Econ 203 Exam 1

Front 1

Definition of Economics

Back 1

An analysis of how individuals and societies must make choices because of the scarcity of resources needed to fulfill unlimited wants.

Thus, because people’s wants are unlimited but resources are scarce, they must make choices.

Front 2

Basic economic resources and examples

Back 2

Land, labor, capital, and entrepreneurship are the basic economic resources.

"Land" refers to any and all natural resources, such as plots of ground on the surface of the earth, rivers, lakes, forests, and mines.

“Labor” refers to the knowledge, skills, and abilities that can be used to produce goods and services.

"Capital" refers to machines, buildings, and tools (i.e., physical capital), and knowledge acquired through education and training (i.e., human capital).

“Entrepreneurship” refers to the ability to organize and lead the production of goods and services as well as the ability to deal with risks and uncertainties associated with such activities.

Front 3

The cause for the scarcity of goods and services

Back 3

Goods and services are scarce because the resources necessary to produce them are scarce.

Front 4

The interpretation of rational decision-making

Back 4

Rational decision-making involves implicitly or explicitly calculating the benefits and costs of an activity to decide if it is worthwhile.

Front 5

The interpretation of marginal analysis in decision-making

Back 5

Marginal analysis involves comparing the additional (marginal) costs and additional (marginal) benefits of an activity before making a decision about undertaking or pursuing that activity.

Front 6

The application of marginal analysis in rational decision-making

Back 6

Marginal analysis in rational decision-making implies making a change only if the expected marginal benefit exceeds the expected marginal cost.

Front 7

Opportunity cost: Origin, definition, and calculation

Back 7

• Opportunity costs arise because of having to make choices due to scarcity of resources.
The opportunity cost of a choice is the value of the best alternative given up when that choice is made.

Opportunity costs can be subjective. For example, if Brad enjoys outdoor swimming, the opportunity cost of cleaning his room is greater on sunny days than it is on rainy days.

Front 8

Production Possibilities Frontier (PPF): Definition, underlying assumptions, and the economic concepts it represents

Back 8

A PPF is an economic model that can be used to illustrate the concepts of scarcity, opportunity cost, economic efficiency or inefficiency, and economic growth or decline.

A PPF is based on the following assumptions: (a) the PPF applies to a particular time period, (b) resources and technology are fixed during that time period, (c) resources can be shifted between the production of alternative goods, and (d) resources are fully and efficiently employed.

Front 9

Interpretation of points on, inside, or outside a PPF

Back 9

Points on the PPF represent efficient combinations of outputs and full employment of resources.

Points inside the PPF represent inefficiency or unemployment of resources (or both).

Points outside the PPF represent currently unattainable combinations of outputs.

Front 10

Interpretation of shifts in a PPF and the underlying causes

Back 10

An outward shift in a PPF reflects economic growth.

An inward shift in a PPF reflects economic decline.

The underlying causes include changes in the quantities of resources available, changes in technology, or both.

For example, an increase in the quantities of resources available or an improvement in technology would shift a PPF outward. The opposite changes would shift the PPF inward.

Front 11

Interpretation of a concave vs. a straight-line PPF

Back 11

A concave PPF reflects that resources are not equally suitable for the production of alternative goods. Thus, as the production of a good is increased, its opportunity cost increases.

A straight-line PPF reflects that resources are equally suitable for the production of alternative goods. Thus, as the production of a good is increased, its opportunity cost remains constant.

Front 12

Basic economic questions every nation must answer

Back 12

What to produce? -- Which goods will be produced?

How to produce? -- Which resources should be used? How should resources be combined to produce each product?

For whom to produce? -- Who are expected to consume the goods produced?

Front 13

Types of economic systems: Differences and examples

Back 13

Capitalist or market economy: Decisions are based on individual choices, which are made using the market process.

Command economy: Individual choices are purported to be reflected in collective decisions, which are made by central planners.

Mixed economy: Combination of capitalism and central planning. This is the dominant economic system in the world because there is private ownership of property but government regulation of individuals reduces some of the flaws of pure capitalism.

Decision-making is typically decentralized under capitalism while it is centralized in command economies.

Front 14

Microeconomics vs. macroeconomics

Back 14

Microeconomics involves the study of the economic behavior of individual decision makers such as persons, households, firms, and government agencies.

Macroeconomics involves the study of the behavior of the economy as a whole as it relates to the level of national output, employment, income, inflation, and interest rate.

