Microeconomics Test 1 Study Guide Economic Methodology 1 9 14 Broken Window fallacy creating jobs only takes other jobs away from a different area The ones who think like this ignore OPPORTUNITY COST Methodological fallacy correlation does not imply causation Just because two events occur together doesn t meant that one causes another Correlation is the tendency for the value of two variables to move in a predictable way I Cause and effect relationship a Event A causes event B the first event is the cause of the second II Reverse Causation III Omitted Variable IV Spurious Correlation a Event B causes event A the second event causes the first This is basically the opposite of cause and effect relationship a Events A B are caused by a 3rd event C No cause and effect relationship between events A B a Event A is completely unrelated in a cause and effect way to event B Neither are the cause nor the effect 1 14 14 Basic Concepts of Economics I Scarcity a Requires making choices b The value of what you are giving up is the cost OPPORTUNITY COST available c Choosing one thing is the same as not choosing another When you make a choice you are forgoing the alternative d SCARCITY wants for resources are larger than the amounts e For a resource to be scarce the resource has have a limited amount AND a large enough desire for that resource II Choices a Principle of substitutions i There is always going to be situations where you will have choose between goods 1 Food as example There are so many kinds of food It depends on the WANT of the person III Opportunity Cost a The value you give up when you choose one thing over another b It has NOTHING to do with price Basic Concepts Continued 1 16 14 Marginal Cost change in total cost when there is a change in the amount of activity I The changes are small usually one unit changes IV Economic thinking is MARNGINAL THINKING a Thinking at the margins usually leads to the correct answer Averages b are frequently misleading It conserves on a scarce resource INFORMATION Trail and error in small amounts cost little and yields a lot of information Value is determined at the margins MB TB Q MB Marginal benefit TB Change in total benefit Q Change in quantity MC TC Q MC Marginal cost TC Change in total cost If MB MC you will need to increase You will gain the more you do of it If MB MC you will need to decrease You will want to do less of it MB MC it s the optimal amount Net gain will be greatest Basic economic decision rule marginal benefit equals marginal cost MB MC V Incentives a People respond to incentives Production Possibilities Frontier 1 21 14 I Productions Possibilities Frontier PPF a The boundary between the combinations of goods and services b We can produce at any point inside the PPF or on the frontier c Points outside the PPF are unattainable d Its separates attainable combinations from the unattainable ones Full employment occurs when all resources are being used and is represented with a point on the frontier Unemployment occurs when some resources aren t being used and is represented with a point inside the PPF Unemployment doesn t only mean people but all so resources II Tradeoffs a Tradeoffs limit what is possible to produce b c To get more of one good we must forgo some other good as we move It forces an exchange of one good for another alone the PPF d PPF is not affected by employment of resources You can move along the PPF but it won t cause the PPF the shift An increase in resources will cause the PPF to shift out A change in technology will so cause a shift in the PPF III Available Resources a Land anything that comes from the earth b Capital anything that will be used to produce good and services in the future i e equipment c Labor Labor force Employed Unemployed Government Spending G2 G1 B A A decrease in private spending and an increase in government spending cause the point on the PPF the move from A to B P2 P1 Private Spending Free Lunch untrue because you will always have to give something up You can t ignore OPPORTUNITY COST 1 23 14 Comparative Advantage I Comparative Advantage a One group might be better at both tasks however one has more of an advantage than the other so they choose to have the other perform the task b The ability to perform an activity or produce a good or service at a lower opportunity cost has the comparative advantage greater economic efficiency c Absolute advantage is when one person can perform a task better if all his energy was focused on it II Comments everything a A person state region or country can have an absolute advantage in b A person state region or country cannot have a comparative advantage in everything c Everyone has a comparative advantage in something III Law of Comparative Advantage a All groups gain by i Specializing in the production of goods for which their opportunity cost is relatively low ii Not producing goods for which their opportunity cost is iii Exchanging the goods they produce for other goods they wish relatively high to consume Demand and Supply 1 28 14 Prices are determined in a market by the interaction of both buyers and sellers in accordance with the laws of supply and demand I Demand a Demand curve is downward sloping b Price and quantity demanded have an inverse relationship i Demand is the entire curve quantity demanded is a single point on the curve c When there is a change in price you move along the demand curve not a shift in the curve d A change in demand cause a change in every quantity demanded II Change in demand are caused by a Prices of related goods b Consumer incomes c Buyer s expectations d Number of buyers e Preferences III Related Goods a Substitutes and complements b Example of complement for demand i Eggs and bacon are complements 1 Price of eggs increases 2 Quantity demanded of eggs decreases a move along the egg demand curve 3 The demand for bacon decreases a left shift in bacon c Example of substitutes for demand demand curve i Bacon and ham are substitutes 1 Price of bacon increases 2 Quantity demand of bacon decreases a move along the 3 Demand for ham increases a right shift in the ham bacon demand curve demand curve IV Buyer s Income a Normal superior goods most goods i If income goes up the demand for these goods also goes up No matter what the price for the good is b Inferior goods i If income goes up the demand for these goods goes down V Supply a Supply cure is upward sloping b Price and quantity supplied are directly related c Change
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