Eco 2023 Final Exam Study Guide
Eco 2023 Final Exam Study Guide ECO 2023
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This 8 page Study Guide was uploaded by Jessica Race on Tuesday April 26, 2016. The Study Guide belongs to ECO 2023 at Florida State University taught by Joseph Calhoun in Spring 2016. Since its upload, it has received 16 views. For similar materials see Principles of Economics: Microeconomics in Economcs at Florida State University.
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Date Created: 04/26/16
Eco 2023 The economic way of thinking 1. There are always tradeoffs - What you give up is your opportunity cost value of next best alternative - There is no such thing as a free lunch 2. Individuals choose purposefully - Referred to as economically behavior try to get the most benefits for the least cost or effect - Also known as rational behavior 3. Incentives matter - As incentives go up, you will be more likely to do something (or try to ), and vice versa - The incentive does not have to be money 4. Think on the margin, not in total or on average - Rule to live by: continue in an activity as long as the expected marginal benefit is greater than the expected marginal cost 5. More information leads to better decision making, but mere information is costly to get. - Refer back to 1. Though 4. 1. There are always tradeoffs 2. Individuals choose purposefully 3. Incentives matter 4. Think on the margin 6. Many choices create a secondary effect - The primary effect is often immediate and visible - Secondary effects usually comes later and is not as visible 7. Value is subjective - Beauty is in the eyes of the beholder - Value is determined by the purchaser 8. Economic thinking is scientific thinking - Economists use data and information generated by people to explain and predict actions Positive and normative economics - Positive economics the scientific study of “what is” among economic relationships - Normative economics judgements about “what ought to be” in economic matters. Normative economics views cannot be proved false because they are based on value judgements - Normative economic views can sometimes influence our attitude toward positive economic analysis Pitfalls to avoid in economic thinking 1. Violation of ceteris paribus - Ceteris paribus is Latin for “other things constant” - We want to isolate variables so we typically allow only one to change at a time 2. Good intentions do not necessarily result in good outcomes 3. Association is NOT causation 4. Fallacy of composition - Assumption: what’s good for the individual is good for the group - Making this assumption when it is false is the fallacy Trade creates value - Two opposing views of trade: 1. When people trade, one person gains and the other person loses Referred to as a zero sum game 2. When people trade, both parties gain Wealth is actually created by trade Voluntary trade creates wealth and promotes economic progress - With or without production, with or without money exchanges, voluntary trade is expected to benefit both parties involved - Potential trades: 1. Finished goods exchanged through barter 2. Finished goods exchanged for money 3. Businesses buying resources 4. Consumers buying products The importance of property rights 1. Common rights – everybody owns it 2. Private rights only one person owns it - Property rights change the incentives for individuals Incentives created by private property rights - Give proper care - Conserve for the future - Use resources in ways other people value - Mitigate possible harm to others Production Possibilities curve (PPC) - PPC also called PP frontier Inside the curve is inefficient Outside the curve is unattainable Anywhere on the curve is efficient and possible - The PPC can shift: Shift out: growth, produce more Shift in: shrink, produce less Law of comparative advantage - Make the good for which you have a low opportunity cost and trade for the good for which you have a high opportunity cost. - AKA: make the stuff you are good at and trade for something you’re not good at Changes in demand verses changes in quantity demand - Demand is the relationship between two variables: price and quantity demand Changes: 1. When price changes, quantity demanded changes but demand does not change + This is movement along the demand curve 2. When something else changes, demand changes (i.e., the relationship changes) + This is movement of the entire curve Changes in supply verses changes in quantity supplied - Price is not the only factor that determines how much a firm makes Changes: 1. When price changes quantity supplied changes but supply does not change + This is movement along then curve 2. When something else changes, supply changes + This is movement of the entire curve How markets respond to changes in supply and demand - This is called supply and demand analysis You