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ECN 104 Lecture Notes - Demand Curve, Absolute Advantage, Marginal Cost

Course Code
ECN 104
Tsogbadral Galaabaatar

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Chapter 1: Ten Principle of Economics 1/11/2013 9:55:00 AM
The word economy comes from the Greek work for “one who manages a
A household faces many decisions
It must decide which members of the household do which tasks and
what each members gets in return
The household must allocate its scarce resources among its various
members, taking into account each member‟s abilities, efforts, and
Like a household, a society faces many decisions
A society must decide what jobs will be done and who will do them
It needs some people to grow food, other people to make clothing,
and still others to design computer software
Once society has allocated people (as well as land, buildings, and
machines) to various jobs, it must allocate the output of goods and
services that they produce
Economics is about…
Scarcity: the limited nature of society‟s resources
The management of society‟s resources (e.g., people, land,
buildings, machinery) is important because resources are scarce
Natural resource, land and worker‟s time are all limited in its
Economics is about how the society manages its limited resources
In most societies, resources are allocated not by a single central
planner but through the combined actions of millions of households
and firms
Economists study how people make decisions:
o Firms: what to produce, how much to produce, how many
workers to hire, etc.
o Individuals: what to purchase, how to save, how many hours
to work, etc.
Economists also study how people interact with one another
o They examine how the multitude of buyers and sellers of a
good together determine the price at which the good is sold
and the quantity that is sold

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Economist analyze forces and trends that affect the economy as a
whole, including the growth in average income, the fraction of
population that cannot find work, and the rate at which prices are
How People Make Decisions
Principle #1: People Face Tradeoffs
To get one thing that we like, we usually have to give up another
thing that we like
Making decisions requires trading off one goal against another
Think of the allocations of your time and money etc.
o If you buy a new iPhone today, you have to wait before
buying a new laptop.
o If you invest in a stock, you are giving up other forms of
investments, such as RESP and bonds.
o For every hour you spend on studying, you could have
When people are grouped into societies, they face different kinds of
The classic tradeoff is between “guns and butter”. The more we
spend on national defence (guns) to protect our shores from foreign
aggressors, the less we can spend on customer good (butter) to
raise our standard of living at home.
The modern tradeoff is between a clean environment and a high
level of income. While pollution regulations give us the benefit of a
cleaner environment and the improved health that come with it,
they have the cost of reducing the incomes of the firms‟ owners,
workers, and customers.
Society faces the tradeoff between efficiency and equity.
Efficiency: the property of society getting the most it can from its
scarce resources
Equity: the property of distributing economic prosperity fairly
among the members of society
Efficiency can be referred to the economic pie, and equity to how
the economic pie is divided among society‟s members

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Principle #2: The Cost of Something is What You Give Up to Get It
Opportunity cost: whatever must be given up to obtain some item
o Decision makers should be aware of the opportunity costs
that accompany each possible action
o To become a doctor, you need to go to medical school. In
addition, you are giving up other career paths.
o Waiting in a long line for a free item costs your time.
o “There is no such thing as a free lunch”
Principle #3: Rational People Think at the Margin
Rational people: people who systematically and purposefully do
the best they can to achieve their objectives, given the
opportunities they have
In economics, we usually assume that firms‟ objective is to
maximize its profit and consumers‟ objective is to achieve the
highest level of satisfaction.
Marginal changes: small incremental adjustments to an existing
situation or plan of action
o “marginal” means “edge”, so marginal changes are
adjustments around the edges of what you are doing
Rational people make decision by comparing marginal benefits and
marginal costs.
o Suppose you have already eaten 3 tacos. Whether to have an
extra taco depends on price of the taco (marginal cost) and
the extra satisfaction it gives (marginal benefit).
o To study one more hour the night before the exam has
benefits and costs (less sleep).
A rational decision maker takes an action if and only if the marginal
benefit of the action exceeds the marginal cost
Principle #4: People Responds to Incentives
Incentive: something, such as a punishment or reward, that
induces a person to act
Rational people respond to incentive
o “People respond to incentives. The rest is commentary.”
o Incentives are crucial to analyzing how markets work
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