ECON 100 - Study Guide - Exam 1
ECON 100 - Study Guide - Exam 1 ECON 100
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This 26 page Study Guide was uploaded by Jay Ko on Sunday September 11, 2016. The Study Guide belongs to ECON 100 at Rice University taught by Dr. James DeNicco in Fall 2016. Since its upload, it has received 19 views. For similar materials see PRINCIPLES OF ECONOMICS in Economics at Rice University.
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Date Created: 09/11/16
ECON 100 – Exam 1 – Study Guide Ch. 1 – Introduction: Ten Principles of Economics • Economics o What is economics – a study of choice in a world of scarcity. • Microeconomics o Microeconomics – the study of how households and firms make decisions and how they interact in markets. • Macroeconomics o Macroeconomics – the study of economy wide phenomena, including inflation, unemployment and economic growth. § Studied to make the world a better place. • Ten Principles of Economics o 1. People Face Trade-offs § Efficiency vs Equality • Efficiency – the property of society getting the most if can from its resource. • Equality – the property of distributing economic prosperity uniformly among the members of society. o 2. The Cost of Something is What You Give Up to Get It § Opportunity Costs: Whatever must be given up to obtain something (direct and indirect) • Ex. Opportunity costs of going to school. o Tuition o Lost salary o Lost leisure time § Production Possibilities Frontier • The Production Possibilities Frontier is a graph that shows the combination of output that the economy can possibly produce given the available factors of production and the available production of technology. o We face trade off and have opportunity costs associated with those trade offs. § Second Model: Production Possibilities Frontier ECON 100 – Exam 1 – Study Guide • Trade offs exist: can’t produce more cars without giving up more computers. • Opportunity costs: how many wings do we have to give up to get another beer? o From A to B, the opportunity cost of producing 100 more IPAs is 200 wings. • Bowed Shape: the opportunity costs increase as we move to one extreme or the other. o At point E, the resources best suited to beer production such as skilled brew master (those left in the brewing industry), are being used in wing production, which is inefficient (big losses for small gains). § Shifts in the Production Possibilities Frontier o 3. Rational People Think at the Margin § Rational People: people who systematically and purposefully do the best they can to achieve their objectives. § Marginal change: a small incremental adjustment to a plan of action. ECON 100 – Exam 1 – Study Guide • When making decisions, people compare the marginal costs to the marginal benefits. § Question: If an airline’s average cost is $500 per seat, should they sell a ticket for an empty seat for $300 or just take off and leave it empty? • Answer: Sell the seat because they would be short just $200 instead of $500. § Marginal decision making can solve puzzles. • Why do we pay so much more for diamonds, than water? We need water to survive but diamonds are just decoration. o A person’s willingness to pay for a good is based on the marginal benefit that an extra unit of the good would yield. The marginal benefit depends on how many units the person already has… water is plentiful. § Example problem: • Answer: D. o By investing a maximum of less than $110 million, John Jacob can still earn profit be it $9M after investing $101M or even just $1M after investing $109M. o John Jacob should spend all the way up to 110M. o 4. People Respond to Incentives § This is a principle that policy makers often forget to take into account – unintended consequences • If you make a rule that companies have to provide health benefits for fulltime workers, defined as works with over 29 hours a week, what are the companies going to do to their workers hours? o Answer: The worker’s house will be cut to below 28 so that health care benefits do not have to be provided. o More marginal benefit, more workers wanted ECON 100 – Exam 1 – Study Guide o 5. Trades Can Make Everyone Better Off § Trade allows countries to specialize and enjoy a great variety of goods and services. • You can make what you have an advantage making and buy the rest from someone else. § Trades can also make everyone worse off. § Economists are in favor of free trade. • Free trade always has winners or losers. § International Trade and TFP • Jimmy D can produce more of both goods with the same amount of resources. o Absolute advantage. o However, trade depends on comparative advantage and not absolute – who has the lower opportunity cost? § Comparative Advantage: The Driving Force of Specialization ECON 100 – Exam 1 – Study Guide • Absolute Advantage: the ability to produce a good using fewer inputs than another producer • Comparative Advantage: the ability to produce a good at ta lower opportunity cost than another producer • The Price of Trade: For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs. § International Trade and TFP • Lucy has the comparative advantage of producing wings – gives up one beer for four wings. • Jimmy D has the comparative advantage of producting beers – gives up one wing for half a beer. • After calculations, if Lucy gives Jimmy D 15 of the 32 wings to Jimmy D in exchange for 5 IPAs, Lucy will have 17 wings and 5 IPAs a day, more than her making both IPAs and wings at the same time. o Lucy’s beer makers will be upset due to loss of work. ECON 100 – Exam 1 – Study Guide o 6. Markets are Usually a Good Way to Organize and Economize § Market Economy – An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. • The Invisible Hand o 7. Governments Can Sometimes Improve Market Outcomes § In order to facilitate The Invisible Hand, the government must enforce rules and maintain institutions that are key to the market economy. • Property Rights – The ability of an individual to own and exercise control over scare resources. o Leads to inequality o Accumulation of capital and wealth o Property rights can be taken away § In order to facilitate efficiency • Market failure: a situation in which a market left on its own fails to allocate resources efficiently. § Anticompetitive companies in the USA to prevent market power. o Externality – which is the impact of one person’s actions on the well-being of a bystander. § Tragedy of the Commons o Market power – which refers to the ability of a single person or small group to unduly influence market prices § Monopolies § In order to facilitate equality: • An economic question but also a question of fairness or social justice. ECON 100 – Exam 1 – Study Guide • Your thoughts on addressing equality are often based on politics. o 8. A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services § Productivity – the quality of goods and services produced from each unit of labor input. • Standard of living depends on productivity. • Productivity depends on capital – machines, human capital, physical capital, natural resources, entrepreneurship, legal and social framework, etc, and natural resources – access and use. o There is a difference between productivity and sustainability. o 9. Prices Rise When the Government Prints Too Much Money § Inflation – an increase in the overall level of prices in the economy. o 10. Society Faces a Short-Run Trade-Off Between Inflation and Unemployment: MAYBE § This is actually debated • This is a belief held in Keynesian theory, but staglation in the 70’s resulted in a lot of critisim and skepticism of this view. • • As prices rise, real wages fall and people will be hired o But it doesn’t always happen this way ECON 100 – Exam 1 – Study Guide Ch. 2 – The Market Forces of Supply and Demand • What is a Market o A market is a group of buyers and sellers of a particular good or service § Buyers are the demand § Sellers are the suppliers or supply § We assume a perfectly competitive market § There needs to be a numerous amount of buyers and sellers § Negotiation exists so that it goes to an average cost. § Price cannot be raised because then no one will buy. § Price cannot be lowered too much because the sellers will make a loss. o The buyers as a group determine the demand for the product, and the sellers as a group determine the supply of the product. o We assume a perfectly competitive market. o To reach the highest form of competition, a market must have two characteristics. § The foods offered for sale are exactly the same § The buyers and seller are so numerous that no single buyer or seller has any influence over the market price. • Buyers and sellers are price takers and must accept the price the market determines. o At the market place, buyers can buy all they want, and sellers can sell all they want. • Market Demand o Quantity Demanded: § The amount of a good buyers are willing and able to purchase o Law of Demand: § The claim that, all other things being held equal, the quantity demanded of a good falls when the price of the good rises. ECON 100 – Exam 1 – Study Guide o Extensive – Lower price, more people want to buy it o Intensive – One person will buy more or less of it • Demand Shifts o Anything that raises the quantity that buyers want to buy at a given price shifts the demand to the right (increases demand). o Anything that lowers the quantity that buyers want to buy at any given price shifts the demand to the left. o Changes in income: § Normal goods: all things equal, as income rises, demand rises (shifts to the