Econ Exam I (lectures 1-4)

Economics

the study of the choices individuals make given the presence of scarcity

Scarcity

limited resources but unlimited wants

-Because of scarcity, we have to make choices

Resources

inputs used to produce goods and services

Human Resources

skill, strength, knowledge

Physical Resources

tools, machines, buildings, etc.

Natural Resources

land, minerals, oceans, rivers

Rationing

allocating a limited supply of goods/resources among people

• -criterion used to determine who will receive and who will go without

The economy

the institutional structure through which individuals in a society coordinate their diverse wants

economic agents

households, firms, government

The economy will answer 3 questions:

1. What and how much to produce

2. How to produce it

3. For whom to produce it

All issues of ALLOCATION

#1 Decision Makers choose purposefully. How do we make rational choices?

• we weigh the costs and benefits

• We economize (getting the maximum benefit at the minimum cost

Utility (in economics)

The subjective benefit or satisfaction an individual expects from the choice or course of action

HAPPINESS

differs widely from person to person

#2 The value of a good or service is subjective

Or, costs and benefits are subjective

• People have different preferences for goods and services

• This is partly why economics is hard → it’s difficult to know how much value a person places on something

• Guess how hard it is to make a good gift for even close friends or family member.

#3 Incentives matter

The payoff derive from a choice increases, people will be more likely to choose it.

• You’d be more likely to bend over to pick up a $20 bill then a quarter

#4 Individuals make decisions at the MARGIN

Economists “think at the margin”

– Actually, everyone thinks at the margin!

– “Additional” is often used as a substitute for

“Marginal”

• Examples:

– Deciding to attend class

– Food consumption choices

The Economic Decision Rule

If the marginal (incremental) benefit of an action exceeds the marginal (incremental) cost, do it.

Basically if the MB > MC, do it

If the MC > MB, don't do it.

#5 The use of scarce resources is costly, so trade-offs must be made

Also known as “there is no such thing as a free lunch” principle.

Opportunity Cost

• The highest valued alternative that must be sacrificed as a result of choosing an option

• NOT the sum of all your forgone opportunities

– subjective

• Examples:

  The Economic cost of…

  …going to college for a year is not just the tuition, books,

  and fees, but also the foregone wages

Explicit costs

costs that require a money payment

Implicit costs

costs that do NOT require a money payment

#6 The acquisition of information is costly

• More information help us to make better choice.

• However, the time needed to gather it is scarce.

- impact of the internet

- Making choices with imperfect information.

#7 Beware of secondary effects

• Secondary effects : The indirect impact of an

event that may not be immediately observable.

• Intended consequences

– Think of medicine.

• Unintended consequences

– Sugar Tariffs in the U.S.

#8 The test of a theory is its ability to predict

…

Economic theory

generalizations about the workings of an abstract economy

Economic models

we use abstract models to study larger, more complex concepts

Positive statement

a statement that can be tested and either proven or disproven

Normative statement

a statement of opinion, cannot be proven or disproven (Key words: ought, should, good, bad)

The Art of Economics

▪ Positive Statement allows us to study

the facts about how the economy

works.

▪ Normative Statement used to identify

problems and prescribe solutions

#9 Forces influence economic outcomes

• Scarcity creates economic forces that ration scarce resources in our economy

• Unhindered- economic forces become market forces.

• Market forces ration goods and services by changing the price level

Invisible Hand

the price mechanism (Adam Smith)

“The market price acts like an invisible hand to guide economic forces to coordinate actions and allocate scarce resources. “

Invisible Handshake

social and historical forces (cultural norms

Invisible Foot

political and legal forces

• • Selling alcohol to underage drinkers

  • Selling marijuana

  • Selling babies

  • Selling body parts

Positive relationship

As X goes up Y goes up

Negative or Inverse relationship

As X goes up, Y goes down

Deterministic Relationship

Independent variable completely determines value of dependent variable

Stochastic Relationship

Other things besides the independent variable influence the value of the dependent variable

Interpret the slope:

As the # of (X) increases by 1 (unit), (Y) increases by (slope)(unit)

• ex: As the number of Doritos increases by 1 bag, the number of bottles of Pepsi decreases by 2 bottles.

