Sara Seals Micro Exam One

economics

the study of how society manages its scarce resources

Principle 1: People Face Trade-offs

quantity vs. quality

efficiency vs equality

Efficiency

max. benefits from scarce resources (ex. drunk driving policy)

equality

when economic prosperity is distributed uniformly among the members of a society (ex. progressive income tax policy)

Principle 2: The cost of something is what you give up to get it

whatever a person has to give up in order to get something else is known as opportunity cost

(the opportunity cost of a resource is the next-highest valued alternative use of that resource)

Principle 3: Rational people think at the margin

rational people compare marginal costs and marginal benefits, by taking action only if marginal benefit > marginal cost

Principle 4: People Respond to Incentives

an incentive is anything- such as punishment or reward- that induces a person to act a certain way

Principle 5: Trade can make everyone better off

trade allows people, companies, and even countries to specialize in what they do best and enjoy a greater variety of goods and services at a lower cost

Principle 6: Markets are usually a good way to organize economic activity

Demonstrated by the collapse of the government- planned economies of comunnism

market economy

the market -made up of millions of companies and individual households- allocates the resources as its members interact for goods and services

(the decentralized decisions made by these companies and households are guided by prices and self interest

the invisible hand

people doing what is best for themself usually benefits the economy

Principle 7: Governments can sometimes improve market outcomes

we rely on the government to enforce property rights and avoid market failure

2 reasons why the market might fail to allocate resources efficiently

externalities and market power

positive externality

an unintended benefit that bystanders receive from others who are doing what is best for themselves

negative externality

an unintended negative consequence that bystanders receive from others who are doing what is best for themselves

market power

when one firm (a monopoly) or small group of firms have market power over an entire market, we tend to see less than efficient quantities being produced and higher than efficient prices are being charged

Principle 8: A country's standard of living depends on its ability to produce goods and services

higher productivity > higher standard of living within a country

productivity

the quantity of goods and services produced from each unit of labor input

Principle 9: Prices rise when the government prints too much money

inflation- the increase in the overall levels of prices in the economy

(when the government prints too much money, the value of that money falls and prices go up)

Principle 10: society faces a short-run trade-off between inflation and unemployment

firms raise their prices when they need to increase their supply to meet excess demand...i.e. inflation... at the same time, these firms will need to hire more workers to produce more goods and services

the economist of a scientist

they use observations, development of theories and the collection and analysis of data

experiments in econ

are nearly impossible, so economists focus on observation to natural experiments, using assumptions to simplify the world and relying on economic models to understand reality

Assumptions

provide a way to allow economist to simplify the complex world

(cetris paribus, too-good world, two-country world, S-R vs L-R)

ceteris paribus

means "other things equal" and helps us to know that no other potential changes are occurring at the same time.

too-good world

our goal in these cases is to simplify reality by making the assumption that we are analyzing a "two-good world" where there are only two goods capable of being produced and/ or consumed

two-country world

"two person world"- we simplify reality by assuming that our model only involves 2 people or 2 countries who can produce and consume the goods/ services in question

there are no other individuals or countries they can trade with, just the other person/ country included in the model

short-run assumptions

what will occur over a short period of time (days)

long-run assumptions

what will occur over a long period of time (years)

positive analysis

the study of "what is" and is descriptive and can be tested with data- does not have to be a true fact

normative analysis

the study of "what ought to be" and is judgemental, prescriptive, and reflects someone's opinion rather than a fact

microeconomics

the study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices

macroeconomics

the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth

the circular flow diagram

provides a visual model of the economy to show how dollars flow through markets and among households and firms. it ignores the roles of government and trade, focusing exclusively on the decision-makers in firms/ households

outputs

the goods and services produced by firms

inputs

include whatever the firms use to produce their goods and services

factors of production

include the inputs that are used to produce output... land, labor, capital

revenue

how much the firm makes from selling their output. it equals the price of the good or service x quantity of the good/ service that is produced and sold

wages

the amount a firm pays a worker an hour

rent

the amount the firm pays for input like location

profit

the difference between a firm's revenues and its costs of production

production possibilites frontier (ppf)

shows the combinations of output an economy can produce and shows us to simplify and better understand economic realities

absolute advantage

the ability to produce a good using fewer inputs than another producer

comparative advantage

the ability to produce a good at a lower opportunity cost than another producer (who gives up less to produce more)

opportunity cost

whatever must be given up to obtain some item. measures the trade-off between the 2 goods that each producer faces

principle of comparative advantage

states that each good should be produced by the individual that has the lower OC of producing that good

price of trade

- points outside the PPF that are only possible through trading

- through specializing in the good in which they have the comparative advantage

- if the price of trade is between the OC of production> the trade benefits both parties