Chapter 1 - Ten Principles of Economics

• management of society’s resources is important; resources are SCARCE

• SCARCITY: limited nature of society’s resources

  • society cannot produce all the goods and services ppl wish to have

• ECONOMICS: study of how society manages its scarce resources

  • study how people make decisions, how people interact w/ each other and how economy as a whole works

• TWO AGENTS: firms and consumers

  • FIRMS: what to produce, how much to produce, how many workers to hire, etc.

  • CONSUMERS: what to buy, how much to save, how many hours to work, etc.

1-1 How People Make Decisions

1-1a Principle 1: People Face Tradeoffs

• to get one thing, we usually have to give up something else

  • e.g. allocations of your time & money etc.

    • if you buy a new iPhone today, you have to wait before buying a new laptop

    • if u invest in TFSA, you are giving up other forms of investments

    • for every hour you spend on studying, you could have worked

• society faces the tradeoff between efficiency and equity (they clash)

  • EFFICIENCY: getting the most out of resources

    • represents the economic pie

  • EQUITY: fairness of economic allocation

    • represents how economic pie is divided among society’s members

1-1b Principle 2: The Cost of Something is What You Give Up to Get It

• OPPORTUNITY COST: what you give up to obtain something

  • to become a doctor, you need to go to medical school

    • in addition you are giving up other careers

  • waiting in a long line for a free item costs your time

1-1c Principle 3: Rational People Think at the Margin

• RATIONAL PEOPLE: someone always tries to do their best to achieve their objectives

  • usually assume the following:

    • firms’ objective is to maximize profit

    • consumers’ objective is to achieve highest level of satisfaction

• MARGINAL CHANGES: small incremental adjustments to an existing situation or plan

• Rational people make decision by comparing marginal benefits and marginal costs

  • e.g. you’ve eaten 3 tacos

    • should you eat another taco?

      • depends on price of the taco (marginal cost)

      • and extra satisfaction it gives (marginal benefit)

1-1d Principle 4: People Respond to Incentives

• INCENTIVE: something that induces action (punishment or reward)

• RATIONAL PEOPLE respond to incentives

  • price of gasoline rises, people drive less

  • neighboring country lets people visit without a visa, # of tourists increase

  • famous food critic is waiting for dinner, chef tries their best

• when governments change rules, it gives an incentive to (some) people to change their actions

  • however, if incentives not thought about clearly, unintended consequences can happen

1-2 How People Interact

1-2a Principle 5: Trade can Make Everyone Better Off

• Trade allows each individual to specialize in activities they do best

  • by doing so, everyone will be better off

  • countries benefit from this too!

  • SEE CHAP 3

1-2b Principle 6: Markets Are Usually a Good Way to Organize Economic Activity

• MARKET ECONOMY: an economy that allocates resources through market forces

  • firms and households make self-interested decisions guided by the market price

  • price reveals buyer’s valuation of the good and the seller’s cost of producing it

• prices adjust to guide the economy to the outcome that maximizes society’s economic well-being (resources allocated efficiently)

• “households and firms interacting in markets act as if they are guided by an INVISIBLE HAND that leads them to desirable market outcomes”

1-2c Principle 7: Governments Can Sometimes Improve Market Outcomes

• MARKET FAILURE: refers to a situation where allocation of resources of market outcome is not efficient

• can happen if:

  • EXTERNALITY: one person’s action affects bystander positively or negatively (e.g. pollution)

  • MARKET POWER: an ability of a single (or small # of) firm (or buyer) to influence market price (e.g. monopoly)

• thus, government can intervene in economy to improve market outcome

  • intervention promotes efficiency

• government can take actions to promote equity (e.g. income tax, welfare systems, etc.)

• one of the most important government role: enforce PROPERTY RIGHTS by law

  • PROPERTY RIGHTS: ability of someone to own and exercise control over scarce resources

1-3 How The Economy as a Whole Works

1-3a Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

• living standards vary a lot across countries and over time

• main determinant of living standard: PRODUCTIVITY

• PRODUCTIVITY: quantity of goods and services produced from each hour of a worker’s time

  • depends on tech, skills of workers and equipment