Microeconomics Chapter 1: The Art and Science of Economic Analysis – Flashcards

the problem is that, although your wants, desires, are virtually unlimited, the resources available to satisfy these wants are scarce - Economics examines how people use their scarce resources to satisfy their unlimited wants 1. Resources 2. Goods and Services 3. Economic Decision Makers 4. A Simple Circular-Flow Model

inputs, or factors of production, used to produce the goods and services that people want a) Labor b) Capital c) Natural Resources d. Entrepreneurial Ability - goods and services are scarce because resources are scarce

human effort, both physical and mental

includes all human creations used to produce goods and services a) Physical Capital = factories, tools, machines, computers, buildings b) Human Capital = knowledge and skill people acquire to increase their productivity

include all gifts of nature (bodies of water, trees, oil reserves, minerals, even animals) a) Renewable Resource = can be drawn on indefinitely if used conservatively (fish, livestock, forests, rivers, groundwater, grasslands, and soil) b) Exhaustible Resource = does not renew itself and so is available in a limited amount (oil or coal - once burned, each barrel of oil or ton of coal is gone forever)

talent required to dream up a new product or find a better way to produce an existing one

is a profit-seeking decision maker who starts with an idea, organizes an enterprise to bring that idea to life, and then assumes the risk of operation - pays resource owners for the opportunity to employ their resources in the firm

payment from an entrepreneur to resource owners for their labor

payment from an entrepreneur to resource owners for the use of their capital

payment from an entrepreneur to resource owners for the use of their natural resources

reward for entrepreneurial ability; sales revenue minus resource cost - entrepreneurs benefit from what is left over after paying other resource suppliers

a) Good = a tangible product used to satisfy human wants (ex: corn, clothes, food, chairs, books) b) Service = an activity, or intangible product, used to satisfy human wants (ex: performance of the Fifth Symphony, lectures, movies, concerts, phone service, wireless connections, yoga lessons, dry cleaning, haircuts) *A good or service is scarce if the amount people desire exceeds the amount available at a zero price

occurs when the amount people desire exceeds the amount available at a zero price - passing up some goods and services or choosing among options because you cannot have everything - without scarcity, there would be no economic problem and no need for prices

Four Types of Decision Makers a. Households (starring role) - As consumers, households demand goods and services produced - As resource owners, households supply labor, capital, natural resources, and entrepreneurial ability to firms, governments, and the rest of the world b. Firms c. Governments d. The Rest of the World (foreign households, foreign firms, and foreign governments that supply resources and products to U.S. markets and demand resources and product from U.S. markets *All three demand the resources that households supply and then use these resources to supply the goods and services that households demand

a set of arrangements by which buyers and sellers carry out exchange at mutually agreeable terms - buyers and sellers carry out exchange - markets determine price, quantity, and quality

a market in which a good or service is bought and sold

a market in which a resource is bought and sold - labor market is the most important resource market

Circular-Flow Model = a diagram that traces the flow of resources, products, income, and revenue among economic decision makers - between households and firms a) Households = SUPPLY labor, capital, natural resources, and entrepreneurial ability to firms through resource markets; DEMAND goods and services from firms through product markets b) Firms = DEMAND labor, capital, natural resources, and entrepreneurial ability from households through resource markets; they also SUPPLY goods and services to households through product markets *What Goes Around Comes Around a) resources and products flow in one direction, such as resources, goods and services, products, labor, capital, natural resources, entrepreneurial ability (counterclockwise) b) the corresponding payments flow in the other direction such as revenue, income, expenditure, wages, interest, rent, profit (clockwise)

1. Rational Self-Interest 2. Choices Requires Time and Information 3. Economic Analysis is Marginal Analysis 4. Microeconomics and Macroeconomics

means that each individual tries to maximize the expected benefit achieved with a given cost or to minimize the expected cost of achieving a given benefit - self-interest includes the welfare of our family, our friends, and perhaps the poor of the world (the lower the personal cost of helping others, the more help we offer)

time and info are scarce and therefore valuable - rational decision makers continue to acquire info as long as the additional benefit expected from that info exceeds the additional cost of gathering it

