Ten Principals of Economics 11 30 2010 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 Ten Principles of Economics How people make decisions 1 People face trade offs 2 The cost of something is what you give up to get it 3 Rational people think at the margin 4 People respond to incentives How people interact 1 Trade can make everyone better off 2 Markets are usually a good way to organize economic activity 3 Governments can sometimes improve market outcomes How the economy works as a whole 1 A country s standard of living depends on its ability to produce goods and services 2 Prices rise when the government prints too much money 3 Society faces a short run trade off between inflation and unemployment Efficiency The property of society getting the most it can from its scarce resources the members of society Equality The property of distributing economic prosperity uniformly among Opportunity Cost Whatever must be given up to obtain some item Rational People People who systematically and purposely do the best they can to achieve their objectives Marginal Change Small incremental adjustments to a plan of action 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 scarce resources Property Rights The ability of an individual to own and exercise control over Externality The impact of a persons actions on the wellbeing of a bystander Market Power The ability of a single economic actor or small group of actors to have a substantial influence on market prices Productivity The quantity of goods and services produced from each unit of Inflation An increase in overall level of prices in an economy Business Cycle Fluctuations in economic activity such as employment and labor input production CHAPTER 1 SUMMARY 1 The fundamental lessons about individual decision making are that people face trade offs among alternative goals that the cost of any action is measured in terms of forgone opportunities that rational people make decisions by comparing marginal costs and marginal benefits and that people change their behavior in response to the incentives they face 2 The fundamental lessons about interactions among people are that trade and interdependence can be mutually beneficial that markets are usually a good way of coordinating economic activity among people and that the government can potentially improve market outcomes by remedying a market failure or by promoting greater economic equality 3 The fundamental lesson about the economy as a whole are that productivity is the ultimate source of living standards that growth in the quantity of money is the ultimate source of inflation and that society faces a short run trade off between inflation and unemployment Thinking like an Economist 11 30 2010 A Circular Flow Diagram A visual model of the economy that shows how dollars flow through markets among households and firms Productions Possibilities Frontier A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology Microeconomics The study of how households and firms make decisions and how they interact in markets Macroeconomics The study of economy wide phenomena including inflation unemployment and economic growth Two types of economic analysis Positive Statements are descriptive They make a claim about how the world is world ought to be Normative Statements are prescriptive They make a claim about how the CHAPTER 2 SUMMARY 1 Economists try to address their subject with a scientist s objectivity Like all scientists they make appropriate assumptions and build simplified models to understand the world around them Two simple economic models are the circular flow diagram and the production possibilities diagram 2 The field of economics is divided into two subfields micro and macroeconomics Microeconomists study decision making by households and firms and the interaction among households and firms in the marketplace Macroeconomists study the forces and trends that affect the economy as a whole 3 A positive statement is an assertion about how the world is A normative statement is an assertion about how the world ought to be When economists make normative statements they are acting more as policy advisers than as scientists 4 Economists who advise policymakers offer conflicting advice either because of differences in scientific judgments or because of differences in values At other times economists are united in the advice they offer but policymakers may choose to ignore it Interdependence and the Gains from Trade The Production Possibilities Frontier PPF is a graph that shows the combination of output that the economy can produce given the available factors of production and the available production technology The opportunity cost of an item is whatever must be given up to obtain that item The opportunity costs of two related goods are reciprocals For both parties to gain from trade the price at which they trade must lie somewhere between the two opportunity costs The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good Comparative advantage is the ability to produce a good at a lower opportunity cost than another producer Chapter Basic Point There are gains from trade and that at the heart of these gains from trade are the differences in opportunity cost or comparative advantage Marginal Changes are small incremental changes to a plan of action Individuals and firms can make better decisions by thinking at the margin A rational decision maker takes an action if and only if the marginal benefit is at least as large as marginal cost The slope of a PPF is always the opportunity cost of the good on the x axis The Market Forces of Supply and Demand 11 30 2010 Market A group of buyers and sellers of a particular good or service Competitive Market A market in which there are many buyers and sellers so that each has a negligible impact on the market price Perfectly Competitive To be perfectly competitive a market must have two qualities The goods offered for sale are all exactly the same and the buyers and sellers are so numerous that no single buyer or seller has any influence on the
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