Economics 224 Final Exam Study Guide Benny Harris Chapter 1 Ten Principles of Economics Scarcity the limited nature of society s resources Economics the study of how society manages its scare resources Principle 1 People face trade offs Efficiency the property of society getting the most it can from its scarce resources Equity the property of distributing economic prosperity fairly among the members of society Principle 2 The cost of something is what you give up to get it Opportunity costs whatever must be given up to obtain an item Principle 3 Rational people think at the margin Rational people people who systematically and purposefully do the best they can to achieve their objectives Marginal changes small incremental adjustments to a plan of action Principle 4 People respond to incentives Incentive something that induces a person to act Principle 5 Trade can make everyone better off Principle 6 Markets are usually a good way to organize economic activity 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 Principle 7 Governments can sometimes improve market outcomes Property rights the ability of an individual to own and exercise control over scarce resources Market failure a situation in which a market left on its own fails to allocate resources efficiently Externality the impact of one person s actions on the wellbeing of a bystander Market power the ability of a single economic actor or small group of actors to have substantial influence on market prices Principle 8 A country s standard of living depends on its ability to produce goods and services Productivity the quantity of goods and services produced from each hour of a worker s time Inflation an increase in the overall level of prices in the economy Principle 10 Society faces a short run trade off between inflation and unemployment increasing amount of money in the economy stimulates the overall level of spending and thus the demand of goods and services higher demand may over time cause firms to raise their prices but in the meantime it also encourages them to increase the quantity of goods and services they produce and to hire more workers to produce those goods and services more hiring means lower unemployment Business cycle fluctuations in economic activity such as employment and production Chapter 2 Thinking Like an Economist Circular flow diagram a visual model of the economy that shows how dollars flow through markets among households and firms Production possibilities frontier a graph that shows the combinations of output that an economy can possibly produce given the available factors of production and the available production technology Microeconomics the study of how households and firms make decisions and how they interact in markets Macroeconomics the study of economy wide phenomena including inflation unemployment and economic growth Positive statements claims that attempt to describe the world as it is Normative statements claims that attempt to prescribe how the world should be Economists disagree on two things value differences therefore different normative views about what the validity of alternative positive theories about how the world works policy should try to accomplish Chapter 3 Interdependence and the Gains from Trade Absolute advantage the ability to produce a good using fewer inputs than another producer Comparative advantage the ability to produce a good at a lower opportunity cost than another producer Imports goods produced abroad and sold domestically Exports goods produced domestically and sold abroad Chapter 4 The Market Forces of Supply and Demand Market group of buyers and sellers of a particular good or service Competitive market a market in which there are many buyers and many sellers so that each has a negligible impact on the market price Quantity demanded the amount of a good that buyers are willing and able to purchase Law of demand the claim that other things equal the quantity demanded of a good falls when the price of a good rises Demand schedule a table that shows the relationship between the price of a good and the quantity demanded Demand curve a graph of the relationship between the price of a good and the quantity demanded Normal good a good for which other things equal an increase in income leads to an increase in demand Inferior good a good for which other things equal an increase in income leads to a decrease in demand EX bus or cab rides Substitutes two goods for which an increase in the price of one leads to an increase in demand of the other Complements two goods for which an increase in the price of one leads to a decrease in the demand for the other Quantity supplied the amount of a good that sellers are willing and able to sell Law of supply the claim that other things equal the quantity supplied of a good rises when the price of the good rises Supply schedule a table that shows the relationship between the price of a good and the quantity supplied Supply curve a graph of the relationship between the price of a good and the quantity supplied Variables that can shift the supply curve include input prices technology expectations number of sellers Equilibrium a situation in which market price has reached the level at which quantity supplied equals quantity demanded where the S and D lines cross Equilibrium price the price that balances quantity supplied and quantity demanded Equilibrium quantity the quantity supplied and the quantity demanded at the equilibrium price Surplus a situation in which quantity supplied is greater than quantity demanded Shortage a situation in which quantity demanded is greater than quantity supplied Law of supply and demand the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance Chapter 5 Elasticity and its application Elasticity a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants Price 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 percentage change in quantity demanded divided by percentage change in price Determinants of price elasticity 1 Availability of close substitutes a More elastic demand because consumers can easily switch to a substituted item 2 Necessities v luxuries 3 Definition of the market 4 Time