ECON 2105, Study guide test 1
ECON 2105, Study guide test 1 ECON 2105
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This 18 page Study Guide was uploaded by Randi on Tuesday September 13, 2016. The Study Guide belongs to ECON 2105 at University of Georgia taught by McWhite in Summer 2016. Since its upload, it has received 180 views. For similar materials see Macroeconomics in Macro Economics at University of Georgia.
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Date Created: 09/13/16
Study Guide test 1 ECON 2105 PROF. MCWHITE Highlight = Important Concept Highlight = Key term Chapter 1: The Five Foundations of Economics • What is economics? o Looking at human behavior, based on choices o In other words, it is the study of making choices in the presence limited resources and unlimited wants (scarcity) o To study the economy you need: § People with wants/needs § Decisions about how to allocate resources § Resources in limited supply § Trade-‐offs o Positive Economics: § Positive Economics consists of facts, not opinions o Normative Economics: § Normative Economics is the opposite of Positive. It is opinion-‐ based. § People argue their viewpoints 2 Divisions of economics: 1. Microeconomics: focused on the decisions of individual units (person/company/country) Ø Concepts like: externalites, Robert’s budget, a firm’s decisions 2. Macroeconomics: focused on interactions of the individuals as a whole economy Ø Concepts like: GDP, inflation, tax policy, exchange rates • What are the five foundations of economics? 1. People respond to incentives o Incentives are motivation factors in making decisions the way we do – they can either be positive or negative *They change our behavior Ø Direct Incentive: hopefully causes the desired result Ø Indirect Incentive: Unexpected behavior 2. Trade-‐offs o Because we cannot do everything, we must consider our options (trade-‐offs) Study Guide test 1 What are the other ways I could allocate my resources? o We make trade-‐offs with our resources 3. Opportunity costs o The next best option that you had to give up o The highest value forgone alternative o The trade-‐off of your next best choice for your resources 4. People make decisions at the margin o Marginal thinking is evaluating the cost/benefit of one more additional unit o This is based off the assumption of the Principle of Self-‐ Interest: People are rational and want to make the best decision on how to spend their resources o Most decisions happen in incremental changes Ø This means they are not “all or nothing.” People stop when the additional cost is greater than the additional benefit of an action. o What is the benefit of getting an additional unit? Ø For example: You are hungry and eat a piece of pizza. The first slice is great, and the second slice is also good. On the third slice, you get full. Is there any benefit in eating the fourth slice? After every slice of pizza, your satisfaction of the next unit, or your marginal benefit, started to diminish. o Your optimal decision point is where the Marginal benefit = the Marginal Cost MB=MC 5. Trade increases total value o Trade is beneficial to all parties involved! o People decide who they want to compete with and who they want to cooperate with o Trade makes us interdependent o People are better off when they specialize in what they are best at and then trade that skill/product with others Study Guide test 1 • What are markets? o A market is a place where buyers/sellers meet to buy/sell goods and services o Markets make us better off because we end up with more stuff! Ø Everyone focuses on their comparative advantage o Markets focus on the relationship between competition and cooperation o Law of Beneficial Specialization: § Workers do whatever involves the lowest opportunity cost compared with other tasks • Comparative advantage o Comparative advantage deals with the differences in opportunity costs between producers. This is the basis for specialized production and trade! o Who is the low-‐cost producer of a good? § Who has the lowest opportunity cost of producing a good? • Absolute advantage o The ability to produce more of a good in comparison to someone else *Just because a producer may have absolute advantage, does not mean they have comparative advantage!!! For example: Hotdogs Buns Murr 20 10 Sal 90 30 Sal has absolute advantage in the production of both hotdogs and buns because he can produce the most. However, Murr has the comparative advantage in the production of buns because he has the lowest opportunity cost. For every 1 bun he produces, he only gives up producing 2 hamburgers, while Sal gives up 3: Murr: 20 Hamburgers = 10 Buns 1 Bun = 2 Hamburgers 10 10 Sal: 90 Hamburgers = 30 Buns 1 Bun = 3 Hamburgers 30 30 On the other hand, Sal has comparative advantage in the production of hamburgers. For every hamburger he produces, he only gives up 1/3 of a bun, while Murr gives up 1/2 a bun: Murr: 20 Hamburgers = 10 Buns 1 Hamburger = 1/2 Bun Study Guide test 1 20 20 Sal: 90 Hamburgers = 30 Buns 1 Hamburger = 1/3 Bun Study Guide test 1 Chapter 2: Model Building and Gains from Trade • Ceteris paribus – “Other things the same” o This term is used to describe static analysis of markets o In a theoretical/perfect market where everything holds constant, what will we observe? • De qustibus non es disputandum – “To each his own” o This term means there is no accounting for tastes/preferences of individuals o Every person has their own likes and dislikes • Law of Increasing relative cost: o Opportunity cost of producing a good rises as a society produces more of it • PRODUCTION POSSIBILITIES FRONTIER (PPF) o Economist use the PPF to show combinations of outputs in an economy given the available factors of production and the production technology o The PPF demonstrates that the economy is constrained by the ability to produce § One product must be given up in order to produce a different product. • At point A, more units of Good A are being produced than Good B. • Point B is not