FSU ECO 2023 - The Economic Way of Thinking

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ECO2023 Microeconomics Final Exam Study Guide The Economic Way of Thinking There are always tradeoffs o Opportunity cost what you give up o NO free Lunch Individuals choose purposefully o Economizing most bang for your buck Incentives matter Think on the margin not in total or on average o Engage in the activity as long as the expected marginal benefit is greater than the expected marginal cost More information leads to better decision making but more info is costly to get Many choices create a secondary effect o Usually comes later and is not as clear or visible Value is subjective o Beauty is in the eyes of the beholder Economic thinking is scientific thinking o Economists use data and info to explain and predict actions Pitfalls to Avoid in Economic Thinking Violation of ceteris paribus other things constant Good intentions DO NOT necessarily result in good outcomes Association is not causation Fallacy of composition o What s good for the individual is good for the group Positive and Normative Economics Normative what ought to be Positive what is What Shall We Give up Opportunity cost what you give up Production Possibilities Curve On the curve efficient Outside the curve unattainable Inside the curve inefficient o Shift out growth produce more o Shift in shrink produce less The Importance of Property Rights Common rights everyone owns it Private rights only one person owns it o Incentives for private property Give proper care Conserve for future Use resources in ways others value Eliminate possible harm to others Trade Creates Value Two opposing views of trade o When people trade one person gains and the other person loses o When people trade both parties gain Voluntary trade creates wealth and promotes economic progress A transaction cost is a monetary or nonmonetary barrier that lowers the benefits of trade Trade Output and Living Standards Law of Comparative Advantage make something you re good at and trade for something you re not good at Changes in Demand vs Changes in Quantity Demanded Demand is the relationship between two variables o Price o Quantity Demanded NOT change When price changes quantity demanded changes but demand does o THIS IS A MOVEMENT ALONG THE CURVE When something else changes demand changes o THIS IS A MOVEMENT OF THE ENTIRE CURVE Changes are usually Income Number of consumers Price of substitutes Expectations Demographics Tastes and preferences Substitute goods used in place of each other Complement goods usually consumed at the same time Changes in Supply vs Changes in Quantity Supplied When price changes quantity supplied changes but supply DOES NOT change o THIS IS A MOVEMENT ALONG THE SUPPLY CURVE When something else changes supply changes o THIS IS A MOVEMENT OF THE ENTIRE CURVE Changes are usually Resource prices labor employees supplies Technology Nature Political economic status Taxes How Markets Respond to Changes in Demand and Supply Demand and Supply Analysis o Identify the change o Determine if supply or demand is affected and how o Draw and read graph Shift left in demand and supply curves decrease Shift right in demand and supply curves increase Invisible Hand Principle Adam Smith o Wealth of Nations o Personal self interest directed by market prices is a powerful force promoting economic progress Elasticity of Demand If price falls quantify demanded rises If price rises quantify demanded falls o Price elasticity seeks to quantify how much quantity demanded rises or falls o Price elasticity of demand percentage change in quantity demanded percentage change in price If elasticity 1 elastic consumers change behavior a lot If elasticity 1 inelastic consumers change behavior a If elasticity 1 unitary elastic consumers don t change little behavior Elasticity is determined by 1 Availability of substitutes a More substitutes more elastic 2 Share of budget a Greater share more elastic b Price of an object rises consumer is more elastic a More time to shop more time to find substitutes 3 Time How Demand Elasticity and Price Changes Affect Total Expenditures on a Product If elastic and price falls much more is purchased TR rises If elastic and price rises a lot less is purchased TR falls If inelastic and price falls a little more is bought TR falls If inelastic and price rises a little less is bought TR rises The Economic Role of Costs Accounting Profit total revenue total out of pocket costs Economic profit total revenue total out of pocket costs explicit costs opportunity costs implicit costs ZERO ECONOMIC PROFIT NORMAL PROFIT RATE Output and Costs in the Short Run ATC AVC AFC Marginal Cost initially falls for two reasons o Increasing marginal returns each additional input adds more to total output than the previous input o Learning by doing experience Marginal Cost rises later because of diminishing marginal returns o At some point each additional input adds less to total output than the previous input Marginal cost either pushes ATC up or down DIMINISHING MARGINAL RETURNS DETERMINE THE SHAPE OF THE COST CURVES Output and Costs in the Long Run In order to produce larger quantities the firm will need to grow and increase their capital Economies of scale benefit is getting bigger ATC is falling Diseconomies of Scale benefit is negative ATC is rising ECONOMIES OF SCALE DETERMINE THE SHAPE OF THE COST CURVES deadweight loss deadweight loss The Economics of Price Controls Price ceiling puts an upper limit on price generates a shortage and a Price floor puts a lower limit on price generates a surplus and a Deadweight Loss DWL loss of gains from trade loss of consumer surplus and producer surplus The Impact of a Tax Statutory incidence who is legally responsible to pay the tax Actual incidence who really pays the tax o Burden is shared between firms and consumers If the tax is legally imposed on sellers shift supply curve If the tax is legally imposed on buyers shift demand curve The more inelastic group has the biggest share of the burden Only people pay taxes not companies The company is just an intermediacy The Impact of a Subsidy The group with the smallest elasticity receives the biggest benefit The more inelastic you are the more taxes you pay but the more subsidy you get The Potential Shortcomings of the Market Markets will usually generate an efficient outcome sometimes they may not o Reasons why the market may produce an inefficient outcome Market failure when the market process of supply and demand the invisible hand and the price system


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FSU ECO 2023 - The Economic Way of Thinking

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