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Chapter 1

Microeconomics

TermDefinition
Individual Choice decision by an individual of what to do, which necessarily involves a decision of what not to do
Microeconomics understanding how individuals make choices (which makes it different from Macroeconomics)
4 Basic Principles behind individual choices 1. Resources are scarce 2. The "real" cost of something is what you must give up to get it 3. "How much?" is a decision at the margin 4. People usually take advantage of opportunities to make themselves better off
Resource anything that can be used to produce something else ex: land, labor, capital
Scarcity Resources are scarce/ quantity available isn't large enough to satisfy all productive uses/ foundation principle of economics ex: petroleum, lumber, intelligence - CHOICES ARE NECESSARY BC RESOURCES ARE SCARCE
Trade-offs Scarcity requires trade-offs/ you might be able to get more of something but only by giving up something else/ make trade-off when you must give something up in order to get something else/ compare costs and benefits
Thomas Malthus early scientist-studied population theory slightly before Darwin/ wrote Essays on Principle of Population (1798)
Essays on the Principle of Population (1798) Observed that plants & animals produce far more offspring than can survive/humans are also capable of over-producing if left unchecked/ingenuity & compassion for each other also seems to have superseded the ability of natural selection to control pop.
Malthus' Conclusion unless population is regulated, famine and poverty could become globally epidemic, the human species could self-destruct
Ecological economics relatively new branch of economics that seeks to merge the fundamentals of ecology with those of economics -human economy is part of the natural world -given our current technological capabilities, the Earth is an extremely scarce ecological resource
Concept of "Malthusian Bottleneck" ecological economics/natural environment provides an essential service in terms of life support for all known species, including us - also provides countless other goods and services that have significant, measurable economic value
Two ways an economy can grow pointed out by ecological economists 1. Greater resource use 2. Technological advancement (using resources more efficiently
Exhaustible Resources can/will be depleted eventually
Renewable resources can be over-harvested to the point of collapse/extinction
Resource Scarcity fundamentally limits the degree to which economic growth can be achieved through increased resource use
Scarcity exists when........ individuals can have more of one good but only by giving up something else
Opportunity Cost the REAL cost of an item/ what you must give up in order to get it/ crucial to understanding individual choices/trade-offs/ what you forgo to obtain your choice - ALL costs are ultimately opportunity costs
You have $1 to spend on a vending machine snack. A bag of chips cost $1 and a candy bar costs $1. If you get chips, the opportunity cost is......... the enjoyment you would have received from the candy bar
Margo spends $10,000 on one year's college tuition. The opportunity cost of spending one year in college for Margo is..... whatever she would have purchased with $10,000 plus what she could have earned had she not been in college
More people choose to get graduate degrees when the job market is poor. Opportunity cost= low bc during a time the job market is poor it would be hard to get a job plus a graduate degree would only help a person get a better job
More people choose to do their own home repairs when the economy is slow and hourly wages are down. Opportunity cost= low bc people save money by doing own repairs bc they aren't making as much money (hourly wages are down) and they aren't paying anyone else to make the repairs
There are more parks in suburban than in urban areas. Opportunity cost= low bc urban areas would need to use that area for something that would produce more revenue like a mall
Fewer students enroll in classes that meet before 10 am. Opportunity cost= the opportunity cost is the amount of sleep students gain or lose by either having early classes or late classes
Making trade-offs at the margin: comparing the costs and benefits of doing a little bit more of an activity versus doing a little bit less
When marginal benefit exceeds marginal costs you should..... Do it! (if you are being rational)
When marginal cost exceeds marginal benefits you should..... Not do it!
