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Econ2106, study guide for 1 exam

by: Daria Trikolenko

Econ2106, study guide for 1 exam Econ 2106

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Daria Trikolenko

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study guide for 1 exam from Chapter1-4
Carycruz Bueno
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This 11 page Study Guide was uploaded by Daria Trikolenko on Saturday September 17, 2016. The Study Guide belongs to Econ 2106 at Georgia State University taught by Carycruz Bueno in Fall 2016. Since its upload, it has received 34 views.


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Date Created: 09/17/16
Chapter 1 Five foundations of economic. Five Foundations of economic: 1) Incentives­ factors that motivate you to act or to exert effort. (study now for exam to get  a good grade instead of going out with friends) ­ Positive: those that encourage action (get a candy after dinner, if child eat all the  soup, even though he doesn’t like it) ­ Negative: also encourage action (follow the rules on the road and not to get  ticket. A potential negative consequence spurs individuals to action. ­ Direct: lower the price of one product, so it will get business from customers who  wouldn’t usually buy it. ­ Indirect: These are incentives that the user gets no personal benefit from.  Charitable donations.  Incentives and innovation­ engine of economic growth. Patent system encourages  innovation by creating a powerful financial reward for creativity. 2) Trade­offs – doing one thing means that you will not have the time, resources and  energy to do something else.  3) Opportunity cost – the highest­valued alternative that must be sacrificed in order to get  something else. Choose the option that gives you the largest benefit. (To go hiking or  buy a ticket on the concert). 4) Marginal thinking­ weighting how much money you want against the grades you want.  The size of the victory. Requires decision­makers to evaluate whether the benefit of one more unit of something is greater that it’s cost.(moving refrigerator from the wall to lean  under it, requires a significant effort and a small benefit, or leave it  and don’t clean) Economic thinking­ the process of systematically evaluating a course of action.  Involves a purposeful evaluation of the available opportunities to make the best decision possible. (Doing more or less of something). 5) Trade – voluntary exchange of goods and services between two or more parties. Markets bring buyers and sellers together to exchange goods and services.  Comparative advantage – situation in which an individual, business, or country can  produce at a lower opportunity cost that a competitor can. (The physician becomes  proficient at dispensing medical advice, and teacher at helping students). Chapter 2 Model Building and Gains from trade. The scientific method in economics.    Economist use the scientific method to answer questions about observable  phenomena and explain how the world works. 1) Researchers observe a phenomenon 2) Construct a model to test the hypothesis 3) Design experiments to test how well model works.  Positive and normative analysis: A positive statement – can be tested and validated, “what is”. (The unemployment  rate is 7%)  A normative statement ­ cannot be tested or validated, “what ought to be”. Key  word­ “should, must”. (An unemployed worker should receive financial assistance) Economic models. 1) Ceteris Paribus­ “other things being equal”. Engineers generally modify only one  element at a time and test only that one element before moving on to test additional  elements. 2) Endogenous versus Exogenous Factors: ­ Endogenous: factors that we know and can control. ­ Exogenous: factors beyond our control, outside the model. 3) The danger of faulty assumptions: we would like to include all the important variables  inside the model and exclude all the variables that should be ignored. Production possibilities frontier: PPF­ is the model that illustrates the combination of outputs that a society can  produce if all of its resources are being used efficiently. C,D – the society using all of its resources in most productive way possible. F (other points under the curve) – indicate an inefficient use of the society’s  resources. (Surfing the web, while on the work place)  Production possibilities frontier and opportunity cost Ex: When the society tries to make as many pizzas as possible, it will be using  skilled and less skilled types of workers. Since resources are not perfectly adaptable,  production does not expand at a constant rate.  Law of increasing relative cost ­ the opportunity cost of producing a good rises as  a society produces more of it. Law of increasing relative cost, which states that the opportunity cost of producing  a good rises as a society produces more of it. Benefits of specialization and trade. Gains from trade:  Each person will specialize in what he or she is better at producing and then will  trade in order to acquire some of the good that the other person produces. Absolute advantage – person has the ability to produce more with the same quantity of resources than Mike can produce. Comparative Advantage:  Looking at Table 2.2, you can see that Debra has a lower opportunity cost of  producing pizzas than Mike—she gives up 2 wings for each pizza she produces, while  he gives up 3 wings for each pizza he produces. Debra has a comparative advantage in producing pizzas. But, does not have a comparative advantage in producing wings.  