Econ Review ECON 2010
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This 16 page Study Guide was uploaded by Leah Barton on Monday February 22, 2016. The Study Guide belongs to ECON 2010 at Western Michigan University taught by Kim in Summer 2015. Since its upload, it has received 150 views. For similar materials see Principles of Microeconmics in Economcs at Western Michigan University.
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Date Created: 02/22/16
Econ 2010, 115 Notes What is economics? - Economics is the study of how people behave. Opportunity Cost - No such thing as a free lunch Scarcity – limited resources -Scarcity is the main source of every economic problem. If there was no scarcity, there would be no economics! Every time you make a choice you are sacrificing something Ex: college is not only the cost of tuition, but also the opportunity cost of not getting a job Women in successful careers postpone having kids because the opportunity cost of being successful in a job outweighs the value of having children. How people make decisions? 1. People face tradeoffs 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 People make decisions by comparing costs and benefits at he a margins Marginal changes - Small incremental adjustments to a plan of action - Ex: (should I eat another slice of pizza? Or not? / Should I push snooze and sleep for another five minutes? Or wake up?) Marginal benefit (MB)= -the benefit of a “small” increase in an activity Marginal cost (MC) = -the opportunity cost of “small” increase in an activity. - Marginal benefits tend to DECREASE as you do more of it - Marginal cost tends to INCREASE as you do more of an activity. - When MB > MC, = incentive. Sunk cost -Cost that have already been incurred and cannot be recovered. Q- You are considering to stay in college another semester so that you can complete a major in economics. In deciding whether or not to stay you should – -compare the cost of staying one more semester to the benefits of staying one more semester. Q-Assume that you already spent 4 years in college (total cost=50,000) and in order to get and Econ minor, you need to stay one more semester. (cost = 5,000, and benefit = 10,000)What should you do? -50,000 is the sunk cost and is not included in the marginal cost of this decision. Therefore, you should stay because the benefits outweigh the cost! “People respond to incentive” Incentive Three basic incentives: 1. Economic/monetary – desire to receive rewards or money 2. Moral - guilt 3. Social – desire to fit in. To behave in a certain way for acceptance *when the three incentives are put together, you get the best results. - exists if MB >MC - Whenever MB and MC change, people’s incentives change - Policies -> unintended consequences - If you don’t take into peoples incentives when making policies, it could be counterproductive or be ineffective. - Ex: Teacher uses clicker questions to check attendance so that she knows students will show up. It was counterproductive because students were forced to come to class specifically for the questions and than did not pay attention and acted as a distraction to others who cared to be there. There were unintended consequences. - Ex: Anti smoking campaign – Economic incentive is that the cost of cigarettes is too expensive and you feel guilty wasting money. Moral incentive is knowing its harmful to you and harmful to others and make you feel guilty. “Trade can make everyone better off” Trade - People gain their ability to trade with one another. - Competition results in gains from trading - trade allows people to specialize in what they do. - Ex: mom cooks dinner, dad shovels driveway. They trade jobs because it allows them to do things they are good at. - -> VOLUNTARY TRADE ONLY “Markets are usually a good way to organize economic activity” Efficiency Market economy - An economy that allocates resources the decentralized (you make your own decisions rather than the government does in centralized economies) decisions of many firms and households as they interact in markets for goods and services - Because households and firms look at price when they decide what to buy and sell, they unknowingly take into account the social costs of their actions - Price guides decision makers to be more efficient Q- In a market economy, economic activity is governed by- A. Self interest and price “Governments can sometimes improve market outcomes” Governments Three main reasons: 1. WE need to protect markets from abuse – we need the government to have a strong legal system to protect the free market. 