Allison Minott

Chapter 1: Economics: Foundations and Models

This chapter begin with talking about how choices affect how and when we reach our goals. The
fact is that we have such limited time and resources to get what we need and want out of life.
Economics-The study of the choices people make to attain their goals, given their scarce resources. The
main ideas to economics is said to be that people are rational, people tend to respond to economic
incentives, and that optimal decisions are made at the margin. In regard to people being rational,
economists believe that consumers make purchases by weighing the benefits versus the cost. If the
benefit outweighs the cost, then the purchase was a rational one. When referring to people responding
to economic incentives, they offer an example that is self-explanatory: If a bank loses $1,200 in a
robbery, yet it would cost almost 100,000 to take the necessary security measures. This concept states
that the bank would chose the robbers over security because it would put them at less of a loss. The
statement “Optimal decisions are made at the margin” means that what little choices you make
eventually snowball into either benefits or costs. Packing your lunch everyday would be a marginal
benefit (MB) because you’re saving a little bit of lunch money at a time. Meanwhile, eating out every
day would be considered a marginal cost (MC) because you’re losing a bit of funds every day. This
chapter mentions also, marginal analysis, which is when you compare your MB’s to your MC’s. The
objective, from an economists point of view, is to continue any activity up until the point where the MB
is equal to your MC. If you make no revenue, what is the point?

This chapter then goes on to say that any society goes through the “economic problem” which is
the fact that there are such minimal resources to work with (workers, raw material, machines etc.). To
counteract this issue, there are trade-offs (you produce more of one product/service, you must produce
less of another.). When evaluating marketing, you first must decide the Opportunity cost, which is the
value of what you are giving up to do said activity (sell goods/services.). To better understand your
market, 3 main questions must be asked: How, what, who? What’s being produced? How is it being
produced? Who is it being produced for? When you know the answer to these questions, you have
enough information to find your Opportunity cost.

To answer the Who what how question, economies use two methods. They could have a
centrally planned economy, where the government decided where economic resources are allocated.
And there is the market economy, which decides by purchase where resources are allocated. Centrally
planned economies tend to not flourish because the need to satisfy government regulations overtakes
the need for consumer satisfaction. They also tend to be unsuccessful in producing low-cost, high quality
produce and services. Market economies tend to rely on privately own firms to decide what and how
something is produced. Because there is more pressure to produce low cost products, market
economies often feel the pressure to find lost-cost production methods. The consumer’s dissatisfaction
means the firms downfall. During the Depression, the government began to regulate the market
economy sue to unemployment. This turned market economies into mixed economies, which were
mostly market because it was still consumer’s tastes, but now the government plays a large role in
determining where the resources are allocated.

Market economies tend to be more efficient than centrally planned economies. There are two
efficiencies to base them off of: allocative efficiency (product is in accordance with consumer
preferences.) and productive efficiency (product/service is produced at the lowest cost). The market
economy is also better at voluntary exchange (consumer and seller are better off because of purchase).
In product efficiency, sellers find a good mix of low cost products and services that creates a margin
benefit. Equity (the fair distribution of economic benefits) can be explained as the off set to efficiency
because you often have to trade one for the other. For everyone to be on level playing fields
economically, that blurs the lines of efficiency because consumer preferences change and businesses
collapse, leaving the working class vulnerable at the end.

Section 3 of Chapter 1 discusses economic models (simplified versions of reality). One purpose
of economic models is to make economic ideas sufficiently explicit and concrete so that individuals,
firms, or the government can use them to make decisions. There are standard models that economists
can use, but when creating their own, they use the following guideline: 1. Decide on the assumptions to
use in developing the model. 2. Formulate a testable hypothesis. 3. Use economic data to test the
hypothesis. 4. Revise the model if it fails to explain the economic data well. 5. Retain the revised model
to help answer similar economic questions in the future. Any model is produced by making assumptions
because models have to be simplified to be useful.

In creating a model, economists have to have several elements. One would be a hypothesis,
which usual involves relationships of elements. An economical variable (ex. Doctor’s salaries can vary)
sometimes shows up when you are dealing with general statistics. Then you test your hypothesis by
analyzing the statistics on the relevant economic variables. Hypothesis’ can be incorrect and therefor
aren’t to be taken as fact. Economists hesitantly accept proven hypotheses because new data can
render the information incorrect throughout time. The process of developing models, testing
hypotheses, and revising models occurs not just in economics but also in disciplines such as physics,
chemistry, and biology. This process is often referred to as the scientific method. Economics is a social
science because it applies the scientific method to the study of the interactions among individuals.

Positive analysis is concerned with what is, and normative analysis is concerned with what ought
to be. Economics is about positive analysis, which measures the costs and benefits of different courses
of action. Microeconomics is the study of how households and firms make choices, how they interact in
markets, and how the government attempts to influence their choices. The level of total investment by
firms in new machinery and equipment helps to determine how rapidly the economy grows—which is a
macroeconomic issue. But to understand how much new machinery and equipment firms decide to
purchase, we have to analyze the incentives individual firms face—which is a microeconomic issue.
These are examples in which Microeconomics and macroeconomics differ.