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The word economy comes from a Greek word for “one who manages a household.”
is the study of how society manages its scarce resources.
PRINCIPLES OF ECONOMICS
A household and an economy face many decisions:
- Who will work?
- What goods and how many of them should be produced?
- What resources should be used in production?
- At what price should the goods be sold?
Society and Scarce Resources:
The management of society’s resources is important because resources are scarce.
Scarcity - means that society has limited resources and therefore cannot produce all the goods and services people wish to have.
TEN PRINCIPLES OF ECONOMICS
How people make decisions.
1. People face tradeoffs.
2. The cost of something is what you give up to get it.
3. Rational people think at the margin.
4. People respond to incentives.
How people interact with each other.
5. Trade can make everyone better off.
6. Markets are usually a good way to organize economic activity.
7. Governments can sometimes
The forces and trends that affect how the economy as a whole works.
8. The standard of living depends on a country’s production.
9. Prices rise when the government prints too much money.
10. Society faces a short-run tradeoff between inflation and unemployment.
Principle #1: People Face Tradeoffs
Nobody gets a free lunch.
To get one thing, we usually have to give up another thing.
Making decisions requires trading off one goal against another.
Efficiency - means society gets the most that it can from its scarce resources
Equity means the benefits of those resources are distributed fairly among the members of society
Principle #2: The Cost of Something Is What You Give Up to Get It.
Decisions require comparing costs and benefits of alternatives.
The opportunity cost of an item is what you give up to obtain that item.
Principle #3: Rational People Think at the Margin.
Marginal changes are small, incremental adjustments to an existing plan of action.
People make decisions by comparing costs and benefits at the margin.
The Rational person establish a cost\benefit analysis or CBA
Choosing OC versus a state school
Principle #4: People Respond to Incentives
Marginal changes in costs or benefits motivate people to respond.
The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs!
Principle #5: Trade Can Make Everyone Better Off
People gain from their ability to trade with one another.
Competition results in gains from trading.
Trade allows people to specialize in what they do best .- Comparative Advantage
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.
Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.”
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.
Principle #7: Governments Can Sometimes Improve Market Outcomes.
Market failure occurs when the market fails to allocate resources efficiently.
When the market fails (breaks down) government can intervene to promote efficiency and equity.
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.
nmarket power, which is the ability of a single person or firm to unduly influence market prices.
Principle #8: The Standard of Living Depends on a Country’s Production.
Standard of living, economically speaking, may be measured in different ways:
1.By comparing personal incomes
2.By comparing the total market value of a nation’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.
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.
Principle #10: Society Faces a Short-run Tradeoff Between Inflation and Unemployment.
- The Phillips Curve illustrates the tradeoff
- between inflation and unemployment:
òInflation ð ñUnemployment
It’s a short-run tradeoff!
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