Econ 101 Final Exam Review Notes PDF

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Econ 101 Final Exam review notes...

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Econ 101 Final Exam:

Exam 1 Materials: Chapter Summaries: Chapter 1: Principles that underlie individual choices: ● Choices are necessary because resources are scarce ● The true cost of something is the opportunity cost ○ Opportunity cost of an item: what you must give up in order to get something ● “How much” is a decision at the margin ○ Comparing the costs and benefits of doing a little bit more of an activity versus doing a little less ● People usually respond to incentives, exploiting opportunities to make themselves better off Interaction: how economies work: ● There are gains from trade: people can get more of what they want through trade than if they tried to be self-sufficient ● Markets move toward equilibrium ○ Equilibrium: no individual would be better off doing something different ● Resources should be used efficiently to achieve society’s goals ● Markets usually lead to efficiency ● When markets don’t achieve efficiency, government intervention can improve society’s welfare Economy-wide interaction: ● One person’s spending is another person’s income; as a result, spending behavior can have repercussions that spread through the economy ● Overall spending sometimes gets out of line with the economy’s market capacity; when spending is too low, the result is a recession and when spending is too high, it causes inflation ● Government policies can change spending; modern governments use macroeconomic policy to affect the overall level of spending in an effort to steer the economy between recession and inflation Chapter 2: Economic trade-offs and models: ● Production possibility frontier: a model that helps economists think about the trade-offs every economy faces

● Comparative advantage: a model that clarifies the principle of gains from trade- trade between individuals and between countries ● Circular-flow diagram: schematic representation that helps us understand how flows of money, goods, and services are channeled through the economy Trade-offs: the production possibilities frontier ● Understanding the trade-offs of trade using a simplified model ● Efficiency: which point is efficient? Where are there no missed opportunities ○ Efficient in production: when the economy as a whole could not produce more of any one good without producing less of another good ○ Efficient in allocation: when the economy allocates its resources so that consumers ● Opportunity cost: what must be given up to buy or make a good ○ Constant opportunity cost: when the opportunity cost of a good is constant, the PPF is a straight line and when opportunity cost is increasing, PPF is not straight ● Economic growth: expansion of the country’s PPF ● Factors of production: resources used to produce goods and services ● Technology: technical means of producing goods and services Comparative Advantage and Gains from Trade: ● Mutual gains that individual can achieve by specializing in different things ● Comparative advantage: a country has a comparative advantage in something if the opportunity cost of that production is lower for that country than for other countries ○ Everyone has a comparative advantage in something and a comparative disadvantage in something ● Absolute advantage: when a country can produce a greater amount using the same amount of resources Transactions: The Circular-Flow Diagram: ● Trade takes the form of bartner when people directly exchange goods or services they want for goods and services that they have ● Circular-flow diagram: represents the transactions in an economy by flows around a circle ○ Households ○ Firms ○ Firms sell goods and and services to households in markets for goods and services ○ Factor markets: where firms buy the resources they need to produce goods and services ○ Income distribution: the way in which total income is divided among the owners of the various factors of production

Using models: ● Positive versus normative economics: ○ Positive economics: describes the way the economy actually works (description) ○ Normative economics: makes prescriptions about the way the economy should work (prescription) ● When and why economists disagree: using different models Chapter 3: Supply and Demand Supply and Demand: a model of a competitive market ● Competitive market: a market in which there are many buyers and sellers of the same good or service, none of whom can influence the price at which the good or service is sold ● Supply and demand model: a model of how a competitive market behaves The demand curve: ● Demand schedule: shows how much of a good or service consumers will want to buy at different prices ● Quantity demanded: the actual amount of a good or service consumers are willing to buy at some specific price ● Demand curve: a graphical representation of the demand schedule; shows the relationship between quantity demanded and price Understanding shifts of the demand curve: ● Increase in quantity demanded at every price: shift right ● Decrease in quantity demanded at every price: shift left The supply curve: ● Quantity supplied: the actual amount good that people are willing to sell at some specific price ● Supply schedule: shows how much of a good or service would be supplied at different prices ● Supply curve: shows the relationship between quantity supplied and price Understanding shifts of the supply curve: ● Increase in quantity supplied at any price: shift right ● Decrease in quantity supplied at any price: shift left Supply, demand, and equilibrium: ● Finding the equilibrium price and quantity: ○ Where supply and demand curves cross

