Economics 130 Final Study Guide Chapters 1-18 CHAPTER 1: Scarcity: unlimited human wants are greater than the available limited resources • Scarcity will always exist in society • There are always limits on the ability of the economy to satisfy public wants Resources: used to produce goods and services, divWe also discuss several other topics like What are the different types of taxes?
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ided into three categories: 1. Land: natural resources-provided by land and are divided into two categories a. Renewable: replaceable; sun/wind/water b. Nonrenewable: limited quantities; forests/coal/oil/diamonds 2. Labor: the mental/physical capacity to produce goods and services a. This is measured by the number of people available for the work and the skill quality of workers 3. Capital: human made good that produces other goods and services a. Capital is NOT money in economics, it is machines, equipment, and factories used to produce the good or service b. Money is not a resource and it is NOT capital Entrepreneurs: people with the creative ability to profit by combining resources to create products. Economics: study of human choices in the face of scarcity. Humans must choose between what is wanted and what is needed. Macroeconomics: the branch of economics which looks at the economy as a whole 1. National economy 2. World economy Microeconomics: the branch of economics which looks at individual decisions 1. Household economy Model: simplified description of reality that helps comprehend and predict variable relationships. 1. The purpose of a model is to predict the results of a change in variables 2. If A happens, then B will happen Mistakes of models: 1. Fail to understand the ceteris paribus assumption 2. Confusing association and causation Ceterus paribus: while some variables change, others remain constant a. Allows economists to focus on selected variables, while the others remain fixed Causation: reading more into variable relationships than is actually there Positive economics: statements about economics that are able to be proven. 1. True/False statements 2. Statements about what the world is, rather than how is should be Normative economics: statements about economics that are opinions rather than facts. 1. Opinions, based on assumptions not facts2. Use world like: good/bad/need/should/ought to 3. Cannot be proven true/false Key points to know: *Economists use a step by step process to solve problems: 1. Problem Identification 2. Develop model based on assumptions 3. Collect data, test the model, and form a conclusion *A model is only valid when the cause-effect relationship is stable over time For example: If Skittles increase price to $1.50 per bag, then there will be less Skittles bought. But if Skittles decreases price to $0.50 a bag, then there will be more Skittles bought. *Many economists tend to disagree. These are centered in positive/normative economics. CHAPTER 2: 3 fundamental questions of economics: What goods and services to produce? How to use the limited resources to produce goods and services? For whom are these goods and resources being produced? Investment: investment is an accumulation of capital Key points to know: *2 key concepts of Chapter 2: 1. Opportunity Cost: the best alternative sacrificed for a chosen alternative. This or that? a. Going to the movie or spend a few hours studying? b. Spend money on pizza or on a new cd? 2. Marginal Analysis: examination of the effects of additions or subtractions from a current situation. a. When the benefits exceed the opportunity costs *Production Possibilities curve: PPC Shows the maximum number of combinations for 2 outputs that an economy can produce given the available resources and technology. 1. Guns vs. Butter example 2. Guns for national economy, butter for individual wants. The more guns produced, the less butter produced. More butter produced, less guns. *There is a point on the PPC where there is maximum production. The point is where efficiency is highest and waste is lowest. Maximum amount of guns and butter are produced, and there is no shortage of either. * Any point inside of the curve is inefficient, because there is waste. Any point above the curve is unattainable, because there are not enough resources to obtain that point. Any point on the curve is efficient.CHAPTER 3: Law of Demand: the inverse relationship between the price of a good and the amount customers are willing to pay for it in a certain period of time. • For example, at a sale, customers are willing to buy more when the price of a good is cut Demand Curve: created when there is a line connecting possible prices and quantity purchased by a customer • Allows an economist to find the quantity demanded by a buyer at any selling price along the curve • The demand curve is a summary of buying intentions Market Demand: determines the curve of market demand. • Economists total the sum of the individual schedules of market demand Demand: the curve that shows the quantities of production that customers are willing to buy at different prices during a certain period of time. Non-price determinants of Demand: factors which influence the position of the demand curve aside form the price. Non-price determinants of demand include: 1. Number of buyers 2. Tastes and preferences 3. Income changes 4. Expectations of buyers 5. Prices of competing goods Change in Quantity demanded: these are changes in price ONLY! This is movement along the curve, not movement of the curve. Change in Demand: an increase or decrease in the quantity demanded at each possible price This shifts the curve, not a movement along the curve. • Increase in demand leads to the curve shifting rightward. • Decrease in demand leads to the curve shifting leftward. 2 categories of goods: Normal/Inferior goods • Normal Goods: Goods which have a direct relationship between changes in income and the demand curve • Inferior Goods: Goods which have an inverse relationship between changes in income and the demand curve -An increase in income causes buyers to purchase more of a good -A fall in income causes the demand curve for inferior goods to shift leftward -A rise in income causes the inferior goods to become reduced in purchases Substitute Goods: goods that can be substituted for one another. There is a direct relationship between the price change of good A and the demand for good B. Complementary Goods: goods that are consumed with one another, but do not have a direct relationship with one another. If the price of good A falls, the demand for good B is not affected.Law of Supply: the direct relationship between the price of a good and the amount sellers are willing to offer for sale in a certain period of time Supply Curve: curve that shows the quantities of a product that sellers are willing to produce and offer for sale at different prices during a certain period of time. Non-price determinants of sellers: 1. Number of Sellers 2. Technology 3. Resource Prices 4. Taxes and Subsidies 5. Expectations of Sellers 6. Competing firm prices Change in quantity supplied: a movement along the supply curve, this is NOT!!! a shift of the curve Change in supply: an increase or decease in the quantity supplied at each possible price.This shifts the entire curve! • Increases shift the curve rightward • Decreases shift the curve leftward Market: any arrangement in which buyers and sellers interact with one another to determine how much to pay for a certain amount of goods. Surplus: quantity supplies exceeds the demand for it Shortage: quantity demanded exceeds the supply Equilibrium: occurs