Principles of Economics Chapter 2 Flashcards
The Economic Problem: Scarcity and Choice
The Three Basic Questions
Every society has some system or process that transforms its scarce resources into useful goods and services. In doing so, it must decide what gets produced, how it is produced, and to whom it is distributed.
primary resources
land, labor, and capital
capital
Things that are produced and then used in the production of other goods and services.
factors of production (or factors)
The inputs into the process of production. Another term for resources.
production
The process that transforms scarce resources into useful goods and services.
inputs or resources
Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants.
outputs
Goods and services of value to households.
Scarcity and Choice in a One-Person Economy
Nearly all the same basic decisions that characterize complex economies must also be made in a simple economy.
opportunity cost
The best alternative that we give up, or forgo, when we
make a choice or decision.
theory of comparative advantage
Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that may be “absolutely” more efficient producers.
absolute advantage
A producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources (a lower absolute cost per unit).
comparative advantage
A producer has a comparative advantage over another in the production of a good or service if he or she can produce that product at a lower opportunity cost.
consumer goods
Goods produced for present consumption.
investment
The process of using resources to produce new capital.
production possibility frontier (ppf)
A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.
marginal rate of transformation (MRT)
The slope of the production possibility frontier (ppf).
Unemployment
During economic downturns or recessions, industrial plants run at less than their total capacity. When there is unemployment of labor and capital, we are not producing all that we can.
Inefficiency
Waste and mismanagement are the results of a firm operating below its potential.
Sometimes inefficiency results from mismanagement of the economy instead of mismanagement of individual private firms.
To be efficient,
an economy must produce what people want.
economic growth
An increase in the total output of an economy. Growth occurs when a society acquires new resources or when it learns to produce more using existing resources.
command economy
An economy in which a central government either directly or indirectly sets output targets, incomes, and prices.
laissez-faire economy
Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.
The behavior of buyers and sellers in a laissez-faire economy determines what gets produced, how it is produced, and who gets it.
market
The institution through which buyers and sellers interact and engage in exchange.
Some markets are simple and others are complex, but they all involve buyers and sellers engaging in exchange.
consumer sovereignty
The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).
free enterprise
The freedom of individuals to start and operate private businesses in search of profits.
Income
is the amount that a household earns each year. It comes in a number of forms: wages, salaries, interest, and the like.
Wealth
is the amount that households have accumulated out of past income through saving or inheritance.
Price Theory
In a free market system, the basic economic questions are answered without the help of a central government plan or directives. This is what the “free” in free market means—the system is left to operate on its own with no outside interference. Individuals pursuing their own self-interest will go into business and produce the products and services that people want. Other individuals will decide whether to acquire skills; whether to work; and whether to buy, sell, invest, or save the income that they earn. The basic coordinating mechanism is price.
Mixed Systems, Markets, and Governments
The differences between command economies and laissez-faire economies in their pure forms are enormous. In fact, these pure forms do not exist in the world; all real systems are in some sense “mixed.”
