Midterm 1 Study Guide
Midterm 1 Study Guide Econ 10A
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This 12 page Study Guide was uploaded by Devon Black on Friday September 30, 2016. The Study Guide belongs to Econ 10A at Harvard University taught by N. Gregory Mankiw in Fall 2016. Since its upload, it has received 13 views. For similar materials see Principles of Economics in Economics at Harvard University.
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Date Created: 09/30/16
Midterm 1 Study Guide: Units 1-3; Chapters 1-9 I) Unit 1: Introduction A) Chapter 1: Ten Principles of Economics 1) Economics requires trade-offs 2) Efficiency vs. equality (a) Bigger pie with some people getter bigger pieces and some getting smaller pieces or a pie in which everybody gets the same size slice 3) People respond to incentives 4) Trade generally makes everybody better off (a) The market can handle itself pretty well (1) Just needs governments to enforce property rights B) Chapter 2: Thinking Like an Economist 1) Economists often simplify the world and make assumptions in order to properly demonstrate a broad idea without getting into the nitty-gritty details 2) Circular Flow Diagram (a) (b) Describes the market (c) Outer loop = money, inner loop = goods and services 3) Production Possibilities Frontier (a) (b) Represents the various numbers of each good a supplier can make when they are only making two goods (c) Anything on the line is efficient (d) Anything under the line is inefficient (e) Anything above the line is done using trade 4) Positive statements are what is 5) Normative statements are what should be 6) Economists disagree on policy because they disagree about which trade- off is more important (e.g. healthcare: billions of dollars vs. millions of people’s lives and health) C) Chapter 3: Interdependence and the Gains from Trade 1) Specialization allows people to produce more of the good that they are better at producing 2) Opportunity cost of one good is the inverse of the opportunity cost of the other (a) Can’t have comparative advantage in both goods (b) Through comparative advantage, gains from trade is still possible even if one supplier has an absolute advantage in both goods (1) Price must lie between the two supplier’s opportunity costs II) Unit 2: How Markets Work A) Chapter 4: The Market Forces of Supply and Demand 1) Most markets are disorganized – don’t all get together and form the price 2) Perfection competition means that no one buyer or supplier can affect the market price (a) People in the market are therefore called “price-takers” since they’re taking the price as a given 3) Demand curve (a) Slopes downward (b) Market demand = sum of individuals’ demands (c) Can shift left (decrease) or right (increase) (d) Factors in shifts (1) Income (i) Normal good (ii) Inferior good (2) Tastes (3) Price of related goods (i) Complements (ii) Substitutes (4) Expectations 4) Supply Curve (a) Slopes upward (b) Market supply = sum of individuals’ supplies (c) Factors in shifts (1) Input prices (2) Technology (3) Expectation (4) Number of sellers 5) Where supply and demand curves meet = equilibrium quantity on the x axis and equilibrium price on the y axis (a) Market clearing price because everyone has been satisfied 6) Shortage = quantity demanded > quantity supplied 7) Surplus = quantity supplied > quantity demanded 8) Difference between shifts along the curve and shifts of the curve 1) 2) No Change in 3) Increase in Supply4) Decrease in Supply Supply 5) No Change in 6) P & Q same 7) P down, Q up 8) P up, Q down Demand 9) Increase in 10) P & Q up 11) P 12) P up, Q Demand ambiguous, Q up ambiguous 13) Decrease in14) P & Q 15) P down, Q 16) P Demand down ambiguous ambiguous, Q down B) Chapter 5: Elasticity and Its Application 1) Elastic responds significantly to change in price & vice versa for inelastic (a) Availability of close substitutes makes items more elastic (b) Luxuries are significantly more elastic than necessities (c) The more broadly defined the market (food vs. ice cream vs. vanilla ice cream), the less elastic it is (d) The more time that passes, the more elastic a good is 2) Price elasticity = % change in quantity demanded / % change in price (a) (b) Elastic = > 1 (1) The flatter the curve, the more elastic it is (2) Infinite elasticity (horizontal line) = perfectly elastic: there is quantity demanded only at one particular price (c) Inelastic = < 1 (1) 0 elasticity (vertical line) = perfectly inelastic: no matter what the price is, the quantity demanded stays the same (d) Unit elastic = 1 (e) Different points on the curve can have different elasticities (1) Low price, high quantity = inelastic (2) High price, low quantity = elastic 3) Total Revenue (a) If demand is inelastic, then increase in price means increase in total revenue (b) Elastic demand means increase in price = decrease in total revenue (c) Unit elastic demand means increase in price = constant