Ten principal of economic
September 10 2012
How people make decisions
1. People face trade offs
-“ There is no such thing as free lunch”
-To get one thing that we like we have to give up another
E.g. spending extra dollar on something is a dollar less for something else
-“Guns and butter”
(Classic example of the trade off in society, when the nation spends more on
national defenses (gun) to protect our shores from foreign aggressors, the
less we can spend on consumer goods (butter) to raise our standard of living
-Efficiency and equity
Efficiency means that society is getting the most it can from its scarce
resources (the size of the economic pie)
Equity is the property of distribution economic prosperity fairly among the
members of society (how pie is divided)
2. The cost of something is what you give up to get it
-Opportunity cost: what must be given up to obtain some item
3. Rational people think at the margin
-Rational people: people whom systematically and purposefully do the best
they can to achieve their objectives given the opportunity they have.
-Marginal (edge) changes/benefit/cost
Marginal changes are adjustment around the edge of what you were doing.
Marginal cost is the cost of the original price
E.g. a man pays 300$ for a $ 500 seat in plane that is about to
take off. It’s profitable because it’s better than flying with
Marginal decision are made if the marginal benefit exceed the marginal cost
-Cost at benefits (additional)
4. People respond to incentives
-Incentive: something that induces a person to act
E.g. when a price of an apple increases, people decides to eat more pears
because the cost of buying an apple is higher.
“People respond to incentives. The rest is commentary”
“ When analyzing any policy, we must consider incentives. Is the policy
changes inventive, it will cause people to alter their behaviors.” How people interact
5. Trade can make everyone better off
-Trade between two countries can make each better off.
6. Markets tend to increase economic efficiency
-Market economy: an economy that allocates resources through the
decentralized decision of many firms and households as they interact in
markets for goods and services.
Firm decides who to hire and what to make. House hold
decides which firms to work for and what to buy with their
“Household and firms interacting in markets as id they are guided by an
“invisible hand” that leads them to desirable market outcomes. ”
-Prices are instrument with which the invisible hand directs economic
Buyer looks at the price when determine how much to
demand, and the seller look at the price when deciding how
much to supply.
Market prices reflect both the value of a good to society of
making the goods.
Impedes: block, stops
7. Sometimes the government can eliminate market inefficiencies (improve
-Property rights: the ability of an individual to own and exercise control
over scarce resources.
E.g. a farmer wont grow food if he expects his crop to be stolen etc.
-The invisible hand counts on our ability to enforce our rights.
-“Invisible hands” are powerful but its not omnipotent. Therefore, we need
government to intervene the economy and change the allocation of resources
that people would choose on their own: to promote efficiency and to promote
equity (to enlarge the pie or to change how the pie is divided).
-Market failure: a situation in which market left on its own fails to allocate
-Externality: exercise on transaction between two people affects a third
person. E.g. pollution
-Market power: the ability of a single economic actor (a small group actors)
to have substantial influences on market prices.
-Invisible hand might fail to ensure that economic prosperity is distributed
An invisible hand does not ensure that everyone has sufficient food,
decent clothing, and adequate health care. -
-Negative externality: when a person affects a cause on a person
How the economy as a whole works
8. A countries standard of living depends on its productivity
-Productivity: the quantity of good and services produced from each hour of
a worker’s time.
-Per capital GDP
-Out puts for workers
9. Prices increases when the government prints too much money
-Inflation: an increase in the overall level of prices in the economy
High inflations imposes various costs on society, keeping inflation at a
low level is a goal of economic policymakers around the world.
What causes inflation? When a government creates large quantities of
the nation’s money, the value of the money falls.
10.There is a short run trade off between inflation and unemployment
-Long run is where the higher level of prices is.
-Short run effects of monetary injection:
Increasing the amount of money in the economy stimulates overall
level of spending and thus demands for goods and services
Higher demand may, over time, cause firm to raise their prices, but in
the meantime, it also encourages them to increase the quantity of
goods and services they produce and hire more workers to produce
those goods and services
More hiring means lower unemployment
- The short run trade off plays a roll in Business cycle: fluctuations in
economic activity, such as employment and productions Macroeconomics
Sept 12 20212
Chapter 1, 2
What is more dangerous, a gun or a swimming pool?
1. Why is economics difficult:
Express idea in economics:
When the price of toffee rises people drink less coffee
(When the price of toffee rises people drink less coffee)
-Diagrams/graphs (demand graphs)
Translate between each different each different form of
2. Economic is a social science
Science = use of scientific method
3. Microeconomics vs. macro economics
Microeconomics: individual household and firms and how they
Macroeconomics: economy-wide phenomena such as interest rates,
unemployment, money and growth
4. Efficiency vs. equity
Efficiency is the size of the pie (size of the share)
Equity is how the pie is divided (does everyone get the same share?)
5. Positive vs. normative analysis
Positive: the world “as it is”
Normative: the world “as it should be”
The world is flat (a)
b. Normative Positive statement is always shorter than normative statement
M: Markets are usually a good way to improve marker efficiency
I: Market tends to increase market efficiency
Diagram or equation
Variables (inflation rates, the amount of coffee sold)
E.g. map of a city (it has a smaller scale)
7. Classify variables
Real variables vs. normal variables
Stock variables* vs. flow variables^
*Snap shot at a point in time
^Time element (per year, per minute)
-Capital stock means quantities of building used to produce goods and services
-Investment is new purchases year add to stock variables
Example of a model: circular flow diagram
Market for good & services $
Market for factor services
What is more dangerous, a gun or a swimming pool?
“ Freakonomics: a rogue economist explores the hidden side of everything” by
Steven d. Levitt and Stephen J. DUBNER
“ NUDGE: improving decision about wealth, wealth, and happiness” by Richard H.
Thaler and Cass R. Sunstein September 13 2012
Why doesn’t Sidney Crosby mow his own lawn?
The production possibilities frontier (PPF)
PPF: the combination of out put that the economy can produce given the available
factors of production and production technology.
Feasible: a combination that lies on the PPF or inside the PPF
Infeasible: a combination that lies above (under) the PPF
Efficient: an out come that occurs if the economy can get all it can from its scarce
resources September 17 2012
Should you and your roommate divide household chores evenly?
There are 2 interior decorator that can paint and wallpaper. They have 40hr
workweeks. Martha can paint 20 rooms or wallpaper 5 rooms; Stewart can paint 10
rooms or wallpaper 8 rooms.
Opportunity cost: whatever must be given up to obtain some item (e.g. Going to
university instead of working)
Paint Paint Stewart
5 Wallpaper 8 Wallpaper
Absolute advantage: the ability to a produce a good with a smaller quantity of
Comparative advantage: the ability to produce a good with a smaller opportunity
cost. (The producer who gives up less of other goods to produce good x has smaller
opportunity cost of production good x
Can’t have compara