ECON 101- Final Exam Guide - Comprehensive Notes for the exam ( 41 pages long!)

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29 Mar 2018
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ECON 101
Final EXAM
STUDY GUIDE
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Textbook Notes
Chapter 1: Ten Principles of Economics
1.1 How People Make Decisions
Principle 1: People Face Trade-Offs
Guns and butter - the more a society spends on a national defense (guns) to protect its shores from
foreign aggressors, the less it can spend on consumer goods (butter) to raise the standard of living at home
Important in modern society is the trade-off between a clean environment and a high level of income
Efficiency - society is getting the maximum benefits from its scarce resources
Refers to the size of the economic pie
Absence of waste
Our producers are our lowest cost producers possible, they are producing the most that they can
The good is being consumed by those who value it the highest
Equality - those benefits are distributed uniformly among society’s members
Refers to how the pie is divided into individual slices
Principle 2: The Cost of Something Is What You Give Up to Get It
Opportunity cost - what you give up to get that item
Value of what certain resources could have produced had they been used in the best alternative way
Could be in terms of time, not only money
When making any decision, decision makers should be aware of the opportunity costs that accompany
each possible action
Principle 3: Rational People Think at the Margin
Rational people - systemically and purposefully do the best they can to achieve their objectives, given the
available opportunities
Marginal change - a small incremental adjustment to an existing plan of action
Adjustments around the edges of what you are doing
Principle 4: People Respond to Incentives
Incentive - something that induces a person to act
Key to analyzing how markets work
Influence of prices on behavior of consumers and producers is crucial to how a market economy
allocates scarce resources
1.2 How People Interact
Principle 5: Trade Can Make Everyone Better Off
Trade between two countries can make each country better off
Allows countries to specialize in what they do best and to enjoy a greater variety of goods and services
Principle 6: Markets are Usually a Good Way to Organize Economic Activity
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Market economy - decisions of a central planner are replaced by the decisions of millions of firms and
households
Firms decide whom to hire and what to make
Households decide which firms to work for and what to buy with their incomes
They interact in the marketplace where prices and self-interest guide their decisions
No one is looking out for the economic well-being of society as a whole
However, market economies have been successful in organizing economic activity to promote overall
economic well-being
Households and firms interacting in markets act as if they are guided by an ‘invisible hand’ that leads them to
desirable market outcomes
Buyers look at the price when determining how much to demand and sellers look at the price when
deciding how much to supply
Market prices reflect both the value of a good to society an the cost to society of making the
good
When a government prevents prices from adjusting naturally to supply and demand, it impedes
the invisible hand’s ability to coordinate the decisions of the households and firms that make up an
economy
Participants in the economy are motivated by self-interest and that the ‘invisible hand’ of the
marketplace guide this self-interest into promoting general economic well-being
Principle 7: Governments Can Sometimes Improve Market Outcomes
The invisible hand can work its magic only if the government enforces the rules and maintains the institutions
that are key to a market economy
Property rights - the ability of an individual to own and exercise control over scarce resources
Market economies need institutions to enforce this so individuals can own and control scarce resources
We rely on government provided police and courts to enforce our rights over the things we produce
The invisible hand counts on our ability to enforce those rights
Although the invisible hand is powerful, it is not able to do anything
Two broad rationals for a government to intervene in the economy and change the allocation of resources
that people would choose on their own
To promote efficiency for to promote equality
Most policies aim either to enlarge the economic pie or to change how the pie is divided
Goal of efficiency
Market failure - refers to a situation in which the market on its own fails to produce an efficient
allocation of resources
Externality - impact of one person’s actions on the well-being of a bystander
Market power - ability of a single person or firm to unduly influence market prices
Goal of equality
Even when the invisible hand yields efficient outcomes, it can nonetheless leave sizable disparities
in economic well-being
Market economy rewards people according to their ability to produce things that other people are willing
to pay for
Invisible hand does not ensure that everyone has sufficient needs
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