Final Exam Study Guide 04 21 2014 Chapter 1 Economics study of the choices people make to attain their goals Scarcity unlimited wants exceed the limited resources available to given scarce resources fulfill those wants Rationality assumption economists generally assume that people are rational people use available info as they act to achieve goals weigh costs and benefits Fundamental questions o What goods and services will be produced o How will the goods services be produced o Who will receive the goods services produced Three key economic ideas o People are rational o People respond to economic incentives o Optimal decisions are made at the margin Marginal Analysis analysis that involves comparing marginal benefits and marginal costs o Economists use marginal to mean extra or additional o Opportunity cost highest valued alternative that must be given up to engage in activity Centrally planned economy gov t decides how economic resources will be allocated Market economy decisions of households and firms interacting in markets allocate economic resources Mixed Economy most economic decisions result from interaction of buyers and sellers in markets but gov t plays significant role in the allocation of resources Efficiency and Equity there is often a tradeoff between efficiency and equity possible cost o Productive efficiency good service is produced at lowest o Allocative efficiency production is in accordance with consumer preferences in particular every good service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of o Equity the fair distribution of economic benefits Scientific method economic model producing it o Method Decide on assumptions to use in developing model Formulate a testable hypothesis Use economic data to test the hypothesis Revise the model if it fails to explain the economic data well Retain the revised model to help answer similar economic questions in the future o Economic variable something measurable that can have different values such as the incomes of doctors Positive analysis concerned with what is Normative analysis concerned with what ought to be Microeconomics study of how households and firms make choices how they interact in markets and how the gov t attempts to influence their choices Macroeconomics the study of the economy as a whole including topics such as inflation unemployment and economic growth Chapter 2 Production possibilities frontier curve showing max attainable combinations of two products that may be produced with available resources and current technology Opportunity cost highest valued alternative that must be given up to engage in activity Increasing marginal opportunity costs bowed outward PPF occurs because some workers machines and other resources are better suited to one use than another Economic growth the amount of physical capital available in the Specialization and gains from trade see trade example on country increases ipad o Absolute advantage ability of an individual firm or country to produce more of a good or service than competitors using the same amount of resources o Comparative advantage ability to produce good service at a lower opportunity cost than competitors Basis for trade Specialize in something when you have the comparative advantage and then trade Market group of buyers sellers of a good service and the institution or arrangement by which they come together to trade o Product market market for goods and services Households are demanders firms are suppliers o Factor market market for the factors of production labor capital natural resources and entrepreneurial activity Circular flow diagram see ipad Legal basis of market system o Property rights rights that individuals firms have to the exclusive use of their property including the right to buy or sell it o Intellectual property rights CHAPTER 3 Law of demand ceteris parabis when the price of a product falls the qty demanded of the product will increase and vice versa Quantity demanded amount of a good service a consumer is willing able to purchase at a given price Market demand demand by all the consumers of a given good or Variables that shift demand service o Income o Prices of related goods o Taste o Population and demographics o Expected future prices Substitution effect change in qty demanded of a good that results from a change in price making the good more less expensive relative to other goods that are substitutes Complements when the price of a good that is a complement increases the qty demended for the complement decreases Law of Supply increases in price cause increase in qty supplied and vice versa Quantity supplied amount of a good or service that a firm is willing and able to supply at a given price Variables that shift market supply o Price of inputs o Technological change o Prices of substitutes in production o Number of firms in market o Expected future prices Market Equilibrium quantity demanded quantity supplied Surplus quantity supplied quantity demanded Shortage quantity demanded quantity supplied CHAPTER 4 Consumer Surplus difference between the highest price a consumer is willing to pay for good service and the price the consumer actually pays o The area on the supply demand graph above the market price line and below the demand curve Marginal Benefit additional benefit to consumer from consuming one more unit of a good or service o Consumer surplus measures the net benefit to consumers Producer surplus difference between lowest price a firm would be willing to accept and the price it actually receives o Area on graph below market price and above supply curve Marginal Cost additional cost to a firm of producing one more unit of a good or service o Producer surplus measure net benefit to producers Surpluses in competitive equilibrium o Marginal benefit marginal cost in comp equilibrium o Deadweight loss reduction in economic surplus resulting from a market not being in economic equilibrium Price Floor legally determined minimum price that sellers may receive o Most common minimum wage Price Ceiling legally determined maximum price o Most common rent control Tax incidence actual division of the burden of a tax between buyers and sellers is tax incidence CHAPTER 7 Comparative advantage produce at a lower OC than competitors Terms of trade ratio at which a country can trade its exports for imports Sources of comparative advantage o Climate and natural resources o