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FINAL EXAM
Test Review
Units Covered
• 1) Intro to Econ
•
•
•
•
2) Supply & Demand
3) Business & Market Structures
4) Government: Fiscal/Monetary Policy
5) Labor & Income Distribution & Globalization
Introduction to Econ Review
Why do we need
Economics?
1) Resources are SCARCE
2) People have Unlimited Wants and Needs
FORCES:
3) Society to allocate resources
• The social science of how society
allocates scarce resources.
Branches of Economics
• Microeconomics looks at individual parts of
economy:
– How households & firms make decisions and interact in
specific markets
• Macroeconomics looks at the entire economy:
– Economy-wide phenomena including: inflation,
unemployment, interest rates & GDP (economic growth)
3 Types of Economic Systems
• MARKET
• COMMAND
• TRADITIONAL
Understand the difference between each one!
They have different goals: GEES
Adam Smith
(1723-90)
• Founder of Free Market Economics
• Argued: Free markets best promote the social
welfare
• Government should not interfere with the free
market (invisible hand regulates the market)
What is an Economy?
• The way goods, services & money flow
through an economic system
The Circular Flow describes how
goods, services & money flow through a
market economy
CIRCULAR FLOW of a Market Economy
Products
PRODUCERS
Circular Flow
Factors of
Production
(Land, Labor & Capital)
CONSUMERS
Gross Domestic Product:
- measures the % rate of economic growth
-
GDP = G + C + I + (X-M)
Exports count, final goods made in USA count
Do not count:
Used goods, imports, intermediate goods
GDP growth: what is too high?
• The economy has a “speed limit”
• Too fast: If GDP grows above 5.0%, the economy may
experience inflation
– Prices rise
• Too slow: If GDP grows below 2%, not enough jobs are
created
– Unemployment rate increases
Business Cycle
PPF Summary
•
Line represents all efficient production points
– Assumes a country uses all of its scarce resources
– It is the “full potential” of a country
Qty
Food
.
(0,100)
•
Points below are inefficient
– wastes scarce resources
•
Points above are not attainable in short run
– With existing technology & resources
•
Long Run goal is to shift the line outward
.
.
C
B
(50,50)
A
(100, 0)
Qty
Shelter
Supply & Demand Review
Utility:
means satisfaction
Marginal Utility: The amount of satisfaction a person gets
from one additional unit of a product
Law of Diminishing Marginal
Utility
• As more units are consumed => additional satisfaction
declines
Equilibrium occurs when Demand = Supply
T-Shirts
Price
-------------- E1
-------------
P1
S1
Q1
D1
Qty
Changing Demand
• Know the difference between a:
• 1) Change in Demand (TIPSE)
– A new demand curve is required when a determinant of demand
changes
– Causes a shift in Demand curve
• 2) Change in Quantity demanded
– Movement along existing curve
Changing Supply
• Know the difference between a:
• 1) Change in Supply (TIN)
– A new demand curve is needed when a determinant of supply
changes
– Causes a shift in Supply curve
• 2) Change in Quantity Supplied
– Movement along existing curve
Change in Quantity
Demanded
• ONLY price changes => Qty Demanded
Changes
Movement along an existing Demand Curve
Only Price Changes
D1
Determinants of Demand
Determinants of Supply
This is what determines if you
should shift the Supply or Demand Curve
TIPSE
[Tastes, income, population, price-complements
Price substitutes, expectations]
NEW Demand Curve
TIN
Technology, input prices
number-sellers
NEW Supply Curve
Problem #1
Event:
BOTTLED WATER
Coke & Pepsi exit bottled water industry
Bottled Water
S2
Price
P2
S1
# Firms ↓
↓
Supply ↓
----------- E2
-------------- E1
----------------------------
$150
TIN
↓
Q2 20K
Know This!
(shifts left)
D1
CHANGE IN SUPPLY
Qty
(or decrease)
Change in QUANTITY DEMANDED
Elastic Goods
Px
• Elastic demand curves are flat
D1
– Sensitive to price changes
Qty
• A % ↑ Price leads to a greater %↓ in Qty
Demanded
Elastic Demand Curve
.
Qty D
falls more
than price
Inelastic Goods
Px
• Inelastic demand curves are steep
– Not Sensitive to price changes
• A %↑ Price leads to a smaller %↓ in Qty
Demanded
D1
Qty
What you need to know!
• More elastic demand curves are flat
• Elastic means Qty D is sensitive to Px Changes
• Total Revenue
goods
=> Prices
elastic
• Total Revenue
goods
=> Prices
inelastic
Market Structure Review
Perfect
Competition
Monopoly
Monopolistic
Competition
Oligopoly
# Sellers
unlimited
One
Many
Several
Ease of
entry
Easy
Impossible
Somewhat
easy
Difficult
Price Taker
Price Setter
Little Px
control
Some Px
control
Price
Control
Importance:
Know the 4 market structures and their characteristics
Number of Firms
Many
firms
Type of Products?
