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Microeconomics Exam 1 Study Guide
1. Market When goods change hands at voluntarily agreed prices.
2. Goods Market Goods move from firms to households, money moves from households to firms.
3. Resource Market Resources move from households to firms, payments move from firms to households.
4. Command Economy Buyers and sellers exchange goods as they are told (N. Korea). 5. Microeconomics Starts with the decisions of many small agents (households and firms), and sees how they come together to determine what happens.
6. Macroeconomics How total levels of output, unemployment, inflation and trade levels are related.
7. Efficiency Society is getting the maximum benefits from its scarce resources (the size of the pie).
8. Equality Those benefits are distributed uniformly among society members (how the pie is divided).
9. Opportunity Cost What you give up to get something. What resources “could have produced” if they were used in the best possible way.
10. Marginal Change A small incremental adjustment to an existing plan of action. 11. Incentive Something that induces a person to act. If you want to learn more check out What are the basic concepts of microeconomics?
Don't forget about the age old question of What does it mean to take an anthropological approach to language?
12. Market Economy Decisions of a central planner are replaced by the decisions of millions of firms and households, guided by an “invisible hand”.
13. Market Failure Market on its own fails to produce an efficient allocation of resources. 14. Externality Impact of one person’s actions on the wellbeing of a bystander. 15. Market Power Ability of a single person/firm to unduly influence market prices (e.g. the owner of a well if everyone needs water).
16. Productivity Amount of goods/services produced by each unit of labor input. 17. Inflation Increase in overall level of prices in the economy. We also discuss several other topics like What does the stefan boltzmann equation tell us?
18. Business Cycle Irregular/unpredictable fluctuations in economic activity (measured by production of goods/services/number of people employed).
19. Circular Flow Diagram The economy is simplified to include only 2 types of decision makers firms and households. Don't forget about the age old question of What is the process of neurulation?
20. Factors of Production Inputs to producing goods and services (labor/land/capital). 21. Production Possibilities Frontier Graph that shows the various combinations of output that the economy can possibly produce given the available factors of
production/available production technology to turn factors into output.
22. Efficient Outcome When the economy is getting all it can from the resources available (points ON the possibility frontier).
23. Inefficient Outcome When less is being produced than is possible (points INSIDE the possibility frontier rather than on the line).
24. Positive Statement How it IS (descriptive).
25. Normative Statement How it SHOULD be (prescriptive).
26. Absolute Advantage The ability to produce a good using fewer inputs than another producer.
27. Comparative Advantage The ability to produce a good at a lower opportunity cost than another producer
28. Imports Goods produced abroad and sold domestically.
29. Exports Goods produced domestically and sold abroad.
30. Job Specialization We don’t have to do everything ourselves we can outsource. Each individual can specialize in what they have a competitive advantage in. If you want to learn more check out How do mcadams and pals define personality?
31. Competitive Market There are so many buyers and sellers that each has a negligible impact on market price.
32. Quantity Demanded The amount of the good that buyers are willing and able to purchase. Determined by price.
33. Law of Demand When the price rises, the quantity demanded falls and vice versa. 34. Demand Schedule Table that shows the relationship between price and quantity demanded.
35. Demand Curve The line relating price and quantity demanded. Slopes downward. 36. Substitutes When a fall in the price of one good raises the demand for another good. Often pairs of goods that are used together. If you want to learn more check out How do microeconomics and macroeconomics differ?
37. Quantity Supplied Amount that sellers are willing and able to sell.
38. Law of Supply Relationship between price and quantity. When price increases, quantity supplied increases.
39. Supply Schedule Table that shows the relationship between price and quantity supplied. 40. Supply Curve Curve relating price and quantity supplied. Slopes upward. 41. Market Supply Sum of the supplies of all sellers.
42. Input Prices How much you pay for the input of your product.
43. Equilibrium Where the supply and demand curves intersect.
44. Equilibrium Price The price at this intersection.
45. Equilibrium Quantity The quantity at this intersection.
46. Surplus When quantity supplied is greater than quantity demanded.
47. Shortage When quantity demanded is greater than quantity supplied. 48. Law of Supply and Demand The price of any good adjusts to bring the quantity supplied and quantity demanded into balance.
