Econ 201 Study Guide One
Econ 201 Study Guide One ECN 201 (Professor Colleen Scott)
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ECN 201 (Professor Colleen Scott)
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This 9 page Study Guide was uploaded by Thanh Notetaker on Friday February 12, 2016. The Study Guide belongs to ECN 201 (Professor Colleen Scott) at La Salle University taught by Colleen Scott in Spring 2016. Since its upload, it has received 57 views. For similar materials see Introductory Microeconomics in Economcs at La Salle University.
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Date Created: 02/12/16
ECON 201 STUDY GUIDE FOR 1 TEST.t Format: All multiple choices Contains: 1) Economic Way of Thinking Economics, Economy: Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. Ten principles of economics: How People Make Decisions 1) People face trade offs. 2) The cost of something is what you give up to get it. 3) Rational People think at the margin. 4) People respond to incentives. How People Interact 5) Trade can make everyone better off. 6) Markets are usually a good way to organize economic activity. 7) Governments can sometimes improve market outcomes. Principles that underlie economy-wide interactions: 8) One person’s spending is another person’s income. 9) Overall spending (total expenditures) sometimes gets out of line with the economy’s productive capacity (total production), causing recessionary gaps or inflationary gaps. 10)Government policies can change spending:(Fiscal policy and Monetary policy) – both shift AD curve. Scarcity; opportunity cost; trade-off (Economizing problem) All economic questions arise because we want more than we can get. Our inability to satisfy all our wants is called scarcity. Because we face scarcity, we must make choices. The economic way of thinking places scarcity and its implication, choice, at center stage. You can think about every choice as a tradeoff—an exchange—giving up one thing to get something else The opportunity cost of something is the highest-valued alternative that must be given up to get it. For example, the opportunity cost of paying housing on campus is that the money could be used for housing off campus Goodluck with the test. Marginal analysis: Weighing the additional costs v additional benefits of a decision (MC, MB) To make a choice at the margin, you evaluate the consequences of making incremental changes in the use of your time. The benefit from pursuing an incremental increase in an activity is its marginal benefit. The opportunity cost of pursuing an incremental increase in an activity is its marginal cost. If the marginal benefit from an incremental increase in an activity exceeds its marginal cost, your rational choice is to do more of that activity. Rational self-interest You make choices that are in your self-interest—choices that you think are best for you. Microeconomics and macroeconomics Microeconomics is the study of choices that individuals and businesses make, the way those choices interact in markets, and the influence of governments. An example of a microeconomic question is: Why are people buying more e-books and fewer hard copy books? Macroeconomics is the study of the performance of the national and global economies. An example of a macroeconomic question is: Why is the unemployment rate in the United States so high? Positive economics v normative economics Economists distinguish between two types of statement: Positive statements and Normative statements A positive statement can be tested by checking it against facts. Whether it is true or not, if it can be tested it is positive A normative statement expresses an opinion and cannot be tested. (if there is “should”, the statement is normative) Production possibilities frontier (PPF) The production possibilities frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot. To illustrate the PPF, we focus on two goods at a time and hold the quantities of all other goods and services constant. Goodluck with the test. Four simplifying assumptions on PPF model 1) We only consider the connection between two goods and services 2) Full employment (resources are use efficiently) 3) Resources are fixed ( besides the quantity of the two services or good, every order factors stay the same) 4) Technology is fixed. Factors of production/inputs/resources (land, labor, physical capital, and human capital) The “gifts of nature” that we use to produce goods and services are land. The work time and work effort that people devote to producing goods and services is labor. The quality of labor depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience. The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services are physical capital. The human resource that organizes land, labor, and capital is entrepreneurship. Technology ( In Economic growth below) Efficiency (productive and allocative) When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency. We are producing at a point on the PPF. When we cannot produce more of any one good without giving up some other good that we value more highly, we have achieved allocative efficiency. We are producing at the point on the PPF that we prefer above all other points. Efficiency v Equity There is a tradeoff between efficiency and equity. To use resources in research and development and to produce new capital, we must decrease our production of consumption goods and services. So economic growth is not free. The opportunity cost of economic growth is less current consumption. Shape of PPF - what it illustrates: Law of increasing opportunity costs Because resources are not equally productive in all activities, the PPF bows outward. The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost. Goodluck with the test. Economic growth (biased and unbiased) The expansion of production possibilities—an increase in the standard of living—is called economic growth. Two key factors influence economic growth: Technological change and Capital accumulation Technological change is the development of new goods and of better ways of producing goods and services. Capital accumulation is the growth of capital resources, which includes human capital. The “invisible hand” theory: Refers to the way in which the individual pursuit of self-interest can lead to good results for society as a whole. Circular flow diagram: Households, firms (businesses), factor (resource, input) markets, market for goods and services (product market) A firm is an economic unit that hires factors of production and organizes those factors to produce and sell goods and services. A market is any arrangement that enables buyers and sellers to get information and do business with each other. Property rights are the social arrangements that govern ownership, use, and disposal of resources, goods or services. Money is any commodity or token that is generally acceptable as a means of payment. 