ECO 105 Goel Exam 1 Study Guide
ECO 105 Goel Exam 1 Study Guide ECO 105
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This 13 page Study Guide was uploaded by Daniel Hemenway on Monday September 14, 2015. The Study Guide belongs to ECO 105 at Illinois State University taught by Rajeev Goel in Fall 2015. Since its upload, it has received 155 views. For similar materials see Principles Economics in Economcs at Illinois State University.
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Date Created: 09/14/15
ECO 105 Goel Exam 1 Study Guide 0 Definition of Economics The study of how scarce resources are allocated among competing endsuses 0 Micro and Macro Economincs Micro Analysis of small Macro Analysis of large Economics Micro Macro Positive Statements Normative Statements Scarce and Free Goods Scarce goods have positive opportunity costs Resources are SCARCE when DEMAND EXCEEDS SUPPLY Free goods have zero opportunity costs 0 Positive and Normative Economics 5 Positive Statements Fact based quotwhat is Normative Statements More opinion based quotwhat should be See chart under micromacro Fallacies in Economics FalseCause Caution about cause and effect Composition Caution about generalization Positive and Negative relationships Positive Both variables move in same dirV Negative Variables move in opposition Independent and Dependent Variables 9 Q Independent Variable Changes by itself 0 On horizontal X axis Dependent Variable Changes as a result of a change in the independent variable On vertical Y axis I39U39O ECO 105 Goel Exam 1 Study Guide 0 Area and Slope Area Area of a Rectangle Length x Width Example The total sales of a Business P x Q can be expressed as the area of a rectangle Q Cost Sales 0 Area of a Triangle 12Base x Height Slope RiseRun 0 Positive relation positive slope 0 Negative relation negative slope Cannot talk about slope of a curve it changes as you move along it Resources Land Labor Capital Entrepreneurship Land Rent Labor Wages Capital nterestTechnology Entrepreneurship Profits Sales Costs Land and Capital have one distinguishing characteristic Unlike capital total aggregate supply of land is fixed Labor Characteristics Cannot be bought or sold 0 Ability to form unions Cares about the kind of work it does Entrepreneurship Characteristics 0 Risk taking ability Profits are residual rewards gets paid after factors costs have been paid Scarcity Choice Specialization Exchange Scarcity PPF gt Choice gt Specialization LCA gt Exchange 0 PPF Production Possibilities Frontier LCA Law of Comparative Advantage ECO 105 Goel Exam 1 Study Guide Opportunity Costs Cost of the Next Best Alternative forgone Scarce goods have positive opportunity costs Free goods have zero opportunity costs 0 The Economic Problem Three Economic Questions 0 m to Produce Necessities vs Luxuries Luxuries are more responsive to income that is free available 0 llowto Produce Labor Intensive vs Capital Intensive 0 Labor Intensive more workers fewer machines 0 Capital Intensive more machines fewer workers 0 For Whom to Produce If a business focuses on necessities they are catering to a bigger population If a business focuses on luxuries they are catering to a smaller population Prices give the business signal businesses will focus more on where they believe the most money can be made 0 PPF Production Possibilities Frontier Shows Maximum Combinations of goods and services that an economy can produce with the Given Resources ie Land Labor Capital Entrepreneurship and Current Technology Talks about production possibilities NOT what should or must be produced Points on the PPF are attainable and efficient points beyond the Frontier are unattainable and points inside the Frontier are attainable but inefficient When Resources andor technology changes the PPF either shifts or rotates ECO 105 Goel Exam 1 Study Guide Good B Z Point A is on the PPF and is A ppF attainable and efficient Point Z is beyond the PPF and is unattainable M Point M is inside the PPF and is attainable but it is inefficient 0 Good A Representation of a SHIFT in the PPF Representation of a ROTATION in the PPF Good B Good B 0 Good A 0 Good A 0 Shape of PPF A PPF has a negative slope due to the positive opportunity cost of producing a good or service and is bowed outward due to the Law of Increasing Cost 0 Law of Increasing Costs Law of Increasing Cost As you produce more of a good or service its Opportunity Cost per unit goes up This is the economic reason for the PPF being Bowed Outward 0 Law of Diminishing Returns Law of Diminishing Returns As one input land labor capital entrepreneurship is increased in equal increments holding all other inputs the