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Economics 1B03 MidTerm 1 Review.docx

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Hannah Holmes

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Economics 1B03 Mid-Term Review Chapter 1 There are never enough resources to satisfy all the wants and needs of a society management of societys resources are scarce Economics study of how society allocates the scarce resources to satisfy peoples unlimited wants Basic principles: households and economies face many decisions (who will work, what goods to produce, what price to sell goods at); every economic issue involves individual choice Scarcity limited resources; can not produce all the goods and products people wish to have Resources often allocated not by a single central planner but through combined actions of millions of households and firms Microeconomics study of the decisions made by households and firms and how they interact in markets (make decisions) ; focus on individual parts; specificity Macroeconomics things that effect economies as a whole and larger scale; economic growth at a national level; ie. inflation, unemployment Market economy allocates resources through the decentralized decisions of firms and households (individuals) (each making own individual decisions with no central consensus) ie. firms decide who to hire, what to buy Command/Centrally planned economy all production and distribution decisions are made by a central authority, like a government; ie. former USSR being told who provides, produces and buys what Traditional economy refers to underdeveloped economies that rely heavily on agriculture for domestic consumption (subsistence economy); economic decisions based on customs, beliefs, religion, habits Mixed economies most economies; combination of market and command economies; mostly free market ex. Canada We assume that when people are making decisions they are acting rationally: Economic rationality making the best decisions that maximize the benefits received from the decision Perfect information We assume people have this when making a decision. Everyone knows everything about everything; not settling for anything less b/c they know what is best. Ex. Firms know all prices Asymmetrical information Hard to have perfect information, some have more info than others; harder to make the best decision. Ex. Sellers have more info than buyers, Lack of perfect info makes it harder to make the best decisions. Resource (factors of production) anything that can be used in production (inputs of production) ; three factors, recently we have been including entrepreneurship as a resource 1. Land (space) 2. Labour (people to create, assemble, produce) 3. Capital (what is needed by the laborers in the space- buildings, physical etc.) Equilibrium when no individual would be better off doing something different; markets usually reach equilibrium through price changes; economys situation is in equilibrium when there is NO incentive for economic actors to change their behavior Economists Role when economists are trying to explain the world, they are scientists; when they are trying to change the world, they are policy advisors Positive statement describes the world as it IS (descriptive analysis) Normative statements describes the world as it SHOULD BE (prescriptive analysis) Economists disagree about the validity of alternative positive theories about how the world works; different values therefore different normative views about what policy should try to accomplish Economic models economists try to model human behavior so we can make accurate predictions about potential economic outcomes; involves making assumptions based on theory; to help us explain how the economy works Circular-Flow Diagram: firms produce and sell goods and services, hire and use factors of production; households buy and consume goods and services, own and sell factors of production - Markets for Goods and Services: firms sell; households buy - Markets for Factors of Production: households sell; firms buy - Factors of Production: land, labour, capital (+entrepreneurs) How People Make Decisions - Gains from trades, we specialize in goods we produce efficiently and trade them for goods other nations produce efficiently that we need. - Between efficiency and equity - Efficiency resources are used as best as possible to meet societys goals. Welfare of society will be maximized. Markets left to operate freely lead to efficiency. Economics* - Equity Fairness. The fair distribution of resources. Political* - Higher equity = lower future efficiency Government redistributes income from rich to the poor, reduces the reward for working hard, people work less and produce fewer goods (increase equity, lowers efficiency) - *Acknowledging tradeoffs with respect to equity and efficiency = good future decisions in society Cost of Something Is What You Give Up to Get It - Facing tradeoffs, thus decisions require comparing the costs and benefits of alternative courses of action - Opportunity cost whatever must be given up to obtain some item; decision makers should be aware of the opportunity costs that accompany each possible action; cost of the BEST forgone alternative - Forgone alternative what you lose in the process of achieving one goal Rational People Think at the Margin - Rational people systematically and purposefully do the best they can to achieve their objectives; rationalize to obtain greatest benefit; know that decisions involve shades of gray; consider marginal changes in their decisions - Marginal changes small incremental adjustments to a plan of action; small changes around the edges (firm producing one more good...) - Marginal benefit depends on how many units a person already has (diamonds have high marginal benefit; water has low) - *Decision based on marginal benefit > marginal cost = rational decision - Marginal changes in costs or benefits motivate people to respond. If adding one more good adds more revenue than cost it should be produced- being rational. People Respond to Incentives - Incentive prospective punishment or reward; play a central role in the study of economics; crucial to analyzing how markets work - Example of policy failing to consider the effects of incentive: seat belt initiative intended to increase safety people then drive faster; therefore, more accidents occur - Must consider not only the direct effects but also the indirect effects of incentives How People Interact Trade Can Make Everyone Better Off - Competition in economy is good: trade amongst countries allows for a greater variety of services - Trade allows countries to specialize in what they do best and enjoy a greater variety of goods and services Markets are Usually a Good Way to Organize Economic Activity - In a market economy no one is looking out for the economic well-being of society as a whole; yet have proven successful in organizing economic activity in a way that promotes overall economic well-being
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