101chapter4 - Chapter 4. Economic Theory, Markets, and...

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Chapter 4. Economic Theory, Markets, and Government Economic Theory Market Failure The Role of Government
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I. Economic Theory Elements objectives constraints choices
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objectives what do we want to do? people: maximize satisfaction firms: max. profits gov't: max. re-election or budget
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constraints limits on how we achieve objectives physical (PPC) financial (budget constraint) legal (property rights)
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choices a statement about likely choice law of demand law of supply
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key assumption people are rational people make best decision give their objectives and constraints rational decisions are consistent forward-looking
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rationality full use all available info when making decisions bounded limited ability to process information
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self-regarding preferences maximize own satisfaction other-regarding preference max. own and others' satisfaction care what others think
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combine theory with observation simplest theory, consistent with observation (Ockham's razor) Theory vs. observation
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match theory? modify theory
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101chapter4 - Chapter 4. Economic Theory, Markets, and...

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