UMD ECON 200 - Chapter 1 – Ten Principles of Economics

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Chapter 1 Ten Principles of Economics 1 People face trade offs o Efficiency and equality 2 the cost of something is what you give up to get it o Opportunity cost Whatever is given up to obtain something 3 rational people think at the margin o rational people o marginal change people who think normally and systematically a small incremental adjustment to a plan of action 4 People respond to incentives 5 Trade can make everyone better off 6 Markets are usually a good way to organize economic activity o market economy an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services 7 Government can sometimes improve market outcomes o property rights the ability of an individual to own and exercise control over scarce resources a situation in which a market left on its own fails to allocate resources efficiently the impact of one person s actions on the well being of a bystander o market failure o externality o market power the ability of a single economic actor to have a substantial influence on market prices 8 a country s standard of living depends on its ability to roduce goods and the quantity of goods and services produced from each unit of labor input 9 prices rise when the government prints too much money an increase in the overall levels of prices in the economy 10 society faces a short run trade off between inflation and services o productivity o inflation unemployment o business cycle fluctuations in economic activity such as employment and production Chapter 2 Thinking Like an Economist The Economist as Scientist o Economists pay close attention to the natural experiments offered by history o Economists make assumptions because they can simplify the complex world and make it easier to understand o The art of scientific thinking is to figure out which assumptions to make Circular Flow Diagram o A visual model of the economy that shows how dollars flow through markets among households and firms Production possibilities frontier o A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology Positive vs normative analysis o Positive statements o Normative statements Why do Economists Disagree Claims that attempt to describe the world as it is Claims that attempt to prescribe how the world should be o They make different assumptions about policy and the world that lead to different outcomes Chapter 4 Supply and Demand Markets and Competition o Market o Competitive Market Demand o Quantity demanded A group of buyers and sellers of a particular good or service A market in which there are many buyers and sellers so that each has a negligible impact on the market price The amount of a good buyers are willing and able to purchase o Law of demand o Demand schedule o Normal good in demand o Inferior good The claim that other things equal the quantity demanded of goods falls when the prices of goods rises A table that shows the relationship between the price of a good and the quantity demanded A good for which an increase in income leads to an increase A good for which an increase in income leads to a decrease in demand o Substitutes o Complements Two goods for which an increase in the price of one leads to an increase in demand for the other Two goods for which an increase in the price leads decrease in demand for the other Supply o Quantity supplied o Law of supply The amount of a good that sellers are willing and able to sell The claim that the quantity supplied of a good rises when the price of a good rises o Supply schedule good and quantity supplied o Supply curve A table that shows the relationship between the price of a A graph of the relationship between the price of a good and the quantity supplied Supply and Demand Together o Equilibrium A situation in which the market price has reached a level at which quantity supplied equals quantity demanded The price that balances quantity supplied and quantity o Equilibrium price demanded o Equilibrium quantity The quantity supplied and the quantity demanded at the equilibrium price o Surplus o Shortage A situation in which quantity supplied is greater than quantity demanded A situation in which quantity demanded is greater than quantity supplied o Law of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and quantity demanded for the good into balance Chapter 5 Elasticity and Its Application The Elasticity of Demand o Elasticity A measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants o Price of elasticity of demand A measure of how much the quantity demanded of a good responds to a change in the price of that good computed as the percentage change in quantity demanded divided by the percentage change in price o Determinants of Elasticity Availability of close substitutes Necessities vs luxuries Definition of the market Time horizon o Total revenue The amount paid by buyers and received by sellers of a good computed as the price of goods times the quantity sold o General rules When demand is inelastic a price elasticity less than 1 price and total revenue move in the same direction When demand is elastic price elasticity greater than 1 price and total revenue move in opposite directions If demand is unit elastic exactly equal to 1 total revenue remains constant when the price changes o Income elasticity of demand A measure of how much the quantity demanded of a good responds to a change in consumer s income computed as the percentage change in quantity demanded divided by the percentage change in income o Cross price elasticity of demand A measure of how much the quantity demanded of one good responds to a change in price of another good computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second The Elasticity of Supply o Price elasticity of supply A measure of how much the quantity supplied of a good responds to a change in the price of that good computed as the percentage change in quantity supplied divided by the percentage change in price Chapter 6 supply Demand and Government Policies Controls on Prices o Price ceiling o Price floor Taxes o Tax incidence A legal maximum on the price at which a good can be sold A legal minimum on the price at which a good can be sold The


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UMD ECON 200 - Chapter 1 – Ten Principles of Economics

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