2. Achieving the greatest amount of efficiency is not the only goal – finding the fastest way to meet a goal. 3. Sometimes the market is not working perfectly -> Market failure Micro vs. Macro Microeconomics - Deals with the behavior of individual entities in the economy and how they respond to change. (Individuals, households, or industries), think small - The study of the choices of individuals and firms the interaction of these choices and the influence that governments exert on these choices. Macroeconomics – The economy as a whole. (Unemployment, national income), think big. – Economics is a science: - Looks at natural experiments throughout history and uses statistical methods to test the models. - You must have proof to support a theory of statement (like the scientific method) - Collect and look at data The economic models: Use scientific method Observe and measure Model building Testing models *the goal of economic models are to simplify reality to increase our understanding of the world. Ex of models: 1. The Circular-Flow Diagram (dollar flows) 2. The Production Possibility Frontier (PPF) -Scarcity -Choice -Opportunity cost -a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology. Ex: -Two goods: computer and wheat -One resource: labor (measure in hours) -Economy has 50,000 labor hours per month available for production -To produce one computer requires 100 hours of labor -Producing one ton of wheat requires 10 hours of labor A. Computer: 50,000, wheat: 0 B. Computer: 40,000, wheat 10,000 C. Computer: 25,000, wheat: 25,000 D. Computer: 10,000, wheat: 40,000 E. Computer: 0, wheat: 50,000 *Graph to find model Positive vs. Normative Statements Positive Statement - Claims that attempt to describe the world as it is - Can easily evaluate if the statement is right or wrong Normative Statement - Claims that attempt to prescribe how the world should be Positive statements can be evaluated using data, while normative statements involve personal viewpoints. Ex: I think today’s temperature is 65 degrees. (Positive Statement) Ex: Purple is prettier than pink (Normative Statement) Ex: GDP fell by .5% last quarter (Positive Statement) Ex: The government should print less money. (Normative Statement) Ex: The DOW rose above 15,000 of May 3 . (Positive Statement) Correlation and Causation *CORRELATION DOES NOT EQUAL CAUSATION. Correlation - When two things are related to each other, but do not cause each other. Causation – When you can claim one thing causes another thing to happen. A B Class Buyer/Seller Experiment explained: -For those of you who did not attend the class bonus experiment, here is a summary of what happened. -In the simulation, individuals were first assigned to be buyers or sellers. -Buyers are also given bid dollars, which was the maximum amount of money that they were permitted to spend on a book. -Sellers were also given a cap on the minimum that they may sell their book for. -If you were a buyer, your goal was to buy a book at the lowest possible ask price from the sellers. -If you were a seller, your goal was to sell your book to the highest possible bid from the buyers. -If each individual met their goal, they gained a profit, or gained in the money they got to keep. Production Possibilities Frontier (PPF) -An economic model; a graph that shows the combination of two goods the economy can possibly produce given the available resources and the available technology. *PPF does not include PRICE 1. Shifting the PPF – (economic growth) the PPF shifts when resources are adjusted. - A increase in resources shifts the entire frontier outwards. - A decrease in resources shifts the entire frontier inwards. 2. Opportunity Cost – what must be given up to obtain something else. - Moving along the PPF involve shifting resources from production of one good to the other. - 2 ways to calculate the PPF: 1.) Calculate slope to tell you the opportunity cost. 2.) Opportunity cost of good X =decrease in good Y/increase in good X - Ex: decrease in wheat/increase in computer - 1000 tons of wheat/100 computers = 10 tons of wheat (this is the opportunity cost, or the wheat your giving up in order to produce more computers.) Q: Ivan receives and allowance from his parents of $20 each week. He spends his entire allowance on two goods: ice cream (which costs $2 each) and tickets to the movies (which costs $10 each) What is the opportunity cost of one movie? What is the opportunity cost of one ice cream cone? A: The opportunity cost of one movie is 5 ice cream cones. ($10 movie/$2 ice creams= 5 ice cream cones) A: The opportunity cost of one ice cream cone 1/5 movies (2 movies/10 ice cream cones = 1/5 movies) *They are reciprocals! Q; Any point on a country’s PPF represents a combination of two goods that an economy… A: can produce using all available resources and technology. Q: Suppose a gardener produces both green beans and corn in her garden. If she must give up 14 bushels of corn to get 5 bushels of green beans, her opportunity cost of 1 bushel of green beans is … A: 2.8 bushels of corn (14 bushels of corn/5 bushels of green beans = 2.8 bushels of corn) 3. Shape of the PPF -Linear the opportunity cost of a good is constant. Assuming all the labor is identical. (This is false because everyone is different) -Bow-shaped the opportunity cost of a good is increasing as the economy produces more of the good. -the shape will be downward sloping Ch. 3 Trade Interdependence -Trade can make everyone better off -People