FINAL EXAM STUDY GUIDEChapter 1• Know that Economics is the study of how we make choices under scarcity• Understand the concept of scarcity: The concept that there is less of a good freely available from nature than people would like.• Know the difference between the different kinds of resources that we use to produce economic goods. 1. Human resources (human capital): Bill Gates creating Windows, Michael Phelps winning all his gold medals.2. Physical resources (physical capital): Machines, buildings, metal.3. Natural resources: Earth, sun, wind, water, rain, gas.• Know the 8 guideposts to economic thinking:1. Resources are scarce, so decision makers must make tradeoffs (Know the concept of opportunity cost)Opportunity Cost: The highest valued alternative that must be sacrificed when choosing an option 2. Individuals are rational: They try to get the most from their limited resources(Most bang for their buck)3. Incentives matter(choice is influenced in a predictable way by changing incentives)4. Individuals make decisions at the margin(To supersize my meal or not)5. Information helps us make better choices but is costly6. Beware of secondary effects Secondary effect: the indirect impact of an event or policy that may not be easily and immediately observable.7. The value of a good or service is subjective(A bottle of water in the desert is worth more than a bottle of water at your house)8. The test of a theory is its ability to predict: If real world events are consistent with a theory, then that theory is valid.• Know the difference between positive and normative economic statements: positive economic statements are testable, normative economic statements are not.• Know the 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• E.g. Child resistant safety caps: Parents felt more safe about their kids getting in the bottles so they left them out and kids still got into them. i. The Nirvana Fallacy: The logical error of comparing the actual situation with its idealized counterpart rather than the actual alternative.ii. E.g. Sweat shops seam bad to us, but for the people who work in them it’s a lot better than other jobs. 3. The belief that association is causation• Superstitions: because I did something, this happened.4. The fallacy of composition: what’s good for one person is good for everybody.• E.g. Everybody stands up at a football game. Chapter 2• Understand how voluntary trade creates value and leads to economic progress (The Candy Game!): When people engage in voluntary trade then they are giving each other what the other wants most. Items are subjective. Apple wants your money and you want the new iPhone. • Know what transaction costs are and understand the importance of middlemen 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. E.g. Publix to buy food.• Know the characteristics and 4 incentives of private property rights. Property Rights: 1. The right to exclusive use of the property2. Legal protection against invasion from other individuals3. The right to sell, transfers, exchange, or mortgage the property 4 incentives of Property Rights:1. Incentive to use resources in ways that are considered beneficial to others. E.g. Using an empty parking lot in the middle of campus.2. Private owners have an incentive to care for and manage what they own. E.g. Driving your car vs. driving a rental car.3. Private owners have an incentive to conserve for the future. E.g. Sharing a popcorn at the movie theatre. 4. Private owners have an incentive to make sure their property does not damage your property. E.g. keep your dog on a leash.• Understand the concept of the Production Possibilities Curve (PPC): The PPC outlines all possible combinations of total output that could be produced, assuming a:o fixed amount of productive resourceso given amount of technical knowledgeo full and efficient use of resources• Be able to read a production possibilities curve and identify efficient, inefficient, and unattainable points, as well as what is produced at each point and what is given up and gained from moving from one point to another. Efficient points: Points on the line. Inefficient points: Points inside the line. Unattainable points: Points outside of the curve. As you move from point on the line to another, you’re giving up the amount of production for one item and gaining more production on another. E.g. If you want to party more then you’re giving up studying time for parting time or vice versa. • Know the four factors that shift the production possibilities curve inward and outwardo A change in the economy’s resource base. Investment: the purchase, construction, or development of resources.o Changes in technology. Technology: the knowledge available in an economy at any given time. o A change in the rules under which the economy functions. E.g. Reducing trade barriers, Jim Crow Lawso Changes in work habits E.g. Harder work shifts the curve outward, but less work shifts the curve inward.• Understand the law of comparative advantage The 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. E.g. Lebron James should play basketball and let his maid clean his house instead of him. He can make more money playing basketball than cleaning his house.• Know the 3 questions that every economy faces 1. What will be produced? 2. How will it be produced? 3. For whom will it be produced?• Understand the difference between socialism and capitalism and know why capitalism tends to work better. o Socialism: a system of economic organization where:1. Ownership and control of the means of production rest with the state2. Resource allocation is determined by centralized planning. Capitalism: A system of economic organization where: 1. Productive resources are owned privately2. Goods and resources are allocated through market prices Why capitalism tends to work (and socialism does not):1. Capitalism is similar to natural
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