ECO2023 Chapter 1

Building an economic model often follows these steps

1. Decide on the assumptions to use in developing the model. 2. Formulate a testable hypothesis. 3. Use economic data to test the hypothesis. 4. Revise the model if it fails to explain the economic data well. 5. Retain the revised model to help answer similar economic questions in the future.

when using formulas

1. Make sure you understand the economic concept the formula represents. 2. Make sure you are using the correct formula for the problem you are solving. 3. Make sure the number you calculate using the formula is economically reasonable. For example, if you are using a formula to calculate a firm's revenue and your answer is a negative number, you know you made a mistake somewhere.

Analyzing markets

1. People are rational 2. People respond to economic incentives 3. Optimal decisions are made at the margin

How will the goods be produced?

A firm might have several different methods for producing its goods and services.

Market

A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.

Scarcity

A situation in which unlimited wants exceed the limited resources available to fulfill those wants

Voluntary exchange

A situation that occurs in markets when both the buyer and the seller of a product are made better off by the transaction. • Each transaction that takes place improves the well-being of the buyer and seller; transactions continue until no further improvement can take place.

positive economic statement

A statement that can be proved or disproved by reference to facts

negative economic statement

A statement that reflects an opinion, which cannot be proved or disproved by reference to the facts

area of triangle

A=1/2bh

Mixed economy

An economy in which most economic decisions result from the interaction of buyers and sellers in markets but in which the government plays a significant role in the allocation of resources.

Market economy

An economy in which the decisions of households and firms interacting in markets allocate economic resources.

Centrally planned economy:

An economy in which the government decides how economic resources will be allocated.

Normative analysis

Analysis concerned with what ought to be

2. People respond to economic incentives

As incentives change, so do the actions that people will take.

marginal analysis

Comparing MC and MB

Assumptions and simplifications

Every model needs them in order to be useful.

Why do we have trade-offs?

In a world of scarcity, we have limited economic resources to satisfy our desires.

What goods and services will be produced?

Individuals, firms, and governments must decide on the goods and services that should be produced. An increase in the production of one good requires the reduction in the production of some other good. This is a trade-off, resulting from the scarcity of productive resources.The highest-valued alternative given up in order to engage in some activity is known as the opportunity cost.

Economically efficient outcomes are not necessarily desirable.

Less efficient outcomes may be more fair or equitable. An important trade-off for a government is that between efficiency and equity.

1. People are rational

Rational consumers and firms weigh the benefits and costs of each action, and try to make the best decision possible

Equity

The fair distribution of economic benefits.

Trade-off:

The idea that, because of scarcity, producing more of one good or service means producing less of another good or service.

Are graphs of economic relationships always straight lines?

The relationship between two variables is linear when it can be represented by a straight line.Few economic relationships are actually linear. However linear approximations are simpler to use, and are often "good enough" in modeling.

Who will receive the goods and services produced?

The way we are most familiar with in the United States is that people with higher incomes obtain more goods and services. Changes in tax and welfare policies change the distribution of income; though people often disagree about the extent to which this "redistribution" is desirable.

Graphs

Use graphs and formulas to analyze economic situations

rational

Using all available information to achieve your goals. Example: Apple doesn't randomly choose the price of its smartwatches; it chooses the price(s) that it thinks will be most profitable.

cause and effect

Using graphs to draw conclusions about cause and effect is dangerous.

3. Optimal decisions are made at the margin

While some decisions are all-or-nothing, most decisions involve doing a little more or a little less of something. Economists think about decisions like this in terms of the marginal cost and benefit (MC and MB): the additional cost or benefit associated with a small amount extra of some action.

Positive analysis

analysis concerned with what is ("Fact")

total revenue

area of a rectangle base x height

Important features of economic models

assumptions,simplifications, testability, and economic variables

GRAPHS

bar and pie line graphs

Making "how much" decisions involves

determining the additional benefits and the additional costs of that activity

nonlinear curve

different slopes at different points

Testability

good models generate testable predictions, which can be verified or disproven using data.

Map

is a simplified model of reality, showing essential details only.

Economics

is the study of the choices people make to attain their goals, given their scarce resources

measure slope of a non-linear curve

is to measure the slope of a tangent line to the curve, at the point we want to know the slope. change of cost ---------- change of quantity

capital

manufactured goods that are used to produce other goods and services

percentage change

new-old/old x 100

which analysis do economists use most often

positive analysis

When analyzing human behavior

positive and normative analysis

economic models

simplified versions of reality used to analyze real-world economic applications

Economic variables

something measurable that can have different values, such as the incomes of doctors.

opportunity cost

the most desirable alternative given up as the result of a decision

technology, in an economic lens

the processes a firm uses to produce goods and services

Macroeconomics

the study of economy-wide phenomena, including inflation, unemployment, and economic growth

Microeconomics

the study of how households and firms make decisions and how they interact in markets

Making optimal decisions "at the margin" requires

weighing the costs and benefits of a decision before deciding if it should be pursued.

Productive efficiency

where goods or services are produced at the lowest possible cost comes about because of competition.

Allocative efficiency

where production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it. arises due to voluntary exchange.

Caveats about market economies (not fully efficient)

• People might not immediately do things in the most efficient way • Governments might interfere with market outcomes • Market outcomes might ignore the desires of people who are not involved in transactions