REVIEW FOR TEST I (Chapters 1-4 of Case, Fair, Oster text) HCCS Spring Branch Campus Instructor: J.H. Ewing What Economics is About Economics deals with the human condition that arises when Wants > Limited Resources. It is sometimes called the science of scarcity. Be able to distinguish Macroeconomics from Microeconomics Macroeconomics deals with issues usually at the national level such as inflation, recession, Gross Domestic Product, unemployment, or monetary and fiscal policy. Microeconomics focuses on the firm and individual consumers and includes issues of market structures, production cost, or individual consumer demand. Economists classify limited resources into Factors of Production Land (fixed in supply; includes undeveloped minerals) Labor (physical and intellectual contributions of individuals) Capital (machinery, tools, human made goods that can produce other goods. Understand the meanings of physical capital, human capital, and financial capital. When economists use the term capital, we usually mean physical capital: machinery, tools, etc.) Entrepreneurship (the risk taker that puts the other factors together; the creator of new products and processes.) Because of the above, there is a necessity to ration these scarce resources. Markets are one means of rationing. Adam Smith described the free market rationing process as an an invisible hand. If we do not use markets and market prices to guide us in rationing, we must use something else: power, persuasion, charm, redistributive political policy, etc. Understand how societies under a variety of political and economic systems must wrestle with the fundamental economic issues economists refer to as the WHAT, HOW, FOR WHOM issues. Decisions involving rationing involve opportunity costs. This is one of the most important concepts in economics. When we allocate scarce resources to produce one thing, those same resources can not be use to produce something else. The next best alternative that we gave up is the opportunity cost of producing the thing we produce. PRODUCTION POSSIBILITIES Understand how a Production Possibility Curve (or frontier) depicts the opportunity costs facing a society. Understand the importance of tradeoffs implicit in opportunity costs. Note Price is not necessary these opportunity costs exist even in a non-money economy. For example, opportunity costs
were quite evident on the Survivor television show in a non-money economy. Understand these other important concepts that are inherent in production possibility curves Efficiency and Inefficiency (We speak of production efficiency and allocative efficiency. Basically, many combinations may be technically possible from a production standpoint, but only one will provide the society the greatest benefit: cost ratio in its collective opinion. The political process helps use determine allocative efficiency.) Points beyond the production-possibility frontier indicate currently unattainable production given the current limited resources. These may be worthy goals. Economic growth may allow us to attain these goals. Understand how changes in technology, resources, and sometimes systems (e.g. changing from a controlled economy to a free market economy.) may shift a production possibility curve. Explore production-possibility curves in more detail, especially adding the concept of rising opportunity cost. Rising opportunity cost are depicted by bowed curves. If the tradeoff is a 1:1 trade off, the production possibility curve is a straight line. This may seem mechanical rise above that to see we increasingly must give up more of another good. We pick the easy mangoes first. As we seek additional mangoes we must forego the opportunity to produce an alternative; thus, the opportunity cost rises. We refer to this as the Principle of Rising Opportunity Costs. The Production-Possibility curves are closely related to WHAT we produce. Beyond What we produce, an economic system must wrestle with HOW we more labor, less land OR more land, less labor. And this, in turn, is closely related to the FOR WHOM question. Land receives rents; Labor receives wages; capital receives interest; and entrepreneurship receives profits (or Functional distribution of income allocates income among the factors of production. In the U.S. currently, Labor receives the lion s share about 70% of the total income.. OTHER SELECT TERMS AND CONCEPTS Understand the meaning and use of these important terms Ceteris Paribus Normative-(sometimes called prescriptive)- ought and Descriptive (sometimes called positive)-- is