when the demand and the supply are equal to one another. This is the goal of the market place • Above equilibrium: an excess of quantity supplied • Below equilibrium: an excess of quantity demanded Price System: creates equilibrium despite rising and falling prices Key Points to Know: *At all prices there is an extra quantity demanded by new, incoming customers. • Population growth increases the number of buyers-curve shifts rightward • Population decline decreases the number of buyers- curve shifts leftward • Change in consumer tastes: means more or less of a product is demanded at each price • Changes in income affect demand *Only at a higher price will it be profitable for sellers to incur the higher Opportunity Cost associated with producing and supplying a larger quantity of product. *Market supply curves are found the same way that Market demand curves are found. The Horizontal sum of the quantities supplied at various prices that might be in the market. *Consumers believe that a reduction in the available supply will drive up prices-so they will stock up at convenient prices.CHAPTER 4: Changes in Demand: an increase in both the equilibrium price and the equilibrium quantity -if demand decreases then both the equilibrium price and equilibrium quantity fall, not necessarily at the same time. This is done to recreate equilibrium Changes in Supply: if there is too little of a product there is a shortage, which causes the value to rise. If there is too much of a product then there is a surplus, which causes the value to lower. Trends in prices over time: by analyzing the supply and demand curves, economists can explain price trends over time • Intervention from the government happens occasionally, which prevents equilibrium from being reached Two types of price controls from the Government: 1. Price Ceiling: a legally established maximum price that a seller can charge, not at equilibrium. Best example of this is rent prices. Governments establish prices like this to keep a good or service from reaching equilibrium price, which is normally higher than many people can afford. Consequences of a price ceiling include shortages, wait lists, and black markets. 2. Price Floors: a legally established minimum price that a seller can be paid, not at equilibrium. Best example of this is minimum wages. Governments establish prices like this to keep workers paid at fair prices, which keep businesses from hiring too many or too few workers. Consequences of a price floor lead to too many workers paid at an unfair price, or too few workers leading to unemployment. o Price ceilings and floors prevent market adjustments, where competition among buyers and sellers bids the price up or down, moving towards equilibrium. Market failure: too much market equilibrium results in either too many or too few resources being used in the production of a good or service. This gives justification for government intervention. Four cases of market failure: 1. Lack of competition 2. Externalities 3. Public Goods 4. Income inequality 1) Lack of Competition: competition must happen for a market to properly function a. Competition must happen between both producers/consumers b. Restricting supply through fake limits on output results in higher prices and profits for the company-wasting resources c. Out of date technology d. Innovation with higher profits but fewer outputs 2) Externalities: a cost of benefit imposed on people other than consumers or producers of a good or service e. Spill over effects/neighborhood effects: those who did not purchase or produce the good or service but enjoy the benefit of it-known as third partiesf. Externalities can be either negative or positive g. If the supply curve fails to include external costs, then the equilibrium price is artificially low and the equilibrium quantity is artificially high. h. When there are externalities, market failure shows incorrect prices and quantities, which misdirects resources. i. External costs lead to the market over allocating resources, and external benefits lead to the market to under allocating resources 3) Public Goods: a good or service with two properties : j. 1. Users collectively consume benefits k. 2. There is no way to exclude those who do not pay for the good or service to not consume it-known as free riders l. Free riders cause markets to fail to provide the good, and everyone believes that someone else with pay for the good, thus allowing them to enjoy it m. Governments can prevent free riders by taxing the good n. If the public good is only in the market place, everyone will wait for someone else to buy it, resulting in underproduction or zero production of public goods 4) Income Inequality: in cases of inefficient competition, externalities, and public goods, the market allocates too few or too many resources to produce an output, this results in unequal distribution of income o. Questions to consider: How equal should the distribution of income be? How much government intervention is necessary? p. To create better distribution of income, the Government uses different methods and programs to transfer money from people with more money to people with little money. q. Food stamps, unemployment compensation, and minimum wage limits are all ways the government uses. CHAPTER 5: Price Elasticity of Demand: the ratio of the percentage change demanded compared to the percentage change in price. This will always be negative, unless it cancels out. Price Elasticity of Demand Midpoint formula: this measures consumer responsiveness or sensitivity to changes in price. Quantity of % changed (-number % dropped/+number % increased in price) 4(-40%/+10%) this means that quantity demanded changes 4% for every 1% increase • Price and Quantity move in opposite directions, resulting in an inverse relationship. The number outside of the parenthesis is considered an elasticity coefficient, which is used to measure the degree of elasticity of the price. The formula for elasticity is: % change in quantity demanded/% change in price • This is solved by taking the midpoints as based points. Midpoint formula is: • Change in quantity/sum of quantity/2 divided by change in price/sum of price/2Simplified formula: Q2 –Q1/Q1+Q2 divided by P2-P1/P1 +P2 Q1: 1st quantity demanded Q2: 2ND quantity demanded P1: 1st Price P2: 2nd Price • The elasticity coefficient is determined by the responsiveness to the quantity demanded during a change in price. 3 possibilities: for error with formulas 1. Numerator is greater than the denominator 2. Denominator is greater than the numerator 3. The numerator and the denominator equal one another Elastic Demand: percent change in quantity demanded is greater than percent change in price • Elastic coefficient is greater than 1. If the Average is greater than 1, then the demand is elastic. Total Revenue: the total amount of dollars a company earns from the sale of a good or service • This is equal to the price multiplied by the quantity. • Total Revenue=Price x Quantity • A decrease in total revenue leads to a price increase, while an increase in total revenue leads to a price decrease. • It is easiest to see if the demand is elastic if the consumers respond to a price change Inelastic demand: percent change in quantity demanded is less than percent change in price • Elastic coefficient is less than 1, so inelastic. If the Average is less than 1, then demand is inelastic. When the demand curve is neither elastic nor inelastic, the total amount of money does not vary with price changes, so demand and supply are equal Unitary Elastic: percent changes in demand equal percent