[PRINECON] (P2) M1: Ten Principles of Economics

Incentive

[P4] –Something that induces a person to act

–Higher price

•Buyers consume less; Sellers produce more

–Public policy

•Change costs or benefits

•Change people’s behavior

•Can have unintended consequences

Seat belt law alters a driver’s cost–benefit calculation (Sam Peltzman, 1975)

[P4] –Seat belts make accidents less costly (reduce the likelihood of injury or death)

•Reduce the benefits of slow, careful driving

–People drive faster and less carefully:

•Larger number of accidents

–Net result: little change in the number of driver deaths and an increase in the number of pedestrian deaths

Principle 4: People Respond to Incentives

Incentive & Seat belt law alters a driver’s cost–benefit calculation (Sam Peltzman, 1975)

Trade

[P5] –Allows each person to specialize in the activities he or she does best

–Enjoy a greater variety of goods and services

Communist countries, central planning

[P6] –Government officials (central planners) are in the best position to allocate the economy’s scarce resources

•What goods and services were produced

•How much was produced

•Who produced and consumed these goods and services

Market economy, allocation of resources

[P6] –Through decentralized decisions of many firms and households

–As they interact in markets for goods and services

–Guided by prices and self-interest

Market economies

[P6]–No one is looking out for the economic well-being of society as a whole

–Have proven remarkably successful in organizing economic activity to promote overall economic well-being

Adam Smith’s “invisible hand”

[P6] –Households and firms interacting in markets

•Act as if they are guided by an “invisible hand”

•Leads them to desirable market outcomes

Corollary: Government intervention

[P6: Adam Smith’s “invisible hand”] Prevents the invisible hand’s ability to coordinate the decisions of the households and firms that make up the economy

Strict controls in the market for taxis

[Adam Smith Would Have Loved Uber,]

–Regulation of insurance and safety

–Limit entry into the market: limited number of taxi medallions or permits

–May determine the prices that taxis are allowed to charge

–To keep unauthorized drivers off the streets and to prevent all drivers from charging unauthorized prices

Uber, launched in 2009

[Adam Smith Would Have Loved Uber,]

–App for smartphones that connects passengers and drivers

–___ cars do not roam the streets looking for taxi-hailing pedestrians

•Not taxis; not subject to the same regulations

•But they offer much the same service

–Often charge less than taxis

–Drivers raise their prices significantly when there is a surge in demand

Adam Smith

was a Scottish economist and philosopher known as the “Father of Economics”.

Surge pricing

[Adam Smith Would Have Loved Uber,]

Increases the quantity of car services supplied when they are most needed

–Allocate the services to those consumers who value them most highly

Not everyone is fond of Uber, Economists love Uber

• ____________

–Traditional taxi drivers

•_____________

–Increase consumer well-being

We need government

[P7]–Enforce rules and maintain institutions that are key to a market economy

–Need institutions to enforce property rights

–Promote efficiency, avoid market failure

–Promote equality, avoid disparities in economic wellbeing

Property rights

[P7]Ability of an individual to own and exercise control over scarce resources

Market failure

[P7] –Situation in which the market left on its own fails to allocate resources efficiently

–Externalities

–Market power

Externality

[P7] –Impact of one person’s actions on the well-being of a bystander

–Pollution

Market power

[P7] –Ability of a single economic actor (or small group of actors) to have a substantial influence on market prices

Market economy rewards people

[P7:Disparities in economic wellbeing] According to their ability to produce things that other people are willing to pay for

Government intervention, public policies

[P7:Disparities in economic wellbeing]

•Aim to achieve a more equal distribution of economic well-being

•May diminish inequality

•Process far from perfect

Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

Large differences in living standards

–Among countries:

•Average annual income, 2014: $55,000 (U.S.); $17,000 (Mexico); $13,000 (China); $6,000 (Nigeria)

–Over time: In the U.S. incomes have historically grown about 2% per year

Productivity

[P8] –Quantity of goods and services produced from each unit of labor input

Higher productivity

[P8] Higher standard of living

Growth rate of nation’s productivity

[P8] Determines growth rate of its average income

Inflation

[P9] An increase in the overall level of prices in the economy

–Growth in quantity of money

–Value of money falls

[P9] Causes for large or persistent inflation (2)

Short-run effects of monetary injections

[P10] –Stimulates the overall level of spending and the demand for goods and services

–Firms raise prices, hire more workers, produce more goods and services

–Lower unemployment

Short-run trade-off between unemployment and inflation

[P10] –Over a period of a year or two, many economic policies push inflation and unemployment in opposite directions

–Key role – analysis of business cycle

Business cycle

[P10] –Fluctuations in economic activity

–Such as employment and production

Principle 6: Markets Are Usually a Good Way to Organize Economic Activity

Communist countries, central planning, Market economy, allocation of resources, Market economies, Adam Smith’s “invisible hand”, & Adam Smith Would Have Loved Uber

Principle 7: Governments Can Sometimes Improve Market Outcomes

We need government, Property rights, Market failure, Externality, Market power, & Disparities in economic wellbeing

Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

Large differences in living standards & Productivity

Principle 9: Prices Rise When the Government Prints Too Much Money

Inflation & Causes for large or persistent inflation

Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment

Short-run effects of monetary injections, Short-run trade-off between unemployment and inflation, & Business cycle