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Chapter 1

EC120 Chapter Notes - Chapter 1: Invisible Hand, Fireproofing, Opportunity Cost

Course Code
Olivia Ozlem Mesta

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Microeconomics: interactions between
- individual households and firms
equilibrium in particular markets
relative prices
Macroeconomics: inflation, unemployment and economic growth
- Whole economy overall rather than just particular parts
- limited nature of societies resources
- We can’t produce all we want to
- study of how society manages its scare resources
- How much to work, save, buy
- How much to produce
Scarce resources: (best alternative use for resources)
- How we make use of the resources we have in more than one way (alternative uses for our resources)
- Scarcity arises from a combination of large human wants/desires and limited resources to attain the
wants/needs of the society
Principle 1: People Face Tradeoffs
- Efficiency vs Equity
- Efficiency: getting most out of scarce resources
- Equity: distributing prosperity fairly among societies members
- Tradeoff: to increase equity, can redistribute income from well off to the poor
- Redistribution in ways that cause the least efficiency loss
Principle 2: The cost of something is what you give up to get
OPPERTUINTY COST: whatever must be given up by choosing one action over another *opportunity cost can only occur
when an action has been taken
Opportunity costs include-
Explicit Costs (out of pocket expenses) ex. Tuition, books, room and board
Implicit Costs (such as foregone earnings) ex. Lost income from choosing school over employment
EX. Going on a 4 week vacation
- Explicit costs include the cost of the trip itself along with associated costs
- Implicit costs include the cost in time away from employment
Sunk Costs: unrecoverable costs
- Costs that are incurred regardless of which course you take
*Decision Making
° A firm/person should engage in one particular activity if those activities benefits exceed the opportunity cost
Principle 3: Rational people think at the margin
Rational: thinking systematically does the best to achieve objectives
But many decisions are not ‘all or nothing’, but involve marginal changes
Marginal change: incremental adjustments to an existing plan
- Evaluating the costs and benefits of marginal changes is an important part of decision making
Ex. A firm considers whether to increase output, comparing the cost of the needed labor and materials to the extra
Incentive: something that induces a person to act i.e the prospect of a reward or punishment
- Rational people respond to incentives because they make decisions by comparing costs and bnefits
Ex. In response to higher gas prices, sales of hybrid cars rise
Ex. In response to higher cigarette taxes, teen smoking falls
The Economy: a group of people interacting with each other
Principle 5: Trade can make everyone better off
- Rather than being self-sufficient, people can specialize in producing one good/service and exchange for other
countries specialized goods/services
Specialization: individuals and organizations focusing on the limited range of production tasks they perform best
Benefits of Specializationget a better price abroad for goods they produce, and buy other goods more cheaply from
abroad than could be produced at home
Principle 6: Markets are usually a good way to organize economic activity
Market: group of buyers and sellers
“Organize economic activity” means –what goods to produce how to produce how much of each to produce- and
who gets the products
° Households and firms acts as if ‘led by an invisible hand’ to promote general economic wellbeing
Invisible hand: aka. Invisible hand of the market-- self-regulating nature of the market place
Invisible hand works through the price system:
- The interaction between buyers and sellers determines prices of goods/services
- Each price reflects the goods value to buyers and the cost of producing the good
- Prices guide self-interested households and firms to make decisions that maximize societies economic wellbeing
by pursuing own personal interests, individuals and the society can factor the prices of some goods/services in the
economy ..
Market failures can come from:
- Lack of competition eg. Monopoly
- Externalities eg. Pollution or fireproofing a home
Externality: is a cost or benefit that is not transmitted through prices- when the production of consumption of a
good affects bystanders
- Lack of information
- Public goodsgoods that are consumed jointly by many people like national defense
**look over more to fully understand**
Principle 7: Governments can sometimes improve market outcomes
- Important role of govn’t: enforce property rights (w/ police, courts)
- People are less inclined to work, produce, invest or purchase if large risk of their property being stolen
Ex. A music company won’t produce c.d’s if too many people avoid paying by making illegal copies
° Government may alter market outcome to promote efficiency
-market failure when the market fails to allocate societies resources efficiently.
Causes of market failure:
- Externalities
- Market power- a single buyer/seller has substantial influence on market price (ex. Monopoly)
° Public Policy may increase efficiency
Principle 8: A countries standard of living depends on its ability to produce goods/services
Productivity: amount of goods/services produced in each hour of a workers time
- Productivity depends on: equipment, skills and technology and other factors including labor unions, competition
Economists play two important roles:
- Social Scientist- try to explain the world
° Economists play the more scientific role by developing and testing theories about how the world works
- Policy Advisors- try to improve the world
Assumptions & Models
° Assumptions simplify the complex world and make it easier to understand
Ex. When studying international trade, we may assume the world has two countries and two good (very unrealistic, but
simplifies the problem and yields useful insight about the more complicated real world)
- Some familiar models; road maps, model airplane, model of human anatomy, model teeth at dentist office
Productions Possibilities Frontier (PPF) :
° A graph that shows the combinations of two goods a country can produce given the available resources
Two goods: computers and wheat
One resource: labour (measured in hours)
Economy has 50,000 labour hours per month available for production.