econ exam
What is economics?
The study of how people make choices with things that are scarce.
People: consumers, businesses, governments, all these people make decisions about things that effect our economy
Things: money, goods/services, resources
Scarcity: limited in availability, e.g resources and money
Scarcity
the idea that resources are insufficient to satisfy unlimited human needs and wants
choice
It is not possible for all human needs and wants to be satisfied, meaning decisions must be made about what will be produced and what will be foregone.
efficiency
Making the best possible use of scarce resources to avoid resource waste
equity
the idea of being fair or just, rather than sameness of treatment
economic well-being
the levels of prosperity, economic satisfaction, and standards of living among members of society
sustainability
the long-term maintenance or viability of any particular activity or policy— the ability of the present generation to satisfy its needs by the use of resources, without limiting future generations’ ability to satisfy their own needs.
change
much of economics is in a continuous state of change, in the institutional, technological, social, political, and cultural environments in which economic events occur
interdependence
the idea that economic decision-makers interact with and depend on each other.
intervention
typically means government intervention— the involvement of foreign parties with the workings of markets
Basic economic problem
How do we best meet our unlimited wants with limited resources?
Opportunity cost
What you give up when you choose one alternative over another
free market economy
In free market economies everything is dictated by the free market (aka the actions and choices of consumers and businesses). They are decentralized, meaning the government doesn’t make decisions on production, jobs and more.
Pros: Competition leads to innovation and quality, freedom to make your own choices, efficiency is improved as profit acts as a signal of whether or not goods are successful.
Cons: If the economy struggles there is no government support in place, the most profitable solutions are often put in place at the cost of the environment and community
Income inequality is large, A market economy will produce what people want, not what they necessarily need.
Planned economy
Called a planned economy because it is controlled by the government, who makes most to all economic decisions. Their goal is to make decisions that are best for the state and create a more equitable/equal society.
Pros: The government controls which products are produced meaning private monopolies cannot develop, Income and social inequality are much lower, Everyone is taken care of.
Cons: Less competition and innovation since production is pre-determined, Productivity and economic growth are low as there is little incentive, Government bureaucracy leads to a lack of supplies and inefficient use of resources.
Mixed economy
Have aspects of both planned and market economies. Some sectors are owned privately by individuals (software services), and some sectors are owned publicly by the gov (hospitals, public education).
Pros: provides an incentive for profit as well as the provision of basic services
Cons: Most of the cons are shared with other types of economic systems
Circular flow of income
Households give firms land, labour, and capital in return for rent, wages, interest and profit in the labour market. Households give expenditure on goods and services to firms in return for goods and services in the product market. Injections are gov spending and exports. Leakages are taxes and imports.
Public sector
The government sector that operates/provides basic services (e.g schools, healthcare, roads) to the public. Their priority is to provide a service
Private sector
the sector of the economy providing goods/services that are free from government control (e.g private businesses). Their priority is to make a profit
Law of demand
As the price of a good increases, the quantity demanded will fall (ceteris paribus). As the price of a good falls, the quantity demanded will increase. This law of demand is therefore and inverse (negative) relationship.
Law of Supply
as the price of a good increases, the quantity supplied will increase (or: as the price of a good falls, the quantity supplied will fall), ceteris paribus. Direct positive relationship
Quantity demanded
how many people are willing/able to pay for a product at a given price. This means that when the price changes, it is not the general desire for that product that changes, but the amount of people who are willing to pay for a product at that price.
Determinants of demand (non-price)
-> A change in the popularity (trends/tastes) of the good or service
→ Marketing
→ Seasonal changes
→ Taxes, Subsidies
→ A change in population/demographics
→ Changes in the state of the economy/consumer incomes
→ Changes in the popularity or price of a substitute good, (such as Coke and Pepsi)
→ Changes in the popularity or price of a complimentary good (such as golf club membership and golf equipment)
determinants of supply (non-price)
Costs of the factors of production (change in cost of land, labour, capital, etc)
Technology advancements
“Shocks” (sudden unpredictable events - natural disaster, drastic change in growing conditions, pandemic, etc)
Prices of related goods
Competitive supply (2 or more goods use same resource – 1 or the other)
Joint Supply (2 or more goods derived from a single product – get both)
Taxes (indirect taxes or taxes on profits) higher taxes = higher costs
Subsidies (payment made to firm by government) more subsidies = lower costs
Number of producers
Supplier expectations (ex: future demand)
Supply + Demand curve changes meaning
As supply and demand increase they will shift right, as they decrease they will shift left. Supply is a line that inclines from the point of origin. Demand is a line that declines from the highest point of the Y axis.
Market equilibrium
the point where the forces of supply and demand are in balance resulting in QD = QS and there is no tendency for price to change.
