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Review for Midterm th

Date of exam: January 14 , 2009 Chapters covered: 1,2,3,4,5,7,9,10,11,13,14 Chapter 1: What is Economics? - Economics o Is business of everyday life o Social science that studies how society uses scarce resources to satisfy wants o Involves study of people o Uses many tools of analysis - Factors that affect production- land, labor, capital, entrepreneurship o Land- Natural resources o Labor- physical and mental efforts of people o Capital- buildings, tools, machines o Entrepreneurship- imagination, innovative thinking, management skills needed to start a business  Entrepreneurs are willing to take risks for profit - Scarcity o Inequality exists between wants and resources available to satisfy them o Resource not available at precise time and place when needed o Must have demand for resource to be scarce - Opportunity costs and Trade offs o Highest valued alternative given up as a result of choice o Ex: working in bookstore, opp. cost is participating in school debate team - Incentives and Disincentives o Incentives  Positive rewards for making choice or behaving in a certain way  May be higher wages, praise, good grades, etc. o Disincentives  Negative or withdrawn reward  Fines, punishment - Marginal o Extra or additional costs or benefits of a decision - 3 questions that every economy must ask- what, how, and for whom o What goods and services to produce? o How should goods and services be produced? o For whom will goods and services be produced? - Microeconomics and Macroeconomics o Macroeconomics- “big picture”  Nationwide, statewide level thinking  Affects large group o Microeconomics- “small picture”  Individuals, families, businesses Chapter 2: Free Enterprise in the United States - Free Enterprise o People in their economic roles are free to make choices - Pillars of Free Enterprise o Private property  Resources products owned by individuals IAHelp.tk

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 Important part of American economic system  Gives reason to use property as efficiently as possible o Specialization  Focusing on producing one or few parts of a product  Allows business to increase amount it produces and sells o Voluntary Exchange  Buying and selling products  Depends on other people to work effectively o The Price System  Monetary prices as a message to allow exchanges between sellers and buyers  Acts as messengers  How willing buyers are to buy  Which resources are least expensive to use in producing  Price is dominant in messaging in market economy  Provide strong incentives for consumers and producers  Higher prices encourages businesses to produce  Lower prices encourages consumers to buy  Profit; prices affect profit o Market Competition  Competition in Resource Markets  Market for producers  Drives price down  Competition in Product Markets  Market for consumers  Drives price up o Entrepreneurship  Motivation that drives business to react to the market  Encouraged by free enterprise Economic Systems o Command economy  Government controls most assets  Centrally based  Orders people to produce o Traditional economy  Relies on traditions to make decisions o Mixed economy  Blend of voluntary exchange, government control, and traditional elements Circular flow of money, resources, and products o See pg. 23 of textbook Goals of the U.S. economic systems o Full employment  Almost all that are , ready, willing and able can find work o Economic growth  Increase in output of production of goods and services during a year o Price stability  Prices do not fluctuate severely  Would cause hardship for businesses and people if happened o Economic freedom

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 High degree of freedom in what to do and what to buy o Economic security  Basic needs of everyone should be met o Economic equity  Fairness and impartiality  Equal economic opportunities o Efficiency  Maximum output of goods from available resources Chapter 3: Demand - Demand o Quantities of a good/service that consumers are willing and able to buy at different prices at a particular time - Law of Demand o Buyers will buy more at lower prices than high o Inverse relationship between quantity demanded and price - Changes in Qd vs. changes in Demand* o Only price can affect Qd o Many thing can affect change in Demand; see “Factors that affect Demand” - Market Demand vs. individual demand o Market demand- sum of all individual demands o Individual demand- demand of an individual - Factors that affect demand o Population  More population  more people to buy stuff  more demand o Income  More income  more money to spend  more demand o Tastes and Preferences  Ex: If [paper] was cool  more buyers  more demand o Future price expectations  If price was predicted to fall  more demand o Change in weather or season  Products that are affected by this, say bottled water, road salt, etc.  If weather/ season change  more demand o Price of complements and substitutes  Price of complements rise  more demand  Price of substitutes rise  less demand for product - Income effect and substitution effect o Income effect- what income does to demand o Substitution effect- what substitutes does to demand (of a certain product) - Price Elasticity of Demand o Measure of the impact of the price effect on demand o When change in demand is large, price is elastic o And vice versa o What affects price elasticity of demand?  Availability of substitutes  More substitutes  more elastic, and vice versa  Percentage of budget for an item  Percentage is greater  more elastic, and vice versa  Time IAHelp.tk

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More time  more elastic, and vice versa

