ECO2013 EXAM 1 STUDY GUIDE CHAPTERS 1 2 3 7 8 Chapter 1 The Economic Approach Adam Smith father of economics o o says that wealth is not about gold or silver it is about productivity Invisible Hand Principle self interest leads to helping others you have to figure out how to help people in order to earn money Economics the study of how individuals make choices and use scarce resources dismal science Thomas Malthus o we all have unlimited wants and limited resources o scarcity there is less of a good freely available from nature than people would like if it has a price it s scarce scarcity is objective and will always be present SCARCITY IS NOT POVERTY scarcity always necessitates rationing allocating a limited supply of a good or resource among people who would like to have more of it choices ALWAYS involve trade offs resources inputs used to produce goods and services human resources cannot be separated from the individual skills knowledge that we acquire through experience education physical capital resources machines tools used to build the goods and services natural resources self explanatory water land oil coal etc 8 guideposts to economic thinking the use of scarce resources is costly so decision makers must have trade offs there is no such thing as free lunch opportunity cost what is given up to get something individuals choose purposefully they try to get the most from the least economizing behavior choosing the option that offers the greatest benefit at the least possible cost utility the subjective benefit or satisfaction a person expects from a choice or course of action people behave rationally understand their preferences and try to get the most from their scarce resources to maximize utility incentives matter choice is influenced in a predictable way by changed in incentives ALL ECONOMICS IS BASED ON THIS STATEMENT incentive a threat of a reward or punishment responses to incentives vary altering incentives alters behavior The Peltzman Effect 1975 good intentions do not guarantee desirable outcomes o individuals make decisions at the margins marginal used to describe the effects of a change in the current situation marginal additional marginal cost cost of producing each additional unit of product diamond water paradox diamonds do nothing yet are expensive we need water to survive yet it s free total benefit does not equal marginal benefit average cost total cost total produced information is costly beware of the secondary effects gathering information isn t free the bigger the decision the more resources you ll use gathering information and shopping secondary effects the indirect impact of an event or policy that may not be easily and immediately observable the value of a good or service is subjective preferences differ among individuals moving goods to those who value them most is a source of economic progress the test of a theory is the ability to predict scientific thinking developing a theory from basic principles and testing it against real world events positive economics can be proven true or false negative economics opinionated cannot be proven true or false REMEMBER DO NOT VIOLATE CETERIS PARIBUS GOOD OUTCOMES DO NOT GUARANTEE DESIRABLE OUTCOMES CORRELATION IS NOT CAUSATION WHAT IS TRUE FOR ONE IS NOT TRUE FOR ALL o o o o o o o o o Chapter 2 Some Tools of the Economist opportunity the highest valued alternative sacrificed in order to choose an option different for each person subjective money doesn t reflect the total opportunity cost of an action o failure to consider opportunity cost leads to false conclusions and poor decision making TRADE MAKES BOTH PARTIES BETTER OFF trade is voluntary we only engage in mutually beneficial trades trade increases the total wealth in an economy and moves goods to people who value them most transaction cost the time effort and other resources needed to search out negotiate and complete an exchange transaction costs are a barrier to trade o middlemen a person who buys and sells goods or services or arranged trades makes trades more efficient and lower their overall cost reduce transaction costs private property rights involves three things 1 right to exclusive use 2 legal protection against invasion 3 right to transfer sell exchange or mortgage owners benefit from using property in ways that others appreciate owners have an incentive to care for their property property rights create an incentive to conserve for future use common property multiple people simultaneously claim a good or resource when everybody owns something nobody owns it tendency to overuse economic growth is hindered without property rights production possibilities curve PPC outlines all possible combinations of output that could be produced holding fixed resources and technology o o slope of PPC amount of one product that must be given up to obtain another points outside the curve are impossible points on the curve are inefficient an outward shift represents economic growth things that shift PPC outward o increase in economy s resources investment improvements that expand on economy s resources called capital formation required a decrease in current consumption creative destruction the replacement of old products and methods by new ones that are superior o advancement in technology o improvements in the rules when contracts are enforced fairly property rights are stable international and domestic trade are open o working harder and giving up leisure divisions of labor method that breaks down the production of a product into a series of specific tasks law of comparative advantage total output will be greatest when each good is produced by the individual with the lowest opportunity cost buyers benefit from lower cost seller benefit from higher output and incomes gains from mass production and innovation 1 mass production can reduce per unit cost 2 no one would produce on a large scale if they couldn t trade and 3 trade allows the economic pie to grow market organization private parties make their own decisions with the guidance of unregulated marked prices buyers and sellers individually decide what to produce how to produce it and who to trade with collective decision making use of the political process to allocate resources the government decides what to produce how to produce it and who will get it o o o o Chapter 3 Supply Demand and the Market Process DEMAND o o o the law of demand there is an inverse relationship between the price of a good and the
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