Economics I: Ten Principles of Economics PDF

Economics I 2. Ten Principles of Economics András Székely-Doby ELTE Faculty of Social Sciences, Department of Economics Scarcity Scarcity means that society has limited resources People cannot produce all the goods and services they want Demands of individuals have no limits They must choo...

Economics I 2. Ten Principles of Economics András Székely-Doby ELTE Faculty of Social Sciences, Department of Economics Scarcity Scarcity means that society has limited resources People cannot produce all the goods and services they want Demands of individuals have no limits They must choose from the available goods and resources Economics is the study of how society manages its scarce resources Economists study how people make decisions ECONOMICS I – ANDRÁS SZÉKELY-DOBY 2 Trade-offs The four principles of individual decision making Principle 1: People face trade-offs If we choose something we must give up something else (trade off): there is no such thing as a free lunch Macroeconomy: What to produce? Investment vs. consumption Trade-off between efficiency and equality ECONOMICS I – ANDRÁS SZÉKELY-DOBY 3 Trade-offs EXERCISE Emily prepares for exams She has 120 hours to learn both economics and history She needs 2 hours of learning to increase her Economics result by 1 point, and 1 hour learning to increase her history result by 1 point She has the same preferences regarding the two results How should she allocate her time according to her preferences? ECONOMICS I – ANDRÁS SZÉKELY-DOBY 4 Trade-offs EXERCISE Emily prepares for exams She has 120 hours to learn both economics and history She needs 2 hours of learning to increase her Economics result by 1 point, and 1 hour learning to increase her history result by 1 point She has the same preferences regarding the two results How should she allocate her time according to her preferences? Economics – 80 hours, history – 40 hours ECONOMICS I – ANDRÁS SZÉKELY-DOBY 5 Trade-offs EXERCISE Frank must decide whether to learn or to play If he learns he will get a better mark in school If he plays he will feel himself much better What should he compare in this case? ECONOMICS I – ANDRÁS SZÉKELY-DOBY 6 Trade-offs EXERCISE Frank must decide whether to learn or to play If he learns he will get a better mark in school If he plays he will feel himself much better What should he compare in this case? He should compare the satisfaction from playing with the satisfaction of a better mark ECONOMICS I – ANDRÁS SZÉKELY-DOBY 7 Opportunity cost Principle 2: The cost of something is what you give up to get it Making decisions requires comparing the costs and benefits of alternative courses of action The opportunity cost of an item is what you give up to get that item Decision makers should take into account the opportunity costs of each possible action ECONOMICS I – ANDRÁS SZÉKELY-DOBY 8 Opportunity cost EXERCISE Opportunity costs in trade-offs How can we compute Emily’s opportunity costs? What is the opportunity cost of 1 point increase in the economics exam? What is the opportunity cost of 1 point increase in the history exam? ECONOMICS I – ANDRÁS SZÉKELY-DOBY 9 Opportunity cost EXERCISE Opportunity costs in trade-offs How can we compute Emily’s opportunity costs? What is the opportunity cost of 1 point increase in the economics exam? It takes 2 hours which could bring 2 points in history What is the opportunity cost of 1 point increase in the history exam? It is half point in the economics exam ECONOMICS I – ANDRÁS SZÉKELY-DOBY 10 Thinking at the margin Principle 3: Rational people think at the margin Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities Economists use the term marginal change to describe a small incremental adjustment to an existing plan of action ECONOMICS I – ANDRÁS SZÉKELY-DOBY 11 Thinking at the margin Margin means “edge,” so marginal changes are adjustments around the edges of what you are doing Rational people make decisions by comparing marginal benefits and marginal costs A rational decision maker takes an action if and only if the action’s marginal benefit exceeds its marginal cost Business decisions: average vs. marginal costs ECONOMICS I – ANDRÁS SZÉKELY-DOBY 12 Thinking at the margin EXERCISE It is 10 pm in the evening Frank spent all his day playing video games He must go to bed at 11 pm What should he do in the remaining one hour? ECONOMICS I – ANDRÁS SZÉKELY-DOBY 13 Thinking at the margin EXERCISE It is 10 pm in the evening Frank spent all his day playing video games He must go to bed at 11 pm What should he do in the remaining one hour? Since we may assume that one additional hour of playing brings him less satisfaction than a possible better result coming from one our learning he should learn ECONOMICS I – ANDRÁS SZÉKELY-DOBY 14 Thinking at the margin EXERCISE Patricia likes eating both pizza and ice cream She, however, likes pizza much more After working she goes to the Italian restaurant What should she order pizza or ice-cream? And after eating two large pizzas? Why? ECONOMICS I – ANDRÁS SZÉKELY-DOBY 15 Thinking