Econ 2000-1 Study Guide For Final ExamSection 1: The Ten Key Elements of Economics Section(This section accompanies pages 5 – 39 in your Common Sense Economics textbook)- Scarcity is the concept that there is not enough of a good freely available from nature so that people can have as much as they would like. This is an objective term very different from poverty.- There are three types of resources: 1. human resources Ex: intelligence, creativity2. physical resources Ex: manmade objects3. natural resources Ex: gold, oil, land, minerals, coal. Comes from nature- Twelve key elements of economic thinking1. Incentives matterA. People respond to changing incentives in a predictable wayB. What is rational for one person is not rational for everyoneC. Utility: The subjective benefit or satisfaction a person expects from a choice or course of action2. No such thing as a free lunch (because resources are scarce, tradeoffs must be made)A. Opportunity Cost: The highest valued alternative that must be sacrificed whenchoosing an option. 3. Decisions are made at the margin:A. Marginal benefit is the item you would be getting for the difference of the marginal costs. Ex: Ponderosa buffest: all you can eat side bar- $7.50steak + all you can eat side bar- $9.00Marginal benefit (MB):steakMarginal cost (MC):$1.50B. Law of Diminishing Marginal Utility: as consumption increases, the marginal utility derived from additional consumption will eventually decline. Ex: banana eating contest resultsC. Understand the concept of the cost-benefit analysis and economic efficiency (You should only do those things where the marginal benefits outweigh the marginal costs). To be economically efficient:1. All actions generating more benefits then costs should be undertaken2. No actions generating more costs then benefits should be undertakenD. People will rationally choose not to become fully informed when making decisions. Ex: You’ll shop around for a new car but not a pencil.4. Voluntary trade promotes economic progressA. Know how trade creates value by putting goods into the hands of those who want them the mostB. Trade makes larger output and consumption levels possible through specialization. (The Law of Comparative Advantage) Ex: Who mows lawn- wage/hour hours costBOB $5 5 $25ßBOBS DAD $20 2 $40BOB has comparative advantage. But his DAD has absolute advantageC. Voluntary trade makes it possible to produce things at a lower cost through mass production techniques. Average total cost= cost/quantity5. Transaction costs are an obstacle to trade: Transaction costs are the time, effort, and other resources needed to search out and complete an exchange. Middleman reduces transaction costs.6. Prices bring the choices of buyers and sellers into balance 7. Profits direct businesses toward activities that increase wealthA. Understand the definitions of profits and losses and their economic role in creating a prosperous societyProfit: An excess of sales revenue relative to the opportunity cost of production. A profit occurs only when the value of the good produced is greater than the valueof the resources used for its production. Loss: A deficit of sales revenue relative to the opportunity cost of productionLosses are penalties imposed on those who produce goods that are valued less than the resources required for their production 8. People Earn Income by Helping OthersA. Entrepreneurs who create things make everybody better off by expanding the pie, rather than taking a slice of it.9. Production, not just jobs, provides the source of high living standards: Know that destruction and jobs that don’t produce useful goods and services do not add to economic growth.10. Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutionsA. Investment makes us richer, but costs in terms of current consumptionB. Improvements in technology spur economic progress (creative destruction: replacing old products and production methods by innovative new ones that consumers judge to be superior). C. Improvements in economic organization can promote growth (private propertyrights, competition, personal and economic freedom).11. The invisible hand and the role of pricesA. The invisible hand: the tendency for people while pursuing their own interests to promote the economic well-being of society. Ex: Choosing what line to go in to benefit you, as well as it benefits others to get out as fast as possible.B. Understand how prices communicate information and promote market order12. Secondary effects: A. Secondary effect: the indirect impact of an event or policy that may not be easily and immediately observable. Ex: Yacht tax: hurt the industry instead of the people who buy them. Viking yacht club: fired 1500 of their 1560 employees- Know the four pitfalls to avoid in economic thinking:1. Violation of ceteris paribus principleceteris paribus: other things constantEx: buying roses: “If the price of roses increases, then people buy less roses [ceteris paribus].”Just because the statement is holding all the time, doesn’t mean that it isn’t true, itstays the same for every other day besides V-day2. The belief that good intentions equal desirable outcomesEx: Endangered species act: bird started to go extinct so government, in order to make sure the bird stayed alive, stated that you cannot build or develop or change land within 50 feet of that tree in order to protect the tree that the bird lives in. so people started to cut down the trees before the bird could nest in it so they could build on their own land and the birds started disappear faster. The intention was good, but the outcome was bad.A. The Nirvana Fallacy: The logical error of comparing the actual situation with its idealized counterpart rather than the actual alternative.Ex: Child labor and sweatshops: they could be starving and working in worst conditions, they are working here because this is the best job available to themat the time. So if you protest these then they could be worst off.3. The fallacy of compositionEx: Standing at a football game: just because you think it’s easier to see the game when standing, others might not agree. 4. The belief that association is causationEx: Initials and performance: saying that initials improve your performance. More K’s in your name mean that you do more strikeouts. More AB’s in your name mean you get better