Macroeconomics Exam 1 Study Guide Chapter 1 The Economic Approach Is Life Getting Better or Worse the first 10 years of this century will very likely go down as the most dispiriting and disillusioning decade Americans have lived through in the post WWII era NBC Wallstreet Journal Poll Rate this last decade Awful 36 Not Good 31 Fair 18 Good 10 Great 5 What objective measures should we analyze Life expectancy health income education entertainment What is economics economics is the study of how we make choices under scarcity choice the act of selecting among alternatives scarcity the concept that there is less of a good freely available from nature than people would like ex time money textbooks Scarcity is not the same thing as poverty Scarcity necessitates rationing A Rationing allocating scarce goods to those who want them B In a market economy price is used to ration goods C Scarcity leads to competitive behavior Resources resources an input used to produce an economic good 1 human resources human capital 2 physical resources physical capital 3 natural resources capital human made resources used to produce other goods and services examples of human capital Albert Einstein The Economic Way of Thinking careful things are not always as they appear 8 Guideposts to Economic Thinking 1 resources are scarce so decision makers must make trade offs No such thing as a free lunch opportunity cost the highest valued alternative that must be sacrificed when choosing an option ex an hour of your time ex guns and butter 1 individuals are rational they try to get the most from their limited resources greatest benefit at least possible cost ex red wine vs spiced rum ex welfare vs education note what is rational for one person may not be rational for everyone 1 incentives matter choice is influenced in a predictable way by changing incentives ex Money Game macro style ex Food Returns in a Restaurant ex Prices 1 individuals make decisions at the margin marginal described the effect of a change in the current situation ex Olive Garden ex trip to mcdonalds cost benefit analysis one will undergo an action when the marginal benefits outweigh the marginal costs ex walk or drive to class 1 information helps us make better choices but is costly ex new house vs new notebook 1 beware of secondary effects economic actions generate both direct and indirect effects secondary effects the indirect impact of an event or policy that may not be easily and immediately observable ex fuel efficiency regulations ex seat belts on airplanes ex sugar tariffs 1 the value of a good or service is subjective because goods are subjective voluntary trade creates value ex How much would you pay for this pack of gum ex Florida State vs Pitt moving goods and services to those who value them most is a primary source of economic progress 1 the test of a theory is its ability to predict if real world events are consistent with a theory then that theory is valid Positive vs Normative Economics positive economics the scientific study of what is testable normative economics judgment about what ought to be not testable 4 pitfalls to avoid in economic thinking 1 violation of ceteris paribus principle ceteris paribus other things constant ex buying eggs 1 good intentions do not guarantee desirable outcomes ex suicide warnings on antidepressant medication ex C H Taxi 1 association is not causation ex playoff beards ex sunspots and economic activity 1 fallacy of composition belief that what is true for one might not be true for all ex when you get a raise vs when everyone gets a raise 2008 tax rebates Microeconomics vs Macroeconomics Microeconomics focuses on how human behavior affects the conduct of affairs within individually defined units such as households or firms the trees Macroeconomics focuses on how human behavior affects outcomes in highly aggregated markets such as the nations market for labor the forest Review 1 What is scarcity 2 What are the 8 guideposts to economic thinking 3 Positive vs Normative economics 4 What are the 4 pitfalls to avoid in economic thinking Chapter 2 Tools of the Economist Trade creates Value Because the value of goods is subjective voluntary trade creates value ex the candy game 1 When individuals engage in voluntary exchange both parties are made better off 2 Channeling goods and resources to those who value them most increases the wealth created by Question If Harry Potter voluntarily trades his cloak of invisibility to Hermione Granger in exchange for A Hermione gains and Harry loses since a cloak of invisibility is obviously worth more B Harry gains and Hermione loses since two spell books are obviously worth more than a a societies resources than two spell books cloak of invisibility C Both parties expect to lose from this transaction D Both parties expect to gain from this transaction Answer Creation of Wealth The process by which some people become rich will make everybody richer ex henry ford Importance of Property Rights Private property rights involve 1 The right to exclusive use of the property 2 Legal protection against invasion from other individuals 3 The right to sell transfer exchange or mortgage the property 4 Incentives of Property Rights 1 Incentive to use resources in ways that are considered beneficial to others ex south park cartmen s amusement park owners bear the cost of ignoring the wishes of others ex reselling your textbook cant resell your textbook if you damage it 1 Private owners have an incentive to care for and manage what they own ex Communal refrigerator vs your own refrigerator 1 Private owners have an incentive to conserve for the future ex Tragedy of the Commons Rainforest ex Endangered species pg 37 1 Private owners have an incentive to make sure their property does not damage property Property Rights and Development Lack of property rights lack of economic progress Production Possiblities Curve PPC PPC outlines all possible combinations of total output that could be produced assuming a 1 fixed amount of productive resources 2 given amount of technical knowledge 3 full and effective use of resources ex exercise vs studying 1 efficient points 2 inefficient points 3 unattainable points 4 how much is produced at a certain point 5 what is given up when moving from one point to another ex guns vs butter can you identify the points how much is being produced at a certain point describe what happens when you move from one point to another 4 factors that shift the PPC 1 A
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