changes in price • If Average equals 1, then the demand is Unit Elastic. Perfectly Elastic: a small change in price causes a large change in demand; the curve is perfectly horizontal Perfectly Inelastic: demand does not change as price changes; the curve is perfectly vertical • The Price elasticity coefficient of demand applies only to a specific range of prices • Any downward sloping straight line demand curve has all three (Unitary Elastic, Perfectly Elastic, and Perfectly inelastic) types of price elasticity of demand Examples of demand: 1. Cars/China=elastic 2. Concert/play tickets=inelastic 3. Car tires=unitary elastic Differences are caused by:1) Availability of Substitutes: these are the most important influence on demand!! a) The demand is for a good is more elastic if it has substitutes that are also in demand b) Limited alternatives result in the demand being more price inelastic i) Price elasticity coefficient of demand is directly related to how available the substitutes of a good are ii) Price elasticity depends on the market used for measuring demand 2) Amount of Money spent on the Good: a) Price elasticity coefficient of demand is directly related to the amount of money spent on a good or service 3) Adjustments to Prices over time: a) As a rule, the price elasticity coefficient of demand is higher the more a change in the price persists IMPORTANT FORMULAS IN CHAPTER 5: • formula for elasticity is: % change in quantity demanded/% change in price ▪ This is solved by taking the midpoints as based points.: • Midpoint formula: Change in quantity/sum of quantity/2 divided by change in price/sum of price/2 • Simplified formula: Q2 –Q1/Q1+Q2 divided by P2-P1/P1 +P2 ▪ Q1: 1st quantity demanded ▪ Q2: 2ND quantity demanded ▪ P1: 1st Price ▪ P2: 2nd Price CHAPTER 6: Explicit Costs: cash that paid for the resources used during production, these include wages, rental fees, maintenance, electricity, etc. Owned by outsiders and MUST be paid by company. Implicit Costs: The opportunity cost of using resources that are owned by the company. Companies do not pay outsiders for the resources. Implicit Costs ARE opportunity Costs. Total opportunity cost of a business is found by adding the explicit + implicit costs. *Find Maximum Profit using Total Revenue –Total Cost Total cost = Implicit Costs/Explicit Costs • Economic Profit equation: Total Revenue-Implicit Costs/Explicit Costs • Normal Profit equation: Total Revenue =Total Costs; this allows the company to break even, no money is owed and nothing is gained, known as zero economic profit • Accounting Profit equation: Total Revenue-Less Explicit Costs o The main type of profit being used and referred to is economic profit There are two types of Inputs: 1. Fixed Inputs: where any resource with which the quantity cannot change during the period being monitored 2. Variable Inputs: Any resource for which the quantity can change during the period being monitored Some Fixed and Variable Inputs are known as:a. Short Run: where the time is too short to change the factors of production, such as farming/crop All Variable Inputs are known as: b. Long Run: where all inputs can be altered at any time a. New firms can enter and old firms can leave **Short Run and Long Run depend on the ability to vary quantity of inputs and outputs Production function is the relationship between the amounts of Output that can be produced from a company and the different quantities of Input that are used. *Using this, economists assume that technology is fixed. • Quantity=Price Marginal Product: the change in the total output by adding 1 unit of a variable input, all other inputs are considered constants o Law of Diminishing Returns: the main principle that at a certain point the Marginal Product curve will decrease, despite additional units being produced Short Run Cost Formulas: the production expands in the short run in 2 categories: 1. Total Variable Cost (TFC): costs that remain constant despite varying output levels: more input = more output=Variable Cost ▪ Wages, fuel, electricity, etc. 2. Total Cost (TC): The total fixed cost (TFC) and the total variable cost (TVC) at each level of output: TC=TFC+TVC 3. Average Fixed Cost (AFC): AFC=TFC/Quantity of output produced, this falls as output is increased 4. Average Variable Cost (AVC): AVC=TVC/Quantity of output produced 5. Average Total Cost (ATC): ATC=TC/Quantity produced o Another way to write this is: ATC=AFC+AVC o this is also known as “per unit cost” Marginal Cost: a change in the total cost when 1 more unit of output is produced o MC=Change in TC/Change in Quantity produced Long Run Average Cost Curves: these operate when the short run is insufficient. Long Runs are possible with all the available inputs. The size of a production plant depends on the Long Run level of expected production 1. Long Run Average Cost Curve (LRAC): this records the lowest cost per unit, where the company can produce any output level, depending on the production plant size 2. Economies of Scale: situations that arise when the LRAC declines as the company produces more amounts of output 3. Diseconomies of Scale: situations that arise when the LRAC rises as the company produces more amounts of output 4. Constant returns to Scale: when a company continually produces more amounts of output but the LRAC does not change, this is known as The Long Run Average Cost is used when: 1. Labor is divided up by talent or skills; specialization happens 2. Quarter efficiency of CapitalCHAPTER 7: Market Structures: classification system for key traits of a market, depends on four key structures and level of perfect competition. Perfect competition: also known as “pure competition” and is characterized by: 1. Number of companies 2. Homogeneous products 3. Easy entry and exit of companies 4. Price 1. Large Number of Small Companies: when each company is small enough so that no single company dominates the market price due output 2. Homogeneous product: in a perfectly competitive market, all goods and services are identical, and buyers do not care which product they buy 3. Very Easy Exit/Entry: in perfect competition there is no barrier to entry and companies are free to exit and enter the market Barriers to Entry: any obstacle that prevents new companies from entering into the market *No market fits all four structures; therefore, Perfect Competition is theoretical, and examples of this include produce/stock markets Price Taker: a perfectly competitive market is known as a price taker, a seller with no control over the price of the product. *the price of the produce is determined by the market supply and demand conditions, not the company. The company must have the power to adjust the price. Companies will not EVER sell below the market place. *Companies can only decide how much quantity to produce for maximum profit 2 profit maximizing methods: o Total Revenue-Total Cost Method o TR=PxQ o Total Fixed Cost=price at zero output o Marginal Revenue=Marginal Cost Method o Compares marginal revenue and marginal cost o Marginal Cost equals the changes in total cost as output levels change 1 unit. A change in total cost occurs at each additional whole unit, rather than at each listed level of output Marginal Revenue: is the change in TR from the additional sale of 1 unit o MR=Change in TR/change in output *Perfectly competitive companies have perfectly elastic demand curves due to the company being a price taker, where the additional sale of 1 unit adds to the Total Revenue Price. *In perfect competition, the companies Marginal Revenue equals the price that is a horizontal demand curve *Both Total Revenue and Total Cost rise as output increases o Marginal Cost=Marginal Revenue; firms maximize profits by producing the output so that Marginal Revenue equals Marginal Costo ATC curve: average profit per unit o Multiply Average profit per unit times quantity of output = profit *Market conditions change the prevailing price *when market price drops the company can only adjust the output to save prices and money *this uses the marginal approach to predict the output decisions *Assume companies compare marginal effects on profit and the marginal change in output Facing a Short Run Loss: use the Marginal Revenue –Marginal Cost rule o Companies maximize profit or minimize loss by using Marginal Revenue = Marginal Cost *If the price is below the smallest point on the AVC curve, each additional unit is insufficient, maximizing loss *Shutting down will allow the company to keep the factory of production, pay fixed costs, and later reopen *As the Marginal Revenue curve follows the Marginal Cost Curve, the MR = MC changes Perfectly Competitive firm’s short run supply curves: the MC curve above the minimum point on its average variable cost curve Perfectly competitive industry short run supply curve: segment of the MC curve above the AVC curve that sets up the PCIS-RSE o The supply curve is derived from the horizontal summation of the MC curves of all companies in the industry above the minimum point of each AVC curve *existing companies react to profit opportunities by building larger or smaller factories, selling or buying land and equipment, and varying other outputs *Profits attract new firms and losses cause exits *established firms will leave if they earn below normal profits; exit or entry is key to the long run supply causes Conditions of long-run perfect competition equilibrium can also be expressed as equality *P=MR=SRMC=SRATC=LRAC CHAPTER 8: Monopoly: the opposite of perfect competition. There are no close substitutes for the good, and has a monopoly three structures: 1. Single Seller 2. Unique Product 3. Impossible market Entry 1. Single Seller: 1 single company is the entire market: provides the supply/product in a market, and determine the price of the good/service 2. Unique Product: no close substitutes on goods/services, leaving little to no competition 3. Impossible market Entry: difficult barriers to overcome in order to enter the marketplace, there are three main barriers in place: 1. Ownership of Resources: complete control of an input prevents entry into a market2. Legal Barriers: most effective barriers, these are licensed by the Government and the government then excludes other businesses form entering the marketplace. Monopoly franchises prevent too many businesses in the same industry. Licenses restrict entry, as do patents and copyrights; this is supposed to encourage entrepreneurship and creativity of new ideas, resulting in a profit for a certain period of time. 3. Economies of Scale: situations that arise when the LRAC declines as the company produces more amounts of output. This is the concept known as survival of the fittest, which forces small companies and businesses out of the marketplace. Because of Economies of Scale, one monopoly can produce enough product and at a lower cost than other smaller businesses. Natural Monopoly: where the long-run average cost of production decreases in the whole market. This means that the one monopoly can produce for the whole market demand at a lower price than smaller firms. Network Good: a good which increases in values as more people use it, resulting in an economy of scale. Network Goods allow Economies of Scale and Monopolies to exist. The more people who are using it, then the benefits everyone receives are increased. o Main difference of a monopoly and Perfect Competition: Demand Curve shape, NOT a cost curve o Perfect competition is a price taker o Monopoly is a Price Maker Price Maker: downward sloping demand curve which allows the firm to choose between the price and output combination points. Monopolies can select the price they want, at the correct level of output, instead of industry price. *Demand curves of Monopolies slope downward, differing from horizontal demand curves and Marginal revenue curves in a perfectly competitive economy. *In a monopoly: TR is related to MR. When MR is above elastic demand, TR increases. When the MR and unit elastic demand intersect, the TR is maximized. When MR is below the elastic demand, the TR decreases, resulting in inelastic demand. *Monopolies will ALWAYS maximize profit by producing on the elastic part of the demand curve. *Profit in the long run will be earned if the monopoly’s demand curve and cost curve positions show profit and are not disturbed. In the long run, the monopoly is flexible, altering the production plant size and lowering cost when needed. *THREATS TO MONOPOLIES: these include entrepreneurs, innovation, competition/consistent losses, new technology, etc. To reduce rivals, monopolies sacrifice short run profits, resulting in more profits in the long run. Price discriminating: when a seller will charge different prices on the same good, these are not justified by cost differences. These are determined by several different market conditions: 1) Seller is a price maker and the monopoly is not only industry setting a price discrimination 2) Seller can segment the market by separating buyers who will pay different prices, resulting in different price elasticities of demand. 3) It is impossible for customers to have Arbitrage, destroying the price discrimination.Arbitrage: earning a profit by buying a good and selling it back at a higher price than originally paid. *College tuition is an example of price discrimination. Buyers view price discrimination as unfair, sellers view it as very fair. *Monopolies are inefficient because resources are wasted in production. Monopolies harm consumers by charging higher prices and producing a lower output than a perfectly competitive market would allow. Key points about Monopolies: o Charge buyers’ higher prices o Not enough resources used, resulting in wasted resources and a greater Marginal Cost o Long-Run economic profit is greater than zero profit o Income is skewed in a monopolies favor Some Economists believe that monopolies are good for the economy, resulting in higher technological change. Others believe that monopolies refuse to innovate goods/services. CHAPTER 9: Monopolistic Competition: market structure that has 3 qualifications: 1. Many small sellers: each company is small enough that changes in price and/or quantity have little to no effect on the market price. 2. Different products: products are not the same, buys can clearly tell which product is being bought. This is very important in monopolistic competition. 3. Easy entry/exit into the market place: companies can easily enter a market or exit depending on the market type. Non-price competition: companies compete using advertising, packaging, and other visual aids to sell products, rather than lower the prices of the products. These factors help to distinguish certain products and goods over others in the market place Monopolistic Competition: ❖ Fails efficiency test due to: ⮚ Misallocated resources ⮚ Output is less due to more options ❖ Monopolistic competition offers more variety and choice and benefits consumers. • A monopolistically competitive demand curve is steeper and less elastic than a perfectly competitive demand curve, and more elastic than a monopolist demand curve. • Monopolistically competitive short run profit is maximized by the MR=MC standard. • Monopolistically competitive companies will not generate an economic profit in the long run, only a normal profit in the long run. Normal profit is the minimum needed to keep the company running. Oligopoly: market structure characterized by 3 qualifications: 1. A few big sellers: a small number of companies are larger and more important than others, they can then affect the market price.2. Homogeneous or differentiated product: buyers can be oblivious to which product they are buying or they can be aware of which product they’re buying. 