Econ 2013 Study Guide For Exam 1 Chapter 1 Know that Economics is the study of how we make choices under scarcity Understand the concept of scarcity o Scarcity the concept that there is less of a good freely available from nature than people would like Ex time money textbooks o Scarcity is not the same thing as poverty o Scarcity requires rationing allocating scarce goods to those who want them In a market economy price is used to ration goods Know the difference between the different kinds of resources that we use to produce economic goods o Resource an input used to produce an economic good o Types of resources Human Resources human capital Ex Albert Einstein s intelligence Chuck Noris Physical Resources physical capital Natural Resources Know the 8 guideposts to economic thinking 1 Resources are scarce so tradeoffs must be made i Opportunity Cost the highest valued alternative that must be sacrificed when choosing an option Ex an hour of your time guns military spending vs butter social spending 2 Individuals are rational They try to get the most from their limited resources i greatest benefit at least possible cost ii what is rational for one person may not be rational for everyone Ex chick fila vs 5 guys burger welfare vs education Incentives matter choice is influenced in a predictable way by changing incentives Individuals make decisions at the margin Ex money game macro style prices i Marginal describes the effect of a change in the current situation 3 4 1 Ex olive garden food prices ii Cost benefit analysis one will undergo an action when the marginal benefits out weigh the marginal costs 5 Information helps us make better choices but is costly Ex new house vs new notebook Ex airport security vs lead clean up 6 Beware of secondary effects economic actions generate both direct and indirect effects i Secondary effects the indirect impact of an event or policy that may not be easily and immediately observable Ex Fuel efficiency trade restrictions 7 The value of a good or service is subjective because the value of goods are subjective voluntary trade creates value Ex How much would you pay for a pack of gum right now i 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 If real world events are consistent with a theory then that theory is valid Know the difference between positive and normative economic statements i positive economics the scientific study of what is statements are testable Ex It is 50 degrees outside the government spends 18 000 000 000 ii normative economics Judgments about what people think ought to be statements are not testable Ex It is too cold outside the government spends too much money Know the four pitfalls to avoid in economic thinking 1 Violation of the ceteris paribus principle Ceteris Paribus other things constant Ex buying eggs 2 The belief that good intentions equal desirable outcomes i e good intentions do not guarantee desirable outcomes Ex suicide warnings on antidepressant medication 3 The belief that association is causation i e association is not causation Ex Tiger Attack Preventing watch sunspots and economic activity 4 The fallacy of composition belief that what is true for one might not be true for all Ex when you get a raise vs when everyone gets a raise Chapter 2 Understand how voluntary trade creates value and leads to economic progress The Candy Game o Trade creates value because the value of goods is subjective voluntary 2 o Trade creates value o Creation of wealth When individuals engage in voluntary exchange both parties are made better off Channeling good and resources to those who value them most increases the wealth created by society s resources The process by which some people become rich will make everybody richer Ex Henry Ford Know the characteristics and 4 incentives of private property rights 1 Incentive to use resources in ways that other people value Ex South Park Cartmen s Amusement Park Owners bear the cost of ignoring the wishes of others Ex reselling your textbook Incentive to care for and manage what you own Ex Communal refrigerator vs your own refrigerator Incentive to conserve for the future 2 3 4 Ex Tragedy of the Commons overuse of non privately owned goods resources engaged species 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 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 PPC outlines all possible combinations of total output that can be produced assuming Fixed amount of productive resources Given amount of technical knowledge Full and efficient use of resources o Identify these points Efficient points on the curve Unattainable points on the outside of the curve Inefficient points on the inside of the curve Know the four factors that shift the production possibilities curve 1 Change in the resource base 2 Change in technology 3 3 Change in rules laws under which an economy operates 4 Change in work habits comparative advantage in a certain good Understand the law of comparative advantage and be able to calculate the opportunity cost of production to figure out who has the o Law of Comparative Advantage 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 make what you can make the cheapest Ex should Floyd Mayweather Jr be his own bodyguard o How to calculate opportunity cost look at examples in notes 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 tends to work better at creating economic growth and prosperity o Capitalism a system of economic organization where 1 productive resources are owned privately 2 goods and resources are allocated through markets Understand the difference between socialism and capitalism and how it relates to economic freedom and know why capitalism Market Organization a method of organization in which private parties make their own plans and decisions with the guidance of market prices o Socialism a system of economic
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