ECO 2023 Fall 2012 Study Guide For the Final ExamChapter 1• Economics -The study of how we make choices under scarcity.• Scarcity - The concept that there is less of a good freely available from nature than people would like.o Necessitates rationing.o Not the same thing as poverty.o Ex. Time, money, cars, etc.o Rationing - Allocating scarce goods to those who want them. In a market economy, price is used to ration goods.o Scarcity leads to competitive behavior.• Resources - An input used to produce an economic good.o Human resources (human capital).o Physical resources (physical capital).o Natural resources.o Capital - 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. Individuals are rational: They try to get the most from their limited resources• Greatest benefit at least possible cost. Ex.- Beer or liquor.3. Incentives matter: Choice is influenced in a predictable way by changing incentives.4. Individuals make decisions at the margin.• Marginal - Describes the effect of a change in the current situation.• Cost-benefit Analysis - One will undergo an action when the marginal benefits outweigh the marginal costs.5. Information helps us make better choices but is costly.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 Statements- The scientific study of what it (testable).• Normative Economic Statements - Judgments about what ought to be (not testable).• Four Pitfalls to Avoid in Economic Thinking -1. Violation of the ceteris paribus principle.• Ceteris Paribus - Other things constant.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.13. 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).• Macroeconomics - Focuses on how human behavior affects outcomes in highly aggregated markets such as the nations market for labor (the forest).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.• How Trade Leads to Economic Progress:1. Gains from specialization and division of labor.2. Gains from mass production methods.3. Gains from innovation.• Transaction Costs - The time, effort, and other resources needed to search out and complete an exchange.• Middlemen - A person who buys and sells goods or services or arranges trades. A 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.• Lack of property rights = lack of economic progress.• Production Possibilities Curve (PPC) - The PPC outlines all possible combinations of 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.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 - The purchase, construction, or development of resources.2. Changes in technology. Technology - The knowledge available in an economy at any given time.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.• Law of Comparative Advantage - The total output of a group of individuals, an entire 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?• Socialism - A system of economic organization where:1. Ownership and control of the means of production rest with the state.2. Resource allocation is determined by centralized planning.• Collective Decision Making - The method of organization that relies on public sector decision making to resolve basic economic questions.• Capitalism - A system of economic organization where:1. Productive resources are owned privately.2. Goods and resources are allocated through market prices.• Market Organization - A method of organization in which private parties make their own plans and decisions with the guidance of market prices.• Capitalism tends to work better than socialism because:31. 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 - The difference
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