Exam 1 Study Guide: Lectures 1-6Lecture 1: The Big Ideas (1-3)Define: - Economy: One who manages a household- Scarcity: the limited nature of society’s resources- Economics: The study of how society manages its scarce resourcesCentral Idea: - The household must allocate scarce resources among its various members, taking into account each member’s abilities, efforts, and desires. - Economics is how people decide what to buy, how much to work, and how much to save and spend- Firms decide how much to produce, and how many workers to hire.- Society decides how to divide its resources between welfare programs, consumer goods, and rational defense. Chapter One: The Ten Big Ideas1. People respond to incentives.a. Incentive: something that induces a person to act; the prospect of a reward or punishment. b. Ex.: When gas prices rise, consumers will buy more hybrid cars and fewer SUV’s. 2. Markets are usually a good way to organize economic activity.a. Market: group of buyers and sellers. They organize economic activity and determine what goodsto produce, how to produce them, how much of each to produce, and who gets them.3. People face trade-offs.a. Efficiency: When society gets its most from scarce resources.b. Equality: When prosperity is distributed uniformly among society’s members.  Central Idea: - Society faces an important trade-off: Efficiency vs. equality or guns vs. butter.- Opportunity cost: making decisions requires comparing costs and benefits of alternative choices. ECON 1 1st EditionLecture 2: The Big Ideas (4-7) Cont. 4. Rational people think at the margin.a. Rational people make decisions by evaluation the costs and benefits of marginal changes and include incremental adjustments to an existing plan. b. Ex.: Sleep more or wake up early to avoid trafficc. It is better to get something rather than nothing.5. The power of tradea. Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for goods. b. Countries can get a better price abroad for goods they produce. They also buy other goods more cheaply from abroad that could be produced at home. 6. The importance of wealth and economic growtha. A country’s standard of living depends on its ability to produce goods and services. b. Productivity: The quantity of goods and services produced from each unit of labor input. i. The most important determinant of living standards is productivity. It depends on the equipment, skills, technology, and available workers. 7. Institutions matter.a. Why are some countries rich and others poor? Because of lacking incentives.i. Role of governmentenforce property rights. People are less inclined to work, produce, invest, or purchase if there is large risk of their property being stolen. b. Market failure: occurs when the market fails to allocate society’s resources efficiently. i. Causes for market failure?1. Externalities: When production or consumption of a good affects bystanders. 2. Market power: When a single buyer or seller has substantial influence on market price.Lecture 3: The Big Ideas (8-10) Cont. and the Power of Trade and Comparative Advantage8. Economic booms and bursts cannot be avoided but they can be regulated (moderated).a. Policy makers use fiscal or monetary policy to smooth out economic volatility. i. Monetary: How much money is printed ii. Fiscal: Tax and regulationsb. Factors that decide whether to print out money:i. Inflationii. Natural disastersiii. Gross Domestic Productiv. Manufacturing9. Prices rise when the government prints too much money.a. Inflation: an increase in the overall level of prices in an economyi. Long run effects: If there is an overflow of money, prices have to rise to keep a balance.ii. Short run effects: It makes the purchase power increase. 1. Result of higher demand may cause firms to raise their prices over time, but in the meantime it encourages them to hire more workers and produce a larger quantity of goods and serviceslower unemployment. 10. Central banking is a hard job. a. Too much money=inflation but not enough=recession.b. Ex.: Investors move money from Greek banks and look at the rest of Europe banks to invest theirmoney. They see Spain is not doing so well. As an investor, they take money out of the Spanish banks. In the end Spain becomes affected. Spain owes money to France, so now France goes down. Now all of Europe is in trouble. We’re linked to Europe, so now we’re affected, not as much as European countries but somewhat. This is how the international market comes into play. Chapter Two: The Power Trade and Comparative Advantage  Central ideas: o Trade makes people better off when preferences differ.o Trade increases productivity through specialization, the division of knowledge, and through comparative advantage.- Production Possibilities Frontier (PPF): Graph that shows combinations of output that the economy can possibly produce given the available factors and production technology.o ***Ex.: Trade between two individuals and two goods. A cattle rancher and a potato farmer.  If the cattle rancher is better at his specialty and at producing potatoes, should he trade?Q: How would you quantify this added benefit? Without trade: Minimum neededto make 1 oz ofAmountproduced in8 hoursFarmer Meat: 60 min/ozPotatoes: 15 min/ozMeat: 8oz Potatoes: 32 oz Rancher Meat: 20 min/ozPotatoes: 10 min/ozMeat: 24 oz Potatoes: 48 ozConclusion: Rancher is better at both!Amount cutin halfMeat PotatoesFarmer (A) 4 oz 16 0zRancher (B) 12 oz 24 ozThe two top graphs demonstrate the comparison with the Farmer’s PPF and the rancher’s PPF. Lecture 4: Specialization and Trade/The Price of Tradeo Specialization and Trade:o Q: How can the farmer and rancher be better off by trading?o Let’s say that the farmer decides to spend all 8 hours producing potatoes (specializing). The rancher spends 6 hours/day raising cattle and 2 hours/day growing potatoes. What happens? Meat PotatoesFarmer 0 oz 32 ozRancher 18 oz in 6 hrs 12 oz in 6 hoursProductionWith trade: Farmer Meat PotatoesRancherMeat PotatoesProduction 0 oz 32 oz 18 oz 12 ozTrade Get 5 oz give 15 oz Give 5oz get 15 ozConsumption 5 oz 17 oz 13 oz 27 ozWithout Trade 4 oz 16 oz 12 oz 24 oz Gains +1 oz +1 oz +1 oz +3 oz They can