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Chapter Review Chapter 2: Thinking Like an Economist

  1. The basic competitive model consists of rational, self-interested individuals and profit-maximizing firms, interacting in competitive markets.
  2. The profit motive and private property provide incentives for rational individuals and firms to work hard and efficiently. Ill-defined or restricted property rights can lead to inefficient behavior.
  3. Society often faces choices between efficiency, which requires incentives that enable people or firms to receive different benefits depending on their performance, and equality, which entails people receiving more or less equal benefits.
  4. The price system in a market economy is one way of allocating goods and services. Other methods include rationing by queue, by lottery, and by coupon.
  5. An opportunity set illustrates what choices are possible. Budget constraints and time constraints define individ¬ uals’ opportunity sets. Both show the trade-offs of how much of one thing a person must give up to get more of another.
  6. A production possibilities curve defines a firm or society’s opportunity set, representing the possible combinations of goods that the firm or society can produce. If a firm or society is producing below its production pos¬ sibilities curve, it is said to be inefficient, since it could produce more of either good without producing less of the other.
  7. The opportunity cost is the cost of using any resource. It is measured by looking at the next-best use to which that resource could be put.
  8. A sunk cost is a past expenditure that cannot be recovered, no matter what choice is made in the present. Thus, rational decision makers ignore them.
  9. Most economic decisions concentrate on choices at the margin, where the marginal (or extra) cost of a course of action is compared with its extra benefits.
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