ECO2013 Exam 1 10/2/13Chapter 1: The Economic ApproachEconomics 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”-wealth of a nation lies in goods and services produced and consumed, not in gold and silverEconomics is about scarcity!Scarcity occurs when there is less of a good or resource available from nature than people would like.Choice is the act of selecting alternatives: the result of scarcity.ScarcityTradeoffsChoicesHuman 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 capitalNatural resources are the things like land, mineral deposits, oceans, and rivers -up to humans to make natural resources for productionScarcity and poverty are not equal.-scarcity is objective-poverty is subjectiveMechanisms that have been used to deal with the problem of scarcity (one or multiple)1. Force2. Tradition3. Authority 4. MarketScarcity 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 conditions-competition among business firms for customers results in newer, better, and less expensive goods and services-encourages discovery and innovation, two important sources of growth and higher living standardsEconomic theory is a set of definitions, postulates, and principles assembled in a manner that makes clear the “cause and effect” relationships8 Guideposts to Economic Thinking1. 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 possible cost.b. Result of rational decision-making.c. Utility: subjective benefit or satisfaction a person expects from a choice or course of action3. 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 goals4. 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 scarceb. Limited knowledge and uncertainty about the outcome generally characterize the decision making process6. Beware the secondary effects: economic actions often generate indirect as well as direct effects.a. May be observable only with timeb. 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 differb. 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 testableNormative economics is the study of “what ought to be”-cannot be proven false-validity rests on value judgmentsCeteris paribus means “other things constant”, helps to describe the effects of one changeGood intents are not enoughAssociation is NOT causation-not only a statistical association-if so, fallacy called post hoc propter ergo hocFallacy 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 wholeChapter 2: Some Tools of the EconomistFailure to consider opportunity cost often leads to unwise decision makingPotential trades= barter and money2 Important Concepts of Voluntary Exchange1. When individuals engage in voluntary exchange, both parties are made better off.a. Trade does not create new material itemsb. 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 costcomparative advantage specializationdivision of laborvoluntary tradeincreased wealthTransaction 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 costsMiddlemen provide buyers and sellers information at a lower cost and arrange trades between them.-ex. Car dealers, grocersProperty rights: the rights to use, control, and obtain the benefits from a good or resourcePrivate property rights: involve 3 things1. The right to exclusive use of the property (that is, the owner has sole possession, control and use of the property, including the right to exclude others).2. 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 propertyCommon ownership occurs when multiple people own a good or resource; no one can prevent another owner from using or damaging the propertyPrivate 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
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