Microeconomics Exam 1 Dr. Trent

Economics is a _________ science

social

Economics is the...

study of human behavior / how society manages its scarce resources

The fundamental economic problem is that...

resources are scarce

Which principles help How People Make Decisions?

Principles 1-4

which principles help How People Interact?

Principles 5-7

Principle 1

People Face Trade-Offs

Tradeoff

Exchange of something for something else

_______ decisions involve tradeoffs

All

Principle 2

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

opportunity cost

what you must give up to obtain it / what you would have gotten if you'd done the other thing

Principle 3

rational people think at the margin

"rational people"

purposefully do the best they can to achieve their objectives

"economic rationality"

people compare the costs and benefits to maximize personal advantage

"thinking at the margin"

people make decisions by evaluating costs and benefits of marginal changes

most choices involve ______ instead of ________

how much, whether or not to do something

Principle 4

People respond to incentives

incentive

something that induces a person to act

_______ people respond to incentives

rational

Principle 5

Trade can make everyone better off

Rather than being self sufficient, people can ______ in producing on good or service and exchange it for other goods

specialize

Principle 6

Markets are usually a good way to organize economic activity

market economy

A ________ _________ allocates resources through the decentralized decisions of many households and firms as they interact in markets

the basis of a market economy

voluntary exchange

When people interact in markets based off their own self interests

they often do what's best for society

Value added exchange

both parties are better after exchange

Principle 7

Governments can sometimes improve market outcomes

Governmental roles

1. Define and enforce property rights

2. Can intervene in the case of market failure

Market failure

when the market fails to allocate society's resources efficiently

Causes of market failure

1. Externalities

2. Market power

3. Information asymmetry

Externalities

when the production or consumption of a good affects bystanders (ex pollution)

Market power

a single buyer or seller has substantial influence on market price (ex monopoly)

Information asymmetry

situation in which one party is more informed than another because of the possession of private information

Efficiency

when society gets the most from its scarce resources (output, economic performance)

Equality

when those benefits are distributed uniformly among society's members (income distribution)

Microeconomics

the study of how households and firms make decisions and how they interact in markets

Macroeconomics

the study of economy-wide phenomena, including inflation, unemployment, and economic growth

Economists use theories to.....

explain the behavior that they see in the real world and to make predictions

The key to understanding economic theory is realizing that theories involve ______

assumptions

factors of production

1. Labor

2. Land

3. Capital

4. Entrepreneurship

Circular flow diagram

a visual model of the economy that shows how dollars flow through markets among households and firms

two types of actors

households and firms

two markets

market for goods and services and market for "factors of production"

Households

own the factors of production, sell/rent them to firms for income

buy and consume goods and services

Firms

buy/hire factors of production, use them to produce goods and services

sell goods and services

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 technology

how does the ppf represent tradeoffs

more of one means sacrificing another

How does the PPF represent opportunity cost

must shift resources from one to another

how might we calculate the opportunity cost numerically

the shape of the ppf

PPF usually has a _____ shape

bow

the shape of the ppf depends on the

resources and inputs use to make the two goods

ppf is bow shaped if some resources

cannot be easily adapted from their use in production of one good to use in the production of another good

what causes economic growth

Additional resources and improvements in technology

the ppf shows

all combinations of two goods that an economy can possibly produce, given its resources and technology

the ppf illustrates the concepts of

trade off, opportunity cost, and efficiency

Theory of Comparative Advantage

free trade and specialization based on comparative advantage will benefit all trading parties, even when some are absolutely more productive than others

Trade is a ___________ game

win-win

trade is based on ______________ that are mutually beneficial

voluntary exchanges

without trade

each nation must consume only what it produces

economists play two roles

1. Scientists: try to explain the world

2. Policy advisors: try to improve it

scientific method

1. devise a theory

2. collect data

3. test theory through an experiment

correlation

two variables occur together

causation

one variable causes the other to occur

positive statements

attempt to describe the world as it is (can be confirmed)

normative statements

attempt to prescribe how the world should be (sounds like an opinion)

exports

goods produced domestically and sold abroad

imports

goods produced abroad and sold domestically