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Chapter 1

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McMaster University
Bridget O' Shaughnessy

Chapter 1 Ten principles of economics Page 3-21 Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have Economics is the study of how society manages its scarce resources Economists study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. They also study how people interact with one another. How people make decisions Principle #1: People face tradeoffs “There is no such thing as a free lunch” which basically means 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. Efficiency means that society is getting the most it can from its scarce resources. Equity means that the benefits of those resources are distributed fairly among society’s members. Principle #2: The cost of something is what you give up to get it The opportunity cost of an item is what you give up to get that item. Principle #3: Rational people think at the margin Rational people are people who systematically and purposefully do the best they can to achieve their objectives, given the opportunities they have. Economists use the term marginal changes to describe small incremental adjustments to and existing plan of action. Rational people often make decisions by comparing marginal benefits and marginal costs. A person’s marginal benefit is the maximum amount they are willing to pay to consume that additional unit of a good or service. In a normal situation, the marginal benefit will decrease as consumption increases. Marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good. A rational decision maker takes an action is and only if the marginal benefit of the action exceeds the marginal cost. Principle #4: People respond to incentives An incentive is something (such as the prospect of a punishment or a reward) that induces a person to act. How people interact Principle #5: trade can make everyone better off
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