[ECON 103] - Midterm Exam Guide - Everything you need to know! (39 pages long)

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ECON 103
MIDTERM EXAM
STUDY GUIDE
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Chapter 1: The Economic Approach
Focus:
What is scarcity? Why is it important?
How does scarcity differ from poverty? Why does it necessitate rationing and
competition?
What is the economic way of thinking?
What is the difference between positive and normative economics?
Origin of Economics:
Adam Smith is considered the father of economics
Wrote The Wealth of Nations in 1776, which attempt to explain why some people/nations
are more or less wealthy than others
Stressed the positive benefit of the free market and of people acting in their own best
interest
By acting in their own interest, consumers create the “invisible hand,” which guides
markets to produce desired goods at low prices.
What is Economics About?
Economics is the study of choices and scarcity
Scarcity is the fundamental concept of economics that indicates that there is less
of a good freely available from nature than people would like.
Scarcity forces us to make choices between alternatives
These choices lead to trade-offs
Resources are used to produce goods and services
Human resources: human knowledge, skill, and strength
Physical goods/capital: human made machines, tools, buildings, etc
Natural resources: come from nature, eg. oil, water, lumber
Scarcity =/= poverty
Scarcity is objective; poverty is subjective. For example, a person who is
considered impoverished in America may have significantly more resources than
someone in another country. Scarcity is fixed - all resources are ultimately
limited.
Scarcity leads to rationing, which leads to competition
Rationing: the control of the distribution of supply and demand. In market
economies, price rationing - where distribution of goods is controlled by their
price - is the most prevalent kind of rationing.
Competition: Becau
The Economic Way of Thinking:
Economic Theory: Set of definitions, postulates, and principles that make clear some
cause-and-effect relationships
1. Use of scarce resources is costly, so people must make trade-offs
Opportunity cost is the highest valued foregone option
2. Individuals choose purposely, in order to get the most out of their limited resources
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Economizing behavior is the act of choosing the option with the greatest benefit at
the least cost.
Utility is the subjective benefit or satisfaction expected from a choice.
3. Incentives matter - changes in incentives influence human behavior in a predictable way.
Basic postulate of economics
4. Individuals make decisions at the margin.
When choosing between two alternatives, people focus on the difference between
costs and benefits. This is called marginal thinking.
Marginal describes the effects of a change in a current situation
“How much more is this?” = marginal thinking
5. Information helps us decide, but acquiring it is costly
People are willing to “shop around” for a deal, but only to a certain degree.
6. Beware of secondary effects - economic actions often generate indirect, unintentional
consequences
Secondary effects are the indirect impacts of a policy that may not be immediately
noticeable. They are often overlooked by policymakers.
7. The value of a good or service is subjective
8. The test of a theory is its ability to predict
Economic thinking is scientific - theories are formed and tested for predictive
value.
Models are often used
Positive vs Normative Economics
Positive economics is scientific and based on verifiable statements.
ie “if gas prices rise, less people will drive”
Normative economics is subjective and based on “how things should be”
ie “food should be cheaper and easier to mass-produce” or “we should grow more
organic food and avoid GMOs”
Both statements are opinions that cannot be proven objectively true or false.
Normative economic views can bias our views toward positive economic analysis
Pitfalls of Economic Thinking
Violations of ceteris paribus
ceteris paribus means “other things constant”
ie analysis like “If housing prices rise, people will buy less houses.” However,
other factors may be at play - if average income is also rising, then people will
buy just as many houses.
Therefore, other factors are not constant and usage of ceteris paribus
would lead to incorrect analysis
Economists must therefore sort out multiple, contrasting factors.
Good intent does not equal desirable outcomes
Just because the proponent of a policy is well-intended, doesn’t mean that the
policy will be successful.
ie the Endangered Species Act - while well-intentioned, has lead to habitat
destruction, as many property owners destroy potential nesting habitats to avoid
losing their property rights.
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