STUDY GUIDE for FINAL EXAM Evans 2013 Fall 2011 CHAPTER 1 THE ECONOMIC APPROACH 1 What is the important driver of human behavior that has resulted in competition social political cultural and even religious traditions across time Incentives People choose profitable trade offs to maxamize their utility pleasure and people weigh costs againts benefits 2 How are poverty and scarcity different Can they both be eliminated Scarcity wanting more than is available Absence of this would imply that all of our desires for goods are fully satisfyed Poverty Not meeting a basic level Absence of this would imply that some basic level of need has been met Scarcity cannot be eliminated Poverty can 3 Rationing Scarce Goods Primitive Society First Come First Served brute force Modern Society Market Economy Price is used to ration goods Price Market System This is superior to other methods because goods are allocated to those willing to give up other things to get them People have incentive to pay the required price 4 Eight Guideposts to Economic Thinking a The use of scarce resources to produce a good is always costly Obtaining more of a scarce good always involves a cost Something must be given up to make obtain something else The oppourtunity cost of the choice is the highest vaued alternative that must be sacrificed There is no such thing as a free lunch Individuals choose purposefully therefore they will economize Economizing Choosing purposefully with least possible cost Incentives matter As benefits change so do the value of goods Economic reasoning focuses on the impact of marginal changes b c d 1 Marginal means the change in benefits compared to the change in thoughts Decisions will be based on marginal costs and marginal benefits utility The Marginal Cost refers to the additional amount required to produce the x 1th unit The Average Cost is the total cost of production of x units of the product divided by x Since information is scarce uncertainty is a fact of life e f g h People take risks It is not unreasonable for people to exhaust all possible sources of information before making decisions but it is costly and time consuming In addition to their initial impact economic events often generate secondary effects that may be felt only with the passage of time Secondary effects are other effects that occur due to an economic event Failure to consider secondary effects can be destructive to public policy Ex Raising minimum wage could lead to inflation The value of a good is subjective and varies with individual preferences Values can change it all depends on supply and demand The test of an economic theory is its ability to predict and explain events in the real world These guideposts are important because they enable us to predict human behavior and thus outcomes to forecast and make the best decisions 5 Positive versus Normative Economic Thinking Positive Thinking what is Can be proven either true false A statement of fact OBJECTIVE Better for decsion making because it is factual Normative Thinking what ought to be A statement of opinion SUBJECTIVE 6 Four Pitfalls to Avoid in Economic Thinking Ceteris Paribus Nothing else changes All other things constant As your realtor I can t tell you how much it s worth to add a swimming pool to your home to increase its market value unless we know what other factors increase the market value of homes Good Intentions vs Good Outcomes Ex Politicians When their term is over they no longer deal with the consequences of their decisions 2 As your next President I plan to reduce drug use among college students by spending more money to apprehend drug pushers Note Studies have shown that it s more effective to spend money on drug abuse education than on apprehension of pushers Fallacy of Composition The view that what is true good for the individual is true good for the group It s great that wages are rising in our community Our elected officials should push for national wage increases Association is Not Causation Statistical association alone cannot establish causation Whenever there has been unusual sunspot activity the economy has been in a recession Therefore sunspot activity causes recessions 7 Opportunity Costs The oppourtunity cost is the highest valued alternative that must be given up sacrificed in order to get something else Includes direct and indirect costs The accountants focus on only numbers while economists measure oppourtunity costs Includes only direct costs CHAPTER 2 SOME TOOLS OF THE ECONOMIST 1 Opportunity Cost for college Direct Costs Tuition rent books Indirect Costs Activities forgone earnings time 2 How Trade Creates Value What is not worth much to someone may be worth a lot more to someone else Ex Ticket Scalping 3 Transactions Costs Transaction Costs are the time effort and other resources needed to search out negotiate and make an exchange They reduce our ability to produce gains from trades Time is money 4 Middlemen Stockbrokers Realtors and Mutual Fund Managers They reduce transaction costs which thereby increase gains from trade They assist in trade Think about having to search forever to find someone selling the shoes you want they do the dirty work so it doesn t take forever 3 5 Opportunity Cost Application Travel Options Taking A Plane it will cost more money but could use time doing other things like earning income spending time with family etc Less costly in the end Taking a Bus it is less expensive but takes more time is less time spent working making income and other things Ends up being more expensive 6 Comparative Advantage Application Specialization Division of Labor The Law of Comparative Advantage is the proposition that the joint output of trading partners will be greatest when each good is produced by the low opportunity cost producer A party should produce a good that incurs the least opportunity cost and trade for goods which incur high opportunity costs to produce Specialization makes workers do only what they are best at having faster production Comes from Adam Smith s idea of an assembly line Calculating Given up Being produced Cost per unit of good being produced 4 bananas 2 apples 2 bananas per each apple produced The opportunity cost of 1 apple is 2 bananas 7 Property Rights Three Incentives Created Property Rights are the right to use control and obtain benefits from a resource good or service Three Incentives Created 1 You have incentive to take care of things you own 2 incentives to conserve for the
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