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Exam 1 BECO Review Chapter 1 10 principles How people make decisions 1. People face trade offs 2. The cost of something is what you give up to get it 3. Rational people think at the margin 4. People respond to incentives (something that induces a person to act, higher price) … How people interact 5. Trade can make everyone better off 6. Markets are usually a good way to organize economic activity 7. Governments can sometimes improve market outcomes How the economy as a whole works 8. A country’s standard of living depends on its ability to produce goods and services. 9. Prices rise when the government prints too much money. (Inflation is an increase in the overall level of the prices in the economy). 10.Society faces a short-run tradeoff between inflation and unemployment  Economists study how people make decisions, how they interact, and the forces/ trends that affect the economy as a whole. o Economics deals with scarcity  Scarcity of time, money, limited resources... typically an opportunity cost of a choice. When a business chooses to produce more on one item, it also choses to do less of something else. For something to be scarce, it must be desirable, limited in quantity, and must have more than one use. Examples:  Gold= strong desire  Skilled professionals (doctors, engineers, teachers)  Commodities like trains, houses, gasoline, and diamonds o What is opportunity cost?  Giving up something to obtain something; a tradeoff.

o Be able to calculate the full cost (including opp. Cost) o What does thinking on the margin mean?  Marginal thinking means considering how much you value an addition of something. Rational people are marginal thinkers, they make decisions by comparing marginal benefits and marginal costs. o Water-diamond paradox  Water needed to survive, diamonds not a necessity. A person’s willingness to pay for a good… In total, water is more important. o Who does trade benefit?  Trade allows each person to specialize in the activities they do best, enjoying a greater variety of goods and services o What is the invisible hand?  Adam Smith  Households and firms interacting in markets, acts as a guide, leads them to desirable market outcomes  Corollary: Government intervention  Government can distort prices and basically prevents the invisible hand’s ability to coordinate the decisions of households and firms that make up the economy. o Increase in money supply leads to inflation, (there is more money chasing the same number of goods, therefore there is a raise in nominal demand and firms have to increase prices while we get inflation. (More money same goods higher prices)). o Short run trade off between unemployment and inflation (printing money, or increasing money supply leads to lower unemployment and high inflation)  Short run effects stimulate the overall level of spending and the demand for goods and services. Firms raise prices, hire more workers, thus more goods and services. Not a long-term solution, but lower unemployment. o The 5 “forgotten” principles:  1. Demand Slopes Down, the more expensive something is the less people want it.  2. Secondary Consequences, (the broken window fallacy: you cannot destroy your way to prosperity, an event that can unforeseen negative ripple effects if money is redirected to

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repairing broken items broken items rather than new goods/services). Good policies often have unintended “unseen consequences.  3. Prosperity Matters, people in richer countries generally have: better health, better work-life balance, minority rights, happier  4. Compound Returns Matter, rule of 70, growing slow for longer is typically better than growing fast in a short time span.  5. One Person’s Expenditure is Another Person’s Income o Millions of individuals and firms decides what’s produced and sold in the economy o Pedestrians were most harmed by the mandatory seat belt law o Richer countries often prefer equality over efficiency because richer countries already have a lot of efficiency. o How can economics (and specifically the economic way of thinking) be useful to business students? economics helps us to make difficult decisions and understand the complexity of the business world o Normative statements tell us how they should be. o Showing a positive relationship between the risk of cancer and the number of lighters in the house is likely an example of omitted variable bias

o Economists do lieu of laboratory experiments find natural experiments in history. o An increase in the price of solo cups would lead to a(n) DECREASE in the demand for ping pong balls o If a cold front would hit Florida, what do you think would happen to the price of mimosas? INCREASE o If demand increases substantially while supply falls a little, then equilibrium quantity will RISE o If the price of babysitting goes up, you are more willing to do it. What rules does this apply? Law of supply o What happens to price when there is an increase in demand AND supply? o At points with ____ price and ____ quantity, the demand curve is elastic HIGH; LOW

o Flatter curves are more elastic o For elastic demand, when prices go up, we demand A LOT LESS. o If marijuana was legalized, it is likely that there would be an increase in demand. If demand is inelastic and supply is perfectly elastic, then this will result in ______. THE SAME PRICE

o The elasticity of demand is always negative o The demand for luxury yachts will be elastic o The price of phones increases by 10% and the quantity demanded decreases by 50%. What is the elasticity of demand, and is this good elastic or inelastic?

