Chapter 1 - ECON Flashcards
A demand curve shifts due to
factors OTHER than a change in price:
An upward demand curve shift is in which direction?
To the right… called a direct relationship. Same with upward Supply curve shifts. To the left would be a downward shift for both.
Examples of upward shifts in demand (more demand)?
- The price of a substitute good looking more attractive (an increase in the price of hamburgers would increase the demand for hot dogs
- Expectations of price changes - consumers may be more likely to buy something now because they EXPECT prices to rise.
- Income Increases - When income increases, demand for certain items increase
- Extent of the market - increase in size of the market because of things like removal of trade barriers, baby boom increasing demand for abby goods, large inflow of immigrants, etc
Examples of downward shifts in demand
- Price of a complement good goes up - If bun prices are up, hot dog demand would go down
- Income increases - for certain goods, demand goes down as a person gains more wealth
- Consumer boycott - If effective, would temporarily decrease demand.
What is an “indeterminate relationship”
A factor that can cause demand to shift up or down. The best example is a change in consumer taste
Price elasticity of demand:
how responsive or sensitive Quantity Demanded of a good or service is to a change in price
formulas to measure price elasticity of demand
If Ed = 1: Unit Elastic. No change in total revenue
If Ed > 1: Elastic. So if Price goes up, Total Revenue can go down
If Ed<1: Inelastic. So if price goes up, total revenue would go up.
Elastic vs Inelastic
- Elastic: meaning consumers are FLEXIBLE. They are willing to go to other products
- Inelastic: customers are NOT flexible. They want this thing no matter what the price. EG - Cancer treatment
Examples of demand elasticity
Assume a firm can sell 110 units for $9 per unit. Company considering a price increase of $2 per unit
Is price or Quantity the numerator?
QUANTITY. Same with Income Elasticity:
Pectentage change in QUANTITY/ Percentage change in income
Direct relationships making supply go up:
- More Number of Producers
- Government subsidies
- Price expectations - “If producers expect higher prices, producers will increase their quantity supplied at any given price”
- Reductions in costs of production and technological advances
An inverse relationship that would make supply go down:
- Increases in production costs
- Prices of other products supplied - if producing product A is more profitable then producing product B, companies will decrease Quantity Supplied of company B
What is the Price Elasticity of Supply
Measure of how sensitive quantity supplied of a good or service is to a change in price or cost.
Price ceiling below equilibrium
A price ceiling is the MAXIMUM price a seller can charge.
POR FAVOR do not confuse the price ceiling and floor. What are they and where do they go?
The price ceiling and floor are results of government intervention in market prices:
- A price floor is ABOVE equilibrium price. (on top)
- A price ceiling is BELOW equilibrium price (on the bottom)
Do not get confuzzled and think that the ceiling is top and floor is on the bottom.
Explain the price ceiling and why it seems like it would help consumers but acutally hurt them?
The government mandates the price to be BELOW equiligrium price. Think of Gas. If ceiling was made $1, consumers would want it at that low price, so quantity demanded is high. However, because the selling price is so low, quantity supplied is going to fall because which gas company would want to sell something so low? Thus, quantity demanded is usually high and if the gas companies decide not to produce much gas to sell, there is a SHORTAGE which would really mess up consumers
Explain the floor, and why it seems like it would help businesses but actually not?
A government imposes a price floor when, for example, it wants to help farmers for a certain crop and say “their prices sold for corn needs to be higher”. Thus, farmers would obv want to produce more things sold at a higher price. But think back to a consumer point of view: who the hell would want to buy corn at such a high price? Thus, quantity supplied is very high and if consumers demand is low there could be a SURPLUS
What leads to a shortage?
Price Ceiling - Shortage
Price Floor - Surplus
For an alternate explanation, watch this coked out white dude explain ceilings and floors
https://www.youtube.com/watch?v=1EzY4Vl460U
by the way - what is Price (or Market) Equilibrium?
where quantity supplied = quanitity demanded. The point where the Supply and Demand curve meet. In other words, there is “adequate supply to satisfy buyers and adequate demand to allow suppliers to sell their output”. All goods offered for sale will be sold.
