LU 1 NEW

• Economy


  The management or law of the household, but it has since been expanded to include the management of larger entities such as businesses, industries, and nations
• Decisions faced by a household and an economy

  • Who will work?
  • What goods and how many of them should be produced?
  • What resources should be used in production?
  • At what price should the goods be sold?
• Ten Principles of Economics

  A set of fundamental principles that describe how people make choices and how those choices interact with the economy as a whole
• Society and Scarce Resources

  • The management of society's resources is important because resources are scarce
  • Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have
• Economics


  The study of how society manages its scarce resources
• How People Make Decisions

  • People face trade-offs
  • The cost of something is what you give up to get it
  • Rational people think at the margin
  • People respond to incentives
• Trade-off

  Making decisions requires trading off one goal against another
• Efficiency

  The ability of an economy to produce the maximum amount of goods and services with the available resources
• Equity

  The fair distribution of resources and income among members of society
• Policies that promote equity

  Can help to reduce income inequality, but may also discourage people from working hard and investing in their education and skills
• Opportunity cost


  What you give up to obtain an item
• Explicit opportunity cost

  Direct, out-of-pocket expenses incurred when making a decision
• Implicit opportunity cost

  The value of the next best alternative that is foregone due to the decision
• Marginal change


  Small, incremental adjustments to an existing plan of action
• Marginal changes can have an impact on the overall outcome, but they do not fundamentally alter the situation
• Marginal changes can be used to analyze the effects of small changes in economic variables on outcomes, such as profits, revenue, and consumer behavior
• Incentive

  Marginal changes in costs or benefits that motivate people to respond
• The decision to choose one alternative over another occurs when that alternative's marginal benefits exceed its marginal costs
• Comparative advantage

  A country's ability to produce a good at a lower opportunity cost than another country
• Market economy

  An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services
• Invisible hand


  The observation that households and firms interacting in markets act as if guided by an "invisible hand" to reach outcomes that tend to maximize the welfare of society as a whole
• Markets are flexible and adaptable, and can respond quickly to changes in supply and demand conditions
• Property rights


  The ability of an individual to own and exercise control over a scarce resource
• Market failure

  When the market fails to allocate resources efficiently
• Externality

  The impact of one person or firm's actions on the well-being of a bystander
• Market power


  The ability of a single person or firm to unduly influence market prices
• Firms with market power may engage in anti-competitive behavior, such as price-fixing or monopolizing a market, which can harm consumers and reduce economic efficiency
• Standard of living

  The level of wealth, comfort, material goods, and necessities available to a certain socioeconomic class in a certain geographic area
• Production

  The creation of goods and services that satisfy human wants and needs
• Productivity

  The amount of goods and services produced from each hour of a worker's time
• Inflation

  An increase in the overall level of prices in the economy
• Phillips Curve

  Illustrates the trade-off between inflation and unemployment
• In the short run, wages and prices are relatively inflexible, meaning they do not adjust quickly to changes in demand and supply
• In the long run, the Phillips curve becomes flatter as prices and wages become more flexible, and the trade-off between inflation and unemployment becomes less significant
• Thinking like an economist

  Involves thinking analytically and objectively, makes use of the scientific method
• Economic models

  Simplify reality in order to improve our understanding of the world
• Circular flow diagram

  • Visual model of the economy that shows how dollars flow through markets among households and firms
  • Shows the interaction between households and firms, and how they exchange goods, services, and money in markets
• Circular flow diagram

  1. Households sell labor, land, and capital to firms

  2. Firms use factors of production to produce goods and services

  3. Firms sell goods and services to households

  4. Households buy goods and services from firms
• Production possibilities frontier

  • Graph that shows fundamental economic problems related to our ability to produce goods and services
  • Shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology
• Efficiency

  Concept illustrated by the production possibilities frontier