Economics Test Review One:

-Chapters 1,3,4,5,6 (No Quantity Control)

Chapter One: Economics and Life

Economics is the study of how people manage resources

o Resources can be tangible or intangible
Time, Money, Experience, Relationships
Economics is usually divided up into two different sections
o Macroeconomics: Study of economics on a regional,
national, or international scale
o Microeconomics: Study of how individuals and firms
manage resources
Rational Behavior is when people make choices to achieve goals
in the most effective way possible
o Compare all possibilities and choose the best one
Scarcity is the condition of wanting more than we can get with
available resources
Opportunity Cost is the value of something you give up in order
to receive
Marginal Decision Making is comparing the additional costs and
benefits of a choice (example of rational behavior)
o This is the idea that rational people compare the additional
benefits of a choice against the additional costs, without
considering related benefits and costs of past choices
o This takes into account sunk costs. Sunk costs are costs
that are already incurred and cannot be recovered or
refunded
o A rational decision maker will continue to take an action if
and only if the marginal benefit is at least as large as the
marginal cost
Total Benefit

Total Cost

Firms:

Total Revenue

Total Production Cost

US EPA

Total Benefit of
Reducing Pollution
Total Value of goods
consumed

Total abetment cost

Consumer

Total cost of goods

consumed

Individuals and firms can make better decisions when thinking at

the margin and deciding if the marginal benefit of an action is
greater than the marginal cost

Efficiency is the use of resources in the most productive way

possible to produce the goods and services that have the
greatest total economic value to society
o Under normal circumstances the economy is operating
efficiently, but there are circumstances that might not
be normal:
Innovation
Market Failure
Intervention
Goals other than profit
The most basic model of the economy is the circular flow
model
o Depicts the flow of dollars and the flow of goods and
services
o These two flows go in the opposite direction
Positive statement is a factual claim about how the world
works
Normative statement is a claim about how the world should
be

Chapter 3: Markets

The term market refers to the buyers and sellers and not a place
o A t-shirt market is made up of people who buy and sell tshirts
A market economy is an economy in which private individuals
rather than a centralized planning authority makes decisions
A competitive market is where the market is fully informed.
Price0taking buyers and sellers easily trade a standardized good
or service
o Standardized good is a good for which any two units have
the same features and is interchangeable
o In competitive markets there are no transaction costs (the
costs incurred by buyer and seller in agreeing to an
executing a sale of goods or services)

o A competitive market does not require anyone to pay to

participate, it is fair and equal
o In a competitive market, the price taker is a buyer or seller
who cannot affect the market price
Features of a Competitive
Market:

Standardized good
Full Information
No transaction costs
Participants are price takers

Demand is how much of something people are willing and able to

buy
o The law of demand is that, all else equal, demand rises
when price falls
o Demand curves have negative slopes due to this on a
graph, demand curve can also be presented in a demand
schedule in tabulated form
o A change in quantity demanded is a move along the
demand curve either up or down. You follow the curve. If
quantity demanded decreases you move up the curve. If
quantity demanded increases you move down the curve
o A change in demand shifts the actual demand curve
Increase in demand shifts the curve right
Decrease in demand shifts the curve left
o The non-price determinants of demand
Consumer Preferences (Less people smoking due to
increased knowledge about health affects of
cigarettes)
Price of related goods
Complements are goods bought together, so
an increase in demand of one will generally
increase the demand of the other
Substitutes are goods that one can replace for
the other.
Income
Normal Goods are goods that demand
increases for when income increases (Good
Quality Meat)

Inferior Goods are goods that demand

increases for when income decreases (Ramen
Noodle)
Expectations
Supply describes how much of a good or service producers will
offer for sale under given circumstances
o Law of supply is a characteristics of supply that states that,
all else equal, quantity supplied rises as price rises
o The supply curve will have a positive slope and can also be
depicted in a supply schedule in tabulated form
o The quantity supplied is the amount of good provided at a
particular price during a period
o A change in supply is a move along the supply curve either
up or down. You follow the curve. If price raises you move
up the supply curve. If prices falls you move down the
supply curve
o A change in the supply shifts the actual supply curve
An increase in supply shifts the curve right
A decrease in supply shifts the curve left
o The non-price determinants of supply
Prices of related goods
Technology
Prices of inputs
Expectations
Numbers of sellers
Where the supply curves cross with the demand curve is the
equilibrium quantity and price
o The demand vs. supply curves will always try to return to
equilibrium
When either supply or demand increases, it is easy to figure out
what happens to the equilibrium quantity or price
When both supply or demand change at the same time, you can
either determine the equilibrium price or the quantity, but not
both, since it can be ambiguous, as you dont know how much
each changed.

Chapter 4: Elasticity

Elasticity is the measure of how much consumers and producers

will respond to a change in market conditions
o Price elasticity of demand is the size of the change in the
quantity demanded of a good or service

o Price elasticity of demand = (Percent Change in Q

Demanded) / (Percent Change in P)
Percent Change in Q = 100 (Q2-Q1)/(Q1)
Percent Change in P = 100(P2-P1)/(P1)
o This calculation encounters problem depending on which
direction on the curve you are moving, the better method
is the mid point method
Percent Change in Q = 100 (Q2-Q1)/ ((Q1+Q2)/2)
Percent Change in P = 100 (P2-P1)/ ((P1+P2)/2)
o Determinants of price elasticity of demand
Availability of substitutes
Degree of necessity
Cost relative to income
Adjustment time
Scope of the market
o You have a few different calculations
Perfectly elastic demand is where the demand curve
is horizontal, so if the price changes demand drops to
zero (Slope equals infinity)
Perfectly inelastic demand is where the demand is
vertical, so the demand is the same regardless of the
price
Elastic is where the absolute value of elasticity is
greater than one
Inelastic is when the absolute value of elasticity is
less than one
Unit Elastics when the absolute value is equal to one

Total Revenue = Price * Quantity

Raising the price can affect total revenue in two ways
o Quantity Effect: a decrease in revenue due to selling fewer
units of the good
o Price effect: an increase in revenue from receiving a higher
price for each unit sold
Price elasticity of supply is calculated the same way as price
elasticity of demand
o Determinants
Availability of inputs
Flexibility of the production process
Adjustment Time
Cross-price elasticity of demand is used when talking about
substitutes or compliments for products A and B
o Cross-price elasticity between A and B = Percent Change in
quantity of A demanded/ percent change in price of B

Income elasticity of demand is a measure of how much the

quantity demanded changes in response to a change in
consumers income
o Income elasticity of demand = Percent change in quantity
demanded/ Percent change in income

(Review Graphs and Price Effect and Quantity Effect)

Chapter 5: