Chap01- Ten principles of Economics Spring 2010

Chap01- Ten principles of Economics Spring 2010 - ECO 201...

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Unformatted text preview: ECO 201 Principles of Microeconomics Marina Irimia-Vladu Spring 2010 Chapter 1 Ten Principles of Economics Outline 1. 2. 3. 4. 5. Why study economics? Definition of Economics 3 Fundamental Economic Questions The Two Branches of Economics The Three Categories of Principles How people make decisions. How people interact with each other. How the economy as a whole works. Why Study Economics? Understand the markets Be more competitive on the job market Understand the government policy Make better decisions Economy. . . . . . The word economy comes from Greek words for "one who manages a household." Scarcity (Scarce Resources) Human needs and wants are unbounded. Resources are limited relative to individuals desires Scarcity. . . means that society has limited resources and therefore cannot produce all the goods and services people wish to have. Definition Economics is the study of how society manages its scarce resources. Household Questions A household faces many decisions: How much to work? What to buy? How much to spend? How much to save? Three Fundamental Economic Questions What to produce? How to produce? For whom to produce? Branches Microeconomics is the study of how individuals and firms make decisions. Macroeconomics is the study of the whole economy, including inflation, unemployment and economic growth. Ten Principles of Economics It is important to understand these principles, not to memorize them: How people make decisions. How people interact with each other. How the economy as a whole works. How people make decisions People face tradeoffs. The cost of something is what you give up to get it. Rational people think at the margin. People respond to incentives. How people interact with each other Trade can make everyone better off. Markets are usually a good way to organize economic activity. Governments can sometimes improve economic outcomes. How the economy as a whole works The standard of living depends on a country's production. Prices rise when the government prints too much money. Society faces a short-run tradeoff between inflation and unemployment. Principle #1: People Face Tradeoffs. To get one thing, we usually have to give up another thing. Guns v. butter Food v. clothing Leisure time v. work Efficiency v. equity Making decisions requires trading off one goal against another. Principle #1: People Face Tradeoffs Efficiency vs. Equity Efficiency means society gets the most that it can from its scarce resources. Equity means the benefits of those resources are distributed fairly among the members of society. Principle #2: The Cost of Something Is What You Give Up to Get It. It is an elaboration of the previous principle. The opportunity cost of an item is what you give up to obtain that item. Explicit (out of pocket expenses) vs. Implicit costs What is the cost of going to a movie? What is the cost of going to college? Air travel vs. car travel What airline company should you fly from Dubai to New York? drive through Principle #3: Rational People Think at the Margin. Take an action marginal benefit > marginal cost Marginal = extra, additional Marginal changes are small, incremental adjustments to an existing plan of action. An airline company, instead of flying with empty seats in the plane, should accept any passenger ready to pay more than the marginal cost of adding one passenger. Parking illegally; smoking exercises 5 and 6 from the end of Chapter 1(homework). Principle #3: Rational People Think at the Margin. Another Example: You have paid $5,000 for your car that does not work any more. You have 2 choices: Sell it as it is for $700 or Repair it for $1,000, and then sell it for sure for $1900. What would you do? Why? Principle #3: Rational People Think at the Margin. Another Example: What would be your answer if you had paid $10,000 for your car? Sunk cost = a cost that has already been incurred and can not be recovered. Unlike opportunity cost, sunk cost should be ignored. Principle #4: People Respond to Incentives. Changes in costs or benefits motivate people to respond. When the price of a good rises, consumers will buy less of it because its cost has risen. When the price of good rises, firms will increase the production of that good. Quizzes during semester and bonus points Parking permit for campus. Social Security system Unemployment benefits & unemployment rate Taxes (Tax= tY) Seat belt laws Principle #5: Trade Can Make Everyone Better Off. People gain from their ability to trade with one another. Every family is involved in trade with other families on a daily basis. Most families do not build their own homes, make their own clothes, or grow their own food. Helping a friend Just like families benefit from trading with one another so do countries. Trade allows people/countries to specialize in what they do best. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity. Market Economy: individuals and private firms make the major decisions about production and consumption. Command Economy: government makes all important decisions about production and distribution. Mixed Economy has elements of both. All modern economies are mixed. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity. Adam Smith Founder of Microeconomics, "Wealth of Nations", 1776 Households and firms interacting in markets act as if guided by an "invisible hand." Although individuals are motivated by selfinterest, an "invisible hand" guides this selfinterest into promoting society's well-being Principle #7: Governments Can Sometimes Improve Market Outcomes. Government can intervene when the market fails (breaks down) to promote efficiency and equity. Market failure occurs when the market fails to allocate resources efficiently. Principle #7: Governments Can Sometimes Improve Market Outcomes. Market failure may be caused by Externality = the impact of one person or firm's actions on the well-being of a bystander. Example: Pollution Market power = the ability of a single firm to influence the market prices. Example: Monopoly Principle #8: The Standard of Living Depends on a Country's Production. Standard of living may be measured in different ways: By comparing personal incomes. By comparing the total market value of a nation's production (GDP=gross domestic product). Principle #8: The Standard of Living Depends on a Country's Production. Almost all variations in living standards are explained by differences in countries' productivities. Productivity = the amount of goods and services produced from each hour of a worker's time. Examples: Farmer: Rancher: 2kg of potatoes/hour; 5 kg meat/hour Principle #9: Prices Rise When the Government Prints Too Much Money. Inflation = an increase in the overall level of prices in the economy. One cause of inflation is the growth in the quantity of money. When the government creates large quantities of money, the value of the money falls. Examples: Germany after World War I (early 1920s) United States in 1970s Principle #10: Society Faces a Short-run Tradeoff Between Inflation and Unemployment. The Phillips Curve illustrates the tradeoff between inflation and unemployment: Inflation Unemployment It's a short-run tradeoff! Table 1 on page 15 in the textbook ...summarizes the Ten Principles of Economics highlighted in this chapter. Summary When individuals make decisions, they face tradeoffs among alternative goals. The cost of any action is measured in terms of foregone opportunities. Rational people make decisions by comparing marginal costs and marginal benefits. People change their behavior in response to the incentives they face. Summary Trade can be mutually beneficial. Markets are usually a good way of coordinating trade among people. Government can improve market outcomes if there is some market failure or if the market outcome is inequitable. Summary Productivity is the ultimate source of living standards. Money growth is the ultimate source of inflation. Society faces a short-run tradeoff between inflation and unemployment. ...
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This note was uploaded on 04/29/2010 for the course ECO 201 taught by Professor Saravia during the Spring '08 term at American University of Sharjah.

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