Chapter 1 Economics the study of human behavior with a particular focus on human decision making Adam Smith Scottish moral philosopher who expressed the first economic ideas in his breakthrough book o Inquiry into the nature of causes of the wealth of nations Scarcity means having to make choices Scarcity fundamental concept of economics that indicates that there is less of a good freely available from nature than people would like Choice the act of selecting among alternatives o Logical consequence of scarcity o Constantly face trade offs between meeting one desire and another Scarcity choices and trade offs provide the foundation for economic analysis Resources an input used to produce economic goods o Land Labor skills natural resources and capital are examples o Ability to produce is limited due to the limited nature of resources o 3 general categories Human Physical Natural Capital human made resources such as tools equipment and structures used to produce other goods and service o They enhance our ability to produce in the future Scarcity and Poverty are not the same Scarcity is an objective concept that describes a factual situation in which the limited nature of our resources keeps us from being able to completely fulfill our desires for goods and services o Objective a fact based on observable phenomena that is not influenced by differences in personal opinion Poverty is a subjective concept that refers to a personal opinion of whether someone meets an arbitrary defined level of income o Subjective an opinion based on personal preferences and value judgments o Distinction between needs and wants helps us understand why it is impossible to define poverty objectively Scarcity necessitates rationing Rationing allocating a limited supply of a good or resource among people who would like to have more of it o When price performs the rationing function the good or resource is allocated to those willing to give up the most other things in order to get it o Scarity makes rationing a necessity If you have to pay for something it is scarce Scarcity leads to competitive behavior Competition is a natural outgrowth of scarcity and the desire of human beings to improve their conditions Competition among business firms for customers results in newer better and less expensive goods and services Etc o Encourages discovery and innovation The economic way of thinking Eight guideposts to economic thinking Economic theory a set of definitions postulates and principles assembled in a manner that makes clear the cause and effect relationships 1 The use of scarce resources is costly so decision makers must make trade offs There is no such thing as a free lunch o Because resources are scare the use of resources to produce one good diverts those resources from the production of other goods Opportunity costs the highest valued alternative that must be sacrificed as a o Always trade offs result of choosing an option 2 Individuals choose purposefully they try to get the most from their limited resources Economizing behavior choosing the option that offers the greatest benefit at the least possible cost o Result of purposeful or rational decision making Utility the subjective benefit or satisfaction a person excepts from a choice or course of action 3 Incentives matter choice is influenced in a predictable way by changes in incentives Basic postulate of all economics Individuals make decisions at the margin 4 When making a choice between two alternatives individuals generally focus on the difference in the costs and benefits between alternatives Marginal decision making thinking at the margin o Term used to describe the effects of a change in the current situation Always involve the effects of net additions to or subtractions from current conditions Additional if often used as a substitute for marginal 5 Although information can help us make better choices its acquisition is costly Because information is costly for people to acquire limited knowledge and uncertainty about the outcome generally characterize the decision making process 6 Beware of the secondary effects economic actions often generate indirect as well as direct effects Secondary effects the indirect impact of an event or policy that may or may not be easily and immediately observable In the area of policy these effects are often both unintended and overlooked 7 The value of a good or service is subjective Preferences differ 8 The test of a theory is its ability to predict Scientific thinking developing a theory from a basic principles and testing it against events in the real world Good theories are consistent with and help explain real world events o Predictive values Positive and normative economics Positive economics the scientific study of what is among economic relationships o Does not tell us which policy is best but can provide evidence about the likely effects of a policy Normative economics judgements about what ought to be in economic matters o Views cannot be proven false because they are based on value judgements o Views can sometimes influence our attitude toward positive economic analysis Pitfalls to avoid in economic thinking Violation of the ceteris paribus condition can lead one to draw the wrong conclusion Ceteris paribus other things constant o Used when the effect of one change is being decribed recognizing that if other things changed they also could affect the result o Economists often descrive the effects of one change knowing that in the real world other things might change and also exert an effect Good intentions do no guarantee desirable outcomes Adverse secondary effects o Indirect and observable over time Association is not causation Post hoc propter ergo hoc fallacy The fallacy of composition what s true for one might not be true for all What is true for the individual may not be true for the group Fallacy of composition erroneous view that what is true for the individual or the part will also be true for the group or the whole Microeconomics the branch of economics that focuses on how human behavior affects the conduct of affairs within narrowly defined units such as individual households or business firms Macroeconomics the branch of economics that focuses on how human behavior affects outcomes in highly aggregated markets such as the markets for labor and consumer products Chapter 2 Opportunity cost Trade creates value Subjective Depends on how the decision maker values the option Based on expectations
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