Chapter One Five Foundations of Economics

Like a good economist, you calculated the opportunity cost of getting your college degree. Suppose that at your university, you will pay $15,000 each year for tuition, $2,000 each year for textbooks, and $8,000 per year for room and board. Before you left for college, your boss at your high-school job offered you a job paying $15,000 per year.Assume that if you decided not to go to college, your parents would not let you live at home. What is your opportunity cost for four years of college?

$128,000 4x($15,000+$2,000+$15,000)

trade-offs

Alternatives that must be given up when one is chosen rather than another, doing one thing often means you will not have the time or money to do something else, every decision incurs a cost

circular flow diagram

a diagram that shows how goods, services, and resources flow through the economy (p. 18)

economic thinking

a purposeful evaluation of the available opportunities to make the best decision possible (p. 17)

unintended consequence

an unplanned result (usually negative and unwanted) of an incentive (example: welfare is good people who are unemployed, however people can take advantage of that)

negative incentives

discourages action by offering undesirable consequences or punishments (example: going to jail for stealing candy from a store)

Direct Incentives

easily recognizable (example: giving a child a gift if they get straight A's)

double coincidence of wants

occurs when each party in an exchange transaction has what the other person desires

scarcity

refers to the inherently limited nature of society's resources, given society's unlimited wants and needs (p. 7)

Circular Flow

shows how goods, services, and resources flow through the economy via commerce between households and firms

markets

systems that bring buyers and sellers together to exchange goods and services (p. 17)

marginal thinking

the evaluation of whether the benefit of one more unit of something is greater than its cost (p. 17), requires economic thinking

opportunity cost

the highest-valued alternative that must be sacrificed to get something else (p. 15), the best possible decision is the one that minimizes the opportunity cost

comparative advantage

the situation where an individual, business, or country can produce at a lower opportunity cost than a competitor can (p. 19)

economics

the study of how individuals and societies allocate their limited resources to satisfy their unlimited wants (p. 7)

microeconomics

the study of the individual units that make up the economy

macroeconomics

the study of the overall aspects and workings of an economy (p. 8)

trade

the voluntary exchange of goods and services between two or more parties (p. 19)

The opportunity cost of attending college is likely to be highest for a high school graduate who..

can immediately take over the family business

what does economics seek to answer?

how individuals and society make decisions about scarce resources

what are the five foundations of economics?

incentives, trade-offs, opportunity cost, marginal thinking, the principle that trade creates value

bartering

individuals trading a good or service in exchange for something they want

Indirect Incentives

more difficult to recognize (example: cheating on a test in order to keep all A's)

Buying and selling textbooks are two separate decisions made at the margin. Textbooks create value both when they are bought and when they are sold.Think about your decision to buy the textbook for this course. You paid $250 for the book, but you would have been willing to pay $400 to use the book for the semester. Suppose that at the end of the semester you could keep your textbook or sell it back to the bookstore. Once you have completed the course, the book is worth only $70 to you. The bookstore will pay you 50% of the original $250. How much total value have you gained?

$205 (look at at this one on homeworK)

Carlos has two options this weekend. He could work at his job and earn $10 per hour for three hours, or he could go to an exhibit at the art museum for that three hours. A ticket for the event costs $30.

$60

trade creates value

Trade creates value because participants in markets are able to specialize in the production of goods and services that they have a comparative advantage in making.

opportunity cost for going to college

When people think about the cost of attending college, they usually think of tuition, room and board, course materials, and travel-related expenses. While those page16 expenses are indeed a part of going to college, they are not its full cost. The opportunity cost is the next-best alternative that is sacrificed. This opportunity cost—or what you potentially could have done if you were not in college—includes the lost income you could have earned working a full-time job. If you consider the cost of attending college plus the forgone income lost while in college, you can see that college is a very expensive proposition

table question

add the total output to the next row down marginal product of labor

positive incentives

encourage action by offering rewards or payments (example: extra credit for participating in class)

incentives

factors that motivate a person to act or exert effort (p. 10), incentives are used to affect how people respond