ECON 202 1nd EditionExam # 1 Study Guide Lectures: 1 - 11What is Economics?Economics – the study of people’s choice about their resources versus their wantsScarcity is the fundamental problem in economicsFive Foundations of Economics1.Incentives Mattera. Positive – encourages behaviorb. Negative – discourages behaviorc. Indirect – action affects the industry/person its taken in or byd. Direct – action affects an industry/person that is seemingly unrelated to the original action2.Life is about Trade-Offs – scarcity forces trade-offs of different things people want3.Opportunity Costs – way to measure the lose from a trade-off4.Marginal Thinkinga. Marginal Benefit – number of units of utility (happiness, satisfaction, etc.) that anadditional unit of a good/service providesb. Law of Diminishing Marginal Utility – marginal benefit decreases as the number of units increases5.Trade Creates Value – if a trade takes place both parties are “better-off”Model Building and Gains from TradeProduction Possibilities Frontier (PPF) – graph that shows all the possibilities of goods and services an economy can produce- Attainable – point of production that resides on or within the PPF; can be produced- Unattainable – point of production that resides outside of the PPF; cannot be produced- Productive efficiency – point of production where the number of one good being produced cannot be increased without decreasing production of the other good- Productive inefficiency – point of production where the amount of one good being produced can be increased without decreasing production of the other goodOpportunity Cost – the “cost” of producing one good over another good- The slope of the PPF tells you the opportunity cost for any combination of goods at a certain point- PPF’s can be linear or bowed-outo Linear – constant opportunity costo Bowed-out – increasing opportunity costEconomic GrowthCan occur if:1. The resources of an economy increase2. The technology of an economy increases- Cost of Economic Growth - In order to grow economically, some consumer goods must be given upSpecialization and Trade- Absolute advantage – one producer can produce more of a good than another producer with the same resources- Comparative advantage – one producer can produce a good at a lower opportunity cost than another producerWhen comparative advantage is present, countries can improve their well being through specialization and trade- Countries specialize in production of one good and then trade the excess to another country for a different goodA trade agreement looks to make both countries better off, to do this the amount traded of one good should be between opportunity cost of both countries to produce that good.Gains from Trade – amount of the goods that could not have been produced by the country alone- Trade does not make everyone happier (outsourcing), but it makes the economy “better-off”Markets and the Nature of CompetitionMarket – interaction of buyers and sellersSpectrum of Economic SystemsPure Communism – nothing is privately owned; the government decides what and how much is producedPure Capitalism – nothing is publically owned; the market decides what and how much is producedSupply and Demand- Prices are signals that steer resourcesDemand – the relationship between the price of a good and the quantity of that good buyers are wiling and able to buy; all things held equal (constants)- Law of Demand - Demand curves slope downwards; negative relationship between price and quantity of a good demandedo Reasons for the Law of Demandi. Substitution Effect – if the price of a good rises, the price of all other goods fall relativelyii. Income Effect – if price falls, buying bower increasesChange in Demand versus Change in Quantity Demanded- A change in demand is a change in the relationship between the price and the quantity demanded of a goodo One of the constants has to change for the demand to change- A change in quantity demanded is a change in how much of a good is wanted at a certain priceThings that will shift a demand curve1. Changes in buyers income – preferences can affect if a good is considered normal or inferiora. Normal goods – demand increases when income increases and vice versab. Inferior goods – demand decreases when income increases and vice versa2. Changes in the price of related goodsa. Substitutes – an increase in the price of good Y causes an increase in the demandfor good Xb. Compliments – an increase in the price of good Y causes a decrease in the demand for good X3. Changes in Buyers Tastes4. Changes in Population and Demographics5. Changes in Buyers expectations of Future PriceSupply – the relationship between the price of a good and the quantity of that good seller are willing and able to sell: all things equal (constants)- Law of Supply – other things equal the higher the price of a god the greater the quantity suppliedChange in Supply versus Change in Quantity Supplied- A change in supply is the change in the relationship between the price and the quantity of a good supplied- A change in Quantity supplied is a change in how much suppliers are willing to sell for a certain priceThings that will shift a Supply Curve1. Changes in Input Prices – an increase in the price of an input used to produce a good decreases the supply of the good2. Technological Change – a technological advancement causes a decreases in input costs and an increase in supply and vice versaa. Similar to PPFs3. Changes in the Prices of Substitutes in Production – if X and Y are substitutes in production then an increase in the price of X causes a decrease in the supply of Y and vice versa4. Changes in the Number of Sellers in the Market – if the number of sellers increases the supply increases and vice versa5. Changes in expected Future Price – if expected future price increases, then current supply decreasesThree Market Conditions1. Equilibrium (Market Clearing Price) – when quantity supplied equals quantity demanded at the going price2. Excess Supply (Surplus) – when quantity supplied is greater than quantity demanded at the going price3. Excess Demand (Shortage) – quantity supplied is less than quantity demanded at the going price- At any given time, a market is either in equilibrium or moving towards itElasticitySensitivity – how a change in price affects the quantity of a