Study Guide for Econ150- Exam 1
Study Guide for Econ150- Exam 1 ECN 150
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This 10 page Study Guide was uploaded by emilyecclestone on Sunday February 14, 2016. The Study Guide belongs to ECN 150 at Wake Forest University taught by Dr. Ryan Safner in Spring 2016. Since its upload, it has received 32 views. For similar materials see Introduction to Economics in Economcs at Wake Forest University.
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Date Created: 02/14/16
Lesson 1- The Economic Way of Thinking • Opportunity Cost- The next best alternative forgone o When a choice is made, there is an opportunity cost o The opportunity cost of a choice is the value of the opportunities lost o More inclusive than "accounting costs" o Opportunity costs are forward-looking • The exist only when you make a new choice o Sunk costs • Non-recoverable costs that were incurred in the past from previous choices • Should not enter into rational future decisions § But often we do--> we are behaviorally primed by the sunk cost fallacy • Pure Logic of Choice--> Value o We pursue our highest-valued (highest utility) goals first • Value is ordinal…a ranking of goals • Value is subjective to each person based on their goals • Scarcity- The shortage that exists when less of something is available than demanded o Unlimited wants and needs, but limited resources o The ultimate cause of the economic problem • Fundamental Economic Problem § Human desires are practically unlimited, but our ability to satisfy them (with goods) are limited • Marginalism o All human action takes place on "the margin" • A small deviation from the status quo of current conditions to attain a particular good o The Law of Diminishing Marginal Utility • For each additional (marginal) unit of a good, all else equal, the additional (marginal) utility gained is less than the previous unit o The Equilibrium Principle- Over time there is a systemic tendency for people to act to the point where all marginal benefits from different actions equalize (equilibrium) • "Cost-Benefit Analysis"- an optimal decision is made by action until just before the point where marginal costs exceed marginal benefits § Marginal Benefit- the benefit gained from one consuming one of more unit of a good § Marginal Cost- the opportunity incurred from consuming one more unit of a good • When MB > MC--> Do less • When MB < MC--> Do more • When MB = MC--> Optimum • The Invisible Hand- A don't interfere approach--> leaving consumers and producers to make their own decisions and gaining maximum benefit for all • Adam Smith- o Known as father of Economics o Believed in the free market o Believed Invisible hand would result in the most efficient outcome Lesson 2- Cooperation & Exchange • Competition- People compete for use of goods o Buyers only compete with other buyers • Buyers want to pay the least for a good, will start out bidding low prices o Sellers only compete with other sellers • Sellers want to gain the most from selling their goods, will start asking high prices • Incentive- the structure of marginal benefits and marginal costs for a particular activity o Incentives matter o Institutions shape incentives and must be critically examined • The Price Mechanism- Price signals which determines allocation of resources through interaction of supply and demand o Moves market into equilibrium o Goods flow to those who value them the highest o Individuals bid away goods based on their willingness and ability to forgo other alternatives to acquire them o Role of the Price Mechanism--> Resource Allocation • Resource Allocation- Examine the way that scarce factors of production (land, labor and capital) are used (allocated) to meet unlimited demand § Scare resources are allocated and reallocated in response to changes in price signals § Price signals are given to producers what consumers wish to buy § Price changes result as a change in equilibrium § A higher prince would provide incentives to firms to produce more, since there is a larger profit • Division of Labor- The ability of people to specialize in production and exchange their produce with other ot acquire all the other desired goods o The more opportunities there are to trade with other people, the greater the benefits of specialization and capital accumulation o The output performed under division of labor exceeds the output performed individually • Why is work under DOL more productive? § Inequality of the distribution of individual abilities § Inequality of the distribution of land/resources and productive opportunities § Some goods require team production • Incentive Compatibility o Trade is incentive-compatible • All parties involved are properly incentivized to engage in it because they believe it will benefit them • Comparative Advantage- Two parties can gain from trade by each specializing by producing the good in which they can have they lowest opportunity cost in producing and exchanging some of it for other goods o A country has a comparative advantage in producing good for which • Absolute Advantage- The ability to produce the same good using fewer inputs than the another producer • Production Possibilities Frontier (PPFs)- Shows all the combinations goods that a producer can produce given its productivity