Revision For Test 1 1 Chapter 1 Ten Principles of Economics Principles related to how people make decisions: People face trade-offs Giving up something and getting something in return The cost of...

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Revision For Test 1 1 Chapter 1 Ten Principles of Economics Principles related to how people make decisions: People face trade-offs Giving up something and getting something in return The cost of something is what you give up to get it Opportunity cost Rational people think at the margin Compare marginal benefits and marginal costs People respond to Incentives Positive incentives vs. negative incentives Principles related to how people Interact Trade can make everyone better off But can make it worse with wrong deals Market are usually a good way to organize economic activity Invisible hand (supply and demand forces) Government can sometimes improve market outcomes In the case of market failures and externalities (positive and negative) Principles related to how the economy as a whole works A country’s standard of living depends on its ability to produce goods and services Production value wise Prices rise when government prints too much money Inflation causes lower value of money causing high prices There is short-run trade off between inflation and unemployment When prices are high, suppliers produce more goods and thus hire more workers causing low unemployment (assume other things are constant) Chapter 2 Thinking like an Economist Economics is a social science Can broadly be divided into Microeconomics and Macroeconomics Micro is the study of individuals Macro is study of aggregates In economics we make assumptions just like in other sciences to keep things focused and simple Here we conclude on the basis of past data as we cannot produce data as per our wish Economic Models Economic models are often composed of diagrams and equations They like science models omit many details to allow us to concentrate on important things These models does not include every feature of the economy Two models in this chapter: Circular Flow Diagram and Production Possibility Frontier First Model A Circular Flow Diagram It shows the flow of goods and services, factors of production and monetary payments between households and firms Households are both suppliers and buyers Firms are also both suppliers and buyers Factors or production are land, labor an capital Factors of payments are rent for capital, wages for labor and interest for capital Monetary payments are price paid and received for the goods and services exchanged Second Model The Production Possibility Frontier It’s a graph which shows the combinations of output the economy can possibly produce given the available factors of production and the available technology Points inside the PPF are although attainable but inefficient Points on the PPF are both attainable and efficient including intercept points Points outside of PPF are not possible to reach Producers face trade off when they move from one point to another on the same PPF A shift in the PPF to right is Economic Growth Positive vs. Normative Statements Positive Statements Are descriptive statements that explain the world as it is. These are facts supported by evidence When economists makes such statements they are called as scientist Negative Statements Are prescriptive statements that provides solutions or suggestion for a problem When economists makes such statements they are called as policy advisers Chapter 3 Interdependence and Gains from Trade People and countries can rarely be completely self sufficient Interdependence arises when people depend on each other for various goods and services Gains arises when people specializes in the production of those goods in which they are expert and then exchange with others This can allow everyone to gain from trade Important Terms Opportunity Cost: Whatever must be given up to get something else Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer Absolute advantage: It’ the ability to produce a good using fewer inputs than another producer Formula When Input Information is Given Absolute Advantage: When input information is given, just look for the lower number. Comparative Advantage: First find out the opportunity cost by using the formula below: Opportunity Cost for Product A Calculate Opportunity Cost for Both Countries for product A and compare. Whoever has lower opportunity cost has the comparative advantage. Formula When Output Information is Given (Including Graph Questions) Absolute Advantage: When output information is given, just look for the higher number. Comparative Advantage: First find out the opportunity cost by using the formula below: Opportunity Cost for Product A Calculate Opportunity Cost for Both Countries for product A and compare. Whoever has lower opportunity cost has the comparative advantage. Gains From Trade Calculate consumption before trade Calculate consumption after trade Formula for consumption after trade = Production after trade + imports – exports Gains from trade = Consumption after trade – consumption before trade Notes: If positive then there is gain, if negative there is a loss. If zero then no gain, no loss. On a PPF the consumption points after the trade may reach outside the PPF when there is gain from trade Production points will still be on the PPF even after trade Chapter 4 The Market Forces of Demand and Supply Market A group of buyers and sellers of a particular good or service. A market can be organized or less organized. Forms of Markets Perfectly Competitive Market Imperfect Competition (monopoly, monopolistic competition, oligopoly) Characteristics of a Perfectly Competitive Market There are a large number of buyers and sellers The price of the product is given therefore, here buyers and sellers are called as “price takers” No single buyer or seller can influence the price of product The goods sold are homogeneous (identical) Close examples: Stock exchange