Chapter 1

Question 1

SCARCITY

Answer 1

society has limited resources & therefore cannot produce all the goods and services people wish to have.

–> Each individual in society = cannot attain the highest standard of living to which he or she might aspire

Question 2

ECONOMICS

Answer 2

is the study of how society manages its scarce resources.

–>Economists study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings

Question 3

Economists also study:

Answer 3

► How people interact with one another

For instance, they examine how the multitude of buyers & sellers of a good together determine the price at which the good is sold and the quantity that is sold.

► Economists analyze forces and trends that affect the economy as a whole

–> including the growth in average income, the fraction of the population that cannot find work, and the rate at which prices are rising.

Question 4

ECONOMY

Answer 4

is just a group of people interacting w/ one another as they go about their lives

Question 5

TRADE-OFFS

Answer 5

to get one thing that we like, we usually have to give up another thing we like

Question 6

EFFICIENCY

Answer 6

the property of society getting the most it can from its scarce resources (size of the economic pie)

Question 7

EQUITY

Answer 7

the property of distributing economic prosperity fairly among the members of society (how the pie is divided into individual sizes)

Question 8

OPPORTUNITY COST of an item

Answer 8

what you GIVE UP to get that item

–> When making any decision, decision makers should be aware of the opportunity cost that accompany each possible action

–>An opportunity cost = an opportunity lost

Question 9

RATIONAL PEOPLE

Answer 9

They know that decisions in life = rarely black & white

–> but usually involve shades of grey

Example: when exams roll around, your decision is not between blowing them off or studying 24 hours a day (black-and-white) --> but whether to spend an extra hour reviewing your notes instead of watching TV

Question 10

MARGINAL CHANGES

Answer 10

describes small incremental adjustments to an existing plan of action

–>So marginal changes = adjustments around the edges of what you are doing

► Rational people = often make decisions by comparing marginal benefits & marginal costs 
► Marginal benefit > marginal cost (will prompt them)

Question 11

INCENTIVE

Answer 11

is something (such as the prospect of a punishment or a reward) that includes a person to act

–> b/c rational people make decisions by comparing costs & benefits, they respond to incentives

–>Incentives = crucial to analyzing how markets work.
► A higher price in a market provides an incentive for buyers to consume less & an incentive for sellers to produce more

–>The influence of prices on the behaviour of consumers & producers = crucial for how the market economy allocates scarce resources

Question 12

Trade Can Make Everyone Better Off

Answer 12

Trade between two countries = can make each country better off

–>Trade allows each person to specialize in the activities he or she does best –> whether it is farming, sewing, or home building

–>By trading with others –> people can buy a greater variety of goods & services at lower cost

Question 13

MARKET ECONOMY

Answer 13

an economy that allocates resources through the decentralized decisions of many firms & households as they interact in markets for goods & services

–> Firms decide whom to hire & what to make

–> Households decide which firms to work for & what to buy w/ their incomes

These firms & households interact in the marketplace
–> where prices and self-interest guide their decisions

Question 14

… in a market economy:

Answer 14

no one = looking out for the economic well-being of society as a whole

–> Free markets contain many buyers & sellers of numerous goods & services –> and all of them are interested primarily in their own self-being

–> Yet, despite centralized decision making & self-interested decision makers –> market economies have proven remarkably successful in organizing economic activities to promote overall economic well-being

Question 15

Governments Can Sometimes Improve Market Outcomes

Answer 15

if the invisible hand = so great, why do we need government?

–> The invisible hand can work its magic only if the government enforces the rules & maintains the institutions that are key to a market economy

–>Most important, market economies = need institutions to enforce property rights–so individuals can own & control scarce resources

Question 16

2 reasons why markets need gov’t intervention

Answer 16

1. To promote efficiency
2. To promote equity

–> That is, most policies = aim either to enlarge the economic pie or to change how the pie is divided

Question 17

MARKET FAILURE

Answer 17

a situation in which a market left on its own fails to allocate resources efficiently

–> One possible cause of market failure is externality.

Question 18

EXTERNALITY

Answer 18

the impact of one person’s actions on the well-being of a bystander

Example: Pollution.
–> market left on it’s own may fail to take the cost of others’ health into consideration

Question 19

CAUSES OF MARKET FAILURE

Answer 19

• externality

- market power

Question 20

MARKET POWER

Answer 20

ability of a single person or firm (or a small group) to unduly influence market prices

Example: if there’s only one well, the owner can charge higher prices b/c it is needed and not subjected to any competition.

Question 21

Goal of economic efficiency

Answer 21

Therefore, in the presence of externalities or market power –> well-designed public policy can enhance economic efficiency

Question 22

Goal of equity

Answer 22

Even when the invisible hand = yielding efficient outcomes –> it nonetheless leave disparities.

–>The invisible hand does not ensure that everyone = has sufficient food, decent clothing, and adequate health care

–> This inequality (depending on one’s political philosophy) –> call for gov’t intervention

Question 23

PRODUCTIVITY

Answer 23

the amount of goods and services produce from each unit of labour unit.

–>In most nations where there’s high productivity most enjoy a high standard of living; vice versa.

–> Similarly, the growth rate of a nation’s productivity determines the growth rate of its average income

If productivity = the primary determination of living standards –> other explanations must be of secondary explanations

Question 24

INFLATION

Answer 24

an increase in the overall level of prices in the economy

–> This particular example = highlights the problem of hyperinflation when prices are increasing at a rate of more than 50% a month.

Question 25

What causes inflatation?

Answer 25

(in large or persistent inflation) growth in the quantity of money.

–> When a gov’t = creates large quantities of the nation’s money –> the value of the money falls

Question 26

Society Faces a Short-Run Trade-off between Inflation and Unemployment

Answer 26

Although a higher level of prices is, in the long run, the primarily effect of increasing the quantity of money –> the short-run story is more complex & more controversial

–> this line of reasoning = leads to one final economy-wide trade-off: a short-run trade-off between inflation & unemployment.

Most accept that society = faces a short-run trade-off between inflation and unemployment

• This simply means that, over a period of a year or two
• -> many economic policies = push inflation and unemployment in opposite directions
• Policymakers face this trade-off regardless of whether inflation & unemployment = both start out at high levels or somewhere in between.
• This short-run trade-off plays a key role in the analysis of the business cycle

Question 27

BUSINESS CYCLE

Answer 27

the irregular & largely unpredictable fluctuations in economic activity –> as measured by the production of goods & services or the # of people employed

–>Policymakers can exploit the short-run trade-off between inflation & unemployment –> using various policy instruments