One
firm
Monopoly
• Tap water
• Electricity
Few
firms
Oligopoly
• Soft Drinks
• Automobiles
Differentiated
products
Monopolistic
Competition
• Shoes
• Restaurants
Identical
products
Perfect
Competition
• Wheat
• Milk
Perfect Competition
Characteristics
• Many Firms
• Homogenous products
• Complete freedom to enter or leave industry
• Perfect information
• No price control—sell at Market Price
– Price Takers
Smith’s two primary laws
• 1) Self-Interest:
• People act in their own self-interest
• Profits or greed motivate individuals
• 2) Competition:
• Lots of producers—you “fear” competition
• Assures goods are produced at the lowest possible
price: economic efficiency
PRICE DISCRIMINATION
• Price discrimination is the business practice of
selling the same good at different prices to different
customers
• For a Firm to price discriminate it must:
– have some market power (some price control)
– be able to identify & separate groups of consumers
– be able to prevent resale between consumers
Unit Wrap Up: 3 Market Failures
• Predatory Pricing
– Is Wal-Mart guilty?
• Negative Externalities
– Pollution
• Price Fixing
– Collusion- do you trust corporations?
Government Review
Gov’t Budget &
Fiscal & Monetary Policy
Deficit & Debt relative to GDP
• Current Deficit = 400 Billion (before financial crisis)
• Current Debt = 11.0 Trillion
• Current GDP = 14.0 Trillion
• Deficit as % of GDP = 3.4% of GDP
– Highest ever (1983) was 6% of GDP
• Debt as % of GDP = 70% of GDP
– Highest ever (1946) was 120% of GDP
2 Types of Fiscal Policy
• Expansionary
Goal: Increase AD (*)
Increase Gov’t Spending
Decrease Taxes
• Restrictive
Goal: Decrease AD
Decrease Gov’t Spending
Increase Taxes
(*) AD = Aggregate Demand which is demand for the entire economy from
Individuals, businesses & Government
FISCAL POLICY
Fiscal Policy will shift AD curve
Economy in recession
AS1
Price
Level
Expansionary fiscal policy needed
AD1
Real
GDP
AD2
Lower Taxes & ↑ Gov’t spending
AD shifts right
End result: higher GDP, more
Jobs & slightly higher inflation
2 Types of Monetary Policy
• LOOSE Monetary Policy
Goal:
AD
– 1) Lower Discount Rate & Use Open Market Operations:
Buy Securities => Increase MS => lower interest rates
• TIGHT Monetary policy
Goal:
AD
1) Raise Discount Rate & Use Open Market Operations
Sell Securities => Decrease MS => raises interest rates
Recession:
GDP growth at -2.0%, Unemployment 7%
Loose Monetary Policy in action
Interest
Rate
MS1 MS2
Price
Level
AS1
Affects AD
i1
---------
i2 --------------MD
Qty of $
Lower interest rates will shift AD to the right
AD1
Real
GDP
AD2
Labor & Income Distribution
Lorenz Curve
Line of Income
equality
Gini Coefficient
Numbers YOU should know for TEST
Wealth vs. Income
• Top 20% has 84% of Wealth
• Top 20% has 50% of Income
• Top 1% has 39% of Wealth
• Top 1% has 15% of Income
Trends in Labor Unions
• Union membership has declined
significantly
• 1953 peak of 36% of labor force
• 2004 dropped to 12% of labor force
Trade & Globalization
Trade Theory
• Understand the theory of Free Trade
• Why trade, in theory, is mutually beneficial
• Understand reasons why Globalization is
rapidly expanding today
Ricardo’s Theory
Here is my great
theory!
Countries should produce (specialize) in goods where they have a
comparative advantage
Trade benefits both parties (each country gets “more”)
Free Trade promotes a more “efficient” world economy
Absolute Advantage is not relevant in trade analysis
Determining Comparative Advantage
BRAZIL
1
1 Coffee = ____Wheat
1 Wheat
1
= ____
Coffee
MEXICO
coffee
wheat
1/2 Wheat
1 Coffee = _____
1 Wheat = ____Coffee
2
Wheat : BRAZIL has comparative advantage---produce only WHEAT
Coffee : MEXICO has comparative advantage---produce only COFFEE
Coffee
BRAZIL
1000
1000
1000
Wheat
MEXICO
500
Wheat
Globalization: Why Now?
1) Fall of Soviet Union
2) Rise of Technology
This combination has made it possible for the world to become one global
Economy:
•The Fall of the Soviet Union meant the end to a purely communist
Economic system.
•The rise of Technology meant it was now possible for information to be shared
around the globe. This has allowed jobs to move more freely between countries
Event:
Globalization Increases
Skilled Workers
Price
TIPSE
↓
S1
Tastes ↑
-------------
P1
↓
------------------- E2
-------------- E1
------------------
P2
Q 1 Q2
Demand ↑
(shifts right)
D1
D2
Qty