49. Price Ceiling A legal maximum on the price at which a good can be sold. 50. Price Floor A legal minimum on the price at which a good can be sold. 51. Welfare Economics The study of how the allocation of resources affects economic wellbeing.
52. Willingness to Pay The maximum amount that a buyer will pay for a good. 53. Consumer Surplus The amount a buyer is willing to pay for a good minus the amount they actually pay for it.
54. Budget Constraint The limit on the consumption bundles that a consumer can afford. Key Concepts
11 Big Ideas:
1.) Things are scarce
a.) Resources are limited but people’s wants are unlimited
2.) People face tradeoffs
a.) To get something, we have to give something up
3.) Cost of something is what you have to give up (Opportunity cost)
a.) Opportunity cost of going to CU = Cost of CU tuition + money you would make if you worked instead of school
4.) When making decisions, it is useful to think “at the margin”
a.) Don’t have to decide between “never eat out” and “always eat out” but rather “do I want to eat out one more time?”
5.) People respond to price changes
a.) To get less people to use US 36: tolls
6.) Trade can make everyone better off
7.) Markets with many buyers and many sellers are a “good” way to organize economic activity
8.) Government can sometimes improve market outcome
a.) Equity concerns
b.) Market power only a few sellers
c.) Externalities there is no market for pollution
9.) Conceptual difference between benefit of a good and its price
10.) Production and consumption decisions coordinated through prices a.) Electric cars use lithium batteries and are becoming more popular. As price rises, miners mine more lithium.
11.) Economics is about predictions
Normative and Positive Economics
○ About linkages
○ Need to know the process
○ About “what IS”
○ About “how the world works”
○ About ranking outcomes
○ Need to know value judgment
○ About “what SHOULD be”
○ About “how we want the world to work”
Circular Flow Model of Economy
● Model to understanding linkages between households and firms
○ Households own resources
○ Firms own technology
○ Goods go from firms to households
○ Resources (labor and capital) go from households to firms
● Exchange of goods for money: GOODS market
● Exchange of resources for money: INPUTS market
Production Possibility Market
● Model to understand connections between:
○ Opportunity costs
● Above the PPF: impossible
● On the PPF: possible given any (consumption good, Investment good) point is as large as possible getting the most possible output and no waste production efficient ● Below PPF: possible but given any consumption good amount, investment good amount can be larger. Not getting the most output, with waste production inefficient ● Slope of Production Possibility Frontier = Opportunity cost
Trade between countries
● A single country cannot consume above its production possibility frontier ● 2 countries together can consume above their PPFs
● Each country must have a lower opportunity cost in one product if they each specialize in that product, and export it, they can both be above their PPF.
● Trade price should be in between the two countries’ opportunity costs for the product ● In trade between countries, COMPARATIVE ADVANTAGE is what matters, not absolute advantage. This means the lowest relative opportunity cost.
● Why mercantilism (going it alone) is wrong:
○ It’s about what happens to the worker who loses his job
○ If countries trade and steel is imported: steel workers are concerned they will lose their jobs
○ Mercantilism presumes they make nothing
○ Modern thinking presumes that they shift to a new job in exporting industry ○ Jobs shift from the contracting sectors to the expanding sectors
Comparing gains and costs of trade
● Gain: Increase in goods consumed
○ Long term or recurring
● Cost: Workers in the contracting sectors lose their jobs. But there is an expanding sector which can rehire them. They may need to move/be retrained so costs are short term and oncerecurring
● Overall: In early years costs may exceed gains but total gains exceed total costs ○ The issue is that cost to a few workers
■ Policy: reduce cost on laidoff workers by using some of growth to retrain them to work in expanding sector
● 2 Properties:
○ There is a standardized product
○ Many buyers and many sellers
● Consequence: Pricetaking
● 1 farmer cannot affect the market price. There are so many buyers and sellers (farmers) that no one will change their prices if he changes his. If he raises his price, he’ll lose sales, if he lowers his price below market price he’ll lose money.