3. Difficult entering/exiting the market place: barriers to entry prevent easy entry, such as legal and financial requirements, patent rights, resource control, and economies of scale. Oligopolies are difficult to evaluate, because they can behave like either a monopoly or a perfectly competitive company. Factors that determine output and price of Oligopolies: ❖ Non-price competition: better products and visual stimuli, such as commercials, ads, and billboards. ❖ Price leadership: strategy where one powerful company sets the price and other smaller companies follow. Smaller companies do not necessarily have to follow the price of the largest company. ❖ Cartel: group of companies that agree to reduce competition and coordinating control of a products output and price. assumes that companies do not collaborate to avoid private competition, they follow the pricing rules, and agree to treaties between companies. ❖ Game theory: a model that demonstrates strategic moves and countermoves between companies. The payoff matrix shows why a competitive oligopoly results in a low-price strategy from both companies, which does not maximize profits. When benefits exceed the costs, cheating threatens agreements between companies to maximize profits. Mutual interdependence: a condition where a decision from one company, such as lowering or raising the price, results in other companies in the market place reacting to that decision. CHAPTER 10: Perfect Competition: • Perfectly competitive labor market: many sellers and buyers of labor • Wages and salaries are determined by demand and supply curves for labor Marginal Revenue Product: increase in the total revenue of a company from the hire of one more unit of labor. In perfect competition, a perfectly competitive company’s marginal revenue is equal to the product of labor x price of the product. Formula: Marginal Revenue Product (MRP)= Product of labor (P) x Price of Product (MP) Demand curve for Labor: assumes that all other inputs are fixed; curve that shows the amount of labor employers are willing to hire at various wages. This is equal to the Marginal Revenue Product of Labor. Formula: Marginal Revenue Product (MRP)=Wage rate Derived demand: the demand for labor and other factors of production depending on buyer demand for final goods and services produced. Supply curve for Labor: curve that shows the amount of labor workers are willing to preform for employers at differing amounts of wages. The market supply curve of labor is found by adding the individual supply curves of labor.Human Capital: the accumulation of education, training, experience, and health that allows workers to be hired for certain jobs. • Wages are determined in a perfectly competitive markets by the labor and demand curves interacting. Power of Employees in the workforce: • Unions increase the demand for labor in the marketplace • Unions decrease the supply of labor in the marketplace • Unions use bargaining to increase wages Unions are important in protecting worker’s rights, however private worker’s union memberships have declined. Changes in Labor Demand: • Unions • Prices of substitute goods • Technology • Demand for final products • Marginal product of Labor Changes in Labor Supply: • Unions • Demographic trends • Expectations of future income • Changes in immigration laws • Education and training Factors which affect Labor: • Distribution of Income • Equality verses Efficiency • Poverty Poverty line: defined by the level of income below where a someone would be considered poor. Antipoverty programs: • Cash for transfer • Social Security • Earned Income Tax credit (EITC) • Unemployment compensation • Temporary Assistance for Needy Families • In-Kind Transfers • Medicare • Medicaid • Supplemental Nutrition Assistance Program (SNAP) • Housing AssistanceIn-kind transfers: government payments in the form of goods and services instead of cash, for example: food stamps, housing, etc. Comparable Worth: employees who work for the same employer are paid the same wage, despite differences, and require the same level of education, training, responsibility, and experience. Using a nonmarket wage setting process will help to determine jobs and compensation based on point scores for different jobs. CHAPTER 11: Gross domestic product (GDP): the market value for finished goods and services that are produced during a year. This is a measure of how well a nations economy is doing. Following requirements are important: 1. GDP focuses on new products, not old data or products 2. GDP only counts finished goods, rather than half completed or expected goods There are two important transactions that occur when dealing with the GDP: 1. Secondhand Transactions: remember, the GDP only focuses on NEW goods and services a. Items not included in sales: used cars, old houses, etc. b. NOTE: sales of a used car or home that was created in a previous GDP period counts towards the current GDP, due to the sale occurring in the present GDP period, despite being constructed or manufactured years ago 2. Nonproductive Financial Transactions: GDP does not count or consider truly private or public financial transactions a. I.E.: stock sales, gifts, bond sales, transfer payments, etc. Transfer Payment: payment from the government to individuals of need or entitlement, they cannot be exchanged for goods or services being produced. These are nonproductive because they are not being put towards new products • Example of Transfer Payments: social security, welfare, benefits, etc. Final Goods: Finished goods and services that are produced for the market and consumers. Intermediate Goods: goods and services which are inputs used to create final goods; these are not considered because this would overstate and/or inflate the GDP. Macroeconomic model: fitting all these concepts together• Circular Flow Model: a circle that demonstrated the flow of money from households to businesses and vice versa. Example below: Product Markets BusinessesHouseholds Factor Markets • Red line: direction of supply, including goods and services and factors of production (land, labor, capital). This line flows clockwise • Blue line: direction of demand, including payments and expenditures. This line goes counter clockwise Expenditure approach: national income accounting method which calculated the GDP by adding the money spent on producing the final goods and services during the year. Ways to measure the GDP: • Circular Flow Model • Expenditure Approach • Personal Consumption Expenditures (C) • Gross Private Domestic Investment (I) • Government Consumption Expenditures and Gross Investment (G) • Net Exports (X-M) Formula for GDP: expressed in trillions of US dollars GDP= C + I + G+ (X-M) Shortcomings of GDP: • Nonmarket Transactions: GDP only counts market transactions • Distribution, Kind, and Quality of Products: GDP counts quantitatively rather than qualitatively measuring outputs of goods and services • Neglect of Quality of Life: GDP does not take into account the amount of hours that are worked and the changes in hours worked • Underground Economy: GDP understates sizable economy’s performances • Economic Bads: Negative by-products are not deducted from GDP, resulting in the GDP overstating the economy’s performances • GDP Alternatives: o Measure of Economic Welfare ( MEW) o Genuine Progress Indicator (GPI) o Human Development Index (HDI) Income types: • National Income (NI): total income earned by resource owners; wages, rents, etc. Amount of money that is earned. o Formula for NI: NI=GDP-depreciation (consumption of fixed capital) • Personal Income (PI): total income that households receive that can be used to consume goods, pay taxes, saved, etc. Amount of money that is received. • Disposable personal income (DI): amount that must be spent or saved per household after taxes have been removed. Nominal GDP: value of finished goods that are based on prices that exist during the production time. Real GDP: value of finished goods that are produced during a certain period of time and based on prices for the year. • Formula for Real GDP: real GDP=nominal GDP/GDP chain index multiplied by 100 GDP chain price Index: a comparison of the price changes in finished goods from one year to another. CHAPTER 12: Business Cycle: differing time periods of economic growth and detraction, this is a way to measure real changes in the real GDP. There are four phases of the business cycle: 1. Peak: the first phase, where the real GDP reaches the maximum level after experiencing a recovery. This is when the economy experiences near or full employment, and when the economy manages very near to the Production Possibilities Curve. 2. Recession: a downward slope of the business cycle where the real GDP experiences a decrease and unemployment increases; this is also known as a contraction. This is when the economy experiences a macro setback, and production capacity is underutilized. The Economy manages far from the PPC curve. a. Note: a recession occurs when the economy has been in a slump for at least six months, or two consecutive quarters. 3. Trough: the phase where the real GDP reaches minimum level after experiencing a recession. However long it is between and peak and a recession is the duration of the trough. A trough is the bottom of the economy and the beginning of the next phase, expansion. 4. Expansion: an upward slope of the business cycle where the real GDP experiences an increase and employment moves more towards full employment. This is also known as a recovery.Economic Growth: the expansion of national output, which is measured by the increase in percentage of the real GDP. Economic growth is the goal of any nation, because it results in a better standard of living, resulting in a larger economy. Economic indicator variables: measure business activity • Split into three categories o Leading indicators: factors which indicate a change before the real GDP changes o Coincident indicators: factors which indicate a change while the real GDP changes o Lagging indicators: factors which indicate a change after the real GDP changes *Formula for Economic Growth: Real GDP=C + I + G + X – M Unemployment rate: percentage of people who are in the civilian labor force and do not have jobs. These people are actively seeking employment at every possibility. • People working at least 1 paid hour a week or 15 unpaid hours a week are considered to be employed. If someone has sought work within the previous month, they are considered to be unemployed. • This does not consider discouraged workers. Discouraged workers are those who would work but have not found work and are now discouraged from finding work because they believe that there are no jobs available. Civilian Labor Force: percentage of people who are 16+ without jobs and are actively seeking jobs. This does not included members of the armed forces, discouraged workers, stay at home parents, and those too old or too young to work. Formula for unemployment rate is: Unemployment rate= unemployed / civilian labor force x 100 Problems with the unemployment rate: • Understates/overstates unemployment rate Three types of unemployment: 1. Frictional: temporary unemployment due to moving and or switching jobs, etc. 2. Structural: unemployment due to worker’s skills being mismatched to the job that is being offered. This can be categorized by four things: a. Lack of Education b. Changes in Demand from the consumers c. Technological Advances d. Globalization: i. Outsourcing: part of globalization; a company in another country will do the work that a firm in the U.S. does but for less money. ii. Offshoring: a work for a company is done by employees that live in another country and are paid less. 3. Cyclical: unemployment from a recession, there is a lack of jobsFull employment: a condition where the economy has an unemployment rate equal to the frictional and structural unemployment rates added together. Also known as the Natural rate of Unemployment. GDP gap: difference between the real GDP and the potential the real GDP has for Full employment. Formula for GDP gap: GDP gap= Real GDP – potential real GDP The gap between the real GDP and the potential real GDP records the loss of money from the loss of real goods and services to the nation as it functions at less time. CHAPTER 13: Inflation: an increase in the price levels of goods and services in the economy. Inflation is the increase in the overall prices, not an increase in the prices of specific products and services. Deflation: a decrease in the price levels of goods and services in the economy. Consumer Price Index (CPI): measure of the changes in prices of goods and services. This is also called the cost-of –living index; it only considers consumer goods and services because it measures how incomes are affected by price increases and decreases. Items purchased by the Government and Businesses are NOT considered. Base year: the year that is the reference for all other years being compared to it. The constant in the equation. Formula for CPI: *CPI=cost of market basket products at current year/cost of same market basket products at base year x 100 Annual rate of inflation formula: *Annual rate of inflation= CPI in given year—CPI of previous year/CPI in previous year x 100 Disinflation: a reduction in the inflation rates. Problems with CPI: • Changes in CPI are based on markets products which do not match products bought by consumers: CPI overstates impact of inflation. • BSL does not have easy time adjusting for changes in quality: CPI understates deterioration of quality. • Base years ignore the laws of Demand: the CPI will overstate price increase impacts. Nominal Income: actual total of money received over a period of time. Real Income: actual total of money received and adjusted for CPI changes Formula for Real Income: *Real income= nominal income / CPI (figured as a decimal or CPI/100) Approximation for percentage rise in nominal income and inflation rate: *% change in real income = % change in nominal income – % change in CPINominal incomes which rise faster than inflation have purchasing power, while nominal incomes which don’t keep up with inflation do not have purchasing power. Salary formula: *Salary in given year= Salary in previous year x CPI given year/ CPI previous year Wealth: the value of the stock and assets that a person owned or owns Nominal interest rate: the real rate of interest that hasn’t been adjusted for inflation. Real interest rate: nominal rate of interest – inflation rate Adjustable-rate mortgage (ARM): a loan for the home which adjusts the nominal interest rate according to the index rate. When the real rate of interest is negative, lenders and savers both