• Marginal cost and benefit (M C and M B): the additional cost or benefit associated

with a small amount extra of some action.

Comparing M C and M B is known as Marginal Analysis

• Opportunity cost: the value of the best alternative given up.

• Example: the opportunity cost of increased funding for health care might be fewer
university scholarships.

TYPES OF ECONOMY

• Market: A group of buyers and sellers of a good or service

• Centrally planned economies: government committees explicitly answer the three

basic questions (What, how, who?).

• Market economies: households and firms answer the three questions every time they
make a choice.

• Mixed economies: some central planning and some markets

• Canada is a mixed economy.

– Hospitals are centrally planned by provincial governments

– Fast food is organized by markets

CENTRAL PLANNING

• Central planning requires the government to figure out all the different things people
want and how to make those things.

• This is really hard and central planners often get it wrong.

• Market economies promote:

– Productive efficiency, where goods or services are produced at the lowest

possible cost; and

– Allocative efficiency, where production is consistent with consumer

preferences: the marginal benefit of production is equal to its marginal cost

• Markets rely on voluntary transactions.

Important Features of Economic Models

Role of Assumptions: every model needs them in order to be useful.

Hypothesis Testing: good models generate testable predictions, which can be verified or
disproven using data.

Economic variables: something measurable that can have different values, such as the incomes
of doctors.

Two types of analysis:

• Positive analysis: analysis relying on facts or logic.

• Normative analysis: analysis relying on value judgments.

– Words like “should” or “ought” are often used.

Terminology

• Technology: the processes a firm uses for turning inputs into outputs of goods and
services

• Capital: durable manufactured goods that are used to produce other goods and
services

Positive and Negative Relationships

In a positive relationship between two economic variables, as one variable increases, the other
variable also increases.

In a negative relationship, as one variable increases, the other decreases.

• The relationship between two variables is linear when it can be represented by a

straight line.

• Few economic relationships are actually linear. However linear approximations are
simpler to use, and are often “good enough” in modeling.

Formula for a Percentage Change

What Causes the U.S.—China Trade Deficit?

China produces many consumer goods at lower costs than other countries can. Buyers,
including those in the United States, are drawn to low prices. Most economists agree that
China's competitive pricing is a result of two factors:
  A lower standard of living, which allows companies in China to pay lower wages to
workers

 An exchange rate that is partially fixed to the value of the dollar

 Labor, goods, and services in China are therefore much cheaper

than in the U.S. If the United States were to implement tariffs or
other policies that influence government agencies and
consumers to purchase goods and services made at home, U.S.
consumers would have to pay higher prices.

 Most people would rather pay as little as possible for computers,

electronics, and clothing—so the U.S. imports much more than it
exports to China. U.S. businesses also use Chinese labor to
assemble or manufacture products to reduce production costs.

U.S. companies that can't compete with cheaper Chinese goods must

find ways to cut costs to stay competitive.

Trade imbalances become an issue when there isn't a relatively equal

amount of trade between trading partners. For example, the U.S. feels
that China isn't living up to its trade obligations, and thus that actions
need to be taken. These usually result in trade embargoes or tariffs
that can raise the costs of imports for the offending nation.

The U.S. economy is affected by the trade deficit. Jobs and capital are
moved offshore, causing financial difficulties for consumers and
smaller businesses.

China is also one of the leading holders of U.S. Treasuries, which it

purchases to reduce the value of its currency, thus allowing it to
maintain a low exchange rate with the dollar. U.S. consumers benefit
from low prices, and the government and economy benefit from capital
being invested into the country.