03 14 2013 Chapter 1 Ten Principles of Economics Scarcity The limited nature of societies resources 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 The management of society s resources is important because resources are scarce members Efficiency Society is getting the maximum benefits from its scarce resources Equality Those benefits are distributed uniformly among society s Opportunity Cost Whatever must be given up to obtain a certain item Rational people People who 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 Incentive Something that induces a person to act Such as the prospect of a punishment or a reward Market Economy Economy that allocates resources through the decentralized decisions of many firms and households they interact in markets for goods and services Property Rights The ability of an individual to own and exercise control over scarce resources Market Failure A situation in which a market left on its own fails to allocate resources efficiently Externality The impact of one person s actions on the well being of a bystander Pollution Possible cause of Market Failure Market power The ability of a single person small group to unduly influence market prices Possible cause of Market Failure Productivity the amount of goods and services produced from each unit of labor input Causes Inflation an increase in the overall level of prices in the economy In most cases of inflation the problem is growth in the quantity of money When a government creates large quantities of the nation s money the value of the money falls Business cycle the irregular and largely unpredictable fluctuations in economic activity as measured by the production of goods and services or the number of people employed Ten Principles of Economics People Face Trade offs Making decisions require trading off one goal against another Every hour given up to do something an hour is lost to do something else Society faces a trade off between Efficiency and Equality The Cost of Something Is What You Give Up to Get It Going to college creates better opportunities in life BUT it is very expensive Spending a year in school wastes a year you could be working at a job Ration People Think at the Margin Decisions are rarely black and white often involve shades of grey uncertainty Rational decision makers take an action if and only if the marginal benefit of the action exceeds the marginal cost Marginal Benefit is small for a cup of water because it is plentiful Marginal benefit for a diamond is large because they are rare People Respond to Incentives Positively or Negatively The price of apples decreases Eat more apples Vice Versa High Gas Prices Buy Smaller Cars More Public Transit Use Trade Can Make Everyone Better Off Usually trade helps out both countries greater variety of goods and services Isolation is BAD Trade allows countries to specialize in what they do best and to enjoy a Trading with others allows people to buy a greater variety of goods and services at a lower cost Markets Are Usually a Good Way to Organize Economic Activity No one is looking out for the economic well being of society as a whole in a free market everyone looks out for their own well being Firms decide who to hire and what to make Adam Smith Invisible hand In any market buyers look at the price when determining how much to demand and sellers look at the price when deciding how much to supply Market prices reflect both the value of a good to society and the cost to society of making the good Governments Can Sometimes Improve Market Outcomes 2 reasons that government would intervene in the economy Promote efficiency Promote equality Governments can SOMETIMES improve market outcomes but not always A Country s Standard of Living Depends on Its Ability to Produce Goods and Services PRODUCTIVITY 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 Growth rate of a nations productivity determines the growth rate of its average income Prices Rise When the Government Prints Too Much Money Inflation follows Society Faces a Short Run Trade off between Inflation and Unemployment Most economists describe the short run effects of monetary injections as 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 lower unemployment Society faces a short run trade off between inflation and unemployment Economists study How people make decisions How much they work What they buy How much they save How they invest their savings How people interact with one another Analyze forces and trends that affect the economy as a whole
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