Microeconomics Chapters 1-3

Micro – Review Notes: Ch. 1 Introduction to Economic Analysis  Microeconomics – the sturdy of choices made by consumers and firms, markets and their consequences, and the role of government in influencing the outcomes of markets  Efficiency – the production of goods and services in a way that will maximize our satisfaction, given the existing amount of labor, machines, and other resources  Economic resources – labor, capital, and our natural resources that can be used to produce goods and services  Scarcity – our wants are greater than our abilities to satisfy them. This leads to necessity for making choices about how we use our resources  Anything becomes scarce if it uses resources that have an alternative use  Choices for an economic system: Every economy must answer the questions – what to produce, how to produce, and for whom to produce  Opportunity cost – what one actually gives up doing when making a choice. It is the value of the best forgone alternative  Sunk cost – a cost that has been already been paid and cannot be recovered  Fixed costs – costs that do not change as we make a decision  Marginal benefit – the increase in benefits resulting from an action or the increase in benefits resulting from producing one more unit of output.  Marginal cost – the increase in costs resulting from an action or the increase in costs resulting from producing one more unit of output.  A decision-making rule – If the additional benefits are greater than the additional costs incurred, go for it. If the additional costs are greater than the additional benefits, do not do it.  Rational decisions are those that make us better off than we were before the decisions were made.  Scarcity and the desire to be as well of as we can possibly be lead us to specialize.  Market – method through which buyers and sellers come together and in so doing determine the prices of goods and the quantities that will be exchanged.  The purpose of money is to make the process of buying and selling our labor and our goods and services easier.  We use markets in our economy to determine what we produce, how we produce, and for whom we produce. Ch. 2 An Economic Model  Economic model – abstract description of a part of an economy. Simplifying assumptions are made, with a goal of understanding and explaining the effects of economic events.  Production possibilities frontier – an economic model showing possible combinations of outputs, given resources and technology  Diminishing Marginal Returns – increasing one input, while holding all other inputs constant, will eventually result in smaller and smaller additions to output. This law is relevant over relatively short periods of time and less relevant over the longer periods.  Principle of increasing marginal costs – as we increase the production of a good, the opportunity cost of producing one more unit of output eventually increases.  Increasing marginal costs result directly from diminishing marginal returns.  Economic efficiency – an economy is satisfying as many of our wants as possible, given our resources. To be economically efficient we must be using all of its resources, technically efficient, and allocatively efficient.  Technical efficiency – the economy is getting the most output from our labor, capital, and land.  Allocative efficiency – given our wants, is the economy producing the kinds of goods and services we value most?  Reaching a point currently outside of the production possibilities frontier is impossible, without more resources or a change in technology. Ch. 3 The US and the World Economy  One way to measure the success of any economy is to see how much it produces.  Gross Domestic Product – the value of all of the final goods and services produced in a country in a year  Economists measure growth in our economy by looking at real GDP, that is, the actual production of goods and services valued at previous prices rather than current prices. The purpose of this adjustment is to eliminate the effects of inflation.  If GDP grows faster than population, we, on average, all have higher standards of living. If population grows faster than GDP, then we are on average worse off.  Of all three measures – GDP, real GDP, and real GDP per capita – real GDP per capita is the best measure of our well-being.  GDP = Consumption + Investment + Government Spending + Net Exports (Exports – Imports)  Consumption – total spending by individuals on consumption goods and services  Investment – spending on new buildings, machines, tools, and new residential construction. Additions to inventories are also included. Investment spending represents an increase in capacity to produce future output.  Government spending – total spending on goods and services by all levels of government. This does not include expenditures normally described as transfer payments – social security, unemployment compensation, and welfare payments  Exports and imports are the total amounts spend in US dollars on goods and services that are exported and imported  Even without a recession, if real GDP is growing more slowly than the labor force, unemployment increases.  Unemployed – individuals without jobs and actively looking for work  The unemployment rate is defined as the number of individuals unemployed divided by the labor force.  Inflation – continual increase in the average price level  Deflation – continual decrease in the average price level  Unemployment means that we are not using all of our available resources. We could be better off. Thus, one of the costs of unemployment is that our economy is not producing as much as it could. Obviously, there are tremendous personal costs borne directly by those who lose their jobs. They have less income and in most cases are forced to change their living standards. So if inflation means that resources are devoted to reducing the effects of inflation and that therefore, few resources are left over to produce other meaningful goods and services, we will not be as well-off as we possibly can be. We are not economically efficient.