Final Exam

Microeconomics

The study of how households and firms make decisions and how they intereact in the economy. Used to predict changes, make personal and managerial decisions, and evaluate the merits of public policies.

Macroeconomics

Involves the study of the economy as a whole. How the national ecomony work

Principles of Decision Making

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

Princples Concerning people's economic interactions

1. Trade makes everyone better off

2. Markets are usually a good way to organize the economy

3. Governments can sometimes improve market outcomes

Principles that describe how the economy works

1. A country's standard of living depends on its ability to produce goods and services.

2. How the ecomoy works is prices rise when government prints too much money.

3. Society faces a short-run trade off between inflation and unemployment.

What does the invisible hand do in the marketplace?

The invisible hand directs households and firms to the best market situations. the invisible hand uses price to lead the economy. The prices of goods help buyers and sellers determine the demand and value of goods. The invisible hand cant function if government controls the prices.

Why do economists make assumptions?

Economists make assumptions to make the world simplier and easier to understand. (must be reasonable and accurate)

Two groups: Firms and Households

Two loops: Outer loop shows the flow of money. Inner loop shos the flow of input and output

The flow of dollars between firms and households

Inflation short cirucuits

Production of Possiblities Frontier

Shows how different combinations of outputs between two products relate to each other. The diagram shows an economy that uses all factors of production and the most effeicent levels of production.

Difference Between Positive and Normative Analysis

Positive analysis: describes a situation

Normative Analysis: recommends how things should be (harder to prove)

Distinguish between cause and effect

1. Ecnomist can be policy advisors

2. Resources used to create products difficult to determine

3. Assumptions

Absolute Advantage

When a producer uses the least amount of input necessary to produce a good.

Ex. Growing flowers and grass in a shorter amount of time

Compartive Advantage

To produce an item and have the lowest opportunity cost.

Are the gains from specialization and trade based on absolute or comparative advantage.

Comparative advantage because each compnay creates a product that they ca produce with the least opporutnity cost the entire economy is producing more products at a lower price.

Free Trade Or Restrictions

I favor free trade because it allows for countries to create certain goods. This allows them to make these goods with very low opportunity cost.

Law of Demand

The law of demand states that if everything else in the ecnonomy is equal, if the price of a good rises, the quantity demand for the good falls. If the price of a good falls, the demand for the good rises.

Shifts in the Demand Curve

1. Income

2. Price of Related Goods

3. Tastes

4. Expectations

5. Number of Buyers

Marginal Utitlity Theory

The more units of a good you recieve, its utility or benefits decline. The more you have a product the less useful it becomes

Law of Supply

If everything elses is equal, the quantity of supplied of a good rises when the price of a that good rises.

Quantity Supplied: Amount of a good that the seller is willing and can sell

Change in supply: Change in how much it costs to produce a good.

Market Equilibrium

When the market prices has reached the point at which the quantity supplied is equal to the quantity demanded.

How to analyze changes in equilibrium

1. Decide if the demand or supply curve is being shifted.

2. Which direction it is shifted

3. Use diagram to see how the shift affected curve

Price System

Determined through supply and demand. Determines how goods and resources will be distrbueted.

Elasticity

The responsivness of a change in quantity to a change in price.

Price Elasticity of Demand

Measures how much quantity demanded responds to a change in price. If the quantity demanded responds substantially to changes in price, we say the demand for the good is elastic. If the quantity demanded responds only slightly to a change in price it is inelastic.

How to compute the price of elasticity of demand

Change in quantity divided by change in price.

Price elasticity of demand = [ (Q₂- Q₁) / (Q₂ + Q₁) / 2]

[ (P₂ - P₁) / (P₂ + P₁) / 2]

How you can raise the price without losing demand from consumers. Compare prices to competitors.

Price Elasticity of Supply

Measures how much the quanitity supplied changes in response to teh price of a good.

Important determinant is time. Supply does not change in a short period of time

Can you always solve problems with a price ceilng?

No, if the price ceiling is below the equilibrium it becomes binding. A binding price ceiling creates a shortage of goods and the sellers must ration their goods among buyers

Does minimum wage laws allow employment to increase and workers to earn higher incomes?

No, when the minimum wage is above the equilibrium the number of employees exceeds the amount that is needed.

