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Book Notes - Chapter 1 Ten Principles of Economics A...

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Chapter 1 – Ten Principles of Economics A. General Overview 1. Scarcity – A society (or any entity) with limited resources who can’t produce all the goods and services people wish to have. 2. Economics – A study of how society manages its scarce resources. i. Resources are not allocated by a single central planner (individual, household, firm, etc.) but through the combined actions of many households and firms. ii. Economists study: a. How people make decisions (how they work, buy, save, and invest). b. How people (buyers/sellers) interact with one another to determine the prices and quantities at which goods/services are sold. c. How economic forces and trends affect people financially (e.g. their average income growth, unemployment, and rising interest rates). B. Principle #1 – People Face Tradeoffs 1. Tradeoff – Sacrificing one thing for another (to get one thing we like, we usually have to give up another thing we like). i. A classic example – “guns and butter”: The more we spend on national defense, the less we can spend on consumer goods to raise our standard of living. ii. Clean environment vs. level of income: Laws that require firms to reduce pollution cause a rise in the cost of producing goods/services (leading to smaller profits, lower wages, and/or higher prices). iii. Efficiency vs. equity: Efficiency (getting the most from scarce resources) and equity (benefits of resources are equally distributed) conflict when govt. policies are made. a. When govt. redistributes income from rich to poor (equity ), it reduces rewards for working hard, leading to less production of goods (reduced efficiency ). C. Principle #2 – Cost of Something is What You Give Up to Get It 1. When facing tradeoffs, making decisions means weighing costs and benefits. 2. Opportunity cost – The next best foregone alternative (what you give up to get something of interest).
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D. Principle #3 – Rational People Think At the Margin 1. Marginal changes – Small, incremental adjustments to an existing plan of action (e.g. taking and extra spoonful of mashed potatoes vs. either taking none or stuffing your plate). 2. Marginal Benefits vs. Marginal Costs – Added benefits or costs per unit of good or service. 3. Rational decisions are made when marginal benefit > marginal cost. 4. In business, given that the unit price of a good or service is sold at a price higher than the marginal cost, the sale is profitable. E. Principle #4 – People Respond to Incentives 1. Incentives – The outcome due to a change in marginal benefits or costs. 2. People respond to incentives by making cost-benefit calculations. F. Principle #5 – Trade Can Make Everyone Better Off 1. Trade allows for specialization in certain goods and allows for a greater variety of goods at lower costs. G. Principle #6 – Markets Organize Economic Activity
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Book Notes - Chapter 1 Ten Principles of Economics A...

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