1 1.2 Economic Theory

2 The Role of Theory Economists develop theories, or ________________ to help explain economic behavior. An economic theory is a simplification of economic reality that is used to make ________________ about the real world, such as what happens to the consumption of Pepsi when its cost increases. To help develop theory, economists make simplifying assumptions. One category of this is the other things _______________________ assumption. This involves identifying and focusing on a variable and assumes nothing else of importance changes.

3 The Role of Theory (continued) Economists also make assumptions about what motivates people – how people behave. These are called ______________ ___________________. The most basic behavioral assumption is that people make choices based on ______________________. Rational self interest means that you try to maximize the expected ____________________ achieved with a given cost, or to minimize the expected _______________ of achieving a given benefit. Rationality implies that each consumer buys the products expected to maximize his or her level of ________________ and that each firm supplies the products expected to maximize that firms _________

4 Normative vs. Positive A positive economic statement is a statement about economic reality that can be supported or rejected by reference to the ____________. A normative economic statement reflects someone’s __________________.

5 Marginal Analysis Marginal means _____________________, additional, extra or one more. A rational decision maker will change the status quo as long as the expected marginal benefit from the change _______________ the expected marginal cost. Rational choice takes time and requires _________________________.

6 Market Economics and National Economics ________________________ focuses on your economic behavior and the economic behavior of others who make choices involving what to buy and sell. Microeconomics is another term for market economics. __________________________ focuses on the performance of the economy as a whole, especially the national economy. Macroeconomics is another term for national economics.

7 Market Participants There are four types of decision makers in the economy – 1. – 2 – 3 – 4 __________________ play the leading role in the economy. ___________________ are the means by which buyers and sellers carry out exchange.