EconomicsField of study, began in 18th centuryFounder = Adam Smith, Scottish prof.Scientific method on people/economicsSmith’s book: The Wealth of NationsSet foundations, published in 1776On British economics, used by US18th centuryEconomics primarily agricultural with industrial revolution underwayProduction/exchanging changed because of Smith’s bookSmith’s principles are relevant todaySince book, economists refined/expanded understanding of economicsMicro-economicsHow people make certain choices in economiesHow people in an economy interact (buying/selling)How resources are allocated to various possible usesTen Principles of EconomicsHow people make decisionsPrinciple 1: People face trade-offsEfficiency vs. equalityMaximum benefits from scarce resources vs. benefits being distributed uniformly among society’s membersScarcity: used to refer to the limited nature of society’s resourcesDecisions are affected by the fact that resources are limitedEx. Time and moneyPrinciple 2: The cost of something is what you give up to get itBecause people face trade-offs, making decisions requires comparing the costs and benefits of possible choicesDecision makers should be aware of the opportunity costs that accompany each possible actionOpportunity cost: the value of the foregone options when one makes a choiceEx. Cost of college is $ spent on it; opportunity cost is loss of time to work, etc.Principle 3: Rational people think at the marginRational people systematically & purposefully do their best to achieve their objectives, given the available opportunitiesMarginal change: small incremental adjustment to an existing plan of action (margin=edge)Marginal cost: extra cost resulting from an increase in production or consumptionMarginal benefit: extra benefit resulting from an increase in production or consumptionRare/good items have higher marginal cost (diamonds vs. water)Will make choice if the marginal benefit of the action > the marginal costPrinciple 4: People respond to incentivesAn incentive is something that induces a person to actBenefit, reduced cost, reward, punishment, etc.“People respond to incentives. The rest is commentary.”Prices affect incentivesHigher price- buyers buy less & sellers produce moreMany policies change the costs or benefits that people face which changes their behaviorEx. Higher gas prices = more hybrid cars, higher cigarette taxes = less teen smokingAn incentive for people & firms is incomeFirm’s income is revenue divided by costs & profitHousehold’s income is personal incomeHow people interactPrinciple 5: Trade can make everyone better offExchange = tradingVoluntary, both parties get something they wantCompetition with buying and finding the lowest prices is good - not buying at all would be even worseTrade allows countries to specialize in what they do best & exchange it for other goods/services rather than being self-sufficientGet a better price abroad for goods they produceBuy other goods more cheaply from abroad than could be produced at homeFour major economic questions1. 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 activityCommunism: gov. runs the economy (Karl Marx)Central planning, answered the 4 questionsTheory: only the gov. could organize the economy in a way that promoted economic well-being (wants “invisible hand” to be the gov.)Market: situations in which exchanges occurMarket economy: allocates resources through the interaction of consumers (individuals, households) & private firmsWhen gov. prevents prices from adjusting to supply & demand, it damages the economy’s ability to coordinate the decisions of households & firmsFamous insight by Adam Smith in The Wealth of NationsConsumers & producers act as if “led by an invisible hand” to promote general economic well-beingPrinciple 7: Governments can sometimes improve market outcomesPeople & organizations can benefit in an economy when the gov.: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.)Can promote efficiency & equalitySet up a “safety net” for the poorDefend workers from their employersProtecting weak firms from stronger competitors (antitrust laws)EfficiencyMarket failure: a situation in which the market on its own fails to produce an efficient allocation of resourcesExternality: 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 pricesEqualityDirectly or indirectly provide goods & services (healthcare, education, mail)Income tax & welfare system aim to create an equal distribution of economic well-beingJust because the gov. can improve on market outcomes, it does not mean that it willPolitical process is not perfectPolicies are sometimes designed to reward the politically powerfulPrinciple 8: A country’s standard of living depends on its ability to produce goods and servicesHigh income countries have more TVs, cars, better nutrition, better healthcare, & longer life expectancy than those in low income countriesVariation of living standards is because of differences in countries’ productivity: the quantity of goods & services produced from each unit of labor inputBoost living standards - policymakers need to raise productivity by improving education & technologyLiving standards are also based on credit labor unions & minimum wage lawsPrinciple 9: Prices rise when the government prints too much moneyInflation: an increase in the overall level of prices in the economyInflation 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 unemploymentIncreasing the amount of money in the economy stimulates the overall level of spending & the demand for goods & servicesHigher demand may over time cause firms to raise their prices & also encourages them to hire more workers and increase productivityMore hiring means lower unemploymentBusiness cycle: the irregular & largely unpredictable fluctuations in economic activity as measured by productivity or the number of people employedPolicymakers influence demand by changing the amount the gov.
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