Reviewer in Econ
Reviewer in Econ 11 Chapter 1
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Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people. Two key ideas in economics: good are scare and society must use its resources efficiently. Efficiency denotes the most effective use of a society’s resources in satisfying people’s wants and needs. An economy is producing efficiently when it cannot make anyone economically better off without making someone else worse off. Adam Smith is considered the founder of the field of microeconomics, the branch of economics which is concerned with the behavior of individual entities such as markets, firms, and households. Economics benefit comes from the self-interested actions of individuals. Macroeconomics is concerned with the overall performance of the economy. (John Maynard Keynes). It examines a wide variety of areas, such as how total investment and consumption are determined, how central banks manage money and interest rates, what causes international financial crises, and why some nations grow rapidly while others stagnate. Scientific approach- involves observing economic affairs and drawing upon statistics and the historical record. Economics relies upon analyses and theories. Theoretical approaches allow economists to make broad generalizations; such as those concerning advantages of international trade and specialization or the disadvantages of tariffs and quotas. Econometrics- specialized technique which applies the tools of statistics to economics problems. Economic fallacies in economic reasoning Post hoc fallacy occurs when we assume that, because one event occurred before another event, the first event caused the second event. Failure to hold other things constant (Remember to hold other things constant when you are analyzing the impact of a variable on the economic system.) The fallacy of composition. When you assume that what is true for the part is also true for the whole. The ultimate goal of economic science is to improve the living conditions of people in their everyday lives. Fundamental economic problems what commodities are produced how these goods are made for whom they are produced Positive economics describes the facts of an economy. It can be resolved by reference to analysis and empirical evidences. Normative economics involves value judgments, and ethical percepts and norms of fairness. There are no right and wrong answers because it involves ethics and
values rather than facts. It can be resolved only by political debate and decisions, not by economic analysis alone. Two economic organizations At one extreme, government makes most economic decisions, with those on top of the hierarchy giving economic commands to those further down the ladder. At the other extreme, decisions are made in markets, where individuals or enterprises voluntarily agree to exchange goods and services, usually through payments of money. 1. Market economy- individuals and private firms make the major decisions about production and consumption. Government keeps its hands off economic decisions (laissez-fare) 2. Command economy- the government makes all important decisions about production and distribution. The government answers the major economic questions through its ownership of resources and its power to enforce decisions. 3. Mixed economy- with elements of market and command. Inputs- commodities or services that are used to produce goods and services. Outputs- various useful goods and services that result from the production process and are either consumed or employed in further production. Factors of production 1. land- natural resources 2. labor- human time spent in production 3. capital- resources from the durable goods of an economy, produced in order to produce yet other goods Production possibility frontier (PPF) shows the maximum amount of production that can be obtained by an economy, given its technological knowledge and quantity of inputs available. By sacrificing current consumption and producing more capital goods, a nation’s economy can grow more rapidly, making possible more of both goods (consumption and capital) in the future. Opportunity cost- value of a good or service forgone Productive efficiency occurs when an economy cannot produce more of one good without producing less of another good; this implies that the economy is on its PPF. Chapter 2
Welfare state- markets direct the detailed activities of day-to-day economic life while government regulates social conditions and provides pensions, health care, and other necessities for poor families. No one individual or organization or government is responsible for solving the economic problems in a market economy. Market- mechanism through which buyers and sellers interact to determine prizes and exchange goods and services.
