Unit 2 Study Guide: Basic Economic Concepts

There are 6 major concepts you will be tested on in this unit:

  • Costs and Benefits
  • Scarcity
  • Incentives
  • Marginal Analysis
  • Socio-Economic Goals
  • Types of Economies

This study guide is organized around these 6 major concepts. Under each concept, you have a list of terms that you will need to be able to define, recognize, and apply, a list of concepts you will need to understand in depth, and some practice questions to test your knowledge.

Costs and Benefits

Vocabulary

Trade-OffOpportunity CostCostsBenefits Wants NeedsEconomics

Concepts to know

  • Economic Decision-making Models
  • Why economists study decisions, not money
  • Opportunity cost vs. Monetary Cost
  • Why opportunity cost is more important
  • Why nothing is free according to an economist
  • How costs and benefits guide decision-making

Check yourself (To do this well, you will need to answer on a separate sheet of paper!)

  1. You decide to spend $1000 to vacation on a cruise ship. What is your opportunity cost? Why?
  2. Define economics.
  3. Economic analysis is a framework for understanding issues that arise because societies have to make ______about how to allocate resources.
  4. According to economists, the real cost of anything is ______
  5. A person who accepts lower wages for higher health benefits is engaging in a ______.
  6. Your mom orders an extra-large pizza - your favorite kind. When will you stop eating it? How would you phrase this in economic terms?

Scarcity

Vocabulary

ScarcityShortageFactors of ProductionLand Labor Capital Physical Capital Human Capital Goods Services Entrepreneurship

Concepts to know

  • Why scarcity is so important in economics
  • Why scarcity always exists in every society
  • The difference between scarcity and a shortage
  • Which factors of production would go into a specific product – categorize as land, labor, capital

Check yourself

  1. You are starting a new business.
  2. What is your business?
  3. What factors of production will you need? Make 4 columns: Land/Labor/Physical Capital/Human Capital
  4. The major problem facing all economic systems is related to ______. Explain why.

Incentives

Vocabulary

IncentiveUnintended ConsequencesVoluntary exchangeProfit motive

Concepts to know

  • Why anything can be an incentive
  • Relationship between private property and incentives
  • Relationship between public property and incentives (rhino’s, fishermen)
  • Relationship between rules, incentives, and behavior

Check yourself

  1. Think about a problem facing society at any level (school, city, state, country, etc).
  2. What is the problem?
  3. What incentives are causing the problem?
  4. Create incentives to solve the problem.
  5. What are possible perverse incentives/unintended consequences created by your solution.
  6. Who benefits in a voluntary exchange, the buyer or the seller?
  7. Why do people take better care of a house they own compared to a home they rent?

Marginal Analysis

Vocabulary

Thinking at the MarginMarginal CostsMarginal Benefits Production Possibilities Graph/Curve/Frontier Efficiency Underutilization

Concepts to know

  • What different things mean on a production possibilities curve
  • what makes them move
  • guns and butter
  • production possibilities in the U.S. during the Great Depression and World War II
  • think about how it changed from the Great Depression, the beginning of World War II, and later into World War II
  • How a production possibilities curve shows fundamental economic concepts
  • scarcity
  • efficiency
  • choice
  • opportunity cost
  • marginal analysis

Check yourself

  1. Create a generic production possibilities graph for the U.S. economy’s production of wheat and corn.
  2. What scarcity issues cause the U.S. to haveto choose between the two?
  3. Draw a graph showing the effect of a new harvesting machine that speeds up the production of wheat.
  4. Suppose farmers are only farming half their land. Draw this point on your graph. What is happening here?
  5. Suppose your alarm clock goes off at 6:00 every morning. Use marginal analysis to decide how many times you would hit the snooze alarm. Draw a chart!
  6. Explain your decision in #2 using the terms “marginal cost” and “marginal benefit”
  7. List three ways in which any location could expand its production possibilities. (You can pick a specific location or just be generic!)

Socio-Economic Goals

Vocabulary

Safety NetEconomic EquityEconomic SecurityEconomic Stability Price Stability Unemployment Standard of Living Economic Efficiency Economic Freedom Economic Growth

Concepts to know

  • How different economies prioritize the various socio-economic goals
  • Examples of policies promoting the various goals

Check yourself

  1. Why is it hard for a society to achieve both freedom and equity?
  2. What effect does freedom seem to have on efficiency and growth? Why?
  3. What unintended consequences seem to happen in societies that guarantee complete security and equity for all individuals no matter what?

Types of Economies

Vocabulary

Economic SystemFactor PaymentsTraditional EconomyMarket EconomyMixed Economy Command/Centrally Planned Economy Specialization Household Firm Profit Profit Motive Incentive Competition Self-Interest Invisible Hand Laissez Faire Privatize Market Product Market Factor Market Circular Flow Socialism Communism

Concepts to know

  • The three questions
  • The role of scarcity in an economic system
  • Circular flow model
  • How the model looks in a market vs. a mixed economy
  • Important characteristics of the three types of economies
  • How the U.S. is and is not like a free market economy
  • How Adam Smith’s invisible hand works
  • Role of government in a market economy
  • Role of government in a centrally planned/command economy
  • Power of individuals/households in a market economy
  • factors of production
  • production decisions

Check yourself

  1. What are the three economic questions? Using just one word, why must they be answered?
  2. The United States is a Mixed Economy. Create a chart with 2 columns labeled Market Economy/Centrally Planned Economy that shows our special mixture.
  3. The major purpose of any economic system is to deal with problems caused by ______.
  4. Whose decisions have the most influence in a market economy?
  5. Why can it be said that consumers in a market economy “vote with their dollars”?
  6. In the United States, how would a producers know how much to produce?
  7. Explain the two factors that contribute to the invisible hand. Why did Adam Smith argue that this would work?
  8. Who must own all resources in a market economy? Why is this so important?
  9. How do prices act as communication tools in a market economy?
  10. Why do firms in a market economy try to give consumers what they want at a good price?

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