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Rational consumers and firms
Weigh costs and benefits to make the best decisions.
Example of rational decision-making
Apple chooses iPhone prices to maximize profit.
Economic incentives
Actions change as incentives change.
Examples of economic incentives
Cash for Clunkers program, COVID-19 stimulus checks.
Unintended consequences of incentives
Changes to the Federal Student Loan Program may incentivize colleges to increase tuition.
Opportunity for borrowing
Students might borrow more, knowing they may not have to repay it all.
Optimal decisions at the margin
Most decisions involve doing a little more or less of something.
Marginal cost (MC)
The additional cost of a small amount extra of some action.
Marginal benefit (MB)
The additional benefit of a small amount extra of some action.
Marginal analysis
Comparing marginal benefits and marginal costs.
Economic questions every society must answer
What goods and services will be produced? How will the goods and services be produced? Who will receive the goods and services produced?
Scarcity leads to trade-offs
Producing more of one good or service means producing less of another.
Trade-off
The idea that, because of scarcity, producing more of one good or service means producing less of another good or service.
Opportunity cost
The highest-valued alternative that must be given up to engage in an activity.
Example of opportunity cost
Increased space exploration funding might mean less funding for cancer research.
Different production methods
Example 1: Music production: Hire a great singer vs. using Auto-Tune. Example 2: Manufacturing: Use more machines or move to a location with cheaper labor.
Distribution of goods and services
In the U.S., people with higher incomes obtain more goods and services.
Tax and welfare policies
Affect income distribution, leading to debates about the desirability of redistribution.
Centrally planned economy
The government decides how economic resources will be allocated.
Market economy
Decisions of households and firms determine the allocation of economic resources.
Mixed economy
Most economic decisions result from the interaction of buyers and sellers in markets, but the government plays a significant role in the allocation of resources.
Productive efficiency
Every good or service is produced at the lowest possible cost.
Allocative efficiency
Production is in accordance with consumer preferences; every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
Voluntary exchange
A situation that occurs in markets when both the buyer and the seller of a product are made better off by the transaction.
Caveats of market efficiency
Markets may not immediately be efficient. Governments might interfere with market outcomes. Market outcomes might ignore the desires of people not involved in transactions, like avoiding pollution.
Equity
The fair distribution of economic benefits.
Trade-off between efficiency and equity
Policies that promote equity, such as income taxes, may reduce efficiency by discouraging work and investment.
Economic models
Economists use models to analyze economic events and government policies.
Steps to build an economic model
Decide on assumptions. Formulate a testable hypothesis. Use economic data to test the hypothesis. Revise the model if it fails to explain the economic data well.
Behavioral assumptions in economic models
Consumers maximize well-being. Firms maximize profits.
Hypothesis
A statement about an economic variable that may be correct or incorrect.
Economic variable
Something measurable that can have different values, such as the number of people employed in manufacturing.
Causal relationships in economics
Most economic hypotheses are about causal relationships.
Statistical methods in economics
Used to evaluate hypotheses using relevant data.
Causal relationships
Most economic hypotheses are about causal relationships.
Statistical methods
Statistical methods are used to evaluate hypotheses using relevant data.
Causality
Difficult to establish causality.
Economic model
Economists accept and use an economic model if it leads to hypotheses that are confirmed by statistical analysis.
Positive analysis
Analysis concerned with what is.
Normative analysis
Analysis concerned with what ought to be.
Economics as a social science
Economics as a social science studies individuals' actions and how they affect outcomes.
Economic analysis
Governments use economic analysis for policy decisions.
Tariff
Economic theory can identify winners and losers from a tariff.
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.
Economic Skills
Economists can describe how choices are made, explain the consequences, and advise on better decisions.
Economics majors
Economics majors develop decision-making skills and earn higher-than-average incomes.
Self-selection
Future high earners may be more attracted to fields like economics.
Technology
The processes a firm uses to produce goods and services.
Capital
Manufactured goods that are used to produce other goods and services.
Graphs and formulas
Graphs and formulas help analyze economic situations.