total revenue 4) Other elasticities (a) Income elasticity: how quantity demanded changes when income changes (b) Cross-price elasticity: how quantity demanded changes for 1 good when the price of another is changed (1) Substitutes (2) Complements C) Chapter 6: Supply, Demand, and Government Policies 1) If the price ceiling is above the equilibrium price, then it is non-binding; if below, it is binding and it prevents market from reaching equilibrium (a) Results in a permanent shortage 2) A price floor is binding if it is above the equilibrium price (a) Results in a permanent surplus 3) Taxes (a) Doesn’t matter who you tax (1) Whoever’s curve is less elastic, they bear more of the burden of the tax (b) Taxes place a wedge between the price the buyers pay and the price the sellers receive (1) To figure out these prices, use the QDand Q eSuations III) Unit 3: Markets and Welfare A) Chapter 7: Consumers, Producers, and the Efficiency of Markets 1) Consumers want to buy a good when the market price is lower than their willingness to pay (a) Demand curve at any Q is Dqual to the willingness to pay of the marginal buyer 2) Area below the demand curve and above the price is the consumer surplus (a) Lower prices = higher consumer surplus (1) Quantity demanded increase because new buyers enter the market 3) On the producer side, the cost to producers is their opportunity cost (a) Area below the price and above the supply curve is the producer surplus 4) Total surplus = benefit to buyers – cost to sellers (a) To the left of Q*, the value to buyers is greater than the cost to sellers and to the right, the cost is greater than the benefit 5) Externalities make welfare depend on more than just buyers and sellers B) Chapter 8: Application: the Costs of Taxation 1) With taxes, government revenue is measured by T*Q 2) Welfare changes with a tax (a) (b) The fall in total surplus of a market is the deadweight loss: the transactions that should’ve taken place but now won’t because of the tax (1) Deadweight loss increases where a curve is more elastic (2) Increase in tax generally means increase in deadweight loss, by a factor of 2 (3) Laffer Curve: to the right of the vertex, lowering tax rates would increase total revenue and vice versa for the left of the vertex C) Chapter 9: Application: International Trade 1) World price compared to domestic price determines if a country will become an exporter or an importer of a good: World price > domestic price = exporter (a) (b) Total surplus increased = benefited by trade 2) (a) Importer (b) Consumers’ surplus increase is greater than the decrease of the producer surplus, so trade is still good for the country 3) Trade increases efficiency 4) Tariffs (a) Raise price of good to benefit the domestic suppliers (b) (c) If the total surplus decreases by a given area, then that area is the deadweight loss of the tariff, some from overproduction and some from under-consumption of the good 5) Benefits of international trade (a) Increased variety of goods (b) Lower costs of goods (c) Increased competition (d) Enhanced flow of ideas and technology Vocabulary Scarcity: the limited nature of society’s resources Economics: the study of how society manages its scarce resources Efficiency: the property of society getting the most it can from its scarce resources Equality: the property of distributing economic prosperity uniformly among the members of society Opportunity Cost: whatever must be given up to obtain some item 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 Incentive: something that induces a person to act 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 Property Rights: the ability of an individual to own and exercise control over scarce resources Market Failure: a situation in which a market left on its own fails to allocate resources efficiently Externality: the impact of one person’s actions on the well-being of a bystander Market Power: the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices Productivity: the quantity of goods and services produced from each unit of labor input Inflation: an increase in the overall level of prices in the economy Business Cycle: fluctuations in economic activity, such as employment and production Circular-flow Diagram: a visual model of the economy that shows how dollars flow through markets among households and firms Production Possibilities Frontier: a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology Microeconomics: The study of how households and firms make decisions and how they interact in markets Macroeconomics: The study of economy-wide phenomena, including inflation, unemployment, and economic growth Positive Statements: claims that attempt to describe the world as it is Normative statements: claims that attempt to prescribe how the world should be Absolute advantage: the ability to produce a good using fewer inputs than another producer Opportunity cost: whatever must be given up to obtain