Study Guide for Praxis Exam—Economics
I.
Microeconomics—Basic Concepts: Scarcity,
A. Terms to define, identify, explain, or differentiate:
1. Resources or factors of production:
a. Land (raw materials)
b. Labor
c. Capital
d. Entrepreneurship
2. Entrepreneur vs. manager
3. Scarcity
4.
5. Costs
6.
Ceteris Paribus
7. Benefits
8. Adam Smith
9.
The Wealth of Nations
10. Production possibilities frontier
11. Law of Increasing Costs
12. Inefficiency
13. Tradeoffs
14. Rational choice
15. Quantity demanded
16. Demand
17. Law of Demand
18. Quantity supplied
19. Supply
20. Normal goods
21. Inferior goods
22. Substitute goods
23. Complementary goods
24. Inputs (factors of production, resources)
25. Substitutes in production
26. By-products (complements in production)
27. Market equilibrium
28. Price ceiling
29. Price floor
30. Excise tax
31. Shortage
32. Surplus
33. Marginal benefits
34. Marginal costs
35. Total revenues
36. Marginal revenues
37. Sunk costs
38. Non-monetary costs
39. Transactions costs
40. Price elasticity of demand
41. Income elasticity of demand
42. Cross elasticity of demand
43. Price elasticity of supply
44. Inelastic
45. Elastic
46. Unit elastic
47. Arbitrage
48. Speculation
49. Mixed models of capitalism and socialism
50. Five-year plans
51. Property rights
52. Scarce vs. non-scarce resources
53. Wants vs. needs
54.
55. Monetary vs. non-monetary costs
56. Positive vs. normative economics
57. Rational vs. Non-rational choices
58. Demand vs. quantity demanded
59. Supply vs. quantity supplied
60. Price floor vs. price ceiling
61. Shortage vs. Scarcity
62. Comparative advantage vs. absolute advantage
63. Capitalism (Free enterprise) vs. Socialism
64. Common property rights vs. private property rights
65. Positive Externality
66. Negative Externality (and Pollution)
67. Pollution or emissions tax
68. Marketable rights for pollution
69. Public Goods
70. Public Goods vs. Governmentally provided goods
71. Free-rider problem
72. The public interest
73. Rational abstention
74. Rational ignorance
75. Rent-seeking
76. Tariff
77. Quota
78. Mercantilism
79. Protectionism
80. Infant industries and strategic industries
81. Dumping
82. Retaliatory trade restrictions
83. Environmental and labor standards
84. Commerce Clause
85. Absolute Advantage
86. Comparative Advantage
87.
88. Sources of Comparative Advantage
89. Gains from Trade
90. Diversity and Gains from Trade
91. Terms of trade
92. David Ricardo
93. International cartels
B. Study Questions:
1. How does scarcity lead to choices? To costs? To competition?
2. Why do economists use the concept of “ceteris paribus” in their reasoning?
3. Why do economists depend so heavily on theory instead of just looking at the facts?
4. Can scarcity be eliminated by changing economic systems (e.g. changing from capitalism to socialism or vice versa)?
5. What factors are assumed to be constant along any given production possibilities frontier?
6. Show why scarcity is not the immediate problem facing an economy that is on the interior of its production possibilities frontier.
7. How is the idea of cost shown with a production possibilities frontier? What is the economic reasoning for costs?
8. How is the Law of Increasing Cost shown with a production possibilities frontier? What is the economic reasoning for this Law of Increasing Costs?
9. For each of the following, show, using a production possibilities frontier diagram, what the effect of:
a. an increase in a country’s immigrant population on the production possibilities frontier?
b. the development of new technology?
c. a war fought within that country’s borders?
d. that country being looted by a conquering nation?
e. moving from an inefficient to an efficient position?
10. How is it that the price of a good affects the Quantity Demanded for that good, but does NOT affect the Demand for that good?
11. What are the factors that affect quantity demanded and in what way (direction, positive or negative) do they tend to affect quantity demanded, ceteris paribus (other things being equal)?
12. What are the factors that affect quantity supplied and in what way (direction, positive or negative) do they tend to affect quantity supplied, ceteris paribus (other things being equal)?