Law of diminishing marginal utility
The more a consumer consumes a particular product, the less satisfying will be the next unit of that product. “the twentieth oreo doesn’t taste as good as the first one” (jk)
Perfect (Pure) Competition:
- Large number of sellers, EACH of which is too small to affect the overall market price
- All firms sell a largely identical product (HOMOGENOUS)
- There is no non-price competition (no adverising)
- Each individual firm faces a demand curve that is PERFECTLY ELASTIC. Thus it is more horizaontal
Pure Monopoly:
- Only one producer
- No close substitutes are availible
- There blocked entry (eg a patent)
- The firm’s demand curve is substantially downward sloping (almost vertical)
Natural Monopoly
“there are very high fixed costs or other barriers to entry in getting started in a certain business or delivering a product or service.” Thus, “it is more efficient for one business to deliver a product than multiple businesses. In these situations, there are often government regulations to prevent high prices and corruption. This efficiency results in lower average costs for us.”
Eg - Public Utilities
Oligopoly:
- Small # of large sellers
- Barriers to entry (cost or patents)
- Non-price competition exists
- Rival actions are observed
- Firm’s demand curve is kinked
- eg - Oil cartel, the Colombian Cartel, etc
predatory pricing:
Charging lower prices temporarily to drive their competitors. Then, they increase their price as monopolists once competitors have been eliminated.
Monopolistic Competition:
- It includes a large number of sellers
- firms sells heterogenous products (substitutes but not identitcal)
- Lots of non-price competition (advertising, feature or quality differentiation)
- It is relatively easy to enter and exit to market
- Demand curve that is slightly or somewhat downward sloping
Formal strategic planning steps
- Creating or updating a mission statement
- Set goals and objectives
- Determine what actions should be taken to meet goals. Also establish obejctives to assess whether those goals were met.
- Ensure that managment is on board/implement the business strategy
Types of business strategies
- Product differentiation strategies
- Cost leadership strategies
GDP
Total dollar value of all the final goods and services produced within one country’s borders
GNP
Gross National Product - Total dollar value of all goods and services produced by a country’s residents regardless of whether produced within or out of that country’s borders. Was emphaiszed before but not so much anymore.
Inflation
% rate of ncrease in the price level of goods and services.
- Rising inflation means that individuals on fixed incomes (or with their past savings) can purchase less can purchase LESS
How to protect oneself from inflation
- Precious Metals - these will fall in price, though, once inflation subdues, so people consider common stock to be better in the long term.
- inflation adjustments in contracts
- TIPS - Treasury Inflation-Indexed Securities
Deflation
general delcine in price level or a negative inflation rate. Normal solution is to INCREASE SUPPLY OF MONEY
Multiplier effect Formula/ Increase in output (equilibirum gdp)
Change in Spending
Marginal Propensity to Save (MPS)
- If MPC is given, 1-MPC=MPS
Three common measures of price inflation
- Consumer Price Index - CPI
- Producer Price Index - PPI
- GDP Deflator - Index used to convert nominal GDP into real GDP
Business Cycles
- Expansion - Typically extended period of increased economic production
- Recession (or Contraction) - Declines in economic production
- Depression - particularly long recession
- Recovery - dearly stages of expansion
Leading Indicators
Predict whether expansions (or recessions) are likely to end within the next few months.
- changes in stock market prices
- average hours worked per week
- new orders for durable goods
- new private housing starts
Types of Unemployment
- Frictional Unemployment - bc of “friction” with management
- Sturctural Unemployment- bc of change in demand (people not wanting horse buggies anymore when automobiles took off) or bc of advances in technology
- Cyclical umeployment - bc of fluctuations in business cycle
- Institutional Unemployment - darn government
Types of interest rates
- Nominal Interest Rates - regularly quoted by financial institutions
- Real interest Rates - adjusted for inflation (expectations generally mimic historical performance)
- Risk-free interest rates - Absolute certainty of being repaid like T-Bonds
- Federal funds rate - rate banks charge eacother and pay one another for short-term loans of reserces at the FED.
- Prime rate - rate banks charge their most creditworthy customers. Usually a 3% premium over the federal funds rate
Two ways governemnt can be involved in ze Economie
Fiscal Policy
Monetary Policy
What does Fiscal Policy entail
Governments controlling levels of taxes, subsidies, and government spending. Governments can run budget surpluses or partake in deficit spending
When is deficit spending ok?
When an Expansionary Fiscal Policy is in place to increase aggregate demand (and ultimately output).
Accoridng to economists, when is an expansionary fiscal policy ok? (Deficit spending)
If:
- GDP (economic production) is below potential
- Financial sector is failing to lend funds adequately
- Unemployment rates too high
When is a budget surplus ok?
When there is a contractionary fiscal policy to reduce aggregate demand (ultimately reducing inflation)
When is a contractional fiscal policy (budget surpluses) ok?
According to economists, it’s when:
- Economic prodcution is above potential
- There are concerns about boom econmic conditions or upcoming inflation rates that may be too high
Monetary Policy
Efforts of FED to manage credit conditiosn, interest rates, and money supply. They can also carry out a expansionary MONETARY policyand a contractional MONETARY policy (dont confuse with expansionary FISCAL and contractional FISCAL)
When would an expansionary monetary policy be desirable? Contractional?
Expansionary monetary - to combat and reduce rising unemployment rates
Contractional Monetary - To reduce inflation rates
Key goals of monetary policy
- Maximizing economic growth
- minimizing unemployment rates
- Minimizing inflation rates
- Minimizing economic and financial flictiations (boom and bust cylces, etc)
Tools of the FED to carry out monetary policies
- Change the Reserve Requirement for banks (not used recently)
- Changing interest rate it charges banks for emergency short-term loans (not used recently)
- Open-market operations - adjust the federal funds rate - the rate banks charge eachother, then buy or sell t-bonds to assure target rates matched. Used more today
Examples of Open Market Operations being done if concerned about high Unemployment rates
Can conduct and EXPANSIONARY MONETARY POLICY. Would lower the target rate for the federal funds rate, then buy gov. securities on the open market.
Seems contradictory, but they spend money to increase the amount of reserves availible for banks to lend out (increasing the money supply)
Open Market Operations being conducted when concerned about a boom or inflation?
Conduct CONTRACTIONARY MONETARY POLICY:
- Increase the target rate for federal funds rate
- Sell government securities (takes money away from banks). Thus, money supply is decreased
Economic Theories
1. Classical Economic Theory - No economic intervention required
- Keynesian Theory - Favors FISCAL policy (lower taxes, more government spending)
- Monetarist Theory - Supports MONETARY theory. (Lots of open market operations)
- Supply-side theory - focuses on the supply curve - “economy’s ability to supply more goods is the most effective way to stimulate economic growth”. Thus, remove more impediments of supply shifts, such as high and unmotivating taxes
- New keynesian theory - Use both Fiscal and Monetary
- Austrian Theory - when excessively low interest rates push companies to undertake long-term projectsthat understiamte demand, resuting in oversupply in one sector (thus higher unemployment)
Components to Compute GDP
(question 1s-8)
“GDP is the sum of consumption, investment, government spending, and net exports”.
NOT part of GDP:
- Household Income
- Financial transactions
- Secondhand Sales
(1s-32) A company has a policy of frequently cutting prices to increase sales. Product demand is significantly elastic. What impact would this have on the company’s situation?
A. Quantity increases proportionally more than the price declines
B. Quantity increases proportionally less than the price declines
C. Price increases proportionally less than the quantity declines
D. Price increases proportionally more than the quantity declines
A. Quantity increases proportionally more than the price declines.
This requires understanding of the Price Elasticity of Demand:
% Change in Quantity Demanded
% Change in Price
(1s-36) If a CPA’s client expected a high inflation rate in the future, the CPA would suggest to a client which of the following types of investments?
A. Precious metals
B. Treasury Bonds
C. Corporate Bonds
D. Common Stock
A. Precious metals
B and C are bonds, which have face values that are fixed and not adjusted for inflation. Common Stock, D, can possibly help, but it also depends on so many other things (industry growth, competition, etc). Thus, precious metals retain the most value independent of an underlying currency.
(1s-37) How does inflation distort reported income?
A. Wages are not reflective of current labor rates
B. Sales are not reflective of current product prices
C. Depreciation is not reflective of current fixed-asset replacement costs
D. Interest expense is not reflective of current borrowing rates
C. Depreciation is not reflective of current fixed-asset replacement costs
It’s C basically because depreciation is based off of a historical cost. Wages usually increase with inflation (increasing costs of living willforce workers to negotiate higher pay). Sales depends on whatever the company sets, so in inflation they obviously set higher prices. Lastly, interest in the short term is based on current rates. Long-term related interest usually has provisions for adjustments for inflation.
Which formula must be used to compute percentage changes for account balances? (1s-39)
Current Balance - Prior Balance
Prior Balance
(#2194) As time elapses:
Consumers become MORE SENSITIVE to change in price and demand is MORE ELASTIC
“As time elapses, consumers have more time to switch to other goods…”
