Economics 2020 Review for First Exam Dr. Patricia Duffy
ECON 2020 Information about EXAM 1 The Exam will Not be Scaled!
Test Format • Multiple Choice Questions worth 3 pts. each. (I haven't finalized the exam yet. There will be 20 to 25 of these.) • Fill-in-the-blank questions • Short Answers -- Math problems and/or Graphs with Explanations (see the homework)
TEST COVERS The test covers chapter 1-4a in the text book. Material from chapter 4 is limited to the work we have covered in class. This material is included in your PowerPoint notes for Chapter 3 – elasticities.
Material from Chapters 1 and 2 • What is the difference between microeconomics and macroeconomics? • What is monetary policy? What is fiscal policy? • What are the three economic functions (goals) of government? • What means does the government use to achieve those goals?
Modern Economics 1776. Adam Smith introduces a new paradigm -- the notion of individual choice shaping market transactions. (Invisible Hand) This new paradigm emancipated trade and industry from the “shackles of feudal aristocracy.”
Three Economic Functions of Government • Increase Efficiency: Promote competition, Curb externalities, Provide public goods. • Promote Equity: Tax and expenditure programs to redistribute income. • Foster macroeconomic Stability: Reduce unemployment and control inflation via monetary and fiscal policy.
What are specific policies to promote equity? • progressive taxation -- higher rates for higher incomes. • transfer payments (such as food stamps or cash welfare payments) • minimum wage laws
Policies to promote stability • Raising the interest rate to curb inflation • Lowering the interest rate to combat a recession • Using counter-cyclical fiscal policy : tax cuts or spending increases to combat a recession; building surpluses in times of prosperity.
Policies to increase efficiency • Anti-trust regulations • Labeling laws (provides information to consumers) • Providing public goods (examples: schools, parks, libraries, public health) • Passing regulations to eliminate externalities or to compensate losers for them.
What are Externalities? Externalities are costs or benefits accruing to individuals who are outside the market.
What are Public Goods? Public goods are goods that provide positive externalities and/or which are not used up by one consumer. The government normally provides public goods because private producers have a hard time collecting fees from all those who benefit.
Production Possibilities Frontier • What is it? • How is it increased? • How is it decreased? • What does it mean to be "on the PPF"?
The Production Possibilities Frontier “Guns and butter” example. Possibilities Butter (mil lb) Guns (1000s) A 0 15 B 1 14 C 2 12 D 3 9 E 4 5 F 5 0
How does a nation turn guns into butter??? The transformation takes place through a shift in resource -- land, labor, capital -- away from production of guns and toward the production of butter. The Production Possibility Frontier shows all possible combinations of two or more outputs that can be produced with a given set of resources, and its technology.
Feasible and Infeasible points Infeasible range Feasible, efficient range Inefficient range
Unemployed Resources If an economy has unemployed resources, it won’t be on the PPF. The Great Depression is an example of a period in which there were unemployed resources. Business cycle depressions, strikes, political changes, or revolutions can cause periods of inefficiency.
Opportunity Cost The value of items not produced because resources were used for another purpose. In the guns and butter example, the opportunity cost for producing more butter involves the guns given up.
Opportunity Cost Opportunity cost is the “revenue foregone” from making one decision instead of another. What is the opportunity cost of going to college? It’s the income you could have earned by working instead of going to class and studying.
Poor and Rich Nations PPF Luxuries Rich nation B A Poor nation Necessities
Scarcity and Efficiency • Scarcity. Resources are (usually) finite. • All “economic goods” are limited in supply, which economists call “scarce.” • In a market economy, “scarce” or limited items have prices associated with them.
Economic Efficiency The economy is producing “efficiently” when it cannot increase the economic welfare of anyone without making at least one person worse off.
Efficiency An economy is producing efficiently if it is producing on the PPF, rather than inside it. Productive efficiency occurs when an economy can’t produce more of one good without producing less of another.
Equity Equity involves the distribution of wealth within a society. In perfect equity, everyone has equal shares. Equity and Efficiency are often competing goals.
Microeconomics . . . is the branch of economics that deals with the behavior of individual entities, such as consumers, firms, households, or markets. A major focus of microeconomics is price determination.