Shortage
Below equilibrium price, Quantity supplied is less than quantity demanded
Surplus
above equilibrium price. Quantity supplied is greater than quantity demanded
Consumer surplus
The highest price consumers are willing to pay for a good minus the price actually paid (equilibrium price)
Producer surplus
The price received by firms selling their goods (equilibrium price) minus the lowest price that they are willing to accept to produce the good.
Necessity goods
Necessity goods are goods that are required to sustain one's daily life/quality of life. These goods tend to be relatively inelastic.
Luxury goods
Goods that are higher quality and more expensive, tend to be more elastic. High income consumers tend to be more inelastic for these goods.
Inferior goods
low quality goods that are cheaper. Also tend to be relatively elastic. As consumer income increases less will purchase inferior goods.
substitutes and elasticity
more sustitues = more elastic
PED formula
PED = % change in quantity demanded/% change in price
formula for PES
PES formula = % change in supply / % change in price.
YED formula
YED = % change in QD/ % change in income
Determmining what type of good based on PED
Elastic means % change in QD is more than % change in price (PED > 1)
Inelastic demand means % change in QD is less than % change in price (PED < 1)
Unit elastic demand means % change is QD is equal to % change in price (PED = 1)
PED perfectly elastic
Perfectly elastic demand means constant price (0% denominator) & a horizontal demand curve
→ PED = infinity
Perfectly inelastic PED
Perfectly inelastic demand means constant QD (0% numerator) and a vertical demand curve
→ PED = 0
PED on revenue
When demand is elastic, a price change causes total revenue to change in the opposite direction
→ this is because the additional revenue gained from increased sales will be greater than the loss of revenue through lower prices
When demand is inelastic, a price change causes revenue to change in the same direction
→ this is because the additional revenue gained from higher prices will be more than the loss of revenue through lower sales
When demand is unitary, a price change has no affect on total revenue
Determining type of good (YED)
Elastic goods = YED > 1
Inelastic goods = 0 < YED > 1
YED unitary = 1
YED negative = < 0
YED values for luxury/quality goods are positive
YED values for necessity goods are positive
YED values for inferior goods are negative
Determining type of good (PES)
PES Elastic- means % change in QS is more than % change in price
→ (PES > 1 = top heavy fraction).
PES Inelastic- means % change in QS is less than % change in price
→ (PES < 1 = bottom heavy fraction).
PES Unitary - means % change in QS is more than % change in price
→ (PES = 1).
Perfectly inelastic (PES)
Perfectly inelastic supply means constant QS and a vertical S curve
→ PES = 0
→ Numerator = 0
Perfectly elastic (PES)
Perfectly elastic supply means constant price and a horizontal Supply curve
→ PES = infinity
→ Denominator = 0
Curve of goods based on elasticity
Elastic = flatter curve
inelastic = steeper curve
perfectly inelastic = vertical line
perfectly elastic = horizontal line
Reasons why governments tax
Generate revenue to pay for public sector services (e.g schools, roads, healthcare)
To influence production levels and consumption habits (can discourage or encourage citizen consumption or suppliers production)
To support domestic producers and consumers
Why governments subsidize
Some goods and services carry significant social benefits to society and their consumption increases wellbeing in consumers
By paying a subsidy to producers, the government protects/guarantees supply and employment in important markets
To support domestic producers
Merit goods
goods or services that governments believe provide positive externalities (effects of society) and therefore they often provide subsidies for (museums, healthy food, environmentally-friendly products)
Demerit goods
Products or services considered unhealthy or socially undesirable, leading to overconsumption and market failure because consumers underestimate their longterm harm
Price ceilings
Price ceiling is a maximum price set below the equilibrium price, resulting in a shortage in the market
→ often placed on necessity goods
--> Price ceilings hurts producers and helps out consumers, can create shortages and loss of tax revenue
Price floors
A price floor is a minimum price set above the equilibrium price, resulting in a surplus in the market
→ placed often on products like cigarettes and alcohol (demerit goods)
→ extra money goes to the producer rather than the government (what happens with taxes)
--> helps producers and hurts consumers, can create surplus and also gaining of tax revenue
What is market failure
Market failure is defined as an inefficient use/misallocation of resources
When does market failure happen
Markets fail when the free market forces of supply and demand lead to an allocation of resources that does not maximise the welfare of a country’s citizens
Output method
Output method - measures the total output produced in a country counting only the final value so that there is no double counting.
Ex: If I produce a dozen eggs and sell them to a grocery store for 1$, and then they sell it to consumers for $4, total output is $4, not $5 (no double counting any value).
Income method
measures the value of all income earned from wages in a country, including benefits such as health insurance, self-employment, rent, shares and bank interest (doesn’t include tax deductions).
Expenditure method
calculates GDP by adding up the total money spent in the economy.
This includes: private spending by households, investment spending by firms, public sector spending by the government,
the value of net exports (exports minus imports, aka what you made on int’l trade).
