ECO2013 Macroeconomics Final Exam Study Guide 1 The Economic Way of Thinking There are Always Trade Offs o What you give up is your opportunity cost The value of the nest best o Opportunity cost is NOT the sum of everything you give up just the next best alternative thing Individuals choose purposefully o This is referred to as economizing behavior or national behavior try to get the most benefits for the least cost of effort Incentives matter o As the incentive goes up you will be more likely to do something o Incentive does not have to be money Think on the margin not in total or on average o Marginal means additional o Marginal cost is additional cost marginal revenue is additional revenue o Continue to engage in an activity as long as the expected marginal benefit is greater than the expected marginal cost o Benefit cost More information leads to better decision making but more information is costly to o The primary effect is often immediate and visible o The secondary effect usually comes later and is not as visible get o There are always trade offs o Individuals choose purposefully o Incentives matter o Think on the margin Many choices create a secondary effect Value is subjective o Beauty is in the eyes of the beholder o Value is determined by the purchaser Economic thinking is scientific thinking predict actions o It is a science 2 Pitfalls to avoid in Economic Thinking Violation of ceteris paribus o Economists use data and information generated by people to explain and o Ceteris paribus other things constant o Want to isolate variables so we typically allow for only one change at a time Good intentions do not necessarily result in good outcomes Association is not causation o Ex Doing superstitious sports activity will have no effect on the actual game Fallacy of composition o Assuming what s good for the individual is good for the group o Making the assumption when it s false is the fallacy 3 What Shall We Give up Opportunity cost value of the next best alternative Ex you spend time and money going to a movie you cannot spend that time at home reading a book and you can t spend the money on something else 4 Trade Creates value Two opposing views of trade o When people trade one person gains and one person loses referred to as a zero sum game o When people trade both parties gain Wealth is created by trade Voluntary trade creates wealth and promotes economic progress o Voluntary trade is expected to benefit both parties involved otherwise it wouldn t occur Potential trades o Barter exchange without money goods for goods o Money exchange goods for money 5 The Importance of Property Rights Two kinds of property rights o Common rights everybody owns it o Private rights only one person owns it U S Constitution Amendment IV o The right that protects people against unreasonable search and seizures which states that there needs to be probable cause to issue a warrant that describes in detail the thing being searched Incentives created by property rights o Give proper care take are of what you own o Conserve for the future o Use resources in ways other people value o Mitigate possible harm to others If you own something you receive 100 of the benefit and cost of owning it If you don t own something you receive less benefit and cost from it 6 Trade Output and Living Standards Law of comparative advantage o Make something you re good at and trade for something you re not good at The law of comparative advantage creates o Low opportunity cost o Comparative advantage o Specialization o Division of labor o Voluntary trade o Increased wealth Adam Smith wrote about this in the Wealth of Nations Self sufficiency is the quickest and most absolute path to poverty 7 Changes In Demand Versus Change In Quantity Demanded When price changes quantity demanded changes o This is a movement along a demand curve When something else changes demand changes o This is a movement of the entire curve o Typical something else changes Income Number of consumers Prices of related goods substitutes and compliments Expectations Demographics Tastes and preferences Why is the consumer buying more or less of something o If price is the reason quantity demanded changes movement along o If anything besides price is the reason demand changes shift the the demand curve demand curve 8 Changes In Supply Versus Change in Quantity Supplied When price changes quantity supplied changes o This is a movement along a supply curve When something else changes supply changes o This is a movement of the entire curve o Typical something else changes Resource prices labor costs paychecks etc Technology better technology more supply Nature Political Taxes Why is the firm producing more or less of something o If price is the reason quantity supplied changes movement along o If anything besides price changes supply changes shift the supply the supply curve curve 9 How Market Prices are Determined Demand and Supply Interact Excess supply surplus and excess demand shortage are not unique points Equilibrium is a unique point because there s only one point of equilibrium 10 How Market Prices respond to Changes in Demand and Supply This is called supply and demand analysis Three step procedure o Identity the change o Determine if supply or demand is affected and how o Reason through the change Invisible Hand Principle o Adam Smith An Inquiry into the Nature and Cause of the Wealth of Nations o Personal self interest directed by market prices is a powerful force promoting economic progress o When you focus on yourself but it consequentially helps others in the process 11 Similarities and Differences between Political and Market Allocation Public choice o Using the tools of economics to understand the political process is called public choice analysis o Public choice decides where to allocate resources Economics of voting o Rational ignorance effect a rational individual has little or no incentive to acquire information needed to cast an informed vote A person doesn t care to become informed o Marginal benefit of voting the chance that your vote was the deciding vote multiplied by how much you care that a certain candidate wins Chance your vote was the deciding vote x how much you care the candidate wins Knowing your vote makes little difference The cost of informing yourself registering to vote and actually voting o Median voter theory a vote maximizing politician in a two party system will be close to the middle do that there is little
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