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Chapter 1:
Ten Principles of Economics
What is Economics?
• Study of how society manages its scarce
• Therefore, basic economic concept is
• What are 5 things that you would like
more of?
Principle #1
People Face Trade-offs
• TINSTAAFL: There Is No Such Thing As
A Free Lunch
- What in life is truly free?
• Making decisions requires trading one
goal for another
• Efficiency vs. Equity: Maximum benefits
to society vs. “fairness”
Principle #2
The Cost of Something is What
You Give Up to Get It
• Making decisions causes people to
consider the costs & benefits of an action
• Opportunity Cost: Whatever must be
given up in order to obtain some item
• Do you go to college?
Principle #3
Rational People Think at the Margin
• Are people rational?
Marginal Benefit vs. Marginal Cost
• Example:
Diamonds vs. Water
Principle #4
People Respond to Incentives
• Incentives change people’s behavior
• Must look at direct & indirect effects of
Ex: Incentive effects of Gas Prices Rising
Is Trade Good for the U.S.?
• Should the U.S. trade more or less
than we do? Why?
Principle #5
Trade Can Make Everyone Better Off
• Trade doesn’t have to result in winners &
losers – both can win!
• Trade allows for specialization in what
you do best
Principle #6
Markets Are Usually a Good Way to
Organize Economic Activity
• Many countries have abandoned centrally
planned economies to develop markets
• Market economy: an economy that
allocates resources through decisions of
many firms and households
• Invisible Hand guides the economy when
everyone does what is best for them
Good Gov’t, Bad Gov’t
• How much/how
little should the
government get
involved in the
• In what situations
does it help to have
gov’t intervention?
Principle #7
Governments Can Sometimes
Improve Market Outcomes
• 2 Biggest Reasons for Intervention:
Efficiency & Equality
• Most useful when there is Market Failure
Ex.: Externalities & Market Power
• This concept produces big disagreements
Principle #8
A Country’s Standard of Living Depends on Its
Ability to Produce Goods & Services
• Huge differences in living standards
around the world
• Explained by differences in productivity
• Broken window fallacy?
Principle #9
Prices Rise When the Government
Prints Too Much Money
• Inflation – increase in overall level of
prices in the economy
• Examples?
Principle #10
Society Faces a Short-Run Trade-off
Between Inflation & Unemployment
• In short run, increase in $ leads to lower
unemployment but higher prices
• Trade-off leads to discussions of business
cycles, fiscal & monetary policy