The Basics of Economics (Chapter 1)

“Billions of people could benefit from better economic policies “Billions of people could benefit from better economic policies. Millions are dying because of bad ones. Sometimes the logic of economics is so compelling that it’s impossible for economists not to take a stand.” Tim Hartford (author of The Undercover Economist)

Economics The study of how society manages its scarce resources by making decisions.

Are these scarce? CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

Yes! All goods and services are scarce!!! CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

Scarcity Since all resources in the world are limited, we are limited into how much we can produce. CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

Service Good To get the benefit, someone or something does it for you To get the benefit, you must actively use it To get the benefit, someone or something does it for you

So back to what economics is… CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

Lets pretend you have found a new tropical island that is inhabited by strange individuals...These people need so much help that they gave you the power to make all of their societal decisions. Currently, the society relies on themselves and their surroundings. Based on all of this info, what are three questions to ask yourself when deciding what is best for society?

MICROECONOMICS is based on the same concept but the decisions that are made are on a much smaller scale…(Individual, Firms, etc). CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

1. Key Economic Questions Society faces many decisions: What goods and services will be produced? Who will produce the goods and services? Who will consume the goods and services?

2. The Factors of Production The resources that are used to produce goods and services LAND LABOR CAPITAL 7

3. Physical vs. Human Capital Physical Capital are the man made assets that are used in production. Ex. shovel, nail, plastic, etc. Human Capital is the knowledge that is needed in production. Ex. a doctor administering an X-Ray, Mr. Barber teaching the most awe-inspiring lessons in the history of education.

4. Market A group of buyers (consumers) and sellers (producers) of a particular good or service

5. The People Who Make Up A Market Households Consumer of goods and services. They ARE the factors of production. Firms Producers of goods and services. They USE the factors of production.

Household or Firm?

Household or Firm?

6. Society and Scarce Resources 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.

Basic Principles of Economics

Principle #1: People Face Trade-offs Brain Drain! If society decides to be more equitable, what will happen to efficiency? Also known as costs What you give up because of a decision Efficiency v. Equity Efficiency means society gets the most that it can from its scarce resources. Equity means the benefits of those resources are distributed evenly among the members of society. 9

Result… Equity Efficiency

Principle #2: The Cost of Something Is What You Give Up to Get It. Basketball star LeBron James decided to give up college and play pro basketball. So, what was his cost? Do you think that was the correct decision? 10

The MOST desirable alternative that is given up because of a decision Opportunity Cost The MOST desirable alternative that is given up because of a decision

Which is the opportunity cost of this decision? 1. You can’t go on your dream vacation 2. You will be paying off the car for over 35 years You decide to buy a $50,000 car. 3. You can’t buy season tickets to your favorite sports team 4. You can’t afford your much needed open heart surgery, oops you’re dead

Should I steal one strawberry from the produce section at Jewel? High Opportunity Cost Low Opportunity Cost Should I rob a bank? Should I steal one strawberry from the produce section at Jewel?

Principle #3: Rational People Think at the Margin. Marginal changes are small, incremental adjustments to a decision. Example: Should I hire one more additional worker? People make decisions by comparing costs and benefits at the margin. 11

Keep adding units until the MB = MC Principle #4: When making decisions, people use the Cost Benefit Analysis When thinking at the margin, you only add one more unit if the marginal benefit (MB) > marginal cost (MC). Keep adding units until the MB = MC MC should never be greater than the MB. Benefits can also be called incentives. 12

What if…. Marginal Benefit = You play the game for a month and quickly lose interest (is that really worth $2,000?) Marginal Cost = $2,000

Principle #5: Trade Can Make Everyone Better Off. Trade allows people to specialize in what they do best. 15

Principle #6: Markets Are Usually a Good Way to Organize Economic Activity. Hey Congress, that’s smart because I am only going to produce what keeps my business running. So, most of society will get what they want. A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. I will let the citizens decide how to answer the key economic questions 16

Adam Smith made the “invisible hand” theory. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity. Adam Smith made the “invisible hand” theory. Because households and firms look at prices when deciding what to buy and sell, they unknowingly regulate the market. 16

Principle #7: Governments Can Sometimes Improve Market Outcomes. Markets work only if property rights are enforced. Property rights are the ability of an individual to own and exercise control over a scarce resource Market failure occurs when the market fails to allocate resources efficiently. When the market fails (breaks down) government can intervene to promote efficiency and equity. 17

Principle #7: Governments Can Sometimes Improve Market Outcomes. Market failure may be caused by: an externality, which is the impact of one person or firm’s actions on the well-being others. market power, which is the ability of a single person or firm to unduly influence market prices. 18