Chapter 1 Ten Principles of Economics Resources are scarce Economics is the study of how society manages its scarce resources How People Make Decisions Principle 1 People face trade offs o Guns and butter the more a society spends on national defense the less it is able to spend on consumer goods o Clean environment and high level of income o Efficiency means that society is getting the maximum benefits from its scarce resources size of economic pie equality means that those benefits are distributed uniformly among society how the pie is divided when the gov tries to cut the economic pie into more equal slices the pie gets smaller Principle 2 The cost of something is what you give up to get it o Opportunity cost what you give up to get something Principle 3 Rational people think at the margin o Rational people systematically and purposefully do the best they can to achieve their objectives given the available opportunities o Marginal change a small incremental adjustment to an existing plan o Rational people make decisions by comparing marginal benefits and of action marginal costs Principle 4 People respond to incentives o Incentives something that induces a person to act such as the prospect of a punishment or reward How People Interact Principle 5 Trade can make everyone better off o Trade allows each person to specialize and allows ppl to buy a greater variety of goods and services at a lower cost Principle 6 Markets are usually a good way to organize economic activity o Market economy the decisions of a central planner are replaced by the decisions of millions of firms and households o Prices guide buyers and sellers to reach outcomes that are beneficial to society as a whole Principle 7 Governments can sometimes improve market outcomes o We need gov to enforce the rules and maintain the institutions that are key to a market economy o Property rights individuals can own and control scarce resources o We need gov to promote efficiency equality o Market failure a situation in which a market when left on its own fails to allocate resources efficiently Externality the impact of one person s actions on the well being of a bystander ex pollution Market power the ability of a single economic actor or small group to have a substantial influence on market prices How the Economy as a Whole Works Principle 8 A country s standard of living depends on its ability to produce goods and services unit of labor input o Productivity the quantity of goods and services produced from each Principle 9 Prices rise when the gov prints too much money o Inflation an increase in the overall level of prices in the economy Principle 10 Society faces a short run trade off between inflation and unemployment o Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services higher demand may over time cause firms to raise their prices but it also encourages them to hire more workers and produce a larger quantity of goods and services more hiring means lower unemployment o Business cycle fluctuations in economic activity such as employment and production o Gov can try to balance inflation and unemployment by changing the amount that it spends the amount it taxes the amount of money it prints
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