Chapter 1- The management is society’s resources is important because resources are scarceo Scarcity – the limited nature of society’s resources- Economics – the study of how society manages its scarce resourceso 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 protectits 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 equalityo Efficiency – the property of society getting the most it can from its scarce resourceso Equality – the property of distributing economic prosperity uniformly among the members of societyo Efficiency refers to the size of the economic pie, and equality refers to how the pie is divided into individual sliceso 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 Opportunity cost – whatever must be given up to obtain some itemo 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 – a small incremental adjustment to a plan of action Rational people often make decisions by comparing marginal benefits and marginal costs A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal costo 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 carso 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 costo Principle 6: 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 marketsfor goods and services- Market economies have proven remarkably successful in organizing economic activity to promote overall economic well-being “Invisible hand”- Directs economic activity Market prices reflect both the value of a good to society and the cost to society ofmaking the good- 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 foro 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- Property rights – the ability of an individual to own and exercise control 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 – a situation in which a market left on its own fails to allocate resources efficientlyo One possible cause of a market failure is an externality Externality – the impact of one person’s actions on the well-being of a bystander Classic example of an externality is pollutiono 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 priceso 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- Productivity – the quantity of goods and services produced from each unit of labor input In nations where workers can produce a large quantity of goods and services perunit 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 incomeo 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 moneyo When a government creates large quantities of the nation’s money, the value of the money fallso 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 themeantime, it also encourages them to hire more workers and produce a larger quantity of goods and serviceso 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 cycleo Business cycle – fluctuations in economic activity, such as employment and productionChapter 2- Economic modelso Circular-flow diagram – a visual model of the economy that shows how dollars flow through markets among households and firms 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
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