Econ 2023 Fall 2012 Study Guide For Exam 2

Chapter 1
Know that Economics is the study of how we make choices under scarcity
Understand the concept of scarcity
Know the difference between the different kinds of resources that we use to produce
economic goods
Know the 8 guideposts to economic thinking:
1. Resources are scarce, so decision makers must make tradeoffs (Know the concept
of opportunity cost)
2. Individuals are rational: They try to get the most from their limited resources
3. Incentives matter
4. Individuals make decisions at the margin
5. Information helps us make better choices but is costly
6. Beware of secondary effects
7. The value of a good or service is subjective
8. The test of a theory is its ability to predict
Know the difference between positive and normative economic statements: positive
economic statements are testable, normative economic statements are not.
Know the four pitfalls to avoid in economic thinking:
1. Violation of the ceteris paribus principle
2. The belief that good intentions equal desirable outcomes
The Nirvana Fallacy: The logical error of comparing the actual situation with
its idealized counterpart rather than the actual alternative.
3. The belief that association is causation
4. The fallacy of composition
Chapter 2
Understand how voluntary trade creates value and leads to economic progress (The
Candy Game!)
Know what transaction costs are and understand the importance of middlemen
Know the characteristics and 4 incentives of private property rights.
Understand the concept of the Production Possibilities Curve (PPC): The PPC
outlines all possible combinations of total output that could be produced, assuming a:
1. fixed amount of productive resources
2. given amount of technical knowledge
3. full and efficient use of resources
Be able to read a production possibilities curve and identify efficient, inefficient, and
unattainable points, as well as what is produced at each point and what is given up
and gained from moving from one point to another.
Know the four factors that shift the production possibilities curve inward and outward
Understand the law of comparative advantage
Know the 3 questions that every economy faces

Understand the difference between socialism and capitalism and know why
capitalism tends to work better.

Chapter 3
Understand the law of demand and why demand curves are downward sloping.
Know that the height of the demand curve is the maximum price consumers are
willing to pay for an additional unit
Know how to find and calculate consumer surplus
Know the difference between a change in quantity demanded (a movement along the
curve caused by a change in the price of the good in question) and a change in
demand (a shift of the curve caused by anything other than the change in price of the
good in question)
Know the shifters of demand:
1. Change in Consumer Income:
A. Normal Goods: I DNormal
B. Inferior Goods: I DInferior
2. Change in the Number of Consumers: # Consumers D
3. Change in the Price of a Related Good:
A. Substitutes: Psubstitute D
B. Compliments: Pcompliments D
4. Change in Expectations
A. Expected Price: Pfuture D
B. Expected Income: Ifuture D
5. Change in Consumer Tastes and Preferences: Tastes and Preferences D
Understand the law of supply and why supply curves are upward sloping. Know that
the height of the supply curve is the minimum price that sellers are willing to accept
to supply an additional unit.
Know how to find and calculate producer surplus
Know the difference between a change in quantity supplied (a movement along the
curve caused by a change in the price of the good in question) and a change in supply
(a shift of the curve caused by anything other than the change in price of the good in
question).
Know the shifters of supply:
1. A change in resource price: Presource S
2. A change in technology: Technology S
3. A change in Nature or Politics: Depends on Change
4. A change in taxes: Taxes S
Understand the concepts of elasticity of supply and elasticity of demand
Know everything there is to know about market equilibrium:
1. All trades generating more benefits than costs are undertaken
2. No trades generating more costs than benefits are undertaken
3. The combined area of producer and consumer surplus is maximized
4. There is nor excess supply or excess demand

Know how to do single and double shift questions where demand or supply (or both)
shift and change equilibrium price and quantity.
Understand the invisible hand principle.

Chapter 4
Understand how the labor market works: (It works the same as the market for goods
and services, with just a different name for price and quantity)
1. Know why labor demand is downward sloping
2. Know why labor supply is upward sloping
Understand how the labor market and goods and services market are linked together
Know the effects of price controls on the market equilibrium (be able to analyze
graphs) and their real-life applications:
1. Price Floors
2. Price Ceilings
Be able to analyze the impact of a tax graph, in particular:
1. What happens to the price that buyers pay (and consumer surplus)
2. What happens to the price that sellers receive (and produce surplus)
3. What happens to the quantity sold
4. What happens to government revenue (be able to calculate)
5. How taxes create deadweight loss (be able to calculate)
Understand that the burden of the tax does not depend on whom the tax is imposed,
but it does depend on elasticity. Whoever is relatively more inelastic will bear the
higher burden of the tax.
Be able to calculate Average Tax Rate (ATR) and Marginal Tax Rate (MTR) and
know whether a tax system is progressive, regressive, or proportional.
Understand the Laffer curve and the general relationship between tax rates and tax
revenue
Understand the concept of subsidies
Chapter 5
Understand the idea of economic efficiency: You should only do those things in
which the benefits outweigh the costs and avoid doing those things in which the costs
outweigh the benefits.
Know the role of government: protect individuals and their property rights and
overcome market failure by providing goods and services that cannot easily be
provided by the market.
Know the four types of market failure:
1. Lack of competition: without competition, firms can hold back production and
raise price.
2. Externalities: Effects of an activity that influence the well being of a nonconsenting third party
A. Negative externalities
B. Positive externalities
2. Public goods: Public goods are those goods that have the following two
characteristics (which can lead to free-riding):
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A. non-rival in consumption
B. non-excludable
3. Lack of Information: Government can provide information through regulations
and licensing requirements, but private market can provide information through
consumer reports, name brands, and franchising.
Chapter 7
Know the fundamentals of consumer choice
1. Limited income necessitates choice
2. Consumers make decisions purposefully
3. One good can be substituted for another
4. Consumers must make decisions without perfect information
5. The law of diminishing marginal utility applies to consumption
Understand the Law of Diminishing Marginal Utility: as the consumption of a
product increases, the marginal utility derived from additional consumption will
eventually decline (banana eating contest)
Understand the concept of consumer equilibrium: consumers maximize utility by
spending their money on what makes them happiest until they are equally happy
wherever they spend their next dollar.
Know why the law of demand holds: when price decreases, quantity demanded
increases because:
1. Substitution effect: the good has become cheaper relative to other goods
2. Income effect: its as if your real income has increased (you can buy more of the
good)
Understand that the opportunity cost of time is different for different people and the
implications of this concept.
Know how to find the market demand curve
Know how to calculate the price elasticity of demand (both if you know the percent
change and if you have to calculate it from scratch), and whether a good is inelastic,
elastic, or unitary elastic based on this calculation.
Know what factors determine the price elasticity of demand for a product.
Know how elasticity affects changes in total revenue (or total expenditures).
Be able to calculate income elasticity of demand and verify if a good is a necessity, a
luxury, or an inferior good.
Be able to calculate price elasticity of supply and know why it is always positive
Chapter 8
Understand the concept of shirking and the principal-agent problem
Know the characteristics of the three types of business firms: Sole Proprietorships,
Partnerships, and Corporations
Know the difference between implicit and explicit costs and the difference between
economic and accounting profits
Understand why the normal profit rate is zero economic profit
Know how to distinguish between the short-run and the long-run

Understand the different types of costs and know how to fill in the cost table
Be able to recognize the cost curves and understand why they slope the way that they
do.
Understand the law of diminishing marginal returns
Be able to identify economies of scale, diseconomies of scale, and constant
economies of scale
Understand the idea of sunk costs
Good Luck!