AP Economics Notes

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economics
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the study of how individuals and nations use scarce resources to satisfy their wants and needs
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two disciplines of economics
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micro – individuals macro – nations
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resources
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anything that can be used to obtain a want or a need
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the basic problem of economics
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scarcity
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seven elements of economic perspective
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1. real cost 2. trade off 3. opportunity cost 4. Law of Diminishing Marginal Utility 5. rational behaviour 6. cost benefit analysis 7. scarcity
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real cost
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trade off + opportunity cost
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trade off
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resources given up to obtain a want or a need
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opportunity cost
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next best alternative for the use of a given up reasource
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rational behaviour
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doing what is in your best interest
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five types of fallacies/mistakes in economic reasoning/research
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1. bias 2. loaded terminology 3. fallacies of composition 4. post hoc ergo proper hoc 5. correlation vs causation
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fallacies of composition
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saying something that applies to one person can apply to everyone
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post hoc ergo proper hoc
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“after this therefore because of this” just because one event (A) preceded another event (B), event A caused event B
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correlation vs causation
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thinking one thing cause another just because there is a correlation between them
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three steps in economic policy
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1. state the goal 2. determine the policy options 3. implement and evaluate the policy that was selected
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eight economic goals
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1. economic growth 2. full employment 3. economic efficiency 4. price-level stability 5. economic freedom 6. equitable distribution of income 7. economic security 8. balance of trade *see page 9*
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ceteris paribus
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“all other things equal” assumption used to rule out the possibility of other factors changing the outcome
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positive statement
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fact
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normative statement
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opinion
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three levels of economics
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1. fact 2. policy 3. theoretical
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At which level do economists usually disagree?
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policy
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inductive reasoning
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start with facts, come up with a theory
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deductive reasoning
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starts with a theory, come up with facts
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complimentary goals and example
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when you work toward one goal, another is achieved ex: economic growth and economic efficiency
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conflicting goals and example
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when you work toward one goal and it hurts another ex: economic freedom and economic security
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production possibility
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maximum possibility to produce
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four assumptions of production possibility problems
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1. dealing with 2 products 2. technology is fixed 3. resources are fix 4. productively efficient and fully employed
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two ways to display production possibility
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schedule (table) and curve (graph)
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corresponding product of 15 units of B A – 0, 1, 2, 3, 4, 5 B – 15, 14, 12, 9, 5, 0
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0 units of A
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opportunity cost of 12 units of B A – 0, 1, 2, 3, 4, 5 B – 15, 14, 12, 9, 5, 0
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3 units of A
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economic efficiency
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productively efficient and allocatively efficient
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productively efficient
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cost efficient (producing on the lowest point on the curve)
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allocatively efficient
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producing what society wants in the quantities they want
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four types of opportunity cost curves
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1. increasing 2. constant 3. decreasing 4. zero
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increasing opportunity cost curve
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– real world – move least productive resource – (appearance) concaved bowed out from origin
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constant opportunity cost curve
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– real world – same interval on both sides of the schedule – (appearance) straight negative diagonal line – usually time
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decreasing opportunity cost curve
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– not in real world – not making good economic decisions – (appearance) convex curving in toward origin
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zero opportunity cost curve
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– not in real world – free product – (appearance) straight line (can be vertical or diagonal – the free product is the product at which is parallel to the curve
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shifting curves
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curve shifts in when resources are taken away curve shifts out when resources are added
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unused resources
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are dormant points on the opportunity cost curve
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economizing problem
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unlimited wants, limited resources
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four general economic systems
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1. pure market 2. pure command 3. mixed economy 4. traditional
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pure market
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capitalism- factors of production are owned by people and businesses (extreme & not in real world)
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pure command
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communism – factors of production are owned by government (extreme & not in real world)
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mixed economy
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factors of production are owned by people businesses, and government (everyone is mixed but on different levels)
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traditional economy
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base economic decisions on history (ex: a guy is a doctor because his dad was a doctor)
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two specific types of economic systems
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1. authoritarian capitalism 2. market socialism
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authoritarian capitalism (definition)
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the people could own the resources but the government has high authority over people’s resources
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authoritarian capitalism (example)
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Nazi Germany
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market socialism (definition)
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government owns the resources but the people had a high degree of influence on how they were used (lead to black market)
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market socialism (example)
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Yugoslavia
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four types of resources
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1. land 2. labor 3. capital 4. enterprenuership
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resource payment for land
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rent
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resource payment for labor
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wages
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resource payment for capital
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interest
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resource payment for enteprenuership
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profit
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market (definition)
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where buyers and sellers come together to make a voluntary exchange
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three key points of the circular flow model
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1. whoever starts it doesn’t have to end it 2. nonstop 3. money and resources/products flow in opposite directions
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what is the household on the input side of the circular flow model?
