ECONOMICS REVIEW FINAL EXAM

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1 ECONOMICS REVIEW FINAL EXAM

2 UNIT 1 INTRO TO ECONOMICS FINAL EXAM REVIEW

3 Unit 1 Economics is the study of how people satisfy their wants and needs when there are limited, or scarce, resources Microeconomics branch of economics dealing with the decisions and behaviors of individuals Macroeconomics branch of economics dealing with the total, or aggregate, economy

4 Unit 1 ECONOMICS How people make choices in the face of scarcity SCARCITY Unlimited wants and needs but limited resources with which to produce goods and services Societies must ask themselves 3 questions What to produce? How to produce? For whom to produce?

5 Unit 1 How do we create goods and services? 4 Factors of Production (CELL) Capital - used to produce goods and services (but not a part of the good or service) Entrepreneurship human resources that organizes other factors of production in order to produce goods and services Land natural resources; gifts of nature Labor work time and effort into producing goods and services

6 Unit 1 Production Possibilities Curve Shows us all the possible points of production if we are fully utilizing our resources ` Represents us being FULLY EFFICIENT with our resources Outside of the Line Impossible 20 Inside of the Line Inefficient

7 Unit 1 ECONOMIC GROWTH Increasing our potential production beyond our current full-efficiency How does one experience economic growth? Increase in QUANTITY of resources Increase in QUALITY of resources Trade

8 Unit 1 ABSOLUTE ADVANTAGE Being able to produce more COMPARATIVE ADVANTAGE Being able to produce at a lower opportunity cost USA Canada Cars 100 ½ Airplanes 75 Airplanes 50 2 Cars 45 3/5 Airplanes 5/3 Cars

9 Unit 1 Goods and Services Business Income (Revenue) PRODUCT MARKET Consumer Spending Goods and Services FIRMS/ BUSINESSES INDIVIDUALS Payment for Factors (Production Costs) Factors of Production FACTOR MARKET Income Factors of Production

10 Unit 1 Types of Economies Command Economy Central authority answers what, how, and for whom to produce Market Economy The market (people and producers) decides what, how, and for whom to produce Mixed Economy Government and markets both help make decisions on what, how and for whom to produce

11 UNIT 2 SUPPLY AND DEMAND FINAL EXAM REVIEW

12 Unit 2 Demand amount of a good or services people want at given prices Law of Demand as price decreases, demand increases Diminishing Marginal Utility

13 Unit 2 Change in Demand shift OF the entire curve Buyers (Number of Buyers) Income Complements Expectations Preferences and Tastes Substitutes Change in Quantity Demanded shift ALONG the curve Change in Price

14 Price Unit 2 Demand Change in DEMAND At every price, there is a new amount of the good or service demanded Quantity

15 Price Unit 2 Demand Change in QUANTITY DEMANDED As the price changes, the quantity that is now being demanded has changed Quantity

16 Unit 2 Supply amount of a good or services producers make at given prices Law of Supply as price increase, supply increases

17 Unit 2 Change in Supply shift OF the entire curve Cost of inputs Productivity Technology Taxes Subsidies Government Regulations Number of Sellers Expectations Supply Shocks Change in Quantity Supplied shift ALONG the curve Change in Price

18 Price Unit 2 Supply Change in Supply At every price, there is a new amount of the good or service supplied Quantity

19 Price Unit 2 Supply Change in QUANTITY Supplied As the price changes, the quantity that is now being supplied has changed Quantity

20 Price Unit 2 EQUILIBRIUM The point where the quantity demanded is equal to the quantity supplied SURPLUS Quantity supplied is greater than quantity demanded; Can be caused by a price floor SHORTAGE Quantity demanded is greater than quantity supplied; Can be caused by a price ceiling Supply Demand Quantity