GDP
Gross Domestic Product (GDP) - the total value of all final goods/services produced in an economy in a given time period (usually one year).
Real GDP
GDP adjusted for the effects of inflation
Per capita GDP
GDP divided by the # of people in a nation.
more accurate measure of living standards because it considers not only the size of a nation's income, but the number of people that it is shared between.
Measuring economic growth (GNI)
Real GNI per capita represents the income per person in a country. A higher. Higher average incomes means a higher welfare and vice versa.
Human development index
is used by the United Nations to measure a country's economic development in terms of life expectancy, education, and living standards. The following criteria are used in the construction of the HDI: Life Expectancy in years (health indicator), Mean years of schooling and expected years of schooling (education indicator)
OECD better life index
a broader measure of well-being which looks at various key factors that affect the welfare of a nation’s population. The Better Life Index uses 11 criteria: Housing, Income, Education, Environment, Health, Happiness, Work Life Balance, etc.
World happiness report
the United Nations has also developed the World Happiness Report which is based on a survey of how people rate their own lives.
Aggregate demand
the total expenditure on all goods and services produced in the economy at a given price level and at a given point in time
→ shows the relationship between the average price level of an economy and the demand for output
→ AD = consumption + investment + government expenditure + (exports - imports)
Consumption
Household spending on final goods and services. Determined by household incomes, interest rates, household indebtedness, inflation, household wealth, and consumer confidence.
Investment
when resources are allocated towards capital goods that can build up the future productivity of an economy. Determined by economic growth, availability of funds, and business confidence.
Government expenditure
pending by the government in the economy, it is an injection into the circular flow. Determinants of this are fiscal policy, taxation, and borrowing
net exports
is the value of a country’s exports LESS their value of imports (net exports = exports - imports). Determinants of next eports are economic growth + demand in overseas markets, demand in domestic markets, exchange rates, and trading strengths/relationships.
Short run aggregate supply
how much producers are willing and able to supply in the short term.
→ There is a positive relationship between the average price level and short-run aggregate supply. This is because as the average price level rises, firms will increase output to take advantage of higher profits (just like in Micro).
Shifts in SRAS curve
The SRAS curve will shift if:
→ There is a change in the costs/price of resources for firms. Ex: if wages or the cost of raw materials fall, then the SRAS curve will shift to the right (Aggregate Supply Increases). If costs increase, supply will shift left (decrease).
→ Taxes are put on products – if a government puts a tax on certain goods, those firms will supply less (shift left) because it is less profitable for them.
Long run aggregate supply
This long-run aggregate supply curve is based on the full employment of the economy (aka the natural rate of employment).
→ This is the level of output/GDP where ALL resources available in the economy (labour, capital) are being fully utilized.
→ In reality this is never the case (always some unemployed and vacant factories)
LRAS inflation
GDP increases above potential, AD rises and the average price level increases. When inflation is happening, wages and cost of resources will also increase, which will bring a full potential LRAS curve
LRAS deflation/recession
AD falls, average prices fall, gdp is also decreased. when deflation happens, wages and prices of resources will also decrease
Shifts in LRAS curve
Potential output/LRAS of an economy can be changed by:
→ Increase/decrease in the number of workers in a country (immigration, demographic changes)
→ Improvement in the skill level of labour force (training, education)
→ Increase in capital available because of added investments
→ Innovation with technology that enhances productivity
→ Increase in availability of natural resources
GDP growth (measuring)
Economic growth is calculated by finding the change in real gdp from one year to the next
→ e.g (2024 real gdp - 2023 real gdp)/2023 real gdp
What is inflation
Inflation is the sustained increase in the general level of prices in an economy
What is disinflation
the fall in the rate of inflation in an economy (the rate at which the general level of prices is increasing falls)
What is deflation
the sustained decrease in the general level of prices in an economy
CPI (measuring inflation)
Consumer price index - used to measure the change in price level in a country over a given time period. The central bank select a representative of basket goods that the average consumer buys, the index has 700 products in the basket, and the prices of the goods in the basket are measured monthly. The higher the proportion of a consumer's income is spent on a good, the greater its impact will have on the index.
Demand pull inflation
Occurs when a rise in aggregate demand pulls the price level in the economy to increase. Often leads to an inflationary gap (actual output is above potential output). This can be caused by: Reduced interest rates raising consumption, rises in house prices that make consumers feel wealthier, high levels of business and consumer confidence, expansionary fiscal policy
Cost pull inflation
Occurs when the short-run aggregate supply in the economy reduces, and rising costs push up the price level (Rising costs cause short-run aggregate supply curve to shift to the left, leading to a rise in the average price level and a fall in the real output). Can be caused by: wage rates rising faster than output costs rise, raw materials costing more, capital costs increasing, and entrepreneurial profit being prioritized.