lose because interest earned does not keep pace with the rate of inflation. Demand-pull inflation: the rise in the general prices that comes from a larger consumer demand. Cost-push inflation: the rise in general prices that comes from a larger cost of production Hyperinflation: inflation rates which cause prices to rise very quickly; an inflation rate which is 100% per year is considered hyperinflation. This can be caused by violent or rapid social and political factors. Wage-price spiral: increases in nominal wages rates are seen in other goods with higher prices, resulting in higher nominal wage rates and prices, this is a loop. CHAPTER 14: Aggregate Demand Curve (AD): curve which shows the level of real GDP bought per household, Government, business, etc. at each possible price. Includes net exports. The aggregated demand curve and the demand curve are different, do not mix them up. Reasons that the Aggregated demand curve slopes down are: • Real Balances effect: impact on total spending is because of the inverse relationship from prices and the values of assets that are fixed nominally. • Interest-rate effect: impact on total spending is because of the direct relationship between prices and interest rates. • Net Export effects: impact on total spending is because of the inverse relationship between prices and net exports. Consumers spend more on goods and services when those prices are low instead of high. The real value of the money spent is shown by the quantities each amount of the good and service are purchased at. Changes in individual components of Aggregate expenditures shift the curve, they DO NOT move the curve. Aggregate Supply Curve (AS): curve which shows the output level of real GDP at each possible price. Keynesians believe that product prices and wages are fixed. Therefore, this model assumes that government will intervene and prevent either a depression or a recession. Keynesians believe that demand independently creates supply. Theories of downward inflexibility include: • Union contracts: keep wage rates from being lowered by businesses • Minimum wage laws: prevent wages from being lowered • Employers think that lowering wages will destroy work ethics and reduce productivity When the Aggregate Supply curve is horizontal and the economy is in recession and not in full employment, the increased Aggregate Demand increases the real GDP and employment. The prices do not change. When the Aggregate Supply curve is vertical and the economy is operating at full employment GDP, the Aggregated demand curve changes at the price level. This opposes Keynesians views because it states that the supply independently creates demand. Keynesians don’t believe the original theory of economic recession, because Keynesians believe that recession prices and wages are not adjusted down to restore an economy to full employment real GDP. Keynesian range: horizontal segments of the Aggregate supply curve, representing a deep recession. As Aggregated demand increases within the Keynesian model, the prices remain the same while the real GDP expands. Intermediate range: rising segment of the Aggregate supply curve, representing near full employment in the economy. Increases in Aggregate demand increase in both price and real GDP. Classical range: vertical segment of the Aggregate supply curve, representing full-employment of an economy. As the economy reaches the full-employment output as described in the Intermediate Range, additional increases in the Aggregate demand cause inflation instead of more real GDP. At equilibrium in the macro-economy, sellers do not overestimate or underestimate real GDP at each price. Stagflation: conditions which occur when an economy experiences both high unemployment and rapid inflation at the same time. Cost-push inflation: the increase in prices which result from the increase in the cost of production and causes the Aggregate supply curve to shift to the left. Demand-pull inflation: a rise in the prices of goods and services that results from excessive demand, which causes a shift to the right in the Aggregate demand curve. The business cycle is a result of the shifting Aggregate demand and supply curve. Short-run aggregate supply curve (SRAS): the curve which shows the real GDP production possibilities at different prices where nominal incomes do not change. Upward slope is due to fixed nominal wages and salaries as price changes. Real income formula: *Real income = nominal income / CPI Long-run Aggregate supply curve (LRAS): the curve which shows the real GDP produced at different prices when the nominal incomes change by the same percentage as price. Vertical shape is the result of nominal wages and salaries slowly changing the same as the percentage price. An increase in the Aggregate demand in the long run results in the short run Aggregate supply curve shifting to the left due to nominal incomes increasing and the economy self-correcting to a higher price during full-employment in the real GDP. A decrease in the Aggregate demand in the long run results in the long run Aggregate supply curve shifting to the right due to nominal incomes falling and the economy self-correcting to a lower price during full-employment in the real GDP. Changes in Potential Real GDP come from two options: 1. Changes in resources 2. Advances in technology A shift right in the long-run Aggregate supply curve represents economic growth in the potential full-employment real GDP. CHAPTER 15: Fiscal policy: deliberate change in taxes to stabilize the economy. Discretionary fiscal policy: believes that the Keynesian policy, which is that the government should manipulate the economy to influence production rates of output, prices, and employment rates in the economy. This policy requires new legislation to change government spending, which takes time to work. Discretionary policy is either expansionary or contractionary. • Expansionary fiscal policy: results from an increase in government spending and a decrease in taxes, or an equal increase in government spending • Contractionary fiscal policy: results from a decrease in government spending and an increase in taxes, or an equal decrease in government spending Marginal Propensity to Consume: the change in consumption spending divided by a change in income. *Formula: MPC = change in consumption spending / change in income Spending Multiplier: any initial change in aggregate demand after a number of spending cycles. This is a chain reaction of more spending which leads to a greater change in demand. *Formula: Spending Multiplier (SM) = 1 / 1 – MPC *Formula: Change in Government spending x SM = Change in income (Y) Tax Multiplier: change in aggregate demand (total spending) that results from the change in taxes from Government spending. *Formula: Tax Multiplier (TM) = 1 – SM Tax Cut: the smaller multiplier and equal government spending Combating recession and inflation are done through changes in taxes and government spending. The change in Aggregate Demand from a change in government spending is equal to the change in government spending multiplied by the spending multiplier. The change in aggregate demand that results from a change in taxes is equal to the change in taxes multiplied by the tax multiplier. In order to combat recession, the increase in government spending or decrease in taxes results in the increase of the Aggregate Demand Curve, which results in the increasing price level and the rising of real GDP. In order to combat inflation, the decrease in government spending or increase in taxes results in the decrease of the Aggregate Demand Curve, which