CIE3M – Grade 11 Economics Exam Economics Exam Notes What is economics? ● Social science that studies how people use scarce resources to satisfy their unlimited wants ● Macroeconomics ○ Examines the economy as a whole (the forest) rather than ● individual units. ○ Concerns itself with aggregate behavior Microeconomics ○ Examines behavior of individual economic units (tree in forest), determines relative prices Scarcity and Choice ● Scarcity and unlimited wants lead to choice Factors of production ● Land (natural resources), Capital (manufactured goods to assist), Labour (mental, physical efforts of people), Entrepreneurship (managerial and decision making skills) Opportunity cost ● Other opportunities/alternatives that are sacrificed Production Possibility Curve ● Scarcity (trade-off) ● Shows maximum output of two goods that an economy can produce if it uses all its resources ● If line is linear, opportunity cost is constant ● Increasing opportunity cost is more common so line is usually curved outwards ○ To produce more of something, more of something else has to be given up ● Points A, B, and C indicate the many combinations of homes and vehicles ● that can be constructed when all resources are fully utilized (perfectly efficient economy produces economy) Moving from Point U to Point A will have no opportunity cost as it will be using idle resources and no sacrifice is made ● Point Q (by pushing the curve forward) is unattainable in the economy and is only attainable when there is an advance is technology and increase in resources (economic growth) ○ Creates a new PPC and parallel to original one if increases in both sectors ○ If only one, lopsided Circular Flow ● Factor market ○ Where factors of production are sold ● Product market ○ In which firms sell their output of goods and services ● Real flows ○ Flows of goods and services and resources ● Nominal flows ○ Flows of expenditure and income Price determination in a free market ● Market price is determined through interaction of supply and demand ○ Consumers will buy more or less depending on the price ○ Businesses will adjust their prices accordingly to the demand and what they have in supply ○ This continues until they reach a point where the most revenue can be found Demand ● people's willingness to purchase a good or service in a range of quantities ● and at a range of prices throughout time Law of demand: ○ ○ Inverse relationship because if price falls, people can afford to buy more ■ Demand curve slopes downwards because inverse ○ Demand curve is a graph showing the demand of various quantities at various prices ● Factors affecting demand ○ Income ■ Increased income = more normal good purchased ■ Eg) luxury cars to normal cars ■ Decreased income = more inferior good purchased ■ Eg) regular ground beef to steaks ○ Prices of Related Goods ■ Substitutes can be used in place of the original ■ Increase of price in one good means demand moves to its substitute ■ Limes and lemons ■ Complements are used together ■ Their prices and demand increase ● ● ● and decrease together ■ Tennis rackets and tennis balls ■ Independent goods are unrelated ■ Milk vs. tires ○ Tastes and Preferences ○ Expectations ■ If price expected to rise in future, demand goes up now ■ More expected income, more demand ○ Population Change in demand vs. change in quantity demanded Change in demand shifts the entire curve ○ Refers to a series of quantities demanded and associated prices ○ Non-price factor Quantity demanded is the quantity demanded at a certain price ○ Change in quantity demanded is a movement along the curve ○ Factor affecting is price Supply ● Law of Supply ○ ○ Direct relationship between quantity supplied and price ● The various quantities of a good or service that sellers are willing and able ● ● ● ● ● ● to sell at various prices Factors affecting supply The number of producers ○ Market supply goes up as number of suppliers go up Price of related products ○ Substitutes in production ○ Complements in production Technology ○ Improvement in technology makes existing factors more productive Expectation ○ If price expected to go up, producer starts to increase present output levels so they can sell higher later Prices of inputs Equilibrium ● ● ● ● ● Quantity demanded = quantity supplied Effect on demand Effect on supply Law of Supply and Demand Elasticity ● Elasticity of demand is a measure of the degree to which quantity ● demanded responds to changes in one of the variable that can affect quantity demanded Coefficient of Elasticity ○ ○ ○ Diagram A – perfectly elastic, Diagram E – perfectly inelastic ● Interpreting the formula ● Factors affecting price elasticity of demand are: ○ Substitutes ■ If a product has substitutes, its demand is likely ● ● elastic ○ Number of uses ■ The greater, the more inelastic, the less, the more elastic ○ Whether or not a product is a want or need ○ Percentage of income spent on commodity ■ If it is very little, like a toothbrush, then demand is likely inelastic ■ If it is large, like a car, demand is likely elastic ○ Time ■ The longer the time period being considered, the more elastic ■ The shorter the period of time, less elastic since it must be sold Cross elasticity of demand measures the effect of a change in the price of a related good on the quantity demanded of the good under consideration ○ If A and B are substitutes, then increase in