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5; ELASTIC o When the demand is _____, price and total revenue move in the same direction. INELASTIC o Complements tend to have negative cross-price elasticity.

Chapter 2 Thinking like an economist Production possibilities frontier: Shows the maximum output combinations of two goods or services an economy can achieve when all resources are fully and efficiently employed. – A graph: Shows various combinations of outputs that the economy can possibly produce – Combinations of output that the economy can possibly produce – Given the available constraints: getting more than one good requires sacrificing some of the other.  Points on the PPF  What points are inefficient, which are impossible? – Inside the PPF inefficient – On the PPF efficient: all resources are fully utilized – Outside the PPF not feasible – Points under the PPF are possible- not efficient some resources are underutilized – Points above the PPF- not possible. – Straight line: constant opp. Cost. Everything about PPF  Why is it bowed outward? This means it’s increasing in opportunity costs.  Where is the efficient level of production? There is no deadweight loss at the level of production. The economy is getting all it can from the scarce resources available. (Trade-off: the only way to produce more of one good is to produce less of another.)  What causes shifts in the PPF (both general shifts and shifts in one good? Technological advance- outward shift, one way of shifting PPF is economic growth, producing more of both goods, a general tech advance will lead to a parallel shift in PPF. o Difference between positive and normative statements  Positive: Describing the world, “X causes Y” statements, EX: taxing this good will make it more expensive.

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 Normative: Explaining how to world should be, “Should” statements, EX: We should have a tax on this good. o Reverse causality and omitted variable bias  Cause and effect= one set of events, causes another set of events. Omitted variables lead to a deceptive graph.  Reverse causality means that X and Y are associated, but not in the way you would expect. Instead of X causing a change in Y, it’s the other way around.  Decide that event A causes event B  Facts: event B causes event A  Omitted variable bias is a type of selection bias that occurs in regression analysis when we don’t include the right controls. Essay topics Ch. 2  Define reverse causality, give example.  Why are PPF functions bowed outward? Chapter 4: Supply and Demand  What happens to equilibrium price and quantity when demand and supply shifts? If the demand curve shifts upward, meaning demand increases but supply holds steady, the equilibrium price and quantity both increase. If the demand curve shifts downward, meaning demand decreases but supply holds steady, the equilibrium price and quantity both decrease.  Know when the price is surely higher or lower, know when quantity is higher or lower, know when the price/ quantity change is ambiguous.  Shifters of Demand: Income (Normal good= increase, Inferior good= decrease), Prices of related goods (Substitutes/ Complements), tastes (change in taste= changes the demand), expectations (expect increase in income, expect higher prices, ex. If you knew Torchy’s were going to double their prices tomorrow, you will buy more today), number of buyers (market demand increases).  Law of Supply: All things are equal, when the price of a good rises, the quantity supplied of the good also rises. When the price falls so does the quantity of supply.

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 Market supply: Sum of the supplies of all sellers for a good or service.  Market Supply Curve: Sum of individual supply curves horizontally. Total quantity of supplied of a good varies, (as the price of good varies and all other factors that affect how much suppliers want to sell are hold constant). Supply Curve: As prices go up, producers are willing to supply more of that good. As prices get higher, more people come into the market to produce it.  Supply shifts: Variables that shift the supply curve are- input prices (supply is negatively related to prices of inputs, higher input prices= decrease in supply), technology (reduces firms’ costs: increase in supply), expectations about the future (affect current supply, expected higher prices- decrease in current supply), number of sellers (market supply increases), and changes in opportunity costs (not cheaper, but important).  Equilibrium: Quantity supplied= Quantity demanded (S & D curves intersect), S=D  Equilibrium Price: balances quantity supplied and quantity demanded. Market-clearing price.  Equilibrium Quantity: Quantity supplied and quantity demanded at the equilibrium price.  BUYERS ARE NOT IN COMETITION WITH SELLERS  **It will never be ambiguous if only one of the curves shift **It might be ambiguous when both shift (it just depends- look @ table) A price is a Signal wrapped in an Incentive: a price increase signals to the market that the good is more scarce- this gave entrepreneurs a way to “entrepreneurialize” situations (ex. Valentine’s day, roses= expensive, this leads to alternative goods as substitutes). “Just have to respond to prices” TEMPORARY DISEQUILIBRIUM A shortage occurs when the quantity demanded is greater than the quantity supplied. *Buyers rush to purchase, prices rise. Excess demand. Upward pressure on price. Decrease in quantity demanded. Increase in quantity supplied.

