Microeconomics Chapters 1 and 2

Economy
a system for coordinating society’s productive activities
is responsible to create the goods and services and deliver them to the people they want to; the extent to which this occurs determines the success of the economic practices

Economics
the study of economies, at the level both of individuals and of society as a whole
focuses on the success of economies to provide the goods and services that the people demand

Market Economy
an economy in which decisions about production and consumption are made by individual producers and consumers
decentralized control, which allows for the individual consumer and the firms to make their own economic choices
this is what the U.S. has

Command Economy
an economy in which their is a central authority making decisions about production and consumption
famous for long lines at shops
occurred in Soviet Union
consumers and producers face scarcity (not enough resources to produce what they needed to, not enough demand, hard to gain access to goods)

Invisible Hand
refers to the way in which the individual pursuit of self interest can lead to good results for society as a whole
idea originated in “The Wealth of Nations” by Adam Smith
America’s market economy wouldn’t be successful without this occurring, as there would be no group/community unity

Microeconomics
the branch of economics that studies how people make decisions and how these decisions interact
focuses on the validity of the invisible hand, and how individuals pursuing their own interests often do promote the interests of society as a whole

Market Failure
occurs when the individual pursuit of self-interest leads to bad results for society as a whole
economic analysis can be used to diagnose cases of market failure and devise solutions to these problems
example: air and water pollution
three principle reasons:
-individual actions have side effects that are not properly taken into account by market
-one party prevents mutually beneficial trades from occurring in attempt to capture a greater share of resources for itself
-some goods, by nature, are unsuited for efficient management by markets

Recession
a downturn in the economy
the economy does not always run smoothly, it experiences fluctuations
U.S. economy experienced this in 2001

Macroeconomics
the branch of economics that is concerned with overall ups and downs in the economy
main concern = recessions
in this branch, economics explain recessions and how government policies can be used to minimize the damage of economic fluctuation

Economic Growth
the growing ability of the economy to produce goods and services
prompts central questions in the study of economics – why does the economy grow over time? why does economic growth occur faster in some locations and times than others?
this process is a good thing, benefits the people

Individual Choice
the decision by an individual of what to do, which necessarily involves a decision of what not to do
every question in economics at the most basic level involves this
all economic activities involve this
four basic principles:
-resources are scarce
-the real cost of something is what you must give up to get it
-“how much” is a decision at the margin
-people usually exploit opportunities to make themselves better off

Resource
anything that can be used to produce something else
land, labor, capital (machinery, buildings, man made productive assets), human capital
scarcity of these things require individuals to make choices and effect the economy

Scarcity
the quantity of available resources isn’t large enough to satisfy all productive users
natural resources that come from the physical environment, human resources (labor, skill, intelligence), clean air and water
it is the basic problem of economics – forces people/communities to make decisions and choices

Opportunity Cost
the real cost of an item: what you must give up in order to get it
central to the study of economics as it includes ALL COSTS and helps economists to understand individual choice

Trade Off
when you compare the costs with the benefits of doing something
central to economics due to the fact that the scarcity of resources (time) require you to make decisions which result in opportunity costs as well as benefits

Marginal Decisions
decisions about whether to do a bit more or a bit less of an activity
important to economics as it answered the questions of what to do with your next hour or what to do with your next dollar

Marginal Analysis
the study of decisions about whether to do a little more or a little less of an activity
plays a central role in economics because it is the key to deciding “how much” of an activity to do

Incentives
anything that offers rewards to people who change their behavior
economists are skeptical of any attempt to change people’s behavior that doesn’t change their incentives
in an economic situation, individuals will exploit opportunities to make themselves better off (basis of all predictions by economists about individual behavior)

Interaction of Choices
my choices affect your choices, and vice versa
a feature of most economic situations
results of this interactions are often quite different from what the individuals intend
in a market economy, there is no head coordinator so the decisions are left to the individuals, but each individual’s choices depend not the choices made by other people
1. there are gains from trade
2. markets move towards equilibrium
3. resources should be used as efficiently as possible to achieve society’s goals
4. markets usually lead to efficiency
5. when market’s don’t achieve efficiency, government intervention can improve society’s welfare

Trade
individuals in a market economy provide goods and services to others and receive goods and services in return
important to economic because it offers many gains (two people can get more of what they want than they could each produce themselves

Gains from Trade
people get more of what they want through trade than they could i they tried to be self-sufficient
market economy is based on trade and the fact that it benefits and connects each member of the population in a more sufficient, specialized way

Specialization
causes an increase in output due to the fact that each person specializes in the task he or she is good at performing
the economy, as a whole, can produce more when each person specializes in a task and trades with others

