Study Guide Exam 1 Macroeconomics 02 10 2014 Chapter 1 Know that Economics is the study of how we make choices under scarcity Understand the concept of scarcity o 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 Ex time money textbooks o Necessitates rationing allocating scarce goods to those who want them o In a market economy price is used to ration goods o Leads to competitive behavior and competition is good o What do we do in the face of scarcity We will never run out of oil because companies are willing to go to great lengths to make profit if the demand is high Know the difference between the different kinds of resources that we use to produce economic goods o Resources an input used to produce an economic good o There are three types of resources human resources physical resources and natural resources o Capital human made resources used to produce other goods and services fighting skills Examples Albert Einstein s ideas and Chuck Norris s Know the 8 guideposts to economic thinking o Resources are scarce so tradeoffs must be made 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 o Individuals are rational They try to get the most from their limited resources Most benefit at the least cost Ex red wine vs spiced rum Ex welfare vs education What is rational for one person may not be rational for everyone o Incentives matter incentives way Choice is influenced in a predictable way by changing People respond to changing incentives in a predictable Utility The subjective benefit or satisfaction a person expects from a choice or course of action o Individuals make decisions at the margin Marginal effect of change in current situation benefits and costs of one more Cost benefit analysis one will undergo an action when the marginal benefits outweigh the marginal costs ex airport security vs lead clean up Know how to identify the marginal costs and the marginal benefits of making a decision Understand the law of diminishing marginal utility and its implications Understand the concept of the cost benefit analysis and economic efficiency You should only do those things where the marginal benefits outweigh the marginal costs o People will rationally choose not to become fully informed when making decisions o Information helps us make better choices but is costly Ex new house vs new notebook o 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 trade restrictions o The value of a good or service is subjective Because goods are subjective voluntary trade creates value Moving goods and services to those who value them most is a primary source of economic progress o The test of a theory is its ability to predict If real world events are consistent with a theory then that theory is valid Know the difference between positive and normative economic statements positive economic statements are testable normative economic statements are not o Positive economics the scientific study of what is testable o Normative economics judgments about what people think ought to be not testable Know the four pitfalls to avoid in economic thinking o Violation of the ceteris paribus principle ceteris paribus other things constant o The belief that good intentions equal desirable outcomes The Nirvana Fallacy The logical error of comparing the actual situation with its idealized counterpart rather than the actual alternative ex Suicide warnings on anti depressant medication ex C H taxi o The belief that association is causation Ex superstitions Ex sunspots and economic activity o The fallacy of composition The belief that what is true for one is true for all Chapter 2 Ex when you get a raise vs when everyone gets a raise Understand how voluntary trade creates value and leads to economic progress The Candy Game o When individuals engage in voluntary exchange both parties are made better off o Channeling goods and resources to those who value them most increases the wealth created by a society s resources Know the characteristics and 4 incentives of private property rights o Private property rights involve The right to exclusive use of the property Legal protection against invasion from other individuals The right to sell transfer exchange or mortgage the property o Use the resource in ways that benefit others o Care for and manage what they own o Private owners have an incentive to conserve for the future Ex reason cows outnumber elephants o Private owners have an incentive to make sure their property does not damage your property Understand the concept of the Production Possibilities Curve PPC Be able to read a production possibilities curve and identify efficient inefficient and unattainable points as well as what is produced at each point and what is given up and gained from moving from one point to another o Production Possibilities Curve outlines all possible combinations of total output that could be produced assuming a Fixed amount of productive resources Given amount of technical knowledge Full and efficient use of resources Inefficient point inside of curve Efficient point on the curve Unattainable point outside of the curve Know the four factors that shift the production possibilities curve o Change in the economy s resource base Investment the purchase construction or development of resources However investment requires us to give up consumption goods o Changes in technology any given time Technology the knowledge available in an economy at Technology determines the amount of output we can generate with our limited resources o A change in the rules under which the economy functions Ex imposing trade barriers Ex eliminate the business franchise tax in WV o A change in work habits Working harder can shift curve outward Working less can shift curve inward Understand the law of comparative advantage o The total output of a group of individuals an entire economy or a group of nations will be the greatest when the output of each good is produced by whoever has the lowest opportunity cost Know the 3 questions that every economy faces o What will be produced o How will it be produced o For whom
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