III. Interaction: How Economies WorkInteraction: How Economies WorkLecture 1Outline of Current LectureI. ObjectivesII. Individual ChoiceIII. Interaction: How Economies WorkCurrent LectureObjectives:- A set of principles for understanding how individuals make choices- A set of principles for understanding how economies work through the interaction of the individual choices- A set of principles for understanding economy-wide interactions.Individual Choice- is the decision by an individual of what to do, which necessarily involves a decision of what not to do. The following are the basic principles behind individual choices:1) Resources are Scarce2) The real cost of something is what you must give up to get it3) “How much?” is a decision at the margin4) People usually take advantage of opportunities to make themselves better off.- Resource- anything that can be used to production something else.- Resources are scarce- that is, the quantity available is not large enough to satisfy all productive uses.- Opportunity Cost- the real cost of an item is its opportunity cost. This concept is crucial to understanding individual choice. For example, should you study for an hour or sleep? Should you go to college or go to work? All costs are ultimately opportunity costs.- “How Much” Is a Decision at the Margin- Individuals make a trade-off when they compare the costs with the benefits of doing something. Decisions about whether to do a bit more or bit less of an activity are called marginal decisions.- Marginal Analysis- making trade-offs at the margin means comparing costs and benefits of doing a little bit more of an activity versus doing a little bit less. Study of such decisions is knows as marginal analysis.- People Want to Make Themselves Better Off- An incentive is anything that offers rewards to people who change their behavior. For example, there are more well-paid jobs available for college graduates with economic degrees. As such, people respond these incentives.Interaction: How Economies WorkInteraction-of choices is a feature of most economic situations. Each individual’s choices affect another individual’s choices.Major principles of interaction of individual choices:1) There are gains from trade2) Markets move toward equilibrium3) Resources should be used as efficiently as possible to achieve society’s goals.4) Markets usually lead to efficiency5) When markets do not achieve efficiency, government intervention can improve society’s welfare. ECON 2106 1st Edition-There Are Gains From Trade- In a market economy, individuals engage in trade; they provide goods and services to others and receive goods and services in return. There are gains from trade because people can get more of what they want to through trade than they could if they tried to be self-sufficient.- The increase in output is due to specialization: each person specializes in the task that he/she isgood at performing- The economy, as a whole, can produce more when each person specializes in a task and trades with