Macro Test 2 Study Guide 1 Chapter 1 The economic approach a Economics is the study of how we make choices under scarcity i Choice The act of selecting among alternatives ii Scarcity The concept that there is less of a good freely available from nature than people would like 1 ex Time money textbooks 2 Scarcity necessitates rationing Rationing Allocating scarce goods to those who want them In a market economy price is used to ration goods a b c Scarcity leads to competitive behavior iii Resources An input used to produce an economic good 1 Human resources human capital 2 Physical resources physical capital 3 Natural resources a Capital Human made resources used to produce other goods and services iv 8 Guideposts to Economic Thinking 1 Resources are scarce so decision makers must make trade offs No such thing as a free lunch a Opportunity Cost The highest valued alternative that must be sacrificed when choosing an option i Ex An hour of your time ii Ex Guns and butter 2 Individuals are rational they try to get the most from their limited resources greatest benefit at least possible cost a Ex Red Wine vs Spiced Rum b Ex welfare vs education c Note What is rational for one person may not be rational for everyone 3 4 Incentives matter choice is influenced in a predictable way by changing incentives Individuals make decisions at the margin a Marginal Describes the effect of a change in the current situation i ii ex Olive Garden ex Trip to Taco Bell b Cost benefit analysis one will undergo an action when the marginal benefits outweigh the marginal costs i ex Airport Security vs Lead Clean Up 5 Information helps us make better choices but is costly a ex New house vs new note book 6 Beware of secondary effects economic actions generate both direct and indirect effects a Secondary effects the indirect impact of an event or policy that may not be easily and immediately observable i ex Fuel efficiency regulations ii ex Trade restrictions 7 The value of services is subjective a Because goods are subjective voluntary trade creates value i ii ex How much would you pay for a pack of gum right now ex Moving goods and services to those who value them most is a primary source of economic progress 8 The test of a theory is its ability to predict a If real world events are consistent with a theory then that theory is valid v Positive vs Normative 1 Positive economics the scientific study of what is testable 2 Normative economics Judgments about what people think ought to be not testable vi 4 pitfalls to avoid in economic thinking 1 Violation of ceteris paribus principle a ceteris paribus other things constant i ex Buying Eggs 2 Good intentions do not guarantee desirable outcomes ex Suicide warnings on antidepressant medication ex C H Taxi 3 Association is not causation ex Superstitions ex Sunspots and economic activity a b a b 4 Fallacy of composition belief that what is true for one might not be true for all a ex When you get a raise Vs When everyone gets a raise vii Microeconomics vs Macroeconomics 1 Microeconomics focuses on how human behavior affects the conduct of affairs within individually defined units such as households or firms the trees 2 Macroeconomics focuses on how human behavior affects outcomes in highly aggregated markets such as the nations market for labor the forest 2 Chapter 2 Tools of the economist a Trade creates value Because the value of goods is subjective voluntary trade creates value i When Individuals engage in voluntary exchange both parties are made better off ii Channeling goods and resources to those who value them most increases the wealth created by a society s resources 1 Creation of wealth a The process by which some people become rich will make everybody richer b Importance of property rights i ex Henry Ford i The right to exclusive use of the property ii Legal protection against invasion from other individuals iii The right to sell transfer exchange or mortgage the property 1 4 incentives of property rights a Incentive to use resources in ways that are considered beneficial to others ex South Park Cartmen s Amusement Park owners bear the cost of ignoring the wishes of others i ii ex Reselling your textbook b Private owners have an incentive to care for and manage what they own i ex Communal refrigerator vs Your own refrigerator c Private owners have an incentive to conserve for the future i ex Tragedy of the Commons ii ex Endangered species pg 27 d Private owners have an incentive to make sure their property does not damage your property 2 Lack of property rights lack of economic progress c Production Possibilities Curve PPC outlines all possible combinations of total output that could be produced assuming a i fixed amount of productive resources ii given amount of technical knowledge iii full and efficient use of resources 1 4 factors that shift the PPC a A change in the economy s resource base i Investment the purchase construction or development of resources b Changes in technology i technology the knowledge available in an economy at any given time c A change in the rules under which the economy functions d Changes in work habits d Law of comparative advantage i The total output of a group of individuals an entire economy or a group of nations will be greatest when the output of each good is produced by whoever has the lowest opportunity cost e Economic organization i Every economy faces 3 questions 1 What will be produced 2 How will it be produced 3 For whom will it be produced 3 Chapter 3 Supply Demand and the Market Process a The demand curve ii Capitalism A system of economic organization where 1 Productive resources are owned privately 2 Goods and resources are allocated through market prices 3 Market organization a method of organization in which private parties make their own plans and decisions with the guidance of market prices iii Socialism a system of economic organization where 1 Ownership and control of the means of production rest with the state 2 Resource allocation is determined by centralized planning 3 Collective decision making the method of organization that relies on public sector decision making to resolve basic economic questions iv Why Capitalism tends to work 1 Capitalism is similar to natural selection It uses the idea of market efficiency 2 Socialism suffers from an information problem i Law of demand There is an inverse negative relationship between the price of a good and the quantity that buyers are willing to purchase 1
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