A NOTE ON GRAPHS AND CHARTS O Understand direct relationships and inverse relationships, especially since these are fundamental to understanding supply curves and demand curves. I will not ask you any questions about the mechanical aspects of slopes of curves. But understand their use in analyzing supply and demand. SUPPLY AND DEMAND: THEORY AND PRACTICE Understand the Law of Demand price and quantity demanded are inversely related Understand the Law of Supply price and quantity supplied are directly related Understand that the two curves represent dynamic forces. Quantity Demanded and Quantity Supplied are equal at the Equilibrium point. Hence, at Equilibrium there is neither a surplus nor a shortage: the market is cleared. At a price other than the equilibrium price, there is either a shortage or a surplus. Economic forces want equilibrium; the dynamic forces inherent in shortages and surpluses push and pull a free market toward Equilibrium. Drawing the supply and demand curves may seem mechanical rise above this and realize that these curves represent forces and dynamics. The curves are merely pictures of these forces. To isolate the effect of particular changes, it is important to hold all other things equal or unchanged. We need ceteris paribus so we can isolate and study the effect of particular changes. When economists use the term change in demand we mean a shift in the demand curve. (Not a move up and down the fixed curve.) What shifts a demand curve? Changes in number of buyers (population, market niches, demographics, etc.) Changes in income (Understand normal goods and inferior goods) Normally, an increase in income leads to an increase in demand for a good. We refer to such goods as Normal goods. However, for the shoe repair or for used cars, for example, the demand may actually decline. We refer to these as inferior goods. It is not the quality that economists are passing judgment on it is the response of demand to a change in income. Changes in Preferences, fads, styles, tastes etc. Changes in expectations of future price or conditions Changes in the prices of other goods and services (Understand Complements and Substitutes) Examples of Complements: printers and inks; automobiles and tires; hardware and software.
Examples of Substitutes: Coca Cola and Pepsi; Petroleum and coal; Driving to work and taking Metro. Taxes or Subsidies Etc. Note: A change in the price of a commodity does not shift a demand curve or a supply curve for that commodity, since these curves already represent the quantity demanded or the quantity supplied at every given price. A change in price points you to a particular quantity demanded or quantity supplied on the existing curve. It does not shift the curve; it indicates a movement along the curve; it depicts the Law of Demand or the Law of Supply. What shifts a supply curve? Changes in the number of suppliers Changes in the cost of resources Changes in technology Changes in expectations of future price Taxes and subsidies Etc. What is meant by a price ceiling? (e.g. rent control). The Ceiling holds price below free market equilibrium price. It resists the upward market pressure. What is meant by a price floor? (e.g. minimum wage, agricultural price supports). Holds price above free market equilibrium price. It resists the downward market pressure. Understand how the change in the price of one good affects the demand of another good: (a) effect on a substitute good; (b) effect on a complementary good. o The supply and demand curves are fundamental tools to help analyze and discuss supply and demand. The demand curve depicts the quantity demanded at every possible price. Thus, a change in price would indicate a different quantity demanded. When economists say that demand has shifted or demand has increased or decreased, we mean that the whole curve has shifted. It takes something other than price to shift the demand curve. (see examples above.) And it takes something other than price to shift a supply curve. Changing the price of that good or service is depicted by a different point on the same curve a movement along the curve. THE CIRCULAR FLOW MODEL We use the Circular Flow Model to depict a basic macro economy. The Factors of Production (inputs) are used by firms to produce outputs of goods and services. The contra flow of money pays the suppliers of the factors of production. These factor payments constitute the purchasing power to buy the firms output. In Equilibrium,
what comes around goes around, and we stay at macro equilibrium. When we encounter macro dis-equilibrium we experience fluctuations in the business cycle: peaks and troughs and expansionary and contractionary phases. We discussed several factors that might affect equilibrium, and we described these as Leakages and Injections: Savings and Investment; Imports and Exports; and Tax Revenue and Government Spending. Having an understanding of this Circular Flow Model will be very important as we move forward with our study of Macroeconomics. The application of supply and demand and market forces are evident in each economic decision: for example, prices of goods and services; payments to the factors of production: wages, rents, interest, profits and losses; and the allocation of the factors of production. THE TEST will ask about 50 questions. Most of these will be multiple choice; some may be matching, fill in the blank, or true/false. You do not need a Scantron. The questions are developed to test your understanding of economic concepts and your ability to apply these concepts. DO NOT merely memorize anything; learn, understand, and be able to apply the fundamental principles we have discussed, and you ll do very well.