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Principles of Economics Test 2, Chapter 5,6,7

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Principles of Economics Test 2, Chapter 5,6,7 Powered By Docstoc
					Limits, Alternatives, &
       Choices

       Chapter 1
  The Economic Perspective
An economic way of thinking
Scarcity & Choice
– Opportunity Costs
      The cost of any good, service, or activity is the value of what must
      be given up to obtain it
      Present Whenever a Decision is Made
– “Can’t have it all”
– “There is no free lunch”
      Marketing Strategies – Brand Awareness
Purposeful Behavior
– Rational Self Interest: Making Decisions to Achieve Maximum
  Utility
– Utility: The Pleasure, Happiness, or Satisfaction obtained from
  consuming a good or service
        Marginal Analysis
“Extra,” “Additional,” “A Change In”
Marginal Benefits
– Perceived Benefit
Marginal Costs
– Added expense beyond the cost of alternative
Expand Output: MB>MC
Reduce Output: MB<MC
Optimal Output: MB=MC
Theories, Principles, & Models
Scientific Method
–   Observe Facts (Real Data)
–   Formulate Hypothesis (Cause & Effect)
–   Test Hypothesis
–   Accept, Reject, or Modify Hypothesis
–   Continue Testing
Generalizations
Other-Things-Equal (Ceteris Paribus)
– Assume that factors other than those being
  considered do not change
Graphical Expression
       Economics Defined
Microeconomics
– Concerned with the individual industry, firm,
  or household and the price of specific
  products and resources
– An examination of the trees, not the forest
Macroeconomics
– Includes measures of total output, total
  employment, total income, aggregate
  expenditures, and the general price level
– A general overview of the forest, not the trees
         Economics Defined
Positive Economics (Theoretical Economics)
– What the economy is actually like (What is)
     “The unemployment rate in France is higher than in the U.S.”
– Focuses on facts and cause & effect relationships
– Includes description, theory development, and theory
  testing
– Avoids value judgments
Normative Economics (Policy Economics)
– What the economy should be like (What ought to be)
     “France ought to undertake policies to make its labor market
     more flexible to reduce unemployment rates.”
– Incorporates value judgments
Individuals’ Economizing Problem
The Economizing Problem
– The need to make choices because economic wants exceed
  economic needs
Limited Income
Unlimited Wants
– Necessities
– Luxuries
A Budget Line (Budget Constraint)
–   Attainable vs. Unattainable
–   Tradeoffs & Opportunity Costs
–   Choice
–   Income Changes
       Increase in Income Shifts Budget Line to Right
       Decrease in Income Shifts Budget Line to Left
Individual’s Economizing
        Problem
$120 Budget             12
DVDs Books
 $20  $10
                        10
 6     0                                 Income = $120
                                                       =6



              Quantity of DVDs
 5     2                         8         Pdvd = $20

 4     4                         6
                                                      Unattainable

 3     6
                                 4                    Income = $120
 2     8                                                  Pb = $10
                                                                          = 12

 1    10                         2   Attainable
 0    12
                                 0
                                     2     4      6   8     10       12   14
                                               Quantity of Books
Society’s Economizing Problem
Scarce Resources
Resource Categories (Factors of Production)
 – Land
       All natural resources used in the production process
 – Labor
       Physical & mental talents of individuals used in producing goods & services
 – Capital (Capital Goods)
       All manufactured aids used in producing consumer goods & services such
       as tools, equipment, factories, transportation
       Economists do not view money as capital as it produces nothing
       Purchase of Capital Goods = Investment
 – Entrepreneurial Ability
       A special kind of human resource, distinct from labor
           –   Takes Initiative
           –   Makes Strategic Decisions
           –   Is an Innovator
           –   Is a Risk Bearer
Production Possibilities Model
Assume:
– Full Employment: Economy is employing all available
  resources
– Fixed Resources: Quantity & quality of all factors of
  production are fixed
– Fixed Technology: State of technology is constant
– Two Goods: Economy only produces two types of
  products
     Consumer Good (Pizza): Directly satisfy wants
     Capital Good (Robots): Indirectly satisfy wants
 Production Possibilities Model
Production Possibilities Table
                                     Production Alternatives
       Type of Product              A    B     C      D        E

