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UD / Economics / ECON 103011 / What is economics system?

What is economics system?

What is economics system?


Exam 1 Study Guide

What is economics system?

Chapter 1

• Scarcity-restricts options and demands choices, resources are limited • Opportunity cost-the price you paid/the thing you gave up in order to get something • Utility-pleasure or satisfaction

• Marginal-extra

• Marginal analysis-comparison of marginal benefit and marginal cost  • We assume everyone acts with rational self-interest, not selfishly

• Other-things-equal/ceteris paribus-the things that aren’t being studied are assumed to  have no effect on the results (Pepsi example-we assume we only change the price of  Pepsi, not price of Coke or taste of Pepsi etc.)

• Microeconomics-the study of individual consumers, firms, or markets (ex. increase in  the market of fashion)

What is laissez-faire?

• Macroeconomics-the study of the market more generally/the entire market (ex. the  unemployment of the United States)

• Positive economics-economic statements that can be true or false, factual (ex. the  economy fell 3 points yesterday)

• Normative economics-economic statements that involve value judgment, up for debate  (ex. the unemployment rate ought to be lower) We also discuss several other topics like What is truman’s point iv program?

• Economizing problem-the need to make choices because economic wants exceed  economic means We also discuss several other topics like What is cell membrane?

• Budget line-a schedule that shows various combinations of two products a consumer  can purchase with specific income (ex. DVD’s and books)

• Trade-offs-giving up purchasing one thing in order to purchase another • Economic resources-capital (machines, things that go into the production of consumer  goods), entrepreneurial ability (innovative ideas, risk taking, bringing resources  together), land (natural resources), and labor (manual and intellectual) • Consumer goods-goods that satisfy consumers immediately  

What is market system?

• Capital goods-goods that help grow economy, goods that help enhance production of  consumer goods

• Production possibility curves/tables

o Law of increasing opportunity cost-as the production of a particular good increases,  the opportunity cost of production of an additional unit increases (ex. additional  robot is 1/4, 1/3, 1/2, and 1 unit of pizza), you have to use less skilled resources or  more scarce materials to produce more units (resources are not interchangeable) Don't forget about the age old question of What is the difference between low fidelity and high fidelity?

o Economic growth-trade, additional resources, education, technology that uses  resources more efficiently, shifts curve outward

Fallacy of composition-good for one person doesn’t mean good for society (ex. Google  maps)

• Direct/positive relationship-both variables move in the same direction • Inverse/negative relationship-two variables move in the opposite direction • Slope-rise divided by run

• Y=a + bx where a is the vertical intercept and b is the slope

• Slope of zero-horizontal line

• Slope of infinity-vertical line

Chapter 2

• Economics system-a particular set of institutional arrangements and a coordinating  mechanism

o Laissez-faire capitalism-government intervention is very minimal and markets and  prices are allowed to direct all economic activity

▪ Governments role is limited to protecting private property from theft and  establishing a legal environment in which contracts are enforced

▪ Believes that government intervention will lead to corruption

o Command systems-governments have total control over all economic activity ▪ Also called communism or socialism Don't forget about the age old question of Why does memory sometimes fail?

▪ Central planning board appointed by government makes all decisions ▪ Government owns all businesses

o Market system-a blend of laissez-faire and command system, some government  intervention takes place

▪ Mix of government initiatives and individuals seeking economic growth through  their own business decisions, resulting in competition among producers ▪ Defined by the market as the dominant force in the economy

• Private property-extensive private ownership of capital, encourages investments,  innovation, exchange, maintenance of property, and economic growth • Freedom of enterprise-entrepreneurs and private businesses are free to obtain and use  economic resources to produce their choice of goods/services to sell them in their  chosen markets

• Freedom of choice-enables owners to employ or dispose of their property and money as  they see fit

• Self-interest-the motivating force of various economic units as they express their free  choice

• Competition-comes from freedom of enterprise and choice that allows the market  system to function

o Two or more buyers and sellers acting independently allows no single buyer or firm  to dictate price We also discuss several other topics like What is the amount of money earned on a regular basis?
We also discuss several other topics like What is post-lactation dependency?

o Freedom of entry or exit into industry allows for adjustments to demand • Market-institution that brings together buyers and sellers

• Specialization-using resources of an individual, firm, region, or nation to produce one or  a few goods/services rather than an entire range of goods/services

o Division of labor-specialization makes use of different abilities, fosters learning by  doing, saves time, and increases efficiency of society

• Medium of exchange-makes trade easier through the use of money • Barter-swapping goods for other goods

• Money-convenient social invention to facilitate exchange of goods and services • Five Fundamental Questions

o Goods that continue to make profits will be produced  

▪ Profits=total revenue – total costs

▪ Consumer sovereignty-crucial in determining the types and quantity of goods  produced

