Midterm 1 Study Guide w Few Questions from Previous Midterm Economic Theory asserts that people will behave in a way that will enhance their over all wellbeing In society there is always an opportunity cost see below for def Production Possibilities Frontier PPF the type of production that is possible within an economy Better Definition It is the maximum attainable combination of two goods that can be produced by the current technology and existing resources of a country Three types of representations o Constant costs does not really represent what an economy produces but it is simpler to look at draw o Increasing costs common PPF 1 litre beer 1 kg chocolate 1 litre of beer 1 kg chocolate o Decreasing costs Beer could become cheaper as you produced more Price of material resources Mass Production is easier The Price will go down Opportunity Cost The highest valued attractive that we have to give up in order to engage in one activity To find the Opportunity Cost O C of an Item 1 Set both sides equal to each other a E g 400 chocolates 800 beers 2 Choose an item in this case chocolates 3 Divide the number to other side a E g Chocolates 800 400 beers b c Do the same to the other side It takes 2 beers to make 1 unit of chocolate i It takes chocolate to make 1 unit of beer Changes within the PPF Increase in Production 1 Better education makes all workers have more production a Tech change Decrease in Production on One Product 2 Half of the cows die a Change on existing resources Constant Production 3 There s a widespread of unemployment a No change in technology or on the existing resources 4 Huge amount of people move to another Decrease in Production country a Less labor resources i Affects both goods The Points Inside PPF under the line produce inefficiently unused goods On the PPF directly on the line produce efficiently all resources are gone Outside the PPF outside the line unattainable not enough resources to achieve producing outside the line PPFs and Trade Why trade o Trade brings goods you cannot produce Absolute Advantage able to produce more Comparative Advantage produce at a lower opportunity cost Czech Opportunity Cost Opportunity Cost Belgium 800 Pizza 800 Beer Beer 600 Pizza 400 1 Pizza 800 800 Beer 1 Pizza 400 600 Beer 1 Pizza 1 Beer Beer 1 Pizza 2 3 600 400 Pizza 1 Beer 3 2 Pizza 1 Beer Czech has an absolute advantage on both pizza and beer Czech has a comparative advantage on producing beer Belgium has a comparative advantage on producing pizza Czech exports beer and imports pizza Belgium exports pizza imports beer 1 When there are no numbers look at the horizontal axis in this case Beer 2 Find out which one has a smaller slope lower OC flatter 3 Belgium has a comparative advantage on 4 Czech must have a comparative advantage beer on pizza NOTE IF ONE COUNTRY HAS A COMPARATIVE ADVANTAGE ON ONE GOOD THE OTHER COUNTRY HAS A COMPARATIVE ADVANTAGE ON THE OTHER GOOD A COUNTRY CANNOT HAVE A COMPARATIVE ADVANTAGE ON BOTH GOODS EXCEPTION OF NOT TRADING Both countries do not trade They have the same slope therefore they do not have a comparative advantage Both countries will not gain anything if they trade with each other DRAWING GRAPHS If goods are flipped If Comparative Advantage exists trades occurs If both countries have constant OC specialize completely The Circular Flow Model Households do not spend all their income o They typically save at least a little Less pressure on flow model each time one saves in banks Savings are a leakage from circular flow o But they do not disrupt the circular flow because they return to the economy as investment Investment in physical assets by firms Financial markets connect savers investors A tax on firms would harm households because firms would have less to pay them Other countries have their own circular flow Product Market o Linked together with other countries through imports and exports Labor Market o Income earned by foreigners in the US o Income earned by Americans abroad SUPPLY AND DEMAND Demand the quantity of a good or service that consumers are willing and able to buy at a given set of prices over a given period of time This is not a want Demand curves slopes down Price is a cost Negative relationship between price and quantity o Giving up stuff o Price of item is its cost o Axes must always be labeled with P price and Q quantity EX Suppose the price of scones fall Income effect can now buy more of everything Substitution effect more scones fewer doughnuts Supply the quantity of a good or service that producers are willing and able to sell at a given set of prices over a given period of time Supply curve slopes up Positive relationship Price is not a sacrifice for producing something o Price is a reward If price of scones rises Current producers make more New producers are attracted Market Equilibrium a balance on both sides Everyone is happy Everyone only includes people who are willing and able to buy produce the good No tendency to change Substitutes two goods that can replace each other to some degree orange and an apple Complements two goods that can be used in a pair Printer and ink Variables that shift market demand Income overall level distribution Prices of related goods Tastes preference Population Expected future prices Variables that shift market supply Prices of inputs cost Technological change Number of firms in the market Other price changes Expected future prices Shifts in a Demand Supply Curve A change in supply demand Occurs if there is a change in one of the variables other than the price of the product that affects the willingness of consumers to buy produce to sell the product Movement along the Demand Supply Curve A change in quantity of demanded refers to a movement along the demand supply curve as a result of change in the product s price Price Ceiling a price regulation that force the price to stay no higher than a specific price level o For it to have any effect it must be placed below the market equilibrium P3 o The overall effect is that there is a shortage QD QS Price Floor a price regulation that force the price to stay no lower than a specific price level o Must be above the market equilibrium to work P1 o The overall effect is that there is an excess surplus QD QS Normative Statement an opinion judgment Positive Statement can be proven true or false MB Marginal Benefit P Price Consumer Surplus Marginal Consumer just on the edge of wanting to pay or not no consumer surplus gets exactly what
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