Economics: A Study of Scarcity and Choice Lesson 1 PDF

Economics: A Study of Scarcity and Choice Economics: A Study of Scarcity and Choice Economy-The word economy comes from the Greek word oikonomos, which means “one who manages a household.” Economics is the study of how society manages its scarce resources. In most societies, resources are allocat...

Economics: A Study of Scarcity and Choice Economics: A Study of Scarcity and Choice Economy-The word economy comes from the Greek word oikonomos, which means “one who manages a household.” Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by an all-powerful dictator but through the combined choices of millions of households and firms. Principles of Economics 1 Principle 1: People Face Trade-offs 2 Principle 2: The Cost of Something Is What You Give Up to Get It You may have heard the old saying, “There ain’t no such thing as a free lunch.” To get something Because people face trade-offs, making decisions that we like, we usually have to give up something requires comparing the costs and benefits of else that we also like. Making decisions requires alternative courses of action. In many cases, trading off one goal against another. however, the cost of an action is not as obvious as it might first appear. Rationality and Marginal Change 1 Principle 3: Rational People Think at the Margin Economists normally assume that people are rational. Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities. Rational people know that decisions in life are rarely black and white but usually involve shades of gray. Economists use the term marginal change to describe a small incremental adjustment to an existing plan of action. Rational people often make decisions by comparing marginal benefits and marginal costs. Responding to Incentives 1 Principle 4: People Respond to Incentives An incentive is something (such as the prospect of a punishment or reward) that induces a person to act. Because rational people make decisions by comparing costs and benefits, they respond to incentives. The Benefits of Trade 1 Principle 5: Trade Can Make Everyone Better Off Companies in the United States and China compete for the same customers in the markets for clothing, toys, solar panels, automobile tires, and many other items. 2 Principle 5: Trade Can Make Everyone Better Off Yet it is easy to be misled when thinking about competition among countries. Trade between the United States and China is not like a sports contest in which one side wins and the other side loses. In fact, the opposite is true: Trade between two countries can make each country better off. The Power of Markets Principle 6: Markets Are Usually a Good Way to Organize Economic Activity 1 In a market economy, the decisions of a central planner are replaced by the decisions of millions of firms and households. Firms decide whom to hire and what to make. Households decide which firms to work for and what to buy with their incomes. These firms and households interact in the marketplace, where prices and self-interest guide their decisions. 2 In any market, buyers look at the price when determining how much to demand, and sellers look at the price when deciding how much to supply. Government's Role in the Economy Principle 7: Governments Can Sometimes Improve Market Outcomes 1 Why do we need government? The government enforces the rules and maintains the institutions that are key to a market economy. Most important, market economies need institutions to enforce property rights so individuals can own and control scarce resources. 2 Economists use the term market failure to refer to a situation in which the market on its own fails to produce an efficient allocation of resources. As we will see, one possible cause of market failure is an externality, which is the impact of one person’s actions on the well- being of a by stander. 3 Another possible cause of market failure is market power, which refers to the ability of a single person or firm (or a small group) to unduly influence market prices. Productivity and Living Standards 1 Principle 8: A Country’s Standard of Living 2 Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Depends on Its Ability to Produce Goods and Services Services Almost all variation in living standards is attributable In nations where workers can produce a large quantity to differences in countries’ productivity—that is, the of goods and services per hour, most people enjoy a amount of goods and services produced by each unit high standard of living; in nations where workers are of labor input. less productive, most people endure a more meager existence. Similarly, the growth rate of a nation’s productivity determines the growth rate of its average income. Inflation and Money Supply 1 Principle 9: Prices Rise When the Government Prints Too Much Money In January 1921, a daily newspaper in Germany cost 0.30 marks. Less than two years later, in November 1922, the same newspaper cost 70,000,000 marks. All other prices in the economy rose by similar amounts. This episode is one of history’s most spectacular examples of inflation, an increase in the overall level of prices in the economy. 2 Principle 9: Prices Rise When the Government Prints Too Much Money What causes inflation? In almost all cases of large or persistent inflation, the culprit is growth in the quantity of money. When a government creates large quantities of the nation’s money, the value of the money falls. In Germany in the early 1920s, when prices were on average tripling every month, the quantity of money was also tripling every month Inflation and Unemployment 1 Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment Although a higher level of prices is, in the long run, the primary effect of increasing the quantity of money, the short-run story is more complex and controversial. Most economists describe the short-run effects of monetary injections as follows: 2 Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services. 3 Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment Higher demand may over time cause firms to raise their prices, but in the meantime, it also encourages them to hire more workers and produce a larger quantity of goods and services. 4 Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment More hiring means lower unemployment.