Principles of Economics
(Elementary)
ECO, KASBIT
Part 1
INTRODUCTION
Economics
• Economics is the study of how society manages its
scarce resources.
• Scarcity: society has limited resources and therefore
cannot produce all the goods and services people
wish to have.
• Resources are allocated through the combined
actions of millions of households and firms,
economists therefore study
• how people make decisions (work, buy, save, invest)
• how people interact with one another (price)
• forces and trends (income growth, unempl. rate, inflation)
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Microeconomics and Macroeconomics
• Microeconomics focuses on the individual parts
of the economy.
• How households and firms make decisions and how
they interact in specific markets (E.g. compulsory
school attendance affects earnings, cafeteria)
• Macroeconomics looks at the economy as a
whole.
• Economy-wide phenomena, including inflation,
unemployment, and economic growth
• Different questions, different approaches
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Ten Principles of
Economics
C1
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Principle #1: People Face Tradeoffs.
“There is no such thing as a free lunch!”
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Principle #1: People Face Tradeoffs.
To get one thing, we usually have to give up
another thing.
• Food v. clothing
• Leisure v. work
Making decisions requires trading
off one goal against another.
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Principle #1: People Face Tradeoffs
• Efficiency v. Equity (Common)
• Efficiency means society gets the most that it can
from its scarce resources. (Bigger pie)
• Equity means the benefits of those resources are
distributed fairly among the members of society.
(Fair pieces)
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Principle #1: People Face Tradeoffs
• Recognizing that people face tradeoffs does not
by itself tell us what decisions they will or
should make:
• Society should not stop protecting the environment
just because environmental regulations reduce our
material standard of living.
• The poor should not be ignored just because helping
them distorts work incentives.
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Principle #2: The Cost of Something Is What
You Give Up to Get It.
• What is the cost to go to college?
• Money (board, room, tuition)?
• Even if we quit school, we would still need a
place to sleep and food to eat, which might cost
more than the life at college.
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Principle #2: The Cost of Something Is What
You Give Up to Get It.
• The largest cost is our time
• When we decide to go to college, we cannot spend
time working and earn wages and experiences.
• The opportunity cost of an item is what we give
up to obtain that item.
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Principle #2: The Cost of Something Is What
You Give Up to Get It.
• Decision maker usually are aware of the
opportunity cost of each action.
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Principle #2: The Cost of Something Is What
You Give Up to Get It.
LA Laker basketball star
Kobe Bryant chose to
skip college and go
straight from high
school to the pros where
he has earned millions
of dollars.
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Principle #3: Rational People Think at the
Margin.
• Marginal changes are small, incremental
adjustments to an existing plan of action.
• Marginal changes are important for decision makers
• When exams roll around, your decision is not between
blowing them off or studying 24 hours a day, but whether
to spend an extra hour reviewing your notes instead of
watching TV.
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Principle #3: Rational People Think at the
Margin.
• We make decision by comparing benefits and
costs at the margin
• To decide whether to take the graduate school, we
compare the additional benefits that two years in
college would offer (higher wages throughout life
and sheer joy of learning) to the additional costs
that you would incur (tuition and the forgone wages
while you’re in college)
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Principle #4: People Respond to Incentives.
• Marginal changes in costs or benefits motivate
people to respond.
• Policy makers should never forget about
incentives
• Seat belt law (“Unsafe at Any Speed” by R. Nader)
• The benefits to slow and careful driving ↓
• Therefore, people drive faster and less carefully.
• Accidents ↑
• Driver deaths →, and pedestrian deaths ↑
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Principle #5: Trade Can Make Everyone
Better Off.
• People gain from their ability to trade with one
another.
• Trade allows people to specialize in what they
do best. (Ch.3)
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Principle #6: Markets Are Usually a Good
Way to Organize Economic Activity.
• 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.
• Households decide what to buy and who to work
for.
• Firms decide who to hire and what to produce.
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Principle #6: Markets Are Usually a Good
Way to Organize Economic Activity.
• Adam Smith made the observation that
households and firms interacting in markets act
as if guided by an “invisible hand.” (p.10)
• Because households and firms look at prices when
deciding what to buy and sell, they unknowingly
take into account the social costs of their actions.
• As a result, prices guide decision makers to reach
outcomes that tend to maximize the welfare of
society as a whole.
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Principle #7: Governments Can Sometimes
Improve Market Outcomes.
• We need government for two reasons:
• Property rights: the invisible hand needs
government to protect it. (law enforcement) (ipad)
• Market failure: it occurs when the market fails to
allocate resources efficiently.
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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 of a bystander.
• market power, which is the ability of a single
person or firm to unduly influence market prices.
(Monopoly)
• When the market fails (breaks down)
government can intervene to promote efficiency
and equity.
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Principle #8: The Standard of Living Depends
on a Country’s Production.
• Almost all variations in living standards are
explained by differences in countries’
productivities.
• Productivity is the amount of goods and
services produced from each hour of a worker’s
time.
• Some commentators have claimed that increased
competition from Japan and other countries explained the
slow growth in U.S. incomes during the 1970s. Yet the real
villain was flagging productivity growth in the United
States.
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6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)
TABLE 6.3 Labor Productivity in Developed Countries
UNITED UNITED
STATES JAPAN FRANCE GERMANY KINGDOM
Real Output per Employed Person (2006)
$82,158 $57,721 $72,949 $60,692 $65,224
Years Annual Rate of Growth of Labor Productivity (%)
1960-1973 2.29 7.86 4.70 3.98 2.84
1974-1982 0.22 2.29 1.73 2.28 1.53
1983-1991 1.54 2.64 1.50 2.07 1.57
1992-2000 1.94 1.08 1.40 1.64 2.22
2001-2006 1.78 1.73 1.02 1.10 1.47
The level of output per employed person in the United States in 2006 was higher than in
other industrial countries. But, until the 1990s, productivity in the United States grew on
average less rapidly than productivity in most other developed nations. Also, productivity
growth during 1974–2006 was much lower in all developed countries than it had been in
the past.
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Principle #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.
• When the government creates
large quantities of money, the
value of the money falls.
• Germany Jan 1921 to Nov 1922, daily
newspaper cost 0.30 marks to 70,000,000
marks.
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Principle #10: Society Faces a Short-run
Tradeoff Between Inflation and
Unemployment.
• The Phillips Curve illustrates the tradeoff
between inflation and unemployment:
Inflation Unemployment
It’s a short-run tradeoff!
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Map
Decision Interact Trends
Tradeoff Trade Productivity
Opportunity Cost Invisible Hand Inflation
Margin Government Philips Curve
Incentives
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Brief Summary
• How people make decisions.
• People face tradeoffs.
• The cost of something is what you give up to get it.
• Rational people think at the margin.
• People respond to incentives.
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Brief Summary
• How people interact with each other.
• Trade can make everyone better off.
• Markets are usually a good way to organize
economic activity.
• Governments can sometimes improve economic
outcomes.
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Brief Summary
• The forces and trends that affect how the
economy as a whole works.
• The standard of living depends on a country’s
production.
• Prices rise when the government prints too much
money.
• Society faces a short-run tradeoff between inflation
and unemployment.
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Something to review
• After Chapter 1:
• Questions for review
• Problems and applications
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