Price- value of the good in terms of money. It serves as signals to producers and consumers. If consumer wants more of any good, the price will rise, sending a signal to producers that more supply is needed. Higher prices tend to reduce consumer purchases and encourage production. Lower prices encourage consumption and discourage production. Prices are the balance wheel of the market mechanism. Market equilibrium represents a balance among all the different buyers and sellers. Too high a price would mean a glut of goods with too much output; too low a price would produce long lines in stores and a deficiency of goods. Profits are net revenues, or the difference between the total sales and total costs. The best way for producers to meet price competition and maximize profits is to keep costs at a minimum by adopting the most efficient methods of production. Monarchs of market place The major forces affecting the shape of the economy are the dual monarchs of tastes and technology. Consumers demand has to dovetail with business supply of goods and services to determine what is ultimately produced. Consumers buy goods and sell factors of production; producers sell goods and buy factors of production. Market failures- markets do not always lead to the most efficient outcome. It concerns monopolies and other forms of imperfect competition. A second failure of the invisible hand comes when there are spillovers or externalities, such as pollution. Trade (specialization and division of labor) Money- means of payment. It provides the yardstick for measuring the economic value of things and for financing trade. Capital goods leverage human labor power into a much more efficient factor of production and allow productivity many times greater than that possible in an earlier age. Specialization has allowed workers to become highly productive in particular occupations and to trade their output for the commodities they need (caused rapid economic growth). Trade can enrich all nations and increase everyone’s living standards. Governments control the money supply through central banks. But like other lubricants, money can get overheated and damage the economic engine. It can grow out of control and cause a hyperinflation, in which prices increase very rapidly. When that happens, people concentrate on spending their money quickly, before it loses its value, rather than investing it for the future. Capital is one of the three major factors of production. The other two, land and labor, are often called primary factors of production. That means their supply is mostly determined by noneconomic factors, such as fertility rate and the country’s geography. Capital, by contrast, has to be produced before you can use it.
Property rights bestow on the owners the ability to use, exchange, paint, dig, drill or exploit their capital goods. The ability of individuals to own and profit from capital is what gives capitalism its name. The most valuable economic resource, labor, cannot be turned into a commodity that is brought and sold as private property. Governments operate by requiring people to pay taxes, regulations and consume certain collective goods and services. Three main economic functions of government 1. increase efficiency by promoting competition, curbing externalities like pollution, and providing public goods 2. promote equity by using tax and expenditure programs to redistribute income toward particular groups 3. foster macroeconomic stability and growth by reducing unemployment and inflation while encouraging economic growth through fiscal policy and monetary regulation Perfect competition- no firm or consumer is large enough to affect the market price. Imperfect competition- buyer or seller affects a good’s price. Imperfect competition leads to prices that rise above cost and to consumer purchases that are reduced below efficient levels. Monopolist- single supplier who alone determines the price of a particular good or service. Externalities- firms or people impose costs or benefits on others outside the marketplace. Public goods- commodities which can be enjoyed by everyone and from which no one can be excluded. Progressive taxation- taxing large incomes at a higher rate than small incomes. It might impose heavy taxes on wealth or on large inheritances to break the chain of privilege. Transfer payments- provides safety net to protect the unfortunate from privatization Inflation (rising prices), recession (high unemployment) Fiscal policy- the power to tax and spend Monetary policy- determining the supply of money and interest rates Economic growth denotes the growth in a nation’s total output, while productivity represents the output per unit input or the efficiency with which resources are used. Chapter 3
Theory of supply and demand- shows how consumer preferences determine consumer demand for commodities, while business costs are the foundation of the supply commodities.
