ECON 0100 1st Edition Exam 1 Study Guide Chapters 1 6 Chapter 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 Questions 1 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 profit 2 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 Interest 1 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 regions 2 Information Age Monopolies 3 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 selfinterest Six Key Ideas Define The Economic Way Of Thinking 1 A choice is a trade off an exchange giving up one thing to get something else 2 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 services 3 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 else 4 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 time 5 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 to pay for an additional unit To describe preferences economists use the concepts of marginal benefit and marginal benefit curve Marginal benefit curve shows relationship between the marginal benefit from a good and the quantity consumed of that good unrelated to PPF The principle of decreasing marginal benefit the more we have of a good the small is its marginal benefit