Economics Study Guide
Economics Study Guide ECON 2005
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This 10 page Study Guide was uploaded by Jenna Davis on Tuesday February 23, 2016. The Study Guide belongs to ECON 2005 at Virginia Polytechnic Institute and State University taught by Steve Trost in Spring 2016. Since its upload, it has received 148 views. For similar materials see Principles of Economics in Economcs at Virginia Polytechnic Institute and State University.
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Date Created: 02/23/16
Economics Study Guide Key Ideas and Terms : Economics: The study of how agents use their scarce resources to satisfy their unlimited wants and the choices agents make (why agents do things) Agents: The people, households, firms, governments, countries, any entity that makes decisions. Households: The consumers that demand goods and services form the product market, and the resource owners that supply the resources; earn income. They determine the types and quantities of inputs supplied and products demanded. Firms: The government and the rest of the world that demand resources and produce goods and services; payment for resources. Supply goods and services to the product market to earn revenue. They determine the types and quantities of products supplied and inputs demanded. Investment: The process of using resources to produce capital goods. Factors of production (Inputs): The resources put into the process of production. Production: The process of taking scarce resources and turning them into goods and services that are useful. Outputs: The usable products: goods and services. Costs and Benefits: the things agents consider when making a decision. If the benefit is greater than the cost, they will do it, but if the cost is greater than the benefit, they will not. Economists have to correctly identify the cost and benefits to study human behavior. Scarcity: The way agents are restricted and why it is hard when making choices is due to scarcity. When the amount people desire exceeds the amount available, causing us to pass up some goods and services. When we use a resource for one thing, we cannot use that resource for something else. Opportunity Cost: The best alternative. It is what we “give up” when we make a choice or decision. It’s the value of the best option forgone. VERY IMPORTANT Absolute Advantage: To be entirely (absolutely) better at the production of a good or service and can produce it using less resources. Comparative Advantage: To be comparatively better at the production of a good or service so it can be produced at a lower opportunity cost. Law of Specialization: Each person should do what they have a comparative advantage in. Even if you have the absolute advantage, you should divide up the responsibilities. If everyone does what they specialize in, then we will produce more stuff as a group. Circular Flow Model: Shows the relationships between products, resources, revenue, incomes. Really shows the interaction in the market economy- between households and firms. Ceteris Paribus: all else equal. Nothing else changes (holding other things constant) Price: the basic coordinating mechanism Consumer Sovereignty: The idea that the consumers determine what is going to be produced by choosing what to purchase and what not to purchase. Free enterprise: Individuals have the freedom to start and operate private businesses. The Fallacy of Composition: The mistake of thinking that what is true for the individual, or part, must necessarily be true for all. Ex: Going to a dining hall at 3:00 because no one will go at that time so it’s less crowded. It would be good if you did it, but what if all the other students did as well? Self-selection: When people choose to be in a group that will be studied. The stats are based on these people. Model: A model is what economists use to explain relationships or make predictions that exist in the world. It is a formal (usually mathematical) statement of a theory. Variable: A measure that can be changed from time to time. Slope: change in Y over the change in X= y2-y1/x2-x1 Positive slope: upward sloping line Negative slope: downward sloping line Marginalism: Analyzing the incremental, additional, or extra costs that arise form a choice or decision; used to describe a change in an economic variable Sunk Costs: Costs that cannot be avoided, regardless of any future actions because they have already been incurred. Production Possibility Frontier (PPF): Shows the trade-off between capital goods and consumer goods. If it is efficient it will be a point ON the PPF. If it is inefficient it will be a point under the PPF. When it is impossible it will be a point on the outside of the PPF. Marginal Rate of Transformation (MRT): The slope of the PPF. Things that can shift the PPF: 1. Change in resource availability 2. Increase in capital stock causing more output 3. Technological change employing resources more efficiently 4. Improvements with formal and informal institutions and economic growth The Law of Increasing Opportunity Cost: As society increases the production of a certain good, it has to give up more and more of the other output good (the opportunity cost of the additional unit rises). Economic Growth: An increase in the total output measured by recognized factors such as the total value of goods and services produced in a given time. Resources Resources: Scarce. The inputs (or factors of production) used to produce the goods and services that people desire. Labor, capital, natural resources, and entrepreneurial ability are categories of resources. Labor: The physical and mental effort used by humans to produce goods and services using/measured by the fundamental resource time. Example: The effort used by a postal worker. Payment= Wage Capital: The buildings, equipment, and human skills (all human creations) used to