Macro Exam 2 Chapter 1 Economics the study of how we make choices under scarcity Scarcity concept that there is less of a good freely available from nature than people would like ex time money cars etc o Not the same thing as poverty o Rationing allocating scarce goods to those who want them o In a market economy price is used to ration goods o Scarcity leads to competitive behavior Resources an input used to produce an economic good o Human resources human capital o Physical resources physical capital o Natural resources o Capital human made resources used to produce other goods and services 8 Guideposts to Economic Thinking o Resources are scarce so decision makers must make tradeoffs Opportunity cost the highest valued alternative that must be sacrificed when choosing an option o Individuals are rational They try to get the most from their limited resources Greatest benefit at least possible cost What s rational for one person may not be rational for everyone beer vs liquor o Incentives matter people respond in predictable ways to changes in costs and benefits Money game penny 1 5 10 o Individuals make decisions at the margin Be able to calculate marginal benefits marginal costs and perform a cost benefit analysis drive or fly example Cost benefit analysis one will undergo an action when the marginal benefits outweigh the marginal costs Drive 8 hours spend 200 or fly 2 hours spend 500 o Information helps us make better choices but is costly we often make decisions without full information o Beware of secondary effects Secondary effect the indirect impact of an event or policy that may not be easily and immediately observable o The value of a good or service is subjective Moving goods and services to those who value them most is a primary source of economic process o The test of a theory is its ability to predict If real world events are consistent with a theory then that theory is valid Positive economics the scientific study of what is testable o Ex It s 100 degrees outside Normative economics judgments about what ought to be not testable o Ex It s too hot outside 4 Pitfalls to avoid in economic thinking o Violation of ceteris paribus principle Ceteris Paribus other things constant o The belief that good intentions guarantee desirable outcomes Nirvana Fallacy the logical error of comparing the actual situation with its idealized counterpart rather than the actual alternative o The belief that association is causation Initials and performance Ex superstitions one is true for all Ex Standing at a football game o Fallacy of composition the fallacious belief that what is true for Chapter 2 Trade creates value o Because the value of goods is subjective voluntary trade creates o When individuals engage in voluntary exchange both parties are value made better off o By channeling goods and resources to those who value them most trade creates value and increases the wealth created by a society s resources o The Candy Game How trade leads to economic progress o Gains from specialization and division of labor o Gains from mass production methods o Gains from innovation Transaction costs the time effort and other resources needed to search out and complete and exchange o Leaves a role for middleman a person who buys and sells goods or services or arranges trade A middleman reduces transaction costs Private Property Rights the right to exclusive use of the property legal protection against invasion from other individuals and the right to sell transfer exchange or mortgage the property 4 Incentives of property rights o Use resources in ways that are considered beneficial to others o To care for and manage what they own o To conserve for the future o To make sure their property does not damage your property Production Possibilities Curve PPC outlines all possible combinations of total output that could be produced assuming o A fixed amount of productive resources o A given amount of technical knowledge o A full and efficient use of resources o The slope of the curve indicates the amount of one good that must be given up to produce more of the other good slope rise run a typical PPC slopes downward to the right o Efficient points are on the curve o Inefficient points are inside the curve o Unattainable points are outside the curve o Opportunity cost what you give up o Increasing opportunity cost bowed outward concaves to the origin rather than downward to the right 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 when moving from one point to another o 4 factors that shift the curve are A change in the economy s resource base Investment the purchase construction or development of resources Changes in technology A change in the rules under which the economy functions Change in work habits Law of Comparative Advantage the total output of a group of individuals an entire economy or a group of nations that will be greatest when the output of each good is produced by whoever has the lower opportunity cost Every economy faces three questions o What will be produced o How will it be produced o From whom will it be produced Socialism a system of economic organization where o Ownership and control of the means of production rest with the state o Resource allocation is determined by centralized planning Capitalism a system of economic organization where o Productive resources are owned privately o Goods and resources are allocated through market prices Why capitalism tends to work and socialism does not o Capitalism is similar to natural selection It uses the idea of market efficiency a method of organization in which private parties make their own plans and decisions with the guidance of market prices o Socialism suffers from an information problem Chapter 3 Law of demand There is an inverse negative relationship between the price of a good and the quantity that buyers are willing to purchase o Results in a downward sloping curve o As price increases quantity demand decreases The height of the demand curve at any quantity shows the maximum price that consumers are willing to pay for an additional unit o Notice that when consumers have more of the good they value it Consumer surplus the difference between the maximum amount consumers would be willing to pay and the amount that they actually pay o Consumer surplus is the area below the demand curve but above Change in
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