Erick Razo MIDTERM 2 Professor Dima Shamoun

Positive Statements refers to what?

Introduction to Economics (ECO 301)

FINAL​ ​Study​ ​Guide 

Everything you need to succeed in ECO 301

Highlight= Important Concept

Highlight= Important Term

Chapter​ ​1​ ​—​ ​Ten​ ​Principles​ ​of​ ​Economics: 

● Scarcity: 

○ “The Idea of how much you want of certain goods and services and how much there is actually available”

○ Having seemingly unlimited human wants in a world of limited resources.

● The​ ​Ten​ ​Principles​ ​of​ ​Economics:

1. Life​ ​is​ ​about​ ​Tradeoffs 

a. There is nothing free.

b. One is always trading off

something

2. Opportunity​ ​Cost 

a. “The highest valued

alternative that you MUST

give up to engage in an

activity”

b. TOTAL COST= Actual cost

+ Opportunity Cost

3. Thinking​ ​at​ ​the​ ​Margin 

a. “To evaluate whether the

Normative Statements refers to what?

If you want to learn more check out business management study guide

benefit of acquiring one

more unit of something is

greater than its cost”

4. Incentives​ ​Matter 

a. “Something that Induces a

person to Act

5. Trade​ ​is​ ​Beneficial 

a. Voluntary trade can make

everyone better off.

6. Markets​ ​are​ ​often​ ​best​ ​at 

organizing​ ​economic​ ​activity 

a. Adam Smith’s “Invisible 

Hand” guides people’s

self-interest into promoting

7. Rule​ ​of​ ​law​ ​can​ ​improve​ ​Market 

Outcome 

a. Governments can interfere

in the Economy if there is a

Market Failure 

b. Market Power: One

company in control of

market

8. Follow​ ​the​ ​Productivity 

a. Productivity: 

i. “It describes how

much output (goods

and services) that

can be produced in

one man-hour”

Microeconomics is the study of what?

9. Prices​ ​rise​ ​when​ ​you​ ​print 

a. Printing more money

decreases the value of

money

b. Inflation 

10.Short-Run​ ​Tradeoffs​ ​Between 

Inflation​ ​and​ ​Unemployment 

a. When inflation is low,

unemployment increases

and vice-versaIf you want to learn more check out bsc2011

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

society’s economic

well-being

Chapter​ ​2​ ​—​ ​ ​Thinking​ ​like​ ​an​ ​Economist: 

● Scientific​ ​Method 

○ Steps​ ​to​ ​Scientific​ ​Method

■ Observation

■ Question

■ Hypothesis

■ Gather Data

■ Test the Hypothesis

● REJECT

■ Fail to Reject

■ Theory

● Positive​ ​and​ ​Normative​ ​Statements: 

○ Positive Statements 

■ It is a statement of fact: it describes how the world IS and one can test it with the scientific method

○ Normative Statements: 

■ “It is a value-judgement: it describes how the world OUGHT to be.

● Macroeconomics​ ​vs.​ ​Microeconomics 

○ Microeconomics: 

■ “The study of how indiv households and firms make decisions and how they interact with the market”

○ Macroeconomics: 

■ “The study of economics-wide phenomenon

● If it talks about government and policy, it is most likely Macro

● Models​ ​of​ ​Economics: 

○ Model: Don't forget about the age old question of paul gilbert sdsu

■ “A simple representation of some aspect of the world. Models can be graphical, theoretical, or mathematical.”

● Models should fit reality and not vice-versa

● Models are judged by how they predict

○ Tradeoffs​ ​in​ ​Models:

■ Signal: 

● “Pattern underlying the data”

● A model that is better at detecting the signal, is also better at predicting

■ Noise: 

● “Random fluctuation

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● A model that picks up more noise may be better at explaining anecdotes,

but worse at predicting.

● The​ ​Production​ ​Possibilities​ ​Frontier​ ​(PPF) 

○ “It is a graphical representation of the maximum amount of any two products that can be produced from a fixed set of resources.”

○ Opportunity Cost: 

■ “The highest valued alternative that you MUST give up to engage in an activity” ■ If you want to learn more check out stockholder equity formula

○ Points​ ​on​ ​PPG

■ ON the Frontier are POSSIBLE and EFFICIENT

■ UNDER the Frontier are POSSIBLE and INEFFICIENT

■ OUTSIDE of the Frontier are IMPOSSIBLE for the current economy

○ Translation​ ​of​ ​PPF

■ Outward Shift:

● Increase in means of Production

○ Land, labour, capital, entrepreneurship

Inward Shift

● Decrease in resources

○ Consumer Goods 

■ “Goods used for Personal satisfaction”

○ Capital Goods: 

■ “Goods used to produce other goods”

○ Trade-Off​ ​between​ ​Consumer​ ​and​ ​Capital​ ​goods.

■ If people decide to save and put their

money in the bank in a way that another We also discuss several other topics like dat study guide

person can use it to create something

new.

● This allows for a shift in the

Production Possibilities Curve.

● The x-axis on the graphs to the right

represent the Percentage of

consumption of goods and the y-axis the on of capital goods.

● If one starts near the y-intercept, it’s most likely going to shift the PPF to

the right.

Chapter​ ​3​ ​—​ ​Interdependence​ ​and​ ​the​ ​Gains​ ​From​ ​Trade 

● David​ ​Ricardo’s​ ​Great​ ​Insight 

○ Trade can achieve the impossible

○ Having equal abilities is a disaster

Erick Razo MIDTERM 2 Professor Dima Shamoun We also discuss several other topics like bsc2010 uf

Introduction to Economics (ECO 301)

● Comparative Advantage 

○ “You can gain by specializing in producing what you do well and exchanging that production for something that you would have trouble making.”

