ECO 2023 Test 1 Study guide Professor McCaleb 10 27 15 Economic methodology notes in class Ceteris Paribus we keep other things constant because we can t test economics Ceteris paribus is the practice of keeping this thing constant Correlation vs causation Correlation is when two variables move in related ways but does not mean one directly cause the other Four reasons for a correlation example more police more crime 1 Cause and effect more police cause high crime rates 2 Reverse causation more crimes cause cities to higher more police 3 Omitted variables larger cities have more crimes and police 4 Spurious correlation police and crimes are unrelated Scarcity and Marginal Analysis in class Scarcity Choice Not enough resources to fill everyone s wants Wants are unlimited exceed resources are limited Scarcity is not the same as shortage shortage depends on price while scarcity is there regardless of price Given options are scarce and can not satisfy all of our desires we must choose how the resource will be used Our choices are always wants not needs Opportunity cost The highest valued alternative given up to forgoe that activity Choosing to do one thing is at the same time choosing not to do another Money is never opportunity cost it has to be the value or benefit forgone Opportunity cost can only be one thing not all the forgone options together Marginal analysis Making choices on the margin means you weigh marginal benefits and marginal costs Marginal benefit additional benefit received for doing one more unit of that activity decreases as you do more Marginal cost additional cost received for doing one more unity of that activity increases as you do more We use it because 1 Leads to correct decisions 2 Conserves on scarce resource information 3 Is descriptive of most real world decision processes When MB MC you gain by doing more When MB MC you gain by doing less When MB MC is most optimal or economically efficient Incentives More marginal benefit means people choose it more more marginal cost means people choose it less Incentives matter the choose to maximize the net gain from each and every activity Production possibilities and comparative advantage Production possibilities The boundary between combinations goods and services you can preform obtainable and the combinations of goods and services you can not preform unobtainable Available resources 1 Land both raw land and natural resources taken from the land 2 Capital machine tools other equipment 3 Labor force all people willing and able to work whether they are currently employed or unemployed Increase in any of the three cause increase in Production and the PPF shift out and vice versa Production possibility frontier Points outside the boundary are unobtainable unachievable combinations while points on or inside the boundary are obtainable achievable combinations Points inside the boundary are inefficient or unemployment not using resources to full potential while points on the boundary are efficient or full employment using resources to full potential When you move from point to point on the boundary you are facing tradeoffs giving up more of one choice for more of the other to make a new choice at efficient full employment Opportunity cost on the PPF Opportunity cost of object x the decrease in quantity of object y the increase in the number of object y as we move along the PPF boundary Shape of PPF is bowed outward because opportunity cost increases Investment Our consumption today determines the position of the future PPF Saving today means more output tomorrow Lower level of current consumption and higher level of investment will have a PPF that shift further than a country choosing high level of current consumption and low level of investment Comparative Advantage Absolute advantage ability to perform more of an activity or produce more of a good or service with the given amount of resources in given time Shows greater physical productivity Comparative advantage ability to perform an activity or produce a good or service at a lower opportunity cost Shows greater economic efficiency Then exchanging the goods they produce for other goods they wish to consume We want to choose the person to specialize in a given activity if the opportunity cost is LOWER You can have absolute advantage in everything but not comparative advantage in everything Everyone has comparative advantage of something Specialization and exchange increase economic efficiency Quantity demanded Supply and Demand in class The amount of a good or service that people are willing and able to buy during a specified period at a specified price It is per unit of time Changes only with price of the given good change in quantity demanded is reflected by movement from one point of the demand curve to another up or down Inverse relationship of price and quantity demanded Demand Relationship between quantity demanded and the price of a good when all other influences on buying plans remain the same Changes with all influences other than price of good change in demand is shown by a shift in the entire curve left or right Prices of related goods can be either substitutes a good consumed in place for another one increases other decreases or complements a good consumed with another good one increases other increases Example of complements bacon and eggs price of eggs goes up quantity demanded of eggs goes down Because the egg now cost more you will consume less bacon and in turn the demand for bacon decreases shifts to the left the reverse is also true Example of substitute ham and bacon price of bacon goes up quantity demanded of bacon goes down Since we will consume less ham we will replace that consumption with ham so demand for ham goes up shifts to the right the reverse is also true Income If their income increases they will usually want to consume more Normal superior good demand increases if income increases Inferior goods demand decreases if income increases ex hamburger meat as you earn more you want higher grade meat Buyers expectations expected future income and expected future prices Number of buyers more buyers means more demand Buyers preferences changed in what we prefer makes us want one thing more than the other Law of demand Price and quantity demanded are negatively related inverse Given the characteristics of the relationship the slope of the demand curve is always negative The negative slope law of demand Quantity supplied The amount of a good
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