The 10 Principles of Economics Breaking down the

The 10 Principles of Economics

Breaking down the 10 Principles: Even though economists might not agree on how the economy will operate best, some things we can rely on to be certain: the 10 principles of economics can be broken down into 3 categories: 1. How people make decisions 2. How people interact 3. How the economy works as a whole

How People Make Decisions Principle 1: People Face Tradeoffs • Making decisions requires trading off one goal against another • Examples: -Personal: You have 2 exams tomorrow (Math and English), but only 3 hours to study before then- when you use some of that time to study English, you are giving up time studying Math. -National: A nation must decide how to spend its money- some possibilities: national defense or consumer goods…whatever they spend on national defense is lost from what they could have spent on consumer goods. -Societal: efficiency versus equity

Efficiency vs. Equity Efficiency: society is getting the most it can from scarce resources Equity: the benefits of those resources are distributed fairly among society’s members Example: government policies aimed at achieving greater equity in society (like Welfare and Income Tax) reduce efficiency overall

How People Make Decisions Principle 2: The cost of something is what you give up to get it • Because people face tradeoffs, making decisions requires comparing the costs and benefits of different courses of action. • Opportunity Cost: whatever must be given up to obtain some item • Example: college athletes going professional- what is the opportunity cost of going pro? What is the opportunity cost of not going pro?

How People Make Decisions Principle 3: Rational People Think at the Margin • Economists use the term Marginal Changes to describe small adjustments to an existing plan of action • Margin means edge, so marginal changes are changes just on the edge of what you are doing • People can make better decisions by thinking at the margin- comparing marginal benefits and marginal costs of a decision - example: is it worth it for airlines to sell standby seats when the plane is not full?

How People Make Decisions Principle 4: People Respond to Incentives • Because people make decisions by comparing costs and benefits, their behavior may change if those costs and benefits change. • People respond to incentives! (something that encourages a person to do something or to work harder) • Think of one example when you have responded to an incentive. Write it down!

How People Interact Principle 5: Trade Can Make Everyone Better Off • Trading- whether it is between two people or between two countries- can make each party better off -Trade allows countries to specialize in what they do best and enjoy a greater variety of goods and services. • Any examples of when you made a trade with someone that made both parties better off? Write in your notebook!

How People Interact Principle 6: Markets are Usually a Good Way to Organize Economic Activities § A market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets. • 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.

How People Interact Principle 6: Markets are Usually a Good Way to Organize Economic Activities • The invisible hand works through the price system: ▫ The interaction of buyers and sellers determines prices. ▫ Each price reflects the good’s value to buyers and the cost of producing the good. ▫ Prices guide self-interested households and firms to make decisions that, in many cases, maximize society’s economic well-being.

How People Interact Principle 7: Governments can Sometimes Improve Market Outcomes • Two broad reasons for gov. to intervene in the economy: to increase efficiency or equity • Market failure: when the market fails to allocate society’s resources efficiently • Causes: ▫ Externalities, when the production or consumption of a good affects bystanders (e. g. pollution) ▫ Market power, a single buyer or seller has substantial influence on market price (e. g. monopoly) • In such cases, public policy may promote efficiency

How People Interact Principle 7: Governments can Sometimes Improve Market Outcomes • Gov. may alter market outcome to promote equity • If the market’s distribution of economic wellbeing is not desirable, tax or welfare policies can change how the market operates and its outcomes.

How The Economy Works as a Whole Principle 8: A Country’s Standard of Living Depends on its Ability to Produce Gods and Services • Huge variation in living standards across countries and over time: ▫ Average income in rich countries is more than ten times average income in poor countries. ▫ The U. S. standard of living today is about eight times larger than 100 years ago.

How The Economy Works as a Whole Principle 8: A Country’s Standard of Living Depends on its Ability to Produce Gods and Services • The most important determinant of living standards: productivity, the amount of goods and services produced per unit of labor. • Productivity depends on the equipment, skills, and technology available to workers. • Other factors (e. g. , labor unions, competition from abroad) have far less impact on living standards.

How The Economy Works as a Whole Principle 9: Prices Rise When the Government Prints Too Much Money • Inflation: increases in the general level of prices. • In the long run, inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall. • The faster the govt creates money, the greater the inflation rate.

How The Economy Works as a Whole 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. • Other factors can make this tradeoff more or less favorable, but the tradeoff is always present.