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Part 1 Introduction.docx

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University of British Columbia
ECON 102

Chapter 1: Ten Principles of Economics 06/27/2013 Scarcity: The limited nature of societies resources Economics: The study of how society manages its scarce resources Economists study how people make decisions and how they interact with other people to buy or sell goods How People Make Decisions Here, we look at the 4 basic principles of decision making Principle #1: People Face Tradeoffs To get one thing we like, we must give up on another. The more time you spend on studying economics, the less time you spend on studying psychology, or using that time for leisure purposes. 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 refers to the size of a pie, and equity refers to how the pie is shared. The two have negative correlation. If you want more equity, the size of the pie becomes smaller. Example: A government may promote a welfare state by redistributing money from the rich to the poor, but this will lower the incentive for people to work hard, thus, GDP will go down. Principle #2: The Cost of Something Is What You Give Up To Get It Because people make trade offs, they must consider the costs and benefits when making those decisions. Example: Going to university does not just cost you tuition fees, dorm room, etc, but it also costs you time, which can be used to make a few bucks. In the long run, you end up with (hopefully) a well paid job and more knowledge. Opportunity cost: Whatever must be given up to obtain some item The fact that we are in university suggests that we think the benefits outweigh the costs. Sellers often mention opportunity cost to buyers who are trying to decide between two purchases. Sellers will encourage the cheaper purchase, while mentioning the sum of money (the difference between the two) that can be potentially saved for additional purchases. This ensures that the seller gets money in his pocket. Principle #3: Rational People Think at the Margin Rational people: People who systematically and purposefully do the best they can to achieve their objectives People will buy available goods which give them the highest levels of satisfaction Marginal changes: Small incremental adjustments to plan of action When there’s a test coming up, you can either chose not to study at all, or choose to study 24 hours a day. Making decisions, as we see here, are not black and white. You may chose to, instead, spend an extra 2 to 3 hours of studying a day, giving up on T.V time. Marginal cost: How much you must pay for an extra number of that good Marginal benefit: How much satisfaction you will get through buying that extra number of good A rational decision maker will take action if and only if the marginal benefit of the action exceeds the marginal cost. Principle #4: People Respond to Incentives Incentive: Something that induces a person to act. Because rational people make decisions by comparing costs and benefits, they respond to incentives. Example: A tax on gasoline will encourage people to drive less Example: A law stating that you must drive with a seat belt on suggests to people that they can drive more recklessly, because their lives are now under some protection. Thus, although this law prevents more deaths, it induces more accidents. How People Interact 3 principles will be talked about here Principle #5: Trade Can Make Everyone Better Off People often think that competition is a bad thing, and that it’s best to isolate oneself from that hectic battle; this is false. If you isolate yourself, it’ll be harder for you to create goods you don’t specialize in. Take a look at the example: If I am specialized at producing A and you are specialized at producing B, I will trade some A for your B, so that we are both better off. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity 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 Adam Smith: “Invisible hand” In a central economy, the government takes over. However, the system usually is too much for politicians to handle. Market economies promote the general economic well-being, but does not promote well-being equally to all individuals. Principle #7: Governments Can Sometimes Improve Market Outcomes The government is needed to institute rules that govern the laws of a market economy, such as property rights. Property rights: The ability of an individual to own and exercise control over scarce resources Policies are also needed to either enlarge the pie or to share it equally Market failure: A situation in which a market left own its own fails to allocate resources efficiently. One possible reason why a market would fail is externality. Another is market power. Externality: The impact of one person’s actions on the well-being of a bystander. Pollution is an externality. Market power: The ability of a single economic actor (or a small group of actors) to have a substantial influence on market prices. This happens when there is no competition. The purpose of government policies is to try to prevent these market failures from happening. Of course, it doesn’t always happen. The invisible hand does not guarantee equality of wealth; it only ensures economic well-being. It’s the government that redistributes the wealth. Of course, it doesn’t always happen. How the economy as a whole works Now, we look at how the economy as a whole works ._. Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services Income determines the quality of life. Here is the primary reason why there are such large differences in living standards: Productivity: The quantity of goods and services produced from each hour of a worker’s time In rich countries, more is produced in the same amount of time. This means the population must be well educated, have the essential tools needed, and must have access to the best available technology. Some people say competition and minimal-wage laws are what increases the standard of living, but productivity is often the way to go. Principle #9: Prices Rise When the Government Prints Too Much Money Inflation: An increase in the overall level of prices in the economy High inflation proposes trouble and costs to society. Thus, governments intervene to keep inflation as low as possible; or to sustain it. When the government prints large amounts of money, money loses its economic value, thus, prices of goods rise. Principle #10: Society Faces a Short-run Tradeoff between Inflation and Unemployment 1. Increasing the amount of money will lead to people wanting to spend more of it. 2. Because there is increased demand, firms will want to rise its prices to maximize profit, while increasing the quantity of goods and services. 3. Increasing productivity means hiring more workers. Thus, the unemployment rate falls. Business cycle: Fluctuations in economic activity such as employment and production The government controls these fluctuations with monetary and fiscal policies; changing the amount a government spends, tax rates, or how much money is being printed. Chapter 2: Thinking Like an Economist 06/27/2013 The Economist As Scientist Yes, economics is actually a science, even though economists don’t use microscopes or test tubes. The Scientific Method: Observation Theory, and More Observation Like all scientists, economists develop hypotheses based on theories. However, evidence can only be found in the real world, and not inside a lab; this makes it an extremely difficult science to study. However, over time, through trial and error, one gathers enough information to know how to act when there is an economic crisis. The Role of Assumptions Assumptions simplify the complex world and make it easier to understand. Assumptions which are made will not apply to every single individual, but the majority of a population. Economists use different assumptions to answer different questions Economic Models Like a plastic figurine of the human body used by biology teachers, economists use models (in the form of diagrams or equations) to help us learn too. Details of a model are often omitted, because they are irrelevant to the main picture. This also improves our understanding of what we want to learn; no muss and fuss. Chapter 2: Thinking Like an Economist
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