ECN104 - Chapter 1 and 2

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ECN104 – Week 1 Notes
Chapter 1: Ten Principles of Economics
Questions:
oWhat kinds of questions does economics address?
oWhat are the principles of how people make decisions?
oWhat are the principles of how people interact?
oWhat are the principles of how the economy as a whole works?
What economics is all about:
oScarcity
The limited nature of society’s resources
oEconomics
The study of how society manages its scarce resources
E.g., How people decide what to buy; How much to work, save,
and spend; 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
How people make decisions
oPrinciple #1: People Face Tradeoffs
All decisions involve tradeoffs
E.g., Going to a party the night before your midterm leaves less
time for studying; Having more money to buy stuff requires
working longer hours, which leaves less leisure time; Protecting
the environment requires resources that could otherwise be
used to produce consumer goods
Society faces an important tradeoff:
Efficiency vs. Equality
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Efficiency
oWhen society gets the most from its scarce
resources
Equality
oWhen prosperity is distributed uniformly among
society’s members
Tradeoff
oTo achieve greater equality, could redistribute
income from wealthy to poor. But this reduces
incentive to work and produce, shrinks the size of
the economic “pie.”
oPrinciple #2: The Cost of Something Is What You Give Up to Get It
Making decisions requires comparing the costs and benefits of
alternative choices
The opportunity cost of any item is whatever must be given
up to obtain it
It is the relevant cost for decision making
E.g., The opportunity cost of…going to college for a year is not
just the tuition, books, and fees, but also the foregone wages;
The opportunity cost…of seeing a movie is not just the price of
the ticket, but the value of the time you spend in the cinema
oPrinciple #3: Rational People Think At The Margin
Rational people
Systematically and purposefully do the best they can to
achieve their objectives
Make decisions by evaluating costs and benefits of
marginal changes – incremental adjustments to an
existing plan
E.g., When a student considers whether to go to college for an
additional year, he compares the fees & foregone wages to the
extra income he could earn with the extra year of education;
When a manager considers whether to increase output, she
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compares the cost of the needed labor and materials to the
extra revenues
oPrinciple #4: People Respond To Incentives
Incentive
Something that induces a person to act
E.g., the prospect of a reward or punishment
Rational people respond to incentives
E.g., When gas prices rise, consumers buy more hybrid
cars and fewer gas guzzling SUVs; When cigarette taxes
increase, teen smoking falls
How people interact
oPrinciple #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
oPrinciple #6: Markets Are Usually A Good Way to Organize Economic
Activity
Market
A group of buyers and sellers (need not to be in a single
location)
“Organize economic activity” means determining
What goods to produce
How to produce
How much of each to produce
Who gets them
A market economy allocates resources through the
decentralized decisions of many households and firms as they
interact in markets
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