Chapter 1 - The Ten Principles of Economics

Question 1

Scarcity

Answer 1

Scarcity signifies that society possesses finite resources, rendering it incapable of producing all the goods and services that individuals desire. It underscores the fundamental economic problem of limited resources and unlimited wants.
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Example: A family may have to choose between a vacation and a new car because their income (resources) is limited.

Question 2

Economics

Answer 2

Economics is the study of how society manages its scarce resources. Economists analyze how individuals, firms, and governments make decisions about the production, distribution, and consumption of goods and services.
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Example: Economists study how the price of gasoline affects the number of miles people drive.

Question 3

Trade-offs

Answer 3

Individuals and society as a whole constantly face trade-offs because of scarcity. To obtain one thing, we must often forgo something else we value.
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Example: A student decides to spend an extra hour studying economics, which means they give up an hour they could have spent sleeping, exercising, or working at their part-time job for extra spending money.

Question 4

Opportunity Cost

Answer 4

Opportunity cost represents the value of the next best alternative that must be sacrificed to obtain something else. It highlights the true cost of a decision, which includes both explicit (monetary) costs and implicit (non-monetary) costs.
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Example: The opportunity cost of going to college includes not only the money spent on tuition, books, room, and board, but also the income a student forgoes by not working full-time.

Question 5

Rational People

Answer 5

Economists often assume that individuals are rational, implying that they make decisions systematically and purposefully to maximize their well-being, considering the available opportunities and constraints.
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Example: College athletes who have the potential to earn millions by leaving school and playing professional sports often decide that the benefits of a college education do not outweigh the high opportunity cost, so they choose to play professionally.

Question 6

Marginal Change

Answer 6

A marginal change refers to a small incremental adjustment to an existing plan of action. Rational people often analyze decisions by comparing the marginal benefits and marginal costs.
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Example: You are considering calling a friend on your cell phone. You decide that talking with her for 10 minutes would give you a benefit that you value at about $7. Your cell phone service costs you $40 per month plus $0.50 per minute for whatever calls you make. You usually talk for 100 minutes a month, so your total monthly bill is $90. Should you make the call? Since the marginal benefit ($7) exceeds the marginal cost ($5 for 10 minutes), you should make the call.

Question 7

Incentive

Answer 7

An incentive is anything (such as a potential reward or punishment) that motivates an individual to act in a particular way. Rational people respond to incentives because they make decisions by weighing costs and benefits.
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Example: When the price of gasoline increases, people are incentivized to drive less, purchase fuel-efficient vehicles, carpool, take public transportation, or move closer to their workplaces.

Question 8

Trade

Answer 8

Trade between individuals, firms, or countries can benefit everyone involved. Trade enables specialization based on comparative advantage, leading to a greater variety of goods and services at lower costs.
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Example: By specializing in the production of goods and services where they have an advantage, and trading with others, countries can access a wider range of products at more affordable prices, ultimately enhancing their overall well-being.

Question 9

Market Economy

Answer 9

In a market economy, the allocation of resources is determined through the decentralized decisions of numerous firms and households interacting in markets, guided by prices and self-interest.
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Example: In a market economy for apples, orchards decide how many apples to grow and at what price to sell them, while consumers decide how many apples to buy based on their preferences and the price. The interaction of supply and demand in the market determines the equilibrium price and quantity of apples.

Question 10

Invisible Hand

Answer 10

This metaphor, coined by economist Adam Smith, describes how the self-interested actions of individuals and firms in a market economy can unintentionally lead to socially desirable outcomes, such as efficient allocation of resources and economic growth.
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Example: When individuals pursue their own self-interest by producing and selling goods or services that others want, they contribute to the overall functioning and prosperity of the economy, even if their primary motivation is personal gain.

