conomics
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by Ron Cronovich
© 2009 South-Western, a part of Cengage Learning, all rights reserved
▪ What kinds of questions does economics address?
▪ What are the principles of how people make
decisions?
▪ What are the principles of how people interact?
▪ What are the principles of how the economy as a
whole works?
How do you spend your
pocket money?
TEN PRINCIPLES OF ECONOMICS
▪ Scarcity: the limited nature of society’s
resources
▪ Economics: the study of how society manages
its scarce resources, e.g.
▪ how people decide what to buy,
how much to work, save, and spend
▪ how firms decide how much to produce,
how many workers to hire
▪ how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs
TEN PRINCIPLES OF ECONOMICS
Principle #1: People Face Tradeoffs
▪ Going to a party the night before our midterm
leaves less time for studying.
▪ Having more money to buy stuff requires working
longer hours, which leaves less time for fun.
▪ Protecting the environment requires resources
that could otherwise be used to produce
consumer goods.
All choices involve trade off!
TEN PRINCIPLES OF ECONOMICS
Principle #1: People Face Tradeoffs
▪ Society faces an important tradeoff:
efficiency vs. equality
▪ Efficiency: when society gets the most from its
scarce resources
▪ Equality: when prosperity is distributed uniformly
among society’s members
▪ Tradeoff: To achieve greater equality,
could redistribute income from wealthy to poor.
But this reduces incentive to work and produce,
shrinks the size of the economic “pie.
TEN PRINCIPLES OF ECONOMICS
Principle #2: The Cost of Something Is
What You Give Up to Get It
▪ Making decisions requires comparing the costs
and benefits of alternative choices.
▪ The opportunity cost of any item is
whatever must be given up to obtain it.
▪ It is the relevant cost for decision making.
TEN PRINCIPLES OF ECONOMICS
Principle #2: The Cost of Something Is
What You Give Up to Get It
Examples:
The opportunity cost of…
…going to college for a year is not just the tuition,
books, and fees, but also the foregone wages.
…seeing a movie is not just the price of the ticket,
but the value of the time you spend in the theater.
TEN PRINCIPLES OF ECONOMICS
Principle #3: Rational People Think at the
Margin
Rational people
▪ systematically and purposefully do the best they
can to achieve their objectives.
▪ make decisions by evaluating costs and benefits
of marginal changes – incremental adjustments
to an existing plan.
TEN PRINCIPLES OF ECONOMICS
Principle #3: Rational People Think at the
Margin
Examples:
▪ When a student considers whether to go to
college for an additional year, he compares the
fees & foregone wages to the extra income
he could earn with the extra year of education.
▪ When a manager considers whether to increase
output, she compares the cost of the needed
labor and materials to the extra revenue.
TEN PRINCIPLES OF ECONOMICS
Principle #4: People Respond to Incentives
▪ Incentive: something that induces a person to
act, i.e. the reward or punishment.
▪ Rational people respond to incentives:
▪ When gas prices increase, people tend to car
pool or use public transportation.
▪ When cigarette taxes increase,
teen smoking falls.
▪ Can you think of policies to encourage people
to move outside the city?
TEN PRINCIPLES OF ECONOMICS
INTERACT
Principle #5: Trade Can Make Everyone
Better Off
▪ Not every country can be self sufficient.
▪ Rather than being self-sufficient,
people can specialize in producing one good or
service and exchange it for other goods.
▪ Countries also benefit from trade & specialization:
▪ Get a better price abroad for goods they produce
▪ Buy other goods more cheaply from abroad than
could be produced at home
TEN PRINCIPLES OF ECONOMICS
Principle #6: Markets Are Usually A Good Way
to Organize Economic Activity
▪ Market: a group of buyers and sellers
(need not be in a single location)
▪ “Organize economic activity means determining
▪ what goods to produce
▪ how to produce them
▪ how much of each to produce
▪ who gets them
TEN PRINCIPLES OF ECONOMICS
Principle #6: Markets Are Usually A Good Way
to Organize Economic Activity
▪ A market economy allocates resources through
the decentralized decisions of many households
and firms as they interact in markets.