Front 15

Division of labor and specialization: Examples and economic significance

Back 15

Example of division of labor: Dividing an assembly process into separate steps.

Example of specialization: An economics professor focuses on a specialty area such as monetary economics or transportation economics.

Division of labor increases productivity and efficiency because tasks can be assigned according to individual strengths and abilities.

Specialization increases productivity and efficiency because individuals specialize on occupations based on their comparative advantages.

Front 16

Interpretation of demand for a good or service and the law of demand

Back 16

The demand for a good reflects the ability and willingness to buy the good.

One must have both the ability and willingness to buy in order to be considered as having a demand for the good.

The actual purchase of a good provides a clear evidence of the demand for the good.

The law of demand states that as the price of a good increases, its quantity demanded decreases and vice versa, all other things remaining constant (ceteris paribus).

The demand curve for a good is a graphical representation of the law of demand and shows the quantity demanded of the good at each possible price.

Front 17

Income vs. substitution effect of a change in price

Back 17

A change in the price of a good causes a change in its quantity demanded through a combination of income and substitution effects.

The income effect refers to the impact of a change in the price of a good on real income. For example, people buy less of a good when its price increases in part because their real income or purchasing power has fallen.

The substitution effect refers to the impact of a change in the price of a substitute good on the consumption of a given good. For example, people increase the consumption of Coke because of an increase in the price of Pepsi.

Front 18

Change in quantity demanded vs. change in demand

Back 18

Change in quantity demanded:
➢ An increase or decrease in the quantity demanded of a good because of a change in the price of that good.
➢ It involves a movement along a specific demand curve.
➢ For example, the effect of a decrease in the price of digital cameras is represented by a movement down along the demand curve.

Change in demand:
➢ An increase or decrease in the quantity demanded of a good because of a change in a demand determinant other than the price of the good.
➢ It involves a shift in the demand curve.
➢ For example, the effect of an increase in consumer income on the quantity demanded of digital cameras is represented by a shift in the demand curve to the right or upward.

As a technical jargon, it should be noted that when the quantity demanded of a good changes as a result of a change in the price of the good, it is called a change in quantity demanded. On the other hand, when the quantity demanded of a good changes as a result of a change in a factor or a combination of factors other than the price of the good, it is called a change in demand.

Front 19

Factors that cause changes in demand or shifts in demand curves

Back 19

Consumer income:
➢ Consumer income and the demand for a good are positively related if the good is normal or negatively related if the good is inferior.
➢ For example, if the demand for gasoline increases as a result of an increase in consumer income, gasoline is a normal good.
➢ If the demand for used cars decreases as a result of an increase in consumer income, used cars are inferior goods.

Consumer tastes or preferences:
➢ Improvements in consumer tastes or preferences for a good increase the demand for that good and vice versa.
➢ For example, if consumers like watching movies on DVDs more now than before, the demand for DVDs will increase.

Prices of related goods:
➢ If an increase in the price of one good causes the demand for another good to increase and vice versa, the goods are substitutes.
➢ For example, if an increase in the price of beef causes the demand for chicken to increase, beef and chicken are substitutes.
➢ If an increase in the price of one good causes the demand for another good to decrease and vice versa, the goods are complements.
➢ For example, if an increase in the price of milk causes the demand for cereals to decrease, milk and cereals are complements.

Consumer expectations:
➢ If expectations of higher income or economic prosperity make people optimistic, demands for goods and services tend to increase.
➢ If expectations of lower income or economic adversity make people pessimistic, demands for goods and services tend to decrease.
➢ Expectations about prices have different impacts on demand.
➢ For example, if consumers expect the price of DVDs to increase 12 percent next week, their demands for DVDs will increase immediately because they want to buy the DVDs before the price increases.
➢ The opposite will happen if consumers expect the price to decrease 12 percent next week.

Number of consumers:
➢ The larger the number of consumers, the higher the demands for goods and services and vice versa.

Front 20

Individual demand vs. market demand

Back 20

Individual demand: An individual consumer’s demand for a good or service. For example, Joe’s demand of 20 dozen Florida oranges per year at prevailing market prices is Joe’s individual demand.

Market demand: The sum of individual demands for a good or service. For example, if the demand side of the market for Florida oranges is made up of 200 consumers, the market demand for Florida oranges is the sum of the 200 individual consumers’ demands.

