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Chapter 1

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Peter Sinclair

EC120 Chapter 1-Ten Principles of Economics Week 1 A society must: -Decide what jobs will be done and who will do them -Needs some people to grow food, make clothing, design computer software, etc. Once society has allocated people (and land, buildings, and machines) to various jobs it must allocate the output of goods and services that they produce. Ex. Who will eat potatoes and who will eat apples. The management of society’s resources is important because resources are scarce. Scarcity-the limited nature of society’s resources. -Society has limited resources and therefore cannot produce all the goods and services demanded. Economics-the study of how society manages its scarce resources Economists study: -how people make decisions -how much people work -what people buy -how much people save -how people invest their savings -how people interact with one another Economists analyze forces and trends that affect the economy as a whole, including: -the growth in average income -the fraction of the population that cannot find work -the rate at which prices rise Economy-a group of people interacting with one another as they go about their lives 4 Principles of Individual Decision Making Principle #1-People Face Tradeoffs -To get one thing we must give up another thing that we may like -Ex. A family has to decide how to spend their income. They can spend it on a vacation or on their kid’s college fund. Whichever one they choose to spend money on, they are taking away money from the other one. -Efficiency vs. Equity. Efficiency-the property of society getting the most it can from its scarce resources. “Economic pie” Equity-the property of distributing economic prosperity fairly among the members of society. “How the pie is divided” EC120 Chapter 1-Ten Principles of Economics Week 1 When government policies are decided these two goals conflict. Ex. Welfare helps those in need. But we take from the money of those who earned it and give it to those who did not earn it. Thus reducing the reward for working hard which makes people not work hard. And therefore the “economic pie” gets smaller when they try to distribute it equally. -Recognizing that people face tradeoffs does not tell us what decisions they should make Principle #2-The Cost of Something is What you Give up to Get it -Opportunity Cost-whatever must be given up to obtain some item -Ex. Going to university. The opportunity cost is the wages you would earn if you did not attend. Principle #3-Rational People Think at the Margin -Rational People-people who systematically and purposefully do the best they can to achieve their objectives. -Economists assume people are rational -Rational people know that decisions are not black and white, they involve some shades of grey -Ex. The decision is not to study 24/7 or blow off exams. Rather it is do you give up an hour of TV for an extra hour of studying? -Marginal Changes-small incremental adjustments to a plan of action -Marginal means “edge” -Rational people use “marginal benefits” and “marginal costs” to make decisions -The reason that people will pay a lot for diamonds is because their willingness to pay for any good is based on the marginal benefit that an extra unit of the good will yield. Principle #4-People Respond to Incentives -Incentive-something that induces a person to act (prospect of a punishment of a reward) -“People respond to incentives. The rest is commentary.” -Ex. A tax on gasoline encourages people to drive smaller, more fuel efficient cars How People Interact with One Another Principle #5-Trade Can Make Everyone Better Off -Trade between two countries can make each other better off -By trading with others, people can buy a greater variety of goods and services at a lower cost -Trade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services Principle #6-Markets are Usually a Good Way to Organize Economic Activity -Centrally planned economies are not beneficial and therefore most markets of the world have changed to a market economy. -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 EC120 Chapter 1-Ten Principles of Economics
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