Principles of Microeconomics Spring 2013 Final Study Guide IMPORTANT TIPS In addition to studying this guide please REVIEW MISSED questions on all your previous quizzes on Blackboard Briefly skim through each chapter in the book after completing the study guide chapter for clarification Chapter 1 The Economic Approach Economics the study of human behavior it is the study of how individuals make choices that are subject to constraints such as scarcity and choice Resources are scarce but demand is unlimited given the right price Scarcity unlimited demand but limited resources which causes rationing of resources that leads to economic choice and competition o Scarcity leads to tradeoffs which result in choices The Economic Way of Thinking the way that economists try to understand human choices 1 There will always be tradeoffs you always exchange one thing for another a Example Even if it is free burrito day at Chipotle there is a opportunity cost of the time given up a tradeoff 2 Opportunity Cost the value of the best forgone alternative a Example The opportunity cost of going to college is the money that could have been earned working a job Individuals choose purposefully people are rational when making choices People will try to get the most value for the lowest price economizing behavior a Example I will rob a low security bank over a high security bank Incentives Matter you will be more likely to do something if you are better compensated and less likely if you are not well compensated for your action a Example I am more likely to go out on a Monday night if it is free cover and free drinks till 1 Individuals think on the margin an individual thinks about the additional marginal benefit versus the additional marginal cost when making a decision Keep doing something as long as the benefit exceeds the cost a Example I will eat at an all you can eat buffet as long as my marginal benefit is greater than zero 6 More information leads to better choices but more information increases costs 3 4 5 a Example If I am buying a new car I will do hours of research before making the purchase but I will not do hours of research for a 1 pack of gum 7 Choices create secondary effects the unforeseen consequences that are not immediately felt a Example Smoking and drinking excessively will not do much harm now but in the long run there is substantial liver and lung damage 8 Valuation is subjective all people value different goods differently a Example A professional coffee machine may be worth 500 dollars to me but it may only be worth 50 to you Valuation depends on many factors 9 Economic thinking is scientific thinking economics tries to explain what the average individual would do not predict individual decisions Positive versus Normative A Positive statement is based on fact and can be proven Normative statements are based on opinion should ought to The Pitfalls of Economic Thinking 1 Violating Ceteris Paribus other things constant when studying one specific variable all other things have to be held constant to be accurate 2 Good intentions do not always lead to good outcomes the primary effect may be good but the secondary effects a Example hooking up with a stranger and consequently contracting a STD that shows up a couple of weeks later 3 Association is not Causation 4 Fallacy of Composition what is good for the individual is not always good for the group Chapter 2 Tools of the Economist The 2 views on trade 1 Zero Sum Game One person gains and the other person loses 2 Positive Sum Game Both parties gain also known as win win What creates value Voluntary trade creates value for both parties Channeling goods to the people that value them the most creates wealth Transaction costs costs uncured through the completion of an exchange o Transaction costs reduce the gains from trade can be monetary or non monetary Middlemen increase the gains from trade by reducing transaction costs o Example It is cheaper to buy a pair of shoes at the mall than paying to fly to China to buy them directly at the production site Property Rights 1 Common rights everybody owns it communally like public sidewalks a Example public sidewalks lakes parks air 2 Private rights ownership is held by an individual a Example my car my house my phone my computer What is the importance of Property rights Property rights are so important because they create incentives to protect and conserve resources and distribute them to people who value them the most o Example A publicly owned hunting reservation will see a larger and faster decrease of animals and resources than a privately owned reservation Incentives created by property rights o Proper care of property o Conservation of property for the future o Use resources in ways other people value them o Reduce the harm their property may cause to others Production Possibilities Curve Shows the maximum combinations of two goods that can be produced from a set of fixed resources holding technology constant and assuming all resources are used efficiently You can only produce more of one good if you produce less of the other PPC Straight line law of constant opportunity cost PPC Bowed inward law of decreasing opportunity cost Economic growth is characterized by an outward shift o Caused by an increase in resources technology improved legal system or more effective labor How to maximize economic efficiency 1 Specialization and division of labor An individual that focuses on one specific task instead of a series of tasks can become very good at his job a Gains from specialization and trade will be achieved when individuals are allowed to pursue their own self interest b Self sufficiency is the quickest path to poverty 2 Comparative Advantage make a good for which you have a low opportunity cost and trade for the good for which you have a high opportunity cost a Individuals firms or countries should produce the goods for which they have the lowest opportunity cost i Trade promotes innovation specialization and mass production 3 Absolute Advantage Produce what you are good at and trade for goods you are not good at producing Societies three question o What to produce Who to produce it For whom to produce it Two types of market organization o Government planning central authority answers society s three questions E g China and Cuba o Market Organization Capitalism characterized by private ownership of assets voluntary contracts and market prices E g U S A o Most economies use a combination
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