Econ Exam 1

Economics is the study of how we make choices under scarcity

• 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

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

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

the act of selecting among alternatives

an input to produce economic goods. (land, labor)

• limited resources
• - land
• -human resources (skills, talent)

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)

the study of "what is" among economic relationships

positive economic statements are testable

judgments about "what ought to be" in economic matters

it can not be tested because they are based on value judgments

• 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)

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.

value is subjective and voluntary trade creates value and economic progression

• 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.

• 1. Gains from specialization and division of labor
• 2. Gains from mass production methods
• 3. Gains from innovation

the time, effort and other resources needed to search out negotiate and complete an exchange.

-leaves a role for a middle man

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

• 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

• 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

Lack of property rights = lack of economic progress

• 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

• 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

• 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

Investment: the purchase, construction, or development of resources

technology: the knowledge available in an economy at any given time.

Technology determines the amount of output we can generate with our limited resources.

• 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

• Every economy faces 3 questions:
• 1. What will be produced?
• 2. How will it be produced?
• 3. For whom will it be produced?

• the method of organization that relies on public sector decision making to resolve
• basic economic questions.

• 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

• Capitalism: A system of economic organization where:
• 1.Productive resources are owned privately
• 2.Goods and resources are allocated through market prices

• 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.

Market organization: a method of organization in which private parties make their own plans and decisions with the guidance of market prices

inverse relationship between price and quantity


Demand curve is downward sloping

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.

• 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)

• 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 P_substitute ↑ → D↑
• B. Compliments P_compliments ↑ →D↓
• 4. Change in expectations
• A. Expected price P_future ↑ → D↑
• B. Expected income I_future ↑ → D↑
• 5. Change in consumer tastes and preferences Preferences↑ → D↑

The law of supply: direct relationship between price and quantity.

Supply curve is upward sloping

• 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.

• 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)

• 2. 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↓