Macroeconomics Chapter 1

describe the five steps by which economists arrive at a useful economic model

In arriving at a useful economic model, these five steps are followed: (1) decide the assumptions to be used; (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; and (5) retain the revised model to help answer similar economic questions in the future.

what is the difference between productive efficiency and allocative efficiency?

Productive efficiency occurs when a good or service is produced at the lowest possible cost. Allocative efficiency means that what is produced reflects consumer preferences—every good or service is produced up to the point at which the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

society's economic problem

Trade-offs force society to make choices when answering the following three fundamental questions: 1. what goods and services will be produced? 2. how will the goods and services be produced? 3. who will receive the goods and services produced?

market

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

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

positive analysis

analysis concerned with what is

normative analysis

analysis concerned with what ought to be

economic variable

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

equity

the fair distribution of economic benefits

opportunity cost

the highest valued alternative that must be given up to engage in an activity

trade-off

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

microeconomics

the study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices

discuss; optimal decisions are made at the margin

"Optimal decisions are made at the margin" means that most decisions are not "all or nothing" but involve doing a little more or a little less of an activity. Therefore, the optimal decision is to continue any activity up to the point where the marginal benefit equals the marginal cost.

discuss; people are rational

"People are rational" is the assumption that decision makers explicitly or implicitly weigh the benefits and costs of each action and then choose an action only if the benefits are expected to outweigh the costs.

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

centrally planned economies have been less efficient than market economies. has this happened by chance, or is there some underlying reason?

a. It is doubtful that centrally planned economies have been less efficient purely by chance. The underlying reason seems to be that centrally planned economies don't provide as strong incentives for hard work and innovation as market economies do. In addition, the people running centrally planned economies cannot make the most efficient decisions because they don't have the information that all the decentralized decision makers possess in a market economy. b. You might still prefer having a centrally planned economy if you considered it to be more equitable. (Also, you might prefer a centrally planned economy if you were in charge.).

discuss; people respond to incentives

"People respond to incentives" by changing their behavior in response to an economic incentive. For example, if health insurance reduces an individual's medical costs from being obese, it may give people an incentive to gain weight.

three key economic ideas

1. people are rational 2. people respond to economic incentives 3. optimal decisions are made at the margin

discuss the difference between microeconomics and macroeconomics

Microeconomics is the study of how households and firms make choices, how they interact in specific markets, and how the government influences their choices. "Micro" means small, and microeconomics deals with individual decision makers. Macroeconomics is the study of the economy as a whole. "Macro" means large, and macroeconomics deals with economy-wide outcomes, such as the inflation rate, the unemployment rate, and the economic growth rate.

what is the difference between normative analysis and positive analysis? is economics concerned mainly with normative or positive analysis? explain

Positive economic analysis concerns what is; that is, it deals with how the economy actually behaves. Normative economic analysis concerns what ought to be. Economics is mainly concerned with positive analysis—conceptualizing and measuring the costs and benefits of different courses of action. Decision makers (including voters and government officials) can use the trade-offs and costs and benefits identified by positive economic analysis in normatively deciding what course of action they should take.

what is scarcity and why is it central to the study of economics?

Scarcity is the situation in which unlimited wants exceed the limited resources available to fulfill those wants. Economics is the study of the choices consumers, business managers, and government officials make to attain their goals. Scarcity is central to economics because scarcity requires people to make choices about how to use their resources to best fulfill their wants. In making choices we must give up other opportunities that we value. What we give up (our second-best choice) is called the opportunity cost of our choice.

what are the three economic questions that all societies must answer? discuss the differences in how the centrally planned, market, and mixed economic systems answer these questions.

The three economic questions that every society must answer are: (1) What goods and services will be produced? (2) How will the goods and services be produced? (3) Who will receive the goods and services? In a centrally planned economy, the government makes most of these decisions. In a pure market economy, almost all of these decisions are made by the decentralized interaction of households and firms in markets. In a mixed economy, most economic decisions result from the interaction of buyers and sellers in markets, but government may play a significant role in the allocation of resources.

economic model

a simplified version of reality used to analyze real world economic situations

productive efficiency

a situation in which a good or service is produced at the lowest possible cost

allocative efficiency

a state of the economy in which 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

marginal analysis

analysis that involves comparing marginal benefits and marginal costs

economics

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

macroeconomics

the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth