Economics Midterm 2 Study Guide

• Economics: A social science that studies the efficient allocation of scarce resources to attain the maximum fulfillment of unlimited human needs.
• Microeconomics: Concerns the economic behavior of individual decision-making units such as households, firms, markets, and industries.
• Macroeconomics: Deals with the aggregate behavior of all decision-making units and the economy as a whole (e.g., national income, employment, inflation).

The Production Possibilities Curve (PPC), also called the Production Possibilities Frontier (PPF), is a curve showing the various possible combinations of two goods or services that a society can produce, given its fixed resources and technology.

The textbook (Fig 1.1, page 12) shows it as a downward-sloping, concave (bowed-out) curve.

• Points on the curve are attainable and efficient (full use of resources).
• Points inside the curve are attainable but inefficient (resources are unemployed or underused).
• Points outside the curve are unattainable with current resources and technology.

The textbook lists three key principles of economics (Section 1.2, page 40-41):

• Optimization: This is the first principle. It means people try to pick the best feasible option, given the available information, knowledge, and experience. This involves evaluating trade-offs, budget constraints, and opportunity costs.
• Equilibrium: This is the second principle. It's a situation where everyone is simultaneously optimizing, so no one believes they would benefit by changing their own behavior, given the choices of others.
• Empiricism: This is the third principle. It refers to analysis that uses data. Economists use data to test theories, evaluate policies, and determine what is causing things to happen in the world.

The problem states the formula for the implicit cost: Opportunity Cost = Commuting Time (hours) x $10/hour. To find the Total Cost (which is what you need for optimization), you must calculate this opportunity cost and add it to the explicit cost (Rent).

Choice: The "Far" apartment is the optimal choice. It has the lowest total cost ($1,180) when considering both the explicit cost (rent) and the implicit opportunity cost (value of your time).

• Demand: The various quantities of a commodity that a consumer is willing and able to purchase at various prices, given other things unchanged.
• Demand Curve: A graph showing the inverse relationship between price and quantity demanded. It slopes downwards from left to right.
• Shifts: The curve shifts due to changes in "demand shifters" (any factor other than the price of the good itself).
  • Shifts Right (Increase): Favorable change in taste, increase in income (for normal goods), increase in the price of substitutes, or an increase in the number of buyers.
  • Shifts Left (Decrease): Unfavorable change in taste, decrease in income (for normal goods), decrease in the price of substitutes, or a decrease in the number of buyers.

• Supply: The various quantities of a product that sellers are willing and able to provide at different prices in a given period of time, other things unchanged.
• Supply Curve: A graph showing the positive (direct) relationship between price and quantity supplied. It slopes upwards from left to right.
• Shifts: The curve shifts due to changes in determinants other than the product's own price.
  • Shifts Right (Increase): Decrease in input prices, technological advancement, good weather, or an increase in subsidies.
  • Shifts Left (Decrease): Increase in input prices, bad weather, or an increase in taxes.

• Budget Line (Constraint): A graph showing the various combinations of two goods that a consumer can purchase, given their limited income and the prices of the two goods.
• Budget Set: This refers to all the combinations on or inside the budget line that are affordable to the consumer.
• Graph ($300 Income):
  • If you spend all $300 on Sweaters ($25 each), you can buy 12 ($300/$25). This is Bundle A and the y-intercept.
  • If you spend all $300 on Jeans ($50 each), you can buy 6 ($300/$50). This is Bundle D and the x-intercept.
  • The budget constraint is the straight line connecting (0 Jeans, 12 Sweaters) and (6 Jeans, 0 Sweaters).
• Income Increase ($600): When income increases (and prices stay the same), the budget line shifts outward/upward parallel to the original line. The consumer can now buy more of both goods. The new intercepts would be 24 Sweaters ($600/$25) or 12 Jeans ($600/$50).

• Elasticity: A measure of the responsiveness of a dependent variable (like quantity) to changes in an independent variable (like price).
• Elasticity of Demand: Measures the degree of responsiveness of quantity demanded to a change in its price, income, or price of related goods.
• Graphs:
  • Elastic Demand: A relatively flat demand curve. A small change in price causes a large change in quantity (e.g., luxury goods).
  • Inelastic Demand: A relatively steep demand curve. A large change in price causes only a small change in quantity (e.g., necessity goods like salt).
  • Perfectly Inelastic Demand: A vertical demand curve. A change in price causes no change in quantity.
• Insulin Example: A diabetic needs insulin to live. A large price increase (from $5 to $10) will likely cause little to no change in the quantity demanded. This is perfectly inelastic demand (or at least highly inelastic), as it is a life-saving necessity with no close substitutes.

• Price Elasticity of Supply (Es): The degree of responsiveness of the quantity supplied of a product to a change in its price. It is calculated as: (Percentage Change in Quantity Supplied) / (Percentage Change in Price).
• Graphs (from Fig 2.6, page 37):
  • Perfectly Elastic Supply (Es = infinity): A horizontal line.
  • Perfectly Inelastic Supply (Es = 0): A vertical line.
  • Unit-Elastic Supply (Es = 1): (The source describes this concept). It means the percentage change in quantity is the same as the percentage change in price.
• Example: A 20% increase in price leads to a 20% increase in quantity supplied.
  • Es = (20% Change in Quantity) / (20% Change in Price) = 1
  • This is called Unit-Elastic Supply.

No, Instagram is not "free" in an economic sense. While it has no monetary price, it has a significant cost.

• Opportunity Cost: The 4 hours spent on social media have a high opportunity cost. This cost is the value of the next best alternative you sacrifice, such as 4 hours of studying, working, or sleeping.
• Trade-off: You are making a choice (a trade-off) to spend your scarce resource (time) on social media instead of those other activities.
• Marginal Analysis: You make the decision to use it "one more minute" at a time. You are weighing the marginal utility (extra satisfaction) of that one extra minute against its marginal cost (what you could be doing in that one minute). You stop scrolling when the marginal cost exceeds the marginal benefit.
• Optimization: You are optimizing (acting rationally) if you are using those 4 hours in a way that maximizes your total satisfaction. If you spend 4 hours on Instagram and later regret not studying (a higher-value activity), you have not optimized your time.

Scarcity is the fundamental economic problem. It refers to the fact that all economic resources (like land, labor, and capital) needed to produce goods and services are finite or limited in supply. However, human wants for these goods and services are unlimited.

Scarcity is this basic imbalance between unlimited wants and limited resources. Because of scarcity, we are forced to make choices, which in turn involves opportunity costs.