13. Along a demand curve, what factors are held constant (with ceteris paribus assumptions) and what are allowed to vary? Along a supply curve, what factors are held constant (with ceteris paribus assumptions) and what are allowed to vary?
14. Why is price inversely related to quantity demanded and positively related to quantity supplied?
15. What are the factors that affect the price elasticity of demand, and how do they affect price elasticity of demand?
16. How is elasticity of demand related to the revenues of sellers? How are price increases and decreases related to revenue increases and decreases when demand is elastic? when it is inelastic? when it is unit elastic?
17. Why do people in markets tend to move price and quantity traded toward equilibrium?
18. How is the behavior of many diverse people coordinated by market processes? Be able to work with supply and demand diagrams.
19. If a price ceiling is enacted that is below the equilibrium price, what will happen to quantity demanded and quantity supplied? Are quantity demanded and quantity supplied equal to each other, or is one of these greater than the other? Which is greater? What is this situation called?
20. If a price ceiling is enacted above the equilibrium price, what will happen to quantity demanded and quantity supplied? Are quantity demanded and quantity supplied equal to each other, or is one of these greater than the other? Which is greater? What is this situation called?
21. If a price floor is enacted that is below the equilibrium price, what will happen to quantity demanded and quantity supplied? Are quantity demanded and quantity supplied equal to each other, or is one of these greater than the other? Which is greater? What is this situation called?
22. If a price floor is enacted above the equilibrium price, what will happen to quantity demanded and quantity supplied? Are quantity demanded and quantity supplied equal to each other, or is one of these greater than the other? Which is greater? What is this situation called?
23. List some of the undesirable effects of price controls.
24. How do prices work as signals and incentives in a capitalist system so that people will know how to get resources to places and markets where they are most valued?
25. How are decisions made in a socialist system to shift resources to more highly valued uses? Who makes these decisions in a socialist system> What are the incentives of the decision makers?
26. Who makes the decisions about resource use in a capitalist or free market society? Who makes these decisions in a socialist society?
27. Even if economic decisions are made in a socialist system using democracy, are there any difficulties of democracies with such decisions?
28. What role does a constitution have in setting boundaries for democratic action in a free-market society? Imagine a setting where one person has ten dollars and two other people have six dollars each. Using majority rule to redistribute the wealth these people have, what are the possibilities for votes to redistribute these dollars if there is no constitutional protection of private property?
29. Why do marginal costs of an activity tend to rise as we increase the amount of that activity?
30. Why do marginal benefits of an activity tend to fall as we increase the amount of that activity?
31.
Explain why net gains (benefits minus costs) are maximized
where marginal benefits are equal to marginal costs?
32. Why are "sunk costs" not really costs (not opportunity costs)?
C. Diagrams, equations, and symbols to be familiar with:
1. Production Possibilities Frontier
2. Supply and Demand Diagram and applications [price ceiling, price floor, shortage, surplus, tax on sellers, tax on buyers, shifts from changes in factors that affect supply and demand, movements along demand and supply curves, Imports (with and without a tariff), Imports (with and without an import quota), Exports]
3. Price Elasticity of Demand, Cross Elasticity of Demand, Income Elasticity of Demand, Price Elasticity of Supply
4. P, Q, D, S, ε
II. Microeconomics—Advanced Concepts: Production, Costs, Market Structure, Factor Markets, Income Distribution
A. Terms to define, identify, explain or differentiate:
1. Total Cost (TC)
2. Fixed Cost (FC)
3. Variable Cost (VC)
4. Average Total Cost (ATC)
5. Average Fixed Cost (AFC)
6. Average Variable Cost (AVC)
7. Marginal Cost (MC)
8. Short-Run (SR) vs. Long-Run (LR) Costs
9. Production Function
10. Marginal Product of Labor MPL
11. Diminishing Returns to Labor
12. Law of Diminishing Returns (AKA Law of Variable Proportions)
