Principles of Economics Exam 1-
Questions and Answers Graded A+
Microeconomics - ANSWER--examines the behavior of specific decision making units
Functioning of individual parts of the economy
Ex. Business firms, households, consumers
Examples
How does Coca Cola decide how many coke cans to produce?
What determines the price of gas?
The impact of an increase in steel pric
Macroeconomics - ANSWER--Looks at the economy as a whole, not as individual parts
-We aggregate (add up) the micro parts to come up with the overall picture
Examples:
-GDP
-CPI
-Inflation and Deflation
-Total employment and unemployment
Gross Domestic Product (GDP) - ANSWER-total output of all goods and services produced within
the boundaries of a country (tangible(food, clothing, cars) and intangible goods (haircuts, house
cleaning, doctor's visits))
Consumer Price Index (CPI) - ANSWER-The average level of prices of all consumer goods and
services
Economics - ANSWER-the study of how scarce resources are allocated among their competing uses
-it's about limited resources and unlimited wants
Factors of production (resources) - ANSWER-land, labor, capital, entrepreneurship (LLEC)
Land - ANSWER--encompasses the land that production takes place and all natural resources:
water, sheep, cows, metal, timber, minerals
-Renewable and non-renewable resources
Labor - ANSWER--the physical and mental abilities of workers
-Quantity and quality (human capital)
-Fixed wages
Capital - ANSWER--goods produced in the economy that are used to produce other goods and
services
-Machines, tools, structures (buildings, factories)
Entrepreneurs - ANSWER--An individual who organizes resources for production, might introduce
new products or techniques.
-Returns vary: reaps the rewards (profits) or bears the consequences (losses)
-Hallmark of the entrepreneur is innovation and risk taking.
Supply and Demand - ANSWER--determines how we use resources
-this also determines the market value
,Adam Smith - ANSWER--The Father of Modern Economics
-The Wealth of Nations in 1776
-Invisible hand: Households and firms interacting in markets guided by process and self-interest,
Leads to the most efficient outcomes
-Wrote about producers benefitting through specilozation in trade and Absolute advantage
Efficiency - ANSWER-getting the most that we can out of our scarce resources (maximum output)
Equity - ANSWER--distributing output in a fair manner
-Examples: progressive income tax system (equity, trying to distribute money more fairly),
unemployment benefits
opportunity cost - ANSWER--Whatever must be given to obtain some item
-Cost of the alternative
-Coming to college after high school
-Opportunity cost college: full-time current wages
-Opportunity cost work: education, higher future wages
-Could be constant resulting in a straight line PPF, or increasing resulting in a concave PPF
-The opportunity cost of a good increases as more of the good is produced.
-Why? Resources are not equally efficient in the production of both goods.
-Some resources are better suited to one task than another. The first resources to "switch" are the
one best suited to switching.
scarcity - ANSWER--The limited nature of society's resources
-All decisions involve trade offs (choices) because of scarcity
-To get something, we usually have to give up something else
Types of Economic Systems - ANSWER-1. Pure Capitalism (market economies)
2. Command/planned economy
3. Mixed economies
Pure Capitalism - ANSWER--Property is privately owned and markets determine what quantities of
goods, services, and resources are sold
-Decisions are made by households and firms
-No government intervention
Command/Planned economy - ANSWER--Pretty much Communist economies (North Korea,
Russia)
-All resources are publicly owned by the government and the central authorities dictate how such
resources are allocated
-What, how, and for whom are decided by government planning
-Companies are assigned specific output goals, given allocation of certain quantity of resources
-Output is distributed in accordance with government objectives
Mixed Economy - ANSWER--USA
-Mixes pure capitalism and command
-Some resources are owned privately, others publicly (schools, Amtrak, public parks)
-Some economic decisions are made by the government, other by market
Market failure - ANSWER-market fails to allocate resources efficiently on its own
Monopoly - ANSWER--One seller of a good or service
,-Price Maker
-Ex. diamonds, Rockefeller, Microsoft in the 2000s, NFL, the College Board
Externalities (market failures) - ANSWER--The impact of one person's actions on the well-being of a
bystander
-Examples: Negative; pollution, smoking/ Positive; education, healthcare (like the flu shot)
Property rights - ANSWER-Ability of an individual to own and exercise control over his/her property
Productivity - ANSWER--The most important determinant of living standards
-Quantity of goods and services produced from each unit of labor input
-Higher productivity---> high standard of living
Growth of a nation's productivity determines the growth rate of its average income
Inflation - ANSWER--an increase in the overall level of prices
-Causes: increase in money supply
Marginal benefit - ANSWER-a maximum amount a consumer is willing to pay for an additional good
or service.