on the PPF curve. There are not enough resources in this market to obtain this output. • Point C displays that the market is under producing and not maximizing their resources. • At point D, more of Good B is being produced. Study Guide test 1 o A PPF shows: § Efficiency: Optimal use of resources § Trade-‐Offs: Constraints to what’s possible, forcing a substitution of one thing to attain another § Opportunity cost: highest forgone alternative § Economic growth: Increase in output • Consumer good: o Any good that’s produced for present consumption o Satisfies wants now • Capital goods: o These goods help in the production of other valuable goods/services in the future o For example: roads/trucks/computers/factories/education • Investment: o Investing is where someone uses their resources to create/buy new capital • Endogerious factors: o Factors that we can control o Example: wind speed • Exogenous factors: o Factors that are beyond our control o Example: air pressure, wind Graphs in Economics: • Casual variable: o Occurring when one variable influences the other • Reverse causation: o Occurs when causation is incorrectly assigned among associated events o Occurs when relationships are not properly understood o Example: Cars that mechanics work on regularly break down. People who visit the dentist are more likely to get a cavity. Study Guide test 1 • Omitted Variable: o A model that incorrectly leaves out one or more important factors o Causes two variable to appear to be directly related when they are not o Example: People become tired when they wear athletic clothes. Drinking a lot of water leads to sunburn. • One variable graphs: Ø Bar graph: compares size/quantity Ø Pie chart: displays proportions Ø Time series: displays single variables across time • Two variable graphs Ø Scatter plots: shows correlation between variables o Positive correlation: When two variables move together in the same direction o Negative correlation: When two variables move in opposite directions Study Guide test 1 Chapter 3: The Market at Work: Supply and Demand • Monopoly: o Exists when a single company supplies the entire market for a particular good or service • Imperfect market: o Either the buyer or seller has an influence on the market price • Competitive market: o There are so many buyers/sellers that each has a negligible impact on the market § This means that because there is such a large quantity of people in the market, if one person decides not to buy or sell a product, it’s not going to make a difference. The market will continue on unaffected o There are little to non transaction costs § Transaction costs are the time/money/effort spent before buying a good o All information is known by both groups • Equilibrium price: o The quantity supplied equals the quantity demanded o No shortage or surplus exists o Also known as the market clearing price § Shortage: the quantity demanded exceeds the quantity supplied § Surplus: the quantity supplied exceeds the quantity demanded • Law of Demand: o Ceteris paribus o As prices decrease, quantity demanded of a good will increase o As prices increase, quantity demanded of a good will decrease § This is an inverse relationship!! o ONLY a change in PRICE causes a change in QUANTITY DEMANDED • Quantity Demanded: o The amount of a good buyers are willing and able to purchase § You must be willing AND able to be apart of this market § Quantity demanded is different from Demand! Study Guide test 1 What causes a change in DEMAND? Everything EXCPET the price of the product! 1. Consumer income • Normal Goods: When income increases, demand increases (shifts right) • Example: You enjoy steak. When your income increased, you began to buy more steak. Market for Steak • Inferior Goods: As income increases, demand for a good decreases (shifts left) • Example: You usually buy a lot of spam when you are tight on money. As your income increases, instead of buying spam, you choose to buy more steak. Study Guide test 1 2. Prices of related goods (substitutes/compliments) • Compliments o A good that goes along with another good o For example: You always eat peanut butter and jelly together. If the price of peanut butter increases, then the demand for jelly decreases. • Substitutes o These are goods that are pretty much the same and can be substituted o As the price for one good increase, the demand for its substitute increase o For example: As the price for Pepsi increases, the demand for Coke increases Study Guide test 1 3. Consumer tastes • Marketing can change consumer tastes. People may prefer one brand over another. 4. Expectations of future events • If consumers expect the price to be lower in the future, they will wait until later to by a good. • If consumers expect prices to rise in the future, they will by the good now 5. Number of buyers in the market Study Guide test 1 • Law of Supply: o The higher the price of a good, the greater will be the quantity supplied o This is a direct relationship o Change in QUANTITY SUPPLIED not SUPPLY What causes a change in SUPPLY? Everything EXCPET price of the product! 1. INPUT PRICES • What goes into creating the product? • If input prices increase, less of the product is going to be made because it is now more expensive to produce. Supply will shift left 2. TECHNOLOGY • What technology is used to create the product? • If technology used to create a particular product improves, more or the product can be made. Supply will shift right 3. EXPECTATIONS 4. NUMBER OF SELLERS • Quantity Supplied: o The amount of a good that sellers are willing and able to sell o If a firm isn’t willing AND able, it is NOT part of the market Study Guide test 1 Chapter 4: Price Controls • Price controls: o Usually enacted to ease perceived burdens on society o Usually do more harm than good o Usually do not help the people they were intended too o Binding price control: § Price floor/ceiling that impacts the market o Black markets: § Illegal markets that can arise because of price controls § There is no rule