21 Price Unit 2 INCREASE IN SUPPLY Price decreases Quantity increases Supply Demand Quantity

22 Price Unit 2 Supply DECREASE IN SUPPLY Price increases Quantity decreases Demand Quantity

23 Price Unit 2 Supply INCREASE IN DEMAND Price increase Quantity increases Demand Quantity

24 Price Unit 2 Supply DECREASE IN DEMAND Price decreases Quantity decreases Demand Quantity

25 Price Unit 2 Increase Supply, Increase Demand Quantity Increases Price?? Supply Demand Quantity

26 Price Unit 2 Increase Supply, Decrease Demand Quantity?? Price Decreases Supply Demand Quantity

27 Price Unit 2 Decrease Supply, Decrease Demand Quantity Decreases Price?? Supply Demand Quantity

28 Price Unit 2 Decrease Supply, Increase Demand Quantity??, Price Increases Supply Demand Quantity

29 Unit 2 Elastic change in price leads to a greater change in quantity demanded Inelastic change in price leads to a smaller change in quantity demanded Unit Elastic change in price leads to an equal change in quantity demanded %ΔQ %ΔP = ΔQ Starting Q ΔP Starting P Let s assume that when the price of salsa dropped from $4 to $3, people went from demanded 200 jars to demanding 300 jars inelastic < 1 (unit elastic) < elastic

30 UNIT 3 MARKETS AND PRODUCTION FINAL EXAM REVIEW

31 Unit 3 Fixed Costs Costs that remain the same (overhead) Variable Costs Costs that change with number of units produced Total Costs Fixed Costs + Variable Costs Marginal Product additional units produced Marginal Cost the additional cost of producing one more unit Total Revenue price x units sold Marginal Revenue additional revenue from each additional unit Profit Total Revenue Total Costs We want to produce where our Marginal Revenue = Marginal Cost Profit Maximization

32 Unit 3 Pure Competition Large number of firms Monopolistic Competition Large number of firms Oligopoly Few strong firms Pure Monopoly One firm Easy entry Easy entry Difficult entry Near impossible entry No control over price No product differentiation Limited control over price Much product differentiation Some control over price Much product differentiation Total control over price None No advertising Much advertising Some advertising None Feed Corn Clothing Automobiles Water

33 Unit 3 Reasons for Market Failure (out of equilibrium) Not enough competition Not enough information Resources can t/won t move Too few public goods Externalities

34 Unit 3 Positive Externalities By-products of consumption that has a benefit on a 3 rd party that is neither a buyer or seller Negative Externalities By-products of consumption that impose a cost on third parties, neither of which is a buyer or seller Education, vaccine, electric vehicles Pollution, second-hand smoke

35 UNIT 4 MEASURING THE ECONOMY FINAL EXAM REVIEW

36 Unit 4 MACROECONOMICS The field of economics that studies the behavior of the aggregate economy. Macroeconomics examines economy-wide phenomena such as changes in unemployment, national income, rate of growth, gross domestic product, inflation and price levels. - Investopedia.com Basically it is the measuring of our economy and then deciding how to fix any issues we see when measuring it.

37 Unit 4 Peak top point where expansion stops and contractions begins Trough bottom point where contraction stops and expansion begins Expansion Also known as boom ; increased employment and output Recession Also known as contraction ; decreased employment and output Trend Line Average growth path; not interrupted by ups and downs

38 Unit 4 GROSS DOMESTIC PRODUCT (GDP) Gross Domestic Product (GDP) is the total market value of all final goods produced within a country s borders during a 12- month period. Used to measure a country s output

39 Unit 4 GROSS DOMESTIC PRODUCT (GDP) What is NOT included? Intermediate Goods Secondhand Sales Nonmarket Transactions Underground Economy

40 Unit 4 GROSS DOMESTIC PRODUCT (GDP) GDP = C + I + G + (X-M) Consumer Spending goods and services Investment new houses, business investment, inventory Government Spending Money government spends Net Exports exports minus imports

41 Unit 4 GROSS DOMESTIC PRODUCT (GDP) Net Exports Exports > Imports = Trade Surplus Exports < Imports = Trade Deficit

42 Unit 4 GDP per Capita Real GDP / Population Consumer Price Index Measures changes in prices over time Uses 1982 as a base year CPI = Current Market Basket Cost Base Market Basket Cost x 100

