Final Economics Study Guide

This guide will help you prepare for your final economics exam. It explains the main topics clearly with simple definitions and examples. It also includes practice questions that are similar to what you might see on the test. The goal is to make studying easier and help you understand the material.

1.0

Core Macroeconomic Concepts

1.1 Business Cycles

Understanding business cycles is a key part of macroeconomics. These cycles are the natural ups and downs of a country's economic activity over time. Economists study them because they affect jobs, production, and how much money people have.

Definition: A business cycle is the repeated rise and fall of economic activity. These changes do not happen on a fixed schedule, but they usually follow a pattern.

The 4 Phases

Boom/Peak This is the highest point of the cycle. The economy is doing very well. Production is high, most people have jobs, and businesses are making money. The economy is working at its full limit.
Recession/Contraction After the peak, the economy slows down. This is called a recession. Production and income go down, and businesses do less activity. Because of this, unemployment (people without jobs) starts to go up.
Trough/Depression The trough is the lowest point. It is the end of the recession. At this stage, unemployment is very high, and many factories are not being used. If this stage is very bad and lasts a long time, it is called a depression.
Recovery/Expansion In this phase, the economy starts to grow again. Businesses hire more people, production increases, and incomes rise. The economy improves and moves toward the next peak.

Business Cycle Diagram

The cycle shows the economy moving up and down around a Growth trend line. The trend line shows long-term growth.

Practice Questions

"What is a business cycle? Describe the 4 main phases and explain what happens to the economy in each phase."
"Draw a business cycle graph. Label the axes (time and output), the trend line, and the 4 phases. Explain what happens to production during the 'Recovery' phase."

1.2 Unemployment and Its Types

Unemployment is very important in macroeconomics. It shows the health of the economy. High unemployment means the economy is struggling, while low unemployment is a good sign.

Key Definitions

Unemployment: When people who are old enough to work do not have a job but are actively looking for one.
Labor Force: All the people who are either working or looking for work.
Full Employment: This does NOT mean 0% unemployment. It means there is no "cyclical" unemployment (unemployment caused by a recession). Some people will always be between jobs.

Formulas

Unemployment Rate = (Number of Unemployed / Labor Force) * 100

Natural Level of Unemployment = Frictional + Structural Unemployment

Frictional Unemployment

Short-term unemployment. This happens when people are moving between jobs or looking for their first job (like new graduates). It is normal and unavoidable.

Structural Unemployment

This happens when there is a mismatch. The workers' skills do not match the available jobs. This can happen because of new technology (machines replacing people) or changes in what people buy.

Cyclical Unemployment

This is caused by the business cycle. When demand for goods is low (like in a recession), companies lay off workers. This type of unemployment goes up during bad economic times.

Practice Questions

"Define unemployment and labor force. List the three main types of unemployment. Explain each one with an example."
"A student just graduated and is looking for her first job. What type of unemployment is this? Why? Can a country have 0% unemployment? Explain using the idea of 'full employment'."

2.0

Consumer Behavior

2.1 Ordinal Utility Theory

This theory explains how people make choices. It says that people don't measure satisfaction with numbers (like "50 happiness points"). Instead, they simply rank what they like.

Definition: In the ordinal approach, a consumer ranks their choices in order (1st, 2nd, 3rd) instead of giving them a score.

Main Assumptions

Rational Consumers: People want to get the most satisfaction possible with the money they have.
Ordinal Utility: Consumers can say "I like A more than B," but they don't say "how much" more.
Diminishing Marginal Rate of Substitution (MRS): If you have a lot of Item A, you are willing to give up some of it to get Item B. But as you get more and more of Item B (and have less of Item A), you become less willing to trade.
Consistency: If you like Pizza more than Burger, and Burger more than Salad, then you MUST like Pizza more than Salad.

2.2 Indifference Curves

Indifference Curve: A line on a graph that shows different combinations of two goods that give the consumer the same level of happiness.

Indifference Map: A group of these curves shown together.

4 Important Rules

Slope down: To get more of one good while staying equally happy, you must give up some of the other good.
Convex to the origin (curved inward): This happens because of Diminishing MRS. The curve gets flatter as you go right.
Higher is better: Curves that are higher up and to the right mean you have more goods. People prefer more goods to fewer goods.
Never cross: Indifference curves cannot intersect. If they did, it would be illogical because one point cannot have two different levels of happiness.

Indifference Map

Practice Questions

"What are the main assumptions of ordinal utility theory? Explain each one simply."
"What is an indifference curve? Draw one and explain why it slopes downward and curves inward. Why can't two indifference curves ever cross?"

