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Mankiw - Chapter_01 & 02 - Chapter 1 Ten Principles...

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1 Mankiw, Principles of Economics Prepared by Moon Young BAEK Yonsei University, Economics Chapter 1 Ten Principles of Economics 1.1 Introduction z The word economy comes from the Greek word oikonomos (“one who manages a household.”) z A household faces many decisions: Why? – it decides how to allocate its scarce resources. z Society also faces many decisions: the management of society’s resources is important because resources are scarce. Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. z Economics is the study of how society manages its scarce resources. 1.2 How people make decisions Principle 1: People face trade-offs . z Making decisions requires trading off one goal against another. z Trade-offs faced by societies: ‘Guns and butter’, clean environment and a high level of income, efficiency and equity Efficiency: the property of society getting the most it can from its scarce resources Equity: the property of distributing economic prosperity fairly among the members of society z Recognizing that people face trade-offs does not by itself tell us what decisions they will or should make. z Acknowledging life’s trade-offs is important because people are likely to make good decisions only if they understand the options that they have available. Principle 2: The cost of something is what you give up to get it. z Because people face trade-offs, making decisions require comparing the costs and benefits of alternative courses of action. z Opportunity cost: whatever must be given up to obtain some item
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2 Mankiw, Principles of Economics Prepared by Moon Young BAEK Yonsei University, Economics When making any decision, decision makers should be aware of the opportunity costs that accompany each possible action. Principle 3: Rational people think at the margin z Economists normally assume that people are rational. Rational people: people who systematically and purposefully do the best they can to achieve their objectives. z Rational consumers who buy a bundle of goods and services to achieve the highest possible level of satisfaction, subject to their incomes and the prices of those goods and services. z Rational firms that decide how many workers to hire and how much of their product to manufacture and sell to maximize profits. z Economists use the term marginal changes to describe small incremental adjustments to an existing plan of action. Rational people often make decisions by comparing marginal benefits and marginal costs. Marginal decision making can help explain some puzzling economic phenomena: a paradox of water and a diamond – Why is water so cheap, while diamonds are so expensive? z People are willing to pay much more for a diamond for a cup of water. Why? A person’s willingness to pay for any good is based on the marginal benefit, and this depends on how many units a person already has.
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