Final Exam Study Guide Chapter 1 The Economic Approach What is economics about o Scarcity and Choice o Scarcity desire outstrips availability from nature o Poverty level of need not met o Competition natural outgrowth of the need to ration scarce goods Economic Way of Thinking o Guideposts The use of scarce resources to produce a good or service is always costly Individuals choose purposefully therefore they will economize Incentives matter Economic reasoning focuses on the impact of marginal changes Economic events often generate secondary effects Since information is scarce uncertainty is a fact of life The value of a good is subjective and varies with individual preferences The test of an economic theory is its ability to predict and explain events n the real world o Economizing gaining a specific benefit at the least possible cost Positives and Normative Economics o Positive Economics the scientific study of what is among economic relationships Can be proved either true or false o Normative Economics Judgments about what ought to be in economic matters Pitfalls to avoid in economic thinking Reflect subjective values o Violation of the ceteris paribus condition Ceteris paribus other things constant o Good intentions do not guarantee desirable outcomes o Fallacy of composition The erroneous view that what is true for the individual is also true for the group o Association is not causation Chapter 2 Tools of the Economist What shall we give up o Opportunity Cost The highest valued activity sacrificed in making a choice o Middleman a person who buys and sells or arranges trades The Importance of Property Rights o Property rights the right to use control and obtain benefits from a resource good or service o Private property rights include The right to exclusive use Legal protection against invaders The right to transfer to another o Incentives of private property Incentives to take care of things and develop resources in ways that are valued by others Private owners can gain by using their resources in ways beneficial to others Incentive to care for and manage what they own Incentive to conserve for the future Production Possibility Curve o Production Possibility Curve is a graph that shows the relationship between two objects o Shifting the PPC Increase in resource base Advancements in technology Improvement in the rules Working harder and giving up current leisure o Division of labor breaks down the production of a good into a series of tasks performed Trade Output and Living Standards by different workers o Specialization increase output Specialization permits individuals to take advantage of their existing skills Specialized workers become more skilled with time Division of labor allows for the adoption of mass production technology o Law of Comparative Advantage Trade items that you have a small opportunity cost for something you have a large one for o Economies of Scale oftentimes large scale production leads to lower per unit costs o Innovation technological change is about figuring out how to get more from existing o Economic goods are the result of human ingenuity and action The size of the economic resources Human Ingenuity and the Creation of Value pie is variable not fixed o An economy s output is limited by its resource base Economic Organization Markets vs Political Planning o Three basic questions faced by all economies are What goods will be produced How will goods be produced For whom will goods be produced o Market Organization A method of organization that allows for unregulated prices and decentralized decisions of private property owners to resolve the basic economic problems Capitalism o Political Organization collective decision making to decide what how and for whom goods and services will be produced Chapter 3 Supply Demand and the Market Process Consumer Choice and the Law of Demand o Law of Demand inverse relationship between the price of a good and the quantity consumers are willing to purchase Availability of substitutes explains this negative relationship o Market Demand Schedule a table that shows the quantity of a good people will demand at varying prices o Consumer Surplus the area below the demand curve but above the actual price paid Difference between the amount consumers are willing to pay and the amount they have to pay for a good Lower market prices increase the amount of consumer surplus in the market o Elastic Demand a change in price leads to a relatively large change in quantity Will be elastic when close substitutes for the good are readily available o Inelastic Demand a change in price leads to a relatively small change in quantity demanded demanded Demand will be inelastic when few if any close substitutes are available Changes in Demand versus Change in Quantity Demanded o Change in Demand a shift in the entire demand curve o Change in Quantity Demanded a movement along the same demand curve in response to a change in its price o Decrease in demand is a shift to the left o Demand Curve Shifters Changes in consumer income Change in the number of consumers Change in the price of a related good Change in expectations Demographic changes Change in consumer tastes and preferences Producer Choice and the Law of Supply o Opportunity cost of production the sum of the producer s costs of employing each resource required to produce the good o Firms will not stay in business for long unless they are able to cover the cost of all the resources employed o Economic Cost the cost of all resources used to produce the good o Accounting Cost often ignores the opportunity costs of resources owned by the firm o Law of Supply there is a positive relationship between the price of a product and the amount of it that will be supplied o Elastic Supply the quantity supplied is sensitive to changes in price thus a change in price leads to a relatively large change in quantity supplied o Inelastic Supply the quantity supplied is not sensitive to changes in price thus a change in price leads to only a relatively small change in quantity supplied Changes in Supply versus Changes in Quantity Supplied o Change in Supply a shift in the entire supply curve o Change in Quantity Supplied movement along the same supply curve in response to a change in its price o Change in the supply Changes in resource prices Changes in technology Elements of nature and political disruptions Changes in taxes How market prices are determined o Market equilibrium the point where supply
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