ECON 200 chapter 1 02 03 2011 Chapter 1 TEN principles of economics Scarcity Society has limited resources and therefore cannot produce all the goods and services people wish to have People face tradeoffs Efficiency and equality o Efficiency society is getting the maximum amount out of its o Equality properly distributing economic prosperity uniformly scarce resources among society s members Efficiency is the size of the economic pie while equality is how the pie is divided into individual slices Greater equality reduces efficiency The cost of something you give up is what you get Opportunity cost whatever must be given up to obtain some item Rational people think at the margin Rational people people who systematically and purposefully do the best they can to achieve their objectives Marginal changes describes small incremental adjustments to a plan of action o Margin edge marginal changes are adjustments around the o Rational people make decisions by comparing marginal edge of what your doing benefits to marginal cost Takes action if marginal benefits exceed marginal cost People respond to incentives 1 Incentive something that induces a person to act o Punishment or reward Trade can make everyone better off Trade allows countries to do what they do best and enjoy a greater variety of goods and service Markets are usually a good way to organize economic activity Market Economy An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services o Firms decide whom to hire and what to make o Households decide which firms to work for and what to buy o No one looks out for the economic well being of society as a with their incomes whole o Adam Smith Households and firms interacting in markets act as if they are guided by an invisible hand that leads them to desirable market outcomes When the government prevents the prices from adjusting naturally to supply and demand it impedes the invisible hand s ability to coordinate decisions of the households and firms that make up the economy Governments can sometimes improve market outcomes Property rights The ability for an individual to own and exercise control over scarce resources o Market economies need government institutions to enforce Market failure a situation in which a market left on its own fails to property rights allocate resources efficiently o Possible cause of market failure is 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 to have a substantial influence on market prices o Market economy rewards people according to their ability to produce things that other people are willing to pay for 2 o The invisible hand does not ensure that food clothes and healthcare intervention This inequality sometimes calls for government A country s standard of living depends on its ability to produce goods and services labor input Productivity the quantity of goods and services from each unit of o Difference in living standards among various countries can be o Relationship between productivity and living standards attributed to productivity influences public policy Boost productivity to increase living standards Prices rise when the government prints too much money Inflations an increase on the overall level of prices in the economy o Most cases the cause is growth in the quantity of money Large quantities of money make the value of it fall Society faces a short run trade off between inflation and unemployment 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 in the meantime it also encourages them to hire more workers and produce a larger quantity of goods and services More hiring means lower unemployment Business cycle Fluctuations in economic activity such as employment and production o policy members can exploit the short run tradeoff changing the amount the government spends taxes printed money CONCLUSION People face tradeoffs o Cost of any action is measured in forgone opportunities o Rational people make decisions by comparing marginal cost to marginal benefits 3 o People change their behavior in response to the incentives they face Interactions among people o Trade and interdependence can be mutually beneficial o Markets are usually a good way to coordinate economic activity among people o Government can improve market outcomes by Remedying market failure Promoting greater economic activity Economy as a whole o Ultimate source of living standards o Growth in the quantity of money is the ultimate source of o Society faces short term tradeoffs between inflation and inflation unemployment APLIA Scarcity Efficiency The condition in which human wants are forever greater than the available supple of time goods and resources Scarcity affects not only individuals but also the society as a whole An outcome is efficient when resources are used in a way that has fully exploited all opportunities to make everyone better off o In an efficient outcome no one can be made better off without making anyone worse off o Outcome is inefficient if some people can be made better off without making others worse off 4 Opportunity cost Incentives When measuring opportunity cost in terms of dollars you include o Actual amount paid explicit cost and monetary value of any other sacrifice implicit cost Opportunity cost in is sum of explicit and implicit cost People take purposeful action in acquiring things they want o As a result how goods are distributed influence how people act o If the distribution of goods is 5 ECON 200 chapter 2 Thinking like an economist 02 03 2011 The scientific method observation theory and more observation The dispassionate development of testing theories about how the world works Assumptions make it easier to understand Economic models Economists make assumptions to simplify the complex world and Economists use models to learn about the world in a simpler way o Most often composed of diagrams and equations Circular flow diagram A visual model of the economy that shows how dollars flow through markets among households and firms o Firms produce goods and services using inputs Inputs or Factors of Production are labor land capital buildings and machines o Households own the factors of production and consume all the
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