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Econ Exam 1
Foundations and Models. Chapter 1, 2, 3, 4, and 5
Terms in this set (75)
a situation in which unlimited wants exceed the limited resources available to fulfill those wants. Thus, people must make choices as they try to attain their goals.
the study of the choices people make to attain their goals, given their scarce resources.
a simplified version of reality used to analyze real-world economic situations. Explore the three key economic ideas: people are rational, people respond to economic incentives, and optimal decisions are made at the margin.
a group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.
'people are rational'
one of three key economic ideas; this assumption does not mean that economists believe everyone knows everything or always makes the best decision. It means that economists assume consumers and firms use all available information as they act to achieve their goals.
'people respond to economic incentives'
one of three key economic ideas; human beings act from a variety of motives, including religious belief, envy, and compassion. Economists emphasize that consumers and firms consistently respond to ____ ____.
'optimal decisions are made at the margin'
one of three key economic ideas; some decisions made are "all or nothing", but most in life involve doing a little more or a little less. Economists reason that the optimal decision is to continue any activity up to the point where the marginal benefit equals the marginal cost, where MB=MC. 'Marginal' meaning "extra" or "additional".
analysis that involves comparing marginal benefits and marginal costs. In business situations, firms often have to make careful calculations to determine, for example, whether the additional revenue received from increasing production is greater or less than the additional cost of the production.
because we live in a world of scarcity, any society faces this problem that it has only a limited amount of economic resources - such as workers, machines, and raw materials - and so can produce only a limited amount of goods and services.
the idea that because of scarcity, producing more of one good or service means producing less of another good or service. These force society to make choices when answering the following three fundamental questions: What goods and services will be produced? How will the goods and services be produced? And who will receive the goods and services produced?
the highest-valued alternative that must be given up to engage in an activity. Consider the example of someone who could receive a salary of $80,000 per year working as a manager at Microsoft but decides to open her own consulting firm instead. In that case, the ______ ___ of her managerial services to her own firm is the $80,000 she gives up by not working for Microsoft, even if she does not explicitly pay herself a salary.
'what goods and services will be produced?'
individuals make these decisions, the answer to the question of what will be produced is determined by the choices that consumers, firms, and the government make. Every day, you help decide which goods and services firms will produce when you choose to buy an iPhone instead of a blackberry. In each case, consumers, firms, and the government face the problem of scarcity by trading off one good or service for another. And each choice made comes with an opportunity cost, measured by the value of the best alternative given up.
'how will the goods and services be produced?'
firms choose how to produce the goods and services they sell, in many cases, firms face a trade-off between using more workers or using more machines.
'who will receive the goods and services produced?'
in the U.S., who receives the goods and services produced depends largely on how income is distributed. Individuals, with the highest income have the ability to buy the most goods and services. Government intervention occurs in the U.S. to redistribute income more equally, because people with higher incomes pay a larger fraction of their incomes in taxes and because the government makes payments to people with low incomes.
centrally planned economy (communism)
an economy in which the government decides how economic resources will be allocated. In the Soviet Union, the government decided what goods to produce, how the goods would be produced and who would receive the goods. Government employees managed factories and stores, the objective of these managers was to follow the government's order rather than to satisfy the wants of consumers. These economies have not been successful in producing, low-cost, high-quality goods and services, as a result the standard of living of the average person tends to be low.
market economy (capitalism)
an economy in which the decisions of households and firms interacting in markets allocate economic resources. These economies rely primarily on privately owned firms to produce goods and services and to decide how to produce them. Markets, rather than the government, determine who receives the goods and services produced. In this economy, firms must produce goods and services that meet the wants of consumers, or the firms will go out of business. In that sense, it is ultimately consumers who decide what goods and services will be produced.
an economy in which most economic decisions result from the interaction of buyers and sellers in markets but in which the government plays a significant role in the allocation of resources.
a type of efficiency; a situation in which a good or service is produced at the lowest possible cost. Achieved when competition among firms in markets forces the firms to produce good and services at the lowest cost.
a type of efficiency; a state of the economy in which production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it. Achieved when the combination of competition among firms and voluntary exchange between firms and consumers results in firms producing the mix of goods and services that consumers prefer most.
a situation that occurs in markets when both the buyer and seller of a product are made better of by the transaction.
the fair distribution of economic benefits. For some people, this involves a more equal distribution of economic benefits than would result from an emphasis on efficiency alone. Although governments may increase equity by reducing the incomes of high-income people and increasing the incomes of the poor, efficiency may be reduced. People have less incentive to open new businesses, to supply labor, and to save if the government takes a significant amount of the income they earn from working or saving. The result is that fewer goods and services are produced and less saving takes place.
