ECO2013 Exam 1 10 2 13 Chapter 1 The Economic Approach Economics is the study of human behavior with a particular focus on human decision making Adam Smith An Inquiry into the Nature and Causes of the Wealth of Nations 1776 free exchange and competitive markets would harness self interest as a creative force invisible hand Economics is about scarcity would like wealth of a nation lies in goods and services produced and consumed not in gold and silver Scarcity occurs when there is less of a good or resource available from nature than people Choice is the act of selecting alternatives the result of scarcity Scarcity Tradeoffs Choices Human resources are the productive knowledge skill and strength of human beings Physical resources are the tools machines and buildings that enhance our ability to produce goods also referred to as capital Natural resources are the things like land mineral deposits oceans and rivers up to humans to make natural resources for production Mechanisms that have been used to deal with the problem of scarcity one or multiple Scarcity and poverty are not equal scarcity is objective poverty is subjective 1 Force 2 Tradition 3 Authority 4 Market Scarcity makes rationing a necessity Hint if you have to pay for something it is scarce competition is a natural outgrowth of scarcity and the desire of human beings to improve their competition among business firms for customers results in newer better and less expensive encourages discovery and innovation two important sources of growth and higher conditions goods and services living standards Economic theory is a set of definitions postulates and principles assembled in a manner that makes clear the cause and effect relationships 8 Guideposts to Economic Thinking 1 The use of scarce resources is costly so decision makers must make trade offs a Opportunity cost is the highest values alternative that is sacrificed 2 Individuals choose purposefully they try to get the most from their limited resources a Economizing behavior choosing the option that offers the greatest benefit at the least b Result of rational decision making c Utility subjective benefit or satisfaction a person expects from a choice or course of possible cost action 3 Incentives matter changes in incentives influence human choices in a predictable way Both monetary and nonmonetary incentives matter a Basic postulate of economics when an option becomes more attractive people will be more likely to choose it b People are motivated by a variety of goals 4 Individuals make decisions at the margins a Focus on the difference in the costs and the benefits between alternatives i Called marginal decision making ii Additional is often used for a substitute for marginal 5 Information is costly a Time needed to gather it is scarce b Limited knowledge and uncertainty about the outcome generally characterize the 6 Beware the secondary effects economic actions often generate indirect as well as direct decision making process effects a May be observable only with time b When a change alters incentives unintended consequences that are quite different from the intended consequences may occur 7 Value of a good or service is subjective a Preferences differ b In economics all individuals preferences are counted equally 8 The test of a theory is its ability to predict a As actual conditions change an economic theory can be tested by comparing its predictions with real world outcomes Scientific positive is the study of the what is in economic relationships involves potentially verifiable or refutable propositions doesn t have to be correct just testable Normative economics is the study of what ought to be Ceteris paribus means other things constant helps to describe the effects of one change cannot be proven false validity rests on value judgments Good intents are not enough Association is NOT causation not only a statistical association if so fallacy called post hoc propter ergo hoc Fallacy of composition erroneous view that what is true for the individual will also be true for the group micro and macro view required micro focuses on decision making of consumers producers and resource suppliers for a specific good resource macro focuses on how the aggregation of individual micro units affects our analysis total consumption spending economy as a whole Chapter 2 Some Tools of the Economist Failure to consider opportunity cost often leads to unwise decision making Potential trades barter and money 2 Important Concepts of Voluntary Exchange 1 When individuals engage in voluntary exchange both parties are made better off a Trade does not create new material items b An exchange will not occur unless both parties agree to it and they will not do so unless the exchange makes them better off 2 By channeling goods and resources to those who value them most trade creates value and increases the wealth created by a society s resources a Trade can create value by moving goods from those who value them less to those who value them more b Material things are not wealth until they are in the hands of someone who values them Low opportunity cost comparative advantage specialization division of labor voluntary trade increased wealth Transaction costs are the time effort and other resources needed to search out negotiate and complete an exchange reduction in transaction costs will increase the gains from trade Internet helps lower transaction costs Middlemen provide buyers and sellers information at a lower cost and arrange trades between them ex Car dealers grocers Private property rights involve 3 things Property rights the rights to use control and obtain the benefits from a good or resource 1 The right to exclusive use of the property that is the owner has sole possession control 2 and use of the property including the right to exclude others Legal protection against invasion from other individuals who would seek to use or abuse the property without the owner s permission 3 The right to transfer sell exchange or mortgage the property Common ownership occurs when multiple people own a good or resource no one can prevent another owner from using or damaging the property Private ownership provides people with a strong incentive to take care of things and develop resources in ways that are highly valued by others clearly defined and enforced private property rights are a key to economic progress because of the powerful incentive effects that private ownership generates 1 Private owners can
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