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What is Economics?
Economics is the study of how we make choices under scarcity
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What are the 8 guide posts to Economic thinking?
- 1. Resources are scarce, so decision makers must make trade offs
- 2. Individuals are rational: They try to get the most from their limited resources
- 3. Incentives matter
- 4. Individuals make decisions at the margin
- 5. Information helps us make better choices but is costly
- 6. Beware of secondary effects
- 7. The value of a good or service is subjective
- 8. The test of a theory is its ability to predict
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What is opportunity cost?
the highest valued alternative sacrificed in order to choose an option
- - what will you give up to do something else
- - sleep 1 hr vs going to class
- - party all night vs studying
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What is scarcity?
the economics concept that there is less of a good freely available from nature than people would like.
- scarce goods - food (milk, bread, eggs, coffee)
- - clothing (shoes, shirts, pants)
- -time
- -education
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What is choice?
the act of selecting among alternatives
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What is a resource?
an input to produce economic goods. (land, labor)
- limited resources
- - land
- -human resources (skills, talent)
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What is capital?
human made resources such as tools, equipment and structures used to produce other goods and services
- -physical resources (tools, machines, buildings)
- -natural resources (land, mineral deposits, oceans and rivers)
- - human resources (knowledge, skill, strength)
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What is a positive economic statement?
the study of "what is" among economic relationships
positive economic statements are testable
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what is a negative economic statement?
judgments about "what ought to be" in economic matters
it can not be tested because they are based on value judgments
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What are the four pitfalls of economic thinking?
- 1. Violation of the ceteris paribus principle
- 2. The belief that good intentions equal desirable outcomes
- 3. The belief that association is causation
- 4. The fallacy of composition (what is true for one may not be true for all)
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What is the ceteris paribus principle?
the ceteris paribus principle states "other things constant"
used when one effect of one change is being described, recognizing that if other things change, they also could affect the result.
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voluntary trade
value is subjective and voluntary trade creates value and economic progression
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how does trade create value
- 1. When individuals engage in voluntary exchange, both parties are made better off
- 2. By channeling goods and resources to those who value them most, trade creates value and increases the wealth created by a society’s resources.
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how does trade lead to economic progress
- 1. Gains from specialization and division of labor
- 2. Gains from mass production methods
- 3. Gains from innovation
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what are transaction costs?
the time, effort and other resources needed to search out negotiate and complete an exchange.
-leaves a role for a middle man
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what is a middlemen?
middlemen- a person who buys and sells goods and services or arranges trade.
they reduce transaction cost
buying from JC Penny instead of directly from the manufacturer
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what are the three characteristics of private property rights
- Private property rights involve:
- 1. The right to exclusive use of the property
- 2. Legal protection against invasion from other individuals
- 3. The right to sell, transfer, exchange, or mortgage the property
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4 incentives of property rights
- 1. Incentive to use resources in ways that are considered beneficial to others.
- ex. Empty lot turn into Hotel, cafe bistro
- -owners bear the cost of ignoring the wishes of others.
- ex. Neutral colors
- 2. Private owners have an incentive to care for and manage what they own
- ex. How do you drive a rental car compared to your own car?
- 3. Private owners have an incentive to conserve for the future
- ex. Popcorn at the movies
- 4. Private owners have an incentive to make sure their property does not damage your property
- ex. keeping dog on a leash
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property rights and development
Lack of property rights = lack of economic progress
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what is a production possibilities curve?
- PPC: outlines all possible combinations of total output that could be produced, assuming a:
- 1. fixed amount of productive resources
- 2. given amount of technical knowledge
- 3. full and efficient use of resources
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graphing the PPC
- The slope of the curve indicates the amount of one good that must be given up to produce more of the
- other good.
- Slope = rise / run
- A PPC is bowed outward because of the concept of increasing opportunity costs
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4 factors that change the PPC
- 1. A change in the economy’s resource base
- 2. changes in technology
- 3. A change in the rules under which the economy functions (jim crow laws)
- 4. change in work habits
- ex. working harder can shift curve outward
- ex. working less can shift curve inward
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what is an investment
Investment: the purchase, construction, or development of resources
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what is technology?
technology: the knowledge available in an economy at any given time.
Technology determines the amount of output we can generate with our limited resources.
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what is the law of comparative advantage?
- The total output of a group of individuals, an entire economy, or a group of nations will
- be greatest when the output of each good is produced by whoever has the lowest opportunity cost
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economic organization
- Every economy faces 3 questions:
- 1. What will be produced?
- 2. How will it be produced?
- 3. For whom will it be produced?
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what is collective decision making?
- the method of organization that relies on public sector decision making to resolve
- basic economic questions.
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What is socialism?
- Socialism: a system of economic organization where:
- 1.Ownership and control of the means of production rest with the state
- 2.Resource allocation is determined by centralized planning
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what is capitalism?
- Capitalism: A system of economic organization where:
- 1.Productive resources are owned privately
- 2.Goods and resources are allocated through market prices
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why does capitalism work better than socialism?
