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HAVE FUN! FINAL EXAM Test Review Units Covered • 1) Intro to Econ • • • • 2) Supply & Demand 3) Business & Market Structures 4) Government: Fiscal/Monetary Policy 5) Labor & Income Distribution & Globalization Introduction to Econ Review Why do we need Economics? 1) Resources are SCARCE 2) People have Unlimited Wants and Needs FORCES: 3) Society to allocate resources • The social science of how society allocates scarce resources. Branches of Economics • Microeconomics looks at individual parts of economy: – How households & firms make decisions and interact in specific markets • Macroeconomics looks at the entire economy: – Economy-wide phenomena including: inflation, unemployment, interest rates & GDP (economic growth) 3 Types of Economic Systems • MARKET • COMMAND • TRADITIONAL Understand the difference between each one! They have different goals: GEES Adam Smith (1723-90) • Founder of Free Market Economics • Argued: Free markets best promote the social welfare • Government should not interfere with the free market (invisible hand regulates the market) What is an Economy? • The way goods, services & money flow through an economic system The Circular Flow describes how goods, services & money flow through a market economy CIRCULAR FLOW of a Market Economy Products PRODUCERS Circular Flow Factors (Land, Labor & Capital) CONSUMERS Gross Domestic Product: - measures the % rate of economic growth - released quarterly in USA - speed limit for USA is 4.0% GDP = G + C + I + (X-M) Business Cycle PPF Summary • Line represents all efficient production points – Assumes a country uses all of its scarce resources Qty Food • • • Points below are inefficient – wastes scarce resources Points above are not attainable in short run – With existing technology & resources Long Run goal is to shift the line outward . (0,100) . . C B (50,50) A (100, 0) Qty Shelter Supply & Demand Review Utility: means satisfaction Marginal Utility: The amount of satisfaction a person gets from one additional unit of a product Law of Diminishing Marginal Utility • As more units are consumed => additional satisfaction declines Equilibrium occurs when Demand = Supply T-Shirts Price -------------- E1 ------------- P1 S1 Q1 D1 Qty Changing Demand • Know the difference between a: • 1) Change in Demand (TIPSE) – A new demand curve is required when a determinant of demand changes – Causes a shift in Demand curve • 2) Change in Quantity demanded – Movement along existing curve Changing Supply • Know the difference between a: • 1) Change in Supply (TIN) – A new demand curve is needed when a determinant of supply changes – Causes a shift in Supply curve • 2) Change in Quantity Supplied – Movement along existing curve Change in Quantity Demanded • ONLY price changes => Qty Demanded Changes Movement along an existing Demand Curve Only Price Changes D1 Determinants of Demand Determinants of Supply This is what determines if you should shift the Supply or Demand Curve TIPSE [Tastes, income, population, price-complements Price substitutes, expectations] NEW Demand Curve TIN Technology, input prices number-sellers NEW Supply Curve Sample Problem Event: Economy starts to boom, jobs are easy to find Automobiles Price TIPSE ↓ S1 Expectations ↑ ------------- P1 ↓ ------------------- E2 -------------- E1 ------------------ P2 Q 1 Q2 Demand ↑ (shifts right) D1 D2 Qty Elastic Goods • Elastic demand curves are flat – Sensitive to price changes Px D1 Qty • A ↑ Price leads to a greater ↓ in Qty Demanded Elastic Demand Curve . Qty D falls more than price Inelastic Goods • Inelastic demand curves are steepPx – Not Sensitive to price changes D1 • A ↑ Price leads to a smaller ↓ in Qty Demanded Qty What you need to know! • More elastic demand curves are flat • Elastic means Qty D is sensitive to Px Changes • Total Revenue goods => Prices elastic • Total Revenue goods => Prices inelastic Market Structure Review Perfect Competition Monopoly Monopolistic Competition Oligopoly # Sellers unlimited One Many Several Ease of entry Easy Impossible Somewhat easy Difficult Price Taker Price Setter Little Px control Some Px control Price Control Importance: Know the 4 market structures and their characteristics Number of Firms Many firms Type of Products? One firm Monopoly • Tap water • Electricity Few firms Oligopoly • Soft Drinks • Automobiles