all economic models are based on making assumptions because models have to be simplified to be useful. Economic models make _____ ____ about the motives of consumers and firms. Economists assume that consumers will buy the goods and services that will maximize their well-being, their satisfaction, and their profits.
something measurable that can have different values, such as the wages of software programmers. A hypothesis in an economic model is a statement that may be either correct or incorrect about an economic variable. An economic hypothesis is usually about a causal relationship.
positive and normative analysis
____ analysis is concerned with 'what is' vs. ____ analysis is concerned with 'what ought to be'. Economics is about the former, which measures the costs and benefits of different courses of action.
the study of how households and firms makes choices, how they interact in markets, and how the government attempts to influence their choices. Issues include explaining how consumers react to changes in product prices and how firms decide what prices to charge for the products they sell. Also involves policy issues, such as analyzing the most efficient way to reduce teenage smoking, analyzing the costs and benefits of approving the sale of a new prescription drug, and analyzing the most efficient way to reduce air pollution.
the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth. Issues include explaining why economies experience periods of recession and increasing unemployment and why, over the long run, some economies have grown much faster than others. Can also involve policy issues, such as whether government intervention can reduce the severity of recessions.
a firm's ____ is the total amount received for selling a good or service. It is calculated by multiplying the price per unit by the number of units sold.
a firm's ___ is the difference between its revenue and its costs. Economists distinguish between accounting profit and economic profit. In calculating accounting profit, we exclude the costs of some economic resources that the firm does not pay for explicitly. In calculating economic profit, we include the opportunity cost of all resources used by the firm.
this term can refer to financial or physical ___. Financial includes stocks and bonds issued by firms, bank accounts, and holdings of money. In economics though, this refers to physical, which includes manufactured goods that are used to produce other goods and services. Examples of physical are computers, factory buildings, machine tools, warehouses, and trucks. The total amount of physical available in a country is referred to as the country's capital stock.
refers to the accumulated training and skills that workers possess. For example, college-educated workers generally have more skills and are more productive than workers who have only high school degrees.
production possibilities curve
a curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology. All combinations of productions of the two products on the frontier are efficient because all available resources are being fully utilized, and the fewest possible resources are being used to produce a given amount of output. Certain points beyond the frontier are unattainable, given a firm's current technology and resources.
increasing marginal opportunity costs
as the economy moves down the production possibilities frontier, it experiences this phenomenon because increasing automobile production by a given quantity requires larger and larger decreases in tank production. These increases can occur because some workers, machines, and other resources are better suited to one use than to other. 'The more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity.
the ability of the economy to increase the production of goods and services, which ultimately raises the standard of living. The increase in the available labor force and the capital stock shifts the production possibilities frontier outward for the US economy, similarly technological changes make it possible to produce more goods with the same number of workers and machinery.
the act of buying and selling. One of the great benefits of this basic economic activity is that it makes it possible for people to become better off by increasing both their production and their consumption.
when workers concentrate on producing those goods and services for which they have a competitive advantage.
the ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources and/or time.
the ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors. The basis for trade is comparative advantage and not absolute advantage. Individuals, firms, and countries are better off if they specialize in producing goods and services for which they have this advantage and obtain other goods and services they need by trading.
perfectly competitive market
the model of demand and supply assumes that we are analyzing this type of market. In this market, there are many buyers and sellers, all the products sold are identical, and there are no barriers to new firms entering the market.
a table showing the relationship between the price of a product and the quantity of the product demanded.
the amount of a good or service that a consumer is willing and able to purchase at a given price.
a curve that shows the relationship between the price of a product and the quantity of the product demanded. A shift is an increase or a decrease in demand, based on the movement direction of the curve. A movement along the curve is an increase or a decrease in quantity demanded.
the demand by all the consumers of a given good or service. The 'market' for a product, such as restaurant meals, that is purchased locally would include all the consumers in a city or relatively small area. The market for a product that is sold internationally, such as energy drinks, would include all the consumers in the world.
law of demand
the rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.
the change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes. When the price of energy drinks falls, consumers will substitute buying energy drinks for buying other goods, such as sports drinks or coffee.
the change in the quantity demanded of a good that results from the effect of a change in the good's price on consumers' purchasing power. Purchasing power is the quantity of goods a consumer can buy with a fixed amount of income. When the price of a good falls, the increased purchasing power of consumers' income will usually lead them to purchase a larger quantity of the good, and vice versa.
ceteris paribus condition
the requirement that when analyzing the relationship between two variables - such as price and quantity demanded - other variables must be held constant. "All else equal".
shifting market demand
variables that influence market demand: 1) income, 2) prices of related goods, 3) tastes, 4) population and demographics, 5) expected future prices.
a good for which the demand increases as income rises and decreases as income falls.
a good for which the demand increases as income falls and decreases as income rises.
goods and services that are used together. The more consumers buy of one, the more they will buy of the other. A decrease in the price of a complement causes the demand curve for a good to shift to the right. An increase in the price of a complement causes the demand curve for a good to shift to the left.
goods and services that can be used for the same purpose. The more you buy of one, the less you will buy of the other. A decrease in the price of a substitute cause the demand curve for a good to shift to the left. An increase in the price of a substitute causes the demand curve for a good to shift to the right.
the amount of a good or service that a firm is willing and able to supply at a given price. Holding other variables constant, when the price of a good rises, producing the good is more profitable, and the quantity supplied will increase. When the price of a good falls, the good is less profitable, and the quantity supplied will decrease.
a table that shows the relationship between the price of a product and the quantity of the product supplied.
a curve that shows the relationship between the price of a product and the quantity of the product supplied.
law of supply
the rule that, holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.
shifting market supply
variables that influence market supply: 1) prices of inputs, 2) technological changes, 3) prices of substitutes in production, 4) number of firms in the market, 5) expected future prices.
a situation in which quantity demanded equals quantity supplied. Where the demand curve crosses the supply curve determines this point.
competitive market equilibrium
a market equilibrium with many buyers and many sellers. Equilibrium in a competitive market results in the economically efficient level of output, where marginal benefit equals marginal cost, also results in the greatest amount of economic surplus, or total net benefit to society, from the production of a good or service.
a situation in which the quantity supplied is greater than the quantity demanded. When this occurs, firms have unsold goods piling up, which gives them an incentive to increase their sales by cutting price. Cutting the price with simultaneously increase the quantity demanded and decrease the quantity supplied.
a situation in which the quantity demanded is greater than the quantity supplied. When this occurs, some consumers will be unable to buy the good at the current price. In this situation, firms will realize that they can raise the price without losing sales. A higher price will simultaneously increase the quantity supplied and decrease the quantity demanded.
price ceiling and price floor
a legally determined maximum price that sellers may charge and a legally determined minimum price sellers may receive. When the government imposes a price ___ or ___, the amount of economic surplus in a market is reduced.
the difference between the highest price a consumer is willing to pay for a good or service and the price the consumer actually pays.
the additional benefit to a consumer from consuming one more unit of a good or service.
the additional cost to a firm of producing one more unit of a good or service.
the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives. The total amount of producer surplus in a market is equal to the area above the market supply curve and below the market price.
the sum of consumer surplus and producer surplus. In a competitive market, with many buyers and sellers and no government restrictions, economic surplus is at a maximum when the market is in equilibrium.
the reduction in economic surplus resulting from a market not being in competitive equilibrium.
a market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus is at a maximum.
effect of taxes
the implementation of taxes affect economic efficiency. We can conclude that the true burden of a tax is not just the amount consumers and producers pay the government but also includes the deadweight loss. The deadweight loss from a tax is referred to as the excess burden of the tax. A tax is efficient if it imposes a small excess burden relative to the tax revenue it raises.
the actual division of the burden of a tax between buyers and sellers in a market.
the effect of shifts in supply on equilibrium
when the supply curve shifts to the right, there will be a surplus at the original equilibrium price. The surplus is eliminated as the equilibrium price falls, and the equilibrium quantity rises. If existing firms exit the market, the supply curve will shift to the left, causing the equilibrium price to rise and the equilibrium quantity to fall.
the effect of shifts in demand on equilibrium
when income increases, the market demand curve for normal goods shifts to the right. This shift causes a shortage at the original equilibrium price. To eliminate shortage, the equilibrium price rises, and the equilibrium quantity rises as well. In contrast, if the price of a substitute good for this normal good, were to fall, the demand for this good would decrease, shifting the demand curve for energy drinks to the left. When the demand curve shifts to the left, the equilibrium price and quantity will BOTH decrease.
demand shifting more than supply (to the right)
whether the price of a product rises or falls over time depends on whether demand shifts to the right more than supply; in this situation, equilibrium quantity rises and equilibrium price rises
supply shifting more than demand (to the right)
whether the price of a product rises or falls over time depends on whether demand shifts to the right more than supply; in this situation, equilibrium quantity rises and equilibrium price falls
shifts in a curve versus movements along a curve
when analyzing markets using demand and supply curves, it is important to remember that 'when a shift in a demand or supply curve causes a change in equilibrium price, the change in price does not cause a further shift in demand or supply. For instance, suppose an increase in supply causes the price of a good to fall, while everything else that affects the willingness of consumers to buy the good is constant. The result will be an increase in the quantity demanded but not an increase in demand. For demand to increase, the whole curve must shift.
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