ECON 101 Exam 1 Study Guide
Economics: the social science that studies the production, distribution, and
consumption of goods and services
Market economy: where production and consumption are the result of
decentralized decisions by many firms and individuals
 What US uses
 Has an “invisible hand”: refers to the way a market economy manages to
harness the power of self-interest for the good of society
Command economy: there is a central authority making decisions about
production and consumption
Microeconomics: the study of how individuals make decisions and how these
decisions interact
 What we are studying
Macroeconomics: the branch of economies that is concerned with overall ups and
downs in the economy
Market failure: when problems such as the individuals pursuit of one’s own
interest instead of promoting the interests of society as a whole make society worse
off
Recessions: periods where economy struggles
Economic growth: the growing ability of the economy to produce goods and
services
Individual choice: the decision by an individual of what to do, which necessarily
involves a decision of what not to do
Resource: anything that can be used to produce something else
Scare: when there are not enough resources to satisfy all the various ways a society
wants to use them
 Ex: Ava finds that there is not enough time after work to have dinner,
exercise, and watch TV, and she must make choices about how to spend her
time.
Opportunity Cost: the real cost of an item; what you must give up in order to get it
 Ex: Black Friday, huge sales for electronics at retail stores. David must decide
between buying a camera at one store or a flat screen at another. Buying one
means losing out on the ability to purchase the other.
Trade-Off: a comparison between the costs and the benefits of doing something
Marginal decisions: decisions about whether to do a bit more or a bit less of an
activity
 Ex: An educational software company wants to expand the number of
economics questions that it offers and is considering hiring another
economist. It compares how much adding another worker will improve the
product with the additional cost.
Marginal Analysis: the study of marginal decisions
 Ex: A choice of what you want to eat, how much you eat, and how much time
you will divide between and eating and spending time with family on
Thanksgiving.
Incentive: anything that offers rewards to people who change their behavior
 Ex: To enhance students to keep up-to-date with economic current events, an
instructor offers extra credit to students for participating in an online
discussion forum, and this sparks a lively debate about environmental policy.
Trade: providing goods and services to others and receive goods and services in
return
Gains from trade: people can get more of what they want through trade than they
could if they tried to be self-sufficient
 Due to specialization: each person specializes in the task that he or she is
good at performing
Equilibrium: when no individual would be better off doing something different
 Ex: All of the family trading desserts until everyone has something they like
Efficient: when an economy takes all opportunities to make some people better off
without making others worse off
 Ex: Eating food in buffet style on thanksgiving
Equity: means that everyone gets their fair share
 Ex: Letting grandparents go through buffet line first so that food distribution
is even
Model: any simplified representation of reality that is used to better understand
real-life situations
Other things equal assumption: means that all relevant factors remain unchanged
Production Possibility Frontier: illustrates the trade offs facing an economy that
produces only two goods. It shows the maximum quantity of one good that can be
produced for any given quantity produced of the other
Factors of Production: resources used to produce goods and services
Technology: the technical means for producing goods and services
Comparative Advantage: when the opportunity cost of producing a good or service
is lower than other countries’.
 Likewise, an individual has a comparative advantage in producing a good or
service if his or her opportunity cost o producing the good or service s lower
than for other people
Absolute Advantage: when a country can produce more output per worker than
other countries.
 Likewise, an individual has an absolute advantage in producing a good or
service is he or she is better at producing it than other people.
 Having an absolute advantage is not the same thing as having a comparative
advantage
Barter: when people directly exchange goods or services that they have for goods
or services that they want
Circular-flow Diagram: represents the transactions in an economy by flows around
a circle
Household: a person or a group of people that share their income
Firm: an organization that produces goods and services for sale
Markets for goods and services: where firms sell goods and services that they
produce in households
Factor Markets: where firms buy the resources they need to produce goods and
services
Income Distribution: the way in which total income is divided among the owners
of the various factors of production
Positive Economics: the branch of economics that described he way the economy
actually works
Normative Economics: makes prescriptions about the way economy should work
Forecast: a simple prediction of the future
Variable: a quantity that can take on more than one value
Casual Relationship: exists between two variables when the value taken by one
variable directly influences or determines the value taken by the other variable.
