Chapter 1: Ten Principles of Economics

Brainstorm What are 5 things that you would like more of?

What is Economics? Study of how society manages its scarce resources Therefore, basic economic concept is Scarcity

Principle #1 People Face Trade-offs -There Is No Such Thing As A Free Lunch -What in life is truly free? Making decisions requires trading one goal for another Efficiency vs. Equity: Maximum benefits to society vs. “fairness”

Principle #2 The Cost of Something is What You Give Up to Get It Making decisions causes people to consider the costs & benefits of an action Opportunity Cost: Whatever must be given up in order to obtain some item Do you go to college?

Principle #3 Rational People Think at the Margin Are people rational? HUGE CONCEPT: Marginal Benefit vs. Marginal Cost - up to and including MB=MC Example: Diamonds vs. Water Airlines

Principle #4 People Respond to Incentives Incentives change people’s behavior Must look at direct & indirect effects of incentives/policies (unintended consequences) Change incentives/change behavior -Ex: Incentive effects of Gas Prices Rising -How can we get you to study more/try harder? (+/-) -Linking teacher pay/jobs to standardized testing? (+/-)

Is Trade Good for the U.S.? Should the U.S. trade more or less than we do? Why?

Principle #5 Trade Can Make Everyone Better Off Trade doesn’t have to result in winners & losers – both can win! Zero-Sum game? - doesn’t have to be Trade allows for specialization in what you do best

Principle #6 Markets Are Usually a Good Way to Organize Economic Activity Many countries have abandoned centrally planned economies to develop markets Market economy: an economy that allocates resources through decisions of many firms and households Invisible Hand guides the economy when everyone does what is best for them

Good Gov’t, Bad Gov’t How much/how little should the government get involved in the economy? In what situations does it help to have gov’t intervention?

Principle #7 Governments Can Sometimes Improve Market Outcomes 2 Biggest Reasons for Intervention: Efficiency & Equality Most useful when there is Market Failure Ex.: Externalities & Market Power This concept produces big disagreements

Principle #8 A Country’s Standard of Living Depends on Its Ability to Produce Goods & Services Huge differences in living standards around the world Explained by differences in productivity Broken window fallacy?

a man's son breaks a pane of glass man will have to pay to replace it. Some consider the boy has actuall done the community a service because ….? his father will have to pay the repair man Who will then presumably spend the extra money on something else…… jump-starting the local economy. Why is this wrong?

the man's son has reduced his father's disposable income,disposable income his father will not be able purchase new shoes or some other luxury good. Thus, the broken window might help the repair man, but at the same time, it robs other industries and reduces the amount being spent on other goods. Moreover, replacing something that has already been purchased is a maintenance cost, rather than a purchase of truly new goods, and maintenance doesn't stimulate production.

 broken window fallacy is often used to discredit the idea that going to war stimulates a country's economy.  This fallacy forgets about the missing third party (such as the shoe maker). In this sense, the fallacy comes from making a decision by looking only at the parties directly involved in the short term, rather than looking at all parties (directly and indirectly) involved in the short and long term.

Principle #9 Prices Rise When the Government Prints Too Much Money Inflation – increase in overall level of prices in the economy Examples?

Principle #10 Society Faces a Short-Run Trade-off Between Inflation & Unemployment In short run, increase in $ leads to lower unemployment but higher prices Trade-off leads to discussions of business cycles, fiscal & monetary policy