▪ Dollar votes-registry of wants of goods by consumers purchases

o Goods will be produced in the most cost-efficient way

▪ Correct mix of labor and capital

▪ Cost of production depends on available technology and prices of resources  which helps determine the technique of production

o Goods will be bought by the consumers who are willing (maximum willingness-to pay exceeds price) and able  

o Markets are dynamic and will adjust to changes in demand by allocating more or  less resources to the good (ex. consumers desire more fruit-resources from other  goods such as vegetables will switch from those goods to fruits)

o Technological advances allow one firm to gain a competitive advantage and gain  more profits

▪ Creative destruction-the creation of new products and production methods  completely destroy the market positions of firms that are wedded to existing  products and methods (ex. cassettes to CD’s to IPods)

• Dollar votes accumulated by a firm promotes firm’s capital goods which lead to  economic growth

• Invisible hand-the underlying competition between consumers and producers that  promotes the public/social interest and balances the market system

o Efficiency-forces most efficient production to lower total costs

o Incentives-greater risk and effort taken by firms leads to greater profits o Freedom-market system freedom of enterprise and choice, free entry and exit  into industry

• Coordination problem-too difficult for command system to make the millions of  decisions consumers and producers make in the market system

• Incentive problem-firms in command system have no incentive to gain an edge on other  firms (because there aren’t any) so technological advances lack and cost of production  does not drop (similar to monopoly)

• Circular flow diagram-illustrates the repetitive flow of goods/services, resources, and  money for a simplified economy with no government

o Households-one or more persons occupying a housing unit

o Businesses-commercial establishment that attempts to earn profit by offering  goods/services

▪ Sole proprietorship-a business that is owned and managed by one person ▪ Partnership-two or more individuals that own and manage a business with  agreement on business decisions

▪ Corporation-an independent legal entity that can acquire resources, own assets,  produce and sell goods, incur debt, extend credit, and sue/be sued

o Product market-the place goods/services are bought and sold  

o Resource market-households sell resources to businesses

• Profit system-the guide for businesses to make profits

Only owners, in the market system, are liable for risk and loosing money

Chapter 3

• Demand-schedule that shows the amount consumers are willing and able to purchase at  a given price

• Law of demand-other-things-equal, as price falls, the quantity demanded increases o Price acts as an obstacle to buyers

o Law of diminishing marginal utility-an additional unit consumed has a lower  marginal benefit than the previous unit consumed, consumers are willing to pay less  and less for an additional unit (ex. slices of pizza)

o Income effect-lower prices make you feel richer because your money goes further  and you will buy additional units

o Substitute effect-switching product to some other similar product that is cheaper  (ex. chicken prices went down, more chicken will be bought because people will  substitute chicken for steak)

o Demand curve=marginal benefit curve

o Only change in price can cause change in quantity demanded, movement along  curve

o Change in demand shifts curve

• Determinants of demand-things that shift demand curve, TRIBE

o Taste preference-consumers will consume more of a product if the newspaper  publishes an article saying how good it is for you

o Related goods

▪ Complementary goods-goods that are used conjointly, as price of  

complementary goods fall, specific good demand increases

▪ Substitute goods-goods that are used instead, as prices of substitute goods falls,  demand for specific goods falls

o Income

▪ Inferior goods-cheap goods, as income falls, demand for specific good increases  (ex. Raman noodles)

▪ Normal goods-most goods, as income rises, demand for specific good increases  (ex. Mercedes)

o Buyers-if there is an influx of new buyers, the demand for specific good will increase  (ex. baby boom increased demand for baby food)

o Expectations-consumers expectations of future prices, if the expectation is that  prices for homes will rises in the future, the demand for houses now will increase • Supply-schedule that shows the amount of supply producers are willing and able to  produce at a specific price

• Law of Supply-other-things-equal, as price rises, the quantity supplied rises o Price acts as an incentive for producers

o At some point costs will rise-more production means higher cost of production o Supply curve=marginal cost curve

o Prices are the only thing that changes the quantity supplied, movement along curve o Change in supply shifts curve

• Determinants of supply-things that shift supply curve, ROTTEN

o Resources price-increase in cost of production, decreases profit and decreases  supply

o Other prices goods-if the price of another good that the producers is able to produce  with the same resources increases, the demand for the specific good will decrease  (ex. if the price of watermelon goes up, farmers will use there land to produce  watermelon instead of cucumbers)

o Taxes and subsidies-taxes increase the cost of production and decrease supply,  increase in subsidies (money paid to producer by government) decreases cost of  production and increases supply

o Technology-technological advancement makes production more efficient decreasing  cost of production and increases supply

o Expectations of producers-the expectation of a price increase in cars in the future  will decrease the supply of cars presently

o Number of sellers-an increase in the number of sellers will increase the supply • Equilibrium price-the price of a product at the point where the quantity supplied equals  quantity demanded

