Principles of Economics Midterm 1 Cheat Sheet

MIDTERM 1 CHEAT SHEET Ch 1: 10 Principles of Economics: 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. 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 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 10: Society faces a short-run trade-off between inflation and unemployment Scarcity: Limited resources and unlimited wants Economics: Study of how society manages its scarce resources Efficiency: The property of society getting the most from its scarce resources Equality: The property of distributing economic prosperity uniformly among society’s members Opportunity cost: Whatever is given up to get something else Rational people: Systematically and purposefully doing the best you can to achieve your objectives Marginal change: An incremental adjustment to an existing plan Incentive: Something that induces a person to act Market economy: An economic system where interaction of households and firms in markets determines the allocation of resources Property rights: The ability of an individual to own and exercise control over scarce resources “Invisible hand”: The principle that self-interested market participants may unknowingly maximize the welfare of society as a whole Market failure: A situation in which the market fails to allocate resources efficiently Externality: When one person’s actions have an impact on a bystander Market power: The ability of an individual or group to substantially influence market prices Monopoly: The case in which there is only one seller in the market Productivity: The amount of goods and services produced from each unit of labor input Inflation: An increase in the overall level of prices Business cycle: Fluctuations in economic activity Ch 2: Circular Flow Diagram: Firms offer goods and services for households to consume. They also offer incomes to the households. Production Possibilities Frontier (PPF): A curve which shows various combinations of the amounts of two goods which can be produced within the given resources and technology. Scientific method: Objective development and testing of theories Economic models: Simplifications of reality based on assumptions Factors of production: Inputs such as land, labor, and capital Efficiency: Getting maximum output from the resources available Microeconomics: The study of how households and firms make decisions and how they interact in markets nomics: The study of economy-wide phenomena Positive statements: Descriptions of the world as it is Normative statements: Prescription for how the world ought to be Macroeco Ch 4: A market is a group of buyers and sellers of a particular good or service. A perfectly competitive market has two main characteristics: -The goods offered for sale are all exactly the same. -The buyers and sellers are so numerous that no one buyer or seller can influence the price. If a market is perfectly competitive, both buyers and sellers are price takers because they cannot influence the price. If a market has only one seller, the market is known as a monopoly. Market demand is the sum of the quantities demanded for each individual buyer at each price. That is, the market demand curve is the horizontal sum of the individual demand curves. Demand Curve Shifts: Increase in demand: If buyers increase the Qd at each price, the demand curve shifts to the right. Decrease in demand: If buyers decrease the Qd, the demand curve shifts to the left factors: Income: A normal good is a good for which an increase in income leads to an increase in demand Prices of Related Goods: Substitutes: Goods can be used in place of one another,.an increase in the price of one leads to an increase in the demand for the other. Complements: Tastes: Expectations: Expectations about future income or prices will affect the demand for a good today. Number of Buyers: An increase in the number of buyers will lead to an increase in the market demand Supply Curve Shifts: Increase in supply: If producers increase the quantity supplied, the curve shifts right. Decrease in supply: If producers decrease the quantity supplied, the curve shifts left. factors: Input Prices: A decrease in the price of an input makes production more profitable and increases supply. Technology: An improvement in technology reduces costs, makes production more profitable, and increases supply. Expectations: Expectations about the future will affect the supply of a good today. Number of Sellers: An increase in the number of sellers will lead to an increase in the market supply. Quantity demanded: The amount of a good that buyers are willing and able to purchase Law of supply: The claim that, other things equal, the quantity supplied of a good rises when the price of the good rises Law of demand: The claim that, other things equal, the quantity demanded of a good falls when the price of the good rises Demand schedule: A table that shows the relationship between the price of a good and the quantity demanded Demand curve: A graph of the relationship between the price of a good and the quantity demanded Normal good: A good for which, other things equal, an increase in income leads to an increase in demand Inferior good: A good for which, other things equal, an increase in income leads to a decrease in demand Substitutes: Two goods for which an increase in the price of one leads to an increase in the demand for the other Complements: Two goods for which an increase in the price of one leads to a decrease in the demand for the other Quantity supplied: The amount of a good that sellers are willing and able to sell Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied Supply curve: A graph of the relationship between the price of a good and the quantity supplied Equilibrium: A situation in which the price has reached the level where quantity supplied equals quantity demanded Equilibrium price: The price that balances quantity supplied and quantity demanded Equilibrium quantity: The quantity supplied and the quantity demanded at the equilibrium price Surplus: A situation in which quantity supplied is greater than quantity demanded Shortage: A situation in which quantity demanded is greater than quantity supplied Law of supply and demand: The claim that the price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance Ch 5: The Elasticity of Demand If the quantity demanded changes substantially from a change in price, demand is elastic. If the quantity demanded changes little from a change in price, demand is inelastic. If elasticity>1, demand is elastic. If elasticity<1, demand is inelastic. If elasticity=1, demand is unit elastic. If elasticity=0, demand is perfectly inelastic (vertical). If elasticity=∞, demand is perfectly elastic (horizontal). Whether a demand curve tends to be price elastic or inelastic depends on the following: Availability of close substitutes: The demand for goods with close substitutes is more sensitive to changes in prices and, thus, is more price elastic. Necessities versus luxuries: The demand for necessities is inelastic while the demand for luxuries is elastic. An increase in price greatly reduces the quantity demanded of a luxury. Definition of the market: The more narrowly we define the market, the more likely there are to be close substitutes and the more price elastic the demand curve. Time horizon: The longer the time period considered, the greater the availability of close substitutes and the more price elastic the demand curve. Midpoint method: In general, the flatter the supply curve, the more elastic. The steeper the supply curve, the more inelastic. Income elasticity Income elasticity is +for normal goods. Income elasticity is - for inferior goods. Elasticity: A measure of the responsiveness of the quantity demanded or quantity supplied to a change in one of its determinants Price elasticity of demand: A measure of how much the quantity demanded of a good responds to a change in the price of that good Elastic: When the quantity demanded or supplied responds substantially to a change in one of its determinants Inelastic: When the quantity demanded or supplied responds only slightly to a change in one of its determinants Total revenue: The amount paid by buyers and received by sellers of a good computed as P × Q Income elasticity of demand A measure of how much the quantity demanded of a good responds to a change in consumers’ income Cross-price elasticity of demand: A measure of how much the quantity demanded of one good responds to a change in the price of another good Price elasticity of supply: A measure of how much the quantity supplied of a good responds to a change in the price of that good Normal good: A good characterized by a positive income elasticity Inferior good: A good characterized by a negative income elasticity