and supply of inputs o Illustrated the trade-off between two goods • Trade-off- Giving up one good to get another Lesson 3- Supply & Demand • Exchange- for every exchange, there is a buyer and a seller o Buyer- gives up good Y to acquire good X o Seller- gives up good X to acquire good Y • Markets- where buyers and sellers come together to carry out an economic transaction • Demand- total amount of goods and services that consumers are willing and able to purchase at a given price in a given time period o Each person has a Maximum Willingness to Pay (WTP)--> reservation price for each marginal unit of the good they want • The Law of Demand- as the price of a product falls, the quantity demanded of the product will usually increase and vice versa o Why? --> Diminishing Marginal Utility • Demand Schedule- expresses a hypothetical amount of a good a person would be willing to buy at any given price o Demand Curve- • Graphical representation of the demand schedule • Represents the relationship between the price and quantity demanded of a good • Represents one's maximum WTP for a good • Market Demand Schedule- derived from adding up all individual demand schedules o Market Demand Curve- • Graphical representation of the market demand schedule • Horizontal sums of individual demand curves • Non-Price Determinants of Demand o Factors that change demand or shift the demand curve for normal and inferior goods • Income- as income rises… § Demand for normal goods rises--> shifts to the right § Demand for inferior goods falls--> shifts to the left § When income gets to a certain level, demand will be 0--> curve disappears • Tastes & Preferences § Change in tastes in favor--> shifts to the right • Price of Substitutes & Complements § As price of substitutes increases--> shifts to the right § As price of complements increases--> shifts to the left • Demographic Changes § If population grows, the demand for most products will increase--> shifts to the right • Will be more demanded at each price level • Movements Along the Demand Curve o A change in price of the good itself leads to movement along the existing demand curve o A change in any other determinants of the demand will always lead in a shift of the demand curve, either to the right or left • Supply- total amount of goods and services producers are willing and able to purchase at a given price in a given time period o Each person has a Minimum Willingness to Accept (WTA)--> reservation price for each marginal unit of the good they own and want to exchange • The Law of Supply- as prices of a product rises, the quantity supplied of the product will usually increase o Price rises but costs do not change--> profitability increases--> supply more (increase profits) o Why? --> Increasing opportunity cost (of holding the good) • Supply Schedule- expresses a hypothetical amount of a good a person would be willing to sell at any given price o Supply Curve- • Graphical representation of the supply schedule • Represents the relationship between the price and quantity supplied of a product • Represents a person's minimum WTA in exchange to give up a good • Market Supply Schedule- derived by adding up individual supply schedules o Market Supply Curve- • Graphical representation of the market supply schedule • Horizontal sum of individual supply curves • Non-Price Determinants of Supply o Factors that change supply or shift the supply curve • Changes in costs of factors of production § Increase in costs of production--> shifts to the left • Land, labor, capital, entrepreneurship • State of Technology § Improvements in technology--> shifts to the right § Natural disasters many move technology backwards--> shifts to the left • Price of Relating Product (Joint/Competitive Supply) § If producer could produce another product with higher profit due to limited resources the supply for the existing product would decrease • Expectations § If demand for the product is likely to rise--> supply increases • Number of Firms in the Marker § More firms producing--> shifts to the right • More are being supplied at each price level • Movements Along the Supply Curve o A change in price of the good itself leads to a movement along the existing supply curve o A change in any other determinants of supply will always lead to a shift of the demand curve either to the left or right • Consumer Surplus- the extra satisfaction gained by consumers from paying a price that is lower that which they are prepared to pay o Value of buyers' benefit from exchanging o CS= Max WTP-Price • Producer Surplus- the excess of actual satisfaction that a producer makes from a given quantity of output o Over and above the amount of the producer would be prepared to accept for that output o Value of sellers' benefit from exchanging o PS= Price-min WTA • Market Equilibrium- where the supply is equal to the demand o The market is in equilibrium when the demand of that product consumers wish to but is equal to the amount of the product wish to buy is equal to the amount of the product the producer wishes to sell o Excess supply- more is being supplied than demanded at P1--> in order to eliminate the surplus, the producer must lower the price o Excess demand- more is being demanded than supplied at P2--> in order to eliminate this shortage, producer must