Independent Variable: the determining variable in a casual relationship
Dependent Variable: the variable it determines in a casual relationship
Curve: a lone on a graph that depicts a relationship between two variables
 May either be a straight line or a curved line
 If the curve is straight line, the variables have a linear relationship
 If the curve is not a straight line, the variables have a nonlinear
relationship
Positive Relationship: when two variable increase at the same time
 It is illustrated by a curve that slopes upward from left to right
Negative Relationship: when two variables increase at the same time
 It is illustrated by a curve that slopes downward from left to right
Horizontal Intercept: the point at which it hits the horizontal axis
 Shows the x-variable when the y-variable is zero
Vertical Intercept: the point at which it hits the vertical axis
 Shows the y-variable when the x-variable is zero
Slope: the measure of how steep a line or curve is; measured by “rise over run”
 Change in X / Change in Y
Nonlinear Curve: a curve in which the slope is not the same between every pair of
points
Absolute Value: is when the value of the negative number without the minus sign
Tangent Line: a straight line that just touches, or is tangent to, a nonlinear curve at
a particular point
 Slope is equal to the slope of the nonlinear curve at that point
Maximum Point: highest point along the curve
Minimum Point: lowest point along the curve
Time-Series Graph: has dates on the horizontal axis and values of a variable that
occurred on those dates on the vertical axis
Scatter Diagram: shows points that correspond to actual observations of the x and
y variables
Pie Chart: shows how some total is divided among its components, usually
expressed in percentages
Bar Graph: used bars of varying height or length to show comparative sizes of
different observations of a variable
Truncated: when some of the values on the axis are omitted, usually to save space
Omitted Variable: an unobserved variable that, through its influence on other
variables, creates the erroneous appearance of a direct casual relationship among
those variables
Reverse Causality: the error when the true direction of causality between two
variables is reversed
Competitive Market: a market in which there are many buyers and sellers of the
same good or service
Supply and Demand Model: the model of how a competitive market behaves
 5 Key Elements in Model:
o Demand curve
o Supply curve
o Set of factors that cause the demand curve to shift and set of factors
that cause the supply curve to shift
o Market equilibrium, including equilibrium price and equilibrium
quantity
o The way the market equilibrium changes when the supply curve or
demand curve shifts
Demand Schedule: shows how much of a good or service consumers will want to
buy at different prices
Quantity Demanded: the actual amount of a good or service consumers are willing
to buy at some specific price
Demand Curve: a graphical representation of the demand schedule
 Shows relationship between quantity demanded and price
Law of Demand: says that the higher the price for a good or service, other things
equal, leads people to demand a smaller quantity of that good or service
Shift of the demand curve: represents a change in quantity demanded at any given
price, represented by the change of the original demand curve to a new position,
denoted by a new demand curve
Movement along the demand curve: is a change in the quantity demanded of a
good arising from a change in the good’s price
Substitutes: what a pair of goods are if a rise in the price of one of the goods leads
to an increase in the demand for the other good
 Ex: Coke and Pepsi
Complements: when a pair of goods leads to a decrease in the demand for the other
good
 Ex: Eggs and bacon
Normal Good: when a rise in income increases the demand for a good
 Ex: When consumers become more wealth, they have more money to spend
at more upscale restaurants
Inferior Good: when a rise in income decreases the demand for a good
 Ex: when consumers are wealthy enough to eat more upscale restaurants,
they tend to eat McDonald’s less
Individual Demand Curve: illustrates the relationship between quantity
demanded and price for an individual consumer
Quantity Supplied: the actual amount of a good or service people are willing to sell
at some specific price
Supply Schedule: shows how much of a good or service would be supplied at
different prices
Supply Curve: shows the relationship between quantity supplied and price
Shift of the supply curve: is a change in the quantity supplied of a good or service
at any given price
Movement along the supply curve: is a change in the quantity supplied of a good
arising from a change in the good’s price
Individual Supply Curve: illustrates the relationship between quantity supplied
and price for an individual producer
Equilibrium Price (Market-clearing Price): when the quantity of a good or
service demanded equals the quantity of that good or service supplied
Equilibrium Quantity: the quantity of the good or service bought and sold at that
price
Surplus: when the quantity supplied exceeds the quantity demanded
 Occurs when the price is above its equilibrium level
Shortage: when the quantity demanded exceeds the quantity supplied
 Occur when te price is below its equilibrium level
Willingness to Pay: the maximum price a consumer would buy a good or service
Individual Consumer Surplus: the net gain to an individual buyer from the
purchase of a good
 Equal to the difference between the buyer’s willingness to pay and the price
paid
Total Consumer Surplus: the sum of the individual consumer surpluses of all the
buyers of a good in a market
Consumer Surplus: often used to refer to both individual and to total consumer
surplus
Cost: the lowest price at which he or she is willing to sell a good
Individual Producer Surplus: the net gain to an individual seller from selling a god
 It is equal to the difference between the price received and the seller’s cost
Total Producer Surplus: the sum of the individual producer surpluses of all the
sellers of a good in a market
Producer Surplus: the term used to refer to both individual and total producer