specialize in trades. -Today we have expanded to trading across borders and benefit from the ability to exchange goods to get a cheaper price. - If there was no trade, you would have to make every single thing that you use! Ex: -Two countries: U.S. and Korea -Two goods: computers and wheat -Resource: labor -How much of both goods do each country produce and consume. Is it self-sufficient? Does it trade with other countries? -Korea has 30,000 labor hours. -One computer takes 125 hours -One ton of wheat takes 25 hours Find the endpoints of the PPF (30,000/125 = 240 computers, 30,000/25 = 1200 tons of wheat) -U.S. has 50,000 hours of labor. -One computer takes 100 hours -One ton of wheat takes 10 hours Find the endpoints of the PPF (50,000/100 = 500 computers, 50,000/10 = 5000 tons of wheat) Consumption without trade Ex: -U.S. produces 3400 tons of wheat. How many computers would the country be able to produce with remaining labor hours? How many computers can the U.S produce? A: (3400 * 10 =34,000 hours of wheat production. 50,000- 34,000=16,000 hours left to produce computers. 16,000/100 = 160 computers) -Korea produces 240 computers. How man tons of wheat would Korea be able to use with its remaining labor hours? A: 240 computers require all of Korea’s 30,000 labor hours. Korea would produce 0 wheat. Consumption with trade Ex: -Suppose the U.S. exports 700 tons of wheat to Korea and imports 110 computers from Korea. U.S. Consumption (160 computers + 110 computers = 270 computers to computers for the U.S. to consume. 3400 tons of wheat - 700 tons of wheat = 2700 tons of wheat for the U.S. to consumer) Korea Consumption (240 computers – 110 computers = 130 computers for Korea to consume. 0 tons of wheat + 700 tons of wheat = 700 tons of wheat for Korea to consume) *With trade you can consume good outside of the PPF line! Both countries will be better off Where do gains come from? Absolute advantage -The ability to produce a good using fewer inputs than another producer -The ability to produce more of a good than others using the same amount of resources Ex: -Country A can produce 100 gallons of ice cream with 8 hours of labor. -Country B can produce 50 gallons of ice cream with 8 hours of labor. Who has the absolute advantage? A: Country A Two measures of the cost of a good -Two countries from trade when each specializes in the good it produces at lowest cost -Absolute advantage measures the cost -Don’t forget about opportunity cost! Comparative advantage -The ability to produce a good at a lower opportunity cost than another producer Ex: -Which country has the comparative advantage in computers? In wheat? Determine opportunity cost! (on PPF, Rise/Run) (Decreasing good/increasing good) Of computers The U.S. = 5000 wheat/500 computers= 10 tons of wheat Korea = 1200 wheat/240 computers= 5 tons of wheat *Korea has the lower opportunity cost and has the comparative advantage Of wheat The U.S. = 500 computers/5000 wheat = 1/10 computers Korea = 240 computers/1200 wheat = 1/5 computers *U.S. has the lower opportunity cost and has the comparative advantage Gains from trade come from COMPARATIVE ADVANTAGE. NOT ABSOLUTE ADVANTAGE! Adam Smith -Who can produce goods using fewer inputs? -First person to realize the absolute advantage of trade and that people should specialize. -Specialization should be given to individuals with the absolute advantage, even if they are not the best at the specialization. David Ricardo -Modified Adam Smith’s view. -Who can produce at the lowest opportunity cost? -Believes people should specialize based on comparative advantage rather than absolute advantage. -Gains from trade arise from comparative advantage Terms of Trade (exchange rate) -Lower opportunity cost </ Terms of Trade </ Higher Opportunity Cost Chapter 4 The Market Forces Supply and Demand Markets -A group of buyers and sellers of a particular good or service. -Any place can be a market. Competitive Markets -Standardized goods (identical) -Full information (assume the buyer knows about the product before purchase) -No transaction costs -Participants are price takers (the price does not change after you make a purchase. Individual buyers and sellers do not influence price. You take the price as given.) Demand -If you demand something then you both want it and you can afford it. -The amount of a good that would be bought at each possible price, during some time period, given the environment. -Given the environment = everything else held constant = ceteris paribus Quantity demanded -The amount of a good that would be bought at a given price, during some time period and given the environment. -One price and one quantity. -Ex: If a Big Mac is $.99, I will buy 2. If it’s $.50, I will buy 3. If it’s $2.00, I will buy 1. Demand Schedule -A table that shows the relationship between the price of a good and the quantity demanded. Law of Demand -As price goes up, quantity demanded goes down -Other things being equal, the quantity demanded is negatively related to the price of a good. How do you find the