Business Studies

Critical thinking

1. In a market economy resources tend to be allocated optimally. Discuss how the interaction of consumers and producers makes this happen.

2.United States has large trade deficits with many countries. Discuss at least two reasons for the trade deficit. Note: Your discussion must be based on positive economic analysis. Avoid interjecting your own personal opinion.

3.Many economists believe there is a conflict between the economic goals of growth and equity. Do you agree or disagree? Provide your reasons.

Summary of Chapter 1: First Principles:

  1. All economic analysis is based on a set of basic principles that apply to three levels of economic activity. First, we study how individuals make choices; second, we study how these choices interact; and third, we study how the economy functions overall.
  2. Everyone has to make choices about what to do and what not to do. Individual choice is the basis of economics—if it doesn’t involve choice, it isn’t economics.
  3. The reason choices must be made is that resources—anything that can be used to produce something else—are scarce. Individuals are limited in their choices by money and time; economies are limited by their supplies of human and natural resources.
  4. Because you must choose among limited alternatives, the true cost of anything is what you must give up to get it—all costs are opportunity costs.
  5. Many economic decisions involve questions not of “whether” but of “how much”—how much to spend on some good, how much to produce, and so on. Such decisions must be made by performing a trade-offat the margin—by comparing the costs and benefits of doing a bit more or a bit less. Decisions of this type are called marginal decisions, and the study of them, marginal analysis, plays a central role in economics.
  6. The study of how people should make decisions is also a good way to understand actual behavior. Individuals usually respond to incentives—exploiting opportunities to make themselves better off.
  7. The next level of economic analysis is the study of interaction—how my choices depend on your choices, and vice versa. When individuals interact, the end result may be different from what anyone intends.
  8. Individuals interact because there are gains from trade: by engaging in the trade of goods and services with one another, the members of an economy can all be made better off. Specialization—each person specializes in the task he or she is good at—is the source of gains from trade.
  9. Because individuals usually respond to incentives, markets normally move toward equilibrium—a situation in which no individual can make himself or herself better off by taking a different action.
  10. An economy is efficient if all opportunities to make some people better off without making other people worse off are taken. Resources should be used as efficiently as possible to achieve society’s goals. But efficiency is not the sole way to evaluate an economy: equity, or fairness, is also desirable, and there is often a trade-off between equity and efficiency.
  11. Markets usually lead to efficiency, with some well-defined exceptions.
  12. When markets fail and do not achieve efficiency, government intervention can improve society’s welfare.
  13. Because people in a market economy earn income by selling things, including their own labor, one person’s spending is another person’s income. As a result, changes in spending behavior can spread throughout the economy.
  14. Overall spending in the economy can get out of line with the economy’s productive capacity. Spending below the economy’s productive capacity leads to a recession; spending in excess of the economy’s productive capacity leads to inflation.
  15. Governments have the ability to strongly affect overall spending, an ability they use in an effort to steer the economy between recession and inflation.

Summary of Chapter 2: Economic Models: Trade-offs and Trade

  1. Almost all economics is based on models, “thought experiments” or simplified versions of reality, many of which use mathematical tools such as graphs. An important assumption in economic models is the other things equal assumption, which allows analysis of the effect of a change in one factor by holding all other relevant factors unchanged.
  2. One important economic model is the production possibility frontier. It illustrates opportunity cost (showing how much less of one good can be produced if more of the other good is produced); efficiency (an economy is efficient in production if it produces on the production possibility frontier and efficient in allocation if it produces the mix of goods and services that people want to consume); and economic growth (an outward shift of the production possibility frontier). There are two basic sources of growth: an increase in factors of production—resources such as land, labor, capital, and human capital, inputs that are not used up in production—and improved technology.
  3. Another important model is comparative advantage, which explains the source of gains from trade between individuals and countries. Everyone has a comparative advantage in something—some good or service in which that person has a lower opportunity cost than everyone else. But it is often confused with absolute advantage, an ability to produce a particular good or service better than anyone else. This confusion leads some to erroneously conclude that there are no gains from trade between people or countries.
  4. In the simplest economies people barter—trade goods and services for one another—rather than trade them for money, as in a modern economy. The circular-flow diagram represents transactions within the economy as flows of goods, services, and money between households and firms. These transactions occur in markets for goods and services and factor markets, markets for factors of production—land, labor, physical capital, and human capital. It is useful in understanding how spending, production, employment, income, and growth are related in the economy. Ultimately, factor markets determine the economy’s income distribution, how an economy’s total income is allocated to the owners of the factors of production.
  5. Economists use economic models for both positive economics, which describes how the economy works, and for normative economics, which prescribes how the economy should Positive economics often involves making forecasts. Economists can determine correct answers for positive questions but typically not for normative questions, which involve value judgments. The exceptions are when policies designed to achieve a certain objective can be clearly ranked in terms of efficiency.
  6. There are two main reasons economists disagree. One, they may disagree about which simplifications to make in a model. Two, economists may disagree—like everyone else—about values.

