Chapter 1 The Big Ideas

Big Ideas in Economics The Big Ideas: Incentives matter Good institutions align self-interest with the social interest Trade-offs are everywhere Thinking on the margin Tampering with the laws of supply and demand has consequences

Big Ideas in Economics The Big Ideas: The importance of wealth and economic growth Institutions matter Economic booms and busts cannot be avoided but can be moderated Prices rise when the government prints too much money Central banking is a hard job

Big Idea One: Incentives Matter Incentives are rewards and penalties that motivate behavior. Economists believe that people respond to incentives in predictable ways. Self-interest is an extremely important incentive in economics.

Good institutions align self-interest with the social interest Big Idea Two: Good Institutions Align Self-Interest with the Social Interest Good institutions align self-interest with the social interest Under the right conditions, markets align self-interest with the social interest. When markets work well, individuals acting in their own self-interest produce outcomes promoting the social interest. Markets do not always align self-interest with the social interest creating an opportunity for government to improve the situation by changing incentives.

Big Idea Three: Trade-offs Are Everywhere All economic activity involves choices of conflicting objectives. The Opportunity Cost of a choice is the value of the opportunities lost. Economists use opportunity costs to measure the extent of the trade-offs involved in economic activity. Recognizing trade-offs is the first step in making wise decisions. It is also important to note that people respond to changes in opportunity costs.

Big Idea Four: Thinking on the Margin Economic activity rarely involves all-or-nothing choices. Trade-offs typically involve decisions about a little bit more or a little bit less. Thinking on the margin is essential to properly analyze how people evaluate the trade-offs they face.

Tampering with the laws of supply and demand has consequences Big Idea Five: Tampering with the Laws of Supply and Demand Has Consequences Tampering with the laws of supply and demand has consequences The model of supply and demand is one of the most important tools in economics and determines the price of goods and services. Interference by government decree in the mechanisms of this model rarely works. Such controls on price tend to make matters worse by interfering with incentives.

Big Idea Six: The Importance of Wealth and Economic Growth Wealth brings higher standards of living. Understanding economic growth (how economies increase wealth) is one of the most important tasks of economics.

Big Idea Seven: Institutions Matter Why are some countries rich and others poor? Incentives to save and invest in physical capital, human capital, innovation, and efficient organizations determine the wealth of nations. Strong institutions that support these incentives foster economic growth. Such institutions include property rights, political stability, honest government, a dependable legal system, and competitive and open markets.

Economic booms and busts cannot be avoided but can be moderated Big Idea Eight: Economic Booms and Busts Cannot Be Avoided but Can Be Moderated Economic booms and busts cannot be avoided but can be moderated Economies do not grow at a constant pace but rather experience ups and downs, booms and bust. These booms and busts are typically normal responses to changing economic conditions. Monetary and fiscal policy are tools used to smooth out the fluctuations of a normal economy. Understanding the promise and the limits of these tools is an important aspect of economics.

Big Idea Nine: Prices Rise When the Government Prints Too Much Money Monetary policy can be used to mitigate economic fluctuations, but it can create unwanted side effects. Inflation is an increase in the general level of prices. Inflation comes about when there is a sustained increase in the supply of money.

Big Idea Ten: Central Banking Is a Hard Job In most nations a central bank sets monetary policy to ease fluctuations in the economy. The difficulty with this approach is that there is a lag (often many months) between a policy decision and its effect on the economy. Economic conditions can change in the meantime however, so the central bank is essentially shooting at a moving target. The problem is that too much or too little money in the economy will influence its general level of prices.

The Biggest Idea of All: Economics Is Fun Of course, the biggest idea of all is that economics is fun! Economics teaches how to make the world a better place. It is about the difference between wealth and poverty, work and unemployment, happiness and squalor. Economics increases an understanding of the distant past, present events, and future possibilities.