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Principles
- for the individual choice
- for the choice interaction
- for the economy-wide interaction
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Individual Choice
Individual choice; the decision by an individual of what to do, or what not to do
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Basic Principles
- Resources are scarce
- the real cost of something is what you must give up to get it
- "How much?" is a decision at the margin
- People usually take advantage of incentives
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Resources Are Scarce
- A resource is anything that can be used to produce something else
- ex: kand, labor, capital
- resources are scarce: unlimited needs with limited resources
- ex: fossil fuels, lumber, (clean), water/ air, intelligence
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Real Cost = what you must give up
- the real cost of an item is it OPPORTUNITY COST: what you must give up in order to get it
- Opportunity cost is crucial to understanding individual choice
- Its all about what you have to forgo, but remember its the forgone value of the BEST ALTERNATIVE ACTIVITY ONLY, not the sume of all
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Decision at the Margin
Trade off b/w costs and benefits of doing something
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Marginal benefit-cost analysis
- making trade off at the margin
- comparing the costs and benefits of doing a little bit more of an activity vs. doing a little bit less
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Taking advantage of incentives
- An incentive is anything that offers rewards to people who change their behavior
- ex: wage increase -> more people want to work
- Ex: price of gasoline increase -> more people demand fuel- efficient vehicles
- People respond to these incentives (or, disincentives)
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Interaction: How Economics Work
Interaction of choices: my choices affect your choices, and vice versa
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Basic Principles
- There are gains from trade
- markets move toward equilibrium
- efficient usage of resources is a good thing for the society
- markets usually lead to efficiency
- when markets fail, government intervention can improve social welfare
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Gains from Trade
- Trade in a market economy: provide goods and services to others and receive other g/s in return
- Gains from trade: get more of what they want through trade than they could under self sufficiency...
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Gains from trade....Due to specialization
- each person specializes in the task that he or she is good at performing
- the economy, as a whole, can produce and consume more
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Equilibrium
- in an economic sense is a situation when no individual woul be better off doing something defferent
- anytime there is a change the conomy will move to a new equilibrium
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Economic efficiency
an economy is efficient if all opportunities are take to make people better off w/o making other people worse off
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Is economic efficiency always the best policy goal?
issue of efficiency vs. equity
- equity: everyone gets his/her fair share..."Fair"?
- Ex. Handicapped -designaed parking spaces in a bus parking lot
- Equity side: making life "fairer"for the andicapped people
- Efficiency side: letting several parking spaces left unused
- How far should we go?
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Markets Usually Lead to Efficiency
- The incentives built into a market economy help resources be used efficiently
- Prices are set where buyers and sellers agree with
- No opportunities are left unexploited
Exceptions: market failure
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Exceptions: market failure
- the individual pursuit of self-interest in the markets can make society worse off
- the market outcome is inefficent
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Market failure (cont)
Negative Externalities
- when producers (sellers) shift cost to others
- Pollution, for ex, is a by product of manufacture
- Total cost = seller's production cost + pollution cost
- When pollution costs are shifted, supply is greater than socially optimal, and so is the pollution
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Positive externalities
- when consumers (buyers) may create benefits for others
- vaccinnations, for ex, can prevent neighbors from getting the flu
- Total benefit= individual benefit + benefits to others
- when more people enjoy "free ride" the aggregate demand for vaccinations is less the socially optimal
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Government Intervention for Makret Failure
- The markert outcome is socially optimal (socially efficient) only when...
- the sellers pay the full costs of production
- the buyers capture the full benefits of g/s
- Government can help the market achieve the socially efficient level of outcome with regulations, taxes, and fines (for negative externalities) or subsidies (for positive externalities)
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Economy- Wide Interactions
Basic Principles
- 1. One person's spending is another person's income
- If you spend less at a grocery store, ther employees may either lose their jobs, or take pay cuts
- 2. Overall spending may exceed or fall below the economy's production capacity (or potential output)
- if spending exceeds potential output, inflation is likely
- if spending falls below pontential output, economic recession and increase in unemployment are likely
- 3. Government policies can change spending
- Monetary/fiscal policies
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