unit 1

homework 1 summary

LO1.1 Define economics and the features of the economic perspective.

Economics is the social science that examines how individuals, institutions, and society make optimal choices under conditions of scarcity. Central to economics is the idea of opportunity cost: the value of the next-best good or service forgone to obtain something.

The economic perspective includes three elements: scarcity and choice, purposeful behavior, and marginal analysis. It sees individuals and institutions as making rational decisions based on comparisons of marginal costs and marginal benefits.

LO1.2 Describe the role of economic theory in economics.

Economists employ the scientific method, in which they form and test hypotheses of cause-and-effect relationships to generate theories, laws, and principles. Economists often combine theories into representations called models.

LO1.3 Distinguish microeconomics from macroeconomics and positive economics from normative economics.

Microeconomics examines the decision making of specific economic units or institutions. Macroeconomics looks at the economy as a whole or its major aggregates.

Positive economic analysis deals with facts; normative economics reflects value judgments.

LO1.4 Explain the individual’s economizing problem and illustrate trade-offs, opportunity costs, and attainable combinations with budget lines.

Individuals face an economizing problem. Because their wants exceed their incomes, they must decide what to purchase and what to forgo. Society also faces an economizing problem. Societal wants exceed the available resources necessary to fulfill them. Society therefore must decide what to produce and what to forgo.

Graphically, a budget line (or budget constraint) illustrates the economizing problem for individuals. The line shows the various combinations of two products that a consumer can purchase with a specific money income, given the prices of the two products.

LO1.5 List the categories of scarce resources and explain society’s economizing problem.

Economic resources are inputs into the production process and can be classified as land, labor, capital, or entrepreneurial ability. Economic resources are also known as factors of production or inputs.

Economists illustrate society’s economizing problem through production possibilities analysis. Production possibilities tables and curves show the different combinations of goods and services that can be produced in a fully employed economy, assuming that resource quantity, resource quality, and technology are fixed.

LO1.6 Apply production possibilities analysis.

An economy that is fully employed and thus operating on its production possibilities curve must sacrifice the output of some types of goods and services to increase the production of others. The gain of one type of good or service is always accompanied by an opportunity cost in the form of the loss of some of the other type of good or ­service.

Because resources are not equally productive in all possible uses, shifting resources from one use to another creates increasing opportunity costs. The production of additional units of one product requires the sacrifice of increasing amounts of the other product.

The optimal (best) point on the production possibilities curve represents the most desirable mix of goods. It requires the expanded production of each good until its marginal benefit (MB) equals its marginal cost (MC).

LO1.7 Explain how economic growth and international trade increase consumption possibilities.

Over time, technological advances and increases in the quantity and quality of resources enable the economy to produce more of all goods and services—that is, to experience economic growth. Society’s choice regarding the mix of consumer goods and capital goods in current output determines the future location of the production possibilities curve and the extent of economic growth.

International trade enables a nation to obtain more goods from its limited resources than its production possibilities curve indicates.

homework 2 summary

LO2.1 Define and explain laissez-faire capitalism, the command system, and the market system.

Laissez-faire capitalism is a hypothetical economic system in which government’s role would be restricted to protecting private property and enforcing contracts. All real-world economic systems feature a larger role for government. Governments in command systems own nearly all property and resources and make nearly all decisions about what to produce, how to produce it, and who gets the output. Most countries today, including the United States, have market systems in which the government does play a large role, but in which most property and resources are privately owned and markets are the major force in determining what to produce, how to produce it, and who gets it.

LO2.2 List the main characteristics of the market system.

The market system is characterized by the private ownership of resources, including capital, and the freedom of individuals to engage in economic activities of their choice to advance their well-being. Self-interest is the driving force of such an economy, and competition functions as a regulatory or control mechanism.

In the market system, markets, prices, and profits organize and coordinate the many millions of individual economic decisions that occur daily.

Specialization, the use of advanced technology, and the extensive use of capital goods are common features of market systems. By functioning as a medium of exchange, money eliminates the problems of bartering and permits easy trade and greater specialization, both domestically and internationally.

LO2.3 Explain how the market system answers the five fundamental questions of what to produce, how to produce, who obtains the output, how to adjust to change, and how to promote progress.

Every economy faces five fundamental questions: (a) What goods and services will be produced? (b) How will the goods and services be produced? (c) Who will get the output? (d) How will the system accommodate change? (e) How will the system promote progress?

The market system produces products whose production and sale yield total revenue sufficient to cover total cost. It does not produce products for which total revenue continuously falls short of total cost. Competition forces firms to use the lowest-cost production techniques.

Economic profit (total revenue minus total cost) indicates that an industry is prosperous and promotes its expansion. Losses signify that an industry is not prosperous and hasten its contraction.

Consumer sovereignty means that both businesses and resource suppliers are subject to consumers’ wants. Through their dollar votes, consumers decide on the composition of output.

The prices that a household receives for the resources it supplies to the economy determine that household’s income. This income determines the household’s claim on the economy’s output.

By communicating changes in consumer tastes to entrepreneurs and resource suppliers, the market system prompts appropriate adjustments in the allocation of the economy’s resources. The market system also encourages technological advance and capital accumulation, both of which raise a nation’s standard of living.

LO2.4 Explain the operation of the “invisible hand.”

Competition, the primary mechanism of control in the market economy, promotes a unity of self-interest and social interests. As if directed by an invisible hand, competition harnesses the self-interested motives of businesses and resource suppliers to further the social interest.

LO2.5 Describe the mechanics of the circular flow model.

The circular flow model illustrates the flows of resources and products from households to businesses and from businesses to households, along with the corresponding monetary flows. Businesses are on the buying side of the resource market and the selling side of the product market. Households are on the selling side of the resource market and the buying side of the product market.

LO2.6 Explain how the market system deals with risk.

By focusing business risks onto owners, the market system encourages the participation of workers and suppliers who dislike risk while at the same time creating a strong incentive for owners to manage business risks prudently.