Econ200 Exam1 What is economics Economics is the study of how society manages its scarce products Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society Equality is the property of distributing economic prosperity uniformly among the members of society Positive vs normative statements Positive statements are claims that attempt to describe the world as it is descriptive facts Ex 1 If taxes were lowered government revenues would actually increase Ex 2 When the government taxes the rich and gives the money to the poor it gives the rich incentive to hide their earnings from the government Normative statements are claims that attempt to prescribe how the world should be ought to be values Ex 1 Taxes are too high Ex 2 It is immoral for a government to redistribute money from one person to another Equilibrium Equilibrium is a situation in which the market price has reached the level at white quantity supplied equals quantity demanded Ceteris paribus Ceteris paribus means to hold all else constant Association vs causation Calculating slopes direct vs indirect relationships A direct relationship between two variables means that they move in the same direction If one increases the other increases If one decreases the other decreases An inverse relationship means that the variables move in opposite directions If one increases the other decreases opportunity cost Opportunity cost is whatever must be given up to obtain some item PPF efficient inefficient unattainable The production possibilities frontier PPF is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available production technology that firms use to turn these factors into output Efficient on the curve Inefficient below the curve Unattainable above the curve law of increasing opportunity cost The law of increasing opportunity cost states that as production of a product increases the cost to produce an additional unit of that product increases as well Some resources are specialized to only efficiently produce one product so using those specialized resouces on a different product is inefficient economic growth comparative advantage Comparative advantage is the ability to producer a good at a lower opportunity cost than another producer Producers specialize in the production of a product in which they have a better comparative advantage Producers come to terms of trade in order to trade the good they specialize for other goods Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage For both parties to benefit from trade the price at which they trade must lie between the two opportunity costs Absolute advantage is the ability to produce a good using fewer inputs than another producer law of demand why does it hold The law of demand is the claim that other things equal the quantity demanded of a good falls when the price of the good rises Shifts in the demand curve determinants of demand income if demand for a good falls when income falls the good is called a normal good if demand for a good rises when income falls the good is called an inferior good price of related goods substitutes demand goes down compliments demand goes up tastes expectations number of consumers The flatter the demand curve that passes through a given point the greater the price elasticity of demand individual vs market demand law of supply why does it hold The law of supply is the claim that other things equal the quantity supplied of a good rises when the price of the good rises Shifts in the supply curve determinants of supply input prices technology expectations number of sellers price of the good itself variable represents movement along the supply or demand curve A surplus is a situation in which the quantity supplied is greater than the quantity demanded Surplus Shortage A shortage is a situation in which the quantity demanded is greater than quantity supplied Law of supply and demand The law of supply and demand is the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into baland Welfare economics Welfare economics is the study of how the allocation of resources affects economic well being consumer surplus A consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it Well being of the buyers Demand curve reflects the buyer s willingness to pay The area below the demand curve and above the price measures the consumer surplus in a market producer surplus A producer surplus is the amount a seller is paid for a good minus the seller s cost of providing it Well being of the sellers Supply curve used to measure producer surplus The area below the price and above the supply curve measures the producer surplus in a market total surplus consumer surplus plus producer surplus price controls ceilings and floors A price ceiling is a legal maximum on the price at which a good can be sold buyers happy 2 outcomes a price ceiling price equilibrium not binding no effect b price ceiling price equilibrium binding constraint causes a shortage A price floor is a legal minimum on the price at which a good can be sold sellers happy 2 outcomes a price floor price equilibrium not binding no effect b price floor price equilibrium binding constraint causes a surplus c ex Price floor minimum wage Workers supply of labor firms demand Minimum wage equilibrium unemployment wage subsidy ex Earned income tax credit perfectly elastic elastic unit elastic inelastic perfectly inelastic Elasticity is a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants A product is elastic if quantity demanded responds substantially to changes in prices Goods with close substitutes more elastic Necessities inelastic Luxuries elastic Narrowly defined markets more elastic Goods tend to have a more elastic demanded over long time horizons i e gasoline Quantity moves proportionately more than the price Quantity moves proportionately less than the price Elastic when e 1 Inelastic when e 1 Perfectly inelastic e 0 Unit elasticity e 1 Same proportionality Demand inelastic increase in price causes an increase in total revenue Demand elastic increase in price causes a decrease in total revenue Same direction Opposite
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