▪ Famous insight by Adam Smith in
The Wealth of Nations (1776):
Each of these households and firms
acts as if “led by an invisible hand
to promote general economic well-being.
TEN PRINCIPLES OF ECONOMICS
Principle #6: Markets Are Usually A Good Way
to Organize Economic Activity
▪ The invisible hand works through the price system:
▪ The interaction of buyers and sellers
determines prices.
▪ Each price reflects the good’s value to buyers
and the cost of producing the good.
▪ Prices guide self-interested households and
firms to make decisions that, in many cases,
maximize society’s economic well-being.
TEN PRINCIPLES OF ECONOMICS
Principle #7: Governments Can Sometimes
Improve Market Outcomes
▪ An important role of the gov. is to enforce property
rights
(through the police, courts)
▪ What are property rights?
-The ability to own, control and use scarce
resources.
-Firms and people will not produce or work unless
they are sure that their output is protected by law
TEN PRINCIPLES OF ECONOMICS
Principle #7: Governments Can Sometimes
Improve Market Outcomes
▪ Market failure: when the market fails to allocate
society’s resources efficiently
▪ Causes:
▪ Externalities, when the production or consumption
of a good affects bystanders (e.g. pollution)
▪ Market power, a single buyer or seller has
substantial influence on market price (e.g. monopoly)
▪ In such cases, public policy may promote efficiency.
TEN PRINCIPLES OF ECONOMICS
Principle #7: Governments Can Sometimes
Improve Market Outcomes
▪ Govt may alter market outcome to promote equity
▪ How can the government promote equity?
▪ If the market’s distribution of economic well-being
is not desirable, tax or welfare policies can change
how the economic “pie is divided.
▪
TEN PRINCIPLES OF ECONOMICS
WORKS
Principle #8: A country’s standard of living
depends on its ability to produce goods &
services.
▪ Huge variation in living standards across
countries and over time:
▪ Average income in rich countries is more than
ten times average income in poor countries.
▪ The U.S. standard of living today is about
eight times larger than 100 years ago.
▪ Can you comment about the distribution of
income today in Egypt?
TEN PRINCIPLES OF ECONOMICS
Principle #8: A country’s standard of living
depends on its ability to produce goods &
services.
▪ The most important determinant of living standards:
productivity, the amount of goods and services
produced per unit of labor.
▪ Productivity depends on the equipment, skills, and
technology available to workers.
▪ Other factors (e.g., labor unions, competition from
abroad) have far less impact on living standards.
TEN PRINCIPLES OF ECONOMICS
Principle #9: Prices rise when the
government prints too much money.
▪ Inflation: increases in the general level of prices.
▪ In the long run, inflation is almost always caused by
excessive growth in the quantity of money, which
causes the value of money to fall.
▪ The faster the govt creates money,
the greater the inflation rate.
TEN PRINCIPLES OF ECONOMICS
Principle #10: Society faces a short-run
tradeoff between inflation and unemployment
▪ In the short-run (1 – 2 years),
many economic policies push inflation and
unemployment in opposite directions.
▪ Other factors can make this tradeoff more or less
favorable, but the tradeoff is always present.
TEN PRINCIPLES OF ECONOMICS
The principles of decision making are:
▪ People face tradeoffs.
▪ The cost of any action is measured in terms of
foregone opportunities.
▪ Rational people make decisions by comparing
marginal costs and marginal benefits.
▪ People respond to incentives.
The principles of interactions among people are:
▪ Trade can be mutually beneficial.
▪ Markets are usually a good way of coordinating
trade.
▪ Govt can potentially improve market outcomes if
there is a market failure or if the market outcome
is inequitable.
The principles of the economy as a whole are:
▪ 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.