right) § Inferior goods: all things equal, as income rises, demand falls (shifts to the left) o Price of Related Goods: § Substitutes: two goods for which an increase in the price of one, leads to an increase in the demand for the other § Complements: two goods for which an increase in the price of one, will lead to a drop in demand for the other. • Ex. When the price of peanut butter goes up, the demand for jelly shifts left. o Other § A Change in Tastes: an introduction of a new flavor will shift the demand curve to the right. • Ex. A new flavor of wings seen on a commercial § A Change in Expectations: If you expect a future recession, your demand will go down now to prepare for possible lost income. • When income goes down, you will buy more inferior goods. § A Change in Number of Buyers: An increase in the number of people who desire a product will increase the products’ demand. • Market Supply ECON 100 – Exam 1 – Study Guide o Quantity Supplied: The amount of a good that sellers are willing and able to sell. o Law of Supply: The claim that, other things equal, the quantity supplied of a good rises when the price of the good rises. • Supply Shifts o Anything that raises the quantity supplied at any given price shifts the supply curve to the right o Anything that lowers the quantity that supplied at any given price shifts the supply curve left o Input Prices § When the price/cost of one or more inputs rises supply less shifts left. • Intensive or extensive. ECON 100 – Exam 1 – Study Guide • The supply of a good is negatively related to the price/cost of the inputs used to make the good. o Technology § The technology used to turn inputs into products can also shift the supply curve. • Ex. Mechanized sausage maker makes it easier and less costly to make sausage – shift right because more sausage can be produced. o Expectations § If a firm expects input cost to rise/fall, it will decrease/increase the supply today and the curve will shift left/right. o Number of Sellers § As the number of producers increase/decrease, the supply curve will shift right/left. • Market Equilibrium o Clears the market because supply = demand • Market Surpluses and Shortages ECON 100 – Exam 1 – Study Guide • Market Equilibrium: Increase in Demand • Market Equilibrium: Decrease in Demand • Market Equilibrium: Increase in Supply ECON 100 – Exam 1 – Study Guide • Market Equilibrium: Decrease in Supply • Market Equilibrium: An Increase in Demand, a Decrease in Supply Ch. 3 – Elasticity and Its Application • Elasticity o Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants. o Price Elasticity of Demand: a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. • Determinant Demand of Elasticity o Ability` of Close Substitutes: goods with close substutes tend to be more elastic. § Ex. If the price of butter goes up, someone will buy more margarine instead. ECON 100 – Exam 1 – Study Guide § Lots of substitutes can change behavior easily and buy the other product. o Necessities versus Luxuries: necessities tend to be less elastic than luxury items. § Ex. I need to take my kids to the doctor even if its more expensive, but the expensive boat can wait and is not needed. o Definition of the Market: broader markets tend to be less elastic. § Ex. The food market can be less elastic than the ice-cream market. § Ex. Broccoli is a narrow market and if the price of broccoli goes up, one can substitute with asparagus. • A broad market = vegetables • The broader the market, the less elastic it is since vegetables are a necessity. o Time Horizons: goods tend to have more elastic demand over longer time horizons. § Ex. When the price of gasoline goes up, initially we don’t decrease out consumption by much because of our dependence, but over time, we can switch to more fuel efficient cars. • Computing Price Elasticity of Demand o Price elasticity of demand = ▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯ ▯▯ ▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯▯ ▯▯▯▯▯▯▯▯▯▯ ▯▯▯▯▯▯ ▯▯ ▯▯▯▯▯▯ § Ex. Price of Jack goes up by 10% and quantity demanded goes down by 20%. ▯▯% • Price elasticity of demand = ▯▯% = 2 • Better Way to Calculate Price Elasticity of Demand – Midpoint Method o Ex. ECON 100 – Exam 1 – Study Guide • • Total Revenue and Price Elasticity of Demand • • Total Revenue and Price Elasticity of Demand o Total Revenue: the amount paid by buyers and received by sellers of a good computed as the price of the good times and quantity sold § Total Rev = P + Q o The impact of price change on total revenue depends on the elasticity of demand. o When demand is inelastic (a price elasticity of less than 1), price and total revenue move in the same direction. o When demand is elastic (a price elasticity greater than 1), price and total revenue e