Marginal = incremental, additional, or extra - a change in an economic variable, a change in the status quo can involve a major economic adjustment - rational decision makers change the status quo if the expected marginal benefit from the change exceeds the expected marginal cost ex: you compare the marginal benefit you expected from eating dessert (the additional pleasure or satisfaction) with its marginal cost (the additional money,time, and calories)

a) Microeconomics = study of your economic behavior and the economic behavior of others who make choices about such matters as how much to study and how much to party, how much to borrow and how much to save, what to buy and what to sell - examines individual economic choices - how markets coordinate the choices of various decision makers - explains how price and quantity are determined in individual markets b) Macroeconomics = studies the performance of the economy as a whole - puts all the pieces together to focus on the big picture - sees the forest not the trees; the beach not the grains of sand

are the rise and fall of economic activity relative to the long-term growth trend of the economy; also called business cycles (vary in length and intensity, but usually involve the entire nation and often other nations too)

- the art of economic analysis focuses on how people use their scarce resources in an attempt to satisfy their unlimited wants - rational self-interest guides individual choice - choice requires time and info and involves a comparison of the expected marginal benefit and the expected marginal cost of alternative actions - microeconomics looks at the individual pieces of the economic puzzle; macroeconomics fits the pieces together to form the big picture

1) The Role of Theory 2) The Scientific Method 3) The Normative Versus Positive 4) Economists Tell Stories 5) Predicting Average Behavior 6) Some Pitfalls of Faulty Economic Analysis

a simplification of reality used to make predictions about cause and effect in the real world - captures the important elements of the problem - the world is so complex that we must use theories to simplify it to make sense of things

people who think a theory provides little aid in practical matters use a different theory that they believe in

Step One: Identify the Question and Define Relevant Variables Step Two: Specify Assumptions Step Three: Formulate a Hypothesis Step Four: Test the Hypothesis

*Variable = a measure that can take on different values at different times

*Other-Things-Constant Assumption = the assumption, when focusing on the relation among key economic variables, that other variables remain unchanged *Behavioral Assumptions = an assumption that describes the expected behavior of economic decision makers, what motivates them (primary behavioral assumption is rational self-interest)

*Hypothesis = a theory or prediction about how key variables relate ex: if the price of Pepsi goes up, other things constant, then the quantity purchased declines

by comparing its predictions with evidence, we test the validity of a hypothesis - test leads to either: a) reject the hypothesis or theory if it predicts worse than the best alternative b) use the hypothesis until a better one comes along

a) Positive Economic Statement = a statement that can be proved or disproved by reference to facts (what IS) - theories are expressed as positive statements b) Normative Economic Statement = a statement that reflects an opinion, which cannot be proved or disproved by reference to the facts (what SHOULD BE)

economists rely on case studies, anecdotes, parables, the personal experience of the listener, and supporting data

goal of an economic theory is to predict the impact of an economic event on economic choices and, in turn, the effect of these choices on particular markets or on the economy as a whole - the random actions of individuals tend to offset one another, so the average behavior of a large group can be predicted more accurately than the behavior of a particular individual

a) The Fallacy That Association is Causation b) The Fallacy of Composition c) The Mistake of Ignoring the Secondary Effects

to assume that A caused event B simply because the two are associated in time (a common error) --> association is not necessarily causation ex: 100% of people who breathe die (but air is obviously not the cause), but 100% of people who do not breathe die as well

the incorrect belief that what is true for the individual, or part, must necessarily be true for the group, or the whole ex: arriving early to buy game tickets does not work if many have the same idea

unintended consequences or secondary effects of economic actions that may develop slowly over time as people react to events - secondary effects can turn out to be more important than the primary effects ex: creating safety caps in pills for babies not to open them, yet elder people weren't able to open them as well

Economics is the only social science and the only business discipline for which the prestigious Nobel Prize is awarded - models usually do a better job of marketing economic sense out of a confusing world than do alternative approaches HOWEVER - not all doctors are healthy, not all carpenters live in perfectly built homes, not all marriage counselors are happily married