13. Average-Marginal Relationship
14. Profit or Loss Rectangle
15. Breakeven Point
16. Shutdown Point
17. Production in the Long Run
18. Cost in the Long Run
19. Long Run Average Total Cost (LRATC) Curve vs. Short Run Average Total Cost (SRATC) Curves
20. Economies and Diseconomies of Scale
21. Minimum Efficient Scale
22. Price Takers
23. Demand as a Price Taker firm see it
24. Free Entry and Exit
25. Competitive Equilibrium
26. Short-run equilibrium for Price Takers (P=MC)
27. Long-run equilibrium for Price Takers (P=MC, min Short run ATC = min Long run ATC; Profit=0)
28. Normal profit vs. accounting profit vs. economic profit
29. Long-run adjustment of supply to changes in demand
30. Changes in number of firms in industry in long run
31. External economies and diseconomies of scale and long run industry supply curve
32. Consumer surplus
33. Producer surplus
34. Deadweight loss
35. Monopoly
36. Market Power
37. Contestable Markets
38. Price Discrimination
39. Barriers to Entry
40. Revenue (R), Average Revenue (AR), Marginal Revenue (MR)
41. Strategic Behavior
42. Game Theory
43. Prisoners’ Dilemma
44. Repeated Prisoners’ Dilemma
45. Payoff matrix
46. Tit-for-tat strategy
47. Cartel
48. Collusive Agreement
49. Sherman Antitrust Act, section 1 and section 2
50. Rule of Reason vs. Per Se Rule
51. Predatory Pricing
52. Clayton Act
53. Merger Policy
54. Horizontal and Vertical Mergers
55. Price Fixing (Cartel Agreements)
56. Market Definition in Antitrust Cases
57. Per Se Rule
58. Treble Damages
59. Resale Price Maintenance
60. Natural Monopolies
61. Economic Regulation
62. Marginal Cost Pricing
63. Average Total Cost Pricing
64. Capture theory of regulation
65. Rent-seeking
66. Fringe benefits as part of wage
67. Real vs. Nominal Wages
68. Marginal Revenue Product of Labor (MRP=MR*MP of Labor)
69. Derived Demand for Labor (Wage = MRP)
70. Labor Supply: Market Work vs. Leisure or Work in the Home
71. Income and Substitution Effects of Wages
72. Backward Bending Supply of Labor
73. Human Capital (another alternative to market work)
74. Industrial Unions
75. Craft Unions
76. Union/Nonunion wage differential
77. Monopsony
78. Bilateral monopoly
79. Wages
80. Profits
81. Interest
82. Economic rent
83. Gini coefficient
B. Study Questions:
1. Why does the production function (total product curve) first rise at an increasing rate? Why does it eventually rise at a decreasing rate?
2. What does the shape of the production function have to do with the shape of the short-run total cost curve?
3. If there is free entry and exit in a market, what effect does positive economic profits have on the change in the number of firms in the industry? what effect does negative economic profits (or losses) have on the change in the number of firms in the industry?
4. Why does AR=P?
5. Why is demand downward sloping for price makers?
6. Why is demand flat for price takers?
7. Why is MR downward sloping?
8. Why is MR<P if Demand is downward sloping? Why is MR=P if demand is flat?
9. Show how MR can be negative?
10. Why is profit maximization the goal of the firm?
11. Why does producing output where MR=MC follow from profit maximization?
12. What price does the firm charge to maximize profits?
13. Why doesn’t a firm want to produce where its demand is inelastic?
14. Profit maximizing output of a price maker?
15. Profit maximizing price of a price maker?
16. What is MR for a price taker?
17. Compare Producer Plus Consumer Surpluses under monopoly and completion: deadweight loss of monopoly.
18. How does the free-rider problem keep markets from reaching an efficient allocation of resources?
19. Why should we be careful about comparisons of monopoly and competitive industries’ producer and consumer surpluses? That is, are competitive industries always more socially beneficial than monopolistic industries?
20. What are types of barriers to entry? Give examples of each.
21. How are patents and copyrights socially beneficial BECAUSE they give firms temporary barriers to entry?
22. What are the three prerequisites for price discrimination? Why are these prerequisites?
23. The prices
for pharmaceutical drugs are higher in the
24. How does a quantity discount work as a form of price discrimination? How do coupons help firms to price discriminate?
25. Be able to show what prices would be charged in two different markets where a firm knew the elasticities of demand in the two markets? (recall that MC=MR and MR1=MR2 in the two markets, where the subscripts refer to the different markets).
