CH 1 and 2 - Ten Principles of Economics

Question 1

what is economics

Answer 1

study of how scarce resources are allocated among alternative uses to satisfy human wants

Question 2

How is the value of things on the market determined

Answer 2

their price and scarcity

Question 3

what is macroeconomics

Answer 3

Studies the structure, operation and performance of the economy as a whole (business cycles, total output of G&S, unemployment and inflation, etc.)
-> deals with major economic issues of the day (how to make the eco better

Question 4

rationality and what it affects

Answer 4

Economists normally assume that people are rational. Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities (choices are constrained by limited resources – income, time).
=> This rationality / maximizing behaviour impacts the 3 main allocation decisions: which goods to produce, how to produce them, and who gets the goods that are produced.

Question 5

trade-off between efficiency and equity

Answer 5

-> often conflict
– Efficiency can be thought as getting the most from scarce resources (making pie as big as possible) -> we can measure it
– Equity can be thought of as sharing resources fairly (who gets to eat the pie) -> we cannot measure it, subjective

Question 6

Opportunity cost

Answer 6

The opportunity cost of an item is what you give up to get that item, true cost of any trade-off. When making any decision, decision makers should be aware of the opportunity costs that accompany each possible action -> everything has a price (material cost + time).

Question 7

marginal changes

Answer 7

small incremental adjustments to an existing plan of action. “margin” means “edge,” so marginal changes are adjustments around the edges of what you are doing. Rational people often make decisions by comparing marginal benefits and marginal costs.

Question 8

marginal decision making

Answer 8

a person’s willingness to pay for a good is based on the marginal benefit that an extra/additional unit of the good will yield. The marginal benefit, in turn, depends on how many units a person already has (does not take into account fixed costs which are often sunk costs)

Question 9

Incentive

Answer 9

something (such as the prospect of a punishment or a reward) that induces a person to act. Because rational people make decisions by comparing costs and benefits, they respond to incentives. Usually, it is the price.

Question 10

market economy

Answer 10

Allocates resources through the free, decentralized and self-interested decisions of buyers and sellers as they interact in markets to determine market prices. The decisions of a central planner are replaced by the decisions of millions of firms and households

Question 11

The invisible hand

Answer 11

-> Adam Smith
-> Households and firms interacting in markets act as if they are guided by an “invisible hand” that leads them to desirable market outcomes. Prices are the instrument with which the invisible hand directs economic activity. In any market, buyers look at the price when determining how much to demand, and sellers look at the price when deciding how much to supply. As a result of the decisions that buyers and sellers make, market prices reflect both the value of a good to society and the cost to society of making the good.

Question 12

purpose of government even with the invisible hand

Answer 12

Invisible hand can work its magic only if the government enforces the rules and maintains the institutions that are key to a market economy. Most importantly, market economies need institutions to enforce property rights (policing, courts) so individuals can own and control scarce resources.
If there are no propriety rights, people are less inclined to work, produced, invest, or purchase because the risk is high that their propriety will be taken from them.

Question 13

purpose of the government - what it promotes

Answer 13

• efficiency : sometimes market fails to lead markets to allocate resources to maximize the size of the economic pie (market failure - externalities)
• equity : change how pie is divided, disparities in economic well-being, not everyone

Question 14

average income

Answer 14

total value of all the goods and services produced in a country divided by population.
There is a large variation in average income around the word that is reflected in various measures of the quality of life. Higher average income = higher standard of life

Question 15

what do a country’s standard of living depend on

Answer 15

productivity (GDP)

Question 16

inflation and cause

Answer 16

a general increase in prices and fall in the purchasing value of money = second measure of macroeconomic performance
growth in the quantity of money that is faster than the rate of growth in the quantity of goods and services being produced (printing too much money)

Question 17

scientific method

Answer 17

interplay between theory and observation/evidence to draw conclusion, however, unlike other sciences, conducting experiments is often impractical => Economists studying inflation are not allowed to manipulate a nation’s monetary policy simply to generate useful data.

Instead -> economists pay close attention to the natural experiments offered by history

Question 18

positive vs normative statements

Answer 18

– Positive statements are descriptive. They make a claim about how the world is.
– Normative statements are prescriptive. They make a claim about how the world ought to be, they are opinions (involves views on ethics, religion, and political philosophy)

Question 19

why economists disagree

Answer 19

1 - validity of alternative positive theories about how the world works
2 - different values (ex.taxing the rich)
3 - multiple ways to achieve a single goal