Economics and Economic Reasoning - Vocabulary Flashcards

Define economics and identify its components.
Discuss various ways in which economists use economic reasoning.
Explain real-world events in terms of economic forces, social forces, and political forces.
Explain how economic insights are developed and used.
Distinguish among positive economics, normative economics, and the art of economics.

Economics is the study of how human beings coordinate their wants and desires, given the decision-making mechanisms, social customs, and political realities of the society.
The three central coordination problems any economy must solve:
- What to produce
- How to produce it
- For whom to produce it

Scarcity exists because individuals want more than can be produced.
Scarcity means the goods available are too few to satisfy individuals’ desires.
The degree of scarcity is constantly changing.
The quantity of goods, services and usable resources depends on technology and human action.

Economic theory is divided into two parts:
- Microeconomics: the study of individual choice, and how that choice is influenced by economic forces.
- Macroeconomics: the study of the economy as a whole.
Microeconomics studies things such as:
- The pricing of firms
- Household decisions on what to buy
- How markets allocate resources among alternative ends
Macroeconomics studies things such as:
- Inflation
- Unemployment
- Economic growth

Economic reasoning or “thinking like an economist” involves:
- Analyzing issues and comparing costs and benefits of a decision
- Abstracting from the unimportant elements of a question and focusing on the important ones
Steve Levitt’s Freakonomics provides examples of “thinking like an economist.” For example, Levitt uses economic reasoning to explain why people become drug dealers: the potential financial benefit of selling drugs is much higher than the cost of giving up a minimum wage job.

If the marginal benefits of doing something exceed the marginal costs, do it.
- MB > MC \Rightarrow \text{Do it}
If the marginal costs of doing something exceed the marginal benefits, don’t do it.
- MC > MB \Rightarrow \text{Don’t do it}

Opportunity cost is the benefit that you might have gained from choosing the next-best alternative.
Opportunity cost should always be less than the benefit of what you have chosen.
Opportunity cost is the basis of cost/benefit economic reasoning.

Individual Decisions: The opportunity cost of college includes:
- Items you could have purchased with the money spent for tuition and books.
- Loss of the income from a full-time job.
Government Decisions: The opportunity cost of money spent on the war on terrorism is less spending on health care or education.

Implicit costs: costs associated with a decision that often are not included in normal accounting costs.
Illusionary sunk costs: costs that show up in financial accounts that are already spent.
Implicit costs should be included in opportunity costs but illusionary sunk costs should not be included.
Costs relevant to decisions are often different from the measured costs.

This one sentence embodies the concept of opportunity cost: There ain’t no such thing as a free lunch. Abbreviated as $ext{TANSTAAFL}.$

Economic forces: the necessary reactions to scarcity.
A market force is an economic force that is given relatively free rein by society to work through the market.
The invisible hand is the price mechanism that guides our actions in a market. The invisible hand is an example of a market force.
- If there is a shortage, prices rise.
- If there is a surplus, prices fall.

What happens in society can be seen as a reaction to, and interaction of:
- Economic forces
- Social forces
- Political forces
Social and political forces influence market forces.
Social and political forces often work together against the invisible hand.

Theories tie together economists’ terminology and knowledge about economic institutions.
Theories are too abstract to apply in specific cases and are often embodied in economic models and principles.
An economic model is a framework that places the generalized insights of the theory in a more specific contextual setting.
An economic principle is a commonly held insight stated as a law or general assumption.

Theories, models, and principles are continually tested to see if the predictions of the model match the data.
Models lead to:
- Theorems (propositions that are logically true based on the assumptions of the model)
- Arrive at policy precepts (policy rules that conclude that a particular course of action is preferable)
These theorems must be combined with knowledge of real-world economic institutions and value judgments to determine economic goals for society.

According to the invisible hand theorem, a market economy, through the price mechanism, will allocate resources efficiently.
- Price tends to fall when quantity supplied is greater than quantity demanded.
- Price tends to rise when the quantity demanded is greater than the quantity supplied.
Efficiency: achieving a goal as cheaply as possible.

Economic institutions are laws, common practices, and organizations in a society that affect the economy.
To apply economic theory to reality, you've got to have a sense of economic institutions.
Economic institutions differ significantly among nations and sometimes seem to operate differently than economic theory predicts.

Economic policies are actions (or inaction) taken by the government to influence economic actions.
There are two types of policy analysis:
- Objective policy analysis keeps value judgments separate from the analysis.
- Subjective policy analysis reflects the analyst’s views of how things should be.

To distinguish between objective and subjective analysis, economics is divided into three categories:
1. Positive economics: the study of what is and how the economy works.
2. Normative economics: the study of what the goals of the economy should be.
3. The art of economics: using the knowledge of positive economics to achieve the goals determined in normative economics.

Positive economics asks questions such as: How does the market for hog bellies work?
Normative economics asks questions such as: What should tax policy be designated to achieve?
The art of economics looks at questions such as: To achieve the goals that society wants to achieve, how would you go about it, given the way that the economy works?