Chapter 1: Ten principles of Economics

Economics is the study of how society manages its scarce resources.

Scarcity refers to the limited nature of society's resources. Economics addresses questions like:

• How people decide what to buy, how much to work, save, and spend

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

• How society divides resources between national defense, consumer goods, and environmental protection.

Ten Principles of Economics are explored:

1. People Face Tradeoffs: All decisions involve tradeoffs4. Society faces a tradeoff between efficiency and equality5.

◦ Efficiency means society gets the most from its scarce resources.

◦ Equality means prosperity is distributed uniformly among society's members5.

◦ Achieving greater equality could involve redistributing income from wealthy to poor, but this may reduce the incentive to work and produce.

2. The Cost of Something Is What You Give Up to Get It: This is also known as opportunity cost, and is the relevant cost for decision making. Examples include the foregone wages when going to college or the value of time spent at a movie.

3. Rational People Think at the Margin: Rational people systematically and purposefully do the best they can to achieve their objectives . They make decisions by evaluating costs and benefits of marginal changes (incremental adjustments to an existing plan).

4. People Respond to Incentives: An incentive is something that induces a person to act, like a reward or punishment. Rational people respond to incentives. For example, consumers may buy more hybrid cars when gas prices rise.

5. Trade Can Make Everyone Better Off: People can specialize in producing one good or service and exchange it for others. Countries benefit from trade by getting better prices abroad and buying goods more cheaply.

6. Markets Are Usually A Good Way to Organize Economic Activity: A market is a group of buyers and sellers. A market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets. The interaction of buyers and sellers determines prices, which reflects the good’s value to buyers and the cost of producing the good.

7. Governments Can Sometimes Improve Market Outcomes: Governments enforce property rights through police and courts. Market failure occurs when the market fails to allocate society's resources efficiently. This can be caused by externalities, like pollution, or by market power, when a single buyer or seller has substantial influence on market price, such as a monopoly. Governments can promote equity by altering market outcomes through tax or welfare policies.

8. A Country's Standard of Living Depends on Its Ability to Produce Goods and Services: Productivity, the amount of goods and services produced per unit of labor, is the most important determinant of living standards. Productivity depends on the equipment, skills, and technology available to workers.

9. Prices Rise When the Government Prints Too Much Money: Inflation is an increase in the general level of prices. In the long run, inflation is caused by excessive growth in the quantity of money.

10. Society Faces a Short-Run Tradeoff Between Inflation and Unemployment: In the short run (1-2 years), many economic policies push inflation and unemployment in opposite directions.

Additional Concepts and Examples:

• Decision-making is central to economics, with individuals deciding how much to save, spend, and work; firms deciding how much to produce and what labor to hire; and society deciding on the allocation of resources between different needs.

• When considering how much to work, individuals face a tradeoff between income and leisure6. Firms decide what kind of labor to hire by weighing the productivity and cost of skilled versus unskilled workers.

• Marginal changes refer to incremental adjustments to an existing plan.

• The invisible hand refers to how self-interested households and firms make decisions that, in many cases, maximize society’s economic well-being.

• Examples of government's role in improving market outcomes include public schools, workplace safety regulations, public highways, and patent laws.

• Property rights are essential for market economies to function, as they protect people's ability to own and control their resources.

• International trade allows countries to sell their exports abroad at higher prices and buy goods from abroad more cheaply.

• A market economy is decentralized, with decisions being made by many households and firms.