TABLE 2.2 The Opportunity Cost of Pizza and Wings Opportunity cost Person 1 Pizza 1 Wing Debra Winger 2 wings ½ pizza Mike Piazza 3 wings ⅓ pizza Finding the Right Price to Facilitate Trade TABLE 2.3 Gaining from Trade Person Opportunity cost Ratio Debra Winger 1 pizza equals 2 wings 1:2 = 0.50 Terms of trade 19 pizzas for 47 wings 19:47 = 0.40 Mike Piazza 1 pizza equals 3 wings 1:3 = 0.33  This means that any exchange with a value lower than 1:2 (0.50) will be beneficial to her since she ends up with more pizza and wings than she had without trade. Mike’s  opportunity cost is 1 pizza per 3 wings, or a ratio of 1:3 (0.33). For trade to be mutually  beneficial, the ratio of the amount exchanged must fall between the ratio of Debra’s  opportunity cost of 1:2 and the ratio of Mike’s opportunity cost of 1:3. Consumer Goods, Capital Goods, and Investment Consumer goods­ any good that is produced for present consumption. Satisfy our  wants now. (food, entertainment, clothing) Capital goods –help in the production of other valuable goods and services in the  future. (roads, factories, trucks, computers) Investments ­ the process of using resources to create or buy new capital. (go to  college and get education, investment in human capital) Chapter3 The market at work: Supply and Demand Competitive market is one in which there are so many buyers and sellers that each has only a small impact on the market price and output. Similar goods and many  participants create highly competitive market, where price and quantity sold are  determined by the market rather than by any one person or business.  Imperfect Market – one in which either the buyer or the seller has an influence on  the market price. (Empire state building, there are no substitution, so it create their own  price)  The more unusual the product being sold, the more control the seller has over the  price. Specialized products give the seller substantial power. Monopoly­ when single company supplies the entire market for a particular good or service.  Demand Quantity demanded­ the amount of good or service purchased at the current price. The law of demand: all things being equal, the quantity demanded falls when the prices rise, and the quantity demanded rises when the price falls.  A demand curve is a graph of the relationship between the prices in the demand  schedule and the quantity demanded at those prices. The market demand is the sum of all the individual quantities demanded by each  buyer in a market at each price.  Shifts in the demand curve !!! A price change causes a movement along a given demand curve, but cannot  cause a shift in the demand curve. 1) Changes in income:  ­ Higher income cause the consumer to buy more of normal goods( meal at restaurant); ­ Inferior good – purchases out of necessity rather than choice. (used cars, hamburger  as opposed to filet mignon). As income increase, the consumer will buy less of inferior  goods. 2) Price of related goods:  ­ Compliments are two goods that are used together. If price of one good rises, demand  for it will go down, as well as demand for compliment good  ­ Substitutes are two goods used in place of each other. If price for one good rises, its  demand will go down, but demand for substitute will go up. 3) Changes in tastes and preferences: while something popular, demand increases. As  soon as it falls out of favor, you can expect demand for it to return to its former level. 4) Expectations regarding the future price: if we expect a price to be higher in the future,  we are likely to buy more today to beat the price increase, this leads to an increase in  current demand.  If we expect a price to decline soon, we might delay the purchase. 5) The number of buyers: demographic changes in society is another source of shift in  demand. Supply The quantity supplied is the amount of a good or service that producers are willing  and able to sell at the current price. Higher prices cause the quantity supplied to  increase.  The  law of supply   states that, all other things being equal, the quantity  supplied increases when the price rises, and the quantity supplied falls when the  price falls. The market supply is the sum of the quantities supplied by each seller in the  market at each price. Shifts in the Supply Curve 1) The cost of inputs. Inputs­ resources used in the production process.(raw materials,  equipment, workers) If the cost of inputs declines, profit margins improve. Improved profit margins make the firm more willing to supply the good. 2) Changes in Technology or the Production Process: An improvement in technology  enables a producer to increase output with the same resources or to produce a given  level of output with fewer resources. (better coffee machine produces more coffee,  reduce line and sell more coffee) 3) Taxes and Subsidies.  ­ Taxes are an added cost of doing business. For example, if property taxes are  increased, this raises the cost of doing business.  ­ A subsidy­ a payment made by the government to encourage the consumption or  production of a good or service. 