Econ 2013 Study Guide For Exam 2Chapter 1• Economics is the study of how we make choices under scarcityo Scarcity means there is only so much of a good to go around, so as a consumer we cannot have all of everything that we want. This is where choice comes in, we as consumers must make choices by picking things we value highly over things we don’t value as high. Rationing is this idea on a larger scale. Because an economy has limited resources, goods, and services to provide, price is used to get these respective items to those value them mosto Leads to competitive behavior; because there is a limited amount of resources, whoever uses them most effectively has the most to gain. Producers compete to try and maximize efficiency• Know the difference between the different kinds of resources that we use to produce economic goodso A resource is an input used to produce a goodo Three types: Human (knowledge, strength, and skill of human beings), Physical (tools machines and buildings), and Natural (land, oceans, and rivers)• Know the 8 guideposts to economic thinking:1. Resources are scarce so decision makers must make trade-offs when choosing between options. The highest valued alternative given up when making a decision is the opportunity cost. Example is Guns and butter2. Individuals are rational; they make decisions that will allow them to get the most from their limited resources. Keep in mind that what is rational for one is not rational for all. Examples given in class were: red wine vs. spiced rum, and Welfare vs. education 3. Incentives matter and choice can be influenced in a predictable way based on these incentives. The macro-style money game in class was used to demonstrate this4. Individuals make decisions at the margin, (margin represents the effect of change in a current situation, ex. Included olive garden and taco-bell) and a cost benefit analysis can be used to determine when the marginal benefits outweigh the marginal costs. Example given was airport security vs. lead clean up5. Information is costly but it helps us make better choices. The amount of information necessary is dependent on how big or important a decision is. Example given was buying a house verse buying a new notebook.6. Beware of secondary effects. Economic actions generate direct and indirect effects. These indirect effects are also called secondary effects, and are not always easily and immediately observable. Examples given were fuel efficiency regulations and trade restrictions7. The value of good or service is subjective, which means that voluntary trade creates value. What one person values low, another person may value much higher. Economic progress is achieved by moving goods and services to those who value them most. Eg. How much would you pay for a pack of gum? And orange bowl tickets 18. The test of a theory is its ability to predict. In order for a theory to be valid, it must be consistent with real world events.• Know the difference between positive and normative economic statements:o Positive economic statements: testable (more concrete, less conceptual)o Normative economic statements: not testable (more conceptual, less concrete)• Know the four pitfalls to avoid in economic thinking:1. Violation of the ceteris paribus (other things constant) principle2. The belief that good intentions equal desirable outcomes3. The belief that association is causation4. The fallacy of composition: what is true for one is true for allChapter 2• Voluntary trade creates value and leads to economic progresso Because the price of a good is subjective, trade allows 2 people to get goods that they both value more highly, making both parties better off. Think about the candy game we did in class. Also on a macroeconomic scale this channels goods and resources to those who value them most and in doing so can increase overall wealth with the same amount of a society’s resources (aka economic progress)• Know the characteristics and 4 incentives of private property rights.o -There is an incentive to use resources in ways that are considered beneficial to others. The cost of ignoring the wishes of others falls on the owner. Southpark: cartman’s amusement park. Reselling textbooko -People care for and manage what they own EG. Communal refrigerator vs your own refrigeratoro -Private owners have an incentive to conserve for the future: eg. Cows outnumber elephantso -Private owners have incentive to make sure their property does not damage your property. Aka liability. EG. Keeping your dog on a leash.• Production Possibilities Curve (PPC). What is produced at each point and what is given up and gained from moving from one point to another?o PPC: outlines all possible combinations of total output that could be produced. Assumes: fixed amount of productive resources, given amount of technical knowledge, and full and efficient use of resourceso Efficient point: on the curveo Inefficient point: inside the curveo Unattainable points: outside the curve• Know the four factors that shift the production possibilities curveo Change in an economy’s resource base o Changes in technology, o Change in rules under which the economy functions; EG. Trade barriers and business franchise tax in West Virginiao Changes in work habits• Understand the law of comparative advantage2o The idea that total output is greatest when each person (or group of people) focuses on what they can produce at the lowest opportunity cost, EG. Should mike Tyson be his own bodyguard?• Know the 3 questions that every economy faceso What will be producedo How it will be producedo Who it will be produced for• The difference between socialism and capitalism and know why capitalism tends to work better:o Capitalism: A system of economic organization where productive resources are privately owned, and goods and resources are allocated through market priceso Socialism: system of economic organization where ownership and control of the means of production rest with the state, and resource allocation is determined by centralized planningo Difference/reasons capitalism works: Socialism suffers an information problem and capitalism operates like a business version of natural selectionChapter 3• Law of demand and why demand curves are downward slopingo Law of demand: there is an inverse (or negative relationship resulting in a downward sloping demand curve) between the price of a good and the quantity that buyers are willing
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