STUDY GUIDE ECO/365

This is a guide, not a giveaway. Everything that is on the exam might not be covered in great detail here. So please study accordingly. You might even have to look these up.

• Know what opportunity costs are:Opportunity cost is the benefit that you might have gained from choosing the next-best alternative . • Know the definition of economics (Micro and Macro):Microeconomics is the study of individual choice, and how that choice is influenced by economic forces. Macroeconomics is the study of the economy as a whole. It considers the problems of inflation, unemployment, business cycles, and growth.

• Know what the invisible hand is:The invisible hand is the price mechanism, the rise and fall of prices that guides our actions in a market . • Know about mergers:a statutory combination of two or more corporations by the transfer of the properties to one surviving; corporation any combination of two or more business enterprises into a single enterprise; an act or instance of merging. • Know about patents :A patent is legal protection of a technical innovation that gives the person holding it sole right to use that innovation —in other words, it gives the holder a monopoly to produce a good. • Know excise taxes and tariffs:An excise tax is a tax that is levied on a specific good . The luxury tax on expensive cars that the United States imposed in 1991 is an example. A tariff is an excise tax on an imported good .

• Know what sunk costs are:A marginal cost is the additional cost to you over and above the cost s you have already incurred . That means not counting sunk costs — costs that have already been incurred and cannot be recovered —in the relevant costs when making a decision. • Know the role politics plays in our economy:Page 11-12;Social, cultural, and political forces play a major role in deciding whether to let market forces operate. Economic reality is determined by a contest among these various forces. • Know what reverse engineering is:Going to the patent office isn’t the only way competitors gather information about competing products. One of the other ways routinely used by firms is called reverse engineering — the process of a firm buying other firms’ products, disassembling them, figuring out what’s special about them, and then copying them within the limits of the law. • Know what exchange rates are and how they work:the exchange rates — the rate at which one country’s cu r rency can be traded for another country’s currency. People exchange currencies to buy goods or assets in other countries. For example, an American who wants to buy stock of a company that trades on the EU stock exchange first needs to buy euros with dollars. • Know about government intervention:People don’t always like the market-determined price. If the invisible hand were the only factor that determined prices, people would have to accept it. But it isn’t; social and political forces also determine price. For example, when prices fall, sellers look to government for ways to hold prices up; when prices rise, buyers look to government for ways to hold prices down. • Know how the government gets its revenue:The United States has a federal government system, which means we have various levels of government (federal, state, and local), each with its own powers. Together they consume about 20 percent of the country’s total output and employ about 22 million individuals. The various levels of government also have a number of programs that redistribute income through taxation and social welfare and assistance programs designed to help specific groups. State and local governments employ over 19 million people and spend about $2.1 trillion a year. As you can see in Figure 3-3(a), state and local governments get much of their income from taxes: property taxes, sales taxes, and state and local income taxes. They spend their tax revenues on public welfare, administration, education (education through high school is available free in U.S. public schools), and transportation. • Know what a cartel is:A cartel is a combination of firms that acts as if it were a single firm; a cartel is a shared monopoly. If oligopolies can limit entry by other firms, they have a strong incentive to cartelize the industry and to act as a monopolist would, restricting output to a level that maximizes profit for the combination of firms. Thus, the cartel model of oligopoly is a model that assumes that oligopolies act as if they were monopolists that have assigned output quotas to individual member firms of the oligopoly so that total output is consistent with joint profit ma x imization. All firms follow a uniform pricing policy that serves their collective interest. • Know what market forces are:One of the important choices that a society must make is whether to allow these economic forces to operate freely and openly or to try to rein them in. A market force is an economic force that is given relatively free rein by society to work through the market . Market forces ration by changing prices. • Know about socialism, capitalism and feudalism:In theory, socialism is an economic system based on individuals’ goodwill toward others, not on their own self-interest, and in which, in principle, society decides what, how, and for whom to produce. The concept of socialism developed in the 1800s as a description of a hypothetical economic system to be contrasted with the predominant market-based economic system of the time, which was called capitalism. Capitalism is defined as an economic system based on the market in which the ownership of the means of production resides with a small group of individuals called capitalists. feudal system the legal and social system that evolved in W Europe in the 8th and 9th centuries, in which vassals were protected and maintained by their lords, usually through the granting of fiefs, and were required to serve under them in war; any social system or society, such as medieval Japan or Ptolemaic Egypt, that resembles medieval European feudalis. • Know what economic policies are:Economic policies are actions (or inaction) taken by government to influence economic actions. • Know what 3 things comprise our market economy:positive