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Midterm 1Chapter 1: Ten Principles of EconomicsHow people make decisions●Principle 1: People Face Trade-offs○Guns and Butter: the more a society spends on national defense, the less it canspend on consumer goods to raise the standard of living at home○Efficiency and Equality■Efficiency: society is getting the maximum benefits from its scarceresources■Equality: those benefits are distributed uniformly among society’smembers■Efficiency refers to the size of the economic pie, and equality refers tohow the pie is divided into individual slices○Policies aimed at equalizing the distribution of economic well-being, individualincome tax--achieve greater equality, reduce efficiency○When the government tries to cut economic pie into more equal slices, the piegets smaller●Principle 2: The cost of something is what you give up to get it○Making decisions requires comparing the costs and benefits of alternative coursesof action○Opportunity Cost:what you give up to get the item●Principle 3: Rational people think at the margin○Rational people:systematically and purposefully do the best they can to achievetheir objectives, given the available opportunities○Marginal change:describe a small incremental adjustment to an existing plan ofaction○Person’s willingness to pay for a good is based on the marginal benefit that anextra unit of the good would yield○MB > MC●Principle 4: People respond to incentives○Incentive:something (such as the prospect of a punishment or reward) thatinduces a person to act○“People respond to incentives. The rest is commentary”○Higher price = people buy less○Policymakers: tax on gas encourages people to drive smaller, more fuel efficientcarsHow people interact●Principle 5: Trade can make everyone better off
●Principle 6: Markets are usually a good way to organize economic activity○Market Economy:decisions of a central planner are replaced by the decisions ofmillions of firms and households○Smith: participants in the economy are motivated by self-interest & invisible handof the marketplace guides this self-interest into promoting general economicwell-being●Principle 7: Governments can sometimes improve market outcomes○Property rights:individuals can own and control scarce resources○Gov intervenes to promote efficiency or equality○Market failure:situation in which the market on its own fails to produce anefficient allocation of resources○Externality:impact of one person’s actions on the well-being of a bystander(possible cause of market failure) example: pollution○Market power:ability of a single person or firm to unduly influence marketprices (possible cause of market failure)How the economy as a whole works●Principle 8: A country’s standard of living depends on its ability to produce goods andservices○Productivity:amount of goods and services produced by each unit of labor input●