Lecture 1: Principles of Economics and Economic Thinking Flashcards
The limited nature of society’s resources.
Scarcity
The study of how society manages its scarce resources. This includes:
1. How people decide what to buy,
2. How much to work, save, and spend,
3. How firms decide how much to produce and how many workers to hire,
4. How society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs.
Economics
What are the 4 Principles under “ How People Make Decisions”
- Principle 1: People Face Tradeoffs
- Principle 2: The Cost of Something is What You Give Up to Get It
- Principle 3: Rational People Think at the Margin
- Principle 4: People Respond to Incentives
These are examples of what Principle?
- Going to a party the night before your midterm leaves less time for studying.
- Working at night at a call center may increase income but has long-term health effects.
- Protecting the environment requires resources that could otherwise be used to produce consumer goods.
Principle #1: People Face Tradeoffs
When society gets the most from its scarce resources.
Efficiency
When prosperity is distributed uniformly among society’s members.
Equality
What is the Tradeoff between Efficiency and Equality?
To achieve greater equality, income could be redistributed from the wealthy to the poor. But this reduces the incentive to work and produce, shrinking the size of the economic “pie.”
What Principle Is This?
Making decisions requires comparing the costs and benefits of alternative choices.
Principle #2: The Cost of Something Is What You Give Up to Get It
The ________ of any item is whatever must be given up to obtain it. It is the relevant cost for decision making.
Opportunity Cost
What Principle Is This?
Rational people systematically and purposefully do the best they can to achieve their objectives and make decisions by evaluating costs and benefits of marginal changes – incremental adjustments to an existing plan.
Principle #3: Rational People Think at the Margin
Who are Rational People?
People who systematically and purposefully do the best they can to achieve their objectives.
What are Marginal Changes?
Incremental adjustments to an existing plan.
What Principle is This?
- When gas prices rise, consumers buy more hybrid cars and fewer gas-guzzling SUVs.
- When cigarette taxes increase, smoking falls. – When teachers give extra points, students attend an activity.
- When the death penalty is imposed, crime is reduced.
Principle #4: People Respond to Incentives
Something that induces a person to act, i.e., the prospect of a reward or punishment. It can be monetary or non-monetary.
Incentives
What are the 3 Principles under “ How People Interact”
- Principle #5: Trade Can Make Everyone Better Off
- Principle #6: Markets Are Usually A Good Way to Organize Economic Activity
- Principle #7: Governments Can Sometimes Improve Market Outcomes
What Principle Is This?
- Important role for govt: enforce property rights (with police, courts).
- People are less inclined to work, produce, invest, or purchase if there is a large risk of their property being stolen.
Principle #7: Governments Can Sometimes Improve Market Outcomes
When the market fails to allocate society’s resources efficiently.
Market Failure
One of the Causes of Market Failure:
- When the production or consumption of a good affects bystanders, e.g., pollution?
Externalities
One of the Causes of Market Failure:
- A single buyer or seller has substantial influence on market price, e.g., monopoly.
Market Power
How can Governments promote Equity in Market Outcomes?
If the market’s distribution of economic well-being is not desirable, tax or welfare policies can change how the economic “pie” is divided.
What are the two roles of Economists?
- Scientists: try to explain the world.
- Policy advisors: try to improve it.
Economists employ the scientific method, the dispassionate development and testing of theories about how the world works. They use theory and observation.
Economists as Scientists
The dispassionate development and testing of theories about how the world works, using theory and observation.
Scientific Method
Why are Assumptions Important in Economics?
Assumptions simplify the complex world, making it easier to understand.