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supply
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what is the household on the output side of the circular flow model?
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demand
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what is the business on the input side of the circular flow model?
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demand
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what is the business on the output side of the circular flow model?
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supply
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six characteristics of money
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1. scarce 2. stable in value 3. be accepted by the people 4. durable 5. divisible 6. portable
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money (definition)
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anything that can be used as a medium of exchange, can store value, and can measure value
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three types of money
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1. commodity 2. representative 3. fiat
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commodity money (definition)
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(also known as mercantile exchange) has value by itself and can be traded for something else
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commodity money (example)
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tobacco leaves in Virginia Colony
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representative money (definition)
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has no value by itself but can be traded for something of value
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representative money (example)
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the Gold Standard (beginning – FDR)
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fiat money (definition)
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has no value by itself and cant be exchanged for anything of value (go to the bank and they’ll only give you money back) based on governmental promise
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fiat money (example)
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U.S. Dollar Today (FDR – present)
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Father of Economics
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Adam Smith
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laisse faire
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hands off government has little influence on economy everyone does what’s in their best interest
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invisible hand
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if laisse faire is enacted, the economy will grow as if driven by an invisible hand
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four basic economic questions
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1. what and how much should be produced? 2. who should produce what? 3. how should goods and services be produced? 4. for whom should goods and services be produced?
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How does a pure market answer the four basic economic questions?
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1. supply and demand 2. people’s choice 3. most cost efficient method 4. whoever wants to and can buy them
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How does a pure command answer the four basic economic questions?
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the government decides all four
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How does a tradition economy answer the four basic economic questions?
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keep doing what they did in the past
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How does a mixed economy answer the four basic economic questions?
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mix of pure command and pure market
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two things needed for compitition
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1. large number of buyers and sellers 2. people must have to have the freedom to leave or enter the market
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dollar votes
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money people spend on the things they want/need the most votes make the demand go up
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geographic specialization
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certain resources are more easily accessible in some areas than others it is sensible for the more accessible areas to produce a surplus and trade/sell for resources less accessible to them
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six characteristics of a market economy
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1. private property 2. freedom of enterprise and choice 3. self interest 4. competition 5. markets and prices 6. little/no government control *see chapter 4*
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demand
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the amount that consumers are willing and able to purchase at all possible prices
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possible prices
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range determined by the area where buyers and sellers will interact
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Which axis is price always on?
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the vertical axis independent
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law of demand
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price and quantity demanded have an inverse relationship
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three reasons for the law of demand
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1. substitution effec 2. income effect 3. law of diminishing marginal utility
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substitution effect
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substitute the more expensive product for the cheaper (more likely to buy)
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income effect
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what you can buy with a set amount of money
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change in quantity demanded (definition)
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a change in the EXACT amount demanded in a given market
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change in quantity demanded (cause)
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price change
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change in quantity demanded (shown)
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by moving a point on the curve
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change in demand (definition)
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change in the amount demanded at ALL possible prices in a given market
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change in demand (cause)
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something other than price *see factors that cause a change in demand*
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change in demand (shown)
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shifting the curve
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increase in supply/demand shifts _____
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right
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decrease in supply/demand shifts ____
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left
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six factors that can cause a change in demand
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1. taste in preference 2. income 3. expectations 4. complimentary goods 5. substitute goods 6. number of buyers
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general relationship between income and demand
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direct (increase in income results in an increase in demand) if the good is inferior however, relationship is inverse (increase income, decreased demand [etc.])
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expectations (demand)
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what you expect price to do in the future (higher prices (negative effect) in future, causes demand to go up now) (lower prices = positive effect)
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supply
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the amount that producers are willing and able to provide at all possible prices
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When are products considered supply?