The Other Branch of Economics . . . is macroeconomics, which is concerned with overall performance of the economy, e.g. inflation, unemployment, growth. Macroeconomics is the more recent of the two branches. It began around 1935, when John Maynard Keynes published General Theory of Employment, Interest, and Money.
Common Logical Fallacies • Post Hoc • Fallacy of Composition • Slippery Slope • Joint Effect • False Dilemma • Wrong Direction (There are others, but know these for the test.)
Positive and Normative Economics • Positive Economics deals with questions that can be analyzed objectively, e.g. “What is the impact of raising taxes?” • Normative Economics involves ethical precepts and norms of fairness, e.g. “Should the poor be required to work to receive government assistance?”
Types of Economies • Command Economy: government makes all important decisions about production and distribution. • Market Economy: individuals and private firms make the major decisions. Extreme case (no government intervention) is called “laissez-faire” economy. • Mixed Economy has elements of both. All modern economies are mixed.
A Market A market is a mechanism by which buyers and sellers interact to determine the price and quantity of a good or service. A market need not be a physical place.
Role of Prices Prices coordinate the decisions of producers and consumers in a market. Higher prices tend to reduce consumer purchases and encourage production. Lower prices encourage consumption and discourage production. Prices are the balance wheel in the market mechanism.
Market Equilibrium A market is in equilibrium when the commodity is neither in glut nor shortage at the prevailing price. A market equilibrium is a balance among all the different buyers and sellers.
Specialization, division of labor, and gains from trade • Specialization occurs when people or countries can concentrate on the items that can be produced most efficiently. • A division of labor allows individuals to perform the tasks they do best. • Because of specialization and division of labor, we experience gains from trade.
Money Our economy functions because we accept money as a means of payment or exchange. Imagine an economy without money, in which barter was the only means of exchange. How would you pay for a pizza? What would you accept as payment at your part-time job?
Three Factors of Production Revisited Land and labor are primary factors of production. Their supply is mostly determined by non-economic factors. Capital items, on the other hand, need to be produced or manufactured. Thus, they are both inputs (for further production) and outputs.
Externalities Externalities are either costs affecting people who are not compensated for them (e.g. pollution), or benefits accruing to people who do not pay for them (an existing restaurant benefiting from the construction of new shopping mall next door). A difference between private and social costs and benefits.
Governments and Externalities Governments more often concerned with negative externalities. Dense population means that spillover effects can annoy or endanger many people. Regulation is a common government intervention to prevent or lessen externalities.
Public Goods Commodities that can benefit many people without being “used up.” The value (usually) cannot be easily divided, as there are benefits to the entire community. Examples: Public schools, parks, public health programs, highways, national defense.
Government and public goods Private provisions of public goods is usually insufficient because “free riders” make it difficult for business to earn profits or because the benefits are widely dispersed. Hence, the government usually provides public goods.
Supply and Demand Supply and Demand determine prices in individual markets. Price is the mechanism that brings supply and demand together.
The Demand Schedule The demand schedule (demand curve) shows the relationship between a commodity’s market price and the quantity of that commodity that consumers are willing and able to purchase, other things held constant.
From individual to market We have seen that individuals will adjust their purchases when prices rise or fall. If the price of a commodity falls, consumers will (normally) purchase more of it. The sum of all the individual demands is the market demand.
Law of Downward Sloping Demand When the price of a commodity is raised (and other things are held constant), buyers tend to buy less of the commodity. Similarly, when the price is lowered, other things being constant, quantity demanded increases.
Market Demand Curve The market demand curve “adds up” all the quantities demanded by individual consumers at a given price. It shows the total amount of a commodity consumers are willing and able to buy at a given price.
Behind the Demand Curve What determines the market demand curve for a commodity? ?
Factors Affecting Demand • Size of market, e.g. how many consumers. • Income levels of consumers. • Prices and availability of related goods. • Tastes and preferences. • Special influences, e.g. climate and conditions.
Change in Demand Demand curves will shift, as income, other prices, market size, or tastes or preferences change. Demand curves do NOT shift when the product's own price changes. That change cause a movement along the original demand curve.
Movement along the demand curve Movement along the demand curve occurs as the good’s own price changes. P As price falls, a greater quantity is demanded. D Q