Differentiated products Monopolistic Competition • Shoes • Restaurants Identical products Perfect Competition • Wheat • Milk Perfect Competition Characteristics • Many Firms • Homogenous products • Complete freedom to enter or leave industry • Perfect information • No price control—sell at Market Price – Price Takers Smith’s two primary laws • 1) Self-Interest: • People act in their own self-interest • Profits or greed motivate individuals • 2) Competition: • Lots of producers—you “fear” competition • Assures goods are produced at the lowest possible price: economic efficiency PRICE DISCRIMINATION • Price discrimination is the business practice of selling the same good at different prices to different customers • For a Firm to price discriminate it must: – have some market power (some price control) – be able to identify & separate groups of consumers – be able to prevent resale between consumers Unit Wrap Up: 3 Market Failures • Predatory Pricing – Is Wal-Mart guilty? • Negative Externalities – Pollution • Price Fixing – Collusion- do you trust corporations? Government Review Gov’t Budget & Fiscal & Monetary Policy Deficit & Debt relative to GDP • Current Deficit = 425 Billion • Current Debt = 9.4 Trillion • Current GDP = 13.5 Trillion • Deficit as % of GDP = 3.1% of GDP – Highest ever (1983) was 6% of GDP • Debt as % of GDP = 70% of GDP – Highest ever (1946) was 120% of GDP 2 Types of Fiscal Policy • Expansionary Goal: Increase AD (*) Increase Gov’t Spending Decrease Taxes • Restrictive Goal: Decrease AD Decrease Gov’t Spending Increase Taxes (*) AD = Aggregate Demand which is demand for the entire economy from Individuals, businesses & Government FISCAL POLICY Fiscal Policy will shift AD curve Economy in recession AS1 Price Level Expansionary fiscal policy needed AD1 Real GDP AD2 Lower Taxes & ↑ Gov’t spending AD shifts right End result: higher GDP, more Jobs & slightly higher inflation 2 Types of Monetary Policy • LOOSE Monetary Policy Goal: AD – 1) Lower Discount Rate & Use Open Market Operations: Buy Securities => Increase MS => lower interest rates • TIGHT Monetary policy Goal: AD 1) Raise Discount Rate & Use Open Market Operations Sell Securities => Decrease MS => raises interest rates Recession: GDP growth at -2.0%, Unemployment 7% Loose Monetary Policy in action Interest Rate MS1 MS2 Price Level AS1 Affects AD i1 --------- i2 --------------MD Qty of $ Lower interest rates will shift AD to the right AD1 Real GDP AD2 Labor & Income Distribution Lorenz Curve Line of Income equality Gini Coefficient between 0 and 1 Numbers YOU should know Wealth vs. Income • Top 20% has 84% of Wealth • Top 20% has 47% of Income • Top 1% has 39% of Wealth • Top 1% has 15% of Income Trend in U.S. Immigration • 1910 15% (of population) • 1950 7% “ “ • 1970 5.0% “ “ • 2004 11.0% “ – 24 million people – 11 million illegal “ (estimate) Trends in Labor Unions • Union membership has declined significantly • 1953 peak of 36% of labor force • 2004 dropped to 12% of labor force Trade & Globalization Trade Theory • Understand the theory of Free Trade • Why trade, in theory, is mutually beneficial • Understand why Globalization is occurring today Ricardo’s Theory Here is my great theory! Countries should produce (specialize) in goods where they have a comparative advantage Trade benefits both parties (each country gets “more”) Free Trade promotes a more “efficient” world economy Absolute Advantage is not relevant in trade analysis Determining Comparative Advantage BRAZIL 1 1 Coffee = ____Wheat 1 Wheat 1 = ____ Coffee MEXICO coffee wheat 1/2 Wheat 1 Coffee = _____ 1 Wheat = ____Coffee 2 Wheat : BRAZIL has comparative advantage---produce only WHEAT Coffee : MEXICO has comparative advantage---produce only COFFEE Coffee BRAZIL 1000 1000 1000 Wheat MEXICO 500 Wheat Globalization: Why Now? 1) Fall of Soviet Union 2) Rise of Technology This combination has made it possible for the world to become one global Economy: •The Fall of the Soviet Union meant the end to a purely communist Economic system. •The rise of Technology meant it was now possible for information to be shared around the globe. This has allowed jobs to move more freely between countries Event: Globalization Increases Skilled Workers Price TIPSE ↓ S1 Tastes ↑ ------------- P1 ↓ ------------------- E2 -------------- E1 ------------------ P2 Q 1 Q2 Demand ↑ (shifts right) D1 D2 Qty