Econ 2013 Study Guide For Exam 1 Chapter 1 Economics the study of how we make choices under scarcity How to get the most out of your life given that you can t have everything Understand the concept of scarcity Scarcity the concept that there is less of a good freely available from nature than people would like scarcity is not the same thing as poverty it just necessitates rationing and leads to competitive behavior Know the difference between the different kinds of resources that we use to produce economic goods Resources an input used to produce an economic good Human resources human capital strength speed etc Physical resources physical capital pens chairs etc Natural resources trees coal etc Know the 8 guideposts to economic thinking 1 Resources are scarce so tradeoffs must be made Opportunity cost the highest valued alternative that must be sacrificed when choosing an option 2 Individuals are rational they try to get the most from their limited resources greatest benefit at least possible cost 3 Incentives matter 4 Individuals make decisions at the margin Marginal describes the effect of a change in the current situation Cost benefit analysis one will undergo an action when the marginal benefits choice is influenced in a predictable way by changing incentives outweighs the marginal costs 5 Information helps us make better choices but is costly 6 Beware of secondary effects Secondary effects the indirect impact of an event or policy that may not be easily economic actions generate both direct and indirect effects and immediately observable 7 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 is a primary source of economic progres 8 The test of a theory is its ability to predict if real world events are consistent with a theory then the theory is valid Know the difference between positive and normative economic statements Positive economics scientific study of what is testable Normative economics judgments about what people think ought to be not testable 1 Know the four pitfalls to avoid in economic thinking 1 Violation of the ceteris paribus principle Ceteris paribus all other things constant Ex buying eggs if the price of eggs go up then less people will buy eggs but not if it s Easter 2 The belief that good intentions equal desirable outcomes they don t 3 The belief that association is causation it isn t 4 The fallacy of composition the belief that what is true for one might not be true for all Joab wanting to get pepper sprayed just to see what it felt like Chapter 2 Understand how voluntary trade creates value and leads to economic progress because the value of a good is subjective voluntary trade creates value When individuals engage in voluntary exchange both parties are made better off Channeling goods and resources to those who value them most increases the Creation of Wealth the process by which some people becoming rich will make wealth created by society s resources Ex The Candy Game everybody richer Ex Henry Ford Know the characteristics and 4 incentives of private property right Private Property Rights Involve 1 Right to exclusive use of the property 2 Legal protection against invasion from others 3 Right to sell transfer exchange or mortgage the property 4 Incentives of Property Rights 1 Incentive to use resources in ways that other people value owners bear the cost of ignoring the wishes of others Ex Cartmen s Amusement Park 2 Incentive care for and manage what you own Ex Communal refrigerator vs Personal refrigerator 3 Incentive to conserve for the future Ex Endangered species 4 Incentive to make sure your property does not damage someone else s property lack of property rights lack of economic progress Understand the concept of the Production Possibilities Curve PPC outlines all possible combinations of total output that could be produced assuming fixed resources technical knowledge and full efficient use of resources Efficient points points on the PPC meaning all resources are being used effectively A B C Inefficient points inside the curve misuse or underuse of some resources D Unattainable points outside the curve not possible with resources given would need more to achieve E 2 Know the four factors that shift the production possibilities curve 1 Change in the resource base Investment the purchase construction or development of new resources requires us to give up consumption goods 2 Change in technology Technology the knowledge available in an economy at any given time determines the amount of output we can generate with our limited resources 3 Change in rules laws under which an economy operates Ex imposing trade barriers 4 Change in work habits Ex working harder can shift the curve outward working less can shift the curve inward The Law of Comparative Advantage total output of a group economy or group of nations will be greatest when the output of each good is produced by whoever has the lowest opportunity cost Not necessarily who has absolute advantage can produce with the lowest resource cost but whomever gives up the least opportunity cost Know the 3 questions that every economy faces 1 What are we going to produce 2 How are we going to produce it 3 For whom will it be produced who gets it once its made Capitalism a system of economic organization where Productive goods are owned privately Goods resources are distributed through market price Market Organization private parties make their own plans and decisions with guidance of market prices Socialism ownership and control of the means of production rest with the state and resource distribution is determined by centralized planning Collective decision making relies on public sector decision making to resolve 3 basic economic questions see above Why Capitalism Tends to Work Better Capitalism is similar to natural selection in that it uses the idea of market efficiency measure of the availability to all participants in a market of the information that provides maximum opportunities to buyers and sellers to effect transactions with minimum transaction costs Socialism suffers from an information problem public sector doesn t know what is right or most beneficial for each individual Chapter 3 Law of Demand there s an inverse negative relationship between the price of a good and the quantity that buyers are willing to purchase Results in a downward sloping curve price quantity demanded Consumer Surplus
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