● Why does the market price fall if it is above the equilibrium price? Because then sellers can’t sell and will cut prices so that they can sell ● Why does the market price rise if it is below the equilibrium price? Because more people want to buy and people will charger more Changes in supply and demand: ● What happens when the demand curve shifts? ○ An increase in demand leads to a movement along the supply curve to a higher equilibrium price and quantity (and vice versa- a decrease in demand leads to a lower equilibrium price and quantity)\ ● What happens when the supply curve shifts? ○ When the supply of a good or service increases, the equilibrium price or service falls and the equilibrium quantity rises ○ When the supply of a good or service decreases, the equilibrium price of the good or service rises and the equilibrium quantity falls ● What happens when the demand and supply curves shift at the same time ○ Effects depend on how much each one shifts Chapter 9: Decision Making by Firms and Individuals: Costs, benefits, and profits: ● Explicit cost: requires an outlay of money ● Implicit cost: does not involve an outlay of money ● Accounting profit: equal to the revenue minus explicit cost ● The opportunity cost of any activity is equal to the explicit cost minus the implicit cost Accounting profit vs economic profit: ● Accounting profit: revenue minus explicit cost ● Economic profit: revenue minus the opportunity cost (usually less than the accounting profit) ● Capital: the total value of the assets of an individual or firm ● Implicit cost of capital: the opportunity cost of the use of one’s own capital Making “either-or” decisions: ● When making an “either-or” choice, chose the one with a positive accounting profit Making “how much” decisions: ● Marginal analysis: comparing the costs and benefits of doing one more unit of something Marginal cost: the cost of producing one more unit of that good or service ● Increasing marginal cost: when each additional unit costs more to produce than the previous one

● Marginal cost curve: shows how the cost of producing one more unit depends on the quantity that has already been produced ● Constant marginal cost: each additional unit costs the same to produce as the previous one ● Decreasing marginal cost: when each additional unit costs less to produce than the previous one Marginal benefit: the additional benefit earned from producing one more unit ● Decreasing marginal benefit: each additional unit yields a smaller benefit than the last unit ● Increasing marginal benefit: each additional unit yields a larger benefit than the last unit ● Marginal benefit curve: shows how the benefit of producing one more unit depends on the quantity that has already been produced Marginal analysis: ● Calculating the differences between costs to see whether the MC is increasing or decreasing ● Optimal quantity: the quantity that generates the highest possible total profit ● Profit-maximizing principle of marginal analysis: the optimal quantity is the largest quantity at which MB is greater than or equal to MC Sunk costs: ● Money that has already been spent and cannot be recovered ● Should be ignored Behavioral Economics: ● Rational, but human ○ Rational decision maker chooses the available option that leads to the outcome he or she most prefers ● Bounded rationality: choosing the option that is close to but not exactly the one that leads to the best possible economic outcome ● Risk aversion: the willingness to sacrifice some economic payoff in order to avoid a potential loss ● Irrational decision maker: chooses an option that leaves him/her worse off than choosing another available option

Exam 2 Materials: Chapter Summaries:

