TEN PRINCIPLES OF ECONOMICS

Chapter 1
TEN PRINCIPLES OF ECONOMICS
The word economy comes from the Greek word for
one who manages a household.
TEN PRINCIPLES OF ECONOMICS
The management of societys resources (e.g., people, land, buildings,
machinery) is important because resources are scarce.
Scarcity: the limited nature of societys resources
TEN PRINCIPLES OF ECONOMICS
Economics: the study of how society manages its scarce resources
HOW PEOPLE MAKE DECISIONS
Principle #1: People Face Tradeoffs
There is no such thing as a free lunch.
Efficiency: the property of society getting the most it can from
its scarce resources
Equity: the property of distributing economic prosperity fairly
among the members of society
HOW PEOPLE MAKE DECISIONS
Principle #2: The Cost of Something Is What You Give Up to Get
It
Opportunity cost: whatever must be given up to obtain some
item

HOW PEOPLE MAKE DECISIONS

Principle #3: Rational People Think at the Margin
Rational people: people who systematically and purposefully
do the best they can to achieve their objectives
Marginal changes: small incremental adjustments to a plan of
action
HOW PEOPLE MAKE DECISIONS
Principle #4: People Respond to Incentives
Describe an important tradeoff you recently faced.
Give an example of some action that has both a monetary and
nonmonetary opportunity cost.
Describe an incentive your parents offered to you in an effort to
influence your behaviour.
HOW PEOPLE INTERACT
Principle #5: Trade Can Make Everyone Better Off
Property rights: the ability of an individual to own and exercise
control over scarce resources
HOW PEOPLE INTERACT
Principle #6: Markets Are Usually a Good Way to Organize
Economic Activity
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

HOW PEOPLE INTERACT

Principle #6: Markets Are Usually a Good Way to Organize

Economic Activity (contd)
In his 1776 book, Adam Smith observed that households and firms
interacting in markets act as if they are guided by an invisible
hand that leads them to desirable market outcomes.

HOW PEOPLE INTERACT

Principle #7: Governments Can Sometimes Improve Market
Outcomes
We need governments for two reasons:
To enforce property rights
Property rights: the ability of an individual to own
and exercise control over scarce resources

HOW PEOPLE INTERACT

Principle #7: Governments Can Sometimes Improve Market
Outcomes (contd)
Because the invisible hand is powerful, but it is not
omnipotent
There are two broad reasons for a government to
intervene in the economy:
The goal of efficiency
The goal of equity

HOW PEOPLE INTERACT

The goal of efficiency

Market failure: a situation in which a market left on its own fails
to allocate resources efficiently
Externality: the impact of one persons actions on the wellbeing of a bystander
The goal of equity
Even when the invisible hand is yielding efficient outcomes, it
can nonetheless leave sizable disparities in economic wellbeing.
Why is a country better off not isolating itself from all other countries?
Why do we have markets and, according to economists, what roles
should government play in them?
HOW THE ECONOMY AS A WHOLE WORKS
Principle #8: A Countrys Standard of Living Depends on Its
Ability to Produce Goods and Services
Productivity: the quantity of goods and services produced from
each hour of a workers time
HOW THE ECONOMY AS A WHOLE WORKS
Principle #9: Prices Rise When the Government Prints Too
Much Money
Inflation: an increase in the overall level of prices in the
economy
What causes inflation?

HOW THE ECONOMY AS A WHOLE WORKS

Principle #10: Society Faces a Short-Run Tradeoff between
Inflation and Unemployment
This short-run tradeoff plays a key role in the analysis of the
business cycle.
Business cycle: the irregular and largely unpredictable
fluctuations in economic activity, as measured by the
production of goods and services or the number of people
employed
List and briefly explain the three principles that describe how the
economy as a whole works.
TABLE 1.1:Ten Principles of Economics
The end
Chapter 1