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Jong Moon Econ 200 Chapter 1 Microeconomics reading notes Basic fact of life People must make choices as they try to attain their goals We must make choices because we live in a world of scarcity o Scarcity A situation in which unlimited wants exceed the limited resource available to fulfill those wants Economics is the study of the choices consumers business managers and government officials make to attain their goals given their scarce resources Three important ideas People are rational people respond to incentives and optimal decisions are made at the margin Economic models are simplified versions of reality used to analyze real world economic situations Three key economic ideas o As you try to achieve your goals you will interact with other people in markets Market A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade o 1 People are rational Economists generally assume people are rational Doesn t mean they think people will always make the best decision or that they know everything It means that economists assume that consumers and firms use all available information as they act to achieve their goals Rational individuals weigh the benefits and costs of each action and choose an action only if the benefits outweigh the costs o 2 People respond to economic incentives Economists emphasize that consumers and firms consistently respond to economic incentives Example Bank doesn t get security measures because it d be cheaper to just deal with robberies o 3 Optimal decisions are made at the margin Some decisions are all or nothing Most decisions though involve doing a little more or a little less The word marginal is used to mean extra or additional Example Should you watch another hour of TV or spend that hour studying The marginal benefit of watching TV is the additional enjoyment that you receive The marginal cost is the lower grade you receive from having studied a little less Economists reason that the optimal decision is to continue any activity up to the point where the marginal benefit equals the marginal cost Marginal analysis Analysis that involves comparing marginal benefits and The economic problem that every society must solve marginal costs o Because we live in a world of scarcity any society faces the economic problem that it has only a limited amount of economic resources so it can produce only a limited amount of goods and services o Therefore every society faces trade offs Trade offs The idea that because of scarcity producing more of one good or service means producing less of another good or service o Opportunity cost The highest valued alternative that must be given up to engage in an activity Example Doctor could get paid 100 000 a year at a hospital but decides to open his own private practice The opportunity cost is the prospective 100 000 he is giving up in order to start his own firm o Trade offs force society to make choices answering the three fundamental questions 1 What goods and services will be produced 2 How will the goods and services be produced 3 Who will receive the goods and service produced o What goods and services will be produced The choices that consumers firms and the government make determines what will be produced In each case they face the problem of scarcity by trading off one good or service for another Also each choice comes with an opportunity cost measured by the value of the best alternative given up o How will the goods and services be produced Firms choose how to produce the goods and services they sell In many cases firms face a trade off between using more workers or using more machines o Who will receive the goods and services produced Who receives the goods and services produced depends largely on how income is distributed Individuals with the highest income have the ability to buy the most goods and services Often people give up buying goods and services to donate to charity o Centrally planned economies versus market economies Societies organize their economies in two main ways A society can have a centrally planned economy in which the government decides how economic resources will be allocated Or a society can have a market economy in which the decisions of households and firms interacting in markets allocate economic resources o The modern mixed economy o Efficiency and equity Soviet Union was an important centrally planned economy Followed government s orders rather than consumer s wants Government employees managed stores and factories Not successful in producing low cost high quality goods and services So the standard of living of the average person tends to be low All the high income democracies such as the US Canada Japan etc have market economies Rely primarily on privately owned firms to produce goods and services and to decide how to produce them Markets determine who receives the goods and services produced Because firms compete to provide high quality products for low cost they are under pressure to use the lowest cost methods of production Income of an individual is determined by the payments he receives for what he has to sell Before the US did little regulation of markets But unemployment rates and business bankruptcies during the Great Depression increased the government intervention in the economy Mixed economy An economy in which most economic decisions result from the interaction of buyers and sellers in markets but in which the government plays a significant role in the allocation of resources Mixed economy is still primarily a market economy because most economic decisions result from the interaction of buyers and sellers in markets Market economies tend to be more efficient than centrally planned economies There are two types of efficiency Productive efficiency and allocative efficiency Productive efficiency A situation in which a good or service is produced at the lowest possible cost Allocative efficiency A state of the economy in which production is in accordance with consumer preferences Every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it Markets tend to be efficient because they promote competition and facilitate voluntary exchange Voluntary exchange A situation that occurs in markets when both the buyer and seller of a product are made better off by the transaction Productive efficiency is achieved when competition among


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UW ECON 200 - Microeconomics reading notes

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