      Pizzas                        0    1      2     3        4
      (in hundred thousands)



      Industrial Robots            10    9      7     4        0
      (in thousands)


                               Plot Points to Create Graph…
Production Possibilities Model
  Production Possibilities Curve
                          14       A’
                          13
                          12                    B’                                Unattainable
                          11
                                   A
                          10
      Industrial Robots
                           9
                                        B                       C’       Economic
                           8
                                                C
                                                                         Growth
                           7
                           6
                                                                             D’
                           5
                                                        D
                           4
                           3                                                      Now Attainable
                           2       Attainable
                           1                                E                     E’
                               0       1    2       3       4        5   6    7   8 9
                                                                     Pizzas
Law of Increasing Opportunity Cost
 The more of a product produced, the greater its
 (marginal) opportunity cost
 Shape of Curve
 – As the slope becomes steeper, opportunity costs
   increase
 – Makes the curve appear concave (bowed out)
 Economic Rationale
 – Economic resources not completely adaptable to
   alternative uses
 – Many resources are better at producing one type of
   good than at producing others
Production Possibilities Model
  Production Possibilities Curve
                          14       A’
                          13
                          12                    B’                                Unattainable
                          11
                                   A
      Industrial Robots   10
                           9
                                        B                       C’       Law of Increasing
                           8
                                                C                        Opportunity Cost
                           7
                           6
                                                                             D’
                           5
                                                        D
                                                                                        Shape of
                           4
                           3
                                                                                        the Curve
                           2       Attainable
                           1                                E                     E’
                               0       1    2       3       4        5   6    7   8 9
                                                                     Pizzas
Production Possibilities Model
  Production Possibilities Curve
                          14       A’
                          13
                          12                B’                         Unattainable
                          11
      Industrial Robots   10
                                                     C’
                           9
                           8
                           7
                           6            U
                                                                  D’
                           5
                                      Under or
                           4
                                    Unemployment
                           3
                           2
                           1                                           E’
                               0    1   2    3   4        5   6    7   8 9
                                                          Pizzas
        Optimal Allocation
Remember:
Expand Output: MB>MC
Reduce Output: MB<MC
Optimal Output: MB=MC
If the additional (marginal) cost of
obtaining an additional product is more
than the additional benefit received, then
it’s not “worth” it to society to produce the
extra unit
Production Possibilities Model
    Optimal Allocation of Resources


     Marginal Benefit & Marginal Cost
                                                                       MC
                                             a                   c
                                        15

                                                    MB = MC

                                        10                e


                                        5
                                             b                  d
                                                                       MB

                                        0    1           2         3
                                                 Quantity of Pizza
Present Choices & Future
      Possibilities
 Compare Two Hypothetical Economies
 Goods for the Future




                                                  Goods for the Future
                                  Future                                            Future
                                  Curve                                             Curve
                                                                              F



                        Current   P                                      Current
                         Curve                                            Curve


                          Goods for the Present                             Goods for the Present
                           Presentville                                       Futureville


 Implications of International Trade
     Pitfalls to Sound Economic
               Reasoning
Biases
– Perceptions not based on facts
Loaded Terminology
– Terms that contain prejudices & value judgments of others
Fallacy of Composition
– What is true for one individual or part of a whole is necessarily true for a
  group of individuals or the whole
Post Hoc Fallacy
– When two events occur in time sequence, the first event is not
  necessarily the cause of the second event
Correlation vs. Causation: Events may be related without a causal
relationship
– Example: The positive relationship between education & income does
  not tell us which causes the increase in the other
– The increased income that occurs with increased education may be
  related to some other factor not under consideration

				
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