• Equilibrium quantity-the quantity of a product at the point where the quantity supplied  equals quantity demanded

• Production efficiency-the production of any particular good in the least costly way • Allocative efficiency-the particular mix of goods and services most highly demanded by  society (occurs at equilibrium)

• Surplus-excess supply, quantity supplied is greater than quantity demanded, wasting  resources

• Shortage-excess demand, quantity demanded is greater than quantity supplied • Complex changes

o Change in supply-decreases in supply will raise prices and decrease quantity of  demand

o Change in demand-decreases in demand will lower prices and decrease the quantity  supplied

o Supply increases and demand decreases-equilibrium price will drop and the  equilibrium quantity will be indeterminate

o Supply decreases and demand increases-equilibrium price will raise and the  equilibrium quantity will be indeterminate

o Supply and demand increase-equilibrium price will be indeterminate and  equilibrium quantity will raise

o Supply and demand decrease-equilibrium price will be indeterminate and  equilibrium quantity will drop

• Price ceiling-a legal limit on the maximum price of a product, rent control, causes  shortages because the price decreases and the producer’s profit goes down and causes  quantity supplied decrease and quantity demanded increase

Price floor-a legal limit on the minimum price of a product, cigarettes/minimum wage,  causes surplus because the price rises and the producer’s profits rise and causes quantity  supplied to increase and quantity demanded to decrease

Chapter 6

• Business Cycle-long-run economics growth and the short-run fluctuations in output and  employment that macroeconomics focuses on

• Recession-when growth is negative for a period of time (usually defined as two straight  quarters of negative growth)

• Real GDP/real gross domestic product-measures the value of final goods and services  produced within the borders of one country during a specific period of time (usually  one year)

• Nominal GDP-allows economists to compare GDP from year to year and country to  county by adjusting all GDP’s to one common currency of a single year (usually current  year)

• Unemployment-the state a person is in if he cannot currently get a job despite being  willing, able, and looking for work

• Inflation-an increase in the overall level of prices  

• Industrial Revolution gave way to the beginning of a gradual increase in the standard of  living which had never before been experienced

• Modern economic growth-output per person rises

• Savings-occurs when a person’s income, after taxes, exceeds their spending • Investment-resources are allocated to economic growth or future output or capital  goods

o Financial investment-investing in stocks and bonds

o Economic investment-investing in capital goods that lead to economic growth • To increase future production, country as a whole must save more for investing that it  spends which leads to trade-offs of consumption goods

• Households are the source of savings while banks and financial institutions are the  source of investing

• Macroeconomics takes into account expectations about the future • If investors are pessimistic about future returns, they will invest less which will slow  future economic growth

• Shocks-situations in which the expected outcome does not occur

o Demand shocks-unexpected changes in demand occur

o Supply shocks-unexpected changes in supply occur (ex. OPEC owning all oil  companies decreases supply in order to raise prices)

• Inventory-a store of output that has been produced but not yet sold

• Inflexible or sticky prices-prices of certain goods that take time to change, mostly  inflexible in the short-run, leading industries to change employment when demand  changes (ex. most goods, newspapers, haircuts)

• Flexible prices-prices of certain goods that have the ability to change quickly (ex. corn,  oil, gasoline)

• Inflexible prices usually occur

o Consumers are more easily able to plan when prices are constant, so producers keep  them steady

o Companies that are losing demand could lower price in order to increase demand,  but opposing companies will likely also drop prices when this occurs, which leads to  a price war, which will hurt the company that first cut prices so companies will  avoid price wars (ex. Pepsi and Coke)

o Over time however, prices become more flexible as employees are willing to accept  pay cuts  

• Great Recession

o Caused by demand shock

o Bubble over the real estate market that had a sudden boom for the first time in  history (had not risen in the past 100 years)

o A bubble is created when one market becomes the sources of savings (1500 tulips,  2000 housing market)

o The value of people’s wealth grew from growth of value of homes and financial  investments and these people took equity line credit on their homes which had an  artificial value  

o These credits eventually were not able to be paid and people owed more money on  their homes than their homes were worth and bank had to foreclose and now  owned a lot of houses which lead individuals and banks to declare bankruptcy

o Minsky explanation-bubble involved too many people in the real estate market o Austrian explanation-the Federal Bank set interest rates too low which promoted  extending too many bad loans  

o Minsky solution-government involvement to stimulate government by buying bad  mortgages (stimulate solution)

o Austrian solution-let people and companies go bankrupt and raise interest rates and  the market will correct itself (structural solution)

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