43 Unit 4 Using CPI to measure inflation Inflation = Change in CPI Starting Year CPI x 100

44 Unit 4 Demand Pull Inflation Shortages lead to increase in price Cost-Push Inflation increase in input costs leads to increase in price Wage-Price Spiral Higher wages mean higher prices which lead to higher wages Excessive Monetary Growth Money supply grows too fast

45 Unit 4 Nominal GDP Doesn t adjust for inflation Uses current prices when calculating change Real GDP Does factor in for inflation Uses base year prices when calculating change Nominal Inflation = Real

46 Unit 4 GDP Deflator GDP Deflator = x 100 Nominal GDP Real GDP Measure inflation in economy as a whole, not just a basket of goods

47 Unit 4 Using GDP Deflator to measure inflation Inflation = Change in GDP Deflator Starting Year GDP Deflator x 100

48 Unit 4 Unemployment Work Force People over 16 either working or looking for a job Included Full Time workers, Part Time Workers, Actively Seeking Not Included Discouraged Workers, Military members, Retirees, Homemakers, Full-time students, institutionalized

49 Adult Population (243.3 Million) Unit 4 Employed (142.5 Million in 2012) Labor Force (155.0 Million) Unemployed (12.5 Million in 2012) Not in Labor Force (88.3 Million in 2012)

50 Unit 4 Unemployment Frictional Workers are between jobs Completely normal and occurs regularly Structural Not enough jobs for everyone who wants one; a mismatch of jobs and workers Happens over time as economy s demand changes Can also be that there are jobs available, but not enough qualified workers (ex: doctors) Cyclical Unemployment that goes along with business cycle Workers may not be needed because of recession Full employment is when there is no longer cyclical unemployment

51 Price Level Unit 4 Shift of AD Curve Change in Consumer Spending Change in Investment Change in Government Spending Change in Net Exports Aggregate Supply (Long Run) Aggregate Supply (Short Run) Aggregate Demand Real GDP

52 Price Level Unit 4 Shift of SRAS Curve Change in Cost of Inputs Change in Expectations Change in Taxes Supply Shocks Aggregate Supply (Long Run) Aggregate Supply (Short Run) Aggregate Demand Real GDP

53 Price Level Unit 4 Shift of LRAS Curve Change in QUANTITY of resources Change in QUALITY of resources Trade Aggregate Supply (Long Run) Aggregate Supply (Short Run) Aggregate Demand Real GDP

54 UNIT 5 BUDGET AND FISCAL POLICY FINAL EXAM REVIEW

55 TOP 4 SPENDING Social Security National Defense Income Security Medicare and Medicaid

56 TOP 4 REVENUE Income Tax Borrowing Payroll Tax Corporate Income Tax

57 Unit 5 DEFICIT SPENDING Spending more than you bring in DEBT Total amount borrowed and still owed Deficit spending leads to debt BALANCED BUDGET Government Spending = Government Revenue

58 Unit 5 Types of Taxes Proportional Regressive Progressive Everyone pays same percentage of their income The lower your income, the greater percentage of your income you pay The higher you income, the greater percentage of your income you pay Flat income tax Sales Tax Current income tax system

59 Price Level Unit 5 Full-Efficiency Output or Potential Output Maximum sustainable output in the long run, given our supply or resources, the technology we have, and the nature of our production Fiscal Policy Producing along PPF Unemployment is at the natural rate, meaning there is no longer cyclical unemployment, only structural and frictional rgdp

60 Price Level Unit 5 Full-Efficiency Output or Potential Output Fiscal Policy When our SRAS and AD intersect at a rgdp which is less than our potential Output is below our potential Real GDP below potential Unemployment is above the natural rate Recessionary Gap rgdp

61 Price Level Unit 5 Full-Efficiency Output or Potential Output SRAS and AD intersect at a rgdp greater than potential Real GDP exceeding potential Fiscal Policy Output above potential Unemployment below natural rate Expansionary Gap rgdp

