Chapter 1 Ten Principles of Economics The economy is like a household people play different roles society has limited resources and therefore cannot produce all goods and Scarcity services people wish to have There aren t enough resources for everyone to be at the same social level the study of how society manages its scarce resources A leader or society can dictate resources Economists study how buyers and sellers interact prices trends etc People influence and economy Economics How People Make Decisions Principle 1 People face trade offs Equality Efficiency If you choose to buy do one thing you can t do the other give something up in exchange for something else benefits are distributed uniformly among society s members society is getting the maximum benefits from its scarce resources o Equality causes a society to become less efficient the more people get equal portions the les goods and services are produced Trade off Principle 2 The cost of something is what you give up to get it Opportunity cost what you give up to get that item Principle 3 Rational people think at the margin Rational people their objectives given the available opportunities Marginal changes systematically and purposefully do the best they can to achieve small incremental adjustments to a plan of action o Marginal cost manufacturer and marginal benefits willingness to pay for a good consumer Principle 4 People respond to incentives Incentive something that induces a person to act Principle 5 Trade can make everyone better off Each country people benefit s from trade because it allows them to specialize in what they do best and gain the most goods and products Principle 6 Markets are usually a good way to organize economic activity Market economy an economy that allocates resources through the decisions of many firms and households as they interact in markets for goods and services No one regulates it consumer producer driven o Invisible hand households and firms are guided to make smart decisions for the market Buyers care about prices price determines demand Sellers care about production prices prices determines supply Price guides buyers and sellers maximize the economy Principle 7 Governments can sometimes improve market outcomes Property rights the ability of an individual to own and exercise control over scares resources government regulates property rights so the invisible hand works properly o Government should intervene in the economy because it promotes efficiency and equality Market failure resources efficiently Externality o Causes market failure o Example pollution a situation in which a market left on its own fails to allocate the impact of one person s actions on the well being of a bystander Market power have a substantial influence on market prices the ability of a single economic actor or small group of actors to o Another potential cause of market failure Principle 8 A country s standard of living depends on its ability to produce goods and services Productivity input the quantity of goods and services produced from each unit of labor o Standard of living is based on productivity both national and individual Principle 9 Prices rise when the government prints too much money Inflation the increase in the overall level of princes in the economy o Too much money in circulation o Caused by rapid growth in printed money Principle 10 Society faces a short run trade off between inflation and unemployment An increase in money increases spending and demand supply and workers hired and as a result unemployment is lowered o Trade off between inflation and unemployment fluctuations in economic activity such as employment and Business cycle production Chapter 2 Thinking Like an Economist Economics theory and observation The economy consists of buying selling trading working hiring manufacturing a diagram that shows how dollars flow through markets among etc Circular Flow households o Firms vs households Factors of production firms produce goods and services using inputs land labor money Households own factors of production and consume all gods and services produced Markets for goods and services households buyers firms Markets for factors of production household sellers firms sellers buyers Microeconomics Production possibilities frontier a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology they interact in markets unemployment economic growth Positive statements Normative statements the study of economy wide phenomena inflation the study of how households and firms make decisions and how prescriptive how the world should be descriptive how the world is Macroeconomics Chapter 3 Interdepended and the Gains from Trade A Parable for the Modern Economy Production Possibilities The proposed trade between two workers offers each of them a combination of two goods that would be impossible in the absence of trade Trade allows each to consume more of each good o Straight line when trade switches off at a constant rate o If producer chooses to be self sufficient rather than trade with each other then he consumes exactly what he produces o Shows trade offs Specialization and Trade As a result of specialization and trade each producer can consume more of both goods without working any more hours Comparative Advantage The Driving Force of Specialization Absolute Advantage Absolute Advantage another producer the ability to produce a good using fewer inputs than Opportunity Cost and Comparative Advantage Opportunity Cost what we give up to get that item o Time spent producing one good takes away time to produce the other good o Measures tradeoff To calculate opportunity cost example meat and potatoes Producing 1 ounce of potatoes takes 10 minutes of work and when the farmer spends 10 minutes producing potatoes he spends 10 minutes less producing meat Because the rancher needs 20 minutes to producer 1 ounce of meat 10 minutes of work would yield to ounce of meat Hence the rancher s opportunity cost of producing 1 ounce of potatoes is ounce of meat o The opportunity cost of meat is the inverse of the opportunity cost of potatoes Because 1 ounce of potatoes costs the rancher ounce of meat 1 ounce of meat costs the rancher 2 ounces of potatoes Similarly because 1 ounce of potatoes costs the farmer ounce of meat 1 ounce of meat costs the farmer 4 ounces of potatoes the ability to produce a good at a lower
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