ECON 201 Midterm Review Economics is the study of how people allocate their limited resources to satisfy their nearly unlimited wants Microeconomics is the study of the individual units that make up the economy Scarcity describes the limited nature of society s resources 5 Economic Foundations 1 Incentives factors that motivate a person to act or exert force Positive incentives encourage action ex end of year bonuses for yearly hard work Negative incentives also encourage action ex fear of speed ticket makes motorist drive speed limit Direct incentive ex mow my lawn and I ll pay you 50 Indirect incentive ex welfare while maintaining incentive to look for jobs Unintended consequences ex people who were supposed to use government assistance as a safety net until they can nd a job but use it as permanent source of income Ex paying for a college education can require spending tens of thousands of dollars that might be used elsewhere instead Ex 2 invitations hiking or concert for the same time Cost of going to the concert is lost opportunity to be on a hike and vice versa 3 Opportunity costs value of whatever you sacri ced in order to get alternative 2 Trade offs giving up one thing in return for another 4 Marginal thinking evaluation of whether the bene t of one more unit of something is 5 Trade creates value both voluntary participants and both get value greater than its cost Economic thinking is the process of systematically evaluating a course of action Marginal analysis breaks down decisions into smaller choices Ex Cleaning bathrooms vacuuming house etc but not dusting under refrigerator because it requires signi cant effort for small bene t Markets bring buyers and sellers together to exchange goods and services Trade is the voluntary exchange of goods and services between 2 or more parties both sides are better off in the end Comparative advantage is when someone can produce at a lower opportunity cost than a competitor can it harnesses the power of specialization it drives trade Absolute advantage is when producer requires smaller amount of inputs to produce good For 2 people to gain from trade price of good must lie between the 2 opportunity costs Model Building and Gains from Trade Positive and Normative Statements It is important that we separate our beliefs about what is desirable from what we believe to be Positive can be classi ed as true or false ex The unemployment rate is 8 Normative cannot be classi ed as true or false usually opinions ex Kanye makes better true or false music than Metallica Economists as Policy Advisors Rarely give straight forward advice because all choices involve trade offs The right choice depends what end result you want Production Possibilities Frontier PPF Illustrates the combinations of outputs that a society can produce if all of its resources are EXAMPLE Wheat and Tv s in Mexico and the U S Quanitity TV s produced being used ef ciently U S Wheat and TV s Production Mexico Wheat and TV Production 200 150 100 50 0 0 50 100 Quantity of Wheat produced Opportunity Cost of 1 Wheat is 1 TV U S Opportunity Cost of 1 TV is 1 2 Wheat 100 200 Opportunity Cost of 1 Wheat is 2 TVs 200 100 Mexico Opportunity Cost of 1 TV is 1 Wheat 50 50 Mexico has comparative advantage in Wheat production because Opp Cost is lower U S has comparative advantage in TV production because Opp Cost is lower Trade 1 Wheat for anything between 1 and 2 TV s If U S is at 50 100 on graph and Mexico is at 50 0 Wheat TV After Trade U S 75 62 5 TRADE 25 Wheat for TV at 1 5 25 x 1 5 37 5 TV Mexico 25 37 5 TV sWheatU S 200100Mexico50505002001000 comparative advantage Specialization Allows for gains from trade Each will maximize their own consumption by specializing in the task for which they have Law of Increasing Relative Cost Opportunity cost of producing good rises as a society produces more of it Types of goods Consumer goods are produced for present consumption ex food movies Capital goods help in the production of other valuable goods and services in the future ex factory Markets Market Economy resources are allocated among households and rms with little or no Market Outcomes of interest government interference Quantity Price on the market price and output no variation in the service or good Desire and or production of good can affect these outcomes Competitive market is one with so many buyers and sellers that each only has a small impact Imperfect market is where either the buyer or the seller has in uence on the market price Demand Demand is when an individual or group wants something so much they pay or trade for it Quantity Demanded is the amount of a good or service purchased at the current price Law of Demand states that if all else is equal the quantity demanded of a good falls as the Demand Schedule table that shows relationship between price of good and quantity Market demand sum of all individual quantities demanded by each buyer in market at each Factors that shift Demand Curve Income price rises demanded price Normal goods purchased more as income rises ex designer clothes luxury causes Inferior goods purchased out of necessity ex generic brand public transportation demand shift to the right causes demand shift to the left Price of related goods Compliment 2 goods that are used or bought together ex tires and cars as price of compliment rises demand for related good falls Substitute 2 goods used in place of each other ex coke and pepsi as price of substitute rises demand for related good rises Tastes Expectations Number of buyers Supply Quantity Supplied amount of good or service producers are willing and able to sell at current price Law of Supply states all other things being equal quantity supplied of good rises as price of good rises and falls when price of good falls Supply Schedule table that shows relationship between price of good and quantity supplied Market Supply sum of the quantities supplied by each seller at each price Factors that shift Supply Curve Input Costs Resources used in the production process ex workers equipment as the price of inputs Tax makes a rm less pro table and less pro ts make them less willing to supply product increases supply shifts left Taxes Subsidies shift the supply curve left Number of Sellers Technology with fewer resources Allows producer to increase output with same resources or produce given level of output Price is the only thing that causes a movement along the S or D curve Changes in other things shift the curves