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Term Test 1 Study Guide

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Jack Carr

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I. Ten Principles of Economics Business Cycle fluctuations in economic activity, e.g. employment & production Economics the study of how society manages its scarce resources Efficiency the property of society getting the most it can from its scarce resources Equity the property of distributing economic prosperity fairly among the members of society Externality the impact of one persons actions on the well-being of a bystander Incentive something that induces a person to act Inflation an increase in the overall level of prices in the economy Marginal Changes small incremental adjustments to a plan of action Market Economy an economy that allocates resources through the decentralized decisions of many firms & households as they interact in markets for goods & services Market Failure a situation in which a market left on its own fails to allocate resources efficiently Market Power the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices Opportunity Cost whatever must be given up to obtain some item Productivity the quantity of goods & services produced from each hour of a workers time Property Rightsthe ability of an individual to own & exercise control over scarce resources Rational People people who systematically and purposefully do the best they can to achieve their objectives Scarcity the limited nature of societys resources Ten Principles of Economics 1) People face trade-offs o Making decisions requires trading off one goal against another o Classic trade-off is between guns & butter (national defence vs. consumer goods) o Society faces trade off of efficiency vs. equity (size of economic pie vs. distribution) 2) The Cost of Something is What You Give Up to Get It 1 o Comparison of costs & benefits of alternative courses of action o Must consider the opportunity cost 3) Rational People Think at the Margin o Marginal changes (small incremental adjustments) to existing plan of action o Decisions made by comparing marginal benefits & marginal costs o A persons willingness to pay for any good is based on marginal benefit that an extra unit will yield o Marginal benefit depends on how many units a person already has o A rational decision maker acts if & only if marginal benefit exceeds marginal cost 4) People Respond to Incentives o Because rational ppl make decisions by comparing costs & benefits o Direct & unintended effects of altering incentives o Alteration of the cost-benefit calculation 5) Trade Can Make Everyone Better Off o Trade allows each person to specialize in the activities heshe does best & enjoy a greater variety of goods & services o Simultaneously competitors & partners 6) Markets Are Usually a Good Way to Organize Economic Activity o Market economy > central planning o Decisions of a central planner = replaced by decisions of millions of firms &households o Firms & households interact in marketplace; prices & self-interest guide decisions 2
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