Difference Between Shifting and Incidence Taxes

Incidence is how the burden of a tax is shared among the people in an economy.

Shifts in the supply and demand curve determine how the burden of tax is shared between the buyer and the seller.

Does it matter whether a tax is levied on buyers or sellers in a market?

No, it does not. All of the tax money is sent to the government. Buyers must pay more, but sellers sell less of a product.

Consumer Surplus

Consumer surplus is the amount a buyer is willimg to pay for an item minus what they actually pay for it. RELATED TO DEMAND

A measure of the benefits a buyer gets from being a part of the market.

Lowering a price can raise consumer surplus.

Producer Surplus

The amount a seller is paid for a good minus the seller's cost of providing it. RELATED TO SUPPLY

As the price rises the amount of sellers willing to sell their good increases

Can social planning yield better market efficiency than market driven solutions?

No, social planning does not consider the equilibrium. Social planning would mean that every good and consumer in the market be know. A free market operating, both producers and consumers recieve the more efficient and equitiable market.

Market Failures Short Circuit Market Efficiency

Market failure can include both market power and externalities. These failures are when some unregulated markets are unable to operate efficiently. These markets affect others and keep them from allocating their own resources efficeintly.

Welfare Economics

Consumer Surplus and producer surplus used to study.

Works to incrase the surplus for both consumers and producers.

Deadweight Loss of Taxation

When the market is distorted by a tax, there is a fall in the total surplus. Consumers respond to incentives. A tax is a not a positive incentive to buy. It is an incentive to buy less. When consumers buy less, the producers make less. This causes the market to shrink. Keeps everyone from seeing the positive.

How are elasticity and deadweight releated?

Elasicity is used to determine if the deadweight loss of a tax is large of small. The larger elasticity of supply and demand, the larger deadweight loss.

Do labor taxes impact labor supply in the short run and long run?

In the short run a raise in labor taxes could impact the labor supply.

Long run- no. People still need wages and jobs

Relationship between the Laffer curve and suppply-side economics

The Laeffer Curve is based on the diea that becuase tax rates are so high, if the taxes wer lowerd it would increase tax revenue. Supply side ecnomics created by Reagan said that high taxes discouraged work.

What happens to the equilibrium price for a good if trade is permitted?

The equilibrium price is likely to rise if trade is permitted because the equilibrium price will have to rise to meet the world price.

Who are the winners and losers from trade?

To decide look at changes in consumer and producer surplus. In a exporting country once trade is allowed consumer surplus goes down. The sellers are winners. IN an importing country the consumers are winners because they purchase at a lower price

Tariff

Tax placed on goods that are being produced abroad and sold domestically.

Tax on imported goods.

Tariff for Auto Industry?

Yes, when compared to an import quota. Needs restriction. That way the country recieving the product gets the money from the tariff

Most signification reason for restricting trade

National Security, not dependent on imports

NAFTA

Multicultural approach to reduce trade restrictions

Positive Externalities

When a person's actions are beneficial to the well-being of another.

Ex. renewing historical pieces, education

Negative Exernalities

When the impact of one person's actions adversely affects other bystanders.

Ex. exhaust, barking dogs

Corrective Tax to deal with negative externality

Taxing a producers right to perform the negative externality

Why is gasoline taxed so heavily?

Corrective Tax

Reduces the amount of people who drive.

Excludability vs. Rival in consumption

A good that is excludable is a good that people can be prevented from using.

A rival in comsumption is good that when one person uses the good it diminishes other's use of the good.

Public Good

Goods that are not excludable or rivals in consumption.

Ex. National Defense

Common Resource

Goods that are not excludable but are rivals in comsuption. When one person uses the resource, less of the resources is available to others

Over the past century, has government grown more or less slowly than the rest of the economy?

Close to the same speed. Keeyp up the ecnomoy to make sure public resources are being efficiently allocated to society

Free-rider problem

The free rider problem is when a person receives the benefit of a good but does not pay for it.

Should government directly produce or subsidize basic research?

Government should subsidize basic reaserch because it allows the government to hire markets to research the areas that are beneficialy to society.

Why are property rights important?

Can prevent market failures. The governement can define property rights and ensure that they are used properly and everyone receives public goods.

What is the relationship between a firm's total revenue, profit, and total cost?