Equilibrium
an economic situation in which no individual would be better off doing something different
markets reach this state through changes in prices (rise and fall until no opportunities for individuals to make themselves better off remain)
central to the practice of economics because it allows us to depend on markets because they work in a predictable way towards equilibrium (can trust markets to supply us with the essentials of life)

Efficiency
when an economy takes all opportunities to make some people better off without making other people worse off
when resources are used in a way that has fully exploited all opportunities to make everyone better off
this time of economy enables enables maximum gains from trade possible given the resources available because there is no way to rearrange resource use to make everyone better off

Equity
means that everyone gets his or her fair share
involves a tradeoff with efficiency (policies that promote this term often come at a cost of decreased efficiency in the economy, and vice versa)
example – parking spots dedicated for the disabled (allow disabled to live a fairer life by not having to work so far because they physically can’t, but hardly are enough disabled people to fill all spots dedicated for them, so some spots go unused)
economists try to use the economy’s resources as efficiently as possible in the pursuit of society’s goals, specifically with this concept in mind

Model
any simplified representation of reality that is used to better understand real-life situations
allow economists to focus on only one change at a time (allow us to hold everything else constant and study how one change affects the overall economic outcome)

Other Things Equal Assumption
means that all other relevant factors remain unchanged
important in an economic model because it allows economists to focus on the effects of only one change at a time

Production Possibility Frontier
illustrates the trade offs facing an economy that produces only two goods
shows the maximum quantity of one good that can be produced for any given quantity produced of the other
if a production point lies inside or on the frontier, it is feasible
if a production point lies outside the frontier, it isn’t feasible
allows us to simplify reality in order to understand some aspects of the real economy better – a good way to illustrate efficiency (no missed opportunities, no one can be better off without making someone else worse off), opportunity cost (true cost of a good is not just the amount of money it costs to buy it, but everything in addition to money that must be given up), and economic growth (growing ability to produce goods and services, outward shift of frontier)

Comparative Advantage
an individual has this advantage in producing a good or service if the opportunity cost of producing the good is lower for that individual than for other people
simplified model, but illustrates that their are gains from trade (both sides can be better off by choosing to specialize in something) and that as long as people have different opportunity costs, everyone has this advantage and this disadvantage in something

Absolute Advantage
in individual has this advantage in an activity if he or she can do it better than other people
can produce more output with a given amount of input (resources, often time)
signifies who can produce more, but doesn’t allow individuals to flourish through trade and gain even more products through cooperation (there are still gains from trade even if one individual has this advantage in both products)

Barter
simplest economic transactions in which an individual directly trades a good or service he or she has for a good or service he or she wants
rare in modern economy – today people trade goods or services for money and then trade money for other goods and services they want

Circular-Flow Diagram
a model that represents the transactions in an economy by flows around a circle
has a flow of physical things (goods, services, labor, raw materials) in one direction and flow of money that pays for these things in the other direction
however, only a model – distinction between firms and households isn’t always clear cut, many of sales firms make are not to households but to other firms, figure doesn’t show government (diverts money from flow in form of taxes)

Household
a person or a group of people that share their income
could be, but isn’t necessarily, a family
important to the economy because they work for the firm that produces goods and services for sale

Firm
an organization that produces goods and services for sale
important to economy because they employ members of households to make goods and services more efficiently for sale

Markets for Goods and Services
firms sell goods and services that they produce to households
flow of goods and services to households and flow of money to firms in return
mutually beneficial relationship that is important to economics

Factor Markets
firms buy the resources they need to produce
by doing so, the firm gives money to the households, which help produce more goods and services that are then sold to the households for money
example – labor market, members of the households working for firms are paid for their time

Factor of Production
a resource used to produce goods and services
labor (work of human beings), land (resource supplied by nature), capital (“created” resources – machines, buildings), human capital (educational achievements and skills of labor force
central to economics because these provide the necessary tools to create goods and services for firms to sell to households in return for money

Positive Economics
the branch of economic analysis that describes the way the economy actually works
definite right and wrong answers
models play crucial role
examples – how much revenue will the tolls on the state turnpike yield next year? how much would that revenue increase if the toll were raised from $1 to $1.50?

Normative Economics
the branch of economic analysis that makes prescriptions about the way the economy should work
attempt to find the “right” answer, in which it sometimes might be a matter of opinion but economists choose the option that makes some people better off without making other people worse off

Forecast
a simple prediction of the future
a major aspect of positive economics, in which economists use models to describe the way the economy really works and make predictions