 A surplus occurs when the quantity supplied is greater than the quantity demanded. *Sellers lower price to outcompete with other sellers. Excess supply. Downward pressure on price. Increase in quantity demanded. Decrease in quantity supplied. Chapter 5: Elasticity  What makes a good more or less elastic? o Elasticity: measure of the responsiveness of quantity demanded or quantity supplied.  Elasticity= price-sensitivity  (the more response to price changes, the more elastic your supply or demand).  E.g.: a drug addict or someone taking medicine is very priceinsensitive. Demand is inelastic. They need their drug or medicine no matter the price.  Demand curve is more vertical  Demand for Coca Cola is elastic; demand is elastic because if the price increases, people can just drink Pepsi.  Demand curve is more horizontal  The more substitutes, the more elastic  Elasticity is greater the more specific the product or industry.  More specific = more substitutes = more elastic  E.g., Coca Cola is more elastic than “cola,” which is more elastic than “soda,” which is more elastic than “drinks.” o o o o

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 Elastic-> increase in price reduces quantity demanded A LOT Inelastic-> increase in prices reduces quantity demanded a little. Flatter curves are more elastic More elastic if: more substitutes, larger budget share (opposite of salt), specific brand (and not broad category), luxury (and not necessary), longer span of time. Second Law of Demand: supply and demand become more elastic over time.

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 E.g.: if price of gas doubles overnight, there’s nothing you can do  But over time, you can buy a car and move to a new apartment  Short run supply/demand is more vertical How does substitutes impact the price of elasticity of demand? o Goods with close substitutes: more elastic demand o Example: if you value beef and pork to be similar quality, then beef’s prices going up will mean you will buy A LOT less beef (b/c you can switch to pork). Are necessities inelastic or elastic? Luxury goods? o Necessities: inelastic demand o Luxuries: elastic demand Elastic demand is greater than 1, inelastic is less than 1. Calculate elasticity using the “normal” formula and midpoint o Computing the price elasticity of demand -percentage change in quantity demanded divided by percentage change in price  E(d)=[%∆Q]/[%∆P]  Midpoint method -Two Points: (Q1, P1) and (Q2, P2)

 What is the relationship between elasticity and total revenue collected? o TR is the amount paid by buyers and received by sellers of a good. o Price of the good times the quantity sold (P x Q) o For a price increase:  If a demand is inelastic, TR increases  If demand is elastic, TR decreases  Be able to calculate total revenue from a demand curve o When demand is inelastic (elasticity < 1)  P and TR move in the same direction o If P ↑, TR also ↑ o When demand is elastic (elasticity > 1)  P and TR move in opposite directions o If P ↑, TR ↓ o If demand is unit elastic (elasticity = 1)

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 Total revenue remains constant when the price changes  What is income elasticity of demand? o How much the quantity demanded of a good response to a change in consumers income o Percentage change in quantity demanded  (divided by the % change in income) o Normal goods  Positive income elasticity  Necessities  Smaller income elasticities  Ex: if your income goes up, you likely won’t buy a ton more of salt of bread  Luxuries  Large income elasticities  Ex: if you win the lottery, your willingness to buy a new boat will increase  Inferior goods  Negative income elasticities  Ex: if you win the lottery, you probably won’t buy ramen noodles anymore  Ex: once you get a raise, you might choose steak over chicken.  When cross-price elasticity is positive, what does this say about the goods? The goods would be defined as Substitutes. (goods that are typically used in place of one another, ex. If beef price goes up, you buy more pork.)

CHAPTER 1 1. Resources are a. scarce for households but plentiful for economies. b. plentiful for households but scarce for economies. c. scarce for households and scarce for economies.

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d. plentiful for households and plentiful for economies. 2. Fundamentally, economics deals with a. scarcity. b. money. c. poverty. d. banking. 3. In most societies, resources are allocated by a. a single central planner. b. a small number of central planners. c. those firms that use resources to provide goods and services. d. the combined actions of millions of households and firms. 4. Economics is the study of how society manages its a. limited wants and unlimited resources. b. unlimited wants and unlimited resources. c. limited wants and limited resources. d. unlimited wants and limited resources. 5. Coal is considered to be a nonrenewable energy source. Which of the following statements is correct? a. Coal is an unlimited resource. b. Coal is a scarce resource. c. Coal is a nonscarce resource. d. Coal is not a resource. 6. What term refers to the idea that society has limited resources and therefore cannot produce all the goods and services people wish to have? a. inefficiency b. inequality c. scarcity d. market failure 7. The adage, "There ain't no such thing as a free lunch," means a. even people on welfare have to pay for food. b. the cost of living is always increasing. c. people face tradeoffs. d. all costs are included in the price of a product. 8. When society requires that firms reduce pollution, there is

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a. a tradeoff because of reduced incomes to the firms' owners and workers. b. a tradeoff only if some firms are forced to close. c. no tradeoff, since the cost of reducing pollution falls only on the firms affected by the requirements. d. no tradeoff, since everyone benefits from reduced pollution. 9. The property of society getting the most it can from its scarce resources is called a. efficiency. b. equality. c. externality. d. productivity. 10. Which of the following is true? a. Efficiency refers to the size of the economic pie; equality refers to how the pie is divided. b. Government policies usually improve upon both equality and efficiency. c. As long as the economic pie continually gets larger, no one will have to go hungry. d. Efficiency and equality can both be achieved if the economic pie is cut into equal pieces. 11. The opportunity cost of an item is a. the number of hours needed to earn money to buy the item. b. what you give up to get that item. c. usually less than the dollar value of the item. d. the dollar value of the item. 12. When computing the opportunity cost of attending a professional football game as a spectator, you should include a. the price you pay for the ticket and the value of your time. b. the price you pay for the ticket, but not the value of your time. c. the value of your time, but not the price you pay for the ticket. d. neither the price of the ticket nor the value of your time. 13. Alana decides to spend 2 hours working overtime rather than going shopping with her friends. She earns $11 per hour for overtime work. Her opportunity cost of working is a. the $22 she earns working. b. the $22 minus the enjoyment she would have received from going shopping. c. the enjoyment she would have received had she gone shopping. d. nothing, since she would have received less than $22 worth of enjoyment from going shopping. 14. For which of the following individuals would the opportunity cost of going to college be highest? a. A promising young mathematician who will command a high salary once she earns her

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college degree b. A student with average grades who has never held a job c. A famous, highly paid actor who wants to take time away from show business to finish college and earn a degree d. A student who is the best player on his college basketball team, but who lacks the skills necessary to play professional basketball 15. Savion's aunt gave him $25 for his birthday with the condition that Savion buys himself something. In deciding how to spend the money, Savion narrows his options down to four choices: Option 1, Option 2, Option 3, and Option 4. Each option costs $25. Finally, he decides on Option 2. The opportunity cost of this decision is a. the value to Savion of the option he would have chosen had Option 2 not been available. b. the value to Savion of Options 1, 3, and 4 combined. c. the average of the values to Savion of Options 1, 3, and 4. d. $25. 16. A hair stylist currently cuts and colors hair for 50 clients per week and earns a profit. He is considering expanding his operation in order to serve more clients. Should he expand? a. Yes, because cutting hair is profitable. b. No, because he may not be able to sell more services. c. It depends on the marginal cost of serving more clients and the marginal revenue he will earn from serving more clients. d. It depends on the average cost of serving more clients and the average revenue he will earn from serving more clients. ...