Macro

CH1: TEN PRINCIPLES OF ECONOMICS

Economics - Defines as the proper allocation and efficient use of  But this reduces incentive to work and produce, shrinks
available resources for the maximum satisfaction of human wants the size of the economic “pie.”
- It is the study of how society manages its scarce resources
- It is a field of knowledge concerned with managing scarce PRINCIPLE 2: The Cost of Something Is What You Give Up to Get It
resources to satisfy unlimited human wants and needs Making decisions - compare costs and benefits of alternative choices
- Is the study of how people choose to allocate their scarce -need to include opportunity costs
resources in order to produce, exchange and consume goods Opportunity cost - whatever must be given up to obtain some item
and services in an attempt to satisfy their unlimited wants  It is the relevant cost for decision making.
What Economics Is All About
Examples: The opportunity cost of…
 Resources are scarce  going to college for a year is not just the tuition, books,
and fees, but also the foregone wages.
Scarcity: the limited nature of society’s resources
 seeing a movie is not just the price of the ticket, but the
 Society has limited resources and cannot produce all the
value of the time you spend in the theater.
goods and services people wish to have
Economics: the study of how society manages its scarce resources
PRINCIPLE 3: Rational People Think at the Margin Rational people
Economists study:
Rational people:
 how people decide what to buy, how much to work, save,
 systematically and purposefully do the best they can to
and spend
achieve their objectives.
 how firms decide how much to produce, how many
 Given the available opportunities
workers to hire
 Make decisions by evaluating costs and benefits of
 how society decides how to divide its resources between
marginal changes, small incremental adjustments to a
national defense, consumer goods, protecting the
plan of action
environment, and other needs
Examples:
The principles of HOW PEOPLE MAKE DECISIONS  Cell phones users with unlimited minutes (the minutes are
free at the margin)
Principle 1: People face trade-offs -often prone to making long/frivolous calls
Principle 2: The cost of something is what you give up to get it -marginal benefit of the call > 0
Principle 3: Rational people think at the margin  A manager considers whether to increase output
Principle 4: People respond to incentives -compares the cost of the needed labor and materials to
the extra revenue.
PRINCIPLE 1: People Face Tradeoffs
 All decisions involve tradeoffs. PRINCIPLE 4: People Respond to Incentives
 To get something that we like, we have to give up Incentive: something that induces a person to act, i.e. the prospect
something else that we also like of a reward or punishment.
Examples:  Rational people respond to incentives.
Examples:
 Going to a party the night before your midterm leaves less
 When gas prices rise, consumers buy more hybrid cars and
time for studying.
fewer gas guzzling SUVs.
 Having more money to buy stuff requires working longer
 When cigarette taxes increase, teen smoking falls.
hours, which leaves less time for leisure.
 Protecting the environment requires resources that could
otherwise be used to produce consumer goods.

Society faces an important tradeoff:

