Econ 201 1st EditionExam 1 Study GuideChapter1.Ten principles of EconomicScarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have.Economics is the study of how society manages its scarce resources.Principle 1.-people face trade offsMaking decisions requires trading off one goal against another.When people are grouped into societies, they face different kinds of trade-offs. One classic trade-off is between “guns and butter.” The more a society spends on national defense (guns) toprotect its shores from foreign aggressors, the less it can spend on consumer goods (butter) to raise the standard of living at home. Also important in modern society is the trade-off between a clean environment and a high level of income. Laws that require firms to reduce pollution raise the cost of producing goods and services. Because of the higher costs, these firms end up earning smaller profits, paying lower wages, charging higher prices, or some combination of these three.Another trade-off society faces is between efficiency and equality. Efficiency means that society is getting the maximum benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society's members.Consider, for instance, policies aimed at equalizing the distribution of economic well-being. Some of these policies, such as the welfare system or unemployment insurance, try to help the members of society who are most in need. Others, such as the individual income tax, ask the financially successful to contribute more than others to support the government.These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.Principle 2: The Cost Of Something Is What You Give Up To Get ItConsider the decision to go to college. The main benefits are intellectual enrichment and a lifetime of better job opportunities.First, it includes some things that are not really costs of going to college. Even if you quit school, you need a place to sleep and food to eat.Second, this calculation ignores the largest cost of going to college—your time. When you spenda year listening to lectures, reading textbooks, and writing papers, you cannot spend that time working at a job.The opportunity cost of an item is what you give up to get that item. When making any decision,decision makers should be aware of the opportunity costs that accompany each possible action.Principle 3: Rational People Think At The MarginRational people systematically and purposefully do the best they can to achieve their objectives,given the available opportunities.Economists use the term marginal change to describe a small incremental adjustment to an existing plan of action. Keep in mind that margin means “edge,” so marginal changes are adjustments around the edges of what you are doing.Marginal decision making can help explain some otherwise puzzling economic phenomena.Principle 4: People Respond To IncentivesAn incentive is something that induces a person to act, such as the prospect of a punishment or a reward. Because rational people make decisions by comparing costs and benefits, they respond to incentives.As we will see, the influence of prices on the behavior of consumers and producers is crucial for how a market economy allocates scarce resources.When policymakers fail to consider how their policies affect incentives, they often end up with unintended consequences.Principle 5: Trade Can Make Everyone Better OffTrade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services.Principle 6: Markets Are Usually A Good Way To Organize Economic ActivityMost countries that once had centrally planned economies have abandoned the system and are instead developing market economies. In a market economy, the decisions of a central planner are replaced by the decisions of millions of firms and households. Firms decide whom to hire and what to make. Households decide which firms to work for and what to buy with their incomes. These firms and households interact in the marketplace, where prices and self-interestguide their decisions.Yet despite decentralized decision making and self-interested decision makers, market economies have proven remarkably successful in organizing economic activity to promote overall economic well-being.Principle 7: Governments Can Sometimes Improve Market OutcomesOne reason we need government is that the invisible hand can work its magic only if the government enforces the rules and maintains the institutions that are key to a market economy.Most important, market economies need institutions to enforce property rights so individuals can own and control scarce resources.Yet there is another reason we need government: The invisible hand is powerful, but it is not omnipotent. There are two broad reasons for a government to intervene in the economy and change the allocation of resources that people would choose on their own: to promote efficiency or to promote equality.Economists use the term market failure to refer to a situation in which the market on its own fails to produce an efficient allocation of resources. As we will see, one possible cause of marketfailure is an externality, which is the impact of one person's actions on the well-being of a bystander.Another possible cause of market failure is market power , which refers to the ability of a single person (or small group) to unduly influence market prices.The invisible hand does not ensure that everyone has sufficient food, decent clothing, and adequate healthcare.Principle 8: A Country's Standard Of Living Depends On Its Ability To Produce Goods And Services.Almost all variation in living standards is attributable to differences in countries' productivity—that is, the amount of goods and services produced from each unit of labor input.the growth rate of a nation's productivity determines the growth rate of its average income.The relationship between productivity and living standards also has profound implications for public policy. When thinking about how any policy will affect living standards, the key question is how it will affect our ability to produce goods and services.Principle 9: Prices Rise When The Government Prints Too Much Moneyinflation , an increase in the overall level of prices in the economy.the culprit is growth in the quantity