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Chapter 1
Ten Principles of
Economics
Scarcity
• Societies face many decisions – who will do
what job, etc.?
• Society has limited resources, therefore
everyone cannot have everything they want
• Scarcity = limited nature of society’s
resources
Economics
•
The study of how society manages its
scarce resources
• Three basic questions of economics:
1. What should be produced?
2. How should it be produced?
3. For whom should it be produced?
4 Factors of Production
1. Land – natural resources, not created by humans
2. Capital – tools, equipment, machinery and
factories used in the production of goods and
services.
3. Labor- people and their efforts, abilities and skills;
everyone except entrepreneurs
4. Entrepreneurs- risk takers in search of profits who
does something new w/ existing resources; they
are the driving force of economy by combining
land, labor and capital into new products
10 Principles of Economics
Principle 1 - People/Societies Face
Trade-offs – “There is no such thing as a
free lunch.”
examples: how to utilize time studying;
how to spend income
*Efficiency vs. Equity* i.e. the size of the
pie vs. how it’s divided.
ex: welfare, the individual income tax
Principle 2 – The Cost of a Decision
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Making decisions requires comparing costs
and benefits of actions
Opportunity Cost – whatever must be
given up to obtain some item
Ex: stay in college or go to NBA?
Principle 3 – People are Rational and
think at the margin
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People will try to achieve objectives as best they
can given the opportunities they have
Marginal changes – small incremental
adjustments to a plan of action. Ex: whether to
study an extra hour for an exam
People compare marginal benefits to marginal
costs
Why is water cheap, and a diamond expensive?
Principle 4 – People Respond to
Incentives
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People respond both directly and indirectly
Example: gas tax in Europe vs. U.S.
Sam Peltzman’s study in 1975 – concluded
that auto safety laws (seatbelts) caused
fewer deaths per accident, but more
accidents AND increased the number of
pedestrian deaths.
Principle 5- Trade benefits
everyone
When people and/or countries trade, it
allows each to specialize in what they do
best. (i.e. at a lower opportunity cost)
 Trade allows people to enjoy a greater
variety of goods and services usually at
lower prices
 Ex: Japan and U.S. – competitors?
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Principle 6 – Markets are usually a
good way to organize economic
activity
Command Economy vs. Market Economy
 Market Economy – allocates resources
through decisions of many firms and
households as they interact in markets for
goods and services
 Adam Smith’s “invisible hand” – people
and firms interacting in markets leads to
desirable market outcomes through prices
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Principle 7 – Gov’ts can sometimes
improve market outcomes
Markets only work if property rights are
enforced
 Gov’ts are involved to promote efficiency
and equity
 Market failure – can occur because of
externalities such as pollution
 Gov’ts intervene to promote equitable
distribution of wealth (income tax, welfare)
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Principle 8 – Standard of Living
depends on production
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U.S. vs. Mexico – In 2003, Americans made an
avg. income of $37,500; the avg. Mexican made
$8,950 … why?
Almost all variations in living standards are
attributed to differences in productivity –
amount of goods and services produced ea.
hour of a worker’s time.
Principle 9 – Prices go up when gov’t
prints too much $
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Inflation – increase in overall level of prices
Causes – Primary cause of inflation is the
growth in the quantity of money.
Examples: Germany in early 1920’s; U.S. in
1970’s
Principle 10 – Society faces short run
trade off b/t inflation and
unemployment
Short-run effects of increasing money supply:
1. Stimulates overall level of spending and thus
the demand for goods/services
2. Encourages firms to increase quantity of
goods produced and to hire more workers
3. More hiring means lower unemployment
SO – in the short-run, many economic policies
push inflation and unemployment in opposite
directions.