Chapter 4: Supply - Supply o Quantity of a good or service producers are willing and able to sell at a particular time. - Law of Supply o Producers make more as price of a product rises - Changes in Qs vs. changes in supply* o Only price can change Qs o Many things affect changes in supply; see “Factors that affect Supply”. - Factors that affect Supply o Price of Inputs  Price of Inputs rise  supply drops o Future price expectations  Future price rises  supply increases o Number of suppliers  Number of suppliers increases  supply increases o Government (not like the other ones…)*  - Price elasticity of Supply o Responsiveness of business is key  Responsiveness is slow  supply inelastic o Time is also key  More time  supply elastic Chapter 5: Market-Clearing Price - Market o Where people trade goods and services for labour, money, etc. (you can define this too ) - Market-Clearing Price o Amount supplied = Amount demanded o Nothing left over o “clears” market - Shortage and Surplus o Surplus: when the price is above the market clearing price; leads to extra inventory o Shortage: when demand is greater than supply; the price is below market clearing; more people are unsatisfied o Surplus of scarce products? Not possible. If the product is scarce, then there is demand for the product making it scarce. That means there cannot be a surplus. - Functions of prices o Messenger  Tells when sellers should sell and buyers should buy o Ration products  Distributing products by price  If you want a Lamborghini that bad, spend less on other products and by the end, you get the money   Auctions are “excellent example of demand affecting price” o Motivator  Provides incentives for people to produce goods and services  Ex: profit incentive: prices can yield profits  profits mean more money to spend  more luxuries - Shifts in demand and supply altogether IAHelp.tk

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o Market- clearing price varies o Incentives also change  products and demands change  Ex: environmentally-unfriendly product’s demand lowers, opp. products demand increases Chapter 7: Business of Free Enterprise - Industry o A group of one or more firms that produce a similar or identical product - Advantages and Disadvantages of small businesses o Advantages  Flexibility  Can be profitable in small markets  “down the street” appeal  Specialize more quickly and effectively o Disadvantages  Higher failure rate than larger businesses  Inexperience  Monetary problems  Hiring and retraining workers - Sole Proprietorship o Definition  Business owned by one person o Advantages  Organization  Easy to start, easy to run  Free to make own decisions  Profits  Gain all profits of business  Taxes  Few legal restrictions  Flexibility  React quickly to problems  Personal Achievement  Success and recognition through individual efforts o Disadvantages  Unlimited Liability  All debts are on bosses head, not businesses (two different things)  Limited funds  Limited money to expand  Limited potential  Lack of opportunities for employees  Limited size and growth  Lack of resources  Fragile existence  Competitor can take large part of business  Market can decline  If owner dies, company ends - Partnership o Definition IAHelp.tk

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 Business organized by two or more people o Advantages  Organization  Easy to form, easy to run  Potential growth  Bring more money into business  Abilities  Fresh ideas from each other o Disadvantages  Unlimited Liability  All individually responsible  If one partner commits crime, all partners are held liable  Limited Life  If a partner dies or leaves, partnership is terminated  Limited funds  Determined on wealth and ability to borrow  Organization  Conflicts may arise form different ideas. Corporation o Definition  Company managed on behalf of owners o Advantages  Limited Liability  Owners held responsible only for debts for investment  Makes possible to raise large amounts of capital  Ease of transfer  Owners can leave or join at will by trading stock  Unlimited life  Corporations can live forever  Ability to raise funds  Sell stock, issue bonds o Disadvantages  Expense  More complicated and costly  Taxation  Taxes earning twice, from profits and dividends  Regulations  Many legal laws to regulate corporations and provide transparency Limited Liability companies o Definition  Combines advantages of corporations and partnerships o Advantages  Benefit of mass Internet use  Limited liability  Function in its own name o Disadvantages  More complicated than partnerships  Taxed as partnerships are taxed

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Non-profit organizations o Do not try to earn a profit o Serve specific purposes o Not subject to income taxes o Income must cover expense o Employ volunteers and paid staff - Cooperatives o Associations of individuals or companies that perform functions for members o Housing co-ops o Consumer co-ops o Producer co-ops - Franchises o License that entitles holder to operate as if a part of a larger chain. o Holder gains popularity and good/bad name of the chain. o Revenue from selling franchises enables company to expand at minimum cost o More capital saved o Franchisers benefit as franchisees try to be successful o Franchisers retain control o A mistake from one franchisee can being a blow to the entire franchise Chapter 9: Production and Productivity - GDP – Gross Domestic Product o Definition  Final value of goods and services produced within a given country within a year o Components  Consumption +Investment + Government Spending + [Exports + Imports] (last two are called Net Exports) - Real GDP vs. Nominal GDP o Real GDP is deflated to a given year’s dollars o Nominal GDP is measured in the dollars of the year when the GDP was announced - Shortcomings of GDP o Does not measure goods and services that are produced but not sold i.e. charity work o Does not measure goods and services produced and consumed by oneself o Does not measure value of leisure time o Does not measure value of illegal activities - Productivity vs. Labor Productivity o Productivity is output of goods and services measured per unit of input of resources o Labor Productivity is amount of goods and services the work force can produce in a given time period. - The relationship between technology and GDP o More technology more productivity  more GDP (like robots on an assembly line) - Fixed cost, variable costs and total costs o Fixed cost  Costs that remain the same regardless of how much the firm produced (i.e. rent of a factory, provided it didn’t expand or anything or a machine – buy it once and it keeps producing; no need to buy a new one for every product) o Variable costs  Costs that change with changing amounts of production  i.e. cost of raw materials; more goods produced  more raw materials needed  higher costs IAHelp.tk

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o Total costs  Sum of fixed and variable costs - Law of diminishing returns o As more and more variable resources are added to fixed resources, the marginal amount produced decreases each time. - Total revenue vs. profit o Total revenue  P x Qs (Price multiplied by quantity sold) o Profit  TR- TC = TP (total revenue subtract total cost = total profit) - Economies of scale o Reductions in cost resulting in mass production Chapter 10: The U.S. Labor Force - Labor force o Employed  Works at least one hour a day with pay  Works 15+ hours without pay in a family business  Holds a job but did not go due to illness, vacation, labor disputes, or bad weather o Unemployed  Temporarily laid off  Reporting to new jobs in 30 days  Not working but looking for a job in the past four weeks - Labor force trends o Agricultural  Declines as country modernizes o Manufacturing  Declines as country modernizes even more o Service  Increases as country modernizes even more. - Human capital o What humans can do to benefit the company - Contingent employment o Definition  Employment of temporary workers o Benefits to the employer  Cheaper labor  Can lay off workers more easily o Drawbacks  More cost to teaching/training new employees - Labor demand, labor supply, equilibrium wage o Like demand, supply, market-clearing price… o Labor demand  Labor demanded from business, producers o Labor supply  Labor supplied from the workforce o Equilibrium wage  Wage at which both supplier and demanders of labor are satisfied - Unskilled, skilled, and professional labor o Skilled IAHelp.tk

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 Engineer  Architect o Unskilled  Builder  Cement Layer  Paper Watcher (inspecting paper) o Professional  Lawyer  Doctor  Executives  Government Officials - Labor unions o Definition  Association of workers that seeks to improve standard of living for workers o Trends  Downward o Reasons for decline  Conflicting objectives  Lessening of demand for unionized workers  Appearance of non-unionized workers  Increasing percentage of labor (college-educated employees, women, service providers) have been reluctant to join unions - Specialization and division of labor o Relation to productivity  Allows people to concentrate on tasks at which they are most productive  More productivity as a result - Minimum wage o Lowest legal wage an employer can pay o $5.15/hr for persons above 20 o $4.25/hr for persons under 20 o Fair Labor Standards Act of 1938 Chapter 11: Competition among Businesses - Market Structure o Set of conditions that describes the characteristics of a market under which a business competes - Perfect Competition o Many businesses o Market determines price o Identical products o Easy to start business - Monopoly o True Monopoly  Controls entire market o Real Monopoly  Dominates industry o Single large business o Determines market price o One product o Difficult to start a business - Monopolistic competition IAHelp.tk

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o Many businesses o Limited ability to set prices o Similar products o Relatively easy to start business - Oligopoly o Few large businesses o Considerable ability to set price o Many forms of product differentiation o Usually in either raw materials or highly technologically advanced sectors of the economy i.e. nickel mining, oil, airplane manufacturing, etc. - Collusion o Formal gathering of company leaders o Restrict production to raise demand and more profits o Illegal in the U.S. o Severe market restrictions against colluding - Mergers o Horizontal  Two or more companies involved in making the same product o Vertical  Two businesses involved in the same business o Conglomerate  Two or more unrelated companies Chapter 13: Money and Financial Institutions - Functions and Characteristics of Money o Stability  Value should be stable, so that it could be used as a form of transfer o Portability  Small and light enough to take with anywhere o Durability  Tough; no-disintegrating-in-the-washer toughness. o Uniformity  The equal denominations of money should be equal o Divisibility  Easy to split up into parts of relative value o Recognizability  Hard to copy, easy to recognize - Money supply o M1  Currency  Traveler’s Checks  Demand Deposits  Other checkable Accounts o M2  M1  Small Savings deposits  Passbook and money Markey savings accounts  Mutual fund money market accounts o M3  M2 IAHelp.tk

