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P R I N C I P L E S O F

P R I N C I P L E S O F. F O U R T H E D I T I O N. Ten Principles of Economics. 1. In this chapter, look for the answers to these questions:. What kinds of questions does economics address? What are the principles of how people make decisions?

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P R I N C I P L E S O F

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  1. P R I N C I P L E S O F FOURTH EDITION Ten Principles of Economics 1

  2. In this chapter, look for the answers to these questions: • What kinds of questions does economics address? • What are the principles of how people make decisions? • What are the principles of how people interact? • What are the principles of how the economy as a whole works? CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  3. Chapter 1 Econ. I’m taking a course that has the highest failure rate at college. Uncle Sam wants you to do better in economics. What is Economics?

  4. “Beautiful forest!. MACROECONOMICS... “Beautiful leaf!” MICROECONOMICS...

  5. . • Macro[national] economics – concerned • with the economy as a whole Macro • examines the “forest, not the trees, • leaves, or specific pieces of bark.” Great Forest! 2. Micro [details of the big picture] – concerned with specific economic units or individual markets under a microscope. Emphasis is on individual households, industries, or firms [like the # of workers employed by Ford] [Concerns the components of the economy] Micro examines the “trees, leaves, & pieces of bark, rather than the forest.” Nice bark!

  6. . Macro[large](telescope)“whole economy” [economy-wide issues]Micro[small](microscope]“segment of the economy” [issues in the economy] “Beautiful, beautiful forest!” “Check out those pieces of bark!. Production MicroeconomicsMacroeconomics How much steel Total industrial output How much office space Gross Domestic Product Prices Price of individual goods Price of medical care Rate of inflation Employment Jobs in the steel industry Total number of jobs Economy’s unemployment

  7. Is the following MicroorMacro? 1. The price of digital cameras increased 5% last year. 2. Unemployment was 5.4% for the U.S. workforce. 3. Unemployment in the auto industry was 8% last year. 4. Duck National Bank lowered its interest rates on CDs to 8%. 5. The Inflation rate rose to 2.7% last year. 6. The computer industry laid off 8% of its workers last year. 7. The price of gasoline rose 25% last year. “What forest, check these branches, limbs, and leaves.”

  8. THE FOUNDATION OF ECONOMICS SOCIETY HAS VIRTUALLYUNLIMITED WANTS... BUT LIMITED OR SCARCE RESOURCES!

  9. What Economics Is All About 0 • Scarcity: the limited nature of society’s resources. • Economics: the study of how society manages its scarce resources, e.g. • how people decide what to buy, how much to work, save, and spend • how firms decide how much to produce, how many workers to hire • how society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  10. Economizing Problem Dealing with“Scarcity”

  11. Scarcity – Wants > Availability of Resources

  12. ECONOMICS - “Science of scarcity” -the study of thechoicespeople make in an effort to satisfy their unlimited needs and wantsfromlimited resources. Opportunity Cost Choices Scarcity Economicsis the academic discipline most discussedby the general public. It is also one of the least understood. [“Language of graphs”]

  13. Scarcity Problem Food, clothing, shelter, BMW, Villa, Nintendo DS, jewelry, iPod, projector, digital camera, good health, children, camcorder, laptop warmth, indoor plumbing, rollerblades, a sense of personal worth, Plasma TV, literacy, high economics grade, cell phone, compact discs, money Land,Labor,Capital,Entrepreneur Rent,Wages,Interest,Profits Limited Resources Unlimited Human Wants “Need” those first three to survive.