The firms total revenue is the amount the firm receives from selling a product. The total cost is the amount the firm pays to buy inputs. A firm's profit is the total revenue minus its total cost.

Opportunity Cost (account doesn't consider)

An accountant would not consider implicit costs to be an opportunity cost because there is on outlay of money by the firm. Ex. Time. If spending time doing something else could earn more money it still is not a loss of money to an accountant

Marginal Product. When is it diminishing?

Marginal product is an increase in output that arises from an additional unit of input. Diminshing marginal product is when the marginal product of an input declines and the quantity of the input increases.

Production Function that exhibits diminishing marginal product labor.

The production function curve begins to get flatter as the number of workers are increased. The cost curve gets steeper as the quantity of output increases. The total-cost curve is a mirror image

Total Cost

Market Value of inputs a firm uses in production

Average total cost

Total cost divided by the quantity of input

Marginal Cost

Incrase in the total cost that comes from an extra unit of production

How does the average total cost curve differ in the short run and long run?

These cures differ because the fixed costs are variable in the long run. All the short run curves lie on or above the long run curve. These differences because there is more flexitility in the long run.

Economies of scale

The long run average total cost declines as output increases

Disecnomies of scale

The long run average total cost rises as output increases. Can be caused when companies expand and the managment is strechted.

Competitive Firm

Competitive firm attempts to maximize their profit. Competitive firms operate in a competitive market. This is a market where all sellers and buyers having the same product.

How does a firm chooses the level of output that maximizes profit?

If the marginal revenue is more than a marginal cost the firm should increase their output. If the marginal cost is more than the marginal revenue the output should be decreased.

MC = MR

Shut Down Decisions

A firm's decision to shut down is not permenent. It still must pay fixed costs. A firm decides to shut down when the price of their good is less that the average variable cost of production. If the price does not cover cost then it makes more sense to shut down

Under what conditions will a firm exit a market?

If the revenue it would get from producing is less than its total cost

Does a firm's price equal marginal cost in the short run, in the long run, or both?

A firm's price equals marginal cost in the long run. As more firms enter the amrket prices and cost start to equal out and form an equilibrium

Is market supply typically more elastic in the short run or in the long run?

A market is typically more elastic in the long run because firms can enter and exit the market more easily in the long run.

Why do competitive firms stay in the business if they make zero profit.

They are making enough money to make up for the time and money spent on keeping the business oing

All costs covered

Why do profits tend to disappear in a competitive industry?

Profit brings more companies into a market. As more companies enter, the supply increases and the price falls. This restores equilibrium.

Why do monopolies arise?

A single firm owns a key resource

A firm can supply a good for less cost than the other firms

Created by government (exclusive rights)

Difference between a competitive demand curve and monoplist's demand curve

A monopoly can influence the price out its output. A competitive firm takes the price given by market conditions

A competitive firm faces a horizontal demand curve because it can sell as little or as much as it wants at a certain price.

A monopolist demand curve slopes downward curve slopes downward because if they raise tyhe price the consumers buy less.

Profit Maximization point for a monopolist

They must choose a quantity where the marginal revenue is equal to the marginal cost. By using the demand curve the firm can find the price that most consumers will buy the good

Why does a monopoly not have a supply curve?

The supply curve tells the quantity that a firm supplies at any given price. A monopoly makes the prices and does not take the prices of the market. A monopolist firm sets the price at the same time they are deciding hoe much of a good to supply

Deadweight cost created by monopolies

Similar to a tax

Can charge prices for a good above marginal price so that not all consumers will value this good at this price and therefore not buy the good.

Price discrimination

The business practice of selling the same good at different prices to different customers.

Coupons for people with certain professions

Two Anti-Trust Laws

Sherman Anit-Trust Act- Reduce the market power of the large trusts that dominated the ecnonomy

Clayton Anti-Trust Act- Strengthened the governement's power and its authorized private lawsuits

Gross Domestic Product (GDP)

The market value of all final goods and services produced within a country.

Martket Value: used to measure the economic activity

All: Legal items

Final: Final good only (counting more than once)

Components of GDP

1. Consumption: how much a household spends on goods

2. Investment: purchase of goods that will be used in the future

3. Governement Purchases: Spending local, state, federal

4. Net Exports: amount spend on domestically produced goods by foreigners minues spending on foreign goods

Real GDP vs. Nominal GDP

Nominal: Production of goods and services valued at current prices

GDP: Production of goods and services valued at constant prices

Why is real GDP more important than nominal GDP?