slope of a demand curve? -Price on the y-axis, quantity on the x-axis. -Will always be a downward sloping curve because they are negatively related. Individual Demand vs. Market Demand -The quantity in the market is the sum of the quantities demanded by all buyers at each price. Determinants of Demand 1. Price of the good 2. Price related to goods 3. Income 4. Population 5. Taste (preference) 6. Expectations A change in price A change in others A change in demand Δ (delta) = change Shift of Demand -A change in demand = shifting the demand curve. -When demand increases, the demand curve shifts to the right. -When demand decreases, the demand curve shifts to the left. -When quantity demanded changes, there is NO SHIFT. The point moves along the demand curve. Substitutes -A good you can use in replace of another. (Margarine instead of butter, Pepsi instead of Coke) -Price increases Demand increases (a rise in the price of laptops will raise the quantity demanded of desktops) Compliment -Goods that are used together (milk and cereal, hamburger and bun) -Price increases Demand decreases (a raise in the price of hot dogs will lower the demand of buns) Income -Normal good -A good for which an increase in income leads to an increase in demand (cars, 5 star restaurants) -Inferior good -A good for which an increase in income leads to a decrease in demand. (fast food restaurants) Population -With more people, demand increases. Taste (Preference) -If you like something more, the demand for that good increases (the new iPhone, the new Star Wars movie) Expectations -Future price changes (if you expect the price to go up in the future, you will demand more today) Supply -The amount of a good that a firm could and would sell at all possible prices, given the environment. Q: What determines how much is supplied to the market? -Free markets determine how much is supplied. -The price! (Important for supply and demand) Supply Schedule -A table that shows the relationship between the price of a good and the quantity supplied. Law of Supply -As the price goes up, quantity supplied goes up -Opposite of the law of demand. -So it is positively related -As a seller, you want to make as much profit as possible. Q: What is the slope of the Supply Curve? -The curve will have a positive slope and increase. Market Supply vs. Individual Supply -The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. -Just add to get the total quantity supplied! -They are also positively related. Determinants of Supply: 1. Price of the good 2. Prices of Inputs 3. Technology 4. Number of Suppliers 5. Expectations of future prices Price decreases Quantity supplied decreases -Just like demand you MOVE ALONG THE SUPPLY CURVE Q: What is the ultimate goal in doing business? -To make a profit! -Profit = total revenue-total cost -Price x quantity A change in supply -Opposite of a change in demand An increase in supply =The entire SC shifts to the right (out) A decrease in supply =The entire SC shifts left (in) Q: What determines cost of production? -if a firm can produce the good cheaper then it will want to produce more of the good at all possible prices. Input prices -The cost of production. -What is used in order to create the output! -Wages cost of machines, rent, raw materials, and workers. Ex: Illegal immigrants are willing to work for low wages. This means less cost of production and the supply will increase. The supply curve will shift to the right because we are supplying more! Technology -Better technology makes firm more efficient = more output for some amount of input. Q: What other factors that effect supply? Number of suppliers -If there are more firms in a industry, then more will be supplied at any price Expectation -Future prices -If you are a seller, you expect the price will go up in the future. Do you sell now or later? You sell later! You will make maximize your profit! -Opposite of demand expectations Ex: Suppose there is an increase in the price of steel. We would expect the supply curve for steel beams to____ -Shift to the left -Price of inputs goes up -Cost of production goes up -Supply goes down -Therefore shifts to the left Equilibrium Price -Where price has reached the level where quantity supplied equals quantity demanded. -On the chart, the demand line and the supply line cross at this point. -A perfect market! Disequilibrium -Shortage (=excess demand) Qs < Qd -Surplus (=excess supply) Qs > Qd Three Steps to Analyze Changes in Equilibrium 1. Decide whether event shifts supply curve, or the demand curve, or both, 2. Decide in which direction curve shifts (left or right?) 3. Use supply-demand diagram to see how the shift changes price and quantity. What happens when both supply and demand shifts at the same time? -Supply increases, Demand increases Price ?, Quantity rises -Supply decreases, Demand deceases Price ?, Quantity falls -Supply increases, Demand decreases Price falls, Quantity ? -Supply decreases, Demand increases Price rises, Quantity ?
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