move in the opposite directions. o When demand is unit elastic (a price elasticity equals to 1), total revenue remains constant when prices change. • Elasticity and Total Revenue Along a Linear Demand Curve ECON 100 – Exam 1 – Study Guide • Income Elasticity of Demand o Income Elasticity of Demand: A measure of how much the quantity demanded of a good responds to a change in consumers. o IED>0: normal good o IED<0: Inferior good • The Cross-Price Elasticity of Demand o The Cross-Price Elasticity of Demand: a measure of how much the quantity demanded of a good responds to a change in the price of another good. o CPED>0:substitute o CPED<0: compliment • Price Elasticity of Supply o Price Elasticity of Supply: a measure how much the quantity supplied of a good responds to a change in the price of that good. ECON 100 – Exam 1 – Study Guide • • Price Elasticity of Supply Can Vary ECON 100 – Exam 1 – Study Guide • Applications – Farming • Applications – OPEC ECON 100 – Exam 1 – Study Guide • Applications – Drugs Ch. 4 – Supply, Demand, and Government Policies • Objective o Evaluate the effects of government policy on supply and demand o How do price ceilings and price floors affect supply and demand? § Ceilings make it so prices of products cannot go that high. § Floors make it so prices of products cannot go that low. o How do taxes affect supply and demand? o Who pays the taxes? o What determines the tax incidence? § Tax incidence – what percentage of the taxes the buyers/sellers pay. § Elasticity of the curve. • Price Controls o Price Ceiling: a legal maximum on the price at which a good can be sold § Price shouldn’t be too high but affordable ECON 100 – Exam 1 – Study Guide § Nothing happens during a price ceiling § The ceiling is nonbinding so it does not matter where it is set above the equilibrium. § Gasoline needs to have a price ceiling. • Price Controls – Long Lines at the Gas Pump o OPEC reduced the supply of oil in 1973 to increase their revenues. § Gas shortages ensued. § Some blamed OPEC while others blamed government price ceilings. • Rent Controls – Shortages in Rentals o Rent is a common way local governments try to help make housing more affordable to the poor. ECON 100 – Exam 1 – Study Guide • Price Controls o Price Floor: a legal minimum on the price at which a good can be sold • Minimum wage o Pros of increasing § People with jobs have more money § Higher wages mean less labor turnover § More buying of goods § Better quality of living § Get people off government programs o Cons of increasing § Unemployment goes up § Cost of producing goods will go up and costs of goods will be sold at more and causes inflation. § Less experience are less likely to be hired § Foreign labor costs less. ECON 100 – Exam 1 – Study Guide § Hiring of people of underground labor. o Firms have the demand. o Households supply the labor. o • Taxes o Tax Incidence: The manner in which the burden of tax is shared among participants • Taxes on Sellers o Suppose a local government imposes a $0.50 tax on ice cream parlors per ice cream cone sold. § Supply shifts left because the business doesn’t want to produce that many cones. • In response, the buy increases price. § Buyers and seller will share the burden, with some of the tax being passed on. § A $0.50 shift in supply increases the equilibrium price by $0.30 and results in a price of $3.30, buyers pay $3.30 and sellers receive $2.80. ECON 100 – Exam 1 – Study Guide • Taxes on Buyers o Suppose a local government imposes a $0.50 tax buyers per ice cream cone bought. o Buyers and sellers will share the burden of the tax. o A $0.50 shift in demand decreases the equilibrium price by $0.20 and the results in a price of $2.80, buyers pay $3.30 and sellers receive $2.80. • Tax Wedge – A Payroll Tax o Just like the goods market, the division f the tax burden between workers and firms does not depend on whether the government levies taxes on the worker or firm or divides the tax equally. • Tax Wedge – A Payroll Tax on Employers ECON 100 – Exam 1 – Study Guide • Tax Wedge – A Payroll Tax on Employees • Elasticity and Tax Incidence ECON 100 – Exam 1 – Study Guide o With relatively inelastic demand, buyers will bear more of the tax burden. o The tax affects the buyer more because his behavior changes less as price change. o Here you see the same size decrease in quantity with a larger change in price for the buyer. • Elasticity and Tax Incidence o With relatively inelastic supply, sellers will bear more of the tax burden. o The tax affects the seller more because his behavior changes less as price changes. ECON 100 – Exam 1 – Study Guide o Here you see the same size decrease in quantity with a larger change in price for the seller.
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