Marginal Decisions decisions about whether to do a bit more or a bit less of an activity -each has a marginal cost and marginal benefit
Marginal Analysis study of marginal decisions
Incentive anything that offers rewards to people who change their behavior/ are everywhere/can be good or bad ex: tax on tobacco and alcohol to prevent/decrease consumption
Disincentives negative incentive
Socio-cultural incentives -Fame -General social pressure -Criminal punishment
Economic incentives -Sale prices -Taxes and subsidies -Monetary rewards, fines, or penalties - Cost reduction -Higher profits
Interaction of Choices my choices affect your choices, and vice versa-is a feature of most economic situations
Principles that underlie the interaction of individual choices: -There are gains from trade -Markets move toward equilibrium -Resources should be used efficiently to achieve society's goals -Markets usually lead to efficiency - when markets don't achieve efficiency, gov interventions can improve society's welfare
Trade provide goods and services to others and receive goods and services in return
Gains from Trade -people can get more of what they want through trade than if they were self-sufficient -better off because you can trade the value of your labor for the value of the things you consume
Specialization each person specializes in the task that he or she is good at performing/economy as a whole can produce more when each person specializes in a task and trades with others
Equilibrium when no individual would be better off doing something different/any time there is a change the economy will move to a new equilibrium
Efficiency in the economy if all opportunities to make some people better off without making other people worse off have been exhausted/ aka when all gains from trade have been exhausted/by definition economic equilibrium is efficient
Equity everyone gets his or her fair share/what is equitable is not necessarily efficient and vice versa/isn't as well defined a concept as efficiency bc people don't always agree to whats "fair"/ political issues can be boiled down to this conflict
Economics as a whole is generally more concerned with efficiency than equity bc: -efficiency fits neatly into the mathematical paradigm we have constructed for ourselves -equity invokes a more emotional, altruistic component of human nature that economists are not typically comfortable with...
Economist's "perfect world" the incentives built into a market economy already ensure that resources are put to their most efficient use (opportunities to make people better off are never wasted)
Invisible Hand Theory Adam Smith's famous theory in Wealth of Nations/foundation principle of modern free-market capitalism/ the idea that the incentives built into a market economy ensure that resources are put to most efficient use
According to First Theorem of Welfare Economics markets are efficient ONLY if: -there is perfect competition -Property rights are well defined -consumers and producers all display perfectly rational behavior -no information asymmetries -no transactions costs -no externalities *very restrictive set of conditions*
Market Failure occurs when one or more of the conditions listed on the previous slide is not met -result: the equilibrium market outcome is inefficient
Monopoly one type of market failure is that which occurs due to market power/ the most extreme type/monopolist reduces production and charges higher prices compared to the efficient market quantity and price/condition of perfect competition is violated
2 key characteristics of Public goods 1. No one can be excluded from benefiting from them 2. One person consuming the public good does not reduce the amount available to others
Second type of market failure occurs when the good is public in nature bc: the characteristics of public goods violate the condition that property rights must be well-defined -no private entity owns the interstate highway system or the military thus market efficiency breaks down
Third type of market failure occurs when consumers or producers do not behave rationally bc: -we make mistakes and miscalculations -make choices that run counter to our own self-interest -generally myopic -act on our emotions
Behavioral Economics devoted to the study of irrational behavior and its implications for economic decision making
4th type of market failure occurs when the parties to a transaction have asymmetric information.... one party knows something about the good or service that the other party doesn't know
Two broad categories of information asymmetry 1. Moral Hazard 2. Adverse selection
Moral Hazard when one party cannot perfectly monitor the other's actions (ex: employer-employee relationship)
Adverse selection when one party cannot know the other party's "type" the latter may present false information about its type (classic Lemons Problem)
Lemons Problem First explained in 1970 by George Akerlof/ buyers cannot distinguish between high quality (peach) and low quality(lemon)-only willing to pay the average price btw a peach and lemon/ more lemons end up being in the market
Transactions costs costs incurred in making an economic exchange (aside from the actual cost of the good or service itself) - can prevent mutually beneficial trades from occurring
3 Main categories of transactions costs: (depending on the good or service these can be significant presenting an impediment to free trade and market efficiency) 1. Search and information costs 2. Bargaining and legal costs 3. Enforcement costs
Externalities occur when individual actions result in economic costs or benefits not taken into account by the market -can be bad (production/consumption process that generates pollution) -good (more people who get vaccinated the less likely others will get sick)
Government Intervention (in markets) can improve market efficiency when market failures exist if properly applied and administered (also can undermine market efficiency)
Examples of gov. interventions to correct market failures: -anti-trust laws and regulation of natural monopolies -provision of public goods -regulations for all sorts of things(reducing asymmetric info, reducing transactions costs, correcting externalities)
Created by: kthomas96