Front 21

Interpretation of supply for a good or service and the law of supply

Back 21

The supply of a good reflects the ability and willingness to sell the good.

There must be both the ability and willingness to sell in order for a good to be considered as being supplied.

Production is a prerequisite for a good to be supplied. However, if the good is produced for personal use or for sale sometime in the future, the good cannot be considered as being supplied at present. This reflects the ability but not the willingness to sell.

Making a good actually available for sale is a clear evidence of the supply of the good.

The law of supply states that as the price of a good increases, its quantity supplied increases and vice versa, all other things remaining constant (ceteris paribus). Thus, the price of a good and its quantity supplied are positively related. The reason is that because production costs rise as output is increased, firms are willing to increase output only if the price of output increases so that they can maintain or increase profits.

The supply curve for a good is a graphical representation of the law of supply and shows the quantity supplied of the good at each possible price.

Front 22

Change in quantity supplied vs. change in supply

Back 22

Change in quantity supplied:
➢ An increase or decrease in the quantity supplied of a good because of a change in the price of that good.
➢ It involves a movement along a specific supply curve.
➢ For example, the effect of a decrease in the price of digital cameras is represented by a movement down along the supply curve.

Change in supply:
➢ An increase or decrease in the quantity supplied of a good because of a change in a supply determinant other than the price of the good.
➢ It involves a shift in the supply curve.
➢ For example, the effect of an increase in the price of microchips on the quantity supplied of digital cameras is represented by a shift in the supply curve to the left or upward.

As a technical jargon, it should be noted that when the quantity supplied of a good changes as a result of a change in the price of the good, it is called a change in quantity supplied. On the other hand, when the quantity supplied of a good changes as a result of a change in a factor or a combination of factors other than the price of the good, it is called a change in supply.

Front 23

Factors that cause changes in supply or shifts in supply curves

Back 23

Prices of inputs:
➢ Decreases in the prices of inputs used to produce a good would increase the supply of the good because the good can be produced at a lower cost, which will increase profit. The opposite is true when input prices increase.
➢ For example, a decrease in the price of microchips will increase the supply of computers.

Technology:
➢ Improvement in the technology of producing a good causes the supply of the good to increase and vice versa.
➢ For example, if the technology of ice cream production improves, the supply of ice cream will increase.

Prices of related goods:
➢ If goods X and Y are substitutes (on the production side), an increase in the price of good X will cause a decrease in the supply of good Y because the producer can increase profits by selling more of good X and will use more resources in the production of good X. This will leave less resources for the production of good Y, thereby decreasing its supply.
➢ Corn and soybeans are examples of substitute products.
➢ If goods X and Y are complements, e.g., joint products (on the production side), an increase in the price of good X will cause an increase in the supply of good Y because the producer can increase profits by selling more of good X and will end up producing more of good Y, a joint product, in the process of producing more of good X.
➢ Lumber and sawdust are examples of complementary products.

Business expectations:
➢ If expectations of higher sales and profits or improved economic outlook make firms optimistic, supplies of goods and services tend to increase.
➢ If expectations of lower sales and profits or dim economic outlook make firms pessimistic, supplies of goods and services tend to decrease.
➢ Expectations about prices have different impacts on supply.
➢ For example, if firms expect the price of DVDs to increase 12 percent next week, their supplies of DVDs will decrease immediately because they want to sell the DVDs when the price increases next week.
➢ The opposite will happen if firms expect the price to decrease 12 percent next week.

Number of firms:
➢ The larger the number of firms, the larger the supplies of goods and services and vice versa.

Front 24

Individual supply vs. market supply

Back 24

Individual supply: An individual seller’s supply of a good or service. For example, XYZ Farm’s supply of 5 tons of Florida oranges per year at prevailing market prices is that farm’s individual supply.

Market supply: The sum of individual supplies of a good or service. For example, if the supply side of the market for Florida oranges is made up of 10 farms, the market supply of Florida oranges is the sum of the 10 individual farms’ supplies.

Front 25

Impacts of varying prices on quantities demanded and supplied in the market: Surplus, shortage, and market equilibrium

Back 25

When the quantity demanded of a good is less than the quantity supplied at the prevailing market price, surplus or excess supply occurs and the price of the good tends to fall.

When the quantity demanded of a good is more than the quantity supplied at the prevailing market price, shortage or excess demand occurs and the price of the good tends to rise.

The most important characteristic of the equilibrium price is that it clears the market, leaving neither a surplus nor a shortage.