Chapter 1 - Economics: Foundations and Models Flashcards
Economics
The study of the choices people make to attain their goals, given their scarce resources.
Scarcity
A situation in which unlimited wants exceed the limited resources available to fulfill those wants.
Everyone faces this and according to economists, this is the only problem in the world.
Economic model
A simplified version of reality used to analyze real-world economic situations.
Market
A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.
1st of 3 important Ideas
- People are rational
Economists assume that consumers and firms use all
available information as they act to achieve their goals, weighing the benefits and costs of each action (Marginal analysis), and choosing an action only if the benefits outweigh the costs— even if it is not always the “best” decision.
Ex. How much coffee to drink, how to get to work, etc
2nd of 3 important Ideas
- People respond to economic incentives
Ex. Women in Quebec have more children than the Canadian average. Landmark cinema ticket on Tuesday.
3rd of 3 important Ideas
- Optimal decisions (best decisions) are made at the margin (more or less).
Most decisions in life involve doing a little more or a little less. 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.
Ex. Taking 4 or 5 courses in a term
Trade-off
The idea that because of scarcity, producing more of a certain good or service requires the sacrifice of another good or service.
Opportunity cost
Highest-valued alternative that must be given up to engage in an activity
1st of three fundamental questions
- What goods and services will be produced?
Determined by the choices made by consumers, firms and governments. Consumers, firms, and the government face the problem of scarcity by trading off one good or service for another. Each choice made comes with an opportunity cost.
2nd of three fundamental questions
- How will the goods and services be produced?
With the most efficient, least-costly methods. Firms choose how to produce the goods and services they sell, often facing a trade-off between using more workers or using more machines.
3rd of three fundamental questions
- Who will receive the goods and services produced?
Those with the greatest willingness & ability to pay. In Canada, who receives the goods and services produced depends largely on how income is distributed. There is disagreement over whether the current attempts to redistribute income are sufficient or whether there should be more or less redistribution.
Centrally planned economy
An economy in which government decides how resources will be allocated
Market economy
Answers to three basic questions are provided by
everyone.
An economy that relies on private ownership of resources in which the decisions of households and firms interacting in markets to allocate economic resources.
Two distinguishing features: (1) markets reward people’s hard work. This is because there is competition.
(2) decision making is shared by everyone in the market
Mixed economy
All modern economies are mixed economies.
An economy where most economic decisions result from the interaction of buyers and sellers in the market but in which the government plays a significant role in the allocation of resources.
Productive efficiency
Good or service is produced at the lowest possible cost
Allocative efficiency
Good or service is produced in accordance with consumer preferences. Every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal (additional) cost of producing it (MB =MC).
Ex. a society with a younger population prefers production of education over production of healthcare
Economic efficiency
Productive efficiency + allocative efficiency
Voluntary exchange
A situation that occurs in markets when both the buyer and seller of a product are made better off by the transaction. Promote competition which in turn promotes both productive and allocative efficiency.
Equity
The fair distribution of economic benefits. It’s the concept of fairness.
How to develop an economic model?
- Decide on the assumptions to use in developing the
model. - Formulate a testable hypothesis
- Use economic data to test the hypothesis
- Revise the model if it fails to explain the economic data well.
- Retain the revised model to help answer similar economic questions in the future.
What is the role of assumptions in economic models?
Economic models make behavioural assumptions about the motives of consumers and firms.
Economic variable
Something measurable that can have different values, such as the incomes of farmers, household expenditure
What is the “scientific method” in economics?
The process of developing models, testing hypotheses, and revising models is often referred to as the scientific method, which economics applies to the study of the interactions among individuals.