3.0

Theory of Costs

A firm's costs are very important for deciding prices and how much to produce. In the short run, at least one thing (like the size of the factory) cannot change.

3.1 Cost Types

TFC (Total Fixed Cost): Costs that stay the same no matter how much you produce (e.g., rent). You pay this even if you produce nothing.
TVC (Total Variable Cost): Costs that change when you produce more (e.g., raw materials, wages).
TC (Total Cost): Fixed Cost + Variable Cost.
AFC (Avg Fixed Cost): Fixed Cost divided by quantity. It always goes down as you produce more.
AVC (Avg Variable Cost): Variable Cost divided by quantity. It is U-shaped.
MC (Marginal Cost): The extra cost to produce one more unit.

Why curves are U-shaped

The curves are U-shaped because of the law of diminishing returns.

This means that as you add more workers to the same machines, eventually each new worker adds less value, so it becomes more expensive to produce more.

Short-Run Cost Curves

Key Relationships:

The Marginal Cost (MC) line cuts through the lowest point of the Average Cost (AC) and AVC lines.
When MC is below Average, the Average goes down. When MC is above Average, the Average goes up.

Practice Questions

"Define AFC, AVC, AC, and MC. Why are the cost curves usually U-shaped?"
"Draw a graph showing AFC, AVC, AC, and MC curves. Make sure to label everything. Explain why the MC curve must cross the AC curve at its lowest point."

4.0

Market Structures

4.1 Perfect Competition

This is a theoretical market where competition is perfect.

Many Sellers & Buyers: No single company is big enough to change the price. Firms are "Price Takers".
Identical Products: Every seller sells the exact same thing (like wheat or corn).
Easy Entry/Exit: Anyone can start or stop a business easily.
Perfect Information: Everyone knows all the prices.

4.2 Oligopoly

A market dominated by a few big companies.

Few Dominant Firms: A few large companies control most of the sales.
Interdependence: This is the most important part. What one company does (like lowering prices) directly affects the others. They watch each other closely.
Barriers to Entry: It is hard for new companies to start (expensive, patents).
Non-Price Competition: They compete with advertising and quality, not just price.

Feature	Perfect Competition	Monopolistic Comp	Oligopoly	Monopoly
Number of Firms	Very Many	Many	Few Big Ones	One
Product Type	Identical	Similar but different	Mixed	Unique
Control Over Price	None (Price Taker)	A little	Some	Total (Price Maker)
Entry Difficulty	Very Easy	Easy	Hard	Impossible/Blocked

Practice Questions

"What are the main rules of Perfect Competition? Why is a firm here called a 'price taker'?"
"Compare Perfect Competition and Oligopoly. Look at the number of firms, the type of product, and how hard it is to start a business."
"Make a table that shows the differences between the four market types: perfect competition, monopolistic competition, oligopoly, and monopoly."

5.0

Problem Solving

5.1 Externalities

An externality is a side effect. It happens when a transaction between two people affects a third person who wasn't involved.

Negative Externality: A harmful side effect. Example: A factory pollutes a river. The factory makes money, but the people living nearby suffer from the pollution.

5.2 How to Solve Cost and Profit Problems

Guide: Maximizing Profit

Perfect Competition

Goal: Find the quantity (q) that makes the most profit.
Golden Rule: Produce at the point where Marginal Revenue (MR) = Marginal Cost (MC).

Example Problem:
Price (P) = $10
Total Cost (TC) = 2 + 10q - 4q² + q³

Find MR: In perfect competition, MR equals the Price. So, MR = 10.
Find MC: Take the derivative of TC. MC = 10 - 8q + 3q².
Set MR = MC: 10 = 10 - 8q + 3q². Solve for q. (Result: q=0 or q=8/3).
Check the Slope: MC must be rising (slope is positive). At q=8/3, the slope is positive, so this is the correct answer.

Shutdown Point: A firm stops producing if the Price is lower than the minimum Average Variable Cost (AVC).
If you are losing more money by operating than by closing, you should close.

Summary

Step 1: MR & MC

MR = 10

MC = 10 - 8q + 3q²

Step 2: Answer

q = 8/3

This is the quantity where profit is highest.

Practice Question

"A firm faces a price of 4 birr. Its total cost function is TC = (1/3)Q³ - 5Q² + 20Q + 50. What output level maximizes profit? What is the total profit?"

Quiz

They are opposites. When workers are very productive (high MPL), costs are low (low MC). When workers become less productive (diminishing returns), costs go up.