same the additions to output will eventually decrease ECO 105 Goel Exam 1 Study Guide Markets Markets are established arrangements where buying and selling of goods and services takes place Eliminates once in a lifetime transactions example garage sales Local vs National Markets Daily and Monthly Markets Goods Markets Walma rt Factor Markets 0 Bank Realestate How has the internet changed markets Allows buyers and sellers to come together that wouldn t normally have the opportunity to Isolated transaction is not a market 0 Circular Flow of Economic Activity gt Goods Market v Dollar Sales 39 9 Q 5 0 90 c i g I g 0 3 What 39 3 2 it n 0 Households Businesses 3 a a C U How For Whom I 2 l O I 3 l l I Income Dollars I Factors Market lt 188 o ECO 105 Goel Exam 1 Study Guide Relative and Money Prices Money Prices Price of a good or service in the unit of currency Relative Prices Price of a good or service in terms of another good or service Can be seen as a Frame of Reference Can also be relative to some other good at another time Microeconomics focuses on Relative Price Frame of Reference Macroeconomics focuses on Money Price Rate of Inflation Example w lVlPZ E L Car 8000 20000 10 Bikes 20 Bikes Bike 800 1000 110 Car 120 Car While both Money Prices have increased from period 1 to 2 only the Relative Price of cars has increased The Relative Price of bikes on the other hand has decreased over the same period Money Price and Relative Price do not necessarily move in the same direction 0 Marginal Analysis quotWhat happens when one more Rational Economic Agents make decisions at the margin undertake those activities whose Marginal Benefits EXCEEDS Marginal Costs Think about economic quotirrationalityquot The Principle of Substitution Principle of Substitution nearly every good or service has a substitute Example Coke and Pepsi Air and Car Travel SpecializationThe Law of Comparative Advantage Law of Comparative Advantage LCA REVIEW ScarcityPPF gt Choice gt Specialization LCA gt Exchange Focuses on specialization It is better for individuals to specialize in those activities in which their Comparative Advantage over other activities is the greatest or their comparative disadvantage is the least Distinction between Comparative vs Absolute Advantage REMEMBER Opportunity Cost is always in terms of something else Example Opp Cost Lawns Opp Cost Pages ECO 105 Goel Exam 1 Study Guide LawnZDay PagesZDay in pages in lawns Jack 2 20 10 220 1quot Jill 8 50 508 625quot 825 g Higher opportunity cost quot Lower opportunity cost Although Jill has an absolute advantage in both her comparative advantage is in mowing lawns Jill should mow and Jack should type because it is his least disadvantage Doctrine of Invisible Hand Adam Smith Father of Modern Economics 17005 When economic agents buyers and sellers act in their self interest without any interference by the government they end up promoting well being of society Invisible hand emphasizes quotHandsof Government It has less relevance in the modern world as all governments interfere to varying degrees in their economies Limitations of Invisible Hand case for government intervention Income Distribution reveals what percentage of individuals are at different wage levels Role of Government Public Goods nonrivalry in consumption nonexclusion Many people can use these at the same time Example Mt Rushmore National Defense Externalities private costs benefits a social costsbenefits Example Congestionpollution pollution from oil company effecting people living around it and if the government steps in to regulate it Monopoly in general is not a bad thing Example of how a monopoly can be bad If there is only one producer of a life saving drug they cannot charge an outrageous price Macroeconomic Instability The government steps in to help out ECO 105 Goel Exam 1 Study Guide 0 Demand Demand The amount people are prepared to buy under specified circumstances during a specified time period Law of Demand There is a negative inverse relationship between the price of a good and its Quantity Demanded Holding other factors constant Demand Curve Shows the various Quantities Demanded at different prices Holding other factors constant Real world behavior is not necessarily a straight line Example D1 SUnit P D1 D O QUnits A negative price and negative quantity don t have economic meaning 0 Individual and Market Demand The Market Demand curve is the Horizontal Sumadding CD of Individual Demand Individual Market Market Demand SMeal SMeal SMeal B 5 5 quotquotquotquotquotquotquotquot quot 5 A A 3 3 quotquotquotquotquotquotquotquotquotquotquotquotquot 3 I DA I I DB I I 2 3 Q 3 4 Q 5 7 Q quot Week Week Week 