Chapter 1
Vocabulary
Scarcity: A situation in which unlimited wants exceed the limited resources available to fulfill
those wants
Economics: Study of the choices people make to attain their goals, given their scarce resources
Market: A group of buyers and sellers of a good or service and the institution of arrangement by
which they come together to trade
Marginal Analysis: Analysis that involves comparing marginal benefits and marginal costs
Trade-off: The idea that, because of scarcity, producing more of one good/service means
producing less of another good/service
Opportunity Cost: The highest-valued alternative that must be given up engaging in some
activity
Centrally Planned Economy: Gov. decides how economic resources will be distributed
Market Economy: The decisions of households and firms interacting in markets distribute
economic resources
Mixed Economy: Economic decisions result from interaction of buyers & sellers in markets, but
the government plays a significant role in the distribution of resources
Productive Efficiency: A good or service is produced at the lowest possible cost
Allocative Efficiency: Production is in accordance with consumer preferences; in particular, every
good/service is produced up to the point where the last unit provides a marginal benefit to
society equal to the marginal cost producing it
Equity: The fair distribution of economic benefits
Economic Variables: Something measurable that can have different values
Positive Analysis: Analysis concerned with what is
Normative Analysis: Analysis concerned with what out to be
Technology: The processes a firm uses to produce goods and services
Capital: Manufactured goods that are used to produce other goods and services
Formulas
Slope = Delta Y over Delta X (Rise over Run)
% Change = [(Value in 2nd period - Value in 1st period) / Value in 1st period] x 100
Total Revenue = Quantity x Price (Area of rectangle = BH)
Area of Triangle = (1/2)(Base)(Height)
Three Key Economic Ideas
People are rational
o Using all available information to achieve their goals
o Weight benefits and costs of each action and try to make the best decision possible
o Ex: Apple chooses the price(s) that they think would be most profitable
People respond to economic incentives
o Change in incentives => that actions that people take change
o Ex: Convicted felons submitted DNA samples => reduced repeat convictions by
serious violent
Optimal decisions are made at the margin
o Decisions involve doing a little more or a little less of something
o Ex: Should you watch an extra hour of TV or study instead?
What Goods & Services Will Be Produced?
Increase in one good = decrease in another good
Individuals, firms, and gov. must decide on the goods/services that should be produced
Opportunity Cost Example:
o The opportunity cost of increased funding for space exploration might be giving up
the opportunity to fund cancer research
Types of Economies
Centrally Planned Economy: Government decides
Market Economy: Households and firms decide
o Efficiency
Tend to be more efficient than centrally planned economies
Market economies promote productive efficiency and allocative efficiency
Productive Efficiency: Good/service is produced as lowest cost
Allocative Efficiency: Production is equal to consumer preferences
o Caveats
People might not immediately do things in the most effective way
Gov. might interfere w/ market outcomes
Market outcome might ignore the desires of people who aren’t involved in
transaction
Mixed Economy: Both gov. and households/firms
Economic Models
Decide on the assumptions to use
Formulate a testable hypothesis
Use economic data to test the hypothesis
Revise the model if it fails to explain the economic data well
Retain the revised model to help answer similar economic questions in the future
Role of Assumptions in Economic Models
Economic models make behavioral assumptions about the motives of consumers and firms
o Consumers buy goods/services to max their well-being (price and demand)
o Firms act to max their profits
Form hypothesis based on these assumptions, and test whether they’re true
Forming Hypothesis in Economic Models
Hypothesis is a statement about an economic variable that may be ether correct or
incorrect
Economic variables: Something measurable that can have different values
o Ex: Increased use of industrial robots and information technology => decline in
manufacturing employment
Most economic hypotheses are about casual relationships