don’t have to use graphs but it’s helpful Use this 3 step procedure: 1. Identify the change 2. Determine if supply or demand is affected and how 3. Draw and read graph (or reason through the change) Invisible hand principles - Adam smith an inquiry into the nature and causes of the wealth of nations - Personal selfinterest directed by market prices is a powerful force promoting economic progress Elasticity of demand - Law of demand states that if price rises (falls), quantity demanded falls (rises) Elasticity gives us more info about the consumers Price elasticity seeks to quantify how much quantity demanded falls (rises) How demand Elasticity and price changes affect total expenditures on a product - Total revenue (TR) to the firm is total expenditure (TE) by the consumer – TR= TE= P*Q If elastic and price falls: P x Q= TR Lower price and lots more is bought, Q dominates equation If elastic and price rises: P x Q = TR Raise price and lots less is bought, Q dominates equation If inelastic and price falls: P x Q = TR Lower price and a little more is bought, P dominates equation If inelastic and price rises: P x Q = TR Raise price a little less is bought, P dominates equation The economic role of cost - Economic profit does not equal account profit Accounting profit = total revenue total outofpocket costs Economic profit= total revenue – total outofpocket costs – opportunity costs Economic profit= total revenue – explicit costs – implicit costs Zero economic profit referred to as normal profit rate Output and costs in the short run - The ability of a firm to make stuff (its production) is intimately tied to costs Output and costs in the long run - Economies of scale is the benefit to the firm from becoming larger Economies of scale means the benefits is getting bigger (ATC is falling) Also referred to as increasing returns of scale Diseconomies of scale means to benefit is negative (ATC is rising) Also referred to as decreasing returns to scale Economics of price controls - 2 kinds of price controls 1. Price ceiling puts an upper limit on price; generates a shortage and a deadweight loss 2. Price floor puts a lower limit on price; generates a surplus and a dead weight loss - Deadweight loss (DWL)= loss of gains from trade; loss of CS and PS The impact of a Tax - Incidence 1. Statutory incidence who is legally responsible to pay the tax This is the tax burden it hinders exchange This is an administrative detail that is mostly irrelevant 2. Actual incidence who really pays the tax This is the more important issue The burden is shared between firms and consumers The impact of a subsidy - Analysis of ethanol subsidies: Ethanol biofuel made from corn to supplement traditional gasoline ( most gas now contains up to 10% ethanol) - Secondary effects: 1. Increase demand for corn (maybe not an equal increase in supply of corn) results in an increase in the price of corn 2. Increase in prices for fed for livestock plus any consumer goods made from corn - So lower price for ethanol but higher prices for milk, soda, and everything else made with corn Who receives the biggest benefit from subsidies? - Ignoring secondary effects, the group with the smallest elasticity receives the biggest benefit - If supply is relatively inelastic and demand is relatively elastic, then suppliers receive most of the benefits - If supply is relatively elastic and demand is relatively inelastic, then consumers receive most of the benefits. Potential shortcoming of the market - Markets will usually generate an efficient outcome, Sometimes they may not - Four reasons why the market may produce an inefficient outcome: 1. A lack of competition 2. Poor info 3. Public goods 4. Externalities Price taker and price searchers - Price taker sellers who must take the market price in order to sell their product. Because each price taker’s output is mall relative to the total market, price takers can sell all their output at the market price, but they are unable to sell any of their output at a price higher than the market price. - Price searcher firms that face a downwardsloping demand curve for their product. The amount the firm is able to sell is inversely related to the price it charges. What are the characteristics of price taker markets? - A price taker must set price equal to the market equilibrium price because 1. Each firm is small relative to the market 2. Each firm sells an identical product 3. There are many buyers in the market 4. No barriers to entry/exit exist How does the price taker maximize profit - The firm’s decision is a twostep process 1. Decide to open or close Close if the firm can’t pay variable cost More specifically, close if: 1. MR< AVC, or 2. TR<TVC 2 If open, decide how much to produce Continue to engage in an activity as long as the expected marginal benefit is greater than the expected marginal cost Specifically, keep producing