raise the price o Changes in determinants cause changes in equilibrium • When there's a change in determinants of supply/demand other than the price of the product, it would lead to a shift of a curve • When demand shifts to D1, Qe is the quantity supplied, but Q2 is the quantity demanded there is excess demand (of x units) • Due to price mechanism, the price will rise until Pe1 where the new equilibrium quantity is demanded and supplied • First Fundamental Welfare Theorem of Economics- markets in competitive equilibrium maximize allocative efficiency of resources o Allocative Efficiency- happens when competitive market is in equilibrium, where resources are allocated in the most efficient way from society's point of view • Social surplus (consumer + producer surplus) is maximized • Marginal social benefit= marginal social cost • The Price Margin o Submarginal buyers- have WTP too low o Submarginal sellers- have WTA too high o Marginal buyers and sellers- may exit the market if the price changes against their favor o Submarginal buyers and sellers- may enter the market if the price changes in their favor o Supermarginal buyers- have WTP high enough o Supermarginal sellers- have WTA low enough • Efficiency- input produces the maximum possible output--> a given output produced at minimum cost • Why do markets tend to equilibrate? Relative Prices Results Shortage Current price is BELOW RAISE current price equilibrium price Surplus Current price is ABOVE LOWER current equilibrium price price o Shortage- demand for a product/service exceeds the available supply->Q > Q D S o Surplus- price is above equilibrium causing quantity demanded to be less than quantity supplied->Q < Q D S • Ceterus Paribus- "all else equal"- all other factors that influence supply and demand are held constant when we draw a curve • Normal Good- a good for which quantity demanded increases with a person’s income and vice versa) • Inferior Good- a good for which quantity demanded decreases with an increase in a person’s income (and vice versa) • Substitute Goods- two goods are substitutes if the quantity demanded for good A increases with an increase in the price of good B (and vice versa) • Complement Goods- two goods are complements if the quantity demanded for good A decreases with an increase in the price of good B (and vice versa) Lesson 4- Supply & Demand Applications • Elasticity- a measure of the "responsiveness of one variable from a change in another variable o Tells us more about the shape of a supply/demand curve • Price Elasticity of Demand- measures the responsiveness of market quantity demanded as a result of a change in price o How much more will people buy (in %) if the price changes (by 1%)? o Mathematically- Elastic Unit Elastic Inelastic |ED|>1 |E D=1 |ED|< 1 %DQ > D DP %DQ = %DP %DQ < %DP D o Intuitively, how do consumers respond to a 1% change in price? Elastic Unit Elastic Inelastic Big response Proportionate response Little response Buy much more Buy equal amount more Buy a little >1% increase Q D 1% increase Q D more <1% increase Q D • Determinants of Elasticity of Demand o Less Elastic • Fewer substitutes • Short run (less time) • Categories of product • Necessities • Small part of budget o More Elastic • More substitutes • Long run (more time) • Specific brands • Luxuries • Large part of budget • 2nd Law of Demand- over time, demand curves tend to become more elastic, ceterus paribus • Total Revenue- the revenue sellers gain from selling their goods o In equilibrium, total revenue to sellers equal to the total expenditures of buyers purchasing goods o TR= P Q * Region of demand curve DTR & DP Elastic E>1 Price & revenue change opposite Unit Elastic E=1 Price & revenue does not change Inelastic E<1 Price & revenue change together • Income Elasticity of Demand- measures the responsiveness of demand to change in consumer's income o E Is positive--> a normal good • Buy more units of the good when you have more income o E Is negative--> an inferior good • Buy less units of the good when you have more income o Necessities--> income inelastic of demand o Luxuries--> income elastic of demand • Cross Price Elasticity of Demand- the responsiveness of the demand for good X to change in the price of good Y o Movement along the curve for one good causing a shift in demand for another o E>0--> goods are substitutes • Buy less units of good A when price of good B falls (buy more instead) & vice- versa o E<0--> goods are complements • Buy more of good A when price of good B galls & vice-versa • Price Elasticity of Supply- measures of the responsiveness of how much the quantity supplied of a good responds to a change in the price of that good o How much more will people sell (in %) if the price changes (by 1%)? o E is infinite--> perfectly elastic S o E Ss less than 1, but greater than 0--> supply is inelastic o E Ss greater than 1, but less than infinity--> supply is elastic o E =1--> supply is Unit Elastic S • Determinants of Elasticity of Supply o Less Elastic • Difficult to increase production at a constant unit cost • Large share of market for inputs • Global supply • Short run o More Elastic • Easy to increase production at a constant unit cost • Small share of market for inputs • Local supply • Long run
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