Unit 1 (Nature and Method of Economics): Chapter 1

Question 1

Economics

Answer 1

the study of how society manages its scarce resources

Question 2

scarcity

Answer 2

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

Question 3

Principle #1: People Face Tradeoffs

Answer 3

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

(E.g.: efficiency vs. equity)

Question 4

rational people

Answer 4

systematically and purposefully do the best they can to achieve their objectives, given the opportunities they have.

Question 5

efficiency

Answer 5

society is getting the maximum benefit from its scarce resources

Question 6

equity

Answer 6

benefits from resources are distributed fairly among society’s members

Question 7

Principle #2: The Cost of Something is What you give up to get it

Answer 7

making decisions requires comparing the costs and benefits of alternative courses of action. There is an opportunity cost to everything.

(e.g. lost time)

Question 8

opportunity cost

Answer 8

what you give up to get that item

Question 9

Principle #3: Rational people think at the margin

Answer 9

rational people know that decisions in life are rarely black and white but usually involve shades of grey and make decisions by comparing marginal benefits and marginal costs (margin means small or incremental)

(e.g. airline selling seats for lower prices last minute)

Question 10

marginal changes

Answer 10

small incremental adjustments to an existing plan of action

Question 11

Principle #4: People respond to incentives

Answer 11

People are rational and will try to get the best deal by comparing costs and benefits and thus are affected by incentives.

e.g. if prices go up, people will not buy the product; if prices are lowered, people will buy the product

e.g. if you forget how policy affects incentives then something like this may happen: seat belt law encouraged people to drive faster since they felt safer wearing a seatbelt but unfortunately this made the road less safe for pedestrians

So remember that people will respond to incentives when you make changes otherwise you may not get the intended result.

Think of the demand curve and the negative slope here.

Question 12

Principle #5: Trade can make everyone better off

Answer 12

It is challenging to grow all your own food, make your own clothes and build your own home since the training required and the tools required costs money and time; but you can do some of the work and give that away in exchange for someone else doing something you don’t have the tools or techniques or time to do yourself.

Question 13

Principle #6: markets are usually a good way to organize economic activity

Answer 13

Instead of having a central planner and communism, have the people decide what to charge and pay since it works better. They vote with their money. Then you will only make things that are actually needed and that are selling.

Question 14

market economy

Answer 14

the decisions of a central planner are replaced by the decisions of millions of firms and households

Question 15

Principle #7: Governments can sometimes improve market outcomes

Answer 15

government can help to enforce rules and maintain institutions that allow for a market economy (such as enforcing property rights so that people have a space to sell and make products)

• can promote efficiency and equity

Question 16

property rights

Answer 16

allows an individual to own and control scarce resources

Question 17

market failure

Answer 17

the market on its own fails to produce an efficient allocation of resources

Question 18

externality

Answer 18

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

Question 19

market power

Answer 19

the ability of a single person or firm to unduly influence market prices

Question 20

Principle #8: a country’s standard of living depends on its ability to produce goods and services

Answer 20

almost all variation in living standards is attributable to differences in countries’ productivity

Question 21

productivity

Answer 21

the amount of goods and services produced from each unit of labour input

Question 22

Principle #9: prices rise when the government prints too much money

Answer 22

Inflation (defined as prices rising) causes issues; inflation is caused by a growth in the quantity of money which lowers the value of the money

Question 23

inflation

Answer 23

an increase in the overall level of prices in the economy

Question 24

Principle #10: society faces a short-run tradeoff between inflation and unemployment

Answer 24

When money quantity is increased, higher prices occur over the long run. But short-term it is more complicated.

• increasing the amount of money increases spending and demand for goods and services
• with higher demand over time, firms will raise their prices but they will also increase productivity and hire more workers

So inflation may occur which is not good but this increases employment which is good.

Question 25

business cycle

Answer 25

the irregular and largely unpredictable fluctuations in economic activity as measured by the production of goods and services or the number of people employed