ch1 intro-ten principles

7/31/2019 Ch1 Intro-Ten Principles

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Ten Principles ofEconomics


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Economy. . .

The word economycomes from aGreek word for

one who manages a household.


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A Household and an Economy

Face Many Decisions:

Who will work?

What goods and how many ofthem should be produced?

What resources should be used in

production?At what price should the goods be

sold?


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Society and ScarceResources:

The management of societys

resources is important becauseresources are scarce.

Scarcity. . . means that societyhas limited resources andtherefore cannot produce all thegoods and services people wish tohave.


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Economics is a Science ofScarcity

Economics is the study of howsociety uses scarce resources to

produce valuable commodities anddistribute them among differentpeople.

Scarcity Efficiency


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Overview of the subject

How people make decisions

How people interact with each other

How economy as whole works


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How People Make Decisions

People face tradeoffs.

The cost of something is whatyou give up to get it.

Rational people think at the

margin.People respond to incentives.


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How People Interact WithEach Other

Trade can make everyone better off.

Markets are usually a good way toorganize economic activity.

Governments can sometimes

improve economic outcomes.


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How the Economy as aWhole Works

A Countrys Standard of LivingDepends on its Ability to Produce

Goods and Services Prices Rise When the Government

Prints Too Much Money

Society Faces a Short-Run Trade Offbetween Inflation andUnemployment


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Principle 1: People FaceTrade Offs

To get one thing, we usually have to giveup another thing. Guns v. butter

Food v. clothing

Leisure time v. work

Efficiency v. equity

Making decisions requires tradingoff one goal against another.


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Principle 1: People FaceTrade Offs

Efficiency v. Equity

Efficiencymeans society gets the most

that it can from its scarce resources. Equitymeans the benefits of those

resources are distributed fairly amongthe members of society.


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Principle 2:The Cost of Something is

What you give up to Get it.

Decisions require comparing costsand benefits of alternatives.

Whether to go to college or to work? Whether to study or go out on a date?

Whether to go to class or sleep in?

The opportunity costof an item iswhat you give up to obtain thatitem.


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Principle 3; Rational PeopleThink at Margin

Marginal changes are small,incremental adjustments to an

existing plan of action.

People make decisions by comparing

costs and benefits at the margin.


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Principle 4:People Respondto Incentive

Marginal changes in costs or benefitsmotivate people to respond.

The decision to choose onealternative over another occurswhen that alternatives marginal

benefits exceed its marginal costs!


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Principle 5:Trade Can MakeEveryone Better Off

People gain from their ability totrade with one another.

Competition results in gains fromtrading.

Trade allows people to specialize in

what they do best.


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Principle 6:Markets are UsuallyGood Way to Organise Activity

A market economyis an economy thatallocates resources through thedecentralized decisions of many firms andhouseholds as they interact in marketsfor goods and services.

Households decide what to buy and who to

work for. Firms decide who to hire and what to produce.


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Principle 6:Markets are UsuallyGood Way to Organise Activity

Adam Smith made the observation thathouseholds and firms interacting inmarkets act as if guided by an invisible

hand. Because households and firms look at prices

when deciding what to buy and sell, theyunknowingly take into account the social costs

of their actions. As a result, prices guide decision makers to

reach outcomes that tend to maximize thewelfare of society as a whole.


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Principle 7:Government CanSometimes Improve the Market

Outcome

Market failure occurs when themarket fails to allocate resourcesefficiently.

When the market fails (breaksdown) government can intervene topromote efficiency and equity.

Principle 7:Government Can


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Principle 7:Government CanSometimes Improve the MarketOutcome

Market failure may be caused by

an externality, which is the impact of

one person or firms actions on thewell-being of a bystander.

market power, which is the ability of asingle person or firm to unduly

influence market prices.


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Principle 8: Standard of LivingDepends on Countrys Production

Standard of living may be measuredin different ways:

By comparing personal incomes. By comparing the total market value of

a nations production.


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Almost all variations in livingstandards are explained by

differences in countriesproductivities.

Productivityis the amount of goods

and services produced from eachhour of a workers time.


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Standard of living may be measuredin different ways:

By comparing personal incomes. By comparing the total market value of

a nations production.

Principle 9: Prices Rise when


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Principle 9: Prices Rise whenGovernment Prints Too MuchMoney

Inflation is an increase in the overalllevel of prices in the economy.

One cause of inflation is the growthin the quantity of money.

When the government creates large

quantities of money, the value ofthe money falls.

Principle 10:Society Faces Short Term


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Principle 10:Society Faces Short TermTrade Off Between Inflation and

Unemployment

The Phillips Curve illustrates thetradeoff between inflation and

unemployment:Inflation Unemployment

Its a short-run tradeoff!

ch1 intro-ten principles

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