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Chapter 1

Chapter 1 Economics.docx

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Harvard University
Economics 10a
Gregory Mankiw

Chapter 1 Economics: Ten Principles of Economics • Scarcity: the limited nature of society’s resources • Economics: the study of how society manages its scarce resources • Adam Smith: o Individuals are best left to their own devicesmotivated by self-interest  The invisible hand guides the self-interest • Ten Principles of Economics: How People Make Decisions: 1. People Face Trade-Offs • Examples of trade-offs that society faces o Guns and butter  Steel is scarceshould a government delineate more steel for guns (military) or butter (industry)  The more society spends on national defense to protect its shores form foreign aggressors, the less it can spend on consumer goods (butter) to raise the standard of living at home o Trade off between a clean environment and a high level of income • Efficiency (size of economic pie) versus equality (how the pie is divided): o Efficiency: the property of society getting the most it can from its scarce resources o Equality: the property of distributing economic prosperity uniformly among the members of society o When the government redistributes income from the rich to the poor, it reduces the reward for working hardWhen the government tries to cut the economic pie into more equal slices, the pie gets smaller 2. The Cost of Something Is What You Give Up to Get It • Opportunity cost: whatever must be given up to obtain some item 3. Rational People Think at the Margin • Rational people: people who systematically and purposefully do the best they can to achieve their objectives • Marginal change: a small incremental adjustment to a plan of action • Arational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost 4. People Respond to Incentives • Incentive: something that induces a person to act • Ahigher price in the market provides an incentive for buyers to consume less and an incentive for sellers to produce more • Policies affect incentives o When analyzing any policy, we must consider not only the direct effects but also the less obvious indirect effects that work though incentives. If the policy changes incentives, it will cause people to alter their behavior How People Interact: 5. Trade Can Make Everyone Better Off • Each family in the economy is competing with all other families • Trade between two countries can make each country better off o Trade allows each person to specialize in the activities he or she does best o By trading with others, people can buy a greater variety of goods and service at a lower cost 6. Markets Are Usually a Good Way to Organize EconomicActivity • Market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in a market for goods and services • Adam Smith (1776): An Inquiry into the Nature and Causes of the Wealth of Nationshouseholds and firms interact in the marketplace as if they are guided by an “invisible hand” that leads them to desirable market outcomes o Market prices reflect both the value of a good to society and the cost to society of making the good o Prices adjust to guide these individual buyers and sellers to reach outcomes that maximize the well-being of society as a whole o When the government prevents prices form adjusting naturally to supply and demand, it impedes the invisible hand’s ability to coordinate the decisions of the households and firms that make up the economy  Failure of communism: central planning lacks the necessary information about consumers’tastes an
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