The real GDP measures the ecnonomy's production of goods and services. This reflects what the people in the economy need and want.

Why should policy makers care about GDP?

GDP leads to a better life. It is the measure of economic well-being. Larger GDP means better healthcare, schools, and other services

Consumer Price Index (CPI)

Measure of the overall cost of the goods and services bought by a typical consumer. The price of goods and services in a current year divided by the price of the good in a base year and then multiplied by 100

Producer Price Index (PPI)

The measure of the cost of a basket of goods and services bought by a firm.

Problem with using CPI (Consumer Price Index) as a measure of inflation?

Subsitution bias: Not all prices change at the same rate

Introduction of new goods: more options

GDP Deflator

Measure of the price level calculated as the ration of nominal GDP to real GDP times 100. It reflects the prices of all goods and services produced domestically

Real interest Rate vs. Nominal Interest Rate

Real interest rate is corrected for inflation. The nominal interest rate measures the change in dollar amounts

Productivity

Quantity of goods and services produced from each unit of labor input.

Measureed by physical capital, human captital, natural resources, and technological knowledge.

Why is savings an important determinant of the growth in captial?

For a society to invest more in capital the people must spend less money and save more of their income. Raise the standard of living

Robert Fogle

Nobel Peace prize for study of nutrition

Role of Property Rights and Political Stability

Work together to effect economic growth.

Property Rights: Exerise authority over the property they own. Enforced by court system.

Political Stability: Unstable government less control over property rights, not invest

Malthus Law

If the population continued to grow that people will continue to live in poverty because there would not be enough resources.

Developed System of finanical institutions

Institution track the movement of resources across the economy. They look at how the resources move between savers to borrowers and coordinate them

Bond vs Stock

Bond: Certificate of indebtedness

Stock: claim to partial ownership in a firm.

How is saving and investment determined in national income accout?

National income made up identites:

GDP: (Y = C + I + G + NX)

Closed Economy: ( Y + C + G = I)

Financial Markets: (Y - C - G = Y)

Loanable Funds Theory of Interest

Interestrates are determined by the supply and demand for loanable funds. (Loanable funds are all the income that people have chosen to save and lend out instead of using). Saving is the source of suppy for loanable funds. Investment is the demand. Interest rate is the price

Is the Federal debt a burden on the ecnonomy?

Eventually, the US has debt with many countries. The larger the debt becomes the less willing other countries will be to accept more debt.

Unable to fund and support activites that help economy grow.

Labor force

Total number of workers inlcuding employed and unemployed

Unemployment Rate

percentage of the labor force that is unemployed

Labor Force Partcipation Rate

The percentage of adult population that is in the labor force

Natural Rate of Unemployment

The normal rate of unemployment around which the unemployment rate fluctuates.

What causes cyclical unemployment?

A deviation of the unemployment rate from the natural rate

Frictional umeployment vs. Structural unemployment

Frictional unemployment: when it takes times for workers to search for the job that best suit their tastes and skills.

Structural unemployment: number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one

Is some unemployment inevitable?

Yes, the economy is always changing. People demand different products and services and firms must adjust their employment accordingly

Why do minimum-wage laws tend to cause unemployment?

When a minimum wage law forces the wage to remain above the level that balances supply and demand, it raises the quantity of labor supplied and reduces the quantity of labor demanded

Efficiency Wages

Wages above equilibrium wages paid by firms to increase worker productivity.

Firms want to hire the most qualified workers. Keep workers from leaving to work for competition

Money

Money is the set of assets in an economy that people regularly use to buy goods and services from other people

Functions of Money

Medium of exchange: itme that buyers give to sellers when they want to purchase a good

Unit of Account: yardstick people use to post prices and record debts

Store Value: an item that people use to transfer purchasing power from present to future

M1 vs M2

M1: demand deposits, traverlers checks, other checkable deposits, and currency

M2: Everything in M1 and saving deposits, small time deposits, money market mutual funds, and few minor categories

Primary Responsiblities of the Fed

Regulate banks and ensure the health of the banking system.