○ Ex.​ ​Friday​ ​and​ ​Crusoe 

■ `Suppose we have Crusoe and Friday stranded on an island. Friday is better than crusoe at plucking apples, whereas crusoe is better than Friday at catching rabbits. Assume 10h work-day

Productivity

Apples

Rabbits

C

10kg/h

2r/h

F

15kg/h

1r/h

Impacts of

DOL

Before

After

50kg; 10r

20r

62.5kg;

12.5r

75kg; 5r

150kg

87.5kg;

7.5r

● FInd the

difference

between TOTAL

after and before

and split that in

half

● Add that to each indiv number

● 150kg-125Kg=25 ● 25/2

● How​ ​do​ ​we​ ​figure​ ​out​ ​who​ ​does​ ​what?​ ​Opportunity​ ​Cost

Crusoe

10a= 2r

5a= 1r

→ Rabbits

Friday

15= 1r

→ Apples

● Friday is Comparatively better at APPLES

● Crusoe is comparatively better at RABBITS

● Production​ ​Possibilities​ ​Frontier

★ It is a straight line because each item is

traded off equally (Opportunity cost is

constant)

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

★ The Economy is the orange line.

★ The red line shows the shift in the

economy's Production possibilities

frontier

● Absolute Advantage: 

○ “The ability to produce a good using fewer inputs than another producer” ● Absolute Equality: 

○ “Everyone is equal in their ability to produce. I.e. they use all the same number of outputs

Chapter​ ​4​ ​—​ ​The​ ​Market​ ​Forces​ ​of​ ​Supply​ ​and​ ​Demand 

● Market​ ​and​ ​Competition: 

○ Market: 

■ “A group of buyers and sellers of a particular good or service”

○ Competition: 

■ “The method used under social cooperation to improve one’s welfare”

● Demand 

○ Law​ ​of​ ​Demand: 

■ “Ceteris Paribus, there is an inverse relationship between the price of a good or service and the quality that people are willing to buy of that good and service.” ■ Quantity Demanded is dependent on price

■ Ex. If the price of beer decreases the quantity demanded will increase

● Reasons​ ​for​ ​Downward​ ​Slope

○ Income​ ​Effect/​ ​Scarcity 

■ Holding your income constant, if the price of a good or service increases then you have less money to spend on.

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

○ Diminishing​ ​Marginal​ ​Utility 

■ This law states that as one’s consumption of a product increases, there is a decrease in the marginal utility that occurs when that person consumes

each additional unit of that product.

■ One can see utility as one’s happiness.

■ Ex. How much happiness do you get as the number of ice cream you

consume increase

○ Substitution​ ​Effect 

■ If the price of a good or service increase, then you switch to buying

substitutes.

● Movement​ ​Along​ ​the​ ​Demand​ ​vs.​ ​Shifts​ ​in​ ​Demand 

○ They are NOT the same

○ Movement​ ​along​ ​Demand

■ Results from a price change alone

■ This is known as change in the quantity demanded

○ Shift​ ​in​ ​the​ ​Demand

■ Occurs when something OTHER than price changes

● This is called a Change in Demand

● Determinants​ ​of​ ​Demand 

1. Change in Income

2. Change in Taste (preferences)

3. Change in the price of related goods (substitutes or complementary)

4. Change in the number of buyers

5. Change in Expectations

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Determinants​ ​of​ ​Demand​ ​Explanation 

1. Change​ ​in​ ​Income

i. Ex. If you get a raise you might be able to afford to buy more ice cream

ii. Inferior Goods 

1. You quit your job to go back to College, so there is an increase of demand of inferior goods, such as ramen noodles and vice-versa.

2. Change​ ​in​ ​Preference

i. Ex. If an article came out stating that consuming an Ice Cream a day can reduce your chances of developing colon cancer, then the demand for Ice Cream would increase.

3. Change​ ​in​ ​the​ ​Price​ ​of​ ​Related​ ​goods

i. Substitutes 

1. Ex. If the price of Guinness beer increases (leftward movement), then the demand of Bud Light will increase.

a. This is because people will not want to spend more money on a

Guinness, when they can jut can a cheaper Bud Light.

ii. Compliments 

1. Ex. If the price of strawberries increases, the demand of whip cream will

decrease.

a. This is because typically strawberries go together.

4. Change​ ​in​ ​the​ ​number​ ​of​ ​buyers

i. Ex. If population decreases so will the demand of Diapers

5. Change​ ​in​ ​Expectations

i. “What you expect to happen in the future affects your actions right now.

ii. Ex. Incandescent light bulbs will be banned next year

1. You are going to increase your purchase of light bulbs now,as you

predicted the future.

iii. Ex. When the new IPhone come out, the old one will decrease in price.

● Supply 

○ The​ ​Law​ ​of​ ​Supply 

■ “Ceteris Paribus, there is a direct relationship between the price of a good or a service and the quality that people are willing to supply of that good and service” ■ If you get paid more, you will do more

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Reasons​ ​for​ ​Upward-Slope 

○ As the price of a good or service increases, the producer attains more revenue, incentivizing them to produce more of that good or service, as the main goal of a producer is to make as much profit as they can.”

● Movement​ ​along​ ​Supply​ ​Vs.​ ​Shifts​ ​in​ ​Supply 

○ Movement along Supply

■ Results from a price change

■ Change in the quantity demanded

○ Shifts of Supply

■ Occurs when some thing other than price changes

■ This is a change in supply

● Determinants​ ​of​ ​Supply 

1. Change in Input Cost

2. Change in Technology

3. Change in Government Policy

4. Change in the Number of Sellers

5. Change in Expectations

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Determinants​ ​of​ ​Demand​ ​Explanations 

1. Change​ ​in​ ​Input​ ​Cost

i. Ex. If price of sugar decreases, then the supply of Ice Cream will Increase and Vice-Versa

2. Change​ ​in​ ​Technology

i. Ex. Invention of Ice Cream Scooper Increased the supply of Ice Cream, making it easier to to produce more.

1. Higher productivity means higher supply 

ii. MOSTLY a change in technology implies an increase in supply.

3. Change​ ​in​ ​Government​ ​Policy

i. Ex. A new tax exempts all organic Ice Cream producers from paying taxes (Increase in Supply)

1. Organic Ice Cream producers will now have more money to produce their product

ii. Ex. If the Government requires Ice Cream companies to provide nutritional facts (Decrease in Supply)

1. Ice Cream companies will now have to spend money on the making of

nutritional Facts labels, which means that they will have less money to

produce Ice Cream.