Time-series graphs
Time-series graphs can be influenced by truncated scales.
Slope of a line
Change in value on the vertical axis divided by the change in value on the horizontal axis.
Percentage change formula
\text{Percentage change} = \frac{\text{Value in the second period} - \text{Value in the first period}}{\text{Value in the first period}} \times 100
Area of a rectangle
\text{Area} = \text{Base} \times \text{Height}
Area of a triangle
\text{Area} = \frac{1}{2} \times \text{Base} \times \text{Height}
Rationality
People make decisions using available information to achieve their goals.
Market
A group of buyers and sellers of a good or service facilitating trade.
Obesity
Obesity is linked to diseases like heart disease and diabetes, posing a major health problem.
Body Mass Index (BMI)
Used to measure weight relative to height; a BMI of 30 or more indicates obesity.
Obesity rates
Have increased significantly; explanations include high-calorie diets, lack of exercise, and less physical activity in jobs.
Health insurance and weight
May create an incentive to gain weight by reducing the costs of obesity.
BMI increase by insurance type
Research indicates people with health insurance are more likely to be overweight; private insurance increased BMI by 1.3 points, while public insurance increased it by 2.3 points.
BMI formula
The formula for calculating BMI is: BMI = (Weight \, in \, pounds/Height \, in \, inches^2) \times 703
Questions societies must answer
What goods and services will be produced? How will the goods and services be produced? Who will receive the goods and services produced?
Income in a market economy
Determined by payments for what one sells; higher training and longer hours generally result in higher income.
Inefficiency causes
Can arise from government interference or environmental damage.
College Football Attendance
Declining attendance is attributed to rising ticket prices and increased opportunity costs.
Opportunity cost of attending games
Includes ticket price plus the value of alternative activities.
Steps to develop a model
Decide on assumptions, formulate a testable hypothesis, test hypothesis with economic data, revise the model if it fails, retain the revised model.
Economics
Analyzes choices made by individuals, businesses, and governments.
Production Possibilities Frontier (PPF)
A curve showing the maximum attainable combinations of two goods that can be produced with available resources and current technology.
Increasing Marginal Opportunity Costs
Some resources are better suited to one task than another; the more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity.
Economic growth
The ability of the economy to increase the production of goods and services, represented by shifts in the PPF.
Trade
The act of buying and selling.
Absolute advantage
The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources.
Comparative advantage
The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors.
Graphs
Simplify and concretize economic ideas.
Types of graphs
Bar graphs, pie charts, and time-series graphs.
Coordinate grids
Have vertical (y-axis) and horizontal (x-axis) axes.
Slope
Indicates how much the y-axis variable changes as the x-axis variable changes.
Slope formula
Measured as slope = \frac{\Delta y}{\Delta x}, also known as rise over run.
Nonlinear curves
Few relationships are linear, but linear approximations can be useful.
Slope of a tangent line
Measured by the slope of the tangent line at a point on a nonlinear curve.
Area of a rectangle formula
Base \times Height
Area of a triangle formula
\frac{1}{2} \times Base \times Height
Summary of using formulas
Understand the economic concept, use the correct formula, ensure the result is economically reasonable.
Points on the PPF
Attainable.
Points below the PPF
Inefficient.
Points above the PPF
Unattainable with current resources.
Households
Individuals who provide factors of production (labor, capital, natural resources, etc.).
Firms
Entities that purchase factors of production from households and use them to create goods and services.
Labor
All types of work.
Natural Resources
Land, water, oil, iron ore, etc.
Entrepreneurial Ability
The ability to bring together the other factors of production to successfully produce and sell goods and services.
Factor Market
A market for the factors of production.
Product Market
A market for goods or services.
Circular-flow Diagram
A model that illustrates how participants in markets are linked.
Free Market
One with few government restrictions on how a good or service can be produced or sold, or on how a factor of production can be employed.
Market Mechanism
Markets with flexible prices allow the collective actions of households and firms to signal the relative worth of goods and services.