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Economics
The study of how society manages its scarce resources.
resources are usually allocated through the combined choices of various households and businesses
economists: examine how people amke these choices, how much they work, what they buy, how much they save, how they invest their savings, etc.
Scarcity
society has limited resources and thus is unable to produce all the goods and services people want. Individuals in a society do not always attain the standard of living to which they may aspire
Opportunity Cost
The cost of something is what you give up to get it.
Marginal Change
Incremental adjustment to an existing plan of action.
Incentive
Something that induces a person to act.
Market
A collection of all the buyers and sellers of a good or service.
Production Possibilities Frontier (PPF)
A graph that shows the various combinations of output the economy can produce given available factors of production.
Market Economy
An economy where decisions are made by the interactions of firms and households in the marketplace rather than a central planner
Invisible Hand
A term used by Adam Smith to describe how individuals' self-interest in a competitive market can lead to positive outcomes for society.
ability of competitive markets to reach desirable outcomes, despite the self-interest of market participants
Efficiency
A situation in which society is getting the most from its scarce resources.
Equality
The property of distributing economic prosperity uniformly among society's members.
Trade-offs
Comparison of the costs and benefits of different alternatives when making a decision.
Fiscal Policy
Government policy that attempts to influence the economy through changes in government spending or taxes.
Inflation
An overall increase in the level of prices in the economy.
principle 1: people face trade offs
Making decisions requires trading off one goal for another
Ex. “guns and butter”: the more a society spends on the military, the less it can spend on consumer goods
Ex. clean environment and level of income: laws requiring firms to reduce pollution may raise the cost of producing goods and services
principle 2: cost of something is what you give up to get it
opportunity cost of an item: what you give up to get it → important to consider when making decisions
Ex. decision to attend college
Main benefits: intellectual enrichment and better job opportunities
Need a place to sleep and food → room and board at college exceed the cost of living and eating at home/apartment
Too busy to spend time working and earning money
principle 3: rational people think at the margin
Rational people: systematically and purposefully do the best they can to achieve their goals given available resources/opportunities
Marginal change: incremental adjustment to an existing plan of action
Rational people make decisions by comparing marginal benefits and marginal costs
A rational decision-maker takes an action only if the action;s marginal benefit exceeds its marginal cost
principle 4: people respond to incentives
Incentive: something that induces a person to act (ex. The prospect of a punishment or reward) → plays a central role in economics
People respond to incentives if they make decisions by comparing costs and beneifts
Key to analyzing how markets work → the influence of prices on the behaviour of consumers and producers is crucial to how a market economy allocates scarce resources
Principle 5: trade can make everyone better off
Trade between countries can make each country better off, rather than being a competition
Even when trade in the world economy is competitive, it can lead to win-win outcomes for the involved countries
Otherwise, these countries would have to provide, manufacture, etc. for themselves with no outside help (which can be less efficient or use up more resources)
Trade allows people to specialize in the activities they do best → through trade, people can buy a greater variety of goods/services at a lower cost
Trade allows countries to specialize in what they do best and enjoy a greater variety of goods and services
principle 6: markets are usually a good way to organize economic activity
When a government prevents prices from adjusting to supply and demand, it impedes the invisible hand’s ability to coordinate the decisions of the firms and households that make up an economy → corollary explains the effect of most taxes on the allocation of resources
Individuals are usually best left to their own devices without the heavy hand of government directing their actions
This philosophy provides intellectual foundation for market economy and freer society
principle 7: governments can sometimes improve market outcomes
Market economics need institutions to enforce property rights so individuals can own and control scarce resources
Ex. farmers will now grow food if they expect their crops to be stolen, etc.
Market participants reply on government-provided police and courts to enforce their rights → invisible hand only works well when the legal system does
Another reason for government is that the invisible hand, while powerful, is not omnipotent
principle 8: A Country’s Standard of Living Depends on its Ability to Produce Goods and Services
Variation in average income across countries is reflected in measures of quality of life
People in high-income countries have more computers, more cars, better nutrition, better healthcare, and a longer life expectancy than those in low-income countries
Almost all variation in living standards is attributable to differences in countries’ productivity
rational people
Systematically and purposefully do the best they can to achieve their objectives gien the available resources/opportunities
Make decisions by evaluation costs and benefits of marginal changes
Small incremental adjustments to a plan of action
thinking at the margin
the ability to evaluate how the costs and benefits of the choice change has they consider making small changes to their plan
rationales for government to intervene in the economy
To promote efficiency
The invisible hand usually leads markets to allocate resources to maximize the size of the economic pie
Market failure: refers to a situation in which the market does not produce an efficient allocation of resources onits own
To promote equality
While the invisible hand may yield efficient outcomes, it can leave large disparities in well-being
Market economy rewards people according to their ability to produce things that other people are willing to pay for
The invisible hand does not ensure that everyone has adequate resources → inequality may call for government intervention
command economy
when a government or political leader unilaterally makes decisions
Severely limits a person/business’ freedom of choice
laissez faire economy
where people have complete freedom in choosing their occupation, what they buy, who they buy from, who they work for, and the government is not involved in any significant way of organizing economic activity
market power
a single buyer/seller that has substantial influence on market price
ex: monopoly when there is only 1 seller of a product
circular flow diagram
Firms: produce goods and services using inputs (ex. Labour, land, capital [buildings and machines]) → factors of production
Households: own the factors of production and consume all the goods and services that the firms produce
Simple way of organizing all the transactions between households and firms in an economy
Households and firms interact in 2 types of markets
Markets for goods and services: households are buyers and firms are sellers
Households buy the output of goods and services that firms produce
Markets for the factors of production: households are sellers and firms are buyers
Households provide the inputs that firms use to produce goods and services
microeconomics
the study of how households and firms make decisions and how they interact in specific markets
