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Chapter 1
Microeconomics
| Term | Definition |
|---|---|
| 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are also capable of over-producing if left unchecked/ingenuity & compassion for each other also seems to have superseded the ability of natural selection to control pop.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) |
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kthomas96
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