Econ 201 – Stuen

Spring 2011

Study Guide for Midterm 1

Chapters 1-3

Key Concepts

Seven Principles:

1. Scarcity

2. Cost-benefit

3. Incentive

4. Comparative advantage

5. Increasing opportunity cost

6. Equilibrium

7. Efficiency

Three famous economists:

1. Adam Smith

2. David Ricardo

3. Alfred Marshall

Chapter 1

Marginal analysis – making decisions based on the extra costs and benefits of an action

• Opportunity costs

• Economic surplus

• Decision pitfalls
Economic models – simplifying descriptions of reality, to make analysis and understanding easier

Normative and Positive economics

Economic naturalism: observing what actions people actually make and trying to understand them, from a
scientific perspective.

Adam Smith and the benefits of free markets

Chapter 2

Production/productivity, specialization

Production advantages:

• Absolute advantage

• Comparative advantage

Production possibilities curves (PPC)

Production possibilities for an economy and increasing opportunity costs

Improvements in the production possibilities: growth

• More resources

• Investment in capital – machines used for production

• Population growth – more people

• Improvements in technology

o More specialization – e.g. Longshoremen

o Increases in knowledge – better machines to work with

Technical change – improvements in the technology of production

• Neutral versus changes that favor some goods over others

Comparative advantage in international trade, David Ricardo

 • Countries export that which they have a comparative advantage in producing

• Benefits versus costs of international trade – to whom do they accrue?

Complications to analysis of international trade benefits

• Differences in regulations

• Offshoring / outsourcing

• International ownership of corporations

• Multiple locations of production

Chapter 3

Economic systems: what, how and for whom?

• market system

• planned system

• mixed system

Market: a set of potential buyers and sellers

Market price: Alfred Marshall

• reservation prices of buyers and sellers

• demand curve

o Income effect

o Substitution effect

• Supply curve

o Reasons for differing costs among sellers

• Equilibrium

o Excess demand: shortage

o Excess supply: surplus

Shocks or changes to market

Changes in the price induce movements along the curves

Shifts in Demand

• Income – normal versus inferior goods

• Changes in prices of complements and substitutes

• Preferences / tastes

• Number of potential buyers

• Expectations about future prices by buyers

Shifts in Supply

• Changes in the prices of inputs

• Technologies

• Weather

• Number of sellers in the market

• Expectations about future prices by sellers

Efficiency in equilibrium: maximum economic surplus to buyers and sellers

Collective action: rules, laws about market activity made by organizations and governments

For public good, collective action can improve on the efficiency of some markets

• pollution

• monopolies

• public goods like parks and national defense