Econs midterm - ten principles of economics (1)

Scarcity

The limited nature of society’s resources: Society has limited resources and, therfore, cannot produce all the goods anf service people want

Economics

They study of how society manages its scarce resources

Economicsts examine

How people decide how much they work, what they buy, how much they save, and how they invest their savings 

How firms decide how much to produce and how many workers to hire 

Forces and trends that affect the overall economy: graoth in average income, unemployment, rate at which prices are rising 

Principle 1: People face trade-offs (Definition)

To get one thing you want, you usually must give up another thing you want. Making decisions: trading off one goal for another 

Principle 1: People face trade-offs (Example)

Efficiency: Society gets the maximum benefits from its scarce resources 

Equality: Economic prosperity is distributed uniformly among society’s members 

To achieve greater equality, we could redistribute income from the wealthy to the poor. But this reduces incentive to work and produce, shrinking the size of the economic “pie”

Principle 2: The cost of something is what you give up to get 

Making decisions: 

• Compare costs with the benefits of alternative decisions 

• Need to include opportunity costs 

Opportunity cost of an item 

• Whatever must be given up to obtain it 

Principle 3: Rational people think at the margins

Rational people 

• Systematically and purposefully do the best they can to achieve their goals, given the available opportunities 

• Make decisions by evaluating the costs and benefits of marginal changes (small incremental adjustments to a plan of action; marginal benefit vs. marginal cost) 

Principle 4: People respond to incentives

Incentive

• Something that induces a person to act

• Can have unintended consequences

People respond to incentives

• Because rational people make decisions by comparing costs and benefits

An increase in the price of doughnuts

• Consumers buy fewer doughnuts

• Sellers produce more doughnuts

Principle 5: Trade can make everyone better off

People benefit from trade

• People can buy a greater variety of goods and services at a lower cost

Countries benefit from trade

• Allows countries to specialize in what they do best

• Enjoy a greater variety of goods and services

Principle 6: Markets are usually a good way to organize economic activity (1)

Market 

• A group of buyers and sellers (need not be in a single location) 

Organize economic activity 

• What goods and services to produce 

• How to produce these goods and services 

• How to allocate them to their final use 

Principle 6: Markets are usually a good way to organize economic activity (2)

Market economy 

• Allocates resources through the decentralized decisions of many firms and households (as they interact in markets for goods and services)

• Proven remarkably successful in organizing economic activity to promote prosperity 

Principle 6: Markets are usually a good way to organize economic activity (3)

Prices

• Determined by the interaction of buyers and sellers

• Reflect the goods’ value to buyers

• Reflect the cost of producing the good

Adam Smith’s invisible hand

• Prices are adjusted to guide market participants to reach outcomes that often maximize the well-being of society as a whole

Principle 7: Governments can sometimes improve the market outcomes (1)

Government: enforce property rights

• Enforce rules and maintain institutions that are key to a market economy

• People are less inclined to work, produce, invest, or purchase if there is a large risk of their property being stolen

• We rely on government-provided police and courts to enforce our rights over the things we produce

Principle 7: Governments can sometimes improve the market outcomes (2)

Government: promote efficiency 

• Avoid market failure: The Market left on its own fails to allocate resources efficiently 

• Externality - source of market failure (How the production or consumption of a good affects bystanders, e.g, pollution)

• Market power - source of market failure (A single buyer or seller has substantial influence on market price, e.g monopoly) 

Principle 7: Governments can sometimes improve the market outcomes (3)

Government: promote equality 

• Avoid disparities in economic well-being 

• Use tax or welfare policies to change how the economic “pie” is divided  

To say that the government can improve the market outcomes 

• Does not mean that it always will 

Principle 8: Country’s Standard of Living depends on its bality to produce goods and service

Huge variation in living standards across countries and over time

Productivity: the most important determinant of living standards

• The quantity of goods and services produced from each unit of labor input

• Depends on the equipment, skills, and technology available to workers,…

Principle 9: Prices rise when the government prints too much money (1)

Inflation

• An increase in the overall level of prices in the economy

High inflation

• Impose various costs on society

Goal of economic policymakers

• Keep inflation at a reasonable rate

In the long run

• Inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall

• The faster the government creates money, the greater the inflation rate

Principle 10: Society faces a short-run trade-off between inflation and unemployment

Short-run trade-off between inflation and unemployment 

• In the short run, many economic policies push inflation and unemployment in opposite directions 

• Other factors can make this trade-off more or less favorable; the trade-off is always present