ECO 2030 1nd Edition Exam 1 Study Guide Lectures 1 15 ECO 2030 Exam 1 Study Guide Economy means oikonomos in Greeks Economy the study of how a society manages its scarce resources Economists study how people make decisions how people interact and how different forces and trends affect the economy 10 Principles 1 people face trade offs 2 the cost of something is what you give up to get it a Opportunity cost what you give up to obtain something different 3 rational people think at the margin a rational people systematically and rationally do the best they can to achieve the best outcome b Marginal changes small incremental adjustments c Marginal Benefits the additional benefits d Marginal costs additional costs e Efficiency criteria Marginal benefits marginal costs 4 People respond to incentives a Higher price people buy less and lower price people buy more b Higher price sellers produce more and lower price sellers produce less 5 Trade can make everyone better off a Allows specialization b we can enjoy a greater variety of goods and services for less cost 6 Markets are usually a good way to organize economic activity a rather than central planners determining prices and allocating resources prices themselves regulate the supply and demand and prices through decentralized decisions of firms and households b Adam Smith s invisible hand households and firms interacting in markets act as if they are guided by an invisible hand which leads them to desirable market outcomes i Corollary government intervention This prevents the natural market outcome of the invisible hand 7 Governments can sometimes improve market outcomes a Government enforces rules b enforce property rights promote efficiency and equality helps avoid inconsistency in economic well being 8 A country s standard of living depends on its ability to produce goods and services a the gap between living standards is explained by differences in productivity b Productivity the quantity of goods produced by each unit of input c Growth rate of a nation s productivity determines growth rate of individual incomes 9 Prices rise when the government prints too much money a Inflation when the government prints too much money and prices rise 10 Society faces a short run trade off between inflation and unemployment a In the short run monetary injections stimulate spending good for the economy b More spending higher prices more goods and more work c Business cycle fluctuations in economic activity The 2 roles of an economist 1 Scientist try to explain the world develop and test theories about how the world works 2 Policy advisor try to improve the world The Circular flow diagram A visual model of the economy shows flow of money between households and firms The 2 types of actors households and firms The 2 types of Markets for goods and services and for Factors of Production Factors of Production Things the economy needs to produce goods and services labor land and capital which is buildings machines etc Households own the factors of production and sell or rent them for income Households buy and consume goods and services Firms buy or hire factors of production to produce goods and services Firms sell goods and services The production possibilities frontier a graph that shows the combination of two goods an economy can produce given the available resources technology and labor Also the line separates the infeasible from the feasible anything to the outside of the line is not possible everything on the line is possible and efficient and possible anything under the line is possible but inefficient resources not fully utilized Any movement along the line resembles an opportunity cost by the slope of the line what you give up to get something else Calculating the rise run will give you the opp cost Remember the steeper the slope of the PPF the greater the opportunity cost the less steep the smaller the opportunity cost Shifts to the PPF if an economy aquires more resources labor or an advancement in technology the PPF can shift outwards if a war or a natural disaster happens it would shift inward The Shape of the PPF in real life the PPF is usually bow shaped meaning the opp cost is not constant along the curve Again the point on the curve that is steepest has the greatest opportunity cost this is because different workers may be better at producing one good than another so the more shifts you make along the curve the less workers you will have that can make the shift efficiently thats why the opp cost is higher Normative Statements attempt to describe what ought to be do not need to be provable or disputable and are made when economists play the policy advisor role Positive statements describe what is with facts do not have to be correct but have to be provable or disputable made when economists play the role of scientists Trade Absolute advantage when a country can produce the same good with fewer inputs However it is not required that both countries have and absolute advantage to gain from trade Comparative advantage the ability to produce a good at a lower opp cost each country should specialize in the good that they have a lower opp cost Markets A Market a group of buyers and sellers of a particular product A Competitive Market has many buyers and sellers who have no effect on price A Perfectly Competitive Market where all goods are the same there are so many buyers and sellers that noone can affect the price they are all price takers Demand and supply Quantity demand the amount of a good that buyers are willing and able to pay Quantity supplied the amount that sellers are willing and able to sell Law of demand quantity demanded falls when price increases and quantity demanded increases when price falls Law of Supply Quantity supplied increases as price increases and quantity supplied decreases when prices fall Demand schedule shows the relationship between the quantity demanded at each price quantity demanded increases as price drops Supply schedule shows the relationship between quantity supplied and price quantity supply increases as price increases Market demand schedule the sum of all individuals demand schedules at each price MArket supply schedule the sum of all sellers supply schedules at each price Demand and supply schedules can be plotted and become demand curves Demand curve shifters things that pertain to changes in consumers demand not price related Increase of number of buyers shifts right Increase in income shifts right