Ten Principles of Economics Chapter 1 Ten Principles of Economics 1

comes from a Greek word for “One who manages a household.” The word Economy . . . comes from a Greek word for “One who manages a household.” 2

A household and an economy face many... Decisions? 3

? ? Decisions Who will work? What to produce? What resources to use? Who will we sell it to? 4

ECONOMICS The science of how to best allocate scarce resources among unlimited wants.

Scarcity... … means that society has less to offer than people wish to have. Managing society’s resources is important because resources are scarce. 5

…how people make decisions. ...how people interact with each other. Economists study. . . …how people make decisions. ...how people interact with each other. …the forces and trends that affect the economy as a whole. 6

Ten Principles of Economics: How People Make Decisions 7

How People Make Decisions 1. People face tradeoffs To get one thing, we usually have to give up another thing. Guns vs. Butter Food vs. Clothing Leisure Time vs. Work Efficiency and Equity 8

How People Make Decisions 1. People face tradeoffs Efficiency means . . . …getting the most you can from scarce resources. Equity means . . . …benefits of resources are distributed fairly among society. 9

How People Make Decisions 2 How People Make Decisions 2. The Cost of Something Is What You Give Up to Get It Decisions require comparing costs and benefits of alternatives Going to college vs. going to work Opportunity Cost is what you give up from one alternative (choice) to get what you want (from another choice) 10

How People Make Decisions 3. Rational People Think at the Margin Marginal changes are small, incremental adjustments to an existing plan of action. Comparing benefits and costs of a critical choice Marginal Benefits => MB Marginal Costs => MC 11

How People Make Decisions 4. People Respond to Incentives Marginal changes in costs or benefits from decisions motivate people to respond. Decision to choose one good over another occurs when MB > MC. 12

Ten Principles of Economics: How People Interact 14

How People Interact 5. Trade Can Make Everyone Better Off Individuals gain from their ability to trade with others. Competition results in gains from trading. Trade allows one to specialize in what they do best. 15

How People Interact 6. Markets Are Usually A Good Way To Organize Economic Activity A market is the most efficient form of economy. The market decides the following questions for us: 1. What will be produced? 2. How will it be produced? 3. When will it be produced? 4. Where will it be produced? 5. Who gets the products produced?

How People Interact 7. Governments Can Sometimes Improve Market Outcomes When the market fails (breaks down) government intervenes to promote Efficiency promote Equity Market failure results in inefficiency - failure of “invisible hand.” 17

How People Interact 7. Governments Can Sometimes Improve Market Outcomes Market failure may be the cause of an externality which is the impact of one person’s actions on the well-being of another person. (example: pollution) Market power is the ability of a single person to unduly influence market prices. 18

How the Economy as a Whole Works 8 How the Economy as a Whole Works 8. Standard of living depends on a country’s production. Standard of Living may be measured in different ways (e.g. personal income or total market value of a nations production.) Differences in standard of living between countries or even states is attributable to the productivity of the country or state. 21

Productivity => Standard of Living How the Economy as a Whole Works 8. Standard of living depends on a country’s production. Productivity is the amount of goods and services produced from different resources Productivity => Standard of Living 22

How the Economy as a Whole Works 9 How the Economy as a Whole Works 9. Prices Rise When The Government Prints Too Much Money Inflation is an increase in the overall level of prices in the economy. One cause of inflation is the growth in the quantity of money. 23

Inflation Unemployment How the Economy as a Whole Works 10. Society Faces a Short-Run Tradeoff Between Inflation and Unemployment Inflation Unemployment A Short-Run Tradeoff. You Choose. This tradeoff is called the Phillips Curve. 24