26. What feature makes monopolistic competition like the competitive model? Like the monopoly model?
27. What is oligopoly and why is it also part way between competition and monopoly? Are oligopoly firms and monopolistically competitive firms price takers or price makers?
28. What are the profit maximizing output and price like in a monopolistic competitive firm in the short run and in the long run? Graph it!
29. Is a price agreed upon by members of a cartel a stable equilibrium? Does it matter if the price setting game is played once or repeatedly? What is the Tit-for-Tat strategy in playing the repeated prisoners’ dilemma?
30. What are the incentives to defect from a cartel? The incentives to cooperate?
31. What is the problem with Marginal Cost pricing of natural monopolies? Average Total Cost Pricing?
32. Why do economists insist that zero pollution is not optimal?
33. How is pollution a conflict in property rights? You buy a house where airliners from a large international airport have long flown over before landing about one quarter of a mile away. Are there any externalities you suffer from this noise pollution? Did the price you pay for the house reflect the noise pollution that invades the quiet of that house? Who suffered the loss?
34. Why are pollution taxes and marketable rights approaches to controlling pollution less costly than the technological standards approach?
35. How does the free-rider problem affect democratic decision making?
36. Why is private-interest or special-interest legislation more likely to pass than public interest (providing real public goods) legislation?
37. Why is the pollution problem reciprocal?
38. How does the free-rider problem keep markets from reaching an efficient allocation of resources?
39. What are some reasons for different people being paid different wages? Human Capital, Compensating Wage Differentials, Discrimination
40. How do increases in minimum wages affect unskilled workers? Skilled workers?
41. What are some of the unintended consequences of higher minimum wages?
42. Why do labor unions, which represent workers who earn well above minimum wage, the main lobbying group fighting for higher minimum wages?
43. Union workers receive wages that are about 15% on average above their nonunion counterparts. Give two explanations for this. Why does it make a difference which explanation is more dominant?
44. Who are helped and who harmed by increases in the minimum wage?
45. In the Middle Ages, the Plague led to substantial (and documented) increases in wages? Why?
46. What happens to the prices in two different countries as a result of international trade? Wages?
47. What are the effects of a larger market? What happens to cost per unit? Number of firms? Price-Cost Margins?
48. What scarce resources are the following payments for, that is, what is being given up? wages, profits, interest, rent
49. How is economic rent related to opportunity cost?
50. Rawls and Nozick offer two competing views of equity or fairness in the income distribution. Contrast these two views.
51. Would those who are the poorest in a society be better off (financially) if there were complete equality or if there were some inequality of income? Why?
C. Diagrams, equations and symbols
1. Production Function (total product curve)
2. Marginal product and average product curve
3. Total cost, fixed cost and variable cost diagram
4. Average fixed cost, average variable cost, average total cost and marginal cost diagram
5. Long-run average cost with multiple possible short-run average cost curves
6. Changes in input prices and effect on cost curves
7. Market demand and supply and price taker demand curve and marginal cost curve diagram (two-panel diagram)
8. Market demand and supply and price taker demand curve and marginal cost curve diagram (two-panel diagram) with profits and long-run firm entry
9. Market demand and supply and price taker demand curve and marginal cost curve diagram (two-panel diagram) with losses and long-run firm exit
10. Monopoly demand, marginal revenue and marginal cost diagram (monopoly price and output setting diagram)
11. MR=P(1-1/ε)
12. Monopolistic competition in short run
13. Monopolistic competition in long-run equilibrium
14. Prisoners’ dilemma matrix
