Chapter 1 The Economic Approach 1 Distinguish between two types of economic statements on your own 2 What is Economics About a Economics tries to explain and predict the behavior of consumers firms and government b Scarcity and Tradeoffs Scarcity leads to tradeoffs which result in making choices i ii Historically mechanisms that have been used to deal with the problem of scarcity 1 Force 2 Tradition emphasized past ways relied on families 3 Authority government and church 4 Market 5 Combinations of 1 4 iii Scarcity requires that some wants remain unfulfilled iv Issues of equity justice and fairness are embedded with scarcity 3 The Economic Way of Thinking a There are always tradeoffs b i What you give up is your opportunity cost value of next best alternative ii Common mistake opportunity cost is NOT the sum of everything you give up iii There is no such thing as a free lunch Individuals choose purposefully i ii Also known as rational behavior Incentives Matter i As the incentive goes up you will be more likely to do something or try to and vice versa ii Referred to as economizing behavior try to get the most benefits for the least cost or effort Incentives don t have to be money d Think on the margin not in total or on average i Marginal means additional or incremental ii Marginal is additional iii Rule to live by Continue to engage in an activity as long as the expected marginal benefit is c greater than the expected marginal cost e More information leads to better decision making but more information is costly to get i Refer back to a through d for reasons f Many choices create a secondary effect The primary effect is often immediate and visible i ii The secondary effect usually comes later and is not visible g Value is subjective i Beauty is in the eyes of the beholder ii Value is determined by the purchaser h Economic thinking is scientific thinking i Economists use data and information generated by people to explain and predict actions 4 Positive and Normative Economics on your own the two statements 5 Pitfalls to Avoid in Economic Thinking a Don t make one of these errors i Violation of ceteris paribus other things constant 1 We want to isolate variables so we typically allow only one to change at a time ii Good intentions do not necessarily result in good outcomes iii Association is NOT causation iv Fallacy of Composition 1 Assumption What s good for the individual is good for the group 2 Making this assumption is the fallacy Chapter 2 Some Tools of the Economist 1 Define and recognize examples of opportunity costs on own 2 List society s three questions and specify the kinds of economic organizations on own 3 Trade Creates Value a Two opposing views of trade i When people trade one person gains and the other person loses b Voluntary trade creates wealth and promotes economic progress i With or without production with or without money exchanges voluntary trade is expected 1 Referred to as a zero sum game ii When people trade both parties gain 1 Wealth is actually created by trade to benefit both parties involved ii Potential trades 1 Finished goods exchanged through barter 2 Finished goods exchanged for money 3 Businesses buying resources 4 Consumers buying products 4 The Importance of Property Rights a Two kinds of property rights i Common rights everybody owns it ii Private rights only one person owns it b Property rights change the incentives for individuals c Incentives created by private property rights i Give proper care ii Conserve for the future iii Use resources in ways other people value iv Mitigate possible harm to others 5 Production Possibilities Curve a PPC also called PP Frontier Graph c A transaction cost is a monetary or nonmonetary barrier that lowers the benefits of trade c Law of Comparative Advantage i Make the good for which you have a low opportunity cost and trade for the good for which b Production Possibilities Curve can shift Shift Out growth produce more i ii Shift In shrink produce less Graph ii you have a high opportunity cost Importance of Comparative Advantage 1 Low opportunity cost 2 Comparative advantage 3 Specialization 4 Voluntary trade 5 Increased wealth Chapter 3 Supply Demand and the Market Process 1 Consumer Choice and the Law of Demand a Relationships Graph 2 The Law of Demand iii Self sufficiency is the quickest and most absolute path to poverty a The inverse relationship between price and quantity demanded when price rises quantity demanded falls Price rises quantity demanded falls price falls quantity demanded rises b Quantity demanded is a number its how many units of a good you bought c We usually draw a picture of this relationship Graph d Why is the demand curve downward sloping i Diminishing Marginal Utility 1 The marginal benefit you receive from an item falls as you gain more of the item 2 The only way to get you to buy more is to lower the price e How do consumers react to price changes i When the price of one good falls people substitute away from relatively more expensive goods to the relatively cheaper goods 1 The substitution effect ii When the price of one good falls real consumer income rises so people buy more it s like getting a raise 1 The income effect f Demand iii Both of these also cause the demand curve to be downward sloping i The Demand curve represents your willingness to pay your maximum price not how much you actually paid ii What if the actual price is lower than your willingness to pay 1 In economics we call this difference consumer surplus CS 2 Graph CS 3 Changes in Demand Versus Changes in Quantity Demanded a Demand is the relationship between two variables price and quantity demanded i Changes 1 When price changes quantity demanded changes but demand does NOT change a This is movement along the demand curve 2 When something else changes demand changes i e the relationship changes a This is movement of the entire curve ii Typical something else changes 1 Income 2 Number of consumers 3 Prices of related goods substitutes and complements 4 Expectations 5 Demographics 6 Tastes and preferences b Another way to think about the difference between demand and quantity demanded i Why is the consumer buying more or less ii iii If price is the reason then quantity demanded changes move along the demand curve If any variable besides price changes than the entire demand curve shifts c The price for one good can be intimately tied to demand for another good i Substitute goods used in place of each other 1 Ex a
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