economics, normative economics, and the art of economics. Positive economics is the study of what is, and how the economy works. Normative economics is the study of what the goals of the economy should be. The art of economics , also called political economy, is the application of the knowledge le arned in positive economics to achieve the goals one has determined in normative economics. • Know about business and what types of business there are:Business is simply the name given to private producing units in our society. The three primary forms of business are sole proprietorships, partnerships, and corporations. Sole proprietorships —businesses that have only one owner—are the easiest to start and have the fewest bureaucratic hassles. Partnerships — businesses with two or more owners—create possibilities for sharing the burden, but they also create unlimited liability for each of the partners. Corporations —businesses that are treated as a person, and are legally owned by their stockholders, who are not liable for the actions of the corporate “person”—are the largest form of business when measured in terms of receipts. In corporations, ownership is separated from control of the firm. Of the 35 million businesses in the United States, approximately 72 percent are sole proprietorships,10 percent are partnerships, and 18 percent are corporations. • Know what an entrepreneur is:entrepreneurship (the ability to organize and get something done) is an important part of business. • Know what profit is:Profit is what’s left over from total revenues after all the appropriate costs have been subtracted. Businesses that guess correctly what the consumer wants generally make a profit. Businesses that guess wrong generally operate at a loss. • Know what monitoring costs are:Monitoring costs are the costs incurred by the organizer of production in seeing to it that the employees do what they’re supposed to do. • Know what globalization means:Globalization is the increasing integration of economies, cultures, and institutions across the world . In a globalized economy, firms think of production and sales at a global level. They produce where costs are lowest, and sell across the world at the highest price they can get. A globalized world is a world in which economies of the world are highly integrated. Globalization has two effects on firms. The first is positive; because the world economy is so much larger than the domestic economy, the rewards for winning globally are much larger than the rewards for winning domestically. The second effect is negative; it is much harder to win, or even to stay in business, competing in a global market. • Know what the balance of trade is:That said, economists also must admit that the lay public does have a point. The comparative advantage model assumes that a country’s imports and exports are equal. That is, its balance of trade— the difference b e tween the value of exports and the value of imports—is zero. • Know the different tax structures:A regressive tax is a tax where lower-income entities pay a higher fraction of their income in taxes than do higher-income entities. (Regressive taxes can also be thought of as taxes where the marginal tax rate is less than the average tax rate. This will be discussed in more detail later.) A proportional tax (sometimes called a flat tax) is a tax where everyone, regardless of income, pays the same fraction of income in taxes. (Proportional taxes can also be thought of as taxes where marginal and average tax rates are the same.) A progressive tax is a tax where lower-income entities pay a lower fraction of their income in taxes than do higher-income entities. (Progressive taxes can also be thought of as taxes where the marginal tax rate is higher than the average tax rate.) • Know what social security is:The first policy question concerns the Social Security (or payroll) tax, which accounts for 35 percent of federal government revenue. In 2012, the standard Social Security and Medicare tax rate was 12.4 percent on wages up to an annual maximum wage of $110,100, and another 2.9 percent on all wages, no matter how high. • Know what substitute and complementary goods are:Positive cross-price elasticities of demand mean the goods are substitutes — goods that can be used in place of one another. When the price of a good goes up, the demand for the substitute goes up.Complements are goods that are used in conjunction with other goods. A fall in the price of a good will increase the demand for its complement. The cross-price elasticity of complements is negative. • Know the different market structures and be able to explain them:Perfect competition: Perfect competition happens when numerous small firms compete against each other. Firms in a competitive industry produce the socially optimal output level at the minimum possible cost per unit. Monopoly: A monopoly is a firm that has no competitors in its industry. It reduces output to drive up prices and increase profits. By doing so, it produces less than the socially optimal output level and produces at higher costs than competitive firms. Oligopoly: An oligopoly is an industry with only a few firms. If they collude, they reduce output and drive up profits the way a monopoly does. However, because of strong incentives to cheat on collusive agreements, oligopoly firms often end up competing against each other. Monopolistic competition: In monopolistic competition, an industry contains many competing firms, each of which has a similar but at least slightly different product. Restaurants, for example, all serve food but of different types and in different locations. Production costs are above what could be achieved if all the firms sold identical products, but consumers benefit from the variety. • Know fixed and variable costs:Fixed costs are costs that are spent and cannot be changed in the period of time under consideration. variable costs — costs that change as output changes. • Know economies of scale and economies of scope:In determining whether an inherent comparative advantage exists, a second complication is economies of scale — the situation in which costs per unit of output fall as output increases. We say that