Inflation - cost of living
As the price level rises in the economy, the cost to households increases. If the price level rises faster than the increase in household incomes, then households will see a fall in their real incomes and material living standards
inflation - investment
high inflation means the cost of borrowing money for investment projects increases, leading to a fall in the level of investment
Inflation - international competition
if a country’s inflation rate is higher than its main international competitors, then the country’s firms will struggle to compete in international markets, leading to a fall in exports and a rise in imports.
Inflation - business costs
an increase in the rate of inflation means that firms have to spend time changing prices as their costs increase. The time they spend changing prices represents an additional cost to business. This is significant when inflation goes to high levels and firms are forced to continuously change prices because they will lose money if they do not.
Inflation - allocative inefficiency
in countries with high inflation, the price of all goods is rising significantly, and it is very difficult for consumers and producers to interpret what changes in price tell them about market conditions on which to base buying and selling conditions. This leads to breakdown of the signalling and incentive functions of price, and resources will not be allocated efficiently.
Inflation - redsitribution of income
Fixed incomes: inflation has a negative effect on the disposable incomes of households whose wages cannot keep up with the increase in the average price level.
Borrowers and lenders: inflation means the real value of money repaid by borrowers is worth less than the money they borrowed from lenders.
What is the labour force
made up of people who work and people who are unemployed, it is the total supply of labour available for the production of goods and services in an economy
Unemployment rate
a percentage of the labour force that is unemployed
Can be calculated as: Number of unemployed/working population x100
Claimant count
one way of measuring unemployment. It is the number of people claiming unemployment benefits in a country
This measure can underestimate the number of unemployed as there are many unemployed people who do not claim benefits (unemployed for a short period of time, too much money in savings)
International labour force survey
method used to measure unemployment in a country. It is a survey of households to establish how many people are unemployed
It often reports a higher number than the claimant count because it includes those who have not claimed benefits who are unemployed
However it is subject to statistical error because it is impossible to survey the whole population
Demand for labour
comes from firms and organisations that employ workers, it can be defined as the number of workers a firm is willing and able to hire at a given market wage rate and a particular point in time.
As the wage rate falls, the quantity demanded for labour rises, and vice versa
supply of labour
the number of people who are willing and able to take a job at a particular market wage rate and a given point in time
As wages rise, quantity of labour supplied increases
At higher wages, there is a greater incentive for individuals to enter the labour market to take a job
Labour market
The labour market is the availability of employment and labour in terms of supply and demand
The price of labour (wage rate) and the number of people employed is determined by the demand and supply of labour
The labour market is in equilibrium when the demand for labour equals the supply of labour
Equality vs equity
Equality refers to the same economic outcomes for different people in society. Often looks at how the income generated by a country’s economic activity is shared amongst the population, Circular flow of income doesn’t show exactly how income is shared.
Equity is fairness in terms of everyone in society having an equal opportunity to achieve an economic outcome
Inequity is the opposite, e.g certain groups in society cannot access certain jobs because of ethnicity, gender, etc.
Income vs wealth
Income is the money a person earns, whereas wealth is the value of assets a person owns
An unequal distribution of income means that a greater proportion of the income in the economy goes to the richest households over the rest of the population
An unequal distribution of wealth menas that the richest households own a greater proportion of the value of assets in a country (e.g property) compared to the rest of the population
Lorenz curve
The Lorenz curve is a graph that illustrates a country’s income distribution
It divides the population into quintiles (fifths) and shows the total progressive accumulation percentage of income accounted for by each quintile (cumulative example = first poorest: 7.2%, second poorest: 14.1%, cumulative income: 7.2%, 21.3%)
To create the graph, each quintile with the cumulative percentage of income is plotted, the Y axis is the cumulative % income, and the X axis the cumulative % population.
Typically drawn with an equal income distribution line as well to show the income inequality against it
Gini coefficient
used to measure the size of a country’s income inequality
The area above the lorenz curve and below the line of perfect income equality is calculated as a proportion of the total area below the line of perfect income equality
Gini coefficient = area A/area A + area B
It is in a percentage or value between 0-1
→ If the answer is ), there is perfect equality
→ if the answer is closer to 1, the more uneven the country’s income is
What is monetary policy
Monetary policy is where the government uses tools like the base interest rates, supply of money, and the minimum reserve requirements to help achieve economic objectives
→ These decisions are controlled by a country’s central bank (Canada = Bank of Canada, US = Federal reserve)
base interest rates
Base interest rates are set by the central bank and have an important impact on interest rates et throughout the economy
→ the base interest rate is the rate of interest the central bank charges to commercial banks (e.g RBC, TD) for lending money (commercial banks need to continuously borrow from the central bank)
→ if the CB raises their base interest rate, commercial banks will have to pay more, and then will raise their interest rates for consumers in turn so that they can still make a profit