- Why capitalism tends to work (and socialism does not):
- 1. Capitalism is similar to natural selection. It uses the idea of market efficiency
- 2. Socialism suffers from an information problem.
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what is market organization?
Market organization: a method of organization in which private parties make their own plans and decisions with the guidance of market prices
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law of demand
inverse relationship between price and quantity
Demand curve is downward sloping
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what is consumer surplus
Consumer surplus: The difference between the maximum amount consumers would be willing to pay and the amount that they actually pay.
Consumer surplus is the area below the demand curve but above the price.
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change in quantity and quantity demanded
- Change in quantity demanded: caused by a change in the current price of the good.
- (shift along the curve)
- Change in demand: caused by a change in anything else that affects demand
- (shifts the demand curve)
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shifters of demand
- 1. Change in consumer income
- A. Normal goods I↑ → DNormal ↑
- B. Inferior goods I↑ → DInferior ↓
- 2. Change in number of consumers
- 3. Change in the price of a related good
- A. Substitutes Psubstitute ↑ → D↑B. Compliments Pcompliments ↑ →D↓
- 4. Change in expectations
- A. Expected price Pfuture ↑ → D↑
- B. Expected income Ifuture ↑ → D↑
- 5. Change in consumer tastes and preferences Preferences↑ → D↑
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law of supply
The law of supply: direct relationship between price and quantity.
Supply curve is upward sloping
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producer surplus
- Producer surplus: The difference between the minimum price suppliers are willing to accept and the
- price they actually receive.
Producer surplus is the area above the supply curve but below price.
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changes in supply and quantity supplied
- Change in quantity supplied: caused by a change in the current price of the good.
- (shift along the curve)
- Change in supply: caused by a change in anything else that affects supply
- (shifts the supply curve)
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shifters of supply
- A change in resource price
: Presource ↑→ S↓
- A change in technology
: Technology ↑ → S↑
- A change in Nature or Politics
: Depends on Change
- A change in taxes
: Taxes ↑ → S↓
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elasticity
Elastic: Change in quantity is sensitive to a change in price (flatter curves)
Inelastic: Change in quantity is not sensitive to a change in price (steeper curves)
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market equilibrium
A state in which the conflicting forces of supply and demand are in balance.
Occurs where the demand curve intersects the supply curve.
- 1. all trades that generate more benefit then costs are undertaken
- 2. No trades where costs exceed benefits are undertaken
- 3. The combined area of consumer and producer surplus is maximized
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market equilibrium cont.
The market equilibrium is economically efficient.
- Efficient: no excess supply or excess demand
- -Excess supply: quantity supplied > quantity demanded
- -Excess demand: quantity demanded > quantity supplied
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All trades generating more benefits than costs are undertaken.
- No trades generating more costs than benefits are undertaken.
- The combined area of producer and consumer surplus is maximized.
- There is nor excess supply or excess demand
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single and or double shifters
- Demand changes:
- Price: moves in same direction
- Quantity: moves in same direction
- Supply changes:
- Price: moves in opposite direction
- Quantity: moves in same direction
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invincible hand principle
- The tendency for people, while pursuing their own interests, to promote the economic well-being of
- society.
(achieved through market prices)
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labor demands
- 1. Firms demand labor
- 2. Labor demand curve is downward sloping because as wage decreases, firms will want to employ more people
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changes in labor demand
- 1. An increase in labor demand (labor demand shifts right)
- 2. A decrease in labor demand (labor demand curve shifts left)
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labor supply
- 1. Workers supply labor
- 2. Labor supply curve is upward sloping because as wage increases, people will want to work more.
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changes in supply
- 1. Increase in labor supply: (labor supply curve shifts right)
- 2. Decrease in labor supply: (labor supply curve shifts left)
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linking the markets
- -There is a close relationship between the demand for products and the demand for resources used to make those products
- -when the demand for a product changes, the demand for the resources used to produce it will change in
- the same direction
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price floor
Price floor: A legally established minimum price buyers must pay for a good or resource
- -A price floor above equilibrium price creates a surplus
- -A price floor below equilibrium price does nothing
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price ceiling
Price ceiling: A legally established maximum price sellers can charge for a good or resource
- -A price ceiling below market equilibrium price creates a shortage
- -A price ceiling above market equilibrium price does nothing
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surplus
Surplus: A condition in which the amount offered for sale is greater than the amount that buyers will purchase at existing prices.
- Also known as excess supply:
- Quantity supplied > Quantity demanded
- The minimum wage is an example of a price floor.
- Raising minimum wage increases excess labor supply (unemployment).
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shortage
Shortage: a condition in which the amount offered for sale is less than the amount demanded by buyers at existing prices
- - Also known as excess demand:
- Quantity demanded > Quantity supplied
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changes in demand
- Demand changes:
- Price: moves in same direction
- Quantity: moves in same direction
- ex. Demand increases
- Price increases
- Quantity increases
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changes in supply
- Supply changes:
- Price: moves in opposite direction
- Quantity: moves in same direction
- ex. Supply increases
- Price decreases
- Quantity increases
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