Econ 200 Chapter 1 Ten Principles of Economics Scarcity society has limited resources and therefore cannot produce all the goods and services people wish to have Economics the study of how society manages its scarce resources How people make decisions how much they work what they buy how much they save and how they invest their savings How People Make Decisions 1 People Face Trade offs we like o To get one thing we like we usually have to give up another thing that o Ex Time if a student spends her time studying 1 subject or divides it between multiple subjects she gives up time she could be spending studying other subjects or even doing other activities such as working sleeping or eating o Another trade off society faces is between efficiency and equality Efficiency means that society is getting the maximum benefits from its scarce resources Equality means that those benefits are distributed uniformly among society s members Efficiency refers to size of economic pie and equality refers to how the pie is divided into individual slices 2 The Cost of Something is What You Give Up to get it o Opportunity cost whatever must be given up to obtain an item 3 Rational People Think at the Margin o Rational People people who systematically and purposefully do the best they can to achieve their objectives Decisions in life are rarely black and white but usually involve shades of gray o Marginal changes small incremental adjustments to a plan of action o A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost Explains why people are willing to pay more for diamonds than for water and why airlines are willing to sell a ticket below average cost o Incentive something that induces a person to act such as the prospect of a punishment or a reward o Ex When price of an apple rises people decide to eat fewer apples At the same time apple orchards decide to hire more workers and harvest more apples A higher price in market provides an incentive for buyers to consume less and an incentive for sellers to produce more 4 People Respond to Incentives How People Interact 5 Trade Can Make Everyone Better Off o Trade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services o The Japanese as well as the French and the Egyptians and the Brazilians are as much our partners in the world economy as they are our competitors 6 Markets are Usually a Good Way to Organize Economic Activity 7 Governments can Sometimes Improve Market Outcomes o Communist countries worked on the premise that government officials were in the best position to control the economy s scarce resources o 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 Prices adjust to guide individual buyers and sellers to reach outcomes that maximize the well being of society as a whole Buyers look at the price when determining how much to demand and sellers look at the price when deciding how much to supply o Market economies need institutions to enforce property rights the ability of an individual to own and exercise control over scarce resources so individuals can own and control scarce resources Ex A farmer won t grow food if he expects his crops to be stolen a restaurant won t serve meals unless it is assured that customers will pay before they leave o Two broad reasons for a government to intervene in the economy and change the allocation of resources that people would choose on their own Goal of efficiency Market failure refers to a situation in which the market on its own fails to produce an efficient allocation of resources One possible cause of market failure is externality which is the impact of one person s actions on the well being of a bystander Example pollution Another possible cause of market failure is market power which refers to the ability of a single person to unduly influence market prices Example If everyone in town needs water but there is only one well the owner of the well is not subject to rigorous competition Goal of equality A market economy rewards people according to their ability to produce things that other people are willing to pay for Example The world s best basketball player earns more than the world s best chess player simply because people are willing to pay more to watch basketball than chess The market system alone does not ensure that everyone has sufficient food decent clothing and adequate healthcare This inequality may call for government intervention Example income tax and welfare system How the Economy as a Whole Works 8 A Country s Standard of Living Depends on Its Ability to Produce Goods and Services o Almost all variation in living standards is attributable to differences in countries 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 per unit of time most people enjoy a high standard of living The growth rate of a nation s productivity determines the growth rate of its average income o To boost living standards policymakers need to raise productivity by ensuring that workers are well educated have the tools needed to produce goods and services and have access to the best available technology 9 Prices Rise When the Government Prints Too Much Money o Inflation an increase in the overall level of prices in the economy o Inflation is a problem o Causes Growth in quantity of money when a government creates large quantities of the nation s money the value of the money falls 10 Society Faces a Short Run Trade Off between Inflation and Unemployment o Short run effects of monetary injections 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 less unemployment o Society faces a short run trade off between inflation and unemployment means that over a period of a year or two many economic policies push inflation and unemployment in opposite directions o The short run tradeoff plays a key role in the analysis of the business cycle the irregular and largely unpredictable fluctuations in the economic activity as
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