ECO2013 Exam 1 study guide Chapter 1 The Economic Approach Economics is the study of human behavior with a particular focus on human decision making o Origins date back to Adam Smith An Inquiry Into the Nature and Causes of the Wealth of Nations 1776 Economics is about scarcity and the choices we have to make because our desire for goods and services is far greater than their availability from nature o Scarcity less of a good freely available from nature than people would like o Choice the act of selecting among alternatives o Resources an input used to produce economic goods Human knowledge skill strength Physical tools machines buildings AKA capital Natural land mineral deposits Scarcity and poverty are not the same thing o Scarcity is an objective concept in which the limited nature of our resources keeps us from being able to completely fulfill our desires o Poverty is a subjective concept that refers to personal opinion of whether someone meets an arbitrary definition level of income Scarcity makes rationing a necessity allocating a limited supple of a good or resource among people who would like to have more of it o Done be either price or a first come first serve basis The Economic Way of Thinking Economic theory developed form basic principles of human behavior Eight guideposts 1 The use of scarce resources is costly so decision makers must make tradeoffs a The highest valued alternative that is sacrificed as a result of choosing an option is the opportunity cost 2 Individuals choose purposefully to get the most from their limited resources a Economizing behavior choosing the option that offers the greatest benefit at the least possible cost b Utility the benefit or satisfaction that an individual expects from the choice of specific alternative 3 4 Incentives matter Individuals make decisions at the margin a When making a choice between two alternatives individuals generally focus on the difference in the costs and benefits between alternatives b Known as marginal decision making used to describe the effects of a change in the current situation 5 Although information can help us make better choices its acquisition is costly 6 Economic actions often generate indirect as well as direct effects a Secondary effect effect that is not immediately visible b Example drinking direct is drunk secondary is hangover 7 The value of a good or service is subjective a People value goods and services differently 8 The test of a theory is its ability to predict a Economic thinking is scientific thinking i The idea is to predict how incentives will affect decision makers and compare predictions against real world events Positive and Normative Economics Scientific economics or positive economics attempts to determine what is among economic relationships o Involve potentially verifiable or refutable propositions Normative economics is about what ought to be in economics matters Views cannot be proven false because they are based on value judgments o Example political party views Pitfalls to Avoid in Economic Thinking Economists often qualify statements with ceteris paribus o Latin meaning for other things constant Fallacy of composition erroneous view that what is true for the individual will also be true for the group o Microeconomics focuses on how human behavior affects the conduct of affairs within narrowly defined units Ex business firms o Macroeconomics focuses on how human behavior affects outcomes in highly aggregated markets such as consumer products Ch 2 Some Tools of the Economist What Shall We Give Up Trade Creates Value Opportunity cost the highest valued alternative sacrificed in order to choose an option Two important aspects of voluntary exchange 1 When individuals engage in a voluntary exchange both parties are made better off a Does not create new material items 2 By channeling goods and resources to those who value them most trade creates value and increases the wealth created by a society s resources a Trade can create value Transaction costs the time effort and other resources needed to search out negotiate and complete an exchange o Can be a barrier to potentially productive exchange o Cost of info transportation and other elements of transaction costs will sometimes be so great that potential gains from trade will go unrealized Reductions in transaction costs will increase gains from trade Middlemen people who buy and sell goods or services or arrange trades They reduce transaction costs Example car dealers The Importance of Property Rights Property rights the rights to use control and obtain the benefits from a good or resource Private property rights property rights that are exclusively held by an owner and protected against invasion by others o Can be transferred sold or mortgaged at the owner s discretion o Involve three things 1 The right to exclusive use of the property 2 Legal protection against invasion from others who seek to use or abuse the property without the owner s permission 3 The right to transfer sell exchange or mortgage the property Common property ownership occurs when multiple people simultaneously have or claim ownership rights to a good or resource Example beaches rivers Incentives to private property ownership 1 Private owners can gain by employing their resources in ways that are beneficial to others and they bear the opportunity cost of ignoring the wishes of others 2 Property owners have a strong incentive to care for and properly manage what they own 3 Private owners have an incentive to conserve for the future particularly if the property is expected to increase the value a Stronger incentive to conserve privately owned property than commonly 4 Private owners have an incentive to lower the chance that their property will cause Market prices give private owners a strong incentive to consider the desires of others and owned property damage to the property of others use their resources in ways others value Production Possibilities Curve Production possibilities curve a curve that outlines all possible combinations of total output that could be produced assuming 1 a fixed amount of productive resources 2 a given amount of technical knowledge and 3 full and efficient use of those resources Four factors that could shift the production possibilities curve 1 An increase in the economy s resource base would expand our ability to produce goods and services a Investment the purchase construction or development of resources including physical assets
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