Econ 2000 1 Study Guide For Final Exam Section 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 creativity 2 physical resources Ex manmade objects 3 natural resources Ex gold oil land minerals coal Comes from nature Twelve key elements of economic thinking 1 Incentives matter A People respond to changing incentives in a predictable way B What is rational for one person is not rational for everyone C Utility The subjective benefit or satisfaction a person expects from a choice or course of action 2 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 when choosing 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 50 steak all you can eat side bar 9 00 Marginal benefit MB steak Marginal cost MC 1 50 B Law of Diminishing Marginal Utility as consumption increases the marginal utility derived from additional consumption will eventually decline Ex banana eating contest results C 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 undertaken 2 No actions generating more costs then benefits should be undertaken D 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 progress A Know how trade creates value by putting goods into the hands of those who want them the most B Trade makes larger output and consumption levels possible through specialization The Law of Comparative Advantage Ex Who mows lawn wage hour hours 5 BOB 5 cost 25 BOBS DAD 20 2 40 BOB has comparative advantage But his DAD has absolute advantage C Voluntary trade makes it possible to produce things at a lower cost through mass production techniques Average total cost cost quantity 5 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 wealth A Understand the definitions of profits and losses and their economic role in creating a prosperous society Profit 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 value of the resources used for its production Loss A deficit of sales revenue relative to the opportunity cost of production Losses 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 Others A 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 institutions A Investment makes us richer but costs in terms of current consumption B 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 property rights competition personal and economic freedom 11 The invisible hand and the role of prices A 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 order 12 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 principle ceteris paribus other things constant 2 Ex 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 it stays the same for every other day besides V day 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 them at the time So if you protest these then they could be worst off 3 The fallacy of composition Ex 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 grades Ex Superstitions basketball team would always win because to be a mountaineer you had to have a beard so when they would win people would point to their beards and be like yeah that s why we won