surpluses
Total Surplus: the total net gain to consumers and producers from trading in the
market
 Is the sum of the producer and consumer surplus
Property Rights: the rights of owners of valuable items, whether resources or
goods, to dispose of those items as they choose
Economic Signal: any piece of information that helps people make better economic
decisions
Inefficient: when there are missed opportunities and some people could be made
better off without making other people worse off
Market Failure: occurs when a market fails to be efficient
Price Controls: legal restrictions on how high or low a market price ay go
Price Ceiling: a maximum price that sellers are allowed to charge
 Often lead to inefficient allocation to consumers: when people want the
good so badly they are willing to pay a high price don’t get it, and some who
care relatively little about the good and are only willing to pay a low price to
get it
 Lead to wasted resources: people expend money, effort, and time to cope
with the shortages caused by the price ceiling
 Leads to Inefficiently Low Quality: sellers offer low-quality goods at a low
price even though buyers would prefer a higher quality at a higher price
Price Floor: a minimum price that buyers are required to pay for
 Lead to inefficient allocation of sales among sellers: those who would be
willing to sell the good at the lowest price are not always those who actually
manage to sell it
 Lead to inefficiency in goods of inefficiently high quality are offered: sellers
offer high-quality goods at a high price, even though buyers would prefer a
lower quality at a lower price
Deadweight Loss: the total surplus that occurs whenever an action or a policy
reduces the quantity transacted below the efficient market equilibrium quantity
Black Market: a market in which goods or services are bought and sold illegally—
either because it is illegal to sell them at all or because the prices charged are
illegally prohibited by a price ceiling
Minimum Wage: a legal floor on the wage rate, which is the market price of labor
Quality Control/Quota: an upper limit on the quantity of some good that can be
bought or sold
 Drives a wedge between the demand price and the supply price of a good;
that is, the price paid by buyers ends up being higher than received by sellers
Quota Limit: the total amount of the good that can be legally transacted
Quota Rent: the difference between the demand and supply price at the quota limit
License: gives the owner the right to supply a good
Demand Price: the price at which consumers will demand that quantity
Supply Price: the price at which producers will supply that quantity
Explicit Cost: a cost that requires an outlay of money
Implicit Cost: does not require an outlay of money; it is measured by the value, in
dollar terms, of benefits that are foregone
Accounting Profit = Revenue – Explicit Cost
Economic Profit = Revenue – Opportunity Cost (of resources used)
Capital: the total value of assets owned by an individual or firm—the physical
assets plus financial assets
Implicit Cost of Capital: the opportunity cost of the use of one’s own capital—the
income earned if the capital had been employed in its next best alternative use
Principle of “either-or” decision making: when faced with an “either-or” choice
between activities, choosing the one with the positive economic profit
Marginal Cost (Variable): the additional cost incurred by producing one more unit
of that good or service
Increasing Marginal Cost: when each additional unit costs more to produce than
the previous one
Marginal Cost Curve: shows how the cost of producing one more unit depends on
the quantity that has already been produced
Constant Marginal Cost: when each additional unit costs the same to produce as
the previous one
Decreasing Marginal Cost: when each additional unit costs less to produce than
the previous one
Marginal Benefit: the additional benefit derived from producing one more unit of
that good or service
Decreasing Marginal Benefit: when each additional unit of the activity yields less
benefit than the previous unit
Marginal Benefit Curve: shows how the benefit from producing one more unit
depends on the quantity that has already been produced
Optimal Quantity: the quantity that generates the highest possible total profit
Profit-Maximizing Principle of Marginal Analysis: when faced with a profitmaximizing “how much” decision, the optimal quantity is the largest quantity at
which the marginal benefit is greater than or equal to marginal cost
Sunk Cost (Fixed): the cost that has already been incurred and is non-recoverable;
should be ignored in decisions about future actions
Rational: decision maker who chooses the available option that leads to the
outcome he or she most prefers
Bounded Rationality: decision maker that makes a choice that is close to but not
exactly the one that leads to the best possible economic outcome
Risk Aversion: the willingness to sacrifice some economic payoff in order to avoid a
potential loss
Irrational: decision maker who chooses and option that leaves him or her worse off
than choosing another available option
Mental Accounting: the habit of mentally assigning dollars to different accounts so
that some dollars are worth more than others
Loss Aversion: oversensitivity to loss, leading to unwillingness to recognize a loss
and move on
Status Quo Bias: the tendency to avoid making a decision and sticking with the
status quo
Y = mx + b
b = y – mx
Errors in interpreting data:
 Concluding ‘A’ caused ‘B’
 Non-sequiturs: illogical decisions
 Fallacy of composition: concluding what's good for one is good for all
Errors in Graphical Conclusions:
 The scale used can alter the appearance of a line/curve
 The slope depends on the beginning and ending points used
Factors that cause S curve to shift right:
 New technology
 Decrease in price of units
 Decrease in interest rates
 Decrease in interest rates
 Decrease in the price of a substitute product
 Increase in the price of a complementary product
 Increase in number of sellers
 Increase in inventory
 More favorable tax policy
 More favorable weather
 Change in expectations (of future prices)