TEN PRINCIPLES OF ECONOMICS

TEN PRINCIPLES OF ECONOMICS

PRINCIPLE #1: PEOPLE FACE TRADEOFFS

Economics is the study of how society manages its scarce resources.

To get one thing that we like, we usually have to give up another thing that we like. The student must decide how to allocate his time. For every hour he studies one subject, he gives up an hour he could have used studying the other.

 Parents must decide how to spend their family income. They can buy food, clothing, or a family vacation. When they choose to spend an extra dinar on one of these goods, they have one less dinar to spend on some other good.

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 alternative courses of action. For example, Decision to go to university:

·         Costs may include additional expenses on room and board, transportation and most of all time.

·         Benefits – better job opportunities.

The opportunity cost of an item is what you give up to get that item.

 PRINCIPLE #3: RATIONAL PEOPLE THINK AT THE MARGIN

Economists use the term marginal changes to describe small incremental adjustments to an existing plan of action. Compare marginal benefits to marginal costs.

Ex:

§  Reduce pollution to the point where: MB=MC

§  To max. Profit, choose Q such that: MR= MC

§  Decision to stay an extra year in school: MB>MC

PRINCIPLE #4: PEOPLE RESPOND TO INCENTIVES

Because people make decisions by comparing costs and benefits, their behavior may change when the costs or benefits change.

A tax on gasoline, for instance, encourages people to drive smaller, more fuel-efficient cars or take public transportation.

What does a subsidy for bread do???????

How about “free” education??????????

PRINCIPLE #5: TRADE CAN MAKE EVERYONE BETTER OFF

Trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy a greater variety of goods and services at lower cost. Countries benefit from the ability to trade with one another. Trade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services.

• How about a country with an absolute advantage in all goods???????????

PRINCIPLE #6: MARKETS ARE USUALLY A GOOD WAY TO ORGANIZE ECONOMIC ACTIVITY

In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, economist Adam Smith made the most famous observation in all of the economics: 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.Prices reflect both the value of a good to society and the cost to society of making the good.

PRINCIPLE #7: GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES

Two reasons for government intervention: efficiency and equity.

1)      Market failure.

One possible cause of market failure is an externality. The Impact of one person’s actions, on the well-being of a bystander.

The classic example of an external benefit is the creation of knowledge:

When a scientist makes an important discovery, he produces a valuable resource that other people can use. In this case, the government can raise economic well-being by subsidizing basic research. Another possible cause of market failure is market power. Market power refers to the ability of a single person to influence market prices.

2)      Redistribution of income

PRINCIPLE #8: A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS AND SERVICES

Almost all variation in living standards is attributable to differences in countries’ productivity—that is, the amount of goods and services produced from each hour of a worker’s time.

In nations where workers can produce a large quantity of goods and services per unit of time, most people enjoy a high standard of living.

To boost living standards, policymakers need to raise productivity by ensuring that workers are well educated, have the tools needed to produce goods and services, and have access to the best available technology.

PRINCIPLE #9: PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY

Inflation is an increase in the overall level of prices in the economy. Because high inflation imposes various costs on society; keeping inflation at a low level is a goal of economic policymakers around the world.

What causes inflation? (Growth in the quantity of money).

   When a government creates large quantities of the nation’s money, the value of the money falls.

PRINCIPLE #10: SOCIETY FACES A SHORT-RUN TRADEOFF BETWEEN INFLATION AND UNEMPLOYMENT

Reducing inflation is often thought to cause a temporary rise in unemployment. The curve that illustrates this tradeoff between inflation and unemployment is called the Phillips curve.

Why do we face this short-run tradeoff? 

   It arises because some prices are slow to adjust.

When the government reduces the quantity of money, it reduces the amount that people spend. This will decrease sales. Lower sales, in turn, cause firms to lay off workers. Thus, the reduction in the quantity of money raises unemployment.

è The tradeoff between inflation and unemployment is only temporary, but it can last for several years.