market, foreign exchange market Demand The quantity demanded is the amount of a good that buyers are willing and able to purchase It is inversely related to the price of the product Law of Demand: It’s the claim that other things equal, the quantity demanded of a good falls when the price of the good rises and vice-versa . Demand Schedule: A table that shows the relationship between the price of a good and the quantity demanded Demand Curve: A graph that shows the relationship between the price of a good and the quantity demanded In a demand curve price is shown on Y axis and quantity demanded is shown on Y axis It is mostly downward sloping from left to right due to inverse or negative relationship Market Demand versus Individual Demand The market demand is the sum of all individual demands for a particular good or service The demand curves are summed horizontally Out of two demand curves, the one relatively steeper is individual demand curve (for one buyer) The curve which is relatively flatter would be for the market demand due to larger quantities (all the buyers together) Determinants of Demand The Income of the consumer Normal goods Inferior goods Price of related goods Substitutes Complements Expectations/Tastes/Fashion Fluctuate depends on various conditions Number of buyers More buyers – high demand Less buyers – less demand . Change in Quantity Demanded vs. Change in Demand Change in Quantity Demanded (movement) When the price of the product itself changes Causes demand curve will move along the same (fixed) demand curve When price increases it will be movement up when price decreases it will be movement downward Change in Demand (shifting) When there is a change in determinants other than the price of the product itself such as income, price of related goods, expectations and number of buyers Causes shifts in the demand curve towards the right or left An increase in demand will result in shifting the demand curve to the right (or upward). A decrease in demand will result in shifting the demand curve to left (or downward) Supply The amount of a good that sellers are willing and able to sell It is positive related to the price of the product A supply schedule shows the relationship between the price of a good and the quantity supplied A supply curve is a graph of the relationship between the price of a good and the quantity supplied A market supply is the summation of individual supplies Determinants of Supply Input Prices High input price – lower supply of output Low input price – high supply of output Technology Advanced technology – high supply Obsolete technology – low supply Expectations Fluctuate depends on various conditions Number of sellers More suppliers – High supply Less suppliers – Low supply Change in Quantity Supplied vs. Change in Supply Change in Quantity Supplied (movement) When the price of the product itself changes Causes the supply curve will move along the same (fixed) When price increases then there is movement up When price decreases then there is movement down Change in Supply (shifting) When there is a change in determinants other than the price of the product itself such as input prices, technology, expectations and number of sellers Causes the supply curve to shift to the right or left A increase in supply causes rightward shift also called as downward shift A decrease in supply causes leftward shift also called as upward shift Supply and Demand together It helps in determining the price of the product Equilibrium: A situation in which the market price has reached the level at which quantity supplied equals quantity demanded It is the point where supply and demand curve intersect each other The quantity demanded at this point is called equilibrium quantity and The price at this point is called as equilibrium price Surplus If the actual market price is higher than the equilibrium price then there will be surplus of good In this situation the quantity supplied is greater than quantity demanded The remedy for surplus is that the producers will lower the prices of product until the market reaches equilibrium Shortage If the actual price is lower that the equilibrium price than there will be shortage of good In this situation the quantity demanded is more than quantity supplied In order to overcome this situation the sellers will rise the price of the product until market reaches equilibrium Changes in Equilibrium No Change in SupplyIncrease in SupplyDecrease in Supply No Change in Demand Price – No Change Quantity – No ChangePrice – Decrease Quantity- Increase Price - Increase Quantity - Decrease Increase in Demand Price – Increase Quantity- IncreasePrice - Ambiguous Quantity - Increase Price – Increase Quantity- Ambiguous Decrease in Demand Price – Decrease Quantity- Decrease Price - Decrease Quantity- Ambiguous Price – Ambiguous Quantity - Decrease Chapter 10: Measuring a National Income The economy of income and expenditure It can be measured by GDP (Gross Domestic Product) GDP measures the total income of everyone in the economy GDP measures total expenditure on an economy’s output of goods and services For an economy as a whole total income must be equal to total expenditure. The Measurement of Gross Domestic Product Definition of GDP: It is the market value of all the final goods and services produced within a country in a given period of time. Explanation of the GDP definition GDP is the market value “…………… of all…………………” “………….final ……………………” “…………Goods and Services……………..” “…………….within a country……………….” “………….in a given period of time…….” Note: The above definition focuses on GDP as total expenditure in the economy. But every dollars that is spent is income for some other. Thus, if we add up all such incomes, then we will get exactly the same answer. Others measures of Income Gross National Product (GNP): It is the total income earned by the nation’s permanent residents. Net National Product (NNP): GNP - Depreciation National Income: NNP – Indirect Taxes +