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Price mechanism- movement of prices, which brings supply and demand into balance or equilibrium. The higher the price of an article, other things held constant, the fewer units consumers willing to buy. The lower its price, the more units of it are bought. The relationship between price and quantity bought is called the demand schedule, or the demand curve (the graphical representation of the demand schedule). Law of downward-sloping demand (quantity demand tends to fall as price rises for two reasons: substitution effect and income effect) Market demand- the sum total of all individual demands. It is found by adding together the quantities demanded by all individuals at each price. Factors affecting the demand curve average income (as people’s incomes rise, individual tends to buy more of almost everything, even if prices don’t change) size of the market (population) prices and availability of related goods tastes or preferences special influences movement along the curve (decrease or increase of quantity demanded or supplied), shift of the curve (demand or supplied increase) Supply schedule (curve)- shows the relationship between its market price and the amount of that commodity that producers are willing to produce and sell, other things held constant. Upward-sloping (law of diminishing returns) Producers supply commodities for profit. One major element underlying the supply curve is the cost of production. When production costs for a good are low relative to the market price, it is profitable for producers to supply a great deal. When production costs are high relative to price, firms produce little, switch to the production of other products, or maybe simply go out of business. Production costs are primarily determined by the prices of inputs (a reduction in the wage paid to autoworkers lowers production costs and increases supply) and technological advances (lower the quantity of inputs needed to produce the same quantity of output). Prices of related goods (if the price of one production substitute rises, the supply of another substitute will decrease) Government policy (removing quotas and tariffs on imported goods increases total goods supply. Special influences Supply increases (decreases) when the amount supplied increases (decreases) at each market price. Market equilibrium comes at the price and quantity where the forces of supply and demand are in balance. At the equilibrium price, the amount the amount that buyers want to buy is just equal to the amount that sellers want to sell. The reason we call this equilibrium is that, when forces of supply and demand are in balance,
there is no reason for price to rise or fall, as long as other things remain unchanged. The market equilibrium price is also called the market-clearing price. The equilibrium price comes at the intersection of the supply and demand curves. Surplus (excess of quantity supplied over quantity demanded)- pressure on price (downward) Shortage (excess of quantity demanded over quantity supplied)- pressure on price (upward) If demand rises, the demand curve shifts to the right, price and quantity go up If demand falls, the demand curve shifts to the left, price and quantity go down If supply rises, the supply curve shifts to the right, price goes down and quantity goes up If supply falls, the supply curve shifts to the left, price goes up and quantity goes down The marketplace, through intersection of supply and demand, does the rationing. This is rationing by purse. Those who have the greatest dollar votes have the greatest influence on what goods are produced.
Product markets- markets for goods and services The quantitative analysis between price and quantity purchased is analyzed using elasticity. Price elasticity of demand and supply- measures how much the quantity demanded and supplied of a good changes when its price changes. The precise definition of these elasticities is the percentage change in quantity demanded and supplied divided by the percentage change in price. When the elasticity of a good is high, the good has “elastic” demand and supply, which means its quantity demanded and supplied responds greatly to price changes. When the elasticity of a good is low, it is “inelastic” and its quantity demanded and supplied responds little to price changes. Demand and supplied elasticities are generally higher in the long run than in the short run. Elasticities tend to be higher when the goods are luxuries, when substitutes are available, and when consumers have more time to adjust their behavior. Completely inelastic demands (zero elasticity)- quantity demanded responds not at all to price changes; such demand is seen to be a vertical demand. By contrast, when demand is infinitely elastic, a tiny change in price will lead to and indefinitely large change in quantity demanded, as in the horizontal demand curve. The slope is not the same as the elasticity because the demand curve’s slope depends upon the changes in P and Q, whereas the elasticity depends upon the
percentage changes in P and Q. The only exceptions are the polar cases of completely elastic and inelastic demands. In a straight line, price elasticity is relatively large when we are high on the linear demand curve. Conversely, when we are in the bottom part, the price elasticity is less than. (ratio of the length of the line segment below the point to the length of the line segment above) Total revenue- price times quantity (P x Q) Elastic demand (revenues increase, when price decreases) Inelastic demand (revenues decrease, when price decreases) Price discrimination- charging different prices for the same service to different customers. In inelastic demand, consumption changes very little in response to price. This means farmers as a whole receive less total revenue when the harvest is good thank when it is bad. The increase in supply arising form an abundant harvest tends to lower the price. But the lower price doesn’t increase quantity demanded very much. For supply the quantity demand to price is positive, while for demand the response is negative. If all inputs can be readily found at going market prices, then output can be greatly increased with the little increase in price. On the other hand, if production capacity is severely limited, then even sharp increases in the price of good will have a small response in production. Governments attempt to help farmers by reducing their production. Production restrictions are typical of government market interferences that raise the incomes of one group at the expense of others. Incidence of tax- the ultimate economic effect of a tax on the real incomes of producers or consumers. Taxes are used to discourage consumption; subsidies are used to encourage production. If demand is inelastic, the cost is shifted to the consumers; if supply is inelastic, the cost is shifted to the suppliers. Price ceilings lead to excess demand; floors lead to excess supply.