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Chapter One

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Chapter One: Scarcity:cornerstone of economic thinkingscarcity leads to tradeoffs which result in making choicesHistorical ways of dealing with scarcity include force/war, tradition (emphasize on past ways), authority (gov. and church), development of markets and a combo of the fourScarcity requires that some wants remain unfulfilledIssues of equity, justice and fairnessThe Eight Guidelines of Economic Thinking:1. There are always tradeoffsWhat you give up is your opportunity cost: the value of the next best alternative. Not the sum of everything you give up.2. Individuals choose purposefullyReferred to as economizing behavior- try to get the most benefits for the least cost or effortAka rational behavior3. Incentives matterDoesn’t have to be moneyAs the incentive increases, you will be more likely to do something4. Think on the margin, not in total or on averageMarginal means additional or incrementalRule to live by: continue to engage in an activity as long as the expected marginal benefit is greater than the expected marginal cost5. More information leads to better decision making, but more information is costly to get.6. Many choices create a secondary effectThe primary effect is often immediate and visibleThe secondary effect usually comes later and is not as visible7. Value is subjectiveDetermined by the purchaser8. Economic thinking is scientific thinkingEconomists use data and information generated by people to explain and predict actionsDon’t make these economic errors:1. Violation of ceteris paribus“all other things constant”we want to isolate variables so we typically allow only one to change at a time2. Good intentions do not necessarily result in good outcomes3. Association is not causation4. Fallacy of Compositionmaking the assumption that what’s good for the individual is good for the group and the assumption turns out to be wrongI. The Economic ApproachEconomics: The study of human behavior, with a focus on decision makingScarcity: a fundamental concept of economics that indicates that there is less of a good freely available from nature than people would likeResource: an input used to produce economic goods. Land, labor, skills, natural resources and capital are examples.Rationing: allocating a limited supply of a good or resource among people who would like to have more of it. When price performs the rationing function, the good or resource is allocated to hose willing to give up the most other things in order to get itHow are scarcity and choice related?Because goods are scarce we must often make a choice among alternatives.How are scarcity and poverty different?Scarcity is objective (factual); because items are scarce we can’t always completely fulfill our desires for goods and services. Poverty is subjective (a matter of opinion)and is usually determined by your level of income. However, what is considered poverty in one country may be considered rich in another.If price is not used as a rationing device, what are other alternatives? Government rationing and first come first serve basisII. The Economic Way of ThinkingOpportunity Cost: the highest valued alternative that must be sacrificed as a result of choosing an optionEconomizing Behavior: choosing the option that offers the greatest benefit at the least possible costUtility: the subjective benefit or satisfaction a person expects from a choice or course of actionMarginal: term used to describe the effects of a change in the current situation, usually the cost of producing an additional unit of a productSecondary Effects: the indirect impact of an event or policy that may not be easily and immediately observable. In policy, these effects are often both unintended and overlookedScientific 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. Theories that are inconsistent with the real world are invalid and must be rejectedThe Eight Guideposts:1. The use of scarce resources is costly, so decision makers must make trade offs2. Individuals choose purposefully – they try to get the most from their limited resources3. Incentives matter – choice is influenced in a predictable way by changes in incentives4. Individuals make decisions at the margin5. Although information can help us make better choices, its acquisition is costly6. Beware of the secondary effects: economic actions often generate indirect as well as direct effects7. The value of a good or service is subjective8. The test of a theory is its ability to predictIII. Positive and Normative EconomicsPositive Economics: attempts to determine what is. A verifiable or refutable proposition.Ex. If the price of gas rises, people will buy less gas.Normative Economics: is about what ought to be. A judgment call, based on preferences and philosophical views of the advocate.Ex. The price of gasoline is too high.IV. Pitfalls to Avoid in Economic ThinkingCeteris Paribus: “other things constant”Fallacy of Composition: erroneous view that what is true for the individual (part) will be true for the group (whole).Four Common Mistakes:1. Violation of the ceteris paribus condition can lead one to draw the wrong conclusion2. Good intentions to not guarantee desirable outcomes3. Association is not causation4. The fallacy of composition: what’s true for one might not be true for allChapter TwoTrade- Two Opposing Views of Trade:1. When people trade, one person gains and the other person losesReferred to as a zero-sum game2. When people trade, both parties gainWealth is actually created by trade- Voluntary trade creates wealth and promotes economic progressWith or without production and money exchanges, voluntary trade is expected to benefit both parties involvedPotential trades:Finished goods exchanged through barterFinished goods exchanged for moneyBusinesses buying resourcesConsumers buying products- transaction cost: a monetary or nonmonetary barrier that lowers the benefits of tradeThe Importance of Property Rights- Two kinds of property rights1. Common rights –everybody owns it2. Private rights –only one person owns it- Incentives created by private property rights:give proper careconserve for the futureuse resources in ways other people valuemitigate possible harms to othersProduction Possibilities Curve- The PPC can shiftshift out: growth/producing more (x)shift in: shrink/produce less (a)Trade, Output, and Living Standards-

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