Chapter 1 Flashcards
Principles of Economics: How People Interact
- Trade makes everyone better off
- Markets are a good way to organize economic activity
- Governments can improve market outcomes
Principles of Economics: How People Make Decisions
- People face trade offs
- The cost of something is what you give up to get it
- Rational people think at the margin
- People respond to incentives
Principles of Economics: How the Economy as a Whole Works (Core of Macroeconomics)
- A country’s standard of living depends on its ability to produce goods/services
- Prices rise when governments print too much money
- Society faces a short-run trade-off between inflation and unemployment
Efficiency
Society is getting the maximum benefits from its scarce resources
Equality
Benefits are distributed equally among members of society
Economics
The study of how society manages its scarce resources
Scarcity
The limited nature of society’s resources
Opportunity cost
What you give up to get something
Rational people
Do the best they can to achieve their objectives given available opportunities
Marginal change
Small incremental adjustment to an existing plan of action. Compare marginal benefits and marginal costs
Incentive
Prospect of reward or punishment that induces a person to act
How trade makes everyone better off
Trade allows everyone to specialize in the activities for which he/she has comparative advantage. By trading with others, people can buy a greater variety of goods and services at a lower cost. Without specialization and trade each person consumes only what he produces.
Market economy
Decisions of a central planner are replaced by the decisions of millions of firms and households
Markets are a good way to organize economic activity (invisible hand)
Although guided by self-interest, households and firms interact in markets as if they are guided by an invisible hand that leads them to desirable market outcomes
Prices are the instrument with which the invisible hand directs economic activity
Why government is needed (to improve market outcomes)
- Enforces the rules and maintains institutions that are key to a market economy, allowing invisible hand to work
- Promote efficiency and equality
Market failure
Market fails to produce efficient allocation of resources on its own. Possible causes include externalities and market power
Externality
Impact of one persons actions on the the well-being of a bystander
Market power
Ability of a single person or firm to unduly influence market prices
Productivity
Amount of goods/services produced by each unit of labor input
How a country’s standard of living depends on its ability to produce goods and services
Nations that produce a large quantity of goods and services per hour most people enjoy a higher standard of living and vice versa. Growth in productivity determines growth rate of average income
Inflation
Increase in overall level of prices in economy caused by the government printing too much money (growth in quantity of money)
How society faces a short-run trade-off between inflation and unemployment
- Increasing amount of money in economy stimulates overall spending and demand for goods and services
- Higher demand causes firms to raise prices and hire more workers to produce more goods and services
- More hiring means lower unemployment q
Business cycle
Irregular and largely unpredictable fluctuations in economic activity as measured by production of goods/services or number of people employed