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when they are on the shelves of the store
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law of supply
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price and quantity supplied have a direct relationship
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change in quantity supplied (definition)
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change in the exact amount that is supplied in a given market
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change in quantity supplied (cause)
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price
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change in quantity supplied (shown)
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moving a point on a curve
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change in supply (definition)
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change in the amount supplied in a given market at all possible prices
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change in supply (cause)
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something other than price *see factors that influence change in supply*
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change in supply (shown)
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shifting the curve
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eight factors that influence a change in supply
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1. government regulations 2. taxes and subsidies 3. number of sellers 4. technology 5. productivity 6. cost of inputs (resource cost) 7. price of other goods 8. expectations
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government regulations
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more regulations motivates them to decrease supply & vice versa (inverse relationship)
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taxes
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increase in taxes = increase cost = decrease profit = decrease supply & vice versa (inverse relationship)
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subsidies
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increase in subsidies = decrease in cost = increase profit = increase supply & vice versa (direct relationship)
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number of sellers relationship to supply
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direct
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technology relationship to supply
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direct
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cost of inputs (resource cost)
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cost of materials need to make a finished product (inverse relationship)
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price of other goods relationship to supply
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inverse
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expectations (supply)
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negative = lower prices in the future positive = higher prices in the future
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price floor
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cannot charge under this minimum price (top line on graph) helps producers creates a surplus
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price ceiling
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cannot charge above this maximum price (bottom line on graph) helps consumers creates a shortage
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price floor (example)
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milk government buy excess and gives to poor
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price ceiling (example)
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public housing government makes up for it to help poor
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normal income
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money you actually have
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real income
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purchasing power
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explicit cost/normal cost
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money to pay to someone else for the resources they own
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implicit cost/economic cost
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what you pay to yourself
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elasticity of demand
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measuring how sensitive consumers are to a price change
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elastic demand
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consumers are sensitive to price change
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How is a perfectly elastic curve represented?
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as a straight horizontal line (does not exist in either supply or demand in real world)
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inelastic demand
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consumers are not sensitive to a price change
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How is a perfectly inelastic curve represented?
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as a straight vertical line (does not exist in demand in real world) (DOES exist in supply in real world)
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unit elastic demand
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dividing line between elastic (top) and inelastic (bottom) not placing a valued judgement on the sensitivity
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more elastic curve
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rotates counter clockwise
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more inelastic curve
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rotates clockwise
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four basic factors that affect elasticity of demand
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1. necessity vs luxury 2. percent of income 3. substitutibility 4. time
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necessity is inelastic or elastic?
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inelastic
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luxury is inelastic or elastic?
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elastic
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larger percent of income is inelastic or elastic?
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elastic
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smaller percent of income is inelastic or elastic?
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inelastic
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longer time to consider is inelastic or elastic?
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elastic
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shorter time to consider is inelastic or elastic?
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inelastic
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elasticity of supply
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how sensitive producers are to a price change
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elastic supply
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producers are sensitive to a price change
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inelastic supply
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producers are not sensitive to a price change
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unit elastic supply
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dividing line between elastic (top) and inelastic (bottom) not placing a valued judgement on the sensitivity
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factor that affects elasticity of supply
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time (if a producer can react quickly, they are more elastic. if it takes a longer time for a producer to react, they are inelastic)
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market period
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time when inputs cannot be changed nothing is a variable
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Qd
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quantity demanded
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revenue test equation
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$ x Qd = Revenue
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% change in $ > % change in Qd
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inelastic
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% change in $ < % change in Qd
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elastic
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% change in $ = % change in Qd
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unit elastic
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if price and revenue are inversely related, it is ____
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elastic
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if price and revenue are directly realte, it is ____
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inelastic
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if revenue does not change, it is ____
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unit elastic
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when do you not use revenue test?
