Week 1 study guide

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Chapter 1 Economic Issues and Concepts Notes
1.1 The Complexity of the Modern Economy
x economy : a system in which scarce resources are allocated among competing uses
x decisions must be made about: which goods are produced, and which are not; who works where and at what wage; and who
consumes what goods at what times, which means that entire combination is remarkably complex, especially in modern societies
The Self-Organizing Economy
x great insight of economists is that an economy based on free-market transactions is self-organizing
x by following their own self-interest, doing what seems best and most profitable for themselves, and responding to the incentives
of prices determined in open markets, people produce a spontaneous economic order
Efficient Organization
x efficiency means that the resources available to the nation are organized so as to produce the largest possible amount of goods
and services that people want to purchase, and to produce them with the least possible amount of resources
Main Characteristics of Market Economies
x self-interest—individuals pursue their own self-interest, buying and selling what seems best for themselves and their families
x incentives—people respond to incentives; sellers usually want to sell more when prices are high; buyers usually want to buy
more when prices are low
x market prices and quantities—prices and quantities are determined in free markets in which would-be sellers compete to sell
their products to would-be buyers
x institutions—all of these activities are governed by a set of institutions largely created by government; the most important are
private property, freedom of contract, and the rule of law; the natures of private property and contractual obligations are defined
by laws passed by legislatures and enforced by the police and the courts
1.2 Scarcity, Choice, and Opportunity Cost
x economics is the study of the use of scarce resources to satisfy unlimited human wants
x land includes all natural endowments such as arable land, forests, lakes, crude oil, and minerals
x labour includes all mental and physical human resources, including entrepreneurial capacity and management skills
x capital includes all manufactured aids to production such as tools, machinery, and buildings
x factors of production : resources used to produce GS; frequently divided into the basic categories of land, labour, and capital
x goods : tangible commodities, such as cars and shoes
x services : intangible commodities, such as haircuts or medical care
x production : the act of making goods or services
x consumption : the act of using goods or services to satisfy wants
Scarcity and Choice
x scarcity implies that choices must be made, and making choices implies the existence of costs
x every time a choice is made, opportunity costs are incurred
x opportunity cost : cost of using resources, measured by benefit given up by not using them in their best alternative use
x production possibilities boundary : a curve showing which alternative combinations of commodities can just be attained if all
available resources are used efficiently; it is the boundary between attainable and unattainable output combinations
x A production possibilities boundary illustrates three concepts: scarcity, choice, and opportunity cost. Scarcity is indicated by the
unattainable combinations outside the boundary; choice, by the need to choose among the alternative attainable points along the
boundary; and opportunity cost, by the negative slope of the boundary.
Four Key Economic Problems
x resource allocation : the allocation of an economy’s scarce resources of land, labour, and capital among alternative uses
x any economy must have some mechanism by which these decisions about resource allocation are made
x questions relating to what is produced and how, and what is consumed and by whom, fall within the realm of microeconomics
x microeconomics : study of causes and consequences of allocation of resources as it is affected by workings of price system
x questions relating to the idleness of resources and the growth of productive capacity fall within the realm of macroeconomics
x macroeconomics : study of determination of economic aggregates such as total output, price level, employment, and growth
1.3 Who Makes the Choices and How?
The Flow of Income and Expenditure
x individuals own factors of production, which they sell to producers and receive payments in return, which is their income
x producers use factor services that they bought to make GS, which they sell to individuals, receiving payments in returns, which
are called the incomes of producers
x individuals sell the services of the factor that they own in what are collectively called factor markets
x producers sell their outputs of goods and services in what are collectively called goods markets
x the prices that are determined in these markets determine the incomes that are earned and the purchasing power of those incomes
x the distribution of income refers to how the nation’s total income is distributed among its citizens
x consumers and producers who are maximizers are constantly making marginal decisions, whether to buy or sell a little bit more
or less of the many things that they buy or sell
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