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Study Guide: Chapters 1, 2, and 3

by: Danielle Sturgeon

Study Guide: Chapters 1, 2, and 3 Eco2013

Marketplace > Florida State University > Business > Eco2013 > Study Guide Chapters 1 2 and 3
Danielle Sturgeon

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Here is a study guide for the exam on chapters 1, 2, and 3. This will also be extremely helpful when it comes time to study for our final
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This 10 page Study Guide was uploaded by Danielle Sturgeon on Thursday September 24, 2015. The Study Guide belongs to Eco2013 at Florida State University taught by Calhoun in Summer 2015. Since its upload, it has received 108 views. For similar materials see Macroeconomics in Business at Florida State University.


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Date Created: 09/24/15
Chapter 1 The Economic Approach 1What is economics about a Economics tries to explain and predict the behavior of consumers rms and government bThe choices that we make due to our desire for a certain good or service 2 Scarcity and Tradeoffs a Scarcity a fundamental concept of economics that indicates that there is less of a good freely available from nature than people would like iScarcity leads to tradeoffs which results in making choices iiHow much are you willing to give up for something you desire LHistorical ways to deal with scarcity 1 Force wars traditions authority government and church the market 2Almost always a combination of all four ways ivScarcity requires that some wants remain un lled vssues of equity justice and fairness are embedded within scarcity 1 However scarcity and poverty are not the same a Scarcity objective concept that describes a factual situation in which the limited nature of our resources keeps us from being able to completely ful ll our desires for goods and services b Poverty subjective concept that refers to a personal opinion of whether someone meets an arbitrarily de ned level of income LScarcity makes rationing a necessity rationing is allocating a limited supply of a good or resource among people who would like to have more of it bChoice The act of selecting among alternatives iWhen we make choices we face tradeoffs between meeting one desire or another 1 Ex Do I spend my last hour watching Net ix or studying for my economics test 2To meet one need the other must go unmet LThe basic ideas of scarcity choice and tradeoffs provide the foundation of economics d Resources the ingredients that people use to produce goods and services iOur ability to produce goods depends on which resources are available to us iiThree categories of resources 1 Human resources the productive knowledge skill and strength of human beings 2 Physical resources tools machines and buildings Enhance our ability to produce goods a Commonly referred to as capital 3Natural resources land mineral deposits oceans rivers etc a Usually only useful once humans discover how to best use these resources 3The Economic Way of Thinking aThere are always tradeoffs iWhat you give up is your opportunity cost value of the next best option iiOpportunity cost is not the sum of everything you have given up rather just what your second choice would have been L No such thing as free lunchquot resources are scarce and so the use of resources to produce one good always diverts those resources from the production of other goods b Individuals choose purposefully iReferred to as economizing behavior trying to get the most bene ts for the least cost or effort 1 Also known as rational behavior iiUtility The bene t or satisfaction one expects from a choice LChoice is subjective what is the primary choice for one person might not be a valuable option to another person ivPeople behave rationally to get the best option at the least possible cost Lincentives Matter iChanges in incentives in uence human choices in a predictable way Both monetary and nonmonetary incentives matter iiAs the incentive goes up you will be more likely to do something and vice versa LThe incentives do not have to be money ivEx Store owners know that they can sell off unwanted inventory if they reduce the price because consumers respond to incentives v As an option becomes more costly less is chosen LPeople do not only respond to incentives because they are sel sh or greedy they are motivated by a variety of goals d Individuals make decisions at the margin iAdditional is often used in place of marginal Ex Marginal costis additional cost iindividuas generally focus on the difference in the costs and bene ts between alternatives when making decisions LA marginal decision is whether it is worth it to get more of something or something better ivMarginal is different than average in that it indicates what the change in total cost would be to produce one more unit e More information is more costly but leads to better decision making i People economize on their search for information ii Eventually you decide whether or not it is worth it to search for more information and you make a choice based on the limited information you have already gathered fMany choices create a secondary effect i The primary effect is often immediate and visible I The secondary effect usually comes later and is not as visible 1 Failure to observe secondary effects is one of the most common economic problems 2Sometimes actions change the incentives people face and they respond accordingly creating secondary effects that were not intended gThe value of a good or service is subjective i Beauty is in the eyes of the beholder ii Value is determined by the purchaser iii Something is only worth so much depending on who wants it 1 Ex A baseball fan values a baseball game ticket much more than someone who doesn t like sports hThe test of a theory is it s ability to predict i Economic thinking is scienti c thinking I How useful an economic theory is depends on how well it predicts the future consequences of economic ac on 4Positive and a econo i b in eco i 5 aVioIati i