4. Change​ ​in​ ​Numbers​ ​of​ ​Sellers

i. Ex. More people opt to sell their organs (Increase in the supply of Organs) ii. Ex. Uber and lyft leave the market for ride-sharing (Decrease in supply) 5. Change​ ​in​ ​Expectations

i. Ex. The Economy is going to bust and housing prices will decrease (Supply Will Increase)

1. One is going to want to sell your house NOW)

ii. Ex. If the Economy sucks right now, but housing prices should pick up next year (Supply will decrease)

1. People are going to wait to sell their houses.

● Supply​ ​and​ ​Demand​ ​Together 

○ Supply

■ Determines producers side of the equation

○ Demand

■ Determines the consumer side of the equation

○ Market Equilibrium: 

■ The place where the quantity demanded and the quantity supplied are equal and the market is balanced

■ The Price at the Equilibrium is the Market Price (Equilibrium Price) and the quantity at the Equilibrium is called the Equilibrium Quantity.

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Analysing​ ​Change​ ​in​ ​Equilibrium ○ Three​ ​Steps:

★ Quantity Demanded is higher than

quantity supplied before the equilibrium. ★ When you are at equilibrium, the quantity demanded and quantity supplied are

equal.

★ Prices are constantly adjusted to reach equilibrium.

1. Decide which curve shifts (Demand, supply, both) 2. Determine the direction of the shift

3. Use the Diagram to determine what happens to the equilibrium price/equilibrium quantity

● Ex. Hidsucker Proxy (1994)

○ Context:

■ Nobody wanted to buy Hula-Hoops so a store owner that sold hula-Hoops began decreasing the price until he reached $0.

■ A small kid began playing with the Hula-hoop and attracted the attention of all of his friends, so everybody headed to the store-owner’s store to buy hula-hoops.

■ Seeing all of this new clientele, the store owner increased the price of the hula-hoops from free to $3.94

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

Chapter​ ​5​ ​—​ ​Elasticity 

● Elasticity​ ​of​ ​Demand 

★ Steps 

1. The Craze= change in

preference= Demand Curve

Shifts

2. The Craze causes Demand to

Shift out

3. The Equilibrium Price and

quantity increase after the craze

○ Refers to the responsiveness of the quantity demanded of a good to a change in: ■ Price of that good (Price Elasticity)

■ Income (Income Elasticity)

■ The price of another good (Cross Elasticity)

○ Price​ ​Elasticity​ ​of​ ​Demand

■ Ex. Why does Royal Blue Groceries get customers, when their prices a so much higher than competitors.

● Because of the convenience of their location (Downtown Austin) and how much people need these goods

■ Determinants​ ​of​ ​Price​ ​Elasticity 

1. Substitutes 

a. If there is availability of close substitute

i. It's is easier to ESCAPE a price increase to the good that

has the substitute

ii. Which means that the demand is more elastic

b. Ex. Eggs and Butter

i. Demand is more elastic for butter than for eggs because

butter is has more substitutes

2. Necessities​ ​vs.​ ​Luxuries 

a. Luxury good= easier to ESCAPE from when their price rises.

i. More elastic demand

b. Necessities are difficult to Escape from when their prices rise

i. More Inelastic Demand

c. Ex. Yachts Vs. Cars

i. A Yacht is easy to escape = Elastic

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

ii. Car is more difficult to escape = Inelastic

iii. In other words, because one needs the car more than the

Yachts, a change in price in cars won’t make your demand

change that much in comparison to if a Yacht’s price

increase.

3. Time​ ​Horizon 

a. Longer time Horizon= More time to adjust to (Escape) price

changes

i. More elastic Demand

b. Shorter Time Horizon= Less time to adjust (Escape) price change)

i. More Inelastic demand

ii. Ex. When you’re on “empty’ in your car tank, then you have

a short time horizon meaning that you won’t really care too

much about the cost of gas and you’ll go to the first one you

find = the demand is Inelastic

iii. The future is always more elastic than the present

4. Definition​ ​of​ ​the​ ​Market 

a. Narrowly defined markets are easier to escape

i. More elastic demand

b. Broadly defined markets are more difficult to escape

i. More Inelastic demand

c. Ex. If the market is defined as “The market for IPhone 8 phones”

people can escape easier than if it's the market for phones in

general.

● Calculating​ ​Elasticity​ ​of​ ​Demand

(Q −Q ) 2 1 

(Q +Q ) 212 1 

Midpoint formula → ElasticityP= εp=

P −P 2 1 

212 1

(P +P )

|Elasticity| < 1

|Elasticity| = 1

|Elasticity| > 1

● Inelastic

● **Raise price

● Unitary Elastic

● **Sweet Point**

● Elastic

● *Reduce

Price*

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Ex. Relationship between Tuition cost and Enrollment at UT

Academic

Year

Undergraduate

Enrollment

Undergraduate

Enrollment

2014-2015

9,930

$39,523

2015-2016

10,064

$39,00

ElasticityP=

(39,000−39,523)

(39,000+39,523) 21 

εp= .052

= − 0

$10,064−$9,930

($10,064+$9,930) 21 

★ Inelastic Demand

★ Negative Captures the

Law of Demand

● Elasticity​ ​and​ ​Revenue 

○ Revenue 

■ “When you multiply the price of a good or service by the number of sells, that is your revenue”

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

■ Changing the price

● If elastic

○ You lose revenue

● If inelastic

○ You gain revenue

○ INcrease for INelastic. 

■ Ex. Seinfeld

● Jerry Seinfeld found a jacket that he liked so much that he did not care

how much money he had to spend on it (For him, the product had Inelastic

demand). His friend George, disagreed with the purchase (Elastic

Demand)

● The​ ​Different​ ​Demand​ ​Curves 

○ Perfectly​ ​Inelastic

★ One would be able to pay anything to get this product.

★ This illustrates that regardless of cost, the quantity demanded stays constant

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

○ Relatively​ ​Inelastic 

○ Relatively​ ​Elastic

★ The responsiveness to a change of price is not extreme

★ Ex. Cigarettes

○ If the price of cigarettes

increases, most of it’s

consumers will keep buying

them, but not as much as

before

★ A change in Price will make a

response on the public

★ Things that have substituted

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

○ Perfectly​ ​Elastic 

● Price Elasticity of Supply 

★ Even a minimal change price, will alter the Quantity demanded dramatically ★ Ex. Dollar Bill

★ Ex. The price of Gas at different gas stations only differs by cents

○ “Refers to the Responsiveness of the quantity supplied of a good to a change in the price of that good’

○ Time​ ​Horizon

■ Is the most important determinant to the elasticity of supply

■ Physical limitation of time = physical limitation of supply

● Ex. One cannot extend the number of hours a day, one can only work for a certain amount of time

● The​ ​Different​ ​Supply​ ​Curves 

Perfectly​ ​Inelastic Relatively​ ​Inelastic

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

Relatively​ ​Elastic Perfectly​ ​Elastic 

● Calculating​ ​Income​ ​Elasticity​ ​of​ ​Demand 

○ “Income Elasticity of demand for good “x” as a result of a change in the income from I1 to I2is:

(Q −Q ) 2 1 

(Q +Q ) 212 1

Midpoint formula → ElasticityI= εI=I −I 2 1 

212 1

(I +I )

○ Income​ ​Elasticity​ ​of​ ​Demand

|Elasticity| < 0

0 < |Elasticity| < 1

|Elasticity| > 1

● Inferior Good

● Normal -- Necessity

● Normal -- Luxury

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Calculating​ ​Cross-Price​ ​Elasticity​ ​of​ ​Demand 

○ “Cross-price Elasticity of demand for good “x” as a result of a change in the price of good “y”

(Q −Q ) x2 x1 

(Q +Q ) 21x2 x1 

Midpoint formula → ElasticityC= εc=

P −P y2 y1

21y2 y1

(P +P )

○ Cross​ ​Price​ ​Elasticity 

|Elasticity| < 0

|Elasticity| = 0

|Elasticity| > 0

● Compliments

● Not Related

● Substitutes

Chapter​ ​6​ ​—​ ​Supply,​ ​Demand​ ​and​ ​Government​ ​Policies 

● Product​ ​Shrinkage 

○ “When the Government enacts price ceiling and the seller has to decrease either the quantity or quality of a product.”

○ Ex. Decrease in the size of black pepper over time

○ Some companies use rhetoric to explain the decrease in quantity (it’s for you health!!) ● Price​ ​Ceiling 

○ “Legally imposed MAXIMUM​ price”

■ When Government place a limit on how

expensive a product or service can be

○ Binding​ ​vs.​ ​Non​ ​Binding 

■ Above Equilibrium

● Non-Binding

● Won’t affect outcome

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

■ Below Equilibrium (THE ONE THAT MATTERS) 

● Binding

● It affects the market and product

○ Ex. Toilet Paper

■ Suppose that legislation was passed that placed a 10 cent price ceiling on each roll of toilet paper

● We don’t know how that would affect the market, as we don’t know the

equilibrium price.

■ We are told that it falls 80% below equilibrium price (From .50 to .10)) 

● Price​ ​Ceilings:​ ​Rent​ ​Control 

★ Before Change:

○ QD=Qs(Quantity B)

★ After Change:

○ QD>QS(QD= C, QS= A)

★ Shortage

○ When there is a legal maximum price of rent

● Surge​ ​Pricing 

○ Prices that fluctuate depending on the market

■ Just regular pricing (Dynamic Pricing/ Flexible Pricing)

● Price​ ​Gouging 

○ “Strategy in which companies take advantage of the inelasticity of their product to increase the price.”

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

○ Ex. Expensive prices for popcorn

● Price​ ​Floors 

○ “Legally imposed MINIMUM​ price”

● Ex. Minimum Wage

★ Above Equilibrium (IMPORTANT ONE)

○ Binding

★ Below Equilibrium

○ Non-Binding

★ Above Equilibrium

○ Binding

★ Surplus in Labour Market

○ Qs>QD 

○ Also Known as Unemployment

★ Quantity= Quantity of Low Skilled labour

● Labour Intensive restaurants get more hurt with minimum wage ● THINK OF MINIMUM WAGE WHEN ASKED ABOUT PRICE FLOORS

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● The​ ​Case​ ​of​ ​Scalpers 

★ The Price of the Scalpers is where Quantity Demanded and Quantity

Supplied Intercept

○ AKA Equilibrium

★ The Supply curve is vertical because there is a limited amount of capacity in the event

● Steps​ ​to​ ​Analyse​ ​Taxes 

1. Decide which Curve Shifts (Supply or Demand)

2. Determine the Direction of the shift

3. Examine how the shift affects equilibrium price and quantity

● ShiftsoftheCurves 

○ Two types of Shifts:

1. Rightward Shift/ Leftward Shift 

● Price does NOT change

● Quantity Demanded/ Quantity Supplied changes

2. Upward Shift/ Downward Shift

● Price Changes

● Quantity Demanded/ Quantity Supplied does NOT change

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Ex. The Outcome of a $1 tax on buyers​ of a pack of cigarettes

★ Analysis 

○ Step​ ​1

■ A tax on buyers shifts the

demand

○ Step​ ​2

■ The Demand Curve Shifts

down (Step not necessary)

○ Step​ ​3

■ The Quantity traded

decreases

■ Price paid increases

■ Price received decreased

■ Buyers bear more of the

burden of tax

● Ex. The Outcome of a $1 Tax on sellers​ of a pack of cigarette

★ Analysis 

○ Step​ ​1

■ A tax on sellers shifts the

supply for cigarettes

○ Step​ ​2

■ The Supply curve shifts up

(Step non necessary)

○ Step​ ​3

■ Quantity traded decreases

■ Price paid increases

■ Price received decreases

■ Buyers bear more of the

burden of the tax

● Conclusions​ ​on​ ​Taxation 

1. It does NOT matter on whom the tax is levied, the market outcome is the same 2. Taxes drive a wedge between the Price paid by buyers and the Price received by sellers

3. Elasticity = Escape → The move elastic side will bear a smaller share of the tax burden (i.e. elasticity affects the tax incidence)

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Ex. The Outcome of a $10,000 tax on buyers​ Beachfront Houses

★ Analysis 

○ Step​ ​1

■ A tax on buyers shifts the

demand for beach-front

houses

○ Step​ ​2

■ The demand curve shifts

down​ (Supply shifts up)

○ Step​ ​3

■ Quantity remains the same

■ Price paid remains the

same

■ Price received decreases

■ Sellers bear the burden of

the tax entirely.