Production Possibility Frontier (PPF)

A graph that shows the possible combinations of two goods (products) or other outcomes (e.g. grades) that can be produced given a fixed level of technology and resources (including time) being used efficiently at a fixed point in time.

A PPF with a constant slope has…

constant opportunity cost or a constant transformation relationship

A PPF with a changing slope has…

changing opportunity costs or a changing transformation relationship

The slope of a PPF changes because of…

diminishing marginal returns

• Does the second bowl of ice cream taste as good as the first? What about the fifith?

The law of increasing marginal opportunity costs

As an economy produces more of a good, the opportunity cost of an additional unit, expressed in terms of other goods sacrificed, will increase.

• Why?

•  All resources are not equally efficient

  or suitable for producing all outputs.

   Comparative Advantage of a resource

What restricts an economy from producing more of everything?”

A lack of resources

Over time, it’s possible for a country to shift its PPF outward…

Economic growth

4 factors that can shift the PPF

outwards:

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 shift the PPF outward

Invention

creating new products (e.g. electricity,

computers, etc.)

Innovation

practical and effective adoption of

new techniques

Entrepreneurs

introduce new products to satisfy

consumers at a lower cost

Negative Shocks

 Earthquake

 Political Upheaval

Uneven Shocks

- Drought

Lettuce…

Positive Shocks

- Technology Breakthrough

- New Natural Resources

Long-term investment

PPFo before capital accumulation

PPF1 during capital accumulation (inwards)

PPF2 after capital accumulation (outwards past original)

Comparative Advantage

if you have the lowest opportunity cost of producing something

Absolute Advantage

if you can produce more of a good with the same amount of resources as someone else.

(due to previous experience and/or natural endowments)

Law of Comparative Advantage

Individuals, firms, regions, or nations can gain by specializing in the production of goods that they produce cheaply (at a low opp. cost) and exchanging them for goods they cannot produce at a low opp. cost.

Quantity Demanded

the amount of a good that households want to consume given their income and prices in a given time period.

demand

is what you are willing and able to buy

given your income and the price of the good

(limited)

want

is a desire, but not necessarily something

you have the resources to buy (unlimited)

Demand Schedule

SHOWS THE RELATIONSHIP

BETWEEN THE PRICE LEVEL AND THE QUANTITY

DEMANDED.

The Demand curve looks like what?

downwards

Law of Demand

As the price of a good increases, the quantity

demanded falls, (ceteris paribus)

ceteris paribus

holding all else constant

the relative price

the price of a good compared to the price of

other goods.

Law of diminishing marginal benefit

(law of diminishing marginal returns)

As more units of a good are consumed,

additional units provide less benefit.

Consumer Surplus

Amount willing to pay - Amount actually must pay

(market equilibrium price)

“the one on top”

in other words it is the area under the demand curve and above the price

Supply is thinking like the…

producer

Quantity Supplied

the amount of a commodity that a firm plans to sell in a given time period at a

given price.

The law of supply

as the price for which a good can be sold increases, the quantity of the good that

is supplied will increase, ceteris paribus

Supply Schedule

shows the relationship between the price level and the quantity supplied

The Supply Curve look like what?

The Law of Increasing Costs

To supply additional units of a good, producers have greater opportunity costs, so the price must rise to induce producers to supply greater quantities.

Producer Surplus

The difference between the price suppliers actually receive (market price) and the minimum price they would be willing to accept)

“the one under or on the bottom”

in other words it is the area under the demand curve and under the price

Equilibrium

in the market, is the point where QS = QD.

(No tendency for change)

Economic efficiency

A situation in which all of the potential gains from trade have been realized. An action is efficient only if it creates more benefit than cost. With well-defined property rights and competition, market equilibrium is efficient.

Disequilibrium

When the market is not in equilibrium, there is either

excess demand or excess supply

Excess supply

a surplus, the quantity supplied is greater than the quantity demanded, and prices fall.

• At a given price, the excess of quantity supplied

  over quantity demanded

• QD < QS

  ◆Price of the good will fall as sellers compete with each

  other to sell more of the good than buyers want

Excess demand

a shortage, the quantity demanded is greater than the quantity supplied, and prices rise.

• At a given price, the excess of quantity

  demanded over quantity supplied

• QD > QS

  ◆Price of the good will rise as buyers compete with

  each other to get more of the good that is available