Econ 104 - L2 - Chapter 2

What are key points Smith argued?

1) [Guild] restrictions reduced the income and wealth of a country and its people by restricting the quantity of goods produced. 2) Pricing coordinates the activities of buyers and sellers better than guilds could. 3) Individuals usually act in a rational, self-interested way. This assumption of rational, self-interested behavior underlies nearly all economic analysis.

How does economics define a product market?

A market for goods—such as computers—or services—such as medical treatment. In product markets, households are demanders and firms are suppliers.

How does economics define a factor market?

A market for the factors of production, such as labor, capital, natural resources, and entrepreneurial ability.

How does economics define a free market?

A market with few government restrictions on how a good or service can be produced or sold or on how a factor of production can be employed. [However,] governments in all modern economies intervene more than is consistent with a fully free market.

What is a circular-flow diagram?

A model that illustrates how participants in markets are linked. *** Like all economic models, the circular-flow diagram is a simplified version of reality. The circular-flow diagram is useful for seeing how product markets, factor markets, and their participants are linked together.

How is scarcity defined in economics?

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

What are the two important points to remember about absolute and comparative advantage?

A) It is possible to have an absolute advantage in producing a good or service without having a comparative advantage. B) It is possible to have a comparative advantage in producing a good or service without having an absolute advantage.

Why are consumers important in a market system?

At the center of the market system is the consumer. To be successful, firms must respond to the desires of consumers. These desires are communicated to firms through prices.

What is the economics?

Economics studies why people, firms, and governments makes the choices they do when resources are scarce

Why are entrepreneurs important?

Entrepreneurs are central to the working of the market system. Entrepreneurs first determine what goods and services they believe consumers want and then decide how to produce those goods and services most profitably, using the available factors of production—labor, capital, and natural resources. Successful entrepreneurs are able to search out opportunities to provide new goods and services. Entrepreneurs make a vital contribution to economic growth through their roles in responding to consumer demand and introducing new products.

What are the four categories of factors of production?

Factors of production are divided into four broad categories: 1) labor--all types of work, 2) Capital - physical capital, 3) Natural resources, and 4) Entrepreneur.

What does the text say individuals must do for the market system to work well?

For the market system to work well, individuals must be willing to take risks. The market system won't work unless a significant number of people are willing to risk their funds by investing them in businesses.

What are the two key groups who participate in markets?

Households and firms

What are the two types of markets households and firms interact in?

Households and firms interact in two types of markets 1) product markets and 2) factor markets.

What is intellectual property?

Intellectual property includes books, films, software, and ideas for new products or new ways of producing products. To protect intellectual property, the federal government grants a patent ***. *** The U.S. Congress provides copyright protection to authors to give them an economic incentive to invest the time and effort ***.

How does economics define factors of production?

Labor, capital, natural resources, and other inputs used to make goods and services.

What do markets determine?

Markets determine the answer to three fundamental questions 1) What goods and services will be produced?; 2) How will the goods and services be produced?; and 3) Who will receive the goods and services produced?

What do outward shifts in the PPF represent?

Outward shifts in the production possibilities frontier represent economic growth because they allow the economy to increase the production of goods and services, which ultimately raises the standard of living.

What is the Production Possibilities Frontier?

PPF is a curve showing the maximum attainable combinations of two goods that can be produced with available resources and current technology. Combinations on the frontier are efficient because all available resources are being fully utilized, and the fewest possible resources are being used to produce a given amount of output.

Why does scarcity exist?

Scarcity exists because we have unlimited wants but only limited resources available to fulfill those wants. Goods and services are scarce. So, too, are the economic resources, or factors of production—workers, capital, natural resources, and entrepreneurial ability—used to make goods and services. Your time is scarce ***.

How does economics define an entrepreneur?

Someone who operates a business, bringing together the factors of production—labor, capital, and natural resources—to produce goods and services.

Who is considered the father of modern economics?

The Scottish philosopher Adam Smith is considered the father of modern economics because his book, An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776, was an early and very influential argument for the free market system. Smith was writing at a time when extensive government restrictions on markets were common. [However, Wealth of Nations was intended to be paired with the book Moral Sentiments -- unfortunately, not taught in economics.]

How does economics define comparative advantage?

The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors.

How does economics define absolute advantage?

The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources.

How does economics define economic growth?

The ability of the economy to increase the production of goods and services.

What is trade?

The act of buying and selling. Markets are fundamentally about trade. Trade is a key activity that takes place in markets. Trade results from the decisions of millions of households and firms around the world. By engaging in trade, people can raise their incomes.

What is the basis for trade?

The basis for trade is comparative advantage, not absolute advantage. Individuals, firms, and countries are better off if they specialize in producing goods and services for which they have a comparative advantage and obtain the other goods and services they need by trading.

Which US Constitutional amendments protect property rights?

The fifth (federal gov shall not deprive without due process of law), and the fourteenth (states shall not deprive without due process of law).

How does economics define opportunity cost?

The highest-valued alternative that must be given up to engage in an activity.

What is the key role of markets?

The key role of markets is to facilitate trade.

What does increasing marginal opportunity costs illustrate?

The more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity.

What is relative price?

The relative price is the price of one good or service relative to the prices of other goods or services. Changes in relative prices provide information, or a signal, to both consumers and firms.

How does economics define property rights?

The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. Property can be physical property, such as a store or factory. Property can also be intangible, such as the right to an idea. If property rights are not well enforced, fewer goods and services will be produced.

Why is the study of behavior important to economics?

To explore how markets work, we must study the behavior of consumers and firms.

Why is trade on the basis of comparative advantage good?

Trading on the basis of comparative advantage makes all participants in trade better off. It's more efficient.

What is direct trade vs indirect trade?

[Direct trade is a good/service for good/service trade. Indirect trade is a good/service trade for money which is later exchanged for another good/service. (i.e., The final good/service is what we're trading our good/service for, but it is indirect.)]

What does the text say government must do to ensure the market system works well?

[Per the text], Government has to take active steps to provide a legal environment that will allow markets to operate efficiently.