STUDY GUIDE for FINAL EXAM ECO2023 04 FALL 2011 Martha Evans Instructor CHAPTER 1 THE ECONOMIC APPROACH 1 What is the important driver of human behavior that has resulted in competition as well as determined social political cultural and even religious traditions across time Scarcity 2 How are poverty and scarcity different Can they both be eliminated Absence of poverty implies some basic level of need has been met An absence of scarcity would imply that all of our desires for goods are fully satisfied We may someday eliminate poverty but scarcity will always be with us 3 How were scarce goods rationed in primitive societies How are they rationed in market economies Which rationing method is superior Scarce goods were rationed on a first come first serve basis In a market setting price is used to ration goods and resources When price is used to ration goods people have a strong incentive to earn income so they will be able to pay the required price The price method is superior 4 Eight Guideposts to Economic Thinking a The use of scarce resources to produce a good is always costly This statement is usually associated with the saying There s no such thing as a free lunch Why does obtaining more of a scarce good ALWAYS involve a cost Someone must give something up if we are to have more of a scarce good The highest valued alternative that must be sacrifices is the opportunity cost of the choice b Individuals choose purposefully therefore they will economize What is meant by economizing Economizing gaining a specific benefit at the least possible cost c Incentives matter How do rational people respond to changes in costs relative to the benefits of their choices As personal benefits from choosing an option increase other things constant a person will be more likely to choose that option As costs from choosing an option increase other things constant a person will be less likely to choose that option d Economic reasoning focuses on the impact of marginal changes What does the term marginal mean Marginal additional Term used to describe the effects of a change in the current situation 1 e f Since information is scarce uncertainty is a fact of life Is it reasonable for people to exhaust all possible sources of information before making decisions Why or why not No At a certain point searching for more additional information is not worth the trouble In addition to their initial impact economic events often generate secondary effects that may be felt only with the passage of time What do we mean by secondary effects Hint I used increases in the minimum wage as an example of a decision that could have secondary effects Secondary effects the indirect impact of an event or policy that may not be easily and immediately observable Often unintended and overlooked g The value of a good is subjective and varies with individual preferences Think of utility or benefit in association with this statement The test of an economic theory is its ability to predict and explain events in the real world These guideposts are important because they enable us to predict human behavior and thus outcomes to forecast and make the best decisions h 5 Positive versus Normative Economic Thinking Which way of thinking is objective Subjective Which way of thinking is a better tool for analysis and decision making and thus to allocate scarce goods Be able to differentiate a positive from a normative statement Positive statements Can be proved either true or false Example The inflation rate rises when the money supply is increased This is a better tool Normative statements Reflect subjective values They cannot be proved true or false Example The inflation rate should be lower Pitfalls to Avoid in Economic Thinking Ceteris Paribus Good Intentions versus Good Outcomes Fallacy of Composition and Association is Not Causation 6 Violation of Ceteris Paribus Latin term meaning other things constant When describing the effect of a change the outcome may be influenced by changes in other things Good intentions do not guarantee good outcomes An unsound proposal will lead to undesirable outcome even if it is supported by proponents with good intentions Fallacy of composition the erroneous view that what is true for the individual or the part is also true for the group or the whole One must beware of the fallacy of composition when shifting from micro to macro units Association Is not causation statistical association alone cannot establish causation Match the following statements with the appropriate fallacies above a As your next President I plan to reduce drug use among college students by spending more money to apprehend drug pushers Note Studies have shown that it s more effective to spend money on drug abuse education than on apprehension of pushers Good intentions do not guarantee good outcomes b Whenever there has been unusual sunspot activity the economy has been in a recession Therefore sunspot activity causes recessions 2 Association is not causation c As your realtor I can t tell you how much it s worth to add a swimming pool to your home to increase its market value unless we know what other factors increase the market value of homes Ceteris Paribus d It s great that wages are rising in our community Our elected officials should push for national wage increases Fallacy of composition CHAPTER 2 SOME TOOLS OF THE ECONOMIST 1 This chapter began with an emphasis on Opportunity Cost How should opportunity cost be considered in these examples What are the opportunity costs of these choices Opportunity cost the highest valued activity sacrificed in making a choice They are subjective and vary across persons When to attend college Whether or not to accept an offer to play professional sports a The opportunity cost of going to college includes monetary costs tuition books and non monetary costs forgone earnings If the opportunity cost of college rises tuition rises or you get a great job offer then one will be less likely to attend college b Take the example of LeBron James He chose not to attend college and go straight to the NBA In his first three year contract he made over 13 million dollars and made 5 million his fourth year Had he gone to a four year college he would have an opportunity cost of 18 million in forgone income c Whether to build a civic center instead of a hospital Build the civic center if it contributes more to the well being of the people in the community more than a hospital 2 How Trade Creates Value Be
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