as long as MR>MC The role of profits and losses Competition promotes prosperity - Economists like competition because: 1. Costs are reduced 2. Prices are reduced 3. Firms because more efficient and have a stronger incentive to innovate 4. Resources are moved from unproductive areas to productive areas Competitive pricesearcher markets - These markets are also called monopolistic competition because they have characteristic’s similar to other types of markets: Many sellers Low entry barriers Sell differentiated but similar products - The same decision rules apply: 1. Close if : MR< AVC, or TR< TVC 2. Keep producing as long as MR>MC But now the firm has some control over price Entrepreneurship and Economic Progress - Entrepreneurs play a vital role in economic progress by discovering new products and services that create wealth - Market forces provide incentives (and signals) for entrepreneurs to try new ideas Evaluating competitive pricesearcher markets - A trade off exists With fewer firms the ATC is lower (good) but product variety is also lower (bad) With more firms the ATC is higher (bad) but the variety is also higher (good) - ATC is higher mainly due to brand promotion - Evaluating these kinds of markets and economic progress Here are two different interpretations: 1. Recall the shortrun dynamics: positive profits, new firms enter, existing firms lose customers Alternative analysis: positive profits, new firms enter, new and existing firms attract customers, both demand curves shift right 2. Recall the long run equilibrium: zero profit, no entry or exit No entrepreneur will want to settle for this As the market conditions begin to reach this point, the entrepreneur must then get creative to keep positive profit Innovation and invention will keep markets away from long run equilibrium Driven by the profit motive, entrepreneurs continually drive economic progress Price discrimination - The practice of selling the same good to two or more groups of people at different prices - Any firm can discriminate that 1. Has a downward sloping demand curve 2. Can separate its customers into at least two groups 3. Can prevent customers from retrading the product - Firms price discriminate to increase the number of sales and profits - Firms price discriminate by setting a relatively high price for those customers with inelastic demand and a relatively low price for those customers with elastic demand Characteristics of monopoly - A true case of monopoly is actually rare. No substitute product is a requirement - Similar to monopolistic competition, the firm now decides price and output The firm is the market Continue to produce as long as MR>MC Price and output of Oligopolies - Each analysis really becomes a case study because: Sometimes oligopolists will act like perfectly competitive firms Sometimes they’ll act like monopolists Many times they switch between the two The demand for resources - The demand for resources is a derived demand it is dependent on the demand for the product - The resource demand curve is downwardsloping because of substitutes 1. If the price of one resource is high the firm will want less of that resource; the firm will find another one that is cheaper 2. If resource prices are high, the product price will be high and fewer people will buy it Marginal productivity and the firm’s hiring decision - More specifically, why do firms hire people? If the firm already has 20 employees, why hire one more? Because that employee’s marginal production adds to total production The supply of resources - The resource supply curve is upward sloping: higher wages increase quantity supplied - An individual person would work more or more people would be willing to work when wages increase Supply, demand, and resource prices - Supply of and demand for resources will determine an equilibrium wage. Why do earnings differ? - Wages differ for two general reasons: 1. Differences in workers: a. Productivity If MP increases, then MRP increases so the individual is more valuable to the firm b. Preferences Preferences can impact productivity c. Race and Gender This is not necessarily discrimination This can also increase wages 2. Differences in jobs: a. Compensating wage differential How much more salary do you require for: A high risk job? A job in an undesirable location? Environmental factors? b. Labor immobility The economics of employment discrimination 1. After adjusting for productivity related factors such as education and experience, there is much less discrimination than there appears to be 2. Usually, discrimination is costly and market forces will put discriminating firms at a disadvantage to compete Link between productivity and earnings - How can you increase productivity? 1. Increase nonhuman capital 2. Improve people’s skills 3. Advance technology
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