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Economics summary Chapter 1-3
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Chapter 1 Limits, Alternatives and ChoicesThe economic perspective
Scarcity and choice
Scare economic resources mean limited goods and services (scarcity means shortage). Opportunity costs: to obtain
more of one thing, society forgoes the opportunity costs of the choice. Another definition: The loss of potential gain
from other alternatives when one alternative is chosen.
Purposeful behavior
Individuals look for and pursue opportunities to increase their utility (beneficial/profitable). Purposeful behavior
simply means that people make decisions with some desired outcome in mind. Rational self-interest is not the same
as selfishness. In the economy, increasing one’s own wage, rent, interest or profit normally requires identifying and
satisfying somebody else’s wants. Self- interested behavior is simply behavior designed to increase personal
satisfaction, however it may be derived (obtain something from a specifying source).
Marginal analysis comparing benefits and costs
The economic perspective focuses largely on marginal analysis. To economists marginal means extra or additional.
Each option involves marginal benefits and because of scarce resources, marginal costs. If the marginal benefit
exceeds its marginal costs (if you could afford it) buy the product e.g. a diamond ring. If the marginal cost is more
than the marginal benefit, you should buy smaller diamond ring or not even if you could afford it. In a world of
scarcity, the decision to obtain the marginal benefit associated with some specific option always includes the
marginal cost of forgoing something else.
Theories, principles and models
Economics relies on the scientific method, that procedure consists of several elements:
Observing real-world behavior and outcomes
Based on those observations, formulating a possible explanation of cause and effect
Testing this explanation by comparing the outcomes of specific event 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. A very well tested and widely accepted theory is referred to as an economic law or an
economic principle.
Economic principles and models are highly useful in analysing economic behaviour and understanding how the
economy operates. They are the tools for ascertaining cause and effect or action and outcome within the economic
system.
Generalizations: Economic principles are generalizations relating to economic behaviour or to the economy itself.
Economic principles are expressed as the tendencies of typical or average consumers, workers or business firms.
Other-things-equal assumption: The assumption that factors other than those being considered do not change. They
assume that all variables except those under immediate consideration are held constant for a particular analysis.
Graphical expression: Many economic models are expressed graphically.
Microeconomics & macroeconomics
Microeconomics is the part of economics concerned with decision-making by individuals. This could be workers,
customer’s households and so on. With microeconomics we measure the price of a specific product, the amount of
employees working in the firm, the revenue or income etc. In microeconomics, the sand, shells and rocks are
examined not the beach.
Macroeconomics looks at the economy as a whole or its major aggregates (A whole formed by combining several
(typically disparate) elements)
Positive and normative economics
Both economics contains positive and normative elements. Positive economics focuses on the cause and effect
relationships positive economics deals with facts (figures). Normative economics, which incorporate value judgment
about how the economy should be like or what particular policy actions should be recommended to achieve a
desirable goal.
,Individual’s economizing problem
The fundamental issue that arises for a society out of the relative scarcity of goods and services compared to
the demand for them by consumers. Solving the economizing problem for
a business involves making decisions about how best to allocate resources to those demanding them given
the company's objectives.
Limited income
Our income comes to us in the form of wages, interests, rent and profit, although we may also receive money from
government programs or family members.
Unlimited income
It depends on each person what they would like, some aim just for the basic needs and wants while others wants be
more luxurious.
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. Society therefore must decide what to
produce and what to forgo.
Budget line
A budget line is a schedule or curve that shows various combinations or two products a consumer can purchase with
a specific money income.
, Society’s economizing problem
Scare resources society has limited or scare resources, meaning all natural, human and manufactured resources that
go into the production of goods and services. Economic resources are also known as factors of production or inputs.
Four main resource categories:
1. Land
2. Labour
3. Capital
4. Entrepreneur ability
Production and possibility model
Society uses its scare resources to produce goods and services. The alternatives and choices it faces can be best
understood through a macroeconomic model of production possibilities.
Full employment: the economy is employing all of its available resources.
Fixed resources the quantity and quality of the factors of production are fixed.
Fixed technology: The state of technology is constant
Two goods: The economy is producing only goods. Consumer goods, products that satisfy our wants
directly. Satisfying our wants indirectly by making possible more efficient production of consumer goods
symbolizes capital goods.
Production possibilities tables illustrate society’s economizing problem. 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. 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.
Optimal allocation
Economic decisions center on comparisons of marginal benefit (MB) and marginal costs (MC) any economic
activity should be expanded as long as marginal benefit exceeds marginal cost and should be reduced if marginal
cost exceeds marginal benefit. The optimal amount of the activity occurs where MB= MC. Society needs to make a
similar assessment about its production decision.
The optimal 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 equals the marginal cost. Over time,
technological advances and increases in the quantity and quality of resources enable to the economy to produce
more of all goods and services, that is, to experience economic growth. Society’s choices 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.
Chapter 2 the market system and the circular flow
Command system
A system where the government, rather than the free market, determines what goods should be produced, how much
should be produced and the price at which the goods will be offered for sale. The command economy is a key
feature of any communist society. China, Cuba, North Korea and the former Soviet Union are examples of countries
that have command economies.
Market system
An economic system in which economic decisions and the pricing of goods and services are guided solely by the
aggregate interactions of a country's citizens and businesses and there is little government intervention or central
planning. This is the opposite of a centrally planned economy, in which government decisions drive most aspects of
a country's economic activity.
Characteristics of the market system
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