ECON102 Study Guide

Unit 1: Overview of Economics

You may also refer to this Macroeconomics Study Guide to review definitions, calculations, and succinct explanations throughout this course.

 

1a. Identify the determinants of demand and supply

Demand

Markets consist of buyers and sellers. Demand is a term that describes the behavior of buyers in the market.

The Law of Demand – What is the relationship between quantity demanded and the price of a good? Do we consume more or less of a good when prices increase or decrease? How does the law of demand help us answer these questions?

Demand Determinants – Many factors affect demand, including income, prices of related goods, population, preferences, etc. Factors other than price are "shifters" of demand – changes in these variables cause the demand curve to shift up or down.

As you study this material, pay attention to the differences between substitutes and complements and their effect on demand. Furthermore, distinguish between normal and inferior goods, and the effects of income on demand for each of these types of goods. Study the effect of these variables on demand by reviewing the graphical analysis presented in the course materials.

The most important determinants of demand include:

• Preferences;
• Prices of related goods and services;
• Income;
• Demographic characteristics;
• Buyer expectations.

IMPORTANT: Pay particular attention to the difference in effects caused by the price of the good and the shifters of demand. A change in the price of a good will not shift the demand curve but cause a movement along the demand curve.

Students may confuse demand and quantity demanded. Consider that quantity demanded is illustrated on a specific point on the demand curve. When the price of the good changes, there is a movement along the demand curve which represents a change in quantity demanded, but demand itself remains in the same position ... it does not change. Subsequently, if an exam question asks you whether demand for a good changes when its price changes, the answer is "no". Demand itself does not shift, only quantity demanded changes.

The Difference between Change in Quantity Demanded and Change in Demand

It is critical to distinguish between a change in quantity demanded, which is a movement along the demand curve caused by a change in price, and a change in demand, which implies a shift of the demand curve itself. A change in demand is caused by a change in a demand shifter. An increase in demand is a shift of the demand curve to the right. A decrease in demand is a shift in the demand curve to the left. The above drawing of a demand curve highlights the difference.

Supply

Supply describes the behavior of sellers in the market. The analysis of supply follows a similar path as the analysis of demand in the previous section.

The Law of Supply – What is the relationship between quantity supplied and the price of a good? Do producers have an incentive to produce and sell more or less of a good when its price increases or decreases? The Law of Supply can help us answer these questions.

Supply Determinants – Many factors affect supply. Factors other than price are "shifters" of supply: changes in these variables cause the supply curve to shift up or down. Study the effect of these variables on supply by reviewing the graphical analysis presented in the course materials.

The most important determinants of supply include:

• Prices of factors of production;
• Returns from alternative activities;
• Technology;
• Seller expectations;
• Natural events;
• The number of sellers.

IMPORTANT: Pay particular attention to the difference in effects caused by the price of the good and the shifters of supply. A change in the price of a good will not shift the supply curve, but cause a movement along it. Why is the price of the good not a shifter of supply?

It is easy to confuse supply and quantity supplied. Consider that quantity supplied is illustrated at a specific point on the supply curve. When the price of the good changes, there is a movement along the supply curve which represents a change in quantity supplied but supply itself remains in the same position … it does not change. Subsequently, if an exam question asks you whether supply for a good changes when its price changes, the answer is "no". Supply itself does not shift, only quantity supplied changes.

The Difference between Change in Quantity Supplied and Change in Supply

It is critical to distinguish between a change in quantity supplied, which is a movement along the supply curve caused by a change in price, and a change in supply, which implies a shift of the supply curve itself.

A change in supply is caused by a change in a supply shifter. An increase in supply is a shift of the supply curve to the right. A decrease in supply is a shift in the supply curve to the left. The above drawing of a supply curve highlights the difference.

1b. Describe how changes in demand and supply lead to changes in a market's equilibrium price and quantity

• What will happen in a free market when a sudden change in demand or supply causes a shortage to occur at the original price? Think about the effect of a shortage on the price of the good.
• What will happen in a free market after a sudden surplus?
• Will sellers have an incentive to raise or lower their prices to eliminate the surplus?
• What happens to the equilibrium point if the government imposes a price control (such as a price ceiling or a price floor)?

Now, let's review two more central concepts to the study of economics which we also explored in ECON101 Microeconomics: equilibrium price and quantity.

In a free market, capitalist, economic system, economists say that buyers and sellers will eventually achieve an equilibrium: the point where demand and supply intersect to create an equilibrium price and quantity in the market. Note that a completely free market economy will always reach equilibrium.

Note that government intervention means the market is no longer free and unable to respond freely. Remember to distinguish among price controls that are binding or effective, and those that are not. As you review this material, it is helpful to draw graphs of demand and supply to analyze the changes in the equilibrium point that result from shifts in demand or supply.

1c. Distinguish microeconomics from macroeconomics

• Define and explain the difference between microeconomics and macroeconomics.
• Name the major economic aggregates macroeconomics analyzes.
• What are the values for these variables in the United States?
• What are the main goals of U.S. economic institutions (including government) with regards to the macroeconomy?

Microeconomics is the field of economics that focuses on individuals, businesses, and their decisions in the marketplace. Macroeconomists, on the other hand, study the entire aggregate economy in a given country and use the statistics they derive to make comparisons about similar economic trends in other countries.

1d. Describe the circular flow model, identifying linkages between the markets for goods and resources as well as the exchanges between businesses and households

• Define the business sector, the household sector, the government sector, the financial sector, and the global marketplace.
• Describe the flow of payments and resources among these economic entities.

A circular flow diagram is one of the most important models in economics because it identifies the economic components and players and their interdependencies.

Spending = Production
↓
Production = Payments to Inputs
↓
Payments to Inputs = Income
↓
Income = Spending

The Circular Flow Diagram

The circular flow of income describes how money flows among different sectors of the economy. This representation includes the five main sectors: households, firms, the government, the financial sector, and the global marketplace.

Unit 1 Vocabulary

• Business sector
• Change in demand
• Change in quantity demanded
• Change in quantity supplied
• Change in supply
• Circular flow diagram
• Complements
• Demand
• Demand shifter
• Equilibrium
• Financial sector
• Global marketplace
• Government sector
• Household sector
• Inferior goods
• Inventory
• Law of demand
• Law of supply
• Normal goods
• Quantity demanded
• Quantity supplied
• Shortage
• Substitutes
• Supply
• Supply shifter
• Surplus