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ECON 102
Maryann Vaughan

10 Principles of Economics- Jan 5th What Economics is All About  Scarcity refers to the limited nature of society’s resources.  Economics is the study of how society manages its scarce resources, including • how people decide how much to work, save, and spend, and what to buy. • how firms decide how much to produce, how many workers to hire. • how society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs. Principle 1: People face Trade-offs All decisions involve trade-offs, ex. -going to a party the night before your midterm leaves less time for studying. -having more money to buy stuff requires working longer house, leaving less time for leisure.  Society faces an important tradeoff: efficiency vs. equity  efficiency: getting the most out of our scarce resources.  equity: distributing prosperity fairly among society’s members.  Tradeoff: Equity can be improved by redistributing income from the well-off to the poor. But this reduces the incentive to work and produce, and shrinks the size of the economic “pie.” Principle 2: The Cost of Something is What you Give up to Get it -making decisions requires comparing the costs and benefits of alternative choices -opportunity cost: whatever must be given up in order to obtain something -ex: The opportunity cost of… …going to college for a year is not just the tuition, books, and fees, but also the foregone wages. …seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater. Principle 3: Rational People Think at the Margin  A person is rational if she systematically and purposefully does the best she can to achieve her objectives, given the opportunities she has.  Many decisions are not “all or nothing,” but involve marginal changes – incremental adjustments to an existing plan of action.  Rational people often make decisions by comparing marginal benefits and marginal costs. (decision rule)  -Ex: A student considers whether to go to college for an additional year, comparing the fees & foregone wages to the extra income he could earn with an extra year of education.  An airline deciding how much to charge passengers who fly standby will compare the extra (marginal) cost of adding a passenger versus the extra revenue (marginal benefit) of filling that seat. Principle 4: People Respond to Incentives  incentive: something that induces a person to act, i.e. the prospect of a reward or punishment.  Rational people respond to incentives because they make decisions by comparing costs and benefits. Examples: • In response to higher gas prices, sales of “hybrid” cars (e.g., Toyota Prius) rise. In response to higher cigarette taxes, the incidence of smoking falls Principle 5: Trade Can make Everyone Better Off  Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods.  Countries also benefit from trade & specialization: • get a better price abroad for goods they produce. • buy other goods more cheaply from abroad than could be produced at home. Principle 6: Markets are Usually a Good Way to Organize Economic Activity  A market is a group of buyers and sellers. (They need not be in a single location.)  “Organize economic activity” means determining • what goods to produce • how to produce them • how much of each to produce • who gets them  In a market economy, these decisions result from the interactions of many households and firms.  Famo
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