produce goods and services. Physical capital is the actual human creations that are used to produce goods and services, ex: factories, tools, technology, buildings, etc. Human capital is the knowledge and skills used to produce goods and services, ex: knowledge of how to do the job you’re performing. Payment= Interest Natural Resources: All gifts of nature including renewable and exhaustible resources used to produce goods and services, ex: land, oil, trees, and water. Payment= “Rent” Entrepreneurial ability: The imagination and talent required to develop a new product/improve an existing one or process, the skills needed to organize production and bring the idea to life, and assumes the risk of operation. Payment= Profit Consumer Goods: Goods produced for consumption. Capital goods are used to produce consumer goods. Capital Goods: Goods that are used to produce other goods and services at a lower price than we otherwise could (consumer goods). Steps of the “Scientific Method”: 1. Define the relevant variables and identify what the question is. 2. Specify assumptions; Ceteris Paribus 3. Make a hypothesis 4. Test the hypothesis; reject it and modify the approach, or use it until a better one shows up Types of Economics/Economies Microeconomics: Studies the choices that entities make; the study of individual behavior in the economy. A lot of microeconomics is just common sense. Why agents do things. Macroeconomics: Studies the aggregated economic effect of those choices (economic behavior of the economy as a whole). Ex: unemployment, inflation, interest rates. Positive Economics: tries to determine the explanation of economic phenomena. Looks at “what is”. It is either true or false. It describes the world as it is. Normative Economics: looks at what should be instead of what is. They look for “ought to” or “should”. Prescriptive economics is when they tell people the thing they should do. Pure Capitalist Economy: The markets determine what, how, and who good will be produced without a government or individual interference. Traditional Economy: When the tradition alone determines the nature of the economic activity. Answers “what gets produced, how is it produced, and who gets it?” Command Economy: The government controls the output targets, incomes, and prices either directly or indirectly. The people in charge answer the questions “what gets produced, how is it produced, and who gets it?” Market Economy: “Laissez-faire” An economy in which the individuals control what they do and pursue their own self-interests without regulation. The market determines what gets produced, how it is produced, and who gets it. They are based on the concepts of private ownership, consumer sovereignty, and free enterprise. For a market economy to work, these four conditions must be met: 1. There must be a market for paid resources (especially labor) 2. There must be a market for goods and services 3. People have to be able to have their own private property 4. There must be economic winners and losers Market Players: Households, firms, government, and the rest of the world Product Markets: A firm selling goods and services that are bought and sold by a household. (Outputs) Resource/ Factor Markets: Where resources are bought and sold and goods and services are exchanged, ex: the job market. (Inputs) Three Main Input Markets: 1. Labor Market- Where firms demand labor and households work for wages for those firms 2. Capital Market- Firms demands funds to buy capital goods so households supply their savings to get interest and claim future profits from the firms 3. Land Market- Households supply their land or other property in exchange for rent from firms. Mixed Economy: All the systems are “mixed” together. The US is the primary example of a mixed economy. We still have some regulations by the government because they are needed to fix the faults in the system. Free Market System: Basic economic questions are answered without the help of a central government, the system is left to operate on its own. Demand Demand: A relationship between the quantity of a good that people will buy and the price of the good Quantity Demanded: The amount of a product that a consumer would buy if the consumer could buy all that he/she wanted at the current market price. Only a change in price of the good can cause a change in society’s “quantity demanded” of that good. Law of Demand: When the price and quantity are inversely related. If the price of a good rises, people buy less of that good (quantity demanded decreases) Two reasons for the Law of Demand: 1. The substitution effect- when the price of a good rises, people choose to buy a different good 2. The income effect- as the price goes up, you buy less of the product because you have less money. Same for the inverse, if the price goes down, people are more likely to buy more of that product because it is cheaper. Demand Schedule: A table that shows how much of a product a household would be willing to buy at various prices (during a fixed time period). Demand Curve: A graph that shows how much of a given product a household would be willing to buy at various prices (given a fixed time period). Things that can shift the demand curve: 1. A change in consumers’ income or wealth Income- The sum of all of a households’ wages, salaries. A flow measure. Wealth- The total value of what a household owns minus what is owes. A stock measure. 2. A change in the price of other products (substitutes or complements) Substitutes: Goods that can serve as replacements for one another. When the price of one product goes up, the demand for the other product rises. Complements: Goods that “go together”. A decrease in the price of one causes more people to buy the other, and vice versa. 