Principles of Economics

Principle 1

Choices are necessary because resources are scarce (Resources are anything that can be used to produce something else: land, labour etc.)

Principle 2

The true cost of a choice is its opportunity cost - EVERY decision involves a trade-off

Opportunity cost of any activity is the value of the next best alternative you give up by choosing it.

Principle 3

‘How much’ is a decision at the margin - decisions involving comparing additional benefits and costs of consuming/producing ONE MORE unit - known as marginal analysis

Principle 4

People (rational agents) usually respond to incentives, and adjust their decisions in a predictable way, (incentives are anything that motivates individuals to act so can be financial, social or moral)

Incentives are central to understanding how people and firms make choices under constraints

Principle 5

There are gains from trade, domestic and international

Trade allows people to specialise in activities they do best and access goods/services others produce more efficiently - specialisation increases total production through the division of labour

Principle 6

Markets move toward equilibrium, S = D, movement towards Eq. is often automatic and driven by individual responses to incentives

Principle 7

Resources should be used efficiently to achieve society’s goals - efficiency means making the best possible use of scarce resources to meet people’s needs and wants - an allocation is efficient if no further improvements can be made to make someone better off without making someone else worse off

NOT the same as equity (fairness),

Principle 8

Markets usually lead to efficiency - individuals pursuing their own interests often promote general welfare

Principle 9

Government intervention can correct market failure (which occur when the pursuit of self interest doesn’t lead to an efficient outcome) and improve society’s welfare through e.g. taxes, subsidies, regulation

Common causes include externalities, market power, asymmetric information

Although govt. failure is also possible so intervention must be carefully designed

Principle 10

One person's spending is another person’s income - this idea forms the basis of the circular flow model and understanding these linkages is crucial for managing aggregate demand and stabilising the economy