2) Specialization and Gains from Trade (constant opportunity costs) Absolute advantage, comparative advantage A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else. A person has an absolute advantage if that person is more productive than others. Goodluck with the test. Absolute advantage involves comparing productivities while comparative advantage involves comparing opportunity costs. How to calculate opportunity cost For example, Fred can produce either 8 tons of wheat or 12 tons of corn and Veronica can produce either 6 tons of wheat or 15 tons of corn. The tradeoff for Fred would be 1w = 1.5c while the tradeoff for Veronica would be 1w =2.5c The opportunity cost of producing 1 ton of wheat for Fred would be 1.5 tons of corn How to determine absolute advantage, How to determine comparative advantage Absolute advantage involves comparing productivities while comparative advantage involves comparing opportunity costs. Fred has the absolute advantage in producing wheat because he can produce 8 while Veronica 6. Fred has the comparative advantage in producing wheat because he can produce 1 ton of wheat with lower opportunity cost (1.5 <2.5) Specialization : Each one focus on producing solely one product that they have comparative advantage in producing Why people and nations trade: Trade can make everyone better off Sources of comparative advantage : Different set of skill, resources and technology 3) The Market Forces of Supply and Demand Competitive market: A competitive market is a market that has many buyers and many sellers so no single buyer or seller can influence the price. Rationing function of prices: The money price of a good is the amount of money needed to buy it. The relative price of a good—the ratio of its money price to the money price of the next best alternative good—is its opportunity cost. Law of Demand (change in quantity demanded), Law of Supply (change in quantity supplied) The law of demand states: Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the larger is the quantity demanded. Goodluck with the test. The law of supply states: Other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied. Income effect, Substitution effect Substitution Effect: When the relative price (opportunity cost) of a good or service rises, people seek substitutes for it, so the quantity demanded of the good or service decreases. Income Effect: When the price of a good or service rises relative to income, people cannot afford all the things they previously bought, so the quantity demanded of the good or service decreases. Difference between a movement along a curve and a shift Movement Along the Demand Curve: When the price of the good changes and other things remain the same, the quantity demanded changes and there is a movement along the demand curve. A Shift of the Demand Curve: If the price remains the same but one of the other influences on buyers’ plans changes, demand changes and the demand curve shifts. Demand schedule, demand curve The term demand refers to the entire relationship between the price of the good and quantity demanded of the good. A demand curve shows the relationship between the quantity demanded of a good and its price when all other influences on consumers’ planned purchases remain the same. Supply schedule, supply curve The term supply refers to the entire relationship between the quantity supplied and the price of a good. The supply curve shows the relationship between the quantity supplied of a good and its price when all other influences on producers’ planned sales remain the same. Individual demand curve, market demand curve Individual supply curve, market supply curve Determinants of Demand (shift factors): 1) The prices of related goods 2) Expected future prices 3) Income 4) Expected future income and credit 5) Population Goodluck with the test. 6) Preferences Determinants of Supply (shift factors): 1) The prices of factors of production 2) The prices of related goods produced 3) Expected future prices 4) The number of suppliers 5) Technology 6) State of nature Equilibrium; Shortage; Surplus: Equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers. The equilibrium price is the price at which the quantity demanded equals the quantity supplied. The equilibrium quantity is the quantity bought and sold at the equilibrium price. At prices above the equilibrium price, the quantity demanded is less than the quantity supplied, there is a surplus. A surplus forces the price down At prices below the equilibrium price, the quantity demanded exceeds the quantity supplied, there is a shortage. A shortage forces the price up. Normal good, inferior good: A normal good is one for which demand increases as income increases. For example, chair, table An inferior good is a good for which demand decreases as income increases. For example, public transportation Substitutes, complements: A substitute is a good that can be used in place of another good. A complement is a good that is used in conjunction with another good. Simultaneous shifts in demand and supply (book, practice problems, handout) 4) Elasticity Price elasticity of demand (calculation using midpoint method and interpretation) The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same. Goodluck with the test. Formula: Elasticity of demand graphically (5 cases) Power Point If the percentage change in the quantity demanded is smaller than the percentage change in price, the price elasticity of demand is less than 1 and the good has inelastic demand. If the percentage change in the quantity demanded is greater than the percentage change in price, the price elasticity of demand is greater than 1 and the good has elastic demand. If the percentage change in the quantity demanded equals the percentage change in price, the price elasticity of demand equals 1 and the good has unit elastic demand. Extreme cases: Perfectly elastic and perfectly inelastic If the quantity demanded doesn’t change when the price changes, the price elasticity of demand is zero and the good has a perfectly inelastic demand. If the percentage change in the quantity demanded is infinitely large when the price barely changes, the price elasticity of demand is infinite and the good has a perfectly elastic demand. Determinants of price elasticity of demand 1) Number of Close substitute If there are a large number of substitute good, that good is more elastically demanded If there are a small number of substitute good, that good is less elastically demanded Necessities, such as food or housing, generally have inelastic demand. Luxuries, such as exotic vacations, generally have elastic demand. 2) The proportion of income (the budget share): 3) Time Horizon: If the changes in takes place in a long period of time (gasoline price rises for the next 10 years) : more elastically demanded If the changes in takes place in a short period time (gasoline price rises for the next 6 months) : less elastically demanded 4) Category: Broadly Defined & Narrowly Defined Good Narrowly Defined (Oranges): more elastically demanded Goodluck with the test. Broadly Defined (Fruit): less elastically demanded Because people can find alternatives for oranges but not an alternative for fruit. Relationship between price elasticity of demand and total revenue (Total Revenue Test) The change in total revenue due to a change in price depends on the elasticity of demand: If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent, and total revenue increases. If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent, and total revenues decreases. If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent, and total revenue remains unchanged. The total revenue test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change (when all other influences on the quantity sold remain the same). If a price cut increases total revenue, demand is elastic. If a price cut decreases total revenue, demand is inelastic. If a price cut leaves total revenue unchanged, demand is unit elastic. Goodluck with the test.
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