15. TP, AP, MP, TC, VC, FC, ATC, AVC, AFC, R, AR, MR
16. Herfindahl Index, H= ΣSi2 , where S=market share of firm i in the industry, summed over all firms in industry
17. Lorenz Curve
18. Monopsony market
19. Bilateral monopoly market
III. Macroeconomics: National Income Accounting, Unemployment and Inflation
A. Terms to define, identify, explain or differentiate:
1. Macroeconomics vs. Microeconomics
2. Gross Domestic Product (GDP)
3. Final goods vs. intermediate goods
4. Double counting
5. Real GDP
6. Nominal GDP
7. National Income (NI)
8. Disposable Personal Income
9. Business cycle, peak and trough, recession and recovery
10. Consumer spending
11. Savings in the economy
12. Consumer durable goods
13. Consumer non-durable goods
14. Investment spending
15. Investment for aggregate economy vs. family’s investments (savings)
16. Inventory investment
17. Business fixed investment
18. Residential investment
19. Government spending
20. Transfer payments
21. Net exports
22. Imports
23. Exports
24. Trade balance
25. Labor Income
26. Capital Income
27. Profits
28. Rental payments
29. Interest payments
30. Depreciation
31. Gross investment
32. Net investment
33. Indirect business taxes
34. Net income to foreigners
35. Statistical discrepancy
36. Value added
37. Savings
38. GDP deflator
39. Base year
40. Price Index
41. Consumer Price Index (CPI)
42. Biases in CPI
43. Inflation
44. Cost-push inflation
45. Demand-pull inflation
46. Civilian labor force
47. Current population survey
48. Working-age population
49. Natural unemployment rate
50. Cyclical unemployment
51. Seasonal unemployment
52. Structural unemployment
53. Frictional unemployment
54. Discouraged workers
55. Underemployment
56. Unemployment rate
57. Labor force participation rate
58. Creative destruction
59. Job vacancies
60. Duration of unemployment
61. Job search
62. Job rationing
63. Efficiency wage
64. Minimum wage
65. Demand for labor curve
66. Supply for labor curve
67. Real wage
68. Actual vs. Potential GDP
69. Recession vs.Depression
70. The Great Depression
71. Stock market bubble
72. Stock market crash
B. Study Questions
1. Why are only final goods and services counted in GDP? Why are money values used? Are used goods counted in GDP?
2. How does GDP undercount actual economic production in an economy?
3. Why makes GDP an inadequate measure of economic well-being?
4. What are the shortcomings in our CPI measure that make it tend to overestimate inflation?
5. How does the Labor Department go about measuring the unemployment rate? What question(s) verify whether the respondent is in or out of the civilian labor force? What question(s) verify whether the respondent is employed or unemployed?
6. What role does inventory investment play in the movement toward equilibrium in the Keynesian model of income determination?
7. What are the costs of high unemployment (higher than the natural rate)? What are the costs of high, anticipated inflation? Of high, unanticipated inflation?
C. Diagrams, equations and symbols
1. Circular flow diagram
2. Y=C+I+G+X
3. CPI formula
4. Inflation rate = [(CPI this year – CPI last year)/CPI last year] * 100
5. GDP deflator formula
6. Real GDP formula
7. Unemployment rate formula
8. GDP, RGDP, CPI, Y, C, I, G, X
IV. Macroeconomics: Macroeconomics: Money and Banking, Monetary Policy, Fiscal Policy, Income Analysis, and International Finance
A. Terms to define, identify, explain or differentiate:
1. Money
2. Barter
3. Double coincidence of wants
4. Commodity money
5. Functions of money: medium of exchange, store of value, unit of account
6. Currency
7. Legal Tender
8. Checking deposits
9. Money supply
10. Liquidity
11. Alternative measures of the Money Supply: M1 and M2
12. Federal Reserve System (the Fed)
13. Political Business Cycles
14. Bank
15. Federal Open Market Committee
16. Balance Sheet
17. Asset
18. Liability
19. Owner’s Equity
20. Bank’s Reserves (including forms reserves are help)
21. Required reserve ratio
22. Fractional reserve system
23. Money creation
24. Deposit expansion
25. Deposit contraction
26. Open market operation
27. Money multiplier
28. Monetary base
29. Ownership of the Fed
30. Federal Reserve Districts
31. Roles of the Fed (Central Bank)
32. Control of the Fed
33.
