Chapter 2: The Economic Problem: Scarcity and Choice

ECON 110 Exam 1

(1) What gets produced?

(2) How is it produced?

(3) Who gets what is produced?

What are the three key features of society determined by individuals’ choices?

Capital

Things that are produced and then used in the production of other goods and services.

Factors of Production (or Factors)

The inputs into the process of production. Another term for resources.

Production

The process that transforms scarce resources into useful goods and services.

Inputs or Resources

Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants.

Outputs

Goods and services of value to households.

Theory of Comparative Advantage

Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that may be “absolutely” more efficient producers.

Absolute Advantage

A producer has __________ over another in the production of a good or service if he or she can produce that product using fewer resources (a lower absolute cost per unit).

Comparative Advantage

A producer has __________ over another in the production of a good or service if he or she can produce that product at a lower opportunity cost.

Consumer Goods

Produced for present consumption.

Capital Goods

Any physical asset used for production.

Investment

The process of using resources to produce new capital.

Production Possibility Frontier (PPF)

A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.

Marginal Rate of Transformation (MRT)

The slope of the production possibility frontier (ppf).

As you continue to increase production of one good, the opportunity cost of producing that next unit increases.

What is the law of increasing opportunity cost?

Unemployment

When there is __________ of labor, we are not producing all that we can.

Inefficiency

Waste and mismanagement are the results of a firm operating below its potential.

Sometimes results from mismanagement of the economy instead of mismanagement of individual private firms.

Output Efficiency

Occurs when the economy is operating at the “right” point on the ppf.

Economic Growth

An increase in the total output of an economy. Growth occurs when a society acquires new resources or when it learns to produce more using existing resources.

Rich countries find it easier than poor countries to devote resources to the production of capital, and the more resources that flow into capital production, the faster the rate of economic growth.

What’s the relationship between capital goods and growth in poor and rich countries?

Command Economy

An economy in which a central government either directly or indirectly sets output targets, incomes, and prices.

Laissez-Faire Economy (The Free Market)

Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.

Market

The institution through which buyers and sellers interact and engage in exchange.

Consumer Sovereignty

The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).

Income

The amount that a household earns each year. It comes in a number of forms, such as wages, salaries, and interest.

Affects the amount of output a household can get.

Price Theory

In a free market system, the basic economic questions are answered without the help of a central government plan or directives. This is what the “free” in free market means–the system is left to operate on its own, with no outside interference. Individuals pursuing their own self-interest will go into business and produce the products and services that people want. Other individuals will decide whether to acquire skills; whether to work; and whether to buy, sell, invest, or save the income that they earn. The basic coordinating mechanism is price.

Mixed Systems, Markets, and Governments

The difference between command economies and laissez-faire economies in their pure forms are enormous. In fact, these pure forms do not exist in the world. All real systems are in some sense “mixed”.

Individual Producers and Private Organizations acting in their own interest

In a free market system/economy, who determines how to organize and coordinate their production (and other production decisions)?