● Ex. The Outcome of a $20 tax on Consumers​ ​of Electricity

★ Analysis 

○ Step​ ​1

■ A tax on consumers shifts

the demand for electricity

○ Step​ ​2

■ The demand curve shifts

down​ ​(supply shifts up)

○ Step​ ​3

■ Quantity remains the same

■ Price paid increases

■ Price received stays the

same

■ Buyers bear the burden of

the tax entirely

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Ex.​ ​The​ ​Outcome​ ​of​ ​a​ ​$10,000​ ​tax​ ​on​ ​buyers​ ​Beachfront​ ​Houses 

★ Analysis 

○ Step​ ​1

■ A tax on buyers shifts the

demand for beach-front

houses

○ Step​ ​2

■ The demand curve shifts

down​ (Supply shifts up)

○ Step​ ​3

■ Quantity remains the same

■ Price paid remains the

same

■ Price received decreases

■ Sellers bear the burden of

the tax entirely.

● The Outcome of a $20 tax on Consumers​ ​of Electricity

★ Analysis 

○ Step​ ​1

■ A tax on consumers shifts

the demand for electricity

○ Step​ ​2

■ The demand curve shifts

down​ ​(supply shifts up)

○ Step​ ​3

■ Quantity remains the same

■ Price paid increases

■ Price received stays the

same

■ Buyers bear the burden of

the tax entirely

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

Chapter​ ​7​ ​—​ ​Consumers,​ ​Producers​ ​and​ ​the​ ​Efficiency​ ​of​ ​Markets: 

● Consumer​ ​Surplus​ ​vs.​ ​Producer​ ​Surplus 

○ Consumer​ ​Surplus 

■ The difference between how much a buyer​ ​is willing to pay for a good and how much the buyer​ ​actually pays for it

■ Consumer Surplus(CS) = Net Gain for Buyers

○ Producer​ ​Surplus 

■ The difference between how much a seller​ is willing to accept for a good and how much the seller​ ​actually gets it for

■ Producer Surplus(PS) = Net Gain for Sellers

○ Ex. The Negotiator

■ The little girl and Adam Sanders were negotiating in a way that each were aiming to maximize their consumer and producer surplus

■ The little girl won because she is getting paid for something that she would of done for the experience (free), thus her surplus was larger than Adam Sanders’. ● Total​ ​Surplus/​ ​Social​ ​Welfare 

○ It is the Consumer Surplus plus the Producer Surplus.

○ It is Equal to the Social Welfare

○

★ Consumer​ ​Surplus 

○ The area under the Demand Curve and above the Market Price

★ Producer​ ​Surplus 

○ The are above the Supply Curve

and below the Market Price

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Effect​ ​of​ ​Price​ ​Control​ ​in​ ​Social​ ​Welfare 

○ Binding​ ​Price​ ​Floor

● Binding​ ​Price​ ​Ceiling

● Efficiency 

★ Deadweight​ ​Loss: 

○ A loss of economic efficiency

○ There are willing buyers and willing sellers

★ Surplus 

○ Although the Producers have a

larger surplus, both the producers

and consumers are at a loss

because of the Deadweight loss.

★ Surplus 

○ Although the Consumers have a

larger surplus, both the producers

and consumers are at loss

because of the Deadweight loss.

○ “When an allocation of resources maximizes total surplus” ○ Equality​ ​vs.​ ​Efficiency

■ The one who is most Inelastic will have the largest surplus. ■ Elasticity determines how different the surplus will be. ■ Rarely will there be equality between the two of them

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

NOT​ ​EQUAL

BUT

EFFICIENT

Chapter​ ​8​ ​—​ ​The​ ​Cost​ ​of​ ​Taxation 

● The​ ​Effect​ ​of​ ​Tax​ ​on​ ​Efficiency 

○ Ex. A $5 tax is levied on the sellers on product X.

■ Equilibrium Price: $20

■ Equilibrium Quantity: 60

○ Before​ ​the​ ​Tax:

★ CS before tax = ½ (60)(10) = 300

★ PS before tax = ½(60)(20) = 600

★ Note: Notice that the supply curve is more inelastic than the Demand curve; hence the larger surplus

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● After​ ​the​ ​Tax

★ CS after tax = ½(50)(5) = 200

★ PS after tax = ½(50(17) = 425

★ Tax Revenue = (50)(5) = 250

★ DWL = ½(5)(10) = 25

★ PS was affected more by the tax because Supply is more inelastic than Demand ★ DWL indicates a loss in efficiency

● Elasticity​ ​effect​ ​on​ ​tax​ ​and​ ​Deadweight​ ​Loss 

○ The more Elastic, the more deadweight loss after the implementation of a tax. ○ Ex. The Outcome of a $10,000 tax on buyes of Beachfront Houses

● The​ ​Laffer​ ​Curve 

★ CS did not change

★ Everything was taken out from PST 

★ With Inelastic Curve, there is no

Deadweight loss.

★ Note: the Supply curve is vertical because the building of beachfront houses requires beachfront land, which is limited.

○ A relationship between tax revenue and rate

★ Low Tax rates and High tax rates yield to the same income 

★ People that are in High income brackets, that have high taxes. Want to lower down to lower brackets to try to pay less

★ Charging 10% sized tax will get the government the same revenue as a 90% tax

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

Chapter​ ​10​ ​—​ ​Externalities:​ ​Price​ ​Cost​ ​vs.​ ​Social​ ​Cost 

● Externalities 

○ Positive​ ​vs.​ ​Negative​ ​Externalities

■ Positive Externalities: 

● “A situation where a voluntary transaction between a seller and a buyer

creates external benefits to a third party”

● An external benefit that is not captured in the economic interaction

● Ex. Lighthouse

○ Other people besides the people that build the lighthouse and the

buyers benefit from without having to pay anything.

● Ex. Axe Effect

○ The scent creates a positive externality because third parties also

benefit (enjoy) the smell besides the person that bought the axe

and the seller who got money from the buyer.

● Ex. The Case of Yards

○ Neighbors benefit from a person hiring someone to take care of

their lawn, as it is nice to look at

★ = Market Equilibrium

without accounting for external benefits

★ = Market Equilibrium

accounting for the external

benefits of a manicured lawn

★ This Positive Externality is bad because the Quantity of the

market is less than the Optimal Quantity

★ There is a surplus that is not being internalized

● Negative Externalities: 

○ “A situation where a voluntary transaction between a seller and a buyer

imposes external cost on a third party”

○ An External cost that is not captured by the Economic interaction

○ Ex. The Case of Aluminum

■ An aluminium company, which sells aluminum to buyers, is

dumping waste into a river, thus, polluting the river for the people

downstream.