34. Monetary Policy
35. Tools of monetary policy (open market operations, discount rate, required reserve ratio
36. Real vs. nominal interest rates
37. Cost of holding money
38. Demand for holding money
39. Allan Greenspan
40. Quantity equation of money (or equation of exchange)
41. Growth form of the quantity equation of money
42. Velocity
43. Relationship between money supply growth and inflation
44. Hyperinflation
45. Bank Panics (runs on banks)
46. FDIC
47. Consumption function
48. Marginal Propensity to Consume (MPC)
49. Marginal Propensity to Save (MPS)
50. Planned vs. unplanned spending
51. Planned inventory investment
52. Unplanned inventory investment
53. National income determination
54. Aggregate demand
55. Real wealth or real balance effect
56. Exchange rate effect
57. Aggregate supply
58. Long-run aggregate supply vs. short-run aggregate supply
59. Sticky prices
60. Expected vs. Unexpected inflation
61. Real vs. nominal wages
62. Countercyclical Policy
63. Crowding –out effect
64. Expansionary Fiscal Policy
65. Contractionary Fiscal Policy
66. Tax Policy
67. Spending Policy
68. Average tax rates
69. Marginal tax rates
70. Automatic stabilizers
71. Discretion vs. Rules Debate for Fiscal Policy
72. Supply-side economics
73. Budget Surplus
74. Budget Deficit
75. National Debt
76. Monetizing the debt
77. Debt-to-GDP ratio
78. Ricardian equivalence
79. Monetary targets
80. Discretion vs. Rules Debate for Monetary Policy
81. Lags in detection, action, and effect in fiscal and monetary policies
82. Uncertainty
83. Milton Friedman
84. Flexible exchange rates
85. Fixed exchange rates
86. Exchange market intervention
87. Balance of Payments
88. Appreciation and depreciation of currencies
89. Bretton Woods system
90. Gold Standard
91.
European Monetary
92. Long-run economic growth
93. Aggregate production function
94. Effects of Labor Supply and Capital on Aggregate Production
95. Technological change and aggregate production
96. Intellectual property rights and technological change
97. Education (especially graduate school education) and technological change
B. Study Questions
1. List at least five different goods that have been used for money.
2. What makes a particular good work well as money? Why would sand not make a good money? Why would fresh tomatoes not make a good money? Why does ice not make a good money? What about a gas? Why does money have to be a good rather than a service?
3. Why do even somewhat primitive societies develop a monetary system of some sort? In other words, why does barter trade not work well for a society?
4. We see how income affects consumption by looking at the consumption function. How do changes in interest rates affect consumption spending? How do changes in expectations affect consumption spending? What other factors affect the consumption spending and can cause shifts in the consumption function?
5. What are the dangers of having the decisions of Federal Reserve System subject to Congressional approval? In other words, why is the independence of the Fed important?
6. How did bank failures lead to the “Greatness” of the Great Depression?
7.
Why have we not had any runs on banks in the
8. How do banks create money by making loans to customers?
9. Neither gold nor silver backs our dollar bills. There are far fewer dollar bills than checking money (so dollar bills do no back our checking money). Why do people still accept payment by check? Are checks “legal tender?”
10. Instead of charging taxes to pay its bills, suppose the government started printing more money or issued debt which the Fed then “monetized.” What would soon happen?
11. What is held constant (employing “ceteris paribus“) and what is allowed to vary in the Keynesian cross diagram? In the aggregate demand/aggregate supply diagram?
12. Compare and contrast fiscal and monetary policy to
13. What will shift the short-run aggregate supply curve? The long-run aggregate supply curve?
14. What are the “twin deficits” and why do they move in the same direction?
15. How does monetary expansion affect aggregate demand? How does government spending increases affect aggregate demand? What about tax cuts?
16. What is the Ricardian equivalence theorem? Find the quote in Ricardo’s book, On the Principles of Political Economy and Taxation (URL: http://www.econlib.org/library/Ricardo/ricP.html), in ch. 17, paragraph 3. Also see Ch. 17 paragraph 5 for Ricardo’s caution concerning debt financing.
17. What is meant by the “roundabout means of production?” Why are savings needed to have investment in capital?
18. Why is technological change a type of entrepreneurship? How do incentives affect technological development?
C. Diagrams, equations and symbols
1. Aggregate Demand and short-run Aggregate Supply diagram
2. Aggregate Demand and long-run Aggregate Supply diagram
3. Keynsian cross diagram
4. M*V=P*Q (equation of exchange)
5. m + v = p + q (growth version of the equation of exchange, where lower case stand for the growth rates in the upper case variables (i.e., m is the annual rate of growth in the money supply, M)
6. Simple Bank Balance Sheet
7. Money multiplier equation(s)
8. Potential and actual GDP (time series diagram)