ECON 201 Exam 1 - Lecture notes 1-7 PDF

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Descriptive notes pertaining to exam 1 about the first 4 chapters...

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Chapter 1: The Five Foundations of Economics ● -

What is economics Scarcity: limited resources given society's unlimited wants Economics is the study of how people allocate their limited resources to satisfy their unlimited wants - Study of how people make decisions - Study of Scarcity ● Micro versus Macro - Microeconomics → study of individual units that make up the economy - Examples: individual choosing a job to go to florida, firm deciding to open a factory - Macroeconomics → the study of overall aspects and workings of an economy - Examples: inflation, unemployment 5 Foundations of Economics 1. Incentives Matter 2. Life is about trade offs 3. Opportunity costs 4. Marginal thinking 5. Trade creates value ➢ -

Incentives matter They are factors that motivate you to act or exert effort People respond to incentives Positive incentives: Encourages action by offering reward Negative incentives: discourages action by providing consequences or punishments Direct (positive or negative): an incentive clearly said and recognized by the person Indirect: a secondary change in behavior brought on by the original incentive Unintended consequences: an unintended result that is usually negative and unwanted of an incentive

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Life is about tradeoffs Scarcity → choice Every decision has a cost Governments have to face trade offs (taxes on highways or education?)

➢ Opportunity Cost - Highest valued alternative that must be sacrificed to get something else - Not all alternatives but the next best thing ● -

Marginal Thinking Economic thinking: requires purposeful evaluation of available resources to make the best decisions Marginal thinking: requires to evaluate whether the benefit of one more unit of something outweighs the cost

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Opportunity cost is subjective Opportunity cost for going to college isn’t the same for everyone (Bill Gates vs. me) Overall consensus, education leads to positive externalities (like a job with a salary, knowledge, etc.)

➢ Trade creates value - Markets → bring buyers and sellers together to exchange goods and services - Trade → voluntary exchange of goods and services between 2 or more parties

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The Circular Flow Shows how resources and final goods and services flow through the economy Households provide firms with labor (resource market) which then can help in producing goods to provide to households (product market) Barter: needs double coincidence of wants (when either party has what each wants) Trade fosters exchange of goods and promotes specialization Comparative advantage: situation where one can produce something at a low opportunity cost than a competitor Trade controversies → outsourcing

Chapter 2: Model Building from Trade ● Scientific Method 1. Observe a phenomena 2. Develop a hypothesis 3. Construct a model to test the hypothesis 4. Design an experiment using a model to see if it works and collects data 5. Verify, revise or refute hypothesis ● ● -

The type of data used in economics is usually historical data not experimental data Positive vs. normative analysis Positive: can be tested describes “ what is” Normative: an opinion, can’t be tested

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Economics Models Used to understand complex real world Simplified versions of reality Built with assumptions Considered good if they predict accurately Mathematical equations Ceteris Paribus Means all other things held equal Holding everything else constant Allows us to isolate the effect of a single variable

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Economic Analysis Endogenous Factors: variables controlled inside a model Independent variables Change this variable ( independent variable) to see the effect it has on the dependant variable Exogenous factors: variables that cannot be accounted for in a model Outside of our control

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Danger of faulty assumptions Must decide what variables to include and exclude from models It’s necessary to examine and evaluate the assumptions in models

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PPF → productions possibilities frontier Illustrates the combos of outputs that a society can produce if all its resources are being used efficiently Assumptions: Technology is fixed Quantity of resources is fixed Society produces only two goods We are unable to produce certain combinations because of scarcity and our limited resources The downward slope represents opportunity cost (must give up one or some of the good in order to produce more of the other good)

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Law of increasing opportunity cost: The opportunity cost of producing a good rises as a society produces more of it As we produce more of one good, we have to give up increasingly larger amounts of the other good PPF will not have a constant slope The slope of PPF is curved because some inputs are better used to produce one good than the other and will be allocated where it can best be used Inputs are not perfectly homogenous Economic growth The process that enables a society to produce more output in the future Can be shown by an outward shift in PPF Can cause a shift in the graph that affects one good or both goods

Chapter 3: The Market at Work: Supply and Demand ● Fundamentals of Markets - Firms: Supply the goods and services - Consumer: purchase the good supplied by the firms

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Exchange happens through prices established in markets Supply and demand change market price Market: where buyers and sellers meet (doesn’t have to be a physical place)

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Market economy: resources are allocated among households and firms with little to no government interference Producers and consumers are motivated by self interest

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Invisible hand: refers to the unobservable market forces that guide resources to their highest valued use Main economic structure of the US

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Competitive market Many buyers and sellers The goods sold by each seller are similar No one buyer or seller has any influence over the price

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Imperfect Market Either the buyer or seller has influence on the price Market power: firms ability to influence price Monopoly: single company that supplies the entire market for a good or service

