Chapter 1 Economics 09 02 2012 Field of study began in 18th century Founder Adam Smith Scottish prof o Scientific method on people economics Smith s book The Wealth of Nations o Set foundations published in 1776 o On British economics used by US 18th century underway o Economics primarily agricultural with industrial revolution Production exchanging changed because of Smith s book Smith s principles are relevant today Since book economists refined expanded understanding of economics Micro economics How people make certain choices in economies How people in an economy interact buying selling How resources are allocated to various possible uses Ten Principles of Economics How people make decisions Principle 1 People face trade offs o Efficiency vs equality Maximum benefits from scarce resources vs benefits being distributed uniformly among society s members o Scarcity used to refer to the limited nature of society s resources o Decisions are affected by the fact that resources are limited Ex Time and money Principle 2 The cost of something is what you give up to get it o Because people face trade offs making decisions requires comparing the costs and benefits of possible choices o Decision makers should be aware of the opportunity costs that accompany each possible action o Opportunity cost the value of the foregone options when one makes a choice Ex Cost of college is spent on it opportunity cost is loss of time to work etc Principle 3 Rational people think at the margin o Rational people systematically purposefully do their best to achieve their objectives given the available opportunities o Marginal change small incremental adjustment to an existing plan of action margin edge o Marginal cost extra cost resulting from an increase in o Marginal benefit extra benefit resulting from an increase in production or consumption production or consumption o Rare good items have higher marginal cost diamonds vs o Will make choice if the marginal benefit of the action the water marginal cost Principle 4 People respond to incentives o An incentive is something that induces a person to act Benefit reduced cost reward punishment etc o People respond to incentives The rest is commentary o Prices affect incentives Higher price buyers buy less sellers produce more o Many policies change the costs or benefits that people face which changes their behavior Ex Higher gas prices more hybrid cars higher cigarette taxes less teen smoking o An incentive for people firms is income Firm s income is revenue divided by costs profit Household s income is personal income How people interact Principle 5 Trade can make everyone better off o Exchange trading Voluntary both parties get something they want o Competition with buying and finding the lowest prices is good not buying at all would be even worse o Trade allows countries to specialize in what they do best exchange it for other goods services rather than being self sufficient Get a better price abroad for goods they produce Buy other goods more cheaply from abroad than could be produced at home Four major economic questions 1 What is produced 2 How are goods produced 3 For whom are goods produced 4 Who decides Principle 6 Markets are usually a good way to organize economic activity o Communism gov runs the economy Karl Marx Central planning answered the 4 questions Theory only the gov could organize the economy in a way that promoted economic well being wants invisible hand to be the gov o Market situations in which exchanges occur o Market economy allocates resources through the interaction of consumers individuals households private firms o When gov prevents prices from adjusting to supply demand it damages the economy s ability to coordinate the decisions of households firms o Famous insight by Adam Smith in The Wealth of Nations Consumers producers act as if led by an invisible hand to promote general economic well being Principle 7 Governments can sometimes improve market outcomes gov o People organizations can benefit in an economy when the Provides basic national security military homeland Provides public safety no public safety will not want to go to a store Establishes enforces property contract rules farmers will not grow crops if he expects them to be stolen etc o Can promote efficiency equality Set up a safety net for the poor Defend workers from their employers Protecting weak firms from stronger competitors antitrust laws Efficiency Market failure a situation in which the market on its own fails to produce an efficient allocation of resources Externality impact of one person s actions on the well being of a bystander pollution Market power the ability of a single person or small group to negatively influence market prices Equality Directly or indirectly provide goods services healthcare education mail Income tax welfare system aim to create an equal distribution of economic well being o Just because the gov can improve on market outcomes it does not mean that it will Political process is not perfect Policies are sometimes designed to reward the politically powerful Principle 8 A country s standard of living depends on its ability to produce goods and services o High income countries have more TVs cars better nutrition better healthcare longer life expectancy than those in low income countries o Variation of living standards is because of differences in countries productivity the quantity of goods services produced from each unit of labor input o Boost living standards policymakers need to raise productivity by improving education technology o Living standards are also based on credit labor unions minimum wage laws Principle 9 Prices rise when the government prints too much money economy o Inflation an increase in the overall level of prices in the o Inflation is typically caused by the growth of the quantity of money more money money is less valuable 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 the demand for goods services o Higher demand may over time cause firms to raise their prices also encourages them to hire more workers and increase productivity o More hiring means lower unemployment o Business cycle the irregular largely unpredictable fluctuations in economic activity as measured by productivity or the number of people employed o Policymakers influence demand by changing the amount the gov spends taxes
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