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

★ If we were taking into account the external costs, it would be

more expensive for the

Companies and the Consumer

● PublicSolutionstoNegativeExternalities 

○ Command and Control Regulations 

■ They are used by regulatory agencies

■ They require the business to do something (adopt a particular technology, etc)

★ The government can implement regulations on the aluminum

company, forcing them to use

more environmentally friendly

practices, however, this will

come into a cost for the

company, as it will lead to an

increase in input cost.

★ If one includes externalities, there is an increase in input

cost

★ By increasing input cost, one can achieve to reach the

Optimal Quantity

● Cost and Benefits 

○ Cost:

■ Administratively Costly

■ Costly to comply with

● Business have to spend a lot

■ Restrict Innovation

■ Create perverse incentives

● Asking to make regulation to cause the demise of

competitor

■ Can create excessive waste if miscalculated

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

○ Benefits:

■ They are clear

■ Easy to enforce

○ Corrective Taxes (Pigovian Taxes) Best​ ​Option 

■ The government sets a price for pollution

■ This forces the business to internalize the negative externality (e.g.

Pollution)

■ Business has to either pay tax (reducing the Q produced) or cut emission to avoid tax.

★ Tax Wedge = Price of Pollution ★ You Impose tax on the Seller (person causing the harm)

● Deadweight Loss 

○ The result that one is looking for when applying the corrective tax to

negative externalities

■ Internalizes the negative externality by reducing excess

output.

● Cost and Benefits 

○ Cost:

■ Politically untenable

● Not attractive to voters

■ Can create excessive waste if miscalculated

○ Benefit

■ They are clear

■ Easy to enforce

■ They don’t create the same perverse incentives as other

types of taxes (e.g. income)

■ They promote innovation

○ Cap and Trade 

■ The Government caps the amount of pollution allowed

■ The Government issues permits to polluting businesses

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

■ Businesses can then trade permits

● High polluters can buy pollution permits from low polluters.

● Cost and Benefits: 

○ Cost:

■ Costly to enforce

■ Can create perverse incentive

■ Can create excessive waste if miscalculated

○ Benefit

■ They promote innovation

● Public​ ​Solutions​ ​to​ ​Positive​ ​Externalities 

○ Subsidies 

■ Subsidized Student loans are a solution to increasing percentage of

students attending college.

■ Ex. Electric Car vs. Gas

○ Private Solution 

■ Types of Solution

● Private Property Rights

● Tort Law

● Private Bargaining

■ Ex. Concrete Company

● A concrete company generates tons of concrete dust sending it to

the neighborhood that is nearby.

○ The people of the neighborhood sue the company for the

negative externality

■ The company is demanded by the government to pay

for damage cost, which is basically a tax on them

○ The Company then bargains with the people by offering to

buy their houses for $1 million each.

○ The company and the people are happy

■ Coase Theorem

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Ronald Coase formulated this theorem in which he said that if one

lets parties to stake a deal, it will do a better job to internalize the

externality

● Ex. Bees and Apples

○ The bee farmers benefit from their neighbors with the apple

orchards and the apple orchards benefit from the bees of the

bee farmers

○ With private bargaining, the bee company might be able to

buy out the apple orchards, internalizing the benefit

○ Although this positive externality helps both of them, allowing

them to bargain with each other allows them to internalize

the problem.

● Transactional Cost 

○ The cost that private parties from striking a deal.

○ Examples of costs

■ Lawyers needed to complete transaction

■ Taking time off work to deal with the transaction

(opportunity cost)

■ Hating the people that you’re making the deal with

○ The ideal is to create institutions that would decrease

transaction cost

■ Ex. U.S. Bank App

● Two ladies sit down in a sporting event and

multiple men with distracting attire sit in front of

them (negative externalities).

● The women use the U.S. Bank app (institution)

to solve the negative externality and buy the

distracting attire from the men

● The app had little transaction cost.

Chapter​ ​11​ ​—​ ​Public​ ​Good​ ​and​ ​Common​ ​Resources 

● Classifying​ ​Goods 

○ Two Questions to determine what type of good a good is:

1. Is the Good Excludable? 

● How costly is it for me to exclude people to use that good?

2. Is it rival in consumption? 

● Does it cost anyone for you to consume that good?

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Private​ ​Good 

○ Ex. A couch

■ Excludible?

● A couch in one’s house is excludable because you can chose who

sits on the couch or not.

■ Rival?

● If one sits in the couch, that person takes physical space, thus,

nobody else can sit on it

● Public​ ​Good 

○ Ex. National Defence

■ Excludible?

● You can’t excludible anybody from defence for, say, not paying

taxes

■ Rival?

● One’s consumption of the national defence does not decrease

anybody else's consumption

● Club​ ​Good 

○ Ex. Cable TV

■ Excludible?

● If you don’t pay for the service, the cable companies can easily stop

providing you form the service

■ Rival?

● Just because you use the service doesn’t mean that you lessen any

body else’s consumption of that good

■ Note: Although WIFI does become laggy the more people use it, relatively, it has less rival consumption than other goods, as the WIFI is still capable

of being used

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Common​ ​Good 

○ Ex. I-35

■ Excludible?

● Anybody can use Interstate 35, no matter if you payed taxes or not.

Nobody can EXCLUDE you from using it

■ Rival?

● There is a physical capacity that I-35 has for it to be efficient to use

it. In other words, the consumption of I-35 from other drivers could

make you not use I-35 if there is a lot of traffic

■ Note: Toll roads are not the same as Interstates, as they can exclude you from using them if you don’t pay the fee, thus, the service is a Private

Good

● Public​ ​Goods​ ​vs.​ ​Publically​ ​Provided​ ​Goods 

○ Just because a good is provided by the government for the public to use, does not mean that the good is a public good

○ In Economics, the only way to classify a good is by asking the questions of whether that good is excludable and does that good rival in consumption

○ Ex. Public Library

■ Although Public Libraries are provided by the government to the public, these goods are Common Goods 

● This is because, although libraries can’t exclude anyone from using them, there is a physical capacity of people that libraries can accommodate.

