ECO 2023 Fall 2012 Study Guide For the Final Exam Chapter 1 Economics Scarcity people would like The study of how we make choices under scarcity The concept that there is less of a good freely available from nature than Allocating scarce goods to those who want them In a market o Necessitates rationing o Not the same thing as poverty o Ex Time money cars etc o Rationing economy price is used to ration goods o Scarcity leads to competitive behavior o Human resources human capital o Physical resources physical capital o Natural resources o Capital Resources An input used to produce an economic good Human made resources used to produce other goods and services 8 Guideposts to Economic Thinking 1 Resources are scarce so decision makers must make tradeoffs Opportunity Cost The highest valued alternative that must be sacrificed when choosing an option Ex An hour of you time how you spend your next 15 etc 2 3 4 Individuals are rational They try to get the most from their limited resources Greatest benefit at least possible cost Ex Beer or liquor Incentives matter Choice is influenced in a predictable way by changing incentives Individuals make decisions at the margin Marginal Cost benefit Analysis Describes the effect of a change in the current situation One will undergo an action when the marginal benefits outweigh the marginal costs Information helps us make better choices but is costly 5 6 Beware of secondary effects Economic actions generate both direct and indirect effects 7 The value of a good or service is subjective 8 The test of a theory is its ability to predict Positive Economic Normative Economic Statements Four Pitfalls to Avoid in Economic Thinking 1 Violation of the ceteris paribus principle Ceteris Paribus Other things constant Statements The scientific study of what it testable Judgments about what ought to be not testable 2 The belief that good intentions equal desirable outcomes The Nirvana Fallacy The logical error of comparing the actual situation with its idealized counterpart rather than the actual alternative 1 3 The belief that association is causation 4 The fallacy of composition The fallacious belief that what is true for one is true for all Microeconomics Focuses on how human behavior affects the conduct of affairs within individually defined units such as households or firms the trees aggregated markets such as the nations market for labor the forest Focuses on how human behavior affects outcomes in highly Macroeconomics Chapter 2 Because the value of goods is subjective voluntary trade creates value 1 When individuals engage in voluntary exchange both parties are made 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 The time effort and other resources needed to search out and A person who buys and sells goods or services or arranges trades A How Trade Leads to Economic Progress Middlemen Transaction Costs 1 Gains from specialization and division of labor 2 Gains from mass production methods 3 Gains from innovation complete an exchange middleman reduces transaction costs Private Property Rights 1 The right to exclusive use of the property 2 Legal protection against invasion from other individuals 3 The right to sell transfer exchange or mortgage the property o 4 Incentives of Property Rights Incentive to use resources in ways that are considered beneficial to others Owners bear the cost of ignoring the wishes of others Private owners have an incentive to care for and manage what they own Private owners have an incentive to conserve for the future Private owners have an incentive to make sure their property does not damage your property Production Possibilities Curve PPC Lack of property rights lack of economic progress total output that could be produced assuming a 1 Fixed amount of productive resources 2 Given amount of technical knowledge 3 Full and efficient use of resources o A PPC is bowed outward because of the concept of increasing opportunity costs The PPC outlines all possible combinations of 2 o Efficient Points B D and C o Inefficient Points A o Unattainable Points X Four Factors that Shift the PPC 1 A change in the economy s resource base Investment 2 Changes in technology Technology time The purchase construction or development of resources The knowledge available in an economy at any given 3 A change in the rules under which our economy functions 4 Changes in work habits Ex Working harder Shift outward Working less Shift inward The total output of a group of individuals an entire Socialism Law of Comparative Advantage A system of economic organization where economy or a group of nations will be greatest when the output of each good is produced by whoever has the lowest opportunity cost 3 Questions Economy Faces 1 What will be produced 2 How will it be produced 3 For whom will it be produced 1 Ownership and control of the means of production rest with the state 2 Resource allocation is determined by centralized planning decision making to resolve basic economic questions 1 Productive resources are owned privately 2 Goods and resources are allocated through market prices own plans and decisions with the guidance of market prices Capitalism tends to work better than socialism because A system of economic organization where Collective Decision Making Market Organization Capitalism A method of organization in which private parties make their The method of organization that relies on public sector 3 1 Capitalism is similar to natural selection It uses the idea of market efficiency 2 Socialism suffers from an information problem Chapter 3 Law of Demand There is an inverse negative relationship between the price of a good and the quantity that buyers are willing to purchase o Results in a downward sloping demand curve o As price increases quantity demanded decreases o The height of the demand curve at any quantity shows the maximum price that consumers are willing to pay for an additional unit o When consumers have more of a good they value it less Consumer Surplus be willing to pay and the amount that they actually pay The difference between the maximum amount consumers would o Consumer surplus is the area below the demand curve but above the price Change in Quantity Demanded A movement along the curve Caused by o A change in the price of that good o Increase in quantity demanded Movement down the curve to the right o Decrease in quantity
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