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on supply
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coefficient test equation
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Ed(or Es) = |((Q1-Q2)/(Q1+Q2)/2)/((P1-P2)/(P1+P2)/2)|
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four types of business organizations
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1. sole proprietership 2. partnership 3. corporation 4. franchise
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sole proprietorship (definition)
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business organization owned and controlled by one person
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sole proprietorship (example)
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Ricatonis
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sole proprietorship (advantages)
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owner gets profit owner gets full control
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sole proprietorship (disadvantages)
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owner responsible for all the costs unlimited liability
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partnership (definition)
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business organization owned and controlled by two people
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partnership (example)
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Fisher-Smith Animal Hospital
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partnership (advantages)
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split costs split work
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partnership (disadvantages)
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split profit unlimited liability
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unlimited liability
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responsible for business beyond value (if you get sued you could lose your business and then your house and car too to make up the cost)
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corporation (definition)
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legal entity with some of the same rights and responsibilities of an individual, owned by shareholders but controlled by a board of directors
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corporation (example)
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Google
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corporation (advantages)
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limited liability easy to transfer ownership owner doesn’t have to worry about how it’s run
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corporation (disadvantages)
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double taxation owner has limited input on how it’s run
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franchise (definition)
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business organization where the owner buys the right and sells its products
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franchise (example)
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Krispy Kreme
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franchise (advantages)
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name recognition free advertising
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franchise (disadvantages)
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large startup fee must sell the products
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merger
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two or more business organizations to form one company
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two ways to form a merger
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1. friendly 2. hostile
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friendly merger
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all parties know about and agree with the merger (can happen with all of the business organizations)
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hostile merger
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at least 1 party doesn’t know about or doesn’t agree with the merger (can only happen with a corporation)
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3 types of mergers
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1. horizontal 2. vertical 3. conglomerate
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horizontal merger (definition and example)
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2 or more business organizations producing the same product at the same level of production join together ex: Nike and Adidas
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vertical merger (definition and example)
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2 or more business organizations producing the same product at different levels of production join together ex: Sears and Craftsmen
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conglomerate merger (definition and example)
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2 unrelated business organizations join together ex: Yamaha
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absolute advantage
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which country can make the most of any one product
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comparative advantage
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who has the cheapest opportunity cost
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law of variable proportions
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states in the short run if 1 input is changed and all others are held constant, then outputs will change
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production function
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how or illustrate law of variable proportion (the large table with multiple rows and columns)
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fixed cost
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cost that doesn’t change with production (rent, taxes)
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variable cost
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a cost that changes with production (wages, utilities)
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total cost
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sum of all costs
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average ____ cost equals
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____ cost divided by total product (fixed, variable, total)
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4 types of market structures
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(Be sure to look at models) 1. perfect competition 2. monopoly 3. monopolistic competition 4. oligopoly
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six characteristics of perfect competition
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1. large number of sellers (not any one seller can effect the market as a whole) 2. price takers (no control over price) 3. all products are identical 4. no value in advertisement 5. almost no barriers to entry 6. do not have non-price competition (ex: farming)
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six characteristics of a monopoly
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(be sure to look at models) 1. 1 seller 2. unique product 3. almost complete control 4. no advertising 5. substantial barriers to enter 6. non-price competition doesn’t exist (ex: public utilities)
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four types of barriers to entry
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1. ownership of essential resources 2. license 3. patents and copyrights 4. economics to scale
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six characteristics of monopolistic competition
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(be sure to look at models) 1. differentiated products (but unique like _monopoly_) 2. many sellers (but not as much as _perfect competition_) 3. have control over price (like _monopoly_) 4. low barriers to entry (like _perfect competition_) 5. advertise 6. non price competition (ex: fast food, women’s clothing)
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excess capacity
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difference in your output from profit maximizing point to product efficiency point (minimum marginal cost = average total cost) what you could produce to become more efficient (but producers care more about profit than efficiency)
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under allocative
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price > marginal cost
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allocative efficient
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price = marginal cost
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two ways to alter excess capacity
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number of sellers ( +:elastic [-ex.cap], -:inelastic [+ex.cap.]) product differentiation ( +:inelastic [+ex.cap], -:elastic[-ex.cap])
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2 sides on the debate over advertising
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1. traditional view 2. new perspective
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three arguments of the traditional view
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1. advertising is persuasive 2. creates concentration (causes demand curve to move to the right and becomes more inelastic like one firm) 3. wasteful (creates a higher point on ATC curve)
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three arguments of the new perspective
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1. ads are informative 2. creates competition (causes demand curve to shift to the left and become elastic like a market) 3. efficient (lower point on the ATC curve)
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six characteristics of an oligopoly
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(be sure to look at models) 1. multiple but few firms 2. standardized (homogeneous) or differentiated products 3. control over price is limited by mutual interdependence 4. significant obstacles to entry 5. advertising 6. non-price competition
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collusions
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cooperation with rivals (illegal for profit)
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price leadership
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when one firm (the leader) announces a price change and the other firms (the followers) soon announce similar changes
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gentlemen’s agreement
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an agreement without writing anything down
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mutual interdependence
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as a producer, I have to take into account my competitors reaction to my price change
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two assumption of mutual interdependence in an oligopoly
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1. if you raise price, your competition will ignore you (increases elasticity) 2. if you lower price, your competition will also lower (decreases elasticity)
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kinked demand curve
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the equilibrium equivalent of the oligopoly
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price rigidity
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oligopoly doesn’t change price because they lose economically
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why does the gap exist in the kinked demand curve?