● If there was only one library in Austin, one could see this more

dramatically. Although the library is provided to the entire community, the

people will struggle to use this good if the library is congested with people

trying to use it.

● The​ ​Tragedy​ ​of​ ​the​ ​Commons 

○ A property that is owned by everyone is owned by no one.

○ No one suffers the consequences of misusing property

○ No one makes money from preserving the property

■ Therefore, quality deteriorates

○ Tragedy of the Anti-Commons

■ In the USSR, the Soviets took ownership of everything

■ People had no property rights, thus, goods were misused

● The​ ​Free​ ​Rider​ ​Problem-​ ​The​ ​Problem​ ​with​ ​Public​ ​Goods 

○ A free rider is a person who received the benefit from using a good without paying for it ○ Non-excludable and non-rivalrous goods (public goods) create an incentive to free ride ○ If everyone free rides, the public good does not get provided

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

■ Ex. There are 300 people in the room and we need 180 people to pay for National Defence, but if everyone wants to free ride, so nobody gets National Defence

○ Non-Provision 

■ The problem with Public Goods is that when there is the ability for people to free ride, everybody is going to want to free ride, increasing the probability that no one will pay for the good or service

○ Private​ ​Provision​ ​of​ ​Public​ ​Goods 

■ The Importance of Property Rights 

● Ex. Trees and Paper

○ If a person advocates for the planting of more trees, they should

advocate for the increase in consumption of paper

■ Although it might seem like an oxymoron, the increase in

demand for paper will cause an incentive for paper

companies to plant more trees in their private property

■ People take care of their private

● Ex. Extinction of Cows?

○ If one consumes beef and milk, you increase the demand of cows,

which incentivises companies to have more cows

■ This reduces the chance of cows going extinct

Chapter​ ​12​ ​—​ ​Firm’s​ ​Production​ ​Costs 

● Why​ ​Start​ ​a​ ​Business? 

○ Profit 

■ Profit is the incentive to provide people with a product

■ Total Profit = Revenue - Total Cost

● Revenue 

○ The price that a product is sold multiplied by the quantity sold

● Total Cost 

○ Implicit cost plus the Explicit cost

■ Accounting Profit vs. Economic Profit 

● Accounting Profit: 

○ Accounting Profit = Total Cost - Explicit Cost

● Economics Profit: 

○ Economic Profit = Total Revenue - (Explicit Cost + Implicit Cost)

○ It is always less than accounting profit

○ Implicit Cost

■ It takes into account opportunity cost

■ Not easy to calculate

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Production​ ​Functions​ ​and​ ​Marginal​ ​Products 

○ Production​ ​Functions 

■ Describes the relationship between the quantity of inputs you use (labour machines, tech, etc) and the quantity of outputs you produce

○ Marginal​ ​Products 

■ Describes the increase in output that results from adding another unit of input, holding all other resource constant.

● Diminishing Marginal Product 

○ The marginal of an input decreases as you add more inputs

○ Holding things constant

● As each additional garbage worker is hired, there is a

decrease in the marginal

trash collected

● ​ ​Production​ ​Cost 

○ Total​ ​Cost

■ Fixed Cost + Variable Cost = Total Cost

● Fixed Cost: 

○ Cost that will not change with output

○ Ex. The cost of the Lecture hall of UT will not increase if we hold

more lectures lectures

● Variable Cost: 

○ Cost will change with input

○ Ex. You will need to increase the number of professors with an

increase in lectures

○ Average​ ​Fixed​ ​Cost 

■ Fixed Cost divided by Output

■ Always decreases with increase of quantity

○ Average​ ​Total​ ​Cost 

■ Total Cost divided by Output

■ Total cost per output

■ Parabola shaped graph

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

○ Average​ ​Variable​ ​Cost 

■ Variable cost divided by Output

■ Parabola shaped graph

○ Marginal​ ​Cost 

■ Change in Total Cost

● How much is an extra unit of

Output going to cost me

● Firm’s​ ​Different​ ​Cost

★ Total Fixed Cost is constant

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● The​ ​Firm’s​ ​Different​ ​Average​ ​Cost 

★ Interception between Marginal cost and Average Total Cost is

always at the vertex of ATC and its called the Efficient Scale 

○ This is the best point to

produce

● Short-RunCostvs.Long-RunCost 

○ Long-run​ ​Cost 

■ All cost are variable

■ Even fix cost becomes variable

■ Sunk Cost 

● Cost that one cannot recover

○ Short-Run​ ​Average​ ​Cost​ ​vs.​ ​Long-Run​ ​Average​ ​Cost

★ Diseconomies of Scale:

○ Is the portion where MC is

above ATC

○ Where one is hiring so

many people that one can’t

coordinate

★ LRAC: How many benefits are

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

Chapter​ ​13​ ​ ​—​ ​ ​Firms​ ​in​ ​Competitive​ ​Markets 

● What​ ​is​ ​a​ ​Competitive​ ​Market? 

○ Characteristics​ ​of​ ​a​ ​competitive​ ​market: 

1. Many sellers

2. Many buyers

3. Similar Goods

4. Free Entry and Exits

● No one prevents you from entry

○ Profits = Entry

○ Loss = Exit

● Profit opportunities will induce people to enter the market

○ Ex. Waving your Dollar bills to the world

○ Different​ ​Market

1. Ex. Dominoes

● more Competitive than the NFL

● The products are homogeneous

2. Ex. Gas

● Homogenous product

● Revenue 

○ In a competitive market price is identical across the board, no matter what the quantity ○ Total​ ​Revenue

■ TR = P x Q

○ Average​ ​Revenue

■ AR = TR/Q

○ Marginal​ ​Revenue

■ MR = Change in TR

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● Revenue​ ​in​ ​a​ ​table

● Revenue​ ​on​ ​a​ ​graph

● Everything​ ​on​ ​a​ ​graph

● Rule​ ​to​ ​Maximize​ ​Profit 

○ One should look at the difference between MR and MC

■ One should produce where MC = MR

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

■ Profit is maximized at the quantity where MC = MR

● The​ ​Dynamics​ ​of​ ​Entry​ ​and​ ​Exit 

★ ATC = TC/Q

○ TC = ATC x Q

★ Profit = TR - TC

○ Profit = (P x Q) - (ATC x Q)

○ Profit = (P - ATC) x Q

★

★ We must look at where P is relative to ATC

★ Short-Run profits induce other firms to enter the market

★ Increased competition drives prices down

★ Profits shrink

★ In the LR, Price is driven down to the lowest possible point (Min of ATC);

and profits are driven down to zero

● ShouldIShutDown?