iii iv b Good c Assoc 1 If events in the real world are consistent with a theory the theory has predictive value and is therefore valid Economists use data and information to explain and predict actions Normative Economics Positive Economics The scienti c study of quotwhat isquot among mic relationships Must be testable but does not need to be correct Normative Economics Judgments about quotwhat ought to bequot nomic matters Cannot be proved false because they are based on value judgments Pitfalls to Avoid in Economic Thinking on of Ceteris Paribus Ceteris Paribus meaning quotother things constantquot basically acknowledging that when the effect of one change is being described you recognize that if other things have changed not remained constant those could have affected the results Ex In science class if you are testing whether amount of water affects plant growth you would only change the amount of water If you also changed the plant type you would have to acknowledge that this also could have affected the results Changing variable A changes outcome B as long as everything else stays constant We want to isolate variables so we typically only allow one to change at a time Intentions Do Not Guarantee Good Outcomes Sometimes people are unaware of the secondary effects of their decisions Secondary effects can sometimes make a decision that seemed great at the time back re and become a negative outcome iation is Not Causation iJust because two events happen in conjunction with one another does not mean that they are at all related ii Those who assume this commit a logical fallacy dThe Fa llacy of Composition What s true for one might not be true for all What is true for the individual may not be true for the group Ex If you stand up at a football game you will be able to see better than before But if everyone stands up at a football game you will probably see the same if not worse than when everyone was sitting down Chapter 2 Some Tools of the Economist 1 What Shall We Give Up a Scarcity means that we can t have everything we want b We constantly face choices that involve tradeoffs c Opportunity Cost i The choice to do one thing is at the same time a choice not to do another thing ii The highest valued alternative sacri ced in order to choose an option is called the opportunity cost of that choice 2 Trade Creates Value a The value of goods and services generally depends on who uses them b Two opposing views of trade i When people trade one person gains and the other person loses ii When people trade both parties gain 1 In this instance trade creates wealth c When individuals engage in a voluntary exchange both parties are made better off i Voluntary trade is expected to bene t both parties involved otherwise it wouldn t occur d By channeling goods and resources to those who value them most trade creates value and increases the wealth created by a society s resources i The value of an item can vary greatly from one person to another ii Material things are not wealth until they are in the possession of someone who values them e Transaction Costs The time effort and other resources needed to search out negotiate and complete an exchange i Sometimes valuable trades will not take place because of high transaction costs ii Gains from trade can go completely unrealized if the person does not think the transaction costs are worth it 3 The Importance of Property Rights a Two kinds of property rights i Common rights everybody or a large group owns it ii Private rights only one person or a small group owns it b Privateproperty rights involve three things C l The right to exclusive use of the property ii Legal protection against invasion from people who could use or abuse the property without permission iii The right to transfer sell exchange or mortgage the property Incentives created by property rights i Give proper care to property 1 Being careless about taking care of private property lessens its value to both the current and any future owner ii Conserve for the future 1 Private owners have an incentive to conserve for the future particularly if the property is expected to increase in value iii Use resources in ways other people value as to increase your chances of wealth 1 Private owners can gain by employing their resources in ways that are bene cial to others and they bear the opportunity cost of ignoring the wishes of others iv Mitigate possible harm to others to avoid lawsuit 1 Private owners have an incentive to lower the chance that their property will cause damage to the property of others because if it does then they will be to blame d Private Ownership and Markets i Private ownership and competitive markets provide the foundation for cooperative behavior among individuals ii Market prices give private owners a strong incentive to consider the desires of others and use their resources in ways others value 4 Production Possibilities Curve a an A curve that outlines all possible combinations of total output that could be produced assuming three things i A xed amount of productive resources ii A given amount of technical knowledge iii Full and efficient use of those resources The slope of the curve indicates the amount of one product that must be given up to produce more of the other Points on the curve efficient points Points under inside the curve inefficient points i Not using resourcestime wiselycompletely e Points outside of the curve unattainable points i You do not have enough moneytimeresources to reach these points f Curve shifting i Curve can shift outward as an indicator of growth producing more 1 An increase in the economy s resource base would expand our ability to produce goods and services 2 Advancements in technology can expand the economy s production possibilities 3 An improvement in the rules under which the economy functions can also increase output 4 By working harder and giving up current leisure we could increase our production of goods and services ii Curve could shift inward as an indicator of negative growthregression not usually a possibility