Chapters 1 3 Study Guide 02 05 2013 Chapter 1 The Economic Approach What is economics about Economics is about scarcity and the choices we have to make because our desire for goods and services is far greater than their availability from nature Four major types of resources The four major types are Resources are the ingredients inputs that people use to produce goods and services Resource Input Land Type Natural Labor Capital Mental Physical Physical Financial Return Output Rent Wage Interests Profit Entrepreneurship Scarcity vs Poverty Scarcity Positive Economics Testable Objective True False Scarcity Poverty Normative Economics Opinion Subjective Opinion Based Asks the question if the price were to be 0 would there be enough Indicates there is less of a good freely available from nature than people would like Positive economics testable concrete yes no The number set to define poverty is based off of some statistics but primarily based off Poverty of opinion Has to do with choice I e In 2010 21 000 total income for a family of 4 was the cut off for poverty Imagine that same family living in Haiti with 21 000 year Economic Way of Thinking Principles of Economic Thinking 1 There is always a trade off We call this trade off our opportunity cost Opportunity cost is what you give up when you do something else When you use resources you re always giving up the opportunity to use them in a It is the most highly valued alternative you could be doing when you are doing different way something If we subsidize losses bailouts the government is supporting the misuse of resources I e seatbelts cost 50 billion year and save 400 lives year Could that 50 billion year be used for something like cancer research that could potentially save 500 lives year Everything has a cost 2 Individuals choose purposefully and therefore economically Trying to get the most for least When things cost the same what gives you the most satisfaction in the end or utility Utility the subjective benefit or satisfaction a person expects from a choice or course of action People behave rationally I e if three things give you the same utility you choose the one that costs the least This cost is a total cost it includes transaction cost opportunity cost etc Transaction cost total cost that it takes to make the transaction Negative incentives i e you will pay me 50 if you do this handicapped parking spots 3 Incentives Matter You can get anything you want with the right incentives Positive vs negative incentives Positive incentives i e I will pay you 50 if you do this People respond to incentives in a predictable way Intended consequences vs actual consequences 4 Economic Thinking is Marginal Thinking People make decisions at the margin What it costs to do one additional thing Describes the effects of a change in the current situation I e what the extra cost is for the producer to produce one additional unit Change from the status quo 5 Information is a Costly Good Implies rational ignorance Rational ignorance after the cost benefit analysis if it costs more to learn something than the benefit of learning it rationally we shouldn t learn it so people are sometimes people make decisions without total and perfect information I e When something costs you a lot you gain more information about it than when something costs you a little pencil vs car 6 Beware of Secondary Effects In addition to immediately visible effects people s decisions produce secondary effects Secondary effects the indirect impact of an event or policy that may not be easily immediately observable In areas of policy these are often overlooked and unintended I e taxing the windows on homes end up with windows with no homes and the government generates no tax 7 The Value of a Good or Service is Subjective People have different preferences and values for goods services 8 Economics is a Science Economics is scientific thinking Scientific Thinking developing a theory from basic principles and testing it against events in the real world Good theories are consistent with and help explain real world events It is testable and we can see if the theories we make help predict future current events Pitfalls to Avoid in Economic Thinking Violation of Ceterus Paribus Ceterus paribus A Latin term meaning other things constant that is used when the effect of one change is being described recognizing that if other things changed they also could affect the result Economists often describe the effects of one change knowing that in the real world other things might change and also exert an effect Violation of this condition can lead one to draw the wrong conclusion We must always assume Ceterus paribus Good Intentions do not Guarantee Good Results There is a tendency to believe if the supporters of a policy have good intentions then their results will be sound as well however this is not always the case I e In Africa the government said poaching is illegal good intention however the numbers of elephants continued to dwindle because the law did not stop poachers bad result So in some countries in Africa the government sold elephants to individuals and if someone wants to hunt an elephant they must purchase that right from the owner of the elephant result was a huge decrease in number of elephants poached Association is not Causation Just because two things are associated with each other does not mean there is a causal relationship and if there is we must make sure the direction of causation is correct I e It s raining b c I m carrying my umbrella causation in the wrong direction Fallacy of composition Assuming what s true for one thing is true for the group However what s true for one thing does not imply truthfulness for the group I e Rick Perry I ve done a lot right in Texas elect me and I ll do the same in the U S Doesn t work like that what s good true for Texas may not be good true for the whole of the U S Chapter 2 Some Tools of the Economist Every economy free market to command market must answer the following questions 1 What to produce 2 How to produce it 3 Who gets what How do we allocate produced goods Command market Demand economy Government answers questions Free market Market answers questions Tools of the economist used to answer those three questions Subjective opinion no one else can tell you what your opportunity cost is Therefore since no one else is telling you your economic efficiency you can be very efficient Failure to consider opportunity cost poor policy
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