The

Fundamental

Principles Of

Economics

There are ten fundamental principles of economicsThese principles of economics have been divided under thethree categories as given below.

1 -• How People Make Decision

2 -• How People Interact

3 -

• How the economy as a whole works

How People make decision

Under this category, there are fourprinciple as given below.

1- People face trade-off

2- Cost of something is what yougive up to get some thing

3- Rational people think at themargin

4- people respond to incentives

1-People face trade offsTrade off means balancing twothings that we need or want butwhich are opposite to each other.

In our real life we always face trade off while makingdecision about some thing. It is because to get one thingthat we like, we usually have to give up another thing thatwe like. So making decisions requires trading off one goalagainst another.

2- Cost of something is whatyou give up to get some thing

People face tradeoffs, so makingdecisions requires comparing thecosts and benefits of alternative

courses of action. When you spend a year listening tolectures, reading textbooks, and writing papers, you cannotspend that time working at a job. For you, the wages givenup to attend school are the cost of your education.

The opportunity cost to attend school or having educationare the wages given up.

So the opportunity cost of an item is what you giveup to get that item. When making any decision, decisionmakers should be aware of the opportunity costs.

3- Rational people think atthe margin

In economics it is assumed thatpeople are rational and rationalpeople make the best decisions by

thinking at the margin (edge)or comparing additional costfor extra benefits.

Suppose you have been to market for shopping from yourhouse by bus by paying Rs.50 bus-fare. There is also circus-show atone corner in the market. You like to watch it but whether to watchit today or come to the next day to watch it, to decide it, youcompare the cost for coming in next day Rs.50 bus-fare + Rs.20circus charge against benefit or utility from watching circus todayorthenextday.

4-People respond toincentivesIncentive means something thatencourages people to dosomething. People make decisionsby comparing costs and benefits,

their behavior may change when the costs or benefitschange. That is, people respond to incentives. When theprice of an apple rises, for instance, people decide to eatmore pears and fewer apples, because the cost of buying anapple is higher. At the same time, apple orchards decide tohire more workers and harvest more apples, because thebenefit of selling an apple is also higher. Thus peoplerespond to incentives.

How People interact

Under this category, there are three principle as given below.

5- Trade can make every one betteroff

6- markets are usually a good way

to organize economic activity

7- Government can sometimes

improve market outcomes

5-Trade can make every onebetter offEither we talk about individuals,society or countries, trade canmake everyone better off. If there

were no trade, we would make every thing that we needby ourselves. Perhaps we would lack to get much that werequire but it is trade that allows individuals, firms orcountries to specialize in that what they do best and enjoya wider variety of goods. Therefore, trade is the one thatcan make everyone better off.

6-Markets are usually agood way to organizeeconomic activity.Markets are usually good way toorganize economic activity. Today,most countries that once had

centrally planned economies have abandoned this system

and are trying to develop market economies. In a marketeconomy, the decisions of a central planner are replaced bythe decisions of millions of firms and households. Firmsdecide whom to hire and what to make. Households decidewhich firms to work for and what to buy with theirincomes. These firms and households interact in themarketplace, where prices and self-interest guide theirdecisions of making economic activities. Thus markets areusually good way to organize economic activities.

7- Government cansometimes improvemarket outcomesMarkets are usually a good way toorganize economic activity. It istrue if only govt. play a crucial role

to settle markets. Govt. provide legal safety to theeconomic agents i.e. producers, firms and consumers.Importantly, markets work only if property rights areenforced. For example, a farmer won’t grow food

if he expects his crops to be stolen, a restaurant won’tserve meals unless it is assured that customer will paybefore they leave. We will rely on govt. provided police &courts to enforce our rights over the things we produce.

And sometimes markets fail to work due to someexternal effects. There is less efficiency, less equality, lackof efficient allocation resources. In such a condition govt.can intervene and improve market outcomes by its publicpolicy.

• Country’s standard of living depends on its ability to produce goods and services.8-

• Prices rise when government prints to much money9-

• Society faces a short-run trade-off between inflation and employment10

How the economy as a whole works

8- Country’s standard of living depends on its ability toproduce goods and services.

The living standard of a country or its peopleprimarily depends on its ability to produce goods andservices. The more the ability to produce goods andservices, the more the people can enjoy required goodsand services and maintain high standard of living.Conversely, where there is low productivity, most of thepeople are compelled to spend a miserly life.

9- Prices rise when government prints to much moneyThe variation in prices of goods and services also

depends on the quantity of money supply in the economy.When the govt. creates large amount of money and letthem go in the circulation, the value of money goes downand prices of goods and services rises. The continuous andsustained rise in price level in called inflation. If such asituation is not timely checked, it brings an adverse effectin the economy.

10- Society faces a short-run trade-off betweeninflation and unemployment,

There is a short-run trade off between inflation andunemployment. With the increase in quantity of moneysupply, the demand for goods and services goes up. It isbecause there is more amount of money in the hand of thebuyers. Consequently, there is an increase in price level(inflation) and in the meantime it also encourages them toincrease the quantity of goods and services they produce.So the producers employ more workers to produce thosegoods and services. It is, employing more workers meanslower unemployment. Thus there is a short-run trade offbetween inflation and unemployment.

Thank You!