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ECO2000 Exam 1 Study Guide Science of how individuals make choices under scarcity Economics is the Scarcity is the Concept that there is not enough of a good freely available from nature so that people can have as much as they would like This is an objective term very different from poverty o Ex Time money cars etc Scarcity necessitates rationing allocate scare goods to those who want them o In a market economy price is used to ration goods Scarcity leads to competitive behavior There are three types of resources 1 Human Resources human capital 2 Physical resources physical capital 3 Natural resources An input used to produce an economic good Resources are Capital is Human made resources used to produce other goods and services Twelve key elements of economic thinking 1 Incentives matter A People respond to changing incentives in a predictable way o Ex money game killer seatbelts prices B What is rational for one person is not rational for everyone o Individuals are rational o Greatest benefit at least possible cost C Utility o The subjective benefit or satisfaction a person expects from a choice or course of action 2 No such thing as a free lunch because resources are scarce tradeoffs must be made A Opportunity Cost an option o The highest valued alternative that must be sacrificed when choosing o Ex An hour of your time how you spend your next 15 1 3 Decisions are made at the margin A Marginal o Describes the effect of a change in the current situation o Marginal change or additional o Ex Supersizing your extra value meal driving or flying B Law of Diminishing Marginal utility o As consumption increases the marginal utility derived from additional consumption will eventually decline o Ex banana eating contest The first banana was very good the third banana was ok and the 15th banana was terrible o When making a decision one compares the marginal benefits and the C Cost benefit analysis marginal costs D To be economically efficient o All actions generating more benefits then costs should be undertaken o No actions generating more costs then benefits should be undertaken You should only do those things where the marginal benefits outweigh the marginal costs E People will rationally choose not to become fully informed when making decisions 4 Voluntary trade promotes economic progress A Because the value of a good or service is subjective voluntary trade moves goods from people who value them less to people who value them more B Trade makes larger output and consumption levels possible through specialization The Law of Comparative Advantage C Law of Comparative advantage o Individuals economics and nations should produce that which they can make at a lower opportunity cost and trade for everything else o Ex Should LeBron James clean his own house Who should mow the D Voluntary trade makes it possible to produce things at a lower cost through lawn mass production techniques 5 Transaction costs are an obstacle to trade A Transaction costs are the time effort and other resources needed to search out and complete an exchange B Middleman reduce transaction costs o A person who buys and sells goods or services or arranges trades 6 Prices bring the choices of buyers and sellers into balance A Market equilibrium o Sellers prefer to sell things for higher prices o Buyers prefer to buy things for lower prices 2 Market prices brings these two conflicting forces into balance 7 Profits direct businesses toward activities that increase wealth A Profits B Loss o An excess of sales revenue relative to the opportunity cost of production o A profit occurs only when the value of the good produced is greater then the value of the resources used for it production o A deficit of sales revenue relative to the opportunity cost of production o Losses are penalties imposed on those who produce goods that are valued less than the resources required for their production 8 People Earn Income by Helping Others A Entrepreneurs who create things make everybody better off by expanding the pie rather than taking a slice of it Process by which some people become rich will make everybody richer Ex Bill Gates 9 Production not just jobs provides the source of high living standards A Destruction and jobs that don t produce useful goods and services do not add to economic growth digging decree o Ex Lets boost the economy Car Allowance Rebate System vs Hole 10 Economic progress comes primarily through trade investment better ways of doing things and sound economic institutions A Investment makes us richer but costs in terms of current consumption o Investment requires us to give up current consumption Ex Picking apples from tree vs planting new apple tree B Improvements in technology spur economic progress o Creative destruction Replacing old products and production methods by innovative new ones that consumers judge to be superior C Improvements in economic organization can promote growth private property rights competition personal and economic freedom 11 The invisible hand and the role of prices A The invisible hand o The tendency for people while pursuing their own interests to promote the economic well being of society B Prices and Market Order o Prices communicate information to decision makers o Prices coordinate the actions of market participants o Prices motivate economic players 3 12 Long term consequences or the secondary effects of an action are often ignored A Secondary effect o The indirect impact of an event or policy that may not be easily and immediately observable o Ex Yacht tax trade restrictions Four Pitfalls to avoid in economic thinking 1 Violation of the ceteris paribus principle Ceteris paribus all other things constant 2 The belief that good intentions equal desirable outcomes A The Nirvana Fallacy o The logical error of comparing the actual situation with its idealized counterpart rather than the actual alternative o Ex Child labor and sweatshops Ex Endangered species act anti depressant medication 3 The fallacy of composition The fallacious belief that what is true for one is true for all Ex Standing at football game 4 The belief that association is causation Supply and Demand Section This section corresponds with the additional reading entitled Supply and Demand Basics located on blackboard Supply and Demand Basics Law of Demand o There is an inverse negative relationship between the price of a good and the quantity that buyers are willing to purchase o Results in a downward sloping demand


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