price of one increases demand of the other, coefficient is positive ○ If A and B are complements, then increase of price in one decreases demand of the other, coefficient is negative Income elasticity of demand is the relative change in quantity demanded divided by the relative change in income ○ For normal goods, the coefficient is positive, as rising income means quantity demanded rises ○ For inferior goods, the coefficient is negative, as decreasing income means quantity demanded rises ○ ● Elasticity of supply is the degree to which quantity offered for sale responds to changes in price ● Price elasticity of supply is the percentage change in quantity supplied ● divided by the percentage change in price ○ Elasticity and inelasticity look the exact same, only with different variable names***** Factors affecting price elasticity of supply ○ Time ■ If time period is short, increase in price does not affect quantity offered for sale significantly (more inelastic) ■ If time period is long, increase in price affects quantity offered significantly (more elastic) ○ Storage cost ■ Non-perishable goods that are stored at low costs tend to be more elastic ■ Perishable goods with high storage costs have tend to be less elastic ○ Production substitutes and compliments ■ Substitutes here are materials used in production ○ that can be replaced with one another ■ If product has many substitutes in production, elasticity is likely to be higher ■ If product has little substitutes in production, elasticity is likely to be lower ■ Complements are goods which, when one is produced, the other is produced as well ■ Supply of a minor joint product is inelastic ■ If cow produces beef and hides, a small increase in hide price is unlikely to cause farmers to kill more cows, since it is the beef they want, so hides are inelastic Elasticity of a rare painting ● Shortage ○ More demanded than supplied ● Surplus ○ More supplied than demanded ● Total revenue = PQ Price ceilings and price floors ● Price ceiling ○ Only effective if price is set below equilibrium ○ Maximum level to which the price is allowed to rise ○ Results in black markets where G/S are sold above maximum price ● Price floor ○ Only effective if price is set above equilibrium ○ Minimum level to which the price is allowed to fall National Income measurement ● Gross domestic product (GDP) – market value of all the final goods/services produced in an economy during a period of time (usually a year) ● Nominal GDP- number value of the good/service (either inflated or deflated) ● Real GDP – actual value of the good/service Income Approach ● Measures total income of those involved in production ● Personal disposable income = personal income – taxes ● Personal income = Consumption + savings + taxes ○ GDP = Wages/salaries + Corporation profits before taxes + ○ Interest/Dividends + Net income of non-farm including rent + net income of farm operators + Indirect taxes less subsidies + Capital consumption allowances Net domestic income = GDP – D (Capital consumption allowances) – Tib (Indirect taxes less subsidies) ■ NDI at factor cost is the total income earned by factors of production Expenditure Approach ● Measures total amount spent on total output ○ GDP = personal expenditure on consumer goods/services + ● gross investment + government expenditure + (exports – imports) Depreciation – the decrease in capital stock to due wear and tear (capital consumption allowance) The Bank of Canada ● serving as the government's bank, stabilizing the economy, preventing ● inflation in Canada and keeping it at or below 2%, managing complicated, large-scale systems, and improving our well-being. Governor: Mark Carney Keynesian vs. Classical economics ● Classical ○ If unemployment developed, there would be a surplus of workers which would cause the wage rate to fall and as it fell, employers would be willing to hire more workers at the lower wage rate. Excess of workers gone. Could not explain economic reality at the time ○ ● Keynesian ○ Shifted emphasis to total spending as a major determinant of level of employment in economy instead of on wages ○ Difficulty dealing with stagflation Government economic policy ● Monetary policy ○ Manipulation of the quantity of credit and money by the central ○ ● Fiscal policy banks Brings out certain desired macroeconomics conditions ○ Changing government spending and taxes to regulate unemployment and inflation Wage Level in Labour Market ● At low wages, only small amounts of labor are offered ○ Households regard leisure and income both as desirable ○ If wage rate increases, households will be willing to sacrifice leisure to offer labor services ○ So, as wage rates increase, so does labor supplied ■ Backwards-bending supply curve exists with high income earners, who can afford to exchange wages for leisure time ● Minimum wage laws Demand and Supply for Labour ● Supply ○ At low wages, only small amounts of labor are offered ■ Households regard leisure and income both as desirable ■ If wage rate increases, households will be willing to sacrifice leisure to offer labor services ■ So, as wage rates increase, so does labor supplied ■ Backwards-bending supply curve exists with high income earners, who can afford to exchange wages for leisure time ● Demand ○ Wage rate falls, more labor is demanded Trade Unions ● Unions increase demand for labor and decrease the supply