Chapter 1: Exploring Economics

2. Dunkin Donuts gave away free cups of coffee to all patrons on National Coffee Day. Explain why economists would state that this coffee actually is not "free" to any patron.

Economically speaking, nothing is actually "free" because everything has an opportunity cost associated with it. In this case, even though there is no explicit cost associated with the coffee, all patrons bear an opportunity cost because they have to give up some of their limited time in order to get the coffee.

List the eight key principles in economics

Economics is concerned with making choices with limited resources - One must think of economics in a broad sense of determining how best to manage all of society's resources (not just money) in order to maximize well-being. When making decisions, one must take into account tradeoffs and opportunity costs - Everyone has limited resources because resources comprise more than just money (ex time limitations, there are only 24 hours in a day). Specialization leads to gains for all involved - Specialization in tasks in which one is more proficient can lead to gains for all parties as long as exchange is possible and those involved trade in a mutually beneficial manner. People respond to incentives, both good and bad - incentives can be formed by policies set by government to encourage individuals and firms to act in certain ways by businesses to encourage consumers to change their consumption habits. Rational behavior requires thinking on the margin - A society must ask itself whether it wants a little bit more or a little bit less of something Markets are generally efficient; when they aren't, government can sometimes correct the failure - The competition of prices and profits drives and disciplines markets and the market forces of supply and demand generally keep the economy in equilibrium. Economic growth, low unemployment, and low inflation are economic goals that do not always coincide - When it comes to the imbalance of unemployment and inflation, government policy is used to correct one problem at the potential expense of exacerbating the other. Institutions and human creativity help explain the wealth of nations - Two important factors influencing the wealth of nations are good institutions (a legal system to enforce contracts and laws) and human creativity (ideas).

The difference between efficiency and equity

Efficiency - How well resources are used and allocated. Do people obtain the goods and services they want at the lowest possible resource cost? This is the chief focus of efficiency. How Efficiency is Measured - Production efficiency: Occurs when goods are produced at the lowest cost.. - Allocative efficiency: Occurs when individuals who desire a product the most obtain those goods and services. - Pareto efficiency: Occurs when society improves the well-being of as many individuals as possible without making anyone worse off. Equity - The fairness of various issues and policies. - Covers ideas like is it fair that CEOs of large companies make hundreds of times more money than their service workers? Is it fair that some have so much and others have so little? Should society take care of the homeless and disabled? Comparison - Both are used to evaluate how resources are used and allocated.

Explain the difference between marginal benefits/costs and total benefits/costs.

- A marginal benefit is a small, but measurable, change in a consumer's advantage if they use an additional unit of a good or service. - A marginal cost is the small but measurable change in the expense to the business if it produces one additional unit. - Total cost is an economic measure that sums all expenses paid to produce a product, purchase an investment, or acquire a piece of equipment including not only the initial cash outlay but also the opportunity cost of their choices. - Total benefit The total amount of satisfaction received from consuming a specified number of units of a good, service, or activity. Comparison - Marginal is a portion and total is the whole.

What ceteris paribus is and how it is used in economics

- Assumption used in economics (and other disciplines as well) that other relevant factors or variables are held constant. - "Holding all other things equal." (we will hold some important variables constant) - Economic theories must be tested. - Used in economics to rule out the possibility of 'other' factors changing. - A prediction of a change in an economy. - Comprehension of the economy. Example: - We can say that if the demand for a given product (chicken), is more than its supply, ceteris paribus will rise. - Thus ceteris paribus means that, as long as all other factors remain constant (such as the existence of a substitute product). Prices will increase in this situation.

1. Explain a situation where scarcity was relevant to you in determining your choice.

- Deciding if I want to study or watch tv. The perk of studying is less work, but no relaxing is the cost. The perk of watching tv is being able to relax, but the cost is schoolwork building up. - Scarcity is relevant in every choice you make. Any time you decide to buy something, you consider your limited income, and any time you decide to spend time on an activity, you consider your limited time. Examples where scarcity was especially relevant could include any time you wanted to buy something but felt you couldn't afford it, or a time you wanted to do something but didn't because you had something else more important to do.

Model building

- Economists boil down facts to their basic relevant elements and use assumptions to develop a stylized (simple) model to analyze the issue. There are always situations that lie outside these models, but they are exceptions. - Supply and demand would be an example of model building.

market equilibrium

- Equilibrium is a state in which market supply and demand balance each other, and as a result, prices become stable. - In economics, economic equilibrium is a situation in which economic forces such as supply and demand are balanced and in the absence of external influences the values of economic variables will not change.

Macroeconomics

- Focuses on the broader issues we face as a nation. - Inflation, unemployment, economic growth, and national output of goods and services affect all of us. - Focuses on the whole rather than part of the economy. Examples: - Business cycles, recession, and unemployment - Looks at policies that increase economic growth, the impact of government spending and taxation, the effects of monetary policy on the economy, and inflation - Looks closely at theories of international trade and international finance macroeconomics "a" = aggregate entities (such as cities or nation as a whole)

The concept of scarcity

- Scarcity is the concept of multiple car dealerships selling cars for availability, but that car is not available to you because it is something you can not. afford/want/need/not a necessity - Our unlimited wants (to buy 3 iPhones )clash with limited resources (not enough money, etc) leading to scarcity. - People must make choices given the resource limitations they face (buying a cheaper smartphone brand then iPhone, buying less than 3 iPhones, etc). - Economics focuses on the distribution of scarce resources to satisfy unlimited wants as fully as possible.