Controls the quantity of money that is made available in the ecnonomy

Central Bank

Institution designed to oversee the banking system and requalte the amount of money in an economy

Federal Open Market Committee

Their decisions give the Fed the power to increase or decrease the amount of dollars in the economyu

Why are open market operations the most important Fed tool?

The dollars that the Fed pays for the bonds increase the amoung of dollars in the economy. When the money supply needs to be reduced the Fed sells governement bonds to the public. The Fed can use open market opereations to change the money supply by a large or small amount without major changes in the law

Discount Rate

The interest rate on the loans that the Fed makes to banks. A bank borrows from the Fed when it has to few reserves to meet its reserve requirement. Alters money supply

Federal Funds Rate

The interest rate at which banks make overnight loans to one another. Wnen one bank is short of resoures another bank that has extra lends some of their reserves

Classical Theory of Inflation

Theory developed by early economists to explain determinants of the price level and the inflation rate. The price level can be viewed as measure of the value of money. A rise in price can mean a lower value of money

Value of Money is determined using the supply and demand for money relationship

The Fed sells bonds in open-market, they receive money in exchange. When the Fed buys bonds they pay out money and expand the money supply.

People hole money because it is used for all exchanges.

Monetary Injection and Adjustment Process

Monetary Injection: shifts supply curve to the right. The value of money decreases and the equilibrium price rises.

Classical Dichotomy and monetary neutrality

Classical Dichotomy: theoritical seperation of nominal and real variables.

Monetary Neutrality: The proposition that changes in the money supply do not affect real variables

Quantity Equation

M x V = P x Y

Increase in the quantity of money in an economy must be reflected in one of the other three variables.

Relationship between money and prices during hyperinflations

During hyperinflation the quantity of money starts growing faster and faster and inflation takes off. When the money stabilizes, the price level stabilizes

Why is inflation like a tax?

When the government prints more money the people have to spend more money and the price of goods increases. This is much like how taxes increase the price of goods.

Shoeleather Cost vs. Menu Costs

Shoeleather costs are the resources wasted when inflation encourages people to reduce their money holdings Menu costs are the costs when firms change their prices

Inflation-induced tax distortion

Inflation tax distortion causes higher inflation that tends to discourage people from saving. To keep taxes from being distorted by inflation the government could use indexation but that would mean even more complicatied tax laws.

Recession vs. Depression

Recession: a period of declining real incomes and raising unemployment

Depression: Severe recession

3 Key Facts of Ecomonic Flucations

Irregular and Unpredictable: flourish, downsize

Most Macroecomic Quantities Fluctate Together:

As output falls, unemployment rises: produce less product

Basic Assumption of Classical Economics and Fallacy

Changes in money supply affect nominal variables but not real variables.

Fallacy: Classical economics is that the theory does not hold in the short run.

Aggregrate Demand and Supply Model

Explain short-run flucuations in ecnomic acitivty arount is long-run tred.

THe aggregrate demand cruve shows the quantity of goods abroad want to buy at each price level

Aggreage Supply Curve shows the quantity of goods that all firms produce in all markets

Why does the aggregrate demand curve slope downward?

Consumers are wealthier and have a higher demand for the consumptions of goods.

Interest Rates Fall

Quantity of money changed.

Govermenet caused shifts

Why is aggregrate supply curve vertical in the long run?

Price level does not affect the long-run determinants of GDP. The economy's labor capital, natural resources, and technology stay the same. Output deos not depend on level of prices

Why is aggregrate supply curve sloped upward in the short run?

Sticky Wage Theory: wages are slow to adjust

Sticky price theory: prices adjust slowly

Two Causes of Inflation

Shifts in aggregrate demand and shifts in the aggregrate supply

Great Depression

Caused by shift aggregrate demand

John Maynard Keynes

Recessions and depressions occur because of inadequate demand for goods and services. Thoery of Income determination C + I + G + F

Liquidity Preference Theory of Interest

Interest rate adjusts to bring moeny supply and money demand into balance

Explain the Multiplier Affect ( and look in book)

Additional shift in the aggregate demand that results when expansionary fiscal policy increase and increase consumer spending

Fiscal Policy

The setting of the level of governemnt spending taxation by government policymakers.

Final Exam

Economics 224 with Balch at University of South Carolina - All Campuses

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