BE

Chapter 1 flashcards

Economics: the study of how individuals and societies allocate their limited resources to satisfy their practically unlimited needs.

 

There are 2 parts of economics

  • Micro: study of individual units (humans) that make up the economy.

    • Focuses on individuals, businesses, and industries

    • Example: How does a rise in sales tax impact the retail industry?

  • Macro: study of the overall aspects and workings of an economy

    • Focuses on the "big picture"

    • Example: Is Japan's economy in a recession?

 

What do Economists do?

  • Study how people decide what to buy, how much to work, save, and spend

  • Study how firms decide how much to produce, how many workers to hire

 

How do people make decisions?

  • Principle 1: people face trade-offs

    • To get something you like, you have to give up something that you also like

    • Example: going to a party the night before an exam

    • Example: having more money to buy stuff

    • Example: Protecting the environment

    • Efficiency: society gets the most from its scarce resources

    • Equality: Prosperity is distributed uniformly among society's members

      • To achieve greater equality, one could redistribute income from the wealthy to the poor

      • But this would reduce incentive to work and produce, shrinking the size of the economic "pie"

  • Principle 2: The cost of something is what you give up to get it

    • Making decisions

      • Compare costs with the benefits of alternatives

      • Need to include opportunity costs

    • Opportunity cost: the highest valued (next best) alternative that must be sacrificed to get something else

      • Whatever must be given up to obtain some item

      • The best possible decision is the one that minimizes the opportunity cost

        • What is the opportunity cost of going to college?

          • Getting a job straight out of school

          • Money

          • Time

          • Leaving hometown

        • What is not an opportunity cost of going to college?

          • Housing

          • Food

  • Principle 3: rational people think at the margin

    • "more is better"

    • Rational people: systematically and purposefully do the best they can to achieve their objectives

      • Given the available opportunities

      • Make decisions by evaluating costs and benefits of marginal changes

        • Small incremental adjustments to a plan of action

      • Examples:

        • cellphone users with unlimited minutes (minutes are free at the margin)

          • More prone to making long/frivolous calls

          • Marginal benefit of the call > 0

      • Marginal thinking: evaluation of the available opportunities to make the best decision possible

      • Marginal benefit: additional benefit derived from extra unit

      • Marginal cost: additional cost incurred from extra unit

        • If marginal benefit is more than marginal cost, DO IT

  • Principle 4: people respond to incentives

    • Incentive: something that induces a person to act

      • Positive: encourage action by offering rewards or payments.

      • Negative: Discourage action by providing undesirable consequences or punishments.

  • Principle 5: Trade can make everyone better off

    • People can buy a greater variety of goods and services at lower cost

    • Countries get a better price abroad (foreign countries) for goods they produce.

  • Principle 6: markets are usually a good way to organize economic activity

    • Market: group of buyers and sellers

    • 2 types of economy

      • Centralized: Government makes decision for firms and households

      • De-Centralized (market): decentralized decisions of many firms and households - as they interact in markets

    • Prices: determined based off of interactions between buyers and sellers

  • Principle 7: Governments can sometimes improve market outcomes

    • Government enforces property rights

      • Enforce rules and maintain institutions that are key to a market economy. People are less inclined to work, produce, invest, or purchase if there is a large risk of their property being stolen.

    • Governments promote efficiency

      • Avoid market failures (market left on its own, fails to allocate resources efficiently)

      • Externality: source of market failure

        • Production or consumption of a good affects bystanders (pollution)

      • Market power: source of market failure

        • A single buyer (company) having the ability to change prices

          • Insulin companies are a good example (cost is close to nothing, and they can charge large amounts for it)

    • Government promotes equality

      • Subsidies, taxes, food stamps, etc.

      • Avoid disparities in economic wellbeing

      • Use tax or welfare policies to change how the economic pie is divided.

  • Principle 8: A country's standard of living depends on its ability to produce goods and services

    • Huge variation of living standards

      • Across countries and overtime

      • Average income in rich countries is more than 10 times the average income of poor country

    • Productivity: most important determinant of living standards

      • Quantity of goods and services produced from each unit of labor input

      • Depends on equipment, skills, and technology available to workers

        • Other factors like labor unions, competition from abroad, have far less impact on living standards (collective bargaining)

  • Principle 9: Prices rise when the government prints too much money

    • Inflation: increase in overall level of prices in the economy

    • In the long run, inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall

    • The faster the government creates money, the greater the inflation rate

  • Principle 10: Society faces a short-run trade-off between inflation and unemployment

    • If inflation is going up, unemployment is going down

    • If inflation is going down, unemployment is going up