62 Expansionary Fiscal Policy Policy put in place, typically in times of recession and low growth, in order to stimulate the economy, specifically the aggregate demand PRICE LEVEL LRAS SRAS Purpose: close a recessionary gap How: Done typically one of three ways Increase government spending Decrease taxes Combination of both AD REAL GDP

63 Contractionary Fiscal Policy Policy put in place, typically in times of boom and extreme growth, in order to alleviate some of the inflationary pressure put on the economy PRICE LEVEL LRAS SRAS Purpose: close an expansionary gap How: Done typically one of three ways Decrease government spending Increase taxes Combination of both AD REAL GDP

64 Unit 5 Fiscal Policy and Stagflation Stagflation Often caused by a decrease in aggregate supply This leads to higher inflation and lower employment 1970s crop failures, higher oil prices, other supply shocks Throughout the 1970s, demand-side policies weren t working Remember Increase AD means more inflation, decrease AD means more unemployment

65 UNIT 6 FEDERAL RESERVE AND MONETARY POLICY FINAL EXAM REVIEW

66 Unit 6 Functions of Money Medium of Exchange Used as payment for a good When I go to Costco and hand them $10 for a pizza, money is being used as a medium of exchange Measure of Value (Unit of Account) Measuring stick in which we can compare the worth or value of something Costco pizza is $10, Papa Johns is $12 I m going with Costco Store of Value Saves the purchasing power of money until needed at a later date Purchasing power financial ability to buy goods and services If I put money away now, I can still but Costco pizza later

67 Unit 6 Characteristics of Money Portability Lightweight, convenient, easily transferred Debit cards, checks, bills, etc. Durability Can hold up over time Coins last for years upon years Paper currency has a respectable lifetime as well Divisibility Can be divided easily to represent exact value of exchange or storage Scarcity Limited supply; money will lose its value when there is too much of it

68 Unit 6 Money Supply M1 Very liquid, or moveable and accessible, funds Money that can be used as medium of exchange on demand Coins and currency Checkable Deposits M2 M1 plus funds that are not as easily accessible Medium of exchange plus store of value M1 Savings Accounts Money Market Mutual Funds Time Deposit (CDs)

69 Board of Governors Federal Open Market Committee (FOMC) Federal Advisory Committee (FAC) 12 Federal Reserve Banks Commercial Banks Thrift Institutions The Public (Households and Businesses

70 Unit 6 JOB OF THE FED Currency Setting Reserve Ratios Maintain Payments Regulating and Supervising Government s Bank Influencing Money Supply Monetary Policy Most important job of the Fed Done primarily by Federal Open Market Committee

71 Interest Rate Interest Rate Unit 6 Monetary Expansion Money Supply and Interest Rates 12% 10% 10% 8% Quantity of Money Quantity of Money

72 Expansionary Monetary Policy AKA: easy money policy Policy put in place, typically in times of recession and low growth, in order to increase the money supply, decreasing interest rates and stimulating the AD PRICE LEVEL LRAS SRAS Purpose: close a recessionary gap How: Decrease Required Reserve Ratio Decrease Discount Rate Buy Government Securities AD REAL GDP

73 Contractionary Monetary Policy AKA: tight money policy Policy put in place, typically in times of boom and extreme growth, in order to decrease money supply, which increases interest rates and shifts AD left PRICE LEVEL LRAS SRAS Purpose: close an expansionary gap How: Increase Required Reserve Ratio Increase Discount Rate Sell Government Securities AD REAL GDP

74 Unit 6 Expansionary Monetary Policy Increase Money Supply Lower Required Reserve Ratio Banks have to keep less required reserves, which means there is an increase in excess reserves that banks have available to lend to customers Lower Discount Rate from Federal Reserve Banks are charged a lower interest rate when borrowing from Fed, which means banks are more likely to take loans from the Fed Buy Gov t Securities on the Open Market The Fed writes a check drawn on themselves to purchase securities. Security dealers make this money and then deposit it into a bank Which leads to an increase of money supply and excess reserves which are loanable funds. As the amount of loanable funds increase, interest rates will go down. When interest rates decrease, businesses and individuals are more willing and able to borrow in order to spend or invest. This causes a shift of the aggregate demand to the right