Marginal cost - ANSWER-the increase in total cost that arises from an extra unit of production
Rational decision maker - ANSWER--Uses all available information
-Make decisions by comparing marginal benefits and marginal costs
-Takes action only if
1.Marginal benefits outweigh marginal costs
2.Marginal changes: Small incremental adjustments to a plan of action
Invisible hand - ANSWER--Households and firms interacting in markets guided by process and self-
interest
-Leads to the most efficient outcomes
-Adam smith's idea
Smith is also considered to be the father of modern economics
- leads buyers and sellers to allocate resources efficiently.
Unemployment - ANSWER--Society faces a short-run trade-off between inflation and unemployment
-Government policies to spur the economy to reduce unemployment results in inflation
market - ANSWER-a group of buyers and sellers (need not be in a single location)
trade - ANSWER--exchange of goods or services
-Allows each person to specialize in the activities he or she does best
-Enjoy a greater variety of goods and services at lower cost
trade offs - ANSWER--People face trade offs
-All decisions involve trade offs (choices) because
-Example you only have $20 in your pocket and you have to decide how to spend it
-Society face tradeoffs
-National defense vs. consumer goods (guns v. butter)
-Clean environment v. high level of income
-Efficiency vs. equity
unemployment benefits/insurance - ANSWER-They support equity, distributing money more fairly
, Progressive tax system - ANSWER-A tax for which higher income taxpayers pay a larger fraction of
their income than do low income taxpayers
Positive statements - ANSWER--the study of 'what is?'; also known as descriptive analysis
-Describes the world as it is
-Deals with facts about the past or predictions about the future that can be justified by examining
evidence
-Used by economists who are scientists/educators
-Ex. There are fewer farmers in MA in 2019 than there were 50 years ago
Normative statements - ANSWER--Prescriptive analysis: cannot be tested or shown to be true or
false
-Reflects personal views, values, and judgements
-Used by economists who are policymakers
-Ex. the government should cut down on its national defense spending (should make it normative)
Economic agents - ANSWER-households and firms, NOT government
Two markets - ANSWER-1. the market for goods and services
2. the market for "factors of production"
Market for Goods and Services - ANSWER--Firms are sellers; they determine supply and get
income from selling goods and services (sales revenue). •
-H/h are buyers; they determine demand and incur expenditures while purchasing goods and
services.
-ex. Walmart
-Also called the output or product market
Market for factors of Production - ANSWER--Example: Labor markets
-H/h own all resources. They sell these resources to firms in return for income.
-H/h are sellers; they determine supply and get income from selling the resources they own.
-Firms are buyers; they determine demand and incur expenditures (spending) while purchasing
resources.
-FOP: land, labor, capital, entreprneurs
Production Possibility Frontier (PPF) - ANSWER-A graph that shows the combinations of output that
the economy can possibly produce given the available factors of production and the available
production technology
PPF Graphs - ANSWER-The company can produce any combination on or inside the line
Points outside are NOT feasible given the economy's resources
The slope measures the oppurtunity cost
Points on (rather than in) the PPF represent efficeint levels of production, once we have reached the
efficiency point in the possibilities frontier, this shows a trade off; the only way to produce more of
one good is to produce less of others
Efficient production - ANSWER-Production is said to be efficient when a country achieves maximum
output from its resources. Producing less than maximum output occurs when resources are left idle
or used ineffectively. Any points below the PPF are inefficient Only points on the PPF signify efficient
production. Thus the PPF consists of all combinations of output that are both feasible and produced
efficiently.