○ He accepts market price = pricetaking
○ Same goes for 1 buyer
● Price is determined jointly by:
○ Eagerness of households wanting to buy
■ Demand side
○ Eagerness of firms wanting to sell
■ Supply side
● How much do people buy?
○ Depends on:
■ Price of related products
○ As the price increases, people buy less
■ LAW OF DEMAND
Movement along vs. Shift of demand curve
● If it’s something on the axis (quantity or price), it moves along the curve ● If it’s something not on the axis (tastes, etc) it shifts the curve
Normal vs Inferior goods
● Normal good: When income goes up, buy more of this good (nice shoes) ● Inferior good: When income goes down, buy more of this good (plastic shoes) Substitutes/Complements
● When the price of a good goes up, the demand for its substitute goes up. ● When the price of a good goes up, the demand for its complement goes down. Equilibrium Price
● Determined by 2 forces:
○ Eagerness of households to buy (demand curve)
○ Eagerness of firms to buy (supply curve)
● Equilibrium is when Quantity demanded = Quantity supplied
● When quantity supplied > quantity demanded, SURPLUS
○ Surplus means system is unbalanced, gives rise to a “force” lowering price ■ Unsold inventory accumulates
■ To get rid of inventory each firm lowers price (to undercut competition) ■ Total market price goes down
■ At lower price, each person wants more (move along demand curve) ■ Each firm produces less (move along supply curve)
■ Surplus shrinks returns to equilibrium
● When quantity supplied < quantity demanded, SHORTAGE
○ Shortage means system is unbalanced, gives rise to a “force” raising prices
■ Each firm can raise prices and not lose sales
■ Total market price goes up
■ As price goes up, people want to buy less (move along demand curve) ■ Each firm is producing more (to fix shortage)
■ Shortage shrinksreturns to equilibrium
Magic of the market
● Prices coordinate activities
○ No one person knows how to make all the aspects of the products we use (e.g. a pencil). To figure out the demand of each material, each worker only needs to know the price at which he sells the material (e.g. the wood he cuts): HE decides how much to cut and it is the exact amount needed from him.
○ Example: Taking ECON2010: More people want to take the class as the price is lowered. There are more people willing to pay $1500 than there are seats, so the university raises the price to fix the shortage.
● Markets give incentives for firms to use better technology
○ Benefits passed to consumer as lower prices
Slope of demand and supply curves
● Price Sensitive:
○ As price changes, quantity demanded/supplied changes a lot
● Steep = Insensitive
○ Changes in price cause little change in quantity
Price Ceilings (rent)
● Without price ceilings
○ Price up demand down shortage shrinks
○ Landlords make lots of money
○ More people become landlords
○ More supply
○ Now equilibrium would still be at same price, but with more supply.
● With price ceilings
○ Immediate shortage
○ Over time no new apartments shortage stays
Price floors (farming)
● Without floor
○ Price down small farmers sell to large farmers
○ Price down large farmers use technology on land of small farmers, supply up ○ Quantity up
● With floor
○ Small slowly sell out to large
○ Chronic surplus
Can measure worth of products by “wellbeing” they bring us
● Benefit = Willingness to pay (what it’s worth to you)
● Price = money you could’ve used to get benefit from other things
● Net benefit from buying = consumer surplus
○ Benefit minus price
● Measure benefits put them in order (biggest benefit first)
○ Each is one unit, but all “worth” a different amount
○ So, each one offers a smaller increase in benefit than the last one (keep decreasing in “worth”)
○ Benefit curve slopes upward, has decreasing steepness
● If you consume 3 units, the margin is between 3 and 4 units
● The marginal benefit is the benefit associated with the unit AT THE MARGIN (4th). ● As margin moves so individual consumes more goods, slope of benefit curve/ benefit of extra unit/ marginal benefit decreases
○ “Law of Diminishing Marginal Benefit”
○ Greatest benefit point: Intersection b/w opportunity cost/price and quantity on “benefit gained vs given up” graph @ Greatest net benefit
○ After this point, the trade off is not worth it.