Chapter 1 The management is society s resources is important because resources are scarce o Scarcity the limited nature of society s resources Economics the study of how society manages its scarce resources o Principle 1 People face trade offs There is no such thing as a free lunch Making decisions requires trading off one goal against another Examples of classic trade offs Guns and butter o The more a society spends on national defense guns to protect its shores from foreign aggressors the less it can spend on consumer goods butter to raise the standard of living at home A clean environment and a high level of income Efficiency and equality o Efficiency its scarce resources uniformly among the members of society o Equality the property of distributing economic prosperity the property of society getting the most it can from o Efficiency refers to the size of the economic pie and equality refers to how the pie is divided into individual slices o Principle 2 The cost of something is what you give up to get it Because people face trade offs making decisions requires comparing the costs and benefits of alternative courses of action whatever must be given up to obtain some item Opportunity cost o Principle 3 Rational people think at the margin Rational people systematically and purposefully do the best they can to achieve their objectives given the available opportunities Marginal change Rational people often make decisions by comparing marginal benefits and a small incremental adjustment to a plan of action marginal costs A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost o Principle 4 People respond to incentives Incentive something that induces a person to act Such as the prospect of a punishment or a reward Rational people respond to incentives A higher price in a market provides an incentive for buyers to consume less and an incentive for sellers to produce more E g a tax on gasoline encourages people to drive smaller more fuel efficient cars o Principle 5 Trade can make everyone better off Trade allows people to specialize in what they do best By trading with others people can buy a greater variety of goods and services at a lower cost o Principle 6 Markets are usually a good way to organize economic activity Market economy decentralized decisions of many firms and households as they interact in markets for goods and services an economy that allocates resources through the Market economies have proven remarkably successful in organizing economic activity to promote overall economic well being Invisible hand Directs economic activity making the good Market prices reflect both the value of a good to society and the cost to society of Prices adjust to guide individual buyers and sellers to reach outcomes that in many cases maximize the well being for society as a whole A market economy rewards people according to their ability to produce things that other people are willing to pay for o Principle 7 Governments can sometimes improve market outcomes The government is needed to enforce rules and maintain the institutions that are key to a market economy Most important market economies need institutions to enforce property rights so individuals can own and control scarce resources the ability of an individual to own and exercise control Property rights over scarce resources We all rely on government provided police and courts to enforce our rights over the things we produce The invisible hand counts on our ability to enforce our rights There are 2 broad reasons for a government to intervene in the economy and change the allocation of resources that people would choose on their own to promote efficiency or to promote equality Market failure allocate resources efficiently a situation in which a market left on its own fails to o One possible cause of a market failure is an externality Externality well being of a bystander the impact of one person s actions on the Classic example of an externality is pollution o Another possible cause of market failure is market power Market power the ability of a single economic actor or small group of actors to have a substantial influence on market prices o Principle 8 A country s standard of living depends on its ability to produce goods and services Almost all variation in living standards is attributable to differences in countries productivity the quantity of goods and services produced from each Productivity unit of labor input In nations where workers can produce a large quantity of goods and services per unit of time most people enjoy a high standard of living in nations where workers are less productive most people endure a more meager existence Similarly the growth rate of a nation s productivity determines the growth rate of its average income o Principle 9 Prices rise when the government prints too much money Inflation an increase in the overall level of prices in the economy Inflation is caused by the growth in the quantity of money o When a government creates large quantities of the nation s money the value of the money falls o Principle 10 Society faces a short run trade off between inflation and unemployment Short run effects of monetary injections include 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 o More hiring means lower unemployment Many economic policies push inflation and unemployment in opposite directions This short run trade off plays a key role in the analysis of the business cycle Chapter 2 o Business cycle employment and production fluctuations in economic activity such as Economic models through markets among households and firms o Circular flow diagram a visual model of the economy that shows how dollars flow Firms produce goods and services using inputs such as labor land and capital buildings and machines These inputs are called factors of production o Households own the factors of production and consume all the goods and services that the firms produce Households and firms interact in 2 types of markets Markets for goods and services o Households are buyers and firms are sellers In particular households buy the output of goods and services that firms produce Markets for the factors of
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