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Demand Quantity demanded: amount of a good buyers are willing and able to pay to purchase at the current price - Law of demand: ceteris paribus, there an inverse relationship between price and the quantity demanded - If the price of a good increases, the quantity of demand decrease (visa versa) - Demand curve is negatively sloped due to the law of demand - Market demand: horizontal summation of all individual quantities demanded by each buyer in the market at each price ➔ Factors that shift demand - Changes in income - Normal good: more income, more you buy - Inferior good: more income, the less you buy - Price of related goods - Complements: goods used together - Substitutes: goods used in place of one another - Changes in tastes and preferences - Price expectation - Number of buyers ● -

Supply Quantity supplied: amount of the goods and services that producers are willing and able

to sell at the current price Law of supply: ceteris paribus, there is a direct relationship between price and quantity supplied - If price of a good increases, quantity supplied increases - Market supply: horizontal sum of all individual quantities supplied by each seller in the market at each price - Change in quantity supplied is a movement along the curve (due to a change in price) - Change in supply is a shift of the curve (due to non price related factors) ➔ Factors that affect supply - Cost of inputs - Changes in technology - Taxes and subsidies - Number of sellers - Price expectations

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Law of supply and demand: the market price of any good will adjust to bring the quantity supplied and the quantity demanded into balance Equilibrium: occurs at a point where the demand curve and supply curve meet Equilibrium price and equilibrium quantity

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Shortage: Occurs when quantity demanded is more than the quantity supplied Below equilibrium “Excess demand”

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Surplus: occurs when quantity supplied is more than the quantity demanded Above equilibrium

Chapter 6: Introduction to Macroeconomics and GDP ● -

Gross Domestic Product: the market value of all final goods and services produced in a nation within a specific period of time Output = GDP = income Production = income Nations that produce large amounts of high valued output are relatively wealthy

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Why worry about GDP Estimate living standards across time and between nations Measures economic growth Measures business cycles

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Measuring living standards Not accurate for cross country comparison Per capita GDP GDP per person

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Measuring economic growth Inflation: growth in the overall prices in an economy (can use GDP to increase) Real GDP: GDP adjusted for changes in prices Economic Growth: measured as the percent change in real per capita GDP

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Measuring the business cycle Short-run fluctuations in economic activity that can cause output to be above or below the long-run trend Economic expansion → (Trough to peak) increasing economic activity Economic contraction → (Peak to trough) decreasing economic activity Recession: short term economic downturn No one can tell you when the next recession is (only can say that it will happen at some point in the future)

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How to measure GDP Market value Quantities would not give enough information Multiply quantity by price to get the market value

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GDP includes both goods and services Goods are the tangibles Services are the intangibles (healthcare, entertainment) Intermediate goods → goods that firms repackage or bundle with other goods to be sold at a later stage Final goods → goods to be sold to the final users or consumers

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Gross DOMESTIC Product Domestic is important because it refers to the goods and services produced here domestically and not overseas Gross National Product: Output produced by workers and resources owned by residents of a nation Production from a particular period avoids issues with double counting (remember milk example) GDP as different types of expenditures GDP = C + I + G + NX C = consumption Final purchases of goods and services by households (not including housing) Durable goods: goods consumed over a long period of time Non durable goods: short period of time I = investment Capital purchase to produce future output Changes in business inventory

Inventories → goods that have been produced but not yet sold Residential housing G = government purchases Spending by state, local and federal governments on goods and services Not included: Transfer payment: government gives us something and they don’t get anything in return like social security or unemployment compensation ❖ NX = net exports - Export → US based production and sold overseas - Import → produce overseas and sold in the US - Imports > export → NX imports → NX >0 Trade surplus ❖ -

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GDP Shtuff Real GDP: measure with price held constant Nominal GDP: measured in current prices (not adjusted for inflation) Price level: index used to measure prices of goods and services in an economy GDP Deflator: measure of the price level that includes prices of all final goods and services Deflate out inflation from nominal GDP to find real GDP When Real GDP changes, we know its a change in output When nominal GDP changes, you can’t be sure that it’s from output or a change in prices Shortcomings of GDP GDP is a measure of production Often used as a proxy for well being Non market goods Underground economy Environmental quality Leisure Non market goods: washing dishes, cleaning Not sold in markets No dollar amount Underground economy: hidden transactions Could be legal → like tips given to a waiter or waitress Could be illegal → trading drugs Size → 10% of US GDP and about 45% in developing countries Quality of the Environment Can’t tell how output is produced Countries can have equal GDP but not same well being Country A → 10 million units of output, clean energy, clean air Country B → 10 million units of output, no environmental standards, health problems

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They produce the same amount of output but have completely different environmental conditions ➔ Leisure time - Doesn’t calculate how long it takes to produce goods and services - Trade Off between labor and leisure - Average work week differs amongst different countries - South korean work week → 46 hours a week - Netherlands work week → 28 hours a week...