Economics Chapter 1: Decision Making

Study Notes

Economics is about the allocation of scarce resources.
Individuals face trade-offs, and the cost of any action is measured in terms of forgone opportunities.
Rational people make decisions by comparing marginal costs and marginal benefits.
People change their behavior in response to incentives.

Principle #1: People Face Trade-offs
- Trade-offs exist in all aspects of life, e.g., how students spend their time, how a family decides to spend its income, and how the government spends tax dollars.
Principle #2: The Cost of Something Is What You Give Up to Get It
- Opportunity cost is the value of the next best alternative that is given up.
- Example: The cost of going to college includes the value of the student's time.
Principle #3: Rational People Think at the Margin
- Marginal change is a small incremental adjustment to a plan of action.
- Examples: Deciding whether to call a friend, studying for another hour, and flying a plane.
Principle #4: People Respond to Incentives
- Incentives induce people to act.
- Changes in incentives affect behavior, e.g., price increases and policy changes.

Principle #5: Trade Can Make Everyone Better Off
- Trade is not a zero-sum game, where one side gains and the other side loses.
- Examples: Trading with other families, countries benefiting from trade, and specialization.
Principle #6: Markets Are Usually a Good Way to Organize Economic Activity
- Definition of a market economy: allocates resources through decentralized decisions.
- Market prices reflect the value of a product to consumers and the cost of resources.
Principle #7: Governments Can Sometimes Improve Market Outcomes
- The invisible hand will only work if the government enforces property rights.
- Market failure occurs when the market fails to allocate resources efficiently, e.g., externalities and market power.
- Government policy can improve efficiency when there is market failure.

Principle #8: A Country's Standard of Living Depends on Its Ability to Produce Goods and Services
- Productivity is the key to a country's standard of living.
- Definition of productivity: the quantity of goods and services produced by each unit of labor input.
Principle #9: Prices Rise When the Government Prints Too Much Money
- Inflation: an increase in the overall level of prices in the economy.
- The value of money falls when the government creates a large amount of money.
Principle #10: Society Faces a Short-Run Trade-off between Inflation and Unemployment
- The short-run effect of a monetary injection is lower unemployment and higher prices.
- Policymakers can exploit this trade-off, but the extent and desirability of these interventions are debated.### Welfare and Incentives
Cutting off welfare benefits after two years gives recipients a greater incentive to find jobs.

Guaranteeing the best healthcare possible would lead to a greater proportion of the nation's output being devoted to medical care.
This could be inefficient if it means people receive more healthcare than they would choose to pay for.
However, providing more healthcare could improve equality, as poor people are less likely to have adequate healthcare.
Increasing healthcare spending would result in a larger slice of the economic pie for each person, but with less of other goods.

Average income in the United States has roughly doubled every 35 years, leading to a better standard of living.
Increased productivity is the main driver of this growth, as an hour of work produces more goods and services than it used to.

If Americans save more, it can lead to more spending on factories, increasing production and productivity.
The benefits of higher productivity are shared between workers, who get paid more for producing more, and factory owners, who get a return on their investments.
However, saving more means giving up spending, so individuals must weigh the benefits of higher incomes against the cost of buying fewer goods.