How People Make Decisions Principle 1 People Face Tradeoffs Ex joining a party vs studying for quiz Our society faces the tradeoff efficiency vs equality Efficiency Get most from scarce resources Equality Prosperity is not distributed uniformly among members Principle 2 cost of something is what you give up to get it Opportunity cost the highest value opp given up Ex Going to college vs working for wages Principle 3 Rational people think at the margin Rational people Do the best they can to achieve their objectives Make decisions by evaluation costs and benefits of marginal changes Principle 4 People respond to incentives Incentive something that induces a person to act Principle 5 Trade can make everyone better off Rather than begin self sufficient people can specialize and exchange Principle 6 Markets are usually a good way to organize economic activity Market A group of buyers and sellers location doesn t matter Market economy allocates resources through the decision of many householders and firms as they interact in market Maximize society s economic well being The invisible hand Principle 7 Governments can sometimes improve market outcomes Important role enforce property rights Market failure market fails to allocate society s resources efficiently Externalities ex pollution When the production or consumption of good affects bystanders Market power A single buyer or seller has substantial influence on market price Gov may alter market outcome to promote equity Principle 8 A country s standard of living depends on its ability of produce goods services Most important determinant of living standard Productivity Depends on equipment skill technology available to workers Principle 9 Prices rise when the government prints too much money Inflation increases in the general level of prices Principle 10 Society faces a short run tradeoff between inflation and unemployment Short run 1 2 years