Summary of Chapter 3: Supply & Demand

  1. The supply and demand model illustrates how a competitive market, one with many buyers and sellers, none of whom can influence the market price, works.
  2. The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that demand curves slope downward; that is, a higher price for a good or service leads people to demand a smaller quantity, other things equal.
  3. A movement along the demand curve occurs when a price change leads to a change in the quantity demanded. When economists talk of increasing or decreasing demand, they mean shifts of the demand curve—a change in the quantity demanded at any given price. An increase in demand causes a rightward shift of the demand curve. A decrease in demand causes a leftward shift.
  4. There are five main factors that shift the demand curve:
    • A change in the prices of related goods or services, such as substitutes or complements
    • A change in income: when income rises, the demand for normal goods increases and the demand for inferior goods decreases
    • A change in tastes
    • A change in expectations
    • A change in the number of consumers
  5. The market demand curve for a good or service is the horizontal sum of the individual demand curves of all consumers in the market.
  6. The supply schedule shows the quantity supplied at each price and is represented graphically by a supply curve. Supply curves usually slope upward.
  7. A movement along the supply curve occurs when a price change leads to a change in the quantity supplied. When economists talk of increasing or decreasing supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price. An increase in supply causes a rightward shift of the supply curve. A decrease in supply causes a leftward shift.
  8. There are five main factors that shift the supply curve:
    • A change in input prices
    • A change in the prices of related goods and services
    • A change in technology
    • A change in expectations
    • A change in the number of producers
  9. The market supply curve for a good or service is the horizontal sum of the individual supply curves of all producers in the market.
  10. The supply and demand model is based on the principle that the price in a market moves to its equilibrium price, or market-clearing price, the price at which the quantity demanded is equal to the quantity supplied. This quantity is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up.
  11. An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect.
  12. Shifts of the demand curve and the supply curve can happen simultaneously. When they shift in opposite directions, the change in equilibrium price is predictable but the change in equilibrium quantity is not. When they shift in the same direction, the change in equilibrium quantity is predictable but the change in equilibrium price is not. In general, the curve that shifts the greater distance has a greater effect on the changes in equilibrium price and quantity.

Summary of Chapter 22: GDP and CPI: Tracking the Macroeconomy.


  1. Economists keep track of the flows of money between sectors with the national income and product accounts, or national accounts. Households earn income via the factor markets from wages, interest on bonds, profit accruing to owners of stocks, and rent on land and structures. In addition, they receive government transfers from the government. Disposable income, total household income minus taxes plus government transfers, is allocated to consumer spending (C) and private savings. Via the financial markets, private savings and foreign lending are channeled to investment spending (I), government borrowing, and foreign borrowing. Government purchases of goods and services (G) are paid for by tax revenues and any government borrowing. Exports (X) generate an inflow of funds into the country from the rest of the world, but imports (IM) lead to an outflow of funds to the rest of the world. Foreigners can also buy stocks and bonds in the U.S. financial markets.
  2. Gross domestic product, or GDP, measures the value of all final goods and services produced in the economy. It does not include the value of intermediate goods and services, but it does include inventories and net exports(XIM). It can be calculated in three ways: add up the value added by all producers; add up all spending on domestically produced final goods and services, leading to the equation GDP = C + I + G + XIM, also known as aggregate spending; or add up all the income paid by domestic firms to factors of production. These three methods are equivalent because in the economy as a whole, total income paid by domestic firms to factors of production must equal total spending on domestically produced final goods and services.
  3. Real GDP is the value of the final goods and services produced calculated using the prices of a selected base year. Except in the base year, real GDP is not the same as nominal GDP, the value of aggregate output calculated using current prices. Analysis of the growth rate of aggregate output must use real GDP because doing so eliminates any change in the value of aggregate output due solely to price changes. Real GDP per capita is a measure of average aggregate output per person but is not in itself an appropriate policy goal. U.S. statistics on real GDP are always expressed in chained dollars.
  4. To measure the aggregate price level, economists calculate the cost of purchasing a market basket. A price index is the ratio of the current cost of that market basket to the cost in a selected base year, multiplied by 100.
  5. The inflation rate is the yearly percent change in a price index, typically based on the consumer price index, or CPI, the most common measure of the aggregate price level. A similar index for goods and services purchased by firms is the producer price index, or Finally, economists also use the GDP deflator, which measures the price level by calculating the ratio of nominal GDP to real GDP times 100.



Last Updated on January 19, 2018