  14. The principles of HOW PEOPLE MAKE DECISIONS 0

  15. THE FOUNDATION OF ECONOMICS SOCIETY HAS VIRTUALLYUNLIMITED WANTS...

  16. GOODS & SERVICES PROVIDE... UTILITY[satisfaction]

  17. Luxuries . V. NECESSITIES Food Shelter Clothing

  18. HOW PEOPLE MAKE DECISIONS 0 Principle #1: People Face Tradeoffs All decisions involve tradeoffs. Examples: • Going to a party the night before your midterm leaves less time for studying. • Having more money to buy stuff requires working longer hours, which leaves less time for leisure. • Protecting the environment requires resources that could otherwise be used to produce consumer goods. CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  19. HOW PEOPLE MAKE DECISIONS 0 Principle #1: People Face Tradeoffs • Society faces an important tradeoff: efficiency vs. equity • efficiency: getting the most out of scarce resources • equity: distributing prosperity fairly among society’s members • Tradeoff: To increase equity, could redistribute income from wealthy to poor. But this reduces incentive to work and produce, shrinks the size of the economic “pie.” CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  20. HOW PEOPLE MAKE DECISIONS Principle #2: The Cost of Something Is What You Give Up to Get It • Making decisions requires comparing the costs and benefits of alternative choices. • The opportunity cost of any item is whatever must be given up to obtain it. • It is the relevant cost for decision making. CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  21. . The Opportunity Cost is the Opportunity Lost 1st Choice (and a good one) [“what is possible for $10,000”] Opportunity Cost 2nd Choice Choices Opportunity Costs Scarcity

  22. HOW PEOPLE MAKE DECISIONS Examples:The opportunity cost of… …going to college for a year is not just the tuition, books, and fees, but also the foregone wages. …seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater. Principle #2: The Cost of Something Is What You Give Up to Get It CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  23. Economic Way of Thinking Do the Benefits outweigh the cost? Scales of Economics Expected marginal benefits Expected marginal costs Choices are primarily marginal – not all or nothing.

  24. HOW PEOPLE MAKE DECISIONS Principle #3: Rational People Think at the Margin • A person is rational if she systematically and purposefully does the best she can to achieve her objectives. • When making decisions, rational consumers and businesspeople evaluate the costs and benefits of marginal changes– incremental adjustments to an existing plan. CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  25. HOW PEOPLE MAKE DECISIONS Principle #3: Rational People Think at the Margin Examples: • A student considers whether to go to college for an additional year, comparing the fees & foregone wages to the extra income he could earn with an extra year of education. • A firm considers whether to increase output, comparing the cost of the needed labor and materials to the extra revenue. CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  26. HOW PEOPLE MAKE DECISIONS Principle #4: People Respond to Incentives • incentive: something that induces a person to act, i.e. the prospect of a reward or punishment. • Rational people respond to incentives. Examples: • When gas prices rise, consumers buy more hybrid cars (e.g., Toyota Prius). • When cigarette taxes increase, teen smoking falls. CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  27. Trade-Offs vs. Opportunity Costs What's the difference?

  28. Trade-Offs …are all the alternatives in making a decision Opportunity Cost …the cost of the next best use of money, time, or resources (you’re 2nd Choice)

  29. Trade-offs … Are all of the alternatives that go into making a decision…. In this case let’s say you have many different choices of what you want to do on Saturday night.

  30. Here are all of your Choices on Saturday night…which are… Go on a Date Hang out with friends Watch TV Study your Economics Hang out with parents Go to bed early These are all of your trade-offs Opportunity Cost is different, though…

  31. Remember… Opportunity Cost is the next highest valued alternative. (The 2nd Best Choice)

  32. As you recall, these are the choices on Saturday night Go on a Date Hang out with friends Watch TV Study your Economics Hang out with parents Go to bed early You choose the one that will give the most satisfaction for the price that has to be paid

  33. The ranking’s are… Go on a Date Hang out with his friends Watch TV Study your Economics Hang out with parents Go to bed early 1 Obviously you do not go through this much thought when making a decision… 3 6 2 4 5

  34. What is the opportunity cost of going on the date?

  35. The opportunity cost was giving up the studying your economics, the 2nd Choice Also, you must consider the financial cost of the date, how else you could have spent the money.

  36. Remembering Opportunity Cost when making a decision is the start of your new way of thinking, the Economic Way of Thinking.

  37. The principles of HOW PEOPLE INTERACT 0

  38. HOW PEOPLE INTERACT Principle #5: Trade Can Make Everyone Better Off • Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. • Countries also benefit from trade & specialization: • get a better price abroad for goods they produce • buy other goods more cheaply from abroad than could be produced at home CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  39. HOW PEOPLE INTERACT Principle #6: Markets Are Usually A Good Way to Organize Economic Activity • Market: a group of buyers and sellers (need not be in a single location) • “Organize economic activity” means determining • what goods to produce • how to produce them • how much of each to produce • who gets them CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

  40. HOW PEOPLE INTERACT Principle #6: Markets Are Usually A Good Way to Organize Economic Activity • In a market economy, these decisions result from the interactions of many households and firms. • Famous insight by Adam Smith in The Wealth of Nations (1776): Each of these households and firms acts as if “led by an invisible hand” to promote general economic well-being. CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

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