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Lecture 1.docx

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Hannah Holmes

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Intro to Econ 10 Principles of Economics – How people make decisions 1. People face tradeoffs  Allocating time/resources between 2 different things.  Efficiency – the property of society getting the most it can from its scarce resources vs. equity – the property of distributing economic prosperity fairly among the members of society (efficiency refers to the size of the economic pie, and equity refers to how the pie is divided) 2. The cost of something is what you give up to get it (opportunity cost, next best alternative)  Making decisions requires comparing the costs and benefits of an alternative action 3. Rational people think at the margin (forward looking; costs and benefits marginal benefit of the action exceeds marginal cost.)  Rational people – people who systematically and purposely do the best they can to achieve their objective o Often make decisions by comparing marginal benefits and marginal costs  Marginal changes – small incremental adjustments to a plan of action o Helps to explain some otherwise puzzling economic phenomena (diamond vs. water) 4. People respond to incentives  Incentive – something (such as the prospect of a punishment or reward) that induces a person to act. o Because rational people make decisions by comparing costs and benefits, they respond to incentives. How people interact 5. Trade can make everyone better off  Trade allows countries to specialize in what they best and to enjoy a greater variety of goods and services 6. Markets tend to increase efficiency (how much stuff we can make; compare with ‘central planning  communism [efficiency vs. equity], people respond to incentives)  Market economy – an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services  Firms decide whom to hire and what to make, households decide which firms to work for and what to buy with their incomes.  “Households and firms interacting in markets act as if they are guided by an “invisible hand” that leads them to desirable market outcomes. o If each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it, the market will settle on a product distribution and prices that are beneficial to all the individual members of a community, and hence to the community as a wh
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