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FINAL STUDY GUIDE 1

FINAL STUDY GUIDE 1 - ECON Midterm I Review Chapter 1 TEN...

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ECON Midterm I Review Chapter 1: TEN PRINCIPLES OF ECONOMICS HOW PEOPLE MAKE DECISIONS Principle 1: People Face Tradeoffs Efficiency : getting the most out of scarce resources v. Equity: distributing prop fairly Example : A student having to study for Psych and English, every hour she studies one subject, she gives up an hour spent on the other subject Example : To equity but redistributing income through welfare and taxes will efficiency as peoples reward for working hard is reduced o As govt tries to cut eco pie into more equal slices, pie gets smaller Principle 2: The Cost of Something Is What You Give Up To Get It Opportunity Cost: what you give up to get an item Example : Choosing to go to college is not just the cost of tuition, but the foregone wages of not getting a job Principle 3: Rational People Think At The Margin Marginal Changes : small incremental adjustments to a plan of action Rational people compare marginal benefits to marginal costs Example : Cost of an airline ticket is $500, but plane is about to take off with 10 empty seats, should airline accept offer of $300? YES b/c average cost is $500 but marginal cost is cost of soda and bag of peanuts People’s willingness to pay for any good is based n the marginal benefit that an extra unit of the good would yield, depending on how many units a person already has. o Why people pay so much for diamonds and so little for a cup of water is because water is plentiful but by contrast, no one needs diamonds to survive but because they’re so rare ppl consider the marginal benefit of an extra diamond to be large Marginal benefit > marginal cost Principle 4: People Respond To Incentives Incentive : something that induces a person to act Example : when price of an apple rises people eat pears (substitutes) at the same times, apple orchards hire more workers to harvest more apples b/c benefit of selling an apple higher Example : Tax on gasoline drives people to use smaller cars HOW PEOPLE INTERACT Principle 5: Trade Can Make Everyone Better Off Trade allows each person to specialize in the activities he or she does best By trading people can get a greater variety of goods and services at lower cost Principle 6: Markets Are Usually a Good Way to Organize Economic Activity Market : Group f Buyers and Sellers o Firms decide whom to hire and what to make
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o Households decide which firms to work for and what to buy with their incomes “Invisible Hand:” leads to desirable market outcomes o Prices reflect goods' value to buyers and cost of producing the good o Process guide self-interested households/firms to make decisions that maximize societies eco well being The gov’t can interfere with Invisible Hand: taxes distort prices and thus decisions of households and firms Principle 7: Governments Can Sometimes Improve Market Outcomes Govt must enforce rules and maintain institutions that are key to market economy
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