## Spring '25 ECO2013 Exam 1 Study Guide ### **Overview of Economics** Economics is the study of how individuals, businesses, and governments allocate scarce resources to satisfy unlimited wants. It is divided into two main branches: 1. **Microeconomics**: Focuses on individual decision-making units, such as households and firms. 2. **Macroeconomics**: Examines the economy as a whole, including topics like inflation, unemployment, and economic growth. --- ### **Key Concepts in Economics** #### **Scarcity and Opportunity Cost** - **Scarcity**: Resources are limited, which forces individuals and societies to make choices. - **Opportunity Cost**: The value of the next best alternative foregone when a choice is made. If you spend $10 on a movie ticket, the opportunity cost is what you could have purchased with that $10 or the time spent doing something else. Always consider opportunity cost when evaluating trade-offs in decision-making. --- #### **The Production Possibilities Frontier (PPF)** The PPF is a graphical representation of the trade-offs between two goods or services that an economy can produce, given its resources and technology. - **Key Features**: - Points on the curve: Efficient use of resources. - Points inside the curve: Inefficient use of resources. - Points outside the curve: Unattainable with current resources. - **Law of Increasing Opportunity Costs**: As production of one good increases, the opportunity cost of producing additional units of that good also increases. If a country produces only cars and computers, moving resources from car production to computer production will increase the opportunity cost as resources are not equally suited for both tasks. Students often confuse points inside the PPF as efficient. Remember, only points on the curve are efficient. --- #### **Supply and Demand** The interaction of supply and demand determines the price and quantity of goods in a market. 1. **Demand**: - Law of Demand: As price decreases, quantity demanded increases (and vice versa). - Demand Curve: Downward sloping. **Determinants of Demand**: - Income - Prices of related goods (substitutes and complements) - Tastes and preferences - Expectations - Number of buyers 2. **Supply**: - Law of Supply: As price increases, quantity supplied increases (and vice versa). - Supply Curve: Upward sloping. **Determinants of Supply**: - Input prices - Technology - Expectations - Number of sellers 3. **Market Equilibrium**: - Occurs where quantity demanded equals quantity supplied. - Changes in demand or supply shift the equilibrium price and quantity. If a new technology reduces production costs for smartphones, the supply curve shifts right, leading to a lower equilibrium price and higher quantity. Do not confuse a movement along the curve (caused by price changes) with a shift of the curve (caused by changes in determinants). --- ### **Macroeconomic Indicators** #### **Gross Domestic Product (GDP)** GDP measures the total value of all final goods and services produced within a country in a given period. - **Components of GDP**: - $GDP = C + I + G + (X - M)$ - $C$: Consumption - $I$: Investment - $G$: Government Spending - $(X - M)$: Net Exports (Exports - Imports) GDP only includes final goods to avoid double counting. Intermediate goods are excluded. #### **Unemployment** Unemployment measures the percentage of the labor force that is jobless and actively seeking work. - **Types of Unemployment**: - **Frictional**: Short-term, due to job transitions. - **Structural**: Mismatch between skills and job requirements. - **Cyclical**: Caused by economic downturns. Full employment occurs when there is no cyclical unemployment, but frictional and structural unemployment still exist. #### **Inflation** Inflation is the rate at which the general level of prices for goods and services rises, eroding purchasing power. - **Measured by**: - Consumer Price Index (CPI) - Producer Price Index (PPI) - **Types of Inflation**: - **Demand-Pull Inflation**: Caused by increased demand. - **Cost-Push Inflation**: Caused by rising production costs. If the CPI increases from 100 to 105, the inflation rate is: $$\text{Inflation Rate} = \frac{105 - 100}{100} \times 100 = 5\%$$ Confusing inflation with deflation. Deflation refers to a decrease in the general price level. --- ### **Economic Systems** Economic systems determine how resources are allocated in a society. 1. **Market Economy**: Decisions are made by individuals and firms interacting in markets. 2. **Command Economy**: Central authority makes all economic decisions. 3. **Mixed Economy**: Combines elements of market and command economies. The United States operates as a mixed economy, with both private enterprise and government intervention. --- ### **Practice Problems** 1. **Opportunity Cost**: - If a country can produce either 10 units of wheat or 5 units of steel, what is the opportunity cost of producing 1 unit of steel? 2. **Supply and Demand**: - If the price of coffee increases, what happens to the demand for tea (a substitute good)? 3. **GDP Calculation**: - Given the following data, calculate GDP: - $C = 500$, $I = 200$, $G = 300$, $X = 100$, $M = 50$ 4. **Inflation**: - If the CPI was 120 last year and 126 this year, what is the inflation rate? --- ### **Key Takeaways** - Scarcity forces trade-offs, and opportunity cost is the value of the next best alternative. - The PPF illustrates efficiency, trade-offs, and opportunity costs. - Supply and demand determine market prices and quantities. - GDP, unemployment, and inflation are critical indicators of economic health. - Economic systems vary in how they allocate resources and make decisions. Review these concepts regularly and practice applying them to real-world scenarios to solidify your understanding.