economics review 2

8/3/2019 Economics Review 2

http://slidepdf.com/reader/full/economics-review-2 1/22

Economics Overview for ETS Test



Adam Smith:

• Division of Labor => greater productivity

(Pin Factory)

• Laissez Faire = Government stay out of the

economy

• Invisible Hand of the Market = what guides

the economy



Supply and Demand Graph

– PRICE

QUANTITY

SUPPLY

DEMAND (down)



Supply and Demand

• Inelastic = steep, increase price to increase

revenues

•

•

Elastic = flat, decrease price to increaserevenues



• Complements (Milk & cookies)

– (Price of Milk increases, demand for cookies

decreases (shifts left)

• If price of a substitute increases, (Coke &

Pepsi) D shifts right.



• Price floor above market equilibrium• => surplus and higher price

• Price ceiling below market• => shortage and lower prices

• A monopoly causes price to increase and Q

to decrease.



International

• If dollar strengthens (appreciates)relative

to the yen:

• 100 yen/$ => 120 yen/$

• US imports more, exports less

•

If US economy is strong => dollar gets stronger(appreciates)



• If dollar weakens (depreciates) relative to the

yen:• 150 yen/$ => 130 yen/$

• US imports less, exports more



• Theory of Comparative Advantage

– says everyone wins with free trade.



• Current international monetary system is

managed float.

• Hedging is used to negate Foreign

Exchange (FX) risk



• Assume exchange rate is 120 yen per $

•

To convert $100 to yen• => 100* 120 yen/$ = 12,000 yen

•

To convert 100 yen to $• => 100 yen/120 = $0.83



• If the population is growing faster than the

economy, the standard of living is declining



Marginal costs and benefits

• Economic decisions are made based on the

marginal (incremental) costs and benefits:

• If Marginal Revenue >= Marginal Cost =>

do it.

• If MR < MC, don’t do it

• Ignore sunk costs

•



• Firm profit is maximized at the Q where MR =

MC, all types of industries

MC

MR

Profit Max Q

$



Expected payoff based on probabilities

• (use a decision tree if complicated):

• EXAMPLE:

•

20% chance you will get into the party, 60%chance you will win $100 at the party

=>Expect to win 0.2 * 0.6 * $100 = $12



Federal Reserve Bank

• = The Fed

• The US Central Bank

•

Monetary Policy: Controls the MoneySupply and the interest rate.



Fed Policy tools include:

• Changing the Reserve Requirement

•

Using Open market operations• to change the MS

• to change market interest rate,

• specifically the Fed Funds rate.



• In a Recession, the Fed will decrease interest

rates to stimulate Investment by firms.



• Market rate of interest

• = real interest rate + expected inflation



Business cycle

• = Recovery (growing real GDP)

•

And Recession (shrinking real GDP, usual rule of

thumb = 2 consecutive quarters)



Fiscal Policy

• = Congress and President, mess with taxes and

government spending

• Recession => Decrease taxes, increase

spending

• Inflation => Increase taxes, decrease

spending



GOOD LUCK!

economics review 2

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