Chapter 4: Consumer and Producer Surplus Consumer Surplus and the Demand Curve: ● Willingness to Pay and the Demand Curve: ○ Willingness to pay: the maximum price at which he or she is willing to buy a good ● Willingness to Pay and Consumer Surplus: ○ The net gain that a buyer achieves from the purchase of a good ● Total Consumer Surplus: ○ The sum of all individual consumer surpluses ● Consumer surplus: used to refer to both individual and total consumer surplus How do changing prices affect consumer surplus? ● Can be seen on a graph: the area under the demand curve but still above the price ● A fall in the price of a good increases consumer surplus in two ways: ○ A gain to consumers who would have bought at the original price and then get to buy it for less at the new, lower price ○ A gain to consumers who are persuaded to buy at the new, lower price (and would not have bought at the older, higher price) Producer Surplus and the Supply Curve: ● Cost and Producer Surplus: ○ Cost: the lowest price at which a potential seller is willing to sell ■ Because the seller has an opportunity cost for giving up the good by selling it ○ Individual consumer surplus: the net gain a seller gets from selling a good; the difference between what a seller actually gets and his cost ○ Total producer surplus: the sum of the individual consumer surpluses of all the sellers of a good in a market ○ Producer surplus: used to refer to both individual and total consumer surpluses ● How do changing prices affect producer surplus? ○ A fall in price increases consumer surplus and decreases producer surplus ○ A rise in price decreases consumer surplus and increases producer surplus Consumer Surplus, Producer Surplus, and Gains from Trade: ● Gains from Trade: ○ The sum of producer and consumer surplus is known as the total surplus generated by the market ● The Efficiency of Markets: ○ How might total surplus be increased? ■ Reallocating consumption among consumers:

● Ex: selling books to different consumers ● This would mean taking away a book from a student who values it more and giving it to a student who values it less, which then reduces the consumer surplus and thus the total surplus also declines ■ Reallocating sales among sellers: ● Ex: taking sales away from sellers who would have sold their books at the market equilibrium price and instead compelling sellers who would not have sold (because their cost was above the market equilibrium price) to sell ● This would reduce total surplus because any student who sells at the market equilibrium has a lower cost than any student who keep their book ■ Changing the quantity traded: ● Compelling sellers to trade either more or less books than the equilibrium quantity ● If any less than the equilibrium quantity is traded, total surplus will fall ○ Once a market is in equilibrium, there is no way to increase gains from trade ○ An efficient market performs four important functions: ■ It allocates consumption of the good to the potential buyers who most value it, as indicated by the fact that they have the highest willingness to pay ■ It allocates sales to potential sellers who most value the right to sell, as indicated by the fact that they have the lowest cost ■ In ensures that every consumer who makes a purchase values the good more than every seller who makes a sale, so that all transactions are mutually beneficial ■ It ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who doesn’t make a sale, so that no mutually beneficial sales are missed ● Equity and Efficiency: ○ The point of efficiency is about how to achieve goals, not what those goals should be ○ Policies that promote efficiency sometimes come at the cost of equity (and vice versa) ● A market economy: ○ The economy as a whole is made up of interrelated markets ○ An efficient market equilibrium maximizes total surplus ○ When each individual market in an economy is efficient (maximizes total surplus), then the economy as a whole is efficient

● Why do markets typically work so well? ○ Well-functioning markets owe their effectiveness to property rights and economic signals ○ Property rights: ■ A system in which valuable items in the economy have specific owners who can dispose of them as they choose ○ Economic signals: ■ Any piece of information that helps people and businesses make better economic decisions ■ Prices are the most important economic signals because they convey information about other people’s costs and willingness to pay ■ Prices can sometimes fail as economic signals; sometimes a price is not an accurate indicator of how desirable a good is; when there is uncertainty about the quality of a good, price alone may not be an accurate indicator of the value of the good (ex: is a used car a “lemon”? You can’t tell from price alone) ● Words of caution: ○ Inefficiency: when markets are inefficient, there are missed opportunities (ways in which production or consumption could be rearranged that would make some people better off without making other people worse off ○ Why are markets inefficient? ■ Monopoly: when a monopolist raises prices to manipulate the market price in order to increase his own profits, he prevents mutually beneficial trade from occurring ■ Externalities: actions of individuals sometimes have side effects on the welfare of others that markets don’t take into account (ex: pollution) ■ Goods are unsuited for efficient management by markets; for example, some goods fall into this category because of private information (info that some people possess and others don’t) ■ Some types of goods that are unsuited for efficient management by markets: public goods, common resources, and artificially scarce goods (incomplete property rights) Chapter 5: Price Controls and Quotas: Meddling with Markets Why do governments control prices? ● Price controls are legal restrictions on how high or low a market price may go ○ Price ceiling: maximum price that sellers are allowed to charge for a good or service ○ Price floor: a minimum price buyers are required to pay for a good or a service Price Ceilings:

