Econ 2106 1st EditionExam # 1 Study Guide Ch.1: Ten Principles of Economics - Scarcity: the limited nature of society’s resources - Economics: the study of how society manages its scarce resources- Principle #1: People face trade-offso Efficiency: the property of society getting the most it can from its scarce resourceso Equality: the property of distributing economic prosperity uniformly among the members of society AKA efficiency refers to the size of the economic pie and equality refers to how that pie is divided- Principle #2: The cost of something is what you give up to get ito Opportunity Cost: whatever must be given up to obtain some item- Principle #3: Rational people think at the margino Rational people: people who systematically and purposefully do the best they can to achieve their objectiveso Marginal change: a small incremental adjustment to a plan of actiono A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost Ex. Selling a plane ticket to a stand-by passenger for $300 when the average costper passenger is $500 but the plane is taking off anyways- Principle #4: People respond to incentives o Incentive: something that induces a person to act- Principle #5: Trade can make everyone better offo Trading allows a greater variety of goods and services at a lower cost- Principle #6: Markets are usually a good way to organize economic activityo Market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services Firms decide whom to hire and what to produce Households decide which firms to work for and what to buyo Adam Smith observed that households and firms interact in markets as if they are being guided by an “invisible hand” that leads them to more desirable market outcomes Prices are the instrument with which the invisible hand directs economic activity(because market reflects both the value of a good to society and the cost to society of making the good)- Communism fails because it eliminates this invisible hand- Principle #7: Governments can sometimes improve market outcomeso Property Rights: the ability of an individual to own and exercise control over scarce resourceso 2 reasons for government to intervene in the economy1. Promote efficiency2. Promote equalityo Market failure: a situation in which a market left on its own fails to allocate resources efficiently  Possible causes of market failure1. Externality: the impact of one person’s actions on the well being of a bystander (ex. Pollution)2. Market Power: the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices (ex. A monopoly) o Government can improve on market outcomes at time but won’t always will - Principle #8: A country’s standard of living depends on its ability to produce goods and serviceso Productivity: the quantity of goods and services produced from each unit of labor input Explains the differences between standard of livings Zhang told us we did not need to know the last 2 principles for the testChapter 2: Thinking Like an Economist- Circular-flow diagram: a visual model of the economy that shows how dollars flow through markets among households and firmso Firms produce goods and services using inputs (labor, land, capital) These inputs are called factors of productiono Households own the factors of production and consume all the goods and services that the firms produce- Households and firms interact in 2 types of markets1. Markets for Goods & Services Households are buyers and firms are sellers2. Markets for the Factors of Production Households are sellers and firms are buyers- Circular-flow diagram is a simple version of the economy; does not account for things like the roles of government and international trade- Production Possibilities Frontier: a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technologyo Efficient outcome: the economy is getting all it can from the resources available On the curveo Inefficient outcome: the economy is producing less than it could from the resources available Inside the curve, belowo Impossible outcome Outside the curve, aboveo Shows the opportunity cost which is the cost of what you give up to get ito Highlights scarcity, efficiency, trade-offs, opportunity cost, and economic growth - Micro vs. Macroo Microeconomics: the study of how households & firms make decisions and how they interact in marketso Macroeconomics: the study of economy-wide phenomena Ex. Inflation, unemployment, and economic growth- Positive vs. Normative Analysiso Positive statements: claims that attempt to describe the world as it is Ex. “Minimum wage laws cause unemployment.”o Normative statements: claims that attempt to prescribe how the world should be Ex. “The government should raise the minimum wage.”o Much of economics is positive because it tries to explain how the economy works yet they often have normative goals of learning how to improve the economy Chapter 3: Interdependence & Gains from Trade- Absolute Advantage: the ability to produce a good using fewer inputs than another producer o Ex. Rancher needs only 10 mins to produce 1 potato and the farmer needs 20 mins to produce 1 potato so the rancher has absolute advantage - Opportunity Cost: whatever must be given up to obtain some itemo Ex. Rancher’s time producing potato is time taken away from producing beef- Comparative Advantage: the ability to produce a good at a lower opportunity cost than another producer o Ex. Rancher gives up 10 oz. of beef to make 20 oz. of potato while farmer gives up 5 oz. of beef to make 20 oz. of potato so farmer has comparative advantage o It’s impossible for one person to have comparative advantage in both goods  The opportunity cost of one good is the inverse for the opportunity cost of another good- Gains from specialization and trade are based on comparative advantage NOT absolute advantageChapter 4: Market Forces of Supply & Demand- Supply & Demand determine the quantity of each good produced and the price at which it is soldo These terms refer to the behavior of people as they interact with one another in competitive markets- Market: a group