ECON 251 Exam 1 Study Guide: Foundations, Markets, Efficiency, and International Trade

Scarcity, Economics, and Fundamental Concepts

Scarcity and Economics

Scarcity is the fundamental economic problem arising because resources are limited while human wants are unlimited. Economics studies how individuals, firms, and societies allocate scarce resources to satisfy competing needs.

• Scarcity: The condition where available resources are insufficient to satisfy all wants.

• Economics: The social science concerned with the production, distribution, and consumption of goods and services.

Three Economic Ideas

• Rational Choices: Individuals make decisions by comparing costs and benefits, choosing the option that maximizes their utility.

• Incentives: Rewards or penalties that influence behavior; positive incentives encourage actions, negative incentives discourage them.

• Choices on the Margin: Decisions are made by evaluating the additional (marginal) benefit and cost of a small change in activity.

Trade-offs and Opportunity Costs

• Trade-offs: Choosing one option means giving up another; every decision involves trade-offs.

• Opportunity Cost: The value of the next best alternative foregone when a choice is made.

• Formula: $\text{Opportunity Cost} = \text{Value of Next Best Alternative}$

Types of Economic Systems

• Centrally Planned Economy: The government makes all decisions about production and allocation.

• Market Economy: Decisions are decentralized, made by households and firms interacting in markets.

• Mixed Economy: Combines elements of both central planning and market mechanisms.

Production Possibilities Frontier (PPF) and Comparative Advantage

Production Possibilities Frontier (PPF)

The PPF is a curve showing the maximum attainable combinations of two goods that can be produced with available resources and technology.

• Graph Interpretation: Points on the PPF represent efficient production; points inside are inefficient, points outside are unattainable.

• Bowed Out vs. Constant Opportunity Cost: A bowed-out PPF indicates increasing opportunity costs; a straight line indicates constant opportunity costs.

• Law of Increasing Marginal Opportunity Cost: As production of one good increases, the opportunity cost of producing additional units rises.

Economic Growth

• Total Growth: Outward shift of the entire PPF, indicating increased capacity for both goods.

• Sector-Specific Growth: Outward shift in only one direction, showing increased capacity for one good.

Absolute and Comparative Advantage

• Absolute Advantage: The ability to produce more of a good with the same resources than another entity.

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than another entity.

• Calculating Opportunity Costs: For each good, compare what must be given up to produce one more unit.

• Example: If Country A can produce 10 cars or 20 computers, the opportunity cost of 1 car is 2 computers.

Market Systems: Demand, Supply, and Equilibrium

Competitive Market

A competitive market is one in which many buyers and sellers interact, and no single participant can influence the price.

• Quantity Demanded (Qd): The amount of a good consumers are willing and able to buy at a given price.

• Law of Demand: As price decreases, quantity demanded increases, ceteris paribus.

• Demand Shifters: Factors other than price that affect demand, such as income, tastes, prices of related goods, expectations, and number of buyers.

• Quantity Supplied (Qs): The amount of a good producers are willing and able to sell at a given price.

• Law of Supply: As price increases, quantity supplied increases, ceteris paribus.

• Supply Shifters: Factors other than price that affect supply, such as input prices, technology, expectations, and number of sellers.

Market Equilibrium

• Definition: The point where quantity demanded equals quantity supplied; the market-clearing price.

• Double Shifters: When both demand and supply curves shift, the effect on equilibrium price and quantity depends on the direction and magnitude of each shift.

• Formula: $\text{Qd} = \text{Qs}$ at equilibrium

Economic Efficiency, Surplus, and Government Interventions

Consumer and Producer Surplus

• Consumer Surplus: The difference between what consumers are willing to pay and what they actually pay.

• Producer Surplus: The difference between the price received by sellers and their minimum acceptable price.

• Marginal Benefit: The additional benefit from consuming one more unit.

• Marginal Cost: The additional cost of producing one more unit.

• Location on Graphs: Consumer surplus is the area above the market price and below the demand curve; producer surplus is the area below the market price and above the supply curve.

• Calculation: Area of relevant triangle or region on the graph.

Total Economic Surplus

• Definition: The sum of consumer and producer surplus; measures total net benefit to society.

• Formula: $\text{Total Economic Surplus} = \text{Consumer Surplus} + \text{Producer Surplus}$

Government Interventions: Price Ceilings and Price Floors

• Price Ceiling: A legal maximum price; binding if set below equilibrium, causing shortages.

• Price Floor: A legal minimum price; binding if set above equilibrium, causing surpluses.

• Effects on Qd vs Qs: Binding ceilings increase Qd and decrease Qs; binding floors decrease Qd and increase Qs.

• Non-binding: If set at or above (ceiling) or at or below (floor) equilibrium, has no effect.

Tax Incidence and Deadweight Loss (DWL)

• Tax Incidence: The division of the tax burden between buyers and sellers.

• Price Received by Seller: Market price minus tax.

• Price Paid by Buyer: Market price plus tax.

• Market Clearing Price: The equilibrium price before tax.

• Tax Size: The amount of the tax per unit.

• Tax Revenue: $\text{Tax Revenue} = \text{Tax Size} \times \text{Quantity Sold}$

• Deadweight Loss (DWL): The reduction in total surplus due to the tax.

• Location on Graphs: DWL is the area between the supply and demand curves lost due to reduced quantity traded.

• Calculation: Area of relevant triangle or region on the graph.

International Trade and Gains from Trade

Gains from Trade

• International Trade: Allows countries to specialize based on comparative advantage, increasing total output and welfare.

• Imports: Goods brought into a country from abroad.

• Exports: Goods sent from a country to abroad.

• Autarky: A situation where a country does not trade with others.

• Free Trade: No restrictions on imports or exports; maximizes gains from trade.

• Comparative Advantage Source: Differences in technology, resources, or opportunity costs.

Tariffs and Quotas

• Tariff: A tax on imports; raises domestic price, reduces imports, creates deadweight loss.

• Quota: A limit on the quantity of imports; similar effects to tariffs.

• World Price: The price of a good on the international market.

• World Price with Tariff: World price plus tariff amount.

• Deadweight Loss (DWL): Lost gains from trade due to tariffs or quotas.

Policy	Effect on Price	Effect on Imports	Deadweight Loss
Free Trade	World Price	Maximum	None
Tariff	World Price + Tariff	Reduced	Present
Quota	World Price (may rise)	Limited	Present

World Trade Organization (WTO) and Anti-Globalization

• WTO: An international body that promotes free trade and resolves trade disputes.

• Anti-Globalization: Opposition to free trade due to concerns about jobs, inequality, environment, or sovereignty.