Chapter 1 - Introduction to Economics

Question 1

Market Economy

Answer 1

decisions about production and consumption are
made by firms and households: price system, markets and incentives determine
what, how and for whom to produce.

Question 2

Planned Economy

Answer 2

The state makes the decisions about the production and the
distribution of goods. Moreover, the state owns the majority of the means of
production and determines the allocation of existing resources for the
production of goods and services.

Question 3

Mixed Economy

Answer 3

Today no society can be completely assigned to one of both
categories. Rather there are mixed economies à answers given by firms,
households and the state.

Question 4

Effieciency vs Equity

Answer 4

Efficiency: Society gets the most that it can from its scarce resources. (“the
size of the cake”)
Equity: The property of distributing economic prosperity (economic well-
being) fairly among the members of society. (“how the cake is divided”)

Question 5

Trade Offs

Answer 5

Making decisions requires trading off one goal against another.

Question 6

Opportunity Cost

Answer 6

The opportunity cost of an item is what you give up to obtain that
item; the value of the benefits foregone

Question 7

Neoclassical microeconomics

Answer 7

(mainstream economics) assumes that humans
are rational and maximize their individual self-interest

Question 8

Behavioral economics

Answer 8

-considers psychological aspects
-doesn’t assume that humans are always rational
-Concept of bounded rationality
* Individuals do not always have all the information to make a
rational decision or do not always have all the tools and abilities
to do an economic calculation.
* Satisficing behavior: after defining a satisfactory result level,
choose an option that meets this level (not all options are
evaluated).
* Improving behavior: individuals try to improve the result
compared to the choice made previously.

Question 9

Market Economy

Answer 9

Adam Smith demonstrated that in a market economy characterized by
competition, the interaction of individuals and businesses leads to
maximizing the well-being of society (the invisible hand).

Question 10

Market failure may be caused by

Answer 10

• an externality, which is the impact of one person or firm’s
  actions on the well-being of a bystander (air pollution, …)
• market power, which is the ability of a single person or firm to
  unduly influence market prices.

Question 11

Positive vs. Normative Statements

Answer 11

-Normative statements deal with ethical concepts and value judgments
-Positive statements describe the facts of an economy and its behavior. How does
unemployment develop, and which objective reasons can explain the developments?