at the margin EXERCISE Patricia likes eating both pizza and ice cream She, however, likes pizza much more After working she goes to the Italian restaurant What should she order pizza or ice-cream? Pizza And after eating two large pizzas? Why? Ice cream because now an additional pizza would bring less satisfaction than an ice cream ECONOMICS I – ANDRÁS SZÉKELY-DOBY 16 Incentives Principle 4: People respond to incentives An incentive is something that induces a person to act, such as the prospect of a punishment or reward Incentives play a central role in the study of economics ECONOMICS I – ANDRÁS SZÉKELY-DOBY 17 Incentives Policies change the costs or benefits that people face and, as a result, alter their behavior In general: different rules and norms (institutions) influence (determine) costs and benefits Institutions therefore can shape how the economy is functioning Fundamental institutions define economic systems ECONOMICS I – ANDRÁS SZÉKELY-DOBY 18 Incentives CASE STUDY Innovation in different economic systems In planned economies rewards of new, innovative methods did not reflect the real value of these innovations Possible medals or a small increase in salary did not motivate bureaucrats to spend their time thinking about new methods Markets do a much better job in this respect ECONOMICS I – ANDRÁS SZÉKELY-DOBY 19 Trade The next three principles concern how people interact with one another Principle 5: Trade can make everyone better off Trade between the United States and China is not like a sports contest in which one side wins and the other side loses The opposite is true: Trade between two countries can make each country better off ECONOMICS I – ANDRÁS SZÉKELY-DOBY 20 Trade Trade allows each person to specialize in the activities she does best Trade also allows countries to specialize in what they do best and to enjoy a greater variety of goods and services ECONOMICS I – ANDRÁS SZÉKELY-DOBY 21 Markets Principle 6: Markets are usually a good way to organize economic activity Markets vs. central planning Central planners decided what goods and services were produced, how much was produced, and who produced and consumed these goods and services In a market economy, these decisions are made by millions of firms and households ECONOMICS I – ANDRÁS SZÉKELY-DOBY 22 Markets Why do markets usually do a better job at organizing economic activities? Households and firms interacting in markets act as if they are guided by an ”invisible hand” that leads them to desirable market outcomes Prices are the instrument with which the invisible hand directs economic activity ECONOMICS I – ANDRÁS SZÉKELY-DOBY 23 Markets CASE STUDY Information deficit in planned economies Central planners are not able to collect and process all the available information in an economy Markets, on the other hand, are able to do this through the signals of the price mechanism Prices convey information to the participants by constantly changing incentives ECONOMICS I – ANDRÁS SZÉKELY-DOBY 24 The government Principle 7: Governments can sometimes improve market outcome If the invisible hand of the market is so great, why do we need government? Market failure is a situation in which a market left on its own fails to allocate resources efficiently Externality is the impact of one person’s actions on the well- being of a bystander ECONOMICS I – ANDRÁS SZÉKELY-DOBY 25 The government Market power means the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices The government enforces the rules and maintains the institutions that are key to a market economy Property rights: regulate the control over goods, and work as incentives ECONOMICS I – ANDRÁS SZÉKELY-DOBY 26 The government CASE STUDY Industrial policy In East Asia the government actively intervened in the economy to carry out its vision The government subsidized industries in order to achieve export successes in the future Gradually these economies have become more and more competitive in world markets, and successfully upgraded their economic structures ECONOMICS I – ANDRÁS SZÉKELY-DOBY 27 Productivity The last three principles concern the workings of the economy as a whole: Principle 8: A country’s standard of living depends on its ability to produce goods and services Large differences in well-being Almost all variation in living standards is attributable to differences in countries’ productivity—that is, the amount of goods and services produced by each unit of labor input ECONOMICS I – ANDRÁS SZÉKELY-DOBY 28 Inflation Principle 9: Prices rise when the government prints too much money Inflation is an increase in the overall level of prices in the economy 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 ECONOMICS I – ANDRÁS SZÉKELY-DOBY 29 Unemployment Principle 10: Society faces a short-run trade-off between inflation and unemployment More money – more expenditures – more demand – more goods – more labor – lower unemployment Economic (business) cycles: Fluctuations of economic activities ECONOMICS I – ANDRÁS SZÉKELY-DOBY 30 Thank you for the attention! András Székely-Doby [email protected]