75 Unit 6 Contractionary Monetary Policy Decrease Money Supply Higher Required Reserve Ratio Banks have to keep more required reserves, which means there is a decrease in excess reserves that banks have available to lend to customers Higher Discount Rate from Federal Reserve Banks are charged a higher interest rate when borrowing from Fed, which means banks are less likely to take out loans from the Fed Sell Gov t Securities on the Open Market The Fed sells government securities to dealers. In order for dealers to purchase these, they must take out money from their banks, decreasing reserves Which leads to a decrease of money supply and excess reserves which are loanable funds. As the amount of loanable funds decrease, interest rates will go up. When interest rates increase, businesses and individuals are less willing and able to borrow in order to spend or invest. This causes a shift of the aggregate demand to the left

76 Unit 6 Expansionary Policies Fiscal Policy Monetary Policy Policy Options Increase Government Spending Decrease Taxes Lower Reserve Ratio Lower Discount Rate Buy Government Securities Money Supply, Interest Rates, Investment, GDP

77 Unit 6 Contractionary Policies Fiscal Policy Monetary Policy Policy Options Decrease Government Spending Increase Taxes Raise Reserve Ratio Raise Discount Rate Sell Government Securities Money Supply, Interest Rates, Investment, GDP

78 UNIT 7 TRADE AND FOREIGN EXCHANGE FINAL EXAM REVIEW

79 Unit 7 Adam Smith ( ) 1776 Wealth of Nations Invisible Hand Individual producers act in their own self-interest As individuals and producers try to maximize their own wealth, through trade, entrepreneurship, etc, society as a whole benefits All of society is benefiting even if individuals and businesses are focusing only on their own self interest

80 Unit 7 ABSOLUTE ADVANTAGE Being able to produce more COMPARATIVE ADVANTAGE Being able to produce at a lower opportunity cost USA Canada Cars 100 ½ Airplanes 75 Airplanes 50 2 Cars 45 3/5 Airplanes 5/3 Cars

81 Unit 7 Terms of Trade We would trade somewhere between opportunity cost ratios Ex. 1 car for every airplanes USA Canada Cars 100 ½ Airplanes 75 Airplanes 50 2 Cars 45 3/5 Airplanes 5/3 Cars

82 Unit 7 Foreign Exchange Different currencies used to facilitate trade bought and sold on the foreign exchange market Foreign Exchange Foreign Exchange Rate the price of one country s currency in terms of another country s currency 1 British Pound ( ) = 1.44 United States Dollars ($) 1 United States Dollar ($) = 0.69 British Pounds ( ) These exchange rates are flexible exchange rates, meaning they change over time and aren t constant

83 What Causes Shifts? Consumers Tastes Relative Incomes Relative Inflation Speculation Price (of USD in GBP) 1.00 /$ 0.69 /$ S-USD D-USD Quantity of USD Traded

84 If the demand for USD increases, this means that GBP are being traded for USD. So as the demand for USD increases, the supply of GBP increases as well. Price (of USD in GBP) S-USD Price (of GBP in USD) S-GBP 1.10 /$ 1.44 $/ S-GBP 0.69 /$ 0.91 $/ D-USD D-USD Quantity of USD Traded D-GBP Quantity of GBP Traded

85 Since 1 USD is now more expensive (in GBP), it is said to have appreciated Since 1 GBP is now cheaper (in USD), it is said to have depreciated Price (of USD in GBP) S-USD Price (of GBP in USD) S-GBP 1.10 /$ 1.44 $/ S-GBP 0.69 /$ 0.91 $/ D-USD D-USD Quantity of USD Traded D-GBP Quantity of GBP Traded