Economics Dr.

Sauer

Chapter 1 Reading Guide: Power of Markets I. Introduction Berlin Wall & Coca-Cola example:

The market aligns incentives in a way that individuals working in self-interest leads to a better standard of living for society as a whole. A modern economy is complex. In a modern economy our lives are getting better. Example 1:

Example 2:

Anecdotes for a market economy vs centrally planned economy:

Economics is Technical Definition: economics is the discipline that studies how people, firms and governments use their scarce resources, and the consequences of those decisions.

According to a fundamental economic assumption, what do individuals do?

Think of 3 examples from your own life: 1)

2)

3)

II. How Individuals Behave Individuals attempt to make themselves as well off as possible, given their individual preferences. Think of some examples of how your personal preferences might differ from that of someone in a developing nation.

Utility maximizing behavior isnt the same thing as being selfish. Explain.

Life is complex and uncertain. Every decision we make involves a tradeoff. Give an example of a tradeoff involving - a present activity and future activity - work vs leisure/family time - two desirable activities in the present Whenever we make a decision, we are weighting the benefits and costs of the action. Benefits can be things other than money. Explain.

Costs can be things other than money. Explain.

Technical definition: An opportunity cost is the cost of any activity as measured by the next-best forgone alternative. Give some examples of how your own behavior is influenced by cost.

Relationship between price of cocaine and cocaine users:

Relationship between price of cigarettes and smoking impact:

Relationship between cost of raising children and fertility:

III. How Firms Behave The goal of a firm is to maximize profits. (Yes, there are non-profit firms but they are relatively small in number as compared to the for-profit firms. The economics of non-profits is an advanced topic to explore) Examples of inputs:

Examples of outputs:

Firms have 5 main decisions to make. 1) 2) 3) 4) 5) A market economy will direct resources to their most productive use. Prices will signal information about the most valuable use. Tuna fishing example:

Profit opportunities attract firms to the market. Explain.

Explain the superstar phenomenon:

Even when there are profit opportunities, sometimes firms are prohibited from entering a market or face obstacles to entering the market. Technical Definition: Barriers to entry are the obstacles that a firm faces when trying to enter a market or industry. Barriers can be legal, geographic or cost-related. Examples of Barriers to Entry:

IV. Prices In a competitive market, the price will settle where the quantity offered for sale matches the quantity that people are willing and able to purchase. If the quantity offered for sale is less than the quantity that customers are looking to purchase, the price of the item will _________________________. If the quantity offered for sale is greater than the quantity that customers are looking to purchase, the price of the item will _________________________. Many firms have some degree of control over the price they charge. What is price discrimination?

Examples:

Think of an example from your own life where you benefited from price discrimination. 4

V. Market Economies Make Our Lives Better Explain how markets and competition are good for consumers.

VI. Markets are Amoral Explain what we mean by amoral.

Give an example of innovations that criminals have come up with.

VII. Prices are Used to Allocate Scarce Resources in a Market System Explain how a centrally planned economy allocates resources.

VIII. Markets that Use Prices are Self-Correcting Explain.

IX. Firms Will Find a Way to Compete Even if Prices are Fixed Airline Example:

South Africa Example:

X. Market Transactions Make Involved Parties Better Off Explain.

XI. Behavioral Economics Economics assumes that people act rationally. That is, in a way that makes them better off, not worse off. Give some examples of how people act irrationally.

Bounded rationality means:

Give examples of common thinking errors that people make. Poor sense of risk and probability:

Lack of self-control:

Lack of information to make informed decision:

Thinking we see patterns:

Give an example from your life where you fell victim to one of the above errors.

___________________________________________________________________________________ In your own words, summarize the main points of this chapter.