ECN 104 Chapter Notes - Chapter 1: Invisible Hand, Opportunity Cost, Market Power

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4 Apr 2012
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Economics is the social science concerned with how individuals, institutions, and society make optimal
(best) choices under conditions of scarcity.
Ten Key Concepts
The Individual
CONCEPT 1 (“Facing Trade-offs”): Scarcity in relation to wants means you face trade-offs;
there-fore, you have to make choices. You have to trade one goal to another.
CONCEPT 2 (“Opportunity Costs”): The cost of the choice you make is what you give up for
it, or the opportunity cost.
CONCEPT 3 (“Choosing a Little More or Less”): Choices are usually made at the margin; we
choose a “little” more or a “little” less of something. People make decisions by comparing
costs and benefits.
CONCEPT 4 (“The Influence of Incentives”): The choices you make are influenced by
incentives. When the price of one thing rises, people stop buying that thing as much and
rely on something else. Discounts and sales.
Interaction among Individuals
CONCEPT 5 (“Specialization and Trade”): Specialization and trade will improve the well-
being of all participants. Competition result in gains from trading and trade allows people to
specialize.
CONCEPT 6 (“The Effectiveness of Markets”): Markets usually do a good job of coordinating
trade among individuals, groups, and nations. Households decide what to buy and who to
work for while firms decide who to hire and what to produce. Adam Smith: invisible hand =
prices
CONCEPT 7 (“The Role of Governments”): Governments can occasionally improve the
coordinating function of markets. When the market fails, the government can promote
efficiency and equity. Failure may be caused by an externality (impact of one person or
firm’s actions on the well-being of a bystander, such as a factory polluting air near a
residential area) or market power (which is the ability of a single person or firm to unduly
influence market prices, such as a monopoly which means higher prices and lower consumer
welfare)
The Economy as a Whole and the Standard of Living
CONCEPT 8 (“Production and the Standard of Living”): The standard of living of the average
person in a particular country is dependent on its production of goods and services. A rise in
the standard of living requires a rise in the output of goods and services.
CONCEPT 9 (“ Money and Inflation”): If the monetary authorities of a country annually print
money in excess of the growth of output of goods and services it will eventually lead to
inflation.
CONCEPT 10 (“Inflation– Unemployment Trade-off”): In the short run, society faces a short-
run trade-off between inflation and its level of unemployment.
Opportunity Costs - Sacrifices; to get more of one thing you forgot the opportunity of getting the next
best thing. The sacrifice is the opportunity cost of the choice. (Example: You can get lunch for free for
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