some item Comparative advantage: the ability to produce a good at a lower opportunity cost than another producer Imports: goods produced abroad and sold domestically Exports: goods produced domestically and sold abroad Market: a group of buyers and sellers of a particular good or service Competitive Market: a market in which there are many buyers and many sellers so that each has a negligible impact on the market price Quantity Demanded: the amount of a good that buyers are willing and able to purchase Law of Demand: the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises Demand Schedule: a table that shows the relationship between the price of a good and the quantity demanded Demand Curve: A graph of the relationship between the price of a good and the quantity demanded Normal Good: a good for which, other things being equal, an increase in income leads to an increase in demand Inferior Good: a good for which, other things being equal, an increase in income leads to a decrease in demand 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 leads to a decrease in the demand for the other Quantity Supplied: the amount of a good that sellers are willing and able to sell Law of Supply: the claim that, other things being equal, the quantity supplied of a good rises when the price of the good rises Supply Schedule: a table that shows the relationship between the price of a good and the quantity supplied Supply Curve: a graph of the relationship between the price of a good and the quantity supplied Equilibrium: a situation in which the market price has reached the level at which quantity supplied equals quantity demanded Equilibrium Price: the price that balances quantity supplied and quantity demanded; AKA market clearing price Equilibrium Quantity: the quantity supplied and the quantity demanded at the equilibrium price Surplus: a situation in which quantity supplied is greater than quantity demanded; AKA excess supply Shortage: a situation in which quantity demanded is greater than quantity supplied; AKA excess demand Law of Supply and Demand: the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants 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 Total Revenue: the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity of the good sold (P x Q) Income Elasticity of Demand: a measure of how much the quantity demanded of a good responds to a change in consumers’ income, computed as the percentage change in quantity demanded divided by percentage change in income Cross-Price Elasticity of Demand: a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in price of the second good Price Elasticity of Supply: a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price Price Ceiling: a legal maximum on the price at which a good can be sold Price Floor: a legal minimum on the price at which a good can be sold Tax Incidence: the manner in which the burden of a tax is shared among participants in a market Welfare Economics: the study of how the allocation of resources affects economic well-being Willingness to Pay: the maximum amount that an individual buyer will pay for a good Consumer Surplus: the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it Marginal Buyer: the buyer who would leave the market first if the price were any higher; the buyer with the lowest willingness to pay Cost: the value of everything a seller must give up to produce a good Producer Surplus: the amount a seller is paid for a good minus the seller’s cost of providing it Marginal Seller: the seller who would leave the market first if the price were any lower; the seller with the highest cost Efficiency: the property of a resource allocation of maximizing the total surplus received by all members of society Equality: the property of distributing economic prosperity uniformly among the members of society Market Power: ability to influence prices Externality: the cost or benefit that affects a part who did not choose to incur that cost or benefit Market Failure: the inability of some unregulated markets to allocate resources efficiently Deadweight Loss: the fall in total surplus that results from a market distortion, such as a tax Underground Economy: jobs whose salaries don’t pay taxes (e.g. under the table jobs, drug trade) Supply-side Economics: cutting taxes encourages people to increase the quantity of labor they supplied World Price: the price of a good that prevails in the world market for that good Price Takers: countries that take the world price of a good as a given Tariff: tax on goods produced abroad and sold domestically Economies of Scale: the advantages a producer may gain by increase the size output of its good (i.e. some goods are made more cheaply only if you make a lot of them) Unilateral Approach: one country does something, e.g. remove trade barriers Multilateral Approach: multiple countries do something, e.g. remove trade barriers
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