ErickRazoMIDTERM2 ProfessorDimaShamoun

Introduction to Economics(ECO301)

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

● The​ ​Short​ ​Run​ ​Market​ ​Supply​ ​Curve 

● The​ ​Long​ ​Run​ ​Market​ ​Supply​ ​Curve 

Chapter​ ​15​ ​—​ ​Measuring​ ​a​ ​Nation’s​ ​Income 

● Gross​ ​Domestic​ ​Product​ ​(GDP) 

○ “Is the Market value all final, goods and services produced within a country in a given period of time.”

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

○ Circular​ ​Flow​ ​Model 

■ If we look at the model, the goods and services provided to the Households by the firms is what we look at for GDP

○ What​ ​is​ ​not​ ​Included​ ​in​ ​GDP 

■ Financial Transactions 

● Buying Stocks

● Bonds

■ Transfer Payments 

● Receiving Welfare Check

■ Second hand-Sales (used items) 

● Buying a used guitar

■ Overseas Production 

● Buying an imported item

● Note: if it's a foreign company, if the good is made in the U.S., it will be

counted for GDP

■ Unreported Transactions 

● Non-Market Transactions 

○ Paying your son for mowing the lawn… if that’s a thing

● Illegal Transactions 

○ Buying Illegal Drugs

● Other Unreported Transactions 

○ Cash tips

■ Intermediate Goods 

● Hot dog bun used for hot dog

○ WHAT​ ​COUNTS​ ​IN​ ​GDP?​ ​GAME

■ Instructions: cover up the “Answer” column and or “Explanation” column with a piece of paper/your hand/by zooming in. Test yourself as she will MOST likely test us on this

Scenario

Answer

Explanation

Hamburger buns bought by McD’s for making Big Mac

NO

Intermediate Good

(not a finished product)

Used Economics Textbook

NO

Secondhand-Sale

(Used good)

A new pair of jeans from Old Navy

YES

Newly acquired shares of Apple Stock

NO

Financial Transactions

(Stocks do not create a new product)

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

Ticket to see Eminem in Concert

YES

New Kia Soul

NO

Overseas Production

(It counts negatively in GDP

Newly purchased $10,000 U.S. Treasury Bill

NO

Financial Transactions

(Bonds do not create a new product)

Social Security Check you receive

NO

Transfer Payments

An egg that you buy to make yourself a breakfast omelet

YES

Note: this is different from the McD’s omelet as the product being bought was the egg individually

A tractor purchase by a farmer to grow corn

YES

Note: Even though it is an intermediate good, it is also a CAPITAL good

The wages that you earn working as an engineer in the U.S.

NO

That would count in GDI (Gross

Domestic Income)

Note: if you work for Fed Gov, your wage is a final product, so it would count towards GDP

○ Intermediate​ ​Steps​ ​and​ ​Value​ ​added​ ​in​ ​Producing​ ​a​ ​Cell-phone

Steps​ ​in​ ​the​ ​Production​ ​Process

Prices​ ​of​ ​the

Intermediate

Steps

Value​ ​added

During​ ​Steps

1.- Outercase

$5

$5

2.- Component Hardware

$15

$10

3.- Install Operating System

$30

$15

4.- Connect to Network

$79

$49

5.- Retail sale Price

$199

$120

Sum​ ​Total

$328

$199

○ The​ ​4​ ​Components​ ​of​ ​GDP

■ C - Consumption

■ I - Investment

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

■ G - Government Purchases

■ NX - Net Exports

○ Exports minus Imports

○ GDP​ ​vs.​ ​Real​ ​GDP 

○ Nominal GDP 

■ Value of goods and services produced at constant prices

■ It does not take inflation into account

○ Real GDP 

■ Value of goods and services provided at current prices

■ It takes inflation into account

■ One must keep a Base year for Real GDP

○ GDP​ ​per​ ​Capita 

○ Measures economics output per person

○ Nominal GDP ÷ Population

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

○ Business​ ​Cycle 

● What​ ​does​ ​GDP​ ​tell​ ​us? 

○ Correlations with an Increase in GDP (and Vice-Versa):

■ Increase in Life Expectancy

■ Increase in Life Satisfaction

■ Increase in Human Development Index

● Problems​ ​with​ ​GDP: 

○ Goodhart's​ ​Law 

■ “Once a social or economics measure is turned into a target policy, it will lose any information content that had qualified it to play such a role in the first place” ○ GDP​ ​does​ ​not​ ​count​ ​Non-Market​ ​Goods

■ Black Market

■ Quality of the Environment

■ Leisure time

■ Income Distribution

Chapter​ ​16​ ​—​ ​Measuring​ ​the​ ​Cost​ ​of​ ​Living 

How to Deal with Changing Prices?

● Consumer​ ​Price​ ​Index​ ​(CPI) 

○ “A measure of the overall cost of the goods and services bought by a typical consumer” ○ Holds goods and services the same to see the change in price.

○ Ex. How to compute you entertainment price Index?

Erick Razo MIDTERM 2 Professor Dima Shamoun

Introduction to Economics (ECO 301)

2013

2014

Good

Quantity

Price

Cost

Price

Cost

Popcorn

2

$4

$8

$6

$12

Lemonade

2

$4

$8

$4

$8

Movie Ticket

1

$8

$8

$10

$10

Basket Price

$24

$30

Index (EPI)

$24 = 1

x100 00 $24 

$30 = 1

x100 25 $24 

● How​ ​to​ ​Calculate​ ​Price​ ​Inflation? 

CPI −CPI 2 1

Inflation Rate = x100 CPI1 

● Problems​ ​withCPI 

○ Substitute​ ​Effect

○ Quality​ ​Changes

■ There is a change in the quality of the product to mask inflation

■ Ex Decrease in size of Skippy Peanut Butter

○ Introduction​ ​of​ ​New​ ​Products

■ CPI does not consider the intro of new products

● Alternative​ ​options 

○ MIT’s Billion Price Project