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 Institutional money market accounts  Large savings deposits  Eurodollars  Other (files that are worth a lot, essentially) - Development of banking o Middle Ages  Stored money for safekeeping  Bartered gold with receipts; early form of money  Goldsmiths were first bankers o Modern Era  Government regulates and supervises banking  Banks are defined as financial institutions that accept demand deposits and makes commercial loans. - Fractional reserves system o Banks hold a fraction of depositor’s money. - Federal reserve system o Nation’s central bank o The “Fed” o 12 central banks, 25 branches o Board of Governors o Fed open Market Committee o Advisory committees - Monetary policy o Government policy that affects interest rates and quantity of money supplied to the economy o Purpose is to reduce the effects of recession or too-rapid expansion Chapter 14: Economic Stability - Business cycle o Expansion  Also called recovery  Output and employment expand o Peak  Temporary maximum of output and employment o Contraction  Also called recession, depression  Total GNP output declines o Trough  Output and employment at minimum - GNP, NI, PI, DI o GNP  Gross National Product  Total market value of all final goods and services produced by American citizens, whether they are in the U.S. or overseas. o NI  National Income  Value of Goods and Services of a given nation in one year o PI  Per Capita Income  The value of goods and services produced by a single person in a given nation in one year. o DI IAHelp.tk

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 Disposable Income  Income received from households, subtract personal taxes. Economic Indicators o Durable Goods orders  Durable goods include items used for three years or more, such as airplanes, cook pots, cars, etc.  A backlog of orders means that the economy is relatively healthy and growing o Housing starts  If economy is strong and growing, then there would be more housing starts. o Jobless claims  If jobless claims are declining, then that means the economy is strong, and there is low unemployment. Recession, Depression, Economic Growth o Recession  See “contraction” for definition  Taxes allow families to be taxed at a lower rate than in boom years, and so provide a tax cut for those families that are affected.  Technically, a recession is a decrease in GDP lasting 2 quarters o Depression  A really bad recession o Economic Growth  When the economy is healthy and growing; unemployment is low, output of goods and services increases. Unemployment o Definition  Rate is number of people looking for a job divided by the number of people in the workforce. o Types  Frictional  Temporary, unavoidable unemployment, i.e. between jobs.  Structural  When the “structure” of the economy changes, i.e. moving from farming to manufacturing, farmers are then unemployed.  Seasonal  Spending part of the year in temporary unemployment, as such as ski resort teachers are unemployed in the summertime  Cyclical  Downturn in the economy, i.e. as in a recession, when people are laid off Full employment o When actual rate of unemployment is equal to natural rate of unemployment, the country is said to be at full employment. Frictional and structural unemployment are still expected. Discouraged workers o Workers who have been without work for so long that they stop looking for work. o Not included in the unemployment rate Inflation, price level, CPI o Inflation  A general rise in overall prices. o Price level

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 o CPI 

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Measure of overall prices.

Separate index that measures the prices of a “market basket” of 300 typical goods that consumers buy.  Good measure of inflation since it is tied to common, everyday products Purchasing power o The value of money in purchasing goods and services o Decreased by inflation; money is worth less, so it buys less. Theories of inflation o Quantity  Keeping prices constant but letting quantity of goods vary. o Cost-push  Rising prices from increases in the cost of production o Demand-pull  Too much money to chase too few goods Fiscal policy o Definition  Usage of government spending and taxation to stabilize the economy o Tools  Government spending  Spending on infrastructure  Subsidies for business  Taxation  Income taxes  Sales taxes o Expansionary/Contractionary  Expansionary  Raise taxes, and decrease government spending to control inflation  Contractionary  Lower taxes, and increase government spending to boost the economy and prevent it from going into a downspin o Limitations  If government reduces taxes, revenues decrease, creating a deficit.  Can crowd out private borrowers, increasing the interest rate, making it harder to borrow money  Government prints money to pay off debt, causing inflation  Increasing taxes is unpopular with the public Classical vs. Keynesian economics o Classical  Government keeps its hands off the economy  As long as economy is without interference from the government, supply and demand can balance. o Keynesian  Supports government intervention for economic stabilization through fiscal and monetary policy  Government spends money  more money for the regular people  more spending and increase in productivity. Multiplier effect

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o Banks lend money  people have money  save in another bank  lends money  people have money… Miscellaneous - Absolute and Comparative Advantages o Absolute Advantage  Being able to produce something more efficiently than another person/nation/etc.  Can we produce more? o Comparative Advantage  Being able to produce a good or service at a lower opportunity cost than another person/nation/etc.  Should we produce more? - Exchange Rates o The value of one country’s currency stated in terms of another country’s currency.

GOOD LUCK

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Review for Economics Final