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Chapter 1

ECON 200 Chapter Notes - Chapter 1: Normative Economics, List Of Fables Characters, Brookings Institution

Course Code
ECON 200

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Chapter 01: Economics: Foundations and Models
We must make choices because we live in a world of scarcity, which mean that although
our wants are unlimited, the resources available to fulfill those wants are limited
You might like to own a BMW and spend each summer vacationing at a five-star
European hotel, but unless Bill Gates is a close and generous relative, you
probably lack the funds to fulfill these dreams
Every day, you make choices as you spend your limited income on many goods and
services available
If you spend an hour studying for your economics midterm, you have one hour
less to study for your history midterm
Firms and governments are in the same situation as you: They must also attain
their goals with limited resources
Economics is the study of the choices consumers, business managers, and government
officials make to attain their goals, given their scarce resources
Three important economic ideas:
People are rational
People respond to economic incentives
Optimal decisions are made at the margin
What goods and services will be produced? How will the goods and services be
produced? Who will receive the goods and services produced?
Consider the roles of economic models in analyzing economic issues
Economic models are simplified versions of reality used to analyze real-world economic
Three Key Economic Ideas
A market is a group of buyers and sellers of a good or service and the institution or
arrangement by which they come together to trade
People are Rational
Economists generally assume that people are rational
This does not mean that economists believe everyone knows everything or always
makes the “best decision
Economists just assume that consumers and firms use all available information as
they act to achieve their goals
Weigh the benefits and costs of each action, and they choose an action only if the benefits
outweigh the costs
People Respond to Economic Incentives
Human beings act from a variety of motives, including envy, compassion, and religious
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Economists emphasize that consumers and firms consistently respond to economic
According to an article in the Wall Street Journal, the FBI couldn’t understand
why banks were not taking steps to improve security in the face of an increase in
robberies. Few banks took FBI advice to increase security because it is less costly
to put up with bank robberies than to take additional security measures
Does Health Insurance Give People an Incentive to Become Obese?
Obesity is an unfortunate medical problem but the fact that obesity is increasing indicates
for some people that obesity is the result of diet and lifestyle choices
This is because of high-calorie fast food, insufficient exercise, and a decline in
physical activity with many jobs
Could health insurance be a cause of obesity?
By reducing some of the costs of obesity, health insurance may give people an
economic incentive to gain weight
This argument may seem implausible and people may become obese without considering
health insurance but if economists are correct about the importance of economic
incentives, then we would expect that if we hold all other personal characteristics—such
as age, gender, and income—constant, people with health insurance will be more likely to
be overweight than people without health insurance
After a study using a sample of 80,000 people from 1989 to 2004, they found that after
controlling for income, people with health insurance were more likely to be overweight
than people without health insurance
Suggests that people respond to economic incentives even when making decisions
about what they eat and how much they exercise
Optimal Decisions are Made at the Margin
Economists use the word marginal to mean “extra” or additional”
Should you watch another hour of television or spend that hour studying? The
marginal benefit (MB) of watching more television is the additional enjoyment
you receive
The marginal cost (MC) is the lower grade you receive from studying a little less
Should Apple produce an additional 300,000 iPhones?
Firms receive revenue from selling goods
Apple’s marginal benefit cost is the additional cost—for wages, parts, and so forth
—of producing 300,000 more phones
Economists reason that the optimal decision is to continue any activity up to the
point where the marginal benefit equals the marginal cost—MB = MC
We often do this without conscious thought, but in business situations, firms often have
to make careful calculations to determine, for example, whether the additional revenue
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received from increasing production is greater or less than the additional cost of the
Economists refer to analysis that involved comparing marginal benefits and
marginal costs as marginal analysis
The Economic Problem That Every Society Must Solve
Every society faces trade-offs: producing more of one good or service means producing
less of another good or service
Best measure of the cost of producing a good or service is the value of what has to
given to produce it
The opportunity cost of any activity—such as producing a good or service—is the
highest-valued alternative that must be given up to engage in that activity
Consider the example of a doctor who could receive a salary of $100,000 per year
working as an employee of a hospital but decides to open his own private practice
The opportunity cost of the physician services he supplies to his own firm
is the $100,000 he gives up by not working for the hospital, even if he
does not explicitly pay himself a salary
Trade-offs force society to make choices when answering the following three
fundamental questions:
1. What goods and services will be produced?
2. How will the goods and services be produced?
3. How will receive the goods and services produced?
What Goods and Services Will Be Produced?
“Society does not make decisions; only individuals make decisions. The answer to this
question of what will be produced is determined by the choices that consumers, firms,
and the government make
Every day you help decide which goods and services firms will produce when you
choose to buy an iPhone instead of a Samsung Galaxy or a mocha rather than a
chai tea
The federal government must choose whether to spend more of its limited budget
on breast cancer research or on repairing highways
In all cases, consumers, firms, and the government face the problem of scarcity by
trading off one good or service for another and each choice made comes with an
opportunity cost, measured by the value of the best alternative given up
How Will the Goods and Services Be Produced?
Firms choose how to produce the goods and services they sell
Firms face a trade-off between using more workers or using more machines
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