4) The Number of Firms in the Industry: Each additional firm that enters the market  increases the available supply of a good. 5) Price Expectations: A seller who expects a higher price for a product in the future may  wish to delay sales until a time when it will bring a higher price. (higher prices for roses  on Valentine’s day). The expectation of lower prices in the future will cause sellers to offer more while  prices are still relatively high. Supply, Demand, and Equilibrium Equilibrium­ point where the demand curve and the supply curve intersect, supply  and demand prfectly balanced. Equilibrium price(market­clearing price)­because quantity supplied equals to the  quantity demanded. Only price at which no surplus or shortage exists. Equilibrium quantity­ quantity supplied equas quantity demanded.  !!! Law of supply and demand­ market prices adjust to bring the quantity  supplied and quantity demanded into balance. Shortages and Surpluses. Shortages­ when there is more demand for a product than sellers are willing to  supply (quantity supplied less than quantity demanded). Surpluse­ excess supply, occurs wheneve the quantity supplied is greater than the quantity demanded.  Chapter 4. Elasticity    Elasticity­the responsiveness of buyers and sellers to change in price or income.  Measures how much consumer and producers change their behavior when prices or  income changes. Price elasticity of demand Price elasticity of demand –responsiveness of quantity demanded to a change in  price. ­ Elastic (sensitive) QD changes significantly as a result of price change ­ Inelastic (insensitive) QD changes a small amount as a result of price change. Even if  price rise we will buy this product. 1) Existence of substitutes (more substitutes­> more elastic): more substitutes lead the  market forces to work in favor the consumer, the price elasticity is elastic, or responsive  to price changes. 2) The share of the budget spent on the good: elasticity of demagd is much more inelastic  for inexpensive items on sale.  3) Necessities vs Luxury goods: demand for necessities ( soap, toothpaste, oil) tend to  have inelastic demand.Thinking about a need, not a price. 4) Time and adjustment process ­ immediate run: no time for consumer to adjust their behavior. (less time­ less  elastic) ­ short run: time for partially  adjust to market conditions (there is some time to  think about and choose less expensive product); ­long run: period of time to fully adjust to market conditions. ( more time­>more elastic) The price elasticity of demand formula The negative (minus) sign in front of the coefficient is equally important. The E   D coefficient reflects this inverse relationship with a negative sign. ( almost always  negative) percentagechange∈thequantitydemanded Price Elasticity for demand=ED= percentagechange∈price Graphing the price elasticity of demand As demand becomes increasingly elastic, or responsive to price changes, the demand  curve flattens. When demand is relatively inelastic, the price elasticity of demand must be relatively close to zero. More substitutes lead to demand for a good to be relatively elastic. Unitary elasticity­ situation in which elasticity is neither elastic nor inelastic. Occurs when  the Ed is exactly ­1, and percent change in price equal to the percent change in quantity  demanded. Slope and elasticity Increased time acts to make demand more elastic. P1to P2 consumers unable to avoid  price increase in D1(immediate run). In short run D2 consumer more flexible to change and  consumption declines to Q2. In the long run D3, there is reduce consumption, quantity demand falls to Q3, because of the higher prices.  Price elasticity of demand and total revenue When price elasticity of demand is elastic, lowering the price will increase total revenue. How changes in income and prices of other goods affect elasticity Income elasticity Measures how change in income affect spending. (income elasticity is positive) %change∈quantitydemanded EI = %change∈income 1) Normal goods­ higher levels of income enable the consumer to purchase more (have positive  income elasticity): ­ Necessities (income elasticity between 0 and 1) ­ Luxuries (income elasticity of demand is greater than 0) 2) Inferior goods (choose not to purchase when their income goes up) Have negative income  elasticity. Cross­price elasticity Measures the responsiveness of the quantity demand of one good to a change in the  price of a related good.  Ec= %change∈quantitydemanded of onegood %change∈the priceof arelated good  If the goods are substitutes, a price rise in one good will cause the quantity demanded of that good to decline. Demand for substitute good will increase Ec>0.  The opposite with compliments. A price increase in one good will make to joint consumption of both goods more expensive. The consumption of both goods will decline Ec<0.  No relationship between goods: Ec=0. What is the Price Elasticity of Supply? The price elasticity of supply is a measure of the responsiveness of the quantity supplied to a change in price. When supply is not able to respond to a change in price, we say it is inelastic. When the ability of the supplier to make quick adjustments is limited, the elasticity less than 1. Determines of the price elasticity of supply. The flexibility of products. To maintain flexibility is to have spare production capacity. Extra capacity enables producers to quickly meet changing price conditions, so supply is more responsive or elastic. Time and the adjusting process. In the immediate run, businesses, just like consumers, are quick with what they have on hands. As we move from the immediate run to the short run and price change persist, supply becomes more elastic. Es= %change∈quantitysupplied. change∈the price


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