Question 11

Market Failure

Answer 11

A market failure arises when the market, operating on its own, fails to efficiently allocate resources. Causes of market failures include externalities and market power.
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Examples:
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Pollution is a negative externality because it imposes costs on society that are not fully reflected in the market price of the polluting good or service.
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A monopoly is an example of market power because it allows a single firm to control the supply of a good or service, potentially leading to higher prices and lower output than in a competitive market.

Question 12

Property Rights

Answer 12

Property rights are the legal rights of individuals or firms to own and control scarce resources. They provide incentives for individuals to produce and innovate, contributing to economic growth and prosperity.
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Example: A farmer will be more likely to invest in improving their land and crops if they have secure property rights that protect their ownership and allow them to reap the rewards of their efforts.

Question 13

Productivity

Answer 13

Productivity measures the efficiency of production, typically expressed as output per unit of labor input. Higher productivity contributes to higher living standards, as it enables the production of more goods and services with the same amount of resources.
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Example: Countries with higher levels of education, technology, and capital tend to have higher productivity, resulting in higher incomes and better living standards for their citizens.

Question 14

Inflation

Answer 14

Inflation is a sustained increase in the general price level of goods and services in an economy over time. High inflation can erode purchasing power and create economic instability.
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Example: In the United States during the 1970s, high inflation led to a significant decline in the purchasing power of the dollar, making it more difficult for people to afford basic necessities

Question 15

Short-Run Trade-Off Between Inflation and Unemployment

Answer 15

This trade-off suggests that, in the short run, economic policies aimed at reducing unemployment can sometimes lead to higher inflation, and policies aimed at reducing inflation can sometimes lead to higher unemployment.
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Example: During an economic downturn, a government may try to stimulate the economy and reduce unemployment by increasing government spending or cutting taxes. While these policies may boost demand and lead to job creation, they can also put upward pressure on prices and lead to inflation in the short run.

Question 16

What are the 10 principles of economics?

Answer 16

A: The 10 principles of economics offer a framework for understanding how individuals, businesses, and societies make decisions about managing scarce resources. Here are the principles presented as questions and answers:
How Individuals Make Decisions:

Principle 1: What is the relationship between choices and scarcity? People face trade-offs in a world of scarcity. To get something we want, we must give up something else.

Principle 2: What is the real cost of something? The cost of something is what you give up to get it (opportunity cost).

Principle 3: How do rational people make decisions? Rational people think at the margin, comparing the marginal benefits and marginal costs of a decision.

Principle 4: What factors influence people’s actions? People respond to incentives, which can be rewards or penalties that influence their choices.

How People Interact:

Principle 5: How can trade benefit those involved? Trade can make everyone better off as it allows for specialization, resulting in a greater variety of goods and services at lower costs.

Principle 6: How is economic activity organized? Markets are usually a good way to organize economic activity, guided by prices and self-interest as if by an “invisible hand”.
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Principle 7: What are the roles of government in a market economy? Governments can sometimes improve market outcomes by enforcing rules, promoting efficiency (addressing market failures like externalities and market power), and promoting equality.
How the Economy as a Whole Works:

Principle 8: What determines a country’s standard of living? A country’s standard of living depends on its ability to produce goods and services (productivity).

Principle 9: What is the connection between money and prices? Prices rise when the government prints too much money (inflation).

Principle 10: What is a significant economic trade-off? Society faces a short-run trade-off between inflation and unemployment.

Question 17

Business Cycle

Answer 17

the irregular and largely unpredictable fluctuations in economic activity, as measured by
the production of goods and services or the number of people employed.

Question 18

Market Power

Answer 18

which refers to the ability of a single
person or firm (or a small group) to unduly influence market prices. For example, if everyone in town needs water but there is only one well, the owner of the
well is not subject to the rigorous competition with which the invisible hand normally keeps self-interest in check; she may take advantage of this opportunity by
restricting the output of water so she can charge a higher price

Question 19

externality

Answer 19

The impact of one
person’s actions on the
well-being of a bystander (Example of pollution)

Question 20

equality

Answer 20

the property of
distributing economic
prosperity uniformly
among the members of
society