Chapter 1 and 2 Notes Intro resources employed in the economic system or simply the economy help us produce goods and services that satisfy many of our economic wants reality is that our economic wants far exceed the productive capacity of our scarce limited resources We are forced to make choices This unyielding truth underlies the definition of economics o Definition The social science concerned with how individuals institutions and society make optimal best choices under conditions of scarcity o It s a social science concerned with how individuals institutions and society make optimal best choices under conditions of scarcity The Economic Perspective Economists view things from a unique perspective This economic perspective or an economic way of thinking has several critical and closely interrelated features o Definition A viewpoint that envisions individuals and institutions making rational decisions by comparing the marginal benefits and marginal costs associated with their actions Scarcity and Choice Scarce economic resources mean limited goods and services Scarcity restricts options and demands choices o Because we can t have it all we must decide what we will have and what we must forgo At the core of economics is the idea that there is no free lunch o You may be treated to lunch making it free from your perspective but o all resources are either privately or collectively owned by members of society someone bears a cost ultimately society bears the cost o society could have used these resources to produce something else it sacrifices those other goods and services in making the lunch available called opportunity costs Definition The amount of other products that must be forgone or sacrificed to produce a unit of a product To obtain more of one thing society forgoes the opportunity of getting the next best thing That sacrifice is the opportunity cost of the choice Purposeful behavior Utility Economics assumes that human behavior reflects rational self interest Individuals look for and pursue opportunities to increase their utility o Definition The want satisfying power of a good or service the satisfaction or pleasure a consumer obtains from the consumption of a good or service or from the consumption of a collection of goods and services the pleasure happiness or satisfaction obtained from consuming a good or service They allocate their time energy and money to maximize their satisfaction they weigh costs and benefits their economic decisions are purposeful or rational not random or chaotic Consumers are purposeful in deciding what goods and services to buy o Examples Business firms are purposeful in deciding what products to produce o Government entities are purposeful in deciding what public services to provide and how to produce them and how to finance them Purposeful behavior does not assume that people and institutions are immune from faulty logic and therefore are perfect decision makers o They make mistakes o economists acknowledge that people are sometimes impulsive or emulative Purposeful behavior simply means that people make decisions with some desired outcome in mind Rational self interest is not the same as selfishness o In the economy increasing one s own wage rent interest or profit normally requires identifying and satisfying somebody else s wants o People make personal sacrifices for others They contribute time and money to charities because they derive pleasure from doing so o These self interested but unselfish acts help maximize the givers satisfaction as much as any personal purchase of goods or services Self interested behavior is simply behavior designed to increase personal satisfaction however it may be derived Marginal Analysis Cost s and Benefit s The economic perspective focuses largely on marginal analysis o Definition The comparison of marginal extra or additional benefits and marginal costs usually for decision making comparisons of marginal benefits and marginal costs usually for decision making To economists marginal means extra additional or a change in Each option involves marginal benefits and because of scarce resources marginal costs In making choices rationally the decision maker must compare those two amounts o Example marginal benefit is the perceived lifetime pleasure utility from the larger size stone o If the marginal benefit of the larger diamond exceeds its marginal cost and you can afford it buy the larger stone o But if the marginal cost is more than the marginal benefit you should buy the smaller diamond instead even if you can afford the larger stone In the world of scarcity the decision to obtain the marginal benefit associated with some specific option always includes the marginal cost of forgoing something else The money spent on the larger size diamond means forgoing some other product o An opportunity cost the value of the next best thing forgone is always present whenever a choice is made Theories Like the physical and life sciences as well as other social sciences economics relies on the scientific method o Definition The procedure for the systematic pursuit of knowledge involving the observation of facts and the formulation and testing of hypotheses to obtain theories principles and laws That procedure consists of several elements Observing real world behavior and outcomes Based on those observations formulating a possible explanation of cause and effect Testing this explanation by comparing the outcomes of specific events to the outcome hypothesis predicted by the hypothesis Accepting rejecting and modifying the hypothesis based on these comparisons Continuing to test the hypothesis against the facts If favorable results accumulate the hypothesis evolves into a theory A very well tested and widely accepted theory is referred to as an economic law or an economic principle o Definition A widely accepted generalization about the economic behavior of individuals or institutions o A statement about economic behavior or the economy that enables prediction of the probable effects of certain actions o Combinations of such laws or principles are incorporated into models which are simplified representations of how something works such as a market or segment of the economy Economists develop theories of the behavior of individuals consumers workers and institutions businesses governments engaged in the production exchange and consumption of goods and services o Theories principles and models are purposeful simplifications