for labor ○ By increasing demand for products of unionized producers ■ Demand for labor increases, which increases wage rate and equilibrium ● Shifting the supply curve leftwards by restricting entry of newcomers into ● certain occupations and professions ○ Wages rise as a result because a shortage of workers Increase in wage rates in one profession may lead to increase in other professions ● Good or bad ○ Unions restrict labor mobility and leads to misallocation of resources ○ Unions increase productivity of workers (protect their rights) ○ Union strikes are crippling and they can be blamed for inflation Unemployment ● Those without work and are actively looking for work ● Unemployment rate: # of unemployed people/# of people in the labor force x 100 ● Unemployment rate expresses # of people unemployed as a percentage of the labor force ● Stats Canada surveys 50000 random people ○ Flawed because some people might not be actively looking for work ● Participation rate: # of labor force/population over 15 x 100 ● Types of Unemployment ○ Frictional ■ Results from people moving between jobs and new workers entering labor force ■ Might take a while ■ Certain amount inevitable ■ Full employment 96% and 4% inevitable frictional unemployment ○ Seasonal ■ Caused by economic slowdowns related to seasonal variations ○ Structural ■ Caused by structural changes in demand patterns ■ Decline of certain industries will result in decline in ■ demand for workers Technological unemployment ■ Jobs become obsolete with introduction of technology ○ Cyclical ■ Correlates with business cycle ■ Due to cyclical changes in economic activity ■ Upswing, less unemployment ● Costs of Unemployment ○ Economic costs ■ Loss of output ■ Loss/reduced income ■ Reduced potential GDP ■ Economic cost of unemployment = potential GDP ● – actual GDP ○ Non-economic costs ■ Depression, discouragement, frustration, violence, theft, vandalism Most likely to be unemployed: Teens (15-24) because of drop-out status and women because of stay-at-home moms Inflation ● Persistent rise in the average level of prices ● Purchasing power will fall ($5 worth more today than it will be with inflation) ● Three types of inflation ○ Creeping inflation ■ Inflation rates of less than 10% ■ No great harm but can develop into more serious ● ● inflation ○ Galloping inflation ■ Inflation rates between 10%-1000% ○ Hyperinflation ■ Inflation rates of more than 1000% Effects of inflation ○ Winners ■ Debtors ■ Repay with money that has lost a lot of value ■ Producers ■ Prices of G/S rise faster than the prices of inputs so profits increase ■ Buy factor inputs at current price but output is sold at higher prices so profits increase ■ Owners of real assets ■ Value of real estate increases ○ Losers ■ Creditors ■ Repaid with money with less purchasing power ■ People on fixed incomes ■ Need to pay more for a given quantity of G/S with unchanged incomes ■ Owners of financial assets Measurement of inflation ○ Consumer Price Index (CPI) measures changes in consumer goods (400 different items) ○ Wholesale price index – changes in prices of goods bought by manufacturers (primary goods) ○ GDP price deflator – changes in average price level of all final goods ○ Rule of 70 – # of years required for price levels to double (N = 70⁄rate of inflation) The Budgeting Process 1. 2. 3. 4. 5. 6. Assess your personal & financial situation Set personal and financial goals Create a budget for fixed and variable expenses based on projected income Monitor current spending patterns Compare your budget to what you have actually spent Review financial progress & revise budgeted amounts Short Term Goals vs. Long Term Goals ● Short term: goals that can be achieved in a few weeks ● Long term: goals for more than one year Fixed vs. Variable Expenses ● Fixed = need (food, water bill, electricity) ● Variable = want Personal Finance Terms ● Interest – a charge for the use of credit or borrowed money ● Gratuity – money earned by service providers in the form of tips given for excellent service ● Salary – money earned by an employee based on an annual amount not based on hours worked ● Wages – money earned by hourly employees so the more hours worked the higher the wage ● Rent – the payment made to an owner of an asset by the user of the asset ● Commissions – money earned by salespeople who earn a percentage of the goods sold ● Allowance – money given to children by parents or guardians ● Mortgage – A debt instrument that is secured by the collateral of specified ● ● ● ● ● ● ● real estate property and that the borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by individuals and businesses to make large purchases of real estate without paying the entire value of the purchase up front Pension income – deductions taken from your pay cheque and invested for future sources of retirement income Secondary market – A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves Bond – A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate Short selling – The selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short Equities – A stock or any other security representing an ownership interest (debt instrument) Illegal insider trading – The buying or selling of a security by someone who has access to material, non-public information about the security Dividend – A distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders.