Econ Chapter 1 - Limits, Alternatives, and Choices

Time

"5th" economic resource

Economic Growth

(1) An outward shift in the production possibilities curve that results from an increase in resource supplies or quality or an improvement in technology; (2) an increase of real output (gross domestic product) or real output per capita.

Economic growth is the result of

(1) increases in supplies of resources, (2) improvements in resource quality, and (3) technological advances. The consequence of growth is that a full-employment economy can enjoy a greater output of both consumption goods and capital goods. Whereas static, no-growth economies must sacrifice some of one good to obtain more of another, dynamic, growing economies can have larger quantities of both goods.

A microeconomist would most likely study:

*A) how consumers respond to a change in gasoline prices* B) the effects of an income tax reduction on the size of the national budget deficit C) the effects of aggregate consumer debt on overall consumption spending D) the relationship between the size of the money supply and the rate of inflation Feedback: Microeconomics is concerned with specific economic units and the operation of individual markets. Macroeconomics, on the other hand, is concerned with the economy as a whole or with basic aggregates such as the money supply or consumer spending.

Consider the problem Marsha faces of how to allocate her weekly allowance between books and videos. An increase in Marsha's allowance will:

*A) shift her budget line to the right* B) shift her budget line to the left C) rotate her budget line, allowing her to buy more books but not more videos D) rotate her budget line, allowing her to buy more videos but not more books Feedback: Increased income allows Marsha to purchase additional books, additional videos, or both but does not change the opportunity cost of one in terms of the other. Her budget line shifts out parallel to itself.

Scientific method -procedure consists of several elements:

- Observing real-world behavior and outcomes. - Based on those observations, formulating a possible explanation of cause and effect (hypothesis). - Testing this explanation by comparing the outcomes of specific events to the outcome predicted by the hypothesis. - Accepting, rejecting, and modifying the hypothesis, based on these comparisons. - Continuing to test the hypothesis against the facts. If favorable results accumulate, the hypothesis evolves into a theory.

ceteris paribus or other-things-equal assumption

- The assumption that factors other than those being considered are held constant - ceteris paribus assumption.

Normative economics

- The part of economics involving value judgments about what the economy should be like - focused on which economic goals and policies should be implemented - policy economics. "what ought to be"

Budget Line

A line that shows the different combinations of two products a consumer can purchase with a specific money income, given the products' prices.

Investment

In economics, spending for the production and accumulation of capital and additions to inventories. (For contrast, see financial investment.)

Aggregate

A collection of specific economic units treated as if they were one unit. Examples: the prices of all individual goods and services are combined into the price level, and all units of output are aggregated into gross domestic product.

Production Possibilities Curve

A curve showing the different combinations of two goods or services that can be produced in a full-employment, full-production economy where the available supplies of resources and technology are fixed.

Economic perspective

A viewpoint that envisions individuals and institutions making rational decisions by comparing the marginal benefits and marginal costs associated with their actions.

Economic Principle

A widely accepted generalization about the economic behavior of individuals or institutions.

The fundamental problem of economics implies that:

A) governments must be relied upon to supply essential goods and services B) inflation and unemployment are unavoidable C) growing populations will deplete natural resources *D) individuals and communities must make choices among competing alternatives* Feedback: The fundamental economic problem is one of scarce resources relative to human wants. Such scarcity can never be eliminated; it implies we must make choices.

Economics is primarily the study of:

A) how scarcity can be eliminated B) how firms manipulate prices C) how government influences resource allocation decisions *D) the problem of scarce resources relative to human wants* Feedback: The fundamental economic problem is one of scarce resources relative to human wants. Such scarcity can never be eliminated; it implies we must make choices.

You should decide to study an extra hour tonight

A) if the marginal cost of studying an extra hour exceeds its marginal benefit *B) if the marginal benefit of studying an extra hour exceeds its marginal cost* C) if you got a lower than expected grade on your last exam D) because studying harder will improve your test scores Feedback: Purposeful behavior in the face of scarcity entails comparing marginal benefit to marginal cost. Any activity whose marginal benefit exceeds its marginal cost should be expanded.

Suppose you have a $20 iTunes gift card with which you can buy (download) songs or videos. Songs cost $1.00 each and videos cost $2.00 each. The opportunity cost of one video:

A) increases as more videos are purchased B) is $1.00 C) is constant and equal to ½ song *D) is constant and equal to 2 songs* Feedback: The purchase of an additional video requires $2.00. At a price of $1.00 each, two songs would have to be given up to obtain the required amount for one video.

The negative slope of the production possibilities curve illustrates that:

A) some resources are always unemployed *B) when resources are fully employed, an economy can produce more of one thing only by producing less of something else* C) opportunity costs are constant D) businesses can sell more goods when their prices are low Feedback: Each point on the production possibilities curve represents some maximum combination of the output of the two goods—the economy has achieved maximum production of one good for a given amount of the other. Increased production of any good requires sacrificing some of the other; the production possibilities curve will exhibit an inverse relationship between the two goods.

Margaret decides to stay home and study for her exam rather than going out to a movie with her friends. Her dilemma is an example of:

A) the economic perspective B) marginal analysis *C) opportunity cost* D) allocative efficiency Feedback: Opportunity cost is defined as the value of the best foregone alternative. In this case, Margaret has foregone the movie in order to study.

Apply production possibilities analysis, increasing opportunity costs, and economic growth.

An economy that is fully employed and thus operating on its production possibilities curve must sacrifice the output of some types of goods and services to increase the production of others. The gain of one type of good or service is always accompanied by an opportunity cost in the form of the loss of some of the other type of good or service. Because resources are not equally productive in all possible uses, shifting resources from one use to another creates increasing opportunity costs. The production of additional units of one product requires the sacrifice of increasing amounts of the other product. The optimal (best) point on the production possibilities curve represents the most desirable mix of goods and is determined by expanding the production of each good until its marginal benefit (MB) equals its marginal cost (MC).

Fallacy of Composition

Another pitfall in economic thinking is the assumption that what is true for one individual or part of a whole is necessarily true for a group of individuals or the whole.

Labor

Any mental or physical exertion on the part of a human being that is used in the production of a good or service. One of the four economic resources.

Correlation but Not Causation

Do not confuse correlation, or connection, with causation. Correlation between two events or two sets of data indicates only that they are associated in some systematic and dependable way.

Generalizations

Economic principles are generalizations relating to economic behavior or to the economy itself. Economic principles are expressed as the tendencies of typical or average consumers, workers, or business firms.

Land

In addition to the part of the earth's surface not covered by water, this term refers to any and all natural resources ("free gifts of nature") that are used to produce goods and services. Thus, it includes the oceans, sunshine, coal deposits, forests, the electromagnetic spectrum, and fisheries. Note that land is one of the four economic resources.

List the categories of scarce resources and delineate the nature of society's economizing problem.

Economic resources are inputs into the production process and can be classified as land, labor, capital, or entrepreneurial ability. Economic resources are also known as factors of production or inputs. Economists illustrate society's economizing problem through production possibilities analysis. Production possibilities tables and curves show the different combinations of goods and services that can be produced in a fully employed economy, assuming that resource quantity, resource quality, and technology are fixed.

Define economics and the features of the economic perspective.

Economics is the social science that examines how individuals, institutions, and society make optimal choices under conditions of scarcity. Central to economics is the idea of opportunity cost: the value of the next-best good or service forgone to obtain something. The economic perspective includes three elements: scarcity and choice, purposeful behavior, and marginal analysis. It sees individuals and institutions making rational decisions based on comparisons of marginal costs and marginal benefits.

Describe the role of economic theory in economics.

Economists employ the scientific method, in which they form and test hypotheses of cause-and-effect relationships to generate theories, laws, and principles. Economists often combine theories into representations called models.

Capital

Human-made resources (buildings, machinery, and equipment) used to produce goods and services; Goods that do not directly satisfy human wants; also called capital goods. One of the four economic resources.

Capital Goods

Human-made resources (buildings, machinery, and equipment) used to produce goods and services; goods that do not directly satisfy human wants; also called capital goods. One of the four economic resources.

Consumer Goods

Products and services that satisfy human wants directly.

Explain the individual's economizing problem and how trade-offs, opportunity costs, and attainable combinations can be illustrated with budget lines.

Individuals face an economizing problem. Because their wants exceed their incomes, they must decide what to purchase and what to forgo. Society also faces an economizing problem. Societal wants exceed the available resources necessary to fulfill them. Society therefore must decide what to produce and what to forgo. Graphically, a budget line (or budget constraint) illustrates the economizing problem for individuals. The line shows the various combinations of two products that a consumer can purchase with a specific money income, given the prices of the two products.

Entrepreneurs

Individuals who provide entrepreneurial ability to firms by setting strategy, advancing innovations, and bearing the financial risk if their firms do poorly.

Graphical expression

Many economic models are expressed graphically. Be sure to read the special appendix at the end of this chapter (1) as a review of graphs.

Distinguish microeconomics from macroeconomics and positive economics from normative economics.

Microeconomics examines the decision making of specific economic units or institutions. Macroeconomics looks at the economy as a whole or its major aggregates. Positive economic analysis deals with facts; normative economics reflects value judgments.

Biases

Most people bring a bundle of biases and preconceptions to the field of economics. All of us must be willing to shed biases and preconceptions that are not supported by facts.

Explain how economic growth and international trade increase consumption possibilities.

Over time, technological advances and increases in the quantity and quality of resources enable the economy to produce more of all goods and services, that is, to experience economic growth. Society's choice as to the mix of consumer goods and capital goods in current output is a major determinant of the future location of the production possibilities curve and thus of the extent of economic growth. International trade enables a nation to obtain more goods from its limited resources than its production possibilities curve indicates.

"No free Lunch"

Someone bears a cost. Because all resources are either privately or collectively owned by members of society, ultimately society bears the cost. Manufacture of the good requires the use of resources that could have been put to alternative uses.

Opportunity Costs

The amount of other products that must be forgone or sacrificed to produce a unit of a product.

Positive economics

The analysis of facts or data to establish scientific generalizations about economic behavior. Focuses on facts and cause-and-effect relationships. Deals with what the economy is actually like Avoids value judgments "what is"

Economizing Problem

The choices necessitated because society's economic wants for goods and services are unlimited but the resources available to satisfy these wants are limited (scarce).

Marginal Analysis

The comparison of marginal ("extra" or "additional") benefits and marginal costs, usually for decision making.

Answer the next question on the basis of the data given in the following production possibilities table:

The data in the table indicate that increasing production of capital goods requires: *A) increasing sacrifices of consumer goods* B) decreasing sacrifices of consumer goods C) constant sacrifices of consumer goods D) no sacrifices of consumer goods Feedback: As capital goods production increases by one unit, production of consumer goods initially decreases by one unit (moving from combination F to combination E), then 2 units (E to D), and so on. This illustrates the law of increasing opportunity costs.

Loaded Terminology

The economic terminology used in newspapers and broadcast media is sometimes emotionally biased, or loaded. The writer or spokesperson may have a cause to promote or an ax to grind and may slant comments accordingly.

Factors of Production (Inputs)

The four economic resources: land, labor, capital, and entrepreneurial ability.

Entrepreneurial Ability

The human resource that combines the other economic resources of land, labor, and capital to produce new products or make innovations in the production of existing products; provided by entrepreneurs.

Economic growth and the production possibilities curve

The increase in supplies of resources, improvements in resource quality, and technological advances that occur in a dynamic economy move the production possibilities curve outward and to the right, allowing the economy to have larger quantities of both types of goods.

Economic Resources

The land, labor, capital, and entrepreneurial ability that are used to produce goods and services; the factors of production.

Economic Rationale

The law of increasing opportunity costs is driven by the fact that economic resources are not completely adaptable to alternative uses. Many resources are better at producing one type of good than at producing others.

Shape of the Curve

The law of increasing opportunity costs is reflected in the shape of the production possibilities curve: The curve is bowed out from the origin of the graph.

Scarcity

The limits placed on the amounts and types of goods and services available for consumption as the result of there being only limited economic resources from which to produce output; the fundamental economic constraint that creates opportunity costs and that necessitates the use of marginal analysis (cost-benefit analysis) to make optimal choices.

Macroeconomics

The part of economics concerned with the performance and behavior of the economy as a whole. Focuses on economic growth, the business cycle, interest rates, inflation, and the behavior of major economic aggregates such as the household, business, and government sectors. The study of the entire economy or a major aggregate of the economy

Microeconomics

The part of economics concerned with: (1)decision making by individual units such as a household, a firm, or an industry and (2) individual markets, specific goods and services, and product and resource prices. The study of the individual consumer, firm, or market

Law of Increasing Opportunity Costs

The principle that as the production of a good increases, the opportunity cost of producing an additional unit rises.

Scientific Method

The procedure for the systematic pursuit of knowledge involving the observation of facts and the formulation and testing of hypotheses to obtain theories, principles, and laws.

Economics

The social science concerned with how individuals, institutions, and society make optimal (best) choices under conditions of scarcity.

Utility

The want-satisfying power of a good or service; the satisfaction or pleasure a consumer obtains from the consumption of a good or service (or from the consumption of a collection of goods and services).

Post Hoc Fallacy

You must think very carefully before concluding that because event A precedes event B, A is the cause of B. This kind of faulty reasoning is known as the post hoc, ergo propter hoc, or "after this, therefore because of this," fallacy.

Self-interested behavior

is simply behavior designed to increase personal satisfaction, however it may be derived.

Optimal Allocation

optimal amount of activity occurs when MB=MC MB - Marginal Benefit MC - Marginal Cost