Introduction to Economics Quiz

Modern Economics

• Modern economics focuses on individual, firm, and government choices regarding resource use.
• The study of economics involves trade-offs driven by scarcity (limited resources.)
• Five core economic concepts include trade-offs, incentives, exchange, information, and distribution.

Trade-offs

• All choices require trade-offs, stemming from scarcity.
• Scarcity involves limited resources, money, and time.

Incentives

• Incentives motivate decision-making, such as rewards and costs reflected in prices.
• Individual choices are influenced by returns anticipated from various activities.

Exchange

• Exchange involves the trade of goods and services.
• Voluntary exchange in markets dictates which goods to produce.
• A market is any location where exchange occurs.

Information

• Informed choices require information.
• Information is similar to other goods/services, but unique in its properties.

Distribution

• Markets determine which goods individuals receive based on demand and supply of resources (goods, labor and capital).
• Markets also determine who receives the produced goods.

The Three Major Markets

• The product market facilitates exchanges of final goods and services.
• The labor market involves workers selling labor and firms hiring workers.
• The capital market encompasses saving and fund-raising by individuals, companies, and governments.

The Two Branches of Economics

• Microeconomics explores the decision-making processes of households and firms in specific industries, focusing on prices and production.
• Macroeconomics focuses on the overall economy by studying aggregate variables' behavior.

The Science of Economics

• Economics is a social science.
• It involves assumptions (hypotheses) and derived conclusions.
• Theories are logical reasoning that connect assumptions to conclusions.
• The accuracy of conclusions is reliant on accurate assumptions.

Positive and Normative Economics

• Positive economics describes the economy's functional aspects (facts), using "is" statements.
• Normative economics evaluates the economy's value and suggests alternative paths (what should be), using "should be" statements.

Thinking Like an Economist (Chapter MI2)

• The basic competitive model assumes rational consumers, profit-maximizing businesses, and competitive markets.
• The role of government is disregarded for initial analysis and exploration of models.

Rational Individuals

• Scarcity necessitates choices.
• Rationality in economics assumes self-interest in decision-making.
• Individuals rationally weigh costs and benefits.
• Individuals with differing interests explain different decisions.
• Economists don't judge preferences but rather accept them.

Competitive Markets

• Competitive markets involve numerous firms offering identical products to multiple consumers.
• Firms in competitive markets act as price takers.
• Firms produce output matching demand.
• Firms are small relative to the market size.
• Firms charging higher prices lose all customers.
• Market price consistency is essential for firms operating in the market.

The Basic Competitive Model as a Benchmark

• The basic competitive model blends rational consumers with profit-maximizing firms in a competitive market to illustrate production and allocation.
• It addresses fundamental questions about production quantity, production methods, recipient determination, and the decision-making process.
• This model isn't a flawless representation of actual economies.

Efficiency in the Basic Competitive Model

• The basic competitive model signifies Pareto efficiency, meaning no resource waste.
• Efficiency implies maximizing output without sacrificing other goods.
• Efficiency implies that maximizing one individual's wellbeing necessarily disadvantages someone else.

Opportunity Sets

• Opportunity sets represent possible goods combinations, impacted by resource limitations (budget, time constraints).
• All combinations are not attainable due to scarcity.
• Budget or time constraints define opportunity sets.

Budget Constraint

• Budget constraints involve limited spending ($120) on goods (pens, books) with specific prices ($10 per pen, $20 per book.)
• Constraints limit achievable combinations.

Time Constraint

• The constraint on daily time (24 hours) limits the achievable activities which may impact decisions.

The Production Possibilities Curve (PPC)

• The PPC shows the trade-offs between goods possibilities given resources and technology.
• PPC is curved due to different required input mixes.
• It illustrates production possibilities for a firm or society.

The Production Possibilities Curve, cont.

• Guns and butter illustrate opportunity costs (the next best option sacrificed).
• The fixed trade-offs in the PPC scenario showcase these costs.

Optimal Production on the PPC

• Points inside the PPC indicate underemployment of resources, thus lower production possibilities.
• Optimal production output would fall on the curve.
• Inefficient points are located inside the curve, implying resource underutilization.

Principle of Diminishing Returns

• Increasing inputs progressively produces progressively smaller output increments, assuming other inputs are held constant.
• Adding consistent units of inputs to fixed inputs leads to a decreasing rate of additional output growth.

Opportunity Costs

• Opportunity cost refers to the value of the next best alternative option sacrificed by choosing a particular action.
• Resource use is constrained by the resources' value.
• Opportunity cost is depicted by the PPC and time/budget limitations.

Opportunity Costs, cont.

• Education opportunity costs comprise tuition, room and board, books, travel, and foregone earnings.

Sunk Costs

• Rational decision-makers disregard sunk costs (past unrecoverable investments).
• Previous investments don't influence future decisions.

Marginal Costs

• Marginal cost is the incremental cost of producing or consuming one additional unit.

Basic Steps of Rational Choice

• Identify opportunity sets.
• Categorize trade-offs.
• Calculate costs accounting for opportunity costs and marginal costs (ignoring sunk costs.)