Week 1: 10 Principles of Economics Flashcards
What questions do we ask about econ?
Who is producing, what, how much production, how much consumption etc
(Decisions and planning)
Why do we need to make decisions?
Time, money, resources are limited- resources are scarce = scarcity
What is economics?
How society manages its scarce resources
What do economists do?
Examine how people make these choices: how much they work, what they buy, how much they save, how they invest their savings etc
Study how people interact with one another
e.g. examine how buyers and sellers together determine the price at which the good is sold
Analyze forces and trends that affect the overall economy
e.g. growth in avg income, fraction of pop that can’t find work, rate at which prices are rising
What is an economy
Group of people dealing with one another as they go about their lives.
What are the 10 principles of economics?
- People face trade offs.
- The cost of something is what you give up to get it
3.Rational people think at the margin - People respond to incentives
- Trade can make everyone better off
- Markets are usually a good way to organize economic activity
- Governments can sometimes improve market outcomes
- A country’s standard of living depends on its ability to produce goods and services
- Prices rise when the government prints too much money
- Society faces a short-term trade-off between inflation and unemployment
Explain people face trade offs.
To get the thing you want, you usually have to give up another thing you want.
Making decisions requires trading off one goal for another
E.g. selena student, needs to decide how to spend her time
studying? if so, for every hour spent she gives up an hour that could have been spent napping, riding etc.
What are some critical trade offs?
Guns and butter- the more spent on military, less can be spent on consumer goods
Trade off between clean environment and level of income
Pollution regulations lead to increased cost of producing goods and services, therefore earn smaller profits, pay lower wages etc.
Yield a cleaner environment but may reduce incomes of regulated firms’ owners, workers, customers
Efficiency and equality
Efficiency: society getting greatest benefits from its scarce resources (size of economic pie)
Equality: these benefits are distributed uniformly among society’s members (how evenly the economic pie is sliced)
Efficiency + equality can conflict
e.g. policies reducing inequality can increase equality but decrease efficiency (society doesn’t benefit as much as a whole)
What is the opportunity cost of an item?
What you give up to get it
E.g. college athletes give up college to play professional sports
(high opportunity cost)
How do rational people think?
… at the margin
Rational people: systematically and purposefully do the best they can to achieve their goals
e.g. how to maximise profit, how much product to sell
Know that many issues in life are not black and white, instead involve shades of grey
Rational people make decisions by comparing marginal benefits and costs
A rational decision maker takes action if and only if the action’s marginal benefit exceeds its marginal cost.
What does marginal change mean
Describes an incremental adjustment to an existing plan of action
margin = edge, therefore means small adjustments around the edges of what you are doing
Example of thinking at the margin?
Decide whether to watch a movie: pay 30 for streaming service (unlimited films), typically watch 5 movies/month. What cost should you consider when deciding whether to stream another movie?
Avg cost: 30/5 = 6
Marginal cost = 0, you pay $30 regardless of how many movies you stream
At the margin, streaming a movie is free
Only cost: time it takes away from doing other activities
What is an incentive?
Something that induces a person to act, e.g. the prospect of a punishment or reward.
People respond to incentives if they make decisions by comparing costs and benefits
Why can trade make everyone better off?
Family example: family gains a lot from being able to trade with others
Family members constantly compete with other families
Trade allows everyone to specialize in the activities they do best.
By trading with others, people can buy a greater variety of goods and services at a lower cost
E.g. family would not be better off isolating themselves, then would need to grow more food, sew their own clothes etc.
What is a 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
(unlike centralized economy, run by gov)
Firms and households interact in the marketplace, where prices and self-interest guide their decisions.
Firms: decide whom to hire and what to make
Households: decide where to work and what to buy with their incomes
What is the “invisible hand” theory?
Firms and households in competitive markets act as if they are guided by an “invisible hand” that leads them to desirable outcomes
(motivated by self-interest)
Prices = instrument with which the “invisible hand” directs economic activity
Sellers = look at price when deciding how much to supply
Buyers = look at price when deciding how much to demand
What are property rights?
The ability of an individual to own and exercise control over scarce resources
Why do we need government?
Invisible hand can only work if they enforce rules and maintains institutions key to a market economy
Causes of market failure?
Externality: impact of one person’s actions on wellbeing of a bystander
e.g. pollution
Market power: ability of a single person/firm to unduly influence market prices
What is a market failure?
A situation in which a market left on its own does not allocate resources efficiently
Why is the invisible hand not omnipotent?
For efficiency, does not account for market failure
For equality: can leave large disparities in well-being even with efficient outcomes
e.g. does not ensure everyone has enough food, clothing, adequate healthcare
even though market economy rewards people according to their ability to produce things that other people are willing to pay for
e.g. basketball player earns more than chess player bc ppl willing to pay more to watch basketball
What is productivity?
The quantity of goods and services produced from each unit of labor input
There is a relationship between productivity and living standards
Can be controlled by policy markers: ensure workers are well-trained, have the tools they need to produce goods and services etc
What is inflation?
Increase in overall level of prices in the economy
Caused by overproduction of money (large quantities of money, which causes its value to fall)
What is the business cycle?
Fluctuations in economic activity, such as employment and production
