Chapter 1 Principles (1-7 only)
• Principle 1: People face trade-offs.
o “To get something that we like, we have to give up something else we also like”
o “guns and butter” = classic trade-off
o Efficiency= society is getting maximum benefits; refers to size of economic pic
o Equality= benefits are distributed uniformly; refers to how the pie is divided into
• Principle 2: The cost of something is what you give up to get it.
o Opportunity cost= what you give up to get a certain item/good
• Principle 3: Rational people think at the margin.
o Marginal change= a small incremental adjustment to an existing plan of action
• Principle 4: People respond to incentives.
o Change the policy → behavior changes
• Principle 5: Trade can make everyone better off.
o Trade between two countries can make each country better off.
• Principle 6: Markets are usually a good way to organize economic activity.
o Central planning= only the government could organize economic activity – abandoned
o Market economy= the decisions of a central planner are replaced by the decisions of
households and firms; act as if they are guided by an “invisible hand”
• Principle 7: Governments can sometimes improve market outcomes.
o Promote efficiency
▪ Sometimes the market fails on its own (market failure)
o Promote equality
Characteristics of a competitive market.
• Competitive market= there are so many buyers and so many sellers that each has a negligible
impact on the market price
o The goods offered for sale are all exactly the same
o The buyers and sellers are so numerous that no single buyer or seller has any influence
over the market price.
Law of demand.
• Law of demand= other things being equal, when the price of a good rises, the quantity
demanded of the good falls, and when the price falls, quantity demanded rises
Shifters of demand curves/supply curves.
• “increase in demand” = any change that increases the quantity demanded at every price shifts
curve to the right
• “decrease in demand” = any change that decreases the quantity demanded at every price shifts
curve to the left
Law of demand= other things being equal, when the price of a good rises, the quantity demanded of the good falls, and when the price falls, quantity demanded rises. Increase in demand = any change that increases the quantity demanded at every price shifts curve to the right. Decrease in demand = any change that decreases the quantity demanded at every price shifts curve to the left. Increase in supply = any change that increases quantity supplied at every price shifts curve to the right. Decrease in supply = any change that decreases quantity supplied at every price shifts curve to the left. Normal good vs. inferior good: normal good= an increase in income leads to an increase in demand. Inferior good= an increase in income leads to a decrease in demand. What is elasticity? : elasticity= measures how much one variable responds to changes in another variable, use price elasticity of demand or supply equation to determine elasticity.