Final study guide ECO2013 Understand Scarcity Choice resources and capital 1 The Economic way of thinking Economic theory Developed from the basic principles of human behavior A set of definitions postulates and principles assembled in a manner that makes clear the cause and effect relationship 8 guideposts to economic thinking 1 The use of scarce resources is costly so decision makers must take trade offs a Opportunity cost The highest valued alternative that must be sacrificed as a result of choosing an option 2 Individuals choose purposefully they try to get the most from their limited resources a Economizing behavior choosing the option that offer the greatest b Utility The subjective benefit or satisfaction a person expects from a benefit at the least possible cost choice or course of action 3 4 Incentives matter changes in incentives influence human choices in a predictable way Both monetary and non monetary incentives matter Individuals make decisions at the margins a Marginal term used to describe the effects of a change in the current situation For example a producer s marginal cost is the cost of producing an additional unit of a product given the producer s current facility and production rate i Thinking on the margin what s the best deal for me Marginal cost is the extra money and what you get in addition is the marginal benefit Ie 50 cents more for the fries in the meal 5 Although information can help us make better choices its acquisition is costly well as direct effects 6 Beware of the secondary effects economic actions often generate indirect as a Secondary effects The direct impact of an event or policy that may not be easily and immediately observable In the area of policy these effects are often both unintended and overlooked 7 The value of a good or service is subjective 8 The test of a theory is its ability to predict a Scientific thinking developing a theory from basic principles and testing it against events in the real world Good theories are consistent with and help explain real world events Theories that are inconsistent with the real world are invalid and must be rejected i When a theory has a predictive value it is valid Scarcity and poverty are not the same Absence of poverty implies that some basic levels of need have been met An absence of scarcity implies that our desires for goods are fully satisfied We may someday eliminate poverty but never scarcity Scarcity and choice are essential in economic analysis 1 Pitfalls to avoid in economic thinking Do not violate Ceteris Paribus Ceteris paribus other things constant Often describe the effect of one change knowing in the real world other things might change and also exert effect We point out pitfalls because sometime statistical data or observations appear inconsistent with economic theories In most of these cases the apparent contradiction reflects the effects of change in other factors which is a violation of Ceteris paribus Good intentions often do not guarantee wanted outcomes Statistical association cannot establish causation This is a post hoc fallacy Just because two things happen at the same time do not mean that one causes the other What is true for the individual may not be true or beneficial for the whole If one person stands up at the football game they will have a much better view When everyone stands up the individual s no longer have that benefit This is a fallacy of composition Microeconomics Focus on how human behavior affects the conduct of affairs within narrowly defined units such as individuals or households Macroeconomics Focus on how human behavior affects outcomes in highly aggregated markets such as the markets for labor or consumer products 2 What shall we give up Opportunity cost The highest valued alternative sacrificed in order to choose an option 2 Trade creates value Value is subjective The value of a good generally depends on who uses them One person may dislike onions but trade it for a tomato that they do like from someone who hate tomatoes and loves onions In the end both are happier and have more value in their new product that they didn t have before 1 When individuals engage in voluntary exchange both parties are made better off Ie Voluntary trade 2 By channeling goods and resources to those who value them most trade creates value and increases the wealth created by a society s resources Note Transaction costs are a barrier to trade Transaction costs The time effort and other resources needed to search out negotiate and compete an exchange 3 The importance of property rights Property rights involve three things 1 The right to exclusive use of the property 2 Legal protection against invasion from other individuals who would seek to use or abuse the property without the owner s permission 3 The right to transfer sell exchange or mortgage the property Key to economic prosperity is Private ownership It provides people with a strong incentive to take care of things and develop resources in ways that are highly valued by others 4 incentives to private property 1 Private owners can gain by employing their resources in ways that are beneficial to others and they bear the opportunity cost of ignoring the wishes of others 2 Private owners have a strong incentive to care for and properly manage what they own 3 Private owners have an incentive to conserve for the future particularly if the property is expected to increase in value 4 Private owners have an incentive to lower the chance that their property will cause damage to the property of others Notes Product possibilities curve A curve that outlines all possible combinations of total output that could be produced assuming 1 a fixed amount of productive resources 2 a given amount of technical knowledge 3 full and efficient use of those resources Product possibilities curve can be shifted outward by 1 investment 2 technological advance 3 improved institutions 4 greater work effort 2 Trade output and living standards Keys to Economic prosperity Gains from trade Trade makes it possible for people to generate more output through specialization and division of labor Division of labor A method that breaks down the production of a product into a series of specific tasks each performed by a different worker Law of comparative advantage states that 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 the person or firm with the lowest
View Full Document
Unlocking...