income cause increase in quantity demanded at each price - Demand for an inferior good is negatively related to income Demand Curve Shifters: Prices of Related Goods - Two goods are substitutes if an increase in the price of one cause an increase in demand of the other - If two goods are complements if an increase in the price of one causes a fall in demand for the other Demand Curve Shifters: Tastes - Anything that causes a shift in the taste toward a good will increase demand for that good and shift its demand curve to the right Ex: Atkins diet became popular in the 90s caused an increase in demand for eggs. Demand Curve Shifters: Expectations - This affects consumer buying decisions Supply Quantity Supplied – the amount that sellers are willing and able to sell at a specific price Supply curve- is a set of various quantities supplied at corresponding prices Law of Supply- the claim that the quantity supplied of a good rises when the price of the good rises The supply schedule - Table that shows relationship between the price of good and the quantity supplied - Table is the same as demand schedule Market SUPPLY - Quantity supplied in the market is the sum of the quantities by all sellers at each price Supply Curve Shifters Input Prices - Wages, prices of raw materials - Fall in input prices makes production more profitable at each output price Technology - Determines how much inputs are required to produce a unit of output Number of Seller - Increase in number of sellers increases the quantity supplied at each price Expectations - Ex: events in Middle East lead to expectations of higher oil prices Equilibrium: the price that equates quantity supplied with quantity demanded - QD=QS Equilibrium Quantity- the quantity supplied and quantity demanded at the equilibrium price Surplus: above the equilibrium - When quantity supplied is greater than quantity demanded Shortage- below equilibrium - When quantity demanded is greater than quantity supplied Three Steps to Analyzing Changes in Equilibrium 1. Decide whether event shifts Supply ir demand or both 2. Decide in which direction curve shifts 3. Use supply demand diagram to see how the shift changes equilibrium P and Q Terms of Shift Vs. Movement along Curve - Change in supply- shift in the S curve o Occurs when a non price determinant of supply changes - Change in the quantity supplied – movement along a fixed S curve o Occurs when price changes - Change in demand – a shift in the D curve o Occurs when a non price determinant of demand changes - Change in the quantity demanded- movement along a fixed D curve o Occurs when price changes Chapter 5 What is price elasticity of demand? - Price Elasticity of Demand - Percentage change in Quantity Demanded divided by percentage change in price - Measures how much quantity demanded responds to a change in price - Measures the price sensitivity of buyers demand Elasticity is pure number Why is calculating elasticity better when using the midpoint methods - because it is the easiest and you only need two points on the graph Calculating Percentage Changes - ((end value- start value)/ (start value)) - Midpoint method is the average - Midpoint is the number halfway between the start and the end values, the average of those value - Doesn’t matter which number is the “start” and the “end” you get the same answer Example: Price= 70 Quantity Demanded= 5000 Price= 90 Quantity Demanded= 3000 What is the Percent change in price? (90- 70)/ 80= .25 Then multiple the .25 by 100 which gives you 25% What is the percent change in demand? (5000-3000)/ 4000= .50 Times the .50 by 100 which gives you 50% Variety of Demand Curves - The slope is the ratio of two changes and elasticity is a ratio of two percent change Rule of thumb: the flatter the curve, the bigger the elasticity The steeper the curve the smaller the elasticity Five different demand curves 1. Elastic Demand: relatively flat curve a. Consumers price sensitivity i. Relatively high ii. Elasticity is greater than 1 2. Inelastic Demand a. Demand curve is relatively steep b. Consumers price sensitivity: relatively low c. Elasticity is less than 1 3. Unit Elastic Demand a. Demand curve is intermediate slope b. Consumers price sensitivity is intermediate c. Elasticity is 1 4. Perfectly Inelastic Demand a. Demand curve is perfectly vertical b. Consumers price sensitivity: there is none c. Elasticity is zero 5. Perfectly Elastic Demand a. Demand curve is horizontal b. Consumers price sensitivity is extreme c. Elasticity: infinity What determines elasticity? - Determinants of Price Elasticity: - The extent to which close substitutes are available - Whether the good is a necessity or a luxury - How broadly or narrowly the good is defined The time horizon- elasticity is higher in the long run than the short run Price elasticity of supply - Measures how much quantity supply responds to a change in price - Measures sellers price sensitivity - Also uses midpoint method - Percent change in quantity supplies/ percent change in price Five classifications Inelastic - Supply curve- relatively steep slope - Sellers price sensitivity is low - Elasticity is less than one Unit Elastic - Supply curve- has intermediate slope - Intermediate price sensitivity - Elasticity is equal to one Elastic - Supply curve is relatively flat - Price sensitivity is high - Elasticity is greater than one Perfectly Elastic - Supply curve is horizontal - Price sensitivity is extreme - Elasticity is infinity Perfectly inelastic - Supply curve is vertical - Price sensitivity is none - Elasticity is zero Determinants of Supply Elasticity - More easily sellers can change the quantity they produce, the greater the price elasticity of supply - For many goods, price elasticity of supply is greater in the long run than in the short run, because new firms can build new factories, or new firms may be able to enter the market. Other Elasticities - Income elasticity of demand: measures how the response of quantity demanded to a change in consumer income 1. For normal goods income elasticity is greater than zero 2. For inferior goods, income elasticity is less than zero - Cross price elasticity of demand 1. Measures demand for one good to changes in price of another good 2. Percent change in quantity demanded for good 1 divided by percent change in price of good 2 3. For substitutes cross price elasticity is greater than zero Complements are less than zero


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