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because of the two assumptions of mutual interdependence (rivals will ignore a price increase but react to a price cut)
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two shortcomings of the kinked demand curve
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1.doesn’t explain how we got price and output 2. doesn’t take into account changes in the economy
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three types of collusions
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1. gentlemen’s agreement 2. price leadership 3. cartels
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cartels
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a group of producers that typically creates a formal written agreement specifying how much each member will produce and charge
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why do oligopolies engage in collusions?
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profit
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why are collusions hard to maintain?
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cheaters cheat
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what are the available variables in the short run?
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anything except the production facility
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what are the available variables in the market period?
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there are none nothing can be changed in the market period
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what are the available variables in the long run?
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everything anything can be changed in the king run (specially the production facility)
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price takers have a ____ product
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standardized
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price makers have a ____ product
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differentiated
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extranality
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economic side effect to an uninvolved third party (can be positive or negative)
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derived demand
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demand for inputs depends on the demand for outputs that they’re used to create
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public policy toward monopolies
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monopolies have been a good thing during the majority of history past 100 years, don’t like monopolies
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why did the public policy toward monopolies change?
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Teddy Roosevelt the Trust Buster
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four government laws dealing with economy
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1. Sherman Act 2. Clayton Act 3. FTC Act 4. Robertson Patman Act (these are in order)
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Sherman Act
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outlawed contracts that restricted trade
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Clayton Act
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outlawed price discrimination
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FTC Act
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created the Federal Trade Commission which has the power to regulate interstate commerce
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Robertson Patman Act
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forbid rebates or discounts
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three characteristics of price takers
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1. standardized product 2. no barriers to entry 3. elastic demand curve
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three characteristics of price makers
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1. differentiated product 2. barriers to entry 3. downsloping demand curve
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why does the supply curve become more elastic from the market period to the short run to the long run?
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because the producers have more time
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*profit maximizing point*
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mc=mr
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productively efficient point
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mc = minimum atc
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how do you know a graph is representing profit maximizing?
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price > atc
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how do you know a graph is representing equilibrium?
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price = atc
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how do you know a graph is representing loss minimizing?
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atc > p > avc
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how do you know a graph is representing shut down?
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p < avc
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price > atc
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profit maximizing graph
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price = atc
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equilibrium graph
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atc > p > avc
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loss minimizing graph
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price < avc
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shut down graph
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profit maximizing is in the _____ run in an oligopoly
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short and long
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profit maximizing is in the _____ run in a monopoly
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short and long
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profit maximizing is in the _____ run in a monopolistic competition
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short
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profit maximizing is in the _____ run in a perfect competition
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short
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which type of curve (graph) is only short run for all types of markets?
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loss minimzing
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which type of curve (graph) is the only one that is short run and long run for all types of markets?
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shut down
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what is the oligopoly equivalent to the equilibrium curve?
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kinked demand
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what is the monopoly equivalent to the equilibrium curve?
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regulated monopoly (be sure to look at this one!)
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seven (possible) areas for a market model (graph)
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1. total cost 2. total revenue 3. variable cost 4. fixed cost 5. profit or loss? 6. price per unit 7. cost per unity
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______ of scale is more efficient
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economies
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______ of scale is less efficient
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diseconomies
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constant returns
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output changes by the same percent as inputs
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percent comparison in economies to scale
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if inputs increase by 10% outputs will increase by more than !0% if inputs decrease by 10% outputs will decrease by less than 10%
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percent comparison in diseconomies to scale
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if inputs increase by 10% outputs will increase by less than 10% if inputs decrease by 10% outputs will decrease by more than 10%
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when is the only time companies will produce in diseconomies to scale?
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if the government makes them
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dilemma of the regulated monopoly
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the monopoly will suffer losses if it produces at the socially optimal price
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fair-return price
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p=ATC (also known as break even)
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socially optimal price
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p=mc (also known as the allocative efficiency point)

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