that black market prices rise/fall in the long run Types of Price Controls: • Price floor: o The price floor is the lowest allowed price that a product can be sold at o Price floor can be binding § This means that the set price is above the equilibrium price o An example of a price floor is the minimum wage § Most minimum wages are non-‐binding P Supply B C Price floor A Demand QD • This figure depicts a binding price floor… it is a price set above the equilibrium point • Point A was the original equilibrium point for the labor market without the minimum wage price floor. • There is now a surplus of labor in the market (unemployment) between points B and C • There are more people demanding jobs versus willing employers Study Guide test 1 • Price ceiling: o A set price that the market cannot exceed o An example is Rent control § Rent control is ineffective for helping low-‐income residents § It usually subsidizes higher-‐income residents’ living § It does not incentivize land lords to keep their apartments in good living condition Supply P A B C Price ceiling Demand QD The figure above depicts a binding price ceiling in rent control o The equilibrium price A is above the set price… the market cannot obtain equilibrium o The distance between point B and C represent the shortage in the housing market § The quantity demanded for housing in point C far exceeds the quantity that is being supplied at point B • Price gouging laws: o Temporary ceiling on prices that sellers can charge during times of national emergency § Typically happen after natural disasters § In most states, this is illegal Study Guide test 1 Chapter 5: The Efficiency of Markets and the Costs of Taxation • Welfare economics: o How the allocation of resources affects economic well-‐being • Equity: o The fairness of the distribution of benefits among the members of society • Willingness to pay o The value the consumer is willing to purchase a good/service for • Willingness to sell: o The value that the seller is willing to sell their good/service for • Total surplus o Also known as social welfare o Economist use this to measure the benefits that markets create • Consumer Surplus: o The difference between the willingness to pay for a good and the price that is paid to get it • Producer surplus: o The difference between the willingness to sell a good and the price that the seller recieves • Elasticity: o Measures how much one variable responds to changes in another variable o Is a numerical measure of the responsiveness of Quantity Demanded or Quantity Supplied to one of its determinants o Elastic good: § A good that is price sensitive § Absolute value of Elasticity of demand > 1 o Inelastic good: § A good that is not price sensitive § Quantity demanded decreases slower with an increase in price • Example: cigarettes § 1> Absolute value of Elasticity of demand > 0 Factors of Elasticity: 1. Number of substitutes • Goods with fewer substitutes tend to be more inelastic • Price elasticity is higher when close substitutes are available Study Guide test 1 2. Time • Price elasticity is higher in the long run than in the short run 3. Budget share • Price elasticity is higher for luxuries than for necessities • People can put off buying “wants” longer than “needs” • Excise tax: o Taxes levied on one particular good/service o The government favors excise taxes on goods that are highly inelastic § There is less Dead Weight Loss on inelastic goods § Dead Weight Loss: • A decrease in economic activity caused by market distortions, such as taxes • Taxes chase out demand and reallocate resources from their most productive use • Incidence of taxation: o The burden of taxation o Who does the tax affect the most? Consumer or seller? Study Guide test 1 Chapter 7: Unemployment • A misconception is that an economy should aim for zero unemployment. o A growing economy has some unemployment o Some unemployment is natural o Natural rate of unemployment: § Typical rate of unemployment that occurs when the economy is growing normally • Labor force: o Someone who is already employed OR actively seeking work Employed + Unemployed = LF • Labor force participation rate: § The portion (percentage) of the population that is in the labor force (LABOR FORCE / ELIGIBLE POPULATION) X 100 • Discouraged workers: o Those who are not working o Have looked for a job within the past year o Are willing to work o Have not sought employment in the past 4 weeks • Underemployed workers: o Workers who have part-‐time jobs o Want a full-‐time job • Unemployed workers: o Someone not working but is actively looking for work o Types: § Structural § Frictional § Cyclical Unemployment Rate: (UNEMPLOYED WORKERS/ LABOR FORCE) X 100 • Creative destruction: o Occurs when the introduction of new products and technologies leads to the end of other industries and jobs o Some jobs become obsolete o This causes Structural Unemployment: § Caused by changes in the industrial makeup of the economy Study Guide test 1 § Tastes as well as technology change… so do jobs § Learning new skills may take a long time or no time at all § A natural disaster can also cause this § Structural and Frictional unemployment will always exist to some degree in society • Frictional Unemployment: o Caused by delays in matching available jobs and workers o The time spent in between jobs for people who have a skill set that the economy needs o Another type of natural unemployment o Causes: § Information: Lack of information on what firms are hiring… it can take time to find a job § Government: Unemployment insurance programs and other job security programs don’t always incentivize people to find work • Cyclical Unemployment: o Changes in the economy will influence the number of workers hired o Caused by recessions o This type generates the greatest concern among economists and policymakers • Full employment output: o When the unemployment rate is equal to its natural rate o There is no cyclical unemployment
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