Incentives

- The factors that motivate individuals and firms to make decisions in their best interest. - The way in which economists think often focuses on how individuals respond to incentives

Tradeoffs

- The sacrifice of some or all of one economic goal, good, or service to achieve some other goal, good, or service. - The recognition that in many situations acquiring more of one thing can often only be done at the expense of getting by with less of something else. - Dividing up tasks - Specializing in activities in which one is more proficient

Economics

- The study of how individuals, firms, and society make decisions to distribute limited resources to many competing wants. - A way of thinking about an issue. - Economics is about making decisions when we can't have everything we want and how we interact with others to maximize our well-being given limitations.

Microeconomics

- The study of the decision-making by individuals, businesses, and industries. - Looks at how markets are structured. - Extends to topics as labor laws, environmental policy, and health care policy. Examples: - What orange juice to buy, what job to take, where to go on vacation - Which items a business should produce and what price should it charge - Whether a market should be left on its own or be regulated microeconomics "i" = individual entities (such as a person or a firm)

Explain the concept of opportunity costs.

- The value of the next best alternative; what you give up to do something or purchase something. - Every activity involves opportunity cost (Sleeping, eating, studying, running, etc...).

Explain the tradeoff between inflation and unemployment.

- When unemployment is high, inflation is low. - When unemployment is low, inflation is high. - When either unemployment or inflation is too high, economic growth can be inhibited. - Goal is to have a balance of the two.

Thinking on the margin

- When you decide how much more or less to do, you are thinking on the margin. - Deciding by thinking on the margin involves comparing the opportunity costs and benefits. -This decision-making process is called a cost/benefit analysis. - Like opportunity cost, thinking at the margin applies not just to individuals, but to businesses and governments as well. - Employers think at the margin when they decide how many workers to hire. - Legislators think at the margin when they decide how much to increase government spending on a particular project.

Inflation

A general increase in prices economy-wide.

invisible hand

Markets promote efficiency through the incentives faced by individuals and firms (as if they were guided by an omnipotent force) is referred to as the invisible hand, a term coined by Adam Smith, considered the father of modern economics.

6. Is ceteris paribus unique to economics?

No. It is common to the sciences. For example, physicists hold everything constant and then change one variable when they run various experiments. This is the logic behind taking one particle and seeing what happens under normal speeds and then taking the same particle and accelerating nearly to the speed of light.

8. Explain why policymakers find it difficult to simultaneously address both high unemployment and high inflation.

Policymakers want both low inflation and low unemployment, but there is a natural tradeoff between these two goals. In order to fight inflation, policymakers typically must accept higher unemployment, and vice versa.

The difference between positive questions and normative economics

Positive Question - A question that can be answered using available information or facts. - Questions that can be answered one way or another as long as the information is available. This does not mean that people always agree on an answer because presentation of facts and information can differ. Normative Question - A question whose answer is based on societal beliefs on what should or should not take place. Comparison: - Positive questions are based and answered on facts and normative questions are based on opinions.

4. The percentage of smokers in the United States has substantially declined in the past 40 years. What major factors have contributed to this decline? Explain how this reflects the principle that people respond to incentives.

There are a number of factors that have contributed to the decline in smoking rates. Two major factors include the fact that cigarettes are significantly more expensive today than they were 40 years ago, and the adverse health effects associated with smoking are more known and apparent today. This reflects the incentive principle because the decline in smoking rates has been caused by the increase in costs associated with smoking.

5. Why should we not expect tax law to be as economically efficient in outcome as possible?

There is an efficiency versus equity tradeoff. Economists can propose the most economically efficient tax laws, but these have to go through apolitical process to become law. The political process ensures that equity considerations come into play. In other words, economists can propose various tax laws, but as soon as someone says that the proposed law is unfair to some person or some group, politicians will take notice and factor this in to the degree they think is warranted.

7. Suppose a friend says the following: "I don't mind paying a high monthly fee for my gym membership because it motivates me to go to the gym more often." Explain what is economically wrong with your friend's reasoning.

This is a violation of the principle that rational behavior requires thinking at the margin. Specifically, once your friend pays for her gym membership, the marginal cost associated with going to the gym is zero (in explicit terms; she would still incur an opportunity cost). Therefore, if she is thinking rationally, the amount she pays for her membership would not be relevant in determining how often she goes to the gym.

3. Lobbyists in Washington, D.C. often pay people to wait in line for them to enter Congress. Suppose the rate is $10/hour. What do you know is true regarding the opportunity costs of lobbyists and those who are paid to wait in line?

We know that those who are willing to wait in line for $10/hour have an opportunity cost that is less than $10/hour; otherwise they would not be willing to wait in line for this amount of money. Similarly, lobbyists who pay someone $10/hour to wait in line must have an opportunity cost above $10/hour; otherwise they would just wait in line themselves.