0 Individual and Market Demand cont Principle of Substitution nearly every good or service has a substitute 0 Example Coke and Pepsi Air and Car Travel ECO 105 Goel Exam 1 Study Guide Factors that Shift the Demand Curve other than price Price of Related Goods Substitutes or Complements Substitutes example Coke and Pepsi Complements example Sugar and Coffee Consumer Income 0 Normal and Inferior Goods Most goods are normal goods Income increases Demand increases 0 Inferior goods Income increases Demand decreases Example Ramen Noodles Consumer Preferences Number of Buyers Buyers Expectations 0 Movement vs Shift in a Curve Applies to both demand and supply curve When the Price of the Good Changes there is a Movement along the Demand or Supply curve Called Change in Quantity DemandedSupplied When Factors Other Than the Price of the good change there is a shift in the Demand or Supply curve Called Change in DemandSupply Movement Shift O DU O o D o ECO 105 Goel Exam 1 Study Guide Supply Supply Quantity Supplied of a good or service is the amount of the good or service offered for sale at a given price Holding other Factors Constant The Supply Curve or supply schedule Of a particular good or service shows the various Quantities Supplied at different prices Holding other Factors Constant The Supply Curve is generally positively sloped Factors Shifting the Supply Curve Prices of Other Goods Other goods the seller is either producing or can produce Prices of Relevant Resources Technology Number of Sellers Seller s Expectations 0 Market Equilibrium Market Equilibrium Is at the the intersection of Demand and Supply Curves Gives Equilibrium price and quantity Equilibrium price is that price at which the Quantity Demanded of a good equals it Quantity Supply Surplus Shortage EQ Q Characteristics Quantity Demanded Quantity Supplied No shortage or surplus The market clears Equilibrium price is stable No tendency to rise or fall Effect on Market EQ of an increase in income P 1 Q U Effect of increase in technology P U Q 1 ECO 105 Goel Exam 1 Study Guide Market Equilibrium cont Effect on Market EQ of an increase in the number sellers and a simultaneous decrease in the number of buyers P U Q depends on amount 0 Elasticity A measure of a variable39s sensitivity to a change in another variable Price Elasticity of Demand ED Responsiveness of Quantity Demanded of a good to changes in its price ED AQD AP Ratio of percentages Does not have a unit ED while always negative is sometimes taken in absolute value for interpretation ED 1 Unit elastic demand ED gt 1 Elastic demand ED lt 1 Inelastic demand Price Elasticity of Demand Determinants 0 Availability of Substitutes More substitutes more elastic demand 0 Relative importance of the good in consumer s budget 0 Time to adjust to price changes 0 Necessities ED lt 1 vs Luxuries ED gt 1 0 Total Revenue Test Total Revenue SALES P x Q If P 1 and TR 1 then ED gt 1 elastic If P 1 and TR 1 then ED lt 1 inelastic If P changes but TR doesn t change then ED 1 unit elastic Useful for businesses considering raising prices ECO 105 Goel Exam 1 Study Guide 0 Elasticity and Slope The more horizontal the curve demand or supply the more elastic and vice versa Perfectly Elastic Perfectly Inelastic S 5 ED 00 ED O D D O Q 0 Q s 5 Es 00 Es O S S O Q 0 Q Income Elasticity of Demand E1 Responsiveness of Quantity Demanded of a good to changes in income E1 AQD AI No absolute value 0 Example E 08 Normal and Necessity 0 Example E 13 Normal and Luxury E gt O Normal Good Positive E lt O Inferior Good Negative E lt 1 Necessity E lt O Luxury ECO 105 Goel Exam 1 Study Guide CrossPrice Elasticity of Demand Exv Responsiveness of Quantity Demanded of a good to changes in price of another good EXY AQD of X A Pof Y No absolute value EXY gt O X and Y are substitutes EXY lt O X and Y are complements EXY O X and Y are unrelated Example X Y and Z are all goods EYz 08 EYx 05 EYZ and EYX are both substitutes Exz 11 0 Exz are complements Price Elasticity of Supply Es Responsiveness of Quantity Supplied of a good to changes in its price Es AQs A P No absolute value Es Depends on i time the seller has time to respond and ii availability of inputs Es O inelastic immediate run no time to alter inputs 0 Es gt O somewhat elastic Short Run time to alter some but not all inputs 0 Es gtgt 0 most elastic Long Run time to alter all inputs Applications of Elasticity Tax Burden and Sales Tax Burden The party buyer or seller with greater unresponsiveness bears greater tax burden Price Changes With inelastic Demands firms can afford to raise prices without worrying about revenue losses
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