chapter 1-4

• Economy is derived from the Greek word oikonomos, meaning "one who manages a household."

Economics Basics

• Households and economies share a common challenge: resource allocation
• Households must decide who does what and receives what in return
• Societies must determine what jobs need to be done and who will do them
• They also must allocate goods and services to the population
• Management of society's resources is crucial due to scarcity
• Scarcity means that society has limited resources and cannot produce all goods and services people want
• Economics studies how society manages its scarce resources
• Economists study how people make decisions: work, buying, saving, and investments
• They also study how people interact and analyze the forces/trends affecting the economy, such as income growth, unemployment, and inflation

10 Principles of Economics

• Ten principles unify central ideas in economics
• These principles give an overview of economics

How People Make Decisions - Principle 1: People Face Trade-offs

• Individuals must make choices that involve trade-offs, giving up something to obtain something else
• Students must divide their time between studying different subjects like economics and psychology
• Parents decide on how to spend family income: food, clothing, vacation, or saving for retirement/college
• Societies face trade-offs
• Classic societal trade-off is between "guns and butter" (national defense vs. consumer goods)
• Pollution regulations offer cleaner environment and improved health, but the price is reduced incomes for firms, workers, and customers
• Another trade-off faced by society is between efficiency and equality
• Efficiency involves society getting maximum benefits from scarce resources
• Equality means distributing economic benefits uniformly among society's members
• Government policies can conflict with these two goals
• Policies aimed at equal distribution of well being, reduce efficiency when government redistributes income from rich to poor
• Reduction in efficiency is caused by reduced rewards for hard work and less production of goods/services
• Tradeoffs exist, and they should be acknowledged when studying economics

How People Make Decisions - Principle 2: The Cost of Something Is What You Give Up to Get It

• Making decisions requires comparing costs and benefits of alternative actions
• Main benefit of attending college is intellectual enrichment and better job opportunites
• Costs include tuition, books, and room and board
• Tuition price includes some things that are not really costs of going to college because everyone needs sleep and shelter
• Room and board only add to the cost to the extent that they are more expensive at college than elsewhere
• Largest cost of college is time, such as a year listening to lectures, reading, textbooks and not working at a job
• Opportunity cost is what is given up to obtain an item
• Decision makers should be aware of opportunity costs for each possible action
• An example involves college athletes who forgo high-paying professional sports careers

How People Make Decisions - Principle 3: Rational People Think at the Margin

• Principle states people are rational, systematically achieve objectives with available opportunities
• Rational people make decisions by comparing marginal benefits and marginal costs
• When considering calling a friend on a cell phone, rational people should only consider the marginal cost
• Cell phone users with unlimited minutes are prone to make long and frivolous calls
• Thinking at the margin is applicable in business, demonstrated by airlines considering standby passengers
• If there are empty seats, the cost of adding one more passenger is tiny, so standby passengers should be allowed to board for a small charge
• Why is water so cheap while diamonds are so expensive?
• Willingness to pay for a good is based on the marginal benefit that an extra unit of the good would yield
• This depends on how many units a person already has
• Water is essential, and abundant, so the opposite is true because people consider the marginal benefit of an extra diamond to be high

How People Make Decisions - Principle 4: People Respond to Incentives

• Incentive induces action (prospect of punishment or reward)
• Incentives are crucial for analyzing how markets work
• When the price of apples rises, people buy less and apple orchards hire more workers to improve market results
• Policymakers should not forget about incentives, as any policy affects the cost/benefit equation for citizens
• A tax on gasoline encourages fuel efficient autos
• A higher gasoline tax also encourages carpooling, public transit, and moving closer to work

How People Interact - Principle 5: Trade Can Make Everyone Better Off

• Trade enables specialization in activities, benefitting families and countries
• Trade provides a greater variety of goods at lower costs, leading to greater national wealth
• Trade competition differs from sports competition where there is a winner and loser

How People Interact - Principle 6: Markets Are Usually a Good Way to Organize Economic Activity

• Communist nations assumed government officials best allocate scarce resources. Central planners decided what, how much, and who produces goods/services
• Most countries abandoned this system and are developing market economies
• Market economy replaces decisions of a central planner with that of millions of firms and households, guided by self-interest
• Economist Adam Smith noted in 1776 that households and firms interacting in markets behave as if guided by an "invisible hand"
• Prices are an instrument used by the invisible hand - buyers and sellers consider prices to determine how much to demand/supply
• Prices adjust to guide individual buyers/sellers to outcomes that, in many cases, maximize society's well-being
• Government prevents prices from adjusting naturally to supply/demand - Smith's insight has important corollary
• Taxes can adversely affect allocation of resources by distorting prices and decisions of households/firms
• Policies that control prices cause great harm, like rent control

How People Interact - Principle 7: Governments Can Sometimes Improve Market Outcomes

• Enforcing rules and maintaining market institutions is government's role
• Market economies need institutions to enforce property rights so people can control scare resources
• Farmers will quit farming if they anticipate crops will be stolen
• 2 reasons for government to intervene in the economy and change resource allocation are promoting efficiency or to promote equality
• Market failure is when the market fails to allocate resources effectively, such as externalities (impact of people's actions on bystanders)
• Externalities lead to pollution due to the effect it has of a good which causes health concerns for neighbors
• Market power is the ability of a single person/firm or small group to influence market prices, like the only well in town
• Public policies are implemented to have well-designed public enhancements on economic efficiency
• The invisible hand does not ensure everyone has sufficient food, adequate health care, etc.
• To achieve distribution of well being, public policies aim to achieve equal distribution of income tax and welfare system

How the Economy as a Whole Works - Principle 8: A Country's Standard of Living Depends on its ability to Produce Goods and Services

• There are staggering differences in living standards around the world, with variation of average income and measures of quality of life
• Variation is attributable to differences in countries' productivity, the amount of goods/services produced per unit of labor input
• Therefore, Policymakers need to raise productivity by ensuring workers are well-educated, have the tools, and have access to technology

How the Economy as a Whole Works - Principle 9: Prices Rise When the Government Prints Too Much Money

• The world faced extreme inflation in the early 1920's when governments created large quantities of nation's money
• Although the US never experienced that inflation, the US still underwent inflation problems, where President Gerald Ford called it the "public enemy number one"

How the Economy as a Whole Works - Principle 10: Society Faces a Sort-Run Trade-off between Inflation and Unemployment

• Monetary injections stimulate spending, demand, may cause firms raise prices and hire more or produce larger quantities
• This leaves to the final economy-wide trade off
• In 2008 and 2009 there were initiatives taken to combat these concerns through the American government

Economists

• Economists become increasingly valuable as you move up career ladder and learn a systematic and disciplined way of thinking
• Training in economics helps individuals better understand fallacies and unintended consequences, such the "broken window" concept
• Individuals are motivated by self-interest and that the market will guide this self interest into promotes general economic well being

Economics Terms

• Scarcity is the limited nature of society's resources
• Economics is managing scarce resources
• Efficiency means society getting the most from scarce resources
• Equality means distributing economic prosperity uniformly
• Opportunity Cost is giving up to obtain an item
• Rational people are those who achieve objectives to best of their ability
• Marginal change means a small incremental adjustment to a plan of action