results in the decreasing price level and the lowering of the real GDP. Intermediate (or Classical) range: fiscal policy which can combat inflation Budget Surplus: an economic condition that results from government revenues exceeding government expenditures. Budget Deficit: an economic condition that results from government expenditures exceeding government revenues. Automatic Stabilizers: Federal tax revenues and expenditures which automatically change levels to stabilize the economy during an expansion or a contraction. Examples of this include: • Transfer payments • Unemployment compensation • Welfare • Tax collections/loans Supply-side fiscal policy: the theory that lower taxes encourage unemployed workers to seek work, saving, and investing; which would shift the aggregate supply curve to the right. This leads to output and employment increasing without inflation. Laffer curve: the curve which represents the relationship between the income tax rate and the amount of income tax revenue collected by the government CHAPTER 16: Government expenditures: Federal, state, and local government outlays for the goods and services that are produced, which includes transfer payments. The government’s portion of the economic activity that has increased since World War II. Most of the growth in government expenditures as a percent of GDP reflects the increasing growth of federal government transfer programs. Benefits-received principle: the concept that those who benefit from government expenditures should pay the taxes that finance those same benefits. This principle applies to certain goods which are private, because public goods cannot be implied to this principle. Ability-to-pay principle: the concept that those who have higher incomes can afford to pay higher taxes. Progressive tax: a tax which charges a higher percent of income as inflation occurs and income rises. Regressive tax: a tax which charges a lower percent of income as inflation occurs and income rises. Proportional tax: a tax which charges the same percent of income, despite the size of the income. This is also known as either a flat-tax rate or a flat tax. Average tax rate: tax divided by the income. *Formula: Average tax rate = total tax due / total taxable income Marginal tax rate: fraction of additional income that is taxed. *Formula: Marginal tax rate = changes in taxes due / changes in taxable income Public choice theory: the analysis of the government’s decision making process for allocating resources in the economy. Benefit-cost analysis: comparing additional units of reward and cost by evaluating economic alternatives. A profit-maximizing form that follows the marginal rule and produces additional units of reward and cost as long as marginal benefits exceed the marginal costs. Rational ignorance: voter’s choice to remain uninformed due to the marginal cost of obtaining information, which is higher than the marginal benefit of knowing it. CHAPTER 17: Federal Budget Balancing Act: the process that the government goes through to balance the budget and manage the national debt. Budget balances are fought over in Congress and follow a number of steps from beginning to end: 1. Presidential Budget Submission: budget that is submitted by Presidents to Congress by the first Monday in February. 2. Budget Resolution: Congress examines the budget and begins debate on how much money the president has proposed for each department. The Congressional Budget Office staff give advise on the budget by analyzing it and then reporting findings at a budget committee hearing in both chambers, House and Senate. Once the budget is approved by Congress, the outline is called a budget resolution. a. Budget Resolution: sets target ranges for government spending, tax revenues, and either a deficit or a surplus. Supposedly guides the choices that the committees make. 3. Budget Passed: Debate between Congress and the President over the budget lasts until October. Meanwhile subcommittees and committees work on specific bills related to spending, and once the budget passes, the President signs the spending and revenue bills, and the budget is official. Changes and imbalances in the budget occur frequently. Budget deficits occur when federal expenditures exceed the taxes that had been collected. Federal expenditures include spending on final goods added to transfer payments. Budget surplus’ occur when taxes that have been collected exceed federal spending. When the government spends over the budget, the United States Treasury borrows money by selling bonds and Treasury Bills, which guarantee specific payments based on interest to repay the loans taken. When interest on the loan accumulates for years, it is called gross public debt, federal debt, or national debt.National debt: total sum of money owed by the federal government to owners of saving bonds or government securities bonds. This includes trust funds provided by Social Security, and federal budget deficits are decreased and budget surpluses are raised because of this. Net public debt: National debt that is subtracted from the interagency borrowing that the federal government does. Debt Ceiling: legislation that resulted in a legal limit being placed on the national debt. Questions about National debts: 1. Can the Government go Bankrupt? a. Reasons to worry about government bankruptcy: i. If households and firms keep spending over the limit, then bankruptcy will occur. The national debt will continue to rise and the government will eventually become broke. b. Reasons to not worry about government bankruptcy: i. Debts can be rolled over by the government indefinitely, which is where the government replaces old bonds with new bonds. 2. Is debt being passed onto the next generation? a. Reasons to worry: i. Fear of debt continually increasing and never being paid off. Debt being passed from one generation to the next with no end date in mind. b. Reasons not to worry: i. Debt depends on whether it is internally or externally held. Redistribution of income and wealth favors upper-income citizens, but it does not change the purchasing power of the U.S. economy. ii. Internal National Debt: the portion of the debt owed to the citizens of a nation. This means that the debt is owned to the nation’s citizens, rather than to another nation. iii. External National Debt: the portion of the debt owned to the citizens of another nation. This means that the debt is owed to the citizens of a foreign nation, rather than to fellow countrymen. 3. Does Government Borrowing push out spending done by private sectors? a. Reasons to worry: i. Crowding-out effect: the reduction in private-sector spending that is from U.S. borrowing which increases the interest rate, lowering consumption by households and investment by businesses. ii. Crowding out only is complete if the economy manages at full employment, but it does not necessarily work if the economy operates at less than full employment. b. Reasons not to worry: i. Crowding-in effect: an increase in private sector spending that is from federal budget deficits by U.S. treasury borrowing. When employment is less than full, consumers that hold more securities spend more because of this additional wealth, and this causes business investment spending to be increased, as businesses experience optimistic profits and expectations. Government spending and borrowing leads to the government competing with private borrowers and this leads to a rise in the interest rates. The rising interest rates result in consumers and businesses not spending as much. This causes the Aggregate Demand and real GDP to increase.