FINAL EXAM

Test Review

HAVE FUN!

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 FlowPRODUCERS CONSUMERS

Factors

Products

CIRCULAR FLOW CIRCULAR FLOW of a Market Economyof a Market Economy

Supply

DemandSupply

Demand

(Land, Labor & Capital)

GDP = G + C + I + (X-M)

Gross Domestic Product: - measures the % rate of economic growth

- released quarterly in USA- speed limit for USA is 4.0%

Business Cycle

PPF Summary• Line represents all efficient production points

– Assumes a country uses all of its scarce resources

• 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

Qty

Food

Qty

Shelter

. B

. A

. C

(100, 0)

(0,100)

(50,50)

(100, 0)

(0,100)

(50,50)

Supply & Demand Review

Law of Diminishing Marginal Utility

• As more units are consumed => additional satisfaction declines

Marginal Utility: The amount of satisfaction a person gets from one additional unit of a product

Utility: means satisfaction

Price

Qty

D1

S1

-------------Q1

E1P1 --------------

T-Shirts

Equilibrium occurs when Demand = Supply

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

D1

Only Price Changes

Movement along an existing Demand Curve

TIPSE TIN

Determinants of Demand Determinants of Supply

[Tastes, income, population, price-complementsPrice substitutes, expectations] Technology, input prices

number-sellers

NEW Demand Curve NEW Supply Curve

This is what determines if youshould shift the Supply or Demand Curve

Sample Problem

Event: Economy starts to boom, jobs are easy to find

Price

Qty

Automobiles

D1

S1

-------------------

-------------

P1

Q1

E1

D2

--------------

------------------

P2

Q2

E2

TIPSE ↓Expectations ↑

↓ Demand ↑ (shifts right)

Elastic Goods

• Elastic demand curves are flat– Sensitive to price changes

• A ↑ Price leads to a greater ↓ in Qty Demanded

D1

Px

Qty

Elastic Demand Curve

Qty Dfalls more than price

.

Inelastic Goods

• Inelastic demand curves are steep– Not Sensitive to price changes

• A ↑ Price leads to a smaller ↓ in Qty DemandedD1

Px

Qty

What you need to know!

• More elastic demand curves are flat

• Elastic means Qty D is sensitive to Px Changes

• Total Revenue => Prices elastic goods

• Total Revenue => Prices inelastic goods

Market Structure Review

PerfectCompetition

MonopolyMonopolisticCompetition

Oligopoly

# Sellers

Ease of entry

Price Control

Importance:

unlimited One Many Several

Easy Impossible Somewhat easy

Difficult

Price Taker Price Setter Little Px control

Some Px control

Know the 4 market structures and their characteristics

• Tap water• Electricity

Monopoly

• Shoes• Restaurants

MonopolisticCompetition

• Soft Drinks• Automobiles

OligopolyPerfect

• Wheat• Milk

Competition

Type of Products?

Identicalproducts

Differentiatedproducts

Onefirm

Fewfirms

Manyfirms

Number of Firms

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 = 425 Billion• Current Debt = 9.4 Trillion• Current GDP = 13.5 Trillion

• Deficit as % of GDP = 3.1% 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 (*)

• Restrictive Goal: Decrease AD

Increase Gov’t SpendingDecrease Taxes

Decrease Gov’t SpendingIncrease Taxes

(*) AD = Aggregate Demand which is demand for the entire economy fromIndividuals, businesses & Government

FISCAL POLICY

PriceLevel

RealGDP

AS1

Fiscal Policy will shift AD curve

AD1 AD2

Economy in recession

Expansionary fiscal policy needed

Lower Taxes & ↑ Gov’t spending

AD shifts right

End result: higher GDP, moreJobs & slightly higher inflation

2 Types of Monetary Policy

• LOOSE Monetary Policy Goal: AD

– 1) Lower Discount Rate & Use Open Market Operations:

• TIGHT Monetary policy Goal: AD

Buy Securities => Increase MS => lower interest rates

Sell Securities => Decrease MS => raises interest rates

1) Raise Discount Rate & Use Open Market Operations

Loose Monetary Policy in action

Affects AD

PriceLevel

RealGDP

AD1

Recession: GDP growth at -2.0%, Unemployment 7%

AS1MS2

MD

InterestRate

Qty of $

MS1

---------------i2---------i1

Lower interest rates will shift AD to the right

AD2

Labor & Income Distribution

Lorenz Curve

Gini Coefficient between0 and 1

Line of Income equality

Wealth vs. Income

• Top 20% has 84% of Wealth

• Top 20% has 47% of Income

• Top 1% has 39% of Wealth

• Top 1% has 15% of Income

Numbers YOU should know

Trend in U.S. Immigration

• 1910 15% (of population)

• 1950 7% “ “

• 1970 5.0% “ “

• 2004 11.0% “ “– 24 million people– 11 million illegal (estimate)

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 why Globalization is occurring today

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

Ricardo’s TheoryHere is my great

theory!

BRAZIL MEXICO

1 Coffee = ____Wheat 1 Coffee = _____ Wheat

1 Wheat = ____ Coffee 1 Wheat = ____Coffee

1/2

2

1

1

Wheat : BRAZIL has comparative advantage---produce only WHEAT

Coffee : MEXICO has comparative advantage---produce only COFFEE

coffee

wheat

1000

500

1000

1000 Wheat

Coffee

Wheat

BRAZIL

MEXICO

Determining Comparative Advantage

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 communistEconomic system.

•The rise of Technology meant it was now possible for information to be sharedaround the globe. This has allowed jobs to move more freely between countries

Event: Globalization Increases

Price

Qty

Skilled Workers

D1

S1

-------------

P1

Q1

E1--------------

Q2

-------------------

D2

------------------

P2 E2

TIPSE ↓Tastes ↑

↓ Demand ↑ (shifts right)