1 Chapter - Ten Principles of Economics A key aspect in society is the managing of the societys resources (people, land, building, machinery) as resources are scarce Scarcity limited nature of societys resources, therefore being unable fulfill the societys wants and needs for goods and services Economics Study of how society manages its scarce resources Resources allocated by millions of households and firms Economists study: o o o o o o How people make decisions How much people work What people buy How much people save How people invest their savings How people interact with each other How the multitude of buyers and sellers of a good together determines the price at which the good is sold and the quantity that is sold
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Analyze forces and trends that affect the economy as a whole Growth in average income Fraction of population unable to find work Rate of rising prices
Principle #1: People Face Tradeoffs Making decisions requires trading off one goal against another More money spent on national defense = less money spent on consumer goods o This we cannot raise standard of living
Clean environment lower level of income Efficiency vs. Equity o Efficiency = the most output of societys scarce resources is being generated
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Equity = benefits distributed fairly among members Efficiency = size of pie; Equity = how pie is divided. When government cuts pie into more pieces, pie gets smaller
Principle #2: Cost Of Something Is What You Give Up To Get It Principle #3: Rational People people who systematically and purposefully do the best they can to achieve their objectives Rational people know decisions in life are not exactly as they seem, but usually involve some other factors Marginal Changes small incremental adjustments to a plan of action o Marginal benefits vs. marginal costs Marginal Benefit the marginal utility of a good or service is the utility gained or lost from an increase or decrease in the availability of a good or service Marginal Cost The increase or decrease in cost of a good or service as a result of an increase or decrease in the output of that good or service Making decisions means comparing and costs benefits of alternative courses of action Opportunity Cost whatever must be given up to obtain some item
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Rational person makes decisions ONLY if marginal benefit is greater than marginal cost
Principle #4 People Respond To Incentives Incentive something that induces a person to act When analyzing policies, we must also consider the indirect effects that work through incentives o If incentives change, people behaviours change
Principle #5 Trade Can Make Everyone Better Off Trade allows each person to specialize in the activities he/she does best People can buy greater variety of goods and services at lower cost through trading
Principle #6 Markets Are Usually A Good Way To Organize Economic Activity
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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 Invisible Hand self-regulating nature of the market. Also, an individual pursuing his own self-interest also tends to promote the good of his community as a whole
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Principle #7 Governments Can Sometimes Improve Market Outcomes Invisible hand only works if government enforces the rules and maintains the institutions that are key to a market economy Markets work if property rights are enforced o Property Rights ability of an individual to own and exercise control over scarce resources
Two reasons for government to intervene and change allocation of resources: 1) 2) Promote Efficiency Promote Equity
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Market Failure a situation in which a market left on its own fails to allocate resources efficiently o Causes of market failure Externality and Market Power Externality the impact of ones actions on the well-being of a bystander Ex. Pollution
Market Power the ability of a single economic actor to have a substantial influence on market prices
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Invisibl e h a n d m a y al s o fail t o e n s u r e e c o n o mic pr o s p e rity is dis trib u t e d e q uit a bly
Principl e # 8 A Cou n tr ys St a n d a r d of Livin g D e p e n d s On Its Ability To Pro d u c e Go o d s & S e rvic e s Livin g s t a n d a r d s is a t t