production exhibits economies of scale when long-run average total costs decrease as out put increases. economies of scope when the costs of producing products are interdependent so that it’s less costly for a firm to produce one good when it’s already producing another.For example, once a firm has set up a large marketing department to sell cereal, the department might be able to use its expertise in marketing a different product— • Know what price takers and price makers are:A price taker is a firm or individual who takes the price determined by market supply and demand as given. A monopoly or a similar company that is able to heavily influence the prices charged for its products because no other companies have the same product or a similar product of the same quality. A price maker is essentially able to charge whatever it wants so long as it does not run afoul of antitrust laws. • Know what barriers to entry is:Barriers to entry are social, political, or economic impediments that prevent firms from entering a market • Know what collusion is:secret agreement or cooperation especially for an illegal or deceitful purpose; The company was acting in collusion with manufacturers to inflate prices; there was collusion between the two companies to fix prices. • Know what a duopoly is:To keep the analysis easy, we will assume there are only two firms in the market, which makes the oligopoly what is called a duopoly — an oligopoly with only two firms. • Know what a patent is:A patent is legal protection of a technical innovation that gives the person holding it sole right to use that innovation —in other words, it gives the holder a monopoly to produce a good. Most patented goods make a loss; in fact, the cost of getting the patent often exceeds the revenues from selling the product. • Know the Clayton Antitrust Act and the Federal Trade Commission Act:In 1914 the Sherman Antitrust Act was clarified and strengthened with the Clayton Antitrust Act, which identified specific practices as illegal and monopolistic. The government brought a lawsuit against Standard Oil for violating the Sherman Antitrust Act. • Know public and private goods:A public good is a good that if supplied to one person must be supplied to all and whose consumption by one individual does not prevent its consumption by another individual. In contrast, a private good is a good that, when consumed by one individual, cannot be consumed by another individual.An example of a private good is an apple; once I eat that apple, no one else can consume it. An example of a public good is national defense, which, if supplied to one, will also protect others. In order to supply defense, governments must require people to pay for it with taxes, rather than leaving it to the market to supply it. • Know the Sherman Antitrust Act:One such cartel was the Standard Oil Trust, created by John D. Rockefeller, which used its monopoly power to close refineries, raise prices, and limit the production of oil. In response the U.S. Congress passed the Sherman Antitrust Act of 1890 —a law designed to regulate the competitive process. • Know about regulation:Regulated natural monopolies have been given the exclusive right to operate in an industry but, in return, they’ve had to agree to have the price they charge and the services they provide regulated. Regulatory boards control the price that natural monopolies charge so that it will be a “fair price,” which they generally define as a price that includes all costs plus a normal return on capital investment (a normal profit, but no economic profit). Most states have a number of regulatory boards. When firms are allowed to pass on all cost increases to earn a normal profit on those costs, they have little or no incentive to hold down costs. In such cases, X-inefficiency develops with a passion, and such monopolies look for capital-intensive projects that will increase their rate bases. To fight such tendencies, regulatory boards must screen every cost and determine which costs are appropriate and which aren’t—an almost impossible job. For example, nuclear power is an extremely capital-intensive method of producing electric power, and regulated electric companies favored nuclear power plants until they were told that some nuclear power plant construction costs could not be passed on. Once regulation gets so specific that it’s scrutinizing every cost, the regulatory process becomes extremely bureaucratic, which itself increases the cost. Moreover, to regulate effectively, the regulators must have independent information and must have a sophisticated understanding of economics, cost accounting, and engineering. Often regulatory boards are made up of volunteer laypeople who start with little expertise; they are exhausted or co-opted by the political infighting they have had to endure by the time they develop some of the expertise they need. As is often the case in economics, there’s no easy answer to the problem. • Know about price discrimination:price-discriminate — to charge different prices to diffe r ent individuals or groups of individuals (for example, students as compared to businesspeople). • Know the laws of supply and demand:The ideas expressed above are the foundation of the law of demand: Quantity demanded rises as price falls, other things constant. Or alternatively: Quantity demanded falls as price rises, other things constant. This law is fundamental to the invisible hand’s ability to coordinate individuals’; There’s a law of supply that corresponds to the law of demand. The law of supply states: Quantity supplied rises as price rises, other things constant. Or alternatively: Quantity supplied falls as price falls, other things constant. • Know the shift factors of supply & demand (what changes it): Important shift factors of demand include: 1. Society’s income. 2. The prices of other goods. 3. Tastes. 4. Expectations. 5. Taxes and subsidies. Shift factors of supply are similar to those for demand. Examples include: 1. Price of inputs. 2. Technology. 3. Expectations. 4. Taxes and subsidies
Study in great detail because this is a significant part of your grade. And there may be other questions on the exam so study accordingly.