ECON 1 Final Review: Supply and Demand, Market Structures, GDP and Macro Policy

Terms in this set (30)

1. Opportunity costThe value of the next best alternative given up when you make a choice. For example, the cost of college includes wages you could have earned.
2. Absolute vs comparative advantageAbsolute advantage: producing more with the same resources. Comparative advantage: producing at a lower opportunity cost. Trade gains come from comparative advantage.
3. What does a production possibilities frontier (PPF) show?The maximum combinations of two goods an economy can produce with its resources. Points inside are inefficient, points outside unattainable; a bowed-out shape reflects increasing opportunity cost.
4. Law of demandOther things equal, when the price of a good rises, the quantity demanded falls, so demand curves slope downward.
5. Change in demand vs change in quantity demandedA price change moves you along the demand curve (quantity demanded). A change in income, tastes, related goods' prices, expectations or number of buyers shifts the whole curve (demand).
6. Normal vs inferior goodDemand for a normal good rises when income rises. Demand for an inferior good falls when income rises.
7. Substitutes vs complementsSubstitutes: a price rise in one raises demand for the other (coffee and tea). Complements: a price rise in one lowers demand for the other (cars and gasoline).
8. Effect of a supply decrease on equilibriumSupply shifts left: equilibrium price rises and equilibrium quantity falls.
9. Price elasticity of demand formulaElasticity = (% change in quantity demanded) / (% change in price), in absolute value. Greater than 1 is elastic, less than 1 is inelastic.
10. How does a price increase affect total revenue for inelastic demand?Total revenue rises, because quantity falls by a smaller percentage than price rises. For elastic demand, revenue falls.
11. Consumer surplus and producer surplusConsumer surplus: willingness to pay minus price paid (area under demand above price). Producer surplus: price received minus cost (area above supply below price).
12. What is deadweight loss?The loss of total surplus when output is not at the efficient level, for example from a tax, price ceiling, price floor or monopoly.
13. Effect of a binding price ceilingSet below equilibrium, it causes a shortage: quantity demanded exceeds quantity supplied. Rent control is a standard example.
14. Tax incidence ruleThe side of the market that is less elastic bears more of a tax burden, regardless of whether the tax is legally placed on buyers or sellers.
15. Marginal cost and average total cost relationshipMC crosses ATC at the minimum point of ATC. When MC is below ATC, ATC is falling; when MC is above ATC, ATC is rising.
16. Profit-maximizing rule for any firmProduce the quantity where marginal revenue equals marginal cost (MR = MC).
17. Perfect competition in the long runFree entry and exit drive economic profit to zero, so price equals minimum average total cost and P = MC.
18. How does a monopoly differ from a competitive firm?A monopolist faces the downward-sloping market demand, so MR < P. It sets MR = MC, producing less and charging more than a competitive market, creating deadweight loss.
19. What is a negative externality and one fix?A cost imposed on third parties not reflected in price, such as pollution, leading to overproduction. A Pigouvian tax equal to the external cost can correct it.
20. Public goods: two defining propertiesNon-rival (one person's use does not reduce another's) and non-excludable (people cannot be kept from using it). They suffer from the free-rider problem.
21. Expenditure approach to GDPGDP = C + I + G + NX: consumption, investment, government purchases, and net exports (exports minus imports).
22. Nominal vs real GDPNominal GDP uses current prices; real GDP uses constant base-year prices, so it measures changes in output alone. GDP deflator = (nominal / real) x 100.
23. Unemployment rate formula and who countsUnemployment rate = unemployed / labor force x 100. The labor force is employed plus unemployed people actively seeking work; discouraged workers are excluded.
24. Three types of unemploymentFrictional (between jobs), structural (skill or location mismatch), and cyclical (due to recessions). The natural rate includes frictional and structural only.
25. Mini-problem: CPI rises from 200 to 210. What is the inflation rate?(210 - 200) / 200 x 100 = 5%.
26. Real interest rate (Fisher relation)Real interest rate is approximately nominal interest rate minus inflation. A 7% nominal rate with 3% inflation gives about a 4% real rate.
27. Simple spending multiplierMultiplier = 1 / (1 - MPC), where MPC is the marginal propensity to consume. With MPC = 0.8, a change in spending is multiplied by 5.
28. Aggregate demand and aggregate supply: effect of a negative demand shock in the short runAD shifts left: output falls, unemployment rises and the price level falls or rises more slowly.
29. Expansionary fiscal policy vs expansionary monetary policyFiscal: the government raises spending or cuts taxes. Monetary: the central bank lowers interest rates or expands the money supply. Both shift aggregate demand right.
30. Quantity theory of money equationM*V = P*Y: money supply times velocity equals the price level times real output. With stable V and Y, faster money growth leads to inflation.

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