Notesale: Turn your study into money

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In this chapter,
look for the answers to these questions:

• 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?

© 2012 Cengage Learning
...
May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use
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Examples:
 Going to a party the night before your midterm
leaves less time for studying
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 Protecting the environment requires resources
that could otherwise be used to produce
consumer goods
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PRINCIPLE #1:

People Face Tradeoffs
 Society faces an important tradeoff:
efficiency vs
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But this reduces incentive to work and produce,
shrinks the size of the economic “pie
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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
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 It is the relevant cost for decision making
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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
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© 2012 Cengage Learning
...
May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use
...

 make decisions by evaluating costs and benefits
of marginal changes, incremental adjustments
to an existing plan
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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
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© 2012 Cengage Learning
...
May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use
...
e
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 Rational people respond to incentives
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 When cigarette taxes increase,
teen smoking falls
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PRINCIPLE #5:

Trade Can Make Everyone Better Off
 Rather than being self-sufficient,
people can specialize in producing one good or
service and exchange it for other goods
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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

© 2012 Cengage Learning
...
May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use
...

 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
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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
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 Prices guide self-interested households and
firms to make decisions that, in many cases,
maximize society’s economic well-being
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PRINCIPLE #7:

Governments Can Sometimes
Improve Market Outcomes
 Important role for govt: enforce property rights
(with police, courts)
 People are less inclined to work, produce,
invest, or purchase if large risk of their property
being stolen
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PRINCIPLE #7:

Governments Can Sometimes
Improve Market Outcomes
 Market failure: when the market fails to allocate
society’s resources efficiently
 Causes of market failure:
 Externalities, when the production or consumption
of a good affects bystanders (e
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pollution)
 Market power, a single buyer or seller has
substantial influence on market price
(e
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monopoly)

 Public policy may promote efficiency
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PRINCIPLE #7:

Governments Can Sometimes
Improve Market Outcomes
 Govt may alter market outcome to
promote equity
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© 2012 Cengage Learning
...
May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use
...

 The U
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standard of living today is about
eight times larger than 100 years ago
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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
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 Other factors (e
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, labor unions, competition from
abroad) have far less impact on living standards
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PRINCIPLE #9:

Prices Rise When the Government Prints
Too Much Money
 Inflation: increases in the general level of prices
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 The faster the govt creates money,
the greater the inflation rate
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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
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© 2012 Cengage Learning
...
May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use

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