Chapter 1 – The Economic Approach1) 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 governmentb) Scarcity and Tradeoffsi) Scarcity leads to tradeoffs which result in making choicesii) 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 1-4iii) Scarcity requires that some wants remain unfulfillediv) Issues of equity, justice and fairness are embedded with scarcity3) The Economic Way of Thinking a) There are always tradeoffsi) What you give up is your opportunity cost-value of next best alternativeii) Common mistake: opportunity cost is NOT the sum of everything you give upiii) There is no such thing as a free lunchb) Individuals choose purposefullyi) Referred to as economizing behavior-try to get the most benefits for the least cost or effortii) Also known as rational behaviorc) Incentives Matteri) As the incentive goes up, you will be more likely to do something (or try to), and vice versaii) Incentives don’t have to be moneyd) Think on the margin, not in total or on averagei) Marginal means additional or incrementalii) Marginal _____ is additional _____iii) Rule to live by: Continue to engage in an activity as long as the expected marginal benefit is greater than the expected marginal coste) More information leads to better decision-making, but more information is costly to geti) Refer back to (a) through (d) for reasonsf) Many choices create a secondary effecti) The primary effect is often immediate and visibleii) The secondary effect usually comes later and is not visibleg) Value is subjectivei) Beauty is in the eyes of the beholderii) Value is determined by the purchaserh) Economic thinking is scientific thinkingi) Economists use data and information generated by people to explain and predict actions4) Positive and Normative Economics (on your own, the two statements)5) Pitfalls to Avoid in Economic Thinkinga) 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 timeii) Good intentions do not necessarily result in good outcomesiii) Association is NOT causationiv) Fallacy of Composition(1) Assumption: What’s good for the individual is good for the group(2) Making this assumption is the fallacyChapter 2 – Some Tools of the Economist1) 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 Valuea) Two opposing views of trade:i) When people trade, one person gains and the other person loses(1) Referred to as a zero-sum gameii) When people trade, both parties gain(1) Wealth is actually created by tradeb) Voluntary trade creates wealth and promotes economic progressi) With or without production, with or without money exchanges, voluntary trade is expected to benefit both parties involvedii) Potential trades:(1) Finished goods exchanged through barter(2) Finished goods exchanged for money(3) Businesses buying resources(4) Consumers buying productsc) A transaction cost is a monetary or nonmonetary barrier that lowers the benefits of trade4) The Importance of Property Rightsa) Two kinds of property rightsi) Common rights – everybody owns itii) Private rights – only one person owns itb) Property rights change the incentives for individuals c) Incentives created by private property rights:i) Give proper careii) Conserve for the futureiii) Use resources in ways other people valueiv) Mitigate possible harm to others5) Production Possibilities Curvea) PPC also called PP FrontierGraphb) Production Possibilities Curve can shift i) Shift Out: growth produce moreii) Shift In: shrink, produce lessGraphc) Law of Comparative Advantagei) Make the good for which you have a low opportunity cost and trade for the good for which you have a high opportunity costii) Importance of Comparative Advantage(1) Low opportunity cost(2) Comparative advantage(3) Specialization(4) Voluntary trade(5) Increased wealthiii) Self-sufficiency is the quickest and most absolute path to povertyChapter 3 – Supply, Demand and the Market Process1) Consumer Choice and the Law of Demanda) Relationships: Graph2) The Law of Demanda) 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 boughtc) 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 pricee) 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 effectii) When the price of one good falls, real consumer income rises so people buy more (it’s like getting a raise)(1) The income effectiii) Both of these also cause the demand curve to be downward slopingf) Demandi) The Demand curve represents your willingness to pay (your maximum price), not how muchyou actually paidii) 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 Demandeda) Demand is the relationship between two variables: price and quantity demandedi) 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 curveii) 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 preferencesb) Another way to think about the difference between demand and quantity demandedi) Why is the consumer buying more (or less)?ii) If price is the reason, then quantity demanded changes; move along the demand curveiii) If any variable besides price
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