● There are not many price ceilings other than rent control ● Sometimes price ceilings are imposed temporarily (i.e., price gouging in the wake of a natural disaster) ● Modeling price ceilings: ○ Price ceilings don’t always cause shortages (i.e., if the price ceiling was above the equilibrium price) ● How do price ceilings cause inefficiency? ○ It reduces the quantity of apartments rented below the efficient level ○ It leads to inefficient allocation of apartments among would-be renters ○ Leads to wasted time and effort as people search for apartments ○ Leads landlords to maintain apartments in inefficiently low quality or condition ● Inefficiently low quantity: landlords have no incentive to improve the quality of their apartment ● Deadweight loss: loss in total surplus that occurs whenever an action or policy reduces the quantity transacted below the efficient market equilibrium quantity ■ A loss in total surplus ● Inefficient allocation to consumers: ○ Some people want the good badly and are willing to pay a high price for it but can’t get the good, and some people who care relatively little about the good and are only willing to pay a low price do get it ● Wasted resources: ○ People expend money, effort, and time to cope with the shortages caused by the price ceiling ● Common side effects of price ceilings: ○ A persistent shortage of the good ○ Inefficiency arising from this persistent shortage in the form of inefficiently low quantity (deadweight loss), inefficient allocation of the good to consumers, resources wasted in searching for the good and the inefficiently low quality of the good offered for sale ○ The emergence of illegal black-market activity Price Floors: ● Minimum wage: a legal floor on the wage rate ● How does a price floor cause inefficiency? ○ It creates deadweight loss by reducing the quantity transacted to below the efficient level ○ It leads to an inefficient allocation of sales among sellers ○ It leads to a waste of resources ○ It leads to sellers providing an inefficiently high-quality product Price Floors and Inefficiently Low Quantity:

● The price floor raises the price of a good to consumers and thus reduces the quantity of that good demanded ● Because sellers can’t sell more units than buyers are willing to buy, a price floor reduces the quantity of a good that is bought and sold below the market equilibrium quantity ● A price floor has the same effect as a price ceiling ● Both price floors and price ceilings have the effect of reducing the quantity bought and sold ● The equilibrium of an efficient market maximizes the sum of consumer and producer surplus, so a price floor that reduces the reduces the quantity supplied beneath the equilibrium quantity reduces total surplus Price Floors and Inefficient Allocation of Sales Among Sellers: ● When there is a price floor, there are sellers who are willing to sell at a lower price who are unable to make sales and sales go to sellers who are only willing to sell at a higher price Price Floors and Wasted Resources: ● A price floor generates inefficiency by wasting resources ● Ex: the government purchases unwanted surpluses of agricultural products caused by price floors (extra products produced at a price that people aren’t willing to buy at because the price was determined by the price floor) Price Floors and Inefficiently High Quality: ● Sellers offer high-quality goods at a high price, even though buyers would prefer a lowerquality product at a lower price (below the price floor) Price Floors and Illegal Activity: ● Price floors provide incentives for illegal activity (ex: minimum wage is a price floor; workers desperate for jobs may agree to work below the minimum wage price floor Why are there price floors? ● Because they benefit some influential buyer or seller of a good Controlling Quantities: ● Quantity control/quota: an upper limit on the quantity of some good that can be bought or sold ● Quota limit: the legal amount of a good that can be legally transacted ● License: gives the owner the right to supply a good The Anatomy of Quantity Controls: ● Demand price: the price at which consumers will demand that quantity

● Supply price: the price of a given quantity is the price at which producers will supply that quantity ● Wedge: a quantity control/quota drives a wedge between the demand price and the supply price of a good, meaning that the price paid by buyers ends up being higher than the price received by sellers ● Quota rent: the difference between the demand and supply price at the quota limit ○ It is the earnings that accrue to the license-holder from ownership of the right to sell the good (aka from owning the license) ○ It is equal to the market price of the license when the licenses are traded The Costs of Quality Controls: ● Inefficiency due to missed opportunities ○ Create deadweight loss by p...