very rare 5 Trade Output and Living Standards a Trade makes it possible for people to generate more output through specialization and division of labor largescale production processes and the dissemination of improved products and production methods i Moves goods from people who value them less to people who value them more b Division of Labor i A method that breaks down the production of a product into a series of speci c tasks each performed by a different worker ii This method allows for more efficiency and a lower production cost c Law of Comparative Advantage i Make the good for which you have a low opportunity cost and trade for the good for which you have a high opportunity cost 1 Do what you do best and trade for the rest 6 Human lngenuity and the Creation of Wealth a Human Ingenuity Economic goods are the result of human ingenuity and action thus the size of the quoteconomic piequot is variable not xed i The size of a country s quoteconomic piequot is most easily thought of as the total dollar value of all goods and services produced during some period of time ii When a person earns income he or she expands the economic pie by more than the amount of the slice that he or she gets making it possible for the rest of us to have a bigger slice too 7 Economic Organization a Every economy faces three basic questions i What will be produced ii How will it be produced iii For whom will it be produced b Market Organization i A method of organization in which private parties make their own plans and decisions with the guidance of unregulated market prices ii Also known as capitalism An economic system in which productive resources are owned privately and goods and resources are allocated through market pdces iii In markets individual buyers and sellers communicate their desires and preferences both directly and indirectly Chapter 3 Demand Supply and the Market Process 1 Consumer Choice and the Law of Demand a As the price of a good increases we have to give up more of other goods if we want to buy it i Basically as the price of a good rises its opportunity cost increases b The Law of Demand i There is an inverse relationship between the price of a good and the quantity of it that buyers are willing to purchase As the price of a good increases consumers will wish to purchase less of it As the price decreases consumers will wish to purchase more of it ii Substitutes products that serve similar purposes An increase in the price of one will cause an increase in demand for the other iii Demand Schedule a table listing the various quantities of something consumers are willing to purchase at different prices 2 Changes in Demand vs Changes in Quantity Demanded a Other Variables besides price determine what you buy i When price changes quantity demanded changes but demand does not change 1 This shifts to another point on the curve ii When something else besides price changes demand changes 1 This is movement of the entire curve b Another way to think about the difference between demand and quantity demanded i Why is the consumer buying more or less 1 If price is the reason then quantity demanded changes move along the demand curve 2 If any variable besides price is the reason then demand changes shift the demand curve c Why would there be a change in demand i Changes in consumer income 1 Consumers can purchase more or less goods if their income goes up or down Changes in the number of consumers in the market 1 If people are only seasonally in a location there is much less demand after everyone leaves iii Changes in the price of a related good 1 Related goods could be substitutes if their price goes up or down it will in uence how much of the other product consumers will or will not buy iv Changes in expectations 1 If there is a natural disaster etc expected changes in demand will result v Demographic changes 1 If the demographic of a population changes there will be demands for different types of products vi Changes in consumer tastes and preferences 1 When people change and acquire new information their wants and needs change 3 Producer Choice and the Law of Supply a Producers convert resources into goods and services by doing the following i Organizing productive inputs and resources like land labor capital natural resources and intermediate goods ii Transforming and combining these inputs into goods and services iii Selling the nal product to consumers b The Law of Supply i The positive relationship between price and quantity supplied when price risesfalls quantity supplied risesfalls c Opportunity cost of production i The value of the production of other goods sacri ced as the result of producing the good d Things that cause changes in supply when anything other than price changes i Changes in resource prices ii Changes in technology iii Elements of nature and political disruptions iv Changes in taxes 4 How Market Prices are Determined Demand and Supply Interact a Market i An abstract concept encompassing the forces of supply and demand and the interaction of buyers and sellers with the potential for exchange to occur b Equilibrium i A state in which the con icting forces of supply and demand are in balance When a market is in equilibrium the decisions of consumers and producers are brought into harmony with one another and the quantity supplied will equal the quantity demanded 5 How Markets Respond to Changes in Demand and Supply a This is called supply and demand analysis b In a market economy when the demand for a good increases its price will rise which will i Motivate consumers to search for substitutes and cut back on additional purchases of the good ii Motivate producers to supply more of the good c When the demand for a product declines the adjustment process sends buyers and sellers just the opposite signals d Invisible Hand Principle i Market prices coordinate the actions of self interested individuals and direct them toward activities that promote the general welfare ii Adam Smith in The Wealth ofNations


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