ECON 0100 1st EditionExam # 1 Study Guide Chapters: 1 - 6Chapter 1 - Economy- “The one who manages households” - The study of choices and their consequences- We want more than we can get- Our inability to satisfy all we want = scarcity- Because of scarcity we must make choices- Choices depend on incentives (a reward that encourages an action or a penalty that discourages an action)- Economics - The social science that studies the choices that individuals, businesses, governments,and entire societies make as they cope with scarcity and the incentives that influences and reconcile those choices- Microeconomics – individuals and businesses and their choices, the way these choices interact in markets, and the influence of governments- Macroeconomics – performance of the national economy and the global economy- Two Big Economic Questions1. How do choices end up determining what, how, and for whom goods and services are produced?- Goods/Services = objects that people value and produce to satisfy human wants- What? Percent of total production (agriculture, services, goods)- How? Goods/services are produced using productive resources called factors of production Land – natural resources Labor – effort of humans, quality depends on knowledge, skill, experience (human capital) Capital – tools businesses use to produce goods/services Entrepreneurship – human resource that organizes land, labor, and capital- For whom? Depends on individuals income Land earns rent Labor earns wages (most income) Capital earns interest Entrepreneurship earns profit2. Does the pursuit of self-interest unintentionally promote the social-interest?- People make choices to pursue self-interest- Social-interest benefits society as a whole Efficiency – resource use is efficient if it is not possible to make someone better off without making someone else worse off Equity – fairness, variety of views about what is fair, does social-interest require “fair-shares”- Four Topics That Illustrate Tension Between Self- and Social-Interest1. Globalization – the expansion of international trade, borrowing and lending, and investment- Self-interest of consumers: low cost goods/services produced in other countries- Self-interest of multinational firms: produce in low-cost regions, sell in high-cost regions2. Information Age Monopolies3. Climate Change - 2/3 of the Carbon emissions from USA, Russia, EU, China, and India- It is in our self-interest to use electricity and gasoline 4. Economic Instability - 1993-2007 incomes in the USA increased 30%- August 2007  financial stress- Lending and borrowing choices of banks and individuals were made in self-interest- Six Key Ideas Define The Economic Way Of Thinking1. A choice is a trade-off: an exchange, giving up one thing to get something else2. People make rational choices by comparing benefits/costs - A rational choice achieves the greatest benefit over cost for the person making the choice  answers the question what goods/services3. Benefit is what you gain from something- Determined by preferences (what a person likes/dislikes)- The most a person is willing to give up for something else4. Cost is what you must give up to get something - Opportunity cost = highest valued alternative that must be given up- The things you can’t afford to buy and the things you can’t do with your time5. Most choices are “how much” choices made at the margin- To make a choice at the margin, evaluate the consequences of making incremental changes in the use of your time- Benefit from an increase in an activity  Marginal Benefit (MB)- Opportunity cost of an increase in an activity  Marginal Cost (MC)- Marginal benefit > marginal cost = rational choice  do more of that activity 6. Choices respond to incentives- Change in marginal cost/benefit  change in incentives  change in choice made- Predict how choices change by looking at changes in incentives- Incentives = key to reconciling self- and social-interest - Economics As a Social Science- How the economic world works- Positive Statement – what is; can be tested by checking it against the facts- Normative Statement – what ought to be; expresses an opinion and cannot be tested (policy goals) Economists test economic models (description of some aspect of the economic world that includes only those features that are needed for the purpose at hand  Compare predictions and facts; also use natural and economic experiments and statistical investigations - Economics As a Policy Tool- Economics – toolkit for advising government, businesses, and individuals- Policy questions involve positive and normative- Normative part is the goal  economists can’t help For a given goal, economists provide a method of evaluating alternative solutions – comparing marginal benefits/costs Chapter 2 - If we want to increase production of one good, we must decrease production of something else  trade-off- Production Possibilities Frontier (PPF): the boundary between those combinations of goods and services that can be produced and those that cannot To illustrate PPF focus on 2 goods at a time, hold quantities of all other goods constant (model economy) (ceteris paribus) Illustrates scarcity because points outside the frontier are unattainable Points inside the frontier are attainable but inefficient- Production Efficiency – we cannot produce more of one good without producing less of another good We produce goods at lowest possible cost Occurs at all points on the PPF - Production inside the PPF  inefficient Resources are unused (idle but could be working) Resources are misallocated (assigned to tasks for which they are not the best match) - Trade-off along the PPF  Opportunity cost is a ratio (decrease of one good/increase of other good)- PPF bows outward because resources are not equally productive in all activities  As the quantity produced of each good increases, so does its opportunity cost Best point on the PPF = where goods/services are produced in the quantities that provide the greatest possible benefit and at the lowest possible cost  allocative efficiency- Marginal cost calculated from slope of PPF  Steeper slope = higher marginal cost- Marginal benefit from a good/service = benefit received from consuming one more unit of it This benefit is subjective – based on preferences Measured by how much someone is willing