3. A change in consumers’ tastes in products: fads, popularity, news. 4. A change in consumers’ expectations (ex: future income or prices) 5. A change in the number of consumers 6. Normal goods: Demand goes up for these goods when income is higher and demand goes down when income is lower. 7. Inferior goods: Demand tends to fall when income rises for these goods. Movement along a Demand Curve: The chance in quantity demanded is caused by a change in price. Market Demand: The sum of all the quantities of a good or service demanded by all the households for that good or service in the market. Supply Law of Supply: The positive relationship between price and quantity of a good supplied. An increase in price will increase the quantity supplied, and a decrease in price will decrease the quantity supplied. Quantity Supplied: The amount of a product that a firm would sell at a particular price. Supply: A relation between the price of a good and the quantity that firms are willing to sell per period. Supply Schedule: A table showing how much of a product firms will sell at various prices. Supply Curve: A graph showing how much of a product firms will sell at various prices. Things that shift the supply curve: 1. A change in technology 2. A change in the price of inputs 3. A change in the price of alternative goods 4. A change in producer expectations- popularity 5. A change in the number of producers Movement along a Supply Curve: The change in quantity supplied caused by a change in price. Market Supply: The sum of all that is supplied of a single product by producers. Market Equilibrium Equilibrium: When the quantity supplied and quantity demanded are equal. There’s no tendency for price to change. It is NOT just where the quantity sold is equal to the quantity bought. Excess Demand or Shortage: When quantity demanded is more than quantity supplied at the current price. Prices tend to rise due to this. The shortages will be shown underneath the equilibrium. Excess Supply or Surplus: When quantity supplied is more than quantity demanded at the current price. Prices tend to fall due to this. The surpluses will be shown above the equilibrium. Supply and Demand Model: If the supply curve shifts back, and the demand shifts back, the equilibrium quantity will fall but price could rise or fall. If the supply curve shifts out, and the demand shifts out, the equilibrium quantity will rise but the price could rise or fall If the supply curve shifts back, and the demand shifts out, the equilibrium price will fall but the price could rise or fall If the supply curve shifts out, and the demand shifts back, the equilibrium price will fall but the price could rise or fall Price Theory Price rationing: The process where the market system allocates goods and services to consumers when the quantity demanded exceeds the quantity supplied. Price Floor: A legislated minimum price. Ex: minimum wage. To have an impact, it must be set above equilibrium price. These lead to surpluses because there’s more supplied than demanded. Ways to get rid of a surplus: 1. Increase demand 2. Decrease supply 3. The government purchasing the surplus and either store it, give it away, or destroy it Price Ceiling: A legislated maximum price. Ex: rent ceilings. To have an impact, it must be set below equilibrium price. These lead to shortages because of searching, the formation of black markets, add-ons, trade-ins, favored customers, etc. Auction: Where the equilibrium price is reached “out loud”. Elasticity Elasticity: The relationship between two variables. Price Elasticity of Demand: Measures how responsive the quantity demanded is to a price change. It’s measured by the percentage change in quantity demanded divided by the percentage change in price. It is greater in the long run because people have a longer chance to adjust. Income Elasticity of Demand: Measures how responsive the quantity demanded is to changes in income. It’s positive for normal goods and negative for inferior goods. It is the percent change in quantity demanded over the percent change in income. Cross-price Elasticity of Demand: Measures how responsive the quantity of one good demanded to a change in the price of another good. If the demand is positive, then the goods are substitutes. If the demand is negative, then the goods are complements. It is the percent change in quantity of X demanded over the percent change in price of Y. Price Elasticity of Supply: Measures how responsive the quantity supplied is to a price change. It’s measured by the percentage change in quantity supplied divided by the percentage change in price. Biggest Determinants of the elasticity of supply are time and production technology. A steeper supply curve will show that it is more inelastic. Perfectly Elastic Supply: a 1% change in price results in infinite % change in quantity. It’s shown by a horizontal line. Elastic Supply: A 1% change in price results in a <1% change in quantity. Unitary Supply: A 1% change in price results in a 1% change in quantity. Inelastic Supply: A 1% change in price results in a >1% change in quantity. Perfectly Inelastic Supply: A 1% change in price results in 0% change in quantity. This is shown by a vertical line. Total Revenue: Price times the quantity demanded Consumer Choice and Demand Utility: The level of satisfaction a consumer gets from their consumption of a good or service. Your tastes and preferences. Utils: What we measure utility with. Every individual is different and gets different amounts of utils from a good or service. Marginal Utility: The additional satisfaction resulting from one unit change of something. Total Utility: The total satisfaction resulting from consumption of a good or service. The Law of Diminishing Marginal Utility: The more of any one good someone consumes, the smaller the increase in your total utility. You will get less utility out of each additional unit consumed. Market systems don’t maximize total social utility.
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