 The more it spend on national defense (guns) to protect
its shores
 the less it can spend on consumer goods (butter)
to raise the standard of living at home
 Pollution regulations: cleaner environment and improved
health
 But at the cost of reducing the incomes of the
firms’ owners, workers and customers
Efficiency: when society gets the most from its scarce resources
Equality: when prosperity is distributed uniformly among society’s
members
Tradeoff:
 To achieve greater equality, could redistribute income
from wealthy to poor.
The principles of HOW PEOPLE INTERACT  Market power - a single buyer or seller has
Principle 5: Trade can make everyone better off substantial influence on market price (e.g.
Principle 6: Markets are usually a good way to organize economic monopoly)
activity Government – promote equality
Principle 7: Government can sometimes improve market outcomes  Avoid disparities in economic wellbeing
 Use of tax or welfare policies to change how the economic
PRINCIPLE 5: Trade Can Make Everyone Better Off “pie” is divided
People benefit from trade:  If the market’s distribution of economic well-being is not
-people can buy a greater variety of good and service at lower cost desirable, tax or welfare policies can change how the
 Rather than being self-sufficient, people can specialize in economic “pie” is divided.
producing one good or service and exchange it for other
goods. The principles of HOW THE ECONOMY AS A WHOLE WORKS
Countries benefit from trade and specialization: Principle 8: A country’s standard of living depends on its ability to
1. Get a better price abroad for goods they produce produce goods and services
2. Buy other goods more cheaply from abroad than could be Principle 9: Prices rise when the government prints too much
produced at home money
Principle 10: Society faces a short-run trade-off between inflation
PRINCIPLE 6: Markets Are Usually A Good Way to Organize and unemployment
Economic Activity
Market: a group of buyers and sellers (need not be in a single PRINCIPLE 8: A Country’s Standard of Living Depends on Its Ability
location) to Produce Goods & Services
 “Organize economic activity” means determining  Huge variation in living standards across countries and
 what goods and services to produce over time:
 how to produce them *Average income in rich countries is more than ten times
 how much of each to produce average income in poor countries.
 who produced and consumed these *The U.S. standard of living today is about eight times
larger than 100 years ago.
Market economy allocates resources through the decentralized Productivity: most important determinant of living standards:
decisions of many firms and household as they interact in markets.  Quantity of goods and services produced from each unit
of labor.
 Famous insight by Adam Smith in The Wealth of Nations  Productivity depends on the equipment, skills, and
(1776): technology available to workers.
-Each of these households and firms acts as if “led by an  Other factors (e.g., labor unions, competition from
invisible hand” to promote general economic well-being. abroad) have far less impact on living standards.
Prices:
-Determined the interaction of buyers and sellers PRINCIPLE 9: Prices Rise When the Government Prints Too Much
-Reflects the good’s value to buyers Money
-Reflect the cost of producing the good. Inflation: increases in the general level of prices.
Invisible hand: Prices guide self-interested households and firms to In the long run:
make decisions that, in many cases, maximize society’s economic  inflation is almost always caused by excessive growth in
well-being. the quantity of money, which causes the value of money
to fall.
PRINCIPLE 7: Governments Can Sometimes Improve Market  The faster the government creates money, the greater the
Outcomes inflation rate.
Important role for govt: enforce property rights (with police, courts)
Government – enforce property rights PRINCIPLE 10: Society Faces a Short-run Tradeoff Between Inflation
-enforce rules and maintain institutions that are key to a market and Unemployment
economy Short-run trade-off between unemployment and inflation
 People are less inclined to work, produce, invest, or  In the short-run, over the (1–2 years), many economic
purchase if large risk of their property being stolen. policies push inflation and unemployment in opposite
Government – promote efficiency directions.
 Avoid market failures: market left on its own fails to  Other factors can make this tradeoff more or less
allocate resources efficiently favorable, but the tradeoff is always present.
 Market failure: when the market fails to allocate society’s
resources efficiently
 Source of market failure:
 Externalities - when the production or
consumption of a good affects bystanders (e.g.
pollution)
Summary Market Power - the ability of a single economic actor (or small group
Fundamental lessons about individual decision making: of actors) to have a substantial influence on market prices
• People face tradeoffs among alternatives goals Productivity - the quantity of goods and services produced from
• The cost of any action is measured in terms of foregone each unit of labor input
opportunities. Inflation - an increase in the overall level of prices in the economy
• Rational people make decisions by comparing marginal costs and Business Cycle - fluctuations in economic activity, such as
marginal benefits. employment and production
 People change their behavior in response to incentives they face
Fundamental lessons about interactions among people: CHAPTER 1 QUICK QUIZ:
• Trade and interdependence can be mutually beneficial. 1. Economics is best defined as the study of…
• Markets are usually a good way of coordinating economic activity a. how society manages its scarce resources.
among people
• Government can potentially improve market outcomes by
2. Your opportunity cost of going to a movie is a…
remedying a market failure or by promoting greater economic c. the total cash expenditure needed to go to the
equality movie plus the value of your time.
Fundamental lessons about the economy as a whole: 3. A marginal change is one that…
• Productivity is the ultimate source of living standards.
b. incrementally alters an existing plan.
• Growth in the quantity of money is the ultimate source of inflation
• Society faces a short-run tradeoff between inflation and 4. Adam Smith’s “invisible hand” refers to…
unemployment. b. the ability of free markets to reach desirable
outcomes, despite the self-interest of market
Ten Principles of Economics: participants.
How People Make Decisions
1: People Face Trade-offs
5. Governments may intervene in a market economy in
2: The Cost of Something Is What You Give Up to Get It 3: Rational order to….
People Think at the Margin a. protect property rights.
4: People Respond to Incentives b. correct a market failure due to externalities.
How People Interact
c. achieve a more equal distribution of income.
5: Trade Can Make Everyone Better Off
6: Markets Are Usually a Good Way to Organize Economic Activity d. All of the above.
7: Governments Can Sometimes Improve Market Outcomes 6. If a nation has high and persistent inflation, the most
How the Economy as a Whole Works likely explanation is….
8: A Country’s Standard of Living Depends on Its Ability to Produce
a. the central bank creating excessive amounts of
Goods and Services
9: Prices Rise When the Government Prints Too Much Money
money.
10: Society Faces a Short-Run Trade-off between Inflation and
Unemployment

Key Concepts:
Scarcity - the limited nature of society’s resources
Economics - the study of how society manages its scarce resources
Efficiency - the property of society getting the most it can from its
scarce resources
Equality - the property of distributing economic prosperity uniformly
among the members of society
Opportunity Cost - whatever must be given up to obtain some item
Rational People - people who systematically and purposefully do the
best they can to achieve their objectives
Marginal Change - a small incremental adjustment to a plan of
action
Incentive - something that induces a person to act
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
Property Rights - the ability of an individual to own and exercise
control over scarce resources
Market Failure - a situation in which a market left on its own fails to
allocate resources efficiently
Externality - the impact of one person’s actions on the well-being of
a bystander