Principles of Economics: Chapter 1

Scarcity

the limited nature of society's resources

economics

study of how society manages its scarce resources

economists study:

1. How people make decisions

2. How people interact with one another

3. Analyze forces and trends that affect the economy as a whole

Principle 1

People face "trade offs"

Making Decisions

trade off one goal against another. Example: a student can choose between sleep or going to class

Efficiency

1. Society getting the most it can from its scarce resources

2. Size of the Economic Pie

Equality

Distributing economic prosperity uniformly among the members of society (how the pie is divided)

Principle 2

The cost of something is what you give up to get it

People face trade offs

Make decisions (compare costs with benefits of alternatives)

Opportunity Cost

Whatever must be given up to obtain one item

Principle 3

Rational people think at the margin

Rational People

Systemically and Purposefully do their best to achieve their objectives

Marginal Changes

Small incremental adjustments to a plan of action

Marginal Benefits

Additional Benefits

Marginal Costs

Additional Costs

Rational Decision maker

Marginal Benefits>Marginal Costs

Principle 4

People respond to incentives

Incentive

Something that induces a person to act

Higher Price

Buyers will consume it less

Sellers will produce it more

Public Policy

1. Change Costs or benefits

2. change people's behavior

Principle 5

Trade can make everyone better off

Trade

1. Allows each person to specialize in the area they do best in

2. Enjoy more goods/services at lower cost

Principle 6

Markets are usually a good way to organize economic activity

Communist Countries

(Central Planning) The government officials allocate economy's scarce resources

1. What goods were produced

2. How much was produced

3. Who produced these goods and services

A Market Economy :

Allocates resources

1. Through decentralized decisions of many firms and households

2. As they interact in markets for goods and services

3. Guided by prices and self interest

Adam Smith's Invisible Hand

Households and firms interacting in the economy act as if they are guided by an invisible hand. This leads to desirable market outcomes.

Corallary

Government Intervention:

Prevents the invisible hands ability to coordinate the decisions of the households and firms that make up an economy

Principle 7

Governments can sometimes improve market outcomes

We need government

1. Enforce rules (i.e. property rights)

2. Promotes efficiency (avoids market failure)

3. Promotes equality (avoids disparities in the economic wellbeing)

Property rights

The ability of the individual to own and exercise control over scarce resources

Market Failure

Situation in which the market on its own fails to produce an efficient allocation of resources

Causes for Market Failure

Externality: impact of one persons action on the well being of the bystander

Market Power: Ability of a single economic actor (or small group of actors) to have a substantial influence on market prices

Disparities in Economic Well being

1. A market economy rewards people according to their ability to produce things that other people are willing to pay for

2. Government intervention: Public policies :: may diminish inequality and process far from perfect

Principle 8

A country's goods and standard of living depends on its ability to produce goods and services

Large differences in living standards

among countries

over time

Explanation

differences in productivity

Productivity

1. Quantity of goods and services produced from each unit of labor input

2. Higher Productivity (higher standard of living)

3. Growth rate of nations productivity (determines growth rate of average income)

Principle 9

Prices rise when the Government prints too much money

Inflation

An increase in the overall level of prices in the economy

Causes for large/persistent inflation

Growth in quantity of money (then the value of money decreases)

Principle 10

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

Short run effects on monetary injections

1. stimulates the level of spending (higher demand of goods and services)

2. Firms raise prices and higher more workers/produce more goods and services

3. lower unemployment

Short run trade-off between unemployment and inflation

Key role- analysis of business cycle

Business Cycle

Fluctuations in economic activity (employment/production)