Exam 1 Flashcards
Scarcity
The limited nature of society’s resources
Nothing is infinite in nature—not even air and water!
Economics
The study of how people allocate their limited resources to satisfy their nearly unlimited wants
The study of how people make decisions
Macroeconomics
Looks at the broader economy, including inflation, growth, employment, interest rates, and productivity
What happens to the economy if there is widespread unemployment?
The Federal Reserve decreases interest rates to spur spending and kick start the economy
The study of the broader economy
The Five Foundations of Economics
Incentives matter
Life is about trade-offs
Opportunity costs
Marginal thinking
Trade creates value
- Incentives Matter
Incentives - Factors that motivate you to act or
exert effort
People respond to incentives!
Incentives are everywhere, and
financial gain often plays a prominent role
Positive incentives -
Tax refund, pay raise, employee of the month award, sticker and a smiley face, extra credit
Negative incentives -
Taxes, jail, fees, fines, spankings, getting grounded, getting fired, failing class
- Life is About Trade-offs
With scarcity, decisions incur costs
Individual examples
Go to theater: do I watch the action movie or the romantic comedy?
Go to food court: do I eat at Sbarro’s or Fuji Garden?
After high school: do I attend Ohio State or Michigan?
Which president do I vote for?
- Opportunity Cost
Opportunity Cost
The highest-valued alternative that must be sacrificed in order to get something else
Multiple trade-offs, but only one opportunity cost
Not all alternatives, just the next best choice
In economics:
The cost of something is what you give up to get it
Scarcity–> Choice –>Opportunity Cost
Opportunity Cost
go to the mall or the pool?
Opportunity cost of going to the mall: Lost opportunity to go to the pool Opportunity cost of going to the pool: Lost opportunity to go to the mall Decision-making key: Minimize opportunity cost by selecting the option that has the largest benefit. Go to whichever you enjoy more, the pool or mall.
- Marginal Thinking
Evaluate whether the benefit of one more unit of something is greater than the cost
Margin examples: one more unit (slice of pizza), one more hour of activity (studying, sleeping)
- Trade Creates Value
Markets
Bring buyers and sellers together to exchange goods and services
Trade
The voluntary exchange of goods and services between two or more parties
Key word = voluntary
You don’t engage in trade if it makes you worse off; therefore, trade only occurs if both parties feel they gain from the trade!
Comparative Advantage
The situation in which an individual, business, or country can produce at a lower opportunity cost than a competitor
Allows gains from trade to occur
Trade Specialization
You go to Starbucks to get coffee.
You go to the doctor when you’re sick.
You don’t have to do everything yourself: people specialize in what they’re best at (lowest opportunity cost) and you can trade with them.
What can be said about scarcity?
Scarcity forces us to make choices.
Scarcity doesn’t affect the super-wealthy.
Scarcity only affects commodities such as oil.
Scarcity generally doesn’t affect our day-to-day living.
Positive statement
A claim that can be tested to be true or false
Normative statement
Statement of opinion; cannot be tested to be true or false
What “ought to be” or “should be”
Why is the PPF downward-sloping?
Must give up one good to increase production of another
Why are we unable to produce certain combinations for the PPF?
Scarcity and limited resources
Efficient points for the PPF
Points ON the PPF (A, B, C, and D)
Inefficient points for the PPF
Points INSIDE the PPF (F)
Workers goofing off, unused buildings
Unattainable (for now) points for the PPF
Points OUTSIDE the PPF (E)
Law of increasing relative cost
Refers to the increasing opportunity cost of production that occurs as you move along the production
As we produce more of good A, we have to give up increasingly larger amounts of good B.
The PPF could shift graphically in two ways
New resources or technology could be introduced that either… Affect the production of one good, or Affect the production of both goods.
Absolute advantage
One person can perform each task more effectively than the other person.
Consumer goods
Goods produced for current consumption
Food, housing, clothing, entertainment
Capital goods
Goods that help produce other valuable goods
Buildings, factories, roads, machinery, computers
Investment
Using resources to make new capital
Elasticity
Responsiveness of buyers and sellers to changes in market conditions.
Why is Elasticity Important
Prices or other demand and supply determinants could change.
Understanding elasticity will help us improve the predictive power of our basic economic model.
Instead of just knowing the direction of a variable change, we can study the size of the change
Price elasticity of demand
A measure of the responsiveness of quantity demanded to a change in price
This gives us the sensitivity of the relationship between these two variables.
Demand is elastic if
Quantity demanded changes significantly as the result of the price change
Elastic = “sensitive” or “responsive”
The Determinants of the Price Elasticity of Demand
Existence of substitutes
Share of the budget spent on the good (expensive items)
Time adjustment process
Existence of substitutes
Goods with lots of substitutes
Canned vegetables, breakfast cereals, many types of products with multiple brands
More elastic
Goods with no good substitutes
Broadway theatre, rare coins, autographs, drinking water, electricity, Super Bowl tickets, medication.
More inelastic
Share of the budget spent on the good
Demand is more elastic for “big ticket” items that make up a large portion of income.
Demand is more inelastic for inexpensive items.
Which would you react to more?
20% sale on a new vehicle you want
20% sale on candy bar
Time and adjustment process
Generally, demand for goods tends to become more elastic over time.
Over time, consumers are
More able to find substitutes
More able to adjust for price changes in other ways
Market economy
Resources are allocated among households and firms with little or no government interference.
The “main” economic structure of the United States
Prices are determined by the forces of supply and demand.
Buying and selling is voluntary.
Characteristics of a competitive market
Many buyers and sellers
No one individual has any influence over the price.
The price is determined by the entire market
Quantity demanded
The amount of a good purchased at a given price
Law of demand
All other things equal, there is an inverse relationship between price and quantity demanded
Inverse: two variables move in opposite directions
Income, diminishing marginal utility, and the substitution effect dictate the law of demand
Income effect
as prices go up, income stays relatively steady so if the price goes above someone’s income, they are out of the market
Diminishing marginal utility
The satisfaction of doing something goes down every time that you use it
Substitution effect
when something gets too expensive, we look for an alternative
Market demand
Horizontal sum of all individual quantities demanded by each buyer in the market at each price
Movement along a demand curve
Caused by a change in the price of the good
Inverse relationship between price and quantity demanded
Shift in demand
Caused by changes in non-price factors
Events that change the
entire market
Entire demand curve will shift to the left or right
Demand Shifters
- Changes in income
- Price of related goods
- Changes in Tastes and Preferences
- Future expectations
- Number of buyers
- Changes in income
Normal good -
Good in which we buy more of when we get more income
Off brand items to name brand items
As income goes up, the demand for higher quality goods goes up
Direct relationship between income and demand
Inferior good -
Good in which we buy less of when we get more income
Name brand goods to off brand goods
As income goes down, demand for less quality goods goes up
Inverse relationship between income and demand
- Price of related goods
Complements -
Two goods used together
If the price of ski’s go down, the demand for ski boots would go up because people who bought the ski’s now need boots
Inverse relationship between the price of good X and demand for good Y
Substitutes -
Goods that can be used in place of each other
If the price of Coke goes down, the demand for Pepsi would go down
Direct relationship between the price of good X and demand for good Y
- Changes in Tastes and Preferences
A good may become more fashionable or may come into season.
New style becomes popular Demand increases (shifts right) as a result
A good may go out of style or out of season.
Demand decreases (shifts left)
Lower demand for frozen pizza in summer
New information about a good
Can change tastes for better or worse
Taking an asprin a day will help reduce the risk of heart attack
- Future expectations
Our consumption today may depend on what we think the price may be tomorrow.
- Number of buyers
Recall the market demand curve
More individual buyers means more market demand.
Aging, immigration, war, and birth rates can affect the number of buyers for various goods.
Assume you like Pepsi, and your income increases.
What happens to the demand/quantity demanded
The demand for Pepsi increases.
Assume the price of Pepsi decreases.
What happens to the demand/quantity demanded
The quantity demanded for Pepsi increases.
Assume the price of Coke decreases.
What happens to the demand/quantity demanded
The demand for Pepsi decreases.
Factors that shift the Demand Curve to the left
Income falls (Demand for a normal good)
Income Rises (Demand for an inferior good)
The price of a substitute falls
The price of a complementary good rises
The good falls out of style
There is a belief that the future price of this good will decline
The number of buyers in the market falls
Factors that shift the Demand Curve to the right
Income rises (Demand for a normal good
Income Falls (Demand for an inferior good)
The price of a substitute good rises
The price of a complementary good falls
The good is currently in style
There is a belief that the future price of the good will rise
The number of buyers in the market increases
Which of the following would increase the demand for drinks the most?
Reduction in the price of a complementary good such as an appetizer and the
Reduction in the price of drinks
Law of supply
All other things equal, there is a direct relationship between price and quantity supplied.
Direct: two variables move in the same direction
Market supply
Horizontal sum of all individual quantities supplied by each seller in the market at each price
Movement along a supply curve
Caused by a change in the price of the good
Direct relationship between price and quantity supplied
Shift in supply
Caused by non-price factors
Entire supply curve will shift to the left or right
Supply Shifters
- The cost of inputs
- Changes in technology
- Taxes and subsidies
- Number of sellers
- Price expectations
- The cost of inputs
Inputs -
Resources used in the production process
Direct relationship between input costs and supply curve
If per unit cost of production goes up, the amount of units available to the market will go down
- Changes in technology
Knowledge that producers have about how to produce a product
Direct relationship between level of technology and supply
- Taxes and subsidies
Tax paid by producer –> added cost of production
Inverse relationship
between taxes and supply
As taxes go down, production cost goes down so production goes up
Subsidy
“Opposite” of a tax; government pays sellers to produce goods.
Direct relationship between subsidies and supply
As subsidies go up, production also goes up
- Number of sellers
Recall the market supply curve
More individual sellers means more market supply.
- Price expectations
Higher price expected tomorrow? If so, delay sales until future, if possible.
Inverse relationship between tomorrow’s expected price and today’s supply
Assume the price of cheese decreases. What will happen in the pizza market?
The supply of pizza increases. – because it didn’t say that the price of pizza changed
Which of the following will cause the supply curve for oranges to shift to the left?
Ice storm strikes Florida
In general, why would the
government enact tougher
pollution standards or tax a
polluting firm?
Pollution is bad!
Political reasons
Encourage the firm to invest in cleaner production methods
How is the price of a good determined?
The market forces of supply AND demand work simultaneously to determine the price.
The law of supply and demand
The price of any good will adjust to bring the quantity supplied and quantity demanded into balance.
Equilibrium point
Graphically, the intersection of supply and demand
Equilibrium price
The price that causes quantity supplied to equal quantity demanded.
The price that “clears the market”
Equilibrium quantity
The numerical quantity (supplied and demanded) at the equilibrium price
Shortage
QD > QS
Occurs at any price below equilibrium
Price will rise over time toward equilibrium
Why does price rise over time with a shortage?
Consumers who value the product will “outbid” other consumers or otherwise show a higher willingness to pay.
Suppliers will see that the price can be raised without a decrease in sales.
Surplus
QS > QD
Occurs at any price above equilibrium
Price will fall over time toward equilibrium.
Why does price fall over time with a surplus?
Firms will have to eventually get rid of mounting inventories of goods.
To do this, they must lower their prices.
PPC Shifters
Change in resource quality/quantity
Change in technology
Change in trade
What is the difference between a change in Qd and a change in demand itself?
Change in demand is caused by non-price factors while a change in Qd comes from a change in price
Demand related to substitutes (linear/inverse)
Linear (as price for A goes up, demand for B goes up)
Demand related to complements (linear/inverse)
Inverse (as price for A goes up, demand for B goes down)
Demand related to normal goods (linear/inverse)
Linear (as income for A goes up, demand for B goes up)
Demand related to inferior goods (linear/inverse)
Inverse (as income for A goes up, demand for B goes down)
Price Ceiling
Maximum legal price a seller can charge for a product.
Goal: Make affordable by keeping price from reaching Eq.
Price Floor
Minimum legal price a seller can sell a product.
Goal: Keep price high by keeping price from falling to Eq.
Subsidies
The government just gives producers money.
The goal is for them to make more of the goods that the government thinks are important.
Double Shift Rule
If TWO curves shift at the same time, EITHER price or quantity will be indeterminate (ambiguous).
Consumer surplus graphically:
The height of the demand curve is our maximum willingness to pay for that unit of the good.
Consumer surplus is the area below the demand curve and above the price, for all units purchased.
Producer